The traditional risk-based investment approach, which determined how a client’s assets are invested based on their risk profile, aims to maximise returns for a given level of risk. Success is measured by comparing returns against market benchmarks, suggesting that investors should be pleased with negative returns, provided they are less negative than the benchmark! The approach also entails a high level of volatility that can decimate a client’s capital, particularly if they need to access their funds in the near term or lose faith in their investment plan and crystalise their losses.
Evidently, the risk-based approach has little regard for a client’s actual investment needs, leading some financial advisors to question whether it is appropriate, especially if a client could achieve an adequate return via more conservative asset allocation then their risk tolerance allows. Likewise, it may not be reasonable to limit and investment target due to personal concerns about higher-risk investments; often a client will be a ‘high-risk' investor when markets are doing well or when they feel financially secure, but quickly switch to being risk adverse if circumstances turned sour.
Fortunately, advisors have access to an alternative approach; goals based investing. This involves investing a client’s capital in accordance with their investment needs, rather than their risk tolerance. The process starts with uncovering the investor's short, intermediate and long-term investment goals. Advisors play a role in ensuring that these are specific and meaningful for the investor, as vague or superficial goals, such as ‘grow wealth,’ may not align with their specific needs. By examining liefestyle factors and objectives, like engaging in further study, starting a business or retiring earlier, allow the identification of financial goals.
Next, the advisor helps the investor prioritise their goals from those that are essential, such as building up an emergency fund, to those that are ‘nice to have’, like overseas holidays or a new car. The advisor then applies a suitable investment strategy to each goal; essential and short-term goals are usually assigned more capital to ensure they are sufficiently funded and a more conservative asset allocation, while lower priority goals and those that are some time off, such as saving for retirement, are typically assigned a riskier asset allocation to boost potential returns.
Asset allocation also requires advisers to consider a client's personal situation, for instance, people with unstable employment are not usually in a position to take on risk, while older investors are more likely to be interested in guaranteeing a stable income than capital appreciation.
Investors may require assistance if their investment goals do not match up with their available capital or target return. This can be a good time to discuss tolerance, should additional risk be required to achieve the chosen goals. Advisors may also suggest adding funds or extending the investment time horizon to ensure targets are realistic.
Lastly, regular reviews are an essential component of Goals Based investing. Under this client-focused approach, success is measured by the progress that has been made towards meeting the target return within the specified time frame. The review is also a great time to check that the client’s goals remain appropriate, as changing life events, like starting a family, being made redundant or receiving an inheritance, may require that objectives and priorities are adjusted.
All of this is possible within the Dynamic Asset suite of investment portfolios.
To learn more, contact Dynamic Asset today.