Retirement: Goal-Based Investing Gains Traction

More financial advisers now see the need for clients to focus on goals—rather than portfolio performance—to determine the annual income they'll need for retirement

By David Bogoslaw

As defined benefit plans fade into history, more American workers are confronting the fact that they will need to be much more active in deciding how to marshal their retirement savings than their parents had to be. But how best to line up what you have now with what you'll need later?

That's where goal-based investing, or what some people call liability-driven investing, comes in. This increasingly popular approach is yet another example of the retail investing world borrowing a page from institutional investors' playbook—trying to manage people's assets so they better match their liabilities, which has long been a focus of pension funds.

The idea expands on a change in thinking about retirement portfolios that target-date funds pioneered: keeping a larger portion of the assets of people approaching retirement age—or who have already retired—invested in higher-return asset classes such as stocks in order to ensure they have ample income for the rest of their lives. (Target-date funds do shift to an ever more conservative asset mix as an investor's retirement date approaches.)

Some of the more aggressive target-date funds that incurred big losses during the 2008-09 market crash have come under attack for being too heavily weighted toward equities—as much as 40% of the portfolio in some funds with target dates as early as 2010. That, and the potential conflicts of interest that arise when mutual fund companies offer target-date retirement plans and make asset allocation calls, has spurred talk of possible regulation of target-date funds' investments.

How Much Will You Need?

Most baby boomers preparing for retirement in the next few years will still receive a pension under their employers' defined benefit plan, which makes the hard call of determining a retiree's annual payout. But as pension plans are increasingly replaced by 401(k)s and other defined contribution plans, the thorny decisions about how to draw down wealth will be left to individual investors. That's why more and more financial advisers see a need to develop financial life plans centered on goals that can determine the annual income streams people need. Some 401(k) plans are just starting to display investors' account balances in the form of annual income streams rather than as lump sums.

"A common roadblock [for self-directed investors] is their relationship to money," says Michael Kay, president of advisory firm Financial Focus in Livingston, N.J. "What is their money history? Are they spenders or savers? Will their behavior be consistent with what their stated goals are?"

It's easier to motivate investors' behavior by emphasizing goals than by focusing on their portfolios' overall performance, says Thomas P. Holland, a partner at Global Vision Advisors outside of Boston. "When you communicate with clients [with specific goals in mind], they're more concerned about being on pace. The conversation is more around what needs to be done to create additional savings and rethinking asset [allocation]," he says.

An investor's stated high tolerance for risk shouldn't be confused with his actual capacity for risk based on his financial circumstances, says Kay at Financial Focus. It's not appropriate for someone who doesn't have an adequate emergency fund of cash to invest in the stock market before they have a safe reserve set aside, he adds.

safe investments for the short term

"In any good financial plan, one starts with a baseline of risk management, [such as] emergency funds and insurance to obviate risk as much as is appropriate, and then starts working up the pyramid to other places that might enhance returns over time," Kay says. "Any investment needs to be linked to a specific time frame."

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