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Goals-based Planning and Using the Market

Goals-based Planning and Using the Market

Few of us have a very complete understanding of what investing is. We may think about it as being smart or lucky enough to pick the right stocks (“winners”) so that our money grows and grows. We may follow our gut or some guru (the wackier the better, apparently), looking for maximum return or yield. Or we go to a well-known firm and put our trust (and a good chunk of our returns) in their hands, their reputation, and the big building that houses their army of analysts. Regardless, the more our money grows, we figure, the better the story will end for us. We can call this investing for maximum return, or “chasing the market.”

Most reputable investment firms will take you to the next step, creating a long-term “balanced” portfolio of stocks and bonds, where one kind of investment tends to offset changes in another. They may give you a short quiz and try to figure out your “risk tolerance” though this is an unsteady barometer that can change with the weather and the temperature of the stock market.

Compared to investing as market chasing, a balanced portfolio sounds almost scientific and can be persuasive, even if it is riskier than it seems or we are led to believe. Some investment managers may try to justify their fees by claiming better than average returns, appealing both to the chase and the balanced approach method at the same time, playing on a desire for maximum return that never seems to go away. We can call this investing for total return, or “trying to tame the market.” This is big-firm mainstream method today.

One weakness of the mainstream method comes into focus when we enter the red zone approaching retirement and realize that sooner or later we will get just one last paycheck. At the end of the day, whether you’ve been chasing or trying to tame the market, whether the market is up or down, the money for retirement expenses has to be there. Trying to tame the markets does not provide that surety. We need a plan for secure retirement income, not a method for growing investments in the market. They aren’t the same thing.

Goals-based planning shifts towards securing personal financial goals and away from a focus on the markets. After you’ve set your goals, understand your necessary expenses and the cost of various things you’d like to do or have, and have determined how well your household balance sheet supports your goals, then you can determine how to use investing as one of several tools to reach your goals and to manage the risks you face along the way. We can call this goals-based investing or “using the market.”

Goals-based planning and investing turns the usual approach upside down—instead of taking risk in the markets to attain some possible reward, you set reachable goals and use investing as one of several risk management tools to ensure you reach them. Financial goals, not market performance are front and center.

Experienced planners of all kinds know that a successful outcome depends on identifying and managing the varied risks that threaten the success of the plan. This is true whether you are planning the construction of an oil-pipeline, a web-based e-commerce application, a family vacation abroad, or secure income for a possible 30-year retirement after a long career in business or a profession. For a goals-based financial plan, these risks include all household risk exposures, including deep risks like inflation and deflation, taxes and regulatory risks, risks of chance and household shocks, longevity risk, and behavioral risks like overspending, and not just the market risk which is the main concern of investing for total return.

Planning isn’t unduly hard or complicated if you have a framework and the knowledge and experience to manage the plan and the risks that threaten it. The framework for a goals-based financial plan is the allocation of financial capital to upside/floor/longevity/reserves. The U/F/L/R allocation crystallizes the household risk management plan by allocating capital to diversification, avoidance, pooling, and retention, the four primary methods for managing risk. This works at a different level and provides a basis in the household balance sheet for the more traditional allocation of stocks/bonds/cash common in investing for total return.

Investing in a stocks/bonds/cash allocation without an upside/floor/longevity/reserves overlay puts your retirement plan at risk. It’s the difference between trying to tame the market and using the market to reach your goals. The planning effort required to ensure a successful outcome throughout retirement compared to the risk of not planning properly seems slight by comparison.

Next time we’ll talk more about the U/F/L/R allocation and how to use the market to reach your goals.

Meanwhile learn more about goals-based planning, household risk exposures and management, and retirement management at the RIIA web site and through these RIIA publications on Amazon. You may also find useful learning about R-MAP Planner, the software tool I built and use for planning.

–Michael Lonier, RMA℠

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