The idea that we should invest to meet our needs and goals is basic common sense. But, somewhat surprisingly, that is not what most of the investment industry does.
The current status quo is that investments are generally built around a reference to a ‘benchmark’ such as shares, property or fixed interest – and the many derivations thereof. Diversified portfolios are then built using Modern Portfolio Theory, based on the assumptions of the Efficient Market Hypothesis, to create an ‘optimal’ Strategic Asset Allocation (SAA) to match a Risk Profile. Your stated risk profile then determines your investments allocation.
Lots of good theory, if all the assumptions hold and everything is readily predicable, but unfortunately, life in the real world doesn’t always work that way. Markets are not always efficient and predictable. Past behaviour is not necessarily reflective of future behaviour, etc…
Then there is a question about whether the idea that how someone ‘feels’ about their investments will perfectly match what they ‘need’ to achieve their stated goals. In practice, they almost never match up. Whilst it’s obviously important to understand and respect someone’s risk tolerance, the reality is, using a risk profile or SAA approach to design portfolios is almost guaranteed NOT to meet your needs.
Goals Based Investing is a simple, rational approach to building portfolios that specifically targets meeting known needs - so long as they are reasonable of course. It’s far more intuitive to understand why you are making an investment, which helps overcome a raft of behavioural finance issues as well as help address technical strategic challenges such as sequencing risk and income / cash flows planning in retirement. It can be used to enhance the application of Modern Portfolio Theory, in the real world.
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