Goals-based investing (GBI) is a method to help people to invest by first establishing the relative importance of different goals. The approach is very similar to the layered method of investing that is often discussed in behavioral portfolio theory (BPT), although there is one key difference. GBI starts with the importance of achieving a goal, whereas behavioral portfolio theory tries to explain why certain portfolios are high-risk and others are not.
On this page, we discuss the goals-based investing approach and how it can be used to build better portfolios for clients. Other methods that are very similar to GBI are Behaviorally Modified Asset Allocation (BMAA) and Behavioral Portfolio Theory (BPT).
Goals-based investing steps
The process consists of the following steps:
- identify essential needs and obligations and quantify them. This includes essential living expenses and should be met with low risk investments as the base layer of the portfolio assets
- Next, identify desired outcomes such as giving to charity which can be met with a layer of moderate risk investments
- Finally, identify the low priority aspirations such as increasing the value of the portfolio to leave it to charity at death. Such a goal can be met with a layer of high-risk investments
Goals-based investing is consistent with the concept of loss aversion in prospect theory. The client is reassured that more important goals are exposed to less risky assets and less potential loss. At the same time, the aspirations are serviced with high risk investments. The approach is best suited to be used to perform wealth preservation rather than wealth accumulation. Mental accounting by using layers also helps the client to better understand the construction of the portfolio
We discussed goals-based investing (GBI), a popular method used by investment professionals to build portfolios in layers that meet investors’ goals. The advantages of the approach is that it is easy to explain and thus easier to hold on to when markets are volatile.