With so many investment options out there, new investors can have a hard time figuring out where to start. Goal-based investing is a modern approach that focuses on helping investors attain specific financial goals. Here’s what you need to know to start your own goal-based investing strategy.
Key takeaways:
- Goal-based investing emphasizes meeting specific financial and life goals.
- Goals can be short-, medium-, or long-term. For example, saving for a down payment, college education, or retirement.
- The focus of goal-based investing is on meeting these goals rather than generating high portfolio returns.
Goal-based investing defined
Goal-based investing has one key difference compared to other forms of investing: It’s a strategy investors use to meet their personal financial and life goals, rather than trying to gain the most return on market investments. Goal-based investments can be short-, medium-, or long-term, and they consist of specific goals. For example, some investing goals might be:
- Saving for a college education
- Saving enough to make a down payment for a home
- Building a retirement nest egg
Understanding goal-based asset allocation
How you choose to allocate your assets in a goal-based investing plan mainly depends on how long you have until you need to meet your goal. For example, an investor who’s going to be ready to retire in the next year or two would allocate their assets much less aggressively than someone starting a retirement fund for 10+ years in the future. The need to meet your individual goals influence goal-based investing much more than risk tolerance, which is one of the main factors that weighs in when building an investment portfolio for the sole reason of generating high returns. Let’s look at a quick example: Investor A is saving for imminent retirement, and investor B is saving for college tuition for a child who is still young. Investor A would have a much more conservative allocation of assets, like 10% in stocks and 90% in bonds or fixed income exchange-traded funds (ETFs). Investor B would likely be more aggressive in their allocation, like a half-and-half mix of equities and fixed income.
Planning your strategy
There are three important things to consider in goal-based investment planning:
1. Your time frame
How soon do you need to reach your investing goal, and how much will you need to invest to get there? Saving for a down payment vs. saving for retirement will take drastically different strategies. You can use various goal-based investing calculators to help determine this, but they will never be 100% accurate since you’ll have to estimate the interest earned on your investments.
2. Present & future cost
When you’re investing to hit specific goals, you should take inflation into consideration. For example, let’s say you’re saving for a child’s college fund, and tuition right now would cost $50,000. But 10–15 years down the road, when they’re ready to start school, the odds are that tuition costs won’t be the same as when you started investing.
3. When to start
Ideally, the best time to begin goal-based investing is as soon as you set your goal. The earlier you start saving and investing, the faster you’ll reach your goal. This is especially important for long-term goal-based investments like retirement, where each year makes a significant impact on how much you earn. There’s no “right” time to begin investing—the sooner, the better.
Short-term goal-based investing
When you want to meet your goal in under three years, that’s a short-term goal-based investment. It’s important to choose an investment option that’s low-risk: Since you don’t have much time, you want to ensure that your invested money is relatively safe. Goal-based mutual fund investing, especially in debt mutual funds and liquid mutual funds, is a lower-risk option for short-term investments. These mutual funds invest in fixed-income instruments and have a minimal interest rate risk.
Medium-term goal-based investing
If you want to achieve your investing goal over a longer period—like three to eight years—it’s typically acceptable to take on more risk than with short-term investments. This provides you with more goal-based investing options. Equity index funds, which are mutual funds that invest in indices like the S&P 500, carry more risk than debt mutual funds, but they instantly add diversity to your investment portfolio. ETFs are a similar investment option; the biggest difference is that ETFs get traded throughout the day just like stocks, but equity index funds only get traded at the end-of-day price.
Long-term goal-based investing
For investing goals that are going to take longer than eight years to reach, most goal-based investors take a little more risk. Long-term goals are typically either education funds or retirement funds. Two higher-risk, higher-reward options for long-term investing are equity mutual funds and individual stocks. Equity mutual funds invest in stocks of various companies based on industry, company size, investment objectives, etc. Purchasing individual stocks has a high potential for big returns but also carries the largest risk, especially for less-experienced investors.
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