is an investment methodology where performance is measured by the success of investments in meeting an individuals personal and lifestyle goals.This differs from conventional investing methodologies, where financial performance is defined as a return against an investment benchmark.This approach results in focus of the investment approach shifting from achieving a higher returns approach to the investment, or exceeding the market returns approach to funding a personal financial goals approach.

Goal Based Investing focuses on investing for ahouseholdbased on their needs and goals, not on theirrisk tolerance.4It is a similar approach toasset-liability managementfor insurance companies andliability-driven investment strategyfor pension funds but integrates financial planning and investment management which insures that household goals are funded in an efficient manner.5Goal Based investing approach has also been employed by university endowment funds in managing their investments6

In Goal Based Investing, theassetsare the full set of resources the investor has available, including financial assets, real estate, employment income, social security, etc. while theliabilitiesare the financial liabilities such as loans, mortgages, etc. in addition to the capitalized value of the households financial goals and aspirations. Goal Based Investing takes into account the progress against goals which are categorized as either essential needs, lifestyle wants or legacy aspirations depending on level of importance to an individual or family.7It also helps to prevent rash investment decisions by providing a clear process for identifying goals and choosing investment strategies for those goals.8These goals may include ability to put children in a good school, retiring early, and be able to afford a quality life after retirement.

Some financial advisors recommend having six months spending saved in an emergency fund. This fund helps satisfy the goal of security. A persons goals may be short term security (the savings account), intermediate term portfolio for a childs education expenses and a longer term fund for eventual retirement. The emergency fund should be invested in very short term low risk investments. The intermediate term fund should be longer and take more risk but only moderately. While the long term fund would likely own long dated bonds, stocks and other equity investments. Circumstances of the individual can satisfy the needs of the various goals or make those needs more aggravated. For instance, a pension benefit or annuity can greatly decrease the need for a retirement fund while a scholarship eligible child can reduce the need for a college fund. An employment contract reduces the need for an emergency fund. A chronic illness might increase the need for an emergency fund.

The key challenge for goal-based investing (GBI) is to implement dedicated investment solutions aiming to generate the highest possible probability of achieving investors goals, and a reasonably low expected shortfall in case adverse market conditions make it unfeasible to achieve those goals. Modern Portfolio Theory or standard portfolio optimisation techniques are not suitable to solve this problem.

Deguest, Martellini, Milhau, Suri and Wang (2015)9introduce a general operational framework, which formalises the goals-based risk allocation approach to wealth management proposed in Chhabra (2005)10, and which allows individual investors to optimally allocate to categories of risks they face across all life stages and wealth segments so as to achieve personally meaningful financial goals. One key feature in developing the risk allocation framework for goals-based wealth management includes the introduction of systematic rule-based multi-period portfolio construction methodologies, which is a required element given that risks and goals typically persist across multiple time frames. Academic research has shown that an efficient use of the three forms of risk management (diversification, hedging and insurance) is required to develop an investment solution framework dedicated to allowing investors to maximise the probabilities of reaching their meaningful goals given their dollar and risk budgets. As a result, the main focus of the framework is on the efficient management of rewarded risk exposures.

GBI strategies aim to secure investors most important goals (labelled as essential, i.e. affordable and secure goals), while also delivering a reasonably high chance of success for achieving other goals, including ambitious ones which cannot be fully funded together with the most essential ones (and which are referred to as aspirational). Holding a leverage-constrained exposure to a well-diversified performance-seeking portfolio (PSP) often leads to modest probabilities of achieving such ambitious goals, and individual investors may increase their chances of meeting these goals by holding aspirational assets which generally contain illiquid concentrated risk exposures, for example under the form of equity ownership in a private business.

The goals-based wealth management framework includes two distinct elements. On the one hand, it involves the disaggregation of investor preferences into groups of goals that have similar key characteristics, with priority ranking and term structure of associated liabilities, and on the other hand it involves the mapping of these groups to optimised performance or hedging portfolios possessing corresponding risk and return characteristics, as well as an efficient allocation to such performance and hedging portfolios. More precisely, the framework involves a number of objective and subjective inputs, as well as a number of building block and asset allocation outputs, all of which are articulated within a five-step process:

1. Objective Inputs – Realistic Description of Market Uncertainty

2. Subjective Inputs – Detailed Description of Investor Situation

3. Building Block Outputs – Goal-Hedging and Performance-Seeking Portfolios

4. Asset Allocation Outputs – Dynamic Split Between Risky and Safe Building Blocks

5. Reporting Outputs – Updated Probabilities of Reaching Goals

In most developed countries, pension systems are being threatened by rising demographic imbalances as well as lower growth in productivity. With the need to supplement public and private retirement benefits via voluntary contributions, individuals are becoming increasingly responsible for their own retirement savings and investment decisions.

The principles of goal-based investing can be applied to the retirement problem (Giron, Martellini, Milhau, Mulvey, and Suri, 2018)11. In retirement investing, the goal is to generate replacement income. The first step is the identification of a safe goal-hedging portfolio (GHP), which effectively and reliably secures an investors essential goal, regardless of assumptions on parameter values such as risk premia on risky assets. In other words, the GHP should secure the purchasing power of retirement savings in terms of replacement income, an objective that is clearly different from securing the nominal value of retirement savings.

A target level of replacement income that the investor would like to reach but is unable to secure given current resources is said to be an aspirational goal. On the other hand, an essential goal is an affordable level of income that the investor would like to secure with the highest confidence level. In most cases, current savings are insufficient to finance the target income level that allow the desired standard of living to be financed, so the investor needs to have access to upside potential via some performance seeking portfolio (PSP). It can be shown that the optimal payoff can be approximated with a simple dynamic GBI strategy in which the dollar allocation to the PSP is given by a multiple of the risk budget, defined as the distance between current savings and a floor equal to the present value of the essential goal.

This form of strategy is reminiscent of the dynamic core-satellite investment approach of Amenc, Malaise, and Martellini (2004)12, with the GHP as the core and the PSP as the satellite. It allows the tracking error with respect to the replacement income portfolio to be managed in a non-symmetric way, by capturing part of the upside of the PSP while limiting funding ratio downside risk to a fixed level. From an implementation standpoint, it has the advantage over the probability-maximising strategy that it is only based on observable parameters.

In order to achieve the highest success probability, the GBI strategy embeds a stop-gain mechanism, by which all assets are transferred to the GHP on the first date the aspirational goal is hit, that is if and when current wealth becomes sufficiently high to purchase the target level of replacement income cash flows. By using the proper GHP and a risk-controlled investment approach, retirement GBI strategies secure a fixed fraction of the purchasing power of each dollar invested without sacrificing upside potential.

TheEDHEC-Princeton indicesare asset allocation benchmarks that have been developed for educational purposes, to give a practical example of application of goal-based investing techniques to the problem of retirement savings13

Aligning Life and Wealth: An Introduction to Goals-Based Investing

Goals-Based Investing, Three Broad Categories.

Retirement: Goal-Based Investing Gains Traction. Archived fromthe originalon 2009-08-22.

Goals-Based Investing, Three Broad Categories.

Goals-Based Investing Saves Investors from Rash Decisions

Deguest, R., L. Martellini, V. Milhau, A. Suri, and H. Wang. 2015. Introducing a Comprehensive Investment Framework for Goals-Based Wealth Management. EDHEC-Risk Institute Publication (March):

Chhabra, A. 2005. Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors. Journal of Wealth Management 7(5): 8-34.

Giron, K., L. Martellini, V. Milhau, J. Mulvey, and A. Suri. 2018. Applying Goal-Based Investing Principles to the retirement Problem. EDHEC-Risk Institute Publication (May):

Amenc, N., P. Malaise, and L. Martellini. 2004. Revisiting Core-Satellite Investing A Dynamic Model of Relative Risk Management. Journal of Portfolio Management 31(1): 64-75.

This page was last edited on 5 March 2020, at 10:54

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