Understanding Goal-Based Investing - SmartAsset

Many investors save as much as they can for as long as they can without a specific goal in mind. While this approach can build a solid nest egg, it lacks one of the most fundamental aspects of setting goals – measuring your progress. Wealth managers use goal-based investing to help clients track progress towards their financial goals with defined yardsticks along the way. Here’s how it works and an example using this strategy. A financial advisor can help you monitor the progress you are making towards your goals.

What Is Goal-Based Investing?

Goal-based investing is linking your investment strategy with your financial goals. It includes setting target results at specific timeframes along the path to your ultimate financial goals. Instead of focusing on achieving the highest returns or building the biggest nest egg, goal-based investing offers short-term goals based on a client’s needs. In addition to retirement, this strategy incorporates intermediate goals like paying for a child’s college education or buying a vacation home.

Depending on how your portfolio has performed, with goal-based investing, you can adjust based on how close or far you are from your goals. High-return investment portfolios can dial-back risk or reduce annual contributions. Those that are behind where they should be may need to increase contributions or take on more risk.

How to Incorporate Goal-Based Investing

Retired man talking to his financial advisor

If goal-based investing sounds like an ideal approach, you can start implementing this strategy right away. Simply follow these seven simple steps to create a goal-based investing plan customized to what’s important to you.

Identify specific investment goals. Make a list of your financial goals (e.g.: college fund, vacation home, retirement) that you want to save for.
How much time do you have? Figure out how many years you have to invest towards each goal. This is critical for the number of years you have to save and how long compound interest can work on your behalf.
Determine how much money is needed. Calculate how much each of these goals will cost in today’s dollars.
Factor in inflation. Inflation causes prices to increase over time. While inflation has been low recently, historical average inflation since 1914 has been 3.24% per year.
Estimate the future cost. Increase the cost of your goals in today’s dollars by inflation over the number of years you have to reach your goal. This helps you understand the targeted amount needed for each of your goals.
Determine a realistic rate of return. Based on your risk tolerance and preferred asset mix, determine what rates of return you can realistically expect from your portfolio.
Calculate how much you need to save. Now that you know how many years you have to reach your goals, the expected future cost and the rate of return, you can calculate how much you need to save on a monthly basis to reach those goals.

Examples of Goal-Based Investing

To help you better understand goal-based investing, here are three common goals that you may have.

Short-term goal. Buying a home. Buying a home is a dream for many Americans. Before starting your search, speak with a real estate agent and a mortgage broker to discuss how much money you’ll need as a down payment and closing costs. Since the goal is to buy a home within a few years, this money is typically best in a high-yield savings account. Meeting this goal is primarily based on how much you can save each month.
Medium-term goal. Saving for college. While many new parents focus on the immediate costs of having a baby, college is just 18 years away. Starting to save while the baby is young makes it easier to meet your goals. Our inflation calculator will help you determine what your ideal college will cost in two decades. Then you can calculate how much to save for college.
Long-term goal. Retirement. Starting to save for retirement early allows your money to compound for decades. While many people recommend setting aside 10% to 15% of your pay for retirement, that may be too much or too little based on your goals. Under this approach, you’ll quantify the income necessary to achieve your desired retirement lifestyle. Then, you can work backward to calculate how much you need to save to make that dream a reality.

The Bottom Line

Goal-based investing defines what it takes to reach your financial goals. It helps you define how much you need to save and what level of risk is appropriate to hit your investment targets. This approach alerts those that are behind on their targets and make adjustments. Additionally, it allows super-savers the ability to dial it back or accelerate their timeframe based on how far ahead they are.

Tips on Investing

Working with a financial advisor helps you quantify your goals. They’ll help you determine realistic investment returns and monthly savings to meet your needs.
Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor, get started now.
Calculating how much you need to save for your goals is the basis for goal-based investing. Our investment calculator lets you run scenarios using different monthly savings, investment returns and other factors.