Do you invest money with the hopes of beating the market? While many investors measure success based on how their portfolios perform against benchmarks, a new approach is gaining momentum. Goal-based investing invites individuals to prioritize their financial goals over solely chasing high market returns. This article will explore how to incorporate goal-based investing into your portfolio.
What Is Goal-Based Investing?
The only constant in life is change, and that mantra reflects itself in people’s finances. You may be saving for your child’s college tuition now and planning your retirement a decade later.
Goal-based investors take a long-term approach and set goals around major milestones. These investors focus on accumulating portfolios to buy homes, pay for higher education, retire or reach other personal financial goals. The goal-based approach rewards maintenance rather than betting on riskier growth assets that can be prone to sharper downtrends during market corrections.
5 Goal-Based Investing Strategies
Goal-based investors consider what they want to achieve and their timeline to determine the best investment plan to get there. A goal-based approach can help you limit risk and lower your downside. Investors can use these strategies to stay aligned with their goals.
Use Your Timeframe to Determine Portfolio Diversification
A couple retiring in a few years has a lower risk tolerance than an investor fresh out of college. Investors seeking less risk tend to buy conservative assets like bonds. Individuals with time on their side often buy equities and wait for those positions to grow over several years.
Incorporate Hedges in Your Portfolio
Hedges minimize your downside if the market takes a hit. Some investors sell covered calls to get an instant premium and a bit of protection if their underlying shares lose value. Private markets can also provide a haven during market volatility. Alternative assets usually do not correlate with the stock market and can produce respectable yields.
Use Cash Flow to Cover Your Cost of Living
Individuals are in a good financial place if their income exceeds expenses. Investors who bring in enough cash flow from their assets to cover living expenses are in an even better position. You can feel more comfortable in retirement when you can count on stable, cash-flow-producing assets that provide more than enough for your living expenses. Some goal-based investors focus on high-yield assets to increase passive income.
Build an Emergency Fund
An emergency fund provides liquid cash you can use for large purchases or to cover an emergency expense. Cash in your bank account can provide more certainty while you put other capital into your investments.
Depending on when you need these funds, you could set up a certificate of deposit (CD) schedule to generate cash flow from your emergency funds. You can buy 1-year CDs every three months. This strategy ensures that funds become available every three months as you grow your emergency fund with a risk-free asset class.
Track Your Progress
Goal-based investors take a long-term approach, but it is easy to lose focus along the way. Tracking your progress each day and conducting more detailed analyses at the end of every quarter and year will help you center your portfolio around your goals.
Investors cannot control their returns. They can only invest in assets that align with their goals and hope for the best. People have the most control over their monthly portfolio contributions. Trimming expenses can yield quick wins, but looking into income growth opportunities can help you grow your portfolio faster.
Goal-oriented investors should set monthly contribution goals that help them achieve long-term objectives.
Income Generating Assets that Help with Cash Flow
Building a high yield portfolio gives you the cash flow you need to cover living expenses. Income producing assets are a fan favorite among retirees due to their predictable passive income. While stock dividends, rental income, and other cash flow are not guaranteed, it offers more comfort than buying assets that do not generate income and hoping to sell them at the right time. These investments can be great additions to any high yield portfolio.
Dividend Stocks
Many corporations offer dividends to their shareholders as a reward for their loyalty. These companies usually pay quarterly dividends and hike them each year. While dividend paying companies tend to be mature entities, their stock prices still correlate with the stock market. Corrections will affect these stocks, but long-term investors have more time to weather the storm.
Real Estate
Rental properties are tangible assets that generate cash flow and give you more control. This asset provides several tax advantages and leverage. While a real estate portfolio can generate solid returns and act as a hedge against inflation and volatility, it’s a lot to manage. You will have to take calls from tenants, hire workers or fix property issues yourself, and manage properties.
Real estate investing is more involved than other assets on this list. You can explore other private assets, such as real estate notes and venture capital, to get less involved. Some funds give you exposure to these assets and handle the work for you.
Bonds and CDs
Bonds are a low-risk asset that provides reliable cash flow. You can invest in Treasury bills for risk-free returns. Corporations also issue bonds that usually have higher interest payments than treasury bills. Some corporate bonds have very little risk and will feel like buying treasury bills. Unprofitable companies are riskier, but their corporate bonds have higher interest rates.
Certificates of deposit are similar to bonds. They provide safe but low returns. Banks ask you to store money in a CD for several months or years, depending on the length of the term. Opting for a long-term CD entitles you to a higher interest rate.
Align Your Portfolio with Your Goals
A goal-based portfolio is unique for every individual. Instead of striving to beat the market, this group of investors considers what they want their money to do for them. This investing strategy doesn’t require you to sacrifice returns. Many goal-oriented investors manage to outperform the market, but that’s a bonus rather than the intended objective.
Frequently Asked Questions
Why is goal-based investing important?
Goal-based investing helps people build portfolios that align with their financial goals instead of measuring success based on outperforming benchmarks.
What is the 4% Rule?
The 4% rule is a retirement principle. Investors following this rule take out 4% of their portfolio each year and live on those funds.
Does the 4% rule for retirement still apply?
The 4% rule has become more difficult to maintain due to inflation. People who want to retire soon should reassess their expenses and how much money they need each year.
About Anna Yen
Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about investment topics ranging from traditional asset classes and derivatives to alternatives like cryptocurrency and real estate. Her work has been published on sites like Quicken and the crypto exchange Bybit.