Goal-based investing is a specific type of investment strategy that uses investing to work toward meeting personal financial goals. With goal-based investing, each of your investments has a purpose related to a goal.
Definition and Examples of Goal-Based Investing
Goal-based investing places your financial goals at the center of your investment strategy. Using a goal-based investment strategy when working with a financial planner can also help them advise you in choosing investment products that work toward meeting those goals.
With goal-based investing, you don’t look at an investment portfolio as an account that is separate from your personal life. Instead, you should think of each investment as having a single purpose. For example, putting money into a 401(k) or an individual retirement account (IRA) to prepare for retirement is a form of goal-based investing.
Goal-based investing allows you to better understand why you are saving money, which can also be quite motivating. If you’re saving to buy a home, for example, knowing that is your goal allows you to visualize what your investment efforts are working toward. You may be able to more easily see what today’s sacrifices, like ordering less take-out food, can lead to—your dream home.
Goal-based investing can also help you determine how comfortable you are with taking risks. The more important a goal is to you, the less risk you may be willing to take.
Financial planners use goal-based investing to help their clients avoid worrying about the short-term volatility that comes from having a higher risk investment portfolio. Instead, they can focus on working toward a long-term goal. For example, losing money this month or quarter likely won't matter in the grand scheme of things if you have two decades for your investments to grow before you plan to achieve your goal.
Ebbs and flows are natural. When you’re investing with a larger goal in mind, it’s easier to step back and look at the bigger picture. Ideally, this will help you build confidence in your investing strategy and you won’t make the mistake of removing money from stocks or index funds that have taken a dip.
How Goal-Based Investing Works
A goal-based approach to investing allows you to play an active role in the decision-making process of investing. Because you’re setting separate goals, you can take your timeline and risk level for each goal into account when choosing investments.
Instead of tracking the success of an investment by considering whether it is outperforming benchmarks, you may measure success by reviewing how well that investment is tracking against the goal set for it.
Goal-based investing can also benefit you from a tax perspective. You can create a goal-based plan that provides a framework for using tax-efficient strategies when deciding where to place investments.
When planning how to save for retirement, for example, you can use goal-based investing to help align your investments with your life goals while also making beneficial tax moves. There are different tax trade-offs to consider when choosing between contributing to retirement accounts like 401(k)s and IRAs.
Knowing what your goals are (like the age you want to retire) can help you choose the right account to help you reach them while enjoying tax breaks—either now or in the future.
Challenges of Goal-Based Investing
As helpful as goal-based investing can be, it doesn’t come without its challenges. Identifying financial goals can be difficult, especially when you need to prioritize a variety of goals that you’ll tackle at different times in your life. It may also not come easy if you're balancing paying down debt like student loans or a mortgage and need don't have the means to invest right now.
If you have money to invest, some common goals for investors include buying a home (or a second home), sending a child to college, or retiring at a certain age. You’ll need to plan out how much money each goal requires and how much risk you can afford to take in order to achieve them. For example, if you want to buy a home in New Jersey that costs $500,000 and plan to put down 20%, you’ll need to have at least $100,000 to do that. Or if your child wants to go to a school that costs $30,000 per year, you may be aiming to have $120,000 saved for when they graduate high school. Different types of investments may help you achieve these goals.
Goal-based investing forces you to sit down and prioritize what matters to you most. That’s not necessarily an easy task to accomplish. But defining your goals, estimating your needs, and mapping out how to meet your goals with goal-based investing can be worth the time and effort.
How To Start Goal-Based Investing
Before investing, take inventory of your finances. Do you have your emergency fund saved? Do you have a lot of debt that you still need to repay? Can you afford to potentially lose the money you invest? Once you have your finances under control, you can start goal-based investing.
First, map out the goals you want to achieve in life. Next, do your research to learn more about the different types of investments available and how much money you may need to get started. Stocks, bonds, exchange-traded funds (ETFs), mutual funds, and more can help you create a balanced portfolio that eventually grows to meet your future goals and needs.
Then consider whether working with a financial advisor or investment broker is right for you. They may be able to help you put a plan in place to consistently invest money every month or year to work toward your goals.
- Goal-based investing plans your investment strategy around the personal goals you’re hoping to meet.
- With goal-based investing, each of your investments has its own unique purpose to help you achieve a specific financial goal.
- You can use goal-based investing to align your investments with your life goals while determining how to make the most beneficial tax moves.
- Goal-based investing forces you to sit down and prioritize what matters to you most, which is not always an easy task, but it can be worth the time and effort.