hen a longtime client announced she wanted to buy a million-dollar vacation home on Martha’s Vineyard within the next ten years for cash, financial advisor Lori Van Dusen didn’t flinch. The woman and her husband, then both fiftysomething surgeons, were already socking away enough to maintain their lifestyle in retirement. And Van Dusen, founder of LVW Advisors in Pittsford, New York, expects clients to share their goals, even those that might seem like a stretch.
That’s because she manages her clients’ money (about $2 billion of it) in three investment buckets: one for essentials (putting the kids through college, maintaining lifestyle in retirement), one for aspirations (that luxe vacation home or round-the-world trip), and one for legacy (philanthropy and bequests). Martha’s Vineyard was an “aspiration,” so Van Dusen started investing the woman’s annual bonus in a portfolio with a more aggressive asset allocation than the couple’s basic retirement kitty. The surgeons were okay taking the added risk, the advisor says, because “they knew even if the money was lost, it wouldn’t change their lifestyle.” After just six years, they had enough to buy the house.
Van Dusen, ranked 69th on our annual list of America’s Top Wealth Advisors, has practiced this sort of goals-based wealth management for three decades, making her an outlier. For most of those years, the conventional approach was to determine a client’s overall risk tolerance (based on answers to a questionnaire, age and total wealth) and then manage all their money as one diversified portfolio, designed in line with modern portfolio theory to maximize returns for that level of risk. Advisors might help clients budget for goals, but it was a separate function.
Now, however, big firms such as UBS, Raymond James and Bank of America’s Merrill Lynch are pushing their advisors to adopt some variant of Van Dusen’s goals-centric investing approach. This shift has a lot to do with economics—both the economics of the advice business and the growing influence of behavioral science on finance.
Academics such as Richard Thaler, who won last year’s Nobel prize in economics, have persuasively described how “mental accounting” leads people to regard money differently depending on what it’s to be used for. They’ve also explained how human tendencies (e.g., hindsight bias, loss aversion) lead too many investors to buy at the top and sell at the bottom.
One objective of goals-based investing is to minimize mistakes such as panic selling. Thaler, a professor at the University of Chicago’s Booth School of Business, argues that matching clients to a portfolio through a traditional risk-tolerance questionnaire just doesn’t accomplish that. “People do not know their risk tolerance. They cannot predict how they will react to something like the financial crisis,’’ he told Forbes. But Thaler adds this caution: “Goals-based investing is easier to say than to implement.”
Indeed, financial advisors might not be so keen to adopt goals-based investing were it not for increased pressure to justify fees averaging 1% of assets a year. Traditionally, they’ve pointed to their portfolio construction and stock-picking skills. But index funds have overshadowed stock picking, and individuals can now get professionally constructed portfolios matching their desired risk level (or, alternatively, their goals) from robo-advisors for just 0.25% of assets a year. To earn their keep now, advisors must offer a more personalized, high-touch approach.
“If you can tell people, ‘I’m working to reach your goals,’ it’s more understandable than if you say, ‘Your portfolio has an expected return of 10% and a standard deviation of 20%,’ ’’ says Sanjiv Das, a finance professor at Santa Clara University. He argues that goals-based money management is compatible with traditional risk-based asset allocation—if risk is redefined as the chance of not meeting a goal. In this construct, the appropriate level of risk varies by goal, since a typical investor will accept only a very small chance of falling short of funding basic retirement needs but opt for a higher level of risk and return when reaching for a dream.
Big firms such as UBS, Raymond James and Bank of America’s Merrill Lynch are now pushing their advisors to adopt some variant of Van Dusen’s goals-centric investing approach.
Jeff Harring, a planner in St. Petersburg, Florida, uses Raymond James software to create separate portfolios for clients’ needs, wants and wishes. “If the market cooperates, you get wishes. If it doesn’t, we pull back to needs,’’ he says.
Not all veteran advisors buy into the goals-based paradigm. “Our job is to make you as much money as we can in a given period rather than planning for specific events,’’ says Stephan Cassaday, who manages $2.8 billion at his firm in McLean, Virginia. He offers clients a choice of six portfolios, each with its own risk, and helps them decide on the right fit. A problem with focusing on goals, Cassaday says, is that they change. “I’ve never met someone who knows exactly what house they want in 30 years.”
In fact, behavioral economists agree that folks don’t know what they’ll want in 30 years. “Most young people cannot even imagine being old, much less thinking about what financial needs they would have. So it makes sense to form goals in stages,’’ Thaler says.
It’s not just age. Life happens. Dana Hanson, who manages $870 million at RZH Advisors in Stamford, Connecticut, with a goals-based approach, reports that one client, upon finishing chemotherapy, announced that she wanted to buy a vacation house in the Caribbean.
Yet the fact that goals change is part of the reason advisors are embracing the approach. If a client needs to report when her dreams or circumstances change, well, that builds a relationship you can’t get from a robo-advisor.
Other factors, too, are encouraging a shift. The proliferation of special tax-favored accounts—529s for college; IRAs and 401(k)s for retirement; donor-advised funds for charitable giving—promotes segregation of investments based on intended use. And today’s computerized asset allocation makes it easy to manage multiple investment pots.
“Most young people cannot even imagine being old, much less thinking about what financial needs they would have. So it makes sense to form goals in stages,’’ says Richard Thaler.
Exactly how goals-based wealth management works varies by firm. This year UBS rolled out to its 7,000 advisors a platform that draws on both behavioral finance and liability-driven investing—the technique pension-fund managers use to match pools of money with liabilities due at different dates. The software combines planning and money management into three “strategies”: liquidity, longevity and legacy.
For a retiree, the liquidity pool covers three years of spending, funded with a bond ladder, in addition to Social Security, pensions and annuities. (The idea is to protect clients from needing or wanting to sell off equities in a bear market.) The longevity bucket includes stocks and is designed to cover expenses, including long-term care, that come due after three years, until the end of life. The legacy strategy, for charity and heirs, might include an even more aggressive equities portfolio, plus a donor-advised fund and concentrated appreciated-stock positions that make sense (for tax reasons) to hold until death.
Note that both UBS and Van Dusen emphasize “legacy.” Very-high-net-worth clients often want to give money away, but only once they’re sure they have enough left for their own needs.
A widow in her mid-50s, with a $30 million net worth, came to Katie Nixon, chief investment officer of Northern Trust Wealth Management in Chicago, for advice. Her estate plan provided $5 million for a private foundation her daughters would run. “She told me, ‘The only thing I regret is I won’t be there to see it,’ ” Nixon recounts. “I told her, ‘That’s the worst plan I’ve heard of. Why don’t you do it in your lifetime?’ ” Using Northern Trust’s goals-based software, Nixon was able to show the widow how she could cover living expenses and her other noncharitable goals for the rest of her life and fund her foundation now.
Reach Halah Touryalai at email@example.com and Ashlea Ebeling at firstname.lastname@example.org. Cover image by Franco Vogt for Forbes.
This story appears in the September 30, 2018 issue of Forbes.