By Eton Advisors Group
The podcast currently has 12 episodes available.
The goals-based investing framework is designed to maximize the probability of achieving our goals. This is a different objective than “maximizing our portfolio return” or “minimizing portfolio risk” and requires that we explicitly define, quantify, and prioritize our goals for all years in our investment time horizon. Once our goals are organized by priority and time horizon, we can then start to assign specific assets or groups of assets to fund particular goals, in essence creating “sub-portfolios,” each of which is designed to fund a personal financial goal.
In general, short-term and high-priority goals ought to be funded with lower-volatility, liquid investments, while longer-term or lower-priority goals can be funded with higher-volatility and illiquid investments. But in a market environment wherein publicly traded equities are trading at very elevated multiples and fixed income investments offer exceptionally low yields, how do we adapt this framework to maintain our path toward goal achievement? This podcast suggests a “barbell” approach which helps maximize the probability of achieving long-term goals and is underpinned by careful cashflow planning, monitoring, and rebalancing.
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As we look forward into 2020 and beyond, we thankfully see the beginning of widespread distribution of a vaccine against COVID-19 and the peaceful transfer of political power after a very contentious election. Yet the prospects for global economic growth are still uncertain and highly dependent upon both the speed at which the pandemic is brought under control and the effectiveness of government policy responses . Equity market valuations in the U.S. are high by most historical measures and fixed income yields are near historical lows. The long-term effects of high levels of global debt on the direction of interest rates, future inflation, and global credit quality are hotly debated.
In this podcast, we describe three potential economic and market scenarios for 2021 and beyond, contemplating how our portfolios might perform in each of these alternative paths. Recognizing the fluidity of our healthcare, economic, and social outcomes over the coming quarters, we suggest several steps investors might consider in positioning their portfolios to deal with ongoing uncertainty.
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The year 2020 has been tumultuous in many different aspects of daily life, including in financial markets which sold off precipitously in the spring only to recover even more robustly over the months which followed. One way to help make sense out of the investment world in 2020 is by examining the various market narratives which dominated over the course of the year.
In his 2019 book Narrative Economics, Nobel-prize winning economist Professor Robert Shiller suggested that financial markets (and even the underlying economy) have become dominated by “narratives,” stories which spread quickly and come to govern investor and consumer behavior. This trend has been encouraged by the rise of passive investing, the decline of fundamental analysis, increased algorithmic/computerized trading by hedge funds, and the overarching impact of social media. In this podcast, we examine several of those narratives seen in 2020 and discuss how we as investors ought to take them into account when constructing and managing our portfolios.
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We often describe goals-based investing as a framework, an approach, or a methodology. A more complete and robust characterization would be to view goals-based investing as a discipline.
Though infrequently used in investment conversation, the term discipline implies more than a single process or mathematical methodology. A discipline can be viewed as a means to an end, a philosophy or mindset which, if practiced consistently and regularly over time, culminates in a type or degree of success which could not be achieved directly and immediately. The discipline of goals-based investing is a set of principles, regular calculations and personal reflections, ways of decision-making, and practices which govern our financial lives. The goal of this discipline is clear and quite different from the common goals expressed by Wall Street: to maximize the probability of achieving our specific financial goals.
Six principles foundational to the discipline of goals-based investing are stated, each of them crystallizing a concept or set of ideas discussed in prior podcasts. The willingness to “…practice radical self-awareness” is highlighted, as above all the goals-based investor must remain ever aware of his own behaviors and tendencies if long-term goals are to remain in focus.
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The notion that more risk equals more reward is a truism of investing and modern portfolio management. So why wouldn’t a rational investor seek out the greatest amount of risk when selecting investments for her portfolio? And how might we go about setting a portfolio “risk budget” that is appropriate for achieving our specific financial goals while simultaneously aligning with our personal risk preferences and tolerances?
There are both quantitative and behavioral reasons for dialing down our allocation to risk. The “smoothing” effect of time on investment returns implies that longer-term goals can be—in fact, need to be—funded by higher risk investments. The priority of our goals one to another also influences our risk appetite, in that higher priority goals require higher levels of statistical confidence that can only be achieved with lower risk investments. In addition, there are the many future unknowns—of both the known and unknown varieties—the potential impact of which are either mitigated or exacerbated by our chosen level of risk. Finally, our own behavioral tendencies influence both the types of risk and the overall level of risk which we can tolerate without succumbing to wealth-destroying behaviors.
Above all, goals-based investors remain ever conscious of the rate of return required to achieve their goals and bear in mind that hurdle rate when reviewing potential investments.
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Individual investments in our portfolios may be viewed as “bundle” of different risks: term risk, default risk, equity risk, alpha risk, illiquidity risk, and leverage risk. Some investments—such as the 30-Year U.S. Treasury Bond—carry only a single type of risk (term risk), while more complex investments or fund vehicles such as venture capital funds may embed multiple types of risk (term, equity, alpha, illiquidity).
Each of these types of risks commands a risk premium—an extra bit of expected return in compensation for the added uncertainty that each type of risk brings. Risk premiums rise and fall over time based on market valuations, the amount of systemwide liquidity available, the level of economic growth and innovation, and the mood or sentiment of investors. Prudent investors often compare the current expected risk premium for a particular type of risk with its historical average to determine whether that added risk is attractive or not, though in the current environment we note that some historical averages no longer seem universally relevant to investors.
Investors applying the goals-based framework understand the specific characteristics of different personal goals suggest that certain types of risk are or are not appropriate. For example, investors whose goals are heavily front-loaded in their time horizon (e.g., years 1-5) will find the risk premium for illiquid investments rarely compensates adequately for the inability to turn the investment back into cash within that time premium; conversely, a multi-generational trust might consciously seek out such a risk and judge the risk premium offered highly acceptable.
Understanding the types of risk available to investors and matching those appropriately to the characteristics of one’s goals is the key to success.
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The Golden Age of Monetary Policy (1980-2019) has ended and the Post-Monetary Era has begun.
The unique market environment which we are calling the “Post-Monetary Era” presents many challenges for investors, suggesting that investors should focus on defining, quantifying, and prioritizing their goals in order to maximize their probability of financial success. This podcast suggests that investors view their goals as “self-imposed liabilities” and organize their investment portfolios accordingly to fund those.
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The Golden Age of Monetary Policy (1980-2019) has ended and the Post-Monetary Era has begun.
Having become accustomed to the “new normal” of Quantitative Easing, ultra-low interest rates, and Fed-suppressed market volatility, investors must now learn to live with a “new, new normal” as the Federal Reserve’s COVID-19 response reset market conditions and expectations. This podcasts describes 7 important facts about the current market environment, all relevant to investment decision-making.
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The Golden Age of Monetary Policy (1980-2019) has ended and the Post-Monetary Era has begun.
This episode explores the consequences of the COVID pandemic's dramatic impacts on the economy and financial markets.
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The Golden Age of Monetary Policy (1980-2019) has ended and the Post-Monetary Era has begun.
This podcast looks at the final stage of the Golden Era when returns to stock and bond investors have been strong but economic growth has been sluggish.
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The podcast currently has 12 episodes available.