GOALS-BASED INVESTING Aligning Life and Wealth

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1 GOALS-BASED INVESTING Aligning Life and Wealth seic.ca

2 Recent surveys show that North American investors are finally taking a more positive view of markets and beginning to commit more capital to riskier assets, such as stocks. However, market events since the 2008 global financial crisis have taken a toll on confidence and undermined many investors trust in their advisors and their willingness to adhere to even a well-designed investment strategy. Savvy financial advisors must continuously assess how well their clients are prepared, both emotionally and financially, for a new bout of severe volatility or the next bear market.

3 Goals-based investing offers a powerful tool to help steel clients against market fear and uncertainty by better managing human preferences, biases and behaviours that can undermine their financial success. By helping clients invest according to their unique needs, desires and time horizons in a way that encourages them to look beyond intermittent market volatility, financial advisors can differentiate themselves from the crowd and improve their own odds for longterm success. Improved Outlook, New Worries, Same Behaviours Investors are increasingly concerned about successfully meeting long-term goals and managing financial risks. Nearly every financial advisor knows that clients, despite understanding the importance of sticking to a disciplined investment strategy, can often be their own worst enemies all too eager to make an irrational decision that will negatively impact their wealth or jeopardize their goals. While one client insists on buying the latest hot stock after there has been a run-up in price, another becomes panicked by market volatility and is ready to abandon a welldesigned investment plan. Clients who make those decisions exhibit what researchers refer to as irrational investment behaviour. Supported by a growing body of evidence and studies, behavioural finance has finally assumed its rightful place in wealth management and portfolio decision-making. The Traditional Approach to Asset Allocation Historically, the investing process has gone like this: Investors identify two or three goals often with the help of an advisor and then lump all assets into a single portfolio or bucket. At that point, they are told to expect a given return based on the historic or expected performance and volatility of various market benchmarks. We do not think it makes sense to identify separate goals and then treat them identically by putting all financial assets into a single bucket. Investors financial goals differ in terms of importance, time horizon and the level of risk the investor is comfortable assuming relative to each goal. For example, logic would dictate that one can take more risk with long-term goals and less risk with short-term ones. Similarly, one would want to take less risk with the funds designated for have-to-have financial goals, such as covering day-to-day living expenses, while accepting more risk for discretionary nice-to-have goals, like luxury vacations. By tracking each goal separately so that they can be monitored more accurately, investors will have a much clearer picture of how well they are succeeding. 2

4 Goals-Based Investing A Better Approach Rather than focusing solely on investment management and performance, goals-based investing is oriented around the individual investor. The efficacy of an investment strategy is not measured only by traditional yardsticks like market indices, benchmarks and standard deviation. Specific goals are very meaningful to clients, and that is what distinguishes SEI s approach from others. Investment strategies are specifically designed around each client s personal goals. Performance is measured by the client s progress toward achieving each stated goal. And risk is viewed as failure to fully achieve each goal. Goals-based investing also recognizes that investors have multiple and sometimes conflicting goals. Rather than pool all client assets into a single portfolio, we create a separate portfolio bucket for each goal. Whether a client wants to accumulate assets for retirement, save for a vacation home, build a legacy for heirs, or achieve any other number of goals, an investment strategy can be specifically tailored to each goal. Exhibit 1 provides an example of how our goalsbased investment approach helps clients order their financial priorities based on needs versus wants, and the time horizon for each goal. Exhibit 1: Prioritizing Financial Goals Examples: Buy vacation home or travel to Europe with family Examples: Leave estate for my children or retire in golf community PRIORITY HAVE TO WANT TO Your goals: Investment objective: grow assets Examples: Pay living expenses Your goals: Your goals: Investment objective: grow assets Examples: Retire comfortably, put kids through university Your goals: Investment objective: preserve guaranteed sum Investment objective: protect against losses, while maintaining steady growth, have enough when the time comes NOW LATER TIME 3

5 The benefits of goals-based investing result from advances in our understanding of human and financial market behaviours " Managing Human Biases and Behaviour A wealth management strategy built around specific goals offers multiple benefits, not the least of which is its value in addressing irrational behaviour by investors. Bad decision-making is often the result of a lack of information, and this is a major shortcoming of traditional investing. Harry Markowitz s landmark work on portfolio selection in 1952 led to Modern Portfolio Theory (MPT) and efficient portfolios for decades the bible of investment practitioners. While the riskreturn framework of MPT remains a critical aspect of sound investment strategy, many financial behaviourists have identified what they view as fundamental flaws in the MPT approach and its standard implementation. Building an efficient portfolio under MPT assumes that each investor has perfect information about economies, markets and securities. It also assumes that investors act rationally, and that financial market returns and volatilities behave according to normal statistical assumptions. However, while these assumptions helped simplify the mathematics of portfolio construction and measurement, we know from experience and common sense that they do not always hold up well in the real world. Most investors have too little information and are driven not by the information they have, but by how they are feeling at a given moment. At the aggregate level, human behavioural tendencies are sometimes reflected in chaotic and closely correlated market movements during times of fear, uncertainty and high volatility, and in widespread investor complacency during times of calm. As a result, behavioural perspectives on investors and financial markets have played an increasingly important role over the last decade. SEI has been on the leading edge of this movement. In 2003, SEI authored the white paper Goals-Based Investing: Integrating Traditional and Behavioral Finance, which was also published in the Spring 2004 issue of The Journal of Wealth Management. Financial theorists and practitioners have continued to develop and refine their frameworks in order to identify the most relevant human preferences and biases, understand their investment and market impacts, and devise methods for effectively managing them. The benefits of goals-based investing result from advances in our understanding of human and financial market behaviours, and integration of that knowledge into traditional asset allocation frameworks. Exhibit 2 (on the following page) lists some of the most common investor behaviours and explains how our Goals-Based Investing approach can help manage them. 4

6 Exhibit 2: Investor Behaviours and Goals-Based Investing BEHAVIOUR Herding DESCRIPTION Many investors display a tendency to imitate others in the belief that other investors possess information that justifies their actions. This behaviour creates a feeling of safety in numbers that is often unwarranted. Extreme herding behaviour is at work in financial market bubbles. HOW SEI GOALS-BASED INVESTING CAN HELP With the confidence inspired by a personal goals-based investment strategy, clients will be able to avoid the sway of public opinion and focus on what is truly important to them. Overconfidence Many investors overestimate their knowledge, predictive ability and skill, resulting in excessive, irrational noise trading and a refusal to adjust their views in the face of contradicting evidence. Overconfidence and a tendency toward noise trading are replaced by a clear vision of where an investor is headed, and the strategy for getting there. Over- and Under-reaction Investors often under- or over-react to new information, even if that information is largely irrelevant to their goals. Clients who focus on what really matters staying on track toward their unique financial goals will tend to be less affected by and reactive to shortterm news flow. Myopic Loss Aversion Most people place an extreme emphasis on loss avoidance. This is reflected in the tendency of many investors to react emotionally to shortterm news flow and market volatility, even when they have a well-designed investment plan in place. SEI s Stability-Focused strategies are designed to limit the maximum loss on a portfolio by employing an objective, rational, decision-making framework. Regret Aversion Most people want to avoid regretting a decision. Among investors, there is a tendency to avoid realizing losses on investments that have declined in value, regardless of the available alternatives. As a result, investors may incur opportunity costs as more compelling investments are foregone. Clients enjoy the benefit of professionally designed and managed strategies that are appropriate to their needs. As a result, they can focus on progress toward their goals instead of picking winners and losers or becoming emotionally attached to their investment holdings. Adapted from Clint Tan Chee Leong, Michael J. Seiler, and Mark Lane (2002), Explaining Apparent Stock Market Anomalies: Irrational Exuberance or Archetypal Human Psychology, The Journal of Wealth Management, Spring 2002, Vol. 4 No. 4, pp

7 We firmly believe this approach will help differentiate financial advisors. Most investment companies still tell the same story the same way, lumping all of a client s financial assets into a single portfolio and focusing on benchmark-relative performance. This leaves advisors to fight an often losing battle against the counterproductive but innate biases and behaviours of their clients. Working with SEI, you will look and sound different from your competition, have the potential to meet client expectations more effectively and be better equipped to deal with irrational and counter-productive investor behaviour. As a result, your clients will behave differently, improving their chances for long-term financial success. SEI s Goals-Based Investing should also help you deepen your client relationships, which is especially important during periods of market upheaval. Studies have shown that market volatility increases the likelihood of clients changing advisors. But if clients (1) understand that they are investing directly in their stated goals, (2) have learned to think about risk in terms of their specific goals rather than just short-term volatility, and (3) are engaged in a relationship explicitly designed to manage harmful behavioural tendencies, then what is the likelihood of any client leaving you? SEI s Goals-Based Investing is designed to help you win your clients lasting confidence. Of course, the person who benefits most from making solid, rational decisions is the investor. Committed to a program of long-term wealth management, and focused on achieving specific goals, your clients will build confidence, maintain a proper perspective and discipline, and remain focused on the ultimate prize achieving their lifelong financial goals. Working with SEI, you will look and sound different from your competition, have the potential to meet client expectations more effectively and be better equipped to deal with irrational and counterproductive investor behaviour." 6

8 SEI s Goals-Based Portfolios SEI offers eight Goals-Based Portfolios, as shown in Exhibits 3 and 4. These portfolios fall into two groups: stability-focused (wealth preservation) and growth-focused (wealth accumulation). The stability-focused portfolios are designed for investors who need to protect against losses while maintaining a comfortable level of growth. Strategies offered are Short Term, Defensive, Conservative and Moderate. Three of the portfolios are managed to a drawdown target, with the objective being to avoid a loss that exceeds a target percentage under most market conditions. For example: the drawdown target of the Defensive Portfolio is -10%, In a poor market scenario, the fund would be managed with the intent of not breaching a 10% loss from its peak valuation. The growth-focused portfolios are designed for investors who need to steadily accumulate assets at a rate consistent with their risk tolerance. Strategies offered are Core Market, Market Growth, Aggressive and Equity. These portfolios are actively managed in an effort to help meet the goal of achieving the highest possible return for a given risk tolerance. We are able to draw from the full range of asset classes. Equity allocations are diversified globally, including developed and emerging markets, and across large- and small-cap stocks. A portion of the portfolio may be assigned to growth-oriented bonds such as high-yield and emerging-market debt. Research suggests that these additional asset classes can deliver long-term returns commensurate with the broad equity market while adding diversification benefits. The key advantage of our approach is that we have more closely aligned risk management with investor perceptions by incorporating insights from behavioural finance into portfolio construction and reporting. 7

9 Overall, our aim is to build diversified portfolios that efficiently generate returns within a specific risk tolerance. Allocations are determined using both quantitative inputs and qualitative judgment. The portfolios are actively managed and adjustments may be made to improve the expected performance relative to each strategy s goals. The key advantage of our approach is that we have more closely aligned risk management with investor perceptions by incorporating insights from behavioural finance into portfolio construction and reporting. Exhibit 3: Description of SEI Goals-Based Portfolios Stability-Focused Portfolios Short Term Defensive Conservative Moderate Growth-Focused Portfolios Core Market Market Growth Aggressive Equity Description Short time horizon in which protection of capital takes precedence Risk control takes precedence over capital appreciation Balance of risk control and capital appreciation Emphasis on growth with secondary objective of risk control Description Growth through broad equity and fixed-income exposures; fixed-income tilt Growth through broad equity and fixed-income exposures; equity tilt Maximum growth of assets over long time horizons Maximum growth of assets over long time horizons; diversified global equities Exhibit 4: Expected Risk and Return Characteristics STABILITY FOCUS SEI s Stability-Focused Portfolios seek growth within a risk budgeting framework to manage the risk of loss. GROWTH FOCUS SEI s Growth-Focused Portfolios seek long term growth in line with the broad equity and fixed income markets. SEI Return Expectation Short Term Defensive Drawdown Target = -10% Conservative Drawdown Target = -20% Moderate Drawdown Target = -30% Core Growth Equity Aggressive Market Growth Canadian Equity Foreign Equity Fixed Income Cash and Equivalents SEI Risk Expectation 8

10 Goals-Based Investing in Practice Exhibit 5 shows a generic example of SEI s Goals-Based asset allocation framework. To understand how our Goals-Based approach might work in practice, consider the two hypothetical scenarios provided in the following discussions. Each scenario is followed by a table like that shown in Exhibit 1, listing the clients various goals by priority and time horizon. While the choice between stability- and growth-focused portfolios is obvious for most of them, the specific strategy selected for each goal will depend on additional details, including specific time horizons and a client s risk tolerance relative to each goal. The process of selecting the right mix of strategies allows you to engage in a greater number of constructive conversations with clients, strengthening your relationships with them and their trust in you. Exhibit 5: Goals-Based Allocation Framework GOAL: BUY A COTTAGE T TO LATER E TO LATER PRIORITY HAVE TO WANT TO HAVE TO NOW WANT TO LATER GOAL: RETIRE COMFORTABLY LATER NOW LATER TIME INVESTOR GOAL BUY A COTTAGE RETIRE COMFORTABLY STRATEGY OBJECTIVES Grow assets Capital growth Maximize total return INVESTMENT COMPONENTS Emphasis on investment components with risk in line with investment goals: shorter-term, nice to have. Fixed Income, Global Managed Volatility Broad mix of alpha and beta sources, including Regional and Global Developed Equities, Emerging Market Equities, Large and Small Cap Equities 9

11 SCENARIO 1 UNIVERSITY PROFESSOR April Jones, a tenured university professor, is divorced and has an adult daughter. She recently returned from field work in Central America, and has a strong desire to go back for a year-long sabbatical and vacation in six to 12 months. April has recently learned that the university has approved her sabbatical request, but it will be unpaid. She hopes to fly her daughter down for two or three visits while she is in Central America, and her ultimate dream is to buy a vacation residence there. April has significant retirement savings in both registered and taxable accounts, and has requested a meeting to discuss her options. After determining that she has enough funds to do this without jeopardizing her retirement security, you set up a stability-focused bucket that will be used to fund her anticipated sabbatical expenses. Exhibit 6: Goals-Based Investing in Practice University Professor WANT TO HAVE TO NOW Year-long sabbatical in six to 12 months (Stability) TIME HORIZON LATER Purchase residence in Central America (Growth) Retirement (Stability/Growth) SCENARIO 2 YOUNG PROFESSIONAL COUPLE Mr. and Mrs. Smith are young professionals with considerable lifetime income potential. They have a baby on the way and intend to forego some of that income while their children are pre-school age. They hope to take a Caribbean cruise before their second baby is born and have saved enough money to do so; they are now waiting for the right package at the right price. They also intend to buy a home in the next two to five years to accommodate their growing family, and have started saving for a down payment. They would like to begin saving for their children s education and their retirement years, and they both agree that if all goes well, one of their dreams is to own a vacation residence in their later years. Both of their employers offer defined-contribution retirement plans. Your first steps may include a conversation around the importance of carrying the proper insurance coverages to protect against liability, health care expenses, loss of income, property loss or damage, etc., as well as determining appropriate contribution rates to their employers retirement plans. Following that, you can employ a goals-based approach for each of your clients financial goals: preserving their vacation funds, saving for a down payment on a house, maintaining their current lifestyle if one of them chooses to stay home with the children (and saving for child-care expenses if they do not) and supplementing their retirement savings if possible. Exhibit 7: Goals-Based Investing in Practice Young Professional Couple WANT TO HAVE TO NOW Caribbean cruise (Stability) Stay-at-home parent (Stability) Child care expenses (Stability) Down payment for home (Stability) TIME HORIZON LATER Vacation residence (Growth) Children s education (Growth/Stability) Retirement (Stability/Growth) 10

12 Reaping the Benefits: Redefine Clients Success and Differentiate Your Practice As these examples demonstrate, SEI s goals-based investing gives advisors a powerful framework for customizing clients investment approaches and helping them realize their most important financial goals. Our approach improves upon traditional portfolio construction and risk management by incorporating cutting-edge insights from behavioural finance, helping your clients focus on the right things and strengthening their trust in you as a result. If you would like to hear more about SEI s Goals-Based Investing programs, we invite you to contact us. For Client Services: or cusconc@rbcdexia.com For Advisor Sales Inquiries: or sales@seic.com SEI Portfolios are designed to meet a wide range of investor goals from capital preservation to maximum growth and spanning a broad risk-return spectrum, allowing investors to participate in different levels of returns commensurate with different levels of risk. Constructed using the SEI Asset Class Funds (the Underlying Funds), each Portfolio is designed to efficiently generate returns within a specific risk tolerance. SEI develops proprietary Capital Market Assumptions ( CMAs ) for its asset classes based on the qualitative judgment of the Portfolio Strategies Group. The Group employs historical scenario analysis, develops its CMAs, and then uses these to determine asset allocation within the SEI Portfolios. SEI Portfolios are automatically rebalanced on a daily basis when the Underlying Funds exceed predetermined thresholds. In order to maintain investments in the relevant mutual funds in the proportions specified for the selected SEI Portfolio, purchases and redemptions within the Underlying Funds will be completed as part of the rebalancing process. From time to time, SEI may change the amount that a Portfolio invests in an Underlying Fund, remove an existing Underlying Fund or add a new Underlying Fund. The portfolio managers or the allocations of assets to a particular portfolio manager are subject to change from time to time at SEI s discretion. Short and long term tax impact of an investment in the SEI Portfolios and the associated rebalancing activity should be considered. There is no guarantee that any particular goals based objective will be attained. Minimum investment for the SEI Portfolios program is $25,000. All distributions made by the Underlying Funds within an SEI Portfolio are set to reinvest automatically for all accounts. Non-registered accounts have the option of receiving the distributions in cash. Portfolio program fees are as described within the Investment Application and Agreement Form completed by the Investor and their Agent and may vary depending on a number of factors, one of which is the share class of the Underlying Funds utilized within the SEI Portfolio. Details concerning the management fees of the Underlying Funds and the various share classes used are available within the SEI Prospectus and the Management Report of Fund Performance which can be obtained from the SEI website or from This material may contain forward-looking information ( FLI ) as such term is defined under applicable Canadian securities laws. FLI is disclosure regarding possible events, conditions or results of operations that is based on assumptions about future economic conditions and courses of action. FLI is subject to a variety of risks, uncertainties and other factors that could cause actual results to differ materially from expectations as expressed or implied in this material. FLI reflects current expectations with respect to current events and is not a guarantee of future performance. Any FLI that may be included or incorporated by reference in this material is presented solely for the purpose of conveying current anticipated expectations and may not be appropriate for any other purposes. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments and the use of an asset allocation service, such as the SEI Portfolios. Please read the prospectus of the mutual funds in which investment may be made under the SEI Portfolio before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The information contained herein is for general information purposes only and is not intended to constitute legal, tax, accounting, securities or investment advice, nor an opinion regarding the appropriateness of any investment. You should not act or rely on the information contained herein without obtaining specific legal, tax, accounting, securities or investment advice from an investment professional. This communication does not constitute any offer or solicitation to residents of the U.S. or the U.K. or to anyone in a jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation. SEI Investments Canada Company is the Manager of the SEI Funds in Canada, and a wholly owned subsidiary of SEI Investments Company SEI (05/12)