Goals Based Investing, the KISS Principle, and the Case for New Financial Instruments

Abstract

There are two approaches to solving investment management challenges. The first (or traditional/mainstream) approach takes existing assets and tries to develop a robust analytic approach based on current theory to develop an appropriate investment solution. Life-cycle investing for retirement is a good example. However, the theory is much more elegant than practice because assets are not suited for a wide range of potential goals, and hence this approach tends to be error-prone, complex, expensive and leave investors with a lot of risk. This then makes the problem well beyond the scope of the average investor or even the advisor. The second approach, described here as the KISS (Keep it Simple and Straightforward) approach, takes a very different tack. It recognizes that with goals-based investing (GBI) each goal is unique. Rather than tweaking the investment solution with ever more complex approaches, it focuses instead on creating goal-appropriate financial instruments, which then trivialize the investment problem (and eliminate previously mentioned challenges). The trick of course would be to establish adequate demand and supply of these instruments to make this approach reasonable and sensible. We use a very simple example of saving for a child’s college to articulate a new instrument that could be a useful addition to the investor’s portfolio tool kit, and if well designed, could reduce the decision to just how much to save (and require just basic multiplication), thereby establishing demand. We also focus on who might be willing to supply such instruments. Using the framework developed, the paper concludes with a broader discussion of other financial instruments for other goals, including saving for retirement. In short, given the typically common nature of all GBI, these innovative instruments will typically be interest-only real bonds (indexed to the appropriate inflation index), that have a forward start date and pay coupons for the period required for the respective goal.