Goal-based financial planning: A better way to measure success

Past performance really doesn’t mean anything

Enter goal-based plans—the way we do advice at Vanguard. These kinds of plans help you focus on how your investments are impacting your life, as opposed to a bunch of percentages that, in and of themselves, are neither good nor bad.

How can a big return not be good? Well, if you earned it by taking on a ton of risk and getting lucky, you’re now set up for a big drop in the future—potentially wiping out any real progress toward your goal.

Why does that happen? Simple. The best performing investments this year are very unlikely to perform as well next year.

This chart shows the annual returns for several investment categories, ranked over a 15-year period. To take one example, U.S. high-yield bonds (in purple) rank anywhere from 2nd place to 10th depending on the year—and that lack of a pattern holds true for any other investment category too.

Investment rankings can be a little jumpy

There’s not a lot of consistency in this chart. For example, high-yield bonds (in purple) ranked anywhere from 2nd place to 10th, depending on the year.

Notes: Asset classes reflect the following benchmarks—for large-capitalization U.S. stocks, the S&P 500 Index; for mid- and small-cap U.S. stocks, the Wilshire 4500 Completion Index; for developed international stock markets, the MSCI World ex USA Index; for emerging markets, the MSCI Emerging Markets Index; for commodities, the Bloomberg Barclays Commodity Index; for U.S. real estate, the FTSE NAREIT Equity REIT Index; for international real estate, the S&P Global ex-U.S. Property Index; for U.S. investment-grade bonds, the Bloomberg Barclays U.S. Aggregate Bond Index; for U.S. high-yield bonds, the Bloomberg Barclays U.S. Corporate High Yield Bond Index; for international bonds, the Bloomberg Barclays Global Aggregate ex-U.S. Index (Hedged); and for emerging-market bonds, the Bloomberg Barclays Emerging Markets USD Aggregate Bond Index. Sources: Vanguard, using data from Morningstar, Inc., and Barclays.

So why not just throw money at whatever investments are topping the charts this year, and then sell and do the same next year? Well, all kinds of data shows that jumping in and out of investments gets you nowhere. If you’ve ever driven in bumper-to-bumper traffic, you’re familiar with the concept. One lane goes faster until it doesn’t, and if you try weaving in and out of traffic, somehow you always end up in the slow lane.

For example, here’s what happened to investors over a recent 15-year period.

How badly do investors fare, compared with their own funds?

And here we see direct evidence of investors behaving badly. In all cases, investors as a whole did not earn the full returns of their funds, thanks to actions like jumping in and out of funds. For example, investors in taxable bond funds earned more than 1 percentage point less per year than the published average fund returns for that time period.

Sources: Vanguard and Morningstar, Inc. Data cover the period from January 1, 2002, through December 31, 2016. The average difference is calculated based on Morningstar data for investor returns and fund returns. Morningstar Investor Return™ assumes that the change in a fund’s total net assets during a given period is driven by both market returns and investor cash flow. To calculate investor return, the change in net assets is discounted by the fund’s investment return to isolate the amount of the change driven by cash flow; then a proprietary model is used to calculate the rate of return that links the beginning net assets and the cash flow to the ending net assets.

In every case, the returns published by the funds (which assume you were invested the entire time) did not equate to the returns actually experienced by investors in those funds, who, unfortunately, were a little impatient.

Shining a light

There’s an old joke about a man looking for his wallet. A police officer discovers him crawling around at night under a streetlamp and asks him what he’s doing. After hearing about the lost wallet, the officer begins to help. “You dropped it around here?” he asks.

“No, across the street,” the man answers. “But the light is better over here.”

It’s human nature to go “where the light is”—and with investments, the light tends to shine brightly on performance. It’s clear, indisputable, easy to find, and easy to compare. But it may not actually show you what you’re looking for.

Back to goal-based plans, which direct the spotlight onto the things you really care about.

We provide Vanguard Personal Advisor clients with updates 4 times a year, and the main thing we’ll highlight is your projected outlook. (You can also log on anytime for an up-to-date look.)

How we rate your outlook

If “How am I doing?” is the question, your projected outlook is the answer.

As long as you’re on track, you may not have the desire to dive too much deeper, but we’ll also let you know how the funds in your portfolio performed. Just take the results—especially the short-term numbers—with a grain of salt.

Maybe this year your investments underperformed the S&P 500. Maybe next year they’ll outperform.

So what? As Yogi Berra once said, “You wouldn’t have won if we’d beaten you.”

You can’t win them all

A big-name index versus a diversified portfolio: You win some, you lose some.

Notes: This chart shows calendar-year returns from 2003 through 2017. Source: Vanguard. The diversified portfolio is weighted 36% CRSP US Total Market Index, 28% Bloomberg Barclays U.S. Aggregate Float Adjusted Index, 24% FTSE Global All Cap ex US Index, and 12% Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index as of July 1, 2015. In prior periods, the composite was 42% CRSP US Total Market Index, 32% Bloomberg Barclays U.S. Aggregate Float Adjusted Index, 18% FTSE Global All Cap ex US Index, and 8% Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index through June 30, 2015; 42% MSCI US Broad Market Index, 40% Bloomberg Barclays U.S. Aggregate Float Adjusted Index, and 18% MSCI ACWI ex USA IMI Index through June 2, 2013; 50% MSCI US Broad Market Index, 40% Bloomberg Barclays U.S. Aggregate Bond Index (with the Bloomberg Barclays U.S. Aggregate Float Adjusted Index used after December 31, 2009), and 10% MSCI EAFE Index through December 15, 2010; and 50% Dow Jones U.S. Total Stock Market Index, 40% Bloomberg Barclays U.S. Aggregate Bond Index, and 10% MSCI EAFE Index through April 22, 2005. International stock benchmark returns are adjusted for withholding taxes. Note that you can’t invest directly in an index.

What’s behind that success measure?

How can we predict your chances of meeting your goal … down to a specific percentage?

It’s actually pretty simple. First, we take about 100 years’ worth of past market data. Then our computers run it through a “blender” and generate about 10,000 different scenarios you might face in the future. We “stress test” your portfolio through all of these scenarios, and then report the percentage of times you met your goal.

This kind of analysis is called a “Monte Carlo” simulation, since random chance is a big part of the input (just like in gambling games like roulette and dice). We’re not assuming any best-case scenarios!

Not only will we report on your headline number, we’ll also let you see how you fared in all of the scenarios.

Behind your outlook: 10,000 potential futures

The darker the shading, the more likely your balance will be somewhere in that range.

Note: This chart is for illustration only and doesn’t represent any specific goal, investment portfolio, or set of market scenarios. Your own outlook will be based on your specific situation and may vary.

If only all success was this easy to measure!

Let’s reach your goals together

A quick peek at your outlook should give you a clear reading on your chances of ultimate success. And anytime you have questions about your outlook, what it means, and how to increase it, our advisors are here to help.


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