Goals-based investing is unnecessarily expensive, inflexible, and psychologically short-sighted.
All investing is inevitably ‘goals-based’ in some form. Portfolios don’t conjure or structure themselves out of the blue.
But not all ways of accounting for goals are equal.
One way, which for many is synonymous with the idea of ‘goals-based investing’, is the pot-based approach: using different accounts or ‘pots’ (each with an independently calculated suitable risk level) for different specific goals.
An alternative is the holistic approach: rather than focus on specific goals in isolation, this sees goals as an interdependent system. A single suitable risk level is calculated for a given investor, rather than for each goal-based account. Goals can still be considered independently where it is helpful to do so, but this is a ‘virtual’ separation, which needn’t be reflected in real-life accounts.
The ‘holistic’ approach is superior, on financial and behavioural grounds, for investors and their advisers. Appropriately managed, it meets all the needs the pot-based approach evolved to address, while avoiding some serious downsides, and accruing additional benefits on top.
Where did matching goals to separate pots come from?
Matching investment risk levels to goals has a long history. In earlier practice, ‘goals’ were often shorthand for product features – Growth, Protection, or Income – but these are better seen as requirements derived from the suitability process (i.e. from accounting for the investor’s circumstances, risk tolerance, and preferences), than as true client ‘goals’.
In today’s more planning-centred world, goal-elicitation is more literal: a goal is how much cash is needed, when, and for what. This ties goals and investment time horizons together in a useful way. But it also encourages the pot-based approach, with portfolios directly linked to isolated future expenditures. Neat in theory, this product-driven origin shows why pots are a poor fit for the fuzzier, shifting goals real people actually have.
What are the benefits of a pot-based approach?
Structuring a portfolio around the ‘goals’ it’s designed to meet can be appealing, for three main reasons:
- Motivation – Dreaming about spending money elicits emotional engagement with a planning process in a way abstractly thinking about portfolio structuring doesn’t. Goals can be a shortcut to jump-starting and maintaining motivation, and can help investors think more deeply about priorities.
- Comfort – Focusing on a goal can offer comforting reassurance when confidence is besieged by market (and circumstantial) uncertainties.
- Clarity – Saving towards a single goal with a single pot of investments comes with the easy illustrative charm of a telethon fundraiser tracking towards its target. No need for complicated calculations, or tricky trade-offs, just one number building towards another.
These benefits, however, only reach so deep. And none of them requires actually dividing a portfolio into pots. Motivation and emotional comfort can both be reached by less costly routes (especially where the investor is working with an adviser), and the clarity of saving towards a single goal is quickly negated by the additional complexity necessary to support the pot-based system.
The holistic approach still delivers these same benefits – motivation, comfort, and clarity – but does so virtually and flexibly, without the financial and behavioural costs of rigid pots.
What are the downsides of a pot-based approach?
Dividing a portfolio into pots, each matched to a goal, and each with an independently calculated suitable risk level, suffers from several shortcomings:
- Misprofiling the investor – Risk Tolerance is a personality trait of the investor as a whole, not of individual pots. Profiling should be done once at the investor level, with Risk Capacity ensuring the right balance of risk across all assets and goals. All the difficulties of assessing risk tolerance accurately are compounded when trying to do so for multiple pots and time horizons: how can an investor express coherent preferences across them all?
- Rigid structures destroy flexibility – Pot systems ossify wealth. Assets are locked away from reallocation just when circumstances demand it, and liquidity is double-counted because each pot is treated as if it must stand alone. This leads to inefficient capital allocation, with too much tied up in ‘safe’ reserves that may never be needed. What looks like certainty is a costly restriction, making adaptation harder when priorities change.
- Suppressed long-term growth – By focusing on ‘protecting’ each specific goal, pot-based approaches prioritise the plan over the planning. They shrink the share of wealth left to grow, sacrificing long-term returns. Yet most goals are staggered across time: viewed as a system, they can be pooled. The risk of missing one goal is diversified across all, much like the way insurance works.
- Short-sighted and psychologically rigid – Humans don’t have machine-like goals. Priorities change, new ones appear, and old ones fade. Pots, however, lock investors into the goals of “past you”, not “present you.” Sunk costs and endowment effects mean portfolios become harder to adapt as life evolves. Most people discover that their most important goals – think of new loves blooming, or old body parts decaying – were absent from any original list, until unexpected ones parachute straight onto the top. The rigidity is both financial (the system becomes ossified) and psychological (investors feel stuck and unable to respond).
- Complex and inefficient to manage – Dividing wealth into pots creates headaches for advisers; repeated recalculations; and psychological complexity for investors. Each decision about risk and contributions in one pot implies decisions about what not to make available for other goals. This is not a problem humans are good at solving. The value of advice lies not in maintaining a rigid network of pots, but in guiding ongoing planning and course corrections as circumstances change – interpreting complexity on behalf of the client, rather than multiplying it.
So while pots promise surface-level benefits, they conceal a tangle of deeper costs. The holistic approach, by contrast, provides the same engagement and reassurance, without the rigidity, inefficiency, and missed opportunities.
What are the additional advantages of the holistic approach?
The key additional benefit of the holistic approach is flexibility, both financial and psychological.
With the suitable risk level for the investor as a whole accurately established, how you meet it is open to any number of approaches that might make each client individually comfortable, e.g. goals targeting (framing portfolios explicitly against future expenditures), a barbell approach (balancing safe and risky assets side by side), or the use of a ‘play pot’ (a small allocation for discretionary risk-taking).
Pot-based approaches evolved from how investors interact with their investments… but investors don’t interact with them directly… they interact with the interface of those investments.
With everything in one ‘pot’, you can present it via any virtual structure you like. It’s far easier to change a presentation than an intricate network of accounts.
A motivating conversation which clarifies the relative prioritisation of an investor’s goals needn’t end with those goals becoming independent targets and rigidly structuring an investment strategy around them. Here the adviser’s role is not to build rigid pots, but to flexibly reframe and adapt the presentation of goals as life changes.
You can even apply different risk levels to different groups of assets – say, holding riskier assets in one place and safer ones in another – as long as they aggregate to the right overall risk level. Just don’t calculate different ‘suitable risk levels’ for different pots… because that would be far from ‘suitable’. Investors need one Suitable Risk Level for their wealth as a whole, and flexible presentation of goals on top of that – not separate risk calculations for each pot.
All investing is about goals, but pots are only one – and often problematic – way of structuring them. The task is not to divide portfolios into pots, but to align one portfolio with life as it actually evolves.
