Setting Great Goals

One common mistake we see when people plan their own retirement is putting the cart before the horse. Too often people look at the investments they have and use a rule of thumb to estimate retirement spending. The 4% rule is the most commonly followed rule of thumb. This rule means setting your withdrawals each year to equal 4% of your initial retirement fund balance means the funds should last 30 years.

I describe this as putting the cart before the horse because the focus here is not on what they want to achieve, but the means they have to achieve it. Instead of this approach, we prefer to start by understanding our client's goals when making their financial plans. If there is a stark difference between their needs and their means, we can reevaluate their goals.

The problem with using a rule of thumb is they cannot possibly account for all the little details which make your position unique. The 4% rule is intended for a period of around 30 years, but does not address the returns of your portfolio, your risk tolerance, actual timeframes, interest rates etc.

Setting good goals puts you in a better position to understand what you need from your investments. Then you can decide what needs to be done to live your best life in retirement.

Putting Goals First

When we put our goals first, the idea is to:

  1. Set goals describing what we want to achieve

  2. Analyse our position to find out if these are achievable

  3. Revisit our goals to ensure we are maximising the value from our investments.

We can repeatedly adjust our goals until they are both achievable and make the most of our investments.

For example, imagine a person needed $30,000 each year from their investments to cover their retirement expenses until they are 90. If they found their investments would not last over this period, they would need to adjust their goals. This may mean spending less or retiring later.

On the other hand, if their investments would balloon in value over this period, their goals were too conservative. This gives them the flexibility to pursue other goals. For some, they can view this as a surplus of capital, maybe to be spent on the big trip they always dreamed of, or to move into their dream home. Others may prefer to simply spend more or leave it to their kids.

When investors start by deciding how much they can withdraw each year, such as with the 4% rule, they lose some of the nuance. They have given themselves a budget of sorts to stick to, but if this budget doesn't match their lifestyle, it will likely create problems when retirement arrives. You do not want to stop working to find you can't realistically get by with the 4% rule. A big lifestyle shift like this is difficult and disappointing.

On the other hand, something we see far more often is investors having much more money than they need later in life. They work out with the 4% rule that they should have enough, but don't spend any of the extra capital. Nearly everyone wants to leave something behind for their kids, but without specific estate goals, their estates can grow large at the expense of their bucket list.

Developing Great Goals

We've talked about retirement above, as this goal is shared by nearly everyone. However, a goal-based financial plan can work for anybody, as long as they have worked out what they want to achieve.

It can be tough to nail down what you want in this way. As an example, nearly every client we see wants both financial security and a comfortable retirement, but these goals aren't quite ready for a plan.

A great goal is quantifiable, measurable and has a timeframe. For the goal of financial security, does this mean wanting a safety net in case of a job loss or unexpected expense? In this case, the goal may be better defined as having 3 months of expenses set aside for emergencies. A comfortable retirement usually means having enough income to cover regular spending, travel and the occasional car upgrade over the next 30 years.

Fleshing out your goals in this way makes it easier to plan ahead. Start with your values and decide broadly what you want. Next try to develop these wants into goals in dollar terms with timeframes. The you can begin analysing your position and refining your goals into a plan.

Examples of Common Goals

The most common financial goal, shared by almost all of our clients, is a comfortable lifestyle in retirement. To develop this goal into something usable in plans, consider the following.

Your general expenses will not likely change considerably when you retire. If you understand roughly how much you spend now, your goal can be to continue spending this much each year until you turn 90. You may also decide to treat travel expenses separately, such as $15,000 every two years until you turn 80. Spending could increase or decrease over time, depending on how you expect your lifestyle to change and what kind of care you want later in life. 

As we mentioned previously, when clients of ours want financial security, to us this means a safety net for emergencies. This may be 3-6 months of spending set aside in a savings account, or more if you have certain emergencies in mind. At the end of the day, your goal should be to have enough money set aside to ease your doubts.

Other common goals are paying for your kid's education, saving up to purchase a house and donating to charity. In each of these cases, be as specific as you can. Which school will you children attend? How much will the house cost and when? Which charities will you support and for how long?

Once you fully understand your long-term financial goals, you will be better positioned to plan for the future. If you are unsure how you will achieve the goals you set, get in touch with an independent financial adviser.

Dimensional Turns 40

Dimensional Fund Advisors have now been in business for over 40 years. Over this time, they have continued to innovate in their field.

Their very first fund, the US Micro Cap Portfolio is still open to investors in the US. It was created in 1981 to offer access to small cap US stocks with index-like diversification. It was the first of it's kind.

Using the same investment philosophy which has guided Dimensional's investments over 40 years, the fund has outperformed it's benchmark by more than 1% p.a. since inception.

Now the company manages more than half a trillion US dollars of client funds, employs more than 1,400 and has offices in 13 major cities across the globe.

Executive Chairman and Founder David Booth shared his own thoughts on the company's successes in the article below.

Dimensional at 40: Timeless Lessons from My Decades in Finance.

Dimensional also celebrated this milestone by ringing the bell at the New York Stock Exchange. You can read about this and see the video below.


Dimensional Celebrates 40 Years of Innovation

Dimensional Fund Advisors, a global leader in systematic factor investing, is celebrating the 40th anniversary of the firm’s founding. To reflect on its role in several industry transformations and highlight its commitment to innovation, Dimensional will ring the bell at the New York Stock Exchange (NYSE) today, host Dimensional Week for employees, and launch an employee podcast featuring first-person stories from inside the company over its four decades. 

“We built the firm on the foundation of implementing the great ideas in finance,” said Founder and Executive Chairman David Booth. “For 40 years, we have trusted markets. And for 40 years, we have built trust with financial professionals and investors around the world. We will continue to work every day to transform the client and investor experience for the better.”

Booth started Dimensional in 1981 from the spare bedroom of his apartment in Brooklyn, N.Y. The new firm was built to apply an academic approach to investing and improve upon indexing. What seemed like a bold idea to many people at the time has become a cornerstone of a better way to invest. Over the past four decades, the industry has made significant progress toward driving down costs, encouraging diversification, and developing innovative solutions that benefit investors.

“Our clients are at the heart of everything we do,” said Dave Butler, Co-CEO of Dimensional. “We are committed to continuing to enhance the solutions and services we deliver based on our clients’ evolving needs, just as we have for the past four decades.”

“Dimensional has a deeply ingrained culture of asking questions, looking at the data, and applying insights that can help long-term investors,” said Co-CEO and Chief Investment Officer Gerard O’Reilly. “We seek to continually evolve while maintaining our focus on rigorous research and implementation.”

“Just as we have helped transform the investor experience through offering broadly diversified, low-cost, systematic portfolios and advocating for professional advice, we will continue to advocate and innovate for the best interests of clients and investors,” Butler added.

Following the NYSE bell ringing, Dimensional will kick off Dimensional Week, an annual event for its nearly 1,500 employees across the firm’s global offices. In addition to presentations, workshops, and conversations, Dimensional will commemorate its 40 years of innovation by giving employees a bespoke hardbound book celebrating the firm’s legacy and achievements and recognizing their central role. In addition, Dimensional will release a special internal podcast series featuring employees and their stories.

The New York Stock Exchange welcomes Dimensional Fund Advisors as it virtually rings The Opening Bell® in celebration of Dimensional ETFs and the 40th anniversary of the firm’s founding.

More Bad Press For Active Managers

Reading the Herald yesterday, a headline stood out to me: KiwiSaver providers told to review fees annually by regulator. It contained more bad news for active managers.

Since the introduction of KiwiSaver more than a decade ago, the FMA has expected fees to drop over time. The expectation was based on costs decreasing as asset bases grew and strong competition in the market.

While fees have decreased somewhat, with many providers introducing cheaper options, the average fee is 1.11% p.a. We believe this is still high given the limited services offered and the FMA seems to agree. They haven't introduced a solid definition of what constitutes an unreasonable fee, but have warned providers they may be starting to take a more hands-on approach.

Despite the headline, this is not the juiciest part of the article. The FMA's research, published in an annual report, found:

  • Managers are not passing on scale benefits to members;

  • No systemic relationship between fees charged and the degree of active management;

  • Active managers do not typically beat their benchmark index after fees.

Managers are being told to complete annual reviews to cover the first two points. The third is just part of being an active manager unfortunately.

It seems unlikely for providers to lower fees without a strong-armed approach from the regulator. Another article, released today, discusses this point. Regarding the FMA's recommendations, Simplicity CEO Sam Stubbs says:

"In a sense it was a good thing but in another sense [the FMA] have also admitted this is a problem they have failed to address. It hasn't been solved in the 12 years [KiwiSaver has been around]."

While fees and services are at the forefront of conversations, we believe it may be more important to discuss the continued failure of active managers to beat their benchmarks.

A common claim by active managers and their proponents is active beats passive in a falling market. The idea here is, while passive investors stay in their seat while shares go down, active investors can nimbly jump in and out, avoiding the losses while getting in on the upswing.

Last year, we saw share markets around the world decrease in value by around a third in only a month. Were active managers able to dodge this tumultuous period? Standard and Poor's Index vs Active report has been released for last year and it doesn't look pretty:

  • 60% of US managers failed to beat their index, 75% over 5 years;

  • 87.5% of Canadian managers failed to beat their index, 99% over 5 years;

  • 56% of Australian managers failed to beat their index, 82% over 5 years.

So active hasn't worked in other parts of the world, but I am still hearing how NZ's smaller market is less efficient. Now the FMA is saying active hasn't worked in the KiwiSaver space.

When will the excuses run out and everyone agree active is a costly, risky and ineffective way to invest? Don't expect it anytime soon!