Goal Factoring: The Fairest Way to Evaluate Advisor Performance
Not too many years ago, the average investor had very little idea what time weighted returns were. But today, there is a higher standard demanded by investors. Many advisors claim time-weighted or internal rate of return (IRR) are now required on statements for many clients. At first the trend seems to make good sense. After all, the days of buying one or two mutual funds for every client are long gone. No doubt about it, investing definitely has got a lot more complicated. That constantly increasing complication would naturally suggest reporting needs to be a lot more complicated for investors to keep up, right?
We don't think so. PureLogix is pioneering a new return measurement. We call it Goal Factoring. Why are we suggesting a new performance measurement? Current performance measurements are too unwieldy for average investors to use on a day-to-day basis. Unlike a portfolio time weighted or internal rate of return, Goal Factoring generates ONE easy-to-understand number that summarizes the performance of your entire portfolio. Goal Factoring separates itself further from other return measurements by incorporating an investor's preference for risk, and time horizon into the calculation at the same time. We think this helps investors put short-term losses more easily into perspective. Other return measurements tend to magnify short-term market corrections making investors more reluctant to stick to their long-term investment plans. Perhaps best of all, anyone can calculate their own personal Goal Factor with nothing more than a business calculator.
How does Goal Factoring work? It focuses on future performance rather than what has happened to the portfolio in the past. Why do we suggest focusing on the future? It 's simple: past performance is no guarantee future returns. So why fixate on the past?
To calculate your own personal Goal Factor, you need to know:
1. How much money you have saved right now. This number represents the present value of your savings
2.How much money you would like to have, or do you need to have for retirement. This number represents the future value your savings.
3. How much money you plan to put away each month between now and retirement
4. How many years you have left to save before retirement.
With these 4 numbers an investor can calculate the compounding return required year after year to reach their future value savings goal. This calculation is the basis for all financial planning. Without it, an investor may have very little idea what their retirement may look like. Although nearly every advisor will calculate this number for you early in your relationship, once your advisor uses the number to help determine the amount of risk you will have to accept to achieve your retirement goals, it is rarely referred to again. To PureLogix, this number represents the cornerstone of meaningful performance measurement.
The compounding return required until retirement is what we refer to as your Goal Factor. Here's how you use it as a performance measure:
Let's say your advisor determines that you require an 8% compounding return each year between now and your retirement 20 years from now. Based on that number you should purchase an investment portfolio that aims at returning between 8%-9% over a 3 or 5 year period. Here's how you evaluate your portfolio's performance: if your Goal Factor gets larger and larger year after year, your portfolio is doing poorly. If your Goal Factor gets smaller and smaller each year, your portfolio is outperforming.
It's that simple! You want to know if you're going to be ok when you retire? Take a look at your current Goal Factor. Does your Goal Factor still look reasonable to you or has it climbed way too high? Use your common sense. If your original Goal Factor was 8% and now your Goal Factor is 12%, you're going to have to take on a lot more risk than you originally agreed to. In this case your advisor has probably made a mistake. If your advisor doesn't address the problem, you should. If your Goal Factor was 8% and now your Goal Factor is 9%, that still sounds reasonably attainable, doesn't it? Stick to your investment plan.
Let's say after your first year in your new portfolio, the markets turn against you, and your portfolio is down around 15% for the year. Yikes! Time to sell that dog right? Well, let's do some Goal Factoring first to see how this short term loss has affected your long term plan. Re-calculate your Goal Factor with the 19 years you have remaining. Even if you were planning to contribute nothing to your retirement plan between now and retirement, your portfolio would still reach your retirement goal by achieving an average return of 9.3% for the rest of the years between now and your retirement. That's a mere 1.3% required return increase for your portfolio to still attain your retirement goal.
In this example, the proper course is to make a SMALL adjustment to your overall portfolio. This adjustment may be as simple as rebalancing your portfolio back to it's benchmark. Markets always revert back to their long-term mean returns. In this example, according to your goal factor, you have plenty of time to wait for the markets, and your portfolio, to return to a more normal long-term trend.
What you need to know about Goal Factoring:
AS A GENERAL RULE OF THUMB, if your Goal Factor climbs 1%, you should probably talk to your advisor to see what changes, if any, are required to keep your retirement plan on track. If your Goal Factor climbs 2% over the Goal Factor you originally set with your advisor, it's time to have a serious discussion. If there is no reasonable explanation for the increased Goal Factor, it's time to find another advisor.
If your Goal Factor falls 2% or more from the Goal Factor you originally set with your advisor, you may want to discuss moving to a more conservative portfolio. Generally speaking, if all goes well with your retirement plan, your portfolio should slowly get more conservative as you approach retirement. Remember, the shorter your time horizon, the more sensitive your Goal Factor will be to short-term market fluctuations.
We don't think so. PureLogix is pioneering a new return measurement. We call it Goal Factoring. Why are we suggesting a new performance measurement? Current performance measurements are too unwieldy for average investors to use on a day-to-day basis. Unlike a portfolio time weighted or internal rate of return, Goal Factoring generates ONE easy-to-understand number that summarizes the performance of your entire portfolio. Goal Factoring separates itself further from other return measurements by incorporating an investor's preference for risk, and time horizon into the calculation at the same time. We think this helps investors put short-term losses more easily into perspective. Other return measurements tend to magnify short-term market corrections making investors more reluctant to stick to their long-term investment plans. Perhaps best of all, anyone can calculate their own personal Goal Factor with nothing more than a business calculator.
How does Goal Factoring work? It focuses on future performance rather than what has happened to the portfolio in the past. Why do we suggest focusing on the future? It 's simple: past performance is no guarantee future returns. So why fixate on the past?
To calculate your own personal Goal Factor, you need to know:
1. How much money you have saved right now. This number represents the present value of your savings
2.How much money you would like to have, or do you need to have for retirement. This number represents the future value your savings.
3. How much money you plan to put away each month between now and retirement
4. How many years you have left to save before retirement.
With these 4 numbers an investor can calculate the compounding return required year after year to reach their future value savings goal. This calculation is the basis for all financial planning. Without it, an investor may have very little idea what their retirement may look like. Although nearly every advisor will calculate this number for you early in your relationship, once your advisor uses the number to help determine the amount of risk you will have to accept to achieve your retirement goals, it is rarely referred to again. To PureLogix, this number represents the cornerstone of meaningful performance measurement.
The compounding return required until retirement is what we refer to as your Goal Factor. Here's how you use it as a performance measure:
Let's say your advisor determines that you require an 8% compounding return each year between now and your retirement 20 years from now. Based on that number you should purchase an investment portfolio that aims at returning between 8%-9% over a 3 or 5 year period. Here's how you evaluate your portfolio's performance: if your Goal Factor gets larger and larger year after year, your portfolio is doing poorly. If your Goal Factor gets smaller and smaller each year, your portfolio is outperforming.
It's that simple! You want to know if you're going to be ok when you retire? Take a look at your current Goal Factor. Does your Goal Factor still look reasonable to you or has it climbed way too high? Use your common sense. If your original Goal Factor was 8% and now your Goal Factor is 12%, you're going to have to take on a lot more risk than you originally agreed to. In this case your advisor has probably made a mistake. If your advisor doesn't address the problem, you should. If your Goal Factor was 8% and now your Goal Factor is 9%, that still sounds reasonably attainable, doesn't it? Stick to your investment plan.
Let's say after your first year in your new portfolio, the markets turn against you, and your portfolio is down around 15% for the year. Yikes! Time to sell that dog right? Well, let's do some Goal Factoring first to see how this short term loss has affected your long term plan. Re-calculate your Goal Factor with the 19 years you have remaining. Even if you were planning to contribute nothing to your retirement plan between now and retirement, your portfolio would still reach your retirement goal by achieving an average return of 9.3% for the rest of the years between now and your retirement. That's a mere 1.3% required return increase for your portfolio to still attain your retirement goal.
In this example, the proper course is to make a SMALL adjustment to your overall portfolio. This adjustment may be as simple as rebalancing your portfolio back to it's benchmark. Markets always revert back to their long-term mean returns. In this example, according to your goal factor, you have plenty of time to wait for the markets, and your portfolio, to return to a more normal long-term trend.
What you need to know about Goal Factoring:
AS A GENERAL RULE OF THUMB, if your Goal Factor climbs 1%, you should probably talk to your advisor to see what changes, if any, are required to keep your retirement plan on track. If your Goal Factor climbs 2% over the Goal Factor you originally set with your advisor, it's time to have a serious discussion. If there is no reasonable explanation for the increased Goal Factor, it's time to find another advisor.
If your Goal Factor falls 2% or more from the Goal Factor you originally set with your advisor, you may want to discuss moving to a more conservative portfolio. Generally speaking, if all goes well with your retirement plan, your portfolio should slowly get more conservative as you approach retirement. Remember, the shorter your time horizon, the more sensitive your Goal Factor will be to short-term market fluctuations.
posted by Edward Iftody, BA, CIM at
11:10 AM
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