Goals-based planning has grown from a niche service offering to a commonplace value proposition. Financial planners have spent the last decade encouraging clients to organize portfolios around achieving long-term goals instead of beating the market.
It's also big business. Technology startups developed to help financial advisors embrace goals-based planning have commanded huge price tags, including eMoney’s sale to Fidelity for $250 million and Envestnet’s acquisition of MoneyGuide for $500 million.
But Michael Kitces, the co-founder of the XY Planning Network and a Financial Planning contributing writer, is
When clients have no idea what they want, how can an advisor build an effective plan to help them get there? In an interview, Kitces explains why it makes more sense to start with what he calls “possibilities-based planning.”
This interview has been edited for length and clarity.
Financial Planning: What’s wrong with goals-based financial planning?
Michael Kitces: Goals-based financial planning derives from this institutional world of liability-driven investing, or LDI. Pensions typically can establish extremely concrete and clear targets of how much money they’re going to have to pay out and when, year by year, for an indefinite future ... then can make a portfolio that matches those goals.
In the past 10 to 20 years, I think we have tried to adapt this to the financial advisor world: Take LDI and match it to individual consumers — they have goals like retirement, we can make a portfolio that matches the retirement goal. The idea is that when consumers know what goal they are working towards, they are more likely to stay the course and stick with it.
All of this fundamentally presumes that if I sit down across from a client, I can make an optimal goals-based portfolio by just asking them what their goals are. No one ever seems to question that first step. But when I sit down across from clients, and say ”tell me about your goals,” virtually no one can articulate them in order to be able to do this process.
We’ve created this elaborate goals-based investing process, but in implementation it has failed in literally step one.
FP: That makes sense from the perspective of a consumer. A 33-year-old without concrete plans for retirement or buying a house, might not know how to answer someone who asks about goals.
MK: Particularly when you try to do this over long time periods, right? Tell me what you want life to be like when you retire at 65, and it’s like, that’s 32 years from now! It’s kind of a little hazy. We can only project so far into the future.
In fact, this is a known and documented behavioral finance bias. It’s called the end-of-history illusion. We don’t know how to envision the distant future. When we ask people to envision the future, they just envision today with a little bit more wrinkles and grey hair.
When you ask someone what their goals are for retirement in 10, 20 or 30 years, the truth is most people don’t even know what’s possible in the first place.
FP: But isn’t this goals-based strategy baked into the financial planning software that a lot of advisors use now? Is there a problem with that?
MK:Yeah, I think there is a huge problem with that. What clients actually need is a possibilities exploration mechanism, and that’s not what planning software is built to do today.
In a way, it highlights how planning software is not actually built for giving people advice. It’s built to fit them to whatever investment product we have.
FP: You mentioned a “possibilities exploration mechanism” and in your podcast, you discuss this idea of “possibilities-based planning.” What is that, and how would advisors use it with clients?
MK: Let’s start showing what’s possible given [a client’s] current trajectory and actions. What else might be possible if they did something different?
I’ll give you an example from an early 50s client whose goal was to retire at 65 with $2 million. Given his current savings patterns and what he actually wanted his retirement to look like, it turned out that lifestyle was possible for him with only $1.7 million. This changes the retirement goal by 15% and he could actually retire at 64.
But what would it look like if maybe he did some consulting for advisory boards instead of work full time? If he did that, he could actually retire at 60, consult for 7 years and be completely out by 67 and only need $1.4 million, because he’s hardly going to be withdrawing from his portfolio in the early years.
In just this discussion about what else might be possible, we’ve gone from $2 million at 65 to $1.4 million at 60, and we’re only like five minutes into a conversation! He didn't know it was possible.
FP: That’s somebody close to retirement and can kind of envision what it would look like. How would this work for someone younger, like an XYPN client?
MK: The starting point is not saying, “tell me your goals” and then tell them how to accomplish that, because the truth is they’re going to be picking goals out of thin air. If I sit down with the average 30-something person who is finally winding down their student loan debt and talk about saving a million dollars for retirement, it’s like — you have to be kidding me.
The reality is they may actually be on track for material wealth by doing nothing more than taking those giant student loan payments they’ve been making and turning it into savings. If you actually just do that and keep living the way you’re living, you might already be on track to be a half-millionaire or millionaire.
Once we know that’s possible, then we can look at other trade offs. For example, and one of the cool things about wrapping up student debt is it cleans up the credit record to go buy a house and get a mortgage. Totally cool, but that has some financial trade-offs. Is house-buying really possible? What does it do to other possibilities later?
There’s no right or wrong answer, because the truth is they are not baked into an endpoint goal yet.
FP: Is there a role that technology can play here? What would that technology look like?
MK: There is absolutely a role that technology can play here. Technology is particularly important because compounding math is not linear, we’re not good at doing it in our heads, and don’t know how to visualize it. That happens to be something that computers are really good at.
[The right technology] would essentially take the current planning process and turn it upside down. Goals come last, not first, because you can’t pick a goal until you know which goals are possible.
FP: Is there anything you’ve seen on the market that would help advisors with this? Or is it an opportunity for a startup or an existing player?
MK: I think it’s largely an opportunity to innovate. There have been a few tools out there that I think have scratched the surface lightly, like Moneyguide’s myBlocks and pieces of eMoney’s Foundational Planning, but they tend to be far too simplistic. They don’t have the richness of inputs that we deal with as financial advisors. They come up particularly short for people in the accumulation phase because they are not very good at showing real-world trade-offs.
FP: Are there any other benefits to this approach to financial planning?
MK: Life comes at you pretty fast and changes really quickly. What’s possible changes on a regular basis: You get the raise you never thought you were going to get, the promotion you didn’t think was coming, or your company goes under in a giant pandemic that nobody saw coming.
What that means is this is a huge opportunity for advisors to add value on an ongoing basis for their accumulator clients by helping them navigate and make decisions on the never-ending flow of trade-offs that keep changing the possibilities.
What we do in the traditional [planning] realm is anything we can do to keep people on track for the goal, whereas as the possibilities-based framework is much more about looking at how what’s possible is changing because of the changes in your life, what we’re going to do to adapt and whether we actually like that outcome better or worse.
FP: So moving from a reactive, prescriptive approach to a more proactive, ongoing engagement approach?
MK: And rather than coming at it from, “we always have to stay the course to stay on track for our goals,” the truth is that when life changes, possibilities change. Let’s talk about that.
FP: So should we completely throw out goals-based planning and all switch to possibilities-based planning?
MK: At the end of a possibilities-based process, you will still come to some set goals. It comes at the end of the process, not the beginning, but at some point you will say that out of all the possibilities, this is the one I want to pursue and these are the trade-offs I’m willing to make. Once I get there, I do still need to implement something to be moving towards that goal.
