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Idea: Goals Based Financial Planning Around Personal Inflation

Imagine you and a friend go out to eat and when the bill arrives your friend asks you to spot them some money. Your friend tells you that times are tough and they are strapped for cash today. You know through social media that they recently took a long road trip all across the U.S. and just bought a new iPhone. You know that this is something your friend does all the time, why is it that your friend is only now asking to borrow money? Well, it could be that they finally maxed out their credit cards, but a more interesting answer may be that their personal inflation rate (based on what they chose to consume) over this time exceeded their wage growth and that your lifestyle allowed you to stay below your personal inflation rate during the same time. So you think to yourself, how can each of us best make sure I can keep up my lifestyle today and also in the future if my friend and I have different inflation rates? Lets first explore what inflation is and how people measure inflation.

Inflation is a tricky beast that economists and central bankers use to make sure that an economy is healthy and does not turn into a state where bricks of cash are needed to purchase every day household items. Fortunately, the U.S. Federal Reserve exists to prevent this nightmare scenario. To accomplish this regulation, the Federal Reserve looks at the Consumer Price Index (CPI) to help them generally gauge how much inflation is in the economy and adjust interest rates through open market operations to help counter inflation. In addition to the ability to adjust interest rates, the U.S. can also pass laws through Congress to set taxes and set spending policies to boost the amount of cash circulating through the economy,

However, CPI is not just a helpful tool for economists but can also serve a financial planner by taking CPI into account when creating retirement portfolios to adjust for inflation to get a real return on investments. For example, if you have a portfolio that is returning 2% in a year but the inflation rate is 4% over that same year, an investment advisor could argue that your portfolio has actually lost money despite gaining 2% because inflation has eroded your ability to purchase similar goods from a year ago. Your investment advisor may recommend that you look into riskier assets that may reward you with a higher return because the risk of not looking for riskier assets mean that you will continue to lose money.

Put another way, people do not sit down and watch money and derive satisfaction from the money alone but rather the things that they can use money to obtain. For that reason, any increase of money through interest or investment should only be good if this person can actually purchase more or at least a similar amount of goods with the money that had grown over any period of time. For example, if you’re Zimbabwean investments grew 2,000% over the period, it would not make you happier if overall inflation on most items grew over 1,000,000%.

So why does all this matter? Currently, an argument is being made that the days of a financial advisor only buying stock and bonds is giving way to the more comprehensive goals based planner. The reasoning is that there is a need to help a client beyond brokering investments and re-balancing a portfolio in order to justify fees and compensation. The logic is sound as many clients can create their own portfolios at a substantially reduced cost. However, a client may not easily make sense of their financial goals and to match financial instruments with their goals as easily without the aid of a financial sounding board.

The idea of deriving value from goals based financial planning is a difficult subject. Perhaps goals based financial planning should continue around simply talking to clients about their goals and matching it with the time frame and risk that they can handle. After all, many people are very risk adverse and may sell off their investments to their detriment. Yet going back to the earlier example of the 2% return portfolio, a client may be so risk adverse that this is the only portfolio they can stomach. In this case, it may be better to achieve an overall lower return over time, but control against bad client investment habits.

I contend however that rather than focusing on risk aversion, goals based financial planning ought to instead focus on loss aversion. In this case, rather than focusing on the returns of portfolios based on the time until goals are achieved and the aversion of a client’s risk profile, a portfolio should instead focus on achieving client goals. Many people have different goals and use money as a tool to purchase instruments only to achieve those goals. For example, if I would be assured that the insured cash I have saved for all my goals would fully cover my goals, it would make very little sense to invest the money in case I should lose it. However, for many people who do not have the cash required to achieve their future goals in the present, a need to grow the wealth is necessary. In this case, the wealth that they have stored up really only exists to achieve their desired lifestyle and anything below that leads to a failure of goals. For this reason, a goals based planner ought to take into account the segmentation of a person’s current and ideal lifestyle with the current anticipated inflation adjusted for a client’s tactical purchasing decisions. Simple put: How much do I need in market returns to achieve my goals and my ideal lifestyle?

The answer is expressed below as a formula:

Minimum Return Required = ( (Inflation Rate of Goal )x (1 – Discount Rates of Purchase)*) ^ Period of Time Until Goal


M = (P x (1 – D))^g

* Discount Rate is a rate at which a client is willing to “wait” an arbitrary additional time until a deal presents itself. For example, they are willing to wait for a 20% correction in a housing market before purchasing.

As a client goes closer towards their goals, a constant re-examination of proximity to their minimum return requirements is necessary. In this case, if a client has done well with their investing and inflation has stayed relatively stable, they can “take risk off the table” or if they are further from their goal, they may need to “re-risk”. Each goal has a different inflation rate that also changes over time and will require similar re-calculations. Simpler goals to calculate such as purchasing a home or college tuition can be directly solved for and monitored using the above formula paired with public facing data from the Bureau of Labor Statistics. Simple goals based formulas can help a client better earmark their investments directly to their goals and with the help of an investment advisor, segment their portfolios accordingly.

Alternatively, if the inflation rate for a goal exceeds possible market returns; such as goal planning for long-term care planning, private education, or cosmetic medical costs, a mixture of projected loan costs and insurance premium costs can be substituted for the minimum return on a specific goal. In such a case, it would “make sense” to take out a loan with a fixed interest rate for a yacht if said yacht inflates faster than your ability to save and invest for that yacht.

Expressed below:

Borrow: Interest Cost < Minimum Required Return

Insure: Insurance IRR > Minimum Required Return

Save/Invest = Interest/Insurance Savings< Minimum Required Return

More complex goals such as retirement planning and legacy planning should require a more comprehensive and personalized inflation adjustment. This should require the work of a comprehensive financial planner that looks at the spending habits and lifestyle habits of an individual. This analysis should couple the behavioral aspects of the client even more carefully as these goals are longer in duration and have a substantial cost over the short term and substantial impact over the long term. After carefully piecing their current lifestyle and working on a future lifestyles projection, a financial planner can work on creating a “Personal CPI” to solve for these more specialized goals. An example for retirement would be expressed below as:

Minimum Return Required = ( (Personal CPI) x (1 – Flexibility)*) ^ Period of Time Until Goal


MRR = (C x (1-F))^p

* Flexibility is the willingness of a client to wait additional years or accept a reduced life style at the time of the portfolio to achieve the goal if the portfolio does not achieve the MRR within the set time frame where F is between 0-1 and is based on the conversation between clients and their planner.

Through segmentation of portfolios around goals and the use of a personalized CPI, a clearer strategy for asset allocation emerges that goes beyond speculation around a client’s risk level and investment time horizon. Investments can then be made with necessary returns in mind to help achieve goals and can also allow for measurements of progress or regression from goals based on investment returns as well as inflation adjustments. In this relationship, a planner’s meeting with a client is necessary in order re-evaluate the importance of goals and re-arrange goals based on the inflation and investment return of each goal rather than just portfolio performance.

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