Before you start putting money into the market, ask yourself one question: What exactly are you saving and investing for?

This is a serious moment of self inquiry. In order to invest for the future you are cutting back on spending your wealth now. There must be some future purpose for this sacrifice—some goal of tomorrow’s spending which outweighs the pleasure of today’s spending.

Goal-based wealth management is not just a cute way to help you manage your investments as easily as you manage your Gmail account—it is necessary for maximizing how effectively you manage your money and investments, including knowing when you can afford to spend more than you might think today.

For those who are new to goal-based wealth management, goals allow you to bucket your money according to  its purpose and when you will need a given amount. When you first sign up with Betterment, you will see the selection of goals below. Each goal you select (and you can select and customize up to 12) has its own portfolio of stocks and bonds customized for the time horizon you set.

“Goals” are a kind of budgeting methodology that have been used for decades (one old version is called the envelope system). Betterment has elevated the framework to apply it to good savings and investment strategy as well.  Why? Because research shows it improves outcomes by encouraging optimal behavior and more precise wealth management (see the reference list below).

Below are some of the behavioral and financial reasons why goal-based wealth management is better.

### 1. Avoid under-saving.

Goal-based wealth management forces you to think about and enumerate your goals, often far in advance. This prevents you from underestimating how much money you’ll need at any point in the future—or misaligning your expectations with your savings ability. It means that present-day you and future you have more common ground.

### 2. Plan ahead, save less, achieve more.

Using goal-based wealth management, you’ll likely see future liabilities coming down the road. And the further in advance you start saving for a goal, the less you’ll actually have to save. Why? The power of returns. The earlier you start saving , the more time you give the market to grow your savings for you.

For example, imagine you know you will want cash to buy a new car—let’s say $65,000 for a very cool Tesla Model S. Being smart, you are not going to finance it (where you pay interest), but rather save up ahead of time. Below you can see the recommended monthly savings required depending on how far in advance you start saving. If you save monthly for one year, you’re essentially saving dollar for dollar for your new car. But if you plan ahead, and start saving five years out, the market can help you—and you only need save$54,720. This is advice you can calculate in your Betterment account:

Monthly savings amounts assume a nominal 7% annual return. Saving amounts are for illustrative purposes only.

When you set up an investment goal at Betterment—for example, saving $150,000 for a home down payment in 10 years—we give you several pieces of advice: The first is a suggested allocation based on your time horizon and the second is advice on how much you need to save on a monthly basis to reach that goal. We also suggest an initial deposit. When you take guesswork out of your plan, it means you are more likely to hit your target. ### 4. Save for a tangible outcome. Goals make it far more likely you’ll save for—and achieve— every one of your goals. When you can attach a real outcome to the purpose of your saving, you’re more likely to actually work toward that goal rather than blind saving. In behavioral psychology, this is called affect—or the concept that we are more motivated by real things than abstract numbers. ### 5. Guilt-free spending. While some might find it surprising, there are people who actually feel guilty and are uncomfortable with spending large amounts of money. This is true even when it’s for a planned, known expenditure. When it comes time to spend your savings, if it comes from an account specifically earmarked for that purpose, you’re not overspending. Goals also make it more likely you only spend the amount saved in the goal, rather than scooping out a lump sum from a general savings account. ### 6. Benefits to an automated plan. For most people, it’s much easier and more practical to invest$125 a week, or $500 a month, than summon up a one-time deposit of$6,000 each year. Automating your saving makes it effortless to do the right thing—save the right amount every month. This kind of of drip-system is not only useful for budgeting and saving on an ongoing basis—it’s also great investment strategy.

First, it ensures your money has maximal time in the market. Second, it is a form of dollar-cost averaging, which diversifies your cost-basis entry points over time compared to a lump-sum purchase. With Betterment, regular auto-deposits also provide an opportunity for rebalancing and tax-loss harvesting, which are investing practices that can improve returns and lower your tax bill over time.

### 7. Turn a bias into a strength.

Goal-based wealth management makes use of ‘partitioning’ and leverages mental accounting to improve your savings behavior. Mental accounting means that you make decisions based on the red or black of each individual account, rather than view them in the aggregate. While this could lead to unwise decisions as it may limit a holistic view of your finances, you can also use mental accounting as a strength. By creating many different mental accounts, you ensure that you are saving optimally for each of them—and do not rely on one account to cover all your required future liabilities.

### 8. Better match assets and liabilities, avoid debt.

Goals makes it easier to close the gap between the money you can afford to spend and the money you want to spend. In investing, we call this matching assets to liabilities. By clearly earmarking the assets of today to the liabilities of tomorrow, we ensure that we aren’t going to go into debt or fail at those goals.

This can also help determine if you’re in danger of paying interest on something you cannot afford. For example, if you fall short of target or goal, like saving \$25,000 for a luxury vacation, you have to decide whether to make up the shortfall with credit—or cut back on what you can afford.

When you use credit or unexpectedly downsize, you are using a form of debt. The first is financial and the second is psychological. Goals help you manifest your intentions without incurring debt of any kind.

### 9. Achieve optimal returns.

Goal-based wealth management matches your time horizon to your asset allocation, which means you take on the optimum amount of risk. When you misallocate, it can mean saving too much or too little, missing out on returns with too conservative a setting, or missing your goal if you take on too much risk.

Occasionally, critics of goal-based investing claim that it causes users to deviate from an optimal allocation because they don’t look at their portfolio holistically. In fact, it has has been shown through a series of papers (see below) that when done correctly, goal-based investing is just as efficient as holistic portfolio management.

Betterment’s algorithms are smart enough to avoid these hazards of goal-based investing. For example, we look across all your goals when utilizing tax-lot information —for example using TaxMin to withdraw—to ensure that one goal is not mis-coordinated with others. You get all the benefit of goal-based wealth management, and none of the downside.

### A reading list

If you would like to get into the nitty-gritty on any of these points, here are my references:

Rha, J.-Y., Montalto, C. P., & Hanna, S. D. (2006). The Effect of Self-Control Mechanisms on Household Saving Behavior. Journal of Financial Counseling and Planning.

Shefrin, H. M., & Thaler, R. H. (1992). Mental accounting, saving, and self-control. In G. Loewenstein & J. Elster (Eds.), Choice over time (pp. 287-330). Russell Sage Foundation.

Shafir, E., & Thaler, R. H. (2006). Invest now, drink later, spend never: On the mental accounting of delayed consumption. Journal of Economic Psychology,27(5), 694-712

Thaler, R. H. (1990). Anomalies: Saving, Fungibility, and Mental Accounts. Journal of Economic Perspectives.

Fox, C. R., Ratner, R. K., & Lieb, D. S. (2005). How subjective grouping of options influences choice and allocation: diversification bias and the phenomenon of partition dependence. Journal of experimental psychology. General, 134(4), 538-55

Das, S., Markowitz, H., Scheid, J., & Statman, M. (2010). Portfolio Optimization with Mental Accounts. Journal of Financial and Quantitative Analysis.

Brunel, J. L. (2006). How Suboptimal—if at all—is goal-based asset allocation?. The Journal of Wealth Management, 9(2), 19-34.

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