Q&A with Zvi Bodie and Rachelle Taqqu about Risk Less and Prosper’s Goal-Driven Approach to Investing

Is there a sense of “swimming upstream” when trying to propagate goal-based investing--as described in your new book Risk Less and Prosper--among existing financial advisors? Conventional practices and economic incentives are so heavily skewed towards modern portfolio theory and growing assets under management. 

Bodie and Taqqu:  We read your question as a riff on what it would take to move mainstream personal investing toward a more customer-centric, goal based model.  You’ve marked some ways that we may be swimming against the tide—and against the interests of today’s investment industry.

But tides turn. It’s true that investment industry incentives don’t always align well with goal based products and advice. Yet, we can expect the coming waves of Boomer retirements to pack a shape-shifting wallop to the entire industry. Demand for products with insurance components (including fixed and variable annuities) is likely to expand quickly. In addition, demand for more customized advisory services and for greater attention to risk management are both likely to soar.

Also, as major dollar amounts move from accumulation to decumulation portfolios, it’s not unreasonable to expect the AUM fee model to lose some practitioner appeal. Retainer fees begin to make more sense in this new scenario. At the same time, new information technology has improved client communication tools and made them less expensive, giving advisors more flexibility.

Annuity Digest:  Looking forward, which segment of the advisor industry is most likely to run with the concept of goal-based investing for retirement planning?  Do you think the larger broker-dealers and wire-houses will be receptive? 

Bodie and Taqqu:  As it responds to these anticipated new demands, the advisory business may be about to undergo great change. Your question may turn out to be more backward-looking than we realize.

For instance, there is now a renewed emphasis in the advisor community on client intimacy and personal counseling. Consider Charley Ellis’s article in last summer’s FAJ (July-Aug 2011). Ellis’s point--that advising should be mostly about counseling (figuring out ‘who you are’ before you worry about where the market is)--is entirely consonant with goal-based investing. (In fact, the article indirectly answers your question about which segment of the advisory industry is going to be most receptive to goal-based investing: it’s the advisors who style themselves counselors, whether they are “financial life coaches” or more traditional investment counselors.) As Ellis notes, the need for investor counseling is made all the more acute by the shift from Defined Benefit to Defined Contribution pensions. 

Annuity Digest:  The risk management orientation of goal-based investing seems to require that practicing advisors develop insurance capabilities.  In reality, though, many of the fee-oriented advisors (both fee-only and fee-based) you reference in the book are not set-up to deal with insurance transactions.  Many NAPFA advisors, for example, outsource insurance transactions to third-parties.  How is the need for insurance product expertise and transactions reconciled with the reality of fee-oriented practices? 

Bodie and Taqqu:  You are absolutely right about the need for advisors to enhance their insurance capabilities. 

Zvi has been insisting for a long time that personal investment advice needs to encompass insurance activities, and his arguments have been gaining a lot of traction lately. Almost all the CFPs we know, for example, are highly motivated right now to learn as much as they can about insurance products, including the many flavors of annuities currently available. We don’t see structural constraints limiting dual certification, and outsourcing remains a viable option as does partnering. 

Annuity Digest:  Asset gathering and management is a very scalable business—both for the fund managers and intermediaries.  In contrast, tasks associated with goal-based investing such as personal budgeting, asset-liability matching and actual execution (e.g. insurance products, laddered TIPS, etc) are not exactly scalable.  How does the industry address this scalability challenge, and how do advisors “do the right thing” without doing missionary work? 

Bodie and Taqqu:  As for barriers posed by an absence of scalability, have a look at Bob Veres’s 2010 review of where the industry stands today. Veres concludes that the proliferation of off-the-shelf software, cloud computing, and outsourced compliance and reporting has removed the competitive edge once held by very large and often impersonal firms. The counseling model, with its dedication of more resources to client interaction, is no longer impractical, and Veres believes we are on the brink of a client services revolution.

Efficiency remains an issue, but plenty of tools for streamlining goal-based advising do exist. There are software solutions for TIPS laddering, goal-identification and personal balance-sheet creation--and more. In addition, PIMCO has launched two funds composed of laddered TIPS. Others may follow. Veritat, a small advisory firm founded by Wharton professor Kent Smetters (Zvi is on its Advisory Board), provides mass customization--by offering goal-driven and relationship-based advisory services online to small investors. These trends should continue. 

Annuity Digest:  Are there pockets among the existing financial advisor landscape where goal-based investing is thriving? 

Bodie and Taqqu:  There are many forward-looking goal-based advisors in practice today, and many are in positions of influence. Through their leadership, goal based educational material is already being incorporated into the essential next step of broad advisor training (for example, in the readings for the CFA exams). We fully expect our book Risk Less and Prosper to help boost advisors’ understanding and skills.

Old paradigms fade slowly. And gradual change can be imperceptible. But as investor demands shift while new educational materials proliferate, we think the scales may tip toward goal-based principles sooner than most people think.

Annuity Digest:  Thank you very much Rachelle and Zvi.

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