The distribution channel that has “changed everything in the immediate annuity market,” she says, is Income Solutions (www.incomesolutions.com), a purchase program of Hueler Investment Services that is the first of its kind, according to Hogan.
“The contracts are from strong insurance companies; and because it sells the annuities on an apples-to-apples basis,” she says, “I receive a market-determined price.”
As a structured product, the inflation-indexed immediate annuity surely dovetails with the life-cycle approach. Both structured products and derivatives—which allow for specific tailoring to client needs—permit risk not only to be diversified but sliced, diced and traded.
Indeed, because of the availability of such vehicles, Hogan says she is seeing a huge shift in the risk paradigm tantamount to the revolutionary change that occurred in 1952 when economist Harry Markowitz initiated Modern Portfolio Theory. Prior to that, risk was assigned: widows and orphans got safe investments, like government bonds; business executives got risky stocks.
“Part of our challenge is to say to a client, ‘What risk do you want to keep, and what risk do you want to [stay away from]?’ Hogan says. “Structured products—used pretty routinely at the institutional level—are now beginning to offer that [option] to the retail investor.”
Risk management is major to Hogan’s process.
“Where the industry is right now,” she says, “there isn’t even a teasing apart of risk capacity versus risk tolerance. But someone can have high risk tolerance but be low on risk-bearing capacity.” Typically, clients don’t even know what their risk tolerance is.
“And when you put that together with the advisor’s [aim], ‘I need them to buy this product,’ the traditional paradigm is the wrong one for helping an individual do what they want to achieve,” Hogan says. “When people go in to talk to a financial advisor—which is not a legally defined term—they think they’re buying advice. They don’t know they’re talking to a sales person.”
One of the guiding principles of life-cycle is to smooth income. It moves wealth from good times to bad times in the safest way possible. Tools for “consumption smoothing” include savings, debt and insurance.
Hogan explains smoothing this way: “Because spending occurs at a different rhythm from money coming in, getting money from when you have it—because of time or circ*mstance—to when you don’t is important. Thinking of wealth as a reservoir—filled with cash reserves, investment portfolio, real estate interests, business interests and even debt—with money going in and out, helps you to smooth income.”
Bonded to Hogan’s forecast that life-cycle is financial planning’s future, is a vastly changed advisor role: Instead of being an authority figure, the FA will morph into “a counselor” with both technical and non-technical skills.
Already, Hogan considers herself a “facilitator”—a bridge between economic theory and what the client is trying to accomplish in blending human capital and financial capital based on values.
“Financial planning is something the client does—I don’t do that for them,” she says. “I create a path: If they’re seeing only one part of an issue, my job is to bring out the other. In a good advisory relationship, the advisor creates an environment where the client will articulate and discover their personal values. But it’s the client’s values, and it’s their discovery.”
To be sure, life planning helps clients zero in on those values and motivations. With Hogan, they emerge as the advisor probes folks to talk about their current and past financial life, what they care deeply about, what worries them, how they define success. In this “values-clarification” process, no numbers are discussed.
“‘What do you really care about?’ is another way of asking ‘What risk are you able to bear, and what risks do you not want or can’t have?’” Hogan notes.
Life-cycle says that clients care most not about portfolio wealth but maintaining their standard of living—that is, not going backward.
“People are telling you, in effect, that they want inflation-protected income. That’s the life-cycle point of view,” Hogan says.
This means the financial plan must address life-time income and longevity to ensure that income keeps up with inflation.
Therefore, the advisor adds, “you would expect the standard retirement product to be an immediate annuity that is indexed to inflation.”
After the client elucidates his or her values, Hogan schedules a follow-up meeting to show all that information on spreadsheets matched with planning topics from a life-cycle viewpoint. She then recommends a financial plan based on and custom-tailored to what the client’s human capital is going to provide.
The whole process, she says, “empowers clients because it puts them—not the portfolio—at the center.”
Life-cycle models were laid out by economists, including Paul Samuelson, Bodie, Merton and Moshe Milevsky, as early as the 1950s and on into the 1970s. “But advisors weren’t drawing on the theory,” Hogan points out.
In fact, only within the last few years was life-cycle introduced into the chartered financial analyst curriculum, according to Hogan. And it is not included in the certified financial planner curriculum at all, she says.
“That’s odd, isn’t it?” Hogan muses.
Yet she discerns “a migration” toward life-cycle investing.
“You’re seeing something that is the beginning of what I think will be mainstream,” Hogan notes.
Post-financial crisis, she has observed that clients and advisors are beginning to talk in life-cycle terms.
“They found out that stocks aren’t safe and that they do care about risk. But I think they’re backing into the life-cycle theory *ss-first, if you will. They’re not saying, ‘I’ve discovered this theory, and now I see how it works.’ They’re saying, ‘Holy cow! This [big investment loss] wasn’t what I signed up for! It’s not acceptable. And I don’t want it to happen again.’”
