Life-Cycle Investing Is Rolling Our Way

Hogan, Paula H.
May 2007
Journal of Financial Planning;May2007, Vol. 20 Issue 5, p46
Academic Journal
• Drawing on 1950s models, the financial planning community uses mainly precautionary savings and diversification strategies to manage personal wealth. But financial economists and many others in the financial services industry have moved on to a new paradigm known as life-cycle investing. • Life-cycle investing is a multi-period model that uses hedging and insuring as well as precautionary saving and diversification as core strategies. Personal wealth is defined as the sum of current financial wealth and the present value of an investor's human capital-that is, what an investor's labor will earn during his or her lifetime. In contrast to the current paradigm, welfare is measured by lifetime consumption, not wealth. • The combination of life-cycle investing theory and the great innovation in the derivatives markets since the 1970s has set the stage for a new generation of retail investment products. The new default 401 (k) withdrawal may soon be an inflation-indexed annuity with a guaranteed floor and participation in market appreciation, • Instead of talking about optimal portfolio withdrawal and rebalancing strategies, clients and their planners will focus more on how much and at what rate to annuitize financial wealth. • At the moment, planners are uncomfortable with such widespread use of options and other derivative securities. But the implication for planners is that this paradigm shift in financial theory and product innovation is about to fundamentally change how we work with clients and how we structure our businesses. INSET: A Step in the Right Direction.


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