This blog is part 3 of a three-part series covering the evolution of investment consulting. This blog explores 2006–Present.

The 70-Year History of Investment Consulting

By Ron Surz, President, Target Date Solutions, President & CEO, PPCA Inc., CFO, GlidePath Wealth Management

Part 3: 2006-Present

To read Part 1: 1950–1985 click here, for Part 2: 1986–2005 click here. 

2006: Target Date Funds & Pension Protection Act of 2006

The consulting industry had an epiphany about 15 years ago that is slowly being integrated into consulting practices. Risk is more complicated than volatility or required return. The epiphany is simple, but very important—age matters. There is a time in everyone’s life when we cannot afford to take risk. Losses sustained during the risk zone spanning the 5–10 years before and after retirement can ruin retirement, even if markets subsequently recover. Target-date funds (TDF) are supposed to provide this protection, although most currently do not. A properly constructed TDF should be no more than 30 percent in risky assets at the target date, but most are more than 80 percent.

A TDF follows a glide path that begins with high risk for young investors and reduces risk through time as the target date approaches. The target date in retirement plans is the retirement date. In other situations, the target date is a date that the fund will be liquidated, like the date a student will start school in college savings plans.

TDFs were not very popular before the passage of the Pension Protection Act of 2006, which made TDFs a qualified default investment alternative (QDIA) in 401(k) plans. Subsequently TDFs have grown to more than $2.5 trillion. They are the biggest deal in pension plans.

The breakthrough for consultants is that a brake needs to be applied to whatever process is used to find a model. That brake is called “risk capacity,” defined as the limit on what an investor can afford. Investors in the risk zone cannot afford much risk.

2013: Rising Equity Glide Path in Retirement

The most recent innovation is about investing for retirees. Wade Pfau, PhD, and Michael Kitces have conducted extensive research on optimal investing in retirement and conclude that it is best to begin retirement cautiously with no more than 30 percent in risky equities and bonds, and to gradually increase risk through time. The cautious beginning is to protect in the risk zone, and the re-risking is to extend the life of investments. To begin retirement cautiously, you need to end your working life the same way with no more than 30 percent in risky investments. In other words, a U-shaped lifetime glide path is optimal, with the bottom of the U in the risk zone. Couple this with the importance of asset allocation, and you have the current best thinking for investment consulting.

Wade Pfau, PhD, is a professor of retirement income and a director of the New York Life Center for Retirement Income and Michael Kitces is a consulting industry luminary.

Conclusion

A lot has improved in 70 years, but not all consultants have evolved. Investment consulting is a credence good like computer technicians and car mechanics. “Trusted advisors” are usually nice people, but not all are financially skilled with the clients’ best interests at heart. The client is best advised to trust but verify. Consultants are best advised to differentiate through innovation.

To explore additional resources and courses available through the Institute visit, www.investmnetsandwealth.org.

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See a recorded webinar of this history here.

Ronald J. Surz is president of PPCA Inc. and its division, Target Date Solutions. He is a pension consulting veteran, having started with A.G. Becker in the 1970s. He earned an MBA in finance from the University of Chicago and an MS in applied mathematics from the University of Illinois. He has published regularly in such publications as the Journal of Wealth Management, the Journal of Investing, Journal of Portfolio Management, Pensions & Investments, Senior Consultant, Horsesmouth, and Investments & Wealth Monitor, as well as contributed to and edited several books. Ron's most recent book is Fiduciary Handbook for Understanding and Selecting Target Date Funds: It's All About the Beneficiaries. Ron has served as a member of the following boards and councils:

• Investment Management Consultants Association (now the Investment & Wealth Institute) Board of Directors
• State of Alaska Investment Advisory Board
• City of San Clemente Finance Committee
• Several CFA Institute Committees
• Sortino Investment Advisors Advisory Committee
• Capital Market Consultants Advisory Committee

References

Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower. 1986. Determinants of Portfolio Performance. Financial Analysts Journal 42, no. 4 (July–August): 39–44.

Haugen, Robert F. 1999. The Inefficient Stock Market: What Pays Off and Why. New York: Prentice Hall

Markowitz, Harry. 1952. Portfolio Selection. Journal of Finance 7, no. 1 (March): 77–91.

Pfau, Wade D., and Michael Kitces. 2013. Reducing Retirement Risk with a Rising Equity Glide-Path (September 12). https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2324930.

Sharpe, William F. 1964. Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. Journal of Finance 19, no. 3 (September): 425–442.

Sortino, Frank A. 2009. The Sortino Framework for Constructing Portfolios: Focusing on Desired Target Return to Optimize Upside Potential Relative to Downside Risk. Elsevier.