Zvi Bodie on Financial Planners and‘First, Do No Harm’by Shelley A. Lee

WITH NOTEWORTHY PEOPLE

10 Questions

Who: Zvi Bodie, Ph.D.What: Professor of management,Boston University, widely publishedauthor of professional books and arti-cles on pension finance and investmentstrategy, and author of Worry FreeInvesting: A Safe Approach to AchievingYour Lifetime Financial Goals.What’s on his mind: “It seemsthat our idea of financial literacy is totransfer risk from the corporatesector—the investment industry andfinancial professionals—to the con-sumer. It’s a type of fraud.”

It’s hard to disagree with BusinessWeek’scharacterization of the 2000s as stocks’“loss decade.” Or with Zvi Bodie’s

analysis that stock risk is dangerous evento investors with a 10-year or more hori-zon. Bodie, a professor at Boston Univer-sity, has been engaged in a long-term cam-paign to get investors—and financialprofessionals—to invest based on themantra “safety first.” And it’s all aboutusing the science, he says. We talked withBodie recently about “misleading” target-date funds, getting clients to retirementsafely, and why a new business model forfinancial planners is imperative.

How did you get interested in whatyou call the fallacy of conventional

wisdom on equity investing, and what wasyour “aha!” moment?

My doctoral dissertation at M.I.T. 35 yearsago was on hedging against inflation, veryappropriate for the early 1970s, when wewere having a serious bout of inflation. Iteven had a national campaign—rememberWIN, or Whip Inflation Now? All the stan-dard economics literature and thinking at thetime was based on equities being the besthedge against inflation. My mentor at M.I.T.was Paul Samuelson, who was a trustee of

TIAA-CREF. He thought that CREF’s strategyof a passive, low-cost strategy of equity index-ing, primarily as a hedge against inflation,was a great idea but a classic example ofdoing the right thing for the wrong reason.Samuelson knew that using equities as aninflation hedge was fallacious thinking andhe was a tremendous influence on me. He’swritten dozens of articles about this and he’ssaid that nothing he’s ever written has beenmore thoroughly ignored.

And did your dissertation verify histhinking?

Yes, I wanted to examine this topic basedon the evidence. In the early 1970s, thestock market had declined by about 50percent—basically the order of magni-tude of our recent downturn—preciselyat a time when inflation reached levelswe hadn’t seen since the end of WorldWar II. It raised the question for me, ifequities weren’t a hedge, what was? Ilooked at all asset classes, including thealmost perfect one that didn’t yet exist inthe U.S. I had just returned from living inIsrael for five years, where almost every-body invested in inflation-protectedbonds. You know, we didn’t invent every-thing here in the U.S.! Irving Fisher, the

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pioneer of financial economics, was also abig proponent of inflation-protected bondsand also greatly influenced my work. Imight add that Fisher was a big proponentof “narrow” banking, treating deposits asabsolutely secure and not to be used forbanks’ risk-taking. Like Samuelson on equi-ties as an inflation hedge, Fisher’s thinkingon banking was mostly ignored. If we trulyhad narrow banking in this country, we’dnever have had our recent crisis.

Why do you think much of the scientific-based thinking on economics

and investing is ignored?

It’s a general problem in our society. Thinkabout this analogy: there’s a science ofnutrition and yet there are all these faddiets not based on science. People ignorethe science; people get bad results. It’s justrooted in our human nature to want tobelieve certain things. Look at the advertis-ing—much of it is bunk. Science should beused to distinguish what’s true and what’snot, based on the evidence.

You’ve had a long-running debate, soto speak, with Jeremy Siegel, about

equities. Doesn’t he use a lot of hard data andevidence to argue for equities?

Jeremy and I were doctoral students atM.I.T., both under Paul Samuelson. We’reactually in complete agreement on every-thing, but Jeremy emphasizes the positiverisk premium of equities and I’m focusedon the risks of equities. My opposition, ifyou will, is not Jeremy. It’s the entireinvestment industry that tries to persuadeinvestors that the risks of equities are less-ened in the long run. And what’s beingalmost completely ignored when investorsand professionals talk about the probabilityof a downturn in equities is the severity ofwhat the downturn could be—as we saw in2009, a loss of 50 percent is no longer justtheoretical. To focus on the probability ofsuccess and leave out of the discussion onthe risk and severity of failure is uncon-scionable.

You recently said that the standardmodel financial professionals use to

give investment advice is fundamentallywrong. What are they doing wrong and whatshould they use?

The big mistake financial planners make isrelying on the investment industry forinvesting expertise. They have the wrongscience. I’ve been incorrectly painted as aperson who says you shouldn’t invest inequities—that’s the sound bite version ofmy philosophy, the way others want toframe it. What I’m really saying is that thecorrect approach to investing is “safetyfirst.” Like the Hippocratic oath: first, dono harm. Isn’t that the basic principle ofany helping profession? Why isn’t that themotto of financial planners? Of course,faulty science leads many of them to denythat they’re doing harm. I’m sure there are quite a few who now

are adjusting their clients’ portfoliostoward “safe.” But it shouldn’t take a crisisto reach that conclusion. And it isn’t justbonds they should be thinking about—con-ventional bonds aren’t safe either. Financialplanners should be recommending TIPs.It’s my soapbox, and that soapbox includeswhy the profession doesn’t understand thatTIPs are a separate asset class—and thesafest, most fundamental one. It really isn’tthat hard to understand that if you want tobuild a safety net for a client’s retirementyou need default-free securities of everymaturity that are linked to the cost ofliving. Billions of dollars went into TIPs in2009, but not necessarily for the right rea-sons. It could be that it’s the bandwagoneverybody jumped on.

You recently said that this lack of“safety first” was perpetuating a kind

of fraud on investors and that we had a sorrystate of financial literacy in this country.

The marketing message is drowning outscience and common sense. Take a look atthe SEC’s Web site and the new video forconsumers, produced by FINRA. First ofall, they are confusing saving and investing.

Zvi Bodie has said that financial

planning has been approached “from

the point of view of practitioners

who are trying to make a buck.” He

also says that risk should be

explained to investors in more

common-sense terms and conven-

tional benchmarks are meaningless to

investors. Why should your clients

care about how their portfolios have

performed versus the S&P 500 if

their goal is to pay for a child’s col-

lege education?

What do you think? Is Bodie right

when he says that your clients are

being exposed to risk they’re not

even aware of and that planners are

taking the easy way out by saying,

“Don’t worry, over time it will all be

all right?”Are TIPs really the answer?

Is “safety first” how you should be

practicing? And what’s wrong with

trying to make a buck?

Share your comments online at

the FPA LinkedIn site. (Member

login required.)

Talking Point

Risk and Reward33

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10 Questions

But it’s worse than that. The video is in asection called “Money Game.” It’s all underthe guise of educating adults, but theydon’t even discuss the tradeoff betweenrisk and reward. This is marketing materialthat has nothing to do with the publicinterest. There are many fine people atboth the SEC and FINRA but the sad newsis that they’re not doing right by thepublic—and that, I’m afraid, is the state offinancial literacy in the U.S. today.

Is your own retirement portfolio 100percent in TIPs?

It is. The correct way to think about invest-ing is as part of a comprehensive approachto life cycle planning. What are the risksyou have at each stage of your life cycle?I’m 66; I don’t want or need an exposure toequities and their risks. It’s different forsomebody in their 30s with a strongprospect for a good career, but even thenyou should be thinking safety first. If youknow exactly what you’ll earn for the next30 years, sure, you can take some equityrisk. When I talk about labor supply in thecontext of financial decision-making, I’mreferring to your own earning potentialand how much control you have over it.For most people that’s the main story,unless you’re very wealthy.

But life cycle apparently means some-thing very different to the investment

industry, right?

Yes, unfortunately the industry has co-opted that term. Used interchangeablywith target-date investing, it’s the newbuzzword of the day. The industry hasinstitutionalized the moldy rule of thumbabout investing in equities equal to 100minus your age, and adjusting as you getolder. These life-cycle or target-date fundsare terribly misleading and are being mar-keted to individuals as a conservativeapproach. Target-date funds are one of thedefault investment options for defined con-tribution plans [under Department ofLabor rules for qualified plans], although

that may change. I took a look at howtarget-date funds performed recently andthose with a target date of 2010 lost morethan 30 percent of their value, on average.Is that appropriate for people close toretirement? Why are these still a safeharbor option? It’s insanity.

Financial planners need a businessmodel that allows them to make a

living. How would your view of “TIPs-for-almost-everybody” allow that?

No question that’s the sticky issue. Manyplanners make most of their money fromassets under management. That has tochange. As long as their business modeland earnings are based on that, they won’tbe giving science-based advice. So whilemany agree in principle with my views,they also say it would require a radical re-thinking of their business model. So youcould say the opportunity is for FPA andthose of stature in the profession to beleaders on new business models. We’ve justhad a crisis [because of] which, I wouldventure, many clients have been very dis-appointed with their advisers. The processof natural selection suggests that adviserswho keep saying and doing the same thingsare not going to survive. Eventually, theprofession will have to come around to abetter approach. There’s a lot of value toclients in being able to structure a ladderof TIPs with a small layer of equity expo-sure on top. It seems to me that’s doing abetter job taking care of clients than pass-ing the money along to a mutual fund andtaking 1 percent.

Who inspires you? And, more specifi-cally, who or what inspires you to

maintain your crusade?

President Obama inspires me. My stu-dents inspire me. In the fall semester, Ico-taught, with my colleague Larry Kot-likoff, a new undergraduate course onhow to apply economics to financial plan-ning. Many students who take courses ineconomics think they’re going to learn

about financial decision-making; instead,they learn about curing inflation andunemployment, decisions that in mostcases they’ll likely never get to make. Wespent a lot of time discussing psychologyand how the framing of advice affectsdecision-making. My message to themwas that if everybody in the investmentindustry frames everything in terms of theprobability of success, steer clear. Thatframing of advice based on success isgoing to maximize the success of a profes-sional putting you in the riskiest invest-ments. The need to make huge improve-ments in financial literacy also inspiresme—my next crusade is to improve thequality of financial education, startingwith the lawyers who regulate the finan-cial industry.

Shelley A. Lee is a writer and business journalist in

Atlanta, Georgia. She can be reached at Shelley@

ashworth-lee.com.

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See Zvi Bodie in person by

attending FPA Retreat 2010,

April 22–25 in San Antonio,

Texas. Register now at

www.FPARetreat.org.