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November 01, 2007 at 04:00 AM
Prof. Bodie combines the easy charm of an accomplished public speaker with the intellectual vigor and clarity of exposition of a Harvard-MIT-trained professor. He is jovial and ebullient as we nosh on pastrami and stuffed cabbage at a deli near his home in Brookline, Mass. And why not? Following our lunch at Rubin’s, he will be at the Royal Sonesta Hotel in Cambridge, the venue for this year’s get-together of the Retirement Income Industry Association, where he will receive the association’s first ever award for Lifetime Achievement in Applied Retirement Research.
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Who: Zvi Bodie, Norman and Adele Barron Professor of Management, Boston University.Where: Rubin’s, 500 Harvard Street, Brookline, Mass., Sept. 17, 2007On the Menu: Cholesterol-laden delicacies and defining risk.
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However, as we peruse the menu he mentions his father was a prize fighter. You can believe it, and not only because Bodie is a big, burly man. When the conversation veers toward the financial advisory industry’s treatment of the consumer, Bodie’s eyes flash with genuine anger.
“Financial planning has always been approached from the point of view of practitioners in the field who are trying to make a buck,” he says, clearly disgusted.
As a believer in capitalism, he says he doesn’t mind when people who have products and services to sell make exaggerated or less-than-true claims. After all, nobody believes everything they hear during pharmaceutical infomercials. It is when those whom consumers are supposed to trust, such as the SEC, knowingly or unknowingly mouth the same untruths on their websites that he gets mad — both as an educator and finance professional.
“Every personal finance book says you have to start with a goal,” he says.
The SEC, too, has a list of five or six different potential goals on its website, all of which are good examples. However, after listing a few of them, Bodie asks the obvious question: “If you have a goal, shouldn’t there be a time horizon associated with this goal?”
If you’re saving to make a down-payment on a house, you have a pretty good idea when you’re planning to buy your own place. If your investment is supposed to provide tuition for your children or grandchildren’s education, this too has a set time frame. And even if your goal is a prosperous or self-sufficient retirement, you can’t avoid thinking of its approximate beginning and, alas, eventual end.
Defining RiskEconomists think of risk as volatility over time. The wider the price fluctuation, the riskier the asset. But in personal finance this definition of risk is not especially relevant, insists Bodie. Applied to a specific goal, he sees risk in far more commonsensical terms — as the probability that you’re going to fall short of attaining your goal.
Volatility can be reduced by diversification — which is what financial advisors typically tell their clients. If you agree with Bodie, however, and assign a specific time period to your goal, diversification may not always work for you. There is no inherent reason in theory or in practice why most assets in your portfolio can’t drop at the same time — which could be exactly the time when you have been planning to achieve your goal.
Or, if you insist on thinking of risk as volatility, Bodie proposes a more relevant measure of it. Typically, the change in the value of your portfolio is gauged against the S&P 500 index or other conventional benchmarks. However, unless your future goal is to buy units of the S&P 500, you really don’t care about this kind of volatility. You need your investments to match the cost of your goal — for instance, college tuition.
