Professional education programs should be anchored in the professional’s job description. If the job descriptions have evolved, could it be that investment management education programs may not match the education requirements of the retirement management professional?
So, who are the investment advisors that are evolving into retirement management professionals? To answer the question, let’s look again at the typology of financial advisors that we first discussed in January. These financial advisors included:o Brokerso Asset Gathererso Insurance Agentso Investment managerso Financial plannerso Wealth managers
Since January, some of our readers have pointed out that we may want to add another category of financial advisors: fiduciary advisors. This is an interesting new category. We are gathering information (total numbers, types of clients, average AUM, preferred designations, preferred product and process categories, etc.) in order to create a clear definition before we add it to the list. Other readers have also suggested that we add call-center representatives to the list because their role is become increasingly important in the delivery of financial advice, especially to investors with lower investable asset balances. Continued feedback is always appreciated.
Executive-search members and partners of the Retirement Income Industry Association are developing individual profiles to better illustrate the specific types of financial advisors who see their practice moving from investment accumulation to retirement income. These profiles and matching job descriptions drive RIIA’s education programs for retirement management professionals. By granting partial credits towards its retirement management professional education programs, RIIA complements existing investment education programs.
Now that we have a sense of the financial advisor types most affected by this change, what are the new and specific professional and practice management skills that must be considered?
At a high level and using terms that would look familiar to an investment advisor, a retirement management professional is responsible for helping investors plan, implement and manage their retirement to achieve and maintain their desired standard of living. This means the preparation, implementation and the ongoing management and monitoring of a retirement plan.
As a point of departure from investment management, developing a customized retirement plan at the appropriate level of detail not only includes consideration of an investor’s financial capital, but should also explicitly take into consideration the investor’s human capital (ability to earn a living from labor) and the investor’s social capital (claims on the earnings of other people’s labor). We started to explore these concepts in our May article and it is time to add to our understanding by observing that this triple documentation of our investor’s sources of capital creates a “life-cycle profile” as shown in Chart 1.
As we already learned in our February article, there are new risk exposures that arise when an investor moves from investment accumulation to retirement income. As a reminder of what these risk exposures may be for a specific investor, let’s take another look at Table 1.
Note that because of the increasing number of relevant risk exposures, this retirement risk profile is likely to be more complicated than a traditional investment risk profile.
To create such a detailed retirement risk profile one would need (i) to give each risk exposure a properly quantified scale for hazard level, investor exposure, consequences and probabilities; (ii) position the investor accurately on such scales; and (iii) track all changes over time. When something starts to look complicated, it is usually time to step back and look for a different route.
Fortunately, we have practical ways to manage this potential combinatorial complexity. No matter how many types of retirement income risks one may list (and there are longer lists than ours), they seem to fall into broad categories. For instance, we can see that our own list of nine retirement risks (shown in Table 1) falls into three broad categories: political risk, business risk and investor risk.
We also notice that some of the detailed risks in each broad category may be more important than others. Not everything can be critically important all the time, right? For instance, we may see that for a specific investor at a specific point in time (i) inflation may be the most critical political risk; (ii) market risk (e.g., Moshe Milevsky’s sequence-of-return lessons from last year’s articles) may be the most important business risk; and (iii) longevity risk may be the most important investor risk.
Armed with such practical simplifications, we are now able to map our investor life-cycle profile (i.e., the investor’s specific sources of human capital, social capital and financial capital) into their retirement risk profile (i.e., the investor’s specific exposures to investor risk, political risk and business risk) as shown in Chart 2.
Rick Miller, founder and CEO of Sensible Financial Planning and Management, points out accurately that this specific selection of risk drivers (longevity, inflation and market) makes this example a retirement income plan rather than a retirement management plan.
Therefore and finally, as show on Chart 3, this practical combination of life-cycle and retirement risk profiles improves our ability to implement a plan with specific allocations to risk management approaches including (i) diversified investments in risky assets; (ii) pooling risks with insurance products; (iii) transforming risk exposure with hedges and options; and (iv) an allocation to the appropriate risk-free asset such as duration-matched TIPS.
Note that investment management professionals primarily allocate the investor’s money to diversified risky assets while retirement management professionals allocate the investor’s money to risk management approaches, only one of which is investments in diversified risky assets.
Retirement management professionals need to know how to set such allocations among (i) investments in diversified risky assets; (ii) insurance products that pool risks including mortality risk; (iii) structured or derivative products that transform risk exposures such as hedges and options; and (iv) appropriate risk-free assets.
Our retirement management professional job descriptions also include assisting the investor in the management of the implemented retirement plan, including its human and social capital aspects. This is a broader role than in investment accumulation. The retirement management professional becomes part lifecycle advisor, part risk management advisor and part financial advisor.
On a regular basis, the retirement management professional will need to monitor and adjust the implementation of the financial plan in light of (i) changes in the investors’ personal situation; (ii) risk management results; (iii) investment performance; and (iv) changes in capital market expectations. Over time and with the help of the annual review process, what may start as a retirement income plan may develop into a retirement management plan. This would especially be the case if, for that specific investor, risks such as health care and disability were to start competing with longevity risk for the top priority in the investor risk category.
This is an evolving situation. We understand the role and the job description of our various types of investment and accumulation-focused financial advisors. We begin to see that the job description of the retirement management professionals will have familiar aspects since investment management (diversified investments in risky assets) remains an important risk management approach in retirement. We also begin to see that the job description of the retirement management professional will call for new professional and practice management skills deriving from the human and social capital aspects of the life-cycle profiles, the retirement risk profile, and the other approaches to risk management including the pooling of risk and the transformation of risk exposures.
Francois Gadenne is chairman and executive director of the Retirement Income Industry Association in Boston; see www.riia-usa.org