“If you take a step back and really think about what we’re in this business for, it’s helping the individual investor,” said Peng Chen, president of Morningstar Ibbotson, in Chicago on Monday in his keynote address at the Center for Due Diligence 2011 conference.
The key to helping your clients, he continued, is understanding their balance sheet. A “total balance sheet perspective” must include an investor’s human capital, or the present value of the investor’s future ability to work.
Chen spoke to a packed room about how to incorporate clients’ human capital when planning for retirement to account for some of the risks they’ll encounter.
In their earning years, clients face expense risk and mortality risk. In their retirement years, they face longevity risk.
While, financially, older investors have more assets than younger investors, in this regard younger investors are richer. As Chen (left) noted, an investor’s ability to work and to continue earning money “directly affects their capacity to take on risk.” Typically, this is also their largest asset.
Clients’ total economic wealth includes both their human capital and their accumulated assets.
“You don’t have to like annuities, but for certain investors, there’s some benefit,” Chen said. There’s a new income frontier that addresses longevity risk, he said. In the average scenario, insurance doesn’t pay off in the long run, Chen said; you don’t decide to file a claim with your homeowner’s insurance and start a fire in your house, he joked. However, in tail scenarios, the longer the tail, the higher the payoff will be.
Chen outlined some scenarios that warrant looking into annuities for clients. Retirees who want to leave money to their heirs shouldn’t buy an annuity he said. But, those who believe they have a high probability of a long life can use a greater percentage of their assets to purchase an annuity.