Paula Hogan, a Milwaukee-based advisor long visible through presentations at FPA and NAPFA meetings, has laid out a model for financial planning that she argues is both more effective and more distinctive than conventional approaches.
In an article published this week in the Journal of Financial Planning, Hogan (left) attempts to integrate well-settled ideas from economics with the realities of dealing with clients in the trenches of financial advisory practices.
“Economists tend to assume that clients come into a planner’s office already knowing where their cash is being spent and able to specify concrete financial goals and the likely path of their earned income, and (icing on the cake) also to specify which expenses are lifetime needs and which are lifetime wants,” Hogan writes. “In the trenches, it is clear that none of these assumptions are true.”
But, Hogan argues, advisors are typically working on commonly based assumptions that economics disavows—for example, the idea that time diminishes the risk of owning stocks. Yes, average stock performance is positive over time, but shortfall risk increases with time, she asserts before asking: “If we offer a financial plan to a client that requires favorable stock performance to succeed, is it a plan or a hope?”
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Rejecting these extremes, Hogan redefines financial planning based on a well-settled economic theory known as the Bodie Merton Samuelson theory of life-cycle saving and investing (LCSI), which seeks to optimize income and spending and match investment risk to goals.
The key effect of this paradigm shift is that “the person is the focus of attention, not the portfolio,” Hogan writes. That is because human capital is more important than financial capital in LCSI. Hogan cites Moshe Milevsky’s famous question, “are you a stock or a bond?” to remind advisors that the investment risk they take should correspond with the volatility of their earned income. She also states the “sobering” truth that “your personal gifts, and what you do with them, are the main levers for influencing your lifetime level of living.”
Given the primacy of earned income, Hogan argues it would be appropriate for planners to make a client’s pay a focus of the annual review to be tracked over time.