A decade ago, Paula H. Hogan had one of those incredible a-ha moments—and her financial advisory practice has never been the same. This was no fleeting “I coulda had a V8!” epiphany. It was profound, with deep implications for the advisor’s business—perhaps even for the entire financial services industry.
That insight hit when the FA, founder and managing member of the Milwaukee-based firm bearing her name, read a couple of eye-opening Financial Analysts Journal articles written by economists: one story by Zvi Bodie, the other by Robert Merton. Both were about life-cycle investing, a school of thought that seeks to optimize income and spending, matching investment risk to goals.
Immediately, Hogan realized that application of this investing philosophy would be the best way to help her clients to safely achieve their goals.
“I thought, ‘This makes sense! It’s not what the industry is doing, but it’s what we should be doing!” says the scholarly Hogan, a Princeton grad with a master’s degree from Harvard.
The advisor indeed wasted no time in transitioning her then-11-year practice to focus on life-cycle investing. And, in an innovative move, she went a step further to meticulously pair the economic theory with the client-centric life-planning method, which integrates personal values with the management of human and financial capital.
Repeatedly named one of the country’s top advisors by a variety of publications, Hogan, 59, sees the marriage of these two disciplines as the clear direction in which financial planning is headed.
“Pulling the two threads together—life-cycle and life planning—is the future of financial planning,” says the advisor, who won a distinguished service award from the National Association of Personal Finance Advisors in 2002 and is a frequent speaker and author.
Hogan’s approach is certainly not the mainstream advisory model now, but she firmly believes it is on the way to becoming standard.
“We’re evolving from product as an advisor’s focus to having a coherent economic theory that makes sense when we sit down and talk to a person about their money. That is what we should be doing,” she says.
Hogan’s idea of combining life planning with life-cycle brings the investment theory into the real world: that is, the advisor working with actual clients.
Most importantly, life planning—drawing mainly from positive psychology, which encourages people to have more fulfilling lives—prompts clients to articulate what they care most about, along with the needs and wants they deem critical as they move into retirement. It is information that is required to effectively implement life-cycle investing: before specific goals can be set, clients’ values need to be clarified.
It’s a rare advisor who is taking a life-cycle point of view. And by integrating life-cycle with life planning, Hogan is way ahead of the curve. This spring, a July 2012 paper she co-authored with advisor Rick Miller, “Explaining Risk to Clients,” is expected to be released as part of a book of symposium proceedings from theWhartonSchool’s Pension Research Council.
A certified financial planner and chartered financial analyst, Hogan manages assets of $199 million from a mix of clients. The RIA has two other advisors in her fee-only practice and is in the process of hiring another.
Prominently displayed in her office is a big poster showing a “Personal Wealth Flow” diagram that Hogan created. Expressing life-cycle investing visually, it plainly shows that the client—not the portfolio—is at the center of her process. The schematic illustrates that money coming in must equal money going out. Writing in the June 2012 Journal of Financial Planning, Hogan described that as a “delicately, finely tuned, always-in-motion system.” She refers to the diagram with prospects and in most every client conversation.
At its heart, life-cycle investing is the theory of how an individual should go about creating life-time financial security.
“You’re matching a coherent economic theory with what the client wants to do. Life-cycle is about optimizing everything, [especially] your future self,” Hogan stresses.
When used for comprehensive financial planning for individuals, life-cycle also applies principles from the pension world. In this goals-based investing philosophy, goals are funded in priority order.
“No matter who you are, you have a limited amount of money. So you want to make sure that the goals you care most about are funded before you run out of money,” Hogan notes.
The cornerstones of life cycle are: (1) human capital—what people do in the world with their skills and talents, and how they are remunerated and (2) that most people care more about lifetime standard of living than about portfolio wealth.
These priorities change the focus of attention from the portfolio to the client and in so doing, from return management to risk management.
Earned income and spending are Hogan’s financial planning touchstones.
From Day One as an FA, she intuitively took a life-planning viewpoint; but it wasn’t until transitioning to life-cycle that Hogan began to overtly, systematically incorporate it into her process.
The be-all and end-all of that process is not to grow a great-big portfolio. Rather, the crux of the matter is what clients care about deeply, their resources and the risks they can afford to take.
“And then we’ll build your portfolio around that,” Hogan says. “It isn’t: ‘You need money. Let’s take some risk and build a big portfolio, and I’ll hold your hand and talk you through if there’s more volatility than you can handle—and it’ll probably turn out all right.’ That [last part] really isn’t such an outrageous statement if you believe that stocks are not risky in the long run. The problem is that stocks are risky in the long run.”
Whereas in the traditional model, “the advisor will likely be selling stock,” Hogan says, in the life-cycle model, “the holy grail for product is probably going to be life-time inflation-indexed income from a diversified selection of strong counterparties.” That is, lifetime immediate annuities.
With life-cycle, the goals that clients care most about must be funded safely. So when investing for “needs,” even compared with the traditionally safe U.S. Treasury bill, lifetime immediate annuities stand out. They “[go] up with inflation but never down,” Hogan writes.
Still, “immediate annuities are almost as volatile as stocks,” she cautions. “So if you’re not doing competitive shopping, you’re not getting best execution.”