The lecture on The Next Generation of Life-Cycle Products given by Professor Zvi Bodie, Norman and Adele Barron Professor of Management at Boston University, comes at a time when most Asian countries face the problem of aging populations, and the world recently faced one of the worst financial crises since the U.S. Great Depression. During the one-and-half-hour lecture, Professor Bodie improved on the audience’s understanding of life-cycle financial products that have become a significant component of everyone’s investment plan. He also shared comments and thoughts on what the objectives of retirement investment products should be, what the existing system is like, and where the problems lie.

What Life-Cycle Investment Products Should Provide

According to Professor Bodie, the ideal products for the mass workforce should allow customers to choose from a wide range of simplified features of financial products, which are sophisticated and smart beneath the product level. He used the iPhone as an example to elaborate on this issue, that while consumers may not understand every piece of its technological detail, they are able to choose the one that fits them best as the iPhone is a very simple yet sophisticated device for the ordinary person to use.

To that point, Professor Bodie does not think that current financial products meet the expectations of consumers. He commented that financial product developers are not using modern financial theory and technology to reduce risks involved in the products sold to consumers, rather simply passing the risk from the corporate sector to individual consumers. He gave the example of target-date mutual funds, also known as life-cycle retirement funds, in the US market. The combination of mutual fund assets in a dynamic asset allocation program that is a function of one’s age, according to him, fail to provide any known schedule of payments nor has a maturity date. It is thus simply another type of risky asset. Professor Bodies pointed out the misnomer of “target-date” for such retirement mutual fund products, because consumers are not guaranteed with the stable income for their retirement, which should be a deserved right of the individual at the “target date”.  

The Role of Modern Technology
     
Professor Bodie believes that the modern technology, together with the development of financial engineering, has made possible the objective to provide consumers with “a hybrid defined contribution / defined benefit pension plan where individuals make contributions to the plan, and these contributions could vary” and “the end result when they retire is a secure life-time income that lasts as long as they live, with full inflation protection”. Such products might involve complicated technological components, but he believes the goal is both clear and viable.

Meanwhile, modern technology also helps to make these products more affordable to middle-income populations. In the past, these retirement investment plans were mostly for high-end consumers but the “time has now come where we really can do that”.

Misleading Consumer Education

Professor Bodie does not agree with the current practices of consumer education. He believes that the current complicated designs coupling modern technology with misguided financial engineering embedded within financial products are even difficult for professionals to comprehend, let alone the consumers, and thus “consumer literacy is misdirected with impossible risk & return objectives”. From his point of view, the education should not be aimed at teaching the mass population to do everything on their own. He argued that the producers are simply trying to transfer risks to the customers instead of reducing the risk, partly because they do not understand how to solve the problems themselves.

The transfer of risk, however, affects the incentives as now the producers are using higher  rates of return to induce consumers to choose riskier investment plans without informing them appropriately about the increased risks. When people retire, chances are that they could either earn higher return from the investment or end up with very little to live on for the rest of their life. In fact, when it comes to retirement products, “safety is the primary concern for investors, even with zero real return” because “people are most vulnerable to risk as they are no longer in the workforce”.

Professor Bodie also expressed explicitly his concerns about fallacious ideas being publicized in most of the current popular financial literature and websites. One of them is the belief that saving is for the short run and investing is for the long run. Such arguments, however, contradict economic fundamentals, which define saving as the part of income not consumed. Another prevalent misleading claim is that diversification can effectively help reduce risk. Again according to financial economics, the best way to deal with risk is to invest in safe assets, such as government bonds. In contrast, diversification often fails in financial crisis when the correlation between assets becomes more positive. Ironically, “diversification does not work when it is needed most”.

Conclusion
     
Professor Bodie believes that consumers should be educated to choose from well-designed yet simplified features of retirement products, with the end result of securing a life-time income that lasts as long as they live, with full inflation protection upon retirement. Producers should not use diversification as an excuse to transfer the risk and responsibility of a safe retirement income stream to consumers. Rather well-trained financial professionals should work with the government to reduce unwanted risks, and offer safe retirement investment plans for the mass population. Thanks to the development of modern technology and financial engineering, the joint efforts from the government and the private sector should be now able to provide the sophisticated financial products to meet these expectations.