Zvi Bodie, the Norman and Adele Barron Professor of Management, Finance, and Economics at BU’s School of Management, discovered a gap between the science and the practice of investment research when he sought a reliable source for investment information on the Web — and found none. “The Securities and Exchange Commission Web site has information, but it’s all been written by the industry,” Bodie says. “It would be like if the Food and Drug Administration was run by and for the pharmaceutical industry.”
To help solve the problem, Bodie has gathered some of the world’s top economic thinkers — including Nobel Prize winners Paul A. Samuelson and Robert C. Merton — for a two-day conference that attempts to bridge the gap between academic knowledge and industry practice. The Future of Life-Cycle Saving and Investing, presented by SMG, the Federal Reserve Bank of Boston, and the Research Foundation of the CFA Institute, will be held at Boston University October 25 to 27.
BU Today talked to Bodie about the problems with current investment practices and the need for consumers to be better informed.
BU Today: Can you explain the concept of life-cycle investing?
Bodie: Life-cycle simply means that how much to save and how much to invest depend very much on where you are in life. Are you young and just starting out, are in your peak earning years, or are you retired? The goals and the rational strategy depend very much on where you are.
And you’ve identified a major discrepancy between the science of investment research and the advice provided by financial advisors.
It’s a real dilemma. Everything on the Web is completely biased to get people to buy the products of the investment industry. My own portfolio has a foundation that rests on inflation-protected securities issued by the U.S. Treasury that I can invest in for free, without paying any fees to anybody — but you can’t find that single piece of advice, which is probably the most important single thing that a person should know, anywhere, unless you happen to go to the Treasury Web site. If you were to go to the Securities and Exchange Commission Web site, they have investor education, but it’s all been written by the industry.
What are some of the differences between the industry publications and the information you’d learn in an economics course?
They redefine the basic terms of reference. For example, I start my investments course by saying, OK, here’s what a risk-free asset is, because you need that as a benchmark for making tradeoffs between risk and reward. The popular literature starts off by saying there is no such thing as risk-free investing.
In economics and finance, saving is simply not consuming all of your income and investing is what you do with that savings — how much goes into safe assets, how much goes into risky assets. That’s the fundamental distinction, and that’s very basic. You go to the popular Web sites on investing, and the first thing they tell you is that saving is what you do for short-run emergencies and investing is what you do in the long run. It’s so transparently self-serving for the industry.
The conference points to pension reform as a specific example of the problem. Can you explain the issues with the current system?
Traditional pension plans, defined benefit plans, that promise career employees that when they reach retirement age they’ll get a lifetime income based on what they earned before they retired, are on the way out. What’s being substituted are self-directed voluntary plans, called defined contribution plans, where employees get to choose — a certain amount is contributed by the employee, and the employer matches it.
The problem with these substitutes is that they pass on all of the risk of investment not being enough — the combination of saving and the decisions you make subjects you to risk, and most people haven’t got a clue how to manage that. It just doesn’t make any sense to put all that risk on ordinary people who don’t know how to handle it. It takes a lot of knowledge to manage an investment portfolio.
It’s my view that we can do better — we meaning the academic community, the scientific community, and the financial services industry. And the government, which has an important role to play.
What can investors do to make sure they’re making informed choices?
They ought to think primarily about how much risk they can take, because they do have some ability to control the degree of risk. The simplest strategy is to start with the least-risky investment alternative, and the least risky alternative will depend on what your goal is. If the goal is to replace your income when you retire, really another way to say that is you’re trying to re-create a defined benefit plan for yourself. So the question is, what kind of products can you invest in that will make you able to do that?