I’m a lucky man. I’ve just returned from a spectacular vacation in Greece made one day longer due to a strike by aircraft controllers in Athens. Danke to the unhappy Greek controller for allowing my family and me to enjoy an unexpected and delightful day of sightseeing in Frankfurt!
My hearty thanks to Francois Gadenne. Thank you, Francois, for taking over this blog in my absence and delivering even more than I promised you would!
Now that I’m back I’ve got a big, big treat. One of the greatest pleasures I receive from my work at the blog is having the opportunity to interview so many world-class individuals, the “Leaders and Innovators” of financial services. I get to learn a lot, and so do you.
Moshe Milevsky is likely the world’s leading authority on the interplay between financial risk management and personal wealth management. His best-selling books, scholarly articles, public speaking appearances and consulting work made him well know to all who are seriously interested in the future of retirement income.
In this extraordinary interview, Milevsky addresses many timely issues including the need for a secondary marketplace for insurance products (well beyond the present life settlement market), the necessity for financial services companies to excel at communications, transformation in the variable annuity market, the need for greater financial literacy, and the prospects for life insurers in terms of Boomer retirement.
Milevsky also reveals some deeply personal insights which demonstrate his devotion to teaching… and warm weather! Enjoy!
Macchia – Moshe, you are an international authority on retirement issues, a PhD, an associate professor of finance at York University, a best-selling author, and Executive Director of the non-profit, Individual Finance and Insurance Decision Center and CEO of the recently launched QWeMA Group. You’ve also written over 40 scholarly research articles, the most prestigious business journals worldwide seek out your views…and you’ve just turned 40. For most people, that would be a lifetime of achievement. You however still have decade’s worth of life expectancy. What are your goals beyond that which you have already accomplished?
Milevsky –I appreciate all of the kind comments and I’m not really sure where to be constructive in terms of answering that question. My interests now lie in bringing together the very, very distinct fields within personal wealth management, which are the traditional asset investment management side versus the liability and insurance side of the personal balance sheet.
For many, many years these two fields, both academically and from a practical point of view operated on a completely different level with different language, different silos, different organizations. When you would buy your car insurance or your home insurance or even your life insurance, nobody asked you about your asset allocation and your risk tolerance, or whether or not you preferred stocks to bonds and what your retirement goals were.
One was an insurance discussion and the other was a financial discussion, and my overall philosophy is to bring these two things together and to have a comprehensive risk management approach to wealth management. In that area I think there is much, much work to be done. I’ve spent a lot of time focusing on annuities and retirement income and pensions. The fields of insurance, like long term care, disability, critical illness, UL, variable universal life, term life insurance, require a more rigorous and comprehensive framework, and I’d like to develop some more academic research into how to go about modeling that in a consistent framework.
Macchia – Interesting. Your answer leads me to recall a question that I’ve asked of a couple of previous interview subjects.
When I entered the life insurance business in 1977, the insurance industry pretty much controlled the pension business. It then seeded away those assets to the mutual fund complexes that approached consumers with an arguably better model in terms of greater transparency as well as the ability to create greater clarity and comfort for consumers.
I’ve often used the analogy that the life insurance business was then like a “black box.” People made purchasing decisions based upon their faith and trust in their agent, without truly understanding the product they were purchasing. I think that you could argue that in the intervening decades this hasn’t changed very much. I’m wondering if you feel that greater transparency is going to be a requisite in terms of the insurance companies and their products reaching their full potential in the income distribution phase?
Milevsky – Absolutely. In fact, I think I’ll take the transparency issue one step forward. It’s not just the matter of transparency in terms of the process and what you’re paying for and what it costs, but a transparency in creating a mark to market value of all your insurance holdings. Dare I say that a secondary market is needed for those same insurance holdings so that you can take a look at whatever you own and sell them at a market price if you don’t need those products anymore? That will increase the transparency as well because then you will have traded market values for these instruments, and you can make much better financial decisions with regards to them.
Contrast that vision with the current state of portfolio holdings and other assets. The black box of investments no longer exists; you can drill down to literally the stocks, the companies that you own. I think that’s what’s going to happen with many of the financial insurance products out there. Obviously, this is a controversial issue. For example, the whole topic of the life settlement business, a secondary market for unwanted life insurance. Open up the newspaper in Florida and you’ll see 12 different advertisements for seminars on how to get rid of your unwanted life insurance policy. Many, many people in the industry think that’s not good, a lot of insurance companies will say that they don’t like that trend, but I think that it’s happening and that’s another step in the transparency process. We have to rationalize pricing. I’m more of an observer than a participant in these markets, but I definitely think that transparency is a good way to describe it.
Macchia – Do you believe or could you buy into the assertion that insurers are going to have to come to terms with handling some short term pain in order to configure themselves for greater long term success?
Milevsky – I think so. In fact, one of the things that I observe is that at the same time that the insurance industry opposes certain developments quite vocally on one side of their mouth, on the other side they are actually developing the infrastructure, the subsidiaries and the ventures to capitalize for the event that they lose what they are arguing on the other side of their mouth. I think that’s an interesting development and they are prepared for the fact that they might have short term pain, but in the end they will be the ones gaining because they are the best entities equipped to manage the markets in mortality, longevity and morbidity risk.
Macchia – Moshe, I would like to ask you about some of the things you’ve said that I’ve read in various articles. I’ve heard you say that retirement is not just about asset allocation, it’s also, and very importantly also, about strategic product allocation. Is this something that you could elaborate on?
Milevsky – Sure. That’s something that’s very close to my heart right now because I’m actually writing quite a number of research papers and developing some intellectual property (IP) via the QWeMA Group to try to build on that. To position what I’m saying, imagine you visit any asset management firm as an individual or as an institution and you’ll probably be shown a beautiful pie chart with how your assets should be allocated amongst many different investments. You’ll have a little sliver of the pie chart that shows emerging markets and a little sliver that shows alternative asset classes and real estate and large cap/small cap value growth. You get this instruction sheet that tells you, “Here’s how you should allocate your assets.”
Right now, however, no one in the industry has that type of approach for the universe of insurance products. That is to say, you as an individual sitting down with someone who says here’s how much long term care you should have, and here is how much critical illness insurance, and here’s how much annuity, and here’s how much of a reverse mortgage you should allocate, and here’s how much life insurance, and most importantly here’s how it all fits with your asset allocation, human capital, personal balance sheet, etc.
What I’m describing is the same kind of thinking used for accumulating wealth for retirement. But when you start to withdraw money, and you have to create your own personal pension, I think it’s critical that we start to think in terms of product allocation and asset allocation combined.
Macchia – I’ve heard you make the analogy while discussing the example of withdrawing money for your own retirement, that you have the personal ability to buy out-of-the-money put options funded by selling out-of-the-money calls, but that most people can’t do that. They’ll need to look at packaged products to achieve the same sort of result. Knowing all that you know, what do you see on the horizon in terms of the evolution of packaged products designed to meet the mass market need?
Milevsky – I think that you’re going to see kind of a bifurcation occur in the way the industry approaches this. I know that when I talk to some of the large producers for some of the wire houses they listen to what I have to say about risk management and retirement income and they immediately have the light bulb come on in their head and they say, “Hey, if the first few years are so critical when you’re withdrawing money, why not buy some puts and fund it by selling calls?” And, “If longevity risk is such a big deal, then why don’t I buy a little bit of the out-of-the-money longevity option, essentially a deferred annuity that pays off if I get to age 95?”
They are financially engineering or creating the packaged products themselves, and they are coming to the realization that they have to do it. But, for many, many other people it’s impossible or just too complicated to manufacture these themselves, and for many smaller investors it becomes prohibitive from a transaction cost point of view. We’re going to see structured products developed that are meant as income vehicles as opposed to accumulation vehicles. It’s not going to be about an indexed linked note that accumulates for 15 years and guarantees you a sum of money. It’s going to be about products where the sum of money is given now or over 5-10 years and it produces incomes with certain guarantees. I personally think you’re going to see much more development in the structured market as a replacement for Define Benefit (DB) pensions.
Macchia – In terms of structured products filtering down to the mass market, when do you expect to see it begin, and what do you think the result will be for insurance companies in terms of potentially significant new competition?
Milevsky – It’s tough to predict these things but I can tell you that as one big company moves in that direction other companies follow very, very quickly soon after. You have to predict when is the first mover going to do it and then everybody else fills in the gap. I’ll give you an example, a case study. I’m a business school professor, so I live on case studies.
In Canada for many, many years we did not have any variable annuities. We had something similar called a Segregated Fund, but there were some important differences and none of them offered any guaranteed living benefits. We certainly didn’t have any GMWBs, GMIBs, etc. Remember that in the US you’ve had them for 6 or 7 years now.
Four months ago the first company in Canada launched the guaranteed minimum withdrawal benefit (GMWB) similar to what is offered in the U.S. within variable annuity contracts. It was Manulife. About four months later the second largest company here, Sun Life, announced that launch of the exact same thing. Another traditional fund company partnered with a Bank to offer a similar product and there will probably be one other insurance company jumping in very, very soon. Seven years we see nothing and then within a six month period everybody steps in.
I think that’s what’s going to happen with some of the innovation in structured products in the US. Wherein there are a number of traditional asset management shops that are thinking about it, and they are talking about it. They’ve been talking about it for years. This is not something new to them. As soon as one of them makes that final move and brings it to market, everybody else will step in. I think that’s what’s going to happen. When will this happen? It’s tough to predict, but my sense is there is going to be clustered. I wouldn’t be surprised if two years from now there are 12 companies offering a new class of products that didn’t exist two years ago.
Macchia –Your comment is very interesting to me, and I’m quite familiar with this copy-cat syndrome among insurers, and deal with it in terms of the technology communications innovations that are my focus.
But I want to go back to variable annuities and income benefits, which you just raised. For some time you were well known as a critic of variable annuities. I believe that you looked at variable annuities anew in the context of the newer guaranteed income riders. I believe that your research concluded that the insurance companies offering these benefits- or at least some of them- may not be charging enough money for the economic benefits that they provide through these riders. Is this accurate? Is this an accurate way of describing your conclusions, and, if so, what are the implications?
Milevsky – As any good academic will tell you about a subject they have written a lot of papers on, it’s difficult to summarize in one paragraph the entirety of the various research results. But the bottom line is, yes. For many, many years the imbedded guarantees and some of the protection features that you had within these products, in my opinion, were overpriced relative to the capital markets value of traded options.
In the language of financial economics we talk about replicating payout more cheaply. You can cook these things for less. In a sense you are paying more than the actual embedded value of the guarantees. This result was described in a number of research reports that I’ve written over the years which got widely cited, and I kind of lost academic interest to be honest in this whole variable annuity market. I’d gone away from this in the late 1999, early 2000 period saying, “I don’t get this whole market. It doesn’t make sense to me. Buy some life insurance. Buy a tax efficient mutual fund, hold on to it. What’s the point?”
Then literally 5 years later with the explosion of living benefit products I took the opportunity to look at these things again, expecting to see the same conclusions that I had seen 5 years earlier. The results were very, very different, however. The features now made more sense to me because they were made to protect against living as opposed to protecting against dying. The features in there were meant to create pensions, and many of us are losing our pensions. The features in there were essentially put options that matured over long periods of time, which are quite expensive in the capital markets.
I inevitably had to change some of the conclusions on these products because the features had changed. There’s actually a story about Prof. John Maynard Keynes, the famous economist. Apparently he was approached by reporters after he released some policy recommendation and they accused him of changing his mind on something. He had been against a certain policy and then had changed his mind in favor. The reporters said to him, “Professor Keynes you’ve changed your mind. Why did you change your mind?” His reaction was, “Look, when the facts change I change my mind.
What do you do?, he said to the reporter.
That was his response to the reporters. Obviously when referring to Prof. Keynes one has to be careful since he is in a completely different league, but I kind of feel the same way here. For many years reporters and writers would call me to basically get negative quotes about variable annuities. Yes, some of them would call with an open and honest intention to discuss the pros and cons of the product, but many others simply wanted to get a live quote from the “professor and researcher” who found that VAs are overpriced. More recently these same people call to discuss the new generation of guaranteed living benefits and now I have to say, wait a minute, you’re talking about the exact opposite exposure here; longevity risk. This is income for life. This is not easy to hedge individually. In fact, call up your favorite OTC put-option market maker. It’s a lot more pricy to replicate. It’s not easy to quantify and do proper risk management. Many of the popular financial writers are still thinking in terms of the old products and guarantees. I finally decided to write an article about this and confess my current frustration, and let it go from there. And that’s what I published in January in Research Magazine.
Macchia – The insurance companies have put a lot of financial engineering behind the development and hedging around these riders. Do you think they are just making a big mistake?
Milevsky – No, absolutely not. I can’t use the word mistake to describe any of this. I think that many of them are making strategic decisions based on a careful cost/benefit analysis. For example, if living benefit riders on a variable annuity generate only 2% of your company’s revenue, and you have exposure to the opposite mortality and morbidity risk then no matter what happens in this particular market it’s not going to impact your overall firm exposure. They can be more lax about hedging out every single possible path. They can be more relaxed about risk management, after all they have natural hedges in place.
On the other hand, if you’re a small company, and this is generating 70% of your revenue, this is starting to pose some systematic risk, especially if you are using static assumptions about policyholder behavior. Practically speaking, it is the stock analysts that have to be weary about profits and earnings. The credit market analysts have to be concerned and the regulators have to be alert.
I know from looking at these things that they are very complicated to hedge. They depend on policy holder behavior, who is going to lapse, when are they going to lapse. They depend on competing products. If somebody comes out with a better product, people are going to lapse, but if they don’t then they are going to hold on. It depends on education, it depends on the intermediary. This is not like put options that you buy on the CBOE where they are commoditized yet, so there are a lot of assumptions there.
Bottom line is I’m wondering, are people getting this right? That’s it. The recent overseas experience with similar products has implications in the U.S. It’s what happened in the UK with Equitable Life. It may be a personal bias, but I was giving a lecture at the London School of Economics a few years ago when the Equitable Life fiasco blew up. This was the largest, most venerable, most prestigious insurance company in the UK having sold guaranteed living benefits. In the year 2000 they literally had to shut down. They were declared insolvent soon after because essentially these guarantees matured in the money and they didn’t have the risk management and hedges in place to cover 100% of the promised payouts. Anybody that lives through that has an obligation to ask how do we make sure that this doesn’t happen in the US? One of the ways is to just make sure that you are vocal and ask questions about risk management practices. I don’t want to be a Cassandra, but at the same time the more that we remind people due diligence is also about risk management, the less the chance this is gong to happen. If insurance companies are selling instruments that are supposed to transfer risk from my personal balance sheet to their corporate balance sheet, I want to understand how they are managing that risk. The answer: “We have scale economics and use the law of large numbers to diversify risk” doesn’t cut it for me.
Macchia – Now, I’d like to ask you about something different. That is the work that led up to the awarding of a patent to you and Dr. Peng Chen. I’m wondering if you could talk about the work that you did that led to that patent, and how you see that patent unfolding now to help financial services companies. How do you see the patent actually impacting the marketplace?
Milevsky – Sure. To be absolutely clear and up front, this is a patent that I developed that was transferred over to Ibbotson Associates, so although I am the inventor, the co-inventor with Dr. Peng Chen, they are the ones that are taking the lead in terms of business and business development, and you should probably ask then a lot more than you should ask me what their strategic plans are.
The research that had led up to it was the very simple question that I was asked almost 10 years ago: What is the most optimal allocation to annuities? How much of my money should be annuitized and how much should not be annuitized? How much should be left liquid? This is a very fundamental question in economics. Asset allocation and portfolio choice has been studied for 20 or 30 years, but nobody ever asked the question in terms of insurance products. The questions were always posed: How much international exposure should you have? How much bonds versus stocks? How much cash versus how much invested? Nobody actually looked at how much should be annuitized.
The research that I had done more in a theoretical point of view was to try to determine an optimum and what kind of framework do you use in order to develop this optimum. That’s kind of the theoretical work behind it. My work with Ibbotson over the years was about trying to implement that in a way that could be understood and used by individuals. The question then got flipped around: What kind of questions do we have to ask people so that their answers will lead us to an optimal allocation of annuities versus non-annuities?
Macchia – There are not that many individuals like yourself who stand at the top of the food chain in terms of understanding all of the intricacies and economic factors and issues that will impact peoples’ retirements. In your view what is the toughest concept for ordinary investors to understand when it comes to their retirement?
Milevsky – I think that they are a collection of behavioral-almost fallacies or behavioral mistakes that people make, and they all have to do with very long and uncertain horizons. I believe that when you tell someone to plan for something that may last only 5 years, or that may last as long as 35 years they then commit a series of mistake behaviorally that all relate to the fact that they don’t’ really know hold long they are going to live. Those mistakes can then become things like not planning to have income for the rest of your life because you don’t know how long it’s going to last. Or a misunderstanding of the impact of inflation. Or not understanding the impact of healthcare costs and what that means in the long term. Or how markets behave in the long run versus the short run. If I can summarize it, the biggest misunderstanding is how to handle horizons that are stochastic.
Macchia – Moshe, a great deal of my work involves the development of the next generation of communications technologies.
In part, my investment in this area derives from my sincere belief that while products and processes will be important in the future, there will be a different driver that will, to a large extent, determine a financial services company’s future success in the retirement income business. I mean by this that the greatest success will not necessarily come to an organization with the “best” product, but rather will come to those organizations which are the best at communicating their value to a large and fluid marketplace.
I believe this is true for many reasons including my own substantial practical experience, as well as the fact that the Baby Boomer cohort is so vast, and the number of financial advisors arguably insufficient to meet all of their needs, that only by using communication tools effectively will companies be able to successfully engage large numbers of consumers. I’m wondering if you can buy into what I’m saying.
Milevsky – I do. In fact I’m really resonating with the first comment that you made that it’s not necessarily the best product that’s going to win. I’m seeing that now, and it would be nice to have kind of a coherent framework to understand why it’s always going to be the second and the third best product that’s going to win.
It might very well be because of their ability to communicate their message better as opposed to the first one that put all its effort into product development and forgot about the second and third steps which are to make sure that people understand this and to communicate it and people absorb it. I see a lot of wholesalers in action that do these seminars and I get to listen before and after to some of the folks that get up and pitch various products. I see that the ones that are able to communicate in an almost simplistic way what a particular product or strategy does end up winning as opposed to the one that comes in with the very long list of product features and kind of confuses people.
Even though it’s really a better product they are not the ones that get the business. It’s almost as if I scale back on the bells and whistles and focus on the 2 or 3 really good things about your product and put the rest of your effort into explaining this to individuals as opposed to the other way around. I really do resonate with that. It’s only with time that I’ve come to appreciate how important the communication part is.
As a graduate student at university you never really appreciate or are taught the importance of clear communication. A professor with a Nobel Prize standing at the black board scribbling with chalk is a genius. It doesn’t matter if he can communicate or not. It’s the thoughts that count. It’s the papers that they wrote. It’s the products that they have helped develop. In time I’ve realized that it’s much more about communication, inspiration and clarity of ideas than it is about the actual development. It’s certainly a combination of the two. I do resonate with your earlier comment.
Macchia – Moshe, I’d like to ask you about the non-profit organization for which you serve as Executive Director, the Individual Finance and Insurance Decision Center. Could you describe the work that you’re doing there and what you’re aiming to achieve?
Milevsky – Sure. The IFID Center is a not for profit that is currently housed at the prestigious Fields Institute in downtown Toronto. Some of your readers might not recognize the Field’s Institute but will have heard of the Field’s Medal. It is a prize that’s awarded every few years to the best mathematicians in the world, similar to the Nobel Prize.
The Fields Institute has incubated and housed The IFID Centre for the last seven years. What we tried to do is to create a network of academic researchers who are interested in personal financial problems. Helping individuals make better decisions in their financial wealth from a distinctly mathematical point of view. We’ve done projects over the years, many of them funded by government agencies, increasingly lately by actual institutions, and many companies in the financial services sector.
They will approach us with a question such as: Is it better for our clients to take on a variable (adjustable) rate mortgage or a long range fixed rate mortgagee? We’ll do a statistical analysis, we’ll develop mathematical models and we’ll tell them things like 80% of the time you’re better off doing that versus this. Or, here are the conditions under which the decision makes sense relative to other assets and liabilities on the balance sheet.
As another example, companies will ask us whether it is better for our clients to have term life insurance or whole life insurance or some combination thereof, and we will again look at the underlying mathematics and analytics and give them rigorous recommendations. That’s what we’ve been doing over the years. We have an affiliated network of researchers, some of them at my own institution, York University, some of them in the US, South America and Australia. They are literally across the world at this point. They collaborate with us on a research projects, present results of their research at seminars and the end result, the output, the deliverable is a white paper or presentation that’s placed on our website and that’s available free for all to the world to download- which then generates its own research.
Macchia – Speaking of research, you have collaborated with Research Magazine on what’s called Retirement Income University where your- and these are by the way extremely well written- efforts to help advisors focus in on some of the insights that they may be lacking. What led to Retirement Income University and what’s your aim with it?
Milevsky – One of the editors (Gil Weinreich) of the magazine contacted me more than a year ago and asked me whether I’d be interested in writing a column for them on the subject of retirement and retirement income. At the time I had a lot of commitments and it was hard to commit to do this on a monthly basis. Gil was very persistent and I would get a weekly email from him asking if I would reconsider and I met with him.
Finally, I realized that his might be a good thing to disseminate some of my ideas beyond just publishing research papers on the website at the IFID Center. What I’m trying to do with the column is to cover systematically what you need to know to be an intelligent practitioner in the field of retirement income planning. I’ve got this list of concepts that I will be elaborating on one month at a time that I think enhances people’s knowledge on retirement income from a slightly academic point of view. To me it’s a bit of a curriculum, where at the university you spend 2 or 3 weeks in a given course and you systematically cover another topic. That’s what I’m trying to do in the column. I believe that this month’s column is on inflation. What do retirees experience in terms of inflation? How does it differ from the rest of the population? Next month I’m looking at the subject of longevity risk, and we’re going to talk about long term care and living benefits on annuities, reverse mortgages, what do people need to know about Medicare, Medicaid, what you need to know about a particular topic condensed to 2000 or 3000 words. That’s the agenda for the next few months.
Macchia – I see. Let me ask you about what’s happening at ground level in terms of retirement income distribution solutions. The way I observe it, and often make the analogy to describe what’s occurring, is that people are coalescing around philosophies that I can almost compare to the various religions that we have in the world. There’s the religion of time segmented or time weighted strategies, there’s the religion of lifetime annuitization, the religion of systematic withdrawals, the religion of combining annuitization and a target date retirement fund. I wonder if you see it as I do and, if you do, do you view this phenomenon as short term or long term in terms of how it will actually play out.
Milevsky – I definitely see that now. It’s almost frustrating to me, at times, to have discussions with people that are entrenched, almost fundamentalists of a particular viewpoint, and to them everything is solvable with one of those philosophies.
You talk to someone who sells or wholesales mutual funds and everything is about proper asset allocation created systematically with a withdrawal plan that is will last, and you should be okay if it’s tax efficient. They don’t see the need for any kind of guarantees or downside protection or annuities or longevity insurance.
You talk to a shop whose specialty is annuities, whether immediate, deferred, fixed, variable or equity-linked and that’s all they do, as you pointed out. Everybody should be annuitized, and the sooner the better.
It’s very much where you happen to land that you then develop this approach and of course the true solution is a combination of all of the above. Anyone who comes in and is able to create- again the word product allocation- but the framework that combines all of these, and maps personal preferences into a combination of these strategies is, I think, the one that’s going to win. I call this comprehensive product allocation taking into account the personal balance sheet
I have actually done some historical research on this. I’ve looked at the genesis of the money management industry. Thirty years to forty years ago you had folks that believed that everybody should have their money in “a few good stocks”. You invest in 2 or 3 companies, you pick utilities, you hold the utilities, you get dividends, there’s no point in buying anything else. There was no rigorous framework for systematic asset allocation across thousands of stocks and tens of asset classes.
There were others that were invested entirely in the Dow 30 stocks, the nifty fifty. You’d have this vehement discussion in the media and all of them kind of ignored the idea of broad asset allocation. Now everybody understands that you’re managing a small piece of your client’s investments and then we have to be diversified across countries, sectors, styles. I think that’s what’s going to happen with these strategy classes. People are going to realize that you need them all in small pieces.
Macchia – That makes sense. Right now, Moshe, I’m reading Walter Isaacson’s wonderful book about Albert Einstein. Einstein has been a hero to me over the years. I’m wondering if he’s a hero to you, or if you have others that you admire?
Milevsky – Absolutely. I sometimes joke that he’s my intellectual grandfather. I use the word grandfather because one of his key students, Arthur Komar, was a professor of physics of mine when I went to Yeshiva University in the late 1980s. In academia your pedigree is based on who are your parents and grandparents and great-grandparents. I’m one generation removed. Einstein trained him at Princeton and then he came from Princeton to train students at Yeshiva University and I got to sit at the knees of the child, or the intellectual child, of Albert Einstein.
Obviously he passed away well before my time so I never got to meet him. But, absolutely. It’s impossible to describe in words the way he changed the world. I mean a patent clerk sitting in Bern, and literally processing patent claims, and when you think about who works in the patent office these days it’s just stunning to believe that he could create a theory that literally changed the way in which we think about the world.
And not just once or twice, but three or four times. What many people don’t realize is that many of the models that we use in financial management are based on these underlying stochastic stimulation models, were actually put on a foundation by Albert Einstein in 1905 – 1906 in his work on Brownian motion. If you’ve ever heard the term Brownian motion applied to modeling stock prices, he’s one of the people that developed that framework and we’re essentially using his model in finance as well.
Macchia – Since we’re thinking in such a broad spectrum right now I’d like to ask you three personal questions.
Milevsky – Sure. You can ask then I’m not sure you’ll get an answer.
Macchia – Well, we’ll see. The first is this: If I could convey to you a magic wand, and by waving this wand you could affect any changes in the world of financial services that you wish to, and could make these changes instantly, what would be the first two changes you’d make?
Milevsky – Oh boy. These kinds of questions have to be mulled over. I’ll probably revise this, but I would say that financial literacy would be the wand that I’d like to wave. I’d like people to graduate from high school with a much more sophisticated financial view of the world than they have right now. I get to see them in their second and third year of university or college and those are the elite ones that actually come to our school and are studying business, and it is very depressing… the level of lack of knowledge.
They will be able to fix your iPod and reconfigure your internet connection and literally do mind altering things when it comes to electronics and gadgetry, but when it comes to simple questions like mortgages or checkbooks, or how do you manage money, or compound interest, they were just never taught this. I think that a magic wand that would increase the level of financial literacy across the planet in terms of the financial services industry would do wonders to avoid many of the problems that the industry faces. On issues like suitable sales, and seniors that didn’t understand what they purchased, and individuals that buy bad products that speculate on things that will never make money. Financial literacy would be a big help, and I’m a big advocate of that. I sometimes get flack when I say this. I have 4 children in school. Let’s teach them a little less Shakespeare and a little more asset allocation.
Macchia – Well said. The next question: If you were not Dr. Milevsky doing what you’re doing now, but instead could have any other career in any other industry or field, what would you choose to be?
Milevsky – I would probably, oddly enough, be a pulpit Rabbi. That’s what my father was (Chief Rabbi of Mexico), and my grandfather was (Chief Rabbi of Uruguay), and my great-grandfather was (Rabbi in Lithuania). I was kind of the black sheep. I was the one that said, you know what I’d like to do is something a little bit more practical or realistic.
Hey, it’s a tough life being a Pulpit Rabbi. The pay isn’t very good and you have a community to manage. Many of them are cranky members of your synagogue. It’s a tough life, but I could see myself doing that in another life. Certainly, not in this one. Obviously it would be a very, very big change for me and I doubt that I will ever do it, but that’s kind of in an alternate world what I would be doing. Probably not the response that you expected.
Macchia – I expect nothing. Whether you said Rabbi or trumpet player I would have been equally unsurprised. You get interesting answers to this question. Now, last question: I’d like you to describe your own retirement in its most conceivably perfect form. What will you be doing?
Milevsky – It terms of the daily activities, I believe deep in my heart that I will continue to teach, lecture and speak until the last day on this earth. I will be speaking in front of undergraduate students or graduate students or fellow research faculty members of even industry practitioners. I hope to be giving seminars until the last possible day.
That said, I most probably won’t be living in Toronto, which is where I and my family are based right now. It will probably be somewhere nice. I think Southern California. Specifically, Orange County and Laguna is very appealing to me. Of course the housing prices there are ridiculous on a professor’s salary, but perhaps 30 more years of saving will get me there.
I will also definitely be writing and publishing research articles. It is an interesting question to ask since last week I attended and gave a presentation at the MDRT meeting in New York. They organized a conference called Boomer Retirement and they invited some very well known speakers. It was a huge honor that I was asked to speak as well, since speaking the night before was Alan Greenspan as well as Ken Dychtwald and other notables..
The reason I mention this is that Alan Greenspan was also asked what he was going to be doing in his retirement. His response was, retire to what? He said: “I’m going to continue doing what I’ve always been doing. Maybe a little more golf.” That was his response to great laughter. , To me he was saying, look, this is what I enjoy doing and plan to continue doing it. That really resonated with me. If I wanted to do something different I would do it now already. I never do an activity where at the end of that I say, Gee, I can’t wait until I retire. I probably won’t be doing the volume and pace of what I do now, probably a little less intense, but definitely teaching and writing.
Macchia – I like your answer. Laguna is one of my favorite places and right now I’m looking right behind my desk and there’s a photo of my wife with a building on the beach that says Laguna Lifeguard Station with her standing in front of it. It’s a special place.
Milevsky – That’s definitely where I’m going to end up. I also spent a couple of years in Mexico when I was a kid growing up, so I’ve picked up Spanish quite fluently, and I like the kind of Latin environment close to Mexico and the fact that everyone there, especially in the services sector, speaks Spanish. To me it’s a special place, not just because of the natural beauty and lifestyle. I will probably be sitting on the Laguna Beach somewhere typing and giving webcasts or something but definitely writing. I have a whole bunch of books that I’m still trying to write, so I need time to do it.
Macchia – The good news is you might have 60 or 70 years left to do it. Hopefully with the right annuitization.
Milevsky – And the right healthcare provider and a better diet and a long list of other things that my wife reminds me of.
Macchia – Moshe, is there anything that I’m forgetting that you’d like to talk about that we haven’t. Anything you think readers…
Milevsky – I think we’ve covered a long list of things and it’s certainly reflects a broad range of my interests. So, the answer to your question is “not that I can think of”, especially as it pertains to retirement and retirement income and financial literacy, so you’ve touched on all of the hot spots.
Macchia – I’ve enjoyed it immensely. Thank you, Moshe.
©Copyright 2007 David A. Macchia. All rights reserved.
Meir Statman’s research focuses on behavioral finance. He attempts to understand how investors and managers make financial decisions and how these decisions are reflected in financial markets. The questions he addresses include: What are the cognitive errors and emotions that influence investors? What are investor aspirations? How can financial advisers and plan sponsors help investors? What is the nature of risk and regret? How do investors form portfolios? How important are tactical asset allocation and strategic asset allocation? What determines stock returns? What are the effects of sentiment?
An interview with 
Macchia – Just by way of background for my readers, would you be kind enough to talk about your position and title at Northwestern Mutual, and specifically, what your role there involves?
In this wide-ranging interview, Phil Eckman, CEO of