October 2015 10 Questions

​David Blanchett on Successful Retirement Planning, Income Annuities, and Questioning Your Assumptions

Journal of Financial Planning: October 2015


Who: David Blanchett, CFP®, CFA

What: Head of retirement research at Morningstar Investment Management, two-time winner of the Journal’s Montgomery-Warschauer award

What’s on his mind: I think financial planners are incredibly valuable, and so doing high-quality research that helps them better help their clients is very important to me both personally and professionally.

Podcast: Listen to our podcast with Blanchett at FPAJournal.org

Regular readers of the Journal likely need no introduction to David Blanchett. But for those less familiar with retirement income planning research, Blanchett’s work is arguably among the most influential in the profession—not to mention prolific. He aims to publish eight to 12 papers a year, and a quick search of our archives reveals more than a dozen papers published in the Journal alone. He’s driven by a genuine desire to help planners help their clients accomplish their goals.

As head of retirement research at Morningstar Investment Management, Blanchett is continually asking questions, driving toward the next piece or research that will impact various facets of the planning profession—from holistic ways to build more efficient portfolios and the best strategies for goals-based investing, to measuring 401(k) plan effectiveness.

The Journal recently sat down with Blanchett, who is a two-time recipient of the Journal’s Montgomery-Warschauer Award (a testament to the impact of his research), to talk about equity glide paths, annuities, successful retirement planning, and his latest research efforts.

1. You have a passion for the kind of research that helps planners and clients make the best retirement planning decisions. Where does this passion stem from?

I think my passion for research comes from a variety of places. First, I think my parents played a major role. They were both teachers and taught me the importance of asking questions. I also learned relatively early on that just because an idea or solution is generally accepted as being correct doesn’t mean that it actually is.

I really like to dig in and understand both the problem and the solution. While this often takes quite a bit of time, I think it has definitely helped me see the big picture better and develop better solutions for clients. I think at the end of the day that’s probably what keeps pushing me to do research—figuring out how to help people accomplish their goals.

2. What do you feel is the No. 1 thing financial planners misunderstand about successful retirement planning?

I often say that while there is no one right way to do successful retirement planning, there are lots of wrong ways.

I think that if you really want to create a successful retirement plan for a client, you need to be knowledgeable about the different potential solutions and relatively free from biases. I think that too often, planners focus on solutions that play to their primary skill sets or method of compensation. While I don’t expect insurance agents to start embracing investment-only solutions or RIAs to start embracing annuities, I think it’s important to be objective and understand the pros and cons of each approach to really help your clients achieve a successful retirement.

3. You won the Journal’s Financial Frontiers award for your December 2007 paper “Dynamic Allocation Strategies for Distribution Portfolios: Determining the Optimal Distribution Glide Path.” Your most recent Journal-published research (“Initial Conditions and Optimal Retirement Glide Paths” in the September issue) also explored the glide path question. How is this topic of the ideal equity glide path progressing from a research standpoint?

I think the way to move research and ideas forward is to have different people approach a problem different ways. There’s no one single best way to solve a problem, and so researchers use different approaches to try and figure out what’s best. Usually there’s consensus, but that definitely hasn’t been the case for the ideal retirement equity glide path!

If you pay attention to the research, though, there is consensus that there is no one shape that’s going to be best for each retiree. Some retirees are going to be better off with an increasing glide path, others with a decreasing glide path, and others with a static glide path. I think the key is understanding your clients and applying the appropriate research to their situation.

4. You’ve also won two Montgomery-Warschauer awards: for the 2013 co-authored paper, “The 4 Percent Rule Is Not Safe in a Low-Yield World,” and the 2014 solo paper, “Exploring the Retirement Consumption Puzzle.” What does winning this award mean to you?

It means a lot, especially given the quality of the papers in the Journal. I’ve been spending an increasing amount of my time over the last decade doing research and knowing that my research is improving the profession is definitely a great feeling.

I think financial planners are incredibly valuable, and so doing high-quality research that helps them better help their clients is very important to me both personally and professionally.

5. As head of retirement research for Morningstar Investment Management, what kind of research are you currently working on?

I’m constantly cycling through a variety of topics. While I actively contribute to the Journal of Financial Planning, I try to publish between eight and 12 papers a year. There really isn’t too much of a method to the madness of my research, though, since I tend to move across topics based on what’s timely and of interest to me. Most of my research revolves around financial planning, but I’ve been doing a little bit less recently on retirement-related topics.

One of my more recent research themes is taking a holistic approach to building more efficient portfolios, something I call taking a “total wealth” perspective. I had a piece that was just published in the Financial Analysts Journal titled “No Portfolio Is an Island” (May/June 2015 issue with co-author Philip U. Straehl). The key behind the research is that all investors have different assets and risks that exist outside the financial assets/portfolio, called background risks, and that these should be considered when determining the efficient allocation for financial assets. I’ve also explored this concept for charities via endowments, and for corporations via defined benefit plans. I’m also doing a few pieces looking at the unique risks associated with different household assets and liabilities.

One recurring research theme that I have written about consistently over the years are topics around 401(k) plans, such as how to determine the optimal default, how to think about building a plan menu, the potential benefits of managed accounts, measuring plan effectiveness, etc. I spend most of my time now working in the defined contribution space, so these papers are mostly based on conversations I have with fellow employees, plan sponsors, participants, consultants, etc.

6. You are also pursuing your Ph.D. in personal financial planning at Texas Tech. What areas of research you are working on in that regard?

I’m currently a doctoral candidate, so I’m most of the way done, I just need to finish my dissertation. I have to write three papers, and while the topics for the second and third papers are still up in the air, I’m already a good way through the first piece, which is going to explore the drivers of time varying risk aversion. Michael Finke, who is my adviser at Texas Tech, actually wrote a paper on this topic about a year and a half ago with Michael Guillemette that was in the Journal—“Do Large Swings in Equity Values Change Risk Tolerance?” (from the June 2014 issue)—and they’re both involved in this paper as well.

We’re using a dataset of over 25,000 Morningstar clients that took the same RTQ (risk tolerance questionnaire) going back almost seven years so we can see how attitudes toward market risk have changed over time and how they have varied by different attributes, such as age, income, savings rate, etc. I think this research has important implications for planners, since it could help provide some guidance around which types of investors are most affected by market swings.

7. You and Paul Kaplan introduced the concept of “gamma” to the profession with your 2013 paper, “Alpha, Beta, and Now ... Gamma.” What was the motivation behind exploring the tangible value of “good” financial planning, and were you surprised by the results of your research?

The idea of trying to quantify the value of financial planning has been an emerging trend in the literature. There was actually research by Vanguard and Financial Engines exploring this, which they called adviser’s alpha and household alpha, respectively, that came out before the gamma piece. There was also a more recent piece in the Journal about zeta (Reducing Wealth Volatility: The Value of Financial Advice as Measured by Zeta,” by John Grable and Swarn Chatterjee, from the August 2014 issue).

The primary motivation for me to write this paper was based on my experience as a financial planner. I think too often we help clients with a variety of things, like insurance, savings, etc., but the client’s key metric of value is whether or not the portfolio beat some benchmark. I think that good investment management is a component of good financial planning, but investment management is only one piece of a very large puzzle.

The goal of the gamma research was to try and quantify the value of the non-investment stuff. We found that doing just five effective financial planning techniques for retirees resulted in a 23 percent increase in retirement income versus a naïve strategy. We only looked at a relatively small slice of all the different things that a financial planner can do. At the end of the day, I’m not really sure it’s going to be possible to quantify all the things financial planners can do to help their clients accomplish their goals, but it’s definitely more than just building a good portfolio. I’m sure I’ll do more in this space in the future.

8. Can you recap for us what your research has shown about using income annuities in retirement planning?

Sure. Annuities can be incredibly beneficial for certain individuals, but the potential benefit is really very client-specific, based on that client’s situation and preferences.

I think that too many people, when they think about annuities, bring a bias to the table. While there are definitely some very bad annuities out there, there are also some very bad mutual funds. When I talk about annuities, though, I’m largely looking at them from the perspective of a fee-based adviser bringing the best annuities to a client. It’s impossible to guarantee income for life from a portfolio, and therefore an annuity may be a great fit for someone who values income security in retirement.

I think compensation structures play a role in how advisers perceive annuities. For example, many advisers who sell annuities aren’t fiduciaries, and so they aren’t worried about putting clients’ interests first, just suitability. At the same time, though, a lot of financial planners get paid based on assets under management, which creates a financial disincentive to recommend an annuity.

9. Your 2015 Montgomery-Warschauer winning paper, “Exploring the Retirement Consumption Puzzle,” noted a “retirement spending smile” effect. Tell us a little about this and what you hope planners take away from this research.

The No. 1 goal with this research was to question common assumptions used to model retirement. Retirement is the most expensive purchase your client is ever going to make, and so it’s important to really understand how much it is going to cost.

The retirement spending smile has to do with how consumption changes throughout retirement. It’s a smile because spending tends to increase faster, relatively speaking, at the beginning and end of retirement. Probably the most important finding in the piece, though, was that most retirees reduce their consumption, in today’s dollars, throughout retirement.

While most research in financial planning, and financial plans in general, assume that retiree spending increases annually with inflation, this doesn’t appear to be the case in reality, at least on average. So running an additional simulation or financial plan where you assume spending in retirement decreases 1 percent per year in real terms is probably a better starting place than the traditional assumption that spending or consumption increases each year with inflation.

10. In your June 2015 Journal paper, “The Value of Goals-Based Financial Planning,” instead of analyzing the optimal portfolios to fund different goals, you instead looked at how to determine which goals should be funded and how to best save toward them over time. In this paper you propose a goals-based financial planning process. How can this process benefit investors?

Well, it’s funny—most research on goals-based planning is all about the investments, not really about funding the goals. The research has largely tried to answer the question: how do you build portfolios that help you best accomplish goals? But in this research, I developed a framework to determine how to go fund goals over the client’s lifetime, given the client’s preferences toward different goals and funded status.

There is often a significant focus on saving for retirement, and I worry this focus may result in a strategy that is suboptimal. We told you to save 12 percent for retirement; well, an important question is: what else is important to you?

The key is just understanding what your clients want to accomplish, and then helping them weigh the options. Very few clients can accomplish all of their goals. The question is: given scarce resources, what is the best way to accomplish what you want to accomplish given what’s out there? This is actually a software solution we’re developing currently that has been a lot of fun.

Carly Schulaka is editor of the Journal. Contact her HERE.

Learn More

Did you miss David Blanchett’s presentation at the FPA Annual Conference in Boston last month?

Access an OnDemand webinar of Blanchett’s education session “Estimating the True Cost of Retirement” (based on his 2015 Montgomery-Warschauer-winning paper “Exploring the Retirement Consumption Puzzle”) and earn 1.5 CFP CE credits.

Visit FPA-BE.org and click on Virtual Learning to access this and several other CE-eligible sessions from the FPA Annual Conference. OnDemand webinars from the conference are expected to be available at the end of October.




General Financial Planning Principles
Retirement Savings and Income Planning