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15 February 2024 Research Foundation

Lifetime Financial Advice: A Personalized Optimal Multilevel Approach

With a foreword by Roger G. Ibbotson

  1. Thomas M. Idzorek, CFA
  2. Paul D. Kaplan, CFA
Economists have long held that financial planning should be based on life-cycle models, but financial planners have not adopted life-cycle finance. A practical, integrated three-stage model that incorporates life-cycle finance is proposed.
Lifetime Financial Advice: A Personalized Optimal Multilevel Approach Read the Book
Cover from Kaplan_RF


For nearly three-quarters of a century, economists have strongly agreed that financial planning should be based on what are known as life-cycle models. At the heart of these life-cycle models is the relatively simple idea that to maximize lifetime utility, most people should save and invest some of their earnings during their working years to provide for their retirement, thus smoothing their inflation-adjusted consumption over their lifetimes. This idea goes back to Irving Fisher in 1930, and no less than eight Nobel Prizes (Samuelson 1970, Friedman 1976, Modigliani 1985, Becker 1992, Lucas 1995, Merton 1997, Fama 2013, and Deaton 2015) have gone to economists who did important work in life-cycle finance. Paradoxically, most financial planners and many investment textbooks are either unaware of or silent on life-cycle models and life-cycle finance.

This book proposes a practical, integrated three-stage model for financial planning that not only embraces life-cycle finance but also integrates it with single-period optimization models. We make three primary contributions to optimal financial planning.

  1. Life-cycle modeling and single-period optimization have remained two distinct endeavors since their respective inceptions more than 50 years ago. Although the idea was anticipated by Samuelson in 1969, to our knowledge, this is the first work that connects them in a meaningful way.
  2. In “net-worth optimization,” the objective function contains both the investor’s liability and human capital modeled as asset class combinations, and in a single optimization, it jointly determines tax-efficient policy portfolios specific to taxable and tax-advantaged assets. This is a significant extension of mean–variance optimization personalized around the investor’s holistic balance sheet.
  3. We expand the alpha-tracking error optimization problem to include a term that captures the direction and magnitude of the investor’s nonpecuniary preferences, a trading cost term, and a realized tax term. All of these terms are then combined with the alpha and tracking error term in a single optimization to simultaneously determine the holdings of investments in multiple accounts with multiple tax treatments. This innovation thus serves as an all-in-one active versus passive optimizer, a nonpecuniary (e.g., environmental, social, and governance) preference optimizer, an asset location optimizer, a rollover optimizer, a tax-loss harvesting optimizer, and a tax-efficient client onboarding optimizer.

Each of these three innovations represents a significant advancement in the implementation of life-cycle finance. Linking them into a cohesive three-stage model is a further advancement and is the most important aspect of our contribution to applied life-cycle finance.

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