The second approach, called the KISS (keep it simple and straightforward) or cash flow-driven approach, takes a very different tack: It recognizes each goal is unique and predominantly about cash flows. Rather than trying to create ever more complex MPT approaches, it focuses on creating goal-appropriate, cash flow-generating financial instruments that investors need, which then trivializes the investment problem and eliminates previously mentioned challenges.
To bring this more readily to defined contribution plan participants, Robert C. Merton, a Nobel laureate and professor of finance at the MIT Sloan School of Management, Cambridge, Mass., and I recommend the U.S. Treasury issue a new "safe" bond instrument — standard-of-living indexed, forward-starting, income-only securities, or SeLFIES. This instrument would ensure retirement security, and the federal (or state) government is a natural issuer, although insurance companies and infrastructure companies could easily issue them as well.
SeLFIES would pay the holder annually for 20 years, starting at a fixed date, a fixed real amount (say $5), indexed to aggregate per capita consumption. Instead of current bonds that index solely to inflation, SeLFIES cover both the risk of inflation and standard-of-living improvements so retirees can maintain a particular lifestyle. A 25-year-old today would purchase the 2058 bond, which would pay the holder from 2058 through 2078. This innovation addresses even the most financially illiterate individual, providing a self-reliant alternative to retirement planning. If the individual targets $50,000 real in retirement, the goal is to buy 10,000 bonds over one's working life ($50,000/$5). The complex decisions of how much to save, how to invest and how to drawdown, are folded into one simple calculation of how many bonds to buy. In addition to being simple to understand, liquid, easily traded at a very low cost and with low credit risk, SeLFIES can be bequeathed to heirs. Buying SeLFIES is similar to creating an "individual DB," with guaranteed cash-flow determined simply by the number of bonds purchased. Individuals could easily change the level of desired cash flows in retirement and the goal is easily recalculated. One can easily see how this cash-flow matching instrument can be created for college savings plans (where now the natural issuers are colleges/universities and the link is to tuition inflation, and the payment is just for four years).
In summary, there are no existing instruments or products that perfectly match the cash profile of various goals. Complex theories have been created to establish optimal dynamic savings, investments and decumulation decisions, but these are error-prone, complex, risky and well beyond the reach of the average population. Maybe Einstein had it right when he stated, "If you can't explain it to a 6-year old, you don't understand it yourself."
We need to make investments easy enough for a 6-year-old to understand, and given the importance of cash flows, with a simple innovation, the KISS approach does just that.