Even the world’s top firms pay Ray Arnott for advice. He explains why a $1 trillion investing industry is built on a flawed premise — and why that’s hurting retirement savings.

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• Rob Arnott, the founder and chairman the Pimco subadviser Research Affiliates LLC, is a man whose expertise is so respected that multiple large firms license his investment ideas.
• In an exclusive interview with Business Insider, Arnott explained why he thinks target-date funds — a wildly popular way to invest for retirement — are a far worse option than many think.
• See the full list of the 100 people transforming business here.

Rob Arnott is no fan of conventional wisdom. In fact, when presented with a widely accepted idea or conclusion, his first reaction is to try and disprove it.

It’s a strategy that’s worked well for Arnott since the start of his career. After years spent watching investors adhere to outdated, if not completely inaccurate philosophies, he decided to challenge those long-standing ideas.

Arnott’s first task was to assess the time-honored tradition of weighting equity indexes by market capitalization. He instead backtested a technique that weighted stocks by revenue, and found that the approach had beaten its market-cap counterpart for decades.

With that epiphany, he was off and running — and a whole new investing subgenre was born.

Fast forward to the present, which finds Arnott continuing to spread the gospel of an investment strategy known as "smart beta," which has evolved into one of the world’s hottest investment strategies.

The backbone of smart beta is a technique he’s pioneered called fundamental indexation, which is a practice that involves buying high and selling low and then using that rebalancing as a source of alpha. After that, any time the link between the price of a stock and its index weighting is broken, the strategy sells on strength and buys on weakness.

If there was any question whether the investing elite like what Arnott has to offer, consider the fact that his firm, Research Affiliates, oversees more than $200 billion for other huge firms. And his roster of licensees includes the likes of Invesco, Charles Schwab, and Pimco.

Read more: The world’s biggest and best firms pay Rob Arnott for advice. He shared his top investing idea for the next 10 years — and gave us a peek inside his unique thought process.

Challenging traditional retirement conventions

In recent years, Arnott has found a new area of conventional wisdom to challenge: the best way to save money for retirement. More specifically, he’s focused on target-date funds, which start out risky when a person is younger before systematically ramping down portfolio risk as retirement approaches.

Put simply, Arnott is no fan of the industry, which he says is now close to $1 trillion in size. And the opinion goes well beyond a lack of efficacy.

He points out that target-date funds can often have the opposite effect that an investor intends. That means peoples’ portfolios could possibly get riskier later in their careers — the exact situation they’re trying to avoid.

"No one’s ever tested its core thesis, which is that starting aggressive and then getting more conservative as you get older leaves you with more money in retirement and less risk when, in fact, it does the opposite," Arnott said.

Read more: 2 of America’s most acclaimed wealth managers for the ultrarich explain why a famous approach to retirement investing is dead wrong — and reveal what people should do instead

To that end, Arnott did his own testing, and found that — over a 41-year period — the inverse of the target-date strategy actually outperformed. 

So what can a young professional do instead? For starters, go with a less risky portfolio right off the bat. Arnott said in an October 2014 study that this lessens the downside risk if unforeseen circumstances or unemployment require an individual to cash out prematurely.

Further, in a September 2012 piece, Arnott laid out a handful of straightforward behaviors that he says will improve anyone’s financial longevity. They include saving aggressively, spending cautiously, and working a few years longer.

After all, as he put it: "No strategy can make up for inadequate savings or premature retirement."

NOW WATCH: The founder and CIO of $12 billion Ariel Investments breaks down how his top-ranked flagship fund has crushed its peers over the past 10 years

See Also:

• MORGAN STANLEY: This earnings season is the ‘moment of truth’ for stocks. Here’s why the signs are pointing to a major disappointment for investors.
• Bank of America has discovered a simple trade that’s tripled the market’s return: Buy stocks the ‘smart money’ hates. Here’s how you can get involved.
• Bank of America scoured hundreds of mutual funds with $1.5 trillion in assets and identified 7 neglected stocks poised to surge after crushing earnings

SEE ALSO: JPMorgan quant mastermind Marko Kolanovic can move markets with a single report. He gave us a peek inside how he analyzes data and makes his big calls.

Source: Business Insider – jciolli@businessinsider.com (Joe Ciolli)