Bogleheads© Conference 2011 - Panel of Experts I Part 1
00:00:00.000 | At this time, I'd like to introduce the experts panel for the Q&A with the experts.
00:00:14.200 | Our first panelist is Director of Personal Finance for Morningstar and Senior Columnist
00:00:19.760 | for Morningstar.com.
00:00:20.760 | She is the author of "30-Minute Money Solutions, a Step-by-Step Guide to Managing Your Finances."
00:00:29.240 | She is also co-author of "Morningstar's Guide to Mutual Funds, Five-Star Strategies
00:00:33.700 | for Success, a National Best Seller."
00:00:37.280 | Before pursuing her current role in 2008, she also served as Morningstar's Director
00:00:42.640 | of Mutual Fund Analysis.
00:00:44.960 | She served as editor of several of Morningstar's publications over the years, including "Practical
00:00:50.640 | Finance," "Morningstar Mutual Funds," and "Morningstar Mutual Fund Investor."
00:00:55.920 | She has worked as an analyst and editor at Morningstar since 1993.
00:01:01.200 | She holds a Bachelor's Degree in Political Science and Russian East European Studies
00:01:05.840 | from the University of Illinois at Urbana-Champaign.
00:01:10.260 | Please welcome Christine Benz.
00:01:18.580 | Our next panelist is a retired neurologist who helped co-found Efficient Frontier Advisors.
00:01:24.680 | He's written several titles on finance and economic history, although his early formative
00:01:30.760 | training in economics was confined to brief stints in the U.S. Postal Service during Christmas
00:01:36.280 | breaks.
00:01:37.280 | His two finance books, "The Intelligent Asset Allocator" and "Core Pillars of Investing,"
00:01:43.400 | as well as the content on his website, efficientfrontier.com, have made him uncomfortably popular among the
00:01:50.480 | financial press.
00:01:52.480 | He's also a big believer in the value of creative non-fiction process.
00:01:57.440 | During the past seven years, he's written two volumes of economic history, "The Bird
00:02:02.480 | of the Plenty" and "A Splendid Exchange."
00:02:05.600 | His latest book, "The Investor's Manifesto," has turned out to be another winner.
00:02:11.620 | He holds both a PhD in chemistry and an MD.
00:02:15.160 | Please welcome one of the smartest guys I know, Dr. Bill Bernstein.
00:02:23.800 | Our next panelist is, without a doubt, one of the very best contributors to our forum
00:02:29.420 | and to the Bogleheads community.
00:02:31.040 | In recognition of her value to the Bogleheads community, Taylor and I crowned her the Queen
00:02:37.240 | of the Bogleheads at Die Hard 6 in D.C. four years ago, so that she could take her rightful
00:02:43.880 | place as one of the recognized leaders of the Bogleheads community.
00:02:48.320 | She joined Rick, Taylor, and I on the book committee on the new Bogleheads Guide to Retirement
00:02:53.640 | Planning.
00:02:54.880 | She's also a forum columnist and shares the writing duties with me for our bi-weekly Bogleheads
00:03:00.480 | View column.
00:03:01.480 | Please welcome our queen, Laura.
00:03:03.880 | Our next panelist is a CEO of Portfolio Solutions, a low-cost investment management firm.
00:03:15.440 | He earned a B.S. in business administration from the University of Rhode Island and a
00:03:20.560 | master's in science and finance from Walsh College.
00:03:23.880 | He also holds the prestigious Charter Financial Analyst designation.
00:03:29.360 | He's written five books on low-cost investing, including All About Index Funds and All About
00:03:34.440 | Asset Allocation.
00:03:35.440 | His ETF book is considered by many to be the Bible in the industry.
00:03:41.240 | He was a member of the book committee on the Bogleheads Guide to Retirement Planning, and
00:03:45.200 | his latest book, The Power of Passive Investing, has received wide acclaim.
00:03:50.320 | And if that's not enough, he's also a Forbes columnist.
00:03:54.660 | Please welcome Rick Ferry.
00:04:01.760 | Our next panelist is the founder of WealthLogic, an hourly-based financial planning and investment
00:04:06.760 | advisory firm that advises clients with portfolios ranging in size from $10,000 to $50 million.
00:04:16.880 | He's mocked on a fairly regular basis by some financial professionals for his hourly fee
00:04:22.560 | business model and its obvious inability to make him rich.
00:04:27.480 | He's also the author of How a Second Grader Beats Wall Street, and he writes the Irrational
00:04:36.320 | Investor blog at cbsmoneywatch.com.
00:04:40.080 | He teaches behavioral finance at the University of Denver and is an adjunct faculty member
00:04:45.620 | at Colorado College.
00:04:47.120 | He has a lot of meaningful credentials after his name.
00:04:50.960 | He's a CFP, a CFA, and an MBA, but claims he can still keep investing simple.
00:04:57.640 | His goal is never to be confused with Jim Cramer.
00:05:00.800 | Please welcome Alan Roth.
00:05:04.080 | And as I said, Bill Schultes was scheduled to be with us, but he couldn't make it.
00:05:12.840 | So we've had several questions from attendees and from the forum.
00:05:19.400 | So let's get right to it.
00:05:22.080 | We have a question.
00:05:23.080 | When I call a question from the attendee, if they would stand up just so that we know
00:05:27.020 | who you are and we can respond to you.
00:05:31.480 | This is from Bob, also known as Shellcroft, Bob Shell.
00:05:36.240 | Bob asks, "The amount of national debt in several nations, Iceland, Greece, Italy, and
00:05:43.360 | Ireland as examples, has become so serious that unpopular austerity measures have been
00:05:48.840 | implemented to calm lenders, stabilize and reduce debt, and avoid more financial crisis.
00:05:56.120 | With so many countries confronting these same and very large debt problems, what in your
00:06:02.920 | view are investors in U.S. equity index funds and investors in international equity index
00:06:09.160 | funds likely to experience in terms of volatility and returns over the next 10 years?"
00:06:15.840 | That's a good question.
00:06:18.840 | We'll start with, on the end, we'll start with Rick.
00:06:25.840 | Rick told me to make sure Alan answered all the questions.
00:06:31.840 | Alan and Christine have to answer all the questions today.
00:06:35.840 | What does it mean in terms of volatility?
00:06:37.840 | Yeah, there's going to be more volatility, but that means that there's also going to
00:06:41.840 | be less people investing in equity, so there'll be a higher risk premium paid to the people
00:06:46.840 | who hang in there.
00:06:48.840 | In my opinion, the risk premium on U.S. equity anyway, particularly large cap U.S. equity,
00:06:54.840 | is going to be higher than what it's been.
00:06:57.840 | I'm estimating that the equity risk premium is going to be about 6% over the next decade
00:07:03.840 | or so, maybe even a little higher than that for large cap U.S. equity.
00:07:07.840 | Internationally, it might be a little bit lower.
00:07:09.840 | A lot of money went into emerging markets.
00:07:11.840 | There might have been too much money going in there.
00:07:14.840 | Europe's going to take a while to resolve their issues.
00:07:17.840 | I'm not a market timer, but I can have an opinion just like everybody else.
00:07:25.840 | In my opinion, the U.S. equity risk premium is going to be good.
00:07:32.840 | It's going to be a little bit higher than average over the next decade.
00:07:35.840 | That's my opinion.
00:07:37.840 | -Ellen, any thoughts?
00:07:41.840 | -Does it seem like the market is much more volatile today?
00:07:46.840 | I just looked it up.
00:07:48.840 | Wilshire gave me some great data.
00:07:50.840 | The monthly standard deviation of the last 10 years is 4.7%.
00:07:56.840 | The previous 30 years was 4.6%.
00:08:02.840 | A tiny bit more volatile, perhaps more volatile on a daily basis.
00:08:06.840 | Today, we have sovereign nations that can go under.
00:08:14.840 | This time, it's different.
00:08:16.840 | The last time, it was different.
00:08:18.840 | The next time, it will be different.
00:08:20.840 | Capitalism will survive.
00:08:24.840 | -I largely agree with what Rick and Allen said.
00:08:27.840 | I might make the case that I think that foreign stocks,
00:08:31.840 | particularly European stocks, are even more attractively priced right now.
00:08:36.840 | It's not difficult to find continental European stocks
00:08:40.840 | selling at single-digit multiples.
00:08:42.840 | I don't know what the European index fund is,
00:08:46.840 | but it's probably fairly close to 10 right now.
00:08:48.840 | Dividend yield fairly close to 4%.
00:08:52.840 | That's discounted a fair amount of bad news,
00:08:55.840 | which is pretty much constant with what Rick said.
00:09:00.840 | I almost think the emerging markets now are almost becoming fairly valued once again.
00:09:06.840 | When I get asked by professional audiences what I think of emerging markets,
00:09:10.840 | I say the wonderful thing about them is that from time to time,
00:09:13.840 | they can become really cheap.
00:09:17.840 | I think that's about to happen.
00:09:19.840 | I'll ask Rick one question, though,
00:09:21.840 | which is that in order to see an equity risk premium of 6%,
00:09:26.840 | are you expecting more price falls to get there,
00:09:28.840 | or do you think we're there already?
00:09:30.840 | In other words, you're predicting that an equity risk premium of 6% or about
00:09:35.840 | on U.S. equities, do you think we're there already,
00:09:38.840 | or do you think the price is going to have to fall to get there?
00:09:40.840 | I think we're there.
00:09:41.840 | I think we're there in the way I calculated.
00:09:46.840 | This is before inflation, so it's a real equity risk premium,
00:09:49.840 | and you have to add an inflation rate on top of this.
00:09:53.840 | I'll get to that in a minute.
00:09:55.840 | Right now we have S&P paying 2.1%, 2.2% dividend.
00:10:04.840 | If dividends are reinvested, there's actually a compounding effect that takes
00:10:07.840 | place over a 10-year period of time.
00:10:09.840 | So, in fact, dividend yield over a 10-year period of time would be more like 2.5.
00:10:14.840 | So there's 2.5 from dividend payments.
00:10:17.840 | GDP, real GDP, is basically the growth of earnings in a very simplified way.
00:10:24.840 | So let's say that real GDP is below normal GDP in this new normal phase that
00:10:29.840 | we have, and so add 2.5% for GDP growth over a 10-year period.
00:10:36.840 | That gets you to 5.
00:10:38.840 | Unlike Jack, I think that the market is discounted quite a bit based on the
00:10:46.840 | risk-off trade that a lot of investors are doing, and I think the P/E multiple of
00:10:51.840 | the market is actually going to expand as opposed to contract.
00:10:54.840 | So instead of taking off one like Jack did, I'm actually adding one, saying that
00:10:59.840 | the P/E of the market is going to go from 12 to perhaps 15, which would be a
00:11:03.840 | normal P/E over a long-term period of time, about 15 or 16.
00:11:07.840 | And if we get that multiple expansion on equities up to 15 or 16 over the next
00:11:12.840 | 10 years, you add another 1%.
00:11:15.840 | So it is 2.5% from dividends, 2.5% from GDP growth, 1% from multiple expansion
00:11:22.840 | up to a normal 15 or 16, and then you add on whatever inflation is.
00:11:27.840 | So 2% inflation.
00:11:29.840 | So that's 6% there, and you add on 2% for inflation to get to 8.
00:11:33.840 | - I don't know about the new normal, because the new normal was appraised
00:11:38.840 | as a coin by the geniuses at PIMCO in April or May of 2009.
00:11:45.840 | So that's a great call if there ever was one.
00:11:48.840 | And low economic growth means low share dilution.
00:11:52.840 | It means high buybacks.
00:11:55.840 | And so it's not necessarily a bad thing for the owners of the common shares.
00:12:03.840 | - One point I would make, I was out at Vanguard yesterday afternoon before
00:12:06.840 | everyone else got there and sitting down with some people in their portfolio
00:12:10.840 | construction group, the folks who do research on issues such as asset
00:12:15.840 | allocation and so forth, and they've got a really compelling paper where they've
00:12:19.840 | looked at the connection between economic growth and market performance
00:12:24.840 | and found almost no correlation.
00:12:27.840 | So I think that that's a good message for anyone who's looking at compelling
00:12:32.840 | growth in emerging markets, weak growth in developed markets, and attempting
00:12:35.840 | to make portfolio decisions based on that.
00:12:38.840 | What they found is that there really isn't a lot of connection.
00:12:42.840 | So I know that it's tempting to pay attention to the headlines,
00:12:46.840 | certainly keep an eye on economic news just for our own lives.
00:12:50.840 | But just in terms of predicting market performance, it's maybe not something
00:12:55.840 | that you want to use to adjust your portfolio.
00:13:00.840 | - Okay. The next question is from Lady Geek.
00:13:05.840 | She will preface it with the comment that this thread, this subject has over
00:13:12.840 | 31,000 views in a six-week period and contains one of the most intensely
00:13:16.840 | argued topics I've seen in quite a walk.
00:13:19.840 | And we'll continue this discussion with the panel, and the answer is yes.
00:13:24.840 | So she said, "With regard to a forum discussion on Trinity study authors update
00:13:30.840 | their results in which Bill Bernstein contributed a few comments.
00:13:34.840 | The first question is, does anyone on the panel recommend changing their target
00:13:39.840 | safe withdrawal rate different than the recommended 4%?
00:13:43.840 | For example, should one plan to vary their withdrawal rates as necessary?"
00:13:49.840 | I'll comment on that first, and I'm sure everybody will have something to say.
00:13:53.840 | But I think it's ridiculous to think that at some point in time, when we retire
00:13:58.840 | at 65, that we are going to set a number that can't be changed.
00:14:03.840 | I mean, we've adapted all of our life and adjusted all of our life to situations,
00:14:08.840 | and to think that we are never going to make any adjustments once we set this
00:14:13.840 | 4% withdrawal rate adjusted for inflation is--to me, it's ridiculous.
00:14:22.840 | - Mel, I'll just respond.
00:14:24.840 | I agree with you.
00:14:25.840 | In general, although I recently had--probably a year ago, I talked to
00:14:29.840 | Harold Deminsky.
00:14:30.840 | Some of you may know him.
00:14:31.840 | He's a noted financial planner.
00:14:33.840 | And I discussed this question of perhaps adjusting withdrawal rates to reflect
00:14:40.840 | market action, so bringing withdrawal rates down at certain points in time.
00:14:45.840 | And he said, from a practitioner's standpoint, he said, "Unfortunately,
00:14:49.840 | sometimes when you're asking retirees to do that, you're asking them to cut out
00:14:54.840 | the things that are their real quality of life items."
00:14:57.840 | So going out to dinner, going to the movies.
00:15:00.840 | And so he said, "It makes all the sense in the world if you have it on paper,
00:15:05.840 | but from a practitioner's standpoint, it can be very difficult to tell people
00:15:09.840 | to cut back on certain things that are really contributing to their quality of
00:15:14.840 | life in their later years."
00:15:17.840 | - Do you want to comment?
00:15:18.840 | Did you comment on that before?
00:15:20.840 | - Yeah.
00:15:21.840 | I mean, I really don't think that I'd change my view.
00:15:28.840 | You know, to me, the guidelines, 2%--what we like to tell people is that,
00:15:32.840 | you know, 2% is bulletproof, 3% is probably safe, 4% is starting to take chances,
00:15:38.840 | and 5%, you're eating Alpo.
00:15:42.840 | And I really, you know, I think that the value of that sort of paradigm is simply
00:15:48.840 | a reality check for people in the saving phase to let them know that, you know,
00:15:53.840 | you've only saved, you know, five times or ten times your annual living expenses.
00:16:00.840 | You're nowhere near done with the job.
00:16:06.840 | - About two years ago, I did a Monte Carlo simulation for an article I did for
00:16:10.840 | Money Magazine, and I felt really good about the simulation because I ran the
00:16:13.840 | results by Bill Bernstein, who agreed.
00:16:17.840 | You may not remember.
00:16:19.840 | But the 4%, I believe, is a theoretical safe withdrawal rate.
00:16:25.840 | It assumes a portfolio, in my model, of a 50/50 low-cost index fund with annual
00:16:32.840 | rebalancing.
00:16:34.840 | What I also did is I looked at what would the safe return for the average investor
00:16:39.840 | who pays the penalty for expenses and pays the 1.5% penalty for emotions.
00:16:45.840 | Gold, you know, going into whatever is hot.
00:16:48.840 | And what I found was that the safe withdrawal rate for the average investor
00:16:54.840 | paying average expenses and having average emotions is only about 2.5%.
00:17:00.840 | - Wow.
00:17:06.840 | - I always like to look at a safe withdrawal rate as whatever the cash flow
00:17:09.840 | is that's coming off of your portfolio.
00:17:11.840 | So if stocks are paying a little over 2% bonds with a combination of total bond
00:17:19.840 | market and some high yield, you can actually bump it up to over 4%, so 2.5 and 4.
00:17:25.840 | So I look right now at the safe withdrawal rate of about 3.5.
00:17:29.840 | I mean, it would be 4, except that the Fed is kind of getting in the way of this
00:17:33.840 | because they're artificially lowering treasury bond rates, which are part of the
00:17:37.840 | aggregate bond market.
00:17:39.840 | So you're getting less from the aggregate bond market than you really should be
00:17:42.840 | as far as the yield.
00:17:44.840 | So right now, my "safe withdrawal rate," and I agree with Alan, it is a theoretical
00:17:49.840 | number.
00:17:50.840 | I mean, I don't think you should be looking at this as, "Is this the only amount of
00:17:58.840 | money you should be taking out of your portfolio?"
00:18:00.840 | Because I'm also under the belief that you're not going to live forever.
00:18:05.840 | Do you want your kids to inherit every dime of principal you currently have now
00:18:09.840 | on an inflation-adjusted basis, or they get what's left?
00:18:15.840 | And you really have to take those things into consideration to determine your
00:18:19.840 | longevity and how much you want to leave to the kids when you die.
00:18:22.840 | And the fact is, and I've been saying this for a long time, you don't spend as much
00:18:25.840 | money when you're 90 years old as you do when you're 65 on an annual basis.
00:18:30.840 | So you have this flattening spending curve that happens, and it's actually what
00:18:36.840 | I've seen with my grandparents and my parents is a decreasing spending later on
00:18:39.840 | in life as you get up into your 80s because you don't take as many vacations,
00:18:43.840 | you don't have two cars, you might sell the vacation home.
00:18:46.840 | And all these things happen later on in life where your cash flow going out just
00:18:49.840 | gets down to your basic living expenses, and that's it.
00:18:52.840 | So you put all these things together in a formula, and the question is,
00:18:55.840 | what is your safe withdrawal rate starting at age 65?
00:18:58.840 | It might be higher than 3.5%.
00:19:01.840 | I always say spend a little more when you're 65 because you're not going to be
00:19:05.840 | able to spend it when you're 95.
00:19:07.840 | And that's my view on this picture.
00:19:10.840 | So I like the Trinity study.
00:19:11.840 | I've seen so many financial planners that look at that and say,
00:19:16.840 | "You need to cut out your magazine subscriptions because you're not going to
00:19:20.840 | have enough money to live on when you're, you know, 113 years old."
00:19:23.840 | [Laughter]
00:19:25.840 | I just don't buy it.
00:19:26.840 | So I think it's like much more to that than just that mathematical number.
00:19:30.840 | Well, a couple of things I'd like to point out.
00:19:32.840 | First of all, the Trinity study shows what worked in the past.
00:19:36.840 | There's no guarantee that that's going to work in the future.
00:19:40.840 | The second thing is is that the Trinity study survival rates use a lot more
00:19:45.840 | equities in their portfolios than some retirees want to hold.
00:19:52.840 | So the other thing to address the point that Rick talked about was it mentioned
00:19:58.840 | you don't spend as much when you're older as you do in the early years of
00:20:02.840 | retirement.
00:20:03.840 | But I would say that I would disagree that some people are going to have to
00:20:07.840 | spend a lot more because they're going to go in long-term care or assisted
00:20:12.840 | living, and that is very, very expensive.
00:20:15.840 | And I can tell you my father, who is 96, is spending an awful lot of money in
00:20:20.840 | assisted living.
00:20:21.840 | So that's something to keep in mind.
00:20:23.840 | But he has you, Mel.
00:20:24.840 | [Laughter]
00:20:27.840 | I'm all serious about this.
00:20:28.840 | The one piece of equity that a lot of people who have children never take into
00:20:32.840 | consideration is the fact that they have children.
00:20:34.840 | And their children have done very well, and their children are not going to let
00:20:37.840 | them eat dog food.
00:20:39.840 | I mean, whether you like it or not, the backup for America is the next
00:20:44.840 | generation, the children who are going to help support the parents if they
00:20:47.840 | need it.
00:20:48.840 | And I know it's never counted in all these formulas, but it exists.
00:20:51.840 | You're not going to let your father get thrown out into the street.
00:20:54.840 | You can --
00:20:55.840 | [Laughter]
00:21:02.840 | I'd just like to comment also.
00:21:03.840 | I think that something like the Trinity Study is useful for people who are not
00:21:07.840 | yet retired also.
00:21:09.840 | It's just a planning tool, sort of a target to think about.
00:21:12.840 | None of us know what the future is going to bring, but if you're trying to
00:21:16.840 | figure out as you approach that date, when can I retire, you've got to have
00:21:20.840 | something to sort of give you a feel for that.
00:21:22.840 | Part of that is sort of whatever your current expense is, sort of being able to
00:21:26.840 | project ahead.
00:21:27.840 | But the farther out you are, the rougher that number is going to be.
00:21:31.840 | And I think it's a very good way to do that.
00:21:34.840 | So if you can aim when you're in your 20s and 30s to try and hit a 2% rate to
00:21:39.840 | cover your living expenses, I think that you're going to be in much better
00:21:42.840 | shape than if you're planning for 7% or 8% or whatever it is.
00:21:46.840 | So I just find it useful as a tool.
00:21:48.840 | It depends, again, like many things in finance, where you are, what stage in
00:21:51.840 | life you are, and where you are in this withdrawal process.
00:21:54.840 | We're still contributing.
00:21:56.840 | I just want to add to that briefly on what Mel said about the study, about the
00:22:00.840 | Trinity study, which is that it's used historical returns with an abnormally
00:22:05.840 | high equity risk premium, a sort we're not going to see for a long time.
00:22:10.840 | And so they recognize that.
00:22:13.840 | I know Wade Fowley, he did the study on my suggestion in a number of different
00:22:17.840 | countries, including Japan, obviously.
00:22:20.840 | In most other countries it comes out much more friendly.
00:22:22.840 | But there's another aspect to that study which very few people comment on, and
00:22:26.840 | it's always useful to keep in mind, which is that almost between about 75%
00:22:31.840 | equity and 25% equity, in other words, between 25-75 and 75-25, the survival
00:22:37.840 | rates were almost the same.
00:22:39.840 | So what that says is that almost really within reason your equity exposure
00:22:44.840 | doesn't matter that much to your survival probability.
00:22:48.840 | What matters is that you keep your discipline.
00:22:52.840 | And one thing that I see from a lot of clients coming in, mistakes that
00:22:56.840 | they've made, is chasing income.
00:22:59.840 | I'll have people that come in with portfolios yielding 6%, 7%, 8%, and I
00:23:04.840 | look at the total return, and it has been quite negative.
00:23:07.840 | So looking at your total return versus income is important.
00:23:11.840 | Don't buy Greek bonds and assume you can have a 65% safe withdrawal rate.
00:23:15.840 | [Laughter]
00:23:18.840 | The second part of the question is, "Which is the better approach for
00:23:22.840 | analysis, Monte Carlo or historical data?"
00:23:32.840 | None of the above.
00:23:38.840 | You have to look at historical data to try to come up with what your
00:23:41.840 | expectations of returns are in the markets.
00:23:44.840 | And I don't mean just doing a naive look back and say, "Well, the return
00:23:48.840 | of the equities have been this, the return of bonds have been that.
00:23:50.840 | Therefore, that's what it's going to be going forward."
00:23:52.840 | And unfortunately, a lot of people who are in this business, that's what
00:23:56.840 | they do, and of course they have terrible, erroneous expectations of return.
00:24:00.840 | I agree with Laura.
00:24:02.840 | I mean, it's more than that.
00:24:03.840 | It's more--it's neither.
00:24:06.840 | It's neither Monte Carlo, and it's neither historical numbers.
00:24:11.840 | I mean, it's more common sense, or I don't know what you want to call it,
00:24:15.840 | but it's not--there's no hard and fast way.
00:24:19.840 | I'm a strong believer in Monte Carlo simulation.
00:24:22.840 | And in 2008, Monte Carlo simulation got bashed.
00:24:26.840 | And it wasn't the Monte Carlo simulation.
00:24:28.840 | It was the incredible assumptions that went into it.
00:24:32.840 | I saw advisors using, "Well, the stock market's going to yield this.
00:24:36.840 | I'm more brilliant.
00:24:38.840 | I'm going to add 2% alpha.
00:24:40.840 | I'll know when to get out.
00:24:41.840 | Let's make the standard deviation of the stock market, you know, 8%."
00:24:45.840 | So you put garbage in a good model, and you're going to get garbage out.
00:24:48.840 | You have to use history to come up with the assumptions.
00:24:54.840 | You have to use common sense coming in with the Monte Carlo simulation.
00:24:59.840 | Using history alone, you know, there's been a lot of criticism that I think
00:25:04.840 | is just on Jeremy Siegel's 200 years of history.
00:25:08.840 | We really only have, since 1926, really good reliable data on the stock market.
00:25:14.840 | So Monte Carlo simulation with real assumptions and common sense.
00:25:22.840 | And the final part of the question, "Is the life cycle finance approach anything new?"
00:25:31.840 | I'm not quite sure.
00:25:33.840 | That sounds like a financial planner question to me.
00:25:35.840 | I'm not sure what the question really is, so hopefully Rick or--
00:25:39.840 | Susan, what did you mean?
00:25:40.840 | I meant as part of that Trinity thread, they were throwing up different approaches
00:25:43.840 | that come up with the number.
00:25:45.840 | And somebody at the end threw in life cycle finance as a Monte Carlo historical,
00:25:50.840 | and then it got discussed rather thoroughly.
00:25:54.840 | I thought it was part of the problem to come up with the safe withdrawal rate.
00:26:00.840 | But maybe they were going a little bit off.
00:26:02.840 | Maybe it was a subtle discussion on something else inside that thread.
00:26:08.840 | That's so easy I'm going to let Rick answer.
00:26:11.840 | [laughter]
00:26:14.840 | I'm really not sure what--
00:26:15.840 | Alan, you're the new guy in the panel.
00:26:17.840 | [laughter]
00:26:19.840 | Christine, too.
00:26:20.840 | [laughter]
00:26:22.840 | Let Mikey do it, Alan.
00:26:24.840 | [laughter]
00:26:26.840 | All right, the next question is from Ken Barrett.
00:26:29.840 | Did anybody want to address that, or did they understand what the question is?
00:26:33.840 | Just discard it then.
00:26:34.840 | Maybe it wasn't--
00:26:35.840 | Okay.
00:26:36.840 | From Ken Bennett.
00:26:38.840 | It says, "The question is a general question for the panel.
00:26:42.840 | "Currently I'm 10 years away from retirement
00:26:44.840 | "and hold approximately three months of salary in an emergency fund.
00:26:48.840 | "What is the recommended time frame for increasing the amount of cash in reserves,
00:26:53.840 | "and how much should I plan on having in that account in retirement?"
00:27:00.840 | So in other words, I think the question is, is that while he's working,
00:27:04.840 | he has a three-month emergency supply.
00:27:06.840 | Now he needs a cash reserve to live on.
00:27:10.840 | When should he start increasing the account
00:27:14.840 | so that in retirement he has what would be considered sufficient funds in cash?
00:27:20.840 | Tomorrow, three months of living expenses would scale the job result,
00:27:27.840 | unless you have really, really, really, really good disability insurance.
00:27:33.840 | That's what I was thinking too, Bill.
00:27:35.840 | One thing I've been talking about,
00:27:37.840 | those yields on CDs and money markets and everything else
00:27:40.840 | are just about as low as they're going to go.
00:27:43.840 | I've been talking about the idea of building a two-part emergency fund,
00:27:46.840 | so one three-month chunk that consists of true cash
00:27:50.840 | and then maybe another portion that consists of a short-term bond fund
00:27:55.840 | with some potential for principal fluctuation,
00:27:57.840 | but you have that truly cash piece for immediate needs.
00:28:03.840 | So my thought is for most people,
00:28:06.840 | they want to nudge that emergency fund out a little bit.
00:28:10.840 | They can do that as long as they do have a piece carved in cash.
00:28:13.840 | And then in terms of enlarging that,
00:28:15.840 | I usually say that retirees should come into retirement
00:28:19.840 | with about two years' worth of living expenses in true cash.
00:28:24.840 | I'm sure some others on the panel feel differently,
00:28:27.840 | and my bias would be to sort of gradually enlarge that
00:28:30.840 | rather than doing that just as you are approaching retirement.
00:28:36.840 | Yeah, I was actually going to say exactly the same thing.
00:28:38.840 | I think now is the time to start with that on a gradual basis
00:28:41.840 | because if you're ten years out,
00:28:43.840 | then you've got plenty of time to sort of slowly build up that cash balance.
00:28:46.840 | But I also agree that three months would make me extremely nervous.
00:28:49.840 | I mean, unless you've got really, really, really solid employment
00:28:53.840 | and disability insurance, and perhaps your portfolio is already large enough
00:28:56.840 | that if you suddenly had to stop working tomorrow,
00:28:58.840 | it wouldn't be a big problem for you financially.
00:29:02.840 | I don't think I have one month's worth of cash in my portfolio.
00:29:06.840 | With that said, I have what I call near cash,
00:29:09.840 | and I've written about an Ally Bank CD that's yielded--
00:29:13.840 | it's a five-year CD, but it's yielding about 2% now,
00:29:17.840 | and it has a 60-day early withdrawal penalty.
00:29:21.840 | So in other words, after 60 days,
00:29:23.840 | I've earned at least as much as the 0.03% that the prime money market is paying.
00:29:29.840 | So having near cash or access to cash via a home equity line of credit
00:29:34.840 | that the bank cannot cancel--
00:29:37.840 | so having access to cash is more important than cash itself.
00:29:43.840 | Yeah, these are all good points.
00:29:45.840 | I agree with Christine that in my own situation where I'm 53
00:29:51.840 | and I'm going to be working for another 10 years at least,
00:29:56.840 | I have one year's worth of liquid assets set aside in a separate account,
00:30:02.840 | but it's divided into two buckets.
00:30:04.840 | I have near-term liquid asset cash,
00:30:08.840 | which is actually just sitting in a money market,
00:30:10.840 | three months' supply of that,
00:30:12.840 | but I have nine months' supply of what corporate America calls
00:30:16.840 | permanent liquid assets,
00:30:18.840 | which the liquid assets sometimes come down a little bit,
00:30:22.840 | so I might end up with two months or something like that,
00:30:25.840 | but then I refund it and it goes back up to three.
00:30:27.840 | So there's different levels of money that you have in your emergency fund
00:30:33.840 | where once you get past three months
00:30:35.840 | and you've got these other nine months there,
00:30:37.840 | these permanent liquid assets you can be more aggressive with.
00:30:40.840 | I have corporate bond funds in there.
00:30:42.840 | I even have some equity funds in there and index funds, equity.
00:30:47.840 | I know that sounds strange to have equity in an emergency fund,
00:30:50.840 | but that's way down here at the bottom
00:30:52.840 | on my one year's worth of permanent liquid assets,
00:30:56.840 | so I've never had to touch it,
00:30:58.840 | and it's going to be a higher rate of return with better taxes
00:31:01.840 | because these are taxable accounts.
00:31:03.840 | Now, my plan is, personally, when I retire,
00:31:06.840 | whenever that is, at age 65 or whenever,
00:31:09.840 | I'm going to have, as Christine suggested,
00:31:11.840 | two years of liquid money in this account,
00:31:15.840 | so I'm going to increase it.
00:31:17.840 | I may not have to increase it that much
00:31:19.840 | because probably my expenses might go down when I retire,
00:31:21.840 | but that's my plan, so I agree with Christine.
00:31:25.840 | Yeah, I mean, when you consider a liquid asset,
00:31:29.840 | I just have a nice range of opinions,
00:31:31.840 | and I think it's a wonderful, wonderful exposition of it.
00:31:34.840 | Certainly I don't mean money markets
00:31:36.840 | or money stuffed in the mattress.
00:31:38.840 | I would define cash as anything
00:31:40.840 | that at the end of the financial world
00:31:42.840 | you're not going to take more than a couple percent of your head on.
00:31:45.840 | I wouldn't put corporate bonds in there.
00:31:47.840 | I'm not putting short munis in there.
00:31:49.840 | I would certainly put CDs in there as well.
00:31:53.840 | So, you know, I certainly don't mean you have to have that much,
00:31:56.840 | you know, a year or two's worth of cash in a money market.
00:31:59.840 | Well, one of the things that I've long advocated
00:32:03.840 | as an emergency fund are I-bonds.
00:32:07.840 | I-bonds, of course, once they get to the one-year spot,
00:32:12.840 | they're like cash,
00:32:14.840 | and yet if you don't need them,
00:32:16.840 | you're earning a very reasonable return,
00:32:19.840 | especially if you bought back when I told you about it.
00:32:21.840 | (laughter)
00:32:24.840 | Those puppies are yielding over 8% right now
00:32:27.840 | for those who didn't get them.
00:32:29.840 | But the point is, is that there's so much flexibility
00:32:32.840 | once you get to the one-year spot
00:32:34.840 | that you can redeem them at any point,
00:32:37.840 | and yet you're not suffering with low yields,
00:32:40.840 | and you're not--if you're looking for the long haul,
00:32:44.840 | you're not getting ravaged by inflation.
00:32:46.840 | Yeah, Mel, it's funny.
00:32:48.840 | I've been working on a thread with some of our users
00:32:50.840 | on Morningstar.com and one of the retirement forums,
00:32:52.840 | and I asked them what their biggest surprises
00:32:54.840 | were in retirement, happy and otherwise,
00:32:57.840 | financial and otherwise,
00:32:59.840 | and a few posters said, "Thank God for those I-bonds,"
00:33:03.840 | and I think they actually took the hat to you guys for it.
00:33:06.840 | (applause)
00:33:12.840 | And don't forget, Mel's unloaded.
00:33:15.840 | Mid-cap seat.
00:33:16.840 | (laughter)
00:33:18.840 | Okay, the next question,
00:33:20.840 | "Should TIPS be part of the portfolio of a younger person,
00:33:24.840 | "say under 40?
00:33:26.840 | "If so, how much of one's bonds should be in TIPS?"
00:33:33.840 | I'm sure there's a lot of different opinions on this,
00:33:36.840 | but basically, when you're working,
00:33:39.840 | normally your wage increases are going to help
00:33:45.840 | keep you up with inflation.
00:33:48.840 | So I don't think it's that important for a younger person,
00:33:52.840 | but it's still a good investment,
00:33:55.840 | and there's nothing to keep a young person from getting that.
00:34:00.840 | My bond portfolio is fixed.
00:34:05.840 | I mean, it doesn't matter if it's somebody who's in their 60s
00:34:09.840 | or somebody who's in their 20s.
00:34:11.840 | It's simply 60% Vanguard aggregate bond market,
00:34:14.840 | total bond market.
00:34:16.840 | What's missing out of the Barclays capital aggregate bond market
00:34:22.840 | are two asset classes.
00:34:24.840 | One of them are TIPS.
00:34:26.840 | TIPS are not included in that.
00:34:28.840 | So if you wanted to have a total bond market,
00:34:30.840 | you would have to add TIPS.
00:34:32.840 | The other side that's not included in that index
00:34:35.840 | is high-yield corporate bonds.
00:34:37.840 | So if you wanted to have a total bond market index,
00:34:41.840 | you'd have to actually include some high yield.
00:34:43.840 | I put 20% in TIPS, 20% in high yield, 60% in the total bond market.
00:34:50.840 | It seems to work so that somebody who's young,
00:34:53.840 | even though they might only have 20% fixed income in their portfolio
00:34:57.840 | because they have a lot of human capital in front of them
00:35:00.840 | and many years to work,
00:35:01.840 | whatever that bond portion is, if it makes sense--
00:35:05.840 | because sometimes it doesn't make sense
00:35:07.840 | because they don't have a lot of money to invest--
00:35:09.840 | but if it makes sense, I think a 20/20/60 strategy has worked very well.
00:35:14.840 | It gives you a little bit of a hedge against unanticipated inflation.
00:35:20.840 | Inflation rate is inherent in all fixed income, including TIPS.
00:35:27.840 | What TIPS gives you a hedge against is a jump in the unanticipated inflation,
00:35:31.840 | an actual jump in inflation that nobody was expecting.
00:35:34.840 | I think we were talking about between 2% and 2.5% expected inflation over the long term.
00:35:38.840 | So if it jumps to 5%, it jumps to 6%, it jumps to 7%,
00:35:41.840 | that's what your TIPS are going to give you, that hedge.
00:35:46.840 | So I think it's important to have some in a portfolio.
00:35:48.840 | I think this was addressed last night at Vanguard, too,
00:35:51.840 | when they were discussing the makeup of the Target Retirement Funds
00:35:55.840 | and why they did not include TIPS in the funds for the long-term funds
00:36:02.840 | and that they did include them in the shorter-term funds.
00:36:06.840 | Yeah, I often look at the data that Ibbotson puts together on asset allocation,
00:36:11.840 | and Ibbotson is under the Morningstar umbrella, so I'm able to harness what they do.
00:36:16.840 | I believe that their TIPS allocations for retirement portfolios
00:36:20.840 | actually run as high as 30% of the fixed income portfolio,
00:36:23.840 | and for younger investors it's more in the range of 20% of the fixed income portfolio.
00:36:29.840 | So it sounds like we're all kind of in the same general ballpark.
00:36:32.840 | I use behavioral finance as a reason to be a little bit active on TIPS,
00:36:38.840 | and I think that as humans we tend to think in nominal terms
00:36:42.840 | rather than in real terms, inflation adjusted, that matters.
00:36:47.840 | In 2008, when the financial system was doomed,
00:36:52.840 | TIPS should have been the safest investment out there,
00:36:56.840 | and as Bill mentioned, they plummeted.
00:36:59.840 | Yields were up to 3.5%, 4%. Boy, would I love to go back.
00:37:03.840 | We did.
00:37:05.840 | A lot of the boy would instead because that was pointed out.
00:37:09.840 | And I did as well. But TIPS are yielding--
00:37:13.840 | I don't completely agree with you, Bill, on TIPS funds.
00:37:16.840 | The Vanguard TIPS fund is now yielding CPI minus about 0.3%,
00:37:24.840 | so I've been taking some out of TIPS, which I believe in, and moving into CDs.
00:37:32.840 | Yeah, I mean, again, the question was addressed to the younger saver.
00:37:36.840 | As I said with Jack earlier, I think that for the retired person,
00:37:40.840 | TIPS are wonderful because it allows them to be certain of their consumption ability
00:37:46.840 | 5 years, 10 years, 15, 20 years, hence.
00:37:49.840 | But I really got religion in '08, '09 about TIPS,
00:37:54.840 | and it made me think more clearly about portfolio construction.
00:37:58.840 | For the young investor who is stock-heavy, there are really only two asset classes.
00:38:03.840 | You've heard me say many times before, there's risky assets and there are riskless assets.
00:38:08.840 | And the riskless assets are there to help you sleep at night.
00:38:11.840 | They're there so that you can buy stocks when they're cheap.
00:38:15.840 | They're there so you can pay your living expenses when you lose your job.
00:38:18.840 | And they're there for when your annoying neighbor with the corner lot
00:38:22.840 | you've had your eye on for the past 10 years suddenly needs liquidity.
00:38:27.840 | And you can be a nice guy and give it to them.
00:38:30.840 | And TIPS are neither fish nor fowl.
00:38:34.840 | They're not going to help you when you really, really, really need them.
00:38:39.840 | And I think for the younger investor, I think that a huge 1% in your bond portfolio is fine.
00:38:45.840 | I think 0% is fine.
00:38:48.840 | Well, I think one thing that amazes me--Alan just touched on it--
00:38:51.840 | that the TIPS and the TIPS funds are showing negative returns.
00:38:56.840 | But that's negative real returns.
00:38:58.840 | So people will sell TIPS and go buy a 1, 1.5% CD,
00:39:04.840 | which in reality has a negative return of 1.5%.
00:39:10.840 | So you need to think in terms of real return
00:39:13.840 | as opposed to just looking at the posted real return that's on Vanguard
00:39:21.840 | and think that if you get more than -0.58 that you're actually doing good.
00:39:27.840 | But people are looking at the nominal return and ignoring what the real return is.
00:39:33.840 | So what you really have to do is make sure that you try to convert the nominal into real
00:39:40.840 | and then compare apples to apples.
00:39:45.840 | The next question is from Willella. Am I pronouncing that correctly?
00:39:49.840 | She says, "I sit on the board that oversees my employer's pension plan.
00:39:54.840 | The plan's expected ROI over 10 years is 8%.
00:40:00.840 | I think this is too high, but the plan advisers don't.
00:40:05.840 | What does the panel think?
00:40:07.840 | Are there any references or sources I can cite to make my case to the board?"
00:40:15.840 | I think you need to check that you're a board member who stole their medications
00:40:21.840 | and to ask what they've been smoking.
00:40:25.840 | If you have a typical 60/40 portfolio, the return of your bond,
00:40:29.840 | the real or the nominal expected return of your bond portfolio is 2% or 3%.
00:40:34.840 | And so to get to 8%, you have to assume an equity return of, I don't know, in the low teens.
00:40:40.840 | Good luck with that.
00:40:44.840 | Yeah, but all of the government pension funds are 8%, so why shouldn't I be?
00:40:50.840 | That's all I'm using as a benchmark.
00:40:52.840 | I mean, I'm looking at what all the governments are saying is their expected rate of return,
00:40:56.840 | and obviously I'm as good of an investor as any state government.
00:40:59.840 | Therefore, why shouldn't we use 8% on my foundation?
00:41:03.840 | I mean, that's the thinking.
00:41:05.840 | I would reckon with the state of Florida pension people.
00:41:08.840 | Aren't they the ones that keep losing hundreds of millions of dollars?
00:41:11.840 | I did a lot of work with somebody from the St. Petersburg Press on the Florida state pension fund,
00:41:19.840 | and what they're disclosing is they're spending $400 million or $500 million a year on their $100 billion fund,
00:41:26.840 | but they're not disclosing the hidden cost of paying the hedge fund managers an incentive.
00:41:32.840 | They won't disclose that because they say it's confidential.
00:41:35.840 | But anyway, so I think the 8% is clearly too high, as Bill said.
00:41:39.840 | I mean, realistically, 6% is a realistic number to have on these funds,
00:41:44.840 | and this 8% is simply to try to--from the pension fund side, it's simply to not have to fund their liabilities.
00:41:51.840 | They say, "Well, we're perfectly--we're well-funded here," or "We're close to being well-funded
00:41:57.840 | because we're using such a high discount rate on our future liabilities," which is just completely unrealistic.
00:42:02.840 | It's going to bite them in the butt, but it makes politicians look good, balances the budget.
00:42:07.840 | So this is what they go with, and unfortunately foundations then look at that and naively say,
00:42:12.840 | "Well, if this is what the state thinks they're going to get, then that's probably what we should use,"
00:42:15.840 | but it's the wrong assumption.
00:42:17.840 | I think they call it kicking the can down the road.
00:42:21.840 | It's reality versus politics, and politics always win.
00:42:25.840 | Rick, you hinted at the presence of alternatives in a lot of these pension accounts,
00:42:30.840 | and it's a good opportunity to check up on what exactly they've got in there
00:42:34.840 | because I know in the state of Illinois they have increasingly been shifting assets
00:42:39.840 | into alternative assets in an effort to boost their expected return,
00:42:44.840 | and I think we can all agree that there are great risks in doing so, and it's a dangerous trend.
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