Bogleheads® Conference 2012 - Panel of Experts I

00:00:00.000 | one of the highlights of the forum, where you get your questions answered, hopefully.

00:00:17.000 | And I'd like to start out by introducing the panelists, and just so you know, they're in alphabetical order, so we don't have a pecking order.

00:00:27.000 | The panelist is Director of Personal Finance for Morningstar and Senior Columnist for Morningstar.com.

00:00:34.000 | She's the author of "30-Minute Solutions, a Step-by-Step Guide to Managing Your Finances."

00:00:40.000 | She's also co-author of "Morningstar Guide to Mutual Funds, Five-Star Strategies for Success," a national bestseller, first published in 2003.

00:00:50.000 | And she's the author of the book "Second Edition," which was published in 2005.

00:00:55.000 | Before assuming her current role in 2008, she also served as Morningstar's Director of Mutual Fund Analysis.

00:01:04.000 | She served as editor of several of Morningstar's publications over the years, including "Practical Finance," "Morningstar Mutual Funds," and "Morningstar Fund Investor."

00:01:16.000 | She has worked as an analyst and editor at Morningstar since 1993.

00:01:21.000 | She holds a bachelor's degree in political science and Russian East European studies from the University of Illinois at Urbana-Champaign.

00:01:29.000 | Please welcome Christine Benz.

00:01:32.000 | [Applause]

00:01:38.000 | Our next panelist is a retired neurologist who helped co-found Efficient Frontier Advisors.

00:01:44.000 | He's written several titles on finance and economic history.

00:01:49.000 | His two finance books, "The Intelligent Asset Allocator" and "The Four Pillars of Investing," as well as the content of his website, efficientfrontiers.com, has made him uncomfortably popular with the financial press.

00:02:04.000 | He's also a big believer in the value of the creative nonfiction process.

00:02:08.000 | He's written two volumes of "Economic History," "The Birth of Plenty," and "A Splendid Exchange."

00:02:15.000 | His latest book, "The Investor's Manifesto," has turned out to be another winner.

00:02:20.000 | He holds both a Ph.D. in chemistry and an M.D.

00:02:24.000 | Please welcome one of the smartest guys I know, Dr. Bill Bernstein.

00:02:28.000 | [Applause]

00:02:34.000 | Our next panelist was scheduled to be Laura, and Laura was not able to make it.

00:02:40.000 | For those who were looking and wondering why Laura wasn't here, she is tied up in Mexico City and couldn't get away.

00:02:47.000 | She sends her warm regards to the crowd, and her mother, the queen mother, is representing her.

00:02:57.000 | Our next panelist is CEO of Portfolio Solutions, a low-fee investment management firm.

00:03:04.000 | He earned his B.S. in business administration from the University of Rhode Island and a master's in science and finance from Walsh College.

00:03:12.000 | He also holds the prestigious CFA designation.

00:03:16.000 | He's written five books on low-cost investing, including "All About Index Funds," "All About Asset Allocation."

00:03:24.000 | His ETF book is considered by many to be the Bible of the ETF industry.

00:03:30.000 | He was also a member of the book committee for the Bogart's Guide to Retirement Planning,

00:03:35.000 | and his latest book, "The Power of Passive Investing," has received wide acclaim.

00:03:41.000 | And if that's not enough, he's also a Forbes columnist.

00:03:44.000 | Please welcome Rick Perry.

00:03:46.000 | [Applause]

00:03:52.000 | Our next panelist is the author of personal finance books, including the recently published "Social Security Made Simple."

00:04:02.000 | He's also written the popular blog "Oblivious Investor," which currently has more than 9,000 subscribers.

00:04:10.000 | He's a Missouri-licensed CPA, and his writing has been featured in a number of places,

00:04:16.000 | including "Money Magazine," "AARP," "Forbes," "CBS News," and "Morningstar."

00:04:22.000 | Please welcome one of the talented Young Rising Boglehead stars, Mike Piper.

00:04:27.000 | [Applause]

00:04:33.000 | Our next panelist is the founder of WealthLogic, an R&D-based financial planning and investment advisory firm

00:04:40.000 | that advises clients for portfolios ranging from $10,000 to $50 million.

00:04:45.000 | He's mocked on a fairly regular basis by some financial professionals for his hourly-fee model

00:04:53.000 | and the model's obvious inability to make him rich.

00:04:56.000 | [Laughter]

00:04:59.000 | He's also the author of "How a Second Grader Beats Wall Street" and writes the "Irrational Investor" column at CBSMoneyWatch.com.

00:05:08.000 | He teaches behavioral finance at the University of Denver and is an adjunct faculty member at Colorado College.

00:05:16.000 | He's got a lot of meaningful credentials after his name.

00:05:19.000 | He's a CFP, a CPA, and an MBA and claims he can still keep investing simple.

00:05:26.000 | [Laughter]

00:05:27.000 | His goal is never to be confused with Jim Framer.

00:05:30.000 | Please welcome Alan Law. [Applause]

00:05:39.000 | In 1998, our final panelist created the Coffeehouse Investor in an effort to bring a simpler and smarter investment philosophy

00:05:47.000 | to individuals and corporations across the nation and around the world.

00:05:51.000 | His work has been featured in the Wall Street Journal, the New York Times, Businessweek, Time,

00:05:57.000 | and he's been a regular contributor on NPR's "Morning Edition."

00:06:01.000 | For 13 years, he worked with retail and institutional accounts for Smith Barney in Seattle.

00:06:07.000 | Like Rick, he eventually saw the light and came over from the dark side.

00:06:11.000 | [Laughter]

00:06:14.000 | He now works as co-owner and financial advisor with San Juan Wealth Management in Kirtland, Washington.

00:06:19.000 | In his spare time, he enjoys mountain climbing, cooking with friends and family, and he loves to golf in the rain.

00:06:25.000 | Please welcome another one of the good guys, my friend, author Bill Schultheiser.

00:06:30.000 | [Applause]

00:06:36.000 | All right, gang, we're going to start out with the questions, and if one person answers

00:06:42.000 | and somebody else has got something to add, please don't consider the question answered just because one person chimed in.

00:06:49.000 | So if you've got something to say, we'd like everybody to contribute.

00:06:53.000 | The first question, and it pays to be the recording secretary because you get your questions moved right to the top.

00:07:01.000 | [Laughter]

00:07:03.000 | The question's from Victoria.

00:07:05.000 | It says, "A question for the panel about the order of distributions in early retirement.

00:07:11.000 | The investor has some sums in the traditional IRA and taxable accounts.

00:07:17.000 | The investor's goals are as follows.

00:07:19.000 | Wait to collect Social Security at the age of 70, complete the alumnate traditional IRA by the age of 70 when the RMDs would have started,

00:07:30.000 | and limit annual traditional IRA withdrawals to stay within the 25% tax bracket.

00:07:38.000 | And the investor has some flexibility in the order of drawing money from the traditional IRA and taxable accounts.

00:07:46.000 | One extreme, withdrawal"--are we all together on this?

00:07:52.000 | [Laughter]

00:07:54.000 | Victoria, you really are working me out here.

00:07:57.000 | [Laughter]

00:07:58.000 | "One extreme, withdraw or convert from the traditional IRA in the beginning of the retirement

00:08:04.000 | and live off the taxable accounts the remaining time to age 70."

00:08:09.000 | So that's one scenario.

00:08:11.000 | "The other extreme, delay the traditional IRA withdrawals and conversions for as long as possible."

00:08:18.000 | Now the questions.

00:08:20.000 | [Laughter]

00:08:22.000 | Which is preferable?

00:08:25.000 | And what are the main considerations when deciding between the two options?

00:08:30.000 | What was the second option?

00:08:31.000 | [Laughter]

00:08:33.000 | The first option--

00:08:34.000 | I got the first option. What's the second option?

00:08:35.000 | The second option is the other extreme is delay the traditional IRA withdrawals and conversions for as long as possible.

00:08:46.000 | I'll take it.

00:08:48.000 | [Laughter]

00:08:52.000 | I've always said investing is simple.

00:08:54.000 | I've never said taxes are.

00:08:58.000 | The answer is clearly it depends.

00:09:01.000 | And it's probably not an either extreme.

00:09:05.000 | You don't want to get rid of your entire traditional IRA, even under the RMD, if you can take it out of the 0% tax bracket.

00:09:14.000 | So you want to take out enough of your traditional IRA that you stay either in the 0% or very low tax bracket.

00:09:23.000 | You don't ever want to let some of your--be below zero.

00:09:29.000 | Even if you don't need the money, do a broad conversion with the difference.

00:09:34.000 | So the answer really is it depends, and it's probably not an either extreme.

00:09:39.000 | Now we're going to have the real CPA, the expert here.

00:09:44.000 | That was a good answer.

00:09:46.000 | I think, in the first place, it's a good idea to prioritize traditional IRA distributions prior to age 70 if you're holding off on Social Security until age 70.

00:09:58.000 | Because what typically happens, or often happens, once you start receiving Social Security benefits,

00:10:04.000 | is that your marginal tax rate ends up being higher than the actual tax bracket you're in.

00:10:10.000 | Because there's this range.

00:10:12.000 | Boba Hett's guy in the retirement plan even called it the "tax hump."

00:10:15.000 | I thought that was a pretty good term.

00:10:17.000 | Where each additional dollar of income doesn't only cause--so for instance, if you're in the 15% tax bracket,

00:10:23.000 | each additional dollar of income doesn't only cause 15 cents of income tax.

00:10:27.000 | It also causes either 50 cents or 85 cents of Social Security benefits to become taxable.

00:10:34.000 | Even if you're in the 15% income tax bracket, once you're receiving Social Security, your marginal tax rate can actually be 22% or 27%.

00:10:43.000 | Sometimes it can be advantageous to go ahead and prioritize traditional IRA distributions prior to receiving Social Security.

00:10:53.000 | That's something that Victoria already posited in her question, which is a good idea.

00:10:57.000 | So I'm not answering her question, I'm just emphasizing part of it as a good idea.

00:11:00.000 | In terms of actually which of those two extremes I think Alan is right, it's going to depend.

00:11:07.000 | And neither extreme is probably the right answer.

00:11:11.000 | I think Vanguard touched on it last night, too, that you want to diversify your future tax obligations.

00:11:17.000 | We never know what is going to happen.

00:11:20.000 | For instance, if you converted everything to the Roth and they put a value-added tax or a national sales tax, you're going to get hit again.

00:11:30.000 | So you may want to consider having some in each to diversify the possible unknown future tax situation.

00:11:40.000 | All right, we'll move on to the next question. It's from Lisa Prius.

00:11:45.000 | Morningstar recently published a paper entitled Pay and Switch, Glad Path Instability.

00:11:52.000 | Among other things, it shows how the glad slopes of several companies' target funds have changed.

00:11:58.000 | Key world prices have been consistent but aggressive.

00:12:02.000 | Vanguard's made a huge change in 2006.

00:12:06.000 | Fidelity has literally been all over the map.

00:12:09.000 | I'd like to hear your comments on glad path instability and the legitimacy of the target date fund approach.

00:12:16.000 | I can tackle that because the question references a Morningstar paper.

00:12:23.000 | And it is something that our team keeps a close eye on, and that's why they only recommend pretty skinny-down group of target date series.

00:12:33.000 | Vanguard's is among the ones that we consider the best.

00:12:38.000 | We also do like the T-Row plan. It is generally more aggressive than most others.

00:12:44.000 | American Funds and J.P. Morgan's also receive top ratings.

00:12:48.000 | But certainly the stability of the glad path figures into our assessment.

00:12:53.000 | We're also looking at a lot of other factors as well, such as costs and quality of underlying options,

00:12:59.000 | when we decide whether or not to recommend these products.

00:13:02.000 | But I do think that target date funds, there's a huge disparity, and we have seen, frankly, some performance chasing going on among the target date providers.

00:13:14.000 | One notable change that we saw among a lot of the plans in the wake of the bear market was to make, generally, the glad path more conservative,

00:13:24.000 | at what, in hindsight, is obviously an inopportune time to have done so.

00:13:29.000 | So I think this should definitely be part of anyone's analysis if they are considering using a target date product.

00:13:37.000 | We normally recommend the people ignore the, in getting to the legitimacy, the second part, the legitimacy of the target date fund approach.

00:13:49.000 | And I am a big fan of the target date approach with some qualifications.

00:13:55.000 | One is you need to look under the hood and ignore the date and look for the fund that has your desired asset allocation.

00:14:06.000 | And one of the reasons I really like them is because it gives you a nicely diversified portfolio in a single holding.

00:14:14.000 | And it's hard to go wrong with that, a fund that rebalances daily.

00:14:20.000 | So it has a lot of advantages, and it's a hands-off approach, and I think it's ideal for the default option on the 401(k).

00:14:32.000 | The only problem is, is that everybody that's the same age is probably going to get stuck in the same fund, which is not the best approach.

00:14:40.000 | But you could do a lot worse than a target date fund.

00:14:45.000 | Yes, sir.

00:14:47.000 | I'm just going to put out a point of clarification because you might hear these terms out there when they're discussing target date funds,

00:14:53.000 | and the two terms are, is it a "to fund" or "through fund."

00:14:58.000 | A "to fund" means on the day that you, that target date, the amount of money that's in your fund should be,

00:15:08.000 | the money that's in your fund should be at all cash.

00:15:11.000 | So the allocation will go from some point in equity all the way down to the target date,

00:15:20.000 | and it will be 100% in cash on the target date.

00:15:23.000 | That's a "to fund."

00:15:25.000 | Then there's a "through fund."

00:15:27.000 | And I think what Morningstar has done is given you an index of the "through funds," which say you're going to a target date for retirement,

00:15:34.000 | and on that target date you're going to have an allocation to equity still.

00:15:37.000 | It might be 30%, it might be 40%, it might be 20%,

00:15:40.000 | but you're going to go through that date.

00:15:42.000 | So just so you have heard these terms before, there are target date "to funds" and target date "through funds."

00:15:50.000 | Well, a while back I wrote a column for Morningstar, and it was titled "Fixing Target Date Funds,"

00:15:58.000 | and one of the recommendations I made in that is when you're going to look at a target date,

00:16:04.000 | I thought that it might be helpful to have a 2050 moderate, conservative, and aggressive,

00:16:11.000 | which might help the young people select something that identifies them.

00:16:18.000 | And even though they all have the same target date on it,

00:16:21.000 | they would have different allocations based on being aggressive, being moderate, or being conservative.

00:16:27.000 | And I would like to see that adopted in the industry,

00:16:31.000 | but I don't think that it's necessarily as complicated as it sounds.

00:16:37.000 | You wouldn't necessarily end up with three particular funds for each year,

00:16:45.000 | because the aggressive for one year might be the same as the moderate in another year.

00:16:52.000 | So actually, they would be in the same fund, the same fund, and I'd like to see that.

00:16:59.000 | I think that would be helpful for young people when they come out,

00:17:02.000 | because some people are conservative, some people want to be aggressive,

00:17:06.000 | and I think that would help them make a better selection.

00:17:12.000 | I would just like to make an additional comment on target date funds.

00:17:15.000 | I saw by the show of hands yesterday afternoon that very few people here actually have target date funds.

00:17:21.000 | Most of you choose to manage your own underlying pieces, and that's fine.

00:17:26.000 | But I am passionate about this idea of benchmarking yourself to see how well you're doing.

00:17:32.000 | So I suggest for most investors creating a simple custom benchmark that mirrors your own asset allocation

00:17:39.000 | and consists of the most vanilla index funds that you can find.

00:17:44.000 | So that's one benchmark.

00:17:45.000 | But a second simple benchmark that I think you should hold yourself to is to look at whether you are doing as well

00:17:51.000 | as a target date fund geared to someone in your general age band and set of situations.

00:17:58.000 | So I think that that's just a good way to see whether you are adding or subtracting value,

00:18:03.000 | and maybe you have something completely different going on so the target date fund isn't relevant to you.

00:18:08.000 | But I think for a lot of people it will help them be honest with themselves about how well their security selection,

00:18:15.000 | how much it's contributing to the bottom line.

00:18:20.000 | Two of the key features that the average investor would have to work on that they don't have to do with target date funds

00:18:27.000 | are both the automatic rebalancing and the getting more conservative as they age.

00:18:32.000 | Those are two things that investors have to do on their own if they have individual funds,

00:18:37.000 | but they don't have to do that with the target date funds.

00:18:41.000 | Can I say one?

00:18:42.000 | Sure.

00:18:43.000 | You know, managers of target date funds are people too,

00:18:46.000 | and I would say that if you can't be right on the asset allocation, be consistent.

00:18:51.000 | And as much as I love target date funds, which harness the power of inertia,

00:18:55.000 | I generally don't recommend them because the asset location for tax efficiency can be done by buying the individual funds.

00:19:06.000 | Yes?

00:19:07.000 | Just a question.

00:19:09.000 | Vanguard brought up that the target date funds rebalance daily.

00:19:15.000 | You just mentioned that's an advantage of target date funds.

00:19:19.000 | This may be a stupid question because I haven't researched the answer, but I know Dr. Bernstein can probably explain it.

00:19:26.000 | If the market took a 50 percent correction in 2008,

00:19:30.000 | wouldn't a target date fund, by rebalancing daily, take a greater than 50 percent correction?

00:19:37.000 | Yeah, that's a good point.

00:19:40.000 | The problem is that when you're running a large institutional fund, you don't have a whole lot of choice but to rebalance daily.

00:19:46.000 | David Swenson made a virtue out of that in his book.

00:19:50.000 | It's not a virtue.

00:19:52.000 | Being able to rebalance intermittently for the individual is a superior strategy for the obvious reason that, you know,

00:20:01.000 | you want to give the market a little bit of time to run both on the upside and downside before you pull the trigger.

00:20:07.000 | That had obvious advantages in 2008-2009 as well as on the way back and as well as on the way up for that.

00:20:14.000 | Yeah, there are a number of studies.

00:20:16.000 | In fact, I read a lot of Morning Story a few years back, and I think 18 months was the ideal time for rebalancing.

00:20:23.000 | The problem is you can argue about whether you should do it on your birthday every year or whatever,

00:20:29.000 | but the problem is a lot of people don't rebalance, and the target date funds do that for them.

00:20:35.000 | If you're a religious, do your rebalancing and so forth.

00:20:38.000 | The more you want to manage your portfolio, that's fine, but what we're talking about is kids coming out of college,

00:20:45.000 | getting their first job, and now HR hands them a packet that's got 40 funds listed, and they don't have a clue of what to do.

00:20:53.000 | So they put 2.5% in every fund, or if there's 10 funds in there, they put 10% in each of the 10,

00:21:00.000 | and four or five of them are large growth funds or whatever.

00:21:04.000 | So the target date funds, I think, are a great starting point for young investors.

00:21:12.000 | Alan correctly mentioned that the fund location is incorrect, but for a lot of investors, their 401(k) is their only investment.

00:21:23.000 | So in that case, there is no location problem because they don't have a taxable account.

00:21:28.000 | But if they have taxable and non-taxable, then the point is well taken that you want to put your equities in your taxable account

00:21:37.000 | and new bonds in your tax deferred accounts, which implies that you're not using the target date funds.

00:21:43.000 | Well, I mean, my point really was the overall risk of a target date fund in a situation like 2008.

00:21:51.000 | The equity portion is not going to have – you know, use a simple example of the market drops 1% 50 trading days in a row,

00:21:59.000 | and they rebalance each day as such as an approximation.

00:22:04.000 | The equity portion of the portfolio is going to take a 20% greater drawdown than if you don't rebalance every day.

00:22:12.000 | Because you're rebalancing and buying the equity portion almost continuously.

00:22:17.000 | 1% every day, you're taking a greater drawdown.

00:22:21.000 | It's putting more risk in the portfolio, the equity portion.

00:22:25.000 | It's not as bad as all that because you're not rebalancing every single day within the fund.

00:22:31.000 | You're simply rebalancing within flows and outflows so that when the market is rapidly moving up or down,

00:22:40.000 | as it did before, during, and after the crisis, they're certainly not rebalancing back to policy every day.

00:22:46.000 | It probably took them several months to catch up at the end.

00:22:49.000 | So it's not quite as bad as doing it in a rebalancing community every day, which would be a disaster.

00:22:57.000 | I know the next question is controversial, so we'll get to that.

00:23:01.000 | It's a question from J.V. Clark '02.

00:23:05.000 | Do you recommend including Social Security and/or a defined benefit plan indexed to inflation as part of one's bond allocation?

00:23:14.000 | And if so, how do you compute their value?

00:23:17.000 | This is my favorite question. That's absolutely every damn year.

00:23:22.000 | [laughter]

00:23:25.000 | And the answer is you can either do it one of two ways, but you can't double count.

00:23:32.000 | Let's say you're someone who needs $70,000 a year to live on, and you're getting $30,000 in Social Security,

00:23:38.000 | so you have a residual need of $40,000 a year.

00:23:42.000 | You can either say that I'm going to annuitize or capitalize my Social Security.

00:23:50.000 | It's worth $300,000, $500,000, $200,000, whatever, but I have to spend $70,000 a year out of my portfolio.

00:23:59.000 | So in other words, you capitalize it into your bond, but then you fully own all of your living expenses as a liability.

00:24:06.000 | So that's method A. Method B is to say, "Ah, I only need $40,000 a year to live on."

00:24:12.000 | Then you sure as heck cannot capitalize your Social Security and pensions as a bond allocation,

00:24:20.000 | because if you say that the third alternative is the incorrect thing, which a lot of people love to do is they say,

00:24:26.000 | "Ah, I'm going to capitalize my Social Security. I now have a $300,000 bond in my portfolio,

00:24:32.000 | and I only need $40,000 a year to live on." Nah, can't do that.

00:24:37.000 | So you do one or the other.

00:24:39.000 | Well, I think that that's a little change in your position, I think, from previous years,

00:24:44.000 | or at least my understanding, because I thought you were saying, "Do it."

00:24:47.000 | No, no, no, no. You do one or you do one or the other.

00:24:50.000 | But Jack is a big fan of doing it, of capitalizing it,

00:24:54.000 | and one of the downsides to capitalizing on that is that you end up with a huge bond allocation

00:25:00.000 | based on your Social Security, so you end up with a much larger equity position

00:25:07.000 | because you're counting your Social Security as bonds.

00:25:11.000 | And when you work 50/50 and Social Security is arbitrarily, we'll say, 30%,

00:25:17.000 | you've got 20% bonds and you've got 80% equity in the rest of your portfolio,

00:25:21.000 | and at a time when you're retired, because we're talking about Social Security,

00:25:25.000 | I think you end up with way, way too much risk for the average investor.

00:25:30.000 | Mel, I'm not sure if I mentioned this last year, if we did talk about this,

00:25:33.000 | but I was speaking with Harold Davinsky, the financial planner,

00:25:36.000 | about this very issue during the 2008 downturn,

00:25:39.000 | and he is against using Social Security as part of the bond allocation,

00:25:43.000 | and he said that it simply doesn't work from a behavioral standpoint,

00:25:47.000 | for the reason you mentioned, that you would say to clients during a market environment like that,

00:25:51.000 | "Oh, your bond position is doing just fine," and the client would say,

00:25:55.000 | "What bond position? I have only stocks and I'm down 35%."

00:25:59.000 | He said that it just doesn't fly with clients,

00:26:03.000 | and the risk level of the equity portfolio is just too much for people to stand on.

00:26:09.000 | I wrote an article with Craig Israelson, who is from Brigham Young University,

00:26:15.000 | and I post it on the website all the time, and it's called "Is a Pension a Bond?"

00:26:21.000 | It also gets into Social Security, and the simplest way of doing this is from a cash flow basis.

00:26:28.000 | Bill, a couple of years ago, one of his choices is to do it from a cash flow basis,

00:26:35.000 | so I'm not going to use the word "capitalization," which is simply, as Bill said,

00:26:39.000 | you have $70,000 a year of liabilities.

00:26:42.000 | That's what your spending is in retirement.

00:26:46.000 | You're getting $30,000 of that covered by Social Security.

00:26:50.000 | Your liability from your savings is $40,000 a year.

00:26:55.000 | Therefore, what asset allocation should you have that will give you $40,000 a year?

00:27:01.000 | That's the easiest way of doing it, so it's not part of your bond allocation.

00:27:06.000 | It's simply covering some of your liabilities, and to look at your asset allocation overall,

00:27:12.000 | you just look at what is not being covered by Social Security or a pension.

00:27:16.000 | I think that's just the simplest way of doing it.

00:27:20.000 | The next question is about wide moats.

00:27:23.000 | It says, "Are wide moats the real deal, or are they the flavor of the month?"

00:27:29.000 | As far as I'm concerned, they're the flavor of the month because I've been hearing about wide moats since--

00:27:34.000 | What are moats?

00:27:35.000 | Moats.

00:27:37.000 | Explain.

00:27:38.000 | Moats. Wide moats.

00:27:41.000 | These are companies that are considered to have wide--they call it wide moats

00:27:46.000 | because they have the technology, they have the patents, and things like that

00:27:51.000 | to protect them from competition.

00:27:54.000 | Think of the old days when they had the moats to protect the castles.

00:27:58.000 | The castle is the company.

00:28:02.000 | The assessment of a company's moat or lack thereof is a big part of our analysis process for individual companies,

00:28:10.000 | and Mel shorthanded it exactly right.

00:28:13.000 | It's a company's sustainable competitive advantage.

00:28:16.000 | This is not a concept that is original to Morningstar.

00:28:19.000 | It's really a Warren Buffett concept, and the idea is that the company,

00:28:23.000 | with the sustainable competitive advantage, would enable you to own it for a longer period of time,

00:28:28.000 | and it would have that ability to fend off competitors over time.

00:28:32.000 | We analyze our performance of the stock ratings, which do hinge both on valuation

00:28:38.000 | and whether a company has a moat,

00:28:41.000 | and what we see in general is pretty good performance from that combination of characteristics,

00:28:47.000 | so both low valuation as well as whether the company has a moat.

00:28:52.000 | In general, the performance is better in down markets than it is in very buoyant up markets,

00:28:58.000 | so our moat rating won't look so good in a 2009-type environment

00:29:03.000 | where a lot of companies that were just lucky to be alive did the best.

00:29:07.000 | The moat ratings did very, very well during the bear market

00:29:10.000 | and have done fairly well over a full market cycle as long as we've been examining them.

00:29:16.000 | There are certainly other companies that do some assessment of the same general thing we're looking for,

00:29:22.000 | but that's the general performance characteristics--strong downside performance,

00:29:27.000 | less strong performance in rallies.

00:29:30.000 | Are we talking about picking stocks?

00:29:33.000 | I guess.

00:29:34.000 | I don't know.

00:29:36.000 | [laughter]

00:29:38.000 | I had to ask Alan to explain what it is.

00:29:40.000 | [laughter]

00:29:42.000 | Yeah, I mean, that's one way of doing it if you want to pick stocks.

00:29:47.000 | You know, if someone put a gun to my head and made me pick stocks,

00:29:51.000 | the criteria that I would use would be obvious qualitative indicators of corporate governance.

00:30:00.000 | Does the CEO fly around in a corporate jet for personal reasons?

00:30:05.000 | Has any highly placed person in that corporation bought a piece of real estate costing more than $10 million?

00:30:13.000 | If you look at those companies that have those characteristics,

00:30:16.000 | and there are a lot of them, they have market returns that are very, very much lower than the stock market.

00:30:25.000 | So that would be--I would never pick stocks, but if I had to pick stocks, I wouldn't pick wide goods.

00:30:30.000 | I'd simply avoid the companies with morally decrepit managements.

00:30:35.000 | [laughter]

00:30:37.000 | [applause]

00:30:41.000 | I think random selection is better than any flavor of the buzz.

00:30:45.000 | [laughter]

00:30:47.000 | Sorry, Christine.

00:30:50.000 | Okay, the next question is for Bill Bernstein.

00:30:54.000 | It says, "In your recent article in Money Magazine,

00:30:57.000 | "you said to have your retirement expenses covered by tips, short-term bonds, and other duties.

00:31:03.000 | "Would you consider Vanguard's short-term investment-grade bond funds

00:31:07.000 | "to be a good substitute for individual short-term bonds?"

00:31:13.000 | If you don't mind taking, you know, a 10% capital haircut during the next crisis, then sure.

00:31:22.000 | Yeah, I think pretty much covers it.

00:31:27.000 | [laughter]

00:31:29.000 | Let me get the cards out.

00:31:32.000 | These are questions that were just--I might have a little more time reading them because of the handwriting,

00:31:37.000 | but these were turned in just recently by the people who are here.

00:31:41.000 | So if I call your name, please stand up just so we can acknowledge you.

00:31:46.000 | Paul Stratton. Paul asks, "With all the investors hunting for yield,

00:31:52.000 | "please discuss how bad non-exchange-traded REITs and similar investments are."

00:32:00.000 | So how bad are non-exchange-traded REITs and similar investments?

00:32:06.000 | Wow, that's a good question.

00:32:08.000 | I've heard a lot of bad things about non-exchange-traded REITs lately.

00:32:13.000 | There's been a lot of fraud, and so is that baked into the price?

00:32:19.000 | I guess that would be my question.

00:32:22.000 | You can't package these things together and sell them as an index

00:32:26.000 | once you have liquidity concerns as well.

00:32:28.000 | So while you're getting paid for taking hold of this risk out there of fraud, this risk of liquidity,

00:32:33.000 | your yield on these things would have to be very high, I think,

00:32:37.000 | to make up for those risks to even consider it.

00:32:40.000 | And then, of course, if you do, you would only consider it for a very, very small portion of your portfolio.

00:32:48.000 | Okay, the next question is from Lady Inc. for Bill Schultheiss.

00:32:51.000 | We weren't done with that.

00:32:53.000 | Oh, I'm sorry.

00:32:54.000 | Just real quickly, I just drafted an article, "Investments from Hell and Non-Traded REITs" in there.

00:33:01.000 | Non-traded REITs have lost a lot of money during the same period

00:33:05.000 | that the Vanguard REIT index fund is up 100-and-some-odd percent.

00:33:11.000 | Non-traded REITs are great for brokers selling them, not so good for the consumer buying them.

00:33:16.000 | Yeah, I subscribe to a periodical called "Investment News,"

00:33:21.000 | which is written for investment professionals.

00:33:28.000 | The reason why I do it is because they're very good at spotting a new, new thing.

00:33:33.000 | A year or two ago, there were a lot of articles about non-traded REITs.

00:33:39.000 | They were usually accompanied by a picture of a guy in a very expensive suit and no neck.

00:33:46.000 | And I subscribe to that magazine just for that reason,

00:33:50.000 | because it's a really good way of spotting early the next investment scandal.

00:33:57.000 | They interviewed me for that magazine just last week.

00:34:03.000 | In the same rag in "Investment News," there's been a lot of press over the last couple of months

00:34:09.000 | on how these non-traded REITs have had to be revaluated or repriced, and they've just gotten hammered.

00:34:15.000 | I think the question is, again, how much do you put in your portfolio, which is probably not very much.

00:34:20.000 | And so is that potential added yield really worth the potential risk of the portfolio?

00:34:26.000 | You're not knowing what's going on in your portfolio with that part that you have allocated to those non-traded REITs.

00:34:34.000 | Okay, next question is for Bill Schulteis from Lady Geek.

00:34:38.000 | He says, "Your eloquently worded post about what the requirements are for managing other people's money

00:34:46.000 | is an inspiration for those who wish to become financial advisors.

00:34:51.000 | While this forum has a generally negative attitude towards financial advisors,

00:34:56.000 | it's mainly due to the cost of portfolio management.

00:34:59.000 | Please expand on the roles that financial advisors play other than portfolio management."

00:35:08.000 | Well, you know, a couple things that are interesting.

00:35:11.000 | Number one, just in chatting with so many of all of you over the last two or three days

00:35:16.000 | and the response from that post on the forum, it's amazing the number of you who have considered

00:35:22.000 | and who want to help people.

00:35:24.000 | Now, you can do that in your spare time, or you can, like some of us, get compensated for it.

00:35:30.000 | But the need is phenomenal.

00:35:32.000 | I look at Rick. Rick, can you stand up over there?

00:35:35.000 | You know, the stuff that Rick is doing, and he actually happens to be in my neck of the woods, is phenomenal.

00:35:40.000 | Where's Chad? Chad, would you stand up?

00:35:43.000 | You know, so many of you folks are saying, "Hey, you know, I want to take this bogal head type

00:35:49.000 | passive philosophy and help people."

00:35:51.000 | And there is an enormous opportunity to help people.

00:35:55.000 | People are screaming for help.

00:35:57.000 | Last night we were talking to some of the folks at Vanguard.

00:36:00.000 | The amount of energy that Vanguard is putting in to helping advisors help investors is off the charts.

00:36:08.000 | I mean, they're really seeing not only helping advisors, but setting up their own systems.

00:36:12.000 | And their own projects to help investors.

00:36:16.000 | It's just an enormous opportunity.

00:36:18.000 | And I think that the benefits of embracing a passive philosophy with clients and people that you want to help is

00:36:30.000 | there's a multitude of benefits.

00:36:32.000 | Number one, you know you're going to capture the asset class's returns.

00:36:36.000 | So performance never becomes an issue.

00:36:39.000 | When we sit down with clients, we never talk about performance.

00:36:43.000 | Like, "Oh, should we be in this fund or that fund?"

00:36:45.000 | That's a non-issue.

00:36:46.000 | What we're talking about are the financial planning issues that matter most of all.

00:36:50.000 | And I have to commend you, Sue, and the other folks who have put together that great, great resource on the

00:36:57.000 | bogal head side.

00:36:58.000 | And also I think that you talked about the Canadian side.

00:37:01.000 | Norton, would you stand up back there?

00:37:03.000 | The amount of effort that you've put forth in helping people work through the financial planning process.

00:37:09.000 | Because that's where -- you know, it's so interesting, the fees on -- what Vanguard is doing.

00:37:15.000 | You know, the fees on the investments are just, you know, contracting to zero.

00:37:21.000 | And what they're doing is they're spending this time on addressing the financial planning and the investment

00:37:29.000 | help for people.

00:37:30.000 | So that's where the real value is, is in helping people.

00:37:33.000 | And so, you know, again, I would encourage all of you who are considering taking this and helping people to

00:37:40.000 | continue to pursue that.

00:37:42.000 | Because there's never been a time in our country where people are looking for help more than they are today.

00:37:48.000 | It's just -- it's a wonderful, wonderful opportunity.

00:37:50.000 | And I'm sure that a lot of other of you have something to add on that.

00:37:55.000 | Well, I think that in following along with this, where each individual can make a difference,

00:38:01.000 | is the lady from Phoenix, Arizona here.

00:38:06.000 | There she is in the back.

00:38:08.000 | Now, there's an individual who is working with a group of high-powered women in the Phoenix area who make a

00:38:15.000 | lot of money but don't have a clue.

00:38:17.000 | And she's working with a group to educate them.

00:38:20.000 | So everybody can take a step like Rick did on his own and like she did on her own to help people who are

00:38:30.000 | looking for help or who need help.

00:38:32.000 | So each individual can make a difference, even if you're only helping one or two people.

00:38:38.000 | It's making an impact.

00:38:40.000 | Have you got a follow-up?

00:38:42.000 | Yeah, I got the follow-up, if that's what you're talking about.

00:38:45.000 | Yeah, the follow-up, what financial planning is about.

00:38:48.000 | So the follow-up is also your insight on how most people view investing and is enlightening.

00:38:55.000 | How should a logo head convey our investing approach to a person who not only has no idea what we're talking

00:39:01.000 | about but is intimidated by the difficulty of managing investments?

00:39:05.000 | Is that the follow-up you were talking about?

00:39:08.000 | Also about the concept of investing as part of the bigger financial planning, estate planning, taxes,

00:39:14.000 | that type of thing.

00:39:15.000 | They need guidance.

00:39:16.000 | Investing is part of a financial plan, and they don't -- we're focused on investing, not the bigger picture,

00:39:21.000 | which I think is more important.

00:39:23.000 | Well, you know, one of the things that's been so impressive, John Vogel said it here yesterday,

00:39:26.000 | and they articulated it again at the Vanguard presentation last night, is the importance of keeping the

00:39:32.000 | investment process simple so that you can, in fact, focus on all those issues that you bring up, Sue.

00:39:39.000 | You know, it's so interesting.

00:39:40.000 | My favorite story is last fall some folks came into our office, you know, a couple of 55 years old,

00:39:45.000 | they're both professionals, and they're both -- you know, and the husband says, "Well, what do you think of

00:39:50.000 | what's going on in Greece?"

00:39:52.000 | And he said, "Well, you know, should we have some gold in our portfolio?"

00:39:55.000 | And after two hours of chatting with them, they're leaving, and the wife says to the husband,

00:40:00.000 | "You know, we've really got to figure out how much we're saving."

00:40:04.000 | And so, you know, two weeks ago somebody asked me a question like, "What do I think of Europe?"

00:40:09.000 | And really for me as a 52-year-old investor, as an investor, I couldn't care less what's going on in Europe.

00:40:16.000 | It's totally irrelevant to me what the stock market does over the next two years.

00:40:21.000 | What's important is how much my wife and I are saving, and are we saving enough so that the glide path

00:40:27.000 | through retirement allows us to meet our financial obligations, and that's what people need clarity in.

00:40:33.000 | I mean, you're alluding to something which is a much bigger problem than the investment process,

00:40:39.000 | which is the entire consumerist ethos of this country.

00:40:43.000 | I mean, the people inside this room are people who generally read wallpaper clips.

00:40:48.000 | But that's -- that's not -- that's not what people outside of this room are doing,

00:40:56.000 | and, you know, it's good luck with changing that.

00:41:01.000 | I would just want to comment on investment management is one slice of the entire big picture.

00:41:10.000 | The question is how do you get advice on the entire big picture, and how do you pay for it?

00:41:17.000 | And there's lots of different theories about once you do your estate planning, once you do your financial plan,

00:41:25.000 | once you do your tax planning, first, how do you pay for that?

00:41:30.000 | And secondly, if it all leads up to hiring somebody else to actually manage your money, manage your portfolio,

00:41:36.000 | how do you pay for that?

00:41:38.000 | So it's -- I believe in the unbundling approach to this, where if you need estate planning, you pay for estate planning.

00:41:44.000 | If you need financial planning, you pay for financial planning.

00:41:47.000 | Other people believe in a bundled approach where you pay one higher fee annually for everything,

00:41:53.000 | and I think you have to decide how often you're going to use those other products and how you have to pay for it.

00:41:59.000 | I'm under the belief that it should be unbundled, and you pay, and you go for the other stuff,

00:42:03.000 | and the actual ongoing investment management, you pay an asset management group, and that's why I'm here.

00:42:09.000 | My belief is actually opposite of that.

00:42:12.000 | I feel that bundling really makes the most sense.

00:42:15.000 | I've never been able to figure out how you can create a financial plan without taking all those different aspects into consideration,

00:42:23.000 | how much risk you need to take and are likely to take.

00:42:26.000 | I mean, there's so many factors that go into that, and it just -- it's -- you know, I just can't see how you go down the street to a financial planner.

00:42:35.000 | Does the financial planner make decisions on how much risk you're going to take and how you allocate your portfolio?

00:42:43.000 | And if the financial planner says, okay, you're going to have a 60/40 portfolio,

00:42:48.000 | then does the financial planner articulate that to the investment advisor or does the client articulate that to the investment advisor?

00:42:56.000 | And when stock market crashes and the person needs to have their hands held, do they call the financial planner or do they call the financial advisor?

00:43:04.000 | I just think that this is all so intertwined.

00:43:07.000 | I mean, for some people who are able to do it, my hat is off to them, but I think it's a very integral process.

00:43:14.000 | I guess I would fall somewhere in between, Rick and Bill, in that I think it really depends on the individual and what they have going on in their lives.

00:43:22.000 | Certainly for people with more complicated situations, small businesses, for example, or something else like that,

00:43:30.000 | then maybe the more holistic approach might make sense.

00:43:34.000 | But I have really gotten to be in favor of the hourly model for a lot of investors like you,

00:43:41.000 | who might need help with a more surgical type of problem where you have a specific question,

00:43:47.000 | such as the first question about the tax planning issues related to taking retirement distributions.

00:43:53.000 | That seems like a great place to check in with a tax advisor.

00:43:57.000 | You don't need to be consulting with that tax advisor on a regular basis, but just to get some guidance on how to proceed,

00:44:04.000 | to me that seems like a great way to go.

00:44:06.000 | So I come down with sort of splitting the difference.

00:44:09.000 | It really depends on who you are and what your needs are.

00:44:12.000 | Thank you, Christine.

00:44:13.000 | I changed my view on why it's better if there were more.

00:44:16.000 | [laughter]

00:44:19.000 | Well, I think Christine brings up a great point, that for a lot of people who have a good handle on the investing process

00:44:26.000 | and don't need the wisdom of the full gamut of financial planning,

00:44:31.000 | hiring someone on an hourly basis makes a ton of sense.

00:44:36.000 | The reality is that from the Boglehead's perspective, I think that the Boglehead crew is very, very unique.

00:44:44.000 | Very, very few investors have the capacity to know how to piecemeal it out effectively.

00:44:51.000 | I think it depends a lot on the size of your portfolio.

00:44:54.000 | The bigger my portfolio, the less interested I would be in paying an assets under management fee for estate planning or tax planning advice.

00:45:05.000 | As a second point, I just want to say thanks for that question,

00:45:09.000 | because I think on the forum we tend to get lost in really small, small, obscure details about portfolios.

00:45:18.000 | I just think it's great to pay attention to talk about other topics that just don't quite get as much coverage,

00:45:25.000 | tax planning, retirement planning, blended claims, social security, things like that.

00:45:29.000 | How much of your portfolio do you annuitize?

00:45:33.000 | I do think the need to take risk, you can't assess that.

00:45:38.000 | Willingness to take risk you can do on a survey profile and it's very inaccurate because it changes over time.

00:45:47.000 | Understanding the need to take risk is very important.

00:45:50.000 | One of the ahas I've had in the last 10 years is that people who come to me very pessimistic about running out of money have saved a bundle.

00:45:58.000 | Those that are very optimistic haven't saved much.

00:46:02.000 | When you think about it, it's those that were worried about it, a little pessimistic,

00:46:07.000 | that actually deferred spending, lived below their means, and those that were optimistic about it spent every penny they had.

00:46:17.000 | The next question is regarding the Bogo Head philosophy as listed here.

00:46:24.000 | There are 10 items on the list.

00:46:26.000 | First, to develop a workable plan.

00:46:29.000 | Two, is invest early and often.

00:46:31.000 | Three, is never bear too little or too much risk.

00:46:35.000 | Four, is diversify.

00:46:37.000 | Five, is never try to time the market.

00:46:39.000 | Six, use index funds when possible.

00:46:42.000 | Seven, keep costs low.

00:46:44.000 | Eight, minimize taxes.

00:46:46.000 | Nine, invest with simplicity.

00:46:48.000 | And 10, stay the course.

00:46:51.000 | And it says if there's anything you would add, if you could, to that philosophy.

00:46:56.000 | And I would say number one has to be you live below your means.

00:47:01.000 | All the rest of the stuff is totally irrelevant if you don't learn to live below your means.

00:47:06.000 | So I think that the number one item that needs to be added to that list is live below your means.

00:47:13.000 | Can I change one of the things on the list?

00:47:15.000 | Sure.

00:47:16.000 | As the author of the all about index funds and probably a prolific reader and analyst about index and index investing,

00:47:27.000 | I would scratch that one about index funds, to use index funds when possible.

00:47:34.000 | There are some index funds out there that are in asset classes I wouldn't use.

00:47:38.000 | For instance, municipal bonds.

00:47:41.000 | There aren't any good municipal bond index funds, really.

00:47:44.000 | There's an ETF out there, MUB, which is okay.

00:47:47.000 | But it has one-third the number of bonds in it as the Vanguard Intermediate-Tier Municipal Bond Fund,

00:47:53.000 | which is actively managed.

00:47:55.000 | And the fee is more than twice the Vanguard Intermediate-Tier Municipal Bond Fund,

00:48:01.000 | which is actively managed.

00:48:03.000 | So even though it is possible to use a municipal bond index fund, I wouldn't use it.

00:48:09.000 | Same thing with high-yield corporate bonds.

00:48:11.000 | I don't want to use an index fund of high-yield corporate bonds.

00:48:14.000 | I would rather use the Vanguard high-yield corporate bonds fund, which is no longer open to investors.

00:48:19.000 | But there's the TIA CREB Institutional Fund, which is pretty good that we're using.

00:48:26.000 | So "when possible" is not the best word.

00:48:30.000 | Maybe you can just change the word.

00:48:32.000 | "When feasible" or "when something," but not just "when possible."

00:48:35.000 | How about just use low-cost funds whenever possible?

00:48:38.000 | Low cost, I think, is key, yes.

00:48:41.000 | Okay.

00:48:43.000 | Are you getting this?

00:48:45.000 | It looks like you're taking notes, Sue, because these are things that we have on the weekly,

00:48:52.000 | and we want to take those comments into consideration.

00:48:56.000 | People who use DFA funds, they are not index funds.

00:48:59.000 | Like I said last night, they're quantitative, classically managed funds, but they don't follow an index.

00:49:04.000 | I mean, Bill, what index do DFA funds follow?

00:49:09.000 | DFA indexes.

00:49:11.000 | Whatever their computers spit out is what they follow.

00:49:16.000 | Jack's made that point several times.

00:49:19.000 | There's nothing magic about indexing.

00:49:21.000 | In fact, indexing does have certain disadvantages,

00:49:25.000 | particularly if you're trying to match and rebalance against a great, big, popular index.

00:49:31.000 | That's actually a disadvantage.

00:49:33.000 | I mean, for those of you out there who want a large-cap index fund,

00:49:36.000 | don't use the index fund.

00:49:38.000 | Try, you know, the 500 fund.

00:49:40.000 | Use the large-cap index fund that will pretty reliably,

00:49:44.000 | at least over the two or three-year horizon, outperform DFI index simply because it doesn't have good balance.

00:49:52.000 | I would recommend changing minimized taxes to maximize after-tax return.

00:49:57.000 | I tell my clients if they want to minimize taxes, give all their money away and quit their jobs.

00:50:02.000 | That's one of the reasons why people don't pay off their mortgage.

00:50:05.000 | I'd lose the tax deduction, but it's the inverse of a bond.

00:50:08.000 | It's the opposite of a bond.

00:50:10.000 | You pay taxes on your total bond fund, which is yielding 1.7%.

00:50:14.000 | You've got a 3.5% mortgage.

00:50:17.000 | You end up paying more taxes, but more importantly, you have a greater after-tax return.

00:50:25.000 | Okay, the next question is from Hank Theory.

00:50:29.000 | Is that the proper way to pronounce your name?

00:50:31.000 | Yeah.

00:50:32.000 | He says, "Most, if not all, of the conditions that led to the 2008 meltdown are still in place.

00:50:39.000 | When will the next meltdown occur?"

00:50:42.000 | [Laughter]

00:50:44.000 | In your opinion.

00:50:46.000 | Yes.

00:50:47.000 | The next meltdown to occur is in China.

00:50:50.000 | That's my opinion.

00:50:52.000 | It will occur because the Chinese financial institutions are hiding bad assets.

00:50:56.000 | It's getting worse.

00:50:58.000 | Yeah, the wonderful talk we saw on the last hour had a very nice graph, that pulse graph.

00:51:06.000 | And if you look at the right side of the graph, you saw that that pulse was wildly oscillating up and down.

00:51:12.000 | We have an unstable financial system.

00:51:15.000 | And the answer to your question is maybe tomorrow, maybe in 10 years.

00:51:21.000 | But financial history tells us that these things occur about once a decade.

00:51:26.000 | And I think that our system, the instability in our system, where we can say that nothing's been fixed,

00:51:32.000 | probably tells us sooner rather than later.

00:51:37.000 | I think from a portfolio perspective, looking back at 2008, it was not fun.

00:51:42.000 | It was a nasty environment.

00:51:44.000 | But also I look at the Boglehead philosophy and also Jack Bogle's simple wisdom of having your age in bonds.

00:51:53.000 | Now I know a lot of people are critical of that simple wisdom.

00:51:56.000 | But to me, that really proved its mettle in 2008.

00:52:00.000 | We had people who were retired and had only 30 to 35 percent of their portfolio in the market.

00:52:07.000 | You know, it wasn't a total disaster.

00:52:09.000 | Yeah, their portfolio was down 7 to 10 percent.

00:52:12.000 | But it wasn't as if they lost 50 percent of their money.

00:52:15.000 | Robert Shiller, I had the wonderful opportunity to listen to him shortly after the market crash.

00:52:22.000 | He said it was just this huge lack of understanding of this simple concept of asset allocation.

00:52:30.000 | And so I think it's important that all of us, instead of trying to look at what's going to happen around the globe,

00:52:37.000 | admit that we're going to have bear markets every couple of years.

00:52:40.000 | I mean, it might be a 20 percent drop. It might be a 35 percent drop.

00:52:44.000 | But it is going to happen. It's a part of life.

00:52:47.000 | And to, you know, allocate your assets accordingly.

00:52:54.000 | Okay, here's a question from Theresa.

00:53:00.000 | What do you see evolving in terms of the municipal debt problems and municipal bankruptcies and impact on related investments?

00:53:13.000 | Well, let's look at the expected rates of return that states are looking at in order to balance their budgets, I guess, going forward on their retirement portfolios.

00:53:28.000 | And I think the average is 7.5 percent annualized.

00:53:32.000 | Now, if we check the yield on the total bond market index fund yesterday, it was about 1.5.

00:53:40.000 | And let's say a state has half their money in fixed income, it might be a little bit conservative,

00:53:48.000 | but 40 percent of fixed income, that's yielding 1.5.

00:53:52.000 | What do you need to get on the other side of the portfolio to get to 7.5?

00:53:58.000 | It's an enormous rate of return.

00:54:00.000 | Now, the stock market, in my opinion, maybe we're going to get 7 percent rate of return,

00:54:05.000 | unless there's tremendous multiple expansion and VEs go back up to 30.

00:54:09.000 | But let's say that VEs just stay around 15, maybe a 7 percent return on equities going forward.

00:54:15.000 | So where does the money come from?

00:54:18.000 | Well, it comes from alternative investments, correct?

00:54:20.000 | All the alternative investments are going to compound at 30 percent compounded annual rate of return for every single state in the country.

00:54:28.000 | Do you believe it?

00:54:30.000 | I don't either.

00:54:31.000 | So there's a problem.

00:54:33.000 | I mean, for political purposes, the rates of return on pension funds are about 2.5 percent, too high.

00:54:43.000 | And once you actually factor in what the actual rate of return will likely be on these pension funds,

00:54:50.000 | then every single state, almost every state out there, is in deep, deep, deep financial trouble.

00:54:54.000 | Yeah, whenever you see the widespread adoption of a particular style of investing, holding on to your wallet tight,

00:55:06.000 | what we're seeing, and Rick wrote about this in Forbes several weeks ago,

00:55:12.000 | and what we're seeing also with the largest pension plans, Rick wrote about it in University Endowments,

00:55:18.000 | is that everybody is adopting the Yale model, which basically says put half of your allocation into alternative assets,

00:55:25.000 | pension funds, private real estate, private equity, commodities.

00:55:31.000 | Whenever you have so much cash chasing so little opportunity, the potential for disaster is enormous.

00:55:42.000 | Just simply, Rick has talked about one dimension of it just now, which is the arithmetic doesn't compute.

00:55:50.000 | If you have one and a half percent bonds returns, you have to get, I don't know, 11, 12, 13 percent stock returns.

00:55:56.000 | But that's not the real ticking time bomb.

00:55:58.000 | The real ticking time bomb is all the crap that people are chasing in all of their portfolios these days.

00:56:08.000 | One comment I would add specifically on munis is that I think you really do have to look at the credit quality of the portfolio

00:56:15.000 | that you're investing in, and also fees go hand in hand with credit quality.

00:56:21.000 | So that's one reason I personally invest in Vanguard's muni bond funds,

00:56:25.000 | because the credit quality is generally higher than the peer group,

00:56:28.000 | in part because the low costs help the funds look competitive on a yield basis,

00:56:33.000 | so they don't have to venture into junky portfolios.

00:56:38.000 | I thought there was an interesting report that came out a few months ago.

00:56:42.000 | It was issued by a government agency that looked at the default rate among municipalities over the past decade or so.

00:56:50.000 | And a lot of people cite that data and say, well, muni default rates have really been quite low over time.

00:56:55.000 | This report looked at, once you added non-rated municipal bonds into the mix,

00:56:59.000 | actually the default rate was much higher, I can't remember what the specific number was,

00:57:03.000 | but it was much higher than had previously been discussed.

00:57:06.000 | So I think you do have to be careful and generally try to keep the credit quality of any muni portfolio high.

00:57:12.000 | If you're owning a junkier, high-yield muni portfolio,

00:57:17.000 | then maybe you want to limit that to the margins of the portfolio.

00:57:21.000 | >> Christine, even if you're just considering the very highest quality municipal bonds,

00:57:31.000 | and you're looking at the historical rate, I question the validity of those historical data

00:57:38.000 | because we're living now in an era with entitlement and pension obligations that we've never had to live with before.

00:57:46.000 | Do you think that those previous data are as relevant as we might like to think they are?

00:57:52.000 | >> I'm just wondering what the answer is.

00:57:57.000 | There are many more defaults out there than what the media is calling a default.

00:58:01.000 | If you're a pensioner and you're getting a pension from the state of Rhode Island,

00:58:05.000 | and the state says, we're cutting your pension, isn't that a default?

00:58:12.000 | It's a default. It's just not a default on the bond.

00:58:15.000 | It's a default against an obligation. That's what a default is.

00:58:19.000 | There's going to be a lot of defaults out there.

00:58:21.000 | The federal government will default.

00:58:23.000 | It may not default on their treasury bonds, but they're going to default on some other obligations.

00:58:26.000 | Call it Medicare, call it Social Security, I don't care what you call it, it's going to be defaults.

00:58:31.000 | It's just not going to be called a default, but that's what it is.

00:58:35.000 | >> It might be that the pension plans have been kicking the can down the road for a long time,

00:58:42.000 | and we're getting to the end of the road.

00:58:45.000 | They were saved, of course, by the rural stock market, which really helped them out.

00:58:51.000 | But basically, a lot of these obligations are coming due because as America ages,

00:58:58.000 | more and more people are retiring, and the obligations are coming due where they have to pay out.

00:59:05.000 | So I think there's probably a -- as Rick alluded to, or as Bill alluded to,

00:59:12.000 | I think there's going to be a lot more of the -- whether they're official or unofficial bankruptcies.

00:59:19.000 | That's my opinion, and that's worth a lot, but that's my opinion.

00:59:25.000 | >> Can I say one thing?

00:59:28.000 | I'm actually more pessimistic than Bill and Rick.

00:59:32.000 | There's about $2.3 trillion of unfunded pension and health care liabilities,

00:59:38.000 | assuming an 8% or 7.5% or 8% return.

00:59:44.000 | And Jack Bogle showed a slide yesterday of the expected DV return of 4.6%.

00:59:51.000 | So the math doesn't add.

00:59:54.000 | Perhaps the U.S. government bills the municipalities out.

00:59:57.000 | Perhaps they're able to renegotiate those defined benefits.

01:00:01.000 | But there is a ton of risk.

01:00:03.000 | I did talk to Jack Bogle about it yesterday, and he's worried as well

01:00:09.000 | and thinks that it could be right, but he's less worried than I am.

01:00:13.000 | >> You'll be pleased to know that I still have my medical license,

01:00:17.000 | but I won't be able to administer ECT right after this.

01:00:24.000 | >> I have a quick question for the planners, though.

01:00:26.000 | Does that mean that for clients who have taxable portfolios that would call for bonds,

01:00:31.000 | does that mean that you're bypassing munis?

01:00:34.000 | >> I always hedge my bet that I'm not necessarily smarter than the market.

01:00:38.000 | The munis make up about 7% of U.S. debt.

01:00:42.000 | So I certainly would not do more than 10% or, at the very most, 14%.

01:00:48.000 | Because, again, if stocks don't do well, then the pension liabilities,

01:00:53.000 | the shortfalls are going to get larger and larger,

01:00:56.000 | and you want your fixed income to be the shock absorber with stocks.

01:01:01.000 | I don't know when we're going to have the next bubble, but we will,

01:01:04.000 | and you want your bonds to be backed by the U.S. government, in my opinion.

01:01:10.000 | >> Is that 7% or 10% of the bond portion of the portfolio?

01:01:15.000 | >> Yes, of the bond portion of the portfolio.

01:01:18.000 | >> What would you say the alternative would be?

01:01:20.000 | Does it mean the tax is a total bond?

01:01:23.000 | >> You're talking -- say that again. I'm sorry to hear the question.

01:01:27.000 | >> You're saying that if you limit the potential bond portion of the fixed income,

01:01:31.000 | then you're putting that tax on the child's portfolio,

01:01:34.000 | and you don't have any money to handle real estate.

01:01:36.000 | >> I have 70% of my own fixed income in CDs,

01:01:39.000 | and CDs that have easy early withdrawal penalties.

01:01:42.000 | So I just opened up a CD this week at a credit union paying 2.2%.

01:01:48.000 | It's five years, but it has a 120-day early withdrawal penalty,

01:01:52.000 | which is like a put to sell it at .73.

01:01:55.000 | So if you compare the 1.5, 1.6 total bond portfolio, I'm earning more.

01:02:01.000 | I'm 100% U.S. government backed, and the total bond has a 5.1-year duration,

01:02:07.000 | which means if interest rates go up by 1%, then it would go down by --

01:02:12.000 | and that's not a prediction, by the way, it's just a possibility --

01:02:15.000 | then the total bond fund would drop by 5.1%,

01:02:20.000 | whereas I could pay that early withdrawal penalty, get my money out,

01:02:24.000 | and reinvest it at a higher rate.

01:02:26.000 | It's a non-Vanguard solution, vividly.

01:02:28.000 | >> I'm just staying with the Vanguard intermediate-term municipal bond fund.

01:02:31.000 | It has thousands and thousands and thousands of securities in it.

01:02:34.000 | Now, I used to manage, for many years, individual municipal bond ladders,

01:02:40.000 | where I would build a municipal bond ladder for each client based on the state that they live in.

01:02:44.000 | I don't do that anymore.

01:02:46.000 | I'm not nearly smart enough to do that anymore.

01:02:48.000 | I used to be smart enough. I'm not smart enough anymore.

01:02:50.000 | Now I just stick with the very, very, very broadly diversified Vanguard municipal bond funds,

01:02:56.000 | and I think we'll be okay.

01:02:58.000 | And they're actively managed.

01:03:01.000 | >> If you want to move away a small portion of your taxable bond allocation,

01:03:08.000 | you can get $10,000 in add-ons, which are tax-deferred.

01:03:12.000 | You can get $20,000 per couple.

01:03:14.000 | If you've got a trustee, you get another $10,000.

01:03:18.000 | You get $5,000 back on your tax return.

01:03:22.000 | So you can get a smaller amount.

01:03:24.000 | In the good old days, you could get $30,000 per person, and those days would drop,

01:03:29.000 | but you could still get $20,000 per couple, which adds to your tax deferral.

01:03:37.000 | And they're currently yielding 2.2, even though the fixed rate is zero.

01:03:42.000 | So they're yielding 2.2%.

01:03:44.000 | I think the next rate has just been calculated at 1.76.

01:03:49.000 | So you'll get 2.2 for the first six months.

01:03:53.000 | You'll get 1.76 for the second six months.

01:03:57.000 | So that takes you out to the year.

01:03:59.000 | You can redeem them if something else more attractive becomes available.

01:04:04.000 | In addition to that, they're very flexible.

01:04:08.000 | If inflation raises and it's over the head and your rate goes up, you can hang on to them.

01:04:17.000 | You can use it for tax-shipping, moving it from your current high tax rate into the future

01:04:24.000 | when you retire and get a lower tax rate.

01:04:26.000 | So it also is free from state and local taxes.

01:04:30.000 | So if you live in a state like New York, New Jersey, California with high state taxes, you can avoid those.

01:04:36.000 | So there's a lot of benefits.

01:04:37.000 | It's just a shame you can't invest more than $10,000 per person.

01:04:45.000 | But that's one option.

01:04:47.000 | At this time, we're going to take a break, and we'll resume with the Q&A after we take a break.

01:04:55.000 | [BLANK_AUDIO]

Bogleheads® Conference 2012 - Panel of Experts I

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