Bogleheads® Conference 2013 - Panel of Experts II
Chapters
0:02:56 Deep Dive into Long-Term Care Insurance
7:25 The Confessions in the Garden of Eden
12:0 Biggest Problem in Investing
17:34 Rebalancing Is Overrated
22:36 What's an Index
28:13 Do You See any Guidance for Improving Financial Literacy in the Nation
40:34 Comment on Guidelines for Managing One's Portfolio Withdrawals during Retirement
45:3 The Total Bond Market Index Fund
46:9 What Is Your Opinion of Stable Value Funds in this Environment
62:3 Cds versus Bonds
65:21 Summary Prospectus for the Vanguard Emerging Markets Government Bond Index Fund
68:3 What Factor Should One Consider When Comparing a Lump Sum versus versus a Pension from a Major Corporation at Age 62
00:00:00.000 | our first panelist is Morningstar's Director of Personal Finance and a senior columnist
00:00:19.600 | for Morningstar.com. Please welcome author Christine Benz. Our next panelist is a vital
00:00:31.320 | member of the Bogo Heads community. She's an author and Forbes.com columnist. Please
00:00:36.880 | welcome the Queen of the Bogo Heads, Laura Delgout. Our next panelist is a retirement
00:00:46.640 | researcher and a professor at American College. Please welcome Dr. Wade Pfau. Our next panel
00:00:56.560 | member is Missouri-licensed CPA and the author of the blog, Oblivious Investor. He's also
00:01:03.560 | authored a number of very successful digital books. Please welcome Mike Piper. Our final
00:01:14.280 | panelist is the creator of the Coffeehouse Investor and an advisor with SoundMark Wealth
00:01:19.600 | Management in Seattle. Please welcome author Bill Schultheis. And again as customary, let
00:01:32.360 | the panel members tell us a little about what's going on in their life at this point in time.
00:01:37.400 | So can we start with Christine and go down and you're welcome to plug your latest book
00:01:41.840 | or whatever's going on. Sure. Can everyone hear me? No? No? No books in the offing, Mel,
00:01:50.680 | but I've been working on a couple of things. I really like the previous panelist's comments
00:01:55.920 | about the psychological impediments to getting people who are retired or close to retired
00:02:02.960 | thinking about total return versus current income. I think people very much want to anchor
00:02:07.320 | on that current income from the portfolio and so I think there are psychological impediments.
00:02:12.360 | I think there are also logistical impediments to doing so. It's just more complicated rather
00:02:17.240 | than just receiving that paycheck from the portfolio. So one of the things that I've
00:02:21.920 | been working on for a good year now or even more is this idea of walking people through
00:02:28.280 | what a total return portfolio looks like in action during retirement, delivering that
00:02:35.000 | total return, that 4% or whatever is needed from the portfolio. So I've been doing a lot
00:02:39.720 | of model portfolios where we kind of go year by year and model out where did we get the
00:02:45.160 | cash that year. So I've been working on that. I'm happy to provide more details on all of
00:02:50.840 | that if people would like it. Another special project that I'll be working on coming up
00:02:55.720 | will be doing a deep dive into long term care insurance. When I'm out and about doing speaking,
00:03:03.440 | I get a lot of questions about long term care and I feel that there's a lot of appetite
00:03:08.440 | for better information about the viability of these products, who it makes sense for,
00:03:13.400 | who it doesn't make sense for, do they make sense at all, given some of the premium increases
00:03:18.360 | that people have had. So I'm going to be spending some time doing a research project on long
00:03:24.760 | term care and will probably be working on that between now and the year end.
00:03:31.880 | So it's a pleasure to be here. I also don't have any books on the horizon or anything
00:03:35.600 | like that. I do have an active blog. My name's kind of hard to spell but I was, so on the
00:03:40.800 | one hand unlucky, on the other hand lucky because there's no one else with the same
00:03:44.400 | name with any sort of internet presence. So if you just Google my name you'll be able
00:03:48.640 | to find my retirement researcher blog and that's the best way to keep track of what
00:03:52.800 | I'm doing. I was in Japan for 10 years, just moved back in March of this year and now work
00:03:57.520 | at the American College, which started in the 1920s to create the CLU designation for
00:04:02.800 | life insurance and now they've started a new PhD program in financial planning and retirement
00:04:07.600 | planning. I'll be teaching in that program and just doing research and trying to write
00:04:12.680 | different research articles. I focus a lot on income annuities, which is a very small
00:04:17.520 | part of that annuity world. I just read recently from Moshe Molesky that income annuities make
00:04:22.960 | up 4% of annuity sales. So if you hear the word annuity, there's a 96% chance you're
00:04:29.080 | hearing something different than what I'm looking at. How they fit into a retirement
00:04:34.080 | income portfolio, what's the safe withdrawal rate, what different types of strategies can
00:04:38.880 | people use to build a retirement income strategy. That's what I'm looking at these days.
00:04:47.760 | No big writing projects at the moment. What I've been spending most of my time on lately
00:04:52.160 | is researching the tax planning ramifications of the Affordable Care Act. So for people
00:04:58.800 | who are going to be retiring prior to Medicare eligibility, how their tax planning will change
00:05:04.920 | as a result of either being able to qualify or not being able to qualify for the premium
00:05:11.560 | subsidies or the other subsidies involved in the act. So no book on that forthcoming,
00:05:19.160 | just researching it because I'm getting questions about it. That's basically it.
00:05:23.160 | We're not a group that's writing a lot. Hopefully you have a book. I don't either.
00:05:31.160 | What have I been spending my time on? Well, I've been spending a lot of time researching
00:05:35.160 | college prices because I have two children and one's a senior and one's a junior in high
00:05:39.160 | school and I have to tell you that, oh my god, it is really, really expensive to send
00:05:43.160 | your children to university. Fortunately, being a BOGO head, we've been working on
00:05:47.160 | that for a while, but nonetheless, my current focus and what I'm thinking about and looking
00:05:53.160 | at right now is how do parents of small children manage to actually set aside not just enough
00:05:59.160 | to be able to retire, but to be able to help their children go to school. I think that's
00:06:04.160 | probably a valid question, not just for parents, but perhaps for grandparents who really want
00:06:08.160 | to be able to help out as well, but the prices in the education arena are somewhat shocking.
00:06:14.160 | It's a little shocking to sit there and look at an admissions presentation that tells you
00:06:18.160 | that a school which is fine, but we're not necessarily world class, it'll be $65,000
00:06:22.160 | a year to send your child to that school. That is what I'm working on.
00:06:28.160 | Well, that sounds like it would make a good article for our Forbes column.
00:06:32.160 | You keep trying, Al.
00:06:37.160 | I'd first like to say that I am honored to be sitting on this panel with the four of
00:06:42.160 | you. I'll tell you, as much as standard deviations and fancy equations are important, it's the
00:06:48.160 | work that Wade and Mike are doing and the ability for Christine to be sharing it in
00:06:55.160 | the Morningstar Forum and Laura to be cheering us all on that really matters the most. I
00:07:01.160 | can tell you all day long I'm sitting down with clients and it's the content that you're
00:07:06.160 | providing, Wade and Mike, that are really having a significant impact on people's lives.
00:07:12.160 | I just want to thank you for all your hard work.
00:07:21.160 | I am working on another book. I've been working on it for the last ten years. It's called
00:07:26.160 | The Confessions in the Garden of Eden. It was 20 years ago in 1993 when Fortune magazine
00:07:33.160 | ran a cover article story saying the coming investor revolt. Basically, they were talking
00:07:38.160 | about how investors were fed up with Wall Street. I used that cover story to go to publishers
00:07:45.160 | and agents to try to get my book published, The Coffee House Investor. I got all the rejection
00:07:51.160 | letters. In fact, my favorite one is one that wrote back saying, "You know, we like the
00:07:56.160 | idea, but really there's not much more to say than an op-ed piece written by John Vogel
00:08:01.160 | on the topic." I still have it. I felt like the whole concept of index funds and passive
00:08:09.160 | investing was the coming trend. Fortunately, I was able to land a spot with an editor and
00:08:18.160 | a publisher who happened to do the book, The Millionaire Next Door. I haven't caught my
00:08:22.160 | breath since. It's been a wonderful ride. What I'm working on right now, let me do a
00:08:29.160 | quick survey. This is what I'm working on. It's the new wave of investing. Who all has
00:08:42.160 | had at one time in their life a passbook savings account? Sure. Who doesn't know what a passbook
00:08:50.160 | savings account is? All the kids. That's what I'm working on. I graduated from college in
00:09:00.160 | 1982. In 1982, two things happened that allowed people to forget what passbook savings accounts
00:09:06.160 | are all about. Number one, in 1982, 401(k)s came into existence. In 1982, the bull market
00:09:13.160 | got its 17-year start. What happened was you had millions and millions of Americans who
00:09:18.160 | shifted their attention away from passbook savings accounts and towards five-star mutual
00:09:23.160 | funds. It's been an abysmal failure. We didn't realize it was an abysmal failure because
00:09:28.160 | for the first 17 years, we had a stock market that was going up, what, 17% a year. I don't
00:09:34.160 | want to dominate the conversation here. It's amazing. We talk about the benefits of investing
00:09:42.160 | in low-cost index funds and the cost efficiencies. That's great, but there's a better benefit
00:09:47.160 | to that. That is that it allows you to invest with 100% confidence so that you're able to
00:09:53.160 | focus on how much you're saving and how much you're spending. That's what counts most of
00:09:58.160 | all. What's interesting is that's what people want. I'm working with different entities.
00:10:05.160 | DFA is coming out with a product. I don't know if Vanguard is or not. I put it on a
00:10:11.160 | question last night, but they didn't ask the question. There's a big company in Seattle
00:10:16.160 | that's working on it that's basically combining defined contribution plan concept with a divine
00:10:22.160 | benefit plan concept so that investors across America can focus on one thing and one thing
00:10:27.160 | only, and that's how much they're saving. They don't have to worry about how much small
00:10:30.160 | cap or how much tips or how much anything else they have. They focus on how much they're
00:10:34.160 | saving. I think that's the future of investing. I think that in 10 years, we won't even have
00:10:39.160 | 401(k)s like we have today because it's an abysmal failure. You can't expect an intelligent
00:10:44.160 | human being who's just graduated from college to save enough and invest it wisely and then
00:10:48.160 | have it make it last their entire period. That's why I'm so interested in what you're
00:10:52.160 | working on, Wade, with the whole annuity thing. People want to cash flow. They want to pay
00:10:56.160 | their bills. They don't want to figure out what the standard deviation is of a smart
00:11:00.160 | beta fund. With that, that's what I'm working on, Mel.
00:11:06.160 | The first panel discussed it, and we want to do the same thing here. We want everybody's
00:11:14.160 | opinion on Jack's thoughts on counting Social Security, the present value of Social Security
00:11:22.160 | as a bond. That's very controversial on the forum, and it was even controversial on the
00:11:28.160 | first panel, so I'd like to have everybody's thoughts on that. We'll start with you, Bill.
00:11:33.160 | I think what Alan Roth said, I agree with him 100%. You take the residual income needs
00:11:41.160 | that you need above your pensions and Social Security, and you create an asset allocation
00:11:46.160 | to make sure that you don't have to spend your stock market money when the market's
00:11:50.160 | down. I agree with that completely. I think that
00:11:54.160 | the success for investing—this group here is not a normal group, and when you look out
00:11:58.160 | at society as a whole, I think that the biggest problem in investing is not whether you've
00:12:02.160 | got the right data, standard deviation, or even asset allocation to some extent. It's
00:12:07.160 | your own behavior. I think that trying to tell people to categorize Social Security
00:12:12.160 | as a bond and then figure out how that applies in your asset allocation is really just setting
00:12:16.160 | people up for failure in the long term. I don't think people can do that, and I think
00:12:20.160 | that just using it to figure out what you need to generate out of your portfolio after
00:12:25.160 | you receive whatever stream of income you're going to get from whatever source, be it Social
00:12:29.160 | Security or something else, is really a simpler and much more successful way to go for the
00:12:33.160 | long term. I agree. The simpler and easier way to do
00:12:39.160 | it is to just count it as income. That's the way I do it. At the same time, I'll
00:12:43.160 | say that it shouldn't matter what you call it, because your asset allocation should be
00:12:49.160 | a function of how much risk you can afford to take on and how much risk you want to take
00:12:54.160 | on. Whether you call your Social Security a bond or call it income or call it rainbows
00:13:00.160 | and unicorns, it doesn't matter. It doesn't change how much risk you can take on. It shouldn't
00:13:07.160 | matter. I think the easiest way to do it, absolutely, is to call it income, but it shouldn't
00:13:12.160 | terribly affect what you actually do with your portfolio.
00:13:15.160 | I think it could, Mike. I think that the situation is if you want to be 50/50 and your Social
00:13:21.160 | Security ends up being 100% of your bonds, you're going to end up with 50% equities,
00:13:29.160 | which is actually you're going to end up with a lot more equities and a lot more risk, which
00:13:34.160 | you alluded to. The bottom line is people are going to look at their statements, and
00:13:40.160 | if they see their statement going down 50%, I don't think that ... I think that's the
00:13:46.160 | effect that you could have by counting that as a bond.
00:13:51.160 | Can I back off there? Sure.
00:13:53.160 | I think that to start by saying, "I'm going to use a 50/50 allocation," is a mistake.
00:13:59.160 | You don't want to start there without having yet decided how you're going to count your
00:14:03.160 | Social Security. I think that that's what I was saying, because ... Let's see. You want
00:14:11.160 | to decide how much risk you can take, right? Then if you decide ... Those two things can't
00:14:19.160 | both make sense. The 50/50 allocation can't make sense in both of those cases. Obviously
00:14:25.160 | you've picked a 50/50 allocation for deciding how to count your Social Security. The way
00:14:31.160 | you chose your allocation doesn't make any sense. You're doing it wrong. That's basically
00:14:35.160 | the short version. Is that making sense? Not really, but ...
00:14:42.160 | All right. My preferred method is to use it as income,
00:14:52.160 | determine your needs, and then the portfolio has to produce the balance.
00:14:57.160 | That's my preferred method as well, for the record.
00:15:02.160 | I like the delineation that Dr. Bernstein made this morning, that you either look at
00:15:07.160 | things from the household balance sheet perspective, where you capitalize Social Security, put
00:15:11.160 | it on the balance sheet. The present value of your lifetime income stream is an asset
00:15:16.160 | that you own, and it can be used to offset a liability you face, which is your lifetime
00:15:21.160 | spending needs. You can either think of it from that balance sheet perspective, or look
00:15:26.160 | at the cash flows from year to year. What are your spending needs in a given year? What
00:15:30.160 | portion of that is covered by Social Security? Having more Social Security does give you
00:15:35.160 | greater risk capacity. It may also reduce your need to take risk, but you have more
00:15:40.160 | risk capacity, because even if your financial assets are gone, you still have the Social
00:15:45.160 | Security income stream. If that's able to cover a substantial part of your lifetime
00:15:49.160 | spending goals, spending needs, then you're going to be in decent shape regardless. You
00:15:54.160 | have the risk capacity. Whether you have the need for risk is another question, but I think
00:15:58.160 | it certainly needs to be part of that calculation of what you're going to do with your financial
00:16:03.160 | assets. You don't decide your asset allocation in isolation before considering what Social
00:16:09.160 | Security does for you, and how that will work into your household balance sheet, and your
00:16:13.160 | household asset allocation, to some extent. Whether it's a stock or a bond, we don't have
00:16:19.160 | to maybe give it a term for that, but it is part of the household assets allocation.
00:16:28.160 | I generally concur with the other panelists on this. One anecdote I would add, I discussed
00:16:33.160 | this with financial planner Harold Domensky. He was, I think, very, very smart about financial
00:16:38.160 | planning matters, as well as some of the behavioral aspects of financial planning, and I asked
00:16:42.160 | him about this very issue. He said, he imagined telling his clients in 2008, "Well, your stock
00:16:50.160 | portfolio, yes, it lost 50%, but your bond portfolio did just fine," meaning Social Security.
00:16:56.160 | The client would say, "What bond portfolio?" They can't see it. It's not tangible to them
00:17:01.160 | in the same way an asset on that portfolio balance sheet that might help neutralize some
00:17:06.160 | of the equity funds losses would do for them. I think that the behavioral aspects of all
00:17:12.160 | of this are very important, and I do think that not including it in the asset allocation
00:17:19.160 | is probably the way to go, thinking of it more as income or salary in the way that Rick
00:17:26.160 | Ferry expressed it.
00:17:28.160 | The next question is very simple. I think this is probably related to Jack's latest
00:17:34.160 | comment that rebalancing is overrated, so the question is, is rebalancing overrated?
00:17:41.160 | I'll take that one. I had mentioned that I had worked on these exercises with our model
00:17:46.160 | in retirement portfolios, and we looked at a 4% withdrawal rate from the portfolios,
00:17:52.160 | and so on a year-by-year basis looked at, "Well, where are we going to get that 4%
00:17:56.160 | for living expenses?" What I found was modeling my portfolios back from 2000 through 2012,
00:18:03.160 | rebalancing worked perfectly in terms of meeting our living expenses to the point that at the
00:18:10.160 | end of 2012, which of course is a pretty good end point because the market was way up at
00:18:16.160 | the end part of that period, but the portfolio, sort of a 50/50% equity bond portfolio, supported
00:18:24.160 | the 4% withdrawal rate with rebalancing pretty much alone and ended up pretty much where
00:18:31.160 | it started in terms of value. So I was very compelled by that from the standpoint of rebalancing
00:18:38.160 | during retirement I think can be a very powerful thing, can help restore balance to the portfolio
00:18:43.160 | and also help support living expenses, so I'm a believer. And the other thing is that
00:18:49.160 | I don't think anyone has typically argued that rebalancing's big benefit has been on
00:18:54.160 | the return front, it's mainly on the risk reduction, volatility reduction front, and
00:18:59.160 | I think that that is still very much true, that the volatility suppression case for rebalancing
00:19:06.160 | is there and that's why I think people should do it.
00:19:10.160 | I might also add a little bit about that, also thinking mostly from the retirement side,
00:19:15.160 | the standard assumption in all the research about safe withdrawal rates is to do that
00:19:19.160 | annual rebalancing to the fixed asset allocation, but it's not necessarily the case that, well
00:19:25.160 | it's not clear what you rebalance to, do you always rebalance to a fixed asset allocation
00:19:29.160 | over time? And some recent research I was doing with Michael Kitsies, we were finding
00:19:34.160 | that some of the downside risks of retirement can be eliminated, or reduced, not eliminated,
00:19:40.160 | but reduced by starting with a lower stock allocation at the retirement date and slowly
00:19:45.160 | creeping back up. So rather than, the safe withdrawal rate type research, the 4% rule,
00:19:51.160 | it assumes that retiring maintains a stock allocation of 50 to 75% over their whole retirement,
00:19:58.160 | and what we were looking at was more like, well start around 20% and then creep up to
00:20:02.160 | 50 or 60% near the end of retirement. And, well you could do that by having that glide
00:20:09.160 | path in mind and then rebalancing to that every year, but in a normal market environment
00:20:14.160 | where stocks, if stocks are doing better than bonds, then not rebalancing will give you
00:20:19.160 | the same sort of effect, your stock portfolio will hopefully be rising over time if you're
00:20:24.160 | withdrawing in some sort of equal proportion from both assets. So at that stage then it
00:20:30.160 | becomes less clear about how important it is to rebalance or what sort of asset allocation
00:20:35.160 | glide path should you be rebalancing to.
00:20:39.160 | I don't think I have a lot to add really. I think the only thing I would say is that
00:20:44.160 | what is overrated is spending a lot of time thinking about the best way to rebalance.
00:20:49.160 | [laughter]
00:20:52.160 | I agree completely with that, and I agree with Christine as well. I think it's more
00:20:56.160 | of a risk management tool than a return tool. I think, again, I'm a big person to watch
00:21:03.160 | in terms of the behavior of people, and people, as we know, we even see it on the forum, people
00:21:08.160 | who are very calm and collected when something moves dramatically in the market, they're
00:21:12.160 | not so calm or collected anymore. And so I think encouraging automatic and good behaviors
00:21:18.160 | that keep people at a comfortable risk level and keep them from doing things to hurt themselves
00:21:23.160 | is actually a pretty good method. I don't think you're going to see a huge amount of
00:21:27.160 | extra return, or I don't think people should really do it for that. I think it's a risk
00:21:30.160 | management tool.
00:21:32.160 | I have nothing to add.
00:21:34.160 | [laughter]
00:21:36.160 | This is for Mike Piper. Mike, would you comment on the proliferation of index funds and index
00:21:44.160 | light funds?
00:21:46.160 | [laughter]
00:21:49.160 | I just asked him, Mike.
00:21:51.160 | [laughter]
00:21:53.160 | I think it's fantastic.
00:21:55.160 | [laughter]
00:21:56.160 | I'll add something to that.
00:21:58.160 | I think what they might be alluding to is, are we going to get in trouble if too many
00:22:03.160 | people index?
00:22:05.160 | I think Gus really covered that in a fantastic way this morning, which is the worry would
00:22:13.160 | be that the market becomes wildly inefficient because everybody's indexing. But as it becomes
00:22:18.160 | more and more efficient, that will bring in active investors because they'll see profit
00:22:22.160 | opportunities. I think there will always be enough active investors seeking those profit
00:22:28.160 | opportunities to keep things reasonably efficient, approximately as efficient as they are now.
00:22:36.160 | I also think the question is, what's an index? I think that you've seen a spreading of the
00:22:42.160 | definition of index, and what we consider to be index funds and what other people call
00:22:46.160 | and say is an index fund is not necessarily the same thing. The question of are there
00:22:52.160 | too many index funds, not necessarily. Are there too many funds that try and identify
00:22:57.160 | themselves as an index fund but is actually a different way of saying an actively managed
00:23:02.160 | fund under the cover of an index fund, those actually worry me a little bit more because
00:23:06.160 | people don't necessarily understand the difference, and they see the word index, and they don't
00:23:11.160 | understand that it's actually not going to do, and it's not going to act the way they
00:23:15.160 | think it's going to act if they invest in it.
00:23:18.160 | I think what, in regards to the proliferation of index funds and which ones are good and
00:23:24.160 | not good, I think Alan Roth again said something that's very, very profound in the earlier
00:23:30.160 | session. He said, "Whatever you choose, stick with it." You know, I go on the forum, I don't
00:23:36.160 | post a lot, but I look at it probably five or six times a day. I love watching what people
00:23:40.160 | are saying, and every time Mel talks about his unloved mid-caps, I think, "God, why don't
00:23:45.160 | I have those mid-caps in my portfolio?" But the important thing is that I'm not selling
00:23:51.160 | something to buy mid-caps. If you embrace a fundamental index source, whatever, you've
00:23:59.160 | got to stick with it because the worst thing that you can do is sell when it begins to
00:24:04.160 | underperform. Because when you do that, then you become a Dalbar statistic. And the last
00:24:10.160 | thing you want to do is become a Dalbar statistic. You know, I thought it was interesting, Walter
00:24:15.160 | Updegrave wrote an article in the last year or so interviewing Don Phillips of Morningstar
00:24:20.160 | who said that, and I would have liked to have asked us this also, but he said that Vanguard's
00:24:25.160 | research showed the same type of Dalbar statistic behavior with the S&P 500 index fund as they
00:24:33.160 | did with actively managed funds. So, you know, the secret is not to buy index funds. The
00:24:38.160 | secret is to buy low-cost, tax-efficient funds that are going to mimic a broad market and
00:24:44.160 | make sure you capture the market's return over the next 15 years.
00:24:48.160 | Bill, we may have some people in the audience who don't know what Dalbar is, so would you
00:24:52.160 | explain that, please?
00:24:53.160 | Okay, I'm sorry. Dalbar is a research company out of Boston, and a lot of people argue whether
00:24:59.160 | or not their research is authentic, but I think it is. I mean, certainly, I don't even
00:25:04.160 | need Dalbar to know that investor behavior encourages them to do the wrong things at
00:25:10.160 | the wrong time, but they have quantified investor behavior, and Christine, I probably am going
00:25:15.160 | to defer to you to talk about it because you know a lot more about it than I do.
00:25:19.160 | Well, we actually do it, too, at Morningstar, Bill. We have statistics called investor returns
00:25:24.160 | that we calculate on a fund-by-fund basis, and I would say, so you can find those on
00:25:29.160 | our website. That's free information. You can find it right alongside the funds total
00:25:33.160 | return tab. You can see a tab called investor returns. I would say the data looks a little
00:25:38.160 | bit noisy on a fund-by-fund basis. You can see some weird things that I wouldn't make
00:25:43.160 | too much of. When you roll them up, though, and look on category-by-category, for example,
00:25:48.160 | you can actually come away with some pretty interesting conclusions. The research that
00:25:52.160 | Don Phillips referenced where he showed that Vanguard index fund investors didn't necessarily
00:25:57.160 | do any better than investors in other funds and fund companies, I think part of that owes
00:26:04.160 | to something that Gus alluded to is back in the mid-90s, some of you, many of you probably
00:26:11.160 | remember, we had that period. It was kind of another nifty-fifty that occurred where
00:26:15.160 | the mega-cap stocks outperformed almost everything else, and I think that went on sort of from
00:26:20.160 | maybe '95 through '97, '98, and that led a lot of hot money, in my view, into index
00:26:29.160 | funds, into the 500 index funds in particular. I think that a lot of those investors have
00:26:35.160 | probably been flushed out of indexing, so I would expect going forward for Vanguard's
00:26:43.160 | dollar-weighted returns or investor returns to look better than they did when they incorporated
00:26:50.160 | that mid-90s period heavily. But I do think that these investor returns statistics are
00:26:56.160 | really, really interesting. One of the biggest takeaways that I have when I look at these
00:27:02.160 | numbers is that there's a very high correlation with volatility, so the higher the volatility
00:27:07.160 | in whatever fund type it is, the worse the investor returns tend to be. So sector funds,
00:27:13.160 | regional funds, terrible-looking investor returns, because what do investors do? They
00:27:18.160 | buy after the asset class has had a big run-up and they lose faith in it once it's had a
00:27:23.160 | terrible run-up performance. On the flip side, a couple of categories where we see very good
00:27:28.160 | investor returns would be any of the multi-asset class categories, so balanced funds, target
00:27:35.160 | date funds. In some cases, actually, the investor returns are higher than the funds published
00:27:41.160 | total returns because investors have done well. They've added to the funds in periods
00:27:46.160 | of weakness, and I think part of that is because these funds are big constituents in 401(k)
00:27:52.160 | plans, and when we look at 401(k) plan participant behavior, what you see is generally a really
00:27:57.160 | lazy investor who doesn't make many changes, and that tends to be very fortuitous in terms
00:28:03.160 | of improving one's return profile.
00:28:06.160 | Next question is directed to Christine, but I'd like everyone to add their thoughts.
00:28:14.160 | Do you see any guidance for improving financial literacy in the nation?
00:28:19.160 | That's a great question and something we've been looking really hard at at Morningstar.
00:28:26.160 | We've been thinking about making a bigger investment in the area of financial literacy
00:28:31.160 | specifically. I think that when you look at the studies, and there was a recent study
00:28:36.160 | that someone forwarded me, I can't remember where it originally appeared, that showed
00:28:40.160 | that financial literacy programs, by and large, are not helpful, that they don't lead to
00:28:45.160 | better outcomes. So that's somewhat daunting. We continue to believe that it's an important
00:28:51.160 | area. I want to focus on that area and help people. I think to the extent that financial
00:28:59.160 | literacy programs are more successful, it's sort of when they get people at that point
00:29:03.160 | of purchase, when they have a vested interest in making decisions. Teaching 12-year-olds
00:29:09.160 | maybe about money management isn't a great way to go about it. It probably won't sink
00:29:14.160 | in, but when you do get that person who is just starting a new job, that's when they
00:29:19.160 | need the guidance on allocating a 401(k) plan, or the person just embarking on college
00:29:24.160 | savings. They're very receptive to being told how to do that job well. So we continue
00:29:31.160 | to plug away, but I think our focus will be less purely educational and more, "Here's
00:29:37.160 | how to get it done. Here are some practical tips to do this job well."
00:29:41.160 | I like Christine's answer, and just add, there's all these kinds of information where
00:29:49.160 | we see that Americans do not understand basic concepts about financial literacy. Yeah, it's
00:29:55.160 | a tough issue of how to improve teaching in that regard, or what to do about it. I personally
00:30:00.160 | just try to focus more at the margin, maybe what Christine said, where people are making
00:30:04.160 | the decisions. So when I'm trying to educate about financial literacy, I assume people
00:30:10.160 | have, they're studying this topic and they care about it, and so they have that vested
00:30:15.160 | interest, and so I'm trying to explain things at a bit higher level. I've seen comments
00:30:18.160 | where people will say, "Well, if you use a 4% withdrawal rate, why does that mean you
00:30:22.160 | need 25 times the amount you're going to withdraw?" And I assume people can do that
00:30:27.160 | arithmetic. I don't know what else I can say about that. But yeah, in those cases where
00:30:35.160 | people just don't have that background to understand that basic arithmetic, it's really
00:30:39.160 | about maybe helping to just say, "Here's what you do, and here's how you can do it.
00:30:43.160 | Here's the choices of Vanguard index funds that you have. There's a couple different
00:30:47.160 | approaches you can take to it, but here's how you register for the account, and this
00:30:52.160 | is just a good way to go if you're not willing to otherwise put a lot of effort into your
00:30:56.160 | investing."
00:30:58.160 | I agree with both Wade and Christine that giving people information at precisely the
00:31:05.160 | right time is critical. I also think that any changes that can make the system less
00:31:11.160 | complicated to navigate are generally advantageous. So I think, for instance, just like Christine
00:31:18.160 | was saying, balanced funds, investors in them tend to perform better. That shouldn't be
00:31:23.160 | terribly surprising. I think it's great that more 401(k) plans are including them and including
00:31:28.160 | them as a default investment option. So I think any changes moving in that direction
00:31:34.160 | to just simply make it so that people have fewer decisions that they need to make correctly
00:31:39.160 | is probably going to be more productive than just trying to bombard people with information
00:31:45.160 | while they're children.
00:31:48.160 | I agree with that. However, I do think there are some basic concepts, because it doesn't
00:31:53.160 | matter if you are spending more than you are earning, you're never going to get to the
00:31:57.160 | point of being able to actually answer the question, "How do I save for college for
00:32:01.160 | my children, or how do I save for my own retirement?" and things like that. So I think it's probably
00:32:05.160 | a lifetime process that has to start with one piece of it early on and then build on
00:32:12.160 | it from there. So to some extent, the schools have responsibility. There's a lot of online
00:32:17.160 | things right now that can appeal to children and some of their financial planning concepts.
00:32:22.160 | I read on the forum a couple of years ago about somebody who I then promptly copied
00:32:27.160 | when dealing with my children. I thought it was a good idea to try and teach them at a
00:32:32.160 | young age, so I started giving them an allowance. They came to me, they were like five, I was
00:32:37.160 | going to give them $10 every time I got paid. They came racing up, I gave them $9. They
00:32:42.160 | said, "Hey, you said $10, Mom." I said, "Right, but you're in the 10% tax bracket."
00:32:46.160 | (laughter)
00:32:51.160 | And then, you know, bribery worked very well at that age, and so I made them save some
00:32:56.160 | of it, and then I told them that the money that was left, the big $3 where they could
00:33:00.160 | spend it on anything, I said that you have a 401(k) matching. It is 100%, so if you put
00:33:06.160 | your $3 in the bank, I will match you $3 and you have that much more to spend. So I think
00:33:11.160 | there are things that can be done at a very early age. I don't remember who it was that
00:33:14.160 | posted this on the forum, but I actually thought it was kind of a brilliant idea, and so they've
00:33:19.160 | been getting indoctrinated as they grow up. I'll let you know in another 10 years if it
00:33:23.160 | works or not. (laughter)
00:33:25.160 | I don't know. But I think it's a lifetime process, and I think people are receptive.
00:33:30.160 | People aren't really necessarily going to want to talk about, you know, how do I withdraw
00:33:34.160 | for retirement when they're 22 years old and in their first year of employment. They tend
00:33:38.160 | to start thinking about how to save for college, you know, just about the time the first child
00:33:42.160 | is born, which is the same time the life insurance discussion oftentimes, you know, pops up onto
00:33:46.160 | the horizon. So I do agree that it's a matter of sort of timing this all out properly.
00:33:51.160 | Well, I think Laura touched on the real secret. It's living below your means. If you don't
00:34:00.160 | live below your means, all of the other stuff is really irrelevant. And the other thing,
00:34:05.160 | the other comment I'd like to make is I think it's sad that people come out of college,
00:34:11.160 | get their first job, they go to HR. HR hands them a package of about a 401(k), and they
00:34:16.160 | have no idea what a 401(k) is. So I think there's got to be some education, at least
00:34:21.160 | so they know what a 401(k) is, and that it's probably a pretty good deal because you're
00:34:27.160 | getting a 50 cent match or a 100% match, whatever it is. So I think there needs to be some education
00:34:36.160 | prior to them coming to that point, because the people in the HR department, number one,
00:34:43.160 | aren't allowed to give advice, and number two, couldn't give it if they were allowed
00:34:48.160 | because they don't know either. So I think there does seem to be, need to be a point
00:34:54.160 | to get them to the point of where they're ready to make a decision. So I think there
00:34:59.160 | does need to be some education prior to that.
00:35:03.160 | Mel, I would just completely agree with that, and one comment I would make is when you look
00:35:08.160 | at some of the materials that participants are given on their 401(k) plans when they
00:35:12.160 | start a job, it's kind of shocking how little good information there is. So sometimes you
00:35:18.160 | see fund name, five year return, and maybe an expense ratio, maybe, maybe just five year
00:35:26.160 | return. What a terrible way to put together an investment portfolio, because what will
00:35:31.160 | the uneducated participant do? Well, they'll just pick the ones that have been the best
00:35:35.160 | performers over the past five years.
00:35:37.160 | Or they'll put 10% in each of the ten funds.
00:35:43.160 | This question is for Wade. At what age should someone nearing 70, or, I'm sorry, I can't
00:35:52.160 | read that word, the age of 70, plan for ordered withdrawal of their retirement assets? So
00:36:01.160 | at what age should somebody really start thinking about how they're going to withdraw at 70
00:36:06.160 | and have when they're forced to take their RMDs?
00:36:12.160 | So one confusion about the RMD issue is you do have the RMD distributions that you have
00:36:18.160 | to make. You don't have to spend that all.
00:36:21.160 | [laughter]
00:36:26.160 | I mean, if you have to withdraw 10%, but you only need to spend a portion of that, you
00:36:30.160 | just reinvest the rest in a taxable portfolio. That does affect your planning because you
00:36:35.160 | have to pay the taxes on the distributions when they come due, so that changes your tax
00:36:41.160 | picture throughout your lifetime.
00:36:43.160 | But beyond that, you don't, I mean, it's this question of, well, what am I going to do about
00:36:48.160 | RMDs? You have to take out what you have to take out and pay taxes on it, but you don't
00:36:53.160 | have to spend it. I'm not sure if that was--
00:36:56.160 | Well, I think what they're trying to figure out is at what age should they start really
00:37:02.160 | thinking about what their RMDs are going to be and how it's going to affect them in their
00:37:07.160 | living expenses, their taxes, and all the other things that go with it because they're
00:37:11.160 | going to have to take it out at that point. So when should they be starting to set things
00:37:18.160 | in motion to start really planning on what's going to happen at that point when they have
00:37:24.160 | to take their RMDs?
00:37:26.160 | I think that's the other thing. Definitely the point that you touched is that just because
00:37:31.160 | you have to take it doesn't mean that you need it. It's just an all the same once they're
00:37:35.160 | cut of your tax deferred investments and what you do with it is your business.
00:37:44.160 | Yeah, so that question, of course, on the one hand, it's best to start as soon as possible
00:37:49.160 | and trying to develop a lifetime budget for your whole life, just trying to project forward
00:37:54.160 | what the salary is going to be and what the expenses are projected on how many people
00:37:59.160 | you have in your household, whether you're going to be paying for kids' college and stuff.
00:38:02.160 | Have a whole lifetime financial plan going out to age 105 or whatever the case may be.
00:38:08.160 | The further you are away from the date that events are going to happen, the more hazy
00:38:12.160 | and fuzzy that's going to be. So as you wait closer to that age 70 to think about it, you're
00:38:18.160 | going to have a better picture about how much you need to spend to maintain your retirement
00:38:22.160 | spending goals and so on. But then it's getting to be so you have less time to adapt to whatever
00:38:27.160 | strategy you want to develop. I think at the point that you really start thinking seriously
00:38:33.160 | about budgeting for retirement, then you want to have a good idea about the tax picture
00:38:38.160 | in your retirement as well. Of course, one of the policy uncertainties or the risks of
00:38:43.160 | retirement is that taxes are going to change. But with the current tax code, you might want
00:38:48.160 | to try to project out, well, if this is how much I'm spending each year and assume my
00:38:52.160 | portfolio earns x percent each year, what's that going to imply for my RMDs? Then what's
00:38:58.160 | the tax bill going to be on that? And plug that into one of the columns of your spreadsheet
00:39:03.160 | for the expenses and then start playing around with if there's any opportunity to make adjustments
00:39:09.160 | to reduce that tax bill. Also, part of this as well is thinking about Social Security
00:39:15.160 | with Social Security up to 85 percent being excludable from your taxes. That becomes,
00:39:22.160 | and if you're delaying to age 70 to begin Social Security, that's part of this problem
00:39:28.160 | as well of what to do about RMDs. But it's very hard to say on any kind of general basis
00:39:35.160 | the best way to approach that other than to try to think ahead that what is my budget
00:39:40.160 | in retirement going to be, including what are my taxes going to be in retirement, and
00:39:44.160 | play around with the variables to see if you might be able to find a way to improve so
00:39:48.160 | that you can spend less on your taxes throughout the lifetime, not just each year, but so that
00:39:55.160 | the present value of your lifetime taxes can get minimized.
00:40:00.160 | And for a retiree, for an early retiree that's in a low income bracket for a few years, that
00:40:08.160 | might be a good time to do some conversions to the Roth IRA too.
00:40:12.160 | Right.
00:40:15.160 | This is a similar question. It said a lot is said about saving for retirement, but much
00:40:21.160 | less is said about managing and depleting your funds during retirement. In particular,
00:40:27.160 | the idea of a safe withdrawal rate seems to be a phantom, since it depends so much on
00:40:32.160 | future performance. Could you please comment on guidelines for managing one's portfolio
00:40:38.160 | withdrawals during retirement? That's very similar to what we just discussed. I don't
00:40:43.160 | know if there's anything anybody wants to add.
00:40:45.160 | Well, I think one of the important things to remember in looking at a withdrawal rate
00:40:50.160 | is to begin a starting point, but to recognize that you've got to revisit that on a consistent
00:40:57.160 | basis. I've got to say, I have never used the 4% withdrawal rate in my planning. First
00:41:04.160 | of all, I think you can throw it out the window because it's based on interest rates that
00:41:09.160 | have just historically been higher than 1% and 2%. But more importantly, everybody's
00:41:17.160 | going to be different. As they mentioned on the earlier panel, there's nothing wrong
00:41:22.160 | with spending down your principal over your lifetime at an intelligent rate. Rich, how
00:41:30.160 | do you want to spend it down? I think the goal is to spend it down to where the check
00:41:35.160 | to the mortuary bounces. But the reality is there's nothing wrong with spending a million
00:41:42.160 | dollar portfolio at age 70 down to $500,000 at age 100 if that's going to accentuate your
00:41:50.160 | life. So everybody's withdrawal rate is going to be different. But what you want to do is
00:41:55.160 | you want to use some assumptions that are meaningful. And by that I mean you don't want
00:42:00.160 | to use a 10% projected portfolio growth rate to get you where you want to go because that's
00:42:06.160 | likely not going to happen. So I guess to summarize it, you want to use good assumptions
00:42:11.160 | and recognize that you're going to have to revisit it on a consistent basis so that what
00:42:15.160 | you want to have happen actually happens.
00:42:18.160 | I'll add a little bit about that. The financial services industry has just figured out in
00:42:25.160 | the last less than 10 years that the retirement problem is very different from the wealth
00:42:30.160 | accumulation problem. Things like modern portfolio theory can apply to wealth accumulation where
00:42:36.160 | you're thinking about maximizing the risk-adjusted return to maximize your wealth accumulation.
00:42:42.160 | But once you hit retirement, it's a fundamentally different problem. In retirement, you shouldn't
00:42:49.160 | be worried about maximizing risk-adjusted returns to your portfolio. What you're wanting
00:42:53.160 | to do is meet your retirement goals, which for most people is going to mean meeting a
00:42:59.160 | sustainable spending stream throughout the retirement period. And so then it's a whole
00:43:03.160 | different perspective on risk and return, and there's a variety of different approaches.
00:43:07.160 | So the safe withdrawal rate question is a very minor part of the retirement income strategy.
00:43:13.160 | It's just putting together your household balance sheet and the role for social security
00:43:18.160 | and other pensions and filling the gap of what you want to spend that you're not able
00:43:23.160 | to spend from other sources. That's what you need to spend from your retirement portfolio.
00:43:28.160 | The safe withdrawal rate, you can use a withdrawal rate higher than the safe withdrawal rate.
00:43:33.160 | If you have a decent spending floor, then if it's not going to be catastrophic to run
00:43:39.160 | out of financial assets there, you can spend down at a higher rate than the safe withdrawal
00:43:42.160 | rate and take your chances that you will either have to reduce spending later on, but at least
00:43:48.160 | you can enjoy that early part of your retirement better. It's really about figuring out what
00:43:51.160 | the budget is and really assessing if that budget implies too high of a withdrawal rate
00:43:58.160 | from your assets. Are you willing to make the cutbacks later on, should you live and
00:44:02.160 | should markets not perform well? Or are you just going to cut your budget now in the hope
00:44:08.160 | of having a more sustainable spending stream? And that's the issue. But that retirement,
00:44:14.160 | it's not just about maximizing wealth anymore. It's about meeting that liability that this
00:44:19.160 | constant spending path, or the retirement spending path that you have in mind, and trying
00:44:23.160 | to meet that as safely as possible, but also considering the trade-offs between upside
00:44:29.160 | potential and downside. Where in retirement that means the downside risk is having to
00:44:34.160 | cut your spending, not the portfolio volatility, but having to cut your spending. And if that's
00:44:39.160 | going to hurt your lifestyle, then that's a substantial risk weighing off against upside
00:44:44.160 | of having a larger legacy or being able to increase your spending if markets do well.
00:44:49.160 | That's how you want to be framing the question, how to meet that spending liability.
00:44:54.160 | We have lots of questions on bonds, as you might suspect. My question for the panel concerns
00:45:04.160 | the total bond market index fund. Based on the recent comments of Jack Bowe and the large
00:45:10.160 | allocation to government bonds compared to corporates, compared to many years ago, would
00:45:15.160 | you expect the index to be updated in the future? And if it were updated, would it be
00:45:21.160 | reasonable to expect the index to include inflation bonds and high yield bonds, considering
00:45:26.160 | the ever-increasing size of both these markets, to be considered a real total bond market?
00:45:34.160 | You should have asked that one to Gus.
00:45:38.160 | Well, I think Gus and Jack both talked about this, but it really is Christine, do you think
00:45:47.160 | they will change the index or they will come out with another index?
00:45:52.160 | To be honest with you, Mel, I don't have a lot of insight into the current index construction,
00:45:58.160 | why those asset classes are excluded, so I can't speak to whether a change in the index
00:46:04.160 | is forthcoming. I really just don't know at all.
00:46:07.160 | Peter Foley asked, what is your opinion of stable value funds in this environment?
00:46:14.160 | We clearly have strong opinions.
00:46:22.160 | Stable value funds, like if they're in a 401(k) or something, I think that they can be good.
00:46:27.160 | Certainly they've been able to generate some higher yields than you can get in a savings
00:46:32.160 | account in a bank or an IRA, but I also feel like you have to look under the hood to see
00:46:38.160 | what stable value funds consist of.
00:46:41.160 | Plus the yields have come down pretty dramatically over where they were a couple years ago even.
00:46:47.160 | We've seen a significant drop, so it's not the great deal that it once was.
00:46:52.160 | I've been hearing a lot of noise regarding the bond market and bond funds.
00:47:00.160 | Can bonds and bond funds still be considered a safe part of asset allocation in a rising
00:47:05.160 | interest rate environment?
00:47:07.160 | What bonds or bond funds do the experts recommend using as the ballast in a portfolio?
00:47:13.160 | High bonds, tips, munis, long, intermediate, short-term, treasuries, total bond markets.
00:47:19.160 | What do you recommend, Bill?
00:47:24.160 | Well, at the risk of being horribly boring, we kind of split our fixed income portfolios
00:47:30.160 | philosophically between the short corporate and the intermediate corporate bond funds.
00:47:36.160 | And we are not, I'm not a big fan of tips, funds, never have been, not because it's not
00:47:45.160 | good, but because I don't understand them fully.
00:47:48.160 | And I, you know, when they got, went up 20% and down, not 20%, but they certainly went
00:47:53.160 | up 15%, they dropped that much.
00:47:55.160 | You know, I think that's what clients expect.
00:47:58.160 | And so we've kind of shied away from them.
00:48:00.160 | I have to say that we kind of market-timed the tip bonds and bought them out four, five,
00:48:06.160 | six years ago and got out of them.
00:48:08.160 | It's, you know, I don't want to say lucky, but they just don't have a return, so we got
00:48:11.160 | out of them.
00:48:12.160 | And I just think to keep it simple, it makes a lot of sense.
00:48:17.160 | And Vanguard has written a great paper on why you should still have bond in your portfolio
00:48:24.160 | and what's going to happen to these bond funds when rates go up.
00:48:27.160 | And we give that to everyone.
00:48:29.160 | And yes, bond funds are going to get hit.
00:48:31.160 | But, you know, they're not going to get slaughtered unless you have the long-term bond fund and
00:48:35.160 | rates go up, you know, five or six or seven percent.
00:48:38.160 | And if you articulate that, you know, in your portfolio, it's still going to act as a diversifier
00:48:45.160 | in your portfolio.
00:48:46.160 | And ultimately, it's probably to your benefit if rates do go up because you're going to
00:48:53.160 | eventually capture the higher returns of the bond fund.
00:48:56.160 | And, again, I just go back to the paper that Vanguard wrote, and I think it's very, very
00:49:01.160 | insightful.
00:49:02.160 | I think people look at, when you have this debate about bond funds, should I or shouldn't
00:49:07.160 | I, people forget that bonds are part of a portfolio and not a standalone item.
00:49:11.160 | You know, hopefully it's not your only investment.
00:49:14.160 | And I also sort of get a bit of humor when people talk about bonds getting slaughtered,
00:49:18.160 | they're going to drop 10 percent.
00:49:20.160 | So, in fact, what I'm going to do is I'm going to get out of my bond fund and jump over to
00:49:24.160 | the equity side where I can lose only 40 or 50 percent with that same money if I'm really,
00:49:29.160 | really lucky.
00:49:30.160 | And so, you know, I think you have to think about why you have bonds in your portfolio,
00:49:34.160 | and it's part of, you know, sort of stabilizing things.
00:49:37.160 | And as we all know, some years, some things are going to do well, and other years, other
00:49:41.160 | things are going to do well.
00:49:42.160 | And none of us, I don't think, know which of those are going to do well.
00:49:45.160 | You can think that you know, you can think you know when it's coming, but personally,
00:49:48.160 | I don't see why there would be a need to make a, you know, a major change at a time like
00:49:52.160 | this.
00:49:53.160 | And, you know, it's there for a reason.
00:49:54.160 | It's part of, it's one piece of a total, and this is why I think some of those target retirement
00:49:59.160 | funds and things like that are very good options because people are not looking at the individual
00:50:03.160 | components.
00:50:04.160 | They're looking at the overall total return.
00:50:06.160 | And so, if your overall portfolio is up 7 percent, do you really care if it was, you
00:50:11.160 | know, international was up, you know, 40 percent and bonds were down 10?
00:50:14.160 | What you really care about is that your total portfolio went up.
00:50:17.160 | And so, you have to keep your eye on the big picture rather than the little tiny components,
00:50:21.160 | you know, in each piece.
00:50:24.160 | I agree.
00:50:25.160 | I think that's one of the huge advantages of the target date funds.
00:50:30.160 | Well, when saving for retirement, I have no problem with bond funds, but I think focus
00:50:34.160 | more on the retirement income phase where I'm not sure what role the bond funds really
00:50:38.160 | have.
00:50:39.160 | They're volatile, and if you want volatility, just go with stocks.
00:50:42.160 | It doesn't seem necessary to just include bonds to reduce the overall volatility of
00:50:46.160 | the portfolio.
00:50:47.160 | Use bonds for what they are.
00:50:49.160 | They're a fixed income instrument, and so buy the bonds, hold them to their maturity
00:50:53.160 | date, and ignore the capital market fluctuations as interest rates go up and down each day.
00:50:58.160 | Or, otherwise, use income annuities, which function much like bonds, except they have
00:51:03.160 | an undefined maturity date, just the age of death of the annuitant.
00:51:07.160 | Either way, you then have income coming, and whether that be tips, like building a ladder
00:51:14.160 | of tips, or building a ladder of treasury bonds, or buying the individual treasury strips
00:51:19.160 | that will mature on different dates, that's the way to use bonds for how they were designed,
00:51:24.160 | which is to meet spending needs at different specific dates in the future.
00:51:29.160 | Again, that can be done with the bond ladder or with an income annuity.
00:51:33.160 | I don't see a real important role for the actual bond funds that are volatile investments
00:51:39.160 | that go up and down.
00:51:44.160 | I would just jump on that, Wade.
00:51:46.160 | I agree with almost everything you say and said, but I do think that funds have a valuable
00:51:51.160 | role in certain fixed income asset classes.
00:51:54.160 | Munis, in particular, to the extent that you have bonds in your taxable account, I would
00:51:58.160 | heavily recommend a fund versus the individual bonds.
00:52:01.160 | The reason is that, as a smaller investor, or even as a larger small investor, it can
00:52:06.160 | be very difficult to get the diversification that you might want in that portfolio.
00:52:10.160 | The other reason is that, for smaller investors, the bid-ask spreads or the trading costs can
00:52:15.160 | be very, very unattractive.
00:52:17.160 | You just have to be careful, certainly in the realm of treasuries or tips.
00:52:20.160 | I think the individual bonds may well be the way to go, but once you move beyond them,
00:52:25.160 | I think you have to be careful because of the diversification as well as the trading
00:52:29.160 | cost question.
00:52:30.160 | I think the common investor may not know or feel comfortable trying to take the bonds
00:52:35.160 | that I'm going to hold for the next 20 years.
00:52:37.160 | Which company do I get into?
00:52:39.160 | I, of course, am going to choose the one that gives me the highest return because what I'm
00:52:42.160 | looking for is the highest monthly coupon.
00:52:45.160 | Unbeknownst to myself, I've just now purchased the most risky bond.
00:52:52.160 | We see this a lot in people chasing returns, and I think they would do the same thing in
00:52:57.160 | bonds, individual bonds.
00:52:59.160 | I think that, behavior-wise, you may actually be better off in a bond fund because I think
00:53:02.160 | people aren't going to focus.
00:53:05.160 | The sophisticated investor may be able to do that, but I think the typical investor
00:53:09.160 | may not really want to cross that line and get into that.
00:53:13.160 | Relative to the bond question, Mel, too, I just would make another comment.
00:53:16.160 | I've been really alarmed at where we have been seeing the flows going in bond funds,
00:53:22.160 | and it's very clear that investors are maybe spooked by interest rates, sensitivity, risk,
00:53:28.160 | but completely comfortable taking a lot of credit risk because we've been seeing the
00:53:33.160 | bank loan fund or the floating rate fund flows explode.
00:53:37.160 | Emerging markets bonds have exploded in terms of new inflows.
00:53:42.160 | This new nontraditional bond category, PIMCO, has its big unconstrained bond fund.
00:53:48.160 | Until recently, that had been getting oodles of flows, and so I think that investors perhaps
00:53:53.160 | are trading one type of risk for another type of risk, which could actually be even more
00:53:59.160 | formidable and lead to even larger losses during certainly an equity market shock.
00:54:05.160 | So I don't imagine anyone in this audience has been doing that, but it has been a trend
00:54:10.160 | I've been watching, and it's one that does work quite a bit.
00:54:15.160 | This is a question for all of the panelists, and since I already did true confessions on
00:54:21.160 | the first panel, we're going to ask the same question again.
00:54:26.160 | What was or is your most humbling investment experience, and what have you learned from it?
00:54:32.160 | Can we start to have the end with Bill?
00:54:35.160 | Oh gosh, my most humbling investment experience happened in 1981.
00:54:41.160 | I was a junior in college at Texas A&M, and I was following the markets.
00:54:45.160 | I moved to Chicago and spent a year trading at the Chicago Board of Trade, or working
00:54:51.160 | at the Chicago Board of Trade with Merrill Lynch, and I was in the Northwestern University's
00:54:58.160 | library lab generating these programs, moving averages on these IBM punch cards, and I had
00:55:07.160 | the system all figured out in trading wheat futures, and I fine-tuned it.
00:55:12.160 | I mean, this stack of cards was about this high, and it would go through the processor,
00:55:17.160 | and I had it down, and so I decided I had like $3,000 to my name, and I said, "Okay,
00:55:23.160 | I'm going to go live," and I opened up a trading account with Lynn Waldock and proceeded
00:55:27.160 | to get my head handed to me.
00:55:29.160 | And I can, you know, ever since then, I felt like I just, I'm not going to take that
00:55:34.160 | type of risk, and I can honestly say I am not sure that I have ever purchased an individual
00:55:41.160 | stock in my life.
00:55:43.160 | And that has, you know, I think that kind of provided the basis for the whole coffeehouse,
00:55:49.160 | let's focus on what's important type story, and it's, you know, I'm lucky I learned
00:55:54.160 | it at age 21 and not at 61, which a lot of people do.
00:56:00.160 | For all this, now I have no grand and glorious story, but I, it's just, I think what got
00:56:04.160 | a lot of us, load funds, load funds, load funds, you know, and why I'm looking back,
00:56:09.160 | why did I pay people for things that I could do myself?
00:56:12.160 | So it wasn't a great story, didn't lose anybody else's money, fortunately, just my own.
00:56:17.160 | [laughter]
00:56:20.160 | My first year out of school, I actually worked as a broker for Edward Jones.
00:56:25.160 | [laughter]
00:56:27.160 | And it gets better.
00:56:30.160 | And short, well, I did that for, I guess, only about a year.
00:56:35.160 | Didn't take me very long to realize I was much more interested in a research sort of
00:56:39.160 | related position than a sales position.
00:56:41.160 | But, so I went to work as a tax accountant, and during that time, I had jury duty one
00:56:46.160 | day, and I'm living in Chicago, so take the train.
00:56:50.160 | And on the train ride there, and then all day in court, because I didn't actually get
00:56:54.160 | called, so I was just sitting there for eight hours, and then on the train home, I read
00:56:59.160 | Bogle's Little Book of Common Sense Investing.
00:57:02.160 | [laughter]
00:57:03.160 | And that was a humbling experience.
00:57:06.160 | [laughter]
00:57:09.160 | Yeah, like Mike, us folks who are on the younger end of the spectrum are really getting to
00:57:13.160 | benefit from the wisdom created by Bogleheads that those of you on the older side of the
00:57:18.160 | spectrum here may not have, well, didn't have available yet.
00:57:21.160 | In 1999, I was still in college, and my grandmother passed away.
00:57:25.160 | I received a $3,000 inheritance in late 1999, which I promptly invested in tech stocks.
00:57:32.160 | [laughter]
00:57:33.160 | So I lost my, I mean, I didn't track it always, but at some point, I think it was down to
00:57:39.160 | $800, and at that point, it was actually a fairly cheap lesson for me.
00:57:46.160 | By the time, I was in college still, by the time I came back from my encore performance
00:57:50.160 | and trying to be an investor, I had already read A Random Walk Down Wall Street and learned
00:57:55.160 | about indexing and so forth, so I was very fortunate to, I learned that lesson, but it
00:58:00.160 | was a fairly cheap tuition for the lesson, and since then, I've benefited a lot from
00:58:06.160 | the community of Bogleheads and so forth.
00:58:09.160 | Well, you can consider it a gift from your grandmother.
00:58:12.160 | [laughter]
00:58:13.160 | [applause]
00:58:14.160 | She's probably saved me hundreds of thousands of dollars.
00:58:19.160 | [laughter]
00:58:20.160 | One mistake that I've been ruminating on recently is that I have in my portfolio still a fund
00:58:29.160 | called Selected American.
00:58:30.160 | It's been in Morningstar's 401(k) plan probably for, probably since the inception of the plan,
00:58:36.160 | and if you had asked me 15 years ago, maybe even 20 years ago, 10 years ago, what was
00:58:42.160 | my highest conviction active fund in my portfolio, I might have said that one.
00:58:48.160 | It is a fund that I think does have a good investment culture, a good stewardship culture,
00:58:55.160 | despite above average costs.
00:58:57.160 | Really, everything would line up in favor of this being an active fund that would outperform
00:59:03.160 | over time, and yet it really hasn't.
00:59:05.160 | I haven't looked at it in the past couple of months, but it's just kind of lived along.
00:59:08.160 | It's not been a disaster, but it's not been great, and so I do have active funds in my
00:59:14.160 | portfolio, the Vanguard Prime Cap Core, I own Longleaf Partners and a couple of others
00:59:19.160 | as well as index products, but a fund like that that at one point I had very high conviction
00:59:24.160 | in that has not outperformed does give me pause, seemingly as someone who would have
00:59:30.160 | had a lot of ability to pick a good active fund.
00:59:33.160 | So just something that I continue to watch, although I do believe that one can select
00:59:41.160 | decent active funds, particularly if you know that you will hang on with them, which is
00:59:47.160 | something that I have done with this fund, but I may not do so forever.
00:59:52.160 | So it's just something that has made me do a little bit of soul searching recently.
00:59:58.160 | Victoria asks, "Please discuss at what level of fixed rates it will become advantageous
01:00:09.160 | to start buying TIPS again?"
01:00:11.160 | Four percent?
01:00:14.160 | Four percent?
01:00:15.160 | I remember those days, and we're not going to see them again, but fortunately I bought
01:00:19.160 | in four percent.
01:00:21.160 | Thanks for letting us know that now.
01:00:23.160 | [laughter]
01:00:25.160 | Well, I'm not convinced that today's rates are a bad time to buy TIPS.
01:00:31.160 | We're not going to see four percent again for the most part because that was just when
01:00:36.160 | TIPS were first introduced and there was not a liquid market.
01:00:39.160 | They didn't have buyers for them, so that was pushing up the yields.
01:00:43.160 | Economists often talk about the real interest rate in the economy being two percent.
01:00:48.160 | So in some extent, if you might think of that as being somewhere where you would expect
01:00:52.160 | TIPS to be on average, but TIPS provide that extra benefit of protection against unexpected
01:00:57.160 | inflation, so there should be a premium for that benefit.
01:01:00.160 | You would expect TIPS yields to be lower than two percent even in that case.
01:01:06.160 | And so we already know that TIPS yields can go negative, but maybe a lot of people would
01:01:11.160 | have thought that was impossible before it happened.
01:01:14.160 | There's no particular reason TIPS yields can't go even further negative.
01:01:18.160 | It's because that's the real yield rather than the after-inflation yield.
01:01:22.160 | So I don't know which direction TIPS are going to go in the future, but I don't necessarily
01:01:27.160 | think it's going to be better to wait than it is to just buy today.
01:01:32.160 | One of the points that Wade just mentioned is that TIPS can go negative, but that's one
01:01:40.160 | of the advantages of iBonds.
01:01:43.160 | The fixed rate or the composite rate can never go below zero.
01:01:47.160 | The only problem now is that you can't buy $30,000 a person like you could in the good
01:01:52.160 | old days with a credit card, no less.
01:01:55.160 | [laughter]
01:01:57.160 | We have a question about CDs versus bonds.
01:02:06.160 | If an investor shops diligently for a CD rate, is there any reason why CDs can't become or
01:02:15.160 | can't be an important part of the fixed income side as opposed to bonds?
01:02:23.160 | I think CDs can be a great part of a portfolio.
01:02:27.160 | Yes.
01:02:29.160 | Christine has to leave, so let's thank her for her work.
01:02:35.160 | [applause]
01:02:37.160 | See, now you're left with three good-looking guys.
01:02:57.160 | [laughter]
01:02:59.160 | Let's shut it down.
01:03:03.160 | [laughter]
01:03:05.160 | All the brains and all the beauty are leaving at once.
01:03:08.160 | [laughter]
01:03:10.160 | Dan Smith asks, and we'll go down the line on this, "Do you read the prospectus?
01:03:19.160 | If so, how do you use it?
01:03:22.160 | What parts do you pay attention to, and what things are you looking for?"
01:03:27.160 | We have a follow-up to this, but let's go with the question first.
01:03:32.160 | Do you read the prospectus, and what parts do you pay attention to,
01:03:36.160 | and what things are you looking for?
01:03:39.160 | Well, if we are looking at investing in a new ETF or a new mutual fund,
01:03:46.160 | we certainly will read the prospectus.
01:03:48.160 | The things we focus on primarily are the costs, and that's about it.
01:03:54.160 | We don't read too many prospectuses because we've got our corporate funds that we use,
01:03:59.160 | and we feel comfortable with that.
01:04:01.160 | Yes, exactly.
01:04:03.160 | I don't switch funds very often, so there's no real need to read prospectuses all the time.
01:04:08.160 | But absolutely, cover to cover, every word, frankly.
01:04:14.160 | I don't know, probably most people don't do that,
01:04:16.160 | but yes, I'm going to get every piece of information I can before putting my money into it.
01:04:20.160 | And what I'm looking for is just surprises.
01:04:22.160 | Anything that I see and read and think, "What does that mean?"
01:04:27.160 | That's what I'm looking for, basically.
01:04:30.160 | When it comes to mutual funds, I've skimmed prospectuses,
01:04:33.160 | but honestly you can't say that I've read one cover to cover.
01:04:36.160 | The only one prospective I've read cover to cover was
01:04:39.160 | for one of the deferred variable annuities out there, the 100-page monster.
01:04:44.160 | I read that one cover to cover because I really wanted to understand
01:04:48.160 | what in the world was going on with that.
01:04:50.160 | Were you able to understand it?
01:04:52.160 | Well, in this particular case, it must have been one of the easier ones.
01:04:58.160 | This one did make sense, but I don't think that's going to be a general trend.
01:05:03.160 | I think I got lucky in that case.
01:05:06.160 | Yes, I'm anal, and yes, I'm reading cover to cover like Mike.
01:05:10.160 | There's a follow-up question that says, "After reading the prospectus,
01:05:16.160 | do you read the summary prospectus for the Vanguard Emerging Markets Government Bond Index Fund?
01:05:27.160 | It explains that because of volatility and stock market correlation,
01:05:32.160 | if your goal is to lower risk and volatility, this fund is not an appropriate investment.
01:05:40.160 | How would you advise a layperson to interpret a statement like that?
01:05:44.160 | Assume that it means what it says and that it's accurate?
01:05:47.160 | Take it literally? Take it with a grain of salt? Or ignore it?"
01:05:53.160 | I would take it at face value.
01:05:56.160 | I would, too, especially when it comes from Vanguard.
01:05:59.160 | They don't try to sugarcoat the thing,
01:06:01.160 | but it may be suitable for people who hang upside down from a tree.
01:06:12.160 | This is another controversial topic on the forum, and I'll ask the panelists,
01:06:20.160 | what are your thoughts on the possibility of a floating money market NAV as opposed to the present fixed NAV?
01:06:27.160 | There have been proposals for just such a regulation, as you're aware.
01:06:33.160 | What are your thoughts, Bill?
01:06:34.160 | I'm not familiar enough with the arguments.
01:06:36.160 | Again, I would defer to what Jack Vogel said.
01:06:41.160 | Well, I disagree with Jack on that.
01:06:43.160 | I think that, in my opinion, and usually when you argue with Jack or Bill Bernstein,
01:06:49.160 | you're probably barking up the wrong tree.
01:06:52.160 | But personally, I would see a mass exodus from money market funds
01:06:57.160 | because, number one, people can go in the bank and get basically the same money market rate
01:07:03.160 | or even more in the bank as a checking account.
01:07:08.160 | In addition to that, when you write a check, it's not a taxable event at a bank,
01:07:12.160 | but when you write a check in your money market, it is a taxable event.
01:07:16.160 | I would not want to be tracking or trying to track or keep track of--
01:07:21.160 | when I wrote that check, the NAV was $0.98.
01:07:26.160 | Can you see the possibility of a tax loss harvesting a money market?
01:07:34.160 | But having to keep track of each check you wrote is basically a taxable event.
01:07:39.160 | For that reason, I think a lot of people would move from money market funds.
01:07:43.160 | I know I probably would.
01:07:45.160 | I think the only redeeming social value would be the fact that it's there
01:07:49.160 | and it's easy to dollar-cost average or move funds from your money market
01:07:54.160 | into another fund or something, but I'm not a proponent of it.
01:08:02.160 | This one is from my brother.
01:08:04.160 | SGM says, "What factors should one consider when comparing a lump sum
01:08:08.160 | versus a pension from a major corporation at age 62?"
01:08:13.160 | I am thinking some factors are PBGC guarantees,
01:08:19.160 | single versus survivor benefits in comparison to annuities,
01:08:24.160 | the availability of COLAs, lump sums that were allowed in the past,
01:08:29.160 | the ability to manage one's money later in life, protection from fraud,
01:08:32.160 | and ongoing fees.
01:08:35.160 | They ask what you should consider, and then they listed a number of items,
01:08:39.160 | which sounds to me like they answered their own question.
01:08:43.160 | Did they leave anything out?
01:08:45.160 | I guess the real question is when someone is confronted with the option of
01:08:51.160 | X number of dollars per month for the rest of their life versus a lump sum,
01:08:56.160 | it's a pretty tough decision for a lot of people
01:08:59.160 | because the dollar amount is often very substantial.
01:09:05.160 | What would you think if somebody offered you that option if you were older?
01:09:11.160 | That was a good list of factors.
01:09:13.160 | The first thing I suppose to do to investigate this would just be to figure out
01:09:19.160 | how much would it cost to buy an immediate annuity offering the same set of cases.
01:09:24.160 | There might be an issue of the credit risk between whoever your pension was
01:09:31.160 | provided from and the insurance company, but beyond that,
01:09:34.160 | if you can take the lump sum and then buy a higher income stream through an income annuity,
01:09:39.160 | then go ahead and take the lump sum and buy the annuity.
01:09:42.160 | If you can't, then that might be an indication that they're really using a higher discount rate
01:09:48.160 | because that lump sum is just a present value calculation.
01:09:51.160 | They know that the likely income stream they're going to have to pay over the lifetime,
01:09:56.160 | and they're discounting that with some interest rate,
01:09:58.160 | which is what they're expecting they could earn on the underlying investments.
01:10:02.160 | If they're going to assume a higher interest rate to get that lump sum lower,
01:10:06.160 | it's probably going to be difficult to be trying to invest on your own
01:10:11.160 | to have that lump sum be able to support a higher income.
01:10:15.160 | In that sort of situation, you're probably going to be better off by just taking the pension,
01:10:22.160 | the income stream, not doing the lump sum.
01:10:25.160 | If the lump sum is generous because they really just want to offload those liabilities,
01:10:29.160 | it could be that you could buy an income annuity that offers a higher rate.
01:10:33.160 | But otherwise, those are the types of factors to look at,
01:10:37.160 | and think seriously about not taking the lump sum if it's not attractive
01:10:41.160 | because you don't just want to get that money today.
01:10:45.160 | Of course, both of us know this.
01:10:47.160 | They're trying to present you with this lump sum that looks really attractive,
01:10:51.160 | and if you're not checking the underlying math of what discount rate they're using,
01:10:55.160 | people are not going to realize it's not a good deal to take that lump sum.
01:11:00.160 | At this time, I'd like to thank the panel members who are still here.
01:11:07.160 | Thank you.
01:11:09.160 | [end of transcript]
01:11:10.160 | Transcription by CastingWords
01:11:11.160 | you
01:11:13.220 | [BLANK_AUDIO]