Bogleheads® Conference 2014 - Panel of Experts II
00:00:00.000 | I got such support, Mel revented and said, "Okay, you can do panel two, but I'm watching
00:00:14.560 | you."
00:00:15.560 | So he's going to sit right over there.
00:00:20.080 | He's going to sit right over there, and he's going to sit right over there, and he's going
00:00:35.360 | to sit right over there, and he's going to sit right over there, and he's going to sit
00:00:47.600 | right over there, and he's going to sit right over there, and he's going to sit right over
00:01:01.320 | there, and he's going to sit right over there, and he's going to sit right over there, and
00:01:15.400 | he's going to sit right over there, and he's going to sit right over there, and he's going
00:01:29.640 | to sit right over there, and he's going to sit right over there, and he's going to sit
00:01:39.720 | right over there, and he's going to sit right over there, and he's going to sit right over
00:01:45.120 | there, and he's going to sit right over there, and he's going to sit right over there, and
00:01:51.720 | he's going to sit right over there, and he's going to sit right over there, and he's going
00:01:55.720 | to sit right over there, and he's going to sit right over there, and he's going to sit
00:02:01.720 | right over there, and he's going to sit right over there, and he's going to sit right over
00:02:09.320 | there, and he's going to sit right over there, and he's going to sit right over there, and
00:02:10.320 | he's going to sit right over there, and he's going to sit right over there, and he's going
00:02:11.320 | to sit right over there, and he's going to sit right over there, and he's going to sit
00:02:12.320 | right over there, and he's going to sit right over there, and he's going to sit right over
00:02:13.320 | there. So that's the first panel, and there are some people on this panel that would probably
00:02:19.640 | like to start with a response to that question as well. So I'll open up the question for
00:02:24.840 | the panel on the question that came up about asset allocation. Which one? Oh, which one
00:02:34.240 | was it? You guys tell me. Rebalancing. Rebalancing, sorry. Rebalancing, yes. The question was,
00:02:43.240 | how often should you rebalance? Well, first, should you rebalance? How often should you
00:02:47.800 | rebalance? Quarterly? Annually? Bans? And so forth. And then the panel was asked to
00:02:55.280 | comment. So we'll start with the left side and work our way up. I think less is more
00:03:03.200 | when it comes to rebalancing, but I like the idea. Vanguard has done some nice research
00:03:06.460 | on this topic too, where you just do that annual check-in, and I think once or twice
00:03:10.840 | a year is plenty. See how much your portfolio has diverged from your targets. Five percentage
00:03:17.600 | points seems reasonable. Vanguard's research generally supports the rebalancing at five
00:03:25.320 | percentage point divergences. I think if you want to be hands-off, or if transaction or
00:03:29.960 | tax costs are a big consideration, or if a lot of your portfolio is taxable, that maybe
00:03:35.440 | would lead toward even higher rebalancing thresholds, maybe 10 percentage points. I
00:03:40.600 | am also a big fan of paying attention to the sub-rebalancing that you can do. So at various
00:03:47.280 | points in time, even though maybe your equity allocation is five percentage points above
00:03:53.200 | your target, you've got specific holdings that have really been the drivers of that
00:03:59.400 | strong performance. So starting your rebalancing there. I also tend to find rebalancing really
00:04:06.400 | effective when I sync it up. I help my mom with her RMDs, and so syncing up the rebalancing
00:04:13.960 | process with that RMD process, we're always trimming whatever has performed best for her.
00:04:19.800 | That's where we go for her RMDs. So just a couple of thoughts on that front, but I
00:04:24.360 | guess I generally agree that less is more. I used to think that picking an asset allocation
00:04:30.760 | was the most important decision, and I've changed my mind. It's committing to stick
00:04:35.360 | to an asset allocation that is even more important. If you look at the Morningstar data over the
00:04:41.960 | last 10 years, you'll just see that the average investor return was 2.49% below the
00:04:47.360 | average fund return. So picking a band, and generally I think five percentage points is
00:04:54.760 | really good, and sticking to it, actually over the long run, it's a risk management
00:05:01.160 | strategy, but it's also a market timing strategy that then happens to work. You're
00:05:06.760 | over the long run selling what's performed best, and buying what's performed the worst.
00:05:14.760 | Contrary in my income.
00:05:18.760 | Rebalancing is definitely a topic about which I do not have strong feelings. If you want
00:05:23.760 | to rebalance every day because you're using a target retirement fund, great. If you want
00:05:28.760 | to rebalance once a year because that's easy, it's easy to remember to do it on your
00:05:31.960 | birthday or half birthday or whatever, great. Just like Alan said, just stick to a plan,
00:05:38.760 | whatever plan it is that you come up with.
00:05:42.760 | May I have some thoughts? By the way, I'm sitting in Jack Fogel's seat. Still feeling.
00:05:54.760 | This did a lot of work on rebalancing, crunched a bunch of numbers. It's overrated. I think
00:06:02.760 | that it's oversold, and I'm not saying this because I'm sitting in Jack's seat,
00:06:06.760 | but I think he said the same thing. I think that as an advisor, and I am an advisor, that
00:06:11.760 | it's used for a lot of marketing by the advisors. I think it actually leads to higher
00:06:17.760 | taxes because you're doing rebalancing when you really don't need it.
00:06:24.760 | My thinking on rebalancing as I continue to crunch these numbers is shifting towards Christine's
00:06:30.760 | less is more idea. I think that you can do this mostly with cash flow, either a distribution
00:06:40.760 | from a required minimum distribution or if you're adding money on a regular basis,
00:06:46.760 | you could use cash to rebalance. Dividends and interest as it comes into your portfolio,
00:06:51.760 | if you take any cash, you can rebalance using that way. I think that's almost enough.
00:06:57.760 | If there is a big shift in the market, 20 percent down, 20 percent up, and your asset
00:07:05.760 | allocation is off by a significant amount, and you want to do a rebalancing, that's
00:07:11.760 | fine. In a taxable account, of course, you want to take long-term capital gains, or if
00:07:15.760 | the market's down, make sure you're not taking any gains, but do it in conjunction
00:07:19.760 | with tax-loss harvesting. I also say that in my research that if you have a portfolio
00:07:26.760 | that's high in equity, 70, 80 percent, if you do rebalancing maybe once every 10 years,
00:07:32.760 | that's probably enough. Those are my new and improved thoughts on rebalancing. I think
00:07:41.760 | that the cash flow side of it is the most important side. Having a plan, as Alan said,
00:07:47.760 | is important as well, but I just think that the whole rebalancing thing has been overhyped
00:07:53.760 | by the advisory community because that's how we get paid after we create a portfolio
00:07:58.760 | for you. I didn't really say that. Rick, I have a follow-up question for you. If I'm
00:08:05.760 | not rebalancing or doing it very frequently and sort of normal equity bond cash relationships
00:08:12.760 | hold, my equity piece is going to be going up and up and up, and that runs contrary to
00:08:16.760 | what most people think about when they're thinking about sort of a glide path. So how
00:08:21.760 | do you get those things together? Okay, Wade isn't here, but Wade's new philosophy
00:08:31.760 | on an asset allocation in retirement is you start out with a relatively low equity exposure,
00:08:38.760 | somewhere between 20 and 40 percent, and I'm actually just finishing up a paper that says
00:08:44.760 | around 30 percent, so I ended up being right in the middle after talking with Wade while
00:08:48.760 | I was here. And then for the rest of your life, you don't rebalance at all. You take
00:08:53.760 | the cash flow from the stocks, you take the cash flow from the bonds, and you let the
00:08:57.760 | equity exposure increase because that's a better match to your future liabilities down
00:09:02.760 | the road. So it's an interesting concept. Wade and Michael Kitsis have developed this
00:09:08.760 | idea. So back to your question. I'm talking about the accumulation years, really, at some
00:09:16.760 | point. So say I want to get my equity piece down to 20 percent of my portfolio, that has
00:09:21.760 | to happen at some point, and if I'm not rebalancing during the accumulation years, how's that
00:09:26.760 | working? Well, again, during the accumulation years, I wrote an article one time called
00:09:31.760 | "The Flight Path Approach to Asset Allocation," where it basically says younger people don't
00:09:35.760 | have a lot of experience in the market. We had a conversation with Mike yesterday or
00:09:40.760 | the day before, and yesterday, actually, talking about the fact that younger people, a lot
00:09:45.760 | of millennials are scared to invest in stocks. So should you just go running in with a 90
00:09:49.760 | percent allocation and say, "Oh, you're young. You should have 100 percent stocks
00:09:52.760 | and 90 percent stocks." I don't think that's the right idea for young people. I think that
00:09:57.760 | starting them out low in stocks and then letting them gradually build as they go through a
00:10:02.760 | few fair markets might be actually a better idea. So then it gets to the question of rebalancing.
00:10:07.760 | If you want to build that equity side over time as they get used to fair markets, maybe
00:10:11.760 | you don't need to rebalance. So all I'm saying is this whole idea of rebalancing, I believe,
00:10:16.760 | needs to be rethought. It's nice. It sounds good. And I'll also tell you that the volatility
00:10:26.760 | of a 60/40/40 portfolio is much higher than the volatility of a 30/70 portfolio. I mean,
00:10:32.760 | it's significantly higher in the variability of that volatility, meaning that if you were
00:10:36.760 | to look at it in your period of time, the volatility is twice as much in a 60/40 as
00:10:41.760 | it is in a 70/30. But the predictability of that volatility is like twice as much as well.
00:10:47.760 | So it's really a swing there versus lower equity. And so we talk about, well, you want
00:10:54.760 | to have a set asset allocation of 60/40 so that you can really hone in your risk on your
00:11:00.760 | portfolio. I mean, I think you're kidding yourself. I mean, you're not going to hone
00:11:05.760 | in the risk of the portfolio. If you have a lot of equity, you're just simply going
00:11:08.760 | to have a lot of risk. So in my opinion, there needs to be a lot more work done and maybe
00:11:13.760 | some better language out there about the benefit of rebalancing. Anybody else?
00:11:20.760 | Yeah. The data actually shows that most financial advisors do the opposite of rebalancing. There
00:11:27.760 | was a lot of data that showed at the height of the market in 2007, very heavy into stocks
00:11:34.760 | at the bottom of the market, March 9th of '09, had turned to cash. So, I mean, rebalancing
00:11:41.760 | is good. I agree that it can be done overkill. I don't think there's a penalty to rebalancing
00:11:45.760 | too much other than the transaction costs and the taxes. But that rebalancing is primarily
00:11:53.760 | managing risk, but it also is a market timing strategy that actually works. We love to call
00:12:01.760 | ourselves contrarians, but it's really hard to buy stocks after they've fallen 50%.
00:12:08.760 | I love your point, Alan. And the other thing is when we look at our investor return data,
00:12:13.760 | and we've talked about this before in this forum, that sort of dollar-weighted return
00:12:17.760 | data that captures investors' flows, we're looking at all investors. So it's not just
00:12:22.760 | the dumb individual investor you often hear about makes these poor timing decisions. Advisors
00:12:27.760 | do it. Institutions do it. When we look at target date funds repositioning in the wake
00:12:33.760 | of the bear market, what were they doing? Well, they were adding to bonds, of course.
00:12:36.760 | And what have they been doing in the past couple of years? Well, many of them have been
00:12:40.760 | adding to equities, again, like Fidelities. So there's plenty of blame to go around in
00:12:45.760 | terms of these timing errors, and I agree that it's sort of an enforced discipline.
00:12:49.760 | Rebalancing helps get you headed in the right direction.
00:12:53.760 | Just one topic that has been touched on, but we haven't actually stated it. People talk
00:12:58.760 | about the tax costs of rebalancing. If you have taxable accounts and tax-sheltered accounts
00:13:03.760 | such as IRAs or 401(k)s, to the extent possible, you want to do your rebalancing in those
00:13:09.760 | tax-sheltered accounts so that there are no tax costs.
00:13:12.760 | And that's a problem if you're doing tax location where you have most of your bonds
00:13:15.760 | in your IRA. Because usually it's stocks that go up, and if the stocks are all in your
00:13:19.760 | personal account and you need to do a rebalance, you're actually going to incur higher taxes.
00:13:24.760 | And so it runs counter to asset location.
00:13:28.760 | Did we solve any problems?
00:13:32.760 | I think that Alan hit it. Whatever works for you. Just be disciplined about it.
00:13:39.760 | That's the right thing to do.
00:13:42.760 | I used to say if you can't be right, at least be consistent, and I've changed that view.
00:13:46.760 | The consistency is more important than being right.
00:13:49.760 | Okay, the next question from the panel. Can you provide some simple, high-level guidelines
00:13:57.760 | for tax-efficient withdrawals in retirement?
00:14:00.760 | Sure. Generally speaking, the first thing you need to figure out is whether you anticipate
00:14:10.760 | spending down your entire portfolio during your lifetime or leaving a large part of it
00:14:14.760 | to your heirs. If you expect to leave a large part of it to your heirs, leaving behind a
00:14:20.760 | large taxable account is often very efficient because they'll get a step-up in cost basis,
00:14:25.760 | which is to say that their cost basis when they inherited will lead to the market value
00:14:30.760 | when you die. Conversely, if you expect to spend it down during your lifetime, then the
00:14:37.760 | taxable account is now the least efficient one, so it's usually the one that you want
00:14:41.760 | to spend on first. And then as far as spending between Roth accounts and tax-deferred accounts,
00:14:47.760 | the question is just the same one that you've been looking at forever in terms of which
00:14:51.760 | one to contribute to. It's just flipped on its head. Is my marginal tax rate higher now
00:14:57.760 | than I expect it to be in the future, or is it lower now than I expect it to be in the future?
00:15:02.760 | And if your tax rate right now when you're starting to take money out is lower than you
00:15:06.760 | expect it to be in the future, perhaps because you haven't started taking Social Security yet,
00:15:11.760 | that's when you want to spend from tax-deferred accounts. If your marginal tax rate is higher
00:15:16.760 | now than you expect it to be in the future, then that's when you would want to prioritize
00:15:20.760 | spending from Roth accounts.
00:15:23.760 | There's nothing—investing is simple. Taxes aren't. You know, there are rules of thumb
00:15:28.760 | that work sometimes, but probably more often than not don't work. Sometimes it's better
00:15:34.760 | to pay taxes at a lower rate sooner than at a higher rate later when Social Security kicks in.
00:15:40.760 | So a bunch of different rules, and I use a strategy of multiple Roth conversions with
00:15:46.760 | being able to recharacterize or hit that undo button the next year to kind of manage the
00:15:52.760 | marginal tax bracket and then to essentially sell it back to the government if the asset
00:15:58.760 | price you did the conversion to goes down.
00:16:03.760 | I think another thing that these guys have alluded to that is really important is the
00:16:07.760 | benefit of tax diversification, which is something that this audience knows well, that the more
00:16:12.760 | different pools with different tax treatments that you can pull from, the more you can sort
00:16:16.760 | of manage those tax brackets on a year-to-year basis. I think sometimes people want that
00:16:20.760 | rule, that they're just going to be dogmatic about, "I'll deplete this and then move on
00:16:24.760 | to that and move on to that," and in reality I think if a tax advisor would look at it
00:16:28.760 | or Mike were to look at it, he would say, "No, we're going to maybe take a little bit
00:16:32.760 | of this this year and a little bit of that," rather than just sort of sequentially going
00:16:36.760 | through each pool of assets.
00:16:39.760 | Sorry, one more thing to add. A lot of times people make the mistake of thinking that their
00:16:44.760 | marginal tax rate is the same as their tax bracket, and that's very often not the case,
00:16:49.760 | especially once you're retired, because there will be various tax breaks for which you qualify,
00:16:54.760 | for which you will not qualify if your income grows too much. So for instance, one of them
00:17:00.760 | is social security. Often none of it is taxed. At the most, 85% of it can be taxed. So when
00:17:07.760 | you're receiving social security, you're in this time where additional income not only
00:17:12.760 | causes the normal amount of income tax, it also causes more social security to become
00:17:17.760 | taxable. So even if you're in, let's say, the 15% tax bracket, you get a marginal tax
00:17:22.760 | rate of 22 or even 27%. And there's another similar sort of thing going on if you retire
00:17:30.760 | prior to Medicare eligibility, you're buying insurance on the exchanges where additional
00:17:35.760 | income can cause the size of your subsidies to go down. So effectively your marginal tax
00:17:39.760 | rate is much higher than the tax bracket you're in. So often the best thing to do, rather
00:17:44.760 | than just looking at the tax brackets and saying, oh, I'm estimating my income to be
00:17:49.760 | such and such amount, is actually to plug numbers into TurboTax, and then move them
00:17:54.760 | around a little bit. If I have an extra $1,000 in tax deferred distributions, how do my taxes
00:18:00.760 | change? Because that's your actual marginal tax rate that's not always going to be the
00:18:04.760 | same as your tax bracket.
00:18:07.760 | Okay, the next question for the panel is, what are your thoughts on obtaining long-term
00:18:12.760 | care insurance versus self-insuring? What asset level would you need to be at if you
00:18:19.760 | decide to self-insure? And then the thoughts on the viability of long-term care insurance
00:18:25.760 | product. There are new blended products that may include annuities and/or life insurance
00:18:31.760 | and ages are in the mid-60s. Anybody have any comments about long-term care?
00:18:38.760 | A lot of questions there. I don't have a hard and fast number on when you should, and
00:18:44.760 | I've been informed, and I think it's a true assertion, that self-insuring is not a proper
00:18:50.760 | term, and that when you're insuring anything, you're pooling your risk with other people.
00:18:55.760 | So it's sort of, I prefer self-fund when we think about paying for long-term care out
00:19:01.760 | of pocket. I guess I'll share a story, though, from my personal life, which is that my mom
00:19:06.760 | and dad, I think, had been advised to self-fund for long-term care costs, and my dad had dementia
00:19:14.760 | and my mom needed care in the home because she had more health care considerations, so
00:19:21.760 | at some point we were in a situation where my dad was, we moved my dad to a facility
00:19:26.760 | with his Alzheimer's to give him more care, and yet we still had caregivers at home for
00:19:31.760 | my mom, and as the person, not writing the checks out of my own accounts, but as the
00:19:36.760 | person overseeing all of this, you can imagine that certainly in a big urban area, that gets
00:19:41.760 | very expensive very quickly. So if you're sort of thinking about self-insuring or self-funding
00:19:47.760 | long-term care, really run the numbers on what these costs could look like for both
00:19:52.760 | you and your spouse and think through kind of the worst case scenario. In terms of the
00:19:59.760 | viability of the long-term care insurance market, I think that arguably the pricing
00:20:06.760 | is as bad as it's going to get in terms of long-term care insurance if you're purchasing
00:20:12.760 | policy today, given how low interest rates are, given that insurers know what they know
00:20:17.760 | about how bad their claims experience has been, that they're pricing it pretty aggressively
00:20:23.760 | to protect themselves on the downside. So I know Michael Kitsis has argued that he thinks
00:20:29.760 | that perhaps the worst is over in terms of long-term care premium increases. I'm not
00:20:34.760 | sure whether that's true, but I guess the more that I've experienced this, the more
00:20:40.760 | that I put myself a little more in that insurance camp as opposed to this idea of self-funding.
00:20:46.760 | It's one of a few subjects that I'm actually agnostic on. It is true insurance, and I'm
00:20:53.760 | a believer in buying insurance, but you can't buy it anymore because of the underpricing
00:20:58.760 | and trying to buy market share. You can't buy it anymore where your rate is going to
00:21:03.760 | be fixed. So you could end up paying for it for 10 years and then many consumers now are
00:21:09.760 | paying 100, 150 percent price increase. So I do believe that if you can self-fund, self-insure,
00:21:19.760 | that's probably the way to go. I don't have it. One easy answer, though, is the question
00:21:26.760 | of should you mix it with a whole life or a universal life or other products to help
00:21:31.760 | that is my answer to that. Okay, this is for Rick Perry. What role should a REIT fund play
00:21:40.760 | in a portfolio for someone who is 8 to 10 years from retirement, and where is it best
00:21:46.760 | placed? Tax deferred question. So REITs are the only alternative asset class that I actually
00:21:58.760 | include in a portfolio, and normally it just goes into the non-taxable account. In fact,
00:22:07.760 | the perfect place for REITs is a Roth IRA because it has both income and growth. If
00:22:15.760 | we can't go into a Roth, then we go into a regular IRA. But REITs are a different animal
00:22:18.760 | than common stock because of flow through. They don't pay any taxes at the corporate
00:22:25.760 | level, as long as they distribute 90% of the free cash flow to the shareholders. It's
00:22:32.760 | a flow through entity, much like a limited partnership. The underlying premise of REITs
00:22:43.760 | is that people rent apartments, they rent office space, they rent store space, now single
00:22:52.760 | family homes, and they pay rent. The income from rents is fairly stable, even during economic
00:23:04.760 | downturns, even though REIT prices will go up and down. The income from real estate is
00:23:10.760 | fairly stable, even during the crash of 2008. It actually becomes a different animal, and
00:23:22.760 | there are times that real estate REITs, like the Vanguard REIT ETF, which is very low cost
00:23:28.760 | and broadly diversified, and equity REITs, there are different types of REITs, but these
00:23:31.760 | are just equity REITs that buy property, will be negatively correlated with the rest of
00:23:36.760 | the stock market. So by having an allocation to REITs, and I think 10% is about right,
00:23:43.760 | you can gain some diversification benefit, and also gain a little bit more income in
00:23:50.760 | your portfolio because of this alternative asset class. That's what I think.
00:23:55.760 | Rick, I have a follow-up question for you on this. In terms of my personal property
00:24:00.760 | ownership, how does that factor into my REIT ownership? And also, what do you think about
00:24:05.760 | direct ownership of property? Because when I think about some of the most well-off seniors
00:24:10.760 | I know, that's in the mix for them. So is that a good idea? Never a good idea because
00:24:15.760 | it's too undiversified an asset?
00:24:17.760 | I think that it complements each other as opposed to one or the other. Owning a home,
00:24:23.760 | owning some rental property, it's very localized. And of course the cash flows and the returns
00:24:29.760 | are better if it's well-managed and it's in a good location. REITs are, you own a
00:24:35.760 | thousand properties, thousands and thousands of properties all over the country in a REIT
00:24:39.760 | index, and so you're getting the market-based return on real estate. And to me, if you're
00:24:45.760 | able to have rental property, if you are doing it directly by buying properties or single
00:24:52.760 | family homes or apartments, or maybe you're getting involved with some very good people
00:25:01.760 | who you know personally who are running partnerships, that's a diversification. I consider it a
00:25:11.760 | complement as opposed to one or the other. And I don't want to get involved in people
00:25:18.760 | who you don't know when it comes to private real estate.
00:25:22.760 | Okay, here's a question for the panel from Samuel Moller. Can you buy an annuity in a
00:25:29.760 | Roth SBIA? Is it a good idea if you're in a high-tax bracket?
00:25:34.760 | You can buy IRA annuities, basically. In terms of income annuities, I'm not aware that
00:25:47.760 | you can buy one within an IRA as such. You can move a portion of your Roth IRA to an
00:25:55.760 | IRA annuity that functions the same way where the payout is from. If it's a Roth, the
00:26:00.760 | payout is from it would be free from income tax.
00:26:03.760 | In most cases, I would say the Roth money is the last money you want to use. So I would
00:26:10.760 | probably recommend against it. I'm not against annuities. The best deferred annuity out there
00:26:16.760 | is delaying Social Security.
00:26:19.760 | For the panel, what do you see as the ideal amount of inflation-protected securities once
00:26:28.760 | you have in your account? Again, count key variables such as age, size of nest date,
00:26:33.760 | so forth, and why. What do you see as the best vehicle for this investment? Vanguard
00:26:39.760 | fund, actual bonds? I'm trying to see the range of responses from experts to help target
00:26:44.760 | an appropriate amount for our proposal.
00:26:47.760 | I will just talk about what Ibbotson puts out in terms of recommended allocations. For
00:26:56.760 | accumulators, certainly young accumulators, nothing in tips or I-bonds or anything like
00:27:00.760 | that. The basic idea is that that human capital over time should be somewhat inflation-adjusted,
00:27:07.760 | that that person should qualify for cost of living increases as the years go by with their
00:27:11.760 | salary. And then the tips allocation begins to step up for people who are in their 50s
00:27:18.760 | and 60s and so on. I believe at the high end, Ibbotson would recommend like a third of overall,
00:27:26.760 | maybe a fourth or a third of overall fixed income exposure going into something that's
00:27:33.760 | inflation-protected.
00:27:35.760 | I believe in the asset class, but the answer is definitely it depends. If you're a government
00:27:41.760 | employee and you have access to the G fund, which is like an intermediate term treasury
00:27:47.760 | with no interest rate risk, that's a much superior product. I'm also a believer in certain
00:27:53.760 | CDs as Bill Bernstein mentioned. But I like the asset class. The single best vehicle,
00:27:59.760 | in my opinion, is the Vanguard inflation-protected, the intermediate term, not the short term.
00:28:04.760 | And then if it's an ETF, probably the iShares tips, even though it has a higher expense
00:28:10.760 | ratio.
00:28:11.760 | I believe it, Christine, on, younger people don't really need tips because in the long
00:28:20.760 | run, stocks are going to take care of any unanticipated inflation that we might have.
00:28:24.760 | Now in the short run, stocks are not the ideal anti-unanticipated inflation vehicle. Tips
00:28:32.760 | are, but I'm not sure if younger people really need that protection. The bond portfolio that
00:28:39.760 | I run, where a retiree may have a greater position in bonds, would have 20% in tips
00:28:45.760 | in it. And the rest of the bond portfolio is intermediate term. And I think that may
00:28:51.760 | be enough.
00:28:52.760 | But I'm not going to state that if somebody wants the 30%, that's fine. Whatever suits
00:29:00.760 | you and makes you feel comfortable, the rate of return and the risks are not that much
00:29:04.760 | different.
00:29:05.760 | I would also say that it depends. From one retiree to another, some are more exposed
00:29:12.760 | to inflation risk than others. If you own your home, you have much less inflation risk
00:29:17.760 | than somebody who's renting. If you have a pension that's inflation-adjusted that
00:29:23.760 | satisfies most of your basic needs, or all of them, you have less inflation risk than
00:29:28.760 | somebody who has only Social Security and it only satisfies a very small part of their
00:29:32.760 | needs. So it varies even among retirees.
00:29:35.760 | Okay, here's a question for the panel from Steve Hewitt. Is the three fund portfolio
00:29:43.760 | the best asset allocation choice, or is tilting small cap in value better over time?
00:29:50.760 | Here we go again.
00:29:53.760 | Yeah, the answer is yes. No, either one. Okay, can I give my little spiel about the
00:30:02.760 | difference between philosophy and strategy here? Would that be okay?
00:30:05.760 | Oh, absolutely. As long as it's not political, because no one would shoot me.
00:30:09.760 | No, I don't think it's political. Okay, so here's my two-minute version of what
00:30:15.760 | we all do as investors and how we become successful investors.
00:30:20.760 | Investing is divided up into three parts. First, you have a philosophy. What do you
00:30:29.760 | believe about the markets? Now, is anybody here not a Boglehead? I'm pretty sure if
00:30:35.760 | you're not a Boglehead, please raise your hand. Okay, so everybody here has the same
00:30:40.760 | philosophy, correct? How many people in this room have exactly the same portfolio?
00:30:48.760 | Nobody, because that's strategy. So, strategy is taking the investments that
00:30:54.760 | are out there. By the way, I used to call them products, but now I...
00:30:57.760 | You have the philosophy of a Boglehead, low-cost, poorly purified, don't try to
00:31:06.760 | time the market, all the good Boglehead beliefs. Now, you look at the investments
00:31:11.760 | that are available, and we're going to build a strategy. Strategy is personal.
00:31:17.760 | Refund portfolio, that works. Heavily tilting towards small-cap value, that
00:31:24.760 | works. It all works. If that's your strategy, as long as you do the third
00:31:30.760 | thing, which is have the discipline to maintain the strategy, it will work. And
00:31:36.760 | who's going to say whether a tilted portfolio is going to outperform a
00:31:40.760 | refund portfolio? No one in this room can say that. I don't know. But if it's your
00:31:45.760 | strategy to do that, as long as you implement that strategy and maintain that
00:31:51.760 | strategy with discipline, and continually remind yourself why you're doing that
00:31:56.760 | through education, then the whole thing works, and you'll be a successful
00:32:01.760 | investor. If you break any link in that chain, then you're not going to be
00:32:06.760 | successful at it. If you lose the philosophy, if you keep shifting the
00:32:09.760 | strategy, if you don't maintain the discipline, it isn't going to work no
00:32:14.760 | matter what you do. That's my answer.
00:32:18.760 | Anybody else?
00:32:20.760 | As the author of How a Second Grader Beat Wall Street, if you look at the
00:32:24.760 | eight lazy portfolios, the last I looked, the three-fund second-grader
00:32:28.760 | portfolio was in first place.
00:32:31.760 | Okay. Here's a question from Dr. Karen Oates. Wayfoud has done new research
00:32:41.760 | and continues to provide new data, which is spinning heads. How does his
00:32:46.760 | research impact on the scholarly research of a distinguished panel?
00:32:51.760 | Of course, Wade is doing great work. I read his research, and it makes a lot of
00:32:59.760 | sense, and it's changed my thinking, as I already have alluded to. I think this
00:33:03.760 | is a huge issue, and it hasn't been given enough thought. So I think Wade's
00:33:07.760 | doing great work.
00:33:09.760 | Anyone else?
00:33:10.760 | I'll just comment. My colleague at Morningstar, Wade's equivalent at
00:33:14.760 | Morningstar, David Blanchett, who's our head of retirement research, continues
00:33:19.760 | to conduct research into this area of optimal retiree glide paths. His
00:33:23.760 | conclusions are different from Wade's. He believes in the traditional glide
00:33:28.760 | path, where you actually get more conservative as the years go by. His
00:33:32.760 | assertions, and he's not here to talk about it, but he and I have talked a lot
00:33:35.760 | about it, his assertion is that the differential, the improvement that Wade
00:33:41.760 | and Michael Kitsis have identified is minor, especially given the psychological
00:33:48.760 | impediments that might accompany a higher equity glide path in retirement.
00:33:53.760 | So that's kind of where he's coming down, and that's the direction that his
00:33:58.760 | research has been pointing in, in support of a more traditional retirement
00:34:03.760 | glide path. So it's safe to say that Morningstar will sort of be in that camp
00:34:08.760 | for now.
00:34:10.760 | And David Blanchett, Michael Kitsis, and I were on a Morningstar panel
00:34:14.760 | talking about glide path, and I'm on David's camp, and I've had a lot of
00:34:18.760 | discussion with Wade on this, who I have immense respect for. The difference
00:34:24.760 | between the flat glide path and the increasing glide path is immaterial. That's
00:34:30.760 | point number one. Point number two is behaviorally it's almost impossible to
00:34:35.760 | get people to stay the course, much less increase equities after the plunge.
00:34:41.760 | And then finally I did my own Monte Carlo simulation that I discussed with
00:34:45.760 | Wade, who I believe agreed with, showing the impact of expenses and emotions,
00:34:52.760 | you know, take that 3.5% down to about 2.5%, and that's the key factor, not
00:34:59.760 | performance chasing, not paying fees. Much more important than the glide path.
00:35:05.760 | Okay, the next question. I'm a retiree. I live partly off my portfolio, and
00:35:11.760 | therefore sensitive to its volatility. Currently my bond allocation is
00:35:16.760 | dedicated entirely to Vanguard's total bond market index fund. In light of
00:35:22.760 | future interest rate increases, should I change this allocation, perhaps I
00:35:27.760 | should diversify into short-term bond fund, or is it some other strategy to
00:35:34.760 | cope with this risk, or should I just do nothing and leave it alone?
00:35:41.760 | Well, I'm not Bill Bernstein. I say you do nothing and leave it alone.
00:35:48.760 | Try to time interest rate movements is extremely difficult. At least I can say
00:35:54.760 | about the stock market over time, it's going to go up and it's going to hit new
00:35:57.760 | highs. I guess with interest rates, the best you can say is they probably won't
00:36:01.760 | drop below zero. That's all you can really say about them. After that, you
00:36:05.760 | really don't know. So I would say that your liabilities if you're retired are
00:36:11.760 | intermediate term, they're not short-term. You should have maybe a short-term
00:36:14.760 | bond fund to cover one or two years of living expenses as an emergency fund,
00:36:19.760 | but after that I think you should have intermediate-term bonds.
00:36:23.760 | I don't believe in short-term bonds. Number one, last year 44 out of the 45
00:36:30.760 | economists interviewed by the Wall Street Journal forecasted that the 10-year
00:36:34.760 | T bond would go up this year and up significantly. One said flat, none said
00:36:39.760 | down. Second piece of data is those economists have a track record of being
00:36:43.760 | directionally correct about a third of the time, less than a point left.
00:36:48.760 | And then third, a strategy that I use of CDs that have easy early withdrawal
00:36:54.760 | penalties gives you kind of an intermediate-term return, and you pay that
00:36:58.760 | easy penalty to get out if rates go up and have much less of a downside than
00:37:04.760 | what might happen to total bond if interest rates did rise. You know,
00:37:10.760 | Goldman Sachs can't take advantage of it because $250,000 of FDIC insurance is
00:37:16.760 | rounded to them, but it is a market inefficiency created by the FDIC and the
00:37:21.760 | NCUA that really gives us the ability to outperform or above-market return.
00:37:30.760 | I like the idea of having some sort of dedicated cash piece in addition to
00:37:34.760 | maybe an intermediate-term bond fund, total bond market or otherwise. That's
00:37:38.760 | kind of the strategy when I talk about this bucket system of retirement
00:37:43.760 | planning, the basic ideas. And there is a drag of having some cash in your
00:37:47.760 | portfolio, of course, relative to having it invested, but the idea is that your
00:37:51.760 | long-term portfolio, including, or your intermediate long-term portfolio, those
00:37:56.760 | pieces will do what they are going to do and they'll maybe be a little bit
00:37:59.760 | volatile, but you know that you have your near-term living expenses locked down
00:38:03.760 | in true cash instruments. That's why I'm a believer in that strategy. I think it
00:38:08.760 | works from a psychological standpoint, that it helps the retiree tolerate those
00:38:13.760 | fluctuations that a company stocks, certainly, but possibly bonds over the
00:38:18.760 | next decade or two.
00:38:21.760 | If you are going to have cash, put it in like a Sallie Mae money market that's
00:38:26.760 | paying 0.9% because a Vanguard prime money market account paying 0.01% will
00:38:32.760 | double in only 6,972 years.
00:38:40.760 | What's the panel's view on non-cap weighted index products? Assuming
00:38:46.760 | implementation was relatively low cost, 30 to 40 basis points, and turnover was
00:38:52.760 | modest, where could they be most effectively used in a diversified equity
00:38:57.760 | portfolio, such as domestic large-cap, small-cap, small-cap value?
00:39:06.760 | Non-cap weighted simply means you're taking a bet to a mid-cap stock. You take
00:39:11.760 | the S&P 500 and you non-cap weight it, you just do an equal weighting, per se,
00:39:16.760 | and you're really, really close to a Morningstar mid-cap style box. You're just
00:39:24.760 | sitting right on the cusp of large-cap, mid-cap. I think you bring the market
00:39:29.760 | capitalization of the S&P from about 50 billion down to close to maybe 11
00:39:35.760 | billion. You're making a bet on mid-cap. If you want to make a bet on mid-cap
00:39:41.760 | stocks, then I think that you'd probably do it cheaper by buying a mid-cap
00:39:46.760 | index fund that's cap-weighted. I think Gus talked about this.
00:39:51.760 | There's cheaper ways to get those risk exposures in your portfolio if you
00:39:56.760 | don't want to do all-cap weighting than doing an alternative weighting like
00:40:02.760 | portfolio.
00:40:04.760 | Anyone else?
00:40:05.760 | I agree.
00:40:06.760 | I do too.
00:40:08.760 | Really?
00:40:09.760 | Do you agree, Mia?
00:40:11.760 | I must be wrong.
00:40:16.760 | Maybe I should change my mind.
00:40:18.760 | This is a question that I asked the last panel. I'd like to have it repeated
00:40:23.760 | for this panel to see if there's any difference of opinion. The question was,
00:40:29.760 | be interested in hearing the panel's viewpoints on portfolio construction in
00:40:33.760 | retirement based on three different approaches, the aging bonds, the bucket
00:40:38.760 | approach, and the liability matching portfolio.
00:40:45.760 | Who wants to go first?
00:40:46.760 | I'll take the bucket one. That was the one that I just talked about, the
00:40:49.760 | basic idea. I've written a lot about this on Morningstar.com, kind of to
00:40:53.760 | illustrate the logistics of this and to get people off this income-only
00:40:56.760 | mindset, which is something I confront a lot in my work where retirees want to
00:41:01.760 | just try to subsist off of whatever income the portfolio kicks off.
00:41:05.760 | The basic idea is that you've got one to two years' worth of living expenses
00:41:10.760 | in true cash instruments, maybe income for years three through eight or three
00:41:16.760 | through ten of retirement in bonds, and then everything else in stocks.
00:41:21.760 | We sort of arrive at those allocations by thinking about, well, 95% of the time
00:41:27.760 | equities are in positive territory over a rolling 10-year period.
00:41:32.760 | So if you have at least a 10-year time horizon, it seems like you could
00:41:35.760 | reasonably put everything for those years in stocks.
00:41:40.760 | And so the idea is that you're using your income distributions from the rest of
00:41:46.760 | the portfolio to fill up that bucket one as you deplete it, as you spend that
00:41:50.760 | money in it, and if that doesn't get you there, then you turn to rebalancing
00:41:54.760 | proceeds to help fill up that bucket one.
00:41:58.760 | So I think it's an easy strategy to understand.
00:42:01.760 | It's an easy strategy to explain.
00:42:05.760 | Hearing from our users, I get the sense that people have some success in
00:42:10.760 | keeping this strategy going in their portfolios.
00:42:13.760 | I think it works from a psychological standpoint, and it would take pains to
00:42:17.760 | note that this is not original to me.
00:42:19.760 | This is really Harold Domensky's strategy, something that he's used with his
00:42:23.760 | clients, and I have just taken the strategy and illustrated it with actual
00:42:29.760 | fund holdings.
00:42:31.760 | But you can find a lot of work on that topic, including some stress tests of
00:42:36.760 | my bucket portfolios that sort of show, well, how did this work on a year-to-year
00:42:41.760 | basis?
00:42:42.760 | Where did we go for cash?
00:42:43.760 | In some years, the income distributions were enough.
00:42:46.760 | In some years, we had to pull from some of the longer-term investments.
00:42:50.760 | So my idea is just to kind of illustrate the logistics of this, which I think
00:42:54.760 | for a lot of individual investors trying to figure this out themselves can be
00:42:58.760 | kind of black boxy.
00:42:59.760 | So I've just been trying to present new life portfolios and show how the cash
00:43:05.760 | flow process would work.
00:43:07.760 | Economic theory would say the bucket approach is buck, but economic theory
00:43:13.760 | seems we're all logical, rational beings, and in reality, we're feeling
00:43:17.760 | beings.
00:43:18.760 | So I come to totally agree with you that the bucket approach kind of
00:43:23.760 | psychologically helps one to stay the course.
00:43:28.760 | As far as the liability matching strategy, that's certainly the safest choice
00:43:33.760 | for those who aren't familiar with the term.
00:43:36.760 | It's basically just one method of implementing it would be a tip slider to
00:43:41.760 | the extent you can build one if bonds maturing every year to cover your living
00:43:45.760 | expenses.
00:43:46.760 | But as Jack said, that's super expensive.
00:43:49.760 | It takes a whole lot of money, especially with tip seals as low as they are.
00:43:54.760 | So one method that I think makes some sense is to use that strategy just for
00:44:01.760 | basic needs, the stuff that you're absolutely unwilling to compromise on to
00:44:06.760 | the extent that your social security or pension or other sources of income
00:44:09.760 | don't satisfy those needs.
00:44:11.760 | A liability matching portfolio to satisfy the remainder of them can make sense.
00:44:15.760 | But again, it's going to be expensive.
00:44:20.760 | That's a good question.
00:44:21.760 | In the end, it's going to be whatever strategy you can maintain as what
00:44:26.760 | Alan keeps referring to.
00:44:29.760 | I never liked aging bonds.
00:44:33.760 | It just seems counterintuitive to me that if you're 40 years old, you should
00:44:39.760 | have 40% of your portfolio of bonds just because you're 40 years old.
00:44:43.760 | Or if you're 50, you should have 50 just because you're 50.
00:44:48.760 | I think that if you have no other way and nothing else to look at, I think
00:44:57.760 | aging bonds is maybe step number one.
00:45:02.760 | But you can quickly go up the ladder to better methodologies than that.
00:45:08.760 | Even if you're going to accumulate assets, you have a 60/40 portfolio.
00:45:13.760 | And when you start decumulating assets, you start with a 30/70 portfolio
00:45:18.760 | and you work from there.
00:45:21.760 | But the bucket approach makes sense.
00:45:24.760 | It gives you a plan for getting income.
00:45:28.760 | And of the three choices, the bucket approach to me makes the most sense.
00:45:34.760 | I'm giving a talk in about a month to a group of financial planners who
00:45:39.760 | definitely believe in the liability approach.
00:45:42.760 | In fact, they take zero-coupon treasury bonds and they ladder them out 15 years
00:45:47.760 | when somebody retires.
00:45:49.760 | How much for the first 15 years of a person's retirement they're going to do
00:45:54.760 | a structured laddered zero-coupon bond portfolio?
00:45:59.760 | I say, "Wow, what a tremendous amount of interest rate risk you take
00:46:04.760 | when you do that to one day structure a laddered portfolio of zero-coupon bonds
00:46:09.760 | out 15 years."
00:46:11.760 | You better hope that interest rates don't go up during that 15-year period of time
00:46:14.760 | or you kind of shot yourself in the foot.
00:46:16.760 | So I'm not all-- Mike makes a good point about perhaps doing some liability
00:46:22.760 | matching with zero-coupon bonds or treasury tips in the very short run.
00:46:29.760 | But I think that of the three choices, the bucket approach makes the most sense.
00:46:36.760 | Next question is from Ray James.
00:46:39.760 | Given the mantra lifestyle and spending won't increase without pay rises,
00:46:44.760 | would the future education costs continue to rise as rapidly like PEs in the stock market?
00:46:52.760 | Does education and health care pricing at some point return to the median?
00:46:56.760 | And any advice on the best investments to protect from these future costs
00:47:00.760 | that are available today?
00:47:06.760 | It has to return to the median at some point, otherwise it becomes the entire economy,
00:47:10.760 | which of course doesn't make any sense as far as how to protect against health insurance.
00:47:16.760 | As far as how to protect against education costs, I'm not really sure.
00:47:21.760 | I think we've seen some preliminary signs that both sets of costs are starting
00:47:27.760 | to modulate a little bit.
00:47:29.760 | Certainly with the health care numbers that we see, I won't get political,
00:47:34.760 | but I think that there's some indication that perhaps the Affordable Care Act
00:47:38.760 | has helped drive down health care costs a little bit.
00:47:42.760 | And we're also seeing it.
00:47:44.760 | I have a colleague who works on the college savings front almost full time
00:47:48.760 | and just talking about funding 529s and all that stuff
00:47:51.760 | and watches college costs very, very, very closely.
00:47:54.760 | And what you continue to see is that costs at the very top tier of universities,
00:47:59.760 | they can continue to push through those increases in tuition.
00:48:04.760 | But kind of at the middle ground, and certainly the state universities
00:48:08.760 | continue to be very constrained as well in terms of being affected by state budgets.
00:48:13.760 | But kind of the middle ground, some of the smaller schools,
00:48:17.760 | the smaller private colleges have in fact begun to modulate tuition increases
00:48:24.760 | a little bit.
00:48:25.760 | We've even seen some declines.
00:48:27.760 | So I hope that trend will persist.
00:48:30.760 | In my past life, a long, long time ago, I was director of financial planning
00:48:35.760 | at the corporate office of Kaiser Permanente.
00:48:38.760 | And you couldn't want a lot of money betting that price increases
00:48:44.760 | would have had to have collapsed a long time before where we are now.
00:48:49.760 | So it is a big threat to health care, in my opinion.
00:48:54.760 | I know we're not supposed to be political, but I'm not optimistic
00:48:59.760 | that our politicians are going to work together to solve
00:49:03.760 | what I think is a huge problem.
00:49:06.760 | But sooner or later, it has to collapse.
00:49:09.760 | Education, sooner or later, it has to slow down.
00:49:15.760 | Neither can be 110% of our GDP.
00:49:23.760 | This relates to our cognitive facilities decline as we age.
00:49:29.760 | The question is, please provide suggestions on how to centralize
00:49:33.760 | our lives in retirement.
00:49:34.760 | For example, is putting investments into a single-target retirement fund
00:49:38.760 | and getting automatic monthly withdrawals a good idea,
00:49:41.760 | like live on autopilot?
00:49:46.760 | I'll take that because it's interesting.
00:49:49.760 | As I've worked more in this retirement planning space
00:49:51.760 | and worked on the logistics of these bucket strategies,
00:49:54.760 | the more I've realized even a simplified version of a retirement portfolio
00:49:59.760 | is pretty darn complicated.
00:50:02.760 | So I think if you're the person who's the main person in charge of your
00:50:07.760 | family's household finances, I think it's really important to start thinking
00:50:11.760 | about how do I simplify this portfolio?
00:50:14.760 | How do I kind of create a succession plan for this portfolio,
00:50:17.760 | especially if I have a spouse or maybe I don't have a spouse?
00:50:21.760 | How do I simplify this whole thing for myself?
00:50:24.760 | And so I often hear that maybe a one-fund solution is a good idea.
00:50:30.760 | My big issue with that approach, whether it's a target date fund
00:50:35.760 | or some sort of a good quality balanced fund or Vanguard Wellington
00:50:38.760 | or something like that, is that when you take those distributions out,
00:50:42.760 | you're getting a portion of your stock holdings and you're getting a portion
00:50:46.760 | of your bond holdings back to you at the same time.
00:50:49.760 | In 2008, you did not want a portion of your stock holdings sent back to you.
00:50:54.760 | You wanted to be able to pick and choose.
00:50:56.760 | You probably wanted to draw from your safe stuff and leave your stocks there to rebound.
00:51:00.760 | So I like the idea of I think a better alternative would be perhaps to have
00:51:05.760 | just a couple-fund portfolio, maybe the three-fund portfolio or whatever it might be,
00:51:09.760 | or I think that Vanguard's managed payout fund--and I know there was some talk
00:51:14.760 | in the previous panel--I think that's actually the right mousetrap
00:51:17.760 | in terms of a more intelligent distribution setup.
00:51:21.760 | And I expect to see more funds in that vein when I think about sort of the suite
00:51:26.760 | of retirement income funds that are out there.
00:51:29.760 | In my view, most of them are not really ready for prime time,
00:51:33.760 | but I do think that that managed payout fund and that the distributions can come
00:51:38.760 | from a variety of sources, income sources, return of your own capital,
00:51:42.760 | which a lot of retirees have a big psychological impediment with,
00:51:45.760 | but sometimes that's the right answer.
00:51:47.760 | I think that that's the right direction, and I would expect to see more growth
00:51:51.760 | in that area.
00:51:53.760 | Frankly, I'm surprised that the managed payout fund has kind of struggled along
00:51:56.760 | because I think it's a very, very good product.
00:51:59.760 | I researched this extensively for a piece that I wrote for AARP magazine,
00:52:04.760 | and what I came down to is the best protection is simplification.
00:52:09.760 | Having a family member that you know and trust and always know
00:52:14.760 | what their key incentives are.
00:52:16.760 | SPIAs, single premium immediate annuities, they do protect you from mistakes
00:52:21.760 | later in life, but I think that they are still oversold.
00:52:26.760 | We're all concerned about do we want to go intermediate term bonds
00:52:30.760 | or stay short term, but when you think of what a SPIA is, it's a bond fund.
00:52:35.760 | It's a bond with a duration for the rest of your life.
00:52:41.760 | I think aside from your portfolio, there's other things you can do to simplify.
00:52:45.760 | Minimize the number of bank accounts you have.
00:52:48.760 | Combine IRAs, 401(k)s into IRAs, and other tax considerations
00:52:52.760 | where you might not necessarily want to do that.
00:52:55.760 | Pay off your mortgage.
00:52:57.760 | Delay Social Security so that there's no decisions to make
00:53:01.760 | once you start taking Social Security.
00:53:03.760 | You don't have to manage it the way you manage your portfolio.
00:53:06.760 | There's a lot of things you can do to simplify things
00:53:09.760 | aside from cutting down the number of funds if that doesn't appeal to you.
00:53:15.760 | I'm just going to change the subject a little bit.
00:53:18.760 | I've been approached at least three times at this conference
00:53:22.760 | with the same question or the same comment, so I'm going to address it.
00:53:30.760 | I'm one of you.
00:53:32.760 | I have a real concern about my spouse.
00:53:34.760 | She doesn't really like this stuff.
00:53:36.760 | I come here, I love this stuff, so I told her about you.
00:53:40.760 | When I die, she's supposed to call me.
00:53:43.760 | [laughter]
00:53:46.760 | How many phone calls have I gotten in the last 11 years
00:53:50.760 | of coming to these conferences where the spouse has called me?
00:53:54.760 | This is good news for you because it means none of you will ever die.
00:53:57.760 | [laughter]
00:53:59.760 | The answer is zero.
00:54:02.760 | If you out here who are well-educated and you're taking the lead
00:54:08.760 | in figuring out what you're currently doing with your own investments,
00:54:14.760 | and if you want your spouse to work with an advisor in my island
00:54:17.760 | or anybody out there, just telling them to pick up the phone
00:54:21.760 | and call that advisor or email that advisor when you're dead doesn't work.
00:54:27.760 | It needs to be something else.
00:54:29.760 | Some sort of a relationship needs to be established with you,
00:54:32.760 | your children, the advisors, so that they have a warm and comfy
00:54:36.760 | and understand the philosophy and perhaps understand the strategy as well,
00:54:41.760 | the discipline, in order to make the transition as well.
00:54:45.760 | I can tell you just by telling your spouse, call Alan or call Rick
00:54:50.760 | or call someone else in the audience or whomever, it doesn't work.
00:54:55.760 | That long-lost cousin from Merrill Lynch always seems to show up in the way.
00:54:59.760 | [laughter]
00:55:01.760 | And the variable annuity sales pitch begins.
00:55:04.760 | [laughter]
00:55:07.760 | All right, a question for the panel from Samuel Lawson.
00:55:11.760 | Evaluate the risk of waiting until later in retirement to buy an annuity,
00:55:16.760 | assuming a pension and Social Security doesn't cover your expected spending.
00:55:26.760 | The older you are, the more life credits you get on buying an annuity.
00:55:30.760 | Again, the single best annuity, and the way I framed it for a client
00:55:35.760 | who wanted to buy a SPIA and take Social Security early was deferring it
00:55:41.760 | for four years from 66 to age 70 was like buying that deferred annuity at a 45% discount.
00:55:50.760 | So again, the longer you wait in buying a SPIA, the more life credits you're getting
00:55:58.760 | and the less that goes to intermediaries, that profit, the agent that sells it to you
00:56:04.760 | and the insurance company needs to make a profit.
00:56:08.760 | Essentially, they're taking your money and they're putting it at roughly 85% in bonds
00:56:13.760 | and 15% in stocks and alternatives.
00:56:17.760 | So it's an indirect, more expensive thing to get, but it does provide those life credits.
00:56:24.760 | It gives some insurance against, you know, longevity.
00:56:30.760 | This is for Christine.
00:56:33.760 | "If we are to retire in two years, we will roll over our 401(k) into Vanguard.
00:56:39.760 | What is the easiest place to put our middle bucket?"
00:56:44.760 | So I guess the question is, well, the way I think about segmenting the portfolio
00:56:50.760 | in terms of the bucket strategy, I kind of said it, that we've got cash for very near-term living expenses
00:56:56.760 | and generally fixed-income instruments for bucket two, which is roughly 3 to 8 years worth of--
00:57:03.760 | for years 3 through 10 of retirement and then stocks beyond that.
00:57:09.760 | So when I think about that bucket two, I think about mainly core fixed-income instruments,
00:57:14.760 | maybe total bond market, maybe some little tweak to give it an extra emphasis on corporates.
00:57:19.760 | I also typically put in--and I know Rick doesn't like short-term bond funds--
00:57:23.760 | but I typically would put in a short-term bond fund sort of at the front end of that bucket two.
00:57:29.760 | The idea is in some sort of catastrophic scenario where the retiree has gone through bucket one
00:57:35.760 | and there's nothing--can't shake out any living expenses or enough living expenses from the portfolio
00:57:41.760 | to refill it, that you would turn to that short-term bond fund as your next-line reserves.
00:57:47.760 | So that's kind of how I think about structuring it at the tail end of bucket two.
00:57:53.760 | You might also think about having some sort of a balanced fund,
00:57:56.760 | whether it's something like Wellesley Income or Wellington even,
00:58:01.760 | to give that portion of the portfolio just a little bit of a growth boost.
00:58:08.760 | This is one for Rick.
00:58:10.760 | I'm age 63 and will probably work for three more years.
00:58:14.760 | Thinking of converting all or most of a small traditional IRA to a Roth IRA before 70 1/2,
00:58:21.760 | what is the best time to do the conversion
00:58:23.760 | and what should be some consideration in the follow-up as well?
00:58:29.760 | I'm actually going to pass on that.
00:58:31.760 | That's a tax question, and I'm not a tax expert, so I'm actually going to pass on it.
00:58:38.760 | Pass it to Mike.
00:58:41.760 | We were talking about it earlier.
00:58:43.760 | It's just how your current marginal tax rate compares to the tax rate you expect to have in the future.
00:58:50.760 | If your current marginal tax rate is higher than the tax rate you expect to have down the road,
00:58:56.760 | Roth conversion does not make sense.
00:59:01.760 | There's possible exceptions if you think that we can come up easier,
00:59:04.760 | so then you're comparing it to their tax rate, actually.
00:59:07.760 | But for the most part, unless your tax rate now is lower than the tax rate you expect to have in the future,
00:59:12.760 | and again, this is a marginal tax rate, then Roth conversions would not make sense.
00:59:18.760 | Although Roth conversions do give you some tax diversification,
00:59:24.760 | and I think the question was on timing.
00:59:27.760 | The best time to do the conversion is January 2nd, the first day the market is open.
00:59:34.760 | And you have until October 15th of the following year to hit that undo button to do that recharacterization to undo it.
00:59:45.760 | And tax planning, that recharacterization helps a whole lot, as well as if the asset goes down,
00:59:53.760 | you hit that undo button and make the government buy it back at the original price.
00:59:59.760 | So I do multiple Roth conversions on my own account every year.
01:00:06.760 | Just adding one more thing.
01:00:08.760 | In terms of the timing from not within the year but one year as opposed to the other,
01:00:13.760 | a lot of it depends on whether in your early years of retirement you will be buying insurance on new exchanges.
01:00:21.760 | If you are not retiring until 65, that's not a concern.
01:00:25.760 | If you have insurance through a former employer, not a concern.
01:00:29.760 | But if you will be buying insurance on those exchanges, you can often qualify for significant subsidies
01:00:34.760 | if you make a point to keep your income low, and Roth conversions would really kind of ruin that.
01:00:39.760 | So in that case then you've got this, let's say you retire at 60,
01:00:43.760 | so you're buying insurance on the exchanges for five years, and then you're starting Social Security at 70.
01:00:48.760 | It's those years after you're finished buying the insurance on the exchange.
01:00:52.760 | So starting at 65 and before Social Security kicks in at 70,
01:00:57.760 | that would be the range when you're most likely to want to be doing the conversions.
01:01:02.760 | The follow-on question, are international bond funds really necessary?
01:01:08.760 | Is there a currency risk associated with them?
01:01:11.760 | And can't one get the benefit of an allocation to bonds with total bond market index?
01:01:18.760 | Okay, I can't answer that one.
01:01:23.760 | The international bond fund question.
01:01:28.760 | I'm agnostic.
01:01:31.760 | These are interest rate-bearing bonds, and whether they're from Europe or Japan,
01:01:38.760 | and then you hedge out the currencies, and that's a little more costly.
01:01:41.760 | The cost of the bond fund is a little higher.
01:01:44.760 | Hedging out the currency is a little higher.
01:01:46.760 | You're sort of eating away at the income from the bond fund.
01:01:51.760 | I think that you could do all the analysis you want about the diversification benefit of it
01:01:57.760 | and how having foreign bonds might give you incrementally a little bit better rate of return on a risk-adjusted basis.
01:02:03.760 | But after the cost of hedging, after the extra fee,
01:02:09.760 | I've never really been sold on the idea of adding an international bond fund.
01:02:14.760 | Even the Vanguard bond fund.
01:02:17.760 | And interesting that Gus was talking about that dinner that we had 10 years ago.
01:02:24.760 | But one of the other things that Gus and I discussed at that dinner was,
01:02:27.760 | why doesn't Vanguard have an international bond fund?
01:02:30.760 | And if Gus is still in the room, is he? I don't think so.
01:02:33.760 | But his answer was, "I don't see any point to it."
01:02:36.760 | And I said, "I agree."
01:02:37.760 | But people want it.
01:02:39.760 | So I think that Vanguard sometimes creates products because people want them,
01:02:43.760 | and then they create the theory after that.
01:02:46.760 | And it's exactly the criticism that Gus had for Smart Beta.
01:02:52.760 | I think that you could say that Vanguard is guilty of the same thing.
01:02:57.760 | They do create products because people want them,
01:03:00.760 | not necessarily because the people at Vanguard actually believe in them.
01:03:04.760 | And if you ask me, or people have asked Gus 10 years ago,
01:03:07.760 | he would say, "I don't see the need for it."
01:03:10.760 | That's right. That's what I believe.
01:03:13.760 | Vanguard has been talking to me about international bonds for many, many years,
01:03:17.760 | and I really did believe it was a 20-year product launch.
01:03:21.760 | And their argument is really that since I believe in international stocks,
01:03:26.760 | why wouldn't I believe in international bonds for diversification?
01:03:30.760 | And I researched this and researched this, and eventually came out kind of lukewarm.
01:03:35.760 | I sold it myself with my toe in the water. It was what Vanguard was hoping for.
01:03:40.760 | And the two reasons--yes, it's hedged to the U.S. dollar, which I happen to agree with.
01:03:45.760 | But with 20 bips plus another 5 bips, or 0.25% in total--
01:03:52.760 | the other 5 bips comes from the hedging costs--
01:03:55.760 | it's three times more expensive than total bond.
01:03:58.760 | And let's face it, if the Vanguard total bond market goes to zero,
01:04:04.760 | that means the Treasury has gone to zero, and that diversification is not going to help.
01:04:11.760 | I kind of agree with what the panelists have said.
01:04:14.760 | I think though Vanguard's product is a good product,
01:04:17.760 | certainly relative to other international bond products on the market,
01:04:21.760 | what I would say is when I look at this category,
01:04:23.760 | it's one of the most diverse of any that we track.
01:04:26.760 | So there are all sorts of different strategies going on.
01:04:29.760 | And really the key differentiator, one of the keys, is this currency hedging thing.
01:04:34.760 | So we at Morningstar strongly favor the hedged type product
01:04:39.760 | because the unhedged product acts very unbond-like,
01:04:44.760 | so you have a lot of currency-related volatility.
01:04:47.760 | So while we favor the hedged products, I think I generally agree with what the other panelists have said.
01:04:54.760 | This is a question for Rick.
01:04:56.760 | Reading much about the world economy slowing and the potential for stagflation/deflation,
01:05:04.760 | any strategies you recommend in this stagflation/deflation environment?
01:05:12.760 | Well, if I knew for a fact that we were actually going to go into a stagflation/deflation environment,
01:05:18.760 | then maybe I could create a strategy that would take advantage of that,
01:05:22.760 | but I'm going to stick to a 20 on my hedge fund.
01:05:27.760 | Stay the course. I mean, you've got a strategy. Stick to it.
01:05:32.760 | If there's a little stagflation or deflation, it will reverse eventually.
01:05:36.760 | You're better off just staying the course.
01:05:40.760 | Bonds. In fact, Vanguard's economic model that I looked at
01:05:43.760 | showed a 15% probability of deflation over the next 10 years.
01:05:49.760 | I spoke to Roger a couple of days ago, and he said they've decreased that probability now.
01:05:56.760 | But again, what will work? Treasury bonds in a deflationary environment.
01:06:02.760 | Go long.
01:06:03.760 | Go long. But again, since we don't know what's going to happen,
01:06:07.760 | and because the yield curve is still relatively steep,
01:06:10.760 | I believe in the intermediate term part of the yield curve, plus CDs.
01:06:18.760 | I've got a couple of questions left. This is for the panel.
01:06:22.760 | Since interest rates are so low, are stock funds better held in a Roth than a bond fund?
01:06:31.760 | Well, if I could get all of my money into a Roth, that's where I'd hold it.
01:06:34.760 | But a stock fund's better in a Roth than a bond fund.
01:06:41.760 | Again, that gets to be a tax question. If the market goes up a lot, then yeah, I think so.
01:06:49.760 | If the market doesn't go up, you probably want it in bonds in your Roth.
01:06:53.760 | But again, we're getting into asset location strategies,
01:06:59.760 | and where should you put your assets based on where taxes are today,
01:07:05.760 | what your income is today, trying to anticipate later on down the road
01:07:10.760 | what taxes are going to be later on down the road,
01:07:13.760 | and what the growth of these assets are going to be.
01:07:18.760 | It's very, very difficult to do, as Alan pointed out.
01:07:21.760 | Taxes are much more difficult to try to figure out.
01:07:24.760 | So the question again was getting back to-
01:07:28.760 | The question was, wouldn't it be better to put bonds or stocks in a Roth, I think,
01:07:32.760 | was the bottom line of the question.
01:07:34.760 | I'm going to say one or the other. I'd say stocks.
01:07:40.760 | I think it's a time horizon question, really.
01:07:42.760 | I mean, you should let that dictate what you hold in that account
01:07:46.760 | based on when you weather and when you expect to tap it.
01:07:49.760 | Certainly, if it's something that you're leaving to kids and grandkids,
01:07:52.760 | I would put long-term, high-growth stuff in it.
01:07:56.760 | If it's something that I expected to need for my living expenses,
01:08:00.760 | I'd have it shortened up accordingly.
01:08:03.760 | I think that you want to locate stocks first in your taxable account,
01:08:09.760 | then your Roth, and the least efficient place is in your IRA.
01:08:13.760 | Mike, I think you may disagree, and we're going to have a talk,
01:08:17.760 | and this guy is really, really smart, and I may be wrong.
01:08:23.760 | I generally wouldn't put anything in taxable unless you have to.
01:08:26.760 | That's where we disagree.
01:08:29.760 | But I still agree with the typical asset location advice
01:08:34.760 | that you'll find on bogal heads, which is to tax shelter your bonds,
01:08:37.760 | which is to say put them in a retirement account prior to tax sheltering your stocks,
01:08:42.760 | even though interest rates are low right now.
01:08:45.760 | Now, that said, the advantageousness of doing that
01:08:50.760 | is certainly less than it is when interest rates are quite high.
01:08:53.760 | But we don't know how long interest rates will stay that way,
01:08:57.760 | because in addition to what Rick was saying about how tax laws change,
01:09:00.760 | obviously market conditions change too.
01:09:03.760 | So basing an asset location decision on exactly where interest rates are today
01:09:08.760 | isn't necessarily a great idea.
01:09:11.760 | It's not bold.
01:09:14.760 | We get into this tax location discussion,
01:09:16.760 | and you can either try to locate all the tax inefficient stuff in your retirement accounts
01:09:21.760 | or more tax efficient stuff like stocks, especially stock ETFs,
01:09:27.760 | not Vanguard per se, but other stock ETFs.
01:09:30.760 | There's a real tax benefit if you're going to do anything other than a Vanguard fund.
01:09:35.760 | If you find an ETF that does it and it's equity,
01:09:39.760 | you'll probably use the ETF because of the tax efficiency of the way ETFs are.
01:09:46.760 | Now, Vanguards are a little bit different.
01:09:48.760 | But this debate between should you do the same asset allocation
01:09:54.760 | and all your accounts are pretty close to it or should you do tax location,
01:10:00.760 | I mean it just keeps going back and forth and back and forth.
01:10:03.760 | And there's benefits to doing one where it's simple
01:10:08.760 | and you don't get fixated on one account and what's going on in that one account,
01:10:14.760 | and there's benefits to doing it the other way.
01:10:16.760 | So, I don't know, this is one of those questions that probably never going to be resolved
01:10:21.760 | because we don't know what the future of taxes are.
01:10:23.760 | They changed. I mean, the last few years,
01:10:26.760 | this whole equation has changed because now dividends are being taxed at a higher rate,
01:10:30.760 | capital gains are being taxed at a higher rate,
01:10:32.760 | plus we have the medical tax on top of that.
01:10:35.760 | I mean, the whole equation changed as taxes changed.
01:10:38.760 | So, it's difficult.
01:10:39.760 | But if you're talking with somebody who's not that sophisticated,
01:10:43.760 | who doesn't get into all this stuff too much,
01:10:46.760 | I'm in the camp of doing the same allocation in both accounts, taxable versus non-taxable,
01:10:52.760 | because it's simple for them and they won't fixate on performance of one account.
01:10:56.760 | So, you do a balanced fund, for example, in both accounts,
01:10:59.760 | as opposed to trying to do stocks in a taxable account and bonds in a retirement account
01:11:05.760 | because they'll just fixate on that one account and they'll probably do the wrong thing at the wrong time.
01:11:09.760 | So, it's sophistication level also of the individual that matters here.
01:11:14.760 | The final question is for Rick and Alan.
01:11:18.760 | Has there been any progress on nominating Jack Vogel for the Presidential Medal of Freedom?
01:11:25.760 | I assume Jack's not here, but the answer is, from what I know,
01:11:29.760 | is that the process has been as far as it can go.
01:11:36.760 | So, all the paperwork is done, if I'm not mistaken.
01:11:39.760 | I don't know if you're involved in this or not.
01:11:41.760 | But now we have to wait through the political process of it,
01:11:45.760 | and this is an election year and things take time.
01:11:48.760 | Well, thank you, panel, for participating.
01:11:51.760 | [Applause]
01:11:56.760 | [Silence]