Note: The following are my notes from the presentation. I’ve made effort to correctly describe what was said, but I must include the caveat that I may not have interpreted everything correctly, etc.
Mr. Bogle started by highlighting that the retirement income system in America is a train wreck. The focus on speculation rather than long-term investing has played a big role in this. The shift from defined-benefit to defined-contribution puts a lot of pressure on investors, many of whom are not equipped to handle their own investing.
He described a series of charts highlighting the difficulty for retirees of earning income in today’s market environment. Stock yields now exceed 10-year Treasury yields, which have fallen to historic lows. Historically, dividend yields have accounted for about half of the long-term return on stocks. Low dividend yields today imply a deadweight loss on the potential for future stock returns. This is a clear indication that future stock returns will be lower. Return on stocks consists of dividend yields, earnings growth and speculative returns (which is the impact of changes in price/earnings valuation levels). His best estimate for expected stock returns for the coming decade is 6.7%, compared to a historic average (1900-2011) of 9.5%. Bond yields are low, but he doesn’t suggest switching to higher yielding bonds with higher credit risk.
What does one do in an environment like this to increase yield without increasing risk? The answer is to cut investment costs. Mutual funds are tremendous consumers of dividend income. Consider large-cap stock funds. The gross yield is currently 2.04%. Average expense ratios on mutual funds are 1.17%. That gives a net yield of 0.87%. Thus, the percentage of yield consumed by the expense ratio: 57%. The situation is even worse for mid-cap and small-cap stock funds. For small-cap stocks, gross yield is 1.67% and the average expense is 1.37%. This means 82% of yield is consumed by costs. Intermediate bond funds have 25-35% of their yields consumed by costs on average. And with low money market rates, 86% of the yields are consumed by costs.
The obvious alternative becomes using low-cost index funds. This will at least allow a lot more of the yields to be kept by investors.
Questions and Answers Session:
Q: What do you foresee for the corporate and government (state and local) pension crisis in America?
A: Return assumptions have obviously been much too high. Expected returns just cannot be met. The funding is a terrible issue. In many states, the funding promises are constitutionally mandated. Pension fund managers don’t seem to care. Pension benefits will have to be cut. No alternative, due to the mathematical reality.
Q: Vanguard dividend-appreciation index and Vanguard dividend-growth fund… how do you think of these as comparing to the typical Vanguard stock index fund?
A: The dividend funds have been very popular recently, and that is a reason to be cautious. It may be too late to pile in, and if these funds have higher risk, this is something which could still manifest. Don’t make big bets. Perhaps consider 20% of the stock portfolio for something like this, and just make sure that the expenses are low no matter what you do.
Q: Vanguard has an emerging market stock fund. How does this play into an asset allocation strategy?
A: He has never been much into international stock funds. He has a home country bias, as he thinks U.S. company’s dominate and the economic system and financial institutions are most stable here. He is not a fan of taking currency risk. Nonetheless, he does not view emerging markets as excessively risky at the current time, and he doesn’t necessarily think that his views about international stocks are appropriate for everyone. He suggests limiting international equity holdings to 20% of the portfolio at most. He doesn’t see high prospects for European countries either. Perhaps 10% in developed markets and 10% in emerging markets for that 20% international allocation.
Q: For retired clients with an income focus, in the past bonds provided much more income. But in generating income over the next 10-15 years, what are your views about what will generate more income: stocks or bonds? Do retirees need more stocks in order to be able to get more income? Are retirees being forced to take greater risk because there are fewer reliable income sources on the bond side?
A: He thinks that you could put together a 3% yield on the bond side by moving a bit toward longer term and corporate bonds. Today’s bond yield and the return over the next 10 years is highly correlated, since coupons account for the bond return. He thinks considering more corporate bonds, and a bit more toward higher yielding equities is about as good as you can get. People may need more income, but bad news: the market doesn’t care whether you need more income or not. Efforts to get greater income creates greater risk. The average family should take care and also avoid junk bonds and other riskier but higher yielding investments.
The combined yield on a stock and bond portfolio has never been worse! But that’s the reality today. It would not be a Bogle move to try and pull more out of the market than it’s willing to provide at a reasonable level of risk.
Q: What are your views about the potential for increased tax rates on dividends and capital gains?
A: The lowest tax rates should be paid on earned labor income. There should be substantial exemptions for lower earning people. Dividends should have the same basic tax rates, though there should be a $15,000 exemption on dividend income to help the families more reliant on their dividend income to survive. As for capital gains, he is appalled by how people can manipulate the tax code where managers manipulate their income flows to call it capital gains rather than labor income. Almost all capital gains earned are gambling earnings based on short-term trading. They are not the result of people providing capital to companies to assist their growth. This sort of gambling income should be taxed at an even higher rate than labor income.
Q: There are many new types of bond funds coming out with wider and more complex strategies. What are your views?
A: Views are mostly negative. Owning the bond market index with low-costs guarantees that you will get your fair share of what the bond market provides. Anything other than that means that you are taking on more risk. He doesn’t like departures which come along to pile on new trends suggesting new and better ways. Avoid the fads of the day. You may be wrong for a while, but in the long run you are better off by piling onto such band wagons as you will ultimately end up joining too late and these alternative strategies inevitably have higher costs which hamper their success from the start. At most, don’t put more than 5-7% of your portfolio into such strategies if you are really intrigued by them.
When investing over a lifetime, taxes and costs are everything. You just don’t want to be fooling around with this type of stuff. He’s a boring and middle of the road kind of guy.
Q: How do we fix the retirement train wreck in America?
A: Make a few incremental changes to Social Security: raise the retirement age, index initial Social Security benefits to prices rather than wages [personal note: I really don’t like this type of reform, as the younger one is, the more they are punished by it, while present elderly don’t share in the reform at all], and increase the payroll tax base.
On the defined-benefit side, bring the assumptions to be in line with the reality, so that companies are forced to start better dealing with the problems and bite the bullet. Companies have a lot of cash today, so it is a good time to take action, and in the long-run this is something which has to be done.
Federal Retirement Board would recommend management companies with low costs and reasonable investment philosophies in order to help households find good options for their investments.
Make it harder to withdraw from retirement funds in the pre-retirement period. The system needs more discipline.
Costs must be lower.
Allow employees to get independent investment advice to help make reasonable chooses and get better asset allocations. Too many people are either far too aggressive in stocks or have far too much cash, and this makes the aggregate averages look better than the reality for individual households.
Q: There was a problem at the Wellington Fund in the mid-1960s where profits were put before people. How did you deal with that?
A: The harder they tried to improve performance, the worst it got. He subsequently made a terrible decision: an unwise merger to bring a go-go fund from the 1960s into the product line to try and fix Wellington. These new managers brought in made the situation much worse. They increased stocks from 65% to 82% at the worst possible time. The average beta for the fund rose from 0.65 to over 1 when the market reached its peak in 1972. It was the worst decision of his life. He was fired from Wellington by the guys that ruined it, then he started Vanguard. In 1978, he decided he would make fixing Wellington as his project for the year to rectify his past mistakes. Since about 1980, Wellington has been the champion balanced fund in the industry.
Q: How do we get the fiduciary standard across?
A: The 1940 Act says there is a fiduciary duty for mutual funds. That is not happening in the mutual fund business. Solutions: require fiduciary duty from all institutional money managers. Put clients first, reasonable costs. Also, active corporate governance is important. Eliminate conflicts of interest.
Thursday, October 4, 2012
The Bigger Picture of Retirement Planning
The FPA Experience 2012 conference has come to a close. In thinking about my biggest takeaway from the conference, I think a point that was really driven home for me was that this blog is really a “Retirement Income Researcher” blog. If I really want to be a “Retirement Researcher,” then there is a whole lot more to the story as it relates to health and well-being, the science of aging, and how to plan for health and housing needs in the face of the physical, mental, and emotional challenges that come with increased longevity.
Two excellent presentations which really drove this point home for me were Karen Schaeffer’s “Financial Issues of Aging – A Practical Guide to Advising Clients,” and Louise Schroeder’s “Helping Clients Plan for Aging Successfully; What’s It All About?”
This is not a comprehensive review of the presentations, but I thought I’d share a couple of the interesting points made.
For instance, when you buy a home, even in your 30s or 40s, it is worthwhile to be thinking ahead if there is a possibility you’d like to make that your family home and remain there for the rest of your life. It could be a problem if all of the bathrooms and bedrooms are on the second floor. Can the home be modified to allow for a reasonable lifestyle without using any stairs? If not, you may be forced to move away sooner than otherwise.
Technology is improving to the point that an elderly person’s home can be filled with sensors which allow for monitoring to make sure that daily activities are taking place and medicine is being consumed, and to monitor for early warning signs of an upcoming health problem. A video demonstration even showed how a retiree who loves playing cards was set up with a computerized solitaire game which also allowed his doctor to monitor his response time and other factors to help watch for the onset of dementia.
Both presentations focused a lot on CCRCs, which I think means Continuing Care Retirement Communities. Innovations in this area provide interesting housing options for retirees, and there are a variety of financial considerations which go into the decisions about these. Despite the idea that the care provided with these may be rather expensive, the downsizing of one’s home, reduced utility bills, and reduced demands on other family members may mean that the overall expenses do not increase with the decision to live in a CCRC.
Louise’s presentation emphasized the idea of aging successfully, which involves (1) avoiding disease, (2) engaging with life, and (3) maintaining one’s cognitive and physical functions. To avoid disease, she emphasized the need to accept responsibility for one’s health and to develop a health and wellness plan which involves diet and exercise. Know the risk factors for various health conditions and focus on prevention. She noted that many sorts of functional losses are exaggerated and can be avoided. It is important to maintain relations with others and to avoid isolation, to stay involved with activities which provide meaning and purpose, and to both give and receive social support through networks of family and friends.
A final issue is to think in advance about who else will have the authority to make financial and health care decisions for a retiree in the event that cognitive or health declines force this situation.
Two excellent presentations which really drove this point home for me were Karen Schaeffer’s “Financial Issues of Aging – A Practical Guide to Advising Clients,” and Louise Schroeder’s “Helping Clients Plan for Aging Successfully; What’s It All About?”
This is not a comprehensive review of the presentations, but I thought I’d share a couple of the interesting points made.
For instance, when you buy a home, even in your 30s or 40s, it is worthwhile to be thinking ahead if there is a possibility you’d like to make that your family home and remain there for the rest of your life. It could be a problem if all of the bathrooms and bedrooms are on the second floor. Can the home be modified to allow for a reasonable lifestyle without using any stairs? If not, you may be forced to move away sooner than otherwise.
Technology is improving to the point that an elderly person’s home can be filled with sensors which allow for monitoring to make sure that daily activities are taking place and medicine is being consumed, and to monitor for early warning signs of an upcoming health problem. A video demonstration even showed how a retiree who loves playing cards was set up with a computerized solitaire game which also allowed his doctor to monitor his response time and other factors to help watch for the onset of dementia.
Both presentations focused a lot on CCRCs, which I think means Continuing Care Retirement Communities. Innovations in this area provide interesting housing options for retirees, and there are a variety of financial considerations which go into the decisions about these. Despite the idea that the care provided with these may be rather expensive, the downsizing of one’s home, reduced utility bills, and reduced demands on other family members may mean that the overall expenses do not increase with the decision to live in a CCRC.
Louise’s presentation emphasized the idea of aging successfully, which involves (1) avoiding disease, (2) engaging with life, and (3) maintaining one’s cognitive and physical functions. To avoid disease, she emphasized the need to accept responsibility for one’s health and to develop a health and wellness plan which involves diet and exercise. Know the risk factors for various health conditions and focus on prevention. She noted that many sorts of functional losses are exaggerated and can be avoided. It is important to maintain relations with others and to avoid isolation, to stay involved with activities which provide meaning and purpose, and to both give and receive social support through networks of family and friends.
A final issue is to think in advance about who else will have the authority to make financial and health care decisions for a retiree in the event that cognitive or health declines force this situation.
Subscribe to:
Posts (Atom)