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TRANSCRIPT

Talli Sperry: Good evening, I’m Talli Sperry. Welcome to tonight’s webcast, How to choose the right investments for you. We’re so glad you’ve joined us for this conversation with Vanguard Senior Financial Advisor Kahlilah Dowe and Investment Research Analyst Kim Stockton.

Whether you’re new to Vanguard or you’ve been with us for some time, thank you for being here. We’d particularly like to welcome not only our clients but also those joining us live through Yahoo Finance and Facebook, as well as attendees from the Forbes Women’s Summit. We’re happy to have you with us.

If you’re new to Vanguard, we want you to know that webcasts like this are meant to give investors like you the best chance for investment success. From providing you with educational and informative content to keeping our costs low to offering you personalized financial advice, everything we do here is focused on helping you reach your goals. And with that said, let’s turn to tonight’s talk with Kahlilah and Kim. Thank you both for being here. Thank you so much for joining us tonight.

Kahlilah Dowe: It’s my pleasure.

Kim Stockton: Thanks for having us.

Talli Sperry: We know that many of you have already submitted questions, and we’ll get to as many of those as possible. But we would encourage you to keep sending them in throughout the webcast.

Before we get started, if you need to access technical help, you’ll see that it’s available by selecting the blue icon, and that’s on your left. And you can learn more about Vanguard’s resources by clicking the green Resource List, and that’s on the far right of the player. You can also view replays of past webcasts or listen to a complete episode of our Investment Commentary Podcast.

And an important note for those joining through Yahoo or Facebook: You won’t be able to interact with the webcast player, so if you wish to submit a question, you can do it by our Facebook page and comment there.

Our topic tonight is How to choose the right investments for you, and I know there’s quite a lot that goes into making those decisions, so we will provide you with a framework for making your investment choices and also some thoughts on how to apply that to your personal situation.

So speaking of that framework, Kim, I know you’ve done a lot of research in this space. Can you talk a little bit about some of the ways that our audience could have the best chance of meeting their goals?

Kim Stockton: Sure. At the highest level, we suggest focusing on what you can control. The best way to do that is really with a top-down approach that begins with your objective, identifying your savings objective, followed by setting your strategic asset allocation, your allocation between stocks and bonds. Then you want to look at the diversification within your stock and bond allocations. And finally, lastly, hone in then on the specific investments and the specific funds that will make up your portfolio.

Talli Sperry: That’s helpful, so it seems like there are actual steps we can follow. We don’t have to jump right in.

Kim Stockton: Exactly.

Talli Sperry: Okay. Really good to know. Thank you.

So those of you who’ve attended our webcasts before know that we like to start off with a poll question to take the pulse of our audience before we begin answering presubmitted or live questions. Right now you’ll see your first question, and that’s on your screen now, that’s asking, “What do you find most challenging about choosing investments?” Is it identifying your goals, finding the right mix of stocks and bonds, or selecting individual investments? Please take a moment to respond, and we’ll get back to your answers in just a few minutes.

So right now let’s go ahead and answer one of our presubmitted questions. Kim, I’m going to send this one to you. And it’s from Rick in Chandler, Arizona. So thanks so much, Rick. And he’s asking, “What are your recommendations for constructing an investment portfolio?” So, Kim, if you could start us off high level, that would be great.

Kim Stockton: Great, sure. So I mentioned the top-down approach. That’s really what we suggest. And with that approach, you want to start identifying your savings objective first. What are you saving for and how much do you want to save? Part of that process is identifying your constraints. What is your individual risk tolerance? What is your time horizon? What liquidity do you require? What’s the tax exposure you’re comfortable with? So those factors—that’s really the critical decision, and that will drive everything else in terms of your portfolio allocations.

The next step is setting your stock and bond allocations. Setting your strategic asset allocation is really important. If we go back 30 years to an academic research study, the study found that for a diversified portfolio with limited market-timing, the single most important factor, the single biggest impact on your return variability and your risk in meeting your objective, is your strategic asset allocation. And there’s been a lot of research since we’ve done it. Others have done it. Active management can muddy things a little bit, but it all basically comes back to the same thing: The strategic asset allocation is going to have the biggest impact on risk in your portfolio. So that’s really an important focus.

And when you set your strategic asset allocation, it’s important to not lose sight of your objective. So if we think of objectives, if you think of an investor, for example, saving for retirement, she knows she needs a million dollars and she wants to accumulate that over 40 years. She has some assumptions about how much she’s going to save over time.

Based on all those assumptions, there is some asset allocation and some required rate of return that is going to get you best to that objective; it’s going to give you the highest chance of success in meeting that objective.

So start with your objective. Then go to your strategic asset allocation, but don’t lose sight of your objective when you’re setting that asset allocation. And then after that we can drill down a little deeper; start looking at the diversification within your stock and bond funds. A good starting point there is a broad market stock or bond index fund. Once you do that, then you select your individual funds.

And it’s really key to go in this order. And if you think about what happens if you don’t do that, so say you start with your individual investments, you start picking funds. We call that fund collecting. What happens is, you end up with a portfolio that may not fit together well. And, more importantly, it is probably not the best portfolio and the best asset allocation that will give you the highest chance of meeting that required return and meeting that savings objective.

Talli Sperry: Yes, that’s really interesting. So keeping our goals in mind is important even before we start to pick things. Okay, good.

So when we see our results from our poll, this is intriguing to me. So it looks like about 10% were concerned with identifying their goals; about 38%, finding the right mix of stocks and bonds—I think that speaks to what you were talking about, Kim—and then 52% were concerned about selecting individual investments. So this feels like your wheelhouse, Kahlilah, so I think we’ve got the right group here tonight.

Kahlilah Dowe: Right. That’s actually not surprising, because I think it’s hardest for investors to make that decision because there are so many options available. So even if you go to the Vanguard website and you start looking at funds first, it can be—

Talli Sperry: A lot!

Kahlilah Dowe: Exactly, yes, so that’s not surprising.

Talli Sperry: Good. I’m glad you two are here to help us tonight, so you can give us a framework; and then, hopefully, we can dive in and know what to do ourselves. So building off that first question, here’s our second poll question to try to gauge our audience. So we’re going to ask you, “How comfortable are you with choosing your investments?” So your answers are, “Very comfortable,” “Somewhat comfortable,” or “Not comfortable at all.” And if you can respond now, we’ll grab your responses shortly, but we’re going to jump into a question for you, Kahlilah.

Kahlilah Dowe: Sure.

Talli Sperry: This is from Shane from Denver, Colorado, who’s asking, “How does an individual determine an appropriate risk profile or asset allocation for their portfolio?” So it seems like a perfectly timed question given our poll.

Kahlilah Dowe: Sure, yes. There are a few things that you could look at, but I think it ultimately comes down to how much risk can you afford to take, and how much risk can you tolerate? And when we look at the first thing—how much risk can you afford to take—that really comes down to how much time you have before you need to start spending from the portfolio? And the second part of that is, Over what time frame will you spend from the portfolio? So if you take, let’s say, a 5-year horizon, if you have a 5-year time horizon and at the end of the 5 years you expect to purchase a home—if you’re going to use all of that money to purchase a home at the end of 5 years—that portfolio is going to be a lot more conservative than, let’s say, a portfolio where you have a 5-year horizon before you retire, but then you spend over the next 30 years or so. So thinking about how much risk you can afford to take, that’s really the first step, or your risk capacity is how we refer to that.

And then looking at your risk tolerance or your ability to withstand market volatility, and that’s another important piece, and some clients will come in where their risk tolerance is right in line with their risk capacity. You may have a higher risk tolerance, and you may be a little bit more aggressive or a little bit more conservative if you have a lower risk tolerance.

When I think about clients who have lower risk tolerances, I think a good indicator would be if market volatility prompts you to walk away from your investment strategy, whether that’s selling investments that you have, whether it’s refraining from investing. So let’s say you’re dollar-cost averaging,* but you stop because the market is volatile. It could be that you just kind of start investing in other investments. So let’s say you look at different investments and decide, I’m going to put my money into this investment because it’s doing better than other investments. Right? So that, I think, is maybe a little bit more insidious because you’re not exactly selling investments. But it really derails you over time.

So when you think about those things and think about your risk tolerance, I’d rather see that investors are maybe being a little bit more conservative but sticking with the strategy over time rather than investing, let’s say, beyond their risk capacity or even at their risk capacity if they can’t stick with it.

Talli Sperry: I think this is helpful. Those are some good guiding principles for us, and I think we can find a little bit more about them in our blogs that are actually listed in your Resource List widget. So you can actually explore there a little bit more about what Kahlilah is saying, because that’s pretty essential content for us as we start this journey, isn’t it?

Kahlilah Dowe: Absolutely.

Talli Sperry: Yes. So our poll results are in, and this is intriguing again. So our audience, about 60% of them are somewhat comfortable choosing investments, 20% are very comfortable—so you guys have got it—and then 20% are not very comfortable. So it seems like we’ve got a really good mix here with us tonight, so thank you all for joining in on the poll.

We’ve actually got a couple of live questions, so thanks for sending them in. Please keep them coming. We always want to make sure we cover what’s important to you, so please do send us those questions. So we’ll take this first one, and this is from William, who’s asking, “Does a high P/E ratio of stocks concern you for investors now trying to build a portfolio?” So I think either one of you could take this from a different angle. But, Kim, maybe we’ll start with you.

Kim Stockton: Sure. It brings up a couple of points. It is true that in the U.S., P/E ratios are high. That means stocks are relatively expensive right now, but that is a good reminder that we also recommend investing outside of the U.S.

And for that reason, if you look at the P/E ratios outside of the U.S., they are a little bit better. Stocks are a little bit cheaper. And as a result of that, what you see is different behavior for stocks in the U.S. versus stocks outside of the U.S. And it’s the same with bonds. That’s one of the reasons why we suggest a diversified allocation globally.

Another factor is that we typically don’t suggest changing asset allocations based on what’s happening in the markets or what’s happening in the economy. Our suggestion is that life stages or life changes should be the impetus for making an asset allocation change but not what’s happening in the market or what’s happening in the economy.

Again, it goes back to focusing on what you control. There’s a lot that we can’t control in the market; markets and economies are cyclical, and that is going to happen. So, again, we suggest determining your objectives, setting your asset allocation, and don’t vary that based on what’s happening in the market.

Talli Sperry: And I think the research you noted earlier in the webcast kind of leant to that as well. There’s a lot of wisdom there.

Kim Stockton: Exactly.

Talli Sperry: Good. Kahlilah, we’ve got a live question for you right now. And this one is from John, who’s asking, “What role should the current investment environment play in deciding what long-term investments to make?” So what would you tell us?

Kahlilah Dowe: I wish I could ask him what he means by the “current investment environment.” So part of it, I think, kind of relates back to the question that we just answered, where in the U.S. P/E ratios are high. So I’ll kind of expand on that.

Honestly, I get concerned when I speak with someone who is holding off on investing because P/E ratios are high, especially if they’re very young and they have a very-long-term horizon, because I always look at that as if you have a long-term horizon and you’re not going to use this money for 10, 20, 30 years, then are P/E ratios really high compared with where they’ll be when you actually need to spend from the portfolio?

So I tend to focus more so when I think about where we are today economically, where the markets are today. I’m looking at that as it relates to money that you actually need to spend from today or sometime soon. So if a client says to me, “Kahlilah, I have $100,000. I’m going to use this money to purchase a home. Tell me what to do with it,” I’m absolutely considering where the markets are today and where we are economically when I think about where that money should go. But if this is money that you won’t need for a really long-term horizon, then I actually don’t focus on that too much.

Talli Sperry: It’s such a great example to show why knowing our goals is really essential for how we build and construct our portfolio. Good.

So to get a little bit more into the details, Bud is asking a question that I think is good for Kim. So, Kim, I think he’s saying what’s on everyone’s mind tonight, which is, “I know each individual is different and has different risk tolerances. But can you give us basic examples of age-appropriate asset allocations?” So what might you say?

Kim Stockton: Sure. That brings up a good point, an important point, and that is: For investors with long-time horizons, asset allocation should change with age.

For example, if you think of an investor saving for retirement, he or she should change their asset allocation along with what we call a retirement savings glide path, which just means larger equity allocations in the beginning, and as you move along through your life stages in the glide path, you slowly “derisk” and move into fixed income allocations.

One way to think about this is, if we use Vanguard Target Retirement Funds, as an example, to provide a typical allocation, and what would be appropriate for a typical investor saving for retirement. All investors are different, as Bud points out, but they can give a guide in terms of what would be appropriate for specific ages.

So if you consider investors younger than age 40, for example, the Target Retirement Funds set them at an asset allocation of 90% equity. So a typical investor is somewhere between 75% and 90% equity. That allocation would be appropriate. And when I say equity, we suggest broad market equity exposure.

Now as you move through the life stages, as you move into the transition stage, then we suggest the asset allocation to equities slowly comes down, so by the time you reach retirement age, say 65, then a more appropriate allocation would be 40% to 50% equities.

And then as you move into retirement, over the next 5 to 7 years, you want to “derisk” pretty quickly, because by the time you get to age 70, 70½, most investors are going to begin taking meaningful withdrawals from their portfolios. So we want to make sure that by that point we are at an asset allocation that can sustain us into late retirement. So there you typically want to have something like 30% equities or less with the remainder in a fixed income portfolio.

Talli Sperry: That’s good. So those were nice guiding principles, and you reference our target-date funds. So I’m assuming if we’d like a review of those, we can look at the target-date funds. Is that correct?

Kim Stockton: Absolutely. Right, that’s a great way to, based on your age and the age that you want to retire, take a look at those asset allocations. And that’s a good guide as to what would be the appropriate allocation for your age.

Talli Sperry: Awesome. Kahlilah, we have a live question for you. This one is asking, “When you speak of short-term horizons versus long-term horizons,” I think this gets back to our last answer, “What do you mean in terms of years?” So can you quantify that a little bit for us?

Kahlilah Dowe: Yes. When I think of a short-term horizon, I’m generally thinking of money that you need to spend in, let’s say, five years or less. And for those goals, we’re generally looking at some cash in the portfolio and also some bonds in the portfolio, very little stock exposure to meet an obligation for 5 years.

More intermediate term, 5 to 10 years, in that case we’re probably looking at a combination of stocks and bonds; and then for anything longer than 10 years, probably a greater equity allocation.

Talli Sperry: Okay, helpful. I think our audience is starting to feel like there’s a lot that we need to know, and there are a lot of pieces and parts of a puzzle we’ve got to put together. So I think Melissa is asking another question that probably is on everyone’s mind, which is, “How do you know when you should work with a personal advisor?”

Kahlilah Dowe: Yes, I think it comes down to a few things. One, when you have a feeling that you need some help—and I know that sounds very obvious, but like Melissa said, there can be a lot of moving pieces; and like Ken mentioned, you have to make decisions around how much you should have in stocks and bonds, what your goals are, a little bit more complicated, what’s your risk tolerance—when you think about getting all of that started, I think it’s a good idea to start with a financial advisor. Even if you’re not consulting with an advisor every year or very often, if you’re just getting started, I think it’s a good idea to speak with a financial advisor.

The other thing that I look at—and this is one of the questions that I ask my clients—is what prompts you to make changes to the portfolio? And that’s a big one because if I’m working with someone who is inclined to make changes in response to what’s happening in the market, I always look at that as an indicator that they probably need some greater direction. And I think that’s also an opportunity to work with an advisor.

Talli Sperry: I think what you note about—when we’re starting out, because we want to get it right when we’re starting out. I know, Kim, you talked about over the long term, we need to make sure our asset allocation is correct so we set ourselves up for success, but the beginning is much more important than we might realize.

I know sometimes people will do it themselves, and then start to work with an advisor, but I think you make a really good point that we want to start strong.

Kahlilah Dowe: Yes, and I would also say when you enter in different stages in your life, certainly when you’re entering a place where you’re going into retirement, and I always say that the stakes are often a lot higher when you get to that point because you’re no longer investing, you’re probably spending from the portfolio, you don’t have the non-portfolio income. Those are all of the things that kind of raise the stakes when you think about making decisions in the portfolio that you later regret. So I think that’s also a good opportunity to consult with an advisor.

Talli Sperry: Yes, the life stages Kim was talking about, really helpful, good.

So I love that my screen is lighting up. Please keep them coming. These are really fun. So we’re going to go to another live question. Kim, this is for you. And Michael is asking, “What part does cash play in asset allocation?”

Kim Stockton: Yes, that’s a great question and one we’ve been getting more and more. If you go back 5 or 10 years ago, we’ve been in a low-interest-rate environment. So cash hasn’t been providing a very high return, but over the last couple of years, the Fed has raised rates 9 times. And with that, our expectations, as well as many others for cash, for the returns there, have improved.

With that, a lot of investors are saying, Should we substitute bonds for cash? You can get a similar return now with cash with a lot less volatility. So if you look at it purely from an asset perspective, cash can look pretty good right now. But the problem with that is, it doesn’t consider the whole portfolio. In general, for investors with long-time horizons, we don’t suggest much of an allocation to cash. Cash is good as a parking place if you are deciding where you want to invest your money. Cash can be good if you have a very-short-time horizon, like 1 to 2 years. For longer time horizons than that, we do recommend a fixed income allocation instead of cash because fixed income is going to provide that portfolio with a ballast. They will provide the diversification to equities that cash will not.

Talli Sperry: Okay, great. So I think throughout the webcast we’ve talked about different investment goals, we’ve talked about maybe saving for a house, we’ve talked about retirement, and we’re talking a lot about asset allocation.

But I want to ask Paul’s, from Oakland, California, question because he asks, “How do we segment allocation when we have multiple investment goals?” So he’s talking about retirement long-term, how short-term? Kahlilah, this feels right up your alley. Can you talk to that?

Kahlilah Dowe: Sure, and that’s fairly common. The majority of our clients have more than one goal for their portfolio: emergency fund, home, education savings, retirement. And I think it’s fine to have separate allocations when you’re saving for all of those goals.

As I said, if something is short-term, you may have a combination of cash and bonds. Intermediate may be some bonds and stocks. And I think that makes sense because we know that you’re going to access some of the money over the short term.

Where I tend to differ a little is when you have, let’s say, investors who have multiple goals, but they’re all long-term goals. Right? So in that case you may not need to have separate asset allocations for all of those goals. In that case, you may apply what we consider a more tax-efficient strategy where you apply your overall asset allocation across the overall portfolio. And then you’d end up with having more of your stocks in the taxable account and more of your bonds in the IRA accounts. And I think that may be more suitable for longer-term goals, even if there’s more than one.

Talli Sperry: Okay, that’s really helpful. I think our previous discussions sparked some commentary because we’re getting a question from LeeAnn, who’s asking, “Does Vanguard have advisors that will provide investing recommendations on the phone if I’m not sure where to invest my money?” Kahlilah, can you speak to that because that’s kind of your day job, right?

Kahlilah Dowe: That’s exactly what we do, yes. So we want to point our clients in the right direction if they need help with asset allocation, if they need help with investment selection. There are also great tools that we offer on the website for clients who maybe are not able to call in. You can go to the website. We have questionnaires there that will allow you to enter information and will actually give you a list of funds that may be suitable for you in that case. So, yes, we offer a lot of direction in that area.

Talli Sperry: That’s awesome. That’s really helpful.

And I’ll just direct you to the Resource List widget, so that’s got some information on Vanguard Personal Advisor Services®, which is the service that Kahlilah’s a part of. So thanks for sharing that.

Kahlilah Dowe: Sure.

Talli Sperry: We’ll jump back to some of your live questions. Keep them coming; these are fun. So this one is asking, “What exactly do you mean when you say ‘fixed income’?” And this is for you as a follow-up, Kim, from Catherine.

Kim Stockton: Yes, sorry. To clarify, fixed income is just a bond. It’s a debt. It can be issued by companies, it can be issued by municipalities, but it’s basically a type of investment which is debt. So you are, as an investor, lending a company or a municipality money, and in return you get a stream of income.

And when we think about fixed income or bonds, we think about the role in the portfolio, as I mentioned. We see fixed income as not the source of growth or return. For that we look to equities. For fixed income, we look to a ballast. And our research has shown when you look at, for example, down equity markets—so the time when you really need diversification, diversification when you need it most. And we look at various asset classes. Fixed income, whether it’s corporate bonds, whether it’s Treasury bonds issued by the government, whether it’s non-U.S. fixed income bonds that are currency-hedged, those are the 3 assets—and fixed income generally—that continually have a positive return when equity markets are down.

Some of the other assets that people think are diversifiers, they simply do not. Things like REITs or commodities are other asset classes, but fixed income consistently acts as the ballast, and that’s why we think it’s an important part of all investors’ portfolios.

Talli Sperry: That’s a really comprehensive explanation, and I like how you talked about where it fits into our portfolio and why it’s important. I think the news often talks more about stocks, and we don’t often talk about this phase, which is really essential for helping us keep to our goals. Good.

Another place we don’t hear a lot about, which is talking about our international equity allocation. So, Kahlilah, I’m going to ask you this question from Charles, who’s just noting, “What’s the recommendation for international equity allocation?” We don’t hear as much about international these days.

Kahlilah Dowe: That’s right. We actually use a range when we think about how much of your stock should be invested internationally. And it really is a function of how much stock you have in the portfolio. So at the low end, we would say you should have at least 30% of your stock invested internationally. At the high end, we’d say 50%.

Our target is more like 40% of the stock invested internationally, and that actually surprises most people that I speak with. They think that we would, I guess, go with something a little bit more cautious when it comes to the international market. But it’s very intentional when we say that investors should have 40% of their stock invested internationally, mainly for diversification. But if you look at it in context of the world stock market, where U.S. stocks make up just a portion of it—last I checked I think it was about 50%, U.S. stocks make up 50% of the world stock market—the rest is international. So from a diversification perspective, we don’t want to leave it out. And even at 40%, that does represent somewhat of a U.S. bias, but we think that’s the right place to start.

Talli Sperry: Okay, good. Very helpful. So, Kim, this is an interesting question; and this is basically about Vanguard. And I’m going to ask you Mark’s question, who’s saying, “Is Vanguard considered a passive investing company?” Maybe you can talk a little bit about our history as you share the answer to this one.

Kim Stockton: That is an interesting question, and we do have a history. We were founded based on index funds. Our founder, John Bogle, created the first index fund. But we do, at this point, have a large majority of active funds as well. So Vanguard has a history with indexing—we were pioneers there—and we think index investment should be a part of all investors’ portfolio. But we also have active funds, and we believe that both active and passive—index funds—can have a role in investors’ portfolios.

Talli Sperry: Yes, it’s interesting, we got a reputation in one space, but we actually began with some active. So I think that’s always interesting, if you look back on our history, which you can find on vanguard.com. Kind of engaging, and it also gives you a breadth of the industry as well and why we do what we do. So very fun.

All right, so I’m going to jump to a presubmitted question. This is from Paula from Denver, who’s noting, “We are recently retired. We do not need high returns, but we’re having a difficult time balancing safety and income.” So we hear this one a lot, and she’s asking, “How do you reconcile those two needs?” Kahlilah?

Kahlilah Dowe: Safety and income. So first, this is excellent because she doesn’t need high returns, which indicates that maybe they’ve saved a lot more than they actually need to spend down or maybe the expenses are just very low. Either way, it sounds like it allows them to be more conservative when they think about how they’re invested.

The trade-off, though, is, if you’re looking for safety as one of the primary objectives, you’re going to sacrifice some on the income. I’m thinking about the clients that I speak with, and it’s rare that I speak with someone who needs maximum safety. So you can usually focus on safety by having some Treasuries in the portfolio, but also when you think about the bonds, having high-quality corporate bonds in the portfolio, mortgage-backed bonds. I think as long as you’re focusing on high-quality investments, you could kind of invest across a range of bond types, and that would help to increase some of the income while still focusing on safety.

The other thing that I look at is the range of maturities. I think that’s really important right now because, well, now, let’s talk about interest rates going down again. But until now, the talk has been about interest rates going up. And with that, I’ve spoken with many, many clients who have had quite a bit in short-term bonds. And that’s another way that many investors are sacrificing on the income for the portfolio. So I think that that’s another way to increase income while still focusing on safety, so making sure that you’re covering short-term bonds but also intermediate-term and some long-term bonds.

And I feel like I’d be remiss if I didn’t say, even though you were in a position perhaps to be more conservative than the average investor who’s retired and maybe spending a little bit more, I still think it’s important to also focus on growing the portfolio, making sure that you have an adequate amount in stocks, because that’s how we support future income.

Talli Sperry: What I like is that you’ve shown us there’s a way to do both so we actually can get safety and income.

Kahlilah Dowe: Exactly.

Talli Sperry: Kim, we’ve got a follow-up for you, and then we’ve got a Facebook Live question. So, Kim, Ann is asking, “What do you mean by an index fund?”

Kim Stockton: Great question. An index fund is different from an active fund primarily with respect to its objective. An index fund has a goal of tracking a market index, and the manager will use quantitative techniques to limit tracking error for the index fund. Compare that with an active fund—an active fund has a different goal, and that is to beat the market. With an active fund, the fund manager will use his or her expertise, experience, to pick individual stock and bond funds, which he or she believes will outperform the market. So that’s really the biggest difference.

Another difference is with respect to risk. In an index fund the risk is aligned to the index. So if you’re investing in a stock market fund—we know the stock market goes up and down—so if you are investing in a stock index fund, your return would go up and down with the stock market.

An active fund adds an element of risk or dispersion around the stock market fund, if we’re talking about an active stock fund. So you can think of that as an added layer of risk, depending on whether the manager outperforms or underperforms the market.

Talli Sperry: Okay, and we would want to pick them probably based on our goals and risk tolerance, right, just being mindful?

Kim Stockton: Right, that’s a big factor, what your risk tolerance is. And, as I mentioned, we do see a role for both in a portfolio for investors who understand the additional risk of active management. We’ve done a lot of research there. We know the majority of managers underperform the index. We know that most individual fund managers don’t persistently outperform so, from one period to the next, very few continue to outperform year after year.

But we also know that some managers have skills and some managers can beat the market, so we certainly see a role, as I mentioned, for both. The thing to think about with active is in terms of what’s the critical success factor, and this is, again, something we’ve researched. We’ve looked at mutual funds. We’ve looked at active funds based on a number of factors. We’ve looked at turnover, expense ratio, tracking error, Sharpe ratios, risk-adjusted return, you name it—many different attributes—and the one factor that has, with some consistency, been the best predictor of future excess return has been expense ratio.

So when we think of the whole portfolio, it’s not active versus index; it’s index and low-cost active for those investors who understand the risk.

Talli Sperry: Good, we want low cost and quality.

Kim Stockton: Yes.

Talli Sperry: All right, so we’re going to go to a Facebook Live question. And this Facebook viewer just said, “Bond return is very low and likely will go lower in the future. Should I adjust my asset allocation?” Kahlilah, what would you say to a client?

Kahlilah Dowe: That’s a good question. Should you adjust the asset allocation? That is absolutely a function of where you are in terms of your financial picture. So I’ll say, I wouldn’t encourage investors to adjust the asset allocation simply because they believe bond returns will be lower sometime in the future. And I have to point out that we’ve heard that quite a bit, that bond returns were going to go down. And before interest rates started going up, there was so much talk around bond prices not only going down, but the thought was that they’re really going to lose value. And it didn’t happen.

So I would encourage investors not to make changes to the portfolio based on where they think the market will go, but also to keep in mind that if you’re adjusting the asset allocation because you think bonds will go down, the question becomes where do you put that money? Do you then move it to stocks, in which case are you then taking on more market risk? Is there a greater risk that you could lose value in the portfolio? Probably so. And when I say probably so, it’s not because I’m estimating that stocks are going to go down. Stocks just inherently have more risk.

So I don’t want investors to lose sight of that when they think about where bond returns may go, whether it’s over the short term or over the long term.

Talli Sperry: Okay, great. We have a question, and this is from Raghavan, who is asking, “Is there a fee to Vanguard Personal Advisor, and how much is it?”

Kahlilah Dowe: So it’s 30 basis points; 3/10 of 1% is the cost of Vanguard Personal Advisor Services.

Talli Sperry: Okay, so that’s pretty low, especially when you consider what you would get.

Kahlilah Dowe: Oh, it is. Yes.

Talli Sperry: Yes, okay, that’s really helpful. And there’s more information I think about cost in our Resource List widget as well. Is that correct?

Kahlilah Dowe: Yes.

Talli Sperry: Okay, good.

Kim, this one is asking, “Can experts beat the index consistently?” So I think this is a little follow-up from what you were just talking about.

Kim Stockton: Yes. Not surprisingly, this is something we have researched a lot. As I mentioned, we’ve looked at it over various time periods. And, in general, the majority of active managers do not beat the index. There are some that do, but the majority do not. And the other important point that I mentioned was, individual fund managers don’t persistently outperform. We researched this over different time frames, but when we look at a manager’s performance in one 5-year period, if we look at the top performers in that period, say the top-quartile performers, and we follow them through to the next 5-year period, if we’re talking about the broad equity market, a very small percentage of those active managers, typically less than 15%, are still in that top quartile. So there’s not a lot of persistence there.

But, again, we know there are some managers who do persistently outperform, and we know that there is some talent and skill there.

Kahlilah Dowe: Yes, and I would just add to that. If you’re going to pursue an active strategy, and I think that’s fine; we actually use actively managed funds in many of our managed portfolios. But I also think that you have to be prepared for the idea that you’re likely going to experience underperformance at some point.

And I’m pointing that out because it’s important to make sure that, if this is the road that you’re going down, you’re going to stick with that strategy, because I think that a lot of people who end up losing money when pursuing active strategies is because they’re not sticking with it over the long term. They may look at it after one year and say, I thought this fund manager did very well over the last 3 years. This didn’t materialize over the last year. Maybe they’re losing that expertise, which may not be the case.

So when I look at an actively managed fund, I expect that there are going to be periods where they outperform the market and some where they underperform the market. So it’s also a question of risk tolerance and whether or not they’re prepared for those ebbs and flows.

Kim Stockton: That’s a really good point, and I’ll just add to that. That’s another thing that we have researched, and we’ve found that even for those managers who over the long term do outperform, we call it a “bumpy road.” There are many years in between for the vast majority of managers who actually end up outperforming where they underperform the market. So you do need to have that understanding that if you are investing in an active manager and you choose a fund, you need to stick it out for a while and understand that you’re going to have some years where you’re underperforming.

Talli Sperry: Speaking of bumpy road, I think choosing a financial advisor can feel a little vulnerable. And I want to ask this question that really tugged at my heartstrings, and this is from David from San Diego, California, who asked, “For those of us with bad financial advisor experiences, how should we think about selecting a financial advisor?” Kahlilah, maybe you can speak to that. And, David, I’m sorry you had a bad experience!

Kahlilah Dowe: Yes, that’s tough. And I know this firsthand because I speak with clients who have had poor experiences with financial advisors in the past, and it is unfortunate because they’ll sometimes come to us, and they know they need help, and they want advice, but they struggle to take advice from us because of their prior experiences.

So I would say, don’t walk away from the help that you need, first and foremost. If you feel like you need help, it’s for the best being in the portfolio. Don’t walk away from it. But I think there are some things that you can do to decrease the likelihood of having a similar experience.

And the first thing that I think about is working with a financial planner who’s also a fiduciary. Certified Financial Planner™ professionals are a great place to start, and that’s important because the CFP® Board actually requires that Certified Financial Planner professionals who also practice financial planning also act as a fiduciary. So that’s a good place to start.

The other thing is making sure that you really understand how financial advisors are being compensated. And I’m pointing that out because the majority of the stories that I hear have something to do with expenses associated with the service. So understanding how they’re being compensated, really making sure that it’s not based on what they’re recommending or services that they’re providing, outside of just the regular management fee.

I also think it’s important to ask questions, to feel comfortable asking questions. And I’m just trying to think about some of the questions that my clients have asked me that have been great questions to put their own minds at ease. So understanding, when an advisor has discretion over your portfolio, what does that actually mean? What changes can they make to the portfolio? What changes can’t they make? Asking questions around what may prompt changes in the portfolio? What are the all-in fees that I’m paying for this service?

And so I think it’s just being able to ask as many questions as you can, and I also think it’s important to keep in mind that if you don’t feel comfortable asking those questions, that’s probably an indicator that you keep looking. And you keep looking until you find someone that you trust and that you’re comfortable with because, ideally, this is the person who’s going to walk you through the hard times. So they have to understand you. You have to feel like they get you, and you have to trust them.

Talli Sperry: I think those are really important elements. And when you note the cost, too, I mean that speaks to long-term performing and actually meeting your goals. And sometimes we’ve seen situations where someone may get high returns, but their costs don’t allow you to actually keep that money. So those are important factors and really finding a match is good too.

Kahlilah Dowe: Absolutely.

Talli Sperry: We have a clarifying question, and this is from Sloan, who’s asking, “Can you explain how the cost of the financial advisor works? I didn’t understand your answer. Something about points? Is it a onetime fee or how does the basis points work?” And this took me a while to get when I first started around here too.

Kahlilah Dowe: Yes, I should have clarified that. So the cost is 3/10 of 1%. You could think of that as $3,000 on every $1 million.

Talli Sperry: Helpful analogy.

Kahlilah Dowe: Yes, so that’s the cost of the service. It’s a yearly fee, but it’s actually assessed on a quarterly basis. And it’s taken directly from the portfolios that we manage.

Talli Sperry: Okay, and that’s just across the board then?

Kahlilah Dowe: Yes.

Talli Sperry: Okay, very helpful. So, Kahlilah, we’ve got another follow-up conversation from Michael, who’s asking, “Does your Personal Advisor Services include tax advice for a person who’s in a retirement and taking distributions from a portfolio?”

Kahlilah Dowe: It depends. Under some circumstances, we do offer assistance with tax planning. So it’s important to know, and I’m actually glad he asked that question because we’re not CPAs. I should say we don’t act in the capacity of CPAs, because some advisors are. But we do offer tax-planning strategies for our clients, depending on the complexity of the situation.

Talli Sperry: Okay, good. And, Kim, sticking on this theme of retirement, I’m going to ask this question from Paul. “How often should you rebalance your portfolio while in retirement, time-based or market-based?”

Kim Stockton: Yes. When we think about rebalancing, there isn’t a critical or optimal number of times to rebalance. The important thing is that you do it, because if you don’t, if you look at the performance of the equity markets over time, you’re going to end up with an overweight to equities, a riskier portfolio than you had planned for. So it’s important to do it.

And when we do look at the numbers, generally for most investors to do it annually or semiannually is a good balance between the cost of rebalancing and managing your risk.

So that’s general guidelines in terms of rebalancing.

Talli Sperry: Okay, helpful.

Kahlilah Dowe: And I’ll just point out really quickly that when you think about rebalancing the portfolio or even reviewing the portfolio, let’s say you’re reviewing it every 6 months or every year, most of the time you’re reviewing the portfolio to see if the market has moved you away from the strategy that you have in place. It’s not so much that you’re reviewing it every 6 months to see if the strategy needs to change. That, I think, is when you get into kind of market-timing.

But if you could review it just to rebalance to see if the market has moved you away from the strategy, hopefully that allows you to take a more objective view when thinking about changes you should make to the portfolio.

Kim Stockton: Yes, important point.

Talli Sperry: Yes.

Kim Stockton: Important point. The goal of rebalancing is to get you back to your strategic asset allocation.

Talli Sperry: Yes, I like having that goal when we look at our strategy because it’s so easy to look at just a number, and that’s not necessarily always where we want to be.

Kahlilah Dowe: Exactly.

Talli Sperry: Good. All right. So, Kahlilah, I think this question from Augie from Syracuse—it’s a presubmitted—is really an important one. And he’s asking, “How do financial advisors determine what investments are appropriate for a given client?” So if someone is having to pay $3 on every $1,000, which would be the equivalent of our Personal Advisor Services from the analogy that you gave, or something else for another financial advisor, how can they really trust the financial advisor is determining things correctly for them? So how do you do it?

Kahlilah Dowe: How can they trust that the financial advisor is making the right decisions with their portfolio?

Talli Sperry: That and—

Kahlilah Dowe: Yes. Wow, that’s a good question.

Talli Sperry: And based on that, just with that in mind, maybe you can talk about how you choose the investments, so you can give us a framework for what we should understand a financial advisor should think through for us.

Kahlilah Dowe: Yes. So I want to answer that first question, though, about how can you trust that the financial advisor is making the right decision. That’s a tough one because you could invest in something and you say, “Wow, this didn’t perform the way I thought it would perform. Was this the right decision?”

I think the way to look at it is whether or not you feel heard when you’re talking about the things that you’re looking for, when you’re talking about your goals and you’re talking about your objectives. And to the extent that you do, I think that’s the basis of the trust that the financial advisor has the information that they need to then make decisions around which investments you should have in the portfolio.

When I think about—let’s say a client comes to me and they say, “Kahlilah, start from square one. I need you to select investments for me,” the first thing that I’m looking at, and Kim touched on this, is to make sure we have the asset allocation right. We want to make sure that we’re using low-cost funds. That’s the basics for everyone.

And then just drilling down a little deeper, when I think about where we customize, I want to make sure that we’re using the right bonds in the portfolio. That oftentimes has to do with the client’s overall financial picture and what their tax situation is like. I want to understand what their values are when I think about which investments we’re holding. Some of my clients will use what we call ESG funds, which are environmental, social, and corporate governance funds, if they feel like they want to exclude companies that don’t necessarily align with their values. Those are some of the things that I’m thinking about and listening for when constructing a portfolio.

We talked about actively managed funds versus index funds. Those are also some of the cues that I’m looking for when a client is talking about how they feel about just getting returns that mirror the market or wanting to get a little bit more. Those are all of the things that I’m considering and kind of piecing together this puzzle to then come up with an investment strategy for a client.

Talli Sperry: That’s helpful. It’s really helpful to have cues to look for because it can be so complicated and comprehensive in the industry.

Kahlilah Dowe: Yes.

Talli Sperry: And I think our next question kind of gets to that. So Brian is asking, “When I dig into the details, it seems like every fund to fund has overlaps with other funds. So what’s the best way to ensure that our investments are actually in different things?”

Kim Stockton: Yes, that’s another good question. In terms of the top-down hierarchy now, we’re talking about stages 3 and 4. Considering the diversification within the stock and bond markets, within those markets, what funds are you going to choose? And that can be tricky, but a good, simple, inexpensive way to get exposure that is market cap-weighted and that will not have overweights to any particular style or size is with broad market index funds. So a broad market stock index fund, for example, will have exposure to small-cap, mid-cap, and large-cap stocks. It’ll also have exposure to growth stocks and value stocks, so that’s a really easy way to make sure that you’re getting exposure to all the various types of risk factors and segments. And we think it’s important that you do that, that you don’t have unintentional overweights or underweights. It’s important to have access and exposure to all of the different segments because the segments tend to be driven by different risk factors.

So because of that, they behave differently; sometimes very differently. So maybe small-cap value is outperforming one year, and then the next year it’s large-cap growth. So the best way to ensure that you have exposure to all of that is by a broad market index fund, which ensures that you have access and exposure to the areas that are outperforming and that will help mitigate some of the impact of sectors or segments that are underperforming.

Talli Sperry: That’s helpful, the well-layered concept there. Good.

All right. Kahlilah, we talked about the fact that you’ll help people set their goals, you’ll help people rebalance their goals. But Christopher from California is asking a question I think probably a lot of our viewers are asking, which is, “I’m only 5 years into investing. I don’t have a lot of assets. Do you have any advice on finding a good financial planner, and is that something I should be thinking about when my portfolio is small?” So any advice, and should we be thinking about this when a portfolio is small and we’re just beginning?

Kahlilah Dowe: Yes. I love that question because over my advice career, I’ve worked with clients at different asset levels; and there are a few things that they have in common regardless of how much they’ve accumulated. One, they’ve usually worked hard for what they’ve accumulated; two, they’ve usually just accumulated this by stashing money away consistently; and then the last thing is that this is money that they’ve usually saved for retirement. It’s what they have to secure their retirement when they don’t have any earned income.

And when you look at it that way, whether it’s tens of thousands or tens of millions, it’s important to make sure that it’s done right. It’s important to make sure that you’re managing the portfolio in a way that’s intentional. And if it’s not something that you can do yourself, then I absolutely think it makes sense to consider engaging an advisor to help you with that.

I think that when it comes down to how often you engage an advisor or the extent of the advice consultation, I think that depends on maybe the complexity of the overall financial picture. But I don’t look at it as a question of how much you’ve accumulated. I think it’s more so a question of what are the stakes or what are the costs? What does it cost you if you don’t make the right decisions and if you’re not intentional about how the portfolio is invested?

Talli Sperry: It’s always good to raise our hand and ask for help if we want to meet our goals, right?

Kahlilah Dowe: Absolutely.

Talli Sperry: Yes. So we’ve covered a lot of material tonight and a lot of content, and I think we’ve all learned a lot from you. Do you have any final thoughts you’d send us off with? Kim?

Kim Stockton: Sure. So, just a reminder, again, I don’t mean to beat a dead horse but can’t state enough that it really is important to take a top-down approach; really focus on setting your objective, what you’re saving for, and how much you need to get there, and everything else should just sort of fall out of that.

Talli Sperry: That’s really helpful because we know those pieces. We are starting from a good place and we start there.

Kim Stockton: Right.

Talli Sperry: Good. Kahlilah?

Kahlilah Dowe: Yes. So the one thing I’ll just leave investors with is that when I think about investment success, and I’ve worked with countless clients over the years, when I think about those who maybe got derailed somewhere along the way, it’s not that they’re necessarily selling when the market is down significantly. I think what tends to happen, and this tends to go under the radar, is that investors make small decisions that they maybe shouldn’t make and then try and course-correct that decision by another decision. And when you add all of that up, that is really what’s eroding the portfolio over time. So I would say if you’re in that cycle, it’s probably a good time to ask for some help.

Talli Sperry: Maybe just stop, pause, and then take a higher-level view to get it all right.

Kahlilah Dowe: Yes. It can be tough, but it can be done.

Talli Sperry: Thank you. So now that you’ve had a chance to hear from Kahlilah about how she and other financial advisors help clients reach their goals, if you would like to find out more information about Vanguard Personal Advisor Services, just select the green Resource List on the far right of the player. And from there, select the link under Vanguard Personal Advisor Services.

You can also refer to the Resource List for the link to our webcast library, which is where we’ll post the full replay of this webcast when it’s available in a few weeks. We’ll also send you a follow-up email after the webcast tonight with a link to the library, which is hosted on vanguard.com.

I want to thank all of you, the members of the Vanguard community and those who may be new to our webcast, for joining us tonight.

If you could just spare a few more seconds of your time, we would appreciate it if you’d take a brief survey by selecting the red Survey widget. It’s the second from the far right at the bottom of your screen. We truly do value your feedback on tonight’s webcast, and we welcome your suggestions for future topics that you’d like us to cover.

We’re so glad you spent your evening with us, and we sincerely hope you learned something that will help you make more informed decisions about your investments. And we’d encourage all of you to continue the conversation with the Vanguard community on our social channels, Facebook.com/Vanguard and on Twitter by going to @Vanguard_Group.

So on behalf of Kahlilah and Kim and all of us here at Vanguard, thank you and good night.


*Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling.



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