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Maria Bruno: Hi. I’m Maria Bruno, head of U.S. Wealth Planning Research here at Vanguard.

Joel Dickson: And I’m Joel Dickson, global head of Advice Methodology at Vanguard. Welcome to our podcast series, The Planner and the Geek, in which we’ll discuss topics that are important to individual investors.

Maria Bruno: And we’ll have some fun along the way.

Joel Dickson: Well, Maria, we’re back.

Maria Bruno: Yes, hello, Joel. Good to be back with you.

Joel Dickson: Can’t believe it’s almost the middle of the year already.

Maria Bruno: It is, and I think that warrants a special guest today.

Joel Dickson: Oh, hey, we do have a special guest joining us for the entire podcast this time too.

Maria Bruno: Yes, I’m very excited about this because I’m in the studio with two trained economists today, so this should be lots of fun.

Joel Dickson: The Geek being one of them, but—

Maria Bruno: The Geek being one of them. We’re also joined today by Roger Aliaga-Díaz. Roger, thank you.

Roger Aliaga-Díaz: Great to be here with you, Maria, Joel.

Maria Bruno: So, for our listeners, Roger—for those individuals who may not be familiar with seeing Roger on Vanguard’s webcast or reading his thought leadership—he is our chief economist for the Americas as part of our Investment Strategy Group. And Roger does a lot of work around monetary policy, international macroeconomics, and finance, so multifaceted there in the econ world. So, thanks for being with us today, Roger.

Roger Aliaga-Díaz: No, it’s great to be here and debate these topics on air with Joel where, we usually do it, like, behind doors.

Joel Dickson: Behind the scenes.

Maria Bruno: Oh, this is going to be fun. Debate with Joel. I should just sit back today.

Joel Dickson: Oh, yes, I’ve tried to forget a lot of macroeconomic stuff. You know, stick with taxes and we’re, we’re good.

Maria Bruno: So, Roger, before we start, I’ve had the privilege of working with you as a colleague and as a friend since you started about ten years ago at Vanguard. So, can you tell us a little bit about yourself and what you’ve been doing both before Vanguard and then also joining us?

Roger Aliaga-Díaz: Oh, absolutely. Yes. Before Vanguard, I was teaching economics. I was in academia for a couple of years after my Ph.D. and doing the academic research, and I joined Vanguard ten years ago, in 2007, basically right before the global financial crisis, so—

Joel Dickson: So, the crisis was your fault, right?

Roger Aliaga-Díaz: Well, I didn’t know I caused it, at least, but I learned a lot from joining the company at that time and a lot of things that they don’t teach in academia or you learn in academia.

Joel Dickson: Look, Roger, I as you and I both know, after the global financial crisis, it seemed like economists in general got a really bad reputation. “Well, why couldn’t you see that coming, what’s the risk?” The models didn’t seem to work and so forth. So—

Roger Aliaga-Díaz: Yes, let’s say, I started my job with a lot of humility in terms of, yes, there’s certainly something that the entire profession basically got a reality check in terms of some of the models and some of the frameworks that have been used to analyze the economy and a lot of revisions, a lot of humility too. So, actually, that’s where it’s connected to the type of things we do at Vanguard from the economics perspective, which is, yes, try to talk about the outlook for the economy, for the markets, to try to analyze the events, what they mean to investors, but always knowing that it’s really hard to basically predict exactly what is going to happen and that a little bit aligns very well with the type of investment philosophy that I found here when I joined ten years ago.

Joel Dickson: Why don’t we get into that a little bit because it does seem, from an investment standpoint so far in 2018, it’s been a lot of talk about, “Oh, the markets seem a lot more volatile, a lot more uncertain, especially on the equity side. And, we’re seeing on the fixed income side what we were talking about historically, low interest rates, oh yes, over the last number of years, we seem to see an increase.” Can you sort of talk a little bit about where we thought we were at the beginning of the year and what might have changed, or not, over the first several months of this year?

Roger Aliaga-Díaz: Yes, absolutely. We were in a very nice place. 2017 was a great year, if you think about it, in terms of very subdued economic trends, not bad, actually good ones, the economy improving, but interest rates kind of on the low side, volatility very subdued, equity market returns very strong. And, from the point of view of investors, that seemed to be kind of the ideal place to be. But to be honest, for example, economists at the Fed were a little bit worried about that almost-perfect picture, too perfect to be true. There was a little bit of concern of complacency in the markets. On the one hand, we were seeing, for example, unemployment rates coming lower, and lower, and lower, labor markets getting tighter. And we were thinking, at some point central banks will have to start moving interest rates and start thinking about normalizing. We cannot depend on QE [quantitative easing] forever, right?

Joel Dickson: So, Roger, this is where sometimes I think the economists get looked at like kind of, like with a weird perspective from others. What’s wrong with people being employed?

Roger Aliaga-Díaz: No, nothing wrong with that. What is wrong is to have an economy at full employment and interest rates at very low levels or even below inflation levels. So, it’s not normal to have the economy reaching pretty much the speed potential, or the production potential, and the economy being fully employed and basically still being on life support with the type of policies such as QE, right? So, there is kind of disconnect there, and in the short term it felt good. I mean, again, that low volatility, interest rates not increasing, markets doing well. But you start wondering, now, what are the implications long-term, what are the risks that are brewing on the back burner, and that’s what some people, for example, policymakers and, honestly, at Vanguard, as we were trying to think a little bit more medium-term, long-term in the economy, it was something that was worrying us, and we were actually saying, most likely than not, at some point things will change. I mean, not drastically but, certainly, as the Fed was very clear, very firm that it was the time to keep moving the rates, the market start moving, in some sense coming back to normal, coming back to what the market normally does. So, again, it doesn’t feel that great, but from a medium- to long-term, I would say it’s actually more normal. Let’s put it that way.

Joel Dickson: So, actually, from that perspective, thinking about 2017 as being the “abnormal,” if you will, and this being a return to normal, is that one way maybe to think about it? It’s just that we got used to the lower volatility, higher returns.

Roger Aliaga-Díaz: Right, hopefully we get to this normal with a little bit higher volatility, but at least with cash rates that are positive in real terms, inflation-adjusted. You want to have that base rate, which is, as you know, the cash rate is the base of the returns for all the other asset classes. In normal conditions, that rate should be positive in real terms. So, being in this situation in which you were losing money in real terms over time, it’s really not sustainable, right? We’ve got to remember monetary policy is something that messes up with rates, basically two grades, with the purpose of achieving that recovery over the short term. But, after a while, that’s all what monetary policy can do. You should go back to the normal market conditions, let market prices determine where things are. And investors should get a return for taking risk, right? Yes, I’m arguing that this is where we should be with all the risk that that entails.

Maria Bruno: So, we’ve talked about last year and transitioning into this year, two things, two big things have happened. One is major tax reform, and the other is the new Fed chair. Can we talk about those two things for a bit?

Roger Aliaga-Díaz: Definitely. Yes, well maybe, and that’s clear, Maria, that there are two policy shocks, as economists call it, the monetary side and the fiscal side. Fiscal, as you guys know, and you have been covering a lot, has basically caught a lot of attention. Normally, the type of fiscal policy that we’ve got is something that we would like to get more when the economy is even weaker, right? But as we were saying before, this fiscal, this tax reform arrived at the time when we were getting to full employment. So, certainly, it has created some more economic activity, more economic growth. We think that the economic growth this year will be faster than otherwise, than without the tax reform. But, at the same time, there are concerns that inflation will be also a little bit higher than without the tax reform, right? So now a little bit the implications for investors are kind of—I mean, there’s that dilemma between, yes, we’re getting a little bit faster growth. I think part of the optimism of the equity market last year was anticipating that tax reform. So, we got the best of it. Now I think that what can come next could be some sort of type of inflation concern. I’m not saying by any means that inflation is going to get out of control, but it certainly goes into the direction to push inflation a little bit upwards.

Joel Dickson: And is that why we’ve seen this increase in interest rates, both at the short end and somewhat at the longer end of the, say, the maturity spectrum of U.S. Treasuries, for example?

Roger Aliaga-Díaz: Certainly. Yes, at the minimum, the Fed reaffirmed the plans that it had about increasing rates through this year and into next.

Joel Dickson: Which would be more on the short end of the curve.

Roger Aliaga-Díaz: Would be more on the short end of the curve. So, for one, as inflation or as the risk of inflation is more out there, certainly the Fed would reassert itself in those rate hikes just to make sure that inflation doesn’t get out of control. And we don’t think that that’s going to happen. We think the Fed has things under control. And, certainly, at the long end, more the long-term rates like the ten-year yield on Treasury rates, for example, on Treasury bonds, you’ve got a little bit of a repricing, of increasing yields. And that volatility itself is much more typical of the type of market movements as different information about inflation comes true, right? One day the bond market finds out that consumer pricing is a little bit higher than expected, so that ten-year starts moving more. That’s something that didn’t happen before, which, again, it was not normal. But certainly, yes, that risk premium we call it, that inflation risk premium, which is kind of a market expression of the concern for inflation, has been shown in that movement in the ten-year yield.

Joel Dickson: In some ways that concept of—people would talk several years ago about—“the new normal” is really just kind of the old abnormal, and how we’re thinking about this going forward is pretty much back to where we might have thought about it before in terms of dynamics between employment and inflation and economic growth and how you balance all of those at the same time, right?

Roger Aliaga-Díaz: Yes, yes, you’re right. You go to a point back three, four years ago in which some of the economists were thinking, “We’re really stuck in this post-financial crisis world with very low rates, very low inflation.” Inflation’s not going to get back to 2%, something that you could argue Japan is living with today and, to some extent, Europe. So, again, this normalization, at least on the inflation side and less on the market volatility—I’m not arguing that this is a good thing but, again, it’s a signature of more normal prices and returns. It feels more like a normalization. There are things that are not going back to the way they were before the financial crisis. For example, when we start talking about the level of GDP growth, economic growth for the U.S., which to a large extent is driven by population growth and productivity and the like, those spirals have changed through time.

Joel Dickson: I’m sorry, changed as in lower going forward?

Roger Aliaga-Díaz: Are lower. Yes, they have decreased significantly. We all know, demographic headwinds, the aging of the population, which is, you know, across most of the other markets, and there has been also a kind of a reduction in the rate of investment and productivity. And we don’t expect that to go back to pre-financial crisis years, at least not in the short term.

Joel Dickson: So, some of the discussion of how do we get back to 3% or 4% economic growth, saying at least in the environment of the foreseeable future, that would be very difficult on a long-term potential standpoint. What could move longer term—GDP and economic growth?

Roger Aliaga-Díaz: Well, I always say there is one part that is more certain that it will be, it won’t happen, or it would be difficult to happen, which is the demographic part. The most accurate forecast economists have are the demographic ones. And population growth is not going to revert too much from where, for example, some of the government offices predict it’s going to be in the next five, ten years, right? So now the wildcard which, again, economists don’t know much about, to be honest, is what drives productivity growth. So, we can measure it more or less. Predicting is very difficult because productivity growth depends a lot on technological innovations and how those technologies are adopted by businesses to make money out of it, to put business ideas around. So, the one thing that can change that long-term picture is that all of a sudden we find out that autonomous vehicles or artificial intelligence or drone delivery or things like that somehow really accelerate economic growth much more than we thought. And, there are precedents for that. I mean, that has happened to us before. I mean, economies—for example, in 1991, very few economies, if any, actually predicted that the internet and e-commerce were coming during that decade, so they were making predictions about long-term growth which were much lower, and all of a sudden, we saw this big spurt of growth in the ‘90s driven by internet and telecommunications technology, right?

Joel Dickson: Well, if artificial intelligence is the key, I mean, Maria already accuses me of just being artificial intelligence. So, it’ll work out all right. Isn’t that right, Maria?

Maria Bruno: Sure, Joel. Sure.

Roger Aliaga-Díaz: What is worse than being artificial intelligence is to be replaced by it.

Joel Dickson: Yes. How about Robo Joel?

Maria Bruno: Oh, I look forward to that one. So, Roger, let’s talk a little bit about our new Fed chair and some of the—what we might expect over the next six months on, you know, maybe some of the Fed actions.

Roger Aliaga-Díaz: Yes, obviously, we all heard the news about the new Fed chair, but, actually, there is a new Fed vice chair, too, and a new head of the New York Federal Reserve. So, these are the three most important jobs in the federal setting, interest rate-setting committee. I think all three of them—they have said to continue with the same type of policies and the same type of reaction to the economic news that Yellen’s Fed had. So, we haven’t seen a significant change. Having said that, market conditions have changed, and economic conditions have changed, and that has led the Fed to be a little bit more assertive at, basically, executing the interest rate hikes that they were planning, right? So, we do think that the Fed is going to increase rates two more times this year. They already increased once in March, so two more times this year for a total of three. Other economists are thinking of four, actually. So that’s where the debate is. Just to give you an idea of how tight the markets are, how concerning is the inflation, that like half of the economists, a little bit more, are talking about three hikes for the year; others are talking about four, right?

Maria Bruno: Yes, I actually had read about that. What’s your prediction, three or four or five?

Roger Aliaga-Díaz: Our prediction is three.

Joel Dickson: Or two, or eight.

Maria Bruno: It doesn’t matter, you’re an economist.

Joel Dickson: Yes, where’s the Magic 8 Ball that I can shake, and ask it a question, and it gives me the answer?

Roger Aliaga-Díaz: Give him a second here. Yes, three.

Maria Bruno: So, you’re not expecting any surprises or anything like that, as far as we can see at this point?

Roger Aliaga-Díaz: Yes, yes, three and, potentially, three more next year, in 2019. The good thing about that is that by the end of this year we will be at positive real rates for cash or for short-term interest rates.

Joel Dickson: And when we think about that kind of outlook for the economy and the dynamics in the place right now, was there anything that you think that investors should think about differently, or how do you take, sort of, “Hey, here are the dynamics and so forth and what that might mean in an investment portfolio context”?

Roger Aliaga-Díaz: Yes, I mean, obviously, there are many questions that investors start asking once you start talking about the interest rate increases by the Fed, right? One of them is, “Hey, if interest rates are increasing, what should I do with my bond portfolio or the bond allocation in my portfolio, right?” And what’s interesting here, of course, is kind of basic; but it’s important—have to keep a distinction between short-term rates, as you were alluding before, and the interest rate you are getting on your bond allocation. If you have the Barclays Agg[regate] or some other fixed income benchmark, that rate does not move one to one with the Fed, right? So that’s, for one—why?—because that rate is more being now determined by long-term growth, long-term inflation, and we don’t see those things moving too much, right? So, first of all, remain calm. See the Fed normalize. It’s good that we’re normalizing. The fact that they’re normalizing means that the economy is doing fairly well, but you may not see a huge impact on your bond allocations, especially in the medium and long term, right? Now, of course, the other question that we get from investors is, “If the short-term bonds and the short-term rates started getting better, especially start getting above inflation, why would you take risk and going out of the yield curve when you can get pretty much the same yield or a good yield in the short term?” So, that’s a good question that is worth exploring a little bit, right?

Maria Bruno: So, a flatter—like a relatively flat yield curve is what? Because when you see short-term interest rates start to go up, you may not see it at the long end. You see it relatively flat.

Roger Aliaga-Díaz: But the long end does not increase that much. Then you get the same rate with the long bond and with the short bond, so why would you invest in the long bond? Because there is more risk in long-term bonds, any little movement in interest rates causes a lot of movement in the return you get from that. But one of the answers to why you still want to be invested in long-term bonds is diversification. In the same way you’re thinking diversification between equities and bonds, you want to diversify duration risk, you want to diversify between short-term and long-term bonds. You never know, I’m not predicting here, you never know when we are going to go into the next recession, and that short-term rates are going to go back to zero and, actually, your long-term bonds are going to do really well, versus you never know when things are going to get relatively out of control. Inflation may increase even more, and your short-rated bonds are going to be good, but your long-term bonds will suffer a little bit, right? Uncertainty around those types of extreme scenarios is a justification for having a well-diversified strategy across the curve, right?

Joel Dickson: Well, and I think that’s an important point, Roger, because what moves markets are not the things that are already expected or priced in the markets, right? It’s shocks, it’s those things that aren’t predicted that move the markets, because otherwise it’s already been sort of—

Roger Aliaga-Díaz: It’s already priced into the curve, yes.

Joel Dickson: Exactly, and those things are so much harder to predict. So, we might know or have a good idea of what the economic environment may be. That, in and of itself, though, is not going to change markets.

Roger Aliaga-Díaz: Right, right.

Joel Dickson: Right.

Roger Aliaga-Díaz: If our view of the economic environment pans out, it happens, then there are no surprises, right? But we know that something will be different, right? Be a geopolitical event or some sort of other unexpected event, market- or policy-driven. And we live day by day with seeing the market reprice information, right?

Joel Dickson: Speaking of geopolitical, kind of geopolitical event, one of the other economic sort of trends or topics that we’ve been hearing quite a bit about in 2018 has been about trade policy and what’s the relationship of globalization versus, say, more of an isolationist sort of view of geopolitical perspectives? How do you think about that in the economic standpoint of what that might mean for either economic growth or how we go about thinking about risks and opportunities in the economy?

Roger Aliaga-Díaz: Yes, certainly that has been a big—basically source of uncertainty, if you will, as basically there are many things that—there are many moving parts on that. Obviously, if many of the trade tensions that we’re seeing back and forth among the different parties, we, U.S. [and] China or U.S. versus NAFTA—trading partners Mexico and Canada, right? If those tensions were to escalate and trade will, could be severely disrupted, that, obviously, would have consequences for both U.S. and the global economy and hence the markets, right? So, trade restriction, when trade decreases, it basically, for one, increases the prices of the imported goods and services, of course. And we have to remember that the U.S., in particular, is basically about 18% of the consumer spending, of the consumption spending in the U.S. is coming from imported goods. So that can basically impact a little bit the world for consumers. It could be another source for inflationary pressures, which they’re already on the up due to a fiscal—to the tax reform and to the fact that the economies of full employment. Now you throw a trade shock, and then now you basically compound those inflationary pressures, right? So that could be the risk. It has to get to a really extreme point for that to really be meaningful.

Joel Dickson: And we don’t see that at this point.

Roger Aliaga-Díaz: We don’t see that. Certainly there is a lot of posturing. There is a lot of initial negotiations. But even with NAFTA, for example, which is the free-trade agreement with North American trading partners Canada and Mexico, it seems that we are at a good place. There is some urgency to basically finish part of that agreement before there are elections in Mexico, there are mid-term elections here in the U.S., and you don’t want that uncertainty of the elections to alter that negotiation. But we do think that, at the same time, we don’t see an end in sight in the short term, or at least in terms of, for example, with China. We may hear more of this rhetoric amount of these trade tensions as specifically the two countries tend to, basically, try to finish some type of trade agreement, right? If the trade tensions were to remain contained to a bilateral relationship between U.S. and China mainly, what’s interesting is that the impact would not be that significant as you may think. For example, the U.S. exports to China are less than 1% of U.S. GDP. Chinese exports to the U.S. are less than 4% of China’s GDP. So, it’s a big number but not something that would completely derail both economies. And in no scenario [we] would think that trade would just stop, right? There would be some more volatility but not necessarily a more extreme scenario. So, basically, I think the bottom line is, we don’t see a major trade disruption as a world base case. There could be some more noise as we go through and potentially impacting inflation pressures and inflation risk. But nothing too drastic.

Maria Bruno: Roger, I have a bit of a tangential question. So, this discussion has led me to think that it might be good to talk about your team in the Investment Strategy Group and how we work with some of our internal business partners, specifically our fund managers. As we think about this, particularly on the fixed income side, can you share a little bit in terms of how the economics team here at Vanguard, you and your team, work with our portfolio management side? Whether it’s the fixed income side or the equity side?

Roger Aliaga-Díaz: Yes, sure. Actually, that’s a very rewarding part of the work we do with my team. We engage with some of the senior portfolio managers that do a lot of the strategies, especially on the rates side, which basically are the portfolio managers in the fixed income side that are looking at the Fed and are basically making some of the duration bets, some of the yield-curve bets based on economic information. We also work with some of the portfolio managers on the inflation-protected securities side, the TIPS market, as a lot of our forecasts and views on inflation are incorporated in their views. And it’s a great collaborative environment. We try to provide as much as possible—some analytics, some quantitative analysis, some forecasts. And, basically, the portfolio managers have basically views about the technicals of the market, have also views about policy, about the economy, and we kind of marry those two and try to validate their ideas. And as you can imagine, there is a healthy dose of debate and differences in point of view that are always welcome, right? But, yes, we have an open channel of communication. And just to give you an idea, when the Fed announces a rate decision, we are up there on the trading floor just to give our initial thoughts and reactions to the markets as the portfolio managers or another economist in Bloomberg or others are talking about it, we also have the in-house view too and try to help them there.

Joel Dickson: But I just want to highlight that, within the fixed income portfolios that we actively manage here at Vanguard, it is an important input and part of the tool set, if you will, of different active risk that the portfolio managers, the portfolio management teams may take on or not take on. And that input is important from the econ team in one source. I mean they’re also getting information from the credit sources, and other forms of active approaches that they may choose. But the econ team certainly has an input into how our fixed income funds are actually run, correct?

Roger Aliaga-Díaz: Absolutely, absolutely. I mean the econ team owns, in some sense, the economic growth goal, the inflation goal, and how those two impact our view on central bank decision. And then, at that point, that’s a critical input into the rates team and the other teams in, if we have a view on what the central banks are going to do, and how that’s going to impact the rest of the curve, how it’s going to impact the long-term bonds, the long-term rates, inflation premiums, and so on, right? So, there is a very clear kind of cascading effect that starts perhaps with the economic forecast, right? So, if we get it wrong, we (LAUGHTER)—everybody gets it wrong.

Joel Dickson: You feel it. Yes.

Maria Bruno: All right, Roger, I think you’ve worked with us long enough to know who the Planner and who the Geek is between the two of us here. But we talked a lot around the likelihood of rising interest rates. We’ve seen some of that happen already. I get a lot of questions, mostly from retirees, questioning in terms of any changes that they should be thinking about their portfolio. What I’m seeing a little bit more is an interest, because of the rise in the interest rates, this interest in terms of, well, should I maybe increase my allocation to cash investments, for instance, because we’re starting to see higher rates at the short end?

Roger Aliaga-Díaz: Right.

Maria Bruno: My response is usually, “No, not necessarily.” Right, the role of cash, at least in our opinion—and, Joel, you can share your thoughts there as well—is really from a liquidity reserve standpoint, right? That emergency reserves—when you think about long-term goals, a balanced, diversified portfolio should be focused on a diversified bond/stock portfolio. That in mind, though, I wanted to get your thoughts and, Joel, you as well, in terms of, hey, is there merit to maybe rethinking that a bit? Should I go a little bit longer in terms of cash? My response to that would be, “No, not necessarily.” How you meet that cash reserve might be a better question in my mind.

Joel Dickson: So, Maria, how about you share with us how do you think about cash in your portfolio?

Maria Bruno: Cash is a four-letter word, Joel. I think I know where you’re headed. So, Roger, I have to watch what I talk to Joel about. Maybe it was in preparation for this podcast, we were talking about cash, and I admitted to Joel. I said, “I’m a little too cash-heavy right now.” And it’s a situation of probably more inertia, although we can discuss this and maybe this is another podcast where we discuss and debate our views on—

Roger Aliaga-Díaz: We are discussing our portfolios.

Maria Bruno: No, we’re not going that far, Roger. No, no, no. I seem to be a little bit more risk-adverse than—just a little bit more risk-adverse, and even debt-adverse than Joel is. So, yes, do I stash it in my mattress? No. I am a little cash-heavy right now. So that led us to this discussion around not just the role of cash, but is there a better use for that cash? And, really, what cash is in terms of either a checking account, a money market fund, for instance, or a CD. There are different definitions of cash.

Roger Aliaga-Díaz: Yes, certainly it’s a valid question. I mean, as the yield curve flattens, which means as the short-term rates get closer and closer to the long-term rates, now it was like a 2-percentage-point difference in returns from a ten-year to a money market or something like, or maybe more than 2-, 3-percentage at some point, now becomes, perhaps in the near future, it becomes like less than 1-percentage [point] difference. So, it’s a valid question. Should I take more risk because as you go into another month, you’re taking more risk, right? So, does that 1% or less pay or reward that risk, right? So, it’s a valid question. I haven’t seen any event in which you will go binary, where you go like from all bonds back to all cash because, again, I think we were chatting about that before, there are unexpected things, right? There are things that just happen in the markets by which you may have been better in cash than in long-term bonds, and there are at points in which actually the opposite is true. So that diversification value, that optionality you want to preserve. But, at the margin, I don’t know, maybe for certain investors it makes sense to actually look at that slightly.

Joel Dickson: Well, yes. We get a number of inquiries from different types of clients, different segments; and there may be a role for cash at different points. I mean, think about millennials straight out of school or something. You know, in the job market this is—Maria’s nephew, for example—and there may be some short-term goals that they are saving for. Well, if you’re saving for something in the next year or two, is it worth taking the market risk of equities or something like that?

Maria Bruno: That’s basic asset allocation, Joel, really, right? When you think about asset allocation, I think risk and time horizon are the two biggest components there. So, if you have a short-term goal, you should have very little, if any, in equities, I would say.

Joel Dickson: Yes. What about something like an emergency account? You hear, “Oh, well, before you start saving—” We talked about this a little bit on a previous podcast, but before you start saving for the long term, cover X number of months of expenses and so forth and maybe as potentially another store or area for a conservative—principally protected to the extent possible, uh, type of approach.

Roger Aliaga-Díaz: And the good thing now is, it costs you less to do it. Like before, when the rates were at zero, to have that reserve that you need to have, you will be giving up some considerable amount of yield there, right? Now as yields normalize, it’s easier to do it. I mean, at least you’re not giving up. I’m sorry, I’m thinking like an economist right now, but—

Maria Bruno: No, you’re doing okay, Roger.

Roger Aliaga-Díaz: I mean, the cost of your reserve is lower because at least you are getting some good yield on it and you have your result that you need.

Joel Dickson: Right. Yes. It’s kind of like before, when real rates on cash were really negative. I mean, like negative 2% negative. It’s like, “Oh, I’m going to save for the future, so I can buy less.” It’s almost the way that it comes. And now, with yields now getting closer to zero or maybe even getting above zero, if the Fed continues to, uh, sort of try to balance the inflationary pressures and economic growth and rates, at least you’re saving to potentially have similar or maybe even a little bit more purchasing power down the road, right?

Roger Aliaga-Díaz: Exactly. Exactly.

Maria Bruno: Joel, I don’t think the role of cash has changed. I do think that for most investors a liquidity reserve of cash investments is very reasonable and prudent. How they hold that cash, whether it’s a bank account or a money market mutual fund, for instance, I think it’s more of a conversation of where to hold that type of cash, because I think there’s a lot of education there in terms of there are different types of cash products, and it may be a combination for many investors.

Joel Dickson: Yes, in many ways the mutual fund industry of the late 1970s, early 1980s, and so forth was built on the back of, or grew on the back of, money market funds—

Maria Bruno: Yes.

Joel Dickson: Investors can choose, say, between money market fund, bank account for different cash sort of needs.

Maria Bruno: Right, in many instances it’s both.

Joel Dickson: Maybe, yes. Maybe it is. What are kind of the things that might determine that choice?

Maria Bruno: I would say, maybe in the past, it was a flexibility type concern for individuals. I think it’s two. One is flexibility, but by and large, due to technology and other advancements, you have flexibility with a mutual fund—a money market mutual fund—as you would with a bank checking account. Checkwriting privileges, for instance, come to mind. There’s the ease and flexibility that you can do it with both accounts. I mean, bank accounts are FDI-insured. Mutual funds are not. So that could be a consideration for some investors.

Roger Aliaga-Díaz: Although I will say that insurance is necessary for the banks and it’s not necessary for the mutual funds, right? I mean because the insurance comes from what the bank is doing with that money.

Joel Dickson: Well—

Roger Aliaga-Díaz: While in the money markets there is no leverage, there is nothing. I mean, it’s just totally transparent. So that insurance is not necessary there. Just having to—

Joel Dickson: So that, yes, and, Roger, I think that’s an important point. We can geek out on this together from the econ side. But, a typical banking function, you have deposits and you have loans.

Roger Aliaga-Díaz: Right.

Joel Dickson: Right, and there could be, if there was all of a sudden, a call on the deposits—

Roger Aliaga-Díaz: The loans are invested in long-term things like building a factory. And while the deposits could be basically called upon like on a day’s notice, and the bank may not have cash to actually honor the deposit. So that’s the risk of a bank run, and that’s where the insurance comes into the—

Joel Dickson: And they hold capital in order—

Roger Aliaga-Díaz: And that’s where they have to hook up, you know, because if the government is going to insure the banks, the banks better put part of their skin in the game, so the capital requirements is a way to have them share into the insurance scheme. But, none of that, in money markets, like none of that is true, basically.

Joel Dickson: Well, Maria, so we talked a little bit about how we see some of our clients use cash from a short-term reserve sort of piece. What are other ways that we see cash being used by clients in maybe different phases of their lives?

Maria Bruno: Yes, Joel, I do get this question. And when you think about retirees, for instance, maybe they—because they’re not working, they don’t have capital coming in, so they may be a little bit more conservative, and maybe they should be. They might have—instead of having three-to-six-month’s worth of living expenses in cash, they might have that up to a year or maybe even 18 months. And in some instances, that’s fine. They may take from their portfolio, whether it’s required minimum distributions from their tax-deferred accounts, this becomes their spending account. And that’s the nice part. We talked about money markets. You can actually have checkwriting and other privileges or automatic exchanges with these funds that make the convenience of it very, very good. So not surprising it comes up on the retiree front. I would also say for individuals that might have shorter-term goals, I think we had talked about this earlier, they might have a little bit more in cash there because they really shouldn’t withstand the market volatility associated with the stock. So there maybe you might have a bond-centric portfolio, maybe some cash to augment that.

Joel Dickson: Yes. That first example that you gave of the sort of retiree-type situation is exactly the way that, for example, my mom ends up using cash in her portfolios. The required minimum distribution with the IRA has to be out by a certain point in time, otherwise big, huge penalties and, and so forth. But she knows that’s going be a spending account for the next year or the rest of the year or whatever it may be. And so, I’m holding that in cash because there’s that difference between maybe when I receive income and when those expenses come out. And I do that in my own account, obviously. I mean, it’s those timing differences. Your income and your expenses don’t necessarily just match up perfectly all the time.

Maria Bruno: Oh no, no one’s really does when you think about it, right?

Joel Dickson: Right.

Maria Bruno: Yes. No, that’s a great use.

Joel Dickson: So. How—? There are probably as many money market funds as there are equity fixed income funds. I mean, that’s not a literal comparison, just that there are a lot of all of those. How should people think about if they have decided a money market fund might be appropriate for some of their cash holdings, how do you think about the different variables that might affect the choice of type of money market fund?

Maria Bruno: Yes, I think the first choice might be whether you invest in a taxable money market account. Those are typically money market accounts that invest in corporates or treasuries, for instance. Much like fixed income securities, that income that you earn as an investor is taxable. And then there’s municipal money markets as well. So, for high-income earners or individuals who live in states with high-income-tax brackets, on an after-tax perspective, a municipal money market might be a better choice from a tax standpoint.

Joel Dickson: Yes, so you have those suballocation sort of pieces, just like you do with other types of vehicles. And client situation can sort of dictate that. And even within the municipals, you’ve got maybe national money market funds, and then you might have certain—in many states certain specific money market funds targeted to certain sort of high-income-tax states. So—

Maria Bruno: And usually it’s yield-driven, and it’s the after-tax yield as an investor that you would want to zero in on.

Joel Dickson: Oh, you’re going to let me geek out on the tax equivalent—

Maria Bruno: Sure, go ahead. It’s like—

Joel Dickson: Tax-equivalent yield calculation.

Maria Bruno: It’s like giving candy to a kid. Go ahead.

Joel Dickson: I like both, candy and taxes.

Maria Bruno: Exactly, exactly.

Joel Dickson: I just don’t like taxes on candy—bi dum bum, yes, thank you. Often the break-even or the decision point on that would be to, that’s one sort of way to look at it. Look at the yield on money market funds you’re comparing, and compare their after-tax equivalent yield. So, if you’re not going to pay tax on the municipal money market fund, and compare that to what the yield is on the taxable money market fund that you might be considering, whether a corporate or prime money market fund, as they often call it, or a government fund, and make the comparison. Basically, reduce the yield by the amount of your marginal tax rate.

Joel Dickson: So—

Maria Bruno: You’re getting all this, Roger?

Roger Aliaga-Díaz: So, I’ve been getting that, basically, the tax-advantaged money markets tend to price in that advantage and then the yield kind of reflects that.

Joel Dickson: Exactly, and that’s what you find.

Roger Aliaga-Díaz: So, at the end, the yields are kind of the same after taxes.

Joel Dickson: They do, yup. That’s been the funny thing. Historically, long periods of time, pretty much for all but the absolute highest-tax-rate individuals at the real short end of the curve, the money market end of the curve, the tradeoff has been, well, it may make some sense for really-high-tax-rate individuals to do municipals. Maybe not so much for intermediate-, moderate-tax-rate individuals. At the longer end of the curve, often it’s a lower breakeven point where the taxable muni thing might switch. But the reason I said “historically” is, over the last several years when interest rates have been so low, there’s kind of been no difference at all, because paying taxes on zero is still zero. It seems like the yields on some of the money market funds—get that quick math there, Maria.

Maria Bruno: Yes, I don’t need a Ph.D. to follow that one.

Joel Dickson: Okay, just checking. But, the interest rates have been very low, there’s been very little difference in yields between taxable money markets and municipal money markets. That’s just simply a reflection of the fact that there’s—

Roger Aliaga-Díaz: There is that lower limit there and, I mean—

Joel Dickson: Yes. There’s not much tax liability when the taxable interest rates are low. But there are, I think, as we said, many, many choices—things that affect the yield or would be the expenses of the fund and how much credit risk you’re taking.

Maria Bruno: That’s a big one, right?

Joel Dickson: Right. So, oftentimes people will look at higher yields and think, oh, it’s a better option, but there is a tradeoff. There is a risk-return tradeoff in money markets just like there is in other types of investments—that often there can be higher yields mean there’s more credit risk or more corporate money market instruments being used that have some increased risk in default. We saw that in the global financial crisis at times, with some of the money market funds at that point in time, some of the underlying instruments. But generally, yes, it’s those characteristics of a personal and risk tolerance nature true with any other type of investment portfolio decision.

Maria Bruno: Yes, Joel, but the one thing I would add is for someone who’s listening to us and wants to learn more, I think is a good source to learn about not just money markets and how they fit in, but asset allocation as a whole, and you said it’s a good source for a future reference. Roger, I have one—actually, I have one question for Roger before we leave.

Joel Dickson: Uh-oh.

Maria Bruno: So—

Joel Dickson: Is this the zinger portion of the, of the—?

Maria Bruno: No, not a zinger, but, as I mentioned at, as I started, I’ve worked with Roger for a decade now, so I’ve gotten to know Roger, and he has another Maria in his life. Do tell. Tell the listeners.

Joel Dickson: Wow! Yes.

Roger Aliaga-Díaz: So, yes, my other Maria, she’s my wife for 18 years and—

Maria Bruno: And what does she do?

Roger Aliaga-Díaz: That’s, well, she’s an economist too.

Maria Bruno: You can stop right there, Roger. What’s dinner—

Joel Dickson: It stays in the family.

Maria Bruno: Yes, what’s dinner conversation like?

Roger Aliaga-Díaz: Yes, well, economic topics are banned from the table conversation.

Maria Bruno: Okay, wise woman.

Roger Aliaga-Díaz: Yes.

Joel Dickson: Really?

Roger Aliaga-Díaz: Yes. I want to bring it up and, “No, let’s talk about something else.” Although we have a few papers that we have coauthored over the years, because she’s not only an economist, she’s in the same area of economics that I do, which is macroeconomics. But, yes, we try to separate the profession from life.

Maria Bruno: Hmm, I didn’t know economists actually could do that, but that’s great.

Joel Dickson: Every now and then.

Maria Bruno: All right, so, Roger, do you listen to podcasts, and if so, are you a consumer?

Roger Aliaga-Díaz: I, absolutely. I’m a follower. I think probably this is a good one.

Maria Bruno: You think it’s a good one!

Joel Dickson: Think it’s a good one.

Roger Aliaga-Díaz: I’m sure.

Joel Dickson: So, you haven’t gone out and listened to it, subscribed to it on iTunes and rated us? Yes, we’re supposed to get that in every podcast though.

Roger Aliaga-Díaz: I’m subscribed. I’m subscribed.

Maria Bruno: No, Roger just found out about it last week when we asked him to be part of it.

Joel Dickson: Yes, exactly.

Maria Bruno: Well, Roger, it was good to have you with us today. Thanks for spending some time with us.

Roger Aliaga-Díaz: It was great to be here. Thank you very much for having me.

Joel Dickson: Yes, you’re the first one that’s been able to put up with us for an entire podcast segment, so we do appreciate that.

Roger Aliaga-Díaz: It’s doable. After the first 15 minutes you’re okay.

Joel Dickson: Oh, wow! Very good. Thank you, Roger.

Maria Bruno: Thanks, Roger.

Roger Aliaga-Díaz: Thank you. Thank you, guys.

Maria Bruno: We hope you enjoyed this episode of The Planner and the Geek. Just a reminder that you can find more episodes of The Planner and the Geek on iTunes and on

Joel Dickson: Or simply subscribe to our series and you won’t miss an episode. And don’t forget to rate us on iTunes. Your ratings will make it easier for others to find us when they’re looking for investing podcasts. Please join us for our next episode of The Planner and the Geek.


All investing is subject to risk, including possible loss of principal.

Diversification does not ensure a profit or protect against a loss.

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund’s trading or through your own redemption of shares. For some investors, a portion of the fund’s income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

We recommend that you consult a tax or financial advisor about your individual situation.

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