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Emily Farrell: Hello, I’m Emily Farrell, and welcome to our live webcast on asset allocation in retirement. And a special welcome to everyone watching this webcast live on Facebook!

Now many consider asset allocation to be the most important factor to achieve your investment goals. But finding the right asset allocation doesn’t have to be difficult. You just have to pay attention to a few important factors.

So to help us walk through those key considerations, I’m joined by Kahlilah Dowe, a Certified Financial Planner™ professional in Vanguard Personal Advisor Services®, and Kimberly Stockton of Vanguard’s Investment Strategy Group. Thank you both for being here.

Kahlilah Dowe: Thank you.

Emily Farrell: So before we get started, just two quick housekeeping items. First, there’s a widget at the bottom of your screen for accessing technical help. It’s the blue widget on the left. And if you’d like to read some of Vanguard’s thought leadership material that relates to our discussion or to view replays of past webcasts, click on the green Resource widget on the far right on the player.

All right, so we’re going to spend most of our time today answering your questions; both questions you’ve already submitted, as well as those you can submit live during our broadcast. And we encourage everyone to send us questions, right?

Emily Farrell: Now, Kahlilah, Kim, before we get into our discussion, we thought it would be interesting to hear about retirement portfolios from real live investors. Would you like to take a look?

Kimberly Stockton: Yes, I would.

Emily Farrell: All right.

Sue Ianieri: Do you manage your own retirement accounts or do you use a financial advisor?

Jim Throne: I manage my own.

Pearl Groff: Myself and a manager.

Howard Behnke: …we pay into the pension plan our entire tenure while we’re teaching, and then when we retire, we reap the benefits.

Sue Ianieri: How do you decide what mix of stocks and bonds are in your retirement account?

Jim Throne: I go the conservative route. I don’t want to lose value, at least initial starting value, and I want to build on that.

Howard Behnke: I only have about 25% in stocks and bonds. The rest is secured savings.

Pearl Groff: The manager usually helps me with that, and I usually try to get a good one…

Sue Ianieri: Are you confident you’re saving enough for retirement?

Jim Throne: Yes, I am.

Pearl Groff: Never but once you get on Social Security, it’s hard, so you definitely need to save…

Jim Tupitza: No one ever saves enough for retirement, but I think I’m fine.

Emily Farrell: Now, Kahlilah, Kim, the biggest takeaway for me, from hearing those responses, was really just the variety. I guess it just kind of shows people are in different places, right?

Kahlilah Dowe: Right, right. And it’s interesting because I think most people have some sort of doubt—even those who say I should be in a good place— there’s still that small question in the back of their minds, about whether or not it’s actually right. So, yes, that was interesting.

Emily Farrell: Kim, any observations?

Kimberly Stockton: Yes, I thought it was very encouraging that the investors were considering their risk tolerance in the asset allocation decision. One thing that I would point out, is sometimes when we think about risk and making asset allocation decisions in retirement, you have to think about more than one risk. Sometimes when you consider yourself a conservative investor and you are lowering risk in one area,that can have the impact of increasing risk in another area. So a conservative investment has lower market risk, yes, but it can also have higher shortfall risk.

Emily Farrell: Yes, definitely something to think about, and I think we’ll probably go back to that point later in our discussion.

So now, for those of you that have joined us before, we like to kick-start our discussion by asking our audience a question, to get to know a little bit about you. Right on your screen you’ll see our first poll question which is, “Where are you in your retirement journey: more than ten years from retirement, five to ten.years from retirement, less than five years from retirement, or retired?” All right, so just take a second, respond, and we’ll get our responses in a few minutes.

But before we get started, there’s a lot to unpack here, and I thought maybe that Kahlilah, you could just kind of set the stage for us, asset allocation in retirement. What should we be thinking about?

Kahlilah Dowe: Yes. So when you think about the asset allocation in retirement, and we’ll probably cover many different questions and many different topics here, but, ultimately, I think it comes down to four key elements.

So the first thing is just being crystal clear about your goals: what it is that the money needs to do for you, why are you investing? So that’s the first thing. It’s also looking at your risk tolerance, and I’m sure that will be kind of a reoccurring theme here. You want to be clear about the level of risk you should take and the level of risk that you can afford to take. And I think it’s important to think about that before it gets to the point where the market is volatile. So, really, in the very beginning and then, of course, reassessing it over time.

The other thing is looking at your available resources. So most investors, when they’re in retirement, have available resources outside of their portfolio. So when you think about your risk tolerance and your goal for the portfolio, part of that is determining how much of your retirement spending does your portfolio have to kind of shoulder, and how much of that is covered through other resources.

And then the other thing is the time horizon, and I’m sure this will come up over and over again. So think about how much time you have to leave the money invested and also the time frame over which you’ll spend from the portfolio.

And that’s probably the one thing that I talk about most and that I have to remind investors of most, especially when the market is volatile, it’s the idea that even though it’s volatile, you still have quite a bit of time to leave the money invested. So those are the four things that I think will kind of come up as the theme here and the four things that investors need to consider most.

Emily Farrell: Yes, and I think that is kind of just a good way to set the tone of the conversation.

So we actually have our poll results back, and if you recall, we were really asking where everyone is in their retirement journey, how far out from retirement they are. And my math’s not great, but close to 70%, 67% are retired. Another 20% are less than 5 years from retirement. I think it kind of sets the stage for where our audience is. Less than 10%, 9% are 5 to 10 years from retirement, and only 2% of those watching at home are more than 10 years from retirement.

So again, I think that we’re right on track. You found the right place for this type of conversation; and, hopefully, we’ll have a lot of great insights for you throughout the conversation.

But you’re not off the hook yet. I actually have another poll question for you, and that is up on your screen right now. So this question is, “Which of the following is the most appropriate asset allocation for a retiree: 50%/50% bonds and stocks, 60% bonds/40% stocks, 80% bonds/20% stocks, or it depends on the individual investor’s situation?” All right, so this is a little bit of a pop quiz, a little bit of a different tone to this one. So, again, take a moment to respond, and we’ll get back to that in just a minute.

All right, so I promise it’s going to be all about questions. You don’t have to hear me talk the whole time, and I have a bunch of questions that were submitted in advance of the webcast so I figured we’d kick it off with one of those.

So Charles from Washington, DC, you’re the lucky first question. Charles asked us, “What is the best investment strategy for asset allocation during retirement?” So no more perfect question to kick it off. Kim?

Kimberly Stockton: That’s a really big question.

Emily Farrell: It sets the stage.

Kimberly Stockton: Yes, definitely. I’ll give you the short version, and then we can get into the details as we move along with our conversation.

So, generally, the best investment strategy that investors can implement is to have a broad market portfolio, diversified internationally, and a portfolio that they can live with in bad markets and good markets, and also one that is made in consideration of their long-term financial objectives.

Emily Farrell: Okay. So definitely some variety, based on individual situation, right?

Kimberly Stockton: Absolutely.

Emily Farrell: Yes, again, that’s probably going to be a recurring theme throughout.

So we’re just going to pause for a second there because, again, I think we have a lot more to unpack, and I think we’re going to talk about it throughout the webcast tonight. But we have our poll results, and if you recall, I tricked the audience, and we’re just quizzing you now. And the question was “Which of the following is the most appropriate asset allocation for a retiree?” All right, everyone at home is pretty smart because 77% said, “It depends on the individual investor’s situation.” So I might have hinted at that a couple of times in the intro, so I’m glad you guys are listening.

But, yes, again, it really depends. Right, Kahlilah?

Kahlilah Dowe: Definitely.

Emily Farrell: So along that line, so, Kahlilah, we had mentioned that you work with Vanguard’s Personal Advisor Services, and we’ve got a question specific to that. James, again in Washington, DC, so our nation’s capital’s paying attention, “How does Vanguard Personal Advisor Services determine asset allocation from the information a client gives them?”

Kahlilah Dowe: Yes, so there are a few things that we look at, but really it starts with just having a conversation with our clients because we want to understand their goals, first and foremost, what it is that they’re investing for. So let’s say it’s retirement. We want to understand how much time they have before they actually retire. So, again, going back to those two things. And that will pretty much give us a range in terms of the asset allocation—how much they should have in stocks versus bonds. And it also gives us what we consider the risk capacity. It tells us how much risk they should take, given the amount of time that they have and how much growth we think they’re going to need in order to meet their goals.

The other thing comes down to the risk tolerance. So we ask specific questions about that. We want to understand how they think about risk. We want to understand their concerns when it comes to risk and that sort of thing. And then based on that, that helps us to fine-tune that range.

So, for example, let’s say based on their time horizon and based on their goal of using the money for retirement, we may say 55% stock, 35% bonds, or 55%/45%. So that’s the range that we’re looking at. Once we have the conversation and they talk to us about their risk tolerance, if they come out as more aggressive, we may say, “Okay, we should go more toward 65%/35%, or more conservative, 55%/35%.” But it’s all based on just having a conversation, trying to understand what it is that the client needs the money to do for them, and then thinking about how we can construct a portfolio that gives them the best chance of reaching that goal.

Emily Farrell: Yes, I imagine that that question and really kind of digging in on risk tolerance is helpful, because just saying, “Hey, what’s your risk tolerance?” someone might think it’s one thing, but kind of digging into it a little bit, that conversation might help really kind of nail it down and maybe someone’s more conservative or less conservative than they originally had replied, right?

Kahlilah Dowe: Oh, absolutely. And one of the things I found is that, you know, we all know that the stock market has done very well recently. And I found that a lot of people, investors, have very high risk tolerances now.

Emily Farrell: Well isn’t that convenient?

Kahlilah Dowe: Right, exactly. But part of it is, “I have a very high risk tolerance because I think this will continue” right? Thinking that the market will continue to go up.

But in my experience, people who have low risk tolerances, they have concerns even when the market is up. Their concern is that it could go down from here. When the market is down, the concern is that it could go down more. So it’s really important to fine-tune it, and it’s not just asking, what is your risk tolerance? It’s kind of unpacking all of the underlying factors that go into that.

Emily Farrell: Absolutely, I bet that’s a really telling conversation. So another asset allocation question was already submitted and Gary from Doylestown, Pennsylvania asked, “Is asset allocation more driven by life stage or personal risk tolerance?” So, Kahlilah, you were kind of getting into this a little bit, but, Kim, you want to take it a step further?

Kimberly Stockton: Sure, yes. I’d say both are very important, obviously. But life stage is, to the extent it goes to your objective, is the factor that investors should consider first.

Emily Farrell: So the starting point?

Kimberly Stockton: Exactly, yes. Really, the objective—what your financial goals are in retirement—that’s going to drive everything else. And some investors think of retirement as one objective, but the reality is that retirees have many investment objectives. You know, that may be meeting basic living expenses. It may be legacy wealth. It may be having a contingency reserve for emergencies. So we think objective is critical and that retirees can have a number of objectives. So that’s first.

But then risk tolerance comes in as well. So if you, for example, have a legacy objective, transferring wealth to heirs, you have potentially a very long time horizon, possibly perpetual time horizon. So that, in of itself, allows you to take more risk. Maybe you could have a larger equity allocation with that type of objective.

But if you think of an investor with a legacy objective, maybe that person just has a low risk tolerance. So despite the long time horizon, he or she still may not be comfortable with a large stock allocation. So objective first then risk tolerance, both important.

Emily Farrell: Yes, absolutely. And it’s a good roadmap.

So there’s already some live questions coming into us, and I’m going to get to those in just a second. There’s actually another great question that was submitted in advance, and I think it really kind of touches on this objective risk tolerance, but more on the objective.

Judy from Sherman, Connecticut, asked us, “Any suggestions for best strategies to balance risk tolerance considerations with the need to achieve growth and income in a low-interest-rate climate?” So, Kahlilah, can you unpack that for us?

Kahlilah Dowe: Yes, so it sounds like she’s asking the question that I hear all the time, which is, “How can I get the growth that I need? How can I get the income that I need without risking too much of what I’ve already accumulated?” Right, that’s like the million dollar question.

And for retirees especially, because they’re spending from the portfolio, and they really can’t take on as much risk as if they were not, for the stocks, I think, which is where you get your growth. When I think about getting the growth but managing the risk, the first thing that comes to mind is just the asset allocation. I think that’s the very first thing that you look at as the best way to get growth and manage risk. That’s what we look to the bonds for. So I would say first and foremost is deciding how much you should have in stocks versus bonds.

I also think diversification is an easy win. So when you think about getting the growth that you need but making sure that you’re not risking too much of what you have, diversifying amongst your stock portfolio is one of the ways that we try and minimize risk.

With bonds, I think it’s a little trickier, especially with interest rates being as low as they are. And a lot of investors, especially retirees, again, kind of feel like they have their backs against the wall, even with interest rates going up. You know, they’ve gone up some. But the question is still, “How can I get the income that I need?” And, unfortunately, a lot of investors are seeking out riskier investments for that reason. So longer-term bonds, bonds of lower quality. And in my experience, they’re not doing that because they want to.

They’re doing that because they feel as though they need to in order to get the income that they need.

So one of the questions that I ask when this comes up is, okay, let’s say the bonds that you have, let’s say high-quality bonds are yielding 2%. If you stick with that 2%, in other words, you’re not getting the 5% that let’s say bonds have yielded on average, if you stick with that 2%, what does that really mean in terms of your financial picture?

And what I find very often is that it doesn’t change the lifestyle. It doesn’t increase the risk of running out of money. So I think that’s an important thing to think about when you think about the yields, and fortunately, interest rates are so low. They’re getting better. Is it a make-or-break-you kind of thing, the fact that you’re kind of stuck with this lower interest rate unless you take on more risk?

The reality is that there is no way to get a higher yield without taking on more risk, unfortunately.

Emily Farrell: Right.

Kahlilah Dowe: So our advice, it really hasn’t changed in this way. Our advice is to make sure you have the right mix of stocks and bonds, to stick with intermediate-term bonds as opposed to I’ll say loading up on long-term bonds, because we’re not saying that you shouldn’t have them at all. And then also sticking with higher-quality bonds. We think ultimately that that is the best way to get the income that you need and also to manage risk.

Emily Farrell: Okay, well I think that’s definitely a little bit of a roadmap there in terms of how you’re thinking about the stock/bond portion of the portfolio, particularly, again, as you mentioned, in current market conditions.

So I have another question that just came in, and I want to get to it because, again, it touches on what to do in a specific market condition. So the question is, “Should the suggested allocation change when market conditions change? For instance, before a recession.” Kim?

Kimberly Stockton: Sure. Well, we generally say that it’s life changes, not market changes, that should drive your asset allocation, your long-term strategic asset allocation. So it’s really important to have a plan upfront so that when we do see downturns in the market, you can stick with your plan and tune out all the noise that you hear from day to day. And really that gives investors the best chance of investment success and meeting their objectives as opposed to abandoning the market and suffering the long-term repercussions for that.

We actually have a chart that we can bring up that will show potential outcomes. And what this chart shows is it starts at the top of the market in 2007, and what you see with the blue line there is an investor that’s 50% stocks, 50% bonds, and he or she stays the course. You see the market decline in 2008 on that chart and what would happen if that investor stayed the course with their strategic asset allocation, stayed 50% stocks/50% bonds.

They end up doing quite well at the end of their time horizon, which, in this case, is ten years. And you also see that in a very short period, they are back to where they started. So they basically break even.

And contrast that with the yellow and the green-blue lines there down at the bottom. That is what would happen if an investor, at the bottom of the market, didn’t stick with the plan, sold their assets, moved from stocks into bonds or to cash. You see the negative returns at the bottom, that’s cash. That’s real returns because they wouldn’t have kept up with inflation. And then we see the bond returns, also a negative return relative to the 50/50 asset allocation.

So it’s tempting, it’s scary, and it really emphasizes the importance of having a plan in place, having a plan in place that you’re comfortable with in all market environments.

Emily Farrell: Yes, so we’ll just put away that crystal ball, put it back on the shelf nice and dusty.

Kahlilah Dowe: Yes, and if I could just add to that.

Emily Farrell: Sure.

Kahlilah Dowe: You know, when I think about the things that derail investors, it’s not that you had 50% in stocks when you should have had 60%, or you had 40% when you should have had 50%. It’s not that. It’s that you made an adjustment to the portfolio at the wrong time. And, actually, I won’t even say at the wrong time. It’s that you made an adjustment to your asset allocation in anticipation of what you thought the market might do or to avoid a particular event in the market.

So when you think about the asset allocation, I think making sure you have the right mix of stocks and bonds is number one. But it’s also having the discipline to stick with that mix of stocks and bonds; and, of course, you review it periodically.

Emily Farrell: Absolutely.

Kahlilah Dowe: But I think the key—I mean we talk about like the time horizon, the risk tolerance, and all those things are important. But you can’t really stick with any of that long term without the discipline. So I kind of look at that as the glue that kind of holds all of this together.

Emily Farrell: Well, so you talked about revisiting it from time to time, and I think that’s a great segue. One of the questions that we had gotten again in advance of the webcast was from Steve in New York, and he asked, “How often do you suggest rebalancing?” Kahlilah, so how often do you revisit it?

Kahlilah Dowe: So I kind of look at it in two says. He said, “How often do you suggest rebalancing the portfolio?” So, again, that starts with knowing how much you should have in stocks versus bonds and then determining how much are you going to allow the portfolio to deviate from that?

Emily Farrell: Like a threshold.

Kahlilah Dowe: Right, that threshold. So we usually say around 5%, right? So if you notice that the portfolio has drifted by 5%, I think rebalancing it as often as needed. So I don’t really have a breakpoint when I say, “After three times, you shouldn’t rebalance anymore.” Any time it deviates beyond, and that’s why we set it at 5% and not 2%. So that way it gives it some time…

Emily Farrell: The market fluctuations aside.

Kahlilah Dowe: Exactly.

Emily Farrell: Actual significant shifts, you know, based on maybe kind of a longer-term trend in the markets, right?

Kahlilah Dowe: Exactly, exactly. That’s what we’re looking for. Definitely any time your financial picture changes, you should review it for sure.

Emily Farrell: But, again, making sure that the asset allocation is appropriate, right?

Kahlilah Dowe: That’s right, that’s exactly what you’re looking for. So if we’re talking about what should trigger you to review it, then I would say once a year. If nothing else comes up, at least once a year you should look at rebalancing the portfolio.

Emily Farrell: That’s doable, right?

Kimberly Stockton: One thing I’d add to that is now is a very important time to look at rebalancing if you haven’t done it in a long time. We are in the second longest bull market in history, pretty close to the longest in a few months. So in a lot of cases, if you haven’t rebalanced recently, your risk profile is probably out of balance.

Emily Farrell: Yes, that’s a good point.

Kahlilah Dowe: Can I just add one other thing?

Emily Farrell: Of course.

Kahlilah Dowe: Because I said rebalance as often as needed, there are tax implications for doing that.

Emily Farrell: That’s a good point.

Kahlilah Dowe: Yes, we don’t want to forget about that. So you want to try and do it in the most tax-efficient way.

Emily Farrell: Sure.

Kahlilah Dowe: So I think this is a great example, where the market has gone up pretty consistently; and we’ve rebalanced portfolios maybe twice so far this year.

So if you could do it in a tax-preferred account, I think that’s best. And then you could also look at using distributions. If you’re retired and you’re taking money from the portfolio, you could use that as an opportunity to rebalance as well.

Emily Farrell: Absolutely. All right, well definitely a good caveat there.

So we’ve talked a little bit about asset allocation in terms of stocks/bonds and getting specific into bonds, Kim, is a question that came in from Alan Caldwell. And he asked, “Why do so many think bonds are ‘less risky?’ Don’t bonds have considerable inflation-rate risk?”

Kimberly Stockton: Yes, it is true that if you compare the volatility of stocks to bonds, bonds are a lot less volatile than stocks. But bonds are not without risk, and there have been down markets. But if you look at the worst bear market in bonds, at least by annual return, it was about 3% negative. Compare that to the worst market in stocks, we’re talking over 40% in 2008. We were close to 40% negative returns in the stock market. So bonds are not risk-free. They do fluctuate, and they fluctuate particularly with interest rates, but they fluctuate a lot less than stocks.

Emily Farrell: Okay. So I have a good follow-up for that, if you don’t mind. And this is, again, another viewer-submitted question from Len in Strongsville, Ohio. I like the name of that town, Strongsville.

“So bonds do not seem like a great investment at this time. Why does Vanguard recommend an investment that may not keep up with inflation?” So, again, you see a little bit of overlap, so I just wanted to jump into that.

Kimberly Stockton: Yes, yes, definitely, and a very timely question. But the way that we think of all asset classes, including bonds, is with respect to their role in a portfolio. So, you know, it’s fine to look at the asset class individually and the risk in return with respect to that asset class, but it’s more important to look at its role in a portfolio.

So for bonds, we see bonds as being really a ballast, so a diversifier for equity risk. Bonds can dampen the volatility of a stock market, and the reason they do that is because they are what’s called imperfectly correlated. So they don’t move exactly with stock returns.

So if the stock market’s down, maybe bonds are down, but not by as much. So they really mitigate some of that volatility that a 100% stock portfolio would otherwise experience. So, you know, it’s really important to have them in the portfolio for just that reason, because they act as a ballast.

But even if you think about bonds long term, it is true that when interest rates go up—which they generally are—it is a negative to the bond return. But there is another component to the bond return and that’s the income, the coupon on the bond. So, you know, if you’re investing in a bond mutual fund, that fund manager is buying new bonds. He or she is buying new bonds at a higher interest rate. So that piece of the return is going up, and that’s improving. And over time, if you are a long-term investor and hold bonds, that piece of it, that income component will make up for that return component loss as interest rates rise.

Emily Farrell: Yes, I think it’s always a really good point to just kind of remember what we’re talking about here. We hear stocks and bonds, we talk about stocks and bonds, but what are we actually talking about?

So, Kahlilah, I have a good segue question for you, speaking of bonds. Gary from Greensboro, North Carolina, asks, “Why not CDs instead of bonds?” That’s interesting, right?

Kahlilah Dowe: Yes, that’s a good question. So I don’t think it has to be one or the other. I think a portfolio could consist of CDs as well as bonds. But I think they serve two different purposes. So CDs are generally more conservative investments, they’re usually better suited for shorter-term goals, and they generally have lower yields. So if you have a goal that you need to meet, let’s say in the next year or two, we wouldn’t necessarily say that money should be in bonds. That may be a better fit for CDs.

But if we’re talking about a long-term portfolio, then I think it’s important to consider the fact that bonds do give higher yields overall.

Kahlilah Dowe: Because I feel like the underlying question is why would I hold onto bonds that will decline in value with interest rates going up, when I could get a CD that has a stable value and that has a stable yield? But there’s a trade-off for having that stable bond and stable yield, which is that you don’t get as much return.

And so, again, going back to your goals, if you’re trying to grow the portfolio or to get income for a future goal, then that becomes more important in addition to what Kim just said, which is we’re really looking for that relationship. So if you ask why would we recommend bonds over CDs for a long-term portfolio, it’s because we’re looking for the relationship that stocks and bonds have together. The fact that there’s less volatility in bonds. Especially in years where the stock market tends to be volatile, what we’ve seen is that bonds typically are not as volatile. And so that’s the relationship that we’re looking for.

Emily Farrell: Okay, interesting. And so while we’re on the topic of investment type, if you will, another live question just came through, and Robert Morris asked us, “Thoughts on gold and silver as a part of our investment strategy?” Kim?

Kimberly Stockton: Sure. Well, gold and silver can be a part of a portfolio.

Emily Farrell: I assume we’re talking not stuff hidden under the mattress here, right, or in grandma’s vault, right?

Kimberly Stockton: Yes, yes. There are investment vehicles for accessing gold. And, typically, when investors are looking to those types of investments, or other alternative types of investments, they’re looking for inflation protection, they’re looking for diversification, or even in some cases return potential. And, really, if you have a broadly diversified portfolio of stocks and bonds, that is more than adequate diversification, inflation protection, and return potential.

So for investors who are considering those types of investments, other alternative investments outside of the stock and bond universe, we think it’s important that they understand the additional risks for those types of investments, usually additional costs, and really a higher level of uncertainty about whether they’re going to, in fact, get to some of those goals.

Emily Farrell: Yes, absolutely. Good points. So I have another bond question, so I think we know what’s on the minds of our audience at home. And JP asked us, “With the yield spread between money market and short and intermediate bonds so narrow, why expose a portfolio to interest rate risk?” Any thoughts?

Kimberly Stockton: Now that’s a good question.

Kahlilah Dowe: It is because I think money market yields have gone up faster. So it is a much smaller spread. I think it’s very similar to the answer about CDs though. And, Kim, I hear your perspective. I think it’s very similar in that it’s not really a suitable longer-term investment and doesn’t give us that relationship that we’re looking for between stock and bond performance in years where the market is volatile. What do you think?

Kimberly Stockton: Yes, I agree. We’ve been getting a lot of questions about alternatives to bonds, to broad market bonds as interest rates rise. So questions about CDs, questions about cash because it is more stable on its own than a bond investment. But it all goes back to the role in the portfolio. If we look at some of these cash-type investments and how well they correlate with the equity markets, they just don’t give the same type of diversification as broad bond market exposure consistently does.

Emily Farrell: Well, so on that page, another question from Chip and he asked, “Where do derivative investments fit, if at all, in a typical retirement portfolio?” So, kind of along the same page?

Kimberly Stockton: Derivatives?

Emily Farrell: Derivatives, yes.

Kimberly Stockton: I would say they don’t have a place in most portfolios. Again, but it’s kind of the same case for any of these alternative type investments. These investments that have a higher level of risk, a higher level of complexity, the question I ask is really do you need them? And I think the answer is, for most investors, no. If an investor is particularly interested in this alternative type of investment, is there potential for some benefit in a portfolio? Sure. But, again, it goes back to need or interest. And if you have the interest and you’re willing to take the risk, potentially experience a higher cost, then that’s a situation where you would consider it.

Emily Farrell: I feel like there’s going to be CliffsNotes for this discussion, which will be RISK in all capital letters with a question mark. But, you know, it’s obviously a really important point. And again, it’s a very individual type of conversation.

So let’s just kind of pivot back to some of the questions that we had gotten at the beginning, which I really feel like kind of go back to that asset allocation or kind of the gist of our conversation. So, Kahlilah, Ron from Aurora, Ohio, asked, “What percent is suggested for emergency funds?” So, again, I think we’re kind of starting at the beginning of how are we going to construct our portfolio, right?

Kahlilah Dowe: Yes. So it’s interesting because when I think of an emergency fund, I don’t really think of it as a percentage of the portfolio because that could be too much or too little for some investors. I really look at it as a function of what you’re spending, right, so if you think about your income versus your expenses. Let’s say you have income of $50,000 a year, expenses of $100,000, you should have about a year’s worth of expenses set aside. And, again, it’s the gap between the income and expenses. So let’s say you have $50,000, right? But that’s money that you expect to spend. That should be set aside. And then in addition to that, I typically recommend having another $50,000, so essentially another year worth of expenses set aside. So, I guess, to answer the question more directly, it comes out to about two years, but really one because that first year, that cash is set aside for spending.

Emily Farrell: I see, okay. All right. So, again, just to kind of recap, it’s not necessarily a percentage, but kind of thinking about your expenses and kind of setting that aside in terms of looking at kind of your current maybe spending situation. That’s the right word.

Kahlilah Dowe: That’s right. That’s right. That’s right. So if you have $50,000 that you need each year, that’s the difference between your income and expenses.

Emily Farrell: Got you.

Kahlilah Dowe: That should be set aside in a cash position in addition to another $50,000 that’s purely an emergency fund. This is money that you do not expect to spend at all.

Emily Farrell: Okay. All right, well, definitely that’s a different kind of way of thinking about emergency funds or, I guess, the emergency portion of your overall financial picture.

So from there, going back to kind of an allocation type of question, Kim, Richard from Chula Vista, California, asked, about the best allocation between foreign and domestic stocks. And I think you talked a little bit about international diversification at the very beginning.

Kimberly Stockton: Sure. So I’ll start with the punchline there.

Emily Farrell: There you go.

Kimberly Stockton: Generally, what we suggest for international equity is an allocation of between 20% and market-cap weight, which is about 47% of non-U.S. stocks as a percentage of your total equity allocation. That’s what we suggest generally. Broadly, and for our target-date funds, we have 40% of equity allocation in non-U.S. equity.

In terms of how we get there and how we arrive at that suggestion, we really take into account a number of factors. Diversification is, obviously, key. So if you look at the historical benefits of diversification from non-U.S. equities, at about 30% to 40% equity, you have received 95% of the diversification benefits of investing outside the U.S. So that’s one factor.

Another factor, as I mentioned, is market-cap weight. That’s the weight that the market places, the market value of non-U.S. equity so we consider that. That’s about 47%.

And then we also look at something called home bias. Home bias is just the tendency for investors to overweight their domestic assets. That’s very understandable. You want to invest in what you know. It’s common everywhere, in the U.S., outside of the U.S. And it’s really, in our view, a form of risk tolerance so it’s something that we think’s important to consider and, also, cost, liquidity, market friction, those type of factors. It’s typically been historically more expensive to invest outside of the U.S., and those costs have come down over the years. And as those costs have come down, we have increased our suggested allocation to outside equity, non-U.S. equity. But very important to have a non-U.S. equity allocation in your portfolio for those important diversification benefits.

Emily Farrell: So we mentioned something in your response, and it was the target-date funds or the Target Retirement Funds. And it reminded me that we have a question from Diane in Hockessin, Delaware. And I’m so sorry, I feel like I butchered that, but “What are the advantages of a target retirement fund?” Kahlilah.

Kahlilah Dowe: Yes. So the target-date funds, they’re actually pretty popular. So quite a few of our investors like them, but they tend to be looking for a similar thing. So let’s say you’re looking for a diversified portfolio, but you don’t want a lot of different funds and you don’t want to have to rebalance between those different funds, the target-date funds could work. So it’s one fund, but they’re a group of underlying investments that you automatically are invested in when you invest in that one fund. And the rebalancing takes place within the fund, so you don’t have to rebalance the portfolio in that way. So that’s one potential advantage.

I think it also comes down to risk tolerance because you have those underlying investments, but you don’t see how they move. In other words, you don’t see what the international stock portion of the portfolio is doing or the U.S. bonds. You simply see one collective share price. So if you have an investor who has, let’s say, a lower risk tolerance and gets concerned when they see that certain pieces of the market are down, you’re kind of sheltered from that. So that could be an advantage.

Also, when you think about taking money from the portfolio, we tend to see them in tax-sheltered accounts most often. But when you think about where money should come from, you don’t have to decide, “Do I take it from this fund or that fund?” It comes from one fund that you see, and then it comes from the underlying investments proportionately.

So I feel like the question could be then, well, why wouldn’t everyone just use that type of fund? Like who would want to do the work if they didn’t have to? So I think there’s some trade-offs when you think of that. When you consider, like I said, taking money out of the portfolio, you take it from that one place. But there are investors who would prefer to be more intentional or more strategic about where they take money from or which fund.

And that’s kind of how we manage portfolios in Personal Advisor Services. We don’t take it from everything proportionately. We decide which fund, and we use it as an opportunity to rebalance. So that’s one trade-off.

The other thing comes down to expense ratios. So they do have slightly higher expense ratios than if you held the underlying investments individually. So that’s something else to consider.

And then one other thing I’ll add is around the rebalancing. Because the target- date funds get progressively more conservative over time, which could be great for some investors—I do see that as a feature—there are some investors who would prefer to decide on their own the rate at which their portfolio gets more conservative. So it’s really just based on each individual investor’s preference, but those are some of the advantages.

Emily Farrell: Yes, so I think, again, it’s all individual preference. And there’s definitely certain ways to do it in these all-in-one funds, which, again, package that glide path as it is down to the appropriate age-based allocation. And other people might want to be hands on or work with an advisor.

So I have another question. So Tom asked us, “How can I learn more about Vanguard advice services?” So I can take that one. I get to be the expert just for one second. I’m just kidding. I’m going to turn it right back to the experts.

But if you go right back to that widget that I had pointed you to in the very beginning of our webcast, there is a link right there and plenty of information about Vanguard Personal Advisor Services. Also, a ton of other good information there as well.

So lots more questions to tackle. So getting back into it, this kind of goes back to Target Retirement Funds. So, Kahlilah, “How do allocations change with age?” So we talked a little bit about age. I think you kind of touched on it in the target-date funds and also earlier in our discussion.

Kahlilah Dowe: Right. So they generally get more conservative with age, but more so your time horizon. And I think it’s important to make that distinction because I work with clients who are, of course, getting older, but their portfolios are not necessarily getting more conservative.

Kahlilah Dowe: And it could be that their time horizon is still far off or they’re investing, like Kim said, for legacies. So, generally speaking, yes, they do get more conservative as you approach your time horizon. Again, the rate at which it gets more conservative is just depending on the risk tolerance and the goal.

Emily Farrell: Okay, great. So, Kim, a live question that goes back to diversification and outside the U.S., and Greg asked us, “Is it really necessary to diversify into non-U.S. bonds?” Can you touch on that?

Kimberly Stockton: Yes. I’m glad we got that question, and we think it is also very important to diversity into non-U.S. bonds.

Emily Farrell: So, yes, we like the question and, yes, it is.

Kimberly Stockton: Yes to both. Strong yes to both. Non-U.S. bonds are very strong diversifiers of not only U.S. bonds but also U.S. and non-U.S. equities. So it’s really a double benefit there, if you will. And I think investors are a lot more trepidatious when it comes to non-U.S. bonds. And that’s understandable. Those markets are really newly developed. It’s only since probably the last 10, 15 years that they’ve become very liquid, there’s been a lot more issuance, and costs have come down a lot. And it’s only since these developments in the markets that we at Vanguard have recommended non-U.S. fixed income. So the diversification benefits have always been there, but it was just expensive to have access to these markets in the past. That’s changed, so we think it is really an important way to lower the volatility of your portfolio.

Emily Farrell: Yes, it’s an interesting reminder that it is only within the last few years that this has evolved.

Kimberly Stockton: Yes. It’s actually the largest investible asset class in the world. Most investors don’t know that, but it is.

Emily Farrell: Well there you go, diversification.

Kimberly Stockton: Got a big gap, in case you don’t have it.

Emily Farrell: So we have a question from Facebook because, as a reminder, we’re live on Facebook as well. And Michael asked us, “Can we talk about TIPS with respect to the fixed income component of retirement portfolios?” So back to bonds. Kim?

Kimberly Stockton: Sure, sure. Yes, so TIPS, Treasury Inflation-Protected Securities.

Emily Farrell: Thank you for defining that, yes.

Kimberly Stockton: Yes, we do think TIPS have a very important role in investors’ retirement portfolios in particular. So if we think of asset allocation and how we get inflation protection for younger investors, they can get that from equity. Equity will outperform inflation over time. Younger investors have a steady stream of income from work in most cases. So that part of their asset base is relatively stable, so they can take on more risk with their asset portfolio. And they have a long time horizon. They can take on equity risk. So equity works in the beginning.

But as investors approach retirement, there we look for inflation protection. As we’re decreasing the equity allocation, we don’t want all that risk and volatility, so there we look for inflation protection from something that moves with inflation. Treasury Inflation-Protected Securities do move with inflation. They are actually adjusted based on inflation every year so that is a way that investors can get inflation protection because it is adjusted with inflation without all that volatility. They’re a bond, so they’re not as volatile as an equity.

Emily Farrell: Okay, interesting. All right. So I have a question that is not about bonds, at least not explicitly about bonds because, again, isn’t it all about stocks and bonds? So Reginald from Glen Head, New York, asked us, “If one has sufficient monthly income from a traditional pension plan, shouldn’t your asset allocation remain on the aggressive side?” These are some great questions. Kahlilah.

Kahlilah Dowe: They are. Theoretically, yes. So if someone came to me and they said, “I either don’t need to spend from the portfolio” or “I have significant income and just need to take a very small piece of the portfolio,” then I think that is an argument for being more aggressive in that you have a greater risk capacity.

Kahlilah Dowe: I still come back to the risk tolerance, though.

Emily Farrell: Capital letters I’m telling you. Capital letters.

Kahlilah Dowe: Exactly, because I’ve experienced where clients have said, “I have this great pension. It’s covering all of my expenses. I won’t take any money out unless I’m going on like, an extravagant vacation or something like that.”

Emily Farrell: Oh, that would sound nice, right.

Kahlilah Dowe: But then when I ask the question, which I ask quite often, “Well, when you think about the goal for the portfolio, is your main objective to grow this as much as you can, or is it more around preserving what you’ve already accumulated or maybe something in the middle?” Very often the answer is, “No, the main goal is to preserve what I’ve already accumulated.” So that to me trumps the income that you have, even though you’re not spending from the portfolio, because what I’m hearing is, “Even though I have this income, I don’t want to take too much risk in the portfolio. Right?

But then you may have someone on the other side, so that’s the other thing. I think that’s completely valid. I think part of having that extra income is that it gives you some flexibility to say how aggressive or how conservative you want to be with the portfolio. But I also work with investors who say, “This money could really work as hard as possible for me since I’m not using it.” And I think that’s right also. But it really comes down to the risk tolerance and how comfortable you are with the ups and downs in the market.

But, yes. So I think you have a greater risk capacity if you have the income, but then you have to decide whether or not you actually want to take on more risk

Emily Farrell: There you go. So a little bit of that risk tolerance, risk capacity, and also available resources, right, at the outset from our four bullets.

Kahlilah: Exactly, yes.

Emily Farrell: Which we would like those to be the key takeaways.

So I still have a couple more questions. Again, those were submitted and keep your questions coming as we’re kind of headed into home. But, Kim, I think this is a good follow-up. So, “Should you change your asset allocation in retirement?” So early on we talked about kind of when to revisit, when to rebalance, when to look at, you know, how your objectives change. So you’re in retirement, should I revisit it?

Kimberly Stockton: Yes. Your asset allocation really should be changing over time, so the answer, I guess, is yes, you should change your asset allocation in retirement. But it’s something that we suggest be done gradually. So, again, if we look at our target-date funds, we start with a higher equity allocation, 90% equity, and we keep that until an investor is age 40. And then we ratchet it down. We take it to 70% equity, gradually decreasing it until we reach retirement. And even when you’re in retirement, we start retirement at about 50% equity, we still take it down a little bit more to end at 30% equity.

Emily Farrell: Yes, so that’s that through strategy, right?

Kimberly Stockton: Yes. Yes, that’s one way to look at the target-date funds. And that’s something that we suggest investors do as well, so not make a drastic change in any one day or time. I just retired, so I’m cutting my equity allocation in half.

Emily Farrell: Woke up and it occurred to me.

Kimberly Stockton: Instead, over time. Over time, gradually decrease the equity allocation.

Emily Farrell: So thinking about that glide path, you talked about Target Retirement Funds or targeted funds in general, and kind of how we think about it, Joel from Delray Beach, Florida, asked us, “Do you subscribe to the approach where you use a rising glide path for equity allocation?”

Kimberly Stockton: Short answer is no.

Emily Farrell: Right to it. Sorry, Joel.

Kimberly Stockton: Yes. Yes, that can be thought of as a U-shaped glide path, right? So the idea is you decrease equity allocation up until you get to retirement. And then at that point, you start to increase your equity allocation and take on more risk. And the rationale is that if there is a downturn in the market right when you retire, if you have a small allocation to equity, you’ll have time to recover from that.

But what that also means, if you think about it, is you’re increasing the equity allocation. So for investors late in retirement, you’re going to end up with a very large equity allocation, a lot of volatility, which we think most investors would not be comfortable with that level of volatility late in retirement. We just don’t think that’s an appropriate risk to take.

Emily Farrell: Yes, that makes sense. So another great question, again, kind of thinking through Vanguard’s view on a stock/bond mix, and this is from Steve in Okemos, Michigan. And I just apologize, these cities, that didn’t sound great.

Kimberly Stockton: That’s sounds right. That was good.

Emily Farrell: Was that right? Here we go, all right. Thank you for the reassurance. “Has Vanguard changed its view of the appropriate mix of stocks and bonds given that people are living much longer and spending significantly more years in retirement?” Okay, so, again, maybe kind of related to that idea should you be upping your equity allocation.

Kimberly Stockton: Yes, yes. So when we’re building the retirement portfolio, I mentioned it’s important to think about different types of risk, not just market risk. Longevity risk is an important consideration. And that’s just the risk of outliving your retirement assets, your financial resources. And definitely that risk has increased as life expectancy has increased in developed countries all around the world. And that is a factor that we think investors who are developing their own asset allocation should consider. We think you should plan beyond your median, your expected life expectancy, definitely. It’s something we think about when we build our Target Retirement Funds and the asset allocation there. We look at various simulations of the probability of meeting retirement income needs.

And in our model, an important factor is life expectancy. So longer life expectancy, that is a longer time horizon that would definitely indicate potentially more risk could be taken and maybe needs to be taken because you’ll be spending longer. And that’s one of the reasons why we have that 30% equity allocation in retirement and we maintain that for what can be a long time horizon.

Emily Farrell: Yes, absolutely something to think about. So I have another interesting question. And, actually, it sounds like a pretty good situation to be in. Suzanne from Fairfield, California—I almost said Connecticut because there’s a Fairfield, Connecticut—asked us, “If an investor is in the position of not needing any of his or her portfolio in retirement, would that change your asset allocation recommendation?” Kahlilah, what do you think?

Kahlilah Dowe: I think it’s similar to the question about the pension.

Emily Farrell: Yes, right.

Kahlilah Dowe: Okay, so I’ll see if I can frame it a little differently. Let’s say you have someone who needs to take a set amount from the portfolio and then something changes within their financial picture, and then suddenly they do not need to take as much as they once did, that would change my investment recommendation. It would at least cause me to revisit it, and figure out whether or not they could take additional risk. So I think that is reasonable. So we would have a conversation about it.

Emily Farrell: Because the objective has changed, and that’s kind of where we started at the beginning.

Kahlilah Dowe: That’s right.

Emily Farrell: The goal is likely shifted if you necessarily don’t need it as much as you thought you did.

Kahlilah Dowe: Right. And that’s exactly what we would need to revisit because you would think that the objective then changes, but it may or may not, right, because they may have additional income and that may prompt them to say, “I could be more aggressive with the portfolio. It could work harder for me.” Or, like I said in the other instance, it may prompt them to say, “I don’t need to be as aggressive as I once was because I have this additional income.”

So that’s where the conversation comes in. But, again, the question was around my recommendation. That would be my lead recommendation to consider it just as a financial advisor.

Emily Farrell: Sure.

Kahlilah Dowe: Consider getting more aggressive because of that, because I mean the goal of it is to grow the portfolio. So to the extent that they could handle the risk, so we have to stress that, it comes down to the risk tolerance. To the extent that they can handle the risk, I think it makes sense to consider getting more aggressive.

Emily Farrell: That makes sense. My recommendation would be to take a really good vacation, but that’s why I’m sitting on this side of the table.

So, believe it or not, we are just about out of time. And I mean it’s been a really great conversation. And I think we definitely kind of saw where some of our heads are at, at home. Lots of conversations about bonds, not totally unexpected. But before I wrap up, I just wanted to see if you had any final thoughts. Kahlilah?

Kahlilah Dowe: Well, I think we covered everything. I usually have final thoughts, but I thought we covered everything pretty well. I’ll go back to what I said earlier around the discipline. I just think it’s important, once you have all of this information, to revisit it from time to time and keep with the discipline strategy. Again, I think, you know, when I look at all the things that derail investors, it’s not the small things, like, I should have been 50%/50%, but I was 40%/60%. It’s making those changes, those kind of spur-of-the-moment changes.

Emily Farrell: The knee-jerk reaction to the market.

Kahlilah Dowe: Right. Those are really the things that I see that are derailing clients. So you want to stay away from that.

Emily Farrell: Kim, any final thoughts?

Kimberly Stockton: I’d go back to what we said at the beginning.

Emily Farrell: Sure.

Kimberly Stockton: Those four factors are really important to keep in mind when you are setting your asset allocation in retirement. And start with the objective. Really the objective, your financial goals, everything else falls out of that in my view. And you have your objective and then you set your risk tolerance and you determine what your risk capacity is. And your risk measures should be related to your objective. So maybe you are concerned about your mutual fund and how its performance is relative to a benchmark, but is that really the risk measure that’s relevant for you or does it matter more whether you’re meeting your retirement income needs and the risk metric related to that? So those are key. Consider your available resources and always, as Kahlilah mentioned, the discipline. Stay the course.

Emily Farrell: Absolutely. And RISK in all capital letters. Anyway, thank you both for such a great conversation. Wonderful insights as always.

Kahlilah Dowe: Thank you.

Kimberly Stockton: Thanks.

Emily Farrell: And thank you all at home. We really appreciate your joining us. If you missed anything or you think you want to rewind to a specific section, don’t worry, in just a few weeks we’ll be sending you an email with a link to view highlights of today’s webcast, and we’ll also be sending transcripts for your convenience.

Now while you’re here, I’d love to encourage you to check out our new podcast, The Planner and the Geek, featuring Vanguard’s own Maria Bruno and Joel Dickson. It’s the first link in that Resource widget and you can listen to our latest episode.

Now if I could just have a few more seconds of your time, and I know just a few more seconds, just take a second. Select the red Survey widget. It’s the second from the right at the bottom of your screen. And if you could take a minute and respond to a quick survey, we’d love your feedback, and we welcome any suggestions about topics that we can cover in the future.

Now from all of us here at Vanguard, thanks once again for joining us. Have a wonderful evening.

Important information 

For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including the possible loss of the money you invest. 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. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

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

Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the work force. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in target date funds is not guaranteed at any time, including on or after the target date.

A Treasury Inflation Protected Securities (TIPS) fund invests in bonds that are backed by the full faith and credit of the federal government and whose principal is adjusted periodically based on inflation. The fund is subject to interest rate risk because although inflation-indexed bonds seek to provide inflation protection, their prices may decline when interest rates rise and vice versa. The fund’s quarterly income distributions are likely to fluctuate considerably more than the income distributions of a typical bond fund. Income fluctuations associated with changes in interest rates are expected to be low; however, income fluctuations associated with changes in inflation are expected to be high. Overall, investors can expect income fluctuations to be high for the fund.

Derivatives are subject to a number of risks, such as liquidity risk interest rate risk, market risk, credit risk, and management risk. A fund investing in a derivative instrument could lose more than the principal amount invested.

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