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Jonathan Cleborne: Good evening, I’m Jon Cleborne, head of Vanguard Personal Advisor Services®. I’ll be your moderator for tonight’s live webcast. Welcome and thanks for joining us.

Before we begin, I’d be remiss not to acknowledge that it’s been a sad few weeks here for us at Vanguard. As many of you already know, on January 16 our founder, Jack Bogle, passed away. Mr. Bogle was a visionary; and perhaps more importantly, he was a deeply passionate crusader for the individual investor. While we’ll miss his daily presence, all of us are working hard to carry forward his legacy.

One of Mr. Bogle’s favorite sayings was “press on regardless.” So in that spirit, we’ll press on with tonight’s conversation.

Tonight I’m going to talk with two senior advisors on my team, Bryan Lewis and Kahlilah Dowe, who both work closely with clients to help them achieve their goals. We’re also joined by Senior Economist Andrew Patterson. Andrew and his team are responsible for helping to develop Vanguard’s economic outlook.

Tonight we’ll talk about the current market environment and the questions that have been coming up recently in our conversations with clients. As a reminder, many of you have submitted questions ahead of time, and we’ll try to get to as many as we can. We also encourage you to submit more throughout the webcast, especially if you hear something you’d like to clarify or you want us to explore further.

Before we get started, if you need to access technical help, it’s available by selecting the blue icon on the left; and you can learn more about Vanguard’s services by clicking the green Resource list on the far right of the player. From there, you can download a copy of the Vanguard economic and market outlook for 2019, which we published a few weeks ago. You can also view webcast replays or listen to a recent podcast episode.

Let’s turn to our guests, Bryan, Kahlilah, and Andrew. Welcome, guys.

Andrew Patterson: Thank you.

Kahlilah Dowe: Thanks for having us.

Jonathan Cleborne: Our topic tonight is cutting through the noise; and, boy, there’s been a lot of noise over the last couple of weeks and months. I saw a stat earlier today that after the market being down 9 % in December, January was the best January for the Dow in 30 years. So it’s crazy—the ups and downs we’ve been seeing.

What are some of the things you’re hearing most frequently in the conversations you’re having with clients right now? Kahlilah, I’ll start with you.

Kahlilah Dowe: Yes, sure, yes. So I think a lot of our clients are focusing on making sure their portfolios are well-positioned. I think what happened in December with the market being down significantly was a wakeup call for investors who were heavy on equities, with the sentiment that the market would continue to go up. And I think we’ve been proactive in talking about the fact that this doesn’t continue forever. So I think investors are taking a hard look at their portfolios right now.

One of things I’ve seen quite often is cash positions where investors are wondering is this the right time to invest money in the market. I’m sure we’ll talk more about that, but more hesitant around just getting into the market in general.

Jonathan Cleborne: Yes, and I suspect, Bryan, you’re probably hearing some of the same stuff.

Bryan Lewis: Exactly, and to Khalilah’s point, I think there’s uncertainty, which is why we have a plan in place. These are markets we’ve accounted for. As investors, we tend to have short memories; but over the last several years, the markets have gone up significantly. And it’s natural for markets to correct themselves, and it’s a matter of reevaluating to make sure the plan, to Kahlilah’s point, still makes sense; assuring clients we’ve planned for these situations; and we’re still on track with their overall portfolio and planning purposes.

Jonathan Cleborne: These are themes we’ll come back to, I suspect, over the conversation tonight.

So, Andrew, maybe I’ll kick it off to you with the first question. This is from Eugene in Durango, Colorado. From your overall review of the data, what’s Vanguard’s perspective on the likelihood of another recession over the next couple of years?

Andrew Patterson: Sure, so that was actually one of the key themes in, you mentioned before our Vanguard economic and market outlook for 2019, so a shameless plug there.

But one of the things we did was we wanted to, knowing recession would be at the front of people’s minds in the current environment, we wanted to take a step back and figure out our own views on the probability of recession coming up.

So what we did was, in regard to the United States, we looked at a number of different sectors and tried to assess the current state of those sectors relative to where they were before previous recessions back in 2007 and 2001. We looked at sectors such as slack—the relative strength of an economy, whether it was too hot, too cold. Consumption—the state of the purchasing power of the consumer, which is impacted by payroll growth, unemployment. We looked at leverage or corporate debt, household debt, asset prices, where they were relative to fair value, our estimates therein. And then monetary policy—another factor we took a look at and where we felt monetary policy was relative to being tight, weak, indifferent.

And looking at all those combined, it seemed like we, rather than being at the late stage of a business cycle expansion, heading to recession, were more toward the latter end of the midcycle. We still have some room to go in terms of growth. Combining all those factors together, we pegged the odds of recession somewhere around 35%. Anytime we’re asked to provide a projection, we like to do it in a probabilistic framework and assess the risk to the upside of the downside because forecasting, it’s a difficult and humbling exercise; and we think it’s important to share with clients what types of risks there are to any forecast.

Jonathan Cleborne: Yes, when you think about those upside and downside risks, I’m curious, what are some of the things you guys are thinking about?

Andrew Patterson: So, actually, I mentioned the 35% probability, which has actually increased since the writing of the piece. The risks there, when we were writing it back in the November time frame, some of those have ebbed, some of those have escalated. The ones that have escalated have been geopolitical concerns —unrest, weakening growth outside of the U.S. Some have abated to an extent—monetary policy, right, where you’ve seen Chair Powell’s comments yesterday walk back the hawkish tone maybe in his December comments, such that the market believes the Fed’s going to be more data-dependent going forward, more ready to react and not on a preset course. That’s removed some of the concerns there, whereas in other areas they may have increased.

Jonathan Cleborne: That’s helpful.

We’ve got our poll results in, so let’s get a sense for how people are feeling.

It looks like the audience, generally speaking, has a good sense. About half the audience has said, “Hey, market volatility is business as usual.” I think a folks are taking that in stride. About 15% coming back as a buying opportunity and about 35% saying it’s a cause for concern. I think reflecting on your comments around the 35% probability of a recession, and they’re probably thinking about that.

Andrew, there’s a question that came in from Sharon in Florida. “As we think about this volatility and what we were just talking about, I think people are trying to put together how to connect the volatility to the fundamentals of what’s going on in the market. Is this volatility being driven by speculation? Is it being driven by emotion? What’s going on in the markets?” I wonder if you might be able to comment on that.

Andrew Patterson: So about fundamentals, I wouldn’t say a whole lot has changed since the fourth quarter of last year. Fundamentals were strong for the duration of 2018. They remained strong at the end of the year. We expect them to continue to remain strong, but less so. We expect growth to be somewhat above trend. Our estimation of trend growth is a long-term equilibrium rate of growth, somewhere around 2%. We’d expect it to come in slightly above that in 2019, whereas it likely came in somewhere around 3% in 2020.

This is a base case for most market participants expecting that type of slowdown. It was confusing why the market was reacting the way it did in the fourth quarter.

If you take a step back and look at things, in particular, uncertainty; and one of the ways we measure uncertainty is a metric that measures economic policy uncertainty. Questions around policy, questions around not only trade policy but also monetary policy, questions around tax reform, the dispersion of economic forecasters’ projections.

When you look at the metrics, the degree of uncertainty in the marketplace was certainly elevated. We’ve seen that play out in a number of survey results, be it household or consumer surveys or surveys of businesses where their expectations for the future are a bit cloudier than they were. We think that, and to your point, Jon, that change in sentiment, deterioration in sentiment, was behind the market moves we’ve witnessed over the past several weeks.

That said, we’ve actually seen a rebound for the month of January. Jon, you mentioned before that this was the best January we’ve seen in 30 years, right? So sentiment has a funny way of correcting itself, so I wouldn’t say that our expectations for economic fundamentals has changed significantly from where we were in Q4. It’s just maybe some of that uncertainty really has abated.

Jonathan Cleborne: I would add, and the comment you made about the 35% chance of a recession, as Vanguard recently increased that, I would take it with a grain of salt. There’s still a 65% chance there’s no recession.

Andrew Patterson: Yes.

Jonathan Cleborne: If you see the weather forecast calling for, “a 35% chance of rain,” you’re not going to change your plans. I think of that as, with the client’s financial plan and strategy, we want to make sure we stay on track, remain disciplined, but certainly take it with a grain of salt.

Kahlilah Dowe: Yes, I would just add, when I think about the idea of is this driven by emotions, and, we want our clients to avoid acting on emotion. I think for the most part they do, but there’s always some clients who feel compelled to make changes to the portfolio. But there’s some overlap when you think if it’s based on emotions or fundamentals because if you think about Vanguard saying, for example, that we expect growth to continue but that it’s going to slow down, I speak with clients who hear that and say, “Okay, so that means I should reduce my stock, right?” So it’s based on what they perceive to be market fundamentals, but it’s emotionally driven.

Thinking about the conversations I’ve had, let’s say you’ve felt comfortable with the portfolio you have until last year, the end of last year, and then suddenly you’re starting to question whether this is the right portfolio for you.

So, I mean, I don’t think that’s unusual. I think it’s okay to question, but that’s different from acting on emotion where you say, “Maybe I should make changes to my portfolio in case something happens.” We look at that as market timing, which I’m sure we’ll come back to. I think it’s easier for clients to make decisions or not make decisions, refrain from making any decisions or changing anything based on emotions if they’re clear on why they hold the investments they hold. Whether it’s 50% in stock or 100% in stock. So taking that long-term approach in thinking about why you selected the investments you have.

Jonathan Cleborne: Well, and that’s one of the things that we spend so much time talking with investors about is why are they positioned the way they are. What are their goals, what is the right way to establish their portfolios?

You know, that actually makes me want to ask another polling question quickly and get a sense for this audience tonight. When was the last time you’ve communicated with a Vanguard advisor? You can choose over a year ago, within the last 12 months, within the last 6 months, or within the last 3 months. Or some of you may not actually be using our advice services. If you could take a moment and respond, we’ll come back. That’ll give us a little bit of a flavor for how often folks are having conversations with their advisors.

You know, Kahlilah, you already touched on this, but we did get a question from James in Michigan, who asks a question we’ve been hearing often, which is, “Should I change my allocation based on current events or the probabilities of recession,” or is that timing the market as his advisor says?

Kahlilah Dowe: Yes. I think his advisor is right. It sounds like timing the market because, well, first, let me just say, sometimes if you’re listening to the news or you’re reading about these events, you feel compelled to do something. And we investors don’t know what to do. But they almost feel like they’re being remiss if they don’t do anything.

Adjusting a portfolio based on changes in world events, first, it sounds like a lot. When I think about how to keep up with a portfolio if you’re making adjustments based on that? Then I think it’s easy to get into a pattern where you’re making changes to the portfolio without a specific goal in mind. That’s when we see investors get in trouble with their portfolios.

I agree with the advisor that you definitely want to refrain from making changes to the portfolio based on world events. If you’re having trouble doing that, I’m not sure of the capacity in which he worked with his advisor, but relying on the advisor more as far as making the investment decisions and perhaps taking a step back may be a good step.

Jonathan Cleborne: Well, and that’s certainly something we want to make sure we get across tonight is that the advisors are there to be helpful to you during these times. And the poll question actually gives me hope because we, as I look at the responses that came back in, we had roughly 10% who haven’t spoken to their advisor in over a year. Somewhere in the neighborhood of about 15% have talked to an advisor within the last 6 to 12 months. Over 40% have talked to somebody in the last 3 months. So they’re taking advantage of that opportunity to get a chance to engage and reassess changes? Has anything changed about my personal situation that would cause me to want to make a change?

Bryan Lewis: And I think clients know what we’re going to say before they call us, but they need to hear it from us; and that’s what Kahlilah and I are here for, as a sounding board, to reiterate we’re still holding true as far as the long-term plan. We’re not going to change our strategy. Did your circumstances change? Well maybe, yes, that’s a reason to make changes. But if you’re reacting to Kahlilah’s point around emotions, well then we should stay the course.

Jonathan Cleborne: Yes, and maybe to build off that question, so Gary in Gainesville asked, “Do Vanguard advisors envision making any changes to accounts during market volatility?” I think it’s hard for folks to envision that we’re going to stay put. Do you want to talk about how you think about that?

Bryan Lewis: We definitely look at, in both the rising markets and markets that are going down, opportunities to rebalance the portfolio. We won’t market-time. That isn’t something we believe in. Jack Bogle always used to talk about it. It’s a loser’s game.

But if you were to market-time, think about it, you have to be right twice. You have to know when to get out; you have to know when to get back in. And maybe you’ll do that correctly a few times, but to consistently do that over a long period is difficult, almost impossible.

So when you look at opportunity areas that, as Khalilah and I look for opportunities around rebalancing, one of the biggest things that all the advisors will do is look at where’s your current asset allocation relative to your target asset allocation? So let’s say as an example your target is 50% stock, 50% bonds, well then what we’ll look for is to make sure you stay within 5% of that at all times.

That could be as high as 55% or as low as 45% in this example. If you’re within that range, we may not make a change. But if, based on, let’s say, the performance of the market in December, you’re now at 43%, you’re outside that 5% threshold, we’d rebalance the portfolio by selling bonds and replenishing the stock. So think of the old adage: Sell high, buy low.

There’s thought and reason behind rebalancing—it’s strategic on our part to remain disciplined. There could be opportunities with that volatility at the end of the year where maybe I raised cash for a client earlier in 2018, and we triggered capital gains. Based on the markets going down, we could have maybe captured some losses to help bring down the tax liability for the client. It depends on the situation, but there are things we’re looking for. However, we’re certainly not going to market-time.

Jonathan Cleborne: Yes.

Kahlilah Dowe: I think we do a good job of making sure portfolios are well-positioned before we get to the point where the market is volatile. I’m reminded of when interest rates started going down. And, Bryan, you remember this when many of our clients couldn’t believe we weren’t recommending longer-term bonds because you couldn’t get a decent yield on intermediate-term bonds, which is what we were recommending.

We saw the same thing when interest rates started going up, and we got calls from investors and they said, “Well, Vanguard is still recommending intermediate-term bonds. Shouldn’t I have short-term bonds in the portfolio?” I think we did and continue to do a good job of anticipating that eventually interest rates will go up, eventually they’ll go down. But making sure the portfolio stays well-positioned throughout those changing markets so our clients or us, acting on behalf of our clients, don’t have to make preemptive moves.

Jonathan Cleborne: We have a question from Floyd, who asks, “Can you describe how an advisor would work with me?” We’ve talked about how we’d handle market volatility, how we’d think about positioning the portfolio more.

Kahlilah, I’ll look to you to start things off. Can you talk about how an advisor works with somebody? About 33% of the audience isn’t working with an advisor today. So maybe give them context around what they could expect.

Kahlilah Dowe: We work with our clients to help them meet their financial goals. Part of that relationship is exploring with our clients, “Well, what are those goals?” Assessing what they’re currently doing, letting them know which adjustments we think they should make. We also work with them as an ongoing partner to make sure they stay on track, to make sure that their overall financial picture, even what they’re doing outside of Vanguard, aligns with the goals that we’ve set for them.

We work with them primarily as behavioral coaches when we think about managing their portfolios. I go back to the uncertainty that we’ve been experiencing in the market lately. The majority of calls with our clients have been more so around coaching them through these difficult times. That’s one of the main ways we work with our clients. We work with clients who are accumulating assets, clients who are already retired, and everything in between.

Jonathan Cleborne: And you get all of that for 30 basis points, so it’s generally a good value.

Bryan Lewis: Yes, and I think with portfolio management, generally this is what we do every day. This is the easy part. But as a financial advisor for my client, I think of myself as a CFO, somebody helping people navigate financial decisions.

Also thing ahead, I like to say we’re very forward thinking. We’re thinking ahead as far as tax planning, estate planning considerations, just other components to that holistic wealth management, and being able to partner with that advisor that knows your situation and is able to just keep you on track in the long run.

Jonathan Cleborne: Lots of questions about the interest rate environment and our clients have an allocation to fixed income in their portfolio, and they’re curious about how that’s going to impact that allocation.

Ralph in Seattle asks, “If the Federal Reserve does do multiple rate increases this year, how might the markets react?” We’ve received clarity on that in the last couple of days. You want to talk about how we’re thinking about Fed policy now, Andrew?

Andrew Patterson: Heading into the year, we were expecting two more rate increases, given Chair Powell’s comments in December. That seemed likely, and the market, seemingly, didn’t take kindly to it.

The Fed has since walked back those comments, and, again, reinforced more of the data dependence and the optionality they have to take a look at the holistic picture, take a look at economic fundamentals, what they’re pointing to, and make decisions based on that, rather than being on a preset course.

Accounting for that, accounting for the policy uncertainty we talked about before, and the impact it could have on growth, employment, inflation—incorporating market volatility, we actually reduced the number of the hikes in terms of our base case expectation down to one. Our expectation is for the Fed to hike rates once more, likely in June.

It’s going to be tough for them to get a hike in March, given everything that’s gone on over the last few months. We think after June it’s going to be tough [to hike rates] in an environment where growth is continuing to slow reasonably. It’s still above trend, but growth continues to slow. At some point, we’re not getting as favorable labor reports as we may have been, so that’s starting to slow in terms of the labor market. It’s going to be tough for them to justify another rate hike or several more rate hikes.

In all likelihood, our base case is for one hike. If for some reason the market were to expect them—now they have different ways of communicating with the market. They have their dot plot, which is showing two hikes right now. They also have things like forward guidance, which is Fed communications.

Right now, they’re banking more on the Fed communications talking about that optionality, rather than that dot plot, which is currently showing two hikes. We think if the market starts to believe they’re going to go two, three, or even more times, that could imply there may be additional volatility.

Jonathan Cleborne: Kahlilah, I have a question for you on that front. Dennis in Elk River, Minnesota, asks, “Should my portfolio still have a significant portion of bonds in a rising rate environment?” It may be rising slower than we’d originally thought.

Andrew Patterson: Yes, I would qualify rising. Again, it’s one, two, three rate hikes. Even then we’re talking about 75 basis points, and we’re still talking about a ten-year Treasury that currently sits around 2.5% compared to historic norms north of 6.0%. So still low by historic standards.

Jonathan Cleborne: How do you talk to clients who are concerned about holding fixed income in this type of an environment?

Kahlilah Dowe: I don’t know if I’d say he should have a significant amount in bonds. It depends on his goal. We have clients who don’t have any bonds in the portfolios and some who have significant amounts.

If you’re focusing on preserving what you’ve already accumulated as part of your objective, then you probably need to have bonds in the portfolio. There’s the risk that interest rates go up and the risk that you have loss of principal. Provided you have that long-term horizon, I’m not concerned when I see a portfolio with even 50% in bonds or more if it’s warranted based on the goals.

The key is to make sure you manage the type of bonds you have in the portfolio, so we want you to have high-quality bonds. We also don’t want you to have a significant amount in bonds that are volatile or more volatile when interest rates go up. We mainly recommend intermediate-term bonds, which help to manage interest rate risk. We’re not ignoring interest rate risk, but we want to be mindful there are clients who choose to have bonds in the portfolio; and they have to because they can’t afford to take on significant equity risk. They need to focus on capital preservation. If it’s a long-term portfolio, we don’t see cash as the best option either.

Most investors need to have bonds, but you want to focus on making sure you have the right type of bonds, high-quality bonds, and you have the maturity that reflects your risk tolerance.

Jonathan Cleborne: Well, it’s not necessarily a bad thing that interest rates go up over time. You’ll see downward pressure on your principal for a time, but the good news is if you’re reinvesting the interest from those bonds, you’re reinvesting it at a higher interest rate, which will pay off over the long run.

Bryan Lewis: Exactly. And usually there’s two reasons investors will get into bonds. One’s for income and the other is more to soften the market decline—a safety net from the stock market.

If you’re a bond investor looking for income, rising interest rates can be a good thing because you’ll be compensated over a longer period. I think of it as somebody who buys a rental property. The idea is extra income. Well if I were to tell you that your tenants are going to be paying you more income each month, you’d be quite happy. You probably don’t care about the underlying value of the property unless you’re going to sell it, and the same thing holds true with bonds—you’re going to gradually see more income with rising interest rates, and that could be a good thing over time. You might see bumps along the way, but over time, you’ll be compensated. That’s why I think it’s important to maintain that discipline and have short-, intermediate-, and long-term bond exposure.

Jonathan Cleborne: Yes, so here’s a question that came in advance. William asks about Vanguard Total Bond Market Index, “Can you discuss the tradeoffs of using the Total Bond Market Index versus a shorter-duration product with bonds that are going to mature in a nearer term?” What do you think?

Bryan Lewis: The Total Bond Market Index is, by definition, an intermediate-term bond fund. So it has short-, intermediate-, and long-term bond exposure— a good core fund to use in a diversified portfolio. When you look at shifting toward short-term or short-duration bonds, for viewers that may not have a good understanding of the relationship with interest rates, so as rates go up, the price of bonds goes down. As a result, the yield goes up. An inverse relationship.

If you’re going from an intermediate-term bond fund to a short-term bond fund, you’re essentially gaining stability, but you’re giving up your income because you’re now taking on more of a stable value potentially. And when you’re doing that, most of the return on a bond fund has to come through the dividend or the yield.

Andrew Patterson: Right.

Bryan Lewis: By doing that, you’re giving up your income. Over a long period, if you look back, intermediate-term bond funds tend to pay better income than short-term bonds. So you’re taking a reduction in income, which, in a low interest rate environment, can be significant on a bond fund.

Although it’s a good idea, I’ve heard this conversation and argument for at least five years as we talked about rising interest rates. It’s important to maintain diversification. We want you to have short-term bonds but not 100% of your portfolio.

Andrew Patterson: Yes, and there’s a perception that short-term bonds are safer in a rising interest rate environment. Well, you have to take a step back and think about what we mean by “rising interest rate environment.”

The current rise in interest rate environment is defined more by Fed policy and rising rates at the short end of the curve. The ten-year Treasury has been relatively well-anchored. It hasn’t moved around as much. Therefore, clients looking to move into short-duration securities are moving into the portion of the yield curve that’s been rising the most.

Jonathan Cleborne: You know, maybe to shift gears for a minute, I’m looking at the other questions submitted in advance. Kahlilah, we talked earlier about rebalancing. Can you talk about Vanguard’s philosophy around rebalancing, and when’s the best time to rebalance and how do we think about rebalancing portfolios?

Kahlilah Dowe: Rebalancing is an important piece of managing a long-term portfolio. It’s the best way to capitalize on a major change in the stock or bond markets. Therefore, we’ve done some rebalancing as of last quarter as the market has gone down. We typically look at rebalancing every 90 days or so. So for clients that we’re managing portfolios for, every 90 days we review the accounts to determine whether it needs rebalancing. So part of it is based on the length of time that’s lapsed, but we also look at how far has the portfolio deviated from what we’re actually targeting. We want to leave room for the market to move the way the market moves. Once you’ve gone beyond 5% of the target, we look at rebalancing the portfolio to get back to the original target.

We also look at the portfolio’s inflows and outflows because we use them as opportunities to rebalance the portfolio by purchasing the asset class that’s down or selling from the asset class that’s gone up. So every 90 days, I’d say, and then after that 5% deviation.

Bryan Lewis: Yes. In addition, if you have a taxable account and you’re worried about the tax implications of rebalancing, you could redirect dividends and capital gains into cash and then redeploy that cash into an asset class in which you’re underweighted. There are many ways to look at it, but anytime new money comes into the portfolio, we use that as an opportunity, to Kahlilah’s point. Then if you’re spending from the portfolio, look at that as a way to say, “All right, if I’m heavy in stocks, maybe I take that from stocks, but let me look in the stock option to see what’s the most tax-effective way to sell stocks to generate cash.”

Kahlilah Dowe: Bryan, that’s a good point about having the income from one stock fund move into another. That’s actually one of the things I’ve used for clients who need to increase international exposure. I’m sure we’ll talk a more about that.

Bryan Lewis: Yes.

Kahlilah Dowe: The challenge we have is that U.S. stocks have gone up compared to international. When you talk about rebalancing a portfolio to decrease U.S. stocks, there’s a large tax bill that comes with that, so we’ll use the option of having dividends pay into another fund to get the additional exposure.

Jonathan Cleborne: Well, that’s a logical next conversation point for us to talk about—international versus U.S. exposure. Last year was a tough year for the international markets. It’s been a horserace so far this year. But can you talk a about, and, Bryan, maybe I’ll kick this to you, how we think about international versus U.S. exposure over time and what’s the right amount of international exposure for an investor?

Bryan Lewis: Vanguard’s recommendation is that you have 40% of stocks invested outside the United States. On the bond side, 30% of your taxable bond exposure should be invested outside the United States. We’ve changed that over the years, not because we’re trying to time the market, but markets change. We certainly try to replicate the market weightings when it comes to domestic versus international. If you look at the market weightings, there’s a larger international exposure. They’re about half-and-half, but recognizing we have a home bias, we want to focus on having some international.

U.S. stocks have done well for a number of years. And international has struggled. This might be a good opportunity if someone is light on international to use this as a chance to move into international, but be mindful of any tax implications. And to Kahlilah’s point about using dividends, maybe capital gains, redeploy that into international.

The dollar has done well. And having exposure outside the dollar through international stocks is another way to diversify a portfolio. Because if you look at the various sectors within the international markets, they have different weightings relative to the U.S. market. So when you start moving dollars overseas, you’re starting to diversify those different sectors and you’re gaining exposure to large companies invested overseas.

Jonathan Cleborne: Yes. It makes sense to maintain that diversification more broadly. I think that’s one of the things you tend to hear from Vanguard, and that’s an important component.

Andrew Patterson: It’s a big part of our outlook for last year and again this year. One of our big calls was trying to highlight the benefits of international diversification and what you might miss from not even diversification but a return perspective by not holding international securities based on our assessment of our outlook for returns over the next ten years on an annualized basis. For non-U.S. equities, we’re talking about 200 basis points more than our domestic equity expectation. Outside the diversification benefit, where if you held a 60/40 portfolio of domestic versus international stocks, you would have been down in the current downturn 1% less than you were if it were 100% domestic stock. That tends to compound and build over time, not to mention our expectation that over the next ten years on an annualized basis, you’re likely to see international equities outperform.

Jonathan Cleborne: Andrew, can you talk about how you all create that outlook? It’s an important concept for folks to understand—we’re doing the research. We’re thinking about what that outlook should be and we factor that into people’s plans. We can talk about how it factors in shortly, but do you want to talk about how that outlook’s actually created?

Andrew Patterson: Sure, absolutely. One of the things that we rely on, and it’s not a crystal ball, right? There are no crystal balls in finance and economics. But one of the things we rely on when we’re forming our equity return expectation is valuations, right? In particular, price-to-earnings ratios. How much are you spending for each dollar of earnings? And one of the historic norms is to compare valuations to where they are relative to history—historic average.

If you’re looking at a historic average of price-to-earnings ratios and comparing today’s price-to-earnings ratio to that, what you’re inherently assuming is that there’s been no structural changes in financial markets or the economy over the entire duration over which you’re taking the average.

People go back to 1926. I have a hard time believing there have been no structural changes in financial markets or the economy since 1926. We take a fair-value estimate. We estimate the fair value of the price-to-earnings ratio. What should the price-to-earnings ratio be accounting for? Yield on the ten-year Treasury, inflation and inflation expectations, those factors representing financial markets and current conditions and expected conditions in the economy.

Look at the fair value of where we would expect the price-to-earnings ratios to be, and we see U.S. equities are above that. The degree to which they’re elevated has actually come down given the recent downturn, but they remain elevated, particularly when you compare those to our fair-value estimates and the current price-to-earnings ratios for non-U.S. international equities.

That’s a big reason why we believe that over time international equities are going to outperform—price-to-earnings ratios are going to return to fair value and, in doing so, you’re going to see likely price increases.

Jonathan Cleborne: When we talked earlier, we said, “Well, we don’t make market-timing calls.” So it’s a good perspective to have. But how does that actually translate into the plan and into the portfolio we construct?

Bryan, do you want to talk about how we think about longer-term projections of market returns and how that plays into how we assess how a plan is constructed?

Bryan Lewis: We stress-test all of our clients’ portfolios through above average, average, or below average market return. We look through all these different components. And we actually find with international particularly, when you combine that with U.S. exposure, it actually helps to reduce risk over time. I want to help my clients get from point A to point B with the least amount of risk. And when you add those international components, over time, you create less risk.

There are periods when having international makes the portfolio more volatile, but over a long period, it’s helped reduce that risk. That’s what we’re trying to do through the Monte Carlo analysis—look through all these different scenarios to say, “Based on 10,000 different simulations, you’re on track.” Or: “No, we need to start saving more for this.” And it takes into account the assumptions we’re making about domestic, international, to Andrew’s point, that we’re feeding the engine and then translating it into 10,000 simulations for our clients.

Jonathan Cleborne: That’s great. I think it’s important for people to understand, to reanchor clients on the notion that your plan is built for all market and economic conditions.

Kahlilah Dowe: Right.

Jonathan Cleborne: As we look at goals, we put a likelihood of success around a goal; and that likelihood of success accounts for market environment like the ones that we’re in.

One thing to think a about for a second is we’ve been talking about the portfolio and how we try to make sure investors are well-situated. When I think about the conversations that we’re having with investors, we’re talking about other things with them too.

Another viewer asks, “Can Vanguard help me think about Social Security and how to approach Social Security?” Kahlilah, can you touch on how we help investors think through that dynamic?

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

Many of our advisors are also Certified Financial Planner (CFP®) professionals. Like Bryan said, we look at ourselves as comprehensive advisors—CFOs, I think you said—of our clients’ financial situations. Part of that is helping them through deciding when they should take Social Security, especially if they’re filing with a spouse. Also, looking at their health care costs and helping them to assess what those costs may be.

Jonathan Cleborne: That’s been a newer capability we’ve rolled out recently to help investors assess, “Well, when I get into retirement, what should I expect my expenses to be?” It’s usually one of their biggest expenses, right?

Kahlilah Dowe: Exactly. And when you think about helping them through life, that’s a major decision they’ll make. So when to take Social Security, how to think about health care, especially if they’re coming up on retirement and they’re not Medicare-eligible yet. Those are the main things we cover.

But we also look at making sure they have the right estate plan in place. So if they have an estate plan, we give them our thoughts if we see something glaring that maybe they haven’t accounted for.

We’re not tax consultants, but we often work with our clients’ tax advisors to help them consider other things outside their investments.

Bryan Lewis: And there’s other things that we will help clients with. Investments is the easy part for us because that’s what we do all day, every day. But when you look at a couple years out, how are you going to account for a lower income, why don’t we start thinking about Roth conversions? How did the recent tax reform affect you? You’re in a higher tax bracket now. Let’s think about Roth conversions now rather than maybe delaying until you’re required to take a distribution from an IRA. So there are other opportunities that we will focus on with our clients after we know what their goals and objectives are, but we’re also forward-thinking about other opportunities that may influence them, not only now but in the future.

Jonathan Cleborne: Charles asks, “All these discussions seem to be relative to longer-term investments. But as retirees, we’re interested in how to grow and protect our assets, in many cases, for the shorter term. So can we please address that?”

When you think about the differences for a portfolio for somebody who is further into retirement relative to how you’re thinking about somebody who’s preparing for retirement, how do you help somebody who’s in retirement get comfortable with these dynamics?

Kahlilah Dowe: Part of what we do in helping clients as they progress throughout their lives is getting them comfortable going from a place of “I’m accumulating assets, I’m saving, I’m investing when the market is going down,” to a place of “I need to sell assets from my portfolio, I need to focus more on preservation, and I’m not adding when the market is going down, and I may even have to sell assets.”

So part of it comes down to, and I think this goes back to the question around bonds, making sure you have the right asset allocation so you’re focusing on preserving what you’ve already accumulated, making sure that you have enough cash set aside in the portfolio so you’re not relying on the portfolio’s current market returns for living expenses.

But I think another part of what we do is just help clients see how we envision it playing out. Because I think that’s the challenge for investors. It’s difficult to look forward and see. I know I worked, and I got paid every two weeks. How do I envision myself getting income from the portfolio?

What we do is to lay out a plan for them to see—these are your income-oriented investments. This is how I expect to generate the income that you need from your portfolio. But it’s also helping them see that even though you’re retired, this is still a long-term portfolio. Right?

What we do is to lay out a plan for them to see—these are your income-oriented investments. This is how I expect to generate the income that you need from your portfolio. But it’s also helping them see that even though you’re retired, this is still a long-term portfolio. Right?

Jonathan Cleborne: Right.

Kahlilah Dowe: So we want to make sure we’re not focusing too much on the short term. If you retire at age 65, you may live for another 20, 30 years.

Jonathan Cleborne: Thirty, yes.

Kahlilah Dowe: Right? Possibly more than that. Even though it’s important to make sure we have a plan in place for the short term, it’s also important to keep that long-term perspective.

Jonathan Cleborne: Yes, you can lose your purchasing power over time if you’re not careful as you see inflation in the broader market.

Maybe to shift gears, one of the conversations we’ve had recently is about clients unnerved by the market environment and were thinking about taking a little bit off the table; maybe moving some money into cash. Bryan, have you been having these conversations? How have you been approaching them?

Bryan Lewis: Yes. Less this month with the return …

Jonathan Cleborne: Yes, fair enough.

Bryan Lewis: Throughout the fourth quarter [of 2018], it came up quite a bit. And it’s natural; investing is emotional, especially when you see your portfolio going down in value. That’s not something I want for my clients; nor do clients want to watch the assets go down in value. It’s crucial that investors have a plan in place. So if you don’t have one, you should create a plan.

And what I mean by a plan is you need to identify what your goals and objectives are. You need to identify your horizon for this money, what your target asset allocation is; identify how often you’re going to save and what your rebalancing strategy will be. Think about budgeting, too—your income and your expenses throughout retirement, which is crucial for people approaching retirement or stepping into retirement—because that gives you peace of mind knowing what you’re spending.

Think of the financial plan as a roadmap or blueprint throughout retirement. It’s going to help you navigate twists and turns in the markets like what we saw in the fourth quarter [of 2018]. But with the financial plan, it’s there; it’s something you can fall back on. And if you feel tempted to make changes, take a step back and think if your circumstances have changed.

If the answer is yes, maybe we should make a change. But if it’s a reaction to what’s going on in the market, well, you probably shouldn’t make that change.

Jonathan Cleborne: That makes sense. I think that’s been generally one of the things that, yes, you’re right, it’s actually got a little quieter over the course of the last couple of weeks, but it was something we were seeing a lot. And who knows, we certainly could see it again.

Let’s shift gear to a question we’re asked a fair amount: annuities. Are they a reasonable alternative given they tend to have more stability relative to a market with a degree of volatility?

Bryan, how do you talk to clients about annuities?

Bryan Lewis: You have to be careful—investors will buy an annuity or look into an annuity because they help provide downside protection.

Another reason you’d want to look at an annuity is if you’re trying to have a predictable stream of income throughout retirement. But it comes at a cost, so depending on the type of annuity you have, you could have investments with high costs. There could be surrender fees. There could be, if you add on riders—like an inflation rider to keep your payments up with inflation—that comes at an extra expense as well. So you have to be careful.

Annuities can be a reasonable option. You have to aware of the all-end costs. If you look at an annuity, look at an insurance company that’s reputable, but be aware of the hidden costs. So what I mean by that is if you have an indexed annuity that tracks the S&P 500, there might be a cap to how much you can earn. So, for example, if you have an annuity that’s capped at 6%, well, if the S&P returns 10%, well, you’re only going to get 6% of that 10%. So every annuity is different.

Check under the hood and read the documents because they can be confusing. There are times when annuities are appropriate, but our approach is that you can likely accomplish what you want through an annuity by using low-cost, diversified mutual funds, having enough cash to cover an emergency, as well as if somebody’s retired, maybe a year’s worth of expenses on the sideline in cash and then have a balanced portfolio of bonds and stocks through low-cost mutual funds. And that would help you throughout volatile times.

Jonathan Cleborne: Yes, that makes sense.

Kahlilah Dowe: I’ll add that, as with any asset class, you want to make sure you know why you hold the investments you hold in the portfolio. Whenever I work with a client who simply transferred an annuity to Vanguard from an outside institution, one of the first questions I ask is, “Well, why did you purchase this annuity to begin with?” And I can honestly say the majority of the people I speak with don’t remember. Really, they don’t remember why they purchased it. And a lot of times, honestly, it was sold to them more so than them seeking it out. So I think that’s an important piece as well. If you decide you want to go in that direction, make sure you’re clear on the purpose the annuity serves.

Jonathan Cleborne: Well, I think, amazingly enough, we’re almost out of time. Can we do a quick round of final thoughts for the audience? Given the backdrop of the broader markets, given the questions you’ve heard, what are some things you’d love for folks to leave with?

Andrew, I’ll kick it over to you first.

Andrew Patterson: Sure. We talked about our expectations for the economy, our expectations for financial markets. I think it’s important that anytime you’re assessing your expectations or asking somebody else for theirs, think about it in a probabilistic and a scenario-based framework where there’s an X% probability that growth is above or below a threshold. Rather than going out and saying, “I believe growth is going to be 2% next year,” you think about the risks of growth coming in below 2% and growth coming in above 2% and what that could mean for your portfolio. But, again, that’s a conversation for you to have with your financial advisor about well maybe it might not mean as much for your portfolio if you start to consider things like goals.

Kahlilah Dowe: Yes, and I would just say just based on what I’m hearing from clients, there’s this sentiment that we’re experiencing unprecedented uncertainty right now. And that may or may not be true, but we’ve seen instances where the market has endured what we’ve thought were catastrophic downturns, and it’s proven its resiliency time and time again even after that.

If you’re certain your portfolio is structured in a way that reflects your goals, your risk tolerance, you should be okay to endure those ups and downs.

Jonathan Cleborne: Yes, in some ways, we’ve almost been conditioned. I think back to a year ago. I saw a stat the other day about four days the market moved by more than 1% in 2017. So we’ve been conditioned to expect nice, steady environments. And, in many ways, what we’ve seen recently, it’s more of a return to normal. It’s actually much more in line with the types of ups and downs you’d typically expect in a market. So it’s interesting to think about how the conditioning of that environment may have affected us and you forget that’s what you get with investing.

Kahlilah Dowe: Right.

Andrew Patterson: Right.

Jonathan Cleborne: Bryan, closing thoughts from you.

Bryan Lewis: Yes. I would say, you know, it’s natural to feel like you need to do something, but sometimes it’s okay to do nothing. So when you look at what we’ve seen recently, go back to that plan. And as I mentioned, if you don’t have a financial plan in place, you should certainly create one. And we’re here to help, so if you have any questions, feel free to give us a call. That’s why Kahlilah and I are talking to clients all day, but we’re that sounding board, we talk through things. But stay disciplined (sometimes that takes patience) and maintain a long-term perspective.

Jonathan Cleborne: Great. Well, we’ve covered a lot of material tonight, so thank you all for your perspectives and for your guidance.

And thank you all to the members of the Vanguard community for joining us. To those of you who may be new to our webcast, we appreciate you tuning in. For those of you who’ve come back, it’s great to have you.

If you’d be gracious enough to share a few more seconds of your time, we’d be grateful if you’d select the red Survey widget. It’s the second from the right at the bottom of your screen. We truly value your feedback on tonight’s webcast and welcome your suggestions for future topics you’d like us to cover.

In a few weeks we’ll send an email with a link that’ll have a replay of tonight’s webcast as well as links to highlights from tonight’s discussion. We’ll also include transcripts for your convenience.

Be sure to check out our podcast series The Planner and the Geek, featuring Vanguard’s own Maria Bruno and the Geek, Joel Dickson. You can go to the first link on the green Resource list and listen to an episode.

We’re so glad you spent your evening with us, and we sincerely hope you benefited from the conversation. We encourage you to continue the conversation with the Vanguard community on our social channels: Facebook ( and Twitter (@vanguardgroup).

On behalf of Kahlilah, Bryan, Andrew, and all of us here at Vanguard, thank you and have a great night.


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