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Gary Gamma: Hello, I’m Gary Gamma. Welcome to our live webcast on the “Keys to a Successful Retirement Plan.” Today, we’ll discuss why setting goals is so important, how to identify risks that can derail you, and how to replace your paycheck. Joining us today to discuss these important items are Kahlilah Dowe, a financial planner in Vanguard Personal Advisor Services, and Jonathan Kahler, an investment analyst in Vanguard Investment Strategy Group. Welcome to you both.

Kahlilah Dowe: Thank you.

Jonathan Kahler: Thanks, Gary.

Gary Gamma: If you’re not familiar with our format, we’ll spend most of the broadcast today answering your questions. But there are two items I’d like to point out first. There’s a blue widget at the bottom left of your screen if you need technical help and a green widget at the bottom right if you’d like to read some of Vanguard’s thought leadership material that relates to our topic today. Sound good?

Kahlilah Dowe: Sounds good.

Jonathan Kahler: That’s great.

Gary Gamma: Great. Now, before we get into our discussion, we’d like to ask the audience a poll question. On your screen now, you should see that question, which is, “Which of the following best describes your situation? I have a plan to help me achieve my retirement goals, I don’t have a plan for achieving my retirement goals, but I understand how to formulate one, or I don’t have a plan to achieve my retirement goals, and I’m unsure how to begin.”

Please think about that, give an answer, and we’ll check back on those answers in a few minutes. Kahlilah, why don’t we get started and go with the first question.

Kahlilah Dowe: Sure.

Gary Gamma: So, we’ve got a question from Roger in California, who writes, “What are the nuts and bolts of actually replacing your paycheck, not just the numbers, but what do you actually do?” So maybe he has multiple accounts, order of withdrawals. What do you do there?

Kahlilah Dowe: Right, that’s what it sounds like, and that’s a great question. It’s one that we get all the time. So let’s say you’ve accumulated or you feel comfortable that you’ve accumulated what you need in order to retire. The question becomes, okay, well, how do I get the income that I actually need? So when you think about replacing the paycheck, I think there’s another question that comes with that. And really the first question, which is how do I get the income that I need to cover living expenses? And that’s important because it can be very different than replacing a paycheck. But I think that’s how most investors look at it, like I’m coming from getting a paycheck every week or every two weeks. How can I keep that going?

So I’ll speak with clients who will often say to me, “I need to get $100,000 from my portfolio every year.” And I may say, “Okay, but how much do you actually need to cover your living expenses?” And it’s often a very different number. It’s maybe 50 or $25,000. So I think that’s part of it.

The other thing is I think most investors think in terms of having the portfolio generate income, so the question becomes how can I structure my portfolio so that it generates a certain amount of income, and how can I keep that income going? And I usually think in forms of dividends when you think of it that way.

The nuts and bolts of it is usually a combination of a few things. So if he has, let’s say, a taxable account, an IRA account, a Roth IRA account; for my clients, let’s say, I’ll just use a real example. Let’s say we need $50,000 from the portfolio. That’s usually a combination of taking the income that the portfolio generates and then selling shares from a taxable account if we have to. Sometimes the income is enough.

If you’re, let’s say 70½ and you have required minimum distributions, that’s often the first source of income. And then if you have a Roth IRA, then we look at maybe spending from that last. So it really depends on the types of accounts that you have first and then a combination of income and selling shares as you need to.

Gary Gamma: So the next question, I think, kind of ties into this whole equation; that’s Stephen in New Jersey said, “How does an individual really know how much they’ll need in retirement? How do you determine your goals?” So related to everything you just said, how does one start the process to really figure out how much they’re going to need?

Kahlilah Dowe: Right, and that’s the million-dollar question. It’s the one that I get all the time, and I think it, so you start asking that question long before you get to retirement. So let’s say ten years out, you should be thinking about, okay, one, what am I going to use this money for? So what are my goals? And then based on that, it’s going to help you decide how much you need. And really, it comes down to the expenses. That’s the main thing, and I think that’s important because I speak with many investors who say, like, “Someone I know needed at least to have, I should have at least $2 million” or “Someone I know couldn’t retire with 1 or 500,000.” It really comes down to how much you plan to spend in retirement. That’s what’s going to drive how much you need to accumulate.

And then, also, I think it’s a matter of testing the portfolio. And we say that a lot because there’s really no way to know outside of using some assumptions around spending, around market returns, around how long you may live. So how long does this portfolio need to last me?

The other thing is, you know, do you plan to spend this money down during your lifetime or are you trying to pass it on to heirs or are you doing some gifting? So you really have to think about your goals first, and then that’s going to help you to kind of back into how much you actually need to meet those goals in retirement.

Gary Gamma: Let’s take a look at the poll results. So 74% of the audience, pretty significant portion there, said that they do have a plan. Now, we’re going to try to talk to everybody here, including those that don’t know where to begin. But does that surprise you that that high of a number actually has a plan to help achieve those retirement goals?

Jonathan Kahler: I think it’s great to hear and, hopefully, with the other 24, 26% we can help them get started at least.

Gary Gamma: Okay, well, we want to ask you another poll question as well: “Which of the following is most likely to prevent you from achieving your financial goals for retirement? A market downturn, not having assets to pay for health care, outliving your assets, significant unexpected expenses, or unfavorable changes to tax rates and/or public policies that impact retirees?” So think about that for a moment, give us an answer; we’ll come back to that question in a second.

Jonathan, I want to bring you into the discussion here. Bill, from New Jersey, writes, “What are the potential risks in a retirement plan and how to avoid them by planning ahead?”

Jonathan Kahler: Yes, and, unfortunately, there are quite a few risks that could derail someone’s retirement plan. Some of them are exactly kind of what we’re mentioning here in the poll question.

A lot of it has to do with the uncertain nature of the time horizon that we’re really planning for. So we have, we’ve got personal risks, which could include unexpected health care expenses or the early death of a spouse that may have financial implications. On the flip side of that, you could have longevity risk, so the risk of outliving your assets or living so long that there’s a risk of outliving your assets.

Then you also have more fundamental risks, so market risks, experiencing bad returns early in retirement, the risk of unexpected high inflation, or tax and policy risks, as we mentioned. So I think it’s really important to think through that and kind of get a personal risk assessment of what really risks you’re most sensitive to and really think through how you can plan for each one of those.

We talk about market risk. You know, we can make sure that we have an appropriate asset allocation, that we have a good mix of stocks and bonds that we’re really comfortable with the risk and return trade-off over a long-term period. If we think about inflation or longevity risk, we can look to make smart decisions with how we use our guaranteed income sources like Social Security, for instance.

Gary Gamma: So you talked about trying to figure out your time horizon. That’s one of the problems. What about health care issues, long-term care? How does that factor in?

Jonathan Kahler: Yes, and that’s really one of the more difficult issues to plan for, right? A lot of people are under the impression that Medicare will cover long-term care costs, and that’s really generally not the case. When we look at research around this, we see that about half of us at some point will need to use the services of a nursing home. Most of those stays are going to be short-term in nature, but about 10% of individuals—it’s a little bit higher for women, a little bit lower for men—but about 10% will need to have long-term care services for three years or more. And that’s really where those expenses can really add up.

So I think it’s important to kind of think through what your personal risk is there and how you would want to handle that scenario, whether it’s the purchase of long-term care insurance, which may be appropriate for some individuals, or if it’s a matter of setting aside assets and self-insuring that need.

Gary Gamma: Yes, no, that’s a tough one. I’m dealing with that situation now with a member of my family in a nursing home. Do you hear these kinds of concerns in your discussions?

Kahlilah Dowe: I do, and I think this is probably the most anxiety-provoking kind of question. Like what about health care, what about long-term care, how can I plan for that? Especially for individuals who are fairly healthy and they have no idea when or how much they may have to pay out for those types of costs.

And some clients have health savings accounts that they use, that they’ve specifically set aside to cover or to start to cover some of those costs. But most investors just say I have this nest egg. It’s going to have to cover all of my expenses, and that’s probably going to be health care and long-term care as well.

And one of the ways that we try and deal with that is to just think about it in the context of your overall spending, and so I think it’s important to have a range where you know what you can spend at the high end and what you can spend at the low end, based on the assets that you’ve accumulated and also based on a projected time horizon.

And so for many investors, they’ll just say, “You know what, I may be able to spend $100,000 per year, but rather than doing that, I’ll go with more like $75,000 as a way to give more of a cushion for unexpected expenses.”

Gary Gamma: Yes. Let’s take a look at the poll results. I think about almost a third of the audience agrees with this general idea. Significant unexpected expenses is a big concern, as well as a market downturn. But then fairly equal numbers on the other ones as well. Any surprises there that people are really concerned about?

Jonathan Kahler: Yes, I think that’s similar to what we were talking about earlier and what we had expected on that one. And, really, yes, it’s kind of the ones that are really the most hard, difficult to plan for.

Gary Gamma: Yes, well, let’s get back to the questions. So Glen from New Jersey wrote, “How do you budget for large, unexpected outlays? For example, a major medical expense.” So kind of building on this topic, how does one actually get to the point of actually doing something about it?

Kahlilah Dowe: Yes, so I think part of it touches on what we just talked about where you, some investors will compartmentalize and say, “This portion of my assets is earmarked for those sorts of expenses” or some will say, “I haven’t included my home in my planning. If push comes to shove, I could use that to cover those types of expenses.”

But really, I think, a more effective strategy for managing those expenses is to just demonstrate some flexibility with the spending. And that leads to other things, but I think coming up on retirement, if you could have as little debt as possible, especially when you think of those big-ticket items like mortgages. If you have very little of those expenses, it gives you a lot more flexibility for unexpected expenses in general, including medical expenses.

Gary Gamma: Yes.

Jonathan Kahler: I think Kahlilah mentioned having the home as the resource of last resort, and that’s often quite common, especially if you think of kind of having to transition into long-term care. You know, that could be a resource that you’d be able to tap the equity in one’s home for that.

Gary Gamma: Yes. We have a live question that came in—I think trying to clarify what you meant by test the portfolio.

Kahlilah Dowe: Yes. So there’s a lot of tools that are available online, even on the Vanguard website, where you can test your portfolio. When I say your portfolio, I mean the amount that you’ve accumulated against different levels of spending. So you may just kind of plug in the numbers and say, “Okay, I have X amount of dollars today. If I’m planning to live until age 90, what’s the maximum amount that I can spend?” And part of that will include some assumptions around return and market returns. And why I really like the idea of testing is because you can use conservative market returns where you assume that you get, let’s say, no more than 5% return or you can use something more aggressive. But either way, it gives you that range when you think about what you could spend at the high end or the low end.

And I think it’s important to know that going into retirement because you may have some years where you’ll say, “Okay, the market is doing very well, so I’m going to spend a little bit more than what I would normally spend, but in years where it may not do as well, you know, knowing what the low end is as well.”

Gary Gamma: Another live question. Jonathan, maybe you want to tackle this one. “What are the pros and cons of relying on dividends and interest as a retirement income strategy, and what to do about it?”

Jonathan Kahler: Sure. Yes, I mean dividends and interest are going to be an important part of your return, but it’s not the only component of your return. A lot of times people will try and target a certain income amount for the portfolio. If they need a certain amount of spending, they may kind of structure their investments so that it’s expected to generate that much income.

I would caution against that to some extent. Income is one part of the return, but then you also have the capital appreciation as well. And sometimes if we target a certain income amount, that can maybe throw the portfolio out of whack and get it concentrated in certain types of investments that may put the portfolio at a greater loss, a greater risk of principal loss.

Kahlilah Dowe: And that’s one of the conversations that we have fairly often in the beginning when you think about retirement, as well as throughout retirement, because I think for many investors, when they think about— So going back to the question about the paycheck, the dividends, the interest, it’s most like a paycheck than anything else. And so many clients feel as though they have a lower chance of running out of money if they can clearly see the dividends and the interest coming in and if they could live off them.

I’ll tell you, it’s rare that I see an instance where dividends and interest cover all of the expenses, so I think going back to what Jonathan said, it’s important to remember that it’s not your only source of income and it doesn’t have to be.

Gary Gamma: Yes. So we talked about a few things people should do, and I think this next question starts to dig into that a little bit more. Rosemary from Louisiana says, “Please give us a checklist of the major financial tasks to be completed before retirement.” Do we have sort of a template there or a checklist somebody could use?

Jonathan Kahler: Yes, I don’t know if there’s a universal list, but it’s definitely important to start that planning as early as you can and while you’re still working ideally. I think it’s, as we talked about earlier, it’s really have well-defined goals for retirement. Those may change over the course of your retirement, but really have a sense of what are the kind of predictable, known expenses that I’m going to have to cover on a monthly basis? What are the maybe more aspirational expenses? If you want to travel, spoil the grandkids, however you envision that phase of your life to be. And then kind of understand or have a realistic framework of what those unexpected expenses might cost, to be able to plan for that.

From there, it’s really a matter of taking a look at what your resources are that you’re bringing into retirement. So kind of understanding how the savings you’ve accumulated, how appropriate that is to meet that liability and if you need to maybe work longer or do some catch-up contributions later in your working career. And then understanding what other benefits you have that will be bringing into retirement—so Social Security and Medicare, understanding what those assets will provide, and how that fits into the broader plan.

Gary Gamma: So you mentioned Social Security. That was the next question, so good segue here. Maria in Massachusetts asks, “When is the best time to collect Social Security?” So, obviously, a lot of things to talk about there. Where would you start?

Jonathan Kahler: Yes, and that really is going to be one of the most important decisions for a lot of investors. It can have quite an impact.

So the way Social Security is structured, it’s going to be based on your earnings history. But then the biggest variable in terms of how much you’re going to be receiving beyond that is the timing of when you start to claim that Social Security benefit. So the full retirement age is going to be between 66 and 67, depending on your birth year, and then you can take Social Security as early as 62 or as late as age 70. So depending on whether you’re taking it before or after that full retirement age, you’re either going to have a reduced benefit or you can earn what’s called delayed retirement credits. And those can be pretty valuable. If you’re delaying between full retirement age and age 70, those credits are worth an increased benefit of 8% a year. So that can really boost the amount of guaranteed income that you’re receiving in retirement.

When we think about some of the risks that we talked about earlier, a lot of those unknowns are around longevity risk, inflation risk, and market risk. And Social Security and the way it’s structured, because it is an inflation-adjusted benefit and it is something that you can’t outlive, maximizing that can really help to hedge some of those more uncertain risks that you have to deal with.

So to the extent that you can delay, either by working longer or if you have assets that you are able to spend down early in retirement, so that you can hold off until a little bit later or age 70, that can really make a big difference in someone’s retirement planning.

Kahlilah Dowe: Yes, and that, of course, is one of the things that we help our clients with planning because it really depends on your personal financial picture. There are some clients where I’ll say, you know, definitely consider taking it early, especially in instances where there are longevity concerns. And if you’re married, that’s the other thing. So there’s been some recent changes in Social Security laws. But there are still some great strategies that investors can use to maximize Social Security benefits if you’re married.

So for clients who are older—let’s say you have one spouse that’s a lot older than another—there are times where I’ll recommend delaying the Social Security benefit so that the younger spouse could ultimately get a higher benefit.

So it really does depend on your specific financial picture. I almost always recommend consulting an advisor when you have to make this decision and just going back to the question about the checklist as well. I think when you’re coming up on retirement, I mean you have all of these decisions to make, starting with “Do I have enough? Where do I need to spend from? Which accounts? Do I do Roth conversions? Do I take Social Security?” That is a great time to consult a financial advisor, just in general, to get your good plan started.

Gary Gamma: And we know Social Security is a pretty in-depth topic, so for the audience, there is some material in the Resource widget, the green Resource widget if you’d like to read more about that.

We have a few live questions coming in. This individual asks, “What percentage of one’s annual expenses should be readily accessible, say in a bank account, and not in the investment portfolio?”

Kahlilah Dowe: What percentage of one’s annual expenses?

Gary Gamma: Yes.

Kahlilah Dowe: So I typically say six months to a year worth of living expenses. That sounds like about half, when you look at it that way. But, again, I say it depends on what your spending is like. So if you have, let’s say, a lot of fixed income sources, let’s say between your pension and Social Security, that pretty much covers all of your expenses, that may be an argument for having less in a cash position than someone who is, let’s say, almost entirely depending on the portfolio to cover living expenses. That would be an argument for having more in cash, one year, or possibly more, depending on the amount that you’re spending.

Gary Gamma: Yes, usually the emergency fund is, we talk about how many months of expenses.

Kahlilah Dowe: Right, six months to a year.

Gary Gamma: Framing it in a different way. Another question from Peter: “What role should a financial advisor play in my investing decision?”

Kahlilah Dowe: In your investing decision? That’s an interesting question. So I think of the financial advisor as kind of the quarterback for your financial planning because an advisor will be able to give you advice or, at the very least, guidance and direct you to other professionals that you may meet, like accountants or estate attorneys.

So I kind of think of the advisor as the person that’s going to kind of stand in the middle, get that bird’s-eye view of your overall financial picture, and say, “Okay, here are the things that you need to think about.”

Gary Gamma: Yes.

Jonathan Kahler: I think it depends on the client too. I mean some want to be really hands-on with their investment decisions, and there the advisor role may be just kind of acting as a backstop or a second opinion to kind of run some of those advice ideas through. Or maybe if you have a really volatile market environment, sometimes the advisor can kind of help to keep an investor on track if they’re having second thoughts about maintaining their asset allocation for the long term.

Gary Gamma: Well, speaking of asset allocation, maybe you want to expand on that a little bit. David from North Carolina writes, “Where can I find a framework or template for asset allocation?” I know we have an Investor Questionnaire in our Resource widget for the audience, but what else would you suggest there?

Jonathan Kahler: Yes, and that’s a really great place to start. I think it really comes down to understanding what your tolerance for risk and volatility is in the portfolio and what your capacity is. So when we talk about risk tolerance, that’s really kind of what can you be comfortable with in terms of fluctuation. So if you see a market environment like we had maybe in 2008, early 2009 where we had equities really, really volatile, a pretty severe downturn, having an asset allocation that would make you comfortable in a situation like that, sticking through that time, and really allowing the portfolio to rebound without being too tempted to maybe sell out of those positions.

And then the capacity for risk. You know, if you have a long-term goal, you have maybe more capacity to take equity risk versus if you have an expense that you know is going to be coming up in the next few years where you may want to take less risk there. It would also depend on what the ultimate goal of the portfolio is. If you’re using the portfolio to generate that steady income for more predictable yearly expenses, you probably want to have a different asset allocation, a more conservative asset allocation compared to a situation where you’re trying to maximize wealth for a possible bequest down the road.

Gary Gamma: I think we’re getting a lot of questions about Vanguard offering advice, and again, in the Resource widget, there is a link in there which talks about our advice services.

I think building on the point you made about changing the asset allocation back in 2007/2008, Gilbert from Texas said, “Assuming your asset allocation is correct, is buy and hold a valid option? More and more financial folks are advising to get out of the market or reallocate during bear cycles.” So, obviously, we’re not going to sit at the table here and give advice, but what do you say to that?

Jonathan Kahler: Yes, and I think what Gilbert’s really getting at there is the issue of market-timing. Generally speaking, it’s something you’d want to steer folks away from. Our research and the research of many others suggests that market-timing is usually not a profitable strategy. And if you think about it, in order to do that in a way that it enhances your portfolio value, you really have to be right twice. You have to know when to make the decision to get out of the market and then when to get back in. And that can be extraordinarily difficult to do.

Often when we see markets reverse themselves from bear markets or corrections, they also often do so quite quickly. So even missing a short period in the market can have an outsized impact over long-term returns.

Gary Gamma: Yes, when we have a protracted bear market, I think investors lose sight of the fact that a lot of the times bear markets recover fairly quickly. Sometimes they last a couple of months, so don’t think it’s going to be a few years. I’m sure you’re hearing a lot of these points when you’re speaking with individuals, right?

Kahlilah Dowe: I do, I do, especially now if we look at where the U.S. stock market is. And it’s interesting because it’s done so well since we came out of the recession that investors are kind of concerned now that, like, something could happen that could cause the market to decline some. He had mentioned, you know, selling if there is a bear market. You know, obviously, that would be the last time, a period you’d want to sell.

But he also mentioned reallocating during a bear market, and I think that’s really how you should think about it. So whether the market is doing very well and we’re in a bull market or down in a bear market, reallocating or rebalancing the portfolio I think makes complete sense.

I think from the clients that I speak with fairly often, I kind of get the sense that clients, they’re getting it a lot more. Having come through 2008 and 2009, they’ve had a chance to see the worst of the market and also the best in that it’s rebounded fairly quickly. And so I think investors are kind of understanding that even though it’s uncertain during those times, we don’t know where the bottom is; selling is not the right thing to do. They don’t always know what to do, but they know that selling is probably the wrong thing.

Gary Gamma: Yes. So you talked about rebalancing. John from D.C. said, “Any advice on rebalancing an asset mix during retirement?”

Kahlilah Dowe: During retirement. Well, I think it’s a very important strategy, especially in retirement, because it’s one of the ways that you minimize the risk in your portfolio by deciding how much you have in stocks versus bonds and making sure that it stays consistent with your investment goals, as opposed to allowing the market to determine your mix of stocks and bonds, which is, essentially, what’s happening if you’re not rebalancing the portfolio. So I think it’s a great way to minimize risk.

One of the things I’ve seen is that many investors are concerned about taxes when it comes to rebalancing, so if equities are doing well, like they have most recently, how can I rebalance the portfolio without paying taxes? And one of the things that we say is that’s one of the good things about equities doing well, that there’s really no way to get around paying the taxes in a taxable account. But rebalancing in the IRA is always an option, so it’s something that we recommend considering.

And also if you’re spending from the portfolio, that can also present an opportunity to do some rebalancing where you take from the asset class that’s given maybe the better performance and has increased that side of the portfolio.

Gary Gamma: Yes, so it really depends on what stage of retirement you’re in. There’s multiple pieces to that. And I think I mentioned it earlier, about the Investor Questionnaire, but since we’re talking about rebalancing, I’ll mention it again. It’s in the Resource widget. It allows individuals to kind of gauge where they should be at, at this point in their life because that’s going to change, and it’s going to continue to change potentially even in retirement.

Kahlilah Dowe: Right.

Gary Gamma: Jim wrote, “What are the keys to planning and managing a successful retirement while in retirement?” So I think we’ve kind of covered this in a few ways, but getting into that specific question, do you have keys that you talk about?

Kahlilah Dowe: While in retirement, okay. So, generally, in retirement you shift from a mind-set of needing to accumulate as much as you can for retirement to how can I make what I’ve already accumulated last throughout retirement? And I think there are some keys or some rules of thumb.

The first thing I would say is not to underestimate the amount of growth that you’ll need in retirement, and I say that because in many of my conversations, investors say, and I hear this very often, “I don’t have a lot of time to recover. Now that I’m retired, I have to be more conservative because I don’t have a lot of time to recover.” When the reality is, if you’re 65, for example, and you’re going to live another 25 or 30 years, you actually have quite a bit of time to recover. And over that time, you have to keep pace with inflation, and growth is an important part of that. So I think that’s one thing.

The other thing is managing taxes, and I think this becomes increasingly important when you’re in retirement because so many of the investors I speak with are concerned with generating income, almost at all costs. Like, “How can I generate as much income as I can?”

And that comes without always thinking about how much of that income am I actually keeping, and so generating income in the most tax-efficient way, I think, is important when you think about the returns that you’re getting.

The other thing is long-term care, and we touched on that some. Having a long-term care strategy in place is important, and that doesn’t necessarily mean long-term care insurance. A lot of investors feel as though they’ve kind of missed the boat if they are retired and they don’t have long-term care insurance. And that’s just one way to cover long-term care.

As I mentioned earlier, and I think Jonathan mentioned this as well, some investors use the equity in their home as a backup. Some investors spend less than what they probably could spend as a way to give themselves some flexibility with that. But either way, I think it’s important to have a plan in place.

The other thing I would say is when you think about the role that an advisor plays, that can be very important, especially going into retirement, because I’ve seen investors who are really almost not moved by market ups and downs at all when they’re accumulating become very concerned about how the market is moving, whether or not they could lose a good portion of their money when they’re not saving; they’re at a point where they’re spending, and their entire nest egg is invested.

And I think the other part of that is mistakes at that point in your life are a lot more costly than when you’re working, you’re still accumulating, perhaps you’re more aggressively invested. You could always add more to the portfolio. You’re not spending. When you get to the point where you’re retired, you’re spending, you have a finite amount of assets to last you, again, making mistakes when the market is down or selling during a bear market—they become a lot more costly.

So if you need to engage an advisor in order to avoid making those types of mistakes or, at least, like I said in the beginning while you’re formulating a plan, it’s probably a good idea.

Gary Gamma: So someone’s retired; Dan in Michigan says, “What type of investments should folks who recently retired consider?” Jonathan, you’re an investment analyst. What would you say there? Are there specific investments that we suggest steering individuals towards who are now in retirement?

Jonathan Kahler: Yes. We talked a lot about asset allocation, getting that mix right between stocks and bonds. But beyond that, there’s a lot of nuanced portfolio construction decisions to make, right?

So I think on the equity side, and really on all sides, the really most important thing is to have as broad of a possible diversification and keep your costs as low as possible. So on the equity side, that means having exposure across market cap and style, having exposure both to U.S. stocks as well as international stocks, both developed and emerging, ideally.

And then on the bond side as well, having diversification, meaning having exposure to issues across the term and credit spectrum, ideally some geographical diversification there as well.

And then there’s other nuances to consider. So if you’re in a higher tax bracket and most of your assets are in taxable accounts, then muni bonds may be an appropriate allocation as well.

Gary Gamma: Follow-up question there; James from Texas says, “How does a pension figure into my asset allocation? Is it part of the bond fixed income side?”

Jonathan Kahler: Yes, I think that’s a pretty common question as to kind of how to think about some of those other income sources in relation to the rest of the portfolio. And I think the answer really kind of depends on the individual. If you’re in a situation where you have Social Security and private pension that’s covering most of your spending needs, some people may look at that and say, “All right, that gives me the capacity to take more risk with my other assets,” and that may lead someone to a more aggressive asset allocation.

But someone else might look at that same situation and think, you know, all right, if I have my spending covered by these guaranteed sources, I don’t really need to take any more risk. So that may lead an individual in a similar situation to have a more conservative allocation if they’re just that more risk-averse and they don’t really need to generate any additional income.

But I think it really depends on kind of what goal those investment assets are really working towards. So if the purpose of those assets are to provide a backstop in case you would need long-term care insurance or long-term care expenses paid for, that may be allocated in one way versus if you’re just trying to maximize those assets for a potential bequest or to maximize discretionary spending maybe.

Gary Gamma: Yes. Kahlilah, Christine from Pennsylvania writes, “How to determine how much we can spend each year from our investments?” So we talked about replacing the paycheck. Now we’re actually talking about how much can we spend from our investments. I know 4% used to be the rule of thumb we always talked about, but lately I’m seeing a lot of alterations to that. What are we saying now on this issue?

Kahlilah Dowe: That’s right. And I still hear the 4% rule quite a bit, but we’d like to be a little bit more deliberate when we think about how much comes out of the portfolio. And I think, again, it comes back to your goals and for investors who have many purposes for the portfolio. So if they’re trying to avoid spending too much so that they leave money for heirs or if they need to cover other costs like long-term care, that’s really going to impact the percentage that you take from the portfolio.

We said this earlier, and I can’t stress it enough, I think if you don’t test the portfolio to see what it can withstand—and not just one time when you retire, I mean throughout your retirement to see how you’re doing with your spending—it’s very difficult to get a clear idea on where you stand.

For many of my clients, we’ll use what we call a more dynamic spending approach where they may come into retirement having an idea of how much they want to spend, or I should say how much they need to spend, and then based on market conditions, we’ll adjust the spending. And we use a rolling three-year average where we’ll look at what the market has done over the last three years, and we’ll say, “Okay, this year you could spend X amount.” Or we may look at it another year and say, “Okay, we should really look at decreasing the expenses.”

So I think that’s a great way to gauge how much you can spend throughout retirement. In the beginning, though, you should come in with some sort of idea on the maximum amount that you could spend, and the best way to do that is to just use those tools online, including the Vanguard website.

Gary Gamma: Yes. Jonathan, live question came in for you. “Are index funds the easiest way to diversify your portfolio between stocks and bonds in retirement?”

Jonathan Kahler: Yes, it’s certainly one way. And generally that’s going to be a little bit more straightforward. When you buy an index fund, you know what you’re getting. You’re going to get the return of that market index minus the costs. So that’s certainly going to be one of the more straightforward ways of kind of knowing what exposure you have and what diversification you have with a particular index fund. But it’s not by any means the only right answer to that question.

Gary Gamma: Right, that’s one way to do it. Another investment question. This one comes up a lot, I’m sure. Steve in Connecticut says, “What is the most tax-efficient order for withdrawing assets for retirement?”

Jonathan Kahler: Yes. And it’s, ultimately, going to be different for each individual. The rule of thumb that we sometimes use is to first spend from taxable accounts. So taxable savings that you would just have capital gains taxes when you would sell appreciated positions, and you’d pay taxes on the income of the portfolio as it comes. And then once those are depleted, you could move to tax-deferred assets—those would be your traditional IRA, traditional 401(k)—and then save the Roth assets, those tax-free assets, for last.

That really gets at trying to keep those tax-deferred assets tax-deferred as long as possible. And that may be the right solution in many situations, but there’s quite a few scenarios where it might make sense to switch that up. And that’s really an area where multi-year tax planning can add quite a lot of value. If you think especially early in retirement, so before age 70 where you have to start pulling out of those tax-deferred accounts with the required minimum distributions, that may be an opportunity to accelerate some of those distributions, maybe target a certain marginal tax bracket so that you’re reducing those accounts and having those required minimum distributions be less once they’re applicable.

So, really, the right answer is going to be different depending on what types of accounts you’re bringing into retirement and what your tax situation is, but there’s definitely a lot of room for a good advisor or a tax planner to help add a lot of value in those situations.

Gary Gamma: Kahlilah, this is kind of a specific question from Gina in Delaware. “Should I use the dollar-cost averaging strategy to withdraw my retirement funds in retirement like I did to invest?” Can you explain the dollar-cost averaging strategy on withdrawing?

Kahlilah Dowe: Yes, yes. So if you think about investing in dollar-cost averaging into the market, you could think of 401(k) contributions where you are investing, let’s say, every two weeks into the market and you’re investing under different market conditions; it’s pretty much the same thing if you look at taking money out. So if you take out, let’s say you need $60,000 for the year, you could take out $5,000 per month and use that to cover living expenses. And that could come from the stock portion of the portfolio. That’s usually what I think about the stock portion when I think of dollar-cost averaging. So it’s one way to get income from the portfolio.

I think we typically go with something that’s a little bit more conservative. We tend to emphasize more stability when we think about current income needs. So, again, using that same example of the $60,000, if we’re starting out, let’s say 2018, that’s your first year of retirement, you need to spend 60,000, I’d probably have that set aside in cash before you get to the point where you actually need to spend it because I tend to shy away from kind of depending on current market returns for current income.

But eventually you may find that you have to sell some investments with that strategy so just thinking about the order of withdrawal, so you have the 60,000 in cash that you need, but we would also look at having the income from the portfolio pay out to help replenish some of the cash that you’re spending throughout the year. So that’s the first part of it.

And then we may get to the end of the year and find that you still need additional income to cover expenses, and at that time we’re looking at selling some shares. But I think doing it that way is a great opportunity to focus on rebalancing the portfolio by being more strategic in terms of which asset you sell at the end of the year. And, again, I’ll contrast that with the dollar-cost averaging where you’re just kind of taking money out of the market regardless of what the market is doing. So it may not be the most effective rebalancing tool. You may find that you still have to do some rebalancing at the end of the year even though you’ve taken out distributions. And that could end in a higher tax bill. So it’s one way to do it, but I would say consider other strategies as well.

Gary Gamma: Yes. We have a live question here kind of based on current events, so maybe both of you want to weigh in here, but Lori asks, “Should we be adjusting our plan’s investment, strategic, or tax due to the proposed tax changes or is it too early to know what those changes might be?” So probably a lot of concern about what’s going on right now with some of the administration policies, but what are we saying on that issue?

Jonathan Kahler: Yes, I think it’s probably too early to make any kind of definite plans, but that question does highlight one issue that’s important, which is kind of having tax diversification. So to the extent that you can have assets in various types of accounts—so Roth accounts, taxable accounts, traditional accounts—that have all these different types of tax treatment, that really gives you a lot more control in retirement of what your tax situation may be and will allow you to have flexibility regardless of what that future tax environment may be.

Gary Gamma: Right. Following up on that, there’s a question from Bruce in Arizona: “What do you think of the idea to decrease your equity exposure to about 30% on your retirement day and then gradually increase your exposure to equities the older you get?” I hadn’t heard that one before.

Jonathan Kahler: Yes, I think what Bruce might be getting at is what’s sometimes referred to as a U-shaped glide path. So when we talk about glide paths, we’re usually talking about how much equity risk we’re taking on at a particular time and how our capacity for that is going to generally get lower over time. So usually you’ll start with a relatively high equity allocation while you’re still working and during the accumulation phase, and then kind of gradually move that equity allocation down to the point where you hit retirement and you have less capacity to maybe respond to market risks and market changes. So it’s more appropriate to have less equity risk at that point.

What some research has suggested is more of a U-shaped glide path, meaning as you get closer to retirement, having a more, I don’t know if 30% is necessarily the right answer, but having a more drastic reduction in your equity risk. And then as you’re going later into retirement is ramping that back up. So that’s kind of where that name comes from.

The idea there is that when you’re approaching retirement, that’s usually where your assets are at maybe their highest level before you’ve started spending from them so you’re maybe more focused on risk there or more susceptible to a bad sequence of returns early in retirement and you may want to de-risk in order to respond to that. That may be appropriate in some situations.

Where I have a little bit of trouble with that is on the assumption that you’re going to then be able to re-risk later in retirement. In my experience in the research that I’ve come across, we generally don’t get any more amenable to risk as we get older. We generally have less and less risk tolerance as we get older. So any plan that would really rely on someone having to increase their equity exposure in order to kind of get that risk-return trade-off that they would need later in retirement, I would question those assumptions a little bit.

One area where I think it could make sense is if you are delaying Social Security, for instance, but you’re not working so you have to rely on the investment portfolio a lot more for a few years early in retirement. That may make sense to have a little bit less equity risk while you’re spending from the portfolio at that higher rate and then get back into equities when you’re spending at a more sustainable rate.

Gary Gamma: Yes. So it’s a plausible strategy, but someone has to have the stomach for it. You’re in retirement; if you’re going to take more risk, know what you’re getting into.

Jonathan Kahler: Yes, and it essentially kind of moves that sequence-of-returns risk from earlier in retirement to later in retirement. So there’s trade-offs there.

Gary Gamma: Kahlilah, question from Jim who wrote, “Do bonds still have a place in a retirement portfolio with stocks? Seems like they have become closely correlated for a while rather than providing an offsetting role. Why would one select low-yielding bonds if they move in the same direction as stocks?”

Kahlilah Dowe: So that’s interesting, the idea that bonds are moving in the same direction as stocks. We haven’t seen that, especially when I think it’s counted most when you think about 2008 and 2009 when the market was down. And that’s really what we think about when we think about the correlation. So we haven’t really seen that bonds have been more correlated with stocks, so I’m curious to understand the period that he’s referring to. But they’re not completely uncorrelated as well. So if stocks are up 5%, bonds are not down 5%. We don’t see that. But I think they’re uncorrelated enough to have bonds provide some downside protection when stocks are down.

And I’m hearing a lot about whether or not bonds still make sense, in part, because interest rates are as low as they are, but also because stocks are doing as well as they’re doing. And I think there’s a lot of investors kind of getting away from the fact that stocks are still stocks and they still carry risk. And so we still look at bonds, even in the environment that we are in right now with low interest rates, we still believe that bonds provide the most downside protection to stocks when stocks are volatile. So, I don’t know. I’m interested, Jonathan, what would we say about the correlation?

Jonathan Kahler: Yes, and it may depend on what types of bonds you’re looking at. It’s not, by any stretch, a monolithic market. So if you think of the returns that you’re getting from bonds, it’s really coming from two sources. You have the return from the duration risk that you’re taking going out on the yield curve and accepting more interest-rate risk in the bonds or credit risk. And the credit risk aspect is going to be more correlated with the equity market.

Because we are in such a low-yield environment, I know a lot of investors are looking at some higher-yielding issues, such as high-yield bonds, junk bonds, and those are the kind of bonds that are going to have a lot more correlation with equity markets.

Gary Gamma: And we’re ten years removed almost from the last bear market where we really did see a strong reason behind having bonds to help out during down markets.

Kahlilah, how do you find/interview a qualified financial advisor to help in planning for retirement? I know this is right in your wheelhouse.

Kahlilah Dowe: Yes, yes.

Gary Gamma: We’ve heard a lot about the importance of advisors for some people. So how do they find one?

Kahlilah Dowe: So you can go to the Certified Financial Planning Board website to find financial planners in your area. We always say think about using a Certified Financial Planner™ because there are standards and certain requirements that Certified Financial Planners have met. So the CFP® Board website, I think, is a good place to start. Vanguard also has financial planners or certified financial advisors, so you may be able to speak with one here.

But also, like I said, if you’re just looking for Certified Financial Planners in general, the CFP Board would probably be a good place to start.

Gary Gamma: Well, time flies, and we’re out of it. Do you have some final thoughts on this issue? We’ve talked about a lot, but how do you want to close it out?

Kahlilah Dowe: So let me see, wow! We have talked about a lot. I would just say for those who are coming up on retirement, I think we’re at an interesting place in the market where this has been the longest-running bull market we’ve seen, and so a lot of investors who probably should have less in equities are pretty high in equities because they don’t want to miss where the market may go from here.

So I would just say, really, if you’re coming up on retirement, take a strong look at your asset allocation. Look at making some adjustments right now. And if I could just add one other thing, don’t worry too much about missing where equities may go. I think you kind of have to get used to the trade-off between very high returns and focusing on preserving what you’ve already accumulated here. So I think this is a good time to look at that even given where equities are right now.

Gary Gamma: Yes. Jonathan?

Jonathan Kahler: Yes, I would say it’s just important to—When we think about retirement planning, it’s not a one-time event. It’s not a plan that you set at age 65 and, you know, walk away for the next 30 years. So it’s really important to kind of revisit the plan that you’ve made and kind of make sure that everything’s working, re-evaluate those goals and those risks, and make sure you’re positioned to meet those goals.

Gary Gamma: Yes. Well, thanks to both of you for being here.

Kahlilah Dowe: Sure.

Gary Gamma: Taking some time out of your day. And thanks to the audience.

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Important information

All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss. Past performance is not a guarantee of future results.

Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling. You should consider whether you would be willing to continue investing during a long downturn in the market, because dollar-cost averaging involves making continuous investments regardless of fluctuating price levels.

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

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

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

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