Thu, 13 Jun 2013
The 401(k) is really a thrift plan that we've tried to redesign into a retirement plan, and it needs to change, says the Vanguard founder.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I'm here at the Morningstar Investment Conference.
The 401(k) industry has increasingly come in for harsh criticism. Joining me to discuss whether that criticism is founded is John C. Bogle. He is the founder of the Vanguard Group.
Jack, thank you so much for being here today.
John C. Bogle: Always good to be with you, Christine.
Benz: Jack, you always have a lot of opinions, all of them interesting. I'd like to get your take on the 401(k) system. You recently appeared in a Frontline PBS special that really suggested that the 401(k) system ought to be dismantled. What's your take on that assertion?
Bogle: Well, on the Frontline, I appeared in that show, and I was telling people the truth about costs was the essential part of it, and how to capture your fair share of market returns. They did a very good job on that to be honest. I thought it was little bit like many things we see in the press and on television--a little bit sensational at the beginning. You can talk all about how people's retirement funds disappeared almost during the market crash of 2007-2009, but that isn't everybody. But television will make it look like it's everybody. So it's certainly slanted and probably oversimplified, and probably not talking about the things that are good about the retirement system.
The essentials are that people ought to save more. It's pretty easy to say, and not so easy to do. Save more and invest intelligently.
Now the problem with 401(k)s are a couple. The big one for me is, it's a thrift plan that we've tried to redesign into a retirement plan. It was never created, the 401(k), to be a retirement plan. So you have all kinds of things that you would not put in a retirement plan, like the ability to take out money when you want to by borrowing, and the ability to make capital withdrawals under certain reasonably extreme circumstances. The ability to take all your money when you move from one job to another, as so many people in America do today. And all that flexibility and letting you have access to your accumulated capital is a terrible way to build up a lifetime retirement plan. It can't be done if you exercise those things.
The fact of the matter is, for example, if needy people could go to their Social Security account and withdraw money whenever they needed it, then they wouldn't have any retirement capital at all.
So, that's what needs to be fixed. Number one, to fix it, to make a little more, shall we say, rigid and less flexible.
Benz: But people are unhappy about the limits that are already imposed on withdrawals prior to retirement age.
Bogle: Well, that's probably because they think of it as a thrift plan. In a thrift plan, you should be able to take it out, you save money and you accumulate, and take it out, send your children to college, whatever else you might do--and that's fine. But it's not fine for a retirement plan. That's the fundamental distinction, I think. So that's one thing that has to happen.
The other thing that has to happen is--if you think about it this way, Christine, we're all indexers. Take all these 401(k) plans together and all the different funds they invest in. And they own the stock market, and they own the index. It may not be exactly, but it probably has a 99% correlation to the total stock market. But they are paying a lot of money by doing it individually, and if they did it collectively, and just put one giant 401(k) index fund into place for every retirement person in a 401(k) in America, you would save billions of dollars, and enrich investors by those billions, just by doing collectively what they're now doing individually. So today, some will be way above average in their returns, some will way below average, but they will all finally be average before costs.
So I don't think in a free country like America that you can basically say that you can only be in there with index funds. That would create a great outcry. I think it's a pretty good idea, by the way, but so far from being doable, practicable or whatever you want to say, that it's just not going to happen.
So I have suggested that we have some kind of a government federal retirement board that determines eligibility. Can your firm offer its services in that system to those investors and corporations? Are you eligible? Are you prudent investors? Are you long-term investors compared to speculators? Are you charging a reasonable fee? I don't know exactly how to set that, but certainly above the index fee but not a lot above it. And just make sure that the choices we make are limited to those that have at least a fighting chance to provide the kind of returns that people are looking forward to getting, or the share of financial market returns people are looking forward to getting. So those changes will be very difficult to do, but they really must be done if we want to create a retirement plan system out of a thrift plan system.
Benz: One would say that some of those safeguards are maybe already in place in terms of some of the ERISA protections related to 401(k) plans. Do you think they are not enough, that people aren't putting necessarily good investments inside of 401(k) plans?
Bogle: The ERISA requirements are in some ways so detailed and complex, that they don't get into, for example, cost. They are flirting with the idea of fiduciary duty, but they haven't quite got there yet, and even when they do, there are going to have to be some guidelines for what "fiduciary duty" means. So I think we're moving in a good direction, but not nearly fast enough. … Think about it this way: When someone retires in America today, they're not going to just die in a street of starvation. In the old days, it was the family that helped them, usually the children out working on the farm. We've come a long from that. But even today, you don't let your parents die, for heaven's sake. So your parents have the reserves for it. That's the retirement plan. Or the family takes care of it, or society takes care of it. And no matter what other fallback plans you have remaining, it's going to cost somebody something, pretty much the same thing. So we have to face up to that fact, and just make sure those retirement resources in an aging country are allocated in the most cost-effective, efficient way.
Benz: One other problem spot in 401(k) plans that we observe is mistimed allocation decisions. So we see participants get out of stocks in early 2009, for example, buying a lot of bonds more recently. How can we help participants make better decisions, and are target-date funds a step in the right direction from that standpoint?
Bogle: Well, we have to get investors everywhere, and not just retirement plan investors, [onto] the idea that these daily leaps and plummets in the stock market are meaningless. As I've said in more occasions than I care to count, Christine, the stock market is a giant distraction to the business of investing. Because investing is owning corporations that provide goods and services, hopefully more and more efficiently to lower prices, and that's capitalism at work. … They make earnings, they reinvest, pay dividends, reinvest the rest to build the business, that's classic capitalism. That's what I call investment return, dividends and earnings growth, dividend yields plus earnings growth in the next say decade, I usually look at.
But here we are looking at things momentarily. Decade outlooks don't change very much over time. So, we've got to get people away from looking at the market, and one of my investment rules, as you well know, is don't peak. Don't look at your retirement plan accumulations. If you don't do it for 50 years, you will be thunderstruck with the amount you have when you open that final statement. You won't even believe it. It will be sensational. By looking, all it does is distract you and get you to take action where none should normally be taken.
Corporations are going to have their ups and downs, naturally, as an economic cycle. But stocks have even greater momentary cycles, because that speculation, how much you pay for a dollar of earnings. And stocks go up and down every day, not based on a change in the fundamentals, because the fundamentals don't change every day for heaven's sake.
So, we're our own worst enemies. So we want to get a little better investor behavior, a little less excitable when things go down or maybe excitable on the upside when things go up, and a little less mournful when things go down. A good rule is, this too shall pass away in both cases--the best of times and the worst of times.
Benz: You made an interesting point in a conversation that we had about target-date funds maybe not suiting people perfectly in that they don't address the fact that most of us will receive Social Security in retirement. Let's talk about that issue?
Bogle: I've had this idea, and it's a simple silly idea like all of mine, very simple, and that is your asset allocation has something to do with your age. As you get older you've got more money at stake, you've got less time to recoup. You're going to have more need for income as compared to capital growth. And when you're younger, it's just the reverse, and also when you're younger, you don't have that much money at stake, so you have less emotion based on it. If you have $1,000 at the end of your first year at work, and it drops 50%, it's $500. It's not going to have anything to do with what your amount of retirement is.
So, the idea of age-based thinking about retirement is, I think, correct. The idea of doing it--and I've said this for a long time although I don't think most people read very carefully--is that it's a rule of thumb. It makes sense in every logical way. But it can't be overdone, and one place I believe it is overdone is, we've set up just about every … target-date fund as if it were all of your assets, and it isn't all of your assets. Most of us at least have Social Security, and some have good pensions, good meaning that the company will endure and continue to pay it, and other sources of income. So, it shouldn't be taken in isolation; you should look at your whole financial picture. What that means is, to give you the typical example, if you want to look at the value of your Social Security, the capitalized value of that future stream of payments, which is a great future stream of payments, Christine ...
Bogle: Probably as good as you can get. It's pretty high and is adjusted for the cost of living…
Benz: It's guaranteed.
Bogle: … and the issuer is, I assume, in spite of what Standard & Poor's might say, money good. So it's a terrific plan. If you capitalize that stream of future payments, most people's Social Security is going to be worth $300,000 or $400,000, let's say $300,000 for an average investor. So, if he has $300,000, which is a lot of money in this market for families in those circumstances, if you have $300,000 all in equity funds, even equity-index funds, and $300,000 in Social Security, you are already at 50-50, fixed income over here, and variable income over here. So, the variable side, you should take account of the fact that income doesn't vary very much. Dividends grow, corporation earnings grow, America grows over time, and we have some productivity improvement usually year after year, not every year, but over time. We have population growth, a few other people do, a lot in the U.S. now based on immigration.
So, GDP will grow, and I'm almost certain, particularly with 35% of the labor force employed by government. We employ ourselves. I'm not sure about that, but that's the concept. So, it's a good idea to take into account. So if you had $300,000 all in equities and $300,000 in Social Security, you're 50-50, you're almost there. When you hit retirement at 60, you should be 60%, using the harsh rule, you should be 60% in bonds and 40% in equities. So, we just have to get used to that way of thinking, and people should be much better educated in all of that.
Benz: Absolutely. Well, Jack, thank you so much. It's always a treat to hear your insights.
Bogle: Good to be with you always, Christine.
Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.