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By Christine Benz | 10-17-2013 08:00 AM

Bogle: Target-Date Funds Have a Flaw

The Vanguard founder says many target-date vehicles are underallocated to equities, and investors need to consider combinations of dividends and other retirement income when setting a specific target date.

Christine Benz: One thing I'd like to get your take on is I often talk to investors who say they want an advisor, and it often comes up in the context of, "I know I won't live forever, I’m comfortable managing our portfolio, but I would like my spouse to have someone take this over, because he or she has no interest." So, I'd like your take on the question of, do most investors need an advisor and how do they begin to conduct due diligence on advisors because it's difficult and there's kind of a lack of transparency?

John C. Bogle: Well, when you think it all the way through, and I try to be pretty balanced about this, I think an awful lot of investors do, in fact, need an advisor. Getting started in investing, for example, if you've never invested before. I can tell you a young person, for example--and I do tell them when they're getting out of college and they're trying to start an IRA or employee savings plan, a thrift plan--just buy a total stock market index for five years and then let's talk about it. You can't go wrong doing that. If the market goes way down, well, how much do you have at stake? Maybe $3,000. It's a drop in the bucket compared with the long run. So, that's the way to start and get used to the market.

Benz: How about target-date funds? Wouldn't that arguably be a good solution for someone like that?

Bogle: Well, I worry about target-date funds, and I've raised this issue and not gotten many responses. But target-date funds, I think, have a flaw, and that is there should be some consideration when you set your target date as to what you will receive from Social Security in particular. I think the math is that if you're a high-earning investor and defer your Social Security payments until you're 70 or 70 1/2, the capitalized value of that Social Security is something like $500,000. And if you're a lower-income investor, an average-income investor, and you retire and start taking payments at 62 1/2 or whatever that number is, the pool is worth, I think, around $300,000.

So, there's an asset, and truth told, it is a fantastic asset. It's got a nice interest rate with an inflation hedge. I'd say it's easy enough to fix the system if we just have a political will to do it. The economics are not that difficult to fix the system. Social Security I regard as safe. If you've had a good company pension, I don't know exactly what that is.

Benz: It's a dwindling share.

Bogle: Yes. If you've got a good one, these are factors to take into account. So, taking let's say $400,000 as the central value of Social Security, it's not this easy because you may die the next day and then all of a sudden--well, I'll give you this example. So, you have $400,000 in equities, 100% of your investments are in equities, $400,000; $400,000 in fixed income in the form of Social Security. And you're 50/50. I mean, people ought to at least do that math and, yes, it's not quite the same. You've got to think about longevity and all that because Social Security is not a permanent asset, and your investments, we hope, are. But at least it ought to be given consideration.

So, I'd say, when you think about Social Security, an awful lot of people in this country using target-date funds are underinvested in equities, and maybe it'd make me look stupid when the next great crash comes. But at least consider it.

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