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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.


Benz: I guess, the risk is, though, for that person who is considering what Social Security contributes to the portfolio, considering the total portfolio, they're seeing stocks gyrate around wildly, if stock are the majority of their portfolio, and they might make some of those behavioral mistakes that we see investors make.

Bogle: You're right, and that's why I'm on this pretty much one-man, I think, crusade to have people, particularly retired people, look not at the value of their portfolio, but at the income stream they get. They're going to go out to the mailbox and they're going to open, let's say, the middle of every month when the fund or group of funds pays their dividends. They're going to get a certain dividend. Dividends are what matter to these people. The stream of income is what matters, and dividends [tend to increase] in history. There have only been a couple of serious drops in the dividends in the Standard & Poor's 500.

Benz: 2008 was one.

Bogle: 2008 was one, and you could argue it's going to happen again and again. But that was when basically the financial system eliminated its dividends, and we're back at the higher level right now. You took like a probably 20% drop in you income--I think, is about the right number--and we're back above that level now.

Look at the dividend and try to ignore the market. As I've often said--nothing like quoting oneself, Christine--the stock market is a giant distraction to the business of indexing, and in particular for the business of retirement investor. It’s the income flow from Social Security, pensions, whatever it might be, and dividend income, and that's what’s important. It's amazing how this dividend line [tends to increase over time] and the market [goes up and down over time], but they track each other in the long run.

Benz: I disrupted your point about young people just starting out. You think they should be majority equity index, and then from there?

Bogle: Well, I'd say entirely. You are putting say $300 away in your first month and you'd be doing pretty well if you can do that. But some of these young people come out of college and they are earning $50,000, $60,000, $100,000 a year. $300? They ought to be putting more away than that; it's a small part of their wealth. Their investment capital is a tiny part of their total capital because the human capital is what's going to determine their future.

Just put it all in there and do it for five years. And I think I said this before, but I'll repeat it: Get used to the fact that markets go up and down. Get used to the fact that it doesn't really matter what they do. I mean, think of what the market has done in ups and downs [during the first couple of weeks of October] around whether the Congress is going to wake up from its torpor and do what's right finally; up and down hundreds of points. People in panic about that are just going to be their own worst enemy.

That's kind of a self-learning program. But suppose someone, which is maybe more typical, parents who've saved a lot of money for their retirement and they in the inevitability of our existence go to their rewards, all of a sudden you've got $250,000, $500,000. Nice parents.

You probably ought to go about systematically thinking what you need. You can get a simple financial plan from a firm like Vanguard or probably any other firm in the industry for a very modest cost to get started. If you need continuous monitoring, you can keep an advisor. But it's expensive to do that continuous monitoring when the basic fact of the matter is you should by and large not do something. Just stand there…

Benz: Just hang on.

Bogle: …when these events come along. Each of us has to figure that out for ourselves as a comfort level. There's the economics of the investing. There's emotions of investing, and some people are emotionally able to that. They have enough understanding, enough background. A lot of people are not, and I do think the advisory business is going to change a lot. I do think that the logical thing is to have more of a fee-based business than the percentage-of-asset-based business, but we'll see how that develops. Advisors are entitled to be worthy of their hire. They are doing something; they are doing something helpful. But they are not shooting the lights out. If I found that advisor that was shooting the lights out, I'd go to the next one. I don't believe in shooting the lights out.