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Rekenthaler Report

Dissenting Views: Retirement Planning and Jack Bogle

The opposition speaks.

Living in a Material World
Last week, I aired the claims of Gaobo Pang and Sylvester J. Schieber's (PS) paper, American Workers' Retirement Income Security Prospects: A Critique of Recent Assessments. That article painted a relatively rosy picture of American retirement planning, stating that pessimistic projections understate the amount of "catch-up" savings that will occur in the final years before retirement. The paper also argued for lower income-replacement ratios than are commonly modeled, in the 60% to 70% range as opposed to 85%. According to the authors, the combination of higher-than-expected savings and lower-than-expected needs will fix much of America's retirement "crisis."

Financial writer (and advisor) Bill Bernstein is having none of that.  

In PS' model, workers "smooth" their consumption over their careers, spending first on housing equity, then on children and educational costs, and then in the 50s and early 60s on retirement. This approach assumes that workers have relatively constant discretionary income while they are employed--that is, their consumption is smooth. It also assumes that when one major cost ends, that people will resist temptation to spend their newfound wealth and instead will funnel those monies toward the next major cost.

Writes Bernstein, "I consider consumption smoothing to be one of the worst ideas ever foisted by mathematically minded, spherical-cow financial economists on sentient human beings." (He had to know that sentence would be quoted.) For him, it's a diet that nobody will follow. "Human beings toil on a hamster wheel of ever-increasing material desires; you might have been happy with a Honda Accord five years ago, but now you need a BMW to satisfy your desire for a decent ride."

Thus, Bernstein quarrels not with PS' numbers, but with the psychology. Yet implicitly, Bernstein appears not to trust the math, either. After all, he recommends that for a healthy retirement, workers save 15% of their annual salaries for 40 years, from age 25 to 65. That almost surely will lead to higher retirement savings than will PS' prescription, because to make up for all that lost ground during the first quarter century of the career, when Bernstein's workers are diligently socking away 15%, the PS employee must save unrealistically heavily from ages 50 to 65 (and hope that the markets are friendly).

What gives?

Part of the discrepancy owes to diverging definitions of "retirement ready." Pang and Schieber have relatively modest goals. For them, a successful retirement--that is, one that does not contribute to a "crisis"--is one that permits a similar lifestyle to the working years, but with no added luxuries. They also don't build a margin of safety into their calculations. Bernstein, being more conservative by nature, aims higher. He writes, "You might be able to get along on as little as 60% of your preretirement income, especially if you are a saver. Just don't get sick, travel, or want to educate your grandkids."

The rest owes to sundry differences in expected returns on investment assets, the rate at which retirement monies can be annuitized, and so forth. In addition, Bernstein assumes larger long-term health-care costs than do Pang and Schieber.

While I regard Bernstein's 15% target as optimistic, and as providing for a wealthier retirement than some might wish (considering the sacrifice required to get there), it's not that far above minimal. Tinkering with Bernstein's spreadsheet, it seems that those willing to settle for a silver (or perhaps bronze) retirement can get there by saving 10% to 12% annually. That remains well above what Americans are now doing, though, so at least some of PS' anticipated consumption-model catch-up savings had better come true. 

Upon Further Explanation
Eric Nelson, author of the Befuddled by John Bogle's Advice blog post that sparked Tuesday's column, posted his response the following day. He also sent me some well-taken thoughts via email. My comments are in bold; Nelson's (abbreviated) responses follow.

From a broad perspective, the DFA mindset on stocks (home in on value) seems similar to the Bogle mindset on bonds (home in on corporates). You no doubt will argue that these are apples and oranges, and I suppose this is so, but I will still argue they are each fruit.

Bogle's views seem to be evolving toward embracing a multifactor view of markets. But only in a limited sense that credit is a higher-risk/higher-expected-return dimension of fixed-income. If so, how about small and value in the stock market? Still nothing on that?

For better or worse, it's a significant change from Bogle's long-held positions on portfolio policy. Either  Vanguard Total Stock Market Index (VTSMX) and  Vanguard Total Bond Market Index (VBMFX) are all you need, or different investors may logically want varying degrees of the different sources of risk/expected return. As the saying goes, you can't be "just a little bit pregnant," but Bogle seems to be trying to pull this off.

I do think that Bogle's comment about possibly cutting back on stocks was made, at least subconsciously, while thinking about investors who now have quite a bit more stocks than they did a few years back because they have not rebalanced. In such a case, his comment makes a good deal more sense than if applied to a constantly rebalanced portfolio (which I imagine is what you do for your clients).

If so, I'm OK with that. I'd strongly prefer that we would rebalance all along (including into stocks in 2008-09, and out of stocks since then). To me, Bogle's indifference to rebalance except for these really big wholesale moves is troubling. But even this isn't my biggest issue.

And that is … so we are cutting back on stocks while taking on additional bond risk through corporates? What kind of portfolio philosophy is that? What are you actually accomplishing?

Most of my business and the value I profess to deliver is behavioral-based. Knowledge, confidence, and discipline. And that also happens to be the hardest thing to get prospective clients to admit or see that they need. So if I am strong-willed enough (my wife calls it something else) to call out cases where others aren't acting appropriately, then it becomes just a little bit easier for the average Joe to admit, "Hey, if industry titans have a hard time staying the course …"

Super Bowl, Schmuper Bowl
So the Super Bowl indicator predicts the direction of the stock market about 75% of the time. That's nothing. Courtesy of Tyler Vigen, a law student who pursues the curious hobby of collecting spurious correlations, I proudly present the Maine Divorce Rate Indicator. If you wish to predict the future price of margarine, that is your guide. (Or should that be vice versa?)

Death through bedsheet entanglement and ski-resort revenue are also close cousins. The savvy ski-resort manager keeps a watchful eye on those bedsheet deaths.

Finally, there is the little-known connection between drowning deaths in a swimming pool and the number of Nicolas Cage movies that are launched. Think of the lives that Cage could save through early retirement! 

If ever a man were suited to become a quantitative mutual fund manager, it is Mr. Tyler Vigen.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

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