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  • Bogleheads® Live with David Blanchett: Episode 14

Bogleheads® Live with David Blanchett: Episode 14

Post on: August 2, 2022 by Jon Luskin

The John C. Bogle Center for Financial Literacy is pleased to sponsor the fourteenth episode of Bogleheads® Live. David Blanchett answers questions regarding retirement planning.

David is the Managing Director, Head of Retirement Research, PGIM DC Solutions.

David Blanchett

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Bogleheads® Live with David Blanchett: Retirement Planning

Jon Luskin: Thank you for joining us for the 14th Bogleheads® Live. My name is Jon Luskin and I'm your host. My guest today is David Blanchett. Today, I'll be asking David all sorts of questions, leaning on his vast research on retirement planning. I'll rotate between asking David questions that I got beforehand from the Bogleheads Forum at bogleheads.org and Bogleheads Reddit and asking live audience questions from the folks here today.

Before that, let's talk about the Bogleheads, a community of investors who believe in keeping it simple, following a small number of tried and true investing principles. You can learn more at the John C. Bogle Center for Financial Literacy at boglecenter.net.

We will be holding the annual Bogleheads conference on October 12th through the 14th in the Chicago area. The speaker lineup is phenomenal and includes Eric Balchunas, author of The Bogle Effect, economist Burton MalkielJason Zweig of the Wall Street Journal, CPA Mike Piper of Oblivious InvestorRick Ferri, host of the Bogleheads On Investing PodcastChristine Benz, director of personal finance at Morningstar, your’s truly and much more. Registration is now open. You can find the link to register pinned to the top of the Investing Theory News and General Forum at Bogleheads.org.

Mark your calendars for future episodes of Bogleheads® Live. Next week Jorge Soriano, Certified Financial Planner ® Enrolled Agent will be answering your questions about annuities, reviewing case studies of what to do with a high-cost complex annuity that perhaps you may have been sold by an advisor in the past.

On July seventh, we'll have another CFP® EA that'll be Stephen Fox. And he'll be fielding questions about tax planning for millennials. Other future guests include Barry RitholtzJ.L. Collins, and Jim Dahle of The White Coat Investor.

David you've done a lot of research on retirement planning. To open our conversation why don’t you tell us a little bit about a recent piece you've been working on that has significant implications for “do-it-yourself” investors.

David Blanchett: I would say some of the more recent stuff I've looked at is how investors respond to market volatility and downturns. I looked at this effect back in 2008, I looked at the effect based upon 2020, and the evidence is pretty overwhelming that older investors - older “do-it-yourself” investors tend to respond to volatility much worse than younger investors do.

And I think it has to do with - the kind of the salience of retirement. but, my research suggests that a lot of folks are gonna make some bad timing decisions in the near future. And my recommendation is what it usually is: hold tight. You better ride out the recent volatility.

 Jon Luskin: We had Eric Balchunas on recently. He's an ETF analyst over at Bloomberg. Eric looks at fund flows all day long as part of what he does. And he can say with confidence with authority, that passive investors are the ones with “strong hands” to use his words. They stick with their funds during market panics. Those folks in active funds - not so much.

Is there a consideration for not just age, but also how they're investing? Younger investors are more likely to hold passive funds. Those older investors…they've been investing for quite a bit. And they bought their active funds quite a while ago. I wonder, with respect to what you just shared with us, if there's a consideration for how those investors invest in addition to just their age?

David Blanchett: Oh, without a doubt. When I'm looking at investor behaviors, it's normally gonna be within a 401k plan. It's a, usually a fixed opportunity set of funds that exist. I do think there's gonna be a lot of dimensions across the decisions investors make. Folks invested in passive funds, have advisors, for example, less likely to trade, I would hope so.

There's obviously gonna be huge differences across different cohorts. Volatility appears to affect trading choices among older investors, more than younger investors.

Jon Luskin: I would imagine that would be the case. “Hey, I'm near retirement…this volatility is gonna be a lot scarier…it's gonna have a lot more near-term consequences…” If you're that younger investor, you're probably rooting for that market crash to be able to buy at those lower prices.

David Blanchett: The funny thing is, the expectation among economists is actually the reverse. When you're doing research, you often look for what you would call attributes that would be associated with sophistication. Individuals who have higher incomes are usually deemed to be more sophisticated. Older participants usually would be more sophisticated because they've had a longer time to invest. They should understand that markets go up and down.

You and I have the same explanation as to why this effect occurs once you've observed it. I think the hypothesis you'd have, if you were doing the research without knowing the outcome, is that younger investors would be more likely to respond to volatility because they haven't played the game before. They haven't experienced, necessarily, ups and downs in the market.

It is somewhat counterintuitive from what you would assume as part of a base hypothesis. Someone who is, say 60 years old, would be better at investing because they've ridden out these periods of volatility before. But I think to your point, exactly, it's that the monies that they're saving for retirement, for example, it means a lot more, right? When you're 40 years old, retirement could be 20-plus years away. When you're 60, there's a very kind of direct implication on a downturn in your portfolio. And so it affects people more and it causes them to react more to that volatility.

Jon Luskin: That absolutely makes sense. I think about how a lot of younger folks today are pretty financially literate because they're just gonna go online and figure out, “Hey, low-cost index funds, are maybe all I need, I just have to leave it alone.” That older generation might not necessarily be willing to jump on Google and then take in some new info.

Twitter David: I've read some of your work over the years, so thank you for your time today. I find it interesting that there are no real inflation-protected annuities - other than Social Security - that you can purchase in the marketplace. As a retiree, you think it makes sense to calculate the net present value of the inflation-protected annuity you get from the government, treat that as an asset on your balance sheet and think of that as a part of your overall bond portfolio and then allocate based on your risk tolerance, your cash flow needs.

If more people did that, especially as they approach retirement, they'd be more relaxed about owning a traditional portfolio of index funds, 60/40, whatever 70/30. And that would, perhaps, lead to better behavior, which as you pointed out earlier among retirees, can get a little bit dysfunctional during times of volatility.

Wade Pfau talks a lot about buffer assets and he seems to be a proponent of annuities. I'm skeptical because of the costs. Insurance companies are gonna get their pound of flesh one way or the other. I was wondering what you thought about this capitalization of the Social Security asset, and then use that as a 

David Blanchett: It's a detriment to the industry that there are no private annuities that have payouts that are explicitly linked to inflation. If you buy an annuity, like an immediate annuity or a deferred income annuity, there is no inflation protection. You can attach what’s called a fixed COLA. So benefits go up 2% a year, but there are obviously pretty significant implications of a fixed COLA if inflation's 8% a year.

That, to me, creates a definite headwind for annuities - even the plain-vanilla type in today's environment. That being said, I think that Social Security is the place to go for guaranteed income for virtually every retiree. To your point, its benefits are linked to inflation. There are tax advantages. There are other assets you could possibly own. And there are spousal benefits.

Now, that being said, I love your comment. And I've been beating this drum for over a year, but I wish more retirees and advisors would try to quantify the value of these pension benefits because pensions, like Social Security, are a bond. If you have a Social Security benefit of say $50,000 a year between a married couple that's worth over a million dollars.

If you don't focus on the economic value of that asset, it might lead to - making to your point - more rash decisions around volatility than you need to, because even if the markets go down, the value of your benefit doesn't necessarily change based upon inflation. Folks should more explicitly consider the role of guaranteed income as part of their portfolio, because to your point, it then would allow you to take on more risks. Now a point that I make there is that having more guaranteed income or bond-like assets increases your risk capacity - your ability to take on risk in your portfolio - you might still have a preference not to be aggressive. But, if you think about two retirees, one who has tons of income coming in from a pension versus someone else who has much less pension income. And then they both have the same portfolio value. The one that has more pension income has more bond-like assets as part of their overall total wealth, and therefore should have a more aggressive portfolio on it.

Jon Luskin: Certainly, we want to take advantage of delaying Social Security. David, I'm curious about how a single premium immediate annuity (SPIA) can manage sequence risk?

Hi folks, Jon Luskin, your Bogleheads® Live host jumping in for a quick podcast edit. Just now in this episode, I used a really nerdy term: “sequence risk.” Let's break that down for those who aren't retirement planning nerds.

Sequence risk is a risk retirees face at the beginning of their retirement. It's the risk that they start retirement during a period of poor stock market returns. For example, at the time of this podcast edit, the U.S. stock market is down almost 20%. Ideally, you'd avoid retiring today, at least if you're looking for your investment portfolio to fund your living expenses in the near term.

That's because selling at a market bottom at the beginning of retirement negatively impacts the success of a retirement plan. Doing that is much more impactful than selling at a market bottom 10 years into retirement. That's because at that point you've already gotten through 10 years of spending. So, you don't need your portfolio to last as long.

And now let's hear David Blanchett’s answer on how an annuity 

David Blanchett: If you ask someone that does research, what an annuity is, they'll almost always want to talk about products that provide some form of guaranteed lifetime income. Usually, the more traditional SPIAs, DIAs, but in reality, an annuity is a very mixed bag of a term.

We have to note that off the bat. If we're talking about annuities that have that more traditional focus of providing that traditional lifetime income, they can be a solid option for someone that wants more certainty. If you're a retiree that is marginally funded, where you don't have tons of excess cash, having an annuity provides a lot more safety, especially earlier in retirement, if it requires you to access your portfolio less.

Virtually all Americans need more guaranteed income. Most Americans can get that from delayed claiming Social Security. I think a problem with the perspective a lot of folks take is that retirement risk is not maximizing economic value at the age of 75.

If people will say, “Oh, I don't wanna delay claiming Social Security. Because what if I die when I'm 72?” Well, wait a minute. If you die when you're 72, your kids get all your stuff. There is no risk there of you having a truly negative outcome from a savings perspective. The real risk in retirement is that you survive to age 105; you deplete all your resources and require cash infusion from your kids.

Guaranteed income that lasts for life can help with that. And it can really help with things like sequence of returns risk. Because, for example, if you buy a SPIA. Most folks that buy them are buying a nominal annuity and therefore the actual value of that will decline, over time, with inflation. But, it requires a lower withdrawal when you first retire.

Jon Luskin: This one is from ER999 from the Bogleheads forums who writes:

Which bonds should be used for a portfolio? Treasuries? AGG? Long term? And does David agree with the idea that bond duration should be matched to the duration of the portfolio?

David Blanchett: I would say that bonds are not where you're taking risk. For the average person, especially who is close to retirement, you want low- to intermediate-duration, high-quality bonds. I'm not a big fan of matching the duration of the bond portfolio to the liability. It just depends on economic conditions. A lot of folks would say, “Well, retirees should own long-term bonds…”

Well, I haven't believed that that makes a lot of sense from a liability-hedging perspective. Sure, in theory, if you have a longer-dated bond, say one that's got a maturity of 20 plus years - that might match the duration of your liability. But then you're locking in the effective return, or yield, over the period.

The question is always before you immunize or lock in a liability or risk: Does it make economic sense to do so? For most people, a high-quality, well-diversified portfolio is the way to go. And if you're goingtake risk in fixed income, maybe take a little bit. But I've always believed that fixed income is the safe assets where when the markets are down, they should do well.

But, if you've held government bonds recently, you've lost something. But if you had, for example, longer-duration and high-yield bonds, those are down just as much or more than markets recently. It's important to think about the components of a portfolio. From my perspective, fixed income was mostly that super safe asset. You take your risk in equities.

Jon Luskin: Absolutely! Amen! I have always been a fan of intermediate-term treasuries - high quality - but they're still gonna give you a little bit of interest.

Christine Benz on Episode 5 talked about just this thing where the best correlation was in diversifying assets, cash, and low to intermediate-term treasuries.

David Blanchett: People talk about correlations a lot. And what's really important to note about bonds, especially, is that what happens when markets go down - and obviously right now is a terrible case study at that...But, on average, Treasuries and high-quality bonds are a high-quality diversifier. When the markets go down, other assets like high yield bonds, actually have a higher correlation when the markets don't do well.

What you really want to think about is not the average correlation, but how they do when markets underperform. That's why having low to intermediate duration and high quality is really important because they really have done the best historically when markets don't do well.

Jon Luskin: When I've come across the research and done a little bit of my own in the subject, which says take risk in stocks, even if that means holding a little bit more of them. Stay safe with bonds. Holding those high-quality bonds that can get you a better risk-adjusted return, a better return for the amount of risk that you're bearing.

Sycamore, from the Bogleheads forums writes:

"The Bogleheads philosophy and many “do-it-yourself” investors place a premium on tax efficient investing as well as using separate funds for stocks and bonds to avoid the problems with “all-in-one-funds.” For some investors, “do-it-yourself” can be difficult. They're faced with questions about when to rebalance, and which fund to withdraw from. Ideally, these problems can be overcome with education."

But, some investors just don't get it. When it comes to investing, they may even be afraid and end up panic selling. Having an all-in-one fund may be appropriate to avoid behavioral issues. Ditto for paying an advisor. How does one know if they're not suited to be a “do-it-yourself” investor?

David Blanchett: First, everyone should be aware of the fact that there are tons of single multi-asset funds where you can get an incredible level of diversification. You can find one fund out there that accomplishes what you wanna accomplish in a portfolio.

One thing that I looked at, for example, in 2020 was how individuals who had multi-fund portfolios versus individual fund portfolios like target date fare. The average person that held a single fund traded more frequently than someone that had a multi-fund portfolio.

If you understand the diversification effects that exist in holding a single fund, that could be fine. From my perspective, the decision about whether you hold one fund or 20 - and the use of an advisor - it's related, but it's a bit different. Financial advisors can provide value in lots of areas.

One area is investment management. I don't think that that's a “commoditized” field, but there are lots of great online resources and tools that you can get for free now. That kind of competitive advantage advisors had is providing this sole source of investment advice 20 years ago. That's come down significantly.

I view the value of advice as being more holistic in terms of having someone that can help you build a portfolio, but also understand what the portfolio is for. What is your optimal risk level? What are you trying to accomplish? How much should you be saving? For someone that's asking this question, “Well, should I hire someone just for the investment angle?” How have you responded to periods of volatility? Are you more likely to make a rash decision? Would having someone to talk to about what you're thinking about doing help you make better choices? If so, I think that it's definitely worthwhile.

Advisors provide lots of different types of value. They charge in lots of different ways. When working with an advisor, understand how they're compensated. Are they a fiduciary? What are their qualifications? How do they get paid? At the end of the day, a high-quality advisor can be more than worth whatever fee they're charging.

Jon Luskin: Balanced funds are traded less…That is a fascinating piece of information. When I work with folks who are thinking about going the DIY route, firing their high-fee advisor, or maybe they have some windfall income and they're not sure what to do - if they're not gonna be an investment geek, certainly - we'll talk about low-cost balanced funds that are an option. If we're talking about all tax advantage accounts, a low-cost target date fund can be a pretty good way to go. If we've got some taxable accounts, then the iShares line of balanced ETFs can also make that investing process pretty simple, pretty easy, and pretty low maintenance.

This one is from username Modified Duration, who references your research entitled The Value of Delayed Social Security Claiming for Higher Earning Women. In that article, David, you write “A healthy, higher earning woman claiming at 62 reduces her social security wealth by more than $179,000. And by more than $214,000, if she has a lower earning male spouse.” Can you tell us a little bit more about this and what this research means for those considering their Social Security claiming strategy?

David Blanchett: One thing that people need to be aware about Social Security is that it's not priced based upon, for example, market interest rates.

If you buy a SPIA or a DIA, the payout that you get is gonna depend - potentially significantly - based upon the prevailing interest rate environment. What can the insurance company do with the money when they invest the premium? Social security isn't like that. Social Security has a payout that is fixed regardless of where rates are.

When I wrote that piece, it's with two professors at The American College - Sophia Duffy and Michael Finke - interest rates were lower. But the point was it is very beneficial for most people, even if you're not of average health, to delay claiming Social Security, given where the payout structures are.

Females especially if, if you look at payout rates, or the income you can get from buying an annuity, it's almost always lower for a female versus a male. And that's because females live between two and five years longer than the average male. There benefits of a female to delay, especially if she's the higher earner can be relatively massive.

The key when talking to retirees is convincing them that it will almost always make sense for you to delay claiming Social Security. And this is my earlier point: if you look at risk correctly - yes, it's possible you could die earlier in retirement and that you wouldn't maximize the wealth you'd pass to your heirs - if you die early. But, delayed claiming creates this massive increase in the income that you can have, that's linked to inflation, that's tax-advantaged. Even if it doesn't make sense, for example, based on the net present value. When you think about risk, correctly, it makes a ton of sense to delay claiming as long as you possibly can to get the highest possible benefits.

Jon Luskin: Absolutely. I could not possibly agree more. If you die too soon, honestly, who cares? At that point, it isn't really gonna matter. That real risk is that you live way too long and delaying Social Security helps manage that much more impactful risk. It's a much bigger deal.

It's really the thing that we need to be thinking about, what we need to be concerned about, and what we need to plan for.

User David78140926 from Twitter asks about the future of the 60/40 portfolio, his hypothesis being that markets have been repriced to deliver reasonable returns for that 60/40. David, what are your thoughts on the viability of the 60/40 portfolio for the next 10 years?

David Blanchett: I have always been a fan of 60/40. I always will be. I think that it made sense to consider maybe some newer investment options when yields were closer to one or 2%. There were some anomalies around things like products called MYGAs or fixed rate annuities. But I'm a big fan. Simplicity actually makes a lot of sense. No one knows where the markets are headed in the future. That 60/40 is a very, very good starting place for most investors. It has been, and likely, always will.

Jon Luskin: Certainly many Bogleheads will echo the exact point that you made. Simplicity is key to investing success. Unnecessary complexity only adds fees and likely taxes as well. It does not guarantee higher returns or reduce risk.

David Blanchett: The only thing that I would suggest people think about, and the problem with 60/40 is this binary perspective on equities and fixed income is the role of real assets in a retirement portfolio. Real assets is a super broad term. There are inflation-adjusted bonds, there's real estate, and there are commodities. Those non-traditional assets should become a larger allocation in a portfolio for retirees. If you're younger, you have this thing called human capital. It's your ability to work and make money. That's linked to inflation. You deplete that as you age.

There are other asset classes that might become more interesting to include in a portfolio when you age. But I still think that those can fit well within that 60/40 framework. It's just how you allocate those risks across equities and fixed.

Twitter David: A follow-up on your comment about real assets as a potential addition to a traditional 60/40. Could you argue that if you own a total market index fund, you get a lot of exposure to real assets anyway? Most companies own land. And they have on their balance sheet myriad real assets. And also most people own their homes.

Other than TIPS, this whole idea of owning real assets as a separate asset class, I scratch my head. Prove to me that you don't get enough real asset exposure by just owning equities via a broad index fund. Thank you.

David Blanchett: You do. It’s this notion of risk and return and inflation is a very real risk to - for lack of our term - for retirees and therefore shifting the allocation, the asset classes in your portfolio, to those asset classes that would do well when inflation is higher. That's just a lot more valuable structurally to a retiree than someone who was in accumulation. There are other shifts that investors should make that are in retirement. I think that they should have, for example, more domestic exposure simply because, and this is maybe to your point, my liabilities as a retiree, if I'm a US retiree are denominated in US dollars, and therefore, while it's, it's awesome if the world economy does great, to the extent that I can capture the risks of, for example, domestic inflation via domestic equities. That makes sense to allocate more to that portfolio. If I'm an accumulation-focused investor, there's definitely a case for the global tangency portfolio with something to invest in.

But as you move into retirement, I do think that it makes sense to restructure some of the exposures based upon the fact that the portfolio now exists more succinctly to fund a liability versus just to do well over time.

Jon Luskin: Any final thoughts you'd like to share? What should "do-it-yourself" investors - what should Bogleheads - know about the research that you've put together?

David Blanchett: There's no one right way to do things. To the extent that you're comfortable investing on your own and you have the capacity to stay the course, do that. My one caveat would be that just because you're a good investor doesn't mean that you're good about financial planning. Even if you can manage your own portfolio, it doesn't mean you shouldn't think about engaging a financial professional - maybe the one you can pay hourly or on retainer - to help you figure out some of the other more complex aspects of financial planning.

I'm a big believer in financial planning. Of which investment is definitely a component - but it's only one part of a much larger puzzle.

Jon Luskin: Our next Bogleheads® Live will have Jorge Soriano, answering questions about annuities, and reviewing case studies of what to do with a high-fee, complex annuity that you may have been sold in the past.

Until then you can access a wealth of information for do-it-yourself investors at the Bogleheads forumBogleheads a WikiBogleheads FacebookBogleheads TwitterBogleheads YouTubeBogleheads local chaptersBogleheads virtual online chaptersThe Bogleheads On Investing Podcast with your host Rick Ferri, and Bogleheads books.

The John C. Bogle Center for Financial Literacy is a 501(c)(3) non-profit organization at Boglecenter.net. Your tax-deductible donations are greatly appreciated.

For our podcast listeners, if you could please take a moment to subscribe and rate the podcast on Apple, Spotify, or wherever you get your podcast.

Speaking of podcasts, we're doing a call for volunteers. We're looking for both podcast editors, and transcribers, and for help with proofing transcriptions. If you want to help spread the message of low-cost investing, shoot me a DM @jonluskin on Twitter.

Thank you to Ryan Barrett who helped proof the fifth episode transcript. That was our interview with Christine Benz of Morningstar.

You can follow the Bogleheads on Twitter.

Finally, we'd love your feedback. If you have a comment or guest suggestion, tag your host @jonluskin on Twitter. At the next Bogleheads® Live, we will have Jorge Soriano answering questions about an old annuity that you're not sure what to do with. Until then, have a great week.

About the author 

Jon Luskin

Board member of the John C. Bogle Center for Financial Literacy


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