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Financial Futures

Martha M. Hamilton
Washington Post Columnist
Tuesday, June 3, 2008 12:00 PM

Washington Post columnist Martha M. Hamilton was online Tuesday, June 3 at noon ET to answer questions about financial planning for retirement.

She was joined by Joel Dickson, portfolio manager for Vanguard.

A transcript follows.

To read past Financial Futures columns, click here.

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Martha M. Hamilton: Good day all, and welcome to our chat. We have as our guest today Joel M. Dickson, who is head of Active Quantitative Strategies for The Vanguard Group, Inc. He's also a tax expert and a former economist with the Federal Reserve, so he has lots of expertise

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Martha M. Hamilton: Just in case you're not sure what active quantitative strategies are--I wasn't sure--I asked Joel to explain it. Here's the answer: My group is responsible for over $20 billion of active equity portfolios at Vanguard. We run these in a quantitative fashion in that we analyze historical market and company information to assess a company's future prospects. So, we do the same things that traditional, fundamental managers do in assessing stocks -- the main difference is that we don't talk to company management. We let the data drive our decisions. In this way, we can assess thousands of securities each day as opposed to a traditional equity analyst who may only be able to cover 40-50 companies.

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Cleveland, Tenn.: I am currently invested with Vanguard's Prime money market and total bond index fund. I know I need to diversify. Am at a standstill whether to invest between the Vanguard total bond market fund and total stock market index or to go with the Vanguard Wellington fund. I am 63 and retired. I am planning a 60 percent stock and 40 percent bond including a 10 percent international stock fund. Your advice is appreciated. Have a great day.

Joel Dickson: As a general rule, I can't give advice on specific funds. However, I think you are approaching this the right way by thinking about overall asset allocation first. Broad market index funds are used by many as a way to implement that asset allocation in a low-cost, diversified way. Today many investors are gravitating toward a single fund solution like a target date fund to achieve these goals. The choice of Wellington Fund in this situation would give you the potential benefits of active management but with less diversification that could be obtained through the use of broad-market funds.

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Martha M. Hamilton: I see we have a few questions about the retirement proposal by Teresa Ghilarducci which I wrote about on Sunday. Since Teresa is going to be my guest two weeks from now, I'm going to save those questions for when she is here to respond.

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Atlanta, Ga.: I'm 55 and my 401k has been stuck in the "lost decade" -- relatively low rate of growth. Now at $600k I'm behind where I should be for this age -- basically I run out of money at 88. Suggestions to avoid another flat decade? Suggestions for how to sustain the nest egg past 88?

Joel Dickson: Unfortunately, the markets are beyond your control. The risk at this point is trying to overcompensate for the feeling of "loss" in terms of lower equity returns over this decade. I'd focus on what you can control like the amount you save, your investment costs, and your asset allocation (based on your risk tolerance). Trying to "catch up" by adjusting your investment portfolio is just as likely to result in further regret as it is to bring you success. Note, too, there are a number of new products that seek to provide sufficient retirement income without the usual drawdown of assets assumed in many of these retirement simulations.

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Washington, D.C.: OK - I'm submitting early because I can't make the discussion. I'm 22. Long story short, I have a car that I need to give back at the end of July, so need to get a car then (not having one is not an option, believe me.) I don't drive THAT much, I only have $7,000 in the bank, and I've seen some awesome lease deals - like $2,000 down and $165 per month. Am I better off getting a $4,000 car now, or getting a 3 year lease on something I can handle (I expect to have more money in 3 years - I have unbelievable student loans right now but have paid off $30,000 of them since the start of this year) I know it's not about retirement, but boy do I need help.

Martha M. Hamilton: I'd get a lower cost used car and keep paying down the student debt.

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San Bruno, Calif.: What does the research show about the average contribution to 401K plans? What percentage contribute the maximum possible during the year?What are differences in behavior in gender, race, and annual income?

Joel Dickson: You might find of interest a comprehensive report that Vanguard publishes annually about participant behavior in 401k plans. I've included a link to our 2007 report.

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Orlando, Fla.: Our 19-year-old daughter is a sophomore in college and doing well. She holds a part-time job and will be moving, with 2 friends, into an apartment in August.

What's the best financial advice -- short-term and long-term -- we can give her?

Thanks!

Martha M. Hamilton: I'd start by telling her to be wary of getting over her head in debt. I'd recommend that she use only a single credit card and use it sparingly. One of my former colleagues had a rule which was not to use credit cards for anything that wouldn't still be around when your bill arrives. It's so convenient, before you know it, you have a bill you can't pay in full. And, of course, she should pay her credit card bills in full and on time. I'd also encourage her to start saving for retirement right away. I know 19 sounds young, but if a retirement savings account is likely to be her main source of retirement income, the earlier she starts, the better. At her age, I'd recommend saving in a Roth, which means she will be paying taxes now on the savings she contributes. Chances are she'll be paying taxes at a significantly higher rate in her future.

Joel Dickson: In terms of long-term investment success, I agree with Martha that it's better to start early. I also think the Roth IRA is a great starting point. In addition to reducing your exposure to higher future tax rates it also divesifies that tax risk because a lot of her future income will be tied to tax rates years from now.

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Orlando, Fla.: Thanks for considering my question. I am 54, and embarking on a second career in advertising. What are some options for my 401k from my first job? Also, how do annuities look to you at this point in my life?

Joel Dickson: Generally speaking, keep it invested! Too many people cash out prior retirement savings which subjects people to additional taxes and penalties. A wise course of action would be to do a rollover into an IRA, which will preserve the tax-deferred status of the portfolio. Consider a broad-based mutual fund portfolio in an IRA; annuities are generally higher-cost and do not offer additional tax-deferred benefits.

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Millbrae, Calif.: You often hear people argue that yesterday's defined benefit pensions are vastly superior to today's 401k plans. Don't you think this is partly an illusion since 401k plans are fully funded while pensions have uncertain guarantees (i.e. companies could go bankrupt, actuarial estimates could be wrong)?

Joel Dickson: There has certainly been some turmoil about defined benefit plan funding. I'd point out that one of the big benefits of 401k plans and IRAs is that they have really allowed investors to self-provision and take charge of their financial future. I think we're in a much more financially literate society today than 25 years ago. Recent changes to defined contribution plans--namely, auto-enrollment and default plan options--greatly improve the chances of the average participant achieving their long-term financial goals.

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Bristol R.I.: On my death my wife will become the beneficiary of my IRA account. Will she be taxed on distributions from my IRA?

Martha M. Hamilton: Yes, the distributions will be taxed. However, she can roll over the account into an account of her own and delay taking distributions until she is 70.5 and then take them based on her own life expectancy. That's my understanding, anyway, but I'll defer to Joel as the tax expert.

Joel Dickson: I believe you have a number of choices. For example, you could become the owner of the IRA or remain as a beneficiary of the IRA. The issue about distributions may also depend on whether or not required distributions had been made from the account. The best reference in my opinion is IRS Publication 590, which is available online at irs.gov. There is a section on inherited IRAs in that publication.

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Richmond, Va.: Thanks for your advice. The older I get, the more I read your work!

Please explain to me how I Bonds work. Also, I'm in my early 40s. What percent of my moderate risk retirement portfolio should be in I-Bonds?

Thanks!

Martha M. Hamilton: Here's a column I wrote about TIPS (Treasury Inflation Protected Securities) and I Bonds and another column comparing the two.

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Washington, D.C.: Hi,

I am 42, and have approximately $175,000 in retirement savings. My employer puts 10% of my salary in each year (when I contribute 3%, first) and I am invested in the Vanguard 500 index fund as my stock choice (I'm also invested in bonds).

I wonder if, at my age, I am being too conservative?

Thank you!

Joel Dickson: You didn't provide a lot of information about your current allocation between stocks and bonds. However, you have quite a long time until retirement. To give you an idea of what some people invest in at your age, Vanguard's Target Retirement 2030 Fund currently allocates about 85% of its assets to stocks and 15% to bonds. Of course, your risk tolerance and time horizon may differ.

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Bethesda, Md.: Hi Martha,

When I met with my financial planner a few days ago he mentioned that I should look into annuities now that I have a good amount of money saved. He didn't mention any specific one but I always thought annuities were for older, closer to retiring people. I'm only 30.

He's not one to try to sell me funds or anything like that so I have to believe that isn't his goal. I don't even know where to begin on researching annuities.

Martha M. Hamilton: If he's talking about a single premium fixed annuity to ensure that you don't outlive your savings, I'd wait until, at least, the interest rate environment is better when you are likely to get more for your money because of higher rates. Here's a column I wrote about annuities that includes some shopping tips.

Joel Dickson: With the proviso that I work in the mutual fund industry, I strongly believe there are better options for long-term accumulation of wealth for a 30 year-old than annuities.

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Arlington Va: I am 38. In terms of how I should be allocating my investments I always get confused about where I should be putting my money at this stage in life in order to prepare for retirement. I've been trying to make sure I am diversifying (some stock funds, some bond funds, CDs, and some individual stock I was given a long time ago). Do you think this strategy is good for a person my age? If not, what should I be doing? Thanks.

Martha M. Hamilton: You may want to look into lifestyle or target date funds which are investments put together by professionals and which adjust your investment allocation as you age. They are certainly an easier approach than trying to do it on your own, although, since they are mutual funds, they aren't guaranteed to provide adequate retirement income. Some early studies show, however, that they appear to do a better job of producing retirement income than do the selection of assets picked by individuals.

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Laurel, Md.: I am looking to grow my 401k & brokerage account in lockstep with each other but my 401k through Vanguard only seems to offer index funds and my brokerage account offers any type of investment. Why is that? And why do you only do top-down research within funds?

Joel Dickson: In a 401k plan, your employer determines the fund offerings that are available.

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Washington, D.C.: I have decided to just give up on the market! It seems like I have a better chance just being a small time landlord building modest equity versus the Wall Street scam that comes every 10 years or so. It seems like just yesterday when everyone was running from dot-com stocks that the talking head raved about 24-7 on cable news. Now we have the most recent scam/greed fest.

Martha M. Hamilton: All I can say is, if by giving up on the market you mean getting out now while it's low, that's probably not a good idea. Markets, whether for equities or for housing, turn around, although often we make investments believing they can only increase in value. According to Richard Marston, a finance professor at the University of Pennsylvania's Wharton School, stocks usually start to rise before a recession ends, and the rebounds can be impressive. After the recessions of 1982, 1991 and 2001, Marston said, the Standard & Poor's 500-stock index rebounded within a year from the bottom of the bear market by 59 percent, 34 percent and 39 percent, respectively.

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Oviedo, Fla.: I'm 49. According to online calculators, I will have $1.3 million for my use at traditional retirement age. How much will inflation make that "seem" like? I assume it won't be the windfall it sounds like - right? What would that be comparable to in today's dollars? (Which I can relate to better than pie-in-the-sky online projections.)

Joel Dickson: You are right to look at inflation as a risk to your retirement security. Some online calculators do explicitly evaluate this impact (I'm not sure if the one you used did so). As a rule of thumb, an annual inflation rate of 3% would mean that your purchasing power halves about every 20-25 years. Or in other words, you would need twice as much money (if the calculator doesn't take it into account) over that period to achieve the same standard of living.

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Rochester, N.Y.: I just skimmed through this discussion and was about to close it, thinking, I really have no idea what they are talking about. But then I thought perhaps you could suggest a book that I could read to cover the basics (but not too basic that it would be annoying) so I can feel more literate in this area and be able to contribute in the future? I have an MD but our education doesn't cover finances and retirement - this is a whole other language to me!

Joel Dickson: Eric Tyson has several good books out on investing basics. Vanguard also publishes a summer reading list of investment books that usually is posted to our website (vanguard.com) at the end of June.

Martha M. Hamilton: There are some good online resources too. Try www.mymoney.gov and www.finra.org/InvestorInformation/index.htm

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Loan help: I'm hoping you can give me some guidance. I have a lot of cc bills (about 15k) and am working to pay them off. I have never missed a payment but the cc companies will not lower the apr which is at 20%. I contacted my bank about one of my cc's and they said I'm eligible for a consolidation loan at 16%. The length of the loan would be 98 months but it can be paid off earlier for no penalty. I would only have to write 1 check to my bank.

I keep thinking this is too good to be true. I have great credit (745 score) but wanted to have everything consolidated to only write 1 check. I'm thinking this will help get out of debt.

Also I have NO plans of using those credit cards. Do I close the accounts or keep them open with a 0 balance? The cards were opened back in 1998 so I have great longevity and I was never late with payments. Ideally I'd get the loan paid off in 2 years and start saving for a house.

Thoughts?

Martha M. Hamilton: The bank will be doing well earning 16 percent. I'd do it, and I'd close at least some of the accounts. You don't say how many credit cards you have, but I would narrow it down to one or two. I think I have read, though, that closing a bunch of accounts at once can hit your credit score, so you may want to check whether that is accurate. If it is, I'd close them more slowly over time. The problem is, when you have a bunch of them, you tend to switch from one to another until you find you're in over your head.

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Washington, D.C.: How difficult do you think it will be to legislate the kind of serious changes to the established tax system that Ghilarducci advocates? Can both political parties find common ground in "creating a new plan"? And if restructuring the tax incentives for businesses, if not for individuals, is too difficult for Congress, what steps can people take to secure their retirement within the existing system?

Joel Dickson: I'll address the last part of this question. Save, save, save! I don't mean to be trite but the most successful investors and the ones who are best able to secure their own retirement are those that have made the commitment to save a substantial portion of income to build up that nest-egg.

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Laurel, Md.: Joel, thanks for responding to the first question. But why you only do top-down research on funds? How does that compare to ETFs that people say are more cost efficient if held for long term?

Joel Dickson: ETFs are really just index funds with a slightly different wrapper. Vanguard offers both ETFs and conventional mutual fund share classes and these investments are managed exactly the same way. The only difference may be costs.

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Ormond Beach, Fla.: I am 59 and a few years away from retirement. I am thinking about investing in individual bonds vs. bond funds but it is so difficult to choose. I called the Bond desk at Vanguard but the guy I spoke with was a total dud on advice. I can invest 100k to 200k in bonds. Should I be in individual bonds? With inflation on the horizon, I am thinking a bond ladder would be the way to go.

Thanks.

Joel Dickson: You might want to check out a research piece Vanguard did on the question of bonds vs. bond funds. You can find it here.

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Martha M. Hamilton: Well, our time is up for today, but I'll be back in two weeks with economist Teresa Ghilarducci to answer questions about her plan for Guaranteed Retirement Accounts or anything else on your mind. Thanks to Joel Dickson for adding his considerable expertise to the endeavor, and thanks to everyone for good questions or just for reading.

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