 Okay, in alphabetical order, I'd like to introduce the panel members. You all have the long bios in your welcome kit. But at the same time, I'm going to do just short introductions. First of all, our first panelist is co-founder of Efficient Frontier Advisors and author of several successful titles on finance and economic history. Please welcome a real one-way favorite, Dr. Bill Brenstein. Our next panelist is the founder of the low-cost investment management firm for portfolio solutions, other of six investment-related books, Forbes.com columnist and a Wall Street Journal expert's contributor. Please welcome Rick Ferry. Our next panelist is the founder of Wealth Logic. He's an author and he writes for CBS MoneyWatch and other publications. Please welcome Alan Roth. Our final panelist, our next panelist is the retired former chief investment officer of Vanguard. He now serves as a senior consultant to Vanguard. Please welcome Gus Salton. Our final panelist who's not on the agenda but is going to join us is none other than the founder of Vanguard, Mr. Jack Bugle. This was my day to listen instead of talk. And they kind of con me into being part of the panel, which I'm happy to do if they want. I think you will find probably quite a bit of silence from me. Quite a bit of silence from me. Can you hear me back there? Quite a bit of silence from me. That doesn't mean I'm not interested in what's going on. This is a terrific panel. And that Gus has just been a huge asset ever since, I guess, September of 1987. And a good friend of mine. And one of the best people around as well as being a brilliant guide around the index fund. Built with ideas, built with convictions, built with passion about the work he's doing. So I salute you, Gus, again. Good job you this morning. I actually wanted to be up here to make a quick announcement. I just haven't been able to get up since I sat down. That's why I'm on the panel. But a couple of things. One of them, I reminded of the story they tell about John Quincy Adams. He's put an age in years, sick in bed. And a friend comes to see him and he says, how is John Quincy Adams today? John Quincy Adams looks at him and says, John Quincy Adams has never been better in his entire life. Things are wonderful. He's at the top of his game. However, the house to John Quincy Adams is falling down. That's the way I feel now. Because everything seems to be going on. I have to get out of here and get a CAT scan on my shoulder to see if there's something going on down there nobody knows about. So I will not be able to be here for the other panel. But I did want to just take this opportunity to thank you all so very much for you. I've had so many nice compliments. You're thanking me for things that any ordinary person would have done in the course of a long career. And I put myself in the ordinary category. But I did have a couple of good ideas. And that turns out world changing ideas. In fact, I just discussed that indexing is changing the world of investing. And so I feel very good to have been a part of that and even a leader. And on that point, by the way, I think it's okay for me to say this. I mentioned the other morning that I had written a letter to the editor of the Wall Street Journal and telling him that the real animal bell lorry had been influenced by the Wall Sangleson. I thought I'd never heard of Jean Palma. At that time. And that Jean Palma's conviction was so great that he started his own, was in the formation, the inspiration for a fund group. But not an index fund group. He's a DFA guy. He believes that the markets, despite the efficient market hypothesis, please have permanent, persistent inefficiencies. So I had a little note from the guy. It looked a long letter to the editor. Very long. Most of them were around 150 to 200 words. This is almost 500. And when I got back to the office yesterday, I think I was there sometime on my yesterday. I got back home from New York. You can probably see that safely. But they're going to publish it tomorrow. Or they say they are. Count on nothing. I mean, this is that well intention. Funny things happen on the way to the Getting Out of the Journal op-ed page. And so we'll see if they publish it. But that's just it. I'll put it on the mobile heads and website on Monday. Because this weekend, I'm not going to work. They want us to thank Kevin Revoily over all those years. Could that better, Kevin? I see you back there. I know you're hiding. Kevin. And we have kind of a good time around the office. I come in, as I come in, I was like the teacher coming into the classroom. And there are Mike and Sarah and Emily chatting up a storm and laughing. I come in, silence. Here he comes. If I can just say something that struck me about Bill Bernstein's remarks yesterday. And that it loves some of the Jewish language expressions. I have a lot of very good friends, many from New York, who use these expressions all the time. So I talk about like the self-evident Jewish expression. Everybody, you don't have to be told what it means when someone says, he's a real schmuck. The first time I was called a mensch, which Bill called the other day. I had no idea what he was talking about. It means something better than a schmuck. So thank you all. And that's probably the last you'll hear from me, except have safe trip back. And I'll be on my way when the next panel takes place. What do you like to do just in case you don't know it? The panel members pay their own way just like everybody else does. So one of the things we do, it's a non-commercial event, but we still let them plug the latest thing that they're doing. So I'd like to give everybody a chance to let us and the audience know what you're up to. Do you have a book coming out? Have you done any papers? And Gus, I'm sure we'd love to hear what you're doing since you retired. And how retirement life is agreeing with you. So can we go down the line? Rick, I heard you got a new book out. And I heard you recently did a white paper. So do you want to tell the people about those items? Sure. I published a white paper. Those of you who are interested in my website, rickferry.com. And the white paper had to do with a case for index funds portfolios. We always look at index funds in each category of investing. So we look at the performance of an index fund, let's say an S&P 500, relative to large cap actively managed funds. We look at the performance of the Vanguard total bond market in relation to actively managed bond funds. And so forth in each category. And Vanguard does an excellent job with a white paper every year called a case for index funds over the case for index funds. But they look at each of these categories. But I thought it would be interesting to take multiple index funds from multiple categories and put them together in a portfolio and then measure the performance of a portfolio of index funds relative to a portfolio or 5,000 randomly selected portfolios of actively managed funds in the same categories. So this study looks at the dynamics of how putting multiple index funds in a portfolio act relative to the individual asset classes and also how well the portfolio performs relative to a portfolio of randomly selected active funds in some interesting things take place, which I can share later if you want or go through it now. But basically you get a, we call it a portfolio multiplier. Things happen in a portfolio when you have all index funds that actually the probability of the portfolio performing actively managed funds actually increases to a fairly significant level depending on how many asset classes you put in over and above what each of the individual asset classes show. So it's kind of an interesting work. I wanted to take indexing, at least a study of indexing to a portfolio level which has not really been looked at yet. In addition to that right now I'm writing a book. And I started it last year, some of you who are here remember, but it never materialized because I was having difficulty writing it so I changed the name of the book and approached it from a different way. And you're all going to recognize this, but the title of the book is called The Three Fund Portfolio. And what it is though is it begins with, what I'll briefly discuss here for a second, is we all have the same philosophy as mobile heads. Everyone here in this room has the same philosophy. However, there are maybe 200 people in this room. I guarantee you none of us have the same portfolio. We all have different strategies. And your strategy is right for you, my strategy is right for me. I'm using the Three Fund Portfolio as the beginning strategy for everybody in the book. And the final part of being a successful passive investor is having the discipline to follow the strategy. And the only way you're going to have the discipline to follow the strategy is if you have the mobile head philosophy. So that's what's going to be in the book. That's what I'm working on. I would say retirement doesn't feel like retirement so far. Now what I thought retirement was, but actually I think I'm just moving on to doing something new for a change. At the end of last year, the very last thing I did was to convince the firm to change equity benchmarks and then took off out the door and said, you know, good luck implementing this. So actually I would pertain to consult on that implementation process during the first five months of this year. I am continuing to do consulting for Vanguard, primarily speaking to clients and symposiums. In addition to that, I'm talking with the university and we'll be taking up a role at the university that has not yet announced it, probably about March or April of next year. So I've been in 68 airplanes this year, so I'm fairly busy. I've pretty much achieved my life's goal, which is to be able to stay in my bathroom until 2 p.m. and play with my rancher. And you know, Jack gave me the opportunity to plug my e-book, so I'm not going to do that. The thing that I've written and I'm proudest of is an article that was in F.A.J. called The Paradox of Wealth. The bad news is you can't get it unless you have a subscription to F.A.J., but the good news is there's a much better working version of it available, the Paradox, although the Larry Siegel's website, Larry Siegel.org, just Google it, you'll find that it's easy enough. It's a much better version because F.A.J. cut the heck out of this. It's called The Paradox of Wealth and it's on Larry Siegel's website, Larry Siegel.org, I think. It's easy to find. If you can't find it, just email me. And I'm casting around for new things to write about. I haven't really settled on anything yet. I may do another finance book. I may do another big picture of history book. I have no idea, but I'm sure having fun figuring it out. Like Bill, I've met my goal of being on a panel with these guys. I'll pay $500 a picture. Aside from my normal writing and CBS Money Watch and Financial Planning magazine and Wall Street Journal Total Return blog, I've written a couple of important pieces coming out early next year in AARP Magazine. And the one I'm most proud of really has little to do with investing. It's called when the numbers stop making sense. How we protect ourselves later on in life if we no longer have our full thinking capacity, cognitive abilities that can be tricked by other people. So certain things that we can do. And it ends up, it may be inevitable, even the mind games, you know, Sudoku, Crossword puzzles may not slow things down. All right, well, we'll start with the Q&A. And Jack, it's good to hear here. Probably the most requested, the number one, the most questions I got was on a subject that's very controversial on the board with its form. And that's treating social security as a bond. So I'd like to, Jack is already touched on that yesterday. So I would like to get the panelists, the panelists, the members to share their thoughts on treating social security as a bond and increasing your equity allocation as a result. Can we start with Alan, please? I think the mathematical answer is that social security is a bond, but we're not mathematical beings. We're emotional beings. So therefore what I tend to do is look at the cash flow for a client that they need above and beyond social security and then design the portfolio that not only matches their willingness to take risk, but even more important, their need to take risk since we can't take the money with us. When they leave, we may not even be on the efficient frontier. We may be on what minimizes the probability of outliving their money. You can do one of two things. You can either capitalize the social security as a bond, but then you can't include your social security payments. Or you have to include yourself. You have to include, you can't include the stream in your living expenses. So if you're making $30,000 a year from social security and you need $70,000 a year to live, you cannot say I only need $40,000 a year and capitalize. You have to do one or the other. You either have to say I can capitalize it, but then you have $70,000 a year in living expenses, or you can say I have $40,000 a year in residual living expenses after the social security comes in, but then you can't capitalize the social security. One or the other can't do it. So I guess this presumes we're going to be able to collect social security. You know, it's very much like a defined benefit plan and, you know, I think Bill and Alan covered it. It's very similar to someone who receives deferred compensation. And, you know, I think with deferred comp, you need to figure out how that's invested and invest around it. So I think, you know, including it in your portfolio is the appropriate way to think about it. Social security I treat as though you're, as pay, just like a pension, it's pay. It doesn't really have a net present value because you can't sell it. You can't cash it in. You can't go to the social security office and say, well, the net present value of my social security is $300,000, give me a check. It is like getting paid without working. When you die, it goes away. The spouse doesn't get it, whether it's with social security there are some partial payments. So I don't treat it as a bond. I look at it the way Bill described it a couple of years ago. And Alan described it a little bit earlier. You look at it as pay, and anything above that that you need to pay your expenses has to come from your portfolio. And then you do an asset allocation on your portfolio to give you that extra income. So that's the way I look at it. Thank you. We have a question from Lady Geat for Bill Bernstein and Rick Ferry. All of the risk of bonds and stocks are very different. Investors sometimes associate a high-yield bond with an equivalent equity portfolio. What is the role of high-yield bonds in a portfolio? A brief introduction for the new investors would be appreciated. That was from Bill Bernstein and Rick Ferry. Go ahead, Bill. A high-yield bond you can think of as being a mix of mostly high-quality bonds and a little bit of stock. So the only thing I would say about high-yield bonds is don't count on it when the excrement hits the ventilating system because you're going to have to take a haircut. That's why I really, except in very exceptional circumstances, don't like high-yield bonds because I believe that the risky assets, the safe assets, don't confuse the two. The high-yield bond is halfway in between. It's neither fission or foul, but I just find it very statically displeasing for that reason. If you're one on high-yield bonds, own T-vills, own little stocks, you've got the same thing, plus you'll sleep better at night. I disagree. It's if it was inefficient. And the argument is a high-yield is inefficient. It acts like equity. It's like a bond. It's an inefficient market. It shouldn't exist, yet it keeps getting bigger and bigger and bigger every year, and the issuance of high-yield bonds keeps getting absorbed. I did a lot of work in separating the credit risk of high-yield bonds from the default risk. With corporate bonds, investment-grade corporate bonds, you have credit risk, and what that is is the possibility of the bond credit degrading down to high-yield. When you get to high-yield, you can actually separate out the credit risk from another type of risk that only shows up in high-yield, and that's the fault risk. I actually stripped out default risk from credit risk, and then I did a correlation of the default risk to equity risk, to see if, in fact, default risk and equity risk are the exact same risk. And the answer is, at times it is, and at times it isn't. So the default risk is actually a unique risk to high-yield bonds. And to the extent that I look at portfolio management as a diversification of risks, if I have this unique risk in high-yield bonds, and it's a big market out there that's at a relatively efficient market, I want to include at least a slice of that in my client's portfolios to actually make the portfolio a little bit more efficient as a portfolio. So I just look at it a little differently. Well, I'd like to add, too, that while the question may be directed to a specific individual or two individuals as in this case, that after they address the question, if the other panelists have any thoughts they'd like to add, please do. If I could just add one thing and I could do agree with Bill on this one, you could make the argument that variable annuities and hedge funds of funds wouldn't exist if there weren't a market for it, but they're sold. It doesn't mean that it's inefficient. And I think you take your risk with equities and you want your fixed income to be the shock absorber, the ballast. I'm not even in agreement with overweighting. That's been great corporate in a total bond portfolio with BND. You know, I mentioned earlier that I like thinking of theory first and figuring out how that applies in practice. Theoretically, a stock is essentially a call option and the strike price is the value of the bond. So it's a call on the value of the firm, but the strike price is the value of all fixed income assets. And so, whether it's a high yield or credit worthy, it is the strike price. I would note that the strike price there is almost by definition a little bit closer to the edge than it would be for a high credit quality bond. So I guess I've always kind of thought of it as a little bit of a hybrid. And I tend to think of things linearly, I guess. If I think of this as the value of the firm and this is the strike price or the value of the bonds and this is the value of the equity in a high yield bond or high yield situation, the bond, the strike price is closer to the edge of the value of the firm and therefore I think does take on some characteristics of the equity market as well. It's kind of a hybrid between fixed income and equity. Two seconds. If you look at the performance of the Vanguard high yield corporate bond fund over the last five years, it has outperformed both bonds and equity. How can it do that if it's a hybrid between bonds and equity? I don't understand. But I'll just leave it there. We can go to the next question now. You know the problem. Because it's basically a low data equity combination and when you go through a very significant bear market it doesn't take the same degree of hit that it was down 55% of the equity market was. Let me just add one more thing. Everyone thinks about the general principle. Don't make the mistake of thinking high yield bonds are a commodity. They're all life. There are staggering differences in quality. Vanguard, because of our policy and all costs when you deliver the same yield that somebody who wants to deliver actually yield with a high expense ratio has to have much lower yield and much lower, much riskier portfolio. So there's a big selection risk in high yield bond funds that you want to be very, very careful about. They're all different. This next question is very interesting and Jack, I think we'll start with you on this and we'll go straight down the line. It says, question for all the panelists. What was or is your most humbling investment experience and what have you learned from it? When I was young, out of college, just out of college, maybe the first five, seven years, many of my friends were in the brokerage business and they always had a great stock for me. And I've now had to differentiate I would say every single one of the damn things was a humbling experience. And one of them was in the original Windsor Fund run by a guy named Bob Kenmore. And I can't remember the name of it, some kind of computer thing. And Kenmore loved it. He had it in the fund. So he talked me into buying it. When I did stocks, I haven't done stocks for, I guess, 40 years, something like that. And I did. And of course that failed like all the rest of it. So the humility you get by not just buying stocks, by buying stocks that are recommended with all due deference, but that are recommended by brokers, is this Ted Kazer's duty squared. Okay, and duty two. One of them was when I was in the Marine Corps and I finally started to accumulate some money. And I bought a very popular financial magazine that you all know but I won't mention the name. And in there I recommended three great stocks for the future. And I bought a $500 worth of each of these three stocks. And within two years, all three were bankrupt. The second one was I was on vacation again in the Marine Corps with a young family. And I walked into an art shop in Honolulu, Hawaii. And I saw these dolly prints on the wall. And I thought that, and I always talked into the fact that these are the greatest investments in a sliced bread. And so I bought one. That was my other second worst investment because they turned out to be a fake dolly. I guess I'll give two quick ones as well. Back in 1983 I was at a conference. I started a gold mining company. I put a venture capital deal together to start a gold mining company. And so I was at an investment conference and was talking with that conference. Well, Milton Friedman had a student named Colin Campbell who was a professor of mine. So I went up to him and asked, do you still keep in touch with Colin Campbell? And so he said, you know, Colin, he said, yeah, I used to be a professor of mine. He said, oh, you're my grandson. So he's my grandson. So he asked me, so what do you do now? I said, well, I put a venture capital deal together to start a gold mine. He says, oh, so you're unemployed. You're unemployed. The other one was, I think you may remember this one. I was actually going out for my interview with Vanguard in September of 1987. I was interviewing with Jeremy Duffield who actually ended up hiring me. But Jeremy said, you know, it was a Saturday. He said, so, you know, come in kind of golf attire, something casual but reasonable. And so it turned out that Friday the day before I was with my wife. Her company was doing an outing and so I was with them and I was wearing actually basketball shoes. And I was in the airplane. I went right from there to the airplane. I was in the airplane flying out here for the interview and I realized the only shoes I had were basketball shoes. And it was 10 o'clock at night by the time I got here. So I interviewed with Jack wearing basketball shoes. I'm not sure I noticed. Well, before I was 40, I've only made every dumb mistake with everyone else in this room. But I think that the biggest mistake I've made in my professional life was not understanding what Warren Buffett has understood most of his life which is that the only saved asset in this world are short-term treasury securities. And during the crisis it really didn't come home to me. And I realized that even short-term imports and even short-term municipal bonds are going to incur a haircut if you want to cash them in to live on or buy even cheaper stocks. I used to be much smarter than I am now. I took my college graduation money in 1979 about a year later and put it in gold. Gold had fallen back from 60 to 64 ounce and I was absolutely sure it was going to double every year. Now, obviously it hasn't even kept up to inflation. If I had discovered Jack Bogle and put it in index fund I would have had a whole heck of a lot more money. It taught me I wasn't as smart as I thought I was and my only excuse is Richard Baylor had not invented behavioral finance so I did not know I was following it. It's not your fault now. Innocent victim here. Well, since it's a true confession time I'll throw mine in too. I started investing in the late 60's and every magazine article that I read about a fund I've never met a fund that I didn't like and didn't buy and I was really reminded a couple of years ago well in 2006 we sold our home and in the attic boxes of all the funds that I used to own back in the days before found Vanguard and investing in that. So I was really reminded of the things that we all go through most of us go through early in our investing career and we just follow all the hot funds we do performance chasing we do everything wrong. Hopefully the forum helps a lot of people from making the same mistakes that we made. So that's one of the reasons we all do what we do to try to keep people from making the same mistakes that we made. Here's a question for Alan with the interest rates at an all time low, where does one get income? I hear a box. Oh, I'm sorry I spoke on a turn. I'll go with the break, let's make it feel good. I reject the fact that rates are near an all time low now if we go back to 1981 you could earn 12% on a CD which meant that after taxes the rates were much higher than you got about 8%. Inflation was as high as 15% so you were 7 percentage points worse off. It felt good because you got to see the statement in Grace. So I tell my clients our portfolio is stored energy that allows us to do what we want with our life and you can't take it with you and it's okay to spin down the principle quit looking for income. Everyone in this room for one reason or another was programmed to put money away to be accumulators and it's very difficult to give yourself permission to spend it down. I don't know what rates are going to do and there may be a reversion to the mean and I use certain CDs that have easy early withdrawal penalties as a put the right to sell it back to the bank. If interest rates do increase but quit chasing income would be my number one recommendation and by the way stocks are yielding 5.1%, 3.1% in terms of a stock buyback which is absolutely returning cash to shareholders and dividend. The income really needs to come from the equity portion of your portfolio. I mean return is return. It doesn't matter whether it comes from capital return or dividends. To me the whole thing of looking for investment income to live on is an oxen moron and I'll second what Alan says is you're a human leader. Don't be afraid to spend a little of that capital and maybe fly first class once in a while. And that's actually Vanguard's position as well but we think of total return investing as opposed to thinking of yield. It's really what is the total return and then you use whatever you need to in capital in addition to the yield. We talked earlier about high dividend yielding stocks. Let's say you get a 4% dividend yielding equity and just for hypothetical reasons say well you're going to get 6% capital appreciation. Is that any better than a 2% yielding equity with an 8% capital appreciation? In fact you could argue that it depends on the tax environment but it could be worse. In the old days when dividends were taxed at ordinary rates you'd actually rather get capital gains but the advantage of thinking total return is you end up with a more broadly diversified portfolio and you're not taking the factor bets that you might with a high dividend yielding portfolio. I'm just going to agree with Bill and Alan and I do like Alan's idea of that a buyback yield is a real cash yield. They're using the cash instead of the pay you in a cash dividend they're using the cash to buy back stocks so why not sell that portion of the stock market that's 3% or so that's the buyback yield and you take that as income as well so I'm on board with everybody so far that it's the total return of the portfolio that matters. We have a question for Gus you mentioned that P.E. is the best predictor of equity returns said you also hammered that beta timing is a fool's game should investors shift or tilt their equity on exposure based on current P.E. ratios? Gus mentioned that P.E. is the best predictor of equity returns he also said that beta timing is a fool's game should investors shift or tilt their equity bond exposure based on current P.E. ratios? Well I think P.E. ratios are actually pretty fair right now that I mentioned earlier Vanguard's conometric model was predicting 69% equity returns which I think is a fine return of return in that segment I think if you look at Schiller P.E.s people say well Schiller P.E.s are still quite high I think in normal times Schiller P.E.s are fine I think today Schiller P.E.s are distorted they're backward looking we know that the market's forward looking Schiller P.E. usually works okay it's just a way to normalize earnings it's going to produce a higher P.E. ratio than you would using the same last 12 months or forward looking you just have to calibrate it because it's on average going to be higher compared to its longer term average right now it's distorted because of the last 10 years we've just seen earnings do crazy things over the last 10 years I think actually using last 12 months would be better than Schiller P.E. and actually forward looking P.E.s are better than the last 12 months because the market's clearly forward looking so from that standpoint I think things are fair maybe we're slightly above long term average typically not where bull markets end but if you look out over 10 years you should get a reasonable rate of return maybe a little bit less than historical averages because I indicated in my one presentation though even though I think there will be reasonable returns in the equity market I still question the idea of throwing caution to the wind and over investing in equities because you are taking greater risk and bonds are there to moderate your portfolio risk and if you believe what I showed with the efficient frontier and the utility curves with lower expected returns both in equities and bonds even though equities are reasonable it still looks like a static asset allocation not necessarily a shift to a new asset allocation so I wouldn't necessarily say move to equities equities I think staying with your long term strategic asset allocation makes a lot of sense and Gus could I just ask you do you use operating earnings or reported earnings to calculate your PE do you look at the past 12 months or the next 12 months typically you look at the next 12 months and look at operating earnings isn't that kind of a cop out running the ship I would have said yeah it's just a way of calibrating things because then you compare things historically the important thing is comparing apples to apples so Schiller is okay if you compare Schiller to Schiller you wouldn't compare Schiller and say well Schiller says the PE ratio is 20 times and the long term average is 15 it's just important to compare apples to apples I think that the best long term work on this is done by Dimson Marsh and Staunton and you can get it for free you'll spend 110 bucks for trying for the optimist but their credit Swiss yearbooks are available online for free and they can be discussed on the the board and what they what we're really talking about here is torquing around your equity allocation based on the valuation and in all just about all 20 countries they looked at over the course of the 20th century Dimson Marsh gained you did not gain any risk-adjusted returns by doing that however what they found was that by adjusting your internal allocations among nations depending upon which countries were achieved that did improve risk-adjusted returns so how do you apply that now as you look around the world today I think that US equities are probably the most expensive I think developed market equities are probably a little less expensive for a very good reason I'm going to add and emerging markets of late have perhaps even become cheaper than developed market stocks as I think someone mentioned last night so you know you can take that for what sport if you want to play that game you can play that game but if you don't want to you'll do just fine as well I knew there was a reason I was overweighted in emerging markets that's not advice I think sticking with an asset allocation is more important than picking it right in the first place we've seen all sorts of data presented last night throughout that the dollar-weighted returns way under perform fund-weighted returns we have all of these sophisticated reasons to change our asset allocation and they typically lead to lower returns so sell equities because equities are up to get back to your target allocation so you're not going to be coming out with the other growth under your fund flow ETF now that got turned on by gas I think that valuations are important as you're getting close to retirement as the amount of money that you have accumulated reaches your goal and you're going to be doing an asset allocation shift down anyway because you've accumulated the amount of money that you need for retirement and the risk then is to lose it so you don't need to take as much risk the question is when do you actually make this shift if it's 2008 early 2009 and the PE of the market is down around 10 I just wouldn't recommend making the shift then I would wait until the market came back to 15 PE or so on the other hand if the market is trading at five times earnings or 30 times earnings like it was in 1999 and you've made a lot of money because of an increase in the speculative premium as Jack would call it in his books and you've made a lot of money and you're at your goal then you might want to do an asset allocation shift a little early but that's probably the only time if you're 25, 30 years old and you're time horizon on taking your money is 20, 30 years out of the story about valuations I will say one more thing and that is that Bill made a comment that we should perhaps look at the valuations of different countries and I think that if you divide your portfolio up among US equities developed markets and emerging markets and have a fixed allocation and then do a rebalancing say once a year that you're actually going to take advantage of what Bill is talking about and not have to work too much on it and that is for everyone bonds, it's about bonds what do you do with dollars set to go into bond index funds I guess this is a nervous investor who is afraid to put the money that's allocated for bond funds to invest it at this time so the question is what do you do with what do you do with it you invest it you know again the role bonds play it's never been what we think is a workforce and a portfolio it has a role as a diversifier to moderate the volatility that we experience in our portfolio and that role hasn't changed the good news is if interest rates start to rise the equity portion of your portfolio is likely to perform pretty well I mean my view of the way things unfold is that the economy starts to get a little bit stronger the Fed backs off in tapers, interest rates rise but the equity market does pretty well in that environment, there's a difference between tapering and tightening so like Rick I'd say stick with your strategic asset allocation and go ahead and make the investment and just recognize that it's there for a reason what if an accident happens what if an economy says something crazy imagine everything well I guess the follow up question on that would be do lump sum or dollar cost average when you're a real nervous investor I'd say just do it I think there's a lot of arrogance in the belief that common wisdom is that quantitative easing has to end which is going to cause rates to go up I think there's arrogance I think the market didn't know that we couldn't buy back our trade degrees indefinitely and we don't know what's going to happen to rates the top economists have been directionally correct on longer term rates far less than a coin flip so just do it in my opinion this one's for Rick and others we've already heard from Gus and Jack spoke briefly on this but Rick and the others what are your thoughts on smart failure so lowly investment advisor I don't know these things so I called up actually emailed the experts I got an opinion from Bill Sharp Nobel laureate Bill Sharp I got an opinion from now Nobel laureate Jean Fama I got an opinion from 10 French and I got an opinion from my friend Rob Arnott okay so three out of four of them said there is no such thing as smart failure and you guessed which one said there was so basically I think that Jean Fama summed it up the best he basically said that if you look at loot versus growth and small cap versus large cap and you do regressions on these returns the regressions are positive that means you could call it a beta and some people do he doesn't call it a beta Fama doesn't call it a beta Bill Sharp doesn't call it a beta he says but some people in academics mathematically would call that excess return premium that we've seen in the market a beta and therefore if you put additional betas in your portfolio in addition to the market it becomes a multi-factor portfolio but there is no such thing as smart beta it's silly to call it smart beta beta is just beta and but you could call it additional beta so that's the right term to use additional betas the most difficult piece I've ever had to write is about a 5600 word piece for financial planning magazine and the current issue where I had to give the portfolio innovative award to Rob Arnott and it is an innovation it's certainly the small cap value tilting and I tend to get small cap value tilting for my client by buying a total stock index and a little bit of a small cap value vanguard index but it's an innovation when you capture 100 million one way or the other I believe it's more of a marketing innovation than and it is a new way as Rick pointed out of allowing individuals to capture that small cap base directly you know outside of DFA which you have to go through advisers it's a buzzword it's like fundamental indexing I don't believe I'm going after dumb beta and that was the biggest thing by the way I really took offense to what Rob you know calling him by the way Rob did not come up with the term smart beta but he just embraced it I was at a conference last week and Rob was speaking and the presentation of his speech was smart beta and he must have said the term 100 times in 40 minutes and it's just driving me crazy but I think the thing that really turns me about smart beta that I don't like is it infers that all of us auto market investors are investing in dumb beta which makes us all dumb and that's what I really don't like about it Jack how do you feel about that I actually think it's misleading you know the ads say this has outperformed the S&P 500 why in the world do you compare a mid cap value portfolio to the S&P 500 I mean our mid cap value index fund has outperformed the S&P 500 but we don't market that so I think it's potentially drawing people into an investment without really realizing what they're getting Gus this next one's for you that said could you please explain how you managed to keep the index fund return so close to the benchmark returns despite transaction cost and cash drag is it all about securities lending what is your secret sauce exactly your secret is safe with us I see Karen DiMotto over there you know indexing is a lot of blocking and tackling it's about this much intellectual property and a ton of blocking and tackling and I think we've got the best traders in the industry they've been with us for as long as the first one joined me in 1989 is there today they're phenomenal and what they do they identify say micro inefficiencies and can add some value one thing we have is an advantage of size and continually going into the marketplace we can find opportunities if you're not continually going into the marketplace you don't have the opportunity to take advantage of it so a lot of it is just being great traders minimizing transaction costs and looking for these micro opportunities in some funds also securities lending in some funds they are enhanced by securities lending in the small cap fund or an international fund in any given year it may be as high as 10 basis points of additional return in a lot of funds though it's a basis point in the S&P 500 large cap segment it's negligible it's not even measurable so it's mostly the skill and expertise of our index team so Rick Edelman is right about hiding 2% trading costs actually you underperform the index by less than the expense which I think is absolutely amazing what you've done for sure thank you let's move to tips now we have a couple of questions the first one is from Victoria can you please discuss at what level of fixed rates it will become advantageous to start buying tips again and the follow up question or associated question is what are the panel's views on tips and the role in a portfolio and the current interest rate and the inflation environment so can we cover the raw tips market then please well I always have tips in a portfolio because the reason they exist is a hedge against unanticipated inflation and since unanticipated inflation is a risk in the portfolio then I always want to have a small portion of my bond portfolio in tips and my allocation has always been 20% and it's worked out fine for me I've been nervous about tips the last several years because real rates have gone negative historically real rates on say a 10 year tip is 175 base points 1 to 3 quarters percent they actually went negative and right now they're still very very low it turns out that the duration on a tips bond the real rate duration is actually quite high like 8 years so if the real rate reverted back to say the longer term average of 1 to 3 quarters percent that's a backup of let's say 150 basis points from here you can lose 12% in principle trying to capture an inflation premium I think this is a point in time where tips really kind of scare me with regard to inflation I've been saying ever since the global financial crisis inflation isn't going to happen a lot of people are worried that the Fed's balance sheet is just ballooned and they're talking about the money supply exploding the money supply is not exploding the Fed's balance sheet is expanding the money supply the money multiplier has collapsed if you look at broader aggregates of money supply they're going at 4 or 5% a year that's basically nominal GDP growth and you need money supply to grow at that level if you don't you're going to start choking off your economy so obviously there's so much slack in the economy right now I personally just have not worried I think Rick's right tips guard against unanticipated inflation against some sort of oil shock or something like that if it's anticipated inflation like you get in the mid 80s actually mid 70s equities are a great inflation hedge in that type of environment equities perform great in the second half of the 70s tips are good for unanticipated inflation I just think they have some risks at this point I think those are all very interesting features of tips and I agree with what Rick and Gus said I see tips as the I see tips having a somewhat different purpose I see them as the ultimate liability matching element in today's portfolio we all have a stream of real liabilities in the future in terms of our retirement and a tips ladder that is adjusted and aimed at that the safest asset they can have and I think it will ensure your retirement the best having said that I will also agree with Gus this ain't the time to be buying the natural rate of the long tips is probably an excess or at least in the vicinity of 2% shorter tips 1 to 2% depending upon the duration and at the shorter end you're still looking at negative yields so I wouldn't be in a rush to buy them right now I'm a hypocrite buying the market when it comes to tips quite a bit I say tips are the lowest risk asset out there because it's the real return that matters and of course the US would never default on it by the way they say that congress has a 5% approval rating I've never met one of those 5% but anyways tips are far more volatile than treasuries and in 2008 when stocks plunged people ran to traditional treasuries not to tips and those yields were 3.5% that was a wonderful time to get into tips I still believe that tips need to be part of the portfolio they give some protection against inflation not as much as stocks but they are a part of the portfolio I just want to just mention one more time that if tips are a strategic allocation it's a certain percentage of your bond portfolio and you're doing rebalancing and when they go to 3.5% you're going to be buying and when they go to a deep negative you're going to be selling because the values have gone up so you are capturing a portfolio benefit by just having a fixed allocation in your portfolio but would you if Gus if you're scared investors are worried about tips too would you recommend cutting back on tips or just holding for somebody who's got 30-40-50% of their bond allocation a retiree who is worried about inflation and that's the reason they have the enlarged allocation of tips would you recommend they cut back on tips the tips are down right down Vanguard's tips problem is down about 6.5% this year so you would be selling in a down market would you cut back you know to Bill's comment you're kind of immunizing your future liabilities there's a reason it's called fixed income it's generally fixed income but it's inflation protected fixed income so if you can live off of the income itself and you don't really care what's happening to the principal a lot of people don't really think that way I mean all of a sudden you lose money in bonds it's all like that go back to the beginning of 1987 it was a collapse in the immune market place and so if you have discipline and you're living off of the income it's going to be inflation adjusted income which should take care of you I think it's okay if you are at all concerned about the principal I'm nervous obviously it's very volatile that's for sure I'd be nervous having 40-50% in tips we have tips in some managed payout funds but it's moderate amount 10% actually two of the managed payout funds don't have it in one day Gus this one's probably for you why did Vanguard buy a market neutral fund it almost seems like something interesting to keep the quants from getting bored now I was actually hired to develop the active quantity program and I was given the index inside as well if you do active quantity you can do passive quantity so I built the active quantity team it's been kind of my pet project my love I'm very intellectually stimulating the reason I like quantitative active quantitative investing is I think that mentioned earlier there are inefficiencies in the marketplace and my belief is those efficiencies arise because we all act irrationally I mean we do irrational stuff all the time so why should we be rational when we invest and that's true with a traditional manager as well they're going to make irrational decisions at times and I like a quantitative form of investing because you create a model based on theory you test to make sure that it worked and then you just rigorously apply you do not let your emotions take over you just use what you think is the right theory and in my view that maximizes the chances that you'll actually be able to add value or find alpha and I think if you look at our active quant group we've had mixed success over the years we've had some really good periods and some dramatic underperformance on average I think we've added a little bit of value and the way I think of a long short market neutral fund is it's really a volatile money market fund it's a money market fund the expected return on it should be money market rate of return plus any alpha which could be minus alpha if you don't have skills so I would hope that over time we'll be able to actually get a return that is greater than a money market rate of return obviously with volatility that you don't experience in money markets Bill this is for you regarding residual living expenses what do you mean by residual just to go back to the example I had before which is if you're living expenses are 70,000 30 in Social Security and you've got 40,000 dollars a year of residual expenses just to amplify that a little bit you should probably have if you're going to retire 25 times your residual living expenses so that's a million bucks this is a question that comes up every time we have a volatile situation I've heard the expression many times over the years it's different this time I've never believed that to be true for a long term investor the current investing environment does seem somewhat unusual with both stock and bond market hosting significant risk my question is is it really different this time no, no and no the new paradigms and this time it's different will kill you and then second of all I wrote a piece on data that Wilshire provided the myth of market volatility markets are no more volatile today than they've been over the last 40 years in 2008 and 2009 it was an exception and there are lots of reasons why we think it's more volatile today and one of those or the index values are so much higher that a 1% change today is a lot of points 30 years ago was much smaller so markets are no more volatile today and this time it's different will kill you the only black swans are the history you have in red I don't think the laws of economics change and therefore things can't be different this time your borrowing costs have to be below your return on equity your growth your GDP is basically related to population growth and increases in productivity I mean these universal laws of economics don't change so even though the markets may be volatile it's not different this time alright we're coming up to the close Rick has to catch a flight we're on schedule we're going to take a break I'd like to thank all the panel members Jack has one final message for us I just in my head like to express my own appreciation for those leadership we'll stop somewhere right now, right here