Vanguard’s ultralow-cost investment products have permanently reshaped not just the advisory business, but the financial services industry as a whole.
The continuing money flows to Vanguard products may be astonishing, but that doesn’t mean all advisors – even those who are fans of what the firm sells – think the Vanguard solution is always the best solution. Financial Planning contributing writer Allan S. Roth, founder of planning firm Wealth Logic in Colorado Springs, Colo., is one of those advisors.
In a story published last week, “Where I Disagree with Vanguard,” Roth engaged two Vanguard executives in thoughtful conversations about fixed income, alternatives, mortgages, money market accounts, risk tolerance and more.
Readers were quick to join the conversation, especially on the topic of annual withdrawals from retirement savings.
“This is a very difficult time for retirees,” a commenter named Dennis L.R. posts, “whether they are just entering or in early retirement. Asset prices have been inflated by zero interest rate policy, so stock and bond incomes are 2% or less. Therefore, if an investor wants to withdraw 4%, he is selling shares. Stock P/Es are already high, so future returns will likely be below average.
“It is very difficult to put together a portfolio of just mutual funds that will safely provide 4% withdrawals for 30 years,” Dennis L.R. continues. “Historically, it was not that difficult. We are in an era of low population and productivity growth. Each month brings us closer to the next recession. Vanguard still has about the lowest expenses, but that is no longer enough.”
Roth replies that recent times have indeed been “historically much tougher for retirees. In 1981, one could earn 12% on a safe CD or bond which yielded about 8% after taxes. Unfortunately, inflation was about 13%, so the retiree lost 5% of her spending power. Last year and this year are much better. It's been a very bad first 16.2 years so far this century for stocks [but] outstanding for bonds as bonds have trounced stocks. I don't know the future. I think reaching for the so-called 4% safe withdrawal rate for 30 years is dangerous,” Roth adds.
Focusing on mathematical logic, reader William P. writes that “withdrawing 4% a year of the amount in the account may result in some years when the disbursement decreases from that of the previous year, but the fund will never be depleted. Plan accordingly.”
Roth posts a reply saying, in part, that “even taking out 50% a year would never completely deplete” an account, though “in a few years, the dollar amount taken out would be tiny.”
PAYING DOWN A MORTGAGE
Another reader weighs in on the merits of paying down a mortgage rather than keeping assets in fixed income, a strategy Roth has embraced.
Reader Mike G. says: “I've seen others compare a mortgage to a bond, but the comparison overlooks some very important issues. The underlying principle for all investing is that greater return requires greater risk. So all investments should be compared in terms of risk and reward. But the risk on a mortgage is very different than the risk on a bond. A mortgage is tied to a dwelling and that dwelling is tied to other expenses like utilities and taxes. It is also where you live.
While paying off a mortgage may result in a fixed increase in available funds, it does not eliminate those associated risks. There are tax implications also. This doesn't mean that paying off a mortgage isn't the best advice for some, it just means the issue is far more complex than comparing mortgage interest rate to bond return and choosing the higher.”
In a reply post, Roth challenges Mike G.’s premise and suggests he and other readers consider an analysis he wrote on the topic in Financial Planning in 2013.
“If you click on the Read More piece called "Tell Clients Time to Pay Off the Mortgage," you'll see more detail why,” Roth says. “Basically, in no way is the mortgage tied to utilities, taxes, or even appreciation of the home. And as mentioned, the tax argument is neutral at best (bonds are taxable like mortgage interest may or may not be tax deductible) and, for most clients, it's tax-advantaged to pay off the mortgage. Liquidity is the one argument against.”
THE INSURANCE OPTION
One reader said Roth had overlooked a key investment option.
“Excellent article,” Anthony M. begins, “but time to think outside of the box a bit. Life insurance cash values (universal or whole life) are generally earning more than any of the alternatives you mentioned. They have tax advantages and are just as liquid or better.
Considering the collateral nature of policy loans, sometimes paying down 6%-8% policy loans is far superior to other safe money/risk-adjusted alternatives you mention. Sometimes the cash values outperform even with the policy/mortality costs being considered.”
Roth wasn’t buying. “I've spent thousands of hours reviewing whole life, universal life and all sorts of annuities. They are indirect investments and not cost effective and I've reached the conclusion that it's generally better to disintermediate the insurance company and agent. Here's a fairly recent piece on that topic: “Is Buy Term and Invest the Difference on Life Support?”
“I agree with you on possible tax-advantages, but not on liquidity and return. As you know, high commissions mean high surrenders. Sure you can borrow your own money, but I've always told people I'd lend them their own money for half the rate charged by the insurance company. As far as returns go,” Roth concludes, “I've yet to see a policy live up to the illustration.”