John Rothmann – I’m John Rothmann…

Mitch Tuchman – And I’m Mitch Tuchman.

John Rothmann – …and our guest on the Retire With More Program is Jay Vivian. He is the man who oversaw the retirement funds — $135 billion in retirement funds for IBM — and when we left off, Mitch, I was on the edge of my chair because he had two conflicting views and, gosh, I’m so indecisive, how do you decide, Mitch?

Mitch Tuchman – Well, let’s set this up a little bit. So, when you’re Jay Vivian and you’re running this kind of money, every smart money manager in the world comes in to see you.

Jay Vivian – Oh, the dumb ones do, too, Mitch.

Mitch Tuchman – And the dumb ones do, the smart ones and the dumb ones! But when they get to see you, you do have access, and so you were telling a great story about how one guy comes in in the morning and says our fund’s going to go long Japan. We see an amazing opportunity. And then that afternoon another guy came in and he says we’re going to sell Japan short, and what did you guys do? I mean two smart guys, conflicting views, great performance…

Jay Vivian – Essentially, we learned that having a really smart guy doesn’t really help you that much, and it’s really hard to make a decision like that, and it comes down to the fact that I ended up, certainly, believing that indexing was the way to go in a lot of areas. Certainly in an area like large-cap stocks. Certainly in trying to time markets and trying to time interest rates, because there’s a ton of smart people out there and they disagree even with each other. So, if they can’t figure it out, how the heck can I figure it out in an ivory tower, like an academic, or in a corporate plan? It’s just really hard to do that. So what you do is you say you know, unless I’m really convinced that I’m smarter than all those guys and gals down on Wall Street, I really shouldn’t try to play in that space.

Mitch Tuchman – And therefore, if I’m not going to play in that space, my default, the other choice is simply to ride the markets and capture those returns, right? And that’s what you decided to do with billions and billions of dollars for IBM employees.

John Rothmann – And Jay, what you’re logically saying, then, is that the safer way to go, but not only safer way to go, the smarter way to go, is what you and Mitch are recommending in Rebalance, and that is to go with an index fund. And just so everyone is clear, can you just quickly define for us, very simply, what exactly is an index fund?

Jay Vivian – You bet. It’s called an index fund because it’s managed against an index and an index is something like the S&P 500 Index, which is the 500 large industrials, and an index fund is a fund which instead of trying to figure out which of those stocks is going to do better and which is going to worse, just says you know, I’m not sure I’m smart enough to do out, let’s just buy the 500 stocks in the S&P 500 and ride them.

The reaction that most people have to that idea of just buying the index or buying an index fund, which replicates the index, the negative reaction is well, you can’t be the index then, so you’re always going to underperform. Well, the answer is you’re not always going to underperform. If it’s a well-managed index fund you’re going to earn the index. And yeah, you’re not going to outperform, but guess what? You’re also not going to underperform. And it turns out that that’s where the real the problem is. It’s like a lot of games that you play, you don’t always win the game by beating the other team at what they’re doing. What you do is end up losing the game by losing.

Look at a game like hockey. How do you win the game? Yeah, you win the game by scoring goals, but you lose the game by letting the other team score goals against you. Same thing with indexing. If you don’t lose, if you can avoid those darn losses, you can on average do better than many of the other participants. This has been particularly true in the last five years, where active managers have underperformed index funds in large numbers, 60%, 70%, by some measures 80% of active managers have unperformed in the last couple years.

Mitch Tuchman – So let’s get back to these target-date funds. We were talking about a target-date fund, has a date on it. That is the date you retire. I think to the average investor who is getting into his 401(k), they think, well, I’m 50 years old, it’s 2015. I’ll probably retire at 65. That’s 2030. I pick the target date 2030 and that’s the end of it. I would say that’s probably a very shortsighted thing to do. Can you help somebody understand what else they should be doing besides just picking a random date on a target-date fund?

Jay Vivian – Well, one thing is, is that going to be enough? One of the worst decisions that people make is how much to defer, how much to save. That’s something that’s a hard judgment to say because you don’t know how long you’re going to live. So 2030, that may well be when you’re going to retire, if you’re going to retire 15 years from now. The bigger question is, how long are you going to live?

Mitch Tuchman – I wish I knew!

Jay Vivian – If you knew that you were going to die in 2030, sad story that you’re only going to live 15 years, but you might not need to save as much. If you knew you were going to live to be 99 like my grandfather did, you’ve got a bigger problem. You’ve got to save a heck of a lot more money and you’ve got to be a lot more careful how much you spend in fees. You’ve got to be a lot more careful that your portfolio is well-diversified. You’ve got to be a lot more careful that you’re protected against other things that might happen between now and then, like healthcare and kids that need help and whatever other expenses you have. So, picking 2030, yeah, that’s a good choice if you’re 50 and you’re going to retire in 15 years, but you’ve got a bunch of other things that you’ve got to think about, too.

Mitch Tuchman – Well, you know, Jay at Rebalance when we’re talking to clients who have these target-date funds in their 401(k) — and we do advise people on money we don’t manage as well as the IRAs that we do, because we like everything to be holistic with our clients — but when we’re looking at these target-date funds, I’m always amazed at how “off” they are. So, guy says to me I’m 50 and I’m going to retire at 65. I look at his target-date fund and there’s just not enough equities in this target-date fund, or when you kind of look at things, he probably ought to be at a much further out target-date fund. And I think that we’re always talking at these glide paths and they’re deceptively easy-looking but they’re really not easy at all.

Jay Vivian – That’s right. I mean, a 2030 fund, for example, that sounds pretty far away, but somebody who’s 50 years old might say, you know, I ought to be taking the risk down, but a 2030 fund really ought to have 70%, maybe 80% equities in it because not only does that fund have to survive the 15 years from now — again we’re talking about a 50-year-old hypothetical investor — until 65, but the average 50-year-old today probably has between 35 and 40 years of life left…35 and 40 years, that’s a long time! So that’s why that investor, even though they may not feel comfortable holding 60%, 70%, 80% in stocks, if they’re going to be living 30, 40, maybe even 50 years, like my grandfather, from age 50, you’ve got some serious thinking to do.

Mitch Tuchman – And Jay, in the industry, these glide paths, and maybe you can explain what a glide path is after I finish my question, but these glide paths, they’re different from purveyor to purveyor to purveyor and, to me, these glide paths were also devised when you could make money on bonds. Now we’ve got depressed bond prices. So, how do you think about glide paths and what should a regular, everyday investor do about that?

Jay Vivian – Well, I like the idea of glide paths for two reasons. One, these funds all automatically rebalance…

John Rothmann – Explain what a glide path is, though.

Jay Vivian – Within a given family of target-date funds there is a typical glide path, and the glide path, what it does is, over time, it gradually takes your risk down. So, for example, the 2030 fund, let’s just say, hypothetically, that the target-date fund at one of these fund families we were talking about a little while ago is 75% in stocks. That number might actually stay at 75% for the next 10 years. So our 50-year-old, when he turns 60 in 2025, it might still have 75% in it. But then it will slowly decrease. So the same fund, the same fund at Vanguard we used as an example before, the 2030 fund, this fund will be around for 50 or 75 years, but that fund’s target equity weight will slowly come down over time as its investors slowly age — or people at least that say they want to invest with the risk associated with retiring in 2030 — that will slowly come down.

Now the 2025 fund is for people who retire a little early. That equity weight will start to come down sooner. The 2050 fund might have, I don’t know, 85% in it now, we could look it up online in a second, and that’s going to come down later. So, if you think about it, and this is hard to do on the radio, but there’s actually a chart that each of these providers has that shows the equity weight at different numbers of years from now.

Mitch Tuchman – It just looks kind of like a plane kind of coming down for a landing.

John Rothmann – Gliding. Gliding to a landing. But I have to ask you a question: So, if I’m 50 years old and I’m planning my retirement, how do I know, what are the benchmarks that I should look for in terms of what I’m going to need to retire? I’ve got to pay my mortgage, my life insurance, property taxes, all these things. How do I figure it out?

Jay Vivian – That’s a very, very hard question, John. The most important one is one we talked about a minute ago, how long you’re going to live? So tell me that.

John Rothmann – If I knew the answer to that, boy, would I have a life insurance policy for you!

Jay Vivian – So, it’s a very hard thing to do, John. What you have to do is you have to try to reduce the risk. The biggest risk, strangely, is that you live a long time because if you live a long time, that means you’ve got to have more money. So you’re right, you’ve got to think about your mortgage. You’ve got to think about your retirement. You’ve got to think about the things you might want to do in retirement. You know, you want to buy that vacation home on the coast? Maybe. Do you want to leave money for your kids? Maybe. Do you want to take that vacation to Outer Mongolia that you always wanted? Maybe.

Whatever it is that you might want to do, you can put that all down on paper, but those are relatively small compared to the risks that you live longer. Now, one of the things that Mitch and I have talked about is, let’s say you’ve got somebody that’s pretty smart, thinks this stuff through, figures out how much they should save. Let’s say they even figure out how much they want to spend, and they look up their life expectancy on some table somewhere. And this 50-year-old, hypothetical person looks up and says, well, based on my genes, okay, my life expectancy is 87. I’m going to die 37 years from now. And he plans really well to have enough money to live to be age 87, and that’s great.

But we all know what the life expectancy of 87 means. That means that of all the people, of all that “cohort,” they call it, all the people with that age and with those characteristics, half of them are going to live until 87 and half of them are going to live more than that. So what that means is that this really smart person, well-intentioned, educated person, did all the stuff — and of course many people don’t do all these things — that person only has a 50% chance of having enough money to live to their life expectancy.

John Rothmann – I hate to do this to you, but we’ve got to glide into a break before we come back for the next segment. Our guest is Jay Vivian. He is the former managing director of IBM’s Retirement Funds. He is absolutely on target, and we’re going to glide into Rebalance-IRA.com, of course this is the Retire With More Program, and when we’re through we’re going to figure out how to do that, and so we will be right back.