Bogleheads® Live Ep 5: Christine Benz on correlations & sustainable distributions

Epi>Episode

Sum>Summary

In this episode, I speak with Christine Benz – Morningstar’s director of personal finance and author of 30-Minute Money Solutions: a Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success –  about asset correlation and sustainable portfolio distribution rates.

In the context of investing, correlation refers to a measure of how two investments move relative to one another. Measured on a scale of -1 to 1, a positive correlation of 1 means that when one security increases in value, so does the other. Conversely, a correlation of negative 1 means that if one security increases in value, the other decreases.

Ideally, a diversified portfolio will contain investments that have low correlation. Though this is not to say that there is no reason to hold positively-correlated asset types. As an example, U.S. stocks and non-US stocks have shown a rising correlation over the past several decades. While correlated, they are structured differently and do deviate from each other, especially in uncertain times. Holding both can allow an investor to realize gains from each while maintaining a more stable portfolio overall.

Correlations can change over time, and, like all investments, past performance does not guarantee future performance. When creating a portfolio and considering the correlation of different assets, it is helpful to also consider the reasons for that correlation. Some assets just make sense to hold as part of your portfolio. For example, when looking to protect against a market panic, you might note that U.S. Treasuries and commodities perform similarly in that scenario. But when you consider why, Treasuries make a lot more sense. Taking a step back from the data can help ensure a rational portfolio mix.

That said, the data needs to be evaluated alongside our more common-sense assumptions. Long-term treasuries, for example, are assumed by many to be the best diversifier for U.S. equities. But the data shows that short- and intermediate-term treasuries provide just as much diversification, with lower volatility and similar yields, notes the findings by Benz.

As another example of how it’s important to take a step back to think about what trends make sense, there is a historically low correlation between overall macroeconomic conditions and equity performance. Future market performance is, however, loosely correlated with market valuation. Returning again to the differences between U.S. and non-US stocks: recently, we’ve had a long-running period of out-performance from U.S. stocks. Many capital market forecasts expect that non-US stocks will have slightly better returns in the coming decade. While the unexpected war in Ukraine has caused the first half of 2022 to disagree with that assessment, market valuation is a work in progress and non-US stocks are still expected to outperform U.S. stocks. Using that example, we can see how valuation can be used as a reference point for determining when to rebalance your portfolio.

Market forecasting, generally, gets a lot of (much deserved) criticism. But when preparing a financial plan, something has to be used as a return assumption. And, past returns aren’t always the best option. Doing so for equities would result in an 11% or 12% return assumption, an unrealistic outcome that would probably lead to under-saving – or over-spending if you’re retired. Market forecasts can offer an alternative to simply extrapolating past performance into the future. Another option is to simply make conservative adjustments to past performance. Then, if you’re wrong, you’ll likely have more money than you need, which isn’t a bad problem to have.

Many investors experience anxiety when switching from the accumulation phase to the distribution phase. One strategy to help ease this anxiety is a “bucket approach,” championed by Harold Evensky. The general concept of this approach is to set aside a cash reserve – a ‘bucket’ – of one to two years’ worth of liquid reserves, and the remainder stays in a total return portfolio that continues to grow. The cash reserve would periodically be re-filled, and the portfolio rebalanced. This provides stability because the retiree can continue to spend from the bucket even if the market conditions have taken a downturn. While multiple buckets can be used, each with varying timeframes, the concept is the same. While the bucket approach provides the client with some comfort, the downside is that keeping funds in a bucket of cash reserves or something similar limits growth and, in the long run, results in poorer performance overall. Getting into portfolio withdrawal rates (the percentage of your portfolio that is withdrawn each year), using a bucket approach requires taking a slightly more conservative approach.

When looking at sustainable distribution rates, we are looking to find out what percentage of your portfolio can be withdrawn each year without coming up short at the end. A big factor to consider is what kind of failure rate the investor finds acceptable. The more risk you’re willing to take withdrawing too much, the higher that distribution rate can be. Using a 90% success and 10% failure rate as a baseline, over a 30-year time horizon, with a balanced portfolio, Morningstar determined 3.3% as a good starting point which can be adjusted for inflation as you go. Reducing that to 3.1% results in a 95% success rate, and 2.5% for a 99% success rate. While not advisable, reducing your withdrawal rate down to 1.9% effectively guarantees you won’t overdraw, according to research by Benz.

Show Notes

Show Notesttps://www.morningstar.com/authors/30/christine-benz" target="_blank" rel="noreferrer noopener">Christine Benz
• Morningstar’s Diversification Landscape
• John C. Bogle
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Bogleheads® Live Transcript

00:12 Jo>Bogleheads® Live Transcriptfor joining us for the fifth Bogleheads® Live. My name is Jon Luskin and I’m the host for today. My co-host for today is Christine Benz, who for Bogleheads® needs little introduction. Christine Benz is Morningstar’s director of personal finance, author of “30-Minute Money Solutions: A Step-by-Step Guide to Managing your Finances,” and author of “Morningstar Guide to Mutual Funds: Five-Star Strategies for Success.” Today, we’ll be discussing two topics with Christine. I’ll rotate between asking Christine questions that I got beforehand from the Bogleheads® forum at bogleheads.org and Bogleheads® of Reddit and taking live audience questions from the folks here today.

But before that, first, let’s start by talking 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.

Also, an announcement: we’ll be holding the annual Bogleheads® conference on October 12th through 14th in the Chicago area. We’re pretty sure the agenda and speaker lineup will knock you out – in a good way.

01:21 And mark your calendars for future episodes of Bogleheads® Live, all times Eastern. On Thursday, April 21st, Avantis Investors’ Sunil Wahal, Ph.D. will be discussing mutual fund costs, and the following Thursday on April 28th at 4:00 PM Eastern time Eric Balchunas will be discussing his new book, The Bogle Effect, How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors’ Trillions. 

01:47 Before we get started on today’s show, a disclaimer. This is for informational and entertainment purposes only, and should not be relied upon as a basis for investment, tax or other financial planning decisions.

Christine, thank you for joining us today on Bogleheads® Live. Before today you shared some great work you’ve done on asset correlation and sustainable portfolio distribution rates. And folks, I know I just said some geeky terms there, so allow me to break that down super quickly. Asset correlation is nerd-speak for just how much two different types of investments perform. For example, frequently when U.S stocks lose value, junk bonds also lose value. Therefore, U.S. stocks and junk bonds are said to be correlated or have a high correlation. Alternatively, when U.S. stocks lose value, Treasuries often gain value. Therefore, those two types of investments – U.S. stocks and U.S. Treasuries – are said to have a low correlation.

02:40 Ideally, one creates an investment portfolio with different types of investments that have low correlation with each other. So, before I dive into sample distribution rates, let’s talk about asset correlation first.

And let me turn it over to you, Christine, and ask you: what do Bogleheads® need to know about asset correlation?

02:57 Christine: So first, thanks, Jon, for hosting these Twitter spaces events. I think it’s a great contribution to the Bogleheads® community, in addition to the great forum that has been there for many years and the great Wiki site that they’ve created. So, thank you for doing that. I’m excited to hear your conversation with Eric Balchunas because his book looks fascinating. I just received my copy the other day and talked to Eric in preparation for the book as he was working on it.

In terms of correlations, I think you stated it nicely, Jon. If you have a portfolio that is diversified, that means that you have asset types that aren’t moving in the same pattern. Stocks and Treasury bonds have historically been a nice uncorrelated pair, where correlations have actually been negative over most of the past 30 years. The bottom line is that if you have a portfolio that is adequately diversified, that does have those negatively-correlated assets, it tends to mean that you are going to have something in your portfolio that is performing poorly at any given point in time.

04:04 So a good example over the past decade was the commodities category. I know it’s a category that Bogleheads® generally downplay or ignore altogether – and it’s hard to argue with that – but that is a category that has historically shown a nice, negative correlation with stocks. And more recently, the commodities categories performed really well as stocks have performed poorly in 2022. So, you’re looking for some asset types that have a negative or low correlation with each other. I think it’s also worth noting that just because something is positively correlated with something else, doesn’t mean that there’s no reason to hold it. A good example of that would be non-U.S. stocks, where over the past several decades we’ve seen rising correlations with U.S. stocks. There are a lot of reasons for that, but one of the key reasons is that globally, the markets have become more correlated with each other, and our economies have become more interdependent.

05:16 Nonetheless, I would argue that investors should continue to maintain globally diversified equity portfolios, in part because there are some great companies that happen to be domiciled outside the U.S.. Another point I would make on the diversification front is that when we do these asset class correlation examinations, it’s like any other measure of past performance where what we’ve seen in the past may not carry forward into the future. In fact, one thing we examined in our research recently was the issue of rising interest rates. If we have an equity selloff that is driven, at least in part, by rising interest rates – which is what we’ve seen so far in 2022 and we saw in the tail end of 2021 – you will potentially see Treasury bonds and other bond types, in fact, performing in sympathy with stocks. So, if stocks are going down because of rising rates, bonds go down during those periods, too. We may indeed see rising correlations among bonds and stocks in the years ahead if we have a persistent pattern of rising yields. 

06:27 There’s a lot to chew on in the realm of correlations. I happen to think it’s fascinating to examine how things move around over periods of time. One category that we were looking at in our paper, that has been somewhat ascendant from the standpoint of delivering nice negative correlation with U.S. equities, is cash. While there’s no reason that cash should have any correlation with anything because it’s not a return producer, what we’ve examined in our paper was the differential in terms of correlations with cash and other bond types. What we’ve seen, especially as yields have been so depressed across the board with fixed income investments, we’ve seen that cash has looked almost as good as bond investments from the standpoint of delivering a low correlation and good diversification for U.S. equity exposure. 

07:24 Jon: That’s wonderful. Thank you so much for sharing that, Christine. Absolutely, correlations are increasing. That’s something I think most investors are aware of, or at least if you’re a super nerd, present company included. And I absolutely agree with you. Yes, correlations are increasing, but you still want that international diversification. Rick Ferri often mentions that U.S. stocks right now are mostly concentrated in tech. So, by diversifying internationally, you get sector diversification, industry diversification, especially now given the way U.S. markets are structured.

07:57 Christine: That’s such a good point, Jon. I would point out that non-U.S. markets do tend to be more in the value space that banks are a bigger percentage of the market, energy companies for better, for worse – more recently for the better – they’re more dominant in non-U.S. markets than in the U.S. market today.

08:16 Jon: Wonderful. Ross, you should be live now to go ahead and ask a question on an asset correlation to Christine Benz.

08:23 Ross: Hi Jon. Hi Christine. Thanks for doing this. So, Christine, if we’re looking at past performance and we know that correlations are dynamic and they change, what process do you think investors should use if they’re trying to build a portfolio for the future? How do they attempt to identify assets that are likely to be less correlated with each other? Thanks. 

08:51 Christine: Thanks for that question, Ross. It’s a good one and one I’ve thought a lot about. What I come back to is that it’s worthwhile to avoid getting stuck in the weeds of examining these correlations, and think about what are the intuitive reasons that these different asset classes might perform differently? I happen to think that the reason that Treasuries and U.S. stocks have been negatively correlated has a good, intuitive underpinning, in that in recessionary environments when stocks often fall and stay down for sustained periods of time, that’s a period when investors are gravitating to safety; it’s oftentimes when the Federal Reserve is taking action to reduce interest rates. That helps underline why we have seen that historically negative correlation between those two assets. As we think about the future, I think that that pattern will persist in a recessionary environment. I think that Treasuries will probably continue to be good equity market ballast.

10:02 I also think that cash is an asset that you want to hold as kind of your safe asset that you could spend from, that you could liquidate in a pinch, no matter what was going on with the stock or bond markets. I would come back to that when I think about constructing a portfolio, rather than kind of getting lost in the matrixes of the asset class correlations, to really step back and think about, well, when equities are in freefall, what are the assets that are likely to deliver at least a stable return, or maybe even a growing return? I think that Treasuries, cash, and core bond fund types are all reasonable places to be. I’m a little less sanguine about some of the other categories, long-term, that have provided good equity market ballast. So, commodities and precious metals have historically been pretty negatively diversified, but I tend to think of those as non-core, non-essential categories for most investors’ portfolios. 

11:08 Jon: I absolutely agree. And I think, perhaps another way to say what you said, Christine, is that there are these asset classes that just make sense to hold as part of your portfolio. When we’re looking at what I should put in my portfolio, it’s not necessarily, ‘oh gosh, what does this number on a spreadsheet say based on historic performance?’ It’s, ‘what is the fundamental reason for this particular asset being a valuable diversifier?’ When you go to that level of analysis, you get a different outcome. When you’re analyzing Treasuries versus commodities, two very different things, maybe they’ve performed similarly under market panics. But if you look at what informs that performance, then you come to the conclusion, ‘hey, Treasuries really do make sense, but I’m not really so sure about commodities.’ As an extreme example of that, there is a book written by a motivational speaker who I won’t name, who tried his stab at doing a personal finance book and the takeaway from his book was: hold a portfolio that’s 70%-ish bonds and 40%-ish long-term Treasuries. The reason he came to that conclusion was his period for analysis was during a period of declining interest rates. So of course, long-term bonds are going to make sense in a period of declining interest rates. But that sort of analysis stopped short at just looking at the numbers rather then going in deeper, recognizing the numbers, but asking ‘why are those numbers that way?’ And when you do that deeper level analysis, that’s when you come to the conclusion: Treasuries, probably; commodities, maybe not so much. 

12:48 Christine: Good point, Jon. I want to make a quick point on the long-term versus intermediate and short-term Treasuries. Some investors take it as an article of faith that the best diversifier for U.S. equities would be to go long in terms of Treasury exposure. The interesting thing is when we examine the data, we see that short and intermediate-term Treasuries confer just as much diversification as do long-term Treasuries. And long-term Treasuries, of course, are also super volatile. I think most individual investors would prefer not to own a long-Treasury fund if they could own an intermediate or short-term fund instead. Especially given how limited the yield differential is on a long versus intermediate and short term. So that’s one thing I would think about. You don’t need to go all the way into long Treasuries to pick up that diversification benefit. Short-term and intermediate-term do a decent job, as well. I think what’s interesting to me is just within the bond space, some of the bond types don’t do as well in terms of conferring diversification benefits. So, Jon, you mentioned junk bonds. That’s a great example of a fixed income type that does not add much diversification from your equity exposure. We tend to see junk bonds move very much in sympathy with the stock market. But it’s interesting when you look at some of these other categories, like actively managed core bond funds, what we call ‘core plus funds’ at Morningstar. These are funds that have the latitude to own, for example, 15% of their portfolios in junk bonds. They might own non-U.S. bonds. They can dabble in some more exotic fixed income types.

14:36  Those are very popular funds, like PIMCO Total Return or Dodge & Cox Income, for example. When we looked at the performance of those assets, we generally see less diversification benefit from those types of funds versus a Treasury fund, for example, or even a total bond market fund, which has significant exposure to government bonds. 

15:01 Jon: Gosh, I love this stuff. I could geek out on bonds all day. To echo something you said earlier: absolutely, long-term Treasuries are weird in that yes, they do have that rallying effect that’s pretty extreme during those market panics. But you’ve got a lot of interest rate risk when you do go long. So intermediate term can be a sweet spot between getting that rally effect of those Treasuries increasing during market panics, being that valuable portfolio diversifier. It’s not quite as strong as what you see with long-term, but then you don’t get that really severe interest rate risk. Let’s jump to David. You’re live, go ahead.

15:40 David: Christine, thank you for doing this. I’ve followed your work over the years and I think you do a tremendous job communicating relatively, at times, esoteric subjects such that people like myself and my mother can understand. So, thank you for that.

15:58 Christine: Thank you.

15:58 David: At the end of the day, correlation is a mathematical construct. I’m not a mathematician but I do kind of like statistics, and I think it’s important. What I’ve noticed over the years, is I think a lot of people confuse correlation with causation. I think your comment about focusing on understanding why two asset classes might have a low correlation is absolutely spot-on. I think there is a tendency to just say, ‘oh, over the last five years, X and Y have had a low correlation, therefore they make sense’ without kind of digging into the fundamental reason why that might be. Which brings me to my question. I find that oftentimes people get confused with the macroeconomic backdrop and the expected return or the actual return of, for example, stocks. This idea that the correlation between a macroeconomic situation and the return of, for example, equities, has historically been very, very low. How do you communicate the fundamental reasons for why the correlation between equities and the macroeconomic situation is, for all intents and purposes, non-existent over long periods of time? Thank you. 

17:38 Christine: Yep. I love your point. I completely agree that rather than getting lost in the weeds where you’re examining these correlations and you see that ‘aha, the utility sector appears to be inversely correlated with the large growth sector. What does it mean?’ That it’s wise to take a step back and think about which of these trends make sense? Where can we find some sort of fundamental underpinning and carry it forward? In terms of the macro-economic conditions not being correlated with equity market performance, you’re absolutely right that historically there hasn’t been a strong connection between the two. I would say if there’s one data point that tends to be loosely correlated with future market performance, it tends to be market valuation. It’s not foolproof and there may be periods of time where some part of the equity market that appears cheap stays cheap, or goes lower for a long period of time. But generally speaking, that is the most predictive thing that you could look at as you’re positioning your portfolio and trying to figure out what will perform well within my stock portfolio. If you can tune in on valuation a little bit, I think that can be your clue to know when to rebalance your portfolio. If stocks have enjoyed an extended upswing, that can often be an opportune time to rebalance out of stocks, and put money toward the safer parts of your portfolio.

I would say if there’s anything that you want to anchor to when thinking about how your portfolio might behave in the future, and think about how to set it up for future success, I think valuation is the thing to focus on. That gets me back to that idea about non-U.S. stocks and the reason to continue to keep the faith in non-U.S. stocks. I think it’s a diversification argument, but it’s also a valuation argument where we’ve had a long running period of out-performance from U.S. stocks relative to non-U.S. stocks. By the estimates of many firms that do these capital markets forecasts, the expectation is that non-U.S. stocks will have better returns over the next decade than U.S. So great questions. And thank you for the kind words, too.

20:01 Jon: Wonderful. Thank you, Christine. Let’s jump to sustainable distribution rates next. Sustainable distribution rate is just the investment nerds’ way of saying ‘how much money can I take out of my savings, my investment portfolio each year, and not have that portfolio run out of room before I run out of life?’ On that topic, I got a question beforehand from the Bogleheads® forum, and then we also have an audience question that we’ll jump to next on sustainable distribution rates. So, Annette Louisianne from the bogleheads.org forum asks: “in a recent excellent podcast on whether this is a good or bad time to retire, Ms. Benz mentioned that all firms Morningstar consulted with believed ex-U.S. would outperform U.S. equities in 2022. Obviously, the Ukraine war had not begun when those predictions were made. What are her thoughts about ex-U.S. investing this year and have any of those firms, to her knowledge, changed their predictions?”

21:06 Christine: Yes. Good question. It kind of gets back to what we were just talking about with the valuation discrepancy between non-U.S. stocks and U.S. stocks. That is the major factor that would lead firms like Vanguard, my colleagues at Morningstar Investment Management, and Schwab to suggest that non-U.S. stocks should perform better than U.S. stocks over the next decade. I took a quick look at this after I saw Annette’s question and I saw that Schwab recently released some updated capital markets forecasts factoring in recent market action, and indeed, the expectation is that non-U.S. stocks will outperform U.S. by a small margin over the next decade. I also took a look at Research Affiliates, which has a nice interactive asset class chart that you can refer to, to gauge that firm’s assessment of forward-looking market return expectations. The firm does have substantially higher expectations for non-U.S. stocks than U.S., especially emerging markets. I would note that this has been a persistent bias on the part of Research Affiliates, that they very much like emerging markets equity. They think that that part of the non-U.S. market will drive much better returns for non-U.S. stocks over the next decade. It’s a work in progress. While in general, we’ve seen non-U.S. stocks perform worse than U.S. stocks year-to-date, I would say that that valuation story is very much alive and well, as 2022 has unfolded. 

22:51 Jon: I like that Schwab updated their crystal ball. 

22:55 Christine: Well, the fact is we’ve all got to use something. I know that people often disparage market forecast, but if you’re doing some sort of financial plan, you have to plug in some sort of return assumption, right? And with fixed income assets, it’s pretty straightforward. Your starting yield is what you could expect to earn roughly, give or take, over the next decade. With equities, you’ve got to use something and I would argue that you shouldn’t use past returns because they’re far too rosy. So, if you were to use 11% or 12% return assumptions for U.S. equities, that’s going to make your plan work out well, but practically speaking it might lead you to under-save or overspend if you’re retired. There are risks to taking past returns and just extrapolating them forward. You need to use something that is based in reality, and that’s where I think these forecasts can come in.

23:48 Jon: Very well said. As a financial planner, I’m biased towards being a little more pessimistic about any future investment return. If we do that and things don’t work out well, then you would have saved extra money, and hopefully that would have balanced out the stock market’s underperformance. Alternatively, if those ultra-pessimistic predictions were too pessimistic, now you’ve got a little bit more money than you need, which is a nice problem to have. Let’s jump to Cody next. Cody, you can ask your question to Christine on sustainable distribution rates.

24:24 Cody: Hi there, Jon and Christine. Great to see you both here. This is an awesome, awesome space. Some white papers and investors suggest that using a bucketing approach is a drag on returns and therefore results in lower sustainable distribution rates. I prefer to align the investments’ risk and return expectations with when the money will be needed to meet living expenses, whether short, intermediate, or long-term savings needs, and also considering of course, asset tax location. I’ve found the approach helps with the real anxiety of moving from accumulation to distribution phases. So, Christine, how do you believe choosing between a total return or a bucketing distribution strategy should change the expectations for sustainable withdrawal rates? 

25:09 Christine: That’s a good question. I’ve seen those papers criticizing the bucket approach, and maybe we should just quickly say what that is. It’s kind of a time segmentation approach where you’re organizing your portfolio by your anticipated spending horizon. I always credit the approach to Harold Evinsky, who is a financial planner and was a professor at Texas Tech in financial planning. Probably 12 years ago, he and I were talking about retirement decumulation and he put the bug in my ear that he used the bucket approach with his clients. The idea is that he would set aside a cash bucket, maybe one to two years’ worth of liquid reserves, and then he would run a total return portfolio alongside of it to deliver the portfolios growth over time. He would manage it and periodically refill that cash bucket as the retirees spent from it using rebalancing. He told me his clients tend to find it a comfortable strategy for their retirements. He’d call them when the market has been down a lot, and they’ll say, ‘well, yeah, I know I’ve got my cash bucket set aside, so I know that that’s not going to jeopardize the cruise that we had planned with our family next year. It’s not going to jeopardize our ability to go out to dinner on Saturday night with our friends.’ So anytime I hear something like that really working with real people in their real lives, I think there’s power in that.

26:47 And so that’s the basic ideas of the bucket strategy. Harold used just two buckets. I’ve talked about three buckets where you’ve got 1) one to two years’ worth of spending and portfolio withdrawals in cash, 2) five to eight years’ worth of portfolio withdrawals and high-quality bonds, and then 3) the remainder of the portfolio in equities and other high-risk assets. That’s where you would put precious metals – to the extent that you owned them – or junk bonds. Anything that’s really volatile and that you’d want to have a nice long-time horizon in mind for, that’s where you would stash that stuff.

27:25 That’s the basic bucket strategy. Certainly, having those liquid reserves on standby is going to drag on the return of the portfolio over time. So, the name of the game is not having more in that cash bucket than you absolutely need. But I do think that behaviorally, the strategy really does work. It works for advisors as a client illustration tool. The interesting thing about it is that if you decompose a bucket portfolio, sort of x-ray it’s asset allocation, oftentimes it’s a 50/50 or 60/40 asset allocation. So, there’s no real magic in the buckets, but it is a way to help someone make peace with their long-term asset allocation plan. I don’t think it’s so at odds with the approach that you’re talking about, Cody, unless I’m misunderstanding how you’re approaching it. I think the two things are really pretty similar. 

28:26 Cody: Yeah. I don’t manage investments as a planner. Two big things I consider: that short-term savings bucket is the 40 part of the 60/40, but at the same time, when I look at other portfolios, a lot of times I see that that 40% is actually in those assets highly correlated with equities (when folks invest in junk bonds). So I think it has to be done like tactfully, but I’m wondering if there has been any studies on how much more conservative the withdrawal rate should be if you’re using that approach.

29:13 Christine: If you’re using a bucket approach, because you’re assuming a slightly lower return potential on the portfolio?

That’s a good question. It seems like you would want to reduce it slightly to account for the fact that you have the persistent drag of cash. It would argue for having a slightly lower starting withdrawal.

29:35 Jon: Fantastic. Great question. Thank you, Cody. Christine, let’s talk about the Morningstar study on sustainable distribution rates. Your study with your associates recently gave some updated data on what folks would expect from a portfolio in terms of sustainable distribution rates, with the caveat that there is a 10% failure rate for whatever the particular sustainable distribution rate is for any given time period that you show in your paper. How should investors interpret that 10% failure rate? And how does that distribution rate change if investors would be more comfortable with a 5%, or even a 1% failure rate? 

30:14 Christine: Good question, Jon. We modeled in a 90% success rate, 10% failure rate as our baseline. But you can certainly change that figure to whatever probability you’re comfortable with. If you’re able to live with the idea of a 20% probability of failure, you can nudge your starting withdrawal rate up a little bit. But if you are wedded to having a very high probability of success, so like 95%, 99%, you would want to take your starting withdrawal rate down. In our paper, the baseline conclusion was that if you want to be 90% certain you won’t run out of money over a 30-year time horizon, and you have a balanced 50/50 or 60/40 portfolio, and you’re using a fixed, real withdrawal system, you’d want to start at 3.3% initially, and then you could inflation-adjust that dollar amount thereafter. If you wanted a 95% success rate, 5% failure rate, that’s a trade-off and you would have to bring that initial withdrawal rate down to 3.1%. At a 99% success rate with a failure rate of only 1%, the starting withdrawal would be 2.5%. So, you can see we’re going down, down, down. And if you wanted to have a 100% success rate on that balanced portfolio over 30-year time horizon, the starting withdrawal would have to be 1.9%, based on our research and using our forward-looking forecast of what our team expects the market to return over the next several decades.

32:00 My advice is: don’t do that. Don’t anchor on a 100% success rate because I think it would probably cause you to under-spend during your retirement, unless you’re really unlucky and everything is terrible over the course of your retirement. Unless you have a lot of wealth and 1.9% is a perfectly livable cashflow for you, be willing to live with a slightly higher probability of failure, and recognize that a 90% success rate is pretty darn high and you’d have to be pretty unlucky to hit that period when the 3.3% initial withdrawal wouldn’t stand up to a 30-year time horizon. 

32:58 Jon: That is so fascinating. Thank you for sharing that. That 2.5% figure for a 99% success rate and that 1.9% distribution rate for a 100% success rate is the lowest number I’ve seen for what is the most conservative distribution rate. Previously, the lowest figure I ever saw for a sustainable distribution rate was something that Wade Pfau put together. He said 2.4%, given all the market events that we’ve seen come out of the Coronavirus crash. 1.9% is a new record in terms of the super conservative distribution rate. But certainly, to your point, that is really for that worst case scenario and probably is not advised if you just want to take a little bit of risk. That is such an interesting data point. Thank you for sharing that. 

33:45 Christine: Sure. And Jon I would just point out, we’re going to be updating this research every year and incorporating new, forward-looking asset class return forecasts. So, stay tuned. We’ll be keeping an eye on it. So far in 2022, we’ve had equity prices fall a little bit, about 10%, on the total U.S. market. And bonds have fallen too, but bond yields have come up. My thought is that as we’re doing sort of a forward-looking expectation, raw materials will look a little better when we revisit this research later this year.

34:25 Jon: Fascinating. I will certainly be checking that out. Han, go ahead and ask your question to Christine on asset correlation or sustainable distribution rate.

34:33 Han: Thank you, Jon. I appreciate it. I have a question regarding to crypto. It has become a new asset class over the last few years, and I don’t know if Morningstar has done any research on this new asset class. I’m just curious to know, what’s your take on it? 

35:00 Christine: Thanks for that question, Han. It’s certainly a hot topic and we do have a small team researching crypto. So, look for more from us on that topic. We did examine crypto and its correlation with U.S. equity because that’s one of the main arguments that you hear crypto enthusiasts advance, is that it’s not correlated with other stuff that might be in your portfolio. And indeed, that was the case earlier in the ascent of crypto. More recently, we’ve seen correlations tighten up a little bit and then they have declined a little bit again, very recently, relative to U.S. equities. It’s something we’ve been watching. I think that that’s a category where perhaps there’s not any real clear intuitive reason that we should see that correlation pattern persist where we would continue to see crypto perform as a good diversifier for equity exposure. In fact, what we’ve tended to see is that it’s a risk asset, a volatile asset, and I think that’s perhaps why we’ve seen some rising correlations recently. We’ve been delving into it, but it’s impossible to pin a value on crypto or tell anyone what it should be worth and whether it’s a good buy or not such a good buy. But we’re watching this evolving landscape and we’ll probably have more to say about it in the years ahead.

36:41 Jon: That’s wonderful. So same takeaway that applies to other asset classes and that is that correlations are dynamic, so they do change over time. Crypto is no exception to that. Christine, before I wrap up, is there anything else you wanted to share before I give the end of the show?

36:58 Christine: I just want to thank everyone for being here. And also, Jon, you mentioned this conference that we have planned in October for the Bogleheads®. It’s going to be a really lovely gathering. I think it’s always one of my favorite times every year. We’re going to be meeting in the Chicago area, October 12th through 14th. I think people will be pleasantly surprised at how we are kind of hanging on to some of the traditions of past Bogleheads® events, but also bringing things forward. I think we may have some interesting things to offer younger investors. So, stay tuned. If people follow the Bogleheads® Twitter handle, then the news will come out there and it will also come out on bogleheads.org. So just to plug-in for keeping an eye on that space.

37:43 Jon: Wonderful. Thank you so much for that. I will definitely be there. I’m very excited to attend the Bogleheads® conference this year, and it will be my second time. I just can’t wait to nerd out on investing with all my fellow Bogleheads®. Man, it’s going to be a real treat. And folks that’s @bogleheads on Twitter and bogleheads.org is where you can find the forums to stay up to date on the latest.

Well, folks that is all the time that we have for today. Thank you to Christine Benz for joining us today. And thank you for everyone who joined us for today’s Bogleheads® Live. Our next Bogleheads® Live will be Thursday, April 21st at 4:00 PM Eastern, 1:00 PM Pacific. We’ll be discussing mutual fund costs with Avantis’ Sunil Wahal. The week after that we’ll have Eric Balchunas and his new book, “The Bogle Effect.” Between now and then you can submit your questions for Sunil and Eric on the Bogleheads® forum at bogleheads.org and on Bogleheads® Reddit.

Until then you can access

• Bogleheads® forum at Bogleheads.org.
• The Bogleheads® Wiki
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• Bogleheads® YouTube channel
• my personal favorite: Bogleheads® local chapters. Shout out to my San Diego group. 
• Bogleheads® virtual chapters 
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• Bogleheads® conferences and
• books.

The John C Bogle Center for Financial Literacy is a 501(c)3 nonprofit organization. At boglecenter.net your tax-deductible donations are greatly appreciated.

Thank you again, everyone. I look forward to seeing you all again on next Thursday, April 21st at 4:00 PM Eastern time, we will be discussing mutual fund costs.

Until then have a great week, and let’s let the trumpet take us out.