The dramatic shift by retirement savers to passive investing means financial advisors will spend less time in the future picking stocks, and that leads to questions about new ways to add value.
Nowhere are those questions more pressing than at Vanguard, the king of passive mutual fund investing. The company has been testing its Personal Advisor Services product, a retail advice platform. Vanguard is also thinking about new ways to help clients with their personal finances that go well beyond their retirement portfolios—from debt management to health insurance and an array of competing objectives within household balance sheets.
WealthManagement.com recently spoke with Steve Utkus, director of the Vanguard Center for Retirement Research, about the fund family’s new direction and the evolution of retirement planning.
WM: What are the ways Vanguard expects to add value in a world where the basics of retirement investing are becoming so automated?
Steve Utkus: An unexpected consequence of auto-enrollment and target-date funds is that the domain of concern is widening. That’s why we struck a partnership with HelloWallet, which offers software combining behavioral economics and the psychology of decision-making. It is fundamentally about debt management—not simply about a retirement plan but what you do about other issues.
We are broadening our focus to areas like health, debt and competing financial objectives. And we’re getting pressure from retirement plan sponsors to do it. They want to be able to help their plan participants make tradeoffs between student debt, housing debt and credit card debt.
WM: And now there is a growing number of people entering retirement carrying student debt. Is Vanguard exploring this?
SU: We’re starting to formulate a research agenda around these topics well beyond the traditional confines of what you should do with your 401(k) or IRA. I see this pressure on all kinds of financial institutions, which is why it’s such an interesting strategic question for us. People have thought of Vanguard as only doing low-cost investing. But now, we have clients asking how they should think about the cost of healthcare in retirement. In the past, advisors have been content with pushing those issues away, but they are crowding in.
WM: How do you think this new holistic set of services will be delivered? Will it be person-to-person, or through technology?
SU: The problem with technology today is that the left hand doesn’t talk to the right. HelloWallet doesn’t talk to Mint.com, and Mint.com doesn’t talk to my 401(k) online enrollment process, which doesn’t talk to my annual benefits enrollment software. But imagine a world where advice about your financial life is embedded in your device instead of a process you have to go through.
WM: Some of this integration would be especially useful for young people just getting started in their financial lives.
SU: Imagine a universal app—Vanguard Money—that actually shows your financial life. Here are the next three things you should do in your financial life—a three-point checklist, and it keeps bugging you until you say you have made those changes.
It’s an exciting time to imagine the future, but there are huge obstacles. One is information security—can we create a solid infrastructure that keeps everyone’s data secure? That’s a big open question right now. The other issue is analytical engines. Everyone has their point of view about what should be the next best thing you should do. You can get good analytical engines, but ease of technology doesn’t ease that challenge.
WM: What’s your take on “leakage” from 401(k) accounts, when people use their accounts for other purposes, such as paying off a loan or buying a home?
SU: A paper published last year by John Sabelhaus [and two co-authors] at the Federal Reserve Board estimates that at certain points in the past decade, for every $2 contributed to any tax-qualified account by people under age 55, $1 left the account. Not so much hardship loans as people changing jobs and using the money for some other purpose. It’s an important tax policy question for Congress because we are subsidizing dollars as well as people.
WM: Some people argue that this is fine—it’s my money, so let me do what I want with it. Yet Congress had a certain intent in creating this tax benefit, which is to encourage retirement saving. It may sound paternalistic, but if this was created to meet a specific objective, why don’t we restrict accounts to that purpose?
SU: In the end, any public policy is a choice between competing sets of objectives. Early on, fund accounts were hinged on their supplemental nature. Even today, the overlap is quite high between defined benefit and defined contribution in wealth distribution. Sixty percent or 70 percent of people with meaningful 401(k) or IRA balances also have a DB plan, although that will phase out over time.
Worldwide, the tightest restrictions on withdrawals are tied to mandatory contribution. In the U.S., contribution is discretionary. There’s been an argument that people at the margin will contribute more if they know they have flexibility, but you can’t run a real experiment where one half of the nation gets access and the other doesn’t—and then we see what happens.
WM: In one of your recent blog posts, you raise the broader question of how 401(k) plans should be structured. Should it be for wealth accumulation, or geared to generating income?
SU: You need income, and you need liquidity. No one seems to have the definitive answer. Robert Merton argues that the goal is inflation-adjusted, steady real income—rising nominal income adjusted for inflation in retirement. But patterns of expenditure in retirement vary. A paper by Michael Hurd and Susann Rohwedder that looks at consumption by retirees shows that spending declines over the contours of their lives, and it’s not just because people are running out of resources. The rich are doing this too.
So, Merton and the actuaries will tell you the goal is inflation-adjusted real income. But if you talk to the typical financial planner who is running calculations, the numbers that you need to save for retirement are dramatically lower when you assume steadily rising expenditures. So that is a big debate.
WM: The one wild card is you have a long-term care risk at the end of the line.
SU: The typical person in America is going to deplete her assets and then Medicaid will pay for care.
WM: Or, you purchase a long-term care insurance policy or self-insure.
SU: Yes, but if you’re actually trying to hedge a part of that risk, you’re only going to hold more liquid assets. So we need to consider re-thinking our retirement planning models to account for people spending a little less every year in retirement and how we model long-term care.
That still leaves open a question about what kind of annuity streams and liquid assets you want to fund a retiree’s needs? And no one really has a clear-cut answer on that yet. At Vanguard, we don’t have a point of view on it. But we need to start thinking about it as we start managing money for people in retirement.