Morningstar - Q2 2021 - 60

Investors

are going to come from. It might be all
from interest, dividends, and fixed income. Or they
might want to sell some equity shares. The
question then is, which shares do you want to sell?
After 2020, you would have wanted to reduce
your holdings in large-cap growth as opposed to
large-cap value by most traditional measures.
Siegel: I see your point. But that's still timing.
When I have tried to actively manage my asset mix
that way, I've usually underperformed. When
I see something getting expensive, I sell it. Then,
it gets even more expensive.
Finke: I tilt toward small-cap value, like a lot
of academics. We've been losers for a decade now.
Every year, you say, " Well, next year is going
to be the year that small-cap value finally outperforms. " I would have sold my large-cap growth,
and I'd just be digging myself a bigger hole.
Siegel: That's what I've done with value, and it
hasn't paid off at all. I've also overweighted
international, so I've found a number of different
ways to lose the timing game.
Finke: The more you know, the better you get at it!

Sticker Shock
Rekenthaler: How about fixed income? Is the general
advice different now with rates where they are?

Siegel: I have bought a lot of TIPS. They've lost
money, but if we start getting 4% or 5% inflation,
which is very possible, they'll make a lot
of money. I'm hedging against risks that I face
personally-like the apartment I'm renting
here on the beach in California. The rent has gone
up 40% in a year. That's a lot of inflation.
Finke: Larry makes a very good point about
inflation for assets that people with money want.
Inflation in general hasn't gone up as much as we
would have expected, but it has for the kind
of stuff that people with money want to buy-like
a home in Pacific Grove, California. Because I
wanted to make this point, I went on Zillow before
this conversation and looked at the price of
houses in Pacific Grove, which is one of my favorite
spots in the United States, one place where

Morningstar Q2 2021

I would like to retire. Housing prices have pretty
much doubled over the last four or five years
in Pacific Grove. Houses in Santa Fe have probably
gone up by a third over the last two or three years.
Even though the cost of milk hasn't gone up all
that much, it's important for retirees to recognize
that the things that they want to buy in retirement
might be a lot more expensive than they'd
anticipated. Jon made the point earlier that you
might have $1.2 million today instead of $1 million
because the market's gone up so much. But if
what you wanted to buy is a house in Pacific Grove,
then you really haven't come out ahead at all.
Guyton: These are good points, especially as
retirees' tastes change. Things that people desire
today might be things that they wouldn't have
thought they desired a couple of years ago. So,
you plan knowing that you need a certain amount
of capital to support your core standard of
living. I don't have to go rent a house in Pacific
Grove to go somewhere warm in the winter, even
though I might want to.

Then, structure your retirement assets so that
you know how much other money you have-
in our firm, we call it discretionary. You can draw
from that on a much more spontaneous and
less structured basis if you do want to rent a house
where the rent has gone up 40%. You know
how much money you have for those off-budget
items, and you can monitor your plan that way.

income is a behavioral phenomenon that investors
are punished for generally. Income investments
are less tax-efficient, and on top of that,
there's a lot of evidence right now that assets that
are producing higher yield are expensive
relative to historical standards. And when they are
this expensive, they historically underperform.
Given the relatively small spread between lowerquality bonds and higher-quality bonds, I'd
guess that the returns are going to be no higher,
but with an absolute certainty of far greater
risk. By focusing too much on income,
investors are setting themselves up for a very
disappointing outcome.
Guyton: To add to that, there are going to be
times when the equities in your portfolio are going
to decline in value. At that point, it is vital
that your fixed-income holdings not also be
participating in the decline.

One of the great features of boring old Treasuries
is they have a tendency to be negatively
correlated with the stock market at exactly the time
you want them to be negatively correlated
with the stock market. Research bears this out.
There are studies comparing portfolios with
a bond component of corporate bonds to either
intermediate Treasuries or T-bills. The portfolio
with T-bills leads to a higher safe withdrawal rate.
When equities are in the tank, interest rates
might be going up or going down. If they're going
down, any kind of Treasury will work. But if
they're going up, you want the shorter-term ones.

Rekenthaler: Retirees often tilt toward higher-income

investing: corporate bonds over Treasuries, or
higher-dividend stocks for equity investments. What
are your thoughts on such practices?

Siegel: It sounds good until you go to do it.
Then, you realize that a certain amount of
efficient-market theory kicks in and that the higher
income means a lower capital gain. The
main thing it does is raise your tax bill. Income
is a legal concept, not an economic one.
It's whatever is subject to the income tax. And
the way that a cash flow is divided between
capital gain and income should be irrelevant to
the total return.
Finke: I agree with Larry completely. I might even
go a step further. I'd say that paying attention to

Right now, having that short-term element
with the most ironclad fixed income to get you
through the next downturn is going to be a
big difference-maker. The Fed bailed out corporate
bondholders by liquefying that market at
the end of March 2020. Otherwise, it was a real
bloodbath for a while.
Siegel: I agree with all of that. I've been saying
the next interest-rate move is up for a long
time. My only concern here is that I was wrong so
many times and I still could be wrong, and
the time when I'm right could be a long way
off. In 1,000 years, we'll look back on this as an
aberration in the history of capital markets,
kind of like we look back on the Great Depression.

Morningstar - Q2 2021

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