Market volatility and you

Tim Buckley: I want to pivot to what we call the rate side of things, where we think interest rates are going, looking forward. If we think about central bank policy, I don't know how to describe it. I mean, the adjectives you hear people throw all around. You hear “unprecedented,” you hear that all the time. You could say “significant,” “monumental.” You could use them all together.

What we've seen from the Fed, well, pretty incredible. What we've seen on the fiscal stimulus side of things, well, you could say the same. What does that mean for rates going forward? What does that mean for inflation? How do you guys think about it in your fixed income team?

John Hollyer: Yes, we're thinking a lot about rates and these important monetary policy points you made, which are happening in the U.S. and around the globe. And to boil it down we'd say, “low for longer.” Rates are likely to maintain a low level for an extended period of time, and we're structuring our strategies around that.

If we look at things like inflation, currently markets are looking at big drops in oil prices and big drops in demand and economic activity, and taking a view that inflation will decline. Markets are pricing in, over 10 years, about a 1% rate of inflation per year, and in near-term projections of one or two years, actually projecting deflation.

In working with our economics team and trying to have a longer-term outlook, we feel like those estimates are probably understating where inflation is likely to wind up. Near term, there are plenty of hurdles, but longer-term, the fiscal and monetary policy stimulus you're talking about is potentially going to sow the seeds for inflation to move back up towards the Fed’s 2% target or higher. So looking at that, we are gradually building positions to have exposure to inflation-indexed bonds that we think, in the long term, have the opportunity to outperform.

Tim: Now, John, that's different than what people are used to. So, most of our clients are used to hearing, well, loose monetary policy and a lot of fiscal spending, expect inflation. But there's just way too much flack in the economy to see that happen. You don't see it happening years out. And so you're saying, what you can get in the TIPS [Treasury Inflation Protected Securities] market? Those are great trades for you right now.

John: Yes, we feel like there's some value there. And again, going with our diversified approach, the strategies in our government funds, we're investing in TIPS. But we're also looking at other areas where there could be outperformance—in mortgage-backed securities, for example. We see that the big drop in rates is likely to give homeowners opportunities to refinance their mortgages. That's a problem for mortgage-backed securities. But what we're finding is there are parts of the mortgage market where that prepayment by homeowners is mispriced and is creating some opportunity that we feel can yield to positive excess returns above expectations for our clients. So it's an area where we're trying to, again, diversify our strategies.

Important information:

All investing is subject to risk, including possible loss of principal.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations. Unlike stocks and bonds, U.S. Treasury bills are guaranteed as to the timely payment of principal and interest.

Diversification does not ensure a profit or protect against a loss.

© 2020 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor of the Vanguard Funds.

Maria talks about what retirees can do for their portfolio.

Rebecca Katz: "What kind of changes would you envision for the average retiree?" So is there something they should be doing differently?

Maria Bruno: Couple things that I would say is, one, make sure that you have liquidity. You know, usually when we talk about liquidity for individuals who are working, it might be on the lower end. Maybe two weeks or a half a month worth of spending in cash reserves for spending type shocks. If you're a retiree, it may make sense to have a little bit more of a buffer. Up to two years is probably reasonable. Anything more than that is a risk because you're not invested in the market. Make sure you have that liquidity buffer as a spending account to make sure that you can meet your spending needs.

Check your asset allocation. If you're someone who is entering retirement, you should be planning for a 30-plus year retirement, so equities do a play a role. A diversified balanced portfolio is prudent.

And the other thing I would say is check your spending patterns. The first place would be to look at discretionary spending. These are things like travel and leisure. I will say that given what's going on right now, that's taken care of itself, right. Yes, because of the stay-at-home mandates, you know, many of us are cutting back on our discretionary spending. Nondiscretionary spending, on the other hand, are things that maybe you can look at and tighten the belt a bit, but you want to be thoughtful in terms of where can you cut back.

So many retirees have been doing this. When you look at the markets when the markets were up, many of them would not spend everything but reinvest in the portfolio, and that's great because then that gives you a buffer in situations like this where the portfolios might be going through some volatile times. So basically have some type of dynamic spending policy where you can tap when the markets are up, but it gives you a little bit more of a floor when the markets are down. So those are a couple of the things that I would reinforce with someone who's either entering retirement or just gauging this through retirement.

IMPORTANT INFORMATION

All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

This webcast is for educational purposes only and does not take into consideration your specific circumstances or other factors that may be important in making investment decisions. We recommend that you consult a tax or financial advisor about your individual situation.

© 2020 The Vanguard Group, Inc. All rights reserved.

Tim Buckley: John, as you know, our clients love hearing from Joe Davis, our global chief economist. But they only hear the surface of his outlook. You get his whole in-depth analysis and you get to debate it with his team. So give us a window into that. What do you guys do? What's your outlook right now and how are you putting it in motion with our funds?

John Hollyer: Yes, Tim, at the highest level, working with Joe, we've gotten his team's insights that this is likely to be a very deep and very sharp downturn—really, historically large. But also, that it's likely to be relatively short-lived. And that will be as the economy reopens and importantly as the benefits of fiscal and monetary stimulus bolster the economy, essentially building a bridge across that deep, short gap to an economic growth phase on the other side.

They've pointed out that the growth, when it happens later this year, might not feel that good, because while growth will be positive, we'll be starting from a very low level—well below the economy's potential growth rate. Now when we take that outlook for eventual return to growth with the large policy, monetary, and fiscal stimulus, it's our view that we would prefer to be taking some extra credit risk at these valuations in the market over the last month and a half.

So using Joe's team's insights and our own credit team's view of the market, we've been using this as an opportunity to raise the credit risk exposure of our funds because we think the returns over time, given this economic outlook, will be pretty attractive. We think, importantly, as well, in working with Joe, that the really vigorous policy response has reduced—not eliminated, but reduced—some of the tail risk of a downside, worse outcome.

Tim: Now John, going back to our earlier conversation, you had mentioned that you had taken some risk off the table. I called it "dry powder," a term you often use. So actually, you've deployed some of that. Not all of it, though. You're ready for further volatility, fair enough?

John: Yes, that's right, Tim. We're looking at current valuations, the valuations we've experienced over the last six or eight weeks, and we've definitely found those attractive. But we have to acknowledge that we don't have perfect foresight. No one does in this environment. And so sticking with that sort of dry powder approach, we've deployed a fair amount of our risk budget. If we do get a downside outcome, things worse than expected, we'll have the potential to add more risk at more attractive prices. That will require some intestinal fortitude because on the way there, some of the investments we've made won't perform that well.

But it's all part of riding through a volatile time like this. You don't have perfect foresight. If you can get things 60% or 70% right, deploy capital when the prices are really attractive, and avoid overinvesting or being overconfident, generally, in the long term, we'll get a good outcome.

Tim: I think it just goes to show why people should really lean on your experts, your portfolio managers, and analysts to help them manage through a crisis like this. People who are still out buying bonds on their own, well, they can't get the diversification, and they don't have that dry powder, or they don't have that ability to do all the analysis that you can do for them with your team.

Important information:

All investing is subject to risk, including possible loss of principal.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

Diversification does not ensure a profit or protect against a loss.

© 2020 The Vanguard Group, Inc. All rights reserved.

Maria and Tim discuss the risks of moving to cash.

Maria Bruno: Sure. There is an opportunity cost to staying in cash either having too much for your portfolio in cash or staying in cash for too long. It may feel safe but, essentially, you're staying in the sidelines and you're foregoing market participation. So you may feel like you're being safe because you're preserving your money. However, when you think about inflation over time, you're actually decreasing your purchase power because your portfolio is not able to grow with inflation. So that's a huge risk over time. So that would be my biggest caveat in terms of staying out of the market.

The other thing is the things that are keeping you from getting out of the market, what's going to make you feel comfortable as an investor to get back into the market. And, essentially, it's market timing.

Tim Buckley: Maria, I would say the person who is thinking of going to cash just be comfortable with that standard of living that you're living well below your means, you're going to cash because you want to take risk off the table, and, look, you're going to lose purchasing power over time. But if it helps you sleep better at night and you're comfortable that living below your means and you're going to be that way because your means will be eroded through inflation over time, then, hey, we're not going to tell you don't do that. But, Maria, you bring up some great points about why it's just for those people who are very well off and living below those means.

IMPORTANT INFORMATION

All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

This webcast is for educational purposes only and does not take into consideration your specific circumstances or other factors that may be important in making investment decisions. We recommend that you consult a tax or financial advisor about your individual situation.

© 2020 The Vanguard Group, Inc. All rights reserved.

Tim Buckley: John, to state the obvious, we've seen massive declines in revenues for firms and for municipalities. So, a lot of people are talking about what's the fallout? Are people missing payments? Will we start to see downgrades of bonds, defaults? What will the workouts look like? Can you give us some perspective about how your team's thinking through this?

John Hollyer: Sure, Tim. And you're right—this is a time when there will be downgrades and there will be defaults. But let's keep it in perspective. If we look at investment grade corporate bonds, for example, even in the worst recessions, it's unusual to have defaults be more than 1% of the bonds. In municipal bonds, defaults are typically well below that, even in the worst recessions. In the high-yield world, it's not unusual to have maybe as high as a 10% or somewhat higher default rate in a really bad year.

But particularly in the case of investment-grade corporate and municipal bonds, if you look at that within a diversified portfolio, and we look at the valuations that we have today, a number of those risks are probably pretty fairly compensated. Downgrade, where the credit rating agencies reduce the credit worthiness estimate of a bond, is also a risk.

If you look at the corporate bond market, there's been some concern that there could be a large volume of downgrade from the investment-grade universe to high yield. Some estimates are that as much as $500 billion of U.S. corporate bonds could be downgraded that way. We've already seen $150 billion downgraded that way. But what we've also seen is that the high-yield market has been able to absorb it.

So, to some degree, the market is functioning in a way to accommodate this. And when you look particularly at higher quality bonds where a downgrade will likely cause the price of the bond to fall—again, in a diversified portfolio—those downgrades and price declines are probably really increasing the yield of the fund, and probably increasing the expected return going forward.

So, the risks are real. They are priced in somewhat, already. And history would tell us that in higher quality segments, these should not become overwhelming. Now this is an unprecedented time, it could be somewhat worse, but we don't expect there to be rampant default in areas like investment-grade corporate and municipal bonds.

Tim: John, fair enough. If we just go back and we step up a level, the strategy that you employ is one that says, well, you've got low expenses. And if you have low expenses, you have a low hurdle to get over. You don't have to earn as much in the market to kind of pay the bills and then make sure our clients get a great return. So you don't have to traffic in the riskiest of bonds out there.

To use a baseball analogy, you like to go out and hit singles time after time after time, and over five, 10-years, even three years, they really crank up, so that you're able to outperform not just competitors, but the actual benchmarks themselves.

John: I think that's right. It's one of the benefits of our structure, where we have a really talented team adding value across a widely diversified set of strategies and leveraging our business model to take a really appropriate amount of risk to produce a top-quartile-type return for our clients, over longer periods of time.

Also, it really supports the "true-to-label" approach that we like to take. Our portfolios can stay invested in the corporate bond market or the mortgage-backed securities market, if that's their primary sandbox, and not go searching really far afield for the kinds of investments that are more speculative. They might pay off, but they also might really surprise an investor to find that their portfolio had those kinds of things in it. We really value that true-to-label approach, and it's supported by the low-fee approach of Vanguard.

Tim: Yes, let's keep it that way. Now let me flip over to a more portfolio strategy for the individual client. We're often telling them, hey, bonds, they're the ballast. They're your ballast so you can weather a storm. And people wonder, have they served that purpose? As the bond expert here, are you happy with how bonds have performed and how they've performed in an individual's portfolio?

John: Yes, I think it's been a good news story for people who were diversified across stocks and bonds. If we go back to the beginning of 2020, interest rates, particularly in government high-quality bonds, were already pretty low. People were questioning, "why do I own bonds?" But if we roll ahead to the end of March, a broad portfolio of high-quality bonds was up about 3% in return, while the S&P 500 was down about 20%.

So there again, even with low yields as your starting point, as a ballast and a diversifier to a portfolio, bonds have again this year proven their merit. I think that is completely in sync with our long-term guidance to be diversified in your investing.

Important information:

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

All investing is subject to risk, including possible loss of principal.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

Diversification does not ensure a profit or protect against a loss.

© 2020 The Vanguard Group, Inc. All rights reserved.

Tim:
Karin, as you know, I'm a little bit of a geek when it comes to technology behind all the advice that you provide. And I think it's helpful for our clients to know the sophistication behind it. So whether you're a retiree or a pre-retiree, we're considering thousands of different market simulations to make sure your portfolio can hold up. So when we say that we've actually stress-tested your portfolio, we've thought about times like we're going through right now.

Karin:
That's exactly right. What you're describing is Monte Carlo simulation. And as you said, we pressure-test the portfolio against 10,000 scenarios—one just like this, and actually, many that are even worse than this. So our portfolios are built to weather this volatility.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

All investing is subject to risk, including the possible loss of principal.

© 2020 The Vanguard Group, Inc. All rights reserved.

Maria explains what the CARES Act means for RMDs.

Rebecca Katz: "What are the pros and cons of not taking IRA RMDs, so required minimum distributions?" When you turn a certain age, you have to take money out of your IRAs, but the CARES Act waived that, and you don't have to take it this year. So can you talk a little bit more about the CARES Act?

Maria Bruno: The CARES Act was passed in late March as part of the stimulus package. I think two key provisions for investors were, one, not having to take required minimum distributions for this year. We essentially get a free pass this year.

So if you don't need the money, the natural inclination is to keep it in the IRA and let the money continue to grow. You participate in the market, hopefully, as the markets ebb and flow and go up.

The other thing to think about though, is this an opportunity from a tax planning standpoint? With RMDs, there are some tactics that you may be able to employ and you don't necessarily have to take the full RMD amount, but if you're in a relatively lower tax bracket this year, then maybe you would want to take that distribution. You may be paying relatively lower taxes. You're lowering your IRA balance, which then will lower future RMDs. So those are a couple things to think about.

A natural inclination would be to not take it, but I would really think about whether there's a tax planning opportunity to take it.

The other thing I will say is if you are enrolled in an automatic RMD program, Vanguard offers one, you do need to actively suspend that if you don't want to take the distribution. So you can go online and suspend that for 2020.

IMPORTANT INFORMATION

All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

This webcast is for educational purposes only and does not take into consideration your specific circumstances or other factors that may be important in making investment decisions. We recommend that you consult a tax or financial advisor about your individual situation.

© 2020 The Vanguard Group, Inc. All rights reserved.

Tim Buckley: These are unprecedented times. We're living with the uncertainty, stress, and challenges of a global health crisis combined with an orchestrated economic shutdown.

We know the slowdown isn't caused by a structural problem, but we don't know how long it will last. Even epidemiologists can't pin down when the virus will subside or when we'll return to some sense of normalcy.

In the meantime, unemployment is surging and the economic data will get worse. Prepare to hear double-digit unemployment numbers and significant contractions in GDP—20% or more for the second quarter.

But don't overreact and don't try to time it. Remember, the markets are forward-looking and much of this news is already priced in. Sure, equity markets could get worse if the slowdown extends further, but also realize that the markets will rebound far before economic data improve. Beyond being lucky, you'll find the markets are close to impossible to time. And you don't want to miss those big rebounds.

All of the negative news and market volatility can weigh on your mind. Here are a couple things you can do to weather this storm and position your portfolio for growth:

First, take a big breath and don't panic. Now isn't the time to make big changes to your portfolio. It might be tempting to move from stocks to cash, but you won't know when to return and you'll miss most of the rebound. Hold your diversification.

If you can stomach the risk, consider rebalancing into equities on a regular basis. Long-term expected returns on equities are at levels we haven't seen since the global financial crisis and will likely outperform bonds and cash over the next ten years.

Keep your spending in check. Avoid making large purchases from your portfolio right now because the opportunity cost is too high. You don't want to lock in losses and miss the great growth opportunities after the storm. This also applies to taking loans from your retirement plans. Make sure you're disciplined with your budget, but it's fine to top off your cash reserve if you need to.

Finally, tune out the noise. It's hard to avoid the constant influx of news about the virus and its impact, but don't let it consume you. Resist the urge to check your portfolio with every dip in the market. Focus on your health and your safety first.

Don't feel like you need to go it alone; Vanguard is here to help you:

You can visit our website for fresh analysis on the markets and our latest recommendations.

You can also reach us by phone or email with specific questions.

If you have a financial advisor, now is a good time to chat with them.

Thank you for your trust and partnership, and stay healthy.

Important information:

All investing is subject to risk, including the possible loss of the money you invest.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

Diversification does not ensure a profit or protect against a loss.

© 2020 The Vanguard Group, Inc. All rights reserved.

Tim:
I look back at 2008‒2009, and I remember people panicking—investors I respected. Some of them were getting out on March 9, 2009. They couldn't handle it anymore, and that's just when the markets took off. No one had predicted that. You always have to remember the markets are forward-looking, and you don't know when they're going to take off—just like you don't know when they're going to tumble. So it's best to be invested than to try to time it, because it's close to impossible.

Karin:
That's exactly right.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

All investing is subject to risk, including the possible loss of principal.

© 2020 The Vanguard Group, Inc. All rights reserved.

Tim Buckley: Kaitlyn, investors are often surprised to find out that we're the third largest active manager in the world. In fact, you lead the group that selects those managers and oversees those managers—some 30 external managers. So that gives you a unique perspective on what's going on in the markets and what they're saying. Any panic out there or are they seeing more opportunities?

Kaitlyn Caughlin: So our external managers are really thinking for the long term, now and like we expect them to do all the time. It's actually one of the things that we consider as a key piece of our active edge: Is that our managers are able to think beyond some of the short-term events and remain really focused on understanding a company's long-term value. So what does that mean we're seeing more tangibly right now? Some of our managers are doing nothing. Their instincts are actually telling them to sit tight, while other managers are actually thinking about it and taking action to reallocate some of their portfolio to their best ideas or even selectively looking to buy new stocks right now because the prices are much more reasonable.

Tim Buckley: I want to key off a couple things that you said there—that long-term orientation of our managers, that there really is no seasonality to active. And we hear it all the time. You hear people. You might hear it in the press. You might hear a couple investment professionals saying, “Hey, active will protect you on the downturn” or “active's where to be when the market comes back.” But that's a very short-term orientation. I think about some of our long-proven managers. Think of Wellington. You think of individuals like Jean Hynes on health care or Kenny Abrams through the years. You look at James Anderson at Baillie Gifford or the team at PRIMECAP. They all have a very long-term view.

Kaitlyn Caughlin: Yes, that's exactly right, because even when you look at the data, if you look back from the 1980s onward and you think about the several bear markets that we've actually experienced, sometimes active outperforms and sometimes it doesn't.

Tim Buckley: I think, actually, most times it doesn't. I mean on average, for the past five downturns, active's only outperformed one of them. Now our managers have done very well, so I'm talking about all active managers in general. So it's not a cure-all for downturns.

Kaitlyn Caughlin: No, it's not. And so what we want our managers doing right now is really doing what an active manager is supposed to do: really thinking about the fundamentals of a company. And so while it might mean that right now there are opportunistic buying opportunities, it's really about the fundamental long-term value that a company represents.

Tim Buckley: And it can take time to actually realize that value. So if you're one of our clients and you invest in these funds, then you probably have to take that same long view, because active returns can be very lumpy.

Kaitlyn Caughlin: Yes, and I actually think that there is an interesting connection there between the external advisors and our clients. We want our external managers taking a long-term view, but it's important for our clients to as well, because when you take on active risk and you are investing in an active portfolio, sometimes as an investor you have to be able to withstand a bit of the bumpy ride that can come along on the road to long-term outperformance.

Important information:
Visit https://vgi.vg/2UpyUpE to obtain a fund prospectus or, if available, a summary prospectus, which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

All investing is subject to risk, including possible loss of principal.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

© 2020 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.

Karin:
There's a lot of sophisticated modeling behind our dynamic spending strategy, but the concept is really simple. What it allows our retirees to do during the drawdown phase is to spend a little more when markets are up and to pull back spending in down markets. We hear client feedback, Tim, and they really like this particular strategy, because it takes the guesswork out of asset drawdown for them. It can be a really daunting experience to save for decades and then, in retirement, try to figure out—in a tumultuous market—how much you can take out of your portfolio. Dynamic spending helps our clients do that.

Tim:
All right, so in that spending, you'll tell me, Tim, spend a few percentage less. But I'm going to guess that, right now, people are spending less already.

Karin:
Exactly. The portfolio strategy and discussions with your advisor can help sort of fine tune that and figure out how much do you need to pull back. Not every client knows. It's not a standard rule of thumb. You might want to know—depending on your current wealth level—how much do I need to pull back, and some of that's going to depend on the duration of this downturn.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

All investing is subject to risk, including the possible loss of principal.

© 2020 The Vanguard Group, Inc. All rights reserved.