David R. Henderson  

Vanguard's Strange Assumption

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I'm a big fan of Vanguard. All of my IRA-type assets are in Vanguard funds. And when I mistakenly claimed in a Wall Street Journal that John (Jack) Bogle, who started Vanguard, had learned from work by Eugene Fama, Bogle was very nice in the way he corrected me and then, when I acknowledged my mistake, wrote the following nice letter to me:

Hi, David,

Belatedly--unlike your prompt response to WSJ!--I offer a hearty and sincere Bogle salute to a man who makes an error (but an understandable one), and then stands tall in acknowledging it, sans hedge clauses, excuses, or defenses. You did just what I hope I'd do under similar circumstances . . . but I'm not sure that I'd measure up to your high standard! Thanks for you candor--and for your character.

Interestingly, The Economist made precisely the same "Fama error," and has agreed to publish my letter setting the record straight. Should be in this week's newspaper (as they call it). These things are never sure, so I've got my fingers crossed.

Best wishes and good luck in all that you undertake.


So please understand that this criticism is friendly fire: I like Vanguard and I just want it to do better.

I've been thinking more about two things: (1) the timing of my retirement and (2) the timing of receiving Social Security. Question (1) is hard to answer. I still love my job and I probably won't retire soon. Question (2) is much easier. Assuming that my health is good when I reach age 66, I will "file and suspend." That is, I will file for Social Security so that my wife can immediately start receiving benefits equal to 50% of the benefits I would qualify for. At the same time, if my expected longevity is good when I reach age 66, I will suspend payments because every year I do so, my payments will rise by 8% (non-compounded) until they max out when I hit age 70. I ran the numbers recently and was shocked at just how much my wife and I will receive.

I was looking around on the Vanguard site the other day and found an article addressing this issue. It's "Social Security: How to decide when it's time," by Colleen Jaconetti. She's got the underlying numbers right, but she computes payments out to various ages as if the real interest rate is zero. So, for example, if you start receiving $3,100 a month at age 70, then, by age 75, your total payments will be $186,000. Divide $3,100 into $186,000 and you get exactly 60. So 60 monthly payments, or 5 years of payments. The only way that makes sense is if the interest rate is zero. Which interest rate: the real or the nominal? Social Security benefits are inflation-adjusted. So she's fine using $3,100 forever, because that's a real number: the nominal number, with low inflation, will be a little higher. You discount real magnitudes by real interest rates. She clearly used a zero real interest rate without ever mentioning that she did so. That's not good financial information. It's mind-boggling (mind-Bogleing?) that Vanguard, where pretty much everyone would understand that getting a real $ today is not the same as getting a real $ tomorrow, would make this mistake.

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CATEGORIES: Finance , Social Security

COMMENTS (3 to date)
dmk writes:

I'm closing in on retirement too and have been contemplating the deciding-when question. It struck me that one straightforward evaluation technique would be to use a high discount rate on future cash flows - a higher rate than one might use when younger. At age 64 my 65th year feels much more real (pun intended) than my 80th year. When I was younger and making personal financial decisions breezy dismissals of difference between age 25 and age 40 seemed easy to make.

Charlie writes:

The real interest rate is currently negative for the next 5 years (look at 5y TIPS). What rate do you want her to use?

mike davis writes:

I think this is what Thaler and Sunstein would call a nudge.

For reasonably healthy people with normal expected lifespans, taking SS early is a really bad financial decision. (Remember, too, early money reduces the survivor benefit. If your soul mate is even a few years younger than you, it can be a spectacularly bad decision.) But very few 62 year olds like their job as much as I like my job. The prospect of cutting back on work and living very modestly is tempting. Less money/more leisure might make sense but I’m pretty sure there’s some sort of optimism bias at work (“I won’t mind not having cable and eating only what produce I can grow.”) By presenting a simplified version of the numbers in such a way as to make the stark financial realities obvious, Vanguard is nudging you away from that bias. They also seem to try and nudge people towards sensible investments, like low cost index-like funds.

The behaviorists have done a great job in making me question the simple view of rational choice. But I’m still not happy to have the government mandated nudges. (Nudges have a way of becoming shoves and even if they stay gentle, the politicians and bureaucrats don’t have the information or incentives to get it right.) On the other hand, though, I think I like getting nudged by institutions that I choose to join.

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