By Dr. Rikki Racela, WCI Columnist
Med students and residents are used to getting barraged with medical questions during rounds, machine gun style, and most of us probably see it as a rite of passage. Back then, we were trying to impress our attendings and answer as many of their questions as correctly as possible. It was a time to show off our knowledge, and I loved it as a med student and resident. There was the satisfaction of knowing the right answer but also learning from the wrong answers.
In that vein, what follows is the financial version of those rapid-fire rounds of questions that will test your knowledge and, more importantly, reinforce some of the facts and concepts that surround personal finance. Many of these are esoteric, but others are quite practical on your journey through financial literacy. Let the financial questioning begin!
#1 How Many Stocks Are in the S&P 500?
B. More than 500
The answer, surprisingly, is B. There are actually 503 stocks in the S&P 500, as of this writing. How the heck is this possible, you ask? The S&P 500 represents the 500 top companies as voted on by the S&P committee. But because some of these companies have different share classes, they may have more than one stock listed in the S&P 500. Like Alphabet, for instance. Ha! Got ya!
#2 IRA Stands For . . .
A. Individual retirement account
B. Individual retirement arrangement
C. Internal revenue account
D. Individual retirement annuity
The answer actually is B. Most people think that IRA stands for individual retirement account, but in IRS speak, it actually stands for individual retirement “arrangement.” So esoteric, I know. I warned you these wouldn't necessarily be easy.
OK, on to more practical stuff.
#3 Which Asset Allocation Is Predicted to Have the Highest Future Return?
A. 70% total US stock market and 30% bonds
B. 30% REITs, 40% total US stock market, 10% total international stock market, and 20% short-term Treasuries
C. 70% total US stock market, 20% commodities, 10% bonds
D. 70% small cap value stocks, 10% commodities, 10% bonds, 10% TIPS
The answer is B. We have to remember Jack Bogle’s macro allocation principle: 94% of your predicted return is due to your allocation either to stocks or bonds. Also, commodities are not thought of as having a predicted equity-like return. So, the macro allocation principle dictates that B is the right answer because it has 80% of its allocation to equity-type investments. You might have thought the answer would be when you have a huge small cap value tilt, but according to the macro allocation principle, you'd still only have a 70% stock allocation in the example above—which is not predicted to do as well as an asset allocation of 80% stocks or REITs (which is an equity-like investment). As Rick Ferri mentioned on the WCI podcast a few years ago, factor tilts are only the icing on the cake. The stock/bond allocation is the cake.
More information here:
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#4 A ‘Clinical' Vignette Question
A 50-year-old early retiree is using the 4% rule to guide their spending in retirement. They retired last year and used 4% of their nest egg, and now they have $1 million left. They are about to withdraw one lump sum from their nest egg for spending for this year. How much do they withdraw?
B. Less than $40,000
C. More than $40,000
The answer is actually C! People always remember Bill Bengen’s 4% rule, but they sometimes forget that it is INFLATION ADJUSTED. This is why he has mentioned that inflation is probably the most dangerous variable in retirement, given the way his rule is structured. If you want to maintain your level of lifestyle and spending in retirement, it makes sense to inflation-adjust your withdrawals as Bengen simulated.
#5 Per the 4% Rule, When Was the Worst Time to Retire in US History?
The answer is C. I sort of hinted with the previous question that high inflation could really decimate your nest egg when you have an inflation-adjusted spending rule such as Bengen’s. That narrows the possible answers to the 1970s when inflation was super hot. Interestingly, the start of the Great Depression in 1929 was not the worst time to retire, as deflation was so bad that you could spend a minimal amount of your portfolio and still maintain your level of lifestyle ($10 withdrawn from your nest egg could possibly buy stuff that was worth $100 previously). Although 1980 was a year when inflation was at its highest and BusinessWeek had pronounced “The Death of Equities” the year before, Paul Volcker, chairman of the Federal Reserve, made sure inflation did not last long as he jacked up the Federal Funds Rate. 1973 was a time of a deep recession and high interest rates, but it does not compare to retiring in 1968—when you would have experienced a future decade of terribly high inflation and two bear markets.
Another point to make about the 4% rule is that the majority of Bengen’s research included a time when the US was on the gold standard, which macroeconomically severely handcuffed the US’s ability to corral inflation, including in 1968. The US came off the gold standard in 1973, and the Millennial Revolution argued inflation now should not be as devastating to the 4% rule, given the ability to control inflation by raising the Fed Funds Rate.
By the way, you know how both stocks AND government bonds got decimated in 2022? This has only happened in two other years over the past century: 1931 and 1969. So yes, if you retired in 1968, your stocks AND bonds were down in the next year, and you also had high inflation! No good.
More information here:
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#6 Who Is Likely Going to Have the Most Baller Retirement?
A. A 30-year-old who starts investing during a 30-year deep secular bear market that recovers five years before they retire, and when they retire at 65, it's at the start of a 30-year secular bull run.
B. A 30-year-old who starts investing during a 30-year secular bull and then retires during another 30-year secular bull run.
C. A 45-year-old who starts investing twice as much money as the investor in Answer A at the start of a 20-year deep secular bear market that recovers five years before they retire, and when they retire at 65, it's at the start of a 30-year secular bull run.
The answer is A. As opposed to SORR, which stands for sequence of returns risk, I’d like to coin my own term regarding the best time to invest: SOAA, or sequence of accumulation awesomeness. The best SOAA is answer A, where you are accumulating and buying stocks dirt cheap before they skyrocket to the moon just in time for you to decumulate and sell when you need the money in retirement. It is not answer C since that investor missed out on 15 years of compounding despite putting in twice as much money annually. Thinking about the historical 10% return of the stock market and using the rule of 72, the investor in answer A would have the first dollars invested 4x even before the investor in answer C had invested their first dime! Don’t believe me? Just check any online financial calculator or use an Excel spreadsheet to check it out.
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#7 An Example of Overspending in Retirement
One of your former practice partners who retired five years prior at the age of 65 comes into the office for a social visit. You notice they are putting on one of those “Everything is not OK, but I will put on this fake smile” smile. “What’s wrong?” you ask. They reply, “You know how you told me to do a 60/40 portfolio and withdraw only 4% of my nest egg, adjusted for inflation? Well, I just couldn’t do it. We were just enjoying retirement so much, traveling, spoiling grandkids, eating out, that we’re spending more like 5%-6%. We’re doomed! What are we supposed to do?” How should you respond assuming your former partner and their spouse will end up spending like any average retiree couple?
A. “Yes, you are screwed! You better jack up your asset allocation to 100% stocks and start eating Alpo (although that stuff is also getting kind of expensive nowadays).”
B. “Dude, you will be fine. Just stick to your level of lifestyle that you are doing without any major spending increases.”
C. “Cut your spending to 2.5%-3% for the next five years to make up for the five years you were spending at 5%-6%.”
D. “You need some extra income. I’m super backed up today. Do you want to see the patient in room 4, and make some extra cash?”
The most reasonable answer is B for two reasons. First, Bengen’s rule was only 4% because it involved the absolute worst time to retire for you not to run out of money, a very unlikely scenario to be recreated. That year was 1968, as mentioned above. Many years in the 4% guideline research has shown that the safe withdrawal rate can be as high as 13%! We have seen two bear markets in the past five years—a very quick one at the end of 2018 that nobody remembers and a bear market during the pandemic which was also very quick and where the market actually finished up on the year. The past five years were nothing compared to the five years after 1968.
Secondly, researcher David Blanchett noted that most retirees follow a pattern of spending called the “retirement spending smile.” At first, retirees spend pretty readily in what is called the “go-go” years. As retirees progress through retirement, their spending naturally decreases, as much as 25% on average. This is called the “slow-go” years. Finally, spending toward the end of retirement increases as medical bills increase, resulting in the “no-go” years. The point is it seems we naturally decrease spending during a huge chunk of a traditional retirement, and that can make up for a little bit of overspending above the 4% rule for the initial part of retirement.
OK, now on to some Bogle trivia.
#8 True or False: Jack Bogle Loved ETFs for Their Low Costs and Tax Efficiency
False. Gus Sauter, Vanguard's retired chief investment officer, loves to retell the story of when he instituted ETFs at Vanguard when Bogle conveniently was on vacation. Apparently, Jack was not a fan of ETFs because of the ability to trade them during the day. It eliminated the friction that would stop investors from trading in and out of the market. He thought eliminating this behavioral protection through ETFs was poisonous to individual investors.
#9 True or False: Jack Bogle Was Always a Fan of Passive Index Funds
The answer is surprisingly false. Before he came up with retail index fund investing for individual investors, Bogle had written a paper under the pseudonym John B. Armstrong in the Financial Analyst Journal lambasting passive mutual fund management. During the early part of his finance career, he was killing it while actively managing money as the CEO of Wellington. It wasn’t until 1974, hamstrung by the Wellington Board’s rules to not actively manage any money, that he came up with passive indexing.
#10 True or Fales: Jack Bogle Invented the Index Fund
The answer is actually false! As our WCI Content Director Josh Katzowitz wrote in 2022, it was a team at Wells Fargo led by Andrew McQuown that invented the index fund in 1971. Bogle was, however, the first one to make the index fund available to individual investors like you and me. God bless that man!
How well did you do on this quiz? Did you find this helpful to reinforce some concepts in finance and financial history? Do you disagree with any of my answers? Comment below!