Episode #101: “The People That Have Come Out Ahead Are the People Who Have Put Their Trust in the System Over the Long-Term”
Guest: Paul Merriman. Paul is a nationally recognized authority on mutual funds, index investing, asset allocation and both buy-and-hold and active management strategies. Now retired from Merriman, the Seattle-based investment advisory firm he founded in 1983, he is dedicated to educating investors, young and old, through weekly articles at Marketwatch.com, and via free eBooks, podcasts, articles, recommendations for mutual funds, ETFs, 401(k) plans and more, at his website. Paul is also the author of four previous books on personal investing, including Financial Fitness Forever: 5 Steps To More Money, Less Risk and More Peace of Mind (McGraw Hill, Oct. 2011). Over the years Paul has led more than 1,000 investor workshops, hosted a weekly radio program and has been a featured guest on local, regional and national television shows.
Date Recorded: 3/29/18
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Summary: In Episode 101, we welcome the great educator, Paul Merriman.
We start with Paul’s background; specifically, the story of an early trading experience with commodities. He doubled his money in days…and then lost everything on the very next trade.
Then the guys dive in, with Meb bringing up something Paul wrote called “The Ultimate Buy & Hold Portfolio” and asking for more detail. Paul starts with the S&P which, even with all its up-and-downs, has done great over the years. But then he walks us through some tweaks – adding large cap, then small cap – he notes the various percentage returns added by each, as well as the effect on volatility. He eventually arrives at a final portfolio, showing us the power of this diversification.
Meb points the conversation toward the behavioral benefit of diversification and says how some listeners will wonder how much money to put into each of the asset classes Paul had identified. Paul tells us he originally put 10% into 10 different asset classes – after all, if each asset class is worthy, then he wants it to be in his portfolio; especially because there’s no way to be certain which one(s) will shine going forward.
Agreeing, Meb touches on being “asset class agnostic” and notes that the problem with being, say, a “gold guy” or any die-hard type of investor, is you get wedded to that asset class. This emotional bond can lead to bad behavior. This leads to a discussion about implementation and the challenges of emotional investing. Paul tells us “I don’t want my emotions to have anything to do with how (my) money is managed.”
The conversation drifts toward the benefits of investing early, yet the challenges of educating young people as to its importance, as well as different investing needs over a lifetime. The guys note how the best thing for a young person would be the markets tanking for 10 years. Of course, that would be terrible for an older investor in/near retirement. This bleeds into a conversation about formally educating the younger generation about investing.
A bit later, Meb asks about the older investor who might have been burned in ’08, is now near retirement, thinks the U.S. market is expensive, yet needs results. What about him? Paul walks us through the realities of losses and gives us his overall thoughts. This morphs into a common question we get – invest everything at once, or drip it in over time? Paul has some thoughts on how to do this in a way that balances math and emotions.
There’s tons more in this episode (it’s one of our longest to date): the challenge of investing in the “shiny object”… how to avoid getting screwed by your advisor… investment newsletters… buy-and-hold versus market timing… the critical nature of understanding past performance… giving money to grandkids… and of course, Paul’s most memorable trade; his involves the ’87 crash.
What are the details? Find out in Episode 101.
Links from the Episode:
- 2:35 (First question) – Welcome our guest Paul Merriman
- 2:56 – Books
- 2:57 – Podcast
- 3:14 – First investments
- 4:32 – Timeline on becoming an investment advisor
- 7:10 – Paul’s framework for investing and putting together a portfolio
- 7:54 – Lessons from 2018 Ultimate Buy and Hold Strategy 2018
- 13:31 – What investors should consider in terms of asset classes and making adjustments to the standard 60/40 portfolio
- 13:56 – How people should implement this plan in their portfolio
- 15:41 – Investing workshop
- 19:57 – How can young investors be encouraged to start early and stick with it through the bad times
- 24:53 – Paul’s thoughts on why everyone isn’t educated on investing and personal finance
- 26:18 – William Bernstein Podcast Episode
- 31:50 – Paul’s advice for investors closer to retirement
- 37:14 – Entering the market mathematically rather than emotionally
- 39:05 – How Paul talks to investors about new investing fads that may not be prudent
- 39:56 – Sponsor: Inspirato
- 45:19 – How to pick a good advisor
- 45:53 – Get Smart or Get Screwed: How To Select The Best and Get The Most From Your Financial Advisor – Merriman
- 50:50- Paul takes issue with the financial stock picking newsletters
- 53:10 – Wes Gray Podcast Episode
- 55:58 – Paul’s thoughts on market timing investment strategies
- 1:03:24 – Simple investment philosophy to avoid shooting yourself in the foot
- 1:08:04 – Elroy Dimson Podcast Episode
- 1:08:07 – Triumph of the Optimists: 101 Years of Global Investment Returns – Dimson, Marsh, Staunton
- 1:08:37 – Among the facts that every investor should know, any that stand out
- 1:08:41 – Video – 50 Facts Every Investor Should Know
- 1:12:22 – The importance of half a percent
- 1:14:47 – Why the boring stuff, like picking funds with the lowest fees, is actually best for your portfolio
- 1:20:36 – The idea of a Forever Fund
- 1:22:18 – Paul’s most memorable trade or investment
- 1:24:56 – How investor experiences can have a long-term impact on people’s lives
Transcript of Episode 101:
Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Meb: Welcome podcast listeners, today we have a fantastic show. Our guest is a nationally recognized authority on mutual funds, investing, asset allocation, all sorts of market strategies. He’s found and run his own billion-dollar investment advisor. He’s also one of the most prolific content creators out there. Certainly, his research was the early inspiration for a lot of the work we’ve done. He’s written multiple books, has a podcast, created tons of informative videos, contributes frequently to marketwatch.com, and has even created an educational foundation a few years ago which provides comprehensive financial education to investors. It’s our pleasure to have him on the show. Welcome, Paul Merriman.
Paul: It’s great to be here, Meb. Thank you very much.
Meb: Paul, I’m so excited to have you on today. We have so many common threads, and thinking, and investing, and ideas and I want to save a lot of time to touch on as many as we can. But we love going back in time with most of our guests and kind of seeing where they started. Do you remember your first investment? Do you remember how you got started in this business? I know you were involved in the brokerage business before the RA, so maybe tell us a little bit about how you got started.
Paul: Well, the first investment might not be recognised as an investment. I was married when I was 19, and trying to learn about the market and lo and behold, a Merrill Lynch guy gets ahold of me and talks me into putting money into a commodity, buying commodities, futures contracts. It seemed like hours, it was actually days. I doubled my money. I could see how easy this process was. It was obvious that I was on my way to a successful career as an investor, I thought that was investing. And the next trade that he said couldn’t miss, I lost everything. And it was an expensive lesson because that money, it was totally gone for the rest of my life, but I learned a lot. I never did it again.
Meb: So maybe it’s actually a cheap lesson, you learned it earlier rather than late. So tell us maybe just a quick timeline on getting up to starting your own investment advisor, and then we’ll dive into some topics there. But what was the progression? Was it, you lost the commodity investments, said, “All right, I’m hooked,” or what was the progression?
Paul: I was hooked on investing, and I thought it would be a thrill to be in the investment, not the investment advisory business. We didn’t even know about that back in the ’60s, but I wanted to be a stockbroker and I kept going to this company called Harris Upham. Eventually, they become part of Smith Barney, and I begged to go to work. I said, “Look, when I get out of college, I’ll work for nothing. I just want to get into the industry.” And back then, they didn’t hire college graduates, they hired people who’ve been out and had some sales training. And so, a starting age was more like 27 and I was 22. But I got them to hire me, and I thought it was going to be an absolutely amazing business.
It didn’t take long for me to figure out the conflicts of interest. And I was a broker for less than three years and I left the business, did some venture capital work, started a couple of companies on my own, and took over a public corporation, a small one in the Pacific Northwest, and got it turned around, and was able to kind of retire, theoretically, at age 40. And so, I decided, “Now I know what I want to do for the rest of my life. I want to be an investment adviser and teach people a better way to invest that does not involve Wall Street.” So I was a relatively early way investment adviser. DFA, Dimensional Funds wasn’t even on the horizon at that point. And so, I got into the business and I did it as a hobby.
I was not looking to make it a big company. And as things happened, I found some really bright people to work with me, and we grew it. When I sold it in 2012, I think we had about 1.6 billion under management, and I took a portion of that and started the Financial Education Foundation. And I’m doing what I love to do, I teach. And that’s how I built my investment advisory firm, was teaching people how to do it on their own. And if you didn’t want to do it on your own, then I was happy to do it for you. But what I really liked was the teaching
Meb: You and I both, I mean it’s funny. We’ve had a number of investors on this podcast that had a pretty similar trajectory. Where they often, you know, got the investing bug young but actually ran operational company, maybe came into some wealth, and looked around, and scratched their head and said, “Man, you know, maybe I can do this as a better offering or I have a lot of friends that are also wealthy that need help.” And that’s how a lot of the investment advisors got started. You know, I’ve read, I can’t even tell you how many hundreds, maybe thousands of your articles over the years, and I always reflect back on the one that was such a wonderful article and maybe we’ll use it as a jumping off point for kind of how you think about asset allocation and putting together a portfolio. But back in the day, it was called ‘The Ultimate Buy and Hold Portfolio,’ or something like that.
Paul: Yeah, that’s it.
Meb: Yeah, I loved it. And it was nice because it walked you through, you know, how to put together a portfolio or how to at least think about a framework for investing. You know, most listeners and investors we encounter that have this kind of soup of investments, or what our friend Josh calls “a mutual fund salad,” where it’s kind of just, you know, all these things haphazardly put together. So maybe talk about how you think about asset allocation in general, and we’ll go on on some tangents. But talk about your framework for investing and putting together a portfolio.
Paul: Well, that ‘Ultimate Buy and Hold Portfolio’ was really, at one point, the most important work that I had done in terms of education. Because my belief is, this could be a very complex process and I wanted to break it down into some very simple steps so that people could see if you did this, here would be the premium you’re likely to get to build a portfolio. And, of course, I’m a believer in massive diversification as a way to protect us from thinking that we’re smart. And so in that ‘Ultimate Buy and Hold Strategy or Portfolio,’ and I update that every year and write a new article about it just to continue to show how it has worked, but I started with the S&P 500 as the base because at least in my years in the business, that’s been the benchmark. The Dow Jones at one point was, but the S&P became the benchmark.
And we know that something like 85% of all the money that’s invested in U.S. corporations is represented by the S&P 500, and we also know it’s very difficult to beat. There’s a lot of stuff we know about it, some of it’s myths. But it’s what people have counted on and people who own the Total Market Index thinking that’s a better way to go, they basically have the S&P 500 working for them. So what I did in that ultimate buy and hold strategy was start out assuming all the money was in the S&P 500. How did you do? And I started back in 1970. And the reason I went back to 1970 is I wanted people to see what happened when you made it through ’73 and ’74. And then eventually you run into ’87, and 2000 through 2002, and 2007 through 2009 just to show that with all that nastiness that you can run into, that that S&P 500 has been a phenomenal investment.
But what happens if you take a small part of that S&P 500 money and you put it into large cap value? So in that Ultimate Buy and Hold Portfolio, we saw what happens with portfolio too, which is 90% S&P 500, 10% large cap value. And what happens? It adds about four-tenths of 1% to the portfolio. Now that doesn’t appear to people to be a life changer. But when you’re looking at money that’s compounding from 1970 through whatever date they were looking at this, we’re now through 2017, that four-tenths of 1% is golden. It means a lot of extra money for you to live on, for you to leave to others. It’s good, and the fun part is we also show the standard deviation. And, of course, and I shouldn’t say of course, but what happened was the standard deviation volatility went down a little bit.
Not enough to change your life or think there isn’t any risk out there, but at least it didn’t go higher. And so, what happens if you then take another 10% of the portfolio and put it in small cap, small cap blend? And we can see what happens, you make a couple two-tenths of 1% better, and then you add small cap value. And then you add reads, and then you add international asset classes, and you keep building in these small little pieces. And by the time you’re done, you’ve got 10 different major asset classes. You’ve got massive diversification. You’ve added about 2% of the compound rate of return, and the standard deviation is virtually where you started. And the amount of money that you had was about, if you started with $100,000, you had about $14 million more dollars by diversifying in these small pieces.
And my hope is that investors will see those small pieces as acceptable. And if I asked people to put everything in small-cap value, that could be frightening people. There are small-cap value in here, but it’s not the driver. It’s just one of many drivers in this diversified portfolio. And I’ve got to admit, I mean, I got to make full disclosure. I didn’t come up with this concept of these asset classes going together. This is the work of Dr. Fama, Dr. French, and all these really bright people at Dimensional Funds. I am just the mouthpiece, in my own way, to tell this story to others so that hopefully, they will take advantage of these same asset classes, and hopefully, their 401(k) plans will have those asset classes available.
Meb: And the nice thing about, you know, putting together a portfolio of assets, of course, is the behavioural reasons about, you know, you mentioned the small-cap value. And whether on paper, that would have the highest return, you know, the challenge of someone sitting through the volatility in Trodowns[SP] is near zero, and we’ll come back to that later. But, you know, a question I think some listeners would ask is that, you know, how do I now decide how much to put into each asset class? And under what conditions should I think about having different allocations? Or is it something that is a fixed percentage portfolio for everyone as the starting point and then you adjust the bonds? What’s the kind of practical way you then adjust that kind of default base case portfolio?
Paul: In the beginning, there was basically one end result, one portfolio. And that was 10% in each of these 10 asset classes. And you end up with international small-cap value and small-cap blend and emerging markets etc. And the reason I did that was because my perception was these were all great asset classes. Not always, but most of the time. And I would have been happy with the returns of any of these asset classes. And I guess if I were willing to accept a lower rate of return, I would have been okay with the S&P 500. Millions of people are okay with just the S&P 500. But I didn’t play favorites. I decided if these are all good asset classes, how can I know what’s going to be the best?
Will grow to be better than value? Will large be better than small for the next 20 years? And they could, and they have been in the past. The things that we expected didn’t happen, that’s part of this process. And so, I felt if I didn’t get into the business of telling people, “Load up on this and put a little of this other stuff around the outside edges to add some additional premium, but have a big core of the S&P 500.” Now, I didn’t want to think that way. I wanted, in essence, to diversify based on asset class not on the size of the companies or cap weighted.
Meb: And we often talk about being asset class agnostic. I think it’s so easy for investors, you know, the same way that they, you know, I would cheer for the Denver Broncos, and someone else is a Redskin’s fan, or someone’s Republican or Democrat. You know, the same way investors, you know, a lot of people say, “I’m a U.S. high dividend guy.” Another person says, “I’m a gold bug.” You know, and the problem with that is you then introduce your emotions and you become mentally wedded to the portfolios. And the nice thing about having a diversified portfolio is you start to lose, theoretically, a little bit of that being emotionally wedded to the fund. So talk to me real quick about implementation. You know, you mentioned DFA which has been a mutual fund manager for decades now. Is there ever a reason to use actively managed funds? What do you think about Vanguard? You know, how do you kind of put this to work for most people? Should they just go buy a target date fund? Maybe talk about the actual kind of implementation.
Paul: Well, the implementation I think is, from my viewpoint as an educator, is going to be totally dependent upon what we can create in terms of the belief system of the investor. I’ve got a workshop coming up on Bainbridge Island next month and it’s open to parents, grandparents, and their children. And I’m thinking ages 16 to 25. And for most of those people, at the end of the day, they are probably better off just to use a target date fund. And start it when they’re… Well, in fact, I’m trying to coerce these parents and grandparents to help them start it right now because of that extra time they’ll have with those assets building and that would be fine. Now, I do try to get them to add some small-cap value to the target date fund. So I’m asking people to use target date funds and some small cap value, so two funds for the rest of your life.
For people though who have the commitment, the willingness to make it more complex because to work with 10 different mutual funds or ETS, that becomes more complex. And you were right, how much you decide to put into fixed income is a big deal, and I’ve done a ton of work in that arena. But that amount of fixed income and let’s say like in my own portfolio, I’ve got a part of my portfolio that’s 50% buy and hold of equities and 50% in bonds. The equities are half U.S. and half international, half large and half small. Half the value, basically a little more than half the value of the balance in growth. All mechanical. By the way, I’ve got to tell the truth on this one. I don’t manage my own money. I’ve never been interested in managing my own money. I don’t want any emotion. I don’t want my emotions to have anything to do with how that money is managed. I do know what I want, but I don’t want to do it.
So I even have an advisor and that’s the way that you just, you have to go either to DFA or Vanguard. And on our website at paulmerriman.com, we have recommendations for Vanguard to try to come as close to that kind of the DFA model as we possibly can for the public. And we do it with ETS, and we have recommendations there as well. It does require some extra work to oversee all of these different asset classes. But if we can add, in the equity portion, 1% to 2% return without exposing our investors to more risk, or substantially more risk if you think there is more risk, that extra 1% or 2% it may mean retiring earlier, it may mean having more to spend when you retire, or it may simply mean that you’ve got a bunch of wealthy kids who pick up all this money when you pass on. But there’s a huge premium for taking the time to do it yourself. And I’ll call it do it right if you’ve got the stomach for it.
Meb: And I think you touched on, you know, a couple interesting points. I mean, one being that there’s a lot of ways to solve this problem and a lot of ways to do it just fine or, you know, great. There’s also a lot of ways to really muck it up. But you mentioned a couple topics that I’d like to expand on. One is you’re trying to educate this younger cohort in Bainbridge. And we read an interesting quote from you on your website. And we’ll show all links to listeners to all of Paul’s articles that we’re talking about, including he mentioned some of these actually implementable allocations with funds etc. But there’s a great quote that says, “I’m always looking for mechanical answers to overcome the emotional challenges of investing. I should have invested much more aggressively over my life. If I hadn’t invested so aggressively in my 20’s and so conservatively for the last 40, but after the early lessons from being too aggressive, I was more comfortable taking a more conservative approach.”
And so talk a little bit about the balances of, you know, you’re talking to these younger investors and some of these Millennials have never seen a bear market. And on paper, all equities, for example, would be maybe the best portfolio for them, but the behavioral reasons to try to mess with that. And so, you also have a comment about save 1,000 a year, retire with millions, another article. Maybe talk a little bit about, you know, kind of how you frame this with young people, the challenges of both, “Hey, start early.” But the flip side of that coin but actually be able to stick with it.
Paul: Yeah. And I think in many ways, a lot of mature investors have some of the same fears. In fact, as we get older those fears of losing what we’ve got become bigger and bigger. But when I could get a hold of young people, and I have a university class at Western Washington University up in Bellingham, Washington that I’ve been supporting for years. And what I tell these kids is that they have to understand that what is right for you would make your parents and your grandparents very unhappy because the best thing that could happen to you is for the market to go down for the first 10 years. And we all know that the sequence of returns can mean a lot to how much we end up with, and there’s just a ton of luck that goes into what we end up being served as investors. And we need to keep a bottle of champagne in the refrigerator just waiting for that big bear market to hit.
And when that thing is down 30%, 40%, 50%, and it will be. In fact, I tell people who will listen to me, if you follow my advice, I absolutely guarantee you will lose money. And what I want to know, if I were your adviser, I would want to know how much are you willing to lose. And one of the wonderful things about that new article regarding starting, you know, investing a $1,000 a year and growing to be worth millions, there are only a couple of years in that last 48 years where you would feel uncomfortable. But if you knew it was coming, if you were prepared for it, if there have been… And how do you do that? How do we allow people, how can we build a what would be a flight simulator? I’ve always called it the flight later, but how do you educate people to know and to expect what is going to happen to their money, and when they lose money?
That is an opportunity for young people, not a penalty. And that’s something that if they just believed that, and if they look at those tables that are in that article about saving $1,000 a year and look at the difference between being all fixed income, 10% equity, 20% equity, 30%, 40%, all the way up to 100% equity, they’re hopefully going to find a column that fits their theoretical personality as an investor. And I want them to focus on that column, know the bad times are coming, expect it. Who’s ever run a business that you don’t have bad times? Who’s ever been married that you haven’t had bad times? But if you get some counselling and you’ve been prepared for it, I think you can make your way through it. And that’s what I’m trying to do, is educate these young people to know what it’s really going to be. Like our industry and you know this, Meb, a chap that our industry is so focused on telling you about upside performance. They don’t spend 5% of their time talking about downside performance, and yet it is the downside performance that turns winners into losers, not how much you make on the upside.
Meb: There’s a couple things I’d like to talk about in there. You know, it’s funny there’s a great investment quote that I love which is, “Investing is the only business when things go on sale, everyone runs out of the store.” I was chatting with it on Twitter the other day with Jim O’Shaughnessy where, you know, this same concept where the media… Every investor looking at the S&P or the Dow, and there’s a number. And as it goes up, you know, typically investors get more excited about it, which is, of course, exactly backwards. And I said, “I wonder if you thought about framing in a different way, you know, whether it’s dividend yield or earnings yield, when the market goes down 20%, 40%, 50%.” If people just presented to the S&P, here’s the yield. You know, or whatever it was, and the yield was going up, you’d get more interested the same way you would with anything else.
But we spent a lot of time on this podcast talking about the education gap. And you’ve spent a lot more time with this than I have and we can go down this alley a little bit. And I find myself constantly these days going back and forth. And part of me wants to fight the good fight and believe it’s possible that investors can get educated and do the right things. And then every day I consistently see people just do these really dumb things over, and just being humans, right? Over, and over, and over again. And I kind of pull my hair out and, you know, I think we had Bernstein, Richard Bernstein on this podcast maybe a year ago. And we were joking because he said, “I used to believe 90% of investors shouldn’t be managing their own money. Now, I believe it’s 99%.” You know.
So talk to me a little bit about your thoughts on education because it’s kind of a crazy scenario to me where every high school in the country teaches Calculus which probably 95% of these students will never use a day in their life after high school. But we certainly weren’t taught it, and to my knowledge, most don’t ever teach a class on personal finance, which is something every single person will use every day for the rest of their life on buying a house, and credit cards, but also investing. Maybe talk a little bit about your thoughts on your experiences and kind of maybe this is some of the work your foundations doing on how… Is this a solvable problem, or what’s been your experience?
Paul: Well, it is solvable but a lot of the research, particularly Dr. Lou Mendell who actually is on our board, is considered to be one of the founding fathers of the financial literacy. And he’s similar age as I am and he’s done a ton of work in surveys and testing. And they find that if you don’t accomplish as much as you think you would when you educate people at a time that they’re not going to use it. Or if you don’t educate people and keep pounding away like you’re trying to teach them Spanish or you try to teach them to get to algebra, and then to calculus. It takes time and the schools are not going to devote the kind of time it takes to become proficient at this investing process.
But when kids get to the university level, all of a sudden we’re getting closer to real-time activity here, which is why I focus so much of my efforts on trying to help these young people at the college level, and there they’re about to use. I talk about how I’m going to help them become multimillionaires. They don’t believe that’s possible. They can’t believe that. In fact, their dream when I came into this business in 1966, everybody wanted to have $1 million someday, at least the young people I talked to. And when I talk to young people today, guess with all the inflation we’ve had since 1966, you’d need like $5, or $6, or $7 million to replicate what $1 million was back in 1966 but the young people are still hoping someday they’ll have $1 million. They don’t get it. They really need to have a lot more than $1 million, and it isn’t all that complex if they learn the basics at about the time they’re going to put it to work which is graduating seniors.
I’ll be speaking to a couple hundred graduating seniors in the month of May up at Western, talking about what they need to be doing to make sure that they take advantage of the possibilities of becoming financially independent, retiring young if that’s what they want to do. By the way, most of them do want to retire young. And what’s the chance that they’re going to retire young if they don’t get this right? But we have to be, we have to be honest with them. I tell them, I have never made an investor any money. I have never made a penny for an investor. And that is because it is the market that makes them money not Paul Merriman, not a stockbroker. If they’ll understand that, that nobody is going to serve this on a tray to them. And I also teach them it is amazing how much of your success is going to come from just pure luck. You’re going to do all the right things. You’re going to put the money out there, and that’s going to be like 1975, for example, to 2000, and 1999, and your money is going to compound at 17% a year with the S&P 500.
I mean, an amazing time, a golden age for investors. People who started in 2000, we know that they have made less than 6%, in fact, closer to 5% since 2000 in the S&P 500. If you were in one group of the other, it was all a matter of luck. And how do you teach them? I think you have to be honest with these kids. And by the way, when you’re honest and they start to believe that Paul Merriman can’t really help them and no broker can help them, they start to understand that, oh, if I own all the stocks, I might, in fact, do okay. Nobody taught me that when I went into the business in the mid ’60s. We didn’t even know what an index fund was. We didn’t have a target date fund. In fact, if we bought a bond fund, we had to pay an 8.5% low.
Meb: Oh my God.
Paul: Investing. Investing has never been easier than it is today, or simpler. It’s still not easy for people, but it’s built to truly do the best that’s possible for the investor. The investor just has to take the step of investing, and the rest can all be just automatic, mechanical, no emotions hopefully.
Meb: Well, I think that’s, you know, one of the things we spend most of our time thinking about here is how do we institute automated processes so that, you know, investors can’t be their own worst enemy. And a lot of that you mentioned is automation, things like automatically contributing to your retirement accounts and dollar cost averaging in is a fantastic one, particularly if you never see the money. That’s a wonderful way to do it. You mentioned having a financial adviser intermediary to kind of talk you off the ledge. There’s a lot of these robot-advisers that I think are fantastic technology but will be interesting to see if they end up preventing people from shooting themselves in the foot when the next bear market comes around.
I think a lot of people listening to this may not be 18 and 20 years old but maybe 40, 50, 60, 70. And they say, “Great. Well, yeah, it’s wonderful for a 50% bear market for my children and grandchildren, but, you know, I’m nearing retirement. I’m already in retirement.” And I look around today, the world and maybe think that U.S. stocks are expensive and bonds are only yielding 2% or 3%. You know, what would you say to kind of the retired investor, and there’s a lot that we talked to, by the way. You know, that really got burned in ’08, ’09, emotionally kind of scarred. They got out, never got back in sort of thing. You know, what do you tell those investors, and what do you tell the older crowd listening to this? Not that they should be hoping for an 80% bear market in stocks, but what are your comments to kind of that crowd?
Paul: Well, when I was an advisor, and I don’t do that at all anymore, I always thought the best time in the business other than teaching was when you can sit down with people and hear their story, their experiences and figure out what do they need, try to find out there what their risk tolerance is. And as you guys know, in a bull market it’s very high and in the bear market, it’s very low. And then you, remember I said, I guarantee you’ll lose money. I really try to figure out how much money are you willing to lose over what period of time. It could be for a year. For some people it’s actually, when you dig into it, it’s for a month. I once had a lady who fired me after one month because her account was down a half of 1%.
And I said, “Well, I told you there will be times that you lost money.” And she said, “Yes.” And I said, “Well, you lost money but it was a very small amount, and in for a very short period of time. Didn’t you believe that you were likely going to lose money?” And her response was so beautiful. She said, “Yes, I thought I would lose money, but I thought I would make money before I lost it.” And so, this is the challenge. I try, for example, with people who have had all these terrible experiences figure out a way, even when they’re older, to dollar cost average into the market to get it right, and not expose them to another radical situation. Because if they’ve been sitting in cash, even if a 50/50 stock bond portfolio is right for them, they know that if they put 50% overnight into stocks, that that 50% can still go down 50% again like it did before.
And so, we’ve got to figure out how to give them an emotional way to deal emotionally with getting that money put back to work. I think that there are a lot of people out there who 40% is the most amount of equities they should have. But even 30% or 20% can make a difference over time by fine-tuning your asset allocation table. It shows how every time you put another 10% in equities, you add about a half a 1% a year to the return. Well, an extra half of 1% is a big deal when you’re taking money out in retirement. But, of course, you’ve got to know then it comes with an exposure to loss that you’ve got to be willing to take. And I find a lot of people, I don’t know how many widows I had to just go out and buy wells [inaudible 00:35:19] fund at Vanguard. Why do they like it? Well, it’s been around, you know, since the beginning of time.
And I take them back to 2008, and I say, “Look what happened in 2008.” “Okay, it went down 10%.” “What happened to your neighbours who invested?” “Oh, well, you know, they went down. They lost half their money or 30% of their money.” Well, if you wouldn’t know of then Wellesley could, who knows? But this is a fund that’s been around for decades and decades and has weathered all the storms. If they put their money into something I recommended was some money, and big, and small, and value, and growth, how can they trust that? That’s not real. But the Wellesley track record to them is real. And that has got me over the hump with a lot of people who would have otherwise not wanted anything to do with the stock market. But when you show them somebody who’s conservatively done it for a long time, you can turn them into believers, at least for a while.
Meb: You know, it’s funny there’s a lot of what we call it like these little minor tricks. And we often say that there’s investment approaches even if you wouldn’t consider them optimal that become optimal if it’s something that causes an investor to stick with their plan. I mean, you had a nice quote where you said, “The key is to find a strategy that works now and for the future. If you find yourself guessing every move, you don’t have a mechanical approach and your future will be based on how you or someone else feels.” And, you know, the topic which you kind of touched on is one that we similarly talk about which is, we get tons of investors say, “Okay, Meb, I’m interested in investing, or I’m finally ready to get back in. Do I put all my money in tomorrow, or should I do something else?”
And we say, you know, “Often mathematically, the correct answer is to put it on tomorrow. But emotionally and behaviorally, you know, we’re totally fine if the dollar-cost averaging over the next amount of months, or even quarters, even years, if that keeps you from hindsight bias and doing something, you know, stupid,” because a lot of people become very emotionally wedded. In one way or the other kind of like the lady you mentioned where had she won before she lost, she might have stuck with it. But because she lost first, it became harder.
Paul: I used to have clients that I could feel that this was going to be emotionally difficult. And then I would show them that everybody in the industry will make the case, mathematically as you said, that just to put the money in. And I understood that they just were having a hard time with that. I might put them in 25% buy and hold. I mean, all in with 25%. Then I might have maybe let’s do it in thirds instead to make it quicker. Third all in, right now. At third, dollar cost averaged in over a year. Another third, dollar cost averaged in over two years. So that if the process becomes more gentle, you get them to do what maybe they should do. And that is to put it all in, but you get them then to accept the idea of a more general way to work the money into the market. But then I tell him, you know, I could dollar cost average your money in for the next three years. And during that three-year period, the market could go up at some, all the time.
At the end of three years, after all that dollar cost averaging being so careful, and the market goes up. The minute, the day you put in your final $1, under that dollar-cost averaging formula, the market can go down 30% or 40%. You never, there is no way that anybody can tell you this is going to, in fact, work for you. Now, somebody who’s 21 years old and you’re having them dollar cost average into an all-equity portfolio for maybe 20 years, and they’re putting money away for 40 years, that is the right thing to do and dollar-cost averaging. And they’re going to get tagged along the way, we know that. But for those people who got a lot of money and they’re trusting you with their life savings at the point that they need the cash flow today, you just never outgrow the potential risk that that market could give you. So even when we find a way that they’ll do it, I still warn them, “This is not perfect.”
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Meb: It’s interesting, you’ve been managing money over a number of cycles and have seen lots of shiny objects. You mentioned back in the day these bond funds had 8% loads and, you know, then there’s been a lot of fads, the internet stocks, and bricks, and emerging markets, and commodities, and probably cryptocurrencies now, and every shiny object imaginable. How do you kind of talk to investors? And there’s been a couple different approaches that people talk about. You know, there’s financial advisers that’d say, “Look, I’m going to let you have 10% of your portfolio, you can light this on fire as you see fit. You want to trade shares of Tesla, you want to go buy some Ethereum, you want to go do whatever.” How do you talk to investors to one, do things in their own best interest when presented with, you know, the shiny new toy of the day that is likely to be a very poor investment? Is there any general advice you have or processed for them to think about it, or do you do some sort of hack? Like some financial advisers do and say, “You know what? Fine, here’s a tiny percentage of your portfolio and you want to exploit it. Go for it.” What’s your general thoughts there?
Paul: I always took a hard line on that because I really believed that they would just let me manage their money by the definition of right through my eyes. That they would have more money to spend and more money to give to their children or lend to their children. And I have would ask them this question, “Are you sure you will never need this 10%? Are you sure there’s nothing that’s going to happen in your life that if that 10% have been able to grow at a reasonable rate of return, that you might need it? You might have a health problem, you might have something happen to a child, a grandchild that you want to dig into your money, your portfolio to be able to help them. Well, if you’ve done this, I’m going to take 10% to many times in your life.
You may need that money back, and the odds are you aren’t going to make money with those speculative faddish kinds of… They’re not investments, they’re speculations generally that they’re all excited about.” I tell them, “If you really want to try to make more money in that last 10%, why don’t you just put that into small-cap value?” I would show them the track record of small-cap value according to the academics going back to 1928, and the return is amazing. Careful to say, can’t say that’s what it’s going to be in the future. In fact, so many people know about it today, it probably won’t be great but it is likely to produce a premium over things that are more conservative. But if you want to make more money, then why don’t you put some more money in something that has a long history that one, we can call an investment and two, it has performed above and beyond what you’re likely to get in the rest of the portfolio.
I use that and I normally won, partly probably because I try to convince them they don’t know but go back to that idea that a lot of our success is luck. Well, there’s also the bad luck as well as the good luck. And how do we know what’s coming? You know that I’ve got a wife in the hospital right now. The problem she has that we didn’t know about a month ago, we weren’t thinking about it. We weren’t planning for it and we didn’t know it was going to come. And so, I would rather have people be able to take care of themselves and their family then their emotions and their ego. And I also go to that line about, if you do well on this investment, it has nothing to do with your analysis.
Meb: That’s probably the worst possible thing that could happen for a young investor or even an older investor, is then using that bucket and having a lot of success and thinking they are, you know, in the next George Soros. And then usually, like you mentioned, a lot of it has to do with luck, and it’s learning the wrong lessons. Well, okay, so let’s say there’s a listener and they’re saying, “Okay, this is sensible. I want to hire a financial adviser.” You know, and the challenge also, you know, the Bernie Madoffs of the world. But that still happens a lot where there’s a lot of bad actors in our world and money often attracts the hucksters. And you had a great book. It’s title, ‘Get Smart or Get Screwed,’ and it was talking about financial advisers and some of the pitfalls to avoid. Maybe talk a little bit about, you know, how to pick a good adviser versus really avoid the ones that don’t have your best interest in mind.
Paul: Well, I think the first thing we all need to do… I mean, remember, this money that we have is a business. It’s not just something that’s out there floating around, it’s a business that needs to be managed. And like I said, I have somebody who manages our investments. And we have it managed in a way that’s very special for me and my personal needs as an investor. I just don’t want to do it. But I would want everybody to take the time to get the education to understand as the boss of your business because that’s what you are. It’s your money, it’s not the adviser’s money. You need to understand what, in fact, are the right things to do with the money, and what are likely the wrong things to do. Warren Buffet, my favourite quote of his, “To be successful, you only have to do a very few things right as long as you don’t do too many things wrong.” Well, there’s only a few things you have to do right, there’s no more than 10 things to be a successful investor that you need to do, at least historically.
Now what we’ve got to do is make sure you don’t do the things that are wrong. Which is why I spend a lot of time talking about the wrong side of the street as I too talking about the right side of the street because I’ve got to try to protect people from those great sales pitches that Wall Street is so famous for. But if your adviser that you think you’re going to hire advocates for active management, advocates for mutual funds with high expenses, advocates for load funds, advocates for putting everything into one asset class. There’s a lot of things they can advocate for that are not in your best interest, and would go according to Warren Buffet, I think, on the things that you would be doing wrong if you did them. And if you don’t know what those things are, you got to find out to become a better boss. Or you better know a lot about the… Well, here, when you say, when I say you better know a lot about that person some other way, maybe you trust your CPA to tell you who they think is an investment adviser that would, in fact, act in your best interest.
But watch out because a lot of people, including attorneys, get a piece of your fee if they recommend you to an adviser, and the adviser then takes your management fee, gives maybe half of it or a third of it to the lawyer who recommended you to that person. Do you think you’re getting the very best that you can possibly get? If that’s what’s happening, and I suspect that would be a small, could be a small conflict of interest. You don’t want any conflicts of interest, which is why I don’t want you to do business with people who are involved in a commission in the process. There should be no commissions. My old firm, we never sold insurance. We told people what they should get, but we never put ourselves in a position where we might end up taking a commission because that creates conflicts of interests that are difficult for humans to deal with.
Meb: It’s interesting if you go back over the years. I mean, one of the beauties of the internet and more and more knowledge being kind of cumulative, there’s a lot of these practices and ideas get the general disinfectant of sunlight shown on them. And so, these high-fee mutual funds, I mean, there’s still, Paul, an S&P 500 mutual fund that charges 2.3% per year. In plenty, they charge over one for the same exact fund you could buy for 0.05%. And so, the internet hasn’t totally cleaned out the investment space but it’s getting better every day. And I think a lot of these bad practices, it’s a one way street. When someone, your parents die or get a divorce, or assets get passed on, you know, I don’t see people moving back to, you know, the relationships that are not in your best interest in these high-fee funds. Because once people get burned, it’s usually not something they go back to. So hopefully, knock on wood, the world’s evolving and things, efforts like your educational foundation help. But I look around today and I still see a lot of stuff where I just shake my head and it’s frustrating.
Paul: Yeah, and a lot of that stuff, Meb, is happening out of the newsletter business. I just I’m thinking about doing a podcast about the Motley Fool. And they’re smart people, no question. And they have a syndicated column that goes out in national newspapers. And when you have a syndicated column nationally and you have a famous name like Motley Fool, then people think, “Boy, I could trust their newsletter to help me make a lot of money,” particularly when they put out advertisements that if you read them, they’re very carefully worded. They make it look like they must have made a 30% compound rate of return over the years because they knew how to buy all these companies at very low prices years ago. And I, by the way, the whole industry tends to beat like that, it’s not just a Motley Fool. But Holbert, Mark Holbert used to track Motley Fool, used to track most of those newsletters. How did they actually do?
Well, through 2015, if you look at the average return of all of the portfolios that the Holbert Financial Digest kept track of that Motley Fool was running, it was a rate of return that was lower than the S&P 500 going back for 10 years. Now, did they have some great winners? Yes. And then I talked to a guy on the phone recently out of Alaska who heard about their great winners and put his money in there, and then promptly over the next couple of years lost about 80% of his money. And, by the way, nobody at Motley Fool is going to call you if you subscribe to their newsletter and say now, “I just want to know, are you willing to lose some? There’s some big profitability potentially here, but are you willing to lose 50% to 80% of your money because these kind of companies do that from time to time?” How many people would put their money into something if you…? If somebody legitimate said, “That can go down 80%. Just want you to know that, but it could also go up 100%.”
Meb: It’s funny you mention that. I mean, there’s a bunch of articles. We had a good friend on the podcast in the early days, Wes Gray, and he talked about anything that promises or even suggested a 20% plus return, he just did the math on it. A 20% plus return, you quickly become, you know, one of the richest people in the world. And a 30% return, you literally own all the assets in the world in a lifetime. And so those returns, while they sound doable and they sound great, you know, historically, markets are a lot harder than that. And so, you know, you always got to ask yourself, “If someone could make 20% plus returns, they would probably be managing their own billion dollars from an island in the Caribbean and probably not selling a newsletter.” So it’s always buyer beware in those situations. But, you know, again, that’s a scenario where people get seduced in that education gap, you know. They want to believe that something is so easy as simply following a newsletter and making 20%, 30%. And unfortunately, that’s not the reality.
Paul: Well, can I mention a great line from Mark Holbert, who I have great admiration for the work that he’s trying to do to help people? He was talking about asking people who subscribe to some of these newsletters that promises amazing returns, and Mark asked them, “Do you really believe that somebody can get you a 30% compound rate of return?” They said, “Of course, not.” And he said, “Well, then why do you subscribe to it?” And their answer is, “Well, if we got half that, we would be happy.”
Meb: That’s funny of Mark.
Paul: And that is that is, you know, the people get into Ponzi schemes, people get into all sorts of pyramid schemes because they think they’re going to somehow outsmart the system.
Meb: Mark’s the best. He, over the last few years, he recently kind of winded down the Financial Digest. But for many years, he was kind of the lone wolf in that world where, very methodically, tracked, you know, these dozens if not hundreds of newsletters. And we’ve written some articles and have been good friends with Mark for years on the blog. And it’s also really like a thankless task. The most challenging business in the world is to be essentially like the policeman or hall cop walking around and saying, “No, actually, 80% of these newsletters are not worthwhile.” And I think a lot of investors, once you say, “You know what? I’m going to put the lens of this is entertainment, and maybe I can implement this entire process at some point.” Because they’re not all bad, there are some certainly there are worthwhile and a lot of writers, they are great. But, you know, the lens of entertainment rather than hard earned cash is, I think, a useful lens to think about it.
We’re gonna touch on a couple more topics and then we can’t keep you for forever but, you know, Paul you have a curious mind, and it’s rare to find this where, you know, a lot of investing to be able to hold kind of two theoretically conflicting philosophies in your head at the same time and not explode, I think, is a rare talent. And so, one of the things you’ve written about over the years as have we, is both, you know, the buy and hold investing, but you’ve also been someone who’s talked about the concept of market timing as well. So maybe talk a little bit about, you know, your thoughts on market timing in general. Maybe how they’ve evolved over the years, and in general, just kind of philosophical leanings on that part of the world as well.
Paul: I do think that market timing works. I mean, start there. A lot of people don’t think that market timing works. I actually have the most successful of all my investments in my portfolio, is a hedge fund that I set up in 1995. And after all fees, it has compounded at over 14% with a downside standard deviation equal to the S&P 500. And during that time, the S&P 500 compound, they had about nine. Now, that by the way, could be luck so we won’t know about the next 15 or 20 years until it happens. But I know that market timing works. And the problem is that it is emotionally, by far, the toughest of all investment strategies I know because it demands something of investors that very few have. They may talk big like they could do it. But when the rubber meets the road, they just don’t have it in them.
Because market timing of the kind that I believe in which is purely trend following, purely mechanical, diversified over sometimes virtually 100 different funds, so you have to lose on so many trades. You have to be willing to sell at a loss. And then when the market turns around and heads back up, get back in at a price higher than you last got out. You have to be willing to underperform significantly in the good times. You have to be willing to lose money in the bad times. Now, what you hope is that you’re not going to lose as much as the people who were buy and holders. For me, because I’ve been there and lived through it, like in 1987, when I had all of our clients’ money out of the market about 30 days before the market crashed in October of ’87. And I got a lot of credit for having called the crash. No, I was out of the market when the market went down. There is a difference because all I did was do what the system said to do and didn’t second guess that.
But most investors, if you had let’s say that you used one market timing system on one fund and you had it all set up like that, and you have three losing trades in a row. You’re out looking for another good market timing system, even though it could be a great market timing system in the long term. There’s nothing unusual about three losing trades in a row. Which is one reason that I used to build portfolios that held many mutual funds, many asset classes. Diversify in a sense the same way that I believe that you should diversify with buy and hold. And, by the way, that investment that compounded at 14%, how did it get such a great return? It did okay as a market timing system, but it also had leverage built in. So it wasn’t magic. It wasn’t some special system. It was a willingness to take on additional risk and use the defensive strategy of the trend following of market time.
Now, in my own portfolio, I am half buy and hold and I am half market timing. The half that is buy and hold because I’m 74 years old and don’t have to take a whole… In fact, I don’t have to take any risk. I choose to do it in the hopes of leaving more to others. But I am 50/50 stocks and bonds, that’s enough equity on a buy and hold basis because that 25% of my portfolio that’s all equities on buy and hold, that part is going down 50% here soon. Now, by the way, soon could be 10 years. But it’s going down a lot and I don’t want to have all my money in equities on a buy and hold basis, even 25%, any more than 25%. Now, the other 50% of my portfolio is 70% equity, 30% fixed income. Now it turns out that the standard deviation, the volatility of a market timing portfolio that is 70% equity and 30% fixed income has the same standard deviation and about the same return as a 50/50 buy and hold.
You can get to the same end result more than likely either way. But buy and hold is so much easier. Buy and hold is so much tax, more tax efficient. So I have the timing in tax-deferred accounts. But I know this, that when the market is screaming, coming off the bottom, and my market timing accounts are not in the market yet because they’re out, having been kicked out because the trend changed. And as a timer, if I had all my money in timing, I might be feeling sad. But I’m not feeling sad because I got 25% of my portfolio in buy and hold and it screaming. It’s making money. It’s making me happy emotionally. I can’t eliminate all emotion, I just don’t what emotion to have anything to do with me getting involved in managing that money.
On the other hand, when the market starts down and I see I’m losing value in that buy and hold portion of the equity, I know that even if I’m not out of equities with the timing portion, that I’ll be getting out sooner or later if the market goes down far enough to break that trend line. And so, I have some peace of mind. So I can find myself as 25% in equity and the rest of it in bonds and cash, in a really bad bear market. So I’m still got some exposure. But then, again, I’ve got the power of that buy and hold in a bull market that you’re just not going to get from timing.
Meb: You know, Paul, this is so interesting because, you know, you and I, we’ve kind of arrived at the same conclusions, you know, having managed money professionally for over a decade now. You know, we’re of the belief that buy and hold is totally fine just fantastic. And also of the belief, me personally, trend following is sort of my desert island strategy. But thinking about every day, more and more about behavioural sort of inputs, you know, we had sort of arrived at this exact conclusion, which was buy and hold allocations are so hard because of the drawdowns when all the news flow happens at the same time, you know. So the media’s talking about the losses, and it’s often during a recession and people are losing their jobs and everything happens at the same time, and you have this feeling of helplessness when you’re not doing anything.
And then the trend following side is hard for different reasons which is often you’re underperforming when the S&P’s going straight up, or other assets are going up, or you’re often underperforming when the markets are kind of chopping. But the good news is during a long drawn out bear market, you’re awfully often out. But it also avoids, by doing 50/50 it avoids that binary thinking. I’m in or I’m out and particularly when you have a number of assets. And this goes along with the old John Bogle quote where he says, people, you know, and obviously he’s not a market timer but a buy and hold guy, but has a half allocation to stocks and bonds.
And people said, “Why is that reallocation?” And he says, “Why spend half of my time worrying I have too much in stocks and the other half my time worrying I have too much in bonds?” And so, that’s the beauty of the timing and buy and hold to me, whereas you spend half of your time saying, “Well, maybe I should be doing market timing,” or half of your time saying, “Maybe I should just do and buy and hold.” You’re never all-in on one investing approach. And to me, that kind of solves a lot of these behavioral quirks that would keep us from shooting ourselves in the foot.
Paul: And you know, earlier you mentioned that quote about me being too cautious. I grew up afraid that the world was coming to an end. And I always had, because there’s always list A, the good news, there’s always list B, the bad news. And I focused a lot on the bad news, and it created fear and that’s how I responded in terms of what I thought might come of the money that I put into the market. And so, I would have been much better off if I had more positive views of the future. But here’s the fact. The longer that the process goes on, the higher the probability of a catastrophic event. Some people think the longer you hold something, the greater the opportunity for success. Now there’s something to that, but there is a probability of the system not surviving.
And, by the way, I don’t have any inside information on this, it’s just the nature of how the system seemed to work. And so, I really do find a great peace of mind in the fact that I’ve got a good portion of my money set to go to cash. I’ve got a lot of bonds too. But I also have to keep in mind that there are Confederate bonds people are still trying to cash in. So we never can really get away from the potential risk of things not going well. But I can tell you, the people that have come out ahead are the people who have put their trust in the system over the long term. And when the bad days come, you hope you saved enough extra sufficient to deal with the bad days.
Meb: And there’s the old quote which is, you know, “Your largest drawdown is always in your future.” And Cliff Asness who runs AQR, a multi-hundred billion dollar institutional manager often says, you know, when looking at history, we’ll take the largest drawdown in many ways for strategies in particular and double it. Because, you know, the future by definition, you know, the drawdown can only get higher. And so, thinking about the possibilities of, yes, let’s look at history as a guide, but also be mindful that, you know, things can happen differently. So like you mentioned your experience in 1987, and then the internet bubble. These have different sort of personalities than other, you know, markets had in the past. And we actually just had on the podcasts author of the book ‘Triumph of the Optimists’ that goes and shows the people that were optimists about investing in financial markets for the past 120 years really we’re the ones that made out and did well. Obviously, you couldn’t put it all in one country or one stock because if you were in Russia or China, you lose all your money. But those that invested in the global portfolio ended up doing okay.
Meb: All right, we’re going to do a couple more quick hits, and we’ve got to start winding down. I don’t want to take up your whole day.
Paul: Okay, you’re the boss.
Meb: We talked about a lot today and, you know, you have a video on your website titled ‘Fifty Facts Every Investor Should Know.’ Are there any that stand out, you know? And maybe we’ve touched on some of them already, but are there any that stand out in your mind as things that people should know, you know, either that they don’t know or you think is an uncommon knowledge or things that are just particularly useful for investors as far as anything we might not have talked about, or reinforce something that we have so far?
Paul: I think that people need to understand that past performance is probably the most important thing for them to really know, to be intimate about past performance. We make a big deal about how past performance is no guarantee of future results. Well, when you say that, you’re always thinking about, “Okay, they said it made 20% but it doesn’t mean it’s going to make 20% again.” That’s not the performance that you need to know about. The performance you need to know about from the past is all the long periods of time that it didn’t do what people thought it was going to do, and that’s just absolutely normal. What they also need to know is performance includes not only good performance but bad performance.
And, again, if it’s bad performance that causes people like in 2008 to jump ship and lose all of their confidence and having their money in equities, they must not have known enough about performance in the past. So you as an investor, every investor has this choice. “Do I base the building of my portfolio on performance from the past, both good and bad?” Which by the way, will probably lead you to a ton of diversification because we just don’t know when the bad stuff is going to come, “Or do I base my decisions about where my money goes based on somebody’s story about what’s going to happen in the future?” Those are two very different approaches to management, or understanding, or dealing with the market. I think people really need to understand that the people who are predicting the future, they don’t know.
But I can tell you, if you go to my website. And, by the way, there’s nothing for sale on my website though there are some free books in them and a book you could buy at Amazon. But what I’m trying to do is to give people a ton of information about the past, page after page of numbers because that is the best way I know for you to see what it might feel like to experience what’s going to happen to your money. That is more dependable and more honest than anybody’s view of the future. That’s how I feel about it, and you have there a lot of smart people predicting the future.
Meb: Yeah. I mean, the problem, if you look at maybe, if not the number on investment stake, it’s certainly in the top three is people extrapolating, especially the recent past of chasing the hot performing asset class fund strategy over the last one to three years. And, you know, that the Morningstar star ratings play it out, almost every single study shows, you know, that people bought what they wish they had bought, and, you know, buy something that’s doing well in the recent past.
Paul: I want to emphasise the importance of 0.5%. When I talk to the college kids, they don’t think 0.5% is a big deal. But a young person in their 20’s putting away $5,000 a year into a 401(k) or an IRA, the difference between 8% and 8.5% after doing that for 40 years, and then taking that money out over 25 years. Because remember, it isn’t just how much we have when we’re 65, it’s how much we take out from 65 to let’s say 90 or 95. And then, it’s how much we leave to others. It’s how much we take out and how much we leave to others that’s the total payoff for all that investing. But for what it’s worth, that half of 1% difference between 8% and 8.5% is almost $2 million on the $200,000 that you put in. Half a percent. And there are so many ways to add a 0.5%.
Oh, by the way, people who retire and start taking money out, and take money out for 25 years. A 0.5% more return can double what you have to spend and leave to others 0.5%. And the good news is there’s at least 10 ways to get an extra 0.5%. Whether it’s lower expenses, using some additional asset classes, reducing turnover, getting rid of active managers. It’s work taking the time to look for those half of one percents. And I hope that our work at paulmerriman.com will help get you there. All I want to do and all I am doing it is teaching. Now, my problem is at 74, who the heck do I get to take over when I’m no longer here to do it. Because that’s my personal goal, is to find somebody to continue the work that I’m doing. And it’s not that I don’t have the money to be able to hire somebody, I just need to be able, after I’m gone, to find somebody I can trust.
Meb: All right. You’re going to get about 75 e-mails from a bunch of listeners at the end of this podcast. Or, you know, Paul, you just hang around another 10, 20 years and we can have little artificial intelligence clone you. And we can just have a robot Paul, just sit there, and not get tired, not have to sleep, just be able to talk all day. You know, it’s interesting if you mention the 10 ways. I think the way that most people almost always want to improve their returns is through something that’s more speculative. But the really boring stuff, and the blocking and tackling of avoiding high fees. And we actually tweeted this the other day. I said, “I just don’t understand at this point how the high fee actively managed mutual fund world.” You know, the case that the media talks about all the flows, you know, bear this out where they’re dying a really, really slow death, but it’s increasing.
But I think that case is actually understated. If you look at the fees of the average mutual fund is 1.25%, but there’s plenty that are 1.5% or 2% or above. But on top of that, the hidden area is the tax inefficiency of those funds which probably, you know, I’ve seen Rob Arnold had a recent speech where he’s talking about that being about 80 basis point disadvantage. So you tack on the extra fees and the taxable inefficiencies, and all of a sudden, you have a 1.5% at least hurdle that those funds have to outperform just to break even with the lower cost ETF or mutual fund. And I think the case of those funds being screwed is understated at this point. I don’t know when we’ll see a Blockbuster Netflix style moment, but I think the flows are only going to accelerate.
Paul: It’s happening. And, by the way, speaking of people who may be applied for the job. By the way, I don’t take any compensation so let’s throw that on the table. But what I hope your listeners will do is to reach out to young people and share information from your work, my work. And also, I encourage, and I always did in my practice, parents and grandparents to help get money started early for them. I’ve got an article entitled ‘How to Turn $3,000 into $50 million.’ It is not a joke. It’s not a scam. It simply is putting about $365 a year away over 21 years, or $3,000 right up front when that new grandchild is born. And you then invest in until they, in your own name, until they get to earning some money where you can take money out of that whatever you put away for them to go into a Roth IRA. If you just did that one thing between the distributions in retirement, and what are left to their errors could realistically be somewhere between $20 million and $50 million. And it just it’s so simple, but people just don’t think about it because there’s no money to be made off selling you the product.
Meb: My favourite though is you always read these heartwarming stories about, you know, the janitor, or the teacher, or someone who had very modest income that was good at that sort of personal finance decision to start early and have it be sort of automated, or just they were diligent about it where they died and left millions of dollars to their favourite charity or in some cases, it’s the humane society or their children. But people always said, you know, “I never knew how that person, you know, they acted like they were very thrifty, but in reality, they had a couple million dollars and invested.” And so those are my favourite stories. I don’t get tired of reading those. Maybe we should do a whole book of those stories to incentivise the young folks and the grandparents.
Paul: As each one of my grandchildren are born, we put in $10,000. We actually give it to them, write them a check. Now, they have 30 days to spend it. None of them ever been able to get up out of the crib and spend it. It then goes into a Crummey Trust which states that they can’t touch it until they’re 65. I can’t be the trustee, I’ve got to have somebody that I can trust to be the trustee. And the money has gone into variable annuities, no load, all value portfolios, small, large U.S. international. And I don’t have to leave them anything more than that. Time. I mean, they have this asset that we just, we’d love to have. Well, I’d love to have their time to have that money work for 65 years. Oh and, by the way, they can’t spend it at age 65 except they can take out 5%. And when they die, it all goes to charity which they get to pick.
Meb: That’s cool. I love that idea. But the funny thing is 65, by the time they’re 65, that means they’re probably like not even middle-aged. People are probably going to be living to like 300 at some point.
Paul: I know.
Meb: That’s interesting. You know, we brainstorm a lot or stuff like that. So I just had my first child who’s getting ready to be one year old And so, it has kind of forced me to think about a lot of these ideas. You know, we used to joke there’s a fund idea, so I would really struggle with… You know, there’s a lot of these behaviour, you know, you focus investors on education and then also on a lot of these behavioural ideas to keep them from doing dumb stuff. But at the end of the day, you know, someone can call you up and say, “Sorry, Paul, you’re fired. I’m going to go put all my money in Lite coin.” Or, “Hey, Meb, I’m closing my account.” And so we had come up with an idea that readers feel free to steal because we have enough terrible ideas here. But we are jokingly calling it the Forever Fund, and I think you’d have to do it as a mutual fund or something similar. Where you said, “Okay, you have a long-term investment horizon. We’re going to launch this fund and have it charge very little, 0% or something very little.
And they don’t invest in, you know, a good global buy and hold allocation.” Something like that, what you talked about, same thing as we’ve talked about. And the kicker would be so that the fund would break even or maybe make a little money just for expenses. But the kicker would be that it would have a 10-year trailing redemption fee. So if you try to redeem it, year one. So this is for the true people that say they have a long-term horizon. All right, you try to redeem in year one, it charges you like 10% or 5% or something. But it stairstep maybe declines for the first 10 years so you have the penalty side that keeps you from doing dumb stuff. And then on the flip side, we said that if you do redeem that redemption fee with so Vanguard has something similar. But the redemption fee doesn’t go to the investment company, it goes to the remaining shareholders. So you have this dual…
Paul: That’s great.
Meb: You see what I’m talking about?
Paul: Yeah, that’s great.
Meb: So you have this dual idea where you not only get penalised if you do something stupid, but you’ll get rewarded for good behaviour which is remaining in the fund. And you get a special maybe call it like that the bad behaviour dividend every year. Anyway, maybe we’ll launch it when we get a little bigger. We’re too small to launch these non-revenue generating ideas, but that’s that’s a pet project idea.
Paul: Oh I wish I had your youth, Meb. That would just make my day, make my life. You do a great job. Keep up the good work.
Meb: Paul, this is been a blast. I’ve had so much fun. We’re going to wind down. We asked this question to everyone, and you may have already touched on it in the beginning. And if it is, feel free to select the second one. But what’s been the most memorable trade or investment in your career? It could be good, it could be bad, but is there anything that just immediately pops up in your head when I say, “What’s been the one that just seared in your brain as the most memorable?”
Paul: Well, that’s kind of easy because it changed my life, one trade. I mentioned earlier that when I got the sale in September of 1987 and went totally to cash, it got me a lot of notoriety. And what came off that, I got on Wall Street Week With Rukeyser which was just a blast. And that weekend after having done that, we had 400 phone calls to our office, people wanting to talk about us helping them. And then that led to me being on Nightly Business Report four or five times with Paul Ganga’s. And, of course, I denied that I did anything than maintain the system. That was it. It’s all I did. But people want to think that there’s some magic way to save you from harm. But the rest of the story is, I lost a lot of business after that trade.
And the reason I lost a lot of business was because a lot of young people don’t know what it was like. It felt like another depression might come out up. There were people calling me wanting to know if the money market funds were going to be okay. It was a very traumatic time, and it’s amazing how we forget that as a nation. And then they would ask a good question. And they would they would ask, “Well, could that have happened to us?” And I said, “Of course, it could have happened the day before I got the money out of the market.” And they said, “You mean, you can’t protect us against a one-day loss of 22%?” I said, “No.” And they said, “Well, you know, we really appreciate the work that you’ve done but this is beyond the risks that we’re willing to take.” And so, I lost business on what was the greatest trade of my career.
Meb: That’s really interesting. You know, you look at how investor experiences form their worldview for the rest of their lives. I mean, Japan’s a great example where they had this massive bubble and then, you know, an entire generation or two of Japanese never want to do invest in equities again because equities don’t go up, why would you ever do that? In 2008, you know, some your comments you just made on ’87 probably have very similar echoes to a lot of investors that experienced ’08 and ’09 and just said, “I can never deal with that again.” It’s interesting that a lot of the pain of that becomes a major hindrance to people ever getting back in, which is a shame.
Paul: By the way, it happens in very quiet ways that we never know about. I just talked to a fellow who lost a ton of money in technology in the 2000-2002 period, and the broker just manipulated his clients. If he would have had a lawsuit, he would have won I’m sure, but it wasn’t his nature to do that. He is now recovered and saved enough money to retire, that’s the good news. The bad news is his daughter saw this happen, and she’s now a successful person making lots of money and saving lots of money. Every penny that she saves for the long term goes into bonds because of the terrible decision that her father made during that terrible period when everybody thought they were going to get rich on technology. And so, the impact is, it happens for a lifetime to people, and that is a shame.
Meb: Well said. Paul, this is been a blast. You mentioned where people can find you. But one more time, what’s the easiest spot if people want to find more info?
Meb: Perfect. Paul, thanks so much for taking time today.
Paul: Good luck to you, Meb, and to your listeners.
Meb: Listeners, thanks for listening today. Awesome episode. You can find the show notes. We’ll post a link to all of the things we talked about today. There’s going to be a lot at mebfaber.com/podcast. If you’re loving the podcast, hating it, whatever, leave a review. Subscribe, let us know what you think at [email protected] Thanks for listening, friends, and good investing.