202 Investing In Retirement with Paul Merriman

202 Investing In Retirement with Paul Merriman

Jason and Paul discuss investing in retirement and why it is important to play defense. 

Paul Merriman 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.

Below is the full transcript:

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Announcer: Welcome back America to Sound Retirement Radio where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. And now, here’s your host, Jason Parker.

Jason: America, welcome back to another round of Sound Retirement Radio. So glad to have you tuning in this morning. You’re listening to Episode 202. And this is going to be a great guest because I have somebody in the studio with me this morning, who I know you’re going to love the show but before we get started, I always like to start the morning right two ways. The first is by renewing our mind and I have a verse here for us from John 16:33,”I have told you these things, so that in me, you may have peace. In this world, you will have trouble but take heart. I have overcome the world.”

 And then I have a joke here for us. This is… now, I love this, I love that our community is helping bring these jokes to me this actually came to us, a woman friend of mine came by and she dropped this off at the office but, “It’s a priest and a pastor are standing by the side of the road holding up a sign that reads, ‘The end is near turn around now before it’s too late.’ A passing drive a passing driver yells, ‘You guys are nuts.’ And speeds past them. From around the curve they hear screeching tires and then a great big splash. The priests turns to the pastor and says, “Do you think we should just put up a sign that says ‘Bridge out’?”

Paul: Oh, man.

Jason: Okay, so you’re listening to Episode 202, I have Paul Merriman right here in the studio with me, Paul, as many people know he had a registered investment advisory firm for 30 years right here in my area, used to have a radio show. Since retiring from his investment advisory firm he’s all about education, financial education, and he started a Financial Education Foundation. They recently won a number one for Life Stages Podcast, but Paul Merriman what a treat and an honor to have you right here in my office with me?

Paul: Jason, it’s wonderful to be here, you got quite, quite a setup here, I wish my studio looked like this. You have to come over and help me would you do that?

Jason: Oh, man. It’s a work in progress, but it is so fun to have you in the studio.

Paul: Thank you.

Jason: As you know, because we’ve had you as a guest in the past. And by the way, our listeners love that show, even to today, it’s one of our most downloaded shows.

Paul: Great.

Jason: And you and I talked about this last time you were in but when I was starting my firm, 10 years, little more than 10 years ago, 12 years ago, I came to one of your presentations, you were doing a presentation, you were still working. I said, “Hey, can I come and listen to what you have to say?” It really influenced me. And so it’s definitely had a lasting impact on the advice that we continue to give people today based on that presentation. Like I said, just really a lot of fun to have you here.

Paul: Well, it’s great to be here. And I hope we can do some really good work here today in educating your listeners.

Jason: Yes. Sound Retirement Radio, Sound Retirement Planning is all about helping people make this transition from the working stage of life and into the retirement stage of life. And you’ve been doing a lot of work regarding your 2 Funds For Life. And so I wanted to start today’s discussion with the philosophy, the idea behind 2 Funds For Life. And then ask, just dive into that a little bit for people that are getting ready to retire. And so give us an overview, what is the 2 Funds For Life? Why are you so fired up over this idea?

Paul: Well, one of the challenges I’m going to have here is that the 2 Funds For Life, combine a target date fund, and a second fund could be a small cap value fund, could be the large cap value fund, but that second fund is going to make up for some huge weaknesses in target date funds. Now, the problem is when you mentioned retirement, is that the way the formula works for this 2 Funds For Life. I don’t want to make this too complicated but I think it’s pretty simple. I take your age, and I multiply it times 1.5. That is how much you would have in the target date fund. The rest of it, you would have in that second fund, the small cap value, for example.

 And the reason that we’ve got an interesting challenge here is when somebody’s 66 years old, 1.5 is 100, which means you have all of your money in the target date fund and nothing in the more risky small cap values. The answer as far as a 2 Fund solution for people who when they’re in retirement, want to hold two funds. Well, it’s got to represent what kind of an investor you are. Do you want to have like a target dat       e fund that as you get older is going to have more and more bonds in the portfolio? Or are you going to be like me, and my wife? And we’re 50, 50 stocks and bonds forever. We’re not going to, we don’t need to start getting rid of stocks because we want to take that risk for grandchildren and the causes that we care about.

 Don’t make it, want to make this too confusing. If people really want to dig into 2 Funds For Life. They could go to 2fundsforlife.com. And that would show them how this all works but the question is, and by the way, I think the story as to why we even have 2 Funds For Life is interesting because I had the good fortune of sitting with John Bogle for about 90 minutes, in June of 2017.

Jason: Wow.

Paul: And he said, and he has been on our radio show for years. And he said, “I like your work but it’s too complicated.” People don’t want to… you may remember with my ultimate buy and hold strategy, there’s 10 different equity funds. And do it yourselfers. I mean, we’ve got an advisor, you can have 10 funds, and manage it okay, because you don’t have to do it. But most people he said the problem with that is not that it’s a bad strategy but it doesn’t work for most people, because they simply won’t take care of it. It’s just too much for them to rebalance and to know when to start cutting back on fixed income, which is where an advisor comes in. And of course, I always, I wanted to be their advisor in those days.

Jason: Sure. Well, the question that I have for you, because obviously you like target date funds.

Paul: Oh, I think, I call it America’s number one retirement investment. And I like it because it does what people don’t do on their own, you can make one decision as a 20 year old and literally never have to do anything again, because the target date fund will make all of the changes necessary. Now, that’s the good news, there is bad news. And that is they’re built to be certainly not bad, but kind of middle of the road, a little bit mediocre, not expecting a real high return but Bogle’s attitude was, “We’re not here to make people wealthy, we’re here to make sure they get through the rest of the life.”

Jason: Yeah. On these target date funds, people have a lot of choices to make about what date they want to be targeted to. And so even though you’re retired, I see sometimes people come in, and they will have a target date fund of say 2020, because they got retirement right on the horizon. That’s going to increase the amount of fixed income, typically in those portfolio, so you have a very conservative asset, a more conservative asset allocation with the assumption that going into bonds is going to be more conservative than being in stocks.

Paul: That’s right, that’s where they work.

Jason: And then you talk about layering in an additional fund for people who have a longer time horizon, and you talk about small cap being an asset class, that looks, if you look historically, you could say, “Boy, this small cap asset class has consistently outperformed, we should maybe have an overweight to the small cap.” For people that are maybe 40 years old, listening to this driving down the road and Seattle this morning, you would want to know include some kind of small cap component to that to give them a little bit bigger boost to their equity position. Is that right?

Paul: Absolutely, and if you took the formula 1.5 times 40 is 60, which means you’ve got 60% in the target date fund and 40% in the small cap value fund. So, yes, I do think that the addition of small cap value or large cap value, will make a sizable difference. In fact, you don’t even have to do the formula, if somebody would just put 10% of their investments in small cap value. And then if they wanted to put the rest in the target date fund, they could just that one decision, particularly for younger people, is likely to give you 20 to 30% more money in retirement than if you didn’t.

Jason: Just by allocating to small cap. Now, here’s the thing that we always have to take into consideration, because there have been and Larry Swedroe which by the way you introduced me and we’ve had him on the show a couple of times. Thank you, thank you for that introduction. And we push, we got to push back a little bit on some of this stuff, because we want our listeners to be thinking, and every prospectus that I’ve ever received, Paul, and I’m sure you have to says, “Past performance is no guarantee of future results.” And that the issue that we ran into with things like saying overweight value versus growth, it’s based on the historical data that we have, these historical data sets that show, well, over a long period of time value outperforms growth.

 We would want to overweight to that, but today, and for the last 10 years, we see where value has underperformed growth significantly. And so the question is, the question I have for you, if we’re using historical data for creating asset allocation, but every prospectus tells us, past performance is no guarantee of future results. At what point when the data changes, like now we’ve got this data set for 10 years where growth has outperformed value, at what point do we look at that? And we say, “Well, geez, maybe we shouldn’t be allocated to small cap value, maybe we should be allocated to small cap growth instead.” When do you decipher the data to say, “Well, we have to think different because the data is changing?”

Paul: Well, I guess you have this challenge. How long does it take to find out that it has changed enough that you should be making that decision. Because if we did, in fact it wasn’t, we didn’t do this table, one of our listeners put this table together for us out of the same database that we use to look back to 1928. And so he looked at every 40 year period, for large cap growth, for small cap growth, for large cap value, small cap value, large cap blend, small cap blend. A lot of different asset classes, the way people use them, today. And in 94% of the 40 year periods, small cap value was the best. It doesn’t even at 40 years, it’s not always going to be the best, you can’t know but what the academics tell us. And I trust the academics more than I trust Wall Street, and more than I trust my next door neighbor. But what the academics believe is this is not going to shock anybody, “Stocks are likely to outperform bonds in the long term.”

 Not for any magic, but because they’re riskier. And if you didn’t get a premium for stocks over bonds, then that would be really foolish to put your money at the risk of going down 50%, when the bond may only go down five or 10%. They also believe that small because it’s riskier than large is going to outperform. Now having said that, from 1970 to 1999 large outperformed small. And so people were up in arms, the small cap of premium.

Jason: That’s a longtime, 29 years, almost 30 years?

Paul: That’s right. And here’s what Dr. Fama, who did this original work said when people challenged him, he said, “Well, you’re not very patient, are you?”

Jason: Well, let’s talk about patience because-

Paul: It is what it is.

Jason: Well, now we’ve got people though, because I think that a big difference that I hear in a lot of the work that you’re doing, because I know you’re so passionate about reaching the young millennials that are so worried because they saw what happened to their parents during the financial crisis that they’re sitting on the sidelines. And I hear that coming through in the show that you do. And by the way, for our listeners, if you don’t know, Paul still has his podcast going strong at Sound Investing. And so we want to encourage you to check out that show and definitely all kinds of great information on there but where was I going with? Oh, the time horizon, the time horizon. A lot of the people listening to Sound Retirement Radio, Sound Retirement Planning, the one asset that they have less of every year as they make this transition into and through retirement is time.

 And I just showed you a minute ago, my retirement budget calculator where we put people’s time in days so that they can understand that they… they may not have patience, they may not have the ability to have a 30 year time horizon if their life expectancy 78 and they’re 65. How do we give people the confidence they need simply? That’s the thing I like about your 2 Fund For Life idea, it gives people a simple framework to work from. But what if their time horizon isn’t long enough to absorb or to make up for some of the shocks that they may experience in the short run?

Paul: Well, first of all, they’re going to have to determine how much they should have in fixed income because for buy and holders, that’s your defense. And if you don’t have the right amount of fixed income, and most people don’t know what that amount is, because they don’t know the implications of 30% fixed income 40, 50 say, what are the implications in terms of return? What does it do there? What does it do to the downside? How much protection against risk do you really have? If you don’t know that, how can you know what the portfolio should look like? What I’ve done is build what’s called the fine tuning table that shows investors over almost 50 years, if you had zero in equity, 10, 20, 30, 40, 50, 60, 70, 80, 90, 100% equity, what was the return? And how much money did you lose in the bad times.

 And if you’re not willing to look at losses, and understand that’s part of the process, then you’re probably, you better have a lot of bonds because losses, beyond somebody risk tolerance, cause people to give up, throw in the towel, throw out the stocks, left with bonds, almost no inflation protection. And that’s a terrible place to be. And if they had only been in the right balance of equity and fixed income, and already knew they were going to lose money along the way, I tell people that if you follow my advice, I guarantee you will lose money. Absolutely  guarantee it. At that point somebody say might say, “Well, how much?” Well, how much depends on, how much you have in fixed income. And when people don’t understand all this stuff, they better have an advisor that understands it, because you can be turned inside out by one terrible market timing move.

 When I say market timing. It’s where you, people in 2008 did this, they sold everything, sold everything. That’s market timing at its worst. It’s what I call the, I can’t stand it anymore timing system, which costs it can literally cut your money, you have a retirement in half by bailing out at the bottom of a bear market that will never recover if that’s where you end up.

Jason: This morning, I got this, you and I you do a lot of speaking for AAII, we’ve had Dr. Cloonan on the show in years past. I’m a lifetime member of AAII so I get these emails from them all the time. Some of them are just trying to sell me stuff, but they do have a lot of good information. But I noticed the headline from the email that I received today said, “When treasury bills are riskier than common stocks,” now maybe that’s just bait. Maybe that’s just click bait to try to get you to click on it. But when you have treasuries, 10 year treasuries that are paying less than 3%, then the question has to become I know the Fed has said in the short term interest rates aren’t going to be going up but, “Do you think treasuries are riskier than common stocks? Do you think this is just bait, click bait on this email from AAII or are there risks that are different with bonds now than have been in years past?”

Paul: Well, from my viewpoint, I’m 75. And I’ve got half my money in stocks, that half is going to lose 50%, I want those bonds there. They’re not there to make money, they are there to protect the portfolio from collapse, because I’m being aggressive enough to have half my money in stocks. I don’t look at bonds as a way to make money, the fact that you make 3%, or whatever it might be that’s factored into the estimated return over time. But compared to the 10%, theoretically, that over time, we’re likely to get with equities. You put them together, you got what six and a half percent that you would have with a 50, 50 strategy. If I gave up and only have the S&P 500.

Jason: Do you ever worry, because I remember this in the financial crisis. And maybe you experienced this too but in 2008, we saw people that lost money, not just in equities, but also they had short term bond positions that had lost money because of the volatility that we saw during that period of time. And remember our audience is not people necessarily everly long timers. And these are people that have accumulated money now they’re trying to transition into retirement. And that, I mean, you walked people, life with people during that period of time, I walked life with people, I remember calling the bond fund manager up and saying, “Hey, this is a short term bond fund. Why in the world are we down 10% in six months, what is going on here?” I mean, it got hit.

Paul: Well, and of course, what I believe and my old firm taught me I mean, we had research people who taught me a lot over the years, is we were holding only governments. And if you go look back at 2008, the government’s dead, okay. High yield bond funds, some of them were down 40%, the Vanguard down about 22% in 2008 but that’s high yield, that stuff’s oftentimes a lot like stocks. On the other hand, if you had a portfolio that was some short term and some intermediate term, no long term, you would have made about 7% in bond funds for 2008. But high grade corporates were down about 10% for the year.

Jason: You know it’s amazing to me as we’re having this conversation, because this is the first time you and I have been face to face sitting in the office together, you’re able to recall these numbers from memory, which is, that’s pretty amazing.

Paul: It’s the only thing in my life, I’m able to do. [crosstalk 00:21:03] it just befuddles me why my brain captures this stuff, I’m passionate about it is part of it, I think. And I love to show people a page of numbers. And the reason I like the numbers, is because you can show somebody a graph. And what their mind does, is they look to where it ended up. And it ignores all the times it was down and came back and so they, “Yeah, I’d like that.” “No, you wouldn’t like that. Put your finger on this column, I want you to go down that column.” I call it the fright simulator. And I want you to see there’s losses, it’s not only how you would feel, “How would your spouse feel?” Because oftentimes, you’ve got a couple and you know this in the business, that oftentimes it’s the husband that wants to be more aggressive, and the wife that wants to be more conservative. That’s my experience for the many years I was in the industry.

 And yet, the husband is the one who’s trusted to take care of the money. The spouse is as nervous as can be, unfair by the way. And normally, the husband doesn’t even understand what they’re doing to that spouse.

Jason: Yeah, and he doesn’t, a lot of times they don’t even understand the risk they’re taking from what I found when we get a chance to talk with some of these people. The cool thing for our people driving down the street this morning in Seattle, I should let them know that you have agreed to stick around a little bit longer for our podcast listeners.

Paul: Oh, absolutely.

Jason: We’re running out of time for our radio listeners but if you want to catch the rest of the show, by all means this is number 202. I’ve got Paul Merriman on the program with me. And we’re talking about retirement planning. We’re talking about investing. Paul, I wanted to ask you before we run out of time on the radio, because this morning, I had a chance to show you our new retirement budget calculator that we’ve been creating and building for people. What were your impressions, as I kind of showed you how that worked and what it did?

Paul: It looks terrific. Now what I want to do, is I want to put it in the hands of a person I know has the patience to use it as you want people to use it. And after I’ve done that, I’ll come back right here and sit and tell you by the way if they never hear from me again. Well, they’re going to say, “Well, what did Paul think?” But I’ll tell you that because-

Jason: You got a guy that likes to crunch numbers [crosstalk 00:23:39].

Paul: Yeah, I mean, we have two people because we are foundation. We have some money, but we don’t have a lot of money. And so we have people who donate their time and some of them are some of the smartest people I’ve ever worked with.

Jason: Man, I would love that. That would be great. Folks, again, if you’ve been just tuning in you’re listening to Episode 202 with Paul Merriman, we’re talking about investing this money that you’ve saved for retirement. Unfortunately, this is our end of time for the radio. We’ll be right back for our podcast listeners.

Announcer: Information and opinions expressed here are believed to be accurate and complete. For general information only and should not be construed as specific tax, legal or financial advice for an individual and does not constitute a solicitation for any securities or insurance products. Please consult with your financial professional before taking action on anything discussed in this program. Parker Financial, its representatives or its affiliates have no liability for investment decisions or other actions taken or made by you based on the information provided in this program. All insurance related discussions are subject to the claims paying ability of the company, investing involves risk.

 Jason Parker is the president of Parker Financial and independent fee based wealth management firm located at 9057, Washington Avenue Northwest Silver Dale, Washington. For additional information, call 1-800-514-5046 or visit us online at soundretirementplanning.com.

Jason: Okay, everybody we’re back. I still got Paul here with me. I’m holding them hostage in my office, we can continue the conversation. Thank you so much.

Paul: Thank you for letting me talk a little more. My wife accuses me of babbling. I’m serious. I’ll get going and I just get so excited. and she’s like, “Settle down, you’re babbling.” It’s your job, it’s your job, when I start babbling, just say, “Paul, you’re babbling.” Okay?

Jason: Okay, I’ll do my best. But I was amazed at how fast the time always goes on the radio, I looked down and we’re at 22 minutes. I thought, “Man, where did the time go?” A minute, when you first came to the office, I took you into my office and I shared with you, I showed you a slide that we will do sometimes at presentations and we’re talking, we’re showing people average returns, standard deviation and the impact that sequence of returns can have on somebody’s retirement portfolio. And how, if you get hit with those negative years early on, the reason I bring this up Paul is because so many people put a focus on the average rate of return. And I produced two slides and showed you the average rate of return was exactly the same. But the amount of money that people have at 17 years later was significantly different, even though they had the exact same average rate of return.

 Maybe take a minute and talk to our listeners about sequence of returns, standard deviation and retirement. Pulling money out of these accounts, because that’s what we’re trying to help people do it Sound Retirement Radio.

Paul: Well, I do think that this decision about how much we can take out is one of the biggest decisions we’ll ever make. And I also think that one of the biggest mistakes that people make is they don’t really understand their cost of living. This may be at retirement, the biggest mistake because if you don’t get that right, how can you know, how much you really need to take out?

Jason: Absolutely.

Paul: And once you find that out, and then you find out what kind of risk you probably have to take in order to take that much out. You start getting down to some pretty big decisions about whether you should even be retiring.

Jason: Yes.

Paul: And I tell people, I don’t care. If you don’t want to hire an advisor for life, I understand that people don’t like spending money on something they don’t think they’re getting value for every day. I’ve lived through that for 30 years but I think every person should go through that analysis to make sure that you’re doing it right. I think for example, when I was watching you go through your new calculator, your budgeting tool here and it’s for so many purposes, for real. But the bottom line is, if a person’s a do it yourself investor, they should start with that, put together what they think is the right, the budget they’re going to have. And then let a professional look at it because that professional knows the mistakes that people make. I was flabbergasted when I was in the business, how many people would come in and they would show me what they think is their cost of living.

 And I say, “Well, what is your tax rate?” “I’m not sure.” “Where are the taxes in this budget?” “Well, we didn’t put that in.” “Well, how can you have a budget?” But people don’t think, “Where is the budget for replacing the roof? That you’re going to have to replace in five or 10 years?” They don’t have it. And so any discussion about taking money out in retirement really has to start with knowing how much. Then you can get into the discussion about what are the combinations of fixed income and equity that are appropriate for you. And as we talked earlier on the show, how much you’re willing to lose.

Jason: It’s so important.

Paul: Is in some ways more important than the upside because what if, like with the S&P 500, what if you would actually believe in 1970, that you should get a 10% compounded rate of return? And your business plan was hope, that was the basis and you hoped that that 10% would flow, and you’d be okay. How are you, and how is your spouse likely to feel, if in 1974, you have just gone through losses that totaled about 50% of what you had in there? Now you decide you see, after the first year of loss in 73, probably what you thought was it’ll come back because after all, the market always comes back. The market doesn’t care about you, you better understand that.

Jason: That’s a great point.

Paul: No allegiance whatsoever. Then you go talk to your advisor, and your advisor says “Well, you know, hang in there.” And sometimes an advisor is so powerful that people will say, “Okay,” there’s this famous book Thinking Fast and Thinking Slow by Daniel Kahneman. And when somebody quickly says, “Okay,” they’re thinking fast, thinking fast is not a good way to make decisions about your money but it’s what people do. You decide to stay the course, you convince your spouse who was scared to death that maybe there could be another year like that again. And of course, the next year, it was worse.

Jason: Wow.

Paul: Now you pull the plug, now you fire the stock market, you fire the advisor, and you take your 30% or 40, or 50% less than you had. Now where do you go?

Jason: Now you’re just, now you’ve locked in those losses, there’s no way to come back.

Paul: And I’m going to tell you what I think is the best solution that I’ve ever found for a strategy for taking money out of your investments in retirement. On my website, I have fixed returns of three, four, five and 6%. And every year you adjust those for inflation, and all of a sudden you’re going to see taken out 6% is going to put you at risk of being broke. Another flight simulator if you want to look at it that way particularly if you walk into 73 and 74. Even if you were half in stocks and half in bonds, it taken out 6% you were going to run out of money. You can take it that way where you look at the different amount you take out fixed plus inflation, or do the, if this is the, I think the biggest step I know I’m babbling, this is the biggest luxury I know of financial luxury, in retirement over save, have more than you need so that you can then use what’s called a variable distribution.

Jason: It is true, but here’s what I find, is that people tend to increase their lifestyle based on what their assets are, for example, somebody comes in and they have $10 million saved. And you would say, “Boy, that that person looks like they’re doing pretty good,” until you start talking about their spending. And they say, “Yeah, I’m spending $600,000 a year.” And all of a sudden that $10 million, doesn’t seem like that much money because they’re spending, they’ve increased their lifestyle to match the assets that they’ve. In theory, I agree what you’re saying there Paul, and at the flip side to it is to you see the FIRE community, Financial Independent Retired Early, these guys, they barely save a million bucks, but they’re retired because they ride a bike everywhere, and they spend $40,000. And they pay nothing for health insurance, because it’s all subsidized by the government, because it’s based on your income, not your assets.

 I see both sides of that equation. But I wanted to ask you, because when we were talking before the show started, you talked about, you said, “I played defense, this is all about defense.”  Talk to us a minute what you mean by defense, why is that so important to you from an investment standpoint?

Paul: Well, because defense protects you against losses that are, you’re not willing to take, you’re not willing to accept, for example, when you buy a mutual fund with low expenses, that’s defense. When you buy a mutual fund that has five times the number of stocks in it than other mutual funds have, that’s defense. When you buy a mutual fund, that doesn’t have much turnover index funds or that way, you have just eliminated some taxes more than likely if you’re not in an IRA. And you also have reduced the cost internally of managing that money, defense. When you add fixed income to the portfolio, defense. I believe in looking for every kind of defense that you can.

Jason: Why?

Paul: Because you don’t know how they’re going to come at you. You don’t know where, but I can tell you. If you’re talking about low expenses versus high expenses, I mean, they’re picking your pocket. That was not a quote from John Bogle. But at some level, you are overpaying for what you’re getting, as far as I’m concerned, I don’t want you to, because I believe and this is the part about investing it think it’s important. And to know what your advisor believes, I believe lower expensive likely going to lead to better returns.

Jason: Let’s talk about that because what do you think is reasonable for somebody to expect to pay in fees? Should they be in a Vanguard fund at nine basis point, seven basis points? Should they be paying an advisor one or 2% per year and management fees? Should they be paying mutual fund expense ratios of point 0.75 to 1.5%? I mean, what do you think is a reasonable cost for somebody to pay? If they want help doing this and they want some kind of fee structure, what do you think is reasonable?

Paul: Now you’re talking about, first let’s talk about the management of the fund. The management of you personally, as a client is much harder, much more complicated than the managing of the mutual fund. I mean, it’s that and more, it’s a commodity because anybody can put together, I got free portfolios at Vanguard and T Rowe Price and Fidelity on my website. And I’m going down to speak in Los Angeles with a guy named Craig Israelsen who teaches Utah some school, he’s got his 7twelve strategy. It’s a great portfolio, there are hundreds of great portfolios. The problem is not managing money anymore, as long as you don’t pay too much. Now you talk about how much is there right amount of pay for the management of the fund.

 Well, if you’re going to use index funds, why would you have an S&P 500 that’s charging 20 basis points, if you could have one that’s charging 10 basis points? But then somebody will say, “Well, okay, I’m not going to put any money in a small cap value index, because they’re charging 20 or 25 basis points.” But wait a minute, the small cap value index, it costs more to manage generally. But more than that, if you want to look at it this way, historically, produces four to 5% premium per year, well, even if it were a 1% premium per year, what I paid 10 basis points more to pick up an extra 1%, I would. I don’t want to just throw out anything that costs more than five 100 or 10 one hundreds, it’s going to… internationals are more expensive. And reads can be more expensive.

Jason: But there’s such a focus or such an emphasis on fees. And Vanguards cut fees down to zero. Fidelity they have a couple of funds now that are zero cost, zero cost funds. And is it?

Paul: Why?

Jason: Well, everybody’s competing, and the dialogue these days is all on fees. But should that be the most important thing for people, you and I again, when we were looking at that scenario, side by side when we said here’s an average return of 6.9. Here’s an average return of 6.9. Here’s a standard deviation of 17. Here’s a standard deviation of six. Here’s people ending up with more money, 17 years later, here’s people with a lot less money 17 years later. I guess my question is, are people putting too much emphasis? Yes, fees are important, but are they putting so much emphasis on it that they’re missing the bigger picture about what the purpose of the money is in the first place?

Paul: Well, that’s another topic in and of itself, the value of whatever your money means to you, etc. I mean, you started this show with a verse from the Bible.

Jason: Yeah (affirmative).

Paul: That’s about your values. And believe me everybody has different values. And I’ve met people that have values about investing that have absolutely nothing, don’t agree with who I am at all but it’s what they believe in. My view is this, expenses are one of those items, I’ve got a book I’m working on right now. And I’ve written about this, and I’ve podcasted about it 12 Million-Dollar Decisions you’re going to make in your life. And you’re going to make them by design, or you going to make them by default, I want you to make them by design. Expenses are just one of the 12, I’m not saying that you should just focus on expenses. I think how much you have in equities.

 That’s the biggie, you want to look over a lifetime, but where the money is, the money in terms of growth is in equities. And so we have all these millennials who are staying in bonds because of what they saw their parents go through in 2008. Well, they’ve decided “Cash is king.” Well, there’s no evidence that cash is king for the long term. And if they would just look at the numbers, and look for example, to see that there’s the lowest S&P 500, 40 year return is about 8.9%. I mean, that’s a huge, that’s a home run, over a lifetime.

Jason: Yeah, I’m just reminded it is, I agree with you over a lifetime but I’m reminded of the impact that the volatility can have on somebody who has taken withdrawals out of that portfolio. And so those average returns are great but if you get an average return that has a lot of volatility, and you’re taking money out, it could really hurt you. I wanted to ask you, we had a chance to talk about this a little bit too beforehand. And in my book, I talk about strategic versus tactical and investment management, strategic asset allocation, I talk about using an index in strategy. We use data from the centers of research on security prices on crisp and keeping the fees as low as possible using low cost index funds, rebalancing those portfolios to maintain that asset allocation.

 That’s what I call strategic asset allocation. Now, I also talked about tactical money management. Tactical money management, in my book, Strategic Asset Allocation, called the science of investing, because of all the academic research, tactical money management, I call the art of investing, because nobody’s won the Nobel Prize in economics for active money management. But you and I talked about the fact that you personally use both a strategic, both a passive and indexing approach as well as an active approach. Here’s another area where you could get a bunch of people in a room and half the room is going to say you should only index and half the room is going to say should only use active management at, we like to tell people it’s okay to use both just as long as we understand what the purpose of the money is what we’re trying to accomplish, and that people understand the pros and the cons.

 But I’d like to hear your thoughts about why you have your money, your own money allocated in such a way, where you use both a passive and an active strategy.

Paul: Well, it goes back to what I believe, and how out of control I know the market can be, and what I can do to protect myself and my family from a market that doesn’t care about me or my family. And so I do believe in terms of buy and hold, a balance of the right amount of equities and the right amount of fixed income, that’s the defense. The low expenses defense again, just like you’re doing. The other half of my money uses what I call market timing, you call it tactical asset allocation. I’ve called it market timing.

Jason: It’s an active approach.

Paul: It is. It is making an attempt to protect people against major declines, it isn’t going to protect against small declines. The reason I don’t get too aggressive about trying to sell people on market timing, even though I use it, and I’m happy I have it. It’s almost like an insurance policy, I can’t call it an insurance policy, because it’s not a guarantee. But in 1987, the reason I ended up getting on Wall Street week with Rukeyser was because in 87, when we had that big crash, I had all of my market timing clients in cash. Now, that’s the good news. The bad news is everybody wanted to give me credit for having called the crash, I didn’t call the crash, I was out of the market when the crash happened, because I was using a mechanical trend following system that says to sell and sometimes when it says to sell, it turns right around after you get out and it goes up.

 People hate that. Sometimes you’ll get out and get back in at a higher price than you got out, they hate that. Sometimes you’ll be sitting in cash when the market is going up, they hate that. I have said many times when it comes to sex, food and money, it’s not an intellectual exercise. This is stuff that is all intuitive. It’s heuristic, what they call here heuristic feeling. And I know from that decades of experience, that people struggle with having the market timing when it’s not doing what they wanted to do. Because people want what they want when they want it and they want it now. And we both know that, that’s one of the challenges is finding people who have the patience to let it all happen over time. Now 19 or 2008, was I happy to have all, at that point I was still working. And I was 100% in equities with the timing. And I lost 18% in 2008. Well, that was okay.

Jason: Because you were still working you had income.

Paul: Well, I had income and it’s okay because it cut the losses in the market by 50%. And what we know is, you know this when you got fixed income in a declining market, and it’s protecting that when the value of the portfolio, then when it turns around and heads up and you have more money than your neighbor, all of a sudden that next bull market from a higher level can take you to a higher place than the person who rode it all the way down to the bottom. I love buy and hold because it does what it’s supposed to do. In a sense, it guarantees something that market timing can’t guarantee. It guarantees if the market falls and then goes back up. That regardless of what the pattern is, you’re going to go back up, whether it’s a flipside back and forth or going straight up, you’re going up.

 With timing, and this is one of the difficult things about timing, is that you don’t know what the pattern is going to be. You can’t say that it’s going to get to a certain point when the stock market is at a certain point, because it’s a different way of managing money. And what people do, if they look too much like their neighbor, they bail out, they don’t like it, if they look too much, don’t look like their neighbor. It’s interesting, when the market goes down, and everybody’s losing they’re way more forgiving as a buy and holder because everybody’s losing with you. But you’re in real trouble if the markets going up and you’re sitting there in cash or losing. This is what I really like about the 50, 50 tactical and strategic is that you give people a way to be right. Another way to be right during the time that other people are maybe feeling a little weak need.

Jason: It’s exactly what we tell people, I say I’d rather be right 50% of the time than wrong 100% of the time. And so by having access to both tools, explaining the pros and cons of both tools, and people are educated, they know, if we’re going to have an active strategy, they’re going to pay a higher fee for it. But they need to be educated about what that is and why they might want to include it and some people don’t. And some people do. And so it’s important that I think they’re getting good information. But it’s really fascinating for me to hear somebody like you who has 30 years of experience as not just running an investment advisory firm. Now you’ve got a foundation teaching finance to people and then to hear what you’re doing as you’re in retirement with your own money, that you still use both an active and-

Paul: I use.

Jason: You do personally.

Paul: But I will tell you that when I’m teaching the public, a do it yourself investors, I don’t spend five minutes teaching them how to be a market timer because it is not made for the amateur. Even professional market timers are known to override their system.

Jason: Yes. I want to switch out of tactical and strategic. I’ve got one more area that I want to cover with you because I bought, I have one of your books at home and I read through it. And in the book you referenced Roger Ibbotson’s work on small cap. And then there’s another area in your book where you say there are certain financial tools to stay away from and one of those financial products you recommend to not ever use is what’s called a fixed indexed annuity. Now, I read an article, white paper that Roger Ibbotson did recently saying that you should consider a fixed indexed annuity as an alternative to a bond position. Saying that if you’re looking for a return sequence, this could be a tool that you would want to use.

 I guess this comes back to the academic research, you’ve got this body of work, and it changes over time. If you were to rewrite your book today, and then the other thing is some of these fixed indexed annuities, now they’re available as a fee based product, you can have an advisor that can recommend these tools. Because I know one of the concerns you always have is how are people being compensated? Are they just trying to sell you something because they’re trying to sell you a product? Are they actually trying to help you structure things in a way that’s best for you? If you were going to be rewriting your book today and maybe you haven’t done a lot of research on the academic research that’s being put out there, but what are your thoughts at a high level as you hear me explain that to you?

Paul: Well, first of all, I have not read Ibbotson’s paper and I know somebody who has read way more than I have is Larry Swedroe. And he has written in his, the book is Alternative Investments. It’s a very fine book. And he talks about the good, the bad and the ugly. And so I would have to read that to see what’s behind that. Now you’re talking about an equity index. Is that correct?

Jason: Yeah, these are, and they come not just as annuities, but you can get them as equity like CDs, you can get them as equity like notes, you can get them as fixed indexed annuities. This is a tool that says you can go up with the market to some level but when the market goes down, you don’t lose anything. And so I would just curious to hear what your thoughts were for somebody that wants to play defense, who wants to have exposure to a tool that works like fixed income that gives them the upside of the equity market, but no downside risk. You know, what are your?

Paul: Well, first of all, I do not believe you’re going to get the upside of the equity market without any downside risk.

Jason: Well, no, they always cap you’re upside, there’s some kind of catch.

Paul: Exactly. Here’s what I’d like to see. Somebody asked me recently, why do I go back to 1970, with all of the studies about the returns and the distributions, with the S&P with large cap value, small cap value, etc. Go back to 1970 and I started doing this before we went through two big bear markets in 2000 to 2002, 2007 through 2009. I wanted to go back far enough that I could see what I would call the worst case situation. If somebody wants to sell me a product that has a dream, or has that something that everybody would love to have, because if you have that, then you can make a million dollars a year. And I would want to know, why are those products not in some of these pension funds? Who are trying to get these kinds of returns without any risk, and aren’t doing this?

 Why aren’t they doing it? Maybe they are, by the way, and I just don’t know it. But I would like to see what kind of return these products would have gotten in all the markets since 1972, same kind of [crosstalk 00:52:03].

Jason: That’s what Roger Ibbotson’s work does. That’s what his white paper does, is he looked backwards and says here’s how these contracts would have worked under these different scenarios. And they come in a lot of different shapes and sizes and flavors. And not that they’re saying there’s one thing I just, when I read that in your book that you are adamantly opposed to it. And then I hear this other body of research saying, “Well, you should look at this as a tool for diversifying your portfolio.” I just wondering if you had read any of the recent work that had been done.

Paul: No, I have not read the Ibbotson work. Certainly, and I would assume knowing Roger Ibbotson that he would have taken out all the, he would have included all the expenses you would have to pay so that it’s fully, fully loaded.

Jason: Exactly, he’s somebody in our industry that I think a lot of people I mean, even though he sold Ibbotson and Associates and now he’s running Zebra Capital Management or whatever it his research firm is, he’s pretty well respected in the investment community for somebody. In fact, I heard him give an interview recently, just a neat guy really spent his life studying the markets kind of like you.

Paul: Well, I don’t care who it is. We do know that professionals can change their spots based on the pressures they have in their life. One of the interesting person who changed his spots was John Bogle. John Bogle didn’t believe in index funds publicly spoke against them.

Jason: Is that right?

Paul: Back before he started his index funds. I don’t know that he hated them but he was in the active management industry. And when he got fired, and I can’t say I know exactly what happened in the story. In fact, he even talked about this when I was in his office with him back in 2017. He got fired, he was looking for a place to land, a way to build a future in an industry. He did not leave Wellington because he wanted to go start another mutual fund family devoted to index funds, not that he hadn’t maybe talked about it, thought about it, was tempted by it and whatnot. But he had to be fired before he was motivated to go do something that turned out to change the world, he literally changed the world. And so I always want to know and Bogle got a quote, it is amazing what a salesperson will not understand if you pay them enough not to understand it.

 And whether it’s Paul Merriman or Roger Ibbotson, or Larry Swedroe, you still have to look and make sure that it is really in your interest. And that’s why it’s good for people like you, you do the groundwork for your clients.

Jason: And this is something that I tell them too, I tell them that at our firm, our job is to help people understand the pros and the cons, understand all the fees, understand the advantages and the disadvantages. But ultimately, I don’t want to make decisions for people, I want them to make educated decisions. But if I’m not willing to look at all of the work that’s being done, am I really serving people the best that I possibly can? And so I have to be in this position where I’m always learning. And as you know, from your years of experience, this industry is not easy. There’s a lot of moving parts, so sometimes I get worried when there’s these do it yourselfers out there. And they’ve read a book on investment management, and they think that they put together one spreadsheet for their retirement and they think, “Oh, I’m going to go, do this thing.”

 And there’s just a lot of responsibility there. That’s why I think it’s so important. I mean, I spend and I’m sure you still spend a lot hours doing this, around 10 to 12 hours a day easily. And I walk life with real people. I know there’s real consequences if we get something wrong. They potentially running out of money in retirement, that’s a huge responsibility. And so it’s, I don’t take it lightly, I know you don’t take it lightly. And so it’s just making sure that we’re doing the due diligence to really help people achieve what they need to achieve the best way possible. And so I’m committed to always look and everything. Now, I’ll tell you there are things that I make sure people stay away from because I’ve done the due diligence, I’ve done the research. And I’ve seen people lose a lot of money and some of these alternatives that can really hurt them.

 And so I would tell everybody to proceed with caution, whatever the financial tool is, make sure you understand, like you’re saying and make sure you understand the pros, the cons, the fees, the liquidity, what are the, how do these things work?

Paul: And I think, I would guess that your clients don’t really understand the seriousness that you have to deal with what you do.

Jason: No.

Paul: Even to this day Jason, I feel better on Saturday and Sunday, because the market is closed. Every day, I felt some level of responsibility, even though I had told them all, “I will never make you any money.”

Jason: You’re going to lose money, I guarantee it.

Paul: Well, I say that, but I also say, “I don’t make you money, the market makes you money.” And anybody who tries to take credit for making you money is really not telling you the whole story but what we’re left with that we can impact is managing the client from hurting themselves.

Jason: Yes, that’s good.

Paul: And when they decide that they want to spend money on something, or they want to retire right now. “Why right now? And I remember a couple of teachers from Oregon, that came up and met with us in Seattle. And they were less than 60 or so and they wanted to retire. I said “Why?” And they said, “Well, three reasons. One, we don’t like the students, two, we don’t like the administration. And three, we’re not all that wild about the other teachers.” We looked at their portfolio and we said, “Five more years.” This was either the last part of 1999, or the early part of 2000. And so they worked for five more years. And they sent me the biggest package of fruits and nuts and candy unfortunately, as a thank you. But there are times you have got to really say things people don’t want to hear it.

Jason: They don’t want to hear it.

Paul: But that’s what they’re paying you for. And they weren’t even paying us they were just asking us what we believe. Which leads me to a question before you cut me off here. I want to make sure I get to with you. I really believe as I said earlier that everybody should go through this analysis. If somebody has gone through your calculator, budgeting and all that. Do you have a way that you actually then meet with people, maybe they’re looking for private management, maybe they’re not?

Jason: That’s exactly what we do. Yeah. I mean, we meet with people all over the country today, Paul, the cool thing is to Zoom meetings, we found that to be a great technology that you probably saw that their stock recently went public, that company went public. But it’s a great technology we can jump on a video screen share. And we do it with people all the time where we consult with them for a fee, we charge anywhere from 500 to $5,000 to put together a comprehensive financial plan for them. And yes, we also help people implement the plan. If some people out there have said, Jason, “We just want the plan we’re going to implement on our own,” and that’s fine. But I would say most of the people that are coming to us from planning, is because they haven’t spent a lifetime doing this, and they’re looking for somebody to actually walk life with them.

 Make sure that the plan is optimized and every year we’re hitting our targets so that we’re reviewing the plan, if something’s not working, hopefully we’re going to know about it years in advance rather than be shocked by it or surprised by it. And so, that’s how we help people, is on a fee based, doing fee based planning for people, fee based investment management. Now at my firm to we are insurance licensed. If people need long term care insurance, medicare insurance, supplemental insurance, if they want to purchase something like an annuity, we can help them there. Or we can just refer them to somebody that does it. We operate as a fiduciary, which means we’re always going to act in their best interest but we also always disclose any conflicts of interest that we have.

Paul: Okay, well, that’s great. And what if it’s a young couple that they really haven’t saved very much, but they both have a dedication to saving? You’ll help them as well, that’s the $500 conversation.

Jason: No, I would actually say that, that’s not where I spent all my time and energy and resources, I everything that we’ve done for the last 10 years is helping people make that transition into retirement. If I’m meeting with, I mean, we do just because family and friends will send people and they want them to get good advice. But I would, I mean, all of the work that I do, and as you know my hours a day are limited. And so we got to focus on where we add the most value. And where we find we add the most value is really giving people a lot of confidence as they’re making that transition into retirement.

Paul: And I have to laugh when I think that I thought I could start an investment advisory firm, and that our minimum size account was $2000. And we charged, that was their investment, not the fee. And we charge them 1%, which meant I could be your advisor for 20 bucks a year. And by the time I left, and my son was running the firm, he convinced me that in order for the advisors to give people the help that they need, and limit the number of accounts they can have, the minimum became 500,000. I mean, it happened over a period of years but I always, every time they raised it, I thought, “No, no, we got to help them.” But you saw you just can’t help everybody.

Jason: No, 10,000 people are retiring every single day. I can’t even put a dent in it. But that’s one of the reasons I built the software because it can help more people.

Paul: And your radio show.

Jason: Yes.

Paul: Because we found the radio show helped a lot of people. And I hope that you’ve got a list of recommended books for them to read. I don’t know that you do. Do you have a list?

Jason: I don’t have anything published but there are a lot of books I would recommend.

Paul: Great. Let’s, get them up on the site.

Jason: Okay, that’s good. But in the meantime, folks, thanks so much, Paul. We’re out of time here.

Paul: Thank you, Jason.

Jason: But I think thanks for being a guest. Thanks for coming into the office. This is so fun for me to face full circle. In fact, it was at the Silver Dale Beach Hotel when I first came to listen to you speak all those years ago. But folks, you’ve been listening to Episode 202. Paul Merriman, you find him on at paulmerriman.com, Sound Investing is his podcast. Again, Paul, thanks for being here.

Paul: Thank you, Jason.


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