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Want to have a very comfortable retirement? Listen in as Paul Merriman discusses the essentials of a great investment.

Paul Merriman is a nationally recognized authority on mutual funds, index investing, asset allocation and both buy-and-hold and active management strategies.

In this episode we discussed:

  • How to choose the best investment advisor. (6:03)
  • How to manage your own retirement portfolio. (15:37)
  • How to calculate your savings for a comfortable retirement. (27:17)
  • The benefits of a three-fund portfolio. (54:30)

You can email Paul Merriman and find out more about his upcoming events.

Paul is also the author of the following books:

Also mentioned this episode was the book The Opposite of Spoiled: Raising Kids Who Are Grounded, Generous, and Smart About Money.

0:00:01 Michael Port: Welcome to Steal the Show with Michael Port. This is Michael. Today’s episode is about investing for retirement. It’s not something that off the bat you might think is normally part of our scope on Steal the Show. But if Steal the Show is about performance in all aspects of life, how you perform in your investments for retirement will influence the quality of your life in the future. And this is not my area of expertise although I study it, every single day in fact because I think it is so important. I’ve brought an expert named Paul Merriman. I’m a big fan of his work, he is a recognized authority on index investing, asset allocation both buy and hold and active management strategies. Although he is not gonna be talking about active management strategies here. He’s now retired from Merriman Inc, the Seattle-based investment advisory firm that he founded in 1983. He is dedicated to educating investors, young and old, through weekly articles at, weekly podcasts, e-books, videos, recommendations for index funds, ETFs, 401K plans and more. All free at his website, Plus, he has a fantastic voice that you’ll enjoy listening to. I hope this episode is going to be a long one. I believe it will. I have a lot of questions for Paul and there’s a lot of ground to cover.

0:01:46 Michael Port: Know this, I will try my best to keep the topic as underwhelming as possible. I try to avoid the use of the word ‘over’ you know what the I-N-G part of that is. Because I think it’s too easy to choose to be over. It’s often a choice and I made the choice earlier on in my life not to pay attention to saving for retirement. I made the choice not to study this. I made the choice to stick my head in the ground and assume that it wasn’t something that I would be any good at or could learn because I’m not a math guy and I’m more of a creative person even though I run businesses, I don’t really think of myself as a financially oriented person but I’ll tell you what, I’ve become one. And sometimes that happens over time because you see the importance of becoming financially minded as you get older and that’s what happened to me. And so now I study it, I study it all the time. I have nothing to sell around it, I never will. It is not gonna be an area of professionalism for me. But it is a hobby and an interest because, well, I wanna have great retirement as early as I possibly can. So my point is, I am gonna do my best to keep it easy to consume and enjoyable to listen to even if you have not historically been interested in learning how to invest for retirement. Before I bring on Paul, here’s a word from our sponsors.

0:03:48 Michael Port: Paul, welcome.

0:03:51 Paul Merriman: Well, it’s great to be here Michael. It is, it’s a joy to be here to share some information with your listeners.

0:03:58 Michael Port: Well, you know I’m a big fan. I read Financial Fitness Forever and it opened me up to some ideas that I had not previously considered and I am a big… So I’m a big fan. I’m just thrilled you’re here and as I mentioned in the intro to my audience this is not a topic that we’ve ever covered on the show before. So you’re here to open Pandora’s box.

0:04:20 Paul Merriman: [laughter] Okay. I had no idea this was going to be the first exposure to this, that’s a wonderful opportunity. That’s a compliment, thank you Michael.

0:04:30 Michael Port: Well, you’re welcome. Of course, I imagine many of my listeners have exposure and experience to different types of investing. Some will be very experienced then others will be less experienced. So we will try to keep somewhere in the middle, I think. So we can speak to both groups but especially for these small business owners because small business owners spend so much time focusing on building businesses and making money, and not as much time on what to do with the money once they’ve made it. We see this consistently.

0:05:07 Paul Merriman: And I agree with that and having been, by the way, a small business person almost all of my life, I understand what it’s like to work 60 and 70 hours a week. There’s not a lot of energy left over for that next step.

0:05:21 Michael Port: There is and by the way of course since we focus on performance we’ve done episodes on voice and speech and gosh, you just have a fantastic voice.

0:05:31 Paul Merriman: Thank you.

0:05:32 Michael Port: You have the comforting uncle voice or grandfather voice.

0:05:40 Paul Merriman: I would wanna actually suggest that that can be trap for a lot of people because there are folks who promote ways to invest that are absolutely not in your best interest but do they have a comforting voice? And so I think at the end of the day it’s about the information and not the voice, but thank you.

0:06:03 Michael Port: That’s a great point. One of the questions that I have here is how can you tell if somebody actually has your best interests in mind?

0:06:14 Paul Merriman: Well, you’d think that would be easy, but there’s so much to potentially know about investing and most people feel that they don’t know enough that you can pull the wool over people’s eyes with just a little bit of information. And so it seems to me the best defense we have to make sure that the people that we’re taking advice from have our best interest at heart is to have a basic understanding of how the process works in your best interest. If you don’t know the difference between passive and active management, if you don’t know the difference between load and no-load funds, if you don’t know the difference between awful, God awful index annuity and how you should be investing, you’re at risk of being trapped in a sense, taken in by a sales pitch that sounds so good, but isn’t. And so, education is absolutely the number one priority even if you’re hiring somebody else to do it.

0:07:25 Michael Port: I spent many many years thinking, “Well, he’s a nice man in a suit. I’m sure he knows what he’s doing. I’ll take his advice.” And I stuck my head in the sand and I bought one bad product after another. Made one bad investment after another until someone opened my eyes and said, “You know, there’s another way of behaving around your financial future even though you don’t think you are a finance person.” And when my eyes were opened, the world changed so I thank you so much for what you’re doing now in your retirement, going out in the world and educating. So why don’t we start with, what’s the difference between passive and active management? What’s a load and what’s a no-load fund?

0:08:10 Paul Merriman: Okay, well first of all, let me take the mutual fund itself because that’s where we have to know about active and passive. Mutual fund, of course, is nothing but a legal entity that allows a manager, oftentimes on behalf of hundreds of thousands of investors, to manage a portfolio as they believe it should be managed on behalf of everyone. And it doesn’t matter whether you have a $1,000 in that mutual fund or you have $1 million, it is all proportional. So what they’re doing for you is exactly the same as they’re doing for the person who has $1 million. But there are things about mutual funds that can rob you. I mean literally rob you of a lifetime of earnings. And a piece I did several years ago about the impact of an additional half of 1%, what it can do in your lifetime. It’s amazing how much more money you’ll have to spend or leave to others. So where could one place that you could earn an extra half of 1% be? And that is the choice between the load and the no-load fund because a load fund has a commission built into it so that when you invest a $1,000, $950 approximately goes to work for you. The other $50, the load, goes to a sales person and the company they work for.

0:09:42 Paul Merriman: Now that $50, if left in the pool to grow for you for the rest of your life, would suggest that you would likely make an extra of half of 1% a year forever because you’ve paid that 5% upfront. Now if that’s the case, would it be worth taking a few minutes to figure out a similar fund, a commission fund, that does not have a commission? That is the no-load mutual fund. And when I first came into the industry back in the 60s, Michael, there were very few no-load funds, basically, people knew about load funds. Everybody accepted the fact that you should leave all this money on the table for somebody else. But today, not only do we have commission free mutual funds and ETFs, but we have funds that are passively managed versus actively managed.

0:10:45 Paul Merriman: Now here’s the difference. And it makes sense that you would want somebody to manage your portfolio in an active way: Buying and selling, trying to make more money on the upside, trying to protect against the down side. It’s an easy sell to somebody whose just getting started with investing. But all of the academic research concludes that if you get into a mutual fund, typically called an index fund, you will reduce, can’t completely eliminate some of this buying and selling, but you will reduce it down to a minimal amount that again will add about a half a percent or more to your returns. In other words, an index fund looks like the S&P 500, owns all S&P 500 stocks, doesn’t make the decision when to get out of Enron and into some other company that’s more popular as of the moment. No, they just expose their investors to that asset class. And by the way, that asset class over the last almost 90 years, has compounded at 10% a year and that includes the depression, that includes World Wars and a lot of other things that could hurt, certainly did hurt at the time but through all of that that index, that 500, that has compounded at about 10%.

0:12:20 Paul Merriman: But if you hire an active manager all of a sudden there’s a cost of buying this and selling this and there’s a cost of having just a few stocks in the portfolio versus in a passively managed index fund having 500 sometimes 5,000 so you have greater diversification, lower expenses to run it and a reduction in the cost of buying and selling. So the passively managed fund in terms of what’s right for you is better than the actively managed fund. But one last point, Michael, the money is made on Wall Street selling people the actively managed funds, so we understand why they wanna sell them, but the question is should you buy them?

0:13:09 Michael Port: And on top of that what’s extraordinary is that over 80% of these actively managed funds under perform the market.

0:13:24 Paul Merriman: Yes.

0:13:24 Michael Port: So not only are you paying more but you’re generally paying more for poorer performance.

0:13:32 Paul Merriman: Yes, and that’s one of the reasons they have poorer performance because typically an actively managed fund will charge anywhere from 10 to 20 times as much to be taken care of for you. It sounds so enticing to think that somebody’s really acting in a way that looks like they care about you but the reality is, and don’t forget everybody in the industry knows this, this isn’t like something the active managers don’t know.

0:14:02 Michael Port: This is no secret.

0:14:03 Paul Merriman: That’s right but you’re talking about the 80% that’s typically over 10 years. You start going out 20, 30, 40 years and maybe 3% of the actively managed funds will in fact outperform the index. But remember this, it isn’t just about what you make, it’s about what you keep. And if you’ve got money in a taxable account, that active management is causing taxable events that you might not have in that index fund. So, it’s also taking some money away not only in terms of all those fees on the inside but on the outside, Uncle Sam wants a piece of the action, that also reduces your long-term return.

0:14:52 Michael Port: It’s one of those things that sometimes when you hear it, you just throw up your hands and say, “Well, what’s a guy gotta do to get a fair shake?” So, do you think…

0:15:01 Paul Merriman: Well, if you think about that, Michael, just what are you gonna do? That’s a great question because once you have an active manager, how do you know when to get rid of them? How do you know if they’re going through a divorce, or they’re ill, or they just hired somebody and let them take over the portfolio? You don’t even know it in most cases. How you manage that and think you’re gonna get a fair shake with the index funds, you don’t ever have to worry about managing the managers again.

0:15:37 Michael Port: So, do you think that the average investor, meaning the person who is just investing for their future for retirement, can manage their portfolio themselves?

0:15:49 Paul Merriman: I do, I absolutely believe they can. Now, I wanna differentiate the managing of these funds with identifying how much you should have in the different, let’s call them asset classes, big companies, small companies, value, growth, and all those. There’s a difference between being able to invest in those, that part is easy. The one point at which I think literally all of us need some help, and I’m only talking about spending a couple of hundred dollars, is that once you think you know what index funds that you should own, do you know how much you should have in the portfolio to defend against the bad times? Because a lot of people think that when they get into an index fund that’s gonna protect them against all of the risks of investing, the taxes, the fees, and all of that.

0:16:50 Paul Merriman: But there’s another risk we wanna be sensitive about and that is what they call market risk. For example, in 2008 when the market went down 40% to 50%, depending on where you might have been in the stock market, it didn’t matter that you had indexes, it didn’t matter that you had 5,000 or 10,000 stocks. The market went down. So, where I think people do need some help is to make sure that they have that right balance of stock funds, equity funds, and bond funds, or fixed income funds. But in terms of simply being able to put money into index funds, the people that provide them, a Vanguard, Fidelity and others, they’ve got people sitting by the phone day and night waiting to help you do that. And then there are people like me and there are others that do this that actually, at no cost to the investor, make recommendations of how you should diversify amongst different index funds because there are big differences between one index fund and another. It’s easy to do and to do it no load. But sometimes you need a little education to start with.

0:18:07 Michael Port: Well, in Financial Fitness Forever and on your website, you have documented various asset allocation recommendations for people who have 401Ks at a number of different companies, for somebody who’s using Vanguard funds, for using Fidelity funds, etcetera. It’s a really wonderful resource but before people jump over there, I wanna make sure that they have a really good understanding of the way that you see the world in terms of these things before they start looking at, well I’m just gonna copy the portfolio because if we are copying something that we don’t understand, we may not stay consistent and hold the course. And holding the course is such an important part of long-term investing and the portfolio that you are known for in the industry is the Ultimate Buy and Hold portfolio and of course, that’s what we’re trying to do.

0:19:02 Michael Port: So investor behavior can be a problem. It can get in our way. In fact, I pulled up some stats, did a little research and according to DALBAR’s quantitative analysis of investor behavior, summary of investment returns as of 12/31/2015, the average investor returns for equity funds over a 30-year period was 3.66% when the S&P 500 returned 10.35% over the same period of time. What’s the problem?

0:19:38 Paul Merriman: That’s a disaster. I said a few minutes ago that a half a percent difference is important, now we’re talking about twice of the three point whatever it is versus the 10%, that’s more than twice the return for not doing anything but putting it into the S&P 500. Now why? Why? What happens to investors that they get such a poor return? And Michael, remember, the word average means some people did worse!

0:20:10 Michael Port: Right.

0:20:10 Paul Merriman: And you’re setting aside money for the long run, for your retirement but you’re doing the wrong things and you’re hurting yourself. You may not even realize it because the fact is, most people don’t know what return they’ve had. They feel like, “Oh, you know, I made some money,” but yeah, but how much and at what risk? Well, here are the things that impacted people. And I’ve been following that DALBAR study for over 10 years. Expenses, bad decisions, bailing out when the markets are low, or stop investing when the markets are low. They both do damage and the people who get the biggest returns over a lifetime are the people who invest when the market is low, not sell out.

0:20:57 Paul Merriman: Also, inside of those figures, because that includes load funds and no load funds, those people who paid a load, that too was a reduction to their long-term return and they thought they were paying that load to get the best advice from some sales person on what they should be doing for the long-term, and it turned out that their advice either did not reflect all the academic research that’s available and obviously, didn’t reflect the risk tolerance of the individual investor. Because it’s not just about how much you make, it is about how much you keep and how much you keep during the worst of times because if you are prone to bail out and look for safety when the going gets tough, you not only just stop participating in the upward trend, long-term trend of the market, you just took your money out when it was down and dirty. The worst time to be taking money out of the market.

0:22:02 Michael Port: What’s so interesting to me is that, it’s almost counter-intuitive, that you can do better by doing less. Just today, you mentioned that you can get on the phone with a Vanguard specialist adviser who has no financial interest in their recommendations to you, they’re not commissioned, they don’t get percentages, nothing. Today I was on the phone with my mother and a Vanguard representative because I wanted my mother to move some money that my grandmother had left and an advisory group had it all in individual stocks. And of course they were taking a fee for their genius. She agreed to do that, and my mother’s very sensible and she’s been really using sort of a broad market, low-fee portfolio for years but when we were moving this money over, I was suggesting that it goes into her current portfolio in its current asset allocation, and she said, “But well, but international is not doing well,” and I said, “Yeah, that’s great! That’s a really great thing.” And she said, “Yeah, but I don’t know. And then the Brexit thing just happened and the Euro zone is gonna have trouble.” I said, “But this is what happens. We get myopically focused on the moment and we run away from valuable investment opportunities because we are influenced by the moment.”

0:23:50 Paul Merriman: You put yourself in a tough position, Michael. And it’s the position that virtually every investment advisor, and I retired from that industry back in 2012. But this is what we have to deal with everyday in counseling people. And it’s not as easy as simply saying, “You have to have international in there because if you don’t, you’re gonna leave money on the table,” because somewhere between that belief and I do believe that that is the case, you’ll do better in the long run having international than without it, but we don’t know. What I do know is, as an advisor, I used to do my best to read the feelings, how deeply held are those feelings because I might overcome their feelings because they think they’re talking to an expert and it’s the right thing to do. And then a month later when bad things happen overseas and the market overseas is falling and the US is doing okay, sometimes that emotion can overcome my intellect without any problem. So we always wanna be sensitive to what do we believe the investor will stick to over the long term. And there are times when I recommend to investors, “Don’t put any internationals in your portfolio because what you’ve just told me is that the highest probability of you jumping ship is going to be when those internationals are struggling.”

0:25:30 Paul Merriman: So, we can build a portfolio to make people good money using only US. That is absolutely legitimate. So if somebody, if you sense as an advisor to somebody that they are likely gonna feel differently about this when there’s a problem and a big problem, then maybe they’re better to have the confidence in the US broadly diversified, not all in the S&P 500, but in the US because that is some basic emotion they have about what they trust. And that is not unusual. One of my favorite books is Your Money and Your Brain by Jason Zweig. Did you ever read it by chance, Michael?

0:26:19 Michael Port: I have it. I’m familiar with it but I’ve never read it.

0:26:21 Paul Merriman: Okay, I promise you’ll just love it. It’s so much fun but it’s all about the behavior of investors with lots of studies to support whatever this academic research has concluded. But in Greece and in New Zealand, this is prior to all the problems in Greece, they found that over 90% of investor’s money was in their own country, the Greeks in Greece and the New Zealanders in New Zealand. Why did they need diversification? They’re a great country. They have great companies. So this home bias is a very common problem for investors. And if we can’t overcome it and we’re gonna set you up for bailing out at the wrong time, it is the wrong thing to do.

0:27:17 Michael Port: That’s a great point. That’s a really really good point. Fortunately my mother, her fundamental belief is sound and she’s comfortable, but she just gets nervous. And her portfolio is well balanced enough to protect her given her age and her needs in the future. So I feel comfortable there. It’s just as an example that happen so often. We really look at the minute by minute as opposed to taking the long view. Okay, so how should someone calculate what they need to save in order to have a comfortable retirement?

0:28:07 Paul Merriman: Here’s another example of where to buy an hour or two of a professional adviser’s, not a professional salesperson, but a professional adviser’s views. Because I can give you a formula, the formula has been around as long as I’ve been in the business and you multiply your cost of living by 25 and that’s how much money you need to have before you retire which suggest then that you’re taking out 4% a year. Now I think some of the most important work that I do is over this whole question about how you take money out of investments in retirement. Now I’m almost 73 and I retired in 2012. And when I put my own plan together, I planned to save enough to meet the distributions I wanted, not the distributions I needed. And oftentimes people don’t even understand the difference between what you need and what you want. But I wanted enough in my portfolio that I could take out twice what I needed and take out 5% instead of 4%. So that would be my own personal view of what I wanted and needed in order to retire.

0:29:41 Paul Merriman: Now somebody is going to retire and just have enough and not want to have extra money that you could for sure protect yourself against the big bear market or for sure protect yourself from some unknown expense that you just hadn’t thought about. Then you can use the 4% formula, that you have a big enough portfolio that you can take 4% out. And of course, then as you know investors have to figure out what kind of portfolios might that be which is another part of this process of planning, is to figure out not only how much you need, but how you should be invested when you’re in retirement.

0:30:24 Michael Port: So, you mentioned advice from an adviser rather than a sales person. So, many people have heard the term fiduciary, especially recently given that the Department of Labor has required that advisers, folks who give advice for money that’s invested in retirement accounts, must act as fiduciaries. Now, the rule is not in place. I don’t want people to start thinking that they’re always getting advice in their best interest. And that’s gonna be something that’s hard to police. That’s a whole another conversation. But, nonetheless, I saw a friend’s portfolio and it was a mess. It was a complete mess and very expensive. And it was set up by a fee for service fiduciary. So, how do you know? First of all, what’s the difference between a fiduciary and a non-fiduciary? Second, how do you know that a fiduciary really does have your best interest in mind? And how do you know that they really know what they’re doing?

0:31:34 Paul Merriman: Well, at almost 73 I may forget one of these along the way here, but I’ll give it a shot.


0:31:38 Michael Port: I’ll come back to them. Sorry. I gave you… I front loaded it with too many just like a loaded fund. Yeah.

0:31:45 Paul Merriman: So, the key to understanding the fiduciary responsibility is that they are by law obligated to act in your best interest. And so, that would give somebody a sense of comfort if they knew their adviser was absolutely committed to them no question. On the other hand, whether you’re talking about a fiduciary where they have that obligation or a non-fiduciary where they’re really responsible not to act in your best interest, but their recommendations by the industry standards are suitable, suitable. Now, let’s talk about what would be suitable for a 70-year-old person. Putting all the money inside of a technology fund? No. That would not be suitable. If they forced you, said, “I want all of my money in the technology fund,” then you are going to probably say, “Well, you’re gonna have to have somebody else help you because that’s just not appropriate.” Or you need to paper your file with letters saying, “I told them not to do it, but better that I do it for them that they go out and do it on their own.” That would be unsuitable.

0:33:08 Paul Merriman: But would it be suitable in that environment to sell them a mutual fund with a very high load, to sell them a mutual fund with very high internal expenses, to sell them a mutual fund that has a lot of turnover buying and selling, so they gotta pay more in taxes? Frighteningly, it is legal. It is okay to do all those things because in a sense, the IRS, the SEC I should say, the SEC has said that these are legal products. They don’t endorse them, but they allow them to be sold. And once they are allowed to be sold, they become suitable as long as you don’t put them in some crazy investment that could lose them 80% of their money. It’s okay to lose them 5% or 10%. That’s okay. But 80%, they don’t want you to do. Now, there’s a problem though. And you’ve struck right on it, Michael. This question of how can you know that your fiduciary is in fact investing in your best interest? Well, I look at the fiduciary responsibility to be a matter of competence and ethics. Not just ethics, competence. Is it possible to get a fiduciary that is incompetent but they care about you and they’re ethical? Absolutely.

0:34:40 Paul Merriman: But it doesn’t stop there because the next level we have to be concerned about would be the firm the adviser works for. Are they competent and ethical? Well, it’s pretty obvious to see the ones that aren’t ethical because they’re paying millions and millions and millions, hundreds of millions in fines for doing things to people that any idiot would understand they knew what they were doing. They may refuse to take any responsibility as they pay the fine, but you know what they did. But then, there’s another level of importance here. It’s not just the adviser and the firm, but it’s also the products that they sell. They should be ethical and competent. Now, if you don’t have the ability to analyze those three levels of what you want from any employee you have on your payroll, ’cause that’s what they are, they are your employee this fiduciary, then you got a problem. And how you gonna solve that? Well, I said early in this interview, education is a big step. But I’m thinking if you really don’t know then you need to probably interview three people who claim to be fiduciaries.

0:36:01 Paul Merriman: But I wanna raise a red flag. You can be bamboozled so easily by a fiduciary because there are fiduciaries in the business today, many of them life insurance salespeople, who have the ability to be like a broker getting a commission, or they can be a fiduciary and not get a commission. They may sell terrible, terrible products but they won’t get a commission, as we know the standard commission of getting 5% off the top, that type of thing. Now, why is this important? I’m gonna tell you a story, and I get mad even thinking about it, but it’s a true story.

0:36:47 Paul Merriman: A lady here in the Pacific Northwest makes herself available to go to very large public companies and make speeches to the people, workshops for the people who are retiring, or they’ve been laid off but they’re leaving the company and the company wants them to get an education so they don’t do something stupid with their money. So people go to this session, and she gives wonderful advice. It’s wonderful advice in terms of how you should view… It doesn’t give you everything, it doesn’t get into “Don’t ever pay a commission,” it doesn’t get into “Make sure all the expenses are rock bottom,” but it gets into enough planning information that people walk away with something, and they want the free consultation.

0:37:36 Paul Merriman: Now, the door is closed. You’re in this lady’s office. And she is giving the advice, and I know a man and his wife, they went there for that advice and they asked, “Are you a fiduciary?” and she said, “Yes.” What she didn’t say is, “I can be a fiduciary if I choose to, but I can also work as a commission-based salesperson.” But they didn’t put that part. She didn’t add that to the discussion so they move along, move along, and she talks them into a product not sold or recommended by a fiduciary but by a commission salesperson. They think this is what a fiduciary would recommend. And by the way, Michael, these are smart people who’ve done well in what they do in their life, but this is not an area that they know a lot about.

0:38:32 Paul Merriman: So they come to me after reading an article in The New York Times. I said, “Look, what they did to you is going to cost you half of your retirement. I can almost guarantee it just from the high expenses and it’s a variable annuity.” It was just absolutely the most horrendous thing to put an investor in. “I’m gonna help get you out of it.” Now, they’re friends so I did that. And we worked hard. I did not ever go in and meet with those people. I educated them exactly what to say, and they said: “Boy, when we get the money back, we’re gonna tell everybody about what terrible folks these people are.” They did get their money back but, “Oh, before we give you the check, would you please sign this guarantee that you’ll never share this information with anybody?”

0:39:26 Michael Port: Really?

0:39:27 Paul Merriman: So nobody in the Seattle area knows to protect themselves from this person.

0:39:33 Michael Port: How is that legal?

0:39:36 Paul Merriman: Well, it’s not unusual to have a settlement where you… That you promise you’ll never disclose this.

0:39:42 Michael Port: Oh, it was a settlement, I see. I thought they’re just taking out their assets. Oh, wow. So they…

0:39:46 Paul Merriman: Oh, no. They got all their money back.

0:39:47 Michael Port: Oh, I got you.

0:39:47 Paul Merriman: They got all their money back.

0:39:48 Michael Port: Yeah. So I see how they could negotiate for that. Wow.

0:39:53 Paul Merriman: Right, right.

0:39:54 Michael Port: Wow.

0:39:55 Paul Merriman: So what I recommend is, go to at least three fiduciaries. Maybe you’ll find at least one of them is really there in your best interest. But if you went to my website,, if you just read the articles I recommend, I think you’d be able to spot a fiduciary from somebody who’s about to reduce the amount of money you have for yourself and your heirs in retirement.

0:40:23 Michael Port: Indeed. Paul, I wanna take a quick break, so we get a word from one of our sponsors. And then when we come back I have… I’m gonna keep you here for the next five days, Paul. I’ve got a whole bunch of questions and the first one we’re gonna get into when we get back is, is it realistic to expect a 12% long-term return? So we’ll be back in a second.


0:40:47 Michael Port: And we’re back to the show. Hey, Paul.

0:40:50 Paul Merriman: Hey. Great to be with you, Michael. Thanks again.

0:40:53 Michael Port: Oh, my gosh. This is fantastic. I’m not kidding. I’m gonna keep you here for a few days. I hope you have food and water nearby.


0:41:00 Paul Merriman: Well, I am on a diet and this would be helpful.


0:41:02 Michael Port: Okay. Is it realistic to expect that kind of significant return, that 12% long-term return? Could people get that?

0:41:12 Paul Merriman: Absolutely. There’s no question they might, I don’t know whether they will. I always have pictured, when I’ve talked to people about the future, a pie graph. And inside of this pie graph is virtually everything to be known about investing. But we all have to kind of build our own pie graph with who we think we are in terms of knowledge, and experience, and so I think about one piece represents what I know I know. And what I know I know is the past. I know a ton about the past. I know, for example, that in the small-cap value asset class, imagine an index that’s filled with nothing but smaller companies. They’re not penny stocks but smaller companies, average size company around $2 billion, so it’s a legitimate company but they’re not the Microsofts of the world. But I know how they’ve done going back to 1928 because the academics have dug out the information on every small-cap value company. And that return, if we look at the average 40-year period is over 16.

0:42:34 Paul Merriman: Okay, I would love to take 12 but I don’t know ’cause I know what I know about the past but then there’s what I know I don’t know. That’s another piece of this pie and what that tells me is, if I wanna know about the future and make recommendations to you based on the future, I have to guarantee you I don’t know because I can’t know and nobody who pretends to know knows, and they all know they don’t know but they pretend because that’s the way they attract customers. But then there’s a piece that represents what you don’t know, you don’t know and because you don’t know, you don’t know it, you can’t know how big that piece of pie is ever but inside that piece of pie could be the very thing that would keep you from making 12% in something that’s made 16 because something happened you didn’t even know could happen.

0:43:32 Paul Merriman: And there are lots of examples of that in our industry but then there’s another piece that represents what you know you know but you’re wrong, and that’s very common that people have an absolute belief that this is the way it is, but they’re wrong. And all the evidence would point and you mentioned it earlier, it’s the counter-intuitive thing, that is the right way to do it, not what we believe is the right way to do it. And finally, and this is very important, there’s what we know we know but we don’t do anything about it. We know that high expenses hurt us in the long run, we know that active manage hurts us in the long run, we know that individual stocks are not likely to make us additional money in the long run, but we ignore all that and what I’m focusing on as best I can for people is what I know I know and trying to get you to do the things that you actually agree with knowing but take care of yourself. And I’m a fine one, I mentioned being on a diet. I’ve literally been on a diet since the 5th grade.


0:44:42 Paul Merriman: I know what I know about diets and it seems it’s the unknown that takes over and creates this body that’s still 40 pounds overweight after losing over 4,000 pounds in my life.

0:44:56 Michael Port: Wow.

0:44:56 Paul Merriman: So this is not always easy being able to put into action what we see that we should do, but the 12%, you can get it with small-cap value, large-cap value, small-cap blend, you can go international and get it at emerging markets. When I say get it, I don’t mean get it but you would have gotten it. There is no risk in the past. We always know what we should have done. And that’s an important concept.

0:45:29 Michael Port: Yeah. Let’s dig a little deeper into that. You have an article that you titled “10 Things Every Investor Should Know About Asset Classes.” What are they? A lot of people are not even sure what an asset class really is.

0:45:45 Paul Merriman: Well, an asset class is simply a kind of a stock… By the way, it could be a bond as well. But the kind of a stock that many of them could have a similar kind of a company, they look alike in some way. For example, how about if we just looked at companies that were from $50 to $60 billion in value? How about if we looked at companies that were $2 billion to $3 billion in value? If you looked at all of them, you would find that they tend to move together. In 1977, the S&P 500 was down 7%. But small-cap value as a group all of them that were called small-cap value, as a group, were up over 20%. And so what the academics are then able to do as they look at these different asset classes, big, small value… By the way, value, those are companies that are out of favor. Growth, companies that are in favor. They tend to move as a group. And here’s the thing that’s so important, the academics believe and show, there’s evidence for this not just a belief, that nobody has the ability to say which of the small-cap value companies or which of the large-cap value companies are going to be the better ones 10 years from now and which are going to be the poorer performers. Because if somebody could do that, you could make unbelievable returns, you could make Warren Buffet look like a piker.


0:47:41 Paul Merriman: So the bottom line is, what the academics say is, there’s so much money to be made historically in simply owning these asset classes, that there’s no reason to try to pick the best ones because you put yourself at greater risk and will likely make less rather than more. Now, if there are good asset classes, are there bad asset classes? And the answer is, historically, going back, in some cases, literally hundreds of years, I guess. But yes, you have the gold, for example, is an asset class that does not give a good risk-adjusted return. Now, might it be a good thing when our currencies are valueless and you have a pound of gold in order to buy a loaf of bread? Yes, that could be viewed as a good thing. But not as an investment because the fact is, all the academic research is here for this, that over the long-run, the return on gold is less than the return on long-term US government bonds at about half the risk in the bond… Two-thirds less risk in the bonds versus the high volatility of gold. So, there are asset classes that are good historically, again looking backwards, and there are asset classes that are not good, looking backwards.

0:49:16 Paul Merriman: But it’s not enough just to know what a good asset class is, and there’s a part on my website, one of the links on that bar is good performance. You need to know about two things regarding each one of these asset classes. What return have they achieved over the long run? That’s always good for thinking positively. But let’s think negatively for a second because it’s just as important. At what risk, what will I have to live through in order to get this possible long-term return? And if that risk is too great, then maybe you better think twice whether you’re gonna have very much in that asset class. And here’s the ringer and the reason that I believe so in what the academics do versus Wall Street. I’m not a Wall Street fan at all, but the academics are the ones who taught us how to combine these asset classes in ways that it smooths the long-term return. Take some of the volatility out, some of the volatility that could hurt people. Let me give you one example: The S&P 500, from 1975 to 1999, it compounds at 17.2%. Somebody who started investing for their retirement in 1975 was… They could retire in 1999, more than likely, if they just let it ride.

0:50:58 Paul Merriman: And when people were asked, how do you think the S&P 500 will do for the next decade? The average response was 20% to 30% in different surveys a year. A year. But they had just gone through this 25-year period of 17% and a five-year period of 28 and a half. Comes reality. For the next 10 years, the S&P 500 actually lost money at a rate of about 1% a year. But if you had included the large and small, the value and growth, US and international, and REITs, and emerging markets, little bits of pieces, you’re not loading up on anything very much, that compound rate of return was over 7% a year. That’s not a home run. But think about the people who might be using that money to live on and take out 4% a year. I call that a home run.

0:52:03 Michael Port: Hey, if I can hit a single even 50% of the time, then I might bet I’m a happy guy.

0:52:12 Paul Merriman: And you know what? Here is a point about these asset classes. In fact, there’s a piece called… A table in there called the Four Fund Solution Table It’s under that performance headline, I think. But it shows the average, the compounded one-year return. Then I looked at 15 years. Because you really shouldn’t be focused on one year but the bad times happen in that one year. You’ve gotta be ready for the worst of times. And I show you the worst of time. But then I go out to 15 years, and then I go out to 40 years. Because we’re not investing for the next year, those of us who are putting money aside for the long-term, which even at almost 73, I’m putting money aside for the long-term. We have to, particularly young people, you’ve got to look out a very long period of time, and guess what? The losing periods virtually disappear. There are no 40-year periods of losing money. There were 40-year periods you may have only made 8%, but there were other 40-year periods you made 16% and 18%.

0:53:23 Michael Port: So, let’s dive into that a little bit. You mentioned the Four Fund Solution. You, as I said before, are known for your Ultimate Buy and Hold portfolio. And the Ultimate Buy and Hold portfolio is what’s considered sliced and diced. It has a number of asset classes. Each asset class holding a small portion of that portfolio, and then there… You’re well-respected, I think, in the Boglehead community. And for those of you who aren’t familiar with that bizarre term, it’s a forum online that is filled with tens and thousands of people who are all interested in their own personal finance and retirement investing and they generally subscribe to Jack Bogle’s theory of low-cost, diversified, long-term, index fund investing.

0:54:30 Michael Port: And there are two caps in there, there are what are called the lumpers and then the slice and dicers. And the lumpers are the people who use generally three funds, maybe four funds but they use a total US stock market fund, a total international stock market fund, and a total US bond market fund. And so they hold the whole market internationally, domestically, and generally they’ll hold less international than US but nonetheless each person chooses their own asset, their own allocations. And then the slice and dicers say, “You know what, I’m gonna own certain asset classes because I think those asset classes are gonna perform better and I think I’m gonna be a little bit more particular about what I don’t want to own.” But generally that means holding more funds. And then balancing requires a little bit more math and maybe a little bit more attention. So, can you speak to this a little bit? Is a three-fund portfolio better for some people or can all average investors do a little bit better by being a little more sliced and diced? What do you think? Can you walk us through these different portfolios, these different solutions?

0:56:07 Paul Merriman: Sure and in fact, allow me to even start at a more basic level, I think. In fact in September I’ll be doing a presentation here on Bainbridge Island to people who work within the non-profit industry because as you know they don’t make a lot of money. But they will still like to retire like everybody else someday and what is the smart thing for them to do in terms of investing? I’ll try my best to help them with saving, that’s a difficult thing. But helping them with investing is in many ways dirt simple if they will agree with me about certain ideas. But for most of those people who are not going to become experts, and I’ll bet you have a lot of listeners that don’t wanna think that they have to be as a do-it-your-selfer are gonna have to do a lot. Well, how about doing nothing? How about simply putting your money into a target date fund that is set up to be adjusted as you get closer and closer to your retirement, you simply put your money into the target date fund that says you’re gonna retire in 2060 and it manages your money kind of the old-fashioned Vanguard way where they’ll have some big US and some big international and then maybe even a little bit in bonds. But it will be very traditional John Bogle kind of portfolio.

0:57:44 Michael Port: Essentially, they have the… It’s a fund made up of different index funds according to the appropriate asset allocation for your agent when you would retire, very straight forward.

0:58:02 Paul Merriman: Yes, and it’s a great fund but from my viewpoint it has the same problem that I had with John Bogle for years. Because he used to come on our radio show out here in Seattle once or twice a year and we would always rib him a little bit because he just wanted to have money in the large-cap funds. He don’t want any small-cap or small-cap value. He didn’t want any large-cap value. He just wanted these very basic holdings that… And he’s right. It’s a very kind of dependable but you leave a lot of money on the table. But maybe that’s okay if it allows you to stay the course, but here’s what I want people to do that like target date funds, I would like you to extend yourself just a little bit. I’d like you to own two funds and I would like you to have the target date fund but I would like you to add maybe 10, maybe 25, maybe even for a very young person, 40% of the portfolio into small-cap value. Why small-cap value? Because those target date funds have almost no small-cap in them and very little value.

0:59:22 Paul Merriman: What do we know about small-cap and value? They make more money over the last 90 years than large-cap and growth. So could you do what it takes to have whoever you’re buying your target date fund from 10% or 25% or 40% in that small-cap value fund and the rest in that target date fund? I think that is a life changer. Now, you’re talking taking it one level higher than that and that is to do it yourself, to put so much money in the large-cap US, the total market indexes is what they call them at Vanguard. So there’s a total market for the US and a total market for international. Nothing wrong with that except you’re likely to leave, notice the word “likely,” likely to leave less to your children and charities ad have less to spend in retirement than if you balance the portfolio to add some small-cap and to add some value.

1:00:29 Paul Merriman: Now here’s what I know historically. In my Ultimate Buy and Hold Strategy article, which is an all equity portfolio then you could add as much fixed income to it as is appropriate. But in that all equity portfolio from 1970 through 2015, by having your portfolio spread amongst 10 different asset classes, instead of basically one or two, it adds about 1% a year. Now I mentioned, and this is the all equity part of your portfolio, I mentioned earlier, Michael, about the half of 1%, what that could do for your life? For a 25-year-old, putting away $5,000 a year for 40 years, and then taking money out of that portfolio for 25 years, so you’ve invested 200,000. And what do you have between distributions and what’s left for the family? About $2 million more if you make 8.5% than if you make 8%.

1:01:37 Paul Merriman: A half of 1% could give you $2 million more to spend and to leave than the 8%. That’s why I’m looking for an extra half a percent. And if thought I could add an extra 1% to your portfolio and not expose you to more risk overall, I would say do it. But I still wanna be sensitive to what you’re comfortable with. I am not all that popular with the Bogleheads. I am oftentimes made fun of partly because I do so much slicing and dicing and secondly, because I sound like a salesperson. I do, don’t I, Michael?

1:02:17 Michael Port: Well, I don’t know about that. I’ve never seen you in there get made fun of that’s for sure. And I have seen a lot of people support you and your work, and are big fans. So just so you know that in case you haven’t seen that.

1:02:32 Paul Merriman: I appreciate that. But these differences that people have are serious differences when people say, “This is the way to do it.” And then somebody else say, “No, do this.” If there are a thousand different financial advisers it doesn’t surprise me when there are a thousand different answers as to how you should do it.

1:02:53 Michael Port: Because of course we don’t know anything about the future.

1:02:57 Paul Merriman: Yeah, exactly.

1:02:58 Michael Port: Right. We only know the past. So, one of the things that I think people may have heard the word value and been like, “Well, what’s the difference between value and growth? And wouldn’t growth be better ’cause it’s growing? I don’t get it. Before I started studying this, I didn’t understand the concept. And there’s some differences in small-cap companies compared to the large-cap companies, and a number of different factors. I don’t think we need to get into all of that, probably a little too wonkish but could you just explain why value companies historically have produced better returns than other companies of the same size?

1:03:47 Paul Merriman: Sure.

1:03:47 Michael Port: Because they’re the same size but there’s a value and there’s a growth company. What’s the difference? And why is value typically expected to give a better return?

1:03:57 Paul Merriman: It’s so simple. It really is simple. Let’s say that you and I go in to borrow money from the bank and we’re sitting there with the banker and they’re asking us information about ourselves and what the money is for. And we looked over and right there at the next desk is Bill Gates, borrowing some money from the bank.


1:04:18 Paul Merriman: That itself sounds silly but assume that he is. Who’s going to pay the lower interest rates? The two of us with minimal assets behind us versus one of the richest people, maybe the richest person in the world? So obviously he pays less because he is less risky. Now, the banks also know that if they do a good job of asking us questions and if they secure the loan with a reasonable amount of collateral, that, [1] they can get a higher return on us maybe instead of 4% interest we pay 7% interest. They also know they take some risk. They’re simply getting the premium for having taken this additional risk than loaning money to Bill Gates. If they could find all of us who are honorable and good business people and we always pay back our loans, they become more profitable. But there is a risk. Now, we think of growth companies, popular companies, companies that are oftentimes selling that relatively high PE ratios, price to earnings ratios. People want those companies because they see they got a great future, and they pay up to get those companies.

1:05:43 Michael Port: Tech start-ups are a great example of those kind of companies.

1:05:50 Paul Merriman: By the way that would probably almost go into a separate group because at this point I’m talking about the well-known, established growth companies. What we would call large growth companies that are worth billions and billions of dollars.

1:06:08 Michael Port: Sure.

1:06:09 Paul Merriman: $50, maybe at $100 billions in value. Those start-up tech companies, of course, they’re very risky as we know. And where do you find these large growth companies in terms of large holdings, in pension plans, 85% of the holdings of US investors are in those kind of companies because they trust them. They’re household names in many cases. Now at the other end of the spectrum are companies that have a problem, and I don’t know what it could be. Sometimes it could be something so simple as, back in the late 90s, Warren Buffet had a terrible time. There was a one-year period his Berkshire Hathaway stock went down 50% while the S&P 500 was going up, and that’s because bricks and mortar companies, kind of companies that Buffet likes, they weren’t doing well. It wasn’t that they weren’t making money but the future was in technology.

1:07:20 Paul Merriman: And whether it was start-up technology or those that are established, that was where things were popping. They were hot. And so the out-of-favor-companies tend to sell for a price that either is a low price to earnings ratio or as the academics discovered, a better way to identify value companies is the relationship between their price and their book value. If you simply liquidated this company tomorrow, what could you get out of it? And those companies that have a low price compared to the book value, they go into this category of whether it’s small companies that are value or large companies that are value, they are somehow companies that are out of favor. By the way, there’s always a reason. It may only be psychological or it may be financial, but there’s a reason. It’s not like this is a magic thing happening. What we know is, as a group, not one by one the academics say, “Don’t even think about buying these companies one by one because they are risky. And you are likely to get a premium as a group. You might not get a premium for taking the risk of one company, but you buy 2,000.”

1:08:47 Paul Merriman: In my own portfolio, I think maybe I’ve got 6,000 or 7,000 and this is just through index funds, 6,000 or 7,000 value companies, that are all out of favor for some reason. And historically, this is gonna make sense, they make more money because if they didn’t make money, if the history of investors was that you invested in these out of favor companies and then you lost money most of the time, they’d say, “Hey, this doesn’t make any sense!” But just like small companies tend to make more money over time, so do out of favor companies make more money over time. And I’m not saying put all your money in those value companies, but I want some of my portfolio and the people who follow my work to be in those companies, never one by one only in the form of an index where you get huge diversification, massive diversification.

1:09:50 Michael Port: And of course, that’s the beauty. You don’t have to do any analysis on any of these companies yourself. You don’t need to pay attention to the stock market everyday, it’s not what you do. You can buy an index fund and that index fund if it holds that asset class, then you’ve got yourself covered. So what I hear you saying is, depending on the level of study you wanna do and involvement you wanna have, in the management of your portfolio, you can either go with a total-world fund, you could break it up a little bit more but still lumped together, total US stock market, total international stock market, total bond market. Or you can start to slice and dice a little bit more by adding in some asset allocations that historically, we don’t know what they’re gonna do in the future, but historically have outperformed some other asset allocations. And that risk is gonna require a better understanding of how the market has worked and currently works to feel comfortable. There’s more volatility in this particular asset class.

1:11:11 Michael Port: So if you’re not comfortable with the choice that you’re making, that’s why you don’t just see somebody else’s portfolio and go, “Well, I guess I’ll pick that.” If you don’t really know why you’re making the choice for the long-term, it’s very likely that you’re gonna get out of that asset class as soon as that asset class runs against what the market is doing overall. So if your friends are all going up and your portfolio is going down because one asset class is going down, you might sell it and then you’ve really hurt your chances of getting a good return over time. So it’s important to consider how involved in this the individual wants to be, is that correct?

1:11:55 Paul Merriman: That is correct. And you’ve just… I mean, there are a whole bunch of things you said in there that I find of interest. But, this whole idea of selling something that is out of favor, here’s what a lot of the industry believes, and I’ve got a list of about a hundred myths and realities that I’m putting together for the future. But one of these myths, I think, is that to be a successful investor, you sell your losers and you let your profits ride, your winners ride. Well, you see, if you picked 10 absolutely amazing asset classes from the past… We don’t know the future again, but you pick 10 of them. In fact, you didn’t have to be right on all 10 of them. If you’re right on nine of them, you’re probably gonna do just fine. But as they went up and down, if when one asset class was doing really well, you wouldn’t hold it. You would sell off the excess profits to bring yourself back to your original asset allocation and you take those excess profits and you would put it into those asset classes that have been struggling recently, believing they’re gonna stop struggling and then they’re gonna be better. Now, that becomes hard to believe when something has been doing poorly.

1:13:20 Paul Merriman: So, I understand why people wanna get rid of their losers. But for many people, the losers are gonna be the most profitable thing that happens to them, and I believe that 100% when it comes to young investors. Best thing, the very best thing that could happen to a young investor is to put that money away every month into their 401K and have the market go down the first 10 years. They’re not investing in Enron or Eastern Air Lines. They’re investing in great companies that happen to be out of favor as a group when the market is down and dirty for a long period of time, but everything about the past says they come back. And when you can spend your early years buying bargains, it makes your retirement so much better.

1:14:16 Michael Port: And I imagine, I don’t hear you suggesting that you should try to time the market but rather, buy and sell in order to rebalance your portfolio to keep it in line with your stated objectives.

1:14:33 Paul Merriman: Yes, and that particularly becomes necessary between the equity portion of your portfolio and the fixed income portion. One of my favorite tools is… It’s a table called “Fine Tuning Your Asset Allocation” and it shows the combination of equity and fixed income in 10% increments. So, you can look at the risk and return of an all-equity portfolio, 50% stocks and bonds, 20% versus 80% stocks and bonds. You can look at all these different combinations in 10% increments. You can see what the likely loss is along the way, because I guarantee, if you follow my advice, there’ll be periods of loss, but how much is what you need to know. And that table is meant to help people make that decision when they see what the roller coaster is going to look and feel like. And until you write it, until it’s more than just a story about the past, I promise it’s a whole different event when you’re on the roller coaster than when you watch it.

1:15:45 Michael Port: Now, I know people are gonna wanna know where they can find this Fine Tuning Your Equity Allocation table.

1:15:53 Paul Merriman: It’s on, where people can find my podcast. And it’s under a link that says “Best Advice.” If people did nothing but read what’s under the link that says “Best Advice,” they would have my best work in terms of decision making.

1:16:16 Michael Port: So, are you a proponent of dollar cost averaging?

1:16:22 Paul Merriman: Oh, I think it’s amazing. I literally think it is the path to success for the majority of investors. And I’ll tell you why I believe that, Michael. Where do we see it that we can actually see it in action, that we can see that people are doing better because they’re dollar cost averaging, putting in $100 every month and buying whatever $100 will buy? When the market’s down, you buy more shares. When the market’s up, you buy fewer shares.

1:16:56 Paul Merriman: But what does it do for your long-term return? So, I can go to Vanguard and I can look at one of their target date funds, where everything is being taken care of for you. You don’t have to rebalance anything. They do it. And I can look on Morningstar at what they call the “fund return,” the share return, and the investor return. So the fund may have compounded, let’s say at 10%, but by tracking the money in and out of the fund, it might show that the real investors only got seven. And that is the case in almost every category of fund you look at, is that the investors aren’t even coming close to the return of the fund and how the fund did. Because investors tend to buy when it’s high, they tend not to buy when it’s low or they sell when it’s low. The impact is, you get lower long-term returns. But what gives me so much hope for individual investors who wanna minimize their involvement, they put their money in target date funds, and the long-term studies are showing that the investors are getting virtually the same return as the fund or better. Or better.

1:18:28 Michael Port: How do you get better than the fund?

1:18:31 Paul Merriman: How do you do better? Well, you maintain this ongoing commitment to buying low, more shares when it’s low and fewer shares when it’s high. Remember, when they look at a fund return over 10 years, they assume there was a $10,000 investment on day one. And what’s it worth at the end of 10 years? It ignores new money coming in or a money coming out.

1:19:00 Michael Port: I see. Now, that makes sense to me.

1:19:02 Paul Merriman: Yeah. And so, what’s happening is, that by being willing to do what is in your best interest, buying when it’s low and buying less when it’s high in terms of shares that you come out ahead of a traditional buy and hold.

1:19:16 Michael Port: Do you prefer rebalancing via cash contributions? Or rebalancing by selling shares or buying shares?

1:19:26 Paul Merriman: Well, if you’re adding money on a regular basis or even once a year because I don’t want you to rebalance more than once a year, you can actually use any new contributions to do the rebalancing. Now, that’s a complex subject because in a sense, let’s say you’re adding money on a monthly basis, it suggest that you’re rebalancing once a month. And we know that if you don’t rebalance too often, you tend to make a better return than if you rebalance often. And it’s very easy to understand in that, if you have more money, let’s say you had a portfolio of 50-50 stocks and bonds. And so, you started the year and the stock funds just went straight up all year, the bond funds did very little, they kind of went sideways all year. Well, if you rebalance every month, you’re going to be taking money out of equities, some money out of equities and put it into bonds, every month, every month. So, what happens is, at the end of the year because you were punishing the part of the portfolio that was most productive, you end up making less money than if you simply let it ride. So, it’s not magic by the way. By getting that higher return, you also took more risk because you had more equity in the portfolio.

1:20:57 Michael Port: So, the rule of thumb is often, rebalance once a year. Sometimes, they say every six months, but once a year. But what’s your trigger? Do you have say, some people have a 5% trigger, if in three months the portfolio goes out of whack by at least 5%, then you’d rebalance then rather than waiting till the end of the year. Do you have a trigger? Do you have a recommendation?

1:21:18 Paul Merriman: I do not. I can tell you that in any period whether it be the last 10 years or the last 25, you can fine tune that process based on the results of that 10 or 25-year period and produce a better return if you use those kind of triggers. But the chance of it being the same the next 10 or 25 years is not nearly as good as you think it would be because while it worked for the last 25, why is it not being that productive this? Because the market will always be different in some way. The reason I don’t encourage people to do it more often, one is, it requires you to do work that you may or may not get a return for, probably not. The other thing is, equity asset classes tend to go on a tear and they gold out for much longer than a month or two, or six months. And so, if you sell the good ones too soon, you leave a lot of money on the table. Also, it’s good when the bad stuff keeps doing worse, which also tends to happen. And so, if you wait awhile, you tend to sell more profits from the good stuff and buy in at lower prices on that part that’s been struggling.

1:22:41 Michael Port: It seems that some of the studies on momentum would support that and that the companies that are doing well for 12 months will often have another 12-month ride and then the companies that are doing poorly for 12 months will have another 12-month loss. So I get that. Of course, this is just a generalization based on some studies that aren’t really I think relevant for the conversation. But I think that that makes sense to me. I get that. It puts it together. It puts in a perspective.

1:23:12 Paul Merriman: Good.

1:23:13 Michael Port: Sometimes people use compound rate of return, and sometimes they say they use annual rate of return. What’s the difference? And what should the average investor be concerned with?

1:23:25 Paul Merriman: Well, I think what I’d like to do is differentiate between the compound rate of return ’cause it could be the compounded annualized return. It’s a question, is it compound or is it average? And the difference is huge. And I go back to that half of 1%. If you’re making your plans based on average rates of return, I can tell you the S&P 500 has an average rate of return of 12% over the last, almost 90 years. Its compound rate of return is 10, and that’s the one that you should think in terms of for the long term. Let me give you an example of why there’s a huge difference. Let’s say that year one, you put in a $100 and the market goes up 50%. So, your $100 is worth $150. Now, let’s say the market goes down at 50%, your $150 becomes $75. The average rate of return plus 50 minus 50 is zero return. The compound rate of return is over a 12% a year loss. Are you with me on that?

1:24:49 Michael Port: Yeah.

1:24:50 Paul Merriman: It’s misleading. And what bugs me so much is that there are people on the radio who will talk about the average return of the S&P 500 is 12%. Well, I can almost guarantee you they’re selling something. They’re selling something because nobody in this business is expecting from the S&P 500 for the long term at 12% compound rate of return, which is what you’ll have to spend, not the average rate of return.

1:25:22 Michael Port: The financial author, Michael Bernstein, said, “The reason that the word guru is so popular, is because the word charlatan is so hard to spell.”


1:25:35 Paul Merriman: Yes, I am not a fan of gurus because they hurt people. They hurt people because they have ways to appear to be trustworthy, and we confuse a past record. Well, I’m a Jim Cramer. Now I happen to have spoken with Jim Cramer. I have a home down in San Miguel de Allende, and he has a couple of homes in San Miguel de Allende. Last I heard, he did. And I like him, I enjoy him, and he comes across as a very humble guy as an individual off of the set. But, what he does on the set is, I think, encourage people to believe that there’s something more than is there. Mark Hulbert, who unfortunately his newsletter has been terminated or disbanded, whatever the word is, but he followed Jim Cramer up until the end of 2015, and I’ve looked, I’ve followed Cramer’s results and it’s about half of that of the S&P 500.

1:26:47 Michael Port: Yeah. Allan Roth, I’m sure you’re familiar, if I guess so?

1:26:51 Paul Merriman: Oh, sure. I know Allan.

1:26:52 Michael Port: Yes. So he did an article where he broke down almost all of the TV personalities and their results over time, and it’s astonishing. Yeah. It’s the old… The monkeys throwing their darts would do a better job.

1:27:12 Paul Merriman: Yes, and there’s a reason for that by the way. Those darts are going to land on a certain number of small-cap value companies.


1:27:23 Paul Merriman: It is interesting all the ways that we mystify this business. That’s why I focus on what University Street has taught us as opposed to Wall Street. I don’t have one sense of trust in Wall Street. I know lots of people who work in the industry, I like them, they’re nice people. But as an industry, I would not ever want to suggest that that would be the basis of one’s plan for guidance for a lifetime.

1:27:54 Michael Port: Last question and it’s a big one. Big one. You wrote a wonderful article and you then did a blog post as a follow-up to it because some folks were not so pleased with the title of the article, they thought it was a little too hyperbolic. But I know it was a great title ’cause it got people to pay attention and it was in fact, accurate. So, your article was about how to turn $3,000 into $50 million, it’s very provocative. So tell us, how we can do this.

1:28:34 Paul Merriman: It’s so simple, and this is what I love about this strategy. Now, I can guarantee this, at age 73, I am not going to turn $3,000 into $50 million. But I know how to do it for a newborn child, and that’s what that article was about. And it does not have to be $3,000 once, it could be $365 a year for 21 years. Here it is, step-by-step. It’s so easy. You put away the $3,000 or the $365 a year into an asset class. It could be an ETF, and I even name on my website the ETFs you could put it into, like Vanguard, or Fidelity, or TD Ameritrade, or Schwab. And you keep putting that money away for that newborn child until they start putting money aside for retirement, that’s when they start earning any money. They’re 15, they earn some money. Legitimately, you can then, in essence, put that into a Roth IRA for that child. But you do that until this money you set aside, either the $3,000 or the $365 a year, you do that until the money’s gone.

1:30:02 Paul Merriman: And it’s all in a Roth IRA now. Now you leave it alone, you leave it alone, you don’t do anything until the child is 65. At that point they start taking out 4% a year. And I assume in the article that they live to be 95. Now from that measly $365 a year, it grows to about a $20 million distribution during your retirement and a $30 million inheritance for children and charities. Now there’s so much that can go wrong. The first thing that can go wrong is that instead of making 12% in small-cap value way down from its historical 16% by the way, instead of getting 12 you get 10. Here’s the good news, the long term return of 10 is not all that bad either and I’ve got tables in that article that you can link to that show the returns of four or five or six all the way up to 12% a year. So you can see over a lifetime what it would mean.

1:31:18 Paul Merriman: The other struggle is keeping this kid’s fingers off of that money. And not everybody understands the reward for delayed gratification. So one of the things I do in another short article that goes along with the basic article is share a letter to a grandchild so that as a grandparent I may not be around in 21 years. So I want somebody to be able to hand that letter to that grandchild. It talks about what this money is about because we’re going to war here. As a grandparent I know what I want my grandchild to do, but I know Wall Street has other uses for that money. The spouse of my grandchild may have other uses for that money. The grandchild may develop habits that lead to other uses for that money. This is not a slam dunk in terms of having to be what we want it to be but we have done the things which should include an education to make it happen. And it will happen to some families. It will change generations to come because you do this right once and it’s gonna be done more than once for others in the family.

1:32:38 Michael Port: Beautiful. I’m sure you know this, many of my listeners may not, but if they own businesses, and they’re C corp or an S corp and they can pay a salary to a child, the child has to be reasonably old enough to do some kind of work that is legitimate in the business. My 11-year-old and 12-year-old can work in the business, they’ll sell, at events they’ll sell T-shirts, they’ll file papers for us, they’ll do online research. It’s a whole bunch of things that they do. And they get paid $6,300 a year for their work. And of course, it’s a business expense so it is tax deductible for me. And because they have such little income, they are not paying any federal taxes and because they have earned income they are allowed to invest in a Roth IRA. So that money is not taxed at the beginning, it’s not taxed in the middle and it’s not taxed at the end. And $6,300 goes into this fund every year for them, each month they get their pay-checks which automatically go right into the Roth and if they pick this up when, as you said,44 they start to work, they’ll produce a significant retirement account pretty early on and will have some assets if, as you said, they don’t muck it up.

1:34:26 Paul Merriman: Yeah. And one of the things… I’m not a tax expert but I did when I had my first grandchild many many decades ago, I had a mail order company that I owned and we hired him to be the model in. He actually made the front page of the… And at that time it was $2,000 that we could give.

1:34:50 Michael Port: So if the child is younger and adorable as most children are…

1:34:54 Paul Merriman: They all are, yeah…

1:34:55 Michael Port: They can’t do their filing or they can’t sell things for you but they could be a model and that’s legitimate work for them, it’s fantastic. I love it. And teaching the delayed gratification is a big deal. I’m not a person who has a natural ability to delay gratification. I have to work against my natural instincts. Like, I’m great at spending money, I’ve got a gift for it.


1:35:19 Michael Port: No really, I’m very good at it.

1:35:20 Paul Merriman: What about your wife?

1:35:22 Michael Port: She’s better than I am. She’s definitely better than I am.

1:35:24 Paul Merriman: Most couples, yeah. Yeah, yeah, yeah.

1:35:26 Michael Port: But the thing is that we got to the point in our life where we saw what we wanted our future to be and because of that, a significant connection that we have to the future we do now what needs to be done to get us where we wanna go, and we know what that number is and we know how much we need to put away each year and we’re doing the work. But with the kids, we have an allowance system set up for them. I read a book called The Opposite of Spoiled, very good book, “The Opposite of Spoiled.” And the author outlined an allowance structure that we adopted, and it’s worked very well to teach them delayed gratification and how money makes money. So, they get an allowance each week, they get an amount equal to their age. So, the 11-year-old gets a $11 and etcetera. And then 10% goes into their giving jar, 50% goes into their savings jar, 40% goes into their spending jar. However, if they take… Anything that they, instead of putting into their spending jar, they put into their savings jar, they get a 50% bonus.

1:36:49 Paul Merriman: I like that.

1:36:49 Michael Port: So if they put their $4 into their savings they get an extra two. Now, they can only spend their savings every six months. However, there are bonuses for saving, too. So, you are de-incentivized to spend it.

1:37:09 Paul Merriman: Oh, I like that.

1:37:10 Michael Port: And so both of the boys saved for an entire year. Now, here’s the thing. All the other things that they… Anything they need we buy. But if they want an app for their phone or something that is really disposable they have to buy it, that’s what they’re getting allowance for and the allowance is not tied to chores, chores are chores, you do chores, you don’t get paid for chores. So, what happens is they don’t buy apps like they used to. They don’t buy the things that aren’t really important and they saved each one for a year. And one of them purchased a computer and the other one purchased parts to build a computer. And now they’re saving again. They’re starting over.

1:37:53 Paul Merriman: That’s great.

1:37:54 Michael Port: Isn’t that cool?

1:37:54 Paul Merriman: That is. What’s the name of that book again?

1:37:56 Michael Port: The Opposite of Spoiled.

1:37:58 Paul Merriman: Okay. Well, I will read that for sure. And [laughter] I hope a lot of your listeners do because these are amazing lessons to be able to teach young people the idea of delayed gratification. We know from the studies that those people who learn delayed gratification, by the time they’re 13 or 14 years old, are the ones who go on to do better in school, they tend to be more socially adjusted, they do better in their work life, and they’re obviously going to probably have a better retirement financially than the people who do not delay gratification. What a bonus to help your children to get there. Congratulations.

1:38:40 Michael Port: Well, I don’t know, don’t give me a pat on the back yet. We’ve got a couple more years to go before they’re out on their own. Hopefully, we won’t screw them up in the next couple of years, but two books that all of our listeners should read. Certainly, we just mentioned, “The Opposite of Spoiled” but that’s for their kids. For them, they need to read, “Financial Fitness Forever.” And that is of course…

1:39:00 Paul Merriman: May I also suggest three free books. I have three, one is, “First-Time Investor: Grow and Protect Your Money.” One is, “101 Investment Decisions Guaranteed to Change Your Financial Future.” And the third one is, “Get Smart or Get Screwed: How To Select The Best and Get The Most Out of Your Financial Advisor.”

1:39:23 Michael Port: Oh, that’s great. That’s fantastic.

1:39:25 Paul Merriman: I hope they’re life changing. Thank you so much.

1:39:27 Michael Port: Well, don’t go yet. I just wanna say one more thing. So, he said those books are free. Usually, when somebody is giving away something for free there’s an opt-in, and then they will start selling you other products, that’s not the case on Paul’s site. He is doing this for you and you’re not gonna start getting marketing emails from Paul trying to get you go to seminars or something like that.

1:39:50 Paul Merriman: Well, if there’s a seminar, it’s free.

1:39:51 Michael Port: Oh, exactly. Exactly. 


1:39:54 Paul Merriman: All the best for you.

1:39:54 Michael Port: Listen Paul, thank you so much. This is really an honor to have you here, I truly appreciate it. You’re a very good man for the work you’re doing and I’ve learned so much from you.

1:40:04 Paul Merriman: Great. Good luck to you and your listeners. Bye-bye now.

1:40:07 Michael Port: Bye-bye. And now a final thanks to our sponsor.


1:40:16 Michael Port: So, remember keep thinking big about who you are and what you offer the world. I love you very much and not in a weird way, but I do, I love you for being the big thinker that you are, for standing in the service of others as you stand in the service of your destiny, and for committing to playing the biggest role that you can in your life. Bye, for now.