Afford Anything - Paul Merriman: The 4-Fund Strategy That Beats the S&P 500

Starting point is 00:00:00 What should your portfolio look like? We're going to discuss that today with investment expert Paul Merriman, a former wealth manager who now runs a foundation dedicated to financial education. Welcome to the Afford Anything Podcast, the show that understands you can afford anything but not everything. Every choice carries a tradeoff. And that applies not just to your money, but to your time, your focus, your energy, to any limited resource you need to manage. So, what matters most? This show is dedicated to exploring that question, and we cover five pillars, financial psychology, increasing your income, investing, real estate, and entrepreneurship. It's double-eye fire.

Starting point is 00:00:43 I'm your host, Paula Pant. I trained in economic reporting at Columbia, and I help you prioritize. And I'm here at the Bogleheads Conference in Minnesota with Paul Merriman. Welcome, Paul. It's great to be here, Paula. Thank you. Thank you so much for joining. Now, the last time you are on the show, we talked about a two-fund portfolio.

Starting point is 00:01:05 This is something good for beginners who want something just a smidge more advanced than target-date funds. With a two-fund portfolio, and we won't go into the details because people can listen to episode 300 in order to dive into that discussion. But with a two-fund portfolio, you talked about how adding just a little bit of additional complexity, that small-cout value funding? Correct. That slight bit of additional complexity can boost your returns while not making your standard deviation go crazy. What I want to talk to you about today are further iterations of that. How do we get just a little bit more sophisticated and a little more sophisticated and a little more sophisticated? Well, I'll address whether the two-fund strategy is for beginners, because theoretically, that is a portfolio you could use for the rest of your life. The Target Date Fund

Starting point is 00:02:03 takes care of moving money from equities to a fixed income, and that slice of small-cap value would give you that extra kick, at least based on history. Probably a half a percent. If you put a little more in, it would be a full percent, but that's a lot over a lifetime. But if you want to get a little more aggressive, you certainly could even do more. But people are really surprised to find out is that a portfolio, I'm talking about the equity part of the portfolio that is half in small cap value and half in the S&P 500 actually does not have any more risk than the portfolio that would be 10 or 20 percent. It is interesting. And the reason that is because they don't go up and down together.

Starting point is 00:03:00 And what it allows you then to do is to get more exposure to small cap value along with the target date fund. And of course, we have a free book for people entitled Two Funds for Life if they really want to dig into that. But to take it the next step, what I think we want to do is to, look at what that target date fund has in it. Does it represent the equities that you want to own for a lifetime? And it's not that they're bad equities. They're just fine equities. But we do know that group of equities that they have there now is kind of like the S&P 500. But if you

Starting point is 00:03:51 replaced that S&P 500 with a portfolio that's 25% in the S&P, 25% in large-cap value, another equity asset class, 25% in small-cap value, and 25% in small-cap blend. And believe it or not, going back all the way to 1928, the volatility is lower with the four funds than the one, and the return is almost 2% higher. And will the future look like the past? We all struggle. With whatever we believe about investing, we do know there is no risk in the past.

Starting point is 00:04:37 We always know what we should have done. What we don't know is the future. But that four fund strategy gives the investor a ton. of diversification. And when you put the four together, you're guaranteed never to be number one at the end of the year. You're guaranteed never to be the last in that year.

Starting point is 00:05:00 And that kind of right down the middle has produced a remarkable long-term return. So I notice right away that you recommend offsetting that S&P 500 exposure with small-cap value and small-cap blend. but I know I'm going to get a bunch of emails from people saying, but look at large cap performance. I mean, this is recency bias at work.

Starting point is 00:05:25 But look at large cap performance. Look at Nvidia. Look at the Magnificent Seven. Look at how well large caps are doing and how much they've driven the overall economy. Yep. And particularly even large cap growth, right? Yep.

Starting point is 00:05:39 What would you say to anybody who raises that objection? You know, what I would challenge them to do is to look at a quilt chart that shows all the way back to 1928 the returns of all four of these major equity asset classes. Now, here's what we know about the S&P 500. It is the highest quality of those four assets, asset classes, which means that they should have the lowest return over time, not the highest. But having said that, when we look at the last, 96 years. Yes, in 41% of those years, you have the worst performance, not bad performance, but the lowest because of less risk. But there are, I think it's 28% where it's the number one.

Starting point is 00:06:32 And oftentimes they're number one many years in a row. And this is what I think investors struggle with. They don't know what to expect. They do not have realistic, expectations because they are stuck with recency bias. And so whatever's happened recently is more important, more likely to continue to do the same thing in the future. And that has cost people tons of money because chasing performance is what gets them in trouble. In fact, small cap value. After it has a five or ten year run, when it has way outperformed the S&B 500,

Starting point is 00:07:16 People then start thinking, well, I've got to have some of my money there. No, that is not the time to go in. The time to go in when it was not number one. And hopefully your dollar cost averaging in, picking up these cheaper shares. By the way, the same is true with the S&P 500. From, as you know, 2000 to 2009, it lost 1% a year. And if you failed to continue to put the money in there, you would have missed the huge run that went on after that ugly 10-year period.

Starting point is 00:07:49 So I think the idea is to be able to know enough about the past so that you have real good expectations. It's a bunch of random stuff that happens. You cannot know when small is going to be the best, when value is going to be the best. These are things that when you look at the quilt chart and it's done in color, so you can see the colors of the different asset classes,

Starting point is 00:08:13 if you get that right, you're going to have the patience to do what John Bogle wanted you to do, stay the course. We just want you to stay the course and things that are likely, we don't know, but likely to produce good returns. You know you have low expenses. We want you to be an index like mutual funds. Those are not difficult decisions, but we all live with the unknown. Nobody knows. And I'm going to share something that I just read in John Mogul's great book, the little book of common sense investing.

Starting point is 00:08:51 Coming back to the conference, I decided I should read it to see what he said that would remind me of something I should be talking about. 1980s and 1990s, we had no idea what was going to happen. Companies did fine, but investors bid the prices of stocks way, way up. worth a lot. That is what Bogle calls the speculative return on those. The speculative return does not last. Eventually, the economics, the profits are going to drive the return on most of these companies. And so how can we know when people are going to get crazy and bid up stuff like with the Mighty Seven, the Magnificent Seven? How are we going to know when that's going to happen? And how are we going to know when they decide enough is enough?

Starting point is 00:09:48 And they feel a little silly that they paid two or three times what they should have. And now they're getting out because, one, the market's going down. And two, they're afraid that it's going to keep going down a whole lot further, which ends up very often giving you a period of time that the market is undervalued. If you want to be a market timer, God bless you. I mean, I'll give you, I wish you the best. but I think people mostly when they try to do market timing, they hurt themselves rather than getting the best that they could. So my goal is to get people to be balanced in equity asset classes that have a long history of success and then keep your hands off.

Starting point is 00:10:31 Don't touch. All right. So I'll tell you the argument that I've heard, and just to be clear, I myself don't believe this, but these are the voices that I hear. There are people who would argue that it's not 1929 anymore. And what we are facing today is an inflection point that's usuring us into a new era due to AI. And that the productivity benefits of AI are going to accrue to the largest companies to meta, to Google, to Amazon. They're going to accrue to those companies in,

Starting point is 00:11:09 such an overwhelming manner that no other company will be able to keep up. So behemoths will become bigger and bigger and bigger. And so they argue, therefore, that we are ushered into a new era of the largest of large caps. It's an argument that's easy to agree with. Right. And it also is an argument that was made many times over the last hundred years, that there were changes in the economy that we're going to create permanent advantages to certain people over others. And the bottom line is, at least from my viewpoint, returns in the future are going to be like returns from the past. If I look at what the S&P 500 did last year, I think up 26%. I went back and looked, lots of years it was up 25 to 30. Now, the reason it was up 26 is going to

Starting point is 00:12:09 different than the previous reasons that it was up 25 to 30. And I looked at every one of the asset classes, and they all showed me the same thing. There was nothing new. As a matter of fact, you just mentioned 1929. A lot of folks may not realize that from 1929 to 1938 and 2000 through 2009, the period 2000 through 2009 was worse. It lost more money than the period 1929. It lost more money than the period 1929 to 1938. And people criticize my work sometimes. They say, why do you go all the way back to 1929 or 28? That stuff doesn't matter.

Starting point is 00:12:50 It isn't what was going on that matters. It's just the market. The market goes through these swings up and down, and it appears to be pretty random, except afterwards we can always explain why it happened. We're experts afterwards. So do I believe that the S&P 500, particularly because of AI and the handful of companies, is going to remain at the top of the list,

Starting point is 00:13:18 when you look at that quilt shirt, you will see lots of times that it was at the top of the list. And then it ended up at the bottom of the list. From 1976 to 1999, the S&P 500 compounded at more than 17%. People were thinking that that was the future. What's happened since 1999, the S&P 500 has compounded at about 7.5%. Now, have things changed? Why would the magnificent, whatever we might have in our economy, why is that the market has produced a lower return today than it had during a period of time that we didn't

Starting point is 00:14:02 have AI to make the case for why things are? are so good. It is the nature of humans. We love telling stories. We feel obliged to make up stories. Some people do it as a profession. They call politicians. But for most of us, we too make up stories. And in most cases, our stories turn out not to be right. Not that we weren't well-intentioned, not that we weren't intelligent, but it's because the market does what it wants to do. And we all think we've got it figured out. I'm trying, I'm preaching if I'm going to call it that for people to give up the attempt to outguess the market and just be the market and be the market in a way that historically it paid a premium because that's all we're looking for is to get a normal

Starting point is 00:14:57 rate of return. What we don't know is that we don't know how good the economy is going to be. And then we don't know how much people are going to pay for whatever earnings that they might make. So there's a whole lot of unknowns that are daunting enough to have to market time and figure the next right move to make. Probably just makes it more difficult and less likely to help you. I like the phrase be the market. It feels like something you'd hear at a yoga class. Like, be the market. You are at one with the market.

Starting point is 00:15:31 Yes. And I love that, too, the idea of it being a peaceful, it's something that you can control. So this is the beauty of an index fund versus actively managed fund. When I just reread Bogel, he said the index fund is the only fund that is honest. Now, I hadn't thought about that when I read it years ago when the book came out. Why is the index fund honest? Because they tell you, we are going to do everything we can to be the market. We're not trying to beat the market. We want to keep the expenses low because we don't have to spend time or money second-guessing and trading and trying to be better than the market. The active manager says, we think we can beat the market.

Starting point is 00:16:23 We got great people, smart people, who are here to take care of your money, and we are going to help you beat the market. Now, what they don't say, if they were really honest, we just want you to know, by the way, that as much as we want to beat the market, the studies show that maybe one out of 10 actively managed funds beat the market over an extended period of time, say 20 years. And the problem is, I would like you to believe that would be us, but the fact is nobody has ever figured out how to pick that fund at a time.

Starting point is 00:17:00 And so I just want you to know that if you hire us, more than likely we're going to underperform our hopes and your expectations. But when you are the market, you are actually picking up the growth of this engine that we have, and it goes way beyond seven companies. It is the whole economy, basically, that you're picking up when you own that S&P 500, and what you hope is that you'll be given the normal return, which, by the way, John Bogle says, is nine and a half percent a year. And that if you look at the return of the market over the last 90-some years, it's been 10.

Starting point is 00:17:42 So what he says is you got nine and a half percent for the engine itself, and one half 1% speculating on the future. So that's the way I look at it. And, of course, when you have a belief, the challenge is what's behind that belief? Remember, show me the meat advertisement. Now, what is the meat behind the things we believe? Nobody argues about low expenses. Nobody seems to argue that lower expenses are better than higher expenses.

Starting point is 00:18:20 Nobody argues that lower taxes is better than higher taxes. Nobody argues about more diversification is better than less diversification. What they get into an argument about is something about which they have no control, and that is what the market's going to do next. And I'm 81 almost, and so I've got a relatively few years to be in the market. And at 81, my wife and I are half in equities and half in bonds. And half in small, half in large, and half in value, a little more than half in value, and a little less than half in growth.

Starting point is 00:19:05 And we stay the course. We take out our annual distribution to live on the first week of the year. And I don't even care what the value of the portfolio is because I can't. can't do anything about it. And it is a waste. If I think about that, be the market. Well, in that piece of being the market, hopefully someday people will be able to say,

Starting point is 00:19:29 I am satisfied being the market, and I am not going to worry about it in the meantime. Because it drives a lot of people nuts. They should be able to do something, take control. And Bobo says, don't do anything. Just stand there. which is the opposite of what we're trained, don't just sit there, get to work. You know, solve the problem.

Starting point is 00:19:53 Right. In fact, the problem is solved if you don't do anything rather than getting in there and monkeying around with your portfolio. But it's human nature to want to do that. I'm curious. You said that you take an annual distribution. Two questions. Number one is, why do you draw down annually rather than quarterly or monthly?

Starting point is 00:20:15 The second question is, do you have a cash? your cash equivalent allocation as a runway to protect you against any dips in the market that would force you to sell off depressed assets? Well, first of all, we are half in bonds. And basically, they're all governments or munis. The second thing is we do keep an extra year or more, depending on what our plans might be in terms of housing or special travels or some things. that nature. It's not what I'd recommend to people who want to be efficient. You're right. If you want

Starting point is 00:20:53 to be efficient and the market generally goes up, take the money out monthly. Don't take it out before you need it. Right. So the market can be working. I'm at the other end of the spectrum. I know who I am. I get nervous when I'm doing things with our investments to underwrite our life at the same time as the market's going up and down. If I take it out the first of the year, I know that's what we have during the year. And that is to cover, by the way, that money we give away as well as the money we use for travel and our basic needs. I don't have to worry about whether the market is up or down in any particular month. And I say to my wife, do you mind if we wait a few weeks before we take the money out?

Starting point is 00:21:38 Because I will be like a lot of people given the choice. I will want to second guess. My emotions become part of the process. I don't want that. And the other part is that my wife likes to spend money. I don't like to spend money. This is very common with couples. And I have found that if we have an agreement, we take 5% out of each year.

Starting point is 00:22:06 That is our money for the year to use and to give. And that that then creates kind of a budget. And so she knows, hey, I got all this money to spend. This is great. And if the market goes up, which it normally does, she gets a raise in what she has to spend. And when the market goes down, we take a cut and pay, which makes me happy because that has an amazing impact on the value of your money over a lifetime. If you can cut back a little bit during the bad times and be willing to spend during the good times,

Starting point is 00:22:42 It works out so much better that way. If you look at the numbers. So emotionally, there's the money. That's for the year. Let's have some fun. Let's not worry about having money. Let's not care of the market's going up or down. And it feels good.

Starting point is 00:23:01 I solve a marital problem. I solve a financial problem. And the market normally goes up. So she knows every year she has a good shot at having more money to spend the next year. You say you spend less than years that the market goes down. Does that mean you reduce what you take out? You mentioned 5%.

Starting point is 00:23:22 Do you reduce that down to 4 or 3%? No. We take 5 of a lower number. Oh, okay. And we have tables for this Boglehead conference, and then you might want to include it in your notes as well. Yeah. We have over 200 tables that are built and charts and things

Starting point is 00:23:40 that are built to help people understand. this process. So I made a page that had links to all of those major groups of tables so people can go and investigate the numbers on their own. As you know, we are purely teachers. We are not managing money. We're not selling anything. We just are trying to teach them the things that we've learned. And I've got a trustworthy group of volunteers who are willing to work for nothing along with me and that's what we spend our time doing. And those tables are the meat. Those numbers are the meat because it's supposed to be, from my viewpoint, we're trying to show the evidence. I want to see the evidence that something is better than something else. And this is our attempt to create

Starting point is 00:24:30 that evidence. All right. I'll get that list of links from you and we will put that in the show notes. So if you're watching on YouTube, that's going to be in the episode description below. And if you are listening on a podcast playing app, we will make sure that it's in the show notes that are on the website. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology, built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the FinTech hustle that got them named one of America's most Innovative companies by Fortune Magazine.

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Starting point is 00:26:26 Head to Wayfair.com now to shop Wayfair's Black Friday deals for up to 70% off. That's W-A-Y-F-A-R.com. Sale ends December 7th. Taking our attention off of distribution and back onto asset allocation, because most of the people who are listening to this are in the accumulation phase. Most of the people who are listening are currently working and saving and investing. We've talked a little bit earlier about how a lot of the growth recently has accrued to just a few companies. And it has raised the question, what about equally weighted indexes?

Starting point is 00:27:15 What if you feel as though the nature of index funds causes you to be so overweighted in just, a few that you should diversify into equally weighted. What are your thoughts there? Well, first of all, the idea of equal weighting of asset classes is what I was talking about just a little while ago, the 25% each in the four different equity asset classes. Right. But then there is the equal weighting of the individual companies. Right. So instead of having cap-weighted portfolios, as the S&P 500 is, you have every company has the same impact percentage-wise, which is a totally different portfolio. Now, people need to understand that now a portfolio is being managed, that is going to be way

Starting point is 00:28:07 more expensive to manage and will have tax consequences, heavy-duty tax consequences in this attempt to keep these companies in that relationship across 500 companies. It's a very different way of managing. There have been funds around for a long period of time back into the 80s. And Invesco has one that's been around, I think, for that whole time. And if you look at its performance compared to the Vanguard S&P 500, most of the time they've done better. They be in the Invesco equal-weighted fund. recently, partly because of the magnificent stephen, there has a bit of an advantage, but it's a very small

Starting point is 00:28:57 advantage. The disadvantage for the equal weighted approach is that you are going to have to pay more in taxes in a taxable account. So I would only use that, if you're going to use that, in a tax-deferred or tax-free account. particularly with the people in the fire movement. A lot of them like the total market index. Yeah. Okay? VTSAX.

Starting point is 00:29:27 We live and breathe it. Well, I want to talk about that because it's important to understand the difference between the S&P 500 and the total market index. There is virtually historically no difference in return. So you could, based on return, be just as excited about. about the S&P 500 as the total market index. Now, recently, the total market index has underperformed, again, because of the magnificent seven. So we have that impact there, too.

Starting point is 00:30:01 What the academics tell us, whether you have 500 big companies that are growth-oriented, or you have 3,500 kind of what the total market index is, that is mostly growth-oriented, you really haven't made a difference. You've got more diversification, but you still are a large growth index, basically, because they're both cap weighted. And the reality is, if you wanted to do something like the total market index instead of the S&P 500, well, why don't you do this? The total market index is about 85% S&P 500. So put 85% of your money in the S&P 500. Now, instead of just adding more logs to the same fire, I want you then to build that other 15% in a different asset class. And that asset class is small cap value. Now you're talking about having possibly a 1%

Starting point is 00:31:11 difference in return with 85 and 15 versus all in the S&P or all in the total market index. Now, people might say, wait a minute now. The total market index has small cap in it. It does. But it has almost equal proportions of small cap growth and small cap value. And small cap growth has a terrible long-term track record. So you're putting half of the small cap in something that doesn't do well, historically 8.3%. And half in 13 or 14% in small cap value.

Starting point is 00:31:52 Well, you average those two out, and you're kind of ending up with more of the S&P 500 in terms of the return implications. So if somebody really believes in the total market index, because they have something more than just the S&P 500, I would much rather you just 85% in S&P, 15% in small cap value. And I guarantee it will be a different return than the total market index. I hope it's better. It could be worse. We don't know. But what you've just done is you've just made it a little more complex.

Starting point is 00:32:35 But there's a reward if you're right. That's the part that nobody can guarantee. But if the future looks anything like the past, you'll be better off with the 8515 than trying to do that under the umbrella of the total market index. So one thing that I noticed right away, yes, we eliminate small cap growth, which historically does poorly. But we also eliminate mid-cap, if we do that. Yes. What are your feelings on mid-cap exposure? Well, here's the thing. Mid-cap exposure is okay. There's nothing wrong with mid-cap exposure,

Starting point is 00:33:15 but the expectation for small-cap value as a different asset class, which mid-cap is different than large-cap, the expectation is that the small-cap value will give a better rate of return. You're still going to have 85% of your portfolio in these very, very large companies. And so to put together another asset class in that portfolio, 15% is not that much. And the reason I come up with 15% is, you're right. In the total market index, the 15% includes small cap and midcap. But again, the expectation from small cap value is a better rate of return. Since 19, 1970, the S&P 500, 10.7, and the small cap value over 13. Now, I can't give you the midcap right off the top of my head. I wish I could.

Starting point is 00:34:13 To what extent should international equities play a role? And I actually want to ask this question in two forms. So my first iteration of this question is for U.S.-based investors. To what extent should international equities play a role? We'll talk about that first, and then I'm going to ask it again for, investors who are based elsewhere outside of the U.S.? Well, if we look at the period from 1970 through 2003, we can see that if you include

Starting point is 00:34:43 internationals, that there will be two decades that you did better having the internationals in the portfolio because in large part it was about currency differences. The academics tell us, though, that over the long term, The currency diversification does not make you more money. There is not a premium for that, but it does take some of the volatility of the returns. And so from my viewpoint, when you look at the returns of large-cap, bland, U.S. and international, and small-cap blend or small-cap value, U.S. and international, if you look at all those choices,

Starting point is 00:35:30 that you have, U.S. and international, of these major asset classes. When you put the combination of U.S. and international versus just the U.S., the return is almost the same. So you have created more diversification, that's a plus. Complications, that's a minus. And tax expenses inside of the international markets, a small minus. do I think that it is good for people who can afford, aren't trying to squeeze all the return they can and have emotional sense of the home bias.

Starting point is 00:36:11 They like having it be all the U.S. because they know the companies. I say to the people like me, being older and not having a whole long time to live and having half of my money inequities, it's half international. but I know that it's not adding any, I'm not expecting a better rate of return. I'm just looking at trying to modify the volatility. For one thing, 50% of your money in equities at age 81 is a fairly aggressive stance because in a target date fund, they'd have you 30% in equities. So I'm being aggressive enough.

Starting point is 00:36:48 Oh, and having half of my money equities in small cap, that's pretty aggressive. So I am an aggressive chicken. I'm trying to give the money a chance to grow, but I'm trying to do it with as little risk as I possibly can. Within the international equity exposure that you have, is it mostly developed markets, or do you have an emerging market exposure in there? Oh, no.

Starting point is 00:37:14 We have, for every equity asset class that we think you could have in your portfolio, we have a recommended ETF. So we have a list that anybody can use, and it has the best international small-cap value ETF. Now, by the way, nobody knows the best. All I know is if you look at the expenses, you look at the diversification, the size of the companies, how discounted the value is, how profitable the companies are, because quality or profits are an important factor to take into consideration that, well, as a matter of fact,

Starting point is 00:37:51 this year, the international small cap value is up 50% more than the U.S. small cap value. And they're going to be years. You're going to do better in the international. And I should clarify for the audience that when you say we have, you're referring to a nonprofit financial education. Yes. Yes. Which you don't take any compensation for.

Starting point is 00:38:13 That is correct. Nor do the other principles who are doing all the heavy lifting in terms of developing the portfolios and all the tables that we provide. Why ETFs, do you prefer ETFs over index funds? Well, certainly I do for taxable accounts. As a matter of fact, you mentioned the equal weighted account. I looked at the at the equal weighted Invesco account and there's what they call a tax cost that Morning Star tracks. The taxable impact on the return of that fund is a negative 2 plus percent. So if you owned it, depend on the state you live in and the tax implications of wherever you are, it's going to cost

Starting point is 00:39:06 you up to 2 percent off of the return is going to be paid for taxes. On the other hand, with the very same fund as an ETF, it's about one-third of 1 percent. So for taxable accounts, the ETF is a no-brainer. For tax-deferred accounts, it doesn't matter as much. But I will say that having talked to people who work at Vanguard, they are trying to get people to use the ETFs as much as possible because they are more efficient. Now, what they don't want people to do, I think,

Starting point is 00:39:43 is to start trading ETS because you can. Right. That's not the reason that they're an advantage. Right. All right. So we've talked about for U.S.-based investors, but what about 90% of the Afford Anything audience is based in the U.S.? The other 10% are based across Canada, the U.K., mainland Europe, and Australia, New Zealand. If you're based, let's just, let's say you're somewhere in mainland Europe, how should you think about asset allocation when it comes to your mix of U.S.-based equities and other international equities?

Starting point is 00:40:18 It's a tough one. And first of all, I don't have the statistical answer for you. What I have is more human emotional answer. I know that home bias is important to most everybody. And so it would not surprise me for Canadians that they could have, if we were building a portfolio of large blend, that there could be a large blend, Canadian portion of the portfolio, and the other half could be distributed amongst these other asset classes that could come out of the U.S.

Starting point is 00:40:59 Typically, the U.S. has been the best at providing these kinds of factor funds so far, as far as I know. And by the way, DFA is available in Canada for people who want to access. the dimensional funds through an advisor. And now that ETS are available, typically ETFs, I think, are available through any market that has access to the U.S. market because they are simply stocks to be traded. Right. But I think maybe the home bias, you allow that, or maybe the home bias gets a third of the

Starting point is 00:41:37 portfolio, maybe a third of the portfolios, U.S., a third of the portfolio is, a third of the portfolio is international. Of course, you want to be in the asset classes that are built to get a better rate of return and have low expenses. Should your U.S. exposure necessarily be lower because of the fact that you live overseas? It's common for people to have home bias, but let's assume that a person didn't. Could they invest in the same way that we have been discussing so far? Or would there be drawbacks to that? I think the drawbacks, and I'm not an expert in this, but I have had correspondence with people in other countries. They have taxable problems with things that are not in their market.

Starting point is 00:42:24 So it gets complex enough that as small as we are and as underpaid as we are. Zero paid. We really focus on mostly U.S. Although we have a lot of folks that follow us overseas, but I think it's more for the asset allocation. Now, they're trying to figure out how to get access in their particular country to these different asset classes. And oftentimes, unfortunately, they have to pay terribly high expenses to get at those asset classes. Right. Yeah, it certainly creates friction and drag.

Starting point is 00:43:14 Turning our attention to another subset of the audience, actually a much bigger. subset of the afford anything audience to the people who are listening who are parents what can parents do to set their kids up given and I'll put the asterisk here given that the people who are listening have kids ranging in age from one to 30 plus yeah yeah I have a 59 year old son so I understand this is to me it's a very important part of our work and that is just nudging people to think in terms of small steps that they can do to help their kids, like the one-year-old.

Starting point is 00:43:57 I have a new granddaughter. She's just about to turn two. And just like the rest of our grandkids, when she was born, we put money into an account that is meant to feed the Roth Kitty when she qualifies to have a Roth. And to put that money away now gets it out of our estate. And to the extent that there'll now be a way to know that we're going to fund a Roth IRA as soon as that child can earn some money, which we all know, starting early, is the big step. And we show if people would take the responsibility of putting aside $365 a year,

Starting point is 00:44:44 a year. A dollar day? Yeah, the dollar day, until the child is 21. And the family tradition will be that the child then will take it on to age 70. And I think a child being born today is probably, I don't know what the fire movement will be like, but will probably be working until they're 70 years old. So what do you do with that $365? I think you invest it in great companies and the best way to be.

Starting point is 00:45:14 invest in great companies is through ETFs, mutual funds, all equities all the time. In fact, I hope when my granddaughter is 18 and she opens up the letter from me and the video from her grandmother and her grandfather, she is going to be committed to doing the same for her children and her grandchildren. But here's what I know. $365 a year socked away as fast as possible and to a Roth, by age 70, at a 10% compound rate of return, will be worth about $2.8 million in equities, all equities. And that's what it should be, I think, all equities for the rest of their life. And that it is such a great lesson when you realize that if you wait for 10 years

Starting point is 00:46:07 and then you start putting away the 365 until they're 70, it's worth about 1.1.5. 1 million. 3,650 becomes worth about $1.7 million more. And this is the reason that we need young people to understand the importance of starting early. And when you start early like that, you also have the foundation to have a conversation. And by the way, what I told my kids when I funded their IRAs when they were young, I said, if I find that you have spent, any of this money before I die or before you're 59 and a half. That's the last money you're going to get from me. And I recently, because my son turned 59, I asked him, did you really believe me? He said, well, I wasn't sure. But none of the kids have touched their hires. We need some rules for sometimes

Starting point is 00:47:05 because they don't understand all the implications of that. But there are so many ways that we can help with 529s and you can even monkey around with an IRA potentially through a 529 if you keep it around until I think they're age 25 or I can't remember the exact date. But there's a lot we can do to get started early and we're never going to miss it. We are not going to miss it. You said your son turned 59. Has he turned 59 and a half? No, he hasn't. I don't think. Are you going to throw a party for him when he turns 59 and a half? Because that's a big birthday in the financial world. You're right.

Starting point is 00:47:47 You're right. I mean, 59 and a half and then 70 and a half. Those are the two big ones. Well, he fired at age 50. I'm a typical parent. I had this picture that the two of us were going to run the – he ran the company with me. And that we were going to do this. And after I got out, he was going to be there to continue to carry the mantle.

Starting point is 00:48:06 And when I retired, he retired. plans we make. Right. And the random events that happen. You know, you talked about the importance of starting early. And I want to highlight one of the things that I know you've done. You helped create a curriculum at a college. It took basically 10 hours of lobbying and working with the university at Western Washington University in Bellingham, Washington.

Starting point is 00:48:35 The program will eventually be required for, all students to graduate, they have to have this 40-hour education. The education is fit to the year they are in school. So when they are freshmen, it's going to be important that they know budgeting and charge cards and all sorts of things, not about investing when they're a freshman. By the time they're a senior, it is important to understand what a 401k plan is. And I want every student to know what an index fund is. I want every student to understand that as soon as they get an amount of money that makes it worthwhile for people to call on them, to try to sell them something that probably isn't in their best interest, that they just need to know that's going to happen.

Starting point is 00:49:27 Because if we do a good job of training them, they won't ever need Wall Street, ever. Beautiful. What an amazing thing. I'm very excited. An amazing thing to do. And I teach there. I'll be able, because I spent half my year in Portland and half my year in Rancho Mirage, I can teach class via Zoom. They accommodate me, so I don't teach every week.

Starting point is 00:49:50 They have a regular professor who teaches, but I get to do a couple of hours of teaching, which I just love. Wow. All right. Final question. Yes. What are some of the biggest mistakes that you see investors make? Well, in, we're talking millions, 12 simple ways to supercharge your retirement, the biggest one, the biggest million dollar, multi-million dollar payoff is the decision stocks over bonds.

Starting point is 00:50:17 It is unbelievable the difference. And just to give you a taste of that, from 1928 until 2023, $100 in bonds, government bonds short to long term, made about two, thousand to about $12,000. $100 in the S&P 500, just a little under a million. In large-cap value, about $3 million. Small-cap blend, about $4 million, and or five. And in small-cap value, almost $15 million. So young people, even people that aren't so young, I want to see a lot of equities in their portfolio as long as they understand the risk they're taking, and it's prudent for them. That's why I don't try to be their investment advisor. And the one thing for younger investors, I don't think that young people really understand what investing is, and I think there are a lot of older people who don't truly understand what it is. It's a partnership. It is a legitimate

Starting point is 00:51:27 business. In fact, it will be a very large legitimate business if you treat it like a business. But the bottom line is you as the senior partner, and the reason you're the senior partner is because you're putting the money in the company. Nobody else is, maybe grandma and grandpa, mom and dad might put it in there. But other than that, you are putting the money in to build that business. And as you, as take that money and you put it into the stock market through a mutual fund where you have literally thousands of companies going to work every day and people work, and they are legitimately working for you. But you're passive.

Starting point is 00:52:12 You know, you're a boss sitting up with a big cigar there not having to do anything. But the bottom line is, people underestimate the importance of the senior partner and that money that goes in. At the end of the first year, if you put in $1,000. And the market goes up 5%. Okay, you have $1,050 approximately. What did the market do? 50 lousy dollars.

Starting point is 00:52:39 What did you do? A thousand. And so you are, as a young investor, or whatever age you are starting to invest, you are the dominant force here. And so I want you to be thinking, how about upping the ante 3% a year? How about doing something that will just force you to save a little more to build your business to be bigger?

Starting point is 00:53:02 Now, I can tell you this. At the end of about 10 years, you are still in charge. You still represent most of the money in that account. But by the time you're 20 years in, you are now a junior partner because the money, the market is paying you much bigger bucks. There'll be a year that you put in 2000 that you're going to make $100,000 from the market. That's likely what's going to happen. And I do believe if we can get first-time investors to realize what that partnership is

Starting point is 00:53:33 and the responsibility you have in growing it, that you're more likely to get in there and do your part. If we don't set expectations for people in life, they don't do much. If we can figure out how to set reasonable expectations, more gets done. And that's what you're trying to do. What we're trying to do is to motivate people to move to action, but to do the right thing. And I'm not going to be around to be preaching this stuff in 10 years, but you still will be and others like you. And I just, I am so hopeful because there weren't people like you around 30 years ago, 20 years ago. It's new.

Starting point is 00:54:23 It's just like at one time, the only show on TV was Wall Street Week or nightly business report. That was it. Now we have 24-hour Bloomberg and CNBC and all the Internet stuff. I mean, investing has never been more, more efficient, cheaper, more diversification. Everything is better today from when I was your age. age, everything. The bad news is there's so much terrible advice on the internet. And I don't know if young people, inexperienced people, uneducated in this particular area, know the difference between a really good con artist and somebody who is teaching them what's in fact in their best

Starting point is 00:55:12 interest. And you and I are going to keep trying. And that's what we do. Thank you, Paul. What are three key takeaways from this conversation. Key takeaway number one, diversify across equity asset classes for better long-term returns. Merriman recommends diversifying across large-cap, small-cap, and value stocks to potentially improve long-term returns while managing risk. Now, that might sound like a duh statement, but it means that you go beyond simply investing in the S&P 500 or in a total stock market index fund. He suggests a simple four-fund strategy that has historically outperformed the S&P 500. If you replaced that S&P 500 with a portfolio that's 25% in the S&P,

Starting point is 00:56:12 25% in large-cap value, another equity asset class, 25% in small cap value and 25% in small cap blend. And believe it or not, going back all the way to 1928, the volatility is lower with the four funds than the one, and the return is almost 2% higher. And will the future look like the past? We all struggled with whatever we believe about investing. we do know there is no risk in the past.

Starting point is 00:56:50 We always know what we should have done. That is key takeaway number one. Key takeaway number two, start investing early and often for significant long-term growth. Merriman emphasizes the importance of starting to invest early and doing so consistently, even if you can only contribute small amounts. He illustrates how investing just $365 per year from birth to age 70 can lead to substantial wealth accumulation. $365 a year socked away as fast as possible into a Roth.

Starting point is 00:57:29 By age 70, at a 10% compound rate of return, will be worth about $2.8 million in equities, all equities. And that's what it should be, I think, all equities for the rest of their life. and that it is such a great lesson when you realize that if you wait for 10 years and then you start putting away the 365 until they're 70, it's worth about $1.1 million. $3,650 becomes worth about $1.7 million more. Now you might be thinking, well, I can't invest from birth. Fair, but you're probably investing more than $365 a year.

Starting point is 00:58:17 Merriman's point with this example is that investing even a small amount of money, a dollar a day, can add up to a very big amount if you do it for a long enough time period. That is the second key takeaway. Key takeaway number three. View investing as a partnership with businesses. Merriman encourages us to think about investing as a partnership with businesses, where we, the investors, are the senior partners providing capital. This perspective can help motivate consistent investing and long-term thinking. As you take that money and you put it into the stock market through a mutual fund where you have literally thousands of companies going to work every day and people work, they are literally.

Starting point is 00:59:10 legitimately working for you. But you're passive. You know, you're a boss sitting up with a big cigar there, not having to do anything. But the bottom line is, people underestimate the importance of the senior partner and that money that goes in. At the end of the first year, if you put in $1,000 and the market goes up 5%, okay, you have $1,050 approximately. What did the market do? 50,000. 50, What did you do? A thousand. And so you are, as a young investor, or whatever age you are starting to invest, you are the dominant force here. Those are three key takeaways from this conversation with acclaimed investor, Paul Merriman. Thank you so much for tuning in.

Starting point is 01:00:01 If you enjoyed today's episode, please follow us in your favorite podcast playing app, whether that's Apple Podcasts or Spotify or whatever else it is you used to listen to podcasts. Also, subscribe to our YouTube channel, YouTube.com slash afford anything and hit the bell for notifications. And as always, if you got value from this episode, please share it with a friend, a family member, a neighbor, a colleague. Share this with the people in your life. That's how you spread the message of strong financial health. Thank you again for tuning in. My name is Paula Pant. This is the Afford Anything podcast, and I'll meet you in the next episode.

Afford Anything - Paul Merriman: The 4-Fund Strategy That Beats the S&P 500

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