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We welcome Paul Merriman back to the show. Today we talk about how handle a bear market. How can we stick to our investment plan when our portfolios drop by 20% or more?

Paul brings his experience and wisdom to this important issue. We discuss everything from defensive moves you can take to whether the market is over-valued.

Topics Covered

  • Paul’s recent meeting with Vanguard founder John Bogle
  • Whether one should diversify beyond the S&P 500
  • The role luck plays in a person’s success
  • Should investors wait to invest until the market comes down?
  • What it means to be a long term investor
  • Paul’s retirement portfolio
  • How to defend against a bear market
  • How to invest a large sum of money
  • The role PE ratios play in valuing the market
  • How to stick to your investment plan when the market drops
  • How to invest 5 years before retirement




Rob: Paul, welcome back to the show.

Paul: Well, it’s great to be back, Rob. Thanks for the invitation.

Rob: How is your summer going?

Paul: It’s been a fantastic summer. I did a little traveling. My wife and I attended this amazing relationship workshop over a weekend. It drives her nuts but while I’m sitting there listening to the experts talk about relationships I’m making notes about how that applies to investing. I learned about love and finance all in one weekend.

Rob: Your poor wife. We feel for her already.

Paul: She survives. And, of course, I had that amazing trip. I mean it was truly one of the highlights of my whole professional life—that meeting with Jack Bogle in his office surrounded by teddy bears and books and what a guy he is. It’s just amazing what he’s done for your listeners and readers and my listeners and readers. He’s a hero.

Rob: How did meeting come about?

Paul: I’ve wanted to do it for a long time and he’s invited me to come back and have lunch with him but as it worked out I called him and said I was going to be on the east coast, and he has this lady, Emily, who has worked for him for 27 years. She adores him. And I think he adores her. She’s a marvelous assistant but she basically set the meeting up. It was supposed to be for 60 minutes but he was kind enough—he could see I had more on my list of things I wanted to talk about and he let me get through everything.

Rob: So are there any nuggets of wisdom or things you’d like to share about with your conversation with Mr. Bogle?

Paul: Yeah, I think there were a number of things that struck me as being important to all investors. Part of what made Jack Bogle—at least from my view, to become so successful is he’s tenacious. He’s passionate. He really believes and lives his own life the way he feels people should invest in terms of his attitude towards money and thrift and frugality and all the things that have made him famous. But the other part that we shouldn’t forget– and I didn’t really understand this until I was in that meeting is how lucky that man was because as I think you know that attempt to start that fund the S&P 500 almost failed. It was a $250 million Dean Witter underwriting that was supposed to start the fund.

They raised $11 million and there were people who wanted to simply return the money to the investors and just forget about it. But Jack was tenacious I think and having spent a little time with him I can imagine what it would be like to have him at the director’s table making his plea to him continue. But then think about this, if you wanted to have fun to sell imagine being able to sell a fund that had the first 25 years of track record that is between 16 and 17 percent compound rate of return. How difficult would that be to sell? And what if I told you that this fund was not only compounded at those returns but that they represented the most conservative, biggest, established companies in the economy? That’s luck because what if he had started that fund in 2000? And from 2000 to 2009 it loses money at one percent a year. How famous would he be if that had been the beginning? And there’s one other thing that struck me because you and I have learned from not only Jack Bogle and Paul Samuelson—and, by the way Paul Samuelson was his kind of hero academically. He based a lot of what he wanted to do it Vanguard based on what Paul Samuelson had had written in his work. You and I look at Dr. Fama and Dr. French and a lot of other experts’ academics who have brought a ton of information to us but he is still stuck. Now, when I when I say stuck I don’t mean unfortunately stuck. But, his commitment is to the information he received and believed back in the ’70s so he’s not really open to Fama and French’s work and the others who have come since. So he is just this firm believer that, basically, you need the S&P 500, maybe the total market index. And, if you’ve got any small-cap in your portfolio three percent is plenty, or whatever the amount is in the total market index. I understand better than I ever did before why he is such an advocate of basically the S&P 500. You and I are trying to get people to look beyond that to diversify beyond that. But that’s his belief system and that’s important in the decisions we all make as investors.

Rob: Right. And in that sense he shares that belief with Warren Buffett who, obviously, buys companies in individual stocks. I mean, what he said about how he wants his wife’s money invested, he just views it as S&P 500. It’s a perspective. One thing you said that really struck me was his view of the role luck played in his success because I’ve come to believe that anyone who attains some level of success, luck is a significant part of it. It doesn’t mean they’re not hard-working. It doesn’t mean they didn’t hustle. It doesn’t mean that in their field they’re not smart. I think it’s actually a sign of positive character. Someone who acknowledges the role that luck played in their success. I know Warren Buffett acknowledges the role that luck played in his success, for example.

Paul: But he was prepared, I think. And I think both of these guys—

Rob: Yeah, but he said, “If I were born in a different time my skill set wouldn’t have been fairy valuable.”

Paul: And he’s right.

Rob: Do you think luck played any role in your success?

Paul: Yes, of course. Although I think I worked hard to try to create opportunities for good fortune. Getting publicity and getting on a national T.V. show—They actually had turned me down probably a dozen times— Wall Street Week did, over the years, as just not fitting in their audience. I’ve always been a little bit of, too much hype. I might be accused of being too much salesmen and not enough academics. I probably came across as somebody who was a bit of a suede-shoe salesperson and they didn’t want that. Then one day they wanted that. It came out of a meeting that they were having. Whatever happened in that meeting, after saying no to me a dozen times, they asked me to come on. That had to happen. Something had to happen in that room that my name came up and that I would fit what they were trying to do with that show. I would call that luck, but it had to come with a lot of effort to get it.

Rob: Sure.

Paul: What about you?

Rob: They say, the harder you work, the luckier you get. Take my business for example. I feel very fortunate to have what I have in terms of the website and everything. I worked very, very, hard and still do. But yeah, there’s no question that luck played a role. Probably one of the luckiest things was timing. If I had started my blog—it wasn’t a business when I started it. It was more of a hobby when I started 10 years ago in May of 2007. But, if I had started it two years ago, I could have worked just as hard as I did 10 years ago and I don’t think I would have achieved the reach that I have. The Internet has changed dramatically in 10 years. I absolutely feel that luck has played a big role. And it’s played a big role in my legal career too. I got very, very, lucky that I ended up working for the law firm that I worked with, and more specifically, the partners that I worked for when I was a young associate. That played a huge role in my success there. Yeah, I think luck has definitely played a big role.

Paul: I talk to a lot of young people. I teach college kids and one of the points I make—and I think Buffett talks about this too, and that is the importance of integrity. If you can build people’s trust you do not have to be a genius. You need to know what you’re doing. But, if you can build people’s trust it is amazing how lucky you will get. I think that is the key to long-term success particularly in this business because there are a lot of people who we know are not trustworthy. They sound trustworthy but we know by their deeds that they aren’t. They’ll get caught eventually. And I think if you can stay on the straight and narrow most people know we can’t tell the future. We do the best we can in getting people to prepare for the future, but we can’t know the future, and yet at some level they want us to know the future and so they put trust that we’re doing the best that we can for them. At least that’s what I hope.

Rob: Yeah, me too. And speaking of the future, the topic for today is bear markets. How do people prepare for a bear markets? Should they prepare for a bear market? And when we have one, how do we ride it out? How do we stick to our investment plan? I suppose one could ask, should we stick to our investment plan? I thought the way we might start, Paul, if it’s okay with you, I get a lot of questions from folks either in the Facebook group or in an email to me that say something like, “The market seems very overvalued right now and I have some money to invest. Should I invest now or should I hold it and wait until sometime in the future?” And just for a point of reference, I’m looking at the Shiller PE ratio right now. The current ratio is about 30—just over 30. Going back—I don’t know how far this goes back. I know because back to at least 1920. But the average is between 16 and 17. But today it stands at 30. So, let me throw this question to you first. If someone has money to invest right now—let’s assume they’re going to follow some low-cost index fund strategy, whether it’s your ultimate buy-and-hold or maybe something different. Should they do it now or should they wait? What do you think?

Paul: I think if you are going to be a long-term successful investor, you’re going to do that based on some discipline. There are a number of disciplines that have historically made sense. Let’s just take the dollar cost averaging approach which probably most of the listeners who are in a 401k plan, that’s what they’ve got if they allow that to happen. And you’ve got to remember that the same concern folks have right now is the market is overvalued. I’ve been there when the PE ratios were six and seven times earnings in the ‘70’s. Guess what people said? The market is overvalued and it’s going down further. So this is a lifetime challenge for investors to find a discipline that they will maintain. If their discipline is buy-and-hold and if their discipline is dollar cost averaging then from my viewpoint that’s what they should do, and to the extent that they don’t have the stomach for the natural losses that are part of the process of investing, they need to have some sort of defense built into their portfolio that neutralizes the losses somewhat when the going gets really tough, because bear markets are just part of the process. There is one every three or four years over the last 100 years taking away about 30 to 35 percent of the value of one’s portfolio. That ought to scare the heck out of anybody who has a low risk tolerance.

Rob: It scares me, kind of. You said a lot there. I want to break it down for people. You mentioned long-term investors. So we are talking about long-term investing, but what does that mean to you? Is there some sort of number of years one should plan to keep their money in the market before they buy a stock index fund? What is long-term investing to you?

Paul: Well, for me it is pretty simple. It’s the rest of my life. I think the key is, when you’re thinking in terms of the rest of your life, how will you change your portfolio during those years, however long that life is? Now, if we want to go into a discussion you might have with a financial planner, they would say, “Okay, let’s look at the money you’re going to need for the next five years.” That’s often a position they’ll take. And they’ll tell you that if you need the money within the next five years you should not have that at risk at all. This could include maybe a child’s educational funding which should be in some sort of a short-term fixed income instrument, so five years is kind of a traditional starting point. But I’m thinking, if you’re an investor you should be looking out 10, 20 or 30 years when we’re talking long-term remembering that for a 10- year period as we know from 2000 through 2009 the S&P 500 loses money. It loses about one percent a year for a decade, so if you’re not willing to kind of live through that, you’re not likely to be a successful investor.

Rob: That’s an interesting data point. I use five years when people ask me. If you’re going to need the money for something in the next five years whether you want to buy a home, or like you said, a child’s education fund, or maybe you’re in retirement and you just need to spend the money to live. I tend to keep it out of the stock market for that period. But you are right. You certainly could have a down market over longer that. There is no magic to five years. You could have a down market for longer than that. It’s interesting, in the 2000, 2009 time period you mentioned, if you could imagine two different investors; one is someone who’s working and contributing to their 401k and IRA. Maybe taxable accounts every month or whatever. And then compare that person from the 2000, 2009 period to retiree who’s living off their investments and not investing any more money in the market. They’re going to experience two very different returns over that time period because the person who’s investing is going to be putting money in when the market’s down during that time period. Of course it didn’t just gradually go down one percent. It went up and went down, it went up. And, of course, it crashed in ’08, ’09 and went back up again. I think when you start to get to the retirement years where you’re really living off the money, I’m not sure what I’ll do when I get there in terms of how many years of expenses I’ll keep out of the market. Do you think that way in terms of your own finances? Do you have certain number of years worth of expenses that you keep out of stocks? Or do you not think of it that way?

Paul: Well, in our portfolio, in the buy-and-hold portion we’re 50/50 stocks and bonds. So, in essence, since we take out five percent a year to live on, we’ve got 10 years worth of money in bonds right now. They are short to intermediate bonds so I’m not taking any risk. That’s the stabilizing part of my portfolio. I’m not looking to bonds for income but for stability. But, I don’t let those bonds just sit there and support that five percent distribution. The distributions come out of a portfolio—the equities are sold off as they go up and that’s rebalanced periodically back to that 50/50. Because the market does mostly go up over time, I keep siphoning off the good stuff to put with the stable stuff and to be there for the long-term. Here’s where it becomes a challenge to investors to do that. That’s easy to do when you’re retired and you’re making money in the market to rebalance and take money out of equities to reward yourself for having been so smart. What happens when the market goes down? Now, in order to rebalance you need to take money out of your bonds and put that money into stocks—Wait a minute… I can remember as an advisor people saying, “Are you sure? I mean, we’ve been we’ve been doing well with the bonds and the stocks I’ve been paying.” And I’d say, “Trust me, this is the way it’s supposed to work.” You take from the rich and give to the poor. You keep rebalancing. Take advantage of those lower prices. And they say, “Okay, okay. We trust you (we think).” And the next year you get back for a meeting and the market has gone down again, and you’re telling them again that it’s time to rebalance. They say, “Are you crazy? That’s what you told us a year ago and we lost more money!” It’s not as easy as it looks for people to do that. This whole idea of buckets of money where you take money out of the fixed-income and just ignore the equities—for some people that may just be the way to do it.

Rob: Right, right. That’s interesting. Certainly, I’ve invested long enough to know there were times when the equities didn’t seem like they could fall and they just kept falling and falling and falling. Yeah, it is hard. No question. One thing you said a few minutes ago, speaking of a falling market, is that you used the term you could add some sort of “defensive element” to a portfolio. What did you mean by that?

Paul: There are a couple of defensive elements. We were talking about the 2000 through 2009 period. The S&P 500 had a horrible return. And, by the way, yes, it was wiped out badly in the 2007 through 2009 bear market but it did that in the 2000 through 2002 bear market as well with almost the same losses, over 50 percent on the S&P 500. So, one thing we know over that period and many others is that when you defensively spread your money amongst not only the U.S. but International, not only large-cap but small-cap, not only growth but value—when you look at that same 2000 through 2009 period, what had been less productive in the previous 10 years because the S&P had been so amazing—in the 10 years the S&P faltered, these other things did okay. In fact, some of them compounded it better than 10 percent a year. That’s one defense.

Rob: Diversification.

Paul: Diversification. Then to diversify away from equities by having fixed-income and also, I think probably the best defense of all—and I would not retire. I’m still working but without pay, but I refused to stop making money and putting it away until I had over twice what I needed to retire. To me, that has always been the thing that really has allowed me to sleep easier. It meant that I kept working a lot longer than a lot of other people in this industry who can get burned-out because it’s an industry that when you’re in the trenches and the market’s going down, it’s a tough business to be in. When it goes down twice in a 10-year period, it’s double trouble. I just stuck to it until I had more than I needed which allowed the market then to do its terrible things without making my life terrible.

Rob: Paul, I’m smiling while you say all this because I imagine the listeners of this show right now. They’re in their car going to work. They’ve got their Starbucks and they took a big drink of coffee right when you said they should save twice as much as they need to retire and they just spit the coffee out all over the dash and windshield. Of course, not everyone can do that, but certainly—

Paul: Well now, wait a minute. I want to challenge that because I want them to take another gulp here. It isn’t all about how much you save. That’s obviously important but everything that happens after you save, if you do the right things— and these are all things that you and I would agree with I believe, index funds, low-cost, broad diversification. Maybe more in equities than you’re comfortable with when you’re young because you have some fear of the market. The two of us would probably tell a 20 some year old to be all in equities. Take the risk of bear markets when you’re young and take advantage of bear markets. There are things you can do that can get you to that point of having over-saved. The last thing you can do is establish a lifestyle that allows you to be able to have doubled what (in essence) you need. My wife and I have a home down in San Miguel de Allende, Mexico. I know lots of people down there who basically are living off of Social Security. And for them to have twice as much as they need might be a $250,000 to $500,000 savings plan, whereas somebody else might require $10 million. So it can be done almost at every level but you’ve got to be smart and you’ve got to really work hard to cover every defensive base you can.

Rob: Right. I guess I would add to it and maybe this goes without saying, but for me one of the biggest, most significant defensive measures (if you will) is, no debt. And I recognize that younger families who are going to buy a home are going to have some debt, but by the time you retire if you don’t have any debt it gives you great flexibility in what you spend from year-to-year. Obviously, you’ve got to survive but beyond that, debt takes away your options and it increases what you need on a monthly basis which makes saving twice what you need—and I’m going to call that the Paul Merriman strategy, all the harder.

Paul: I’ve got a question for you.

Rob: Okay.

Paul: There’s one other thing I think is really important here. How important do you think it is that your spouse agrees with whatever strategy you have toward saving, investing and creating in a lifestyle that in fact allows you to live within whatever those parameters are? How important do you think that is, Rob?

Rob: That’s critical. That’s a good point because I get emails from folks that say, “Yeah, I’m with you Rob, but my significant other—we don’t see eye-to-eye.” In my case, my wife and I have very, very, similar views of money. We’ve been married 29 years now, in a couple of weeks—I’ve got to get a gift! I have nothing for her at this point. But, I didn’t ask her about money. I didn’t know her credit score. I didn’t know if she had debt or not or if she was frugal or spent money differently than I did. In fact, the truth is, when we got married I was far worse with money than she was. I changed after I got out of law school. I’m not really sure why. I guess I felt like it was time to grow up but, yeah, if you don’t see eye-to-eye, it’s something you’ve got to work on. We all know that money is one of the most leading causes of divorce and just general trouble in a relationship. To me it’s critical. What do you think, Paul?

Paul: I think so. Unfortunately, life has not been easy for me always, Rob. I’ve been married four times. I hate to admit that but that’s given me a ton of experience that I would not otherwise have in terms of dealing with money. You talk about wanting to pay off the mortgage. Every time I got married one of my first objectives was to pay off the mortgage. And when you’ve got to do that four times it’s hard. You’ve got to work a lot of long hours. But, I will tell you, one of the problems was that we did not have agreements on some of those financial decisions. The other thing that causes problems is when somebody that is a workaholic. I’m not accusing you of this but I’ve spent a lifetime of working way more hours than I should have. Was that driving me to save more money? Was I kind of digging my own hole by focusing too much on money? I try to counsel young people to find a balance. I didn’t until I was in my 60s. Everybody’s got a story which, but the way, Rob, is why I think most people need to find an advisor to work with. If for only a year—if for only three months, to kind of work through those stories to find out what makes you special as an investor.

Rob: Well, I feel very fortunate in the sense that my wife and I have seen eye-to-eye. By the way, and this will have already been published by the time folks listen to our discussion today but I met with two different advisors. Both of whom were guests on my show. They were both very different in their approach to helping people. And I found the experience in both cases to be very rewarding. I learned a lot. Not so much from a portfolio construction perspective but a lot of interesting guidance particularly on tax issues for me that I think will benefit my wife and I significantly. So, whether you have someone manage your investments is one thing, I do agree. I think a lot of people can benefit from talking to an advisor (as you say) even if it’s just for a short period of time. I couldn’t agree more.

You mentioned the Shiller PE ratio. It stands at 30. I’m looking at this chart that they have on the website. And if I’m reading it correctly there’s only been one period in our history going back to 1880 where the Shiller PE ratio was higher than it is today. If we go back to 1929, it was basically the same as it is today, around 30. The only time it was higher was in December of 1999. It was 44. There was some period of time where it was going up to that point, of course, and coming down. But it hit its peak there in December of 1999. So it’s 30 today. Do you find that a meaningful data point in assessing whether the market is overvalued? Or, regardless of your answer to that question, whether it should influence the way we invest?

Paul: I have dealt with that when I’ve talked to people who have lump-sum investments to make. Oftentimes those people do not have a history of investing. This is something that’s happened—maybe they have inherited money or maybe they’ve gotten a big rollover from a pension fund that now they have responsibility to put to work. Those people I often recommend they dollar-cost average into the market. And I would do that regardless of whether the market was high or low, only because even low markets can go lower.

The worst thing that can happen to an investor is to have them dump a bunch of money in the market and immediately it goes down 30 percent. They have likely been ruined for life as an investor because of the pain of seeing that money evaporate. To see that lost, they just can’t trust the market anymore. So, dollar-cost averaging is an emotional answer for people who could otherwise lump-sum, because the industry says, “Put it all in. Whenever you’ve got it, put it in.”

So then there’s the question about whether a young person who doesn’t have a lot of money second guess the market and maybe stop investing for a while in 401k plan and instead, putting that money in cash. Now they’ve become a market timer. What do they know about market timing? Almost nothing. They don’t know about the pain of timing. They don’t know about the responsibility of timing. They don’t know what it means to get on the wrong side of the market and not being able to figure out how to get back in the market when, in fact, the market does something that is different than what they expected. There are people still sitting in cash from 2008 trying to figure out how to get in the market.

Rob: Right.

Paul: Again, this is where it really is valuable to talk to somebody who can walk them through who they are and what they’re likely to do to stay the course. But the case for the likely loss that’s ahead of an investor today is very good. We were eight years into a bull market. Bull markets don’t go this long, very often. They do tend to do better after huge declines like they had gone through before this bull market started back in March of 2009. There’s just such a high probability that the market’s going to correct but in the ‘90s it went 10 years without a 10 percent decline. Ten years! What if you were sitting there waiting for that 20 percent decline (which is what a bear market is defined a) to wait to get into the market? You missed the ‘90s. So for most people even though it’s uncomfortable as can be, if they are a dollar-cost averaging into a 401k, just ignore the market. Because the minute you start letting the market—and there is always a good reason to be in and there’s always a good reason to get out. List A and list B, the good news and the bad. It’s always there so you can rely on something to keep you out or you can rely on something else to keep you in. The best thing to keep you in is the fact that you don’t know what the future’s going to bring. But the past—and this is something Dr. Gottman this last weekend in this relationship thing that my wife and I went to, he said that 60 percent of the things he thought would be the outcome of research that he was doing on couples turned out to be wrong, and that he believed that we should be acting on what we know, not what we guess. The minute we start doing what you’re doing there, is you’re starting to guess about the future and that’s dangerous because people get backwards on where they should be and sometimes never get out of that rut. In fact, I’ve seen investors who made one bad move in their life and it ruined them for the rest of their life as far as their trust in the investment process. So, I say stay the course. Don’t second guess your strategy unless your strategy is to be a market timer where you have a mechanical system and you do exactly what the system says to do. But guess how many people out of a 100 will do what the system says to do? Maybe, one! So market timing is a dead end for 99 percent of investors.

Rob: Right. Well, the other thing is when people ask the question, “Is the market overvalued?” they focus on the PE ratio. The Shiller PE ratio comes up a lot and that’s certainly a relevant data point, I suppose, but my view on it is, even if we assume the market is overvalued it doesn’t mean it’s going to go down. Or at least not go down any time soon. I think you made that point about the ‘90s, right? Eventually it went down. But it took a decade. Just because it seems undervalued doesn’t mean it’s going to go up. I’ve experienced that myself with individual stock investing. You can sit on a stock with a really low PE ratio for years. The other thing I think people—

Paul: I was once—

Rob: Go ahead.

Paul: I was just going to say I was once on a show called, Nightly Business Report with Paul Kangas on PBS and it was at a point that the economy was in the dumps and PE ratios were sky high. I’ll never forget my stance. My stance was, this is a very dangerous time. PE ratios are very high and at these levels the market rarely makes any money. Paul’s position was that those PEs were going to come way down when earnings go way up and in hindsight we’re going to find out that these were not high prices but low prices. And guess what? Paul Kangas was right and I was dead wrong. Those high PE ratios turned out to be of a false alarm.

Rob: That’s a good point. I mean, the PE ratio is not just about price. It’s also about earnings. And again, you see this in individual stocks where you see a PE that seems high but you realize it was based on the trailing 12 months of a company and for whatever reason they had some unique events that year that depressed their earnings. So it’s not necessarily a great barometer. The other thing is that when you value any asset, one of the key things to consider is the prevailing interest rates. That basically is a significant factor in valuations. For example, when we look back at December 1999 with the high Shiller PE, interest rates were over six percent for a 10-year Treasury. Today they’re two and a quarter. So that changes asset values. Not just of stocks but of any asset you want to buy. Listeners know that I make fun of my ability to predict anything. I predict that the Ohio State Buckeyes will win the national championship every single year.

Paul: Every year?

Rob: I think that’s a solid prediction. I don’t know why anyone would disagree with that but I also predicted that interest rates would start rising in 2010. So far I’m only off by seven years. But some day I will predict this. You know, they say predict what or when but never both. So I will predict that someday interest rates are going to rise.

Paul: I think that’s a good prediction but it can be a long time before we get back to what many of us knew in the ‘70s and ‘80s when I actually bought a CD from the Bank of Chicago for five years that paid 16 percent in my IRA.

Rob: First of all, I hope we never get back to those days.

Paul: I know.

Rob: But here’s the other thing. Do you remember this—because I had a CD as well and I was earning 16 percent. I was a kid—well not a kid, a teenager, and I can remember people being afraid. They didn’t want to lock their money away for five years. They were afraid rates would go higher.

Paul: That’s why I only bought a five year maturity. Exactly— guilty as charged.

Rob: Yeah. But I only had six months maturity so that tells you where I—again, that again shows my ability to predict rates. But I do think that valuations will come down. Again, that’s my terrible prediction but I’m going to predict it anyway, when interest rates go up. Don’t ask me when that’s going to happen. There are other factors. Interest rates can go up because the economy’s doing better and that can produce greater earnings so that can affect valuations. It sounds like you and I pretty much agree, that you should just keep investing and let the market just do what the market does which is go up and go down.

Paul: The course that I sponsor at Western Washington University is a four-credit course so they get about 40 hours of education and testing. In that 40 hours they do not learn what a PE ratio is. There is no reason for a young investor to know what a PE ratio is. Now, I know there are people right now saying, “Are you kidding! It’s one of the most important things that we should know. How can you know if a stock is good or bad?” And that’s exactly why I don’t want those young people to know what a PE ratio is because I don’t want them to even consider investing in individual stocks. In fact, I want them to be an index fund so they never have to go through that painful educational process to learn that in trying to pick individual stocks they’re likely to come out behind instead of ahead. That’s how I feel about the PE ratio. Not necessary.

Rob: You and I are very similar because you tell people not to “time the market” but I do know that as you said, half your portfolio is a market timing approach. I tell folks not to invest in individual stocks and just stick with index funds. I invest in individual stocks so does that make us hypocrites?

Paul: Well, actually I think what it makes us is, better teachers. I used to do six hour workshops when I was building my business. The morning was dedicated to buy-and-hold and the afternoon was dedicated to market timing. People would walk out of there and say, “What the heck does this guy believe in? Is a Republican or a Democrat?” because I made the case that both strategies are legitimate. Our business became much more successful when I just put the market timing on the back burner, carefully ferreted out the few clients that it was appropriate for, and made sure that I did what I could to take care of them with that approach and spent almost all my energy on buy-and-hold. Why? Because that’s what the public claims they believe in. So my job and I think your job is to teach people to be better buy-and-holders. You and I both know that if we tried to teach them what we know about being stock pickers—I mean, are you qualified to teach that, really? I’m not.

Rob: I don’t think I would teach it. I’ve never really thought about whether I’m qualified. Ask me that in 20 years, Paul, and I have the answer for you.

Paul: Okay. But we want to share information with people that they are most likely to apply and put to work and change their lives. And my sense is, from everything that I’ve seen, the majority of people who have individual stocks number, have no idea what their long-term return has been on that portfolio. They have no way to measure. I cannot find a stock broker that will show me his or her track record on how they’ve done for their portfolios of equities. Whereas, I can look at the S&P. I can look at Fidelity Magellan. I could I can look at mutual funds that have 30 or 40 year track records and know what they look like in the good times and the bad and the long-term. How can you make a real judgment about a strategy if you can’t measure that stuff?

Rob: That’s so true. I track the performance on my individual stocks but I almost never look at it. In fact, you were talking I looked it up. I tracked it all Morningstar. But it’s not an easy thing to do actually. Particularly with dividends and reinvestments, and not reinvesting them and taking some money out—it’s a hassle. It’s much easier to track your performance with an index fund. Okay. So, at the end of the day the goal here was to help people figure out—number one, if they should use sort PE or some view of market valuation to decide whether to invest. I think we’ve covered our views on that. And the second one was how to help people stick to their investment plan when the market eventually does go down, as we all know it will at some point. You had mentioned staying diversified, having some exposure to fixed-income, saving twice what they need for retirement. Are there any other last tips (before we bring the show to a conclusion) that people can kind of keep in mind for when the market does drop by 10, 20, 30 percent or more?

Paul: Well, I think they need to accept the fact that’s going to happen and to know that if they haven’t been through that— some people have been through it many times so they’re crusty and know how to live through it without much problem. But, for people who face it for the first time, it can be a challenge. And I think people need to belly up to the bar and sign up for the downside just like they’re signing up for the upside. I built a table called the, Fine Tuning Your Asset Allocation Table. It’s at paulmerriman.com. And on that table I have broken down portfolios of all equities to 10 percent equities, 90 percent bonds, 20 percent equity, 80 percent bonds, et cetera. You can look at each column and see not only what the return was but what the losses were in the worst of times—the worst year, the worst 36 months, and the worst 60 months. Know that that’s going to happen to you and are you willing to accept that? If you’re not, maybe you should move over a column and have more fixed-income. Maybe you should move over two columns and have more fixed-income. But then you’ve got to save more money because the return is not going to be is good. I’ve tried to give people tools and not just with 50/50 but 70/30 with all US, with the S&P 500 on its own so you can compare these different combinations of equities and fixed income to kind of try to figure out who you. But be affirm. You’re going to have to live through that loss and say that you’re willing to do it.

Rob: Right. I’ll find that table and include a link to it in the article to go with this.

Paul: Oh, great.

Rob: The only thing I would add, from my perspective is—Well, first of all, understanding that markets go down, understanding the history, setting the right expectations I think is critical in anything, in just about any endeavor. The other things that kind of help me; one is recognizing that when that when the price of an asset goes down whether it’s a stock or in our case an index fund, the businesses behind those stocks are still doing business. They’re still manufacturing products. They’re still providing services. They’re still making money. For those that pay a dividend they’re still paying that dividend most of the time. I mean, certainly there are exceptions such as the banking or auto industries in ’08 and ’09. But they’re continuing to pay a dividend. The fact that the market goes down usually doesn’t change that significantly, and those dividends get reinvested. When they get reinvested they’re buying more shares because the price is lower. And when the company continues with its buyback policy (if it has one) and it’s buying back its own shares, it’s getting more shares for the dollar because the price is lower. That’s sort of an academic thing, I suppose. Some people may not take comfort in that but I do because I know long-term it’s going to make me wealthier. That doesn’t cover up the 30 percent loss in the market. I mean, it’s not like I skipped down the street knowing that the buybacks are going to go a little further but it does give me some comfort. The other thing I do, by the way, Paul, is sometimes I just don’t look. There are periods of time I don’t look at my balance. That sounds kind of silly in a way but it helps me. I will say that I have lived through a number of bad markets already. I’m not sure but in some ways that helps me. At the same time, I have more to lose today than I did even in ’08, ’09. Certainly more than 2000 and 2002. So, when we hit that next bad market it’ll be interesting. I’m confident I won’t change my investment strategy. What will be interesting though is how I regulate my emotions and how easy or difficult that will be. I guess we’ll find out.

Paul: I have one suggestion to our listeners. Many people out there have been good been good savers. They’ve diversified. They’ve made a lot of money over the years. They still maybe have five years to work. But they have enough money that they could retire right now. When I was an advisor, I would normally try to convince that individual to make an adjustment in their portfolio as if they retired, because they don’t need to take the high risk anymore. I ran into a lot of folks who had an 100 percent in equities with the plan to go 60/40 when they retired. I would say, “Well, what would happen if in the next five years the market did go down 50 percent, would that change your future?” And they would normally say, “Yes, that would have a big impact.” I would try to have them consider changing their portfolio to the 60/40 now and lock in that retirement that they are looking forward to. And then they don’t have to continue to take that high risk. That is another good reason for people maybe to sit down with an advisor to find out if they are actually taking too much risk. Because a lot of people are. And, it will come back to haunt a certain percentage of them and they don’t have to go through that.

Rob: Right. Great point. Well, Paul, any last thoughts? I mean, we’ve been at this for an hour. If we haven’t covered this topic by now we’re not going to.

Paul: Well, there’s an article I wrote, Twenty-two Things You Should Know About Bear Markets.

Rob: Alright. Well, I’ll include that in the show notes too.

Paul: That would be good because it talks about the numbers behind historical bear markets. How long they last, how deep they go, and how far they come back. So, there you go. I always enjoy this, Rob. I wish you and all the listeners well and we’ll hopefully talk soon.

Rob: Absolutely, Paul. Thank you so much.

Paul: My pleasure.

Author Bio

Total Articles: 1081
Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

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