Over the past several months, listeners to the podcast have been clamoring for me to have Paul Merriman on the show. His Ultimate Buy and Hold Strategy has been a consistent topic of conversation in the Facebook group as well. Well, today I’m happy to report that we finally have Paul on the show.

We spend a lot of time discussing his Ultimate Buy and Hold Strategy. So, let’s take a good look at what it actually entails. Following that, you’ll find a list of the resources we discuss in the interview and a complete transcript.

Paul Merriman’s Ultimate Buy and Hold Strategy

Asset allocation is like a recipe. You have to decide what ingredients you want (asset classes) and how much of each ingredient. Paul’s Ultimate Buy and Hold Strategy uses historical data to construct eight investing recipes. These recipes focus exclusively on the equity portion of a portfolio.

As a baseline, he starts with a 100% S&P 500 portfolio, then tracks the returns and standard deviation for 47 years. This #1 portfolio would grow at an annualized compound return of 9.3% (after accounting for 1% in fees). The result would turn a $100,000 investment into more than $6.5 million.

As an aside, the 1% in fees reduces returns by more than most would think. The S&P 500 portfolio would return 10.3% without the fee. That “small” adjustment would increase the portfolio from $6.5 million to . . . over $10 million. Fees matter. A lot.

Read More: How to Determine Your 401(k) Fees

From portfolio #1, Paul begins to add additional asset classes. Portfolio #2, for example, reduces the S&P 500 exposure to 90% and adds 10% to large-cap value. The result is an increase in the returns to 9.7% and a decrease in the standard deviation (which is a measure of volatility).

You’ll notice he uses abbreviations for the asset classes. Here’s what each one represents:

  • US LCV: U.S. large-cap value
  • US SCB: U.S. small-cap blend
  • US SCV: U.S. small-cap value
  • REIT: Real estate
  • Int’l LCB: International large-cap blend
  • Int’l LCV: International large-cap value
  • Int’l SCB: International small-cap blend
  • Int’l SCV: International small-cap value
  • Em Mrkt: Emerging Market

Related: Large Cap vs Mid Cap vs Small Cap Mutual Funds

Resources Discussed in the Interview

Paul Merriman Interview


Rob: Paul, welcome to the show.

Paul: Rob, it is great to be with you. Thank you for having me.

Rob: I’m thrilled to be able to get to know you. We’ve talked some before this interview and having you on this show was important to my sanity and I’m going to tell you why. I get email after email” “Paul Merriman says this…” “Paul Merriman believes that.” “When are you going to have Paul on the show?” It was driving me crazy, so thank you for taking the time this morning to spend with us.

Paul: Well, I hope I don’t disappoint those people but it’s great to have a chance to share. That’s what my life is all about.

Rob: I can’t imagine you’ll disappoint anyone. The main topic of our talk today is going to be your ultimate buy-and-hold strategy. But, before we get to that, can we spend just a few minutes getting to know you? I know from our previous conversations that you “retired,” so to speak. You retired at the ripe old age of 40.

Paul: That was number one.

Rob: How did that come about?

Paul: Luck has a lot to do with life but you still have to take advantage of the opportunities. I ended up running a small public corporation that was going bankrupt. In fact, it was planned to go bankrupt 7 days after I took over as the president of the company. I kept them out of bankruptcy. I didn’t know anything about how to manufacture things or anything about the business in terms of running the business but I knew how to talk to the people about money. I got them new money and they survived. That actually led to my retirement at age 40.

Rob: And that, as you said, was your first retirement. What did you do after your first retirement?

Paul: I did what I thought would be something that would be absolutely amazing and fun that would help other people—I wanted to teach people how to invest their money. Even though nobody knew me as an investment advisor, I became one and built an investment advisory firm from 1983 through 2012 when I sold out and I retired once again.

Rob: There you go, your second retirement. Before you started your firm, your experience with investing, was it just based on your own personal investing or did you have a background in investing before you started Merriman Wealth Management?

Paul: I don’t know if you’re going to count this as experience in the industry, but for a couple of years in the ‘60s I was a stockbroker. That was my exposure to investing money. Of course, the reason I didn’t stay in that business is because the conflicts of interest are so overwhelming that I got out. But, there were things I learned that later when I was in a position financially to start over and apply the safe and sane ways to invest, I was able to invest and help a lot of people.

Rob: I’m curious. Do you think the conflicts of interest you saw back in—did you say the 1960s?

Paul: Yes. I was in business from December of ‘66 until January of ‘69.

Rob: Okay. Do you think the conflicts of interest you experienced back then changed any? Are they different? Are they the same?

Paul: They’re the same.

Rob: Can you give us an example?

Paul: Sure. We talked about the biggest hurdle for investors which are psychological hurdles. It’s not about knowing how to invest. That’s all in the textbooks and anybody can read those. The problems we have are getting over the psychological challenges of dealing with money and all the fear and greed. When you become a commission-based salesperson, you’re right back with the same set of problems. It’s just that you’re not facing those psychological problems as an investor. You’re now a salesperson. You’ve got bills to pay and people are yelling at you to get on the phone and make cold calls. We both know who the boss is in that business. When you’re a commission salesperson, you are not the boss. You are working for the boss who is telling you what to say, what to do, and how much they expect out of you each month in terms of productions. Those are overwhelming, psychological challenges for a lot of people to deal with.

Rob: Yeah. Up until the time you started your wealth-management firm, were you managing your own personal investments yourself or did you hire someone to help you?

Paul: At that point, I did it myself. Until I really kind of learned the inside story to successful investing, it was only then that I realized I needed to have somebody else take care of my money because it is not obvious to the personal investor, all of the challenges that they have. I know what their dreams are. I know what they want out of their investments, at least from my experience in the business—they want performance. I think I fell into some of those same traps. In fact, it was terrible. When I was a broker for those couple of years, they actually kind of teach you to be that way because short-term performance becomes very, very important. I got over that hump but wish I had learned those lessons much earlier in life which is why I still teach high-school and college kids when asked, to show them what I believe in and what I think will make them more money with less risk and with peace of mind. Having an advisor, for me, is part of that building of peace of mind. By the way, Rob, I’ve got a spouse who is 4 years younger than I. She’s got an MBA. She’s very smart but that does not make a person an investor. I want to make sure that not only am I taken care of, but when I’m gone, she’s taken care of by someone who really knows the ropes.

Rob: Can you give us any kind of insight into that? Who will that be? How have you set that up? I take it you’re the investor in the family, as am I…

Paul: Yes.

Rob: What do you do to make sure your spouse is taken care of if you’re gone?

Paul: Well, there are a couple of things. It was the same thing in terms of how I approached work as an investment advisor. I was big on education. I built the business based on education but I also based relationships with my clients based on education which meant not just that the husband, spouse, or whoever the interested investor might be, I wanted the couple to get the education. But, at the end of the day, with many couples, there’s one that really likes this process while the other really wants to find someone they can trust will take care of them. I’ve found that the secret in relationships oftentimes with a couple wasn’t that I got a disinterested spouse— by the way, they were never really disinterested. They just didn’t want to face all those ideas. But, if I could get them to trust me— trust that I was absolutely doing everything in their best interest, that they would then be ready to work with me if, as in most cases, the husband, pre-deceased them. I got the same thing with my wife. She knows Tyler. She knows that Tyler is doing everything that I believe in. And, by the way, I think this is one reason why your listeners need to get an education. At some point along the way, they’re going to ask for professional help and are they getting a professional who is doing what is in your best interest? I think, not only does my wife understand that my kids now understand what the steps are that are in your best interest. That, plus a relationship and I don’t have to worry about my wife being taken advantage of by some unscrupulous salesperson.

Rob: Right. Do you have someone now that helps you with your investments or is this just someone your wife will turn to in the future if she needs to?

Paul: I don’t spend any time, personally, on my investments. My advisor knows exactly what I’m trying to achieve and my own personal portfolio is not normal if you want to identify it that way (laughs). I do something a little bit different than most investors but it has to do with my peace of mind. I don’t want to face it every day. I don’t want to think about it. My job is to educate people on how to invest their money. I’ve got somebody I absolutely trust. I was involved in hiring this person, by the way, many, many years ago so it’s not like I didn’t know what I was getting into because he believes exactly the same things I believe, but I know he will do what I believe. I also know that if I get involved in the process, a lifetime of savings just sitting there—I actually have to struggle with some of the psychological challenges of fear. More fear than greed because I’m not greedy anymore. I’m 73. I just want to make sure this money lasts.

Rob: You said something that caught my attention. I’m not sure whether or not you’ll dive into it a little bit but you said you did something a little bit different than most investors, with your portfolio. Are you comfortable sharing what that is?

Paul: Oh, of course! It’s a little confusing to people sometimes because it’s like me professing to be a Republican and a Democrat at the same time and that would be confusing—

Rob: That would be impossible!

Paul: Well, let me see if it is impossible. I believe, 100 percent, in buy and hold. From everything I know having been around this industry since the mid-60s, both emotionally and financially, that people are going to be better off with a carefully built, buy and hold portfolio. I also happen to believe in market timing. In other words, buy and hold is a legitimate strategy and I know how to do that, but so is market timing a legitimate strategy.

Rob: I’ve got to tell you. Right now you’ve just shocked everyone listening to this podcast. They’ve probably rewound that 4 or 5 times to make sure they’ve heard you correctly.

Paul: Well, let me finish that thought and maybe that won’t confuse them. I know how to use market timing in a completely mechanical way and to completely eliminate my emotions in the decision-making part of the management of that portfolio that uses the market timing. But here’s the problem. Maybe one out of 100— or one out of 500 — individuals could do this on their own, so my work in trying to help people is to show them how to invest on their own. And, if that’s the case, I don’t want to suggest that they market time because I believe they will fail. Then they’ll say, “You know that market timing? I tried it in the past and it didn’t work. I’m never doing that again.” Well, that’s okay. But what I want to make sure you do is something that is probably much easier to deal with because there is no harder, emotional strategy than market timing. Buy and hold is absolutely doable by any investor if they understand the steps and the rules.

Rob: Interesting. Well, I don’t want to spend a lot of time on the market timing piece today. Maybe we can have you back on the show at some point to discuss that but I do have two questions about it. One question is why do you do it? Why don’t we start there? Why do you bother with market timing? Why not just have 100 percent buy and hold?

Paul: Well, let’s talk about what I’m trying to achieve with buy and hold as an investor. In my particular case, I’m 50 percent equity and 50 percent fixed-income. The good news is, when the market collapses, that 50 percent that’s in fixed-income is going to protect me from the huge—maybe a 50 percent loss. We’ve had a couple of them in the last 17 years where the market went down over 50 percent. And God help you if you were in the NASDAQ or the Tech wreck of 2000 and 2002 where people lost 80 percent and in some cases, all of their money. That fixed income is really precious when the market is going down. Remember I said I don’t want to run out of money before I run out of life? Well, I know that with that 50 percent fixed-income, taking out 5 percent a year, I know I’ve got many, many years—at least 10 years that I can, in theory, take 5 percent out. Now, what about the equity part? Am I going to sit there and just watch it evaporate and not do anything? Well, the answer is, yes. That’s the way buy and hold works. And that’s why it’s so important to have the right balance of fixed income in equity to make sure that it matches your willingness to lose money. Market timing is not about making money, by the way. That’s what a lot of people think—if you market time you’re going to beat the market. No, you’re not going to beat the market! What you’re there to do is defend against the worst markets. Remember in 1987, Rob, when the market went down 22 percent in one day?

Rob: I do.

Paul: I was totally in cash! Totally in money market funds. I had been there for over a month, by the way. It’s not like I saw that terrible problem coming at all. In fact, it was that one move that got me on Bruckheimer’s Wall Street Week because they wanted to find out how this guy knew to be out of the market when the market went through a 22 percent, one-day decline. Of course, the answer is that I didn’t know there was going to be a 22 percent decline. I just happened to be out of the market when it collapsed. And, what trend-following market timing does, particularly in the equity part of your portfolio, is give you an exit strategy.

Let’s think about my portfolio for just a second. Here I am, 50 percent buy and hold with half of that in equities which means is if half of my portfolio is in market timing and the other half is in buy and hold, then 25 percent is in buy and hold in equities. Again, there is no protection against the downside on that part of the portfolio. In the market timing part of the portfolio, I am actually 70 percent in equities and 30 percent in fixed-income but there is an exit strategy for the 70 percent. Investing is not about being perfect. In the buy and hold, not every stock goes up. Many of the stocks actually go out of business. That’s the reason I have 10,000 stocks in my portfolio. But with the market timing, there’s a way to exit and get yourself over into a money-market account to wait until the mechanical trend-following system says it is okay, then you get back in. By the way, you diversify that timing portion of your portfolio amongst large companies and small companies and value, growth and international, REITs and emerging markets. All those same kinds of asset classes are there that are in the buy and hold part of the portfolio. That all sounded very simple. Just follow the mechanical system and you’d get out. The problem is, the system is wrong, a lot. And people just can’t take being wrong a lot. You have 2 or 3 losing trades in a row and they say, “Are you kidding? This is the path to success?” Then you get back into the market a price higher than you last got out and they’re saying, “Wait a minute. Do you realize when you do that I now have you now have fewer shares than you had before?” Then, if you start believing in market timing, you start believing it is magic. And it’s not magic. It’s a lot of work. Again, I don’t want to do it. I know how it’s done and I’ve been around it since 1983, but that’s why I do it. I’ve always got a smile on my face. Something in my portfolio is doing fine because part of it is buy and hold and those equity asset classes are spread all over the globe. Part of it’s in fixed-income. Over in equities with the timing, I could be out when the market’s going down a lot. Again, there is a chance for a smile on my face. I sleep easy.

Investing is not about being perfect. In the buy and hold, not every stock goes up. Many of the stocks actually go out of business. That’s the reason I have 10,000 stocks in my portfolio. But with the market timing, there’s a way to exit and get yourself over into a money-market account to wait until the mechanical trend-following system says it is okay, then you get back in. By the way, you diversify that timing portion of your portfolio amongst large companies and small companies and value, growth and international, REITs and emerging markets. All those same kinds of asset classes are there that are in the buy and hold part of the portfolio. That all sounded very simple. Just follow the mechanical system and you’d get out.

Then you get back into the market a price higher than you last got out and they’re saying, “Wait a minute. Do you realize when you do that I now have you now have fewer shares than you had before?” Then, if you start believing in market timing, you start believing it is magic. And it’s not magic. It’s a lot of work. Again, I don’t want to do it. I know how it’s done and I’ve been around it since 1983, but that’s why I do it. I’ve always got a smile on my face. Something in my portfolio is doing fine because part of it is buy and hold and those equity asset classes are spread all over the globe. Part of it’s in fixed-income. Over in equities with the timing, I could be out when the market’s going down a lot. Again, there is a chance for a smile on my face. I sleep easy.

Rob: Is this what caused you to go to cash a month before the ‘87 crash?

Paul: That was simply a change in the trend. That’s all it was. And it could have been another losing trade for me.

Rob: Whatever the triggers are that can cause you to go in and out of the market, do you take the entire 70 percent in and out? Or is it on an asset class basis?

Paul: Good question. Asset class, by asset class, because there are times that a small in value might be doing just fine while large growth is going through terrible times. Again, I’m not second-guessing what’s going to be best mixed. I think that’s important. Eliminate that from the thinking about how to make money and you’re about 90 percent there in terms of being a successful investor.

Rob: Yeah. One last quick question on momentum investing and then we’ll move on to buy and hold. For those that think they’re the one in 100 or one in 500 that can do this, do you have any resources that you’ve written or any resources you can recommend that they read about this approach to investing?

Paul: There’s a fellow, Leslie Masonson, who has written a book I think is called, All About Market Timing. It’s a good basic primer on how to use timing. Knowing how to do it is not difficult. Doing it is difficult. Rob, I’ve literally been on a diet since the fifth grade. I have lost over 4,000 pounds and I know so much about losing weight. Don’t challenge my ability to understand how to lose weight, just challenge my actions and ask, “Why, after 73 years, are you still 30 pounds overweight if you’re so smart?” It’s because, when it comes to sex, food, and money, we are not talking about the intellect, we’re talking about the emotional part of the human mind, and those emotions rule. The question is: how do we get the bad emotions out of the way and let the intellect do what it can do if you can eliminate the fight with your emotions?

Rob: Right. I hear you. I’ve got the same problems. I’m not going to tell you how much weight I’ve lost.


Rob: Let’s talk about your ultimate buy and hold strategy which I think is maybe one of the best things you’re known for. I’ve got your updated chart which I’ll share in the Facebook group and in the show notes. And I’ll link to your site where you describe it in more detail. But as a start, can you just give us an overview of what this is and why you created it?

Paul: I think it is probably one of the best learning tools I’ve found in convincing people that there is an advantage of expanding beyond the S&P 500 or the total market index which is basically large-cap growth. I am not anti-S&P 500 or anti-total market index. I just think, for those who are looking to get better rates of return without taking substantially more risk—and I’m very clear about that risk in the work that I do. But they need to somehow, in a very simple ways, see how this actually can happen. We have some of the finest people behind what I’m teaching. I’m talking about some of the greatest minds in the world, on how to invest successfully. The good news is I don’t have to pay them a penny because they’re not on my payroll. But, if you look at the work of Dr. Fauna and Dr. French and many others, what they’ve taught us is by diversifying in a certain way you can actually create higher rates of return and not take any more risk. Or again, it could be a slight amount of risk for a big increase in return. Here’s what typically happens… Somebody lays out a pie graph and says, “Here’s how you should slice and dice the market.” And they show the results for having done that. And a person that oftentimes has no sense of how you got there—what was in that pie graph in terms of those asset classes that impacted the final return. So, I broke it down. And there is an article that goes along with the table, and podcasts to go along with the article and table. I broke it down into steps, baby steps. You start with portfolio one which is all S&P 500. Then I start taking little pieces of other asset classes that have historically (in almost every case) out-performed the S&P 500—in some cases going back almost 90 years, and by a substantial amount. So I add a little large-cap value, watch the impact of a 90/10—90 S&P and 10 percent large-cap value. What you find out is there’s just a little tiny, small amount of additional return. I don’t want you to think it’s a small amount of additional return because I’m looking for every 1/10 of 1 percent I can find for an investor so I show them. Assuming that in 1970 you had $100,000. You put it in the S&P 500. What happens with that small increase in return when you put 10 percent in large-cap value? It’s a lot of money. That’s because of compounding and people really underestimate the power of compounding over time. Then I say, “Okay, how about another 10 percent?” Let’s put a little small-cap blend. We know we liked the large-cap blend. That’s the S&P. So what happens when you add some small-cap blend? What happens if you add a little bit of small-cap value? Every time I take a step I show the increase in return if there is one. And then I show what happens to your original investment. I do that all the way through, not just the US asset classes I would like you to own, but also the international asset classes. You add a substantial return but then you’ve always got to ask about risk. It turns out that the standard deviation, the one-weighted measure of volatility for the portfolio that has all these little bits and pieces put together, it’s almost the same standard deviation as the S&P 500. Now, if we look closely, and I show this in another table, you’ll find out that the portfolio with all those different asset classes does, in fact, in a major bear market, lose a little bit more. So, it might be okay for a 20-year-old to have all their money in this strategy but it might not be okay for somebody who is 73 so that’s where we have to decide how much fixed income. If people actually believed the past—and this is the problem we all have because we know there is no risk in the past. We know what we should have done. But, if we did believe this and we did believe these returns, I can tell you, the academic community absolutely believes that value will do better than growth in the future. They just won’t tell you how much. They won’t even tell you how much growth it’s likely to make. They’ll just say, “Value will do better and here’s why…” and, “Small-cap should do better and here’s why…” If we could believe the past instead of making up stories about the future, about which we cannot know, maybe we’ll have a portfolio that is protected against most of the forces of evil—the forces of evil being things that are going to cost you money. And that you’ll do well and meet your needs. Quite honestly, Rob, in all of my years in this business, I’ve rarely met somebody who couldn’t meet all their needs if they just got market rates of return which means they don’t need market timing. They don’t stock-picking or any of these fancy things that the industry suggests you should have. They just need to get positioned in those asset classes as efficiently as possible.

Rob: That’s great. I’ve got a ton of questions for you.

Paul: I’m ready.

Rob: Let’s dive in. First of all, where do you get your data for all the return data, standard deviation data and all the asset classes and combination of asset classes?

Paul: Most people are not going to have direct access to the database at Dimensional Fund Advisor. They are the ultimate index family of funds in the industry that is not available to investors who want to invest directly like they can at Vanguard. But you can also go to Ibbotson. Ibbotson has most of the same data. You go to your local library and they will probably have the stocks, bonds, and T-bills—studies that go back to the 1920s. That’s the database. DFA, Dr. Fauna and Dr. French I mentioned earlier are really the research powerhouse behind how DFA which has constructed not only their portfolios but their funds to be as profitable as possible. If you’re in small-cap value, what can you do to be the very best at small-cap value all based on academic research? That’s the good news. The bad news is it doesn’t mean it will work in the future. But that’s where the data comes from.

Rob: Yeah. How confident are you in that question? I’ve read Bogle’s book, Don’t Count On It, and when he talks about things like small-cap value he says they outperform but if you look at the data it’s because of a couple of outside years. If you take those out they really don’t outperform so we should assume it will repeat itself in the future.

Paul: You know what? I think if people will take the time to look at some of the work on my website that goes back to 1928. I look at not only every year but every 15-year period, every 40-year period. I think you’re going to find that is not true. It isn’t just a few years. For example, here’s what I know about the average 15 years with a large-cap blend. The average is 10.7. By the way, that’s the S&P 500. The large-cap value is 13.2. The Small-cap blend is 13.8. The small-cap value is 16.1. That’s a big difference. Having said that, when I tell you that I believe (and as the academic community believe) that stocks will outperform bonds, maybe not. That they believe the value will outperform growth? We don’t know that for sure. And we go right down the line and I can say, well, I can’t guarantee it, Rob, but I believe it based on what we know about the past because that’s all I have to go by. I cannot go by the promises of Wall Street. If people think that Donald Trump makes some claims that are over the top, try listening to Wall Street for a little while and you’ll hear the same kind of claims. It’s the nature of the beast. So, here’s what I know. I know that in the portfolio I recommend to your listeners, it will have growth and it will have value. If it turns out that growth does better than value for the next 20 years—and there has been a period when growth did better than value. It didn’t mean value lost money. It just didn’t make more money than growth. But, if I have them both in my portfolio, I was wrong, but you had growth. It’s the same with large and small. If small underperforms, fine, I’ve got lots of large in my portfolio as well as US and International. I have no claim that any of these things are going to reproduce themselves but that’s the whole idea of diversification. I’m in the Pacific Northwest, 2000. I was very anti-technology. By the way, I wasn’t anti-technology, I was anti-thinking there was a new era. And I wrote about it in January of 2000. This is not a new era. It could have been a new era but it turned out it wasn’t a new era. In 2000, Microsoft was selling for about what it is selling for today. Who would have believed that? Yet Microsoft makes billions and billions of dollars. Melinda (not Bill) Gates is one of the 50 most powerful people in the world, or impactful people in the world according to the new Fortune magazine. Yet, even being that smart doesn’t mean you’re going to turn out a lot of profits. Diversification means you don’t know. Just say it… “I don’t know and I don’t care.” What I do care is that capitalism survives. If you really want to worry about your investments, worry that capitalism will survive. I’ve put my marker on capitalism. There is too much money to be made in the capitalistic system for it to fail. Having said that, it can fail. We know it can fail which is why I have part of my money in market timing.

Rob: You’ve got this set up over a 47-year period beginning in 1970 but it sounds like, from what you’ve told us, you’ve actually tested this over different time periods.

Paul: Well, I can’t test it all. In fact, I can’t even test every asset class through that whole 1970 through 2016 period. What I can do with the major US asset classes like large, small, value, growth, I can go back from the database and look at the returns. Hypothetical, of course, because what they did, Rob, was the academics had a bunch of students go back and dig out information on every company in the US market. It was either identified as large or small if they were broken down into 10 percent deciles so they could look at what happened within each tenth of those public companies. Those that were out of favor, those that were in favor. It’s been a massive study but it’s not real. It’s hypothetical because nobody knew to do that in—

Rob: We didn’t have all the indexes that we have today.

Paul: No.

Rob: I’m curious. I’d like to put some numbers on this. You start with a $100,000 investment in 1970 and the S&P 500 portfolio by itself grows to $6.5 million and, that’s assuming a one percent management fee.

Paul: Yeah, can I talk about that one percent for a second?

Rob: Sure.

Paul: Because that’s kind of a problem. What 9.3 percent compound rate of return. Why 9.3 when you look at other information I put out and it’s 10.3. That’s for a couple of reasons. One, I wanted to lower expectations because when you don’t take a management fee of some sort out of all of these fees returns you see on that table, the final number becomes so large that people just throw it right in the trash saying, “What do you mean? That can’t be possible!” It’s like when I tell people a 12 percent return is possible over their lifetime. They don’t believe it. “Nobody’s ever done that!” Well, Warren Buffet has and more. He invests in a certain way that you can invest as well. That 9.3 takes that one percent out and everything else in that table—one percent has been taken right off the top.

Rob: Right, right. So the S&P 500 is $6.5 million after a one percent management fee. As you add all the different asset classes; large-cap value, small-cap blend, small-cap value, REITs, International and Emerging markets over that period, instead of $65 million, you end up with $15.3 million which is a pretty big number. My question for you is this; this all assumes an initial investment of $100,000 in 1970. Have you ever run these numbers with an assumption, rather than a lump sum investment at the start of the period—let’s say a monthly investment of $100 to $500 each month, through that time period to see if the results are different?

Paul: It is absolutely guaranteed to be different. This is an important lesson for investors. When you see the return of any mutual fund, it is what they call a time-weighted return. I recently did an article about the returns of Vanguard target-date funds and over a 10-year period, the target-date funds made 5 to 6 percent while, interestingly enough, investors made as much as 2 percent a year more. More! And the reason they made more is because they were dollar-cost averaging. Those are dollar-weighted returns which are not the same as time-weighted returns. If you could make 2 percent more, wouldn’t you do that? If we could teach young people to celebrate a bear market and when the market is down like it was the early part of this recent 10-year period, and you get a chance to dollar-cost average into lousy returns, a falling market, people panicking and liquidating their portfolios because it’s scaring them, you come out ahead. If I do this—if I just assumed that I put away a certain amount of money each year from 1970 through 2016, I would come up with one number. If I then took the returns of 2016 and invested backward to 1970, I’d come out with a totally different return. So, dollar-weighted returns, whether you’re putting money or taking money out, those returns are going to be different than the time-weighted. The reason this is important is because there are people who will look at the returns of those target-date funds at Vanguard and see they made, say, maybe 5 or 6 percent a year and think that was a terrible return. They don’t even realize they did appreciatively better.

Rob: Yeah.

Paul: They need to understand that so they have a real benchmark in the time-weighted returns of mutual funds, are not, at the end of the day, what you get in your life. They are your personal dollar-weighted returns.

Rob: That’s such an important point. I’m glad you gave us that background. Some people ask me if dollar-weighted averaging is a good way to go. There is a practical side to it too though that I think people miss. For most people, that’s the only way they can invest. They put a few hundred bucks a month into their 401k. That’s their only option. They don’t have $100,000 in their back pocket just to invest at one time.

Paul: What they should know and celebrate is that they are using a strategy that virtually every smart person in this industry agrees with— particularly if they stick with index funds, low-cost and blah, blah, blah, they’re likely to end up in the top 5 percent of all investors for the amount of money they put in—when they put it in, of course. I can’t control that. But, they are going to be amongst the very best money-makers over that period of time and I think they have a hard time believing that because they don’t think they know enough. But, they can know enough. It’s actually very simple. It’s only Wall Street that wants you to think you don’t know enough.

Rob: Right. Absolutely. I’m looking at the asset classes you’ve included in your buy and hold strategy. You’ve obviously got a blend. The S&P 500 is a blend of value and growth and you’ve got a small-cap blend. But you also have some value. You have some large-cap value, and small-cap value. Did you ever test this portfolio with other asset classes? For example, a large-cap growth fund or a small-cap growth fund just to see how the results would vary?

Paul: Yes. And we have information on small and large growth that goes back—they used to have it in their database going back to 1928, I believe. They don’t have it going back that far, right now. I’m not actually sure why. They must have had some question about the validity of it going back that far. But, we do have that data. By the way, growth is not evil although Larry Swedroe, somebody I really respect, who writes a lot about investing, has written about an investor’s “black hole” and its growth. Particularly small growth has a very, very poor long-term track record going back to the ‘20s. It’s amazing that it’s as poor as it is. Now, having said that, it doesn’t mean it won’t do well for a long period of time because all of these asset classes, including one of the worst asset classes of all, would be precious metals. When I say the worst I don’t mean that gold is bad. I’m just saying, if we look at the last 15 years, we see an asset class (if we want to call it an asset class) that has made less than government bonds but at 10 times more risk. So do I want to encourage somebody to put an asset class in the portfolio that is, in fact, going to lead to lower returns based on long history? I don’t because I’ve got to take money out of something good to put it into something bad.

Rob: Right.

Paul: And I don’t want to do that.

Rob: I wouldn’t want to do that either. Paul, you and I are in total agreement.

Paul: Bogle and Buffet and a lot of really smart, famous people agree with that position on gold. But, what we do want is to find the asset classes that historically have done better than the S&P 500 that, when combined with the S&P 500, keep it within the risk people expect from the S&P 500. I didn’t throw growth out entirely. You may or may not ask this question but a question that is often asked is, “If growth is this bad, why have it in there?” Here’s why you want it in there, particularly for people like me. If there is a collapse—and I’m talking about a serious bear market, growth companies are less risky than value companies. That’s important. So yes, we have the S&P 500 in there. We’d make more if we didn’t. Yes, we have IFA in there, that’s the international equivalent of the S&P 500 and we’d make more if we didn’t. But that’s only 20 percent of the equity portfolio because they’ve got these little 10 percent pieces. It’s not like it’s overwhelming the portfolio but it is there to stand up in a catastrophic situation.

Rob: That’s interesting. It brings me to the next question. How should someone use the data you provide in your buy-and-hold portfolio to actually make investing decisions? One thing I’ve noticed, you gave a good reason why you want some growth in your portfolio. However, you do show portfolio 8 which, other than the 10 percent in emerging markets, is all value. Large-cap value, small-cap value. International large-cap value and international small-cap value. Then emerging markets. It basically has no growth or very little growth. Is that portfolio there just to sort of show the outcome? Or do you actually think some folks might do well to follow?

Paul: Oh, I absolutely believe it’s something some folks should follow. I wrote an article about how to turn $3,000 into $50 million. The idea is, you put money away for a newborn child. The money is there whether it’s $3,000 once or $365 each year for 21 years. As it grows and the kid starts earning money, you siphon off money from that account (that’s been growing) and put it into a Roth IRA until the money runs out. That money just continues to grow. Then the money is put into small-cap value. Is that appropriate for a newborn child where you’re investing for 65 years from now? Absolutely! All I have to do is look at all the 40-year periods and say to the extent that you tell me it’s smart to put money into the S&P 500 for the long term, I have to conclude it’s even smarter to put it into small-cap value as an asset class. Not just any individual company, but as an asset class. In this particular case, as you mentioned, it’s big value and small value. It’s US value and international value. And it’s also emerging markets. If you look at these emerging market funds, they’re very value-oriented. So, if I have a Roth IRA, it’s invested this way. It’s all value.

Rob: Okay.

Paul: I’m 73. It’s not from my life. It’s money that’s for the next generation or maybe the next generation after that. Let’s say one of your listeners has got a portfolio within their 401k. And let’s say they don’t have a lot of small-cap in their portfolio. They don’t have a lot of value in their portfolio and they certainly don’t have it in the international markets, so they might go do an IRA. And they might use this, all-value portfolio as a place to put some money. They might be putting away $15,000 in that well-diversified portfolio but what’s the impact of then having this $5,000 or $5,500 a year to put away in, hopefully, a Roth IRA? Yes, it’s appropriate. And, by the way, in the bulk of my buy and hold, it’s there but it’s also there along with the growth. I want people to see that it may be the value part of your portfolio—even if it’s only 10 percent, it may be doing the best job—working the hardest. I recently saw a question, “Is your money working hard for you?” Well, here’s an answer to a question we should all be asking as well as, “Should I have some investments in my portfolio that are working harder?” I have always believed, there’s a chance that if you work harder, you make more. You and I both know we’re ‘early risers’, right?

Rob: Yep.

Paul: That’s not something I learned in retirement. I mean, I was up at 4:30 this morning because I used to get up at 4:30 in the morning when I was working. So, I think value works harder. But, if somebody is afraid of value, that’s fine. I don’t have any problem with that. They can maybe only make it a small part of their portfolio and just have it there to increase their return a little. But, as you noted from this table, a change from 9.7 to 9.9 added another $600,000. Even a change from 10.3 to 10.4 added about $400,000 or so. Every little one-tenth of one percent is worth fighting for and we have to fight hard. I don’t have to fight hard because I’m old and have plenty of money. I over-saved before I ever retired. But young people today who may not have Social Security, who may not have a pension, whose parents may not leave them anything, they need to make everything do the best that it can without doing anything stupid. My favorite Warren Buffett quote is; To be a success, you only have to do very few things right, as long as you don’t do too many things wrong. I want to focus on both in my educational material.

Rob: In terms of doing things wrong, do you believe there is a place for actively managed mutual funds in a buy and hold portfolio or should it all be index?

Paul: Let me give you the argument from Wall Street. For a long time, Wall Street said they realized the S&P 500 had such an amazing sales pitch behind it which had to do with great performance. Remember, from 1995 to 1999 the S&P 500 compounded at over 28 percent a year. The public likes performance and this is the S&P 500, the 500 largest companies, how can I not have my money there? The chasing performance is a really big challenge for investors. Do me a favor, would you please ask me that question again?

Rob: Sure, it was whether you think actively managed mutual funds have a place in the buy and hold portfolio strategy?

Paul: How the industry responded to that was, they started telling people the S&P 500 is a good core holding. Around there we want to put you into some funds that are actively managed that give you a chance for a higher rate of return. The best sales pitch they could have given. The honest sales pitch they could have given because they probably knew this… If you want to get higher rates of return let’s add some other indexes to the portfolio, like large and small-cap value, international small-cap, emerging markets—I mean, you could have the same thing that I’ve done. They knew you could do that. It’s not as though I discovered this. This has been around for a long time. But they didn’t. They sold what they made a living selling. One of John Bogle’s great quotes is, “It’s amazing what a salesperson can believe if you pay them enough to believe it.”

Rob: Right.

Paul: No, you do not need to have part of your portfolio in actively managed funds. Now, I’ve talked to a lot of people who have put money in the contra fund decades ago, or Dodge and Cox decades ago and they’ve got huge taxable events. Would I liquidate that and put it an IRA and put it into index funds? Sure, I think that would be okay. But I also know how people are about “the horse that got them there.” They want to continue to ride something. Loyalty is a big deal. I’ve been teaching people in the academic community how to put together a portfolio for decades. It’s almost impossible to get them to sell their TIAA CREF and go into Vanguard even though Vanguard may have lower expenses, have more index funds, et cetera, they got there with TIAA CREF so don’t tread on it.

Rob: Sure. Yeah, I confess. I’m probably that way a little bit with some things. When I buy individual stocks I don’t ever like to sell them. In the few minutes we have left, I want to turn to two more questions. One is about motif investing because I know you’ve implementing a number of your portfolios using motif so I want to talk about that. Before we do that, the other question I want to get to is, if someone looks at your buy and hold portfolio and say, “Paul, I appreciate the work you’re doing. This makes all kinds of sense, I get it. I even understand standard deviation. But for me, I just want to put it all in a target-date fund, ” at Fidelity or Vanguard or whatever. What would you say to that person?

Paul: I’d say that’s a great idea. I have no problem with that. I think target-date funds are probably one of the greatest investment products ever designed. It is the equivalent of people who went to work for a company and it was pension trustees who managed the money within the pension fund so it was professionally managed for their life. Then when they retired, even though each account wasn’t specifically built for you, the company had the money to be able to pay you those pension obligations. That’s what a target-date fund is. It’s professionals sitting there putting together the portfolio that matches who you are as an investor. Now, that’s the good news. There is bad news. The bad news is that the mutual fund companies are pretty much backed into a corner where they’re obligated to put together a portfolio that serves the masses because, when you go to Vanguard—and I love Vanguard. Vanguard has made people so much money. Like TIAA CREF is to those professors, Vanguard is all kinds of individual small investors as well as large, but their target-date fund is built for almost the lowest level of risk of people that are going to come to them which is okay for the people who want a very conservative approach. But if I told you the right thing to do with your 401k is to put it in bonds for the rest of your life, you would say, “Well, Paul, don’t you think it would be a good idea to add some of those things that grow faster? Wouldn’t it be smart to put 20 or 30 percent into stocks?” and I say, “Oh, no, no, no, you should have bonds. That’s where you’re safe from blah, blah, blah…” Well, in a sense, that’s what’s happened. The target-date funds are built for the lowest kind of denominator in terms of risk tolerance and we know if you want to accumulate billions and billions of dollars, keep that risk as low as you can while still giving them a chance to get a reasonable rate of return and you will get that, I believe, from the Vanguard target-date funds—as an example. But what do we do for people who find out that there is such a thing as small-cap value?

Rob: Right.

Paul: What do you do with that as an investor? Well, you could go do it in your IRA. In fact, there are a lot of cases where I tell people to invest in their 401k up until their match, then go and do an IRA next because you have access to asset classes you can’t get in your IRA. What can you do, if, in fact, all you have is a 401k? You’re not going anywhere else and you want to keep it simple. Is there anything you can do about that Vanguard target-date fund, 2060? I’ll tell you what you can do. There is an article I wrote about how to double your target-date return in one simple step. Take some of the Vanguard small-cap value funds and add it to your portfolio. “Oh, my God! That’s too complicated, Paul.” No, it isn’t. Instead of putting 100 percent in the 20/60 target-date fund, put 75 percent there and 25 percent into the small-cap value. Put 10 percent into the small-cap value. In some cases, when I’m able to look at that personal situation, I even suggest putting 40 percent into small-cap value. We’re talking about 40 years from now. What else we know, Rob, is that target-date fund is sitting on 10 percent in bonds at age 20! What the heck is that about? That means you’re going to make one-half to six-tenths of one percent less for all the years you have 10 percent in bonds. That’s the impact on the return of your portfolio. Is that what you want to do to a 29-year-old?

Rob: What age should you start adding bonds or fixed-income investments to a portfolio?

Paul: I think you’ve just asked one of the most important questions in this industry. There is no, one, answer. That’s why the answer for target-date funds is not for Vanguard to have one. Vanguard should have at least 4 target-date funds. Vanguard feels people won’t know how to deal with that. They’ll have to make a decision which one is right for them and they’ll start chasing performance. Probably some would. But how about one where you start going to bonds at age 35. And another one where you start going to bonds at 45. I talk to a lot of people who are retired and still have all their money in stocks. That’s outrageous! How can anybody have all their money in stocks? Well, I just talked this last week to brothers who are both police officers and have so much in pension and Social Security they’re never going to touch, possibly. They’re in retirement so it’s okay for them to put that all in stocks. They have that kind of risk tolerance.

Rob: Yes. That’s a good perspective. I really appreciate that. Particularly on the target-date funds. Alright. In the few minutes we have left—and I appreciate your time this morning, Paul, particularly since you’ve been up since 4:30. Although, that might even be getting up late for you. I’m not sure. I’m not even convinced you sleep!

Paul: Oh, I do!

Rob: Anyhow, tell us what you’re doing with Motif?

Paul: A lot. For some period of time, it’s kind of consumed my life because Motif has an amazing possibility for an investor. Maybe Motif will be good for about 10 percent of young investors, I don’t know. I’ve got to find that out because there are a lot of hurdles to using Motif. But here’s what I love about Motif. A person can invest $1,000 and right now I have about 70 portfolios there from all equity, then in 10 percent increments going down to maybe 30 percent equity and 70 percent fixed-income. I’ve got all small-cap value. I’ve got some that are 70 percent US and 30 percent international. Some are 50/50. I’ve tried to create this whole range of choices an investor can make—probably too many. What a person can do is put the $1,000 in there and, in essence, with a push of a button, they can buy 10, 20 or 30 different stocks or ETFs. Not mutual funds. I wish they could do it with mutual funds because that would be amazing but the cost to do that is $9.95. That’s the total commission for 30 trades—up to 30 trades. It would be the same if you only had 5 ETFs in the portfolio. Also, a year from now if you wanted to rebalance you could rebalance back to the original asset allocation. Again, with the push of a button. What is ever that easy? What I’m trying to figure out—and I’ve had a lot of feedback from people is, what steps can you take to absolutely minimize the expenses at Motif and accomplish what you want with Motif. Going to some of the major hitters in the industry, I believe if I can convince people like Larry Swedroe and Bill Bernstein and others to go to Motif and build their best portfolio. And I’m thinking young investors. I had people call me with millions of dollars—and they’re going to get a trade for $9.95 and they’re thinking they can have someone manage their money for $9.95. Well, that’s the good news. The bad news is you shouldn’t be at Motif, you should be at Vanguard because there are a lot of advantages once you have a certain amount of money to be at Vanguard in their Admiral shares. Then I even show you what ETFs you can add to the Vanguard portfolio to kind of create the same thing. It would require a little more work but you’d be paid more with higher returns. So I’ve got to figure out exactly what kind of investor is going to be able to use Motif and how to help them do it in the most cost-efficient way. I am not on Motif’s payroll. Having said that, I need full disclosure here, Rob. If you do a $9.95 trade at Motif, my foundation which is who I work for without compensation—my foundation gets $1. Let me tell you how you can opt-out of that. You can go into that portfolio, copy it and put it on a custom motif. Make a little change to it and then call it your own. And my foundation won’t get a dollar!

Rob: Just a little background on that for people who may not be familiar with Motif. You can create your own portfolio. Paul’s done it. I can do it. Anyone can do it. If someone says, “Hey, I like the motif Rob created, or Paul created so I’m going to invest in it,” the creator of the motif gets $1.

Paul: Yes.

Rob: Of course, if I’m going to invest in one of your portfolios, one of your motifs, it doesn’t cost me anymore because you created the motif. It’s still $9.95, right?

Paul: Yes. And, by the way, something we do is go in and reallocate back to the original asset allocation which you’re going to have to manually do it you’re doing this yourself. We do it periodically. Plus, we’re evaluating the ETFs to see if we should make a change. So, the next time you rebalance, you not only rebalance, you also pick up what we think is a better ETF. I’m not selling that. In fact, it would really make me happy when we have more people like me who have motifs up there so people aren’t forced to get somebody like me to get the kind of huge—this is not a life changer for me. Although, I’ve got to tell you the truth, Rob, if I could get 100,000 to follow my work on Motif, when I’m dead and buried my foundation will have $100,000 to help continue to do this. Because, all of my IRA when I die, goes to the foundation. I’m not sure that makes my kids happy, but they say it makes them happy. I’m focused on getting that foundation to be there beyond my life.

Rob: What I’ll do, Paul, is link to your Motif page which shows all of your motifs which I’ve spent some time studying. I will link to those in the show notes as well as put a link up on the Facebook group so folks can check it out. Then, as you develop that more and get a better sense of it, obviously, we can report back to everyone. But I think it’s terrific and I’d love to see others who have a similar platform as you do, create their own motif. I guess we’ll have to see if that happens. Hey, I’ve got to tell you… it’s been a thrill to talk with you today. You’re just a natural-born communicator and educator and I can’t thank you enough for being on the show.

Paul: It’s a pleasure. And I hope this is one of the many conversations we’ll have because I think what you’re doing is exactly what I’m trying to do, give people a great education through other people as well as putting your fingerprint and thumbprint on it too. From everything I’ve seen, I believe you’re working in the best interest of the people you’re presenting to. And I applaud you for that. Thank you for having me on.

Rob: Thank you, Paul. I appreciate it. And we will definitely be talking again in the future.

Paul: Great.


  • Rob Berger

    Rob Berger is the founder of Dough Roller and the Dough Roller Money Podcast. A former securities law attorney and Forbes deputy editor, Rob is the author of the book Retire Before Mom and Dad. He educates independent investors on his YouTube channel and at RobBerger.com.