WCI #50: An Interview with Paul Merriman

This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli. Welcome to Podcast 50, an interview with Paul Merriman.

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Welcome back to the show. Hope you're having a great day today. Hope you're on your way home from work instead of into work. But even if you're on your way into work, focus on the wonderful good you're going to be doing today in your career. It really is a serious dedication what you've done with your life and I'm proud of you and glad you've done it. Our quote of the day today comes from Joan Rivers. People say that money is not the key to happiness, but I always figured if you have enough money, you can have a key made. We have a special guest on the podcast today. Paul Merriman began his career in the 1960s as a broker for a major Wall street firm. The conflicts of interest there quickly drove him out of that career. He then had a stint helping raise venture capital for small businesses before becoming the president of a manufacturing company for a few years. He then created an independent investment management firm in the early 80s. However, that's not what he is best known for. He is best known for his work, a large percentage of which is done on a volunteer basis, educating the individual investor. He's held over a thousand investor workshops, written seven books on investing, and started a foundation that funds a four credit personal investing course at his alma mater, Western Washington University. He also has a weekly podcast called Sound Investing, which is which has been named as the best money podcast by Money magazine. Paul, welcome to the show.

Well, it's great to be here Jim. Just for full Disclosure, that award from Money magazine came in 2008. So I've got to work a little harder because seems that they're ignoring my work.

Well, here's the wonderful thing. I mean, hardly anybody was blogging in 2008, much less podcasting. So the fact that you were out there way ahead of the curve is still pretty darn impressive in my view. Now, I understand you're currently spending part of the year in Seattle and part in Mexico. Tell us about where you're at now and how you decided to split up your living situation that way.

Well, like many people planning for retirement, we thought that the idea would be to spend a good part of the year down in Mexico, where it's warm and where my wife can use her Spanish speaking abilities, which I don't, by the way. And then it turned out after we changed houses around and bought a small house here on Bainbridge island and the big house in Mexico, that family was way more important and all the things we're committed to here. So. So we now are most of the time here in the northwest, and Mexico has become very secondary. But, man, it's beautiful down there. We have a home in San Miguel de Allende, one of the most wonderful cities in the world, and it's rated that way by a lot of travel magazines and whatnot. But I can tell you there's some interesting thing about San Miguel for me is I have met many people who are retired who are basically living on Social Security down there and living well. So I can see why Mexico is attractive to people who maybe didn't save enough in their working years.

That is an excellent point. We talk a lot on this show as well as on the blog about geographic arbitrage. And most of the time we're talking about physicians moving from the Bay Area to somewhere in the Midwest when they have lower taxes, lower cost of living, and often higher pay. But it certainly applies at the time of retirement, particularly for people who didn't save that much. There are wonderful places in Mexico and Central America and other places throughout the world, the Far east, where you can live like a king on really not that much money. So that's an excellent point.

Well, we've loved it.

Your career is impressive for many reasons, not the least of which is that you've continued to work long after you had enough money to retire. Can you tell us a little bit about the passion that led you to do that?

Well, actually, my idea of how much I needed to have available when I retired was more than I needed. That was something I very specifically decided that if I could save and accumulate twice what I really need, then I would be able to have a very different distribution strategy than if I retired with what I guess we could call enough. So I kept working long after I had to. But the other side is I love my work. And the day that I retired, I started foundation, the Financial Education Foundation. That is just as much work as when I was making money. And you mentioned that I was working mostly on a volunteer basis. Actually, Jim, when I retired, I promised my wife I would never work for money again. In fact, just recently, I turned down a free dinner from somebody who I gave some just some generic financial advice. I said, I can't do it. I can't break the promise.

That's really neat. I love to hear that. Now, of all these things you've accomplished with your career, what are you most proud of?

Well, that's an interesting question. I almost look at this process as one individual at a time. You're not an investment advisor as I understand it.

That's correct. I'm practicing physician. And a blogger is probably the best way to describe me.

And in a sense what I am now is a practicing teacher and a blogger. And I'm not allowed to give specific advice. But as it was when I was in the business, I built my business, my investment advisory practice, by giving free workshops. They lasted three to six hours. If you went for three hours, you learned all about buy and hold. If you went for six, you learned about buy and hold and market timing. And you could leave there and do everything yourself if you didn't want to do it yourself. My firm was more than happy to do it for you. And there are a lot of people who just aren't going to do this and maintain it like they should. So we built a really nice business. When I retired, all I did was I stopped the part where I was hands on helping people manage their money and devoted all of my energy to teaching. But even as a teacher, you can see that spark, that moment that you change somebody's life by giving them a piece of information that means they'll have more to retire on, or they'll be able to retire earlier, or they'll leave more to children and charities. And so I love it all. I love this. Whether it's hands on direct with a client who's got the money in their pocket and want me to do it and the people who are do it yourselfers and I'm able to actually show them how to do it. And as you and I both Know when somebody actually found a way that they never had to pay another investment advisory fee. Again, that is a big bottom line number.

Yeah, it sure does add up. Especially when you multiply out an asset under management fee for decades. It really adds up to a lot of money. Now I have a discussion I've had with lots of different people over the years about what percentage of investors can't or won't do it for themselves. What percentage of investors do you think can effectively be do it yourself investors?

Well, I guess the question I would have would be how would we define effectively or efficiently or properly whatever it is that would say they have done it because just because you end up with enough money, maybe in large part because you saved a lot of money, but maybe you didn't invest it as wisely as you should. I have a lifetime of experience, not with investing since the fifth grade. Investing didn't start until I was 19. But I've been on a diet since the fifth grade. And I know now for having been on a diet, I'm 74 now, Jim. I know what it takes. It's a three by five card and one side is the diet and the other side is the exercise program. And then there's a little piece down at the bottom of side two that says drink lots of water. So this process of dieting is actually, and being healthy is fairly simple, except I unfortunately have a record of having lost over £4,000. Literally I've lost it and then I gain it and I lose it. I'm still 30 pounds overweight. Is it because I'm not smart enough to do it? No, to do it. And I think most people are smart enough to invest. But I think anybody and you've interviewed a lot of folks who have said, Jonathan Clements, for example, would say the biggest enemy we have is that face in the mirror. And I am that face in the mirror when it comes to eating and dieting. But I've learned how to control the investing discipline where I haven't been able to do it. With the dieting, I suspect, I suspect the odds are not all that different. I understand something like 5% of the people are able to lose weight today and still keep that weight off for a year. That doesn't sound like a very good success rate to me. But I wouldn't be surprised to find out that that kind of number also applies to the individual taking care of their money. The one thing that I think makes it very different is you and I can get an education sufficiently to pick a strategy, do it and set it and forget it. You can't do that with dieting because you got to come back and face a plate of food and do something about it at least three times a day. And with investing properly, you do it once and maybe you come back and look at your plate again a year later. So that makes it possible to be better than 5%, but I would guess not more than 25% are really investing the way that they should. They may do okay, but they could do a lot better.

Yeah, I. I'm not surprised to see you pick that number. When I talk to Bill Bernstein, he tells me 1%. I've kind of thrown out the 20% rate. The 20% of physicians could do this themselves. And, you know, it's interesting, when I talk to a do it yourself investor, somebody who's really just become a do it yourself investor in the last year or two, they are convinced that everybody can do this themselves. But I think until you've really had interactions with hundreds and thousands of people out there, you realize that there is a significant chunk that just cannot and will not. They don't have enough interest in it to develop either the knowledge required or the discipline required to do it. And so I think there's going to be a place for investment advisors for a long, long time. And I don't think this is really going to be, you know, an industry that's going to disappear by any means, like a lot of do it yourselfers think.

And can I add one more item? I think that's important, Jim, and that is Dalbar. You know, the Dalbar studies, I'm sure, and they are controversial, but they talk about the returns that individuals get and the returns the mutual funds get. And that difference is substantial. If you believe dalbar, it's probably 50% less in many cases than what the market got. And that's just basically not totally, but mostly about people being emotionally driven. It's what I call the I can't stand it anymore strategy, that they are emotionally driven and they're making decisions to sell at the wrong time and even to buy at the wrong time. And when you look at the difference between fund returns and investor returns, sometimes it can be 2, 3, 4% a year different. And that comes because of mostly bad behavior. And bad behavior tends in some part of our lives to be a problem for all of us. Not just a few of us, but all of us. The question is, is it in the area of finances, in the area of how we treat other people? Bad behavior is common.

Yeah, for sure. The Dalbar data is flawed, but I think the basic premise that there is a behavior gap is very much true. I think quantifying it is difficult. The devil's in the details there, but I have no doubt whatsoever that there is a behavior gap. So you alluded to a different distribution strategy that having twice as much as you needed, twice enough has allowed you to use. I don't talk a lot on the blog or the podcast about distribution strategies. I think listeners would be interested in hearing yours and how that's different by having far more than enough.

Well, I have two articles and two sets of tables that I update every year. And the first table is aimed at the people who retire with enough. And so we look at the implications of going back to 1970 as from 70 to 2017 now. But how, how did it look if you were 20% equities or 30 or 40 or 50 or 60 or even 100%, if from 1970 through 2017 you took money out at 4% or 5% or 6%, by the way, you go broke pretty quick at 6%. But, but it allows people to see on a fixed distribution, saving enough, adjusting for retirement. What happened during this particular almost 50 year period now for people who have saved more than enough, they I think have access to maybe the greatest financial thing that a person, luxury that a person could have in retirement. And that is the ability to take out a higher percentage and be able to sustain a bigger drawdown in the market. So for example, my wife and I, we saved twice as much as we needed to retire. And then that allowed us to take out 5% a year instead of 4% or 3% like so many of the, of the experts say. In fact, we could take out 6% a year so that we could do more. But here's what happens when you take a variable distribution, a percentage instead of a fixed amount, plus inflation, then you're ready to roll with the punches that you're going to get from the market. And those of course are the bear markets where it tries to take away 30 or 40 or 50% of the value of your equity. That when you take a variable distribution and when the market's down, you're going to take out less. When the market's up, you're going to take out more. Now this may not seem like a big deal, but when you look at the tables, and I got tons of tables, I really believe in the numbers. It's a better than a story as far as I'm concerned. But when you see what happens when you pull your horns in when the market is down, and then you. And then you release them when the market is up. It's huge. Actually, you could see with the s and P500, if you took out 5% fixed and adjusted for inflation, you'll go broke in a matter of years, starting in maybe 20 years, starting in 1970. On the other hand, if you took out a variable 5%, and so you, you kind of rolled with the punches when the market was up and down. You. You end up with all the money you need for 48 years. So that. That fixed versus variable is a big deal. But let me tell you about one more thing I love about it. I am frugal. I always been frugal. I would call it prudent. Of course, other people would call it cheap. And the people who would call it cheap are probably the people that aren't savers like I am. So here's what I know. I know that my wife is a spender. God love her, she thinks this money is there to be spent. Now it's fair. I got to give her credit. We do give away 30% of what we have to spend to nonprofits. So it's not like she's just about money for herself, but she still likes to spend the money. I like to save money, and that's been that. I've been that way all my life. She has been as she is all of her life. We came to the agreement. She would make me happy if she'd be willing to roll with the punch and in essence, take less money when the market is down, and I would be happy for her to spend more when the market is up. And as an advisor, I found this strategy solved a lot of the financial angst that couples have where one is a saver and one is a spender. It's a very big, emotional decision.

That's very interesting. And I bet that would help a lot of people to adopt that strategy as well. And I'm certainly a big fan of a variable adjust as you go type of withdrawal strategy. I think it's crazy to lock in how much you're going to take out 25 years from now, you know, into your strategy. Now, I think it's interesting to look at these safe withdrawal rate studies and kind of give you an idea of what ballpark you should start in. But as an actual withdrawal strategy, I think that's pretty insane. And so I really like your variable strategy. I think that's great.

Well, if I could add one more thing, Jim, about your comments, A good one. Now I think about the people you serve and I'm guessing most of the people you serve. By the way, I think your site is absolutely wonderful. There is so much great information there. You must have some very happy followers. But I think most of those people, if they're following your work, they're going to end up with more money than they need. In other words, they will have over saved. Now not all of them, but most of them. I actually try to help people from the day they first think about investing. And a lot of the folks that read my material are folks who have way under saved. And those people have more challenges, I think, than a lot of your readers. I would guess a few of your readers are known for spending, but most probably are doing a good job of finding that balance.

Yeah, I think for sure we've got the whole spectrum reading the site. Everybody from physicians that still haven't broken even yet. They're still not back to broke in their 40s to, to multimillionaires in their 40s. And so it's really quite a wide spectrum. Despite having similar incomes, I'm always pretty surprised at just how wide the range is. I was looking at average data the other day in preparation for a talk I was given at the White Coat Investor conference. And the average physician retires with a net worth of just over 2 million. And so but that the range around that is pretty broad. I was really surprised just how broad that is from people, you know, with closer to 10 million and with people who never become millionaires in their lives despite 20 or 30 years of a physician level salary. So there really is quite a bit of variability even among a relatively high income group of people.

Well, and Interestingly enough, that $2 million, I love the goal that so many people have. They had it when I came into the industry back in the mid-60s and they still have the same goal today. Oh, if I could just have a million dollars. Well, in fact, if you wanted a million dollars in 1966 when I, when I started, and today if you wanted to look at inflation since then, you really need five to six million dollars to do the same thing that you were just hoping you might do in your lifetime in 1966, so $2 million is, is not as much. But you know what I believe, Jim, is with a little tweaking on how these folks invest their money, and I'm not talking about speculation, not for a moment, but with a little tweaking, they ought to end up probably with a lot more than $2 million that is a great segue.

And let's move into talking about investing now. Among boglehead types, your name comes up, particularly with regards to two controversial topics you already mentioned, one which is market timing. We'll get to that a little bit later. But the other involves tilting a portfolio, particularly to the small and value factors. I want to spend a few minutes talking about those and that controversy. Do you think most investors should be tilting their portfolios to the small and value factors?

Well, let me make sure they understand what that means because I think an investor should look at the implications of being based on a cap weighted capitalization. Weighted portfolio like The S&P 500, as you know, is mostly going to be very large companies and mostly growth companies. Value, it does not play as much a part of that index as growth does because it's cap weighted. And now you do get small companies in the S&P 500, but it's a very small amount and it's not enough to have any real impact in terms of the small cap premium. Same thing with value. It's not enough value to have the impact that the value premium could add to your portfolio. But I can tell you what I like about The S&P 500, that is, or the total market Index. They're basically historically the same return and the same risk. But what I like about it is people have the perception that these are companies that I can trust, that they're the largest. And it does represent probably 85% of the US public corporate value in either the total market index or the S&P 500. So there's confidence and there's a feeling of stability. But for those who will take the time to get the education and look at the premium that historically comes from small cap and value and add those to a portfolio where instead of cap weighting your portfolio so the big companies represent most of the value, how about considering a portfolio that has an equal part of large and small, an equal part of growth and value, in fact, maybe even a little overweighting to value. An equal part of US and international, of course, how much fixed income versus equities, That's a whole other evaluation. But instead of cap weighting your portfolio, you're equally weighting your portfolio or some percentage one way or the other. But you are giving higher weighting to the small cap and to the value than you would get in a cap weighted portfolio. Now here's the part that I like. If I look at numbers, I go back to 1926 or I go back to 1970 and I see the results of combination combinations of large and small and value and growth. It turns out the risk is almost the same. I mean, we could argue how you identify risk. And you would say, somebody would say, well, look at here, Paul, even in your own tables, you show that the worst year was a loss of 51% with your all equity versus a loss of 43% with the S&P 500. So there's the, there's the asset class weighted at 51% loss versus the 43% with the cap weighted. Well, wait a minute, that happened one year, one 12 month period. And what you got for that, for taking that extra risk for one year was this huge premium of maybe 2 to 3% a year. And here's what I believe, and I think most of the professional people who have come on and worked with you, Jim, is you should never take a risk for which you do not get a premium. So if I expected to get the same return, or let's say I expected to take more risk and get a higher return from equal weighting them rather than capitalization weighting them, then it becomes a question of how much more risk do I take? And it's so small and it's so seldom that it's meaningless except at the moment that you're losing it. And then it becomes very meaningful. And if people will listen to what I say about loss and what other people say about loss, I tell people, you follow my guidance, I guarantee you'll lose money. Guarantee it. Without question, you will lose money along the way. But how much are you willing to lose? Build your portfolio with the right amount of fixed income and the right amount of equity to address that loss. That is your kind of your maximum exposure to loss that you're willing to live with and stay the course. You can adjust all of that. But first you have to understand the history of these asset classes. And if you do, I think people will feel many, not all, because some people remember they're confident in the s and P500, and that's fine. But I want people to do better, particularly people who may not have Social Security 40 or 50 years from now, who may not have the kind of health care being paid for, who may not have a pension fund. There are a lot of things, a lot of reasons why young people today have to figure out how to do better without doing something stupid.

Now, when it comes to these, these factors, these premiums, there's a little bit of a debate as to whether it's a risk story or a behavior story. You know, whether you're getting this premium for investing in small companies because they're riskier than large companies or whether it's simply due to people being confident in these large, stodgy, you know, confidence building companies. And so they ignore the small companies a little bit more. And that that behavioral explanation implies there's a free lunch there. Which side of this debate do you fall on? Is it a behavioral story or is it a risk story?

You know, you know something, Jim, I don't care because I don't know. I know what the academics tell me. The academics will tell me that we are getting a premium for the higher risk of small cap. And if there were not a premium for those small companies, why would anybody take the risk of putting money into something that's riskier without getting some sort of a premium? Now, let's go somewhere where that's a little more complex, a little more subtle. Let's talk about growth versus value. Because there again we have this belief that that value factor pays a premium. But think about it, really great companies, great management, lots of access to money in good industries. People are going to pay up for those companies because they are less risky. But if you, and you know this as well as I, that the studies show that if you buy the companies that are out of favor as a group, you don't even have to buy the special companies, buy them all in an index that historically those companies that are out of favor as a group do better than the companies that are of higher quality and as they should. It's no different between stocks and bonds. Why do stocks over the long term make more than bonds? Because they're more risky. Now then you bring in maybe the psychological effect of the pricing and maybe there are these periods where people feel very, very confident and they pay higher prices than they should for everything. Well, you know, that's part of this process. And nobody, I don't think is ever going to figure that out. I just watched John Oliver's piece on cryptocurrencies this morning. It's so good because it just shows once again how people are being tricked and scammed into making investments in things that virtually have no value. By the way, I'm not saying that all cryptocurrencies are bad. I'm saying there are lots of situations where people are willing just jump on the bandwagon and they want to ride that pony home for the big prize when in fact what they're doing is they're paying for somebody else's kids to go to college somewhere. Rather than their own. That's the part, the human part that I don't know how to measure, except I know this, that when we rebalance and we rebalance from large cap to small because large has been doing better, we're forcing ourselves to do something that's so contrary and that is to sell high and buy low. And so, and what does that do in the long run? It does what we all believe in in our hearts, that we should sell high and buy low, but don't know how to do it. And when you rebalance and sell what's been doing well lately and put it into what's been struggling, and I'm not talking about cryptocurrencies here, but great asset classes, we are likely to take advantage of all those human emotions and flip flopping the market, however that works. And I think that's a strategy that can be made absolutely mechanical so that you don't have to let your, your emotions get into that decision making process. Like trying to decide, am I going to have those potatoes tonight? I want those potatoes so much.

But that's exactly, that's exactly right. I mean, rebalancing does force you to sell high and buy lower, at least redirect your new contributions into what's been struggling lately. And I, I think it's a fantastic antidote to the bad investing behavior that we see people doing all the time, really. But there is that underlying premise that you mentioned, the asset classes have to be good to start with. You know, you don't want to rebalance into something that's, you know, beanie babies because you'll just rebalance into it as it goes to zero, you know. And so I think, I think you have to first construct a good portfolio and then you can be confident the rebalancing into it will be a good move over the years.

Well, and it doesn't surprise us that people believe in holding on to what's been making you money and not rebalancing because Wall street has told them, let your profits run and cut your losses short. If you have great asset classes, a history, let's say, of 100 years of performance doesn't mean you're going to get it in the future. But at least you've got the performance from the past and you're not then wanting to sell something, get out of it when it's down. In fact, this is what I want for our young people. I don't want you to have any bonds in your target date fund when you're in your 20s. I want you to have a chance to be buying those really great asset classes when they're in decline, that is in their best interest. I don't like it because I'm 74 and living off the money, but they should.

Yeah, I think it's Bill Bernstein that said the young investors should get down on their knees and pray for a bear market. And I think as long as the markets end in the same place, I think that's, that's good advice. There's some people that would argue that, you know, a bear now might mean they don't actually end up in the same place 50 or 60 years from now. And I think that really comes down to whether it affects the economy or not.

Well, now let me talk about that because I do a piece that shows the one year average return over the last 88 years. The same view of 15 years. And then I look at 40 years. And if you look at the very best and worst 40 years going back almost 90 years, the difference between the S&P 500 best 40 years was 12 and a half. The worst 40 years was 8.9. And it only gets better from there. When you look at large cap value and small cap value and et cetera, these other asset classes. When you got 40 years on your side and many people do, I think about my grandchildren, 4 year old grandchild, what's he going to live to be? 110 maybe. And that means that he's got not 40 years, he's got a good 90 years to be investing.

Yeah. Now there's been a few people and I'm pretty sure how you're going to answer this question, but I'm going to ask it anyway because I want the readers to or the listeners to hear you answer this question. The last two or three years growth has been outperforming value. And I'm seeing the question more and more often, is value broken? What's your answer to that?

Well, let me just go back in history a bit here and look at 1999. 1999 was the end of a period that created amazing returns. As a matter of fact, I met with John Bogle for 90 minutes in his office last June and one of the points I made was to him was how lucky he had been. Amazingly lucky guy because he starts a fund which people called Bogle's Folly in 1976, I think August of 1976. From 76 to 99, the S&P 500 compounded at over 16% a year. That is dumb luck because you can't know that now think about the people who bought the S&P 500 in 1999 or 2000. And you look at the last 17 years and what do we see? You know, it's about a 5 or 6% compound rate of return. Does that mean we throw the S&P 500 out of the portfolio or are we going to believe the longer term results? The same thing happened during that period of time over about a 30 year period ending in 99. Small cap did okay, but large cap did better. And they were saying the same thing back then. The small cap premium is dead, blah blah, blah. And then what happened for the next 17 years? The small cap premium not only came back, but it came back with a vengeance. And for example, from 2000 through 2009, the S&P 500 has this famous lost decade where it lost almost 1% a year while small caps and other asset classes made 7 to 10% a year. This is the way it works. And what traps people is they look at short periods of time. And by the way, the academics will tell you 30 years is a short period of time. Now at age 74 isn't a short period to me. But I do know that when I own big and small and I own value and growth and I own US and international and REITs and emerging markets, something's going to go wrong. I have no idea what it is, but I own, I say we, I should say we. We own about 15,000 different stocks in our portfolio. They all belong in one of those groups, Big, small, value, growth, etc. And I don't know which ones are going to take us home. But I still have to believe in the capitalistic system because that's what makes this all work. Theoretically, if that fails and could, it could fail. But if that fails, then I'm wrong because I should have been in what bonds? Well, if that fails, I don't know about bonds either.

At a certain point the right asset class is an AK47 and canned goods.

There you go. That's right. Or try to cash out a Confederate bond these days, I mean, you know, there's so many things we can't know, so much luck involved. The one thing we should do if that's true is diversify beyond reason. And that's what I want people to do. It's what we do. But diversify where?

Now a more difficult question I think that a lot of people struggle with after they've seen this data on small cap stocks and value stocks is how much they should tilt their portfolio. Do you have any advice for people who are trying to decide how big of a tilt to small in value they should have?

Well, I do and it's not going to sound very academic because I make this claim that we have this choice between believing Wall street or Main street, our neighborhood or what I call University street. And I come down in favor of University Street. And here's what I've decided. I do believe that over the long term there are about 10 asset classes that are likely to perform well. I believe those that represent the larger companies like the S&P 500 or IFA internationally, that they won't make as much as the small cap or the small cap value or large cap value. So I said, look, if they're all good asset classes, why don't I just basically put 10% in each? Now if you do that and you use large blend, small blend along with large value and small value, because blend has some value in it, you are by default ending up with more value than growth. And I so I've got 10% large cap blend in US and international, large cap value, US international, I have REITs, I have emerging markets. But basically it's about 10% each of 10 different asset classes. Remember, this is not looking at capitalization weighting because that would have most of the money and large growth, but rather asset class rating. And how could I know which is going to do better? If you go back 100 years and you look at what part of the world the US market represented, in fact, if you go back 30 years, the US didn't represent that much of the market as it does now, 30 years from now, who knows? What we do know is there's no risk in the past. We always know what we should have done. But I don't know what to do about the future. So I okay, I'll take equities and I'm not going to. I'm placing no big bets, none, because I placed the big bets on how much I have in stocks. That is a big bet. The bonds, they're just there for stability and those I have all in governments and basically short to intermediate because I don't want to get caught with it ever. Ever. They're always short to intermediate. I'm not market timing those bonds, I'm just keeping them very low risk. And governments, because when that stuff hits the fan, where do people rush in 2008? To corporates. Even high grade corporates? No, they rush to government bonds did the same thing when the market collapsed in 87. That's the nature did the same thing when the market collapsed. 73, 74. So those bonds are there for nothing more as far as I'm concerned. Stability. While I'm looking for the stocks to give me the growth, let's move on.

To a couple other, you know, sometimes controversial topics. Can you give us your thoughts on using DFA funds versus Vanguard funds?

Yes, I have all. I have all my, almost all of my equity funds that are buy and hold are in dfa. Dimensional funds constructs their portfolios and yes, they cost more, but they aren't prohibitive. But they do cost more. They construct their portfolios and they manage their portfolios to be as tax and as cost efficient as possible. And their small caps are generally smaller than Vanguard. Their value is generally more discounted. It is discounted in the value at Vanguard. Let me just give you an example. If you looked at the large cap value index at Vanguard, you would see basically that it's a split of the S&P 500, more or less. Half goes to value, half goes to growth. In the case of dfa, what they do is they take a much smaller group of companies. So their average size large cap value company is much smaller than large cap value at Vanguard. So if you believe size matters, there's an advantage to dfi, dfa. Secondly, they're more deeply discounted. They're more value oriented at DFA than they are at Vanguard. And even John Bogle admits that the people at Vanguard, the investors, chase performance and you can see it in their dollar weighted returns of the investors at DFA because theoretically every client has to come through an advisor. That's not as true as it used to be, but it's mostly true. But theoretically there's less. Well, no, there's less turnover at dfa. You can see it at Morningstar that the turnover at DFA is lower there than at Vanguard. Now what does that at the end of the day likely mean? When I was in the business, and I'm no longer an investment advisor, as I said earlier, but when I was in the business, what I concluded looking at the numbers is that if somebody's charging you a fee, then probably there is a break even to some profit for let's say 60% equity and 40% fixed income, that you will get some return on having paid a fee. But we're missing something really important there, Jim. The fact is that when I look at the people I worked for, for they weren't going to take care of their portfolio. They wouldn't be rebalancing if they did it on their own, they wouldn't be going into small cap or international small cap value. They wouldn't even know what that was. The advisors, the clients of advisors are mostly people who aren't doing it on their own. And are they better not doing it on their own or letting a DFA advisor do it as best they can? In most cases they come out ahead. Now there's a little fly in the ointment here. When Vanguard started charging 30 basis points to manage the portfolios. I'm a great fan of Vanguard. I love Vanguard and I have a lot of people go to Vanguard and pay that that 30 basis points. But the reality is that if somebody charged you 1% and did DFA versus somebody getting Vanguard and paying 30 basis points, they're likely going to come out ahead at DFA because as you know, probably most of the money that's managed there under that program at Vanguard is total market in us, total market international, some US and some international bonds as opposed to big small value growth US International that are going to be more or less evenly balanced. Totally different approaches. And I'm okay with the Vanguard approach. By the way, you did that article about 150 portfolios that have done better than yours saying that most of us would not do as well as any of these. 150. I looked through that article. Virtually every one of them I thought was okay. I just think that DFA puts money management on a platter in a way that you just can't get in any other restaurant. And so I have a huge bias to that. And of course it probably helps that that's what I do with my own money. And so I look careful, more carefully at it than the average investor is going to look at it.

So you think these Bogle heads that are advocating a three fund portfolio are probably leaving a fair amount of money on the table over the course of their investing lifetimes?

Yes, sure. But that's probably okay for them. You know, I here's what I know about bogleheads that I've met and I love going on there from time to time and sharing my beliefs. What I found. They tend to be pretty frugal people. They don't take very much out of their investment. They're not taking 5% out of their investments. I'll bet they're probably taking three, maybe even less as a group. In fact, I love engineers as clients. They take forever to become a client because they look and they look and they look, but they don't take very much out of their investments. They tend to be conservative. And these boglehead strategies, three fund strategies or two fund strategies, they're fine. They're just not going to put a lot of extra money in the, in the family's pocket. But it's going to be better than probably 80% of the investors even that way. And you stay tuned because this is going to be big, I think. Jim, I've got a two and three fund portfolio series coming out that will be out probably in September, October in fact, I'm planning to talk about it at the National AAII conference in Las Vegas in October. But I do believe I would love to have a one fund solution that was the best because I don't make anything on any of this. All I want to do is help people get someplace where it's a good place to be, where they're likely to stay the course and not be jumping ship. Because Wall street, you know this Wall Street's going to be trying to come up with ideas of why you should sell what you got at Vanguard, sell what you got at dfa, sell what you sell, whatever you've got and put it into what we have to offer. And so I'm looking for something that will help somebody protect themselves against Wall street for the rest of their life.

Let's move on to another controversial topic that you frequently advocate for but also warn against. You've said before that market timing will not work for most investors. But you and your wife have half of your personal retirement portfolio managed using market timing. And my understanding is you're talking about a simple trend following system. Explain why you think you can do it but most others cannot.

Well, I first of all, having been around market timing professionally since 1983 and having been exposed to it in the 60s and I started studying it then to the initiated like this must be financial nirvana. And first of all, market timers have a tendency to optimize whatever they're doing so much that it looks like it's easy money. But the fact is, from everything I know, having done it for many years, it is a strategy that will lower your risk and in some cases by a lot. And why is that? Because the system will have you out of the market in a money market fund part of the time. And so the total volatility over time is going to be lower because when you're in the market it's the same volatility as the market. When you're out of the market, there's no volatility. So over time it has to have lower volatility now one of the problem problems is that people then start to think that, okay, if I use market timing and I protect against the downside that I'm going to make more money. Probably not. What you're going to do is you're going to reduce your risk. You may actually make less money. In fact, you'll probably make less money because if you have an all equity portfolio and you market time that portfolio, you're probably going to get a return that is similar to a 70, 30 stock bond portfolio if you're out of the market about 30% of the time. So there's no magic here on the upside. Now does that mean that somebody could get lucky and their system would create better returns? Of course, that's no different than buy and hold. I'm saying buy indexes. Could somebody buy 10 stocks just randomly and beat my index of 500 companies or the company I the fund I invest in? Of course they could. So you're going to have some outliers. But if you look at all of the timing systems all of the time, you're going to find out that the averages aren't all that great. Plus, if I ask you to buy and hold and I take your hand and I show you the funds to buy and you do that and I'm there, you read my articles and they remind you why we believe these things. So you stay the course. The odds are very high that you could in fact stay the course for a lifetime. You have to know when to start adding more ball. Pretty simple. So that you have a lifetime strategy. Market timing. Oh my God. Market timing. You got to be in there, you got to trade. If you start trading and doing the timing, guess what? You're going to have multiple losing trades in a row. Immediately people think that the systems are broken and I understand that. And you have a year, the market is up. Market timing should underperform the bull markets because it spends part of the time on the sidelines. And what do they expect? They expect you should get all of the return on the upside. Then the bear market comes like 2008. The timing system that an all equity timing system that I had in 2008, it was down about 15 or 16%. It didn't make money. Yeah, but you had market timing. Why didn't you, didn't you know to get out? No, nobody knows when to get out. And so you, the system, the trend following system, do what it says, but it loses less is what happened. But is it possible, is it possible that you could actually lose more than what the market lost. And the honest answer is yes, it could have. How could it? Well, it could if on the way you got out, as the market was going down, then it started to go up again. So it triggered a buy signal and then it fell again and then it starts up again, triggers a buy signal, and then it falls again. You can see what's happening, Jim, is that they're taking wax out of your money and then you're getting back in after it goes back up. And all of a sudden you could have a situation where having the timing made it worse rather than better. Timers don't tell that story because they're in the business, just like Wall Street's in the business about putting their best face on. I think every advisor, every mutual fund should be able to tell people, you invest in this Janus fund and from time to time you're going to go down 60 to 80%. Now if you're not comfortable with that, please don't send us your money. But they don't do that. They'll tell you that there's risk and they can't guarantee that you won't lose money. But they don't tell people what the worst periods are likely to look at. So when they happen, it's a big surprise. It's the same with market timing, but you're so close to it happening time and time again, you get disappointed, you look for another market time, you look for another market, you say, God, market timing doesn't work. Well, if you try to do the same thing buying individual stocks, you may come to the conclusion that buying stocks doesn't work, when in fact there's a 200 Yurik's proof that it does work.

So as far as these trend following systems, I think it might be helpful to the listeners if you explain exactly what you mean by that and which of these trend following systems you think is best for an individual investor to use.

Well, first of all, they're very simple. Let's say you have 150 day moving average system, and when the average of the last 50 days, 15 days, breaks below the current price, then you get out the current price of whatever it is you're holding. And then when that average of the last hundred and fifty days the market has gone up and finally it breaks above the current price, you get back in. It's very simple to do. The problem is about half of the buys and sell you're going to, you're going to fail. A lot of the time you're waiting for a big trend on the Upside and a big trend on the downside. And those things have always happened eventually. And that's where in essence you get well with these timing systems. But it can be a long wait. Now what I like about 150 or 200 days is you're not going to have a lot of activity. You may trade two or three times a a year. If you go to 10 days, a moving average, you're going to be in and out of the market and in and out and, and every time you trade an etf, don't forget there's a spread between the bid and ask. You may be in a fund where you get, they don't charge you a commission, but you're still going to pay the spread between the bid and ask, which is going to be silently eating away at your money. Now let me tell you how I think you can, can in fact put a portfolio together. It won't surprise you to know that this is how my money is managed. And I don't do it myself. I have a life and I don't want to watch the market every day. What I believe in, and I think I was the first market timer back in the 80s to recommend this. I believe that asset allocation, because we don't know which asset classes are going to do well. I believe that asset allocation is just as important with timing as it is with buy and hold. So I want some large and small and value and growth and US and international market time bonds. And the portfolio should be built just as we build buy and hold portfolios based on the likely exposure to the downside and the likely profitability on the upside. And that can all be figured out. Whether you choose to believe it or not. It can be figured out. Looking backwards, I have one market timing portfolio that has when it's fully invested, over 100 different ETFs and mutual funds. Each one is being managed with a trend following system. Again, a reason I wouldn't want to do it myself. But that way you have this massive diversification. Not going to make you look like a hero because one of those hundred funds is going to work real well with a market timing system. Another is going to be terrible. You don't know, but I'm looking kind of for the general direction, a general way to get out. In 1987 we were totally out of the market. About a month before the market had its 22% one day loss. And people asked me, they said customers were happy. They said could you, could you have in fact been in the market? And in fact, Dick Fabian Another timer ended up actually being in the market on that horrible day. And my answer was yes. If the market had tumbled 22% before we got out, of course we would have been there. We would have possibly gotten out the day after it went down 22%. So it's very tricky. It's very hard to stay the course. Moving averages. Short ones are hard to keep up, long ones are easy to keep up. And here's what I love. I mentioned that I'm half buy and hold, half timing. I'm trying to put a smile on my face in every market cycle. And in 2008 it won't surprise you to know that my smile on my face came from the market timing part of my portfolio and, and the bond part of my portfolio is 50, 50 stocks and bonds. So I've got the defense with the bonds, I've got some of the equity with timing. The other is buy and hold. But I also know that my buy and hold equities, when that market turns around and it skyrockets, and it skyrockets so fast, I mean it's breathtaking sometimes how fast it'll go up after a lengthy decline. My buy and hold portion, it's doing it for me. And I'm sitting there seeing my market timing portion in cash and the market is just screaming. I think, oh God, at least I've got that buy and hold part working for me. That's the emotional part.

It sounds like a little bit of regret management. Try to manage your regrets no matter what happens.

That's exactly what it is, Jim.

Now do you think it's worthwhile incorporating a trend following system in a taxable non qualified account or is this something that should really only be done inside a tax protected retirement account?

That's important. It's built because it's not tax efficient. It should be in a tax deferred account. And by the way, I don't think young people should be using market timing. That's in a sense like having bonds in your portfolio when you're in your 20s. No way. You want. Again we go back to Bernstein's comment about wanting to be part thanking the gods, the investment gods for giving us a chance to buy low. No, you don't want a timing system if you're in your 20s. Plus it's a waste of time. You got better things to do with your life than sit around and figure out and worry by the way and worry. I will tell you, most market timers second guess their systems. Most market timers do not follow the systems they say they believe in.

Yeah, obviously not following the system is usually a huge investment mistake, whether the system is buying old or whether the system is following a trend. Now, we're starting to get a little bit short on time here, but I wanted to ask you at least one more question here specific to my audience. My audience is primarily high income professionals like doctors. Can you tell me what mistakes you have seen? Doctors in particular, but also high income professionals of other types making over the years? What mistakes are specific to docs?

Well, that's, that's a tough one. I remember back in the 70s, 80s, I went to a sales presentation by a company that sold limited partnerships to doctors or to people who had extra money to invest. And I kind of weaseled my way into the presentation. I was asked to attend it by somebody who was being pressured to buy some of their products. And when it started, the man who was leading the day, and there were people from all over the country, had come for this sales day conference, all with the same company. And the leader came down, they did it in the theater. He walked down this middle aisle and he had a white smock on and he had a stethoscope. And he walked up onto the stage with something in his hand, turned out to be an elephant gun. And he said, ladies and gentlemen, today I am going to teach you how to hunt elephants. I am going to teach you how to sell to doctors. So there's a lot of emotions around money. There's pride, there's ego, there's fear of law, there's the hate of the government who's taxing me. There are all these things that the professional salespeople know about doctors as a group. Now it may be very different today, I don't know, but that's the way it was. And so they went on to tell them how to sell these products to this market. And the doctors like to think, let me not say doctors, because I got lots of friends who are the same way. People who have a lot of education like to think they know a lot. And that includes something as dirt simple as investing. I mean, if I can learn to be a doctor, this investing thing should be a piece of cake. But the industry is going to crawl across crushed glass to get to these people with all this money. And by the way, even when they don't have money, there's a lot of people who want to crawl across that glass because they know they're going to have money. And I remember when I entered the securities business, I was a broker for three years back in the 60s, one of the brokers in the office put his arm around me and he said, paul, I want you to know we're not here to make money for our clients. And of course, I was dumbfounded. I thought that's what it was all about. He said, no, we are here to create loyalty. It must be so difficult. Your attachment, their attachment to you should be so great that kicking you off the payroll is like kicking a child out of the house. And they know how to appeal to people. In fact, a broker once told me, I call about every three or four calls. I'll just call to say hi and see how things are going, maybe make a little report on how the market's doing. But I don't make it a sales call because I don't want them to think that the only reason I call them is to make a sale. Now, I've got a book entitled Get Smart or Get Screwed. How to select the best and get the most out of your financial advisor. And in that book, it's an ebook on paulmerman.com in that book, I have 80 reasons why you should never do business with somebody who makes a commission. Now, I suspect you come from the same place as I do, Jim, in terms of protecting the people you're writing to, but there are a lot of people who can't judge who's acting in their best interest. There is the big difference between the courtship, the honeymoon, and reality. And, boy, does that industry know how to court.

Yeah, that is for sure. That's great advice for doctors. I really appreciate that, and I appreciate you being on the show today, Paul. We're running a little bit long, but that's okay. I think the great thing about the podcast format is you can make it as long as you want. And so when you. When you're having a good conversation, I don't like to cut it off. And I think this was an excellent conversation. And I really appreciate you taking the time out of your schedule to come talk to our listeners and to teach them a little bit from your experience and from, you know, this wealth of knowledge you have about investing. And I appreciate you coming on the show. Thank you very much for your time.

Thank you, Jim.

That was great getting Paul on the show. You know, he emailed me out of the blue introducing himself. It's like, you know, Jack Bogle or Bill Bernstein calling you up and. And trying to tell you who they are. And I replied back to him, paul, I know very well who you are, and it would be an honor to get you on the show. I told him when we were lining this up that he was a controversial figure in the Bogleheads community, not only for his advocacy of a tilted portfolio, but also the trend following bit. So I wanted to focus the podcast heavily on those aspects. I've been impressed with some of the trend following data over the years, but I don't use it in my portfolio, nor do I tilt my portfolio anywhere near as much as he does. That's a very individual decision and you have to decide what is right for you. Don't tilt more than you believe in these factors in these risk premiums. And if you're going to use a trend following system, make it simple, make it mechanical, write it down, do it only in tax protected accounts, and for heaven's sake, stay the course with it. No investing strategy works if you don't follow it. Paul is going to run this podcast on his own show a week after we run it here at the White Coat Investor. So I just wanted to make a shout out to his listeners, particularly to doctors and other high income professionals, to come over and check out what we have to offer here at the White Coat Investor. For White Coat Investor listeners, check out Paul's stuff@paulmerriman.com or his podcast Sound Investing, available wherever podcasts are found and downloaded.

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