Dear Friends,

We often talk about how the past is knowable while the future is not. Until last week, I could not imagine that we would be witnessing a war in Europe, and on the heels of a global pandemic. Growing up and living in post-WWII US, Canada and Western Europe, most of us have enjoyed an unprecedented time of opportunities, innovations, prosperity and peace; much to be grateful for.

But when circumstances beyond our control change quickly, and not as we’d like, I’ve found a useful response is to stay calm, not act on emotion, and focus on what’s important to me. First, I want to focus on you, as a sound investor. Second, I want to celebrate a great friend who is an integral part of our financial education work.

When you are a “buy-and-holder,” you are positioned and ready for a war at all times. If you’ve followed our academic-based research, you understand that there have always been wars, recessions, depressions, crises, bear markets, rebounds and bull markets. Often the event that causes the damage — or a surprising run up — could not be anticipated. This is why we encourage you to understand risk and return, set up smartly diversified portfolios, and exercise the discipline to stay the course no matter what. History proves there are always good times and bad, in endless cycles.

Is now the time to reevaluate your investments for the future? If your comfort level with loss has changed due to a major shift in personal circumstances, then perhaps so. But it is another matter to change in response to global events in the moment. One could say, “Hey Paul, you’re 78 and your portfolio should be at 60/40 bonds to equities.” But my chosen glide path is 50/50 forever, and I’m sticking to it.

For more insights on this subject, I recommend this article, “The Relationship Between War & The Stock Market” by Ben Carlson.

In this week’s podcast, “You can retire with millions more,” I discuss the long-term impact of using regular Fixed Contributions, and our updated Tables for 2022. Before listening to this podcast, I suggest you review the YouTube 2022 updates on The Ultimate Buy and Hold, Fine Tuning Your Asset Allocation, and No-Nonsense Portfolios.

I reference 9 tables that investors can use to compare the long-term results of using each of these different equity combinations, with the addition of bonds for more conservative investors. The purpose of the tables and this podcast is to help young investors understand the long-term impact of a small monthly investment along with 3% annual increases. The corresponding Fine Tuning Tables are used for return calculations.

I present the case that even simple diversification, as compared to one asset class, can double the value of your portfolio over a 10 year period. I also show how the sequence of return can mean a $1.5 million difference, and suggest using The Merriman Lifetime Investment Calculator to test different beginning dates to see the impact of different sequences of return. The point is to help you consider building different portfolio combinations with unique parts of your long-term investments so you are sure to stay the course.

30 Years of Collaboration

I want to celebrate with you the collaboration and wonderful friendship I’ve enjoyed with Richard Buck, working together for 30 years to help investors make sound investing choices. It began at Merriman Wealth Management with Rich, a financial writer for a Seattle newspaper, writing website articles to attract clients to our investment philosophies and to keep our clients informed. In those days, we offered free live workshops for 3 and 6 hours.

I presented to between 10 and 100 people each time, and with any luck they might have mentioned our work to friends and family. Today, I might speak to a dozen people via Zoom, and then put the recording on YouTube where more than 100,000 people have seen it, as is the case with “My Favorite 12 Vanguard Funds for Retirees”, presented to the Bainbridge Senior Center.

It is the same for the articles Rich and I write together, in which I generally suggest the article focus and outline while Rich comes up with an interesting way to present the topic. He writes the article and I do a final edit. In the early days, all that work ended up in the hands of 500 to 1000 readers (and articles were sometimes much longer than our Marketwatch.com articles). Today, an article might get 5,000 readers or, as is the case of “How to buy 10 years of retirement for $3650,” more than 325,000 readers.

Over the past 2 years, here are the views of the 7 most popular articles at “MarketWatch”:

Today we don’t write for clients. Since starting our financial education foundation in 2012, we’ve focused entirely on helping do-it-yourself investors. We have two major goals:

1. Attract DIY investors of all ages to our educational material
2. Continue to educate them on the steps to building and maintaining a portfolio of equity and fixed-income funds, which meet their need for return and risk tolerance.

Every year about this time, Rich and I update the historical returns of the many portfolios we recommend, with invaluable help from Daryl Bahls. That history rolls out of the annual updates of the Ultimate Buy and Hold Portfolio, Fine Tuning Your Asset Allocation, Fixed Contributions, Fixed Distributions, and Variable Distributions Portfolio recommendations at Schwab, Vanguard, Fidelity and T. Rowe Price, including traditional mutual funds and Best In Class ETFs.

Rich has been an integral part of all of this over the last 30 years: writing our books, articles, white papers and, at one time, interoffice memos to employees at our old firm. I am grateful for such a capable and faithful colleague and friend. Happy Anniversary, Rich!

And, as some of you know, Rich has an unusual hobby. Under the pseudonym of Sam Waldron, he hosts a weekly old-style online “radio-style” show, “45 RPM, Music of the 40s and 50s.” Described as “a musical journey back to the days when he was young. Each one-hour show combines stories and recordings centered on a theme.”

I hope you’ll join me in congratulating Rich on having passed his 200th weekly show, a tribute to Rosemary Clooney. Tune in to https://samwaldron.com/ and you just might find yourself singing along or dancing up a storm… which, by the way, is another great antidote to worrying about the problems of the world.

I have asked “Sam” to share a collection of songs from the period he loves so much that remind him of the 30 years of our work together. I look forward to see what he comes up with. I hope it doesn’t start with “My Friend The Witch Doctor.”

Q&A with Chris Pedersen

SPY or RSP?

Q: When you guys talk about the S&P 500, are you referencing more SPY or RSP? Intuitively, it seems like RSP would give more exposure to “up and comers,” whereas SPY is dominated by 5 or so companies, all essentially tech.

A: The S&P 500 is a capitalization-weighted large-cap blend index. SPY is a capitalization-weighted index fund that tracks the S&P 500 index, so yes, when we talk about investing in the S&P 500 or large-cap blend, the SPY fund would be a representative choice. You’re right that it’s heavily tilted toward a handful of technology companies, but that’s because those are the companies that have done well lately. Over time, the industry-sector tilts will vary as different businesses thrive and investor tastes change. The RSP fund includes companies from the same index, but instead of holding them in proportion to their capitalization-weighting, it holds an equal dollar value of each stock. On the plus side, this means you get a little bit of a tilt towards the smaller, out-of-favor (cheap or value) companies, but it also triggers a lot of trading. As stock prices fluctuate, the fund must buy and sell shares when it rebalances quarterly. It also has an expense ratio that’s higher at 0.20% vs. 0.095%. Since 2003, it has outperformed SPY by about 1% per year after expenses, but it’s also had more volatility (2.5% higher standard deviation) and deeper drawdowns (~55% vs. ~50%). I agree that it’s an interesting option for someone willing to put up with the higher volatility & expenses, provided they’re comfortable not following the crowd.

Alternatives to Vanguard’s Taxable Dividends

Q: My husband and I began managing our investments last fall. We just reviewed our Vanguard statement and saw that we have over $26,000 in dividends in that time frame in our taxable brokerage account, in addition to the already substantial taxable event we created and planned for when we broke away from our advisor, cashed out, and reinvested the brokerage account. We had used your 2 fund strategy when setting up our new account. Is there a better way to invest in this kind of account rather than using target date funds and small-cap value in a taxable account so that it grows without getting hit with big, taxable dividends? Since our investment is now almost back to the value it was in September, we thought now might be a good time to make the change.

A: Yes, Vanguard target-retirement funds shocked us all when they managed their funds in such a way that it triggered such an uncharacteristic capital gains distribution for retail investors. Until this event, their capital gains and dividend distributions had been low enough that holding them in a taxable account, though not ideal, was okay. We can all hope that this doesn’t happen again, but where possible, I’ll be recommending that target-date mutual funds be held in tax-deferred or tax-free accounts moving forward. ETFs would fix this, but I’m unaware of major providers offering target-date ETFs at this time.

There is a potential benefit from your capital gains distribution. If you reinvest it in the fund, you will increase the cost basis of your investment which reduces the future capital gain when you eventually sell it. You still have to pay taxes on the distribution, but even if you only invest the remainder after paying today’s taxes, you’ll get a reduction in future taxes. Whether you end up better off or not over the long haul depends on many things, but especially the tax rates today vs. those when the fund is sold in the future.

There’s one other bit of positive news, and that’s that Vanguard has lowered the expense ratio on their target retirement funds to 0.08%. I realize it’s another small consolation, but the gyrations which led to the capital gains distributions may have been instrumental in getting to this lower expense ratio.

Am I doing the right thing with my 2-Fund for Life Portfolio?

Q: I’m a big fan of your work and you’ve completely sold me on small-cap value. I’ve figured out that I have a high risk tolerance (within index funds) and, after listening to some of your talks, I put together a simple 2-fund portfolio but wanted any input you’re willing to give on the portfolio. I am 28 years old, expect to retire at 60 and my current retirement savings is $80k.`

The portfolio I’ve started to craft is 50% total market (VTI) 50% small-cap value (SLYV). My question/concern is: am I missing any potential returns by eliminating the SCB/SCG components or am I enhancing potential returns by doing so? This has certainly been volatile through the month of January, but I have had no issues holding through this and adding to it this week.

A: Congratulations on getting off to a great start at an early age! The portfolio you’ve decided on is similar to the 50% S&P 500, 50% US SCV portfolio Paul’s been talking about. The backtesting says you’re not giving up much by skipping the small-cap blend and large-cap growth parts of the portfolio, but there is a potential behavioral cost. When small-cap blend or large-cap growth is the best-performing asset, you won’t be holding a fund focused on them. If you can ignore that, you won’t care. If you can’t, you might be better off with a more complex portfolio. One way to deal with it is to remember that the VTI fund holds almost everything. No one can tell you which approach will do best in the future, but the backtesting says the 50% total US market plus 50% US small-cap value is well-diversified and has delivered better returns per unit of risk than the S&P 500 alone over the long term.

Does M1 update automatically?

Q: If I have already have an M1 Finance account with the Ultimate Buy and Hold strategy, is that automatically updated on M1 with 2022 suggestions or would I have to do that manually?

A: Unfortunately, M1 requires you to do it manually. When we update our best-in-class recommendations, we will create new Pies on our website that you can load into your account and use to make the change. Please consider taxes and trading costs before blindly adopting the changes.

Why are Avantis ETFs on your “Best in Class” list?

Q: I recently became aware of The Merriman Financial Education Foundation and I very much like what you offer. I’m curious though how Avantis ETFs, which have only been around for about a year, made it to the “Best in Class” list, but Dimensional Fund ETFs, with their longer track records, did not.

A: When the Best-in-Class ETFs were last updated, the relevant and interesting DFA ETFs were not available. I will be updating our recommendations this year and will consider the new DFA ETFs as part of that process. At this point, I don’t expect major changes because many of the other funds, including Avantis, have proven to be excellent choices.

Rebalancing year-by-year

Q: My daughter started her first job last year and opened a 401(K). I advised her to follow your Two Funds for Life strategy and to rebalance annually on her birthday. Her 26th birthday is coming up this month and I have a question. This past year she was investing 37% in a TDF and 63% in a small-cap blend (No ACV available in her 401(K)). When she turns 26, should she rebalance back to 37-63, then change future contributions to 39-61? Or do you rebalance forward to the 39-61? Do you rebalance back or forward?

A: The good news is that there’s no need to be overly precise. Plus or minus a few percent here and there will get lost in the noise of market returns. If I were using the 1.5xAge 2 Funds for Life approach, I’d calculate the allocation percentages at the beginning of the year based my age at the time and use them to rebalance and set contribution percentages for the following year. So, if I had just turned 26 (oh, to be young again!), I would rebalance to 39% in the target-date fund, and 61% in the second fund (small-cap blend in her case). I would also set the contribution percentages for the coming year to match that 39% TDF, 61% SCB allocation.

Editor’s Note: Learn all about Two Funds for Life strategies in Chris Pedersen’s book, 2 Funds for Life – A quest for simple & effective investing strategies. All profits from the sale are generously donated by the author to support our Foundation.

Personal Story

Paul, That was an excellent video on teen investing! My son is 17 and now starting to make decent money with his first job. I’ve always wanted to talk to him about investing, like my dad did with me. And I always wondered what the best investment would be for a teen starting out, and how that would roll over once he got a ‘career’ job. Meaning, if he started now, what investment vehicle would he use and how would that be combined with the 401k he sets up with an employer?

Now I know!! It’s the Roth IRA that we will try to get him a nice lump sum of money in over the next 5-10 years. And then he can decide if he wants to let it ride after that (not contribute any future money to) and then just focus on contributing to his 401K. Thank you so much for this timely advice to help beef up his wealth when it’s time for him to retire. I have followed many of your investing principals over the years and love the contributions you are making to the investment world, for those willing to listen :-). – Kevin D.

Helping you build a better financial future,
with more peace of mind,
Paul

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