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Paul Merriman: 9 Radical Recommendations For Your Retirement Portfolio
This is radically awful advice...put everything in equities? I can tell you from actual experience that unless someone has way too MUCH money, they will not be able to handle the volatility of an all-equity portfolio in retirement. And I also know that folks who don't NEED to generate big returns are often the worst at handling bear markets. Perhaps, just perhaps, it might be ok if a person was taking no withdrawals. But when you combine a 4-5% annual withdrawal in year one of retirement with a bear market, it has the makings of a disaster for long-term survival. Think about starting retirement and withdrawing 4-5% in 2007 and 2008, and combine that with what happened to the markets then.
Obviously Mr. Merriman has either too much money himself, which would allow him to be 100% in stocks (50% in international), or he has never advised real-life, ordinary investors. I have been in this business for almost 30 years, and I am looking at retiring in 5-7 years. I can tell you even I would not follow Mr. Merriman's advice, and I have a lot more risk tolerance than all of our retired clients.
But when you combine a 4-5% annual withdrawal in year one of retirement with a bear market, it has the makings of a disaster for long-term survival. Think about starting retirement and withdrawing 4-5% in 2007 and 2008, and combine that with what happened to the markets then.
Great comment! Sometime I wonder where Mr. Merriman comes up with these ideas.
Reply to @BobC: Bob, it appears that he is targeting this advice as a 20-yr plan for investors in their 20's to 30's. For them I think the advice has merit and they can do without a bond fund until their 40's and 50's.
What it doesn't address is helping that age group adopt a savings mentality when many in that group struggle to just make ends meet. That's a hard fight. I believe many in that age group are also woefully lacking in financial acumen, heck, I'd bet half of them couldn't even balance a check book. By the time they figure it out most will be far behind the 8-ball looking for that winning lottery ticket or worse, easy prey for all the shysters and pseudo experts out there promising plans and systems doubling their money.
I speak as a father to 4 in this age group. After 30-years I've finally gotten one to think beyond the end of his nose. Unfortunately he's the one who's in the best financial shape already.
I think we can also look at recent retiree's and the boomers coming up the ladder and see proof of same. You'll find many of these non-planners taking your order at Mac & Don's or similar. Just sad.
The logical extreme of his portfolio philosophy over decades that exploited two efficient market hypothesis holes - "value premium" and "small premium". He even had an article in MW earlier this year that would have sent his loyal buy and hold cult following into conniptions. Mentioned that he used a part of his portfolio for momentum trading, the third EMH hole.
This is a good example of the point in my previous post that people start to confuse empirical evidence for natural law and use it for the future.
You can run this advice in most of the garbage-in-garbage-out Monte Carlo simulators and it will likely split out anywhere between 60% and 80% confidence (depending on the garbage-in it has been programmed with and the number of simulations) that it will be successful for anybody let alone 20 year olds.
Any 20 year old that follows this but unlucky enough to face an extended bear market in say the last 5 years of the next 20 years when his portfolio had reached its peak will be one sorry ass he followed this advise. Even if his Monte Carlo simulator had told him the likelihood of such a bear period was very small as divined by its programmers.
Interesting recommendations, not entirely unreasonable, but... I wonder whether he assumes that the present overvaluation of small-cap stocks is a myth? Is it? GMO expects that they will deliver negative returns -4.5% per year in average for the next 7 years, much, much worse than bonds or anything else. So shall we buy small cap stocks, as he recommends, or sell them, or chose which ones to buy and which to sell, or wait 7 years and then reconsider?
Reply to @cman: How so sorry-ass? Anyone @30 +/- who follows this advice should be fine by then, in my experience, via natural law or caprice. They will have become able to take a bear hit. No? Am I missing something in what you fear? I myself have very much followed this advice, or tried to, for 35 years, meaning hired managers who do this; and with two kids +/-30yo I get to watch how their implementations of my advice goes as well, as it is along these lines. Deep reading during my investment time was enough to persuade me utterly (and no, I don't read better than anyone else, nor am smarter; to the contrary; just lots and lots and lots of skeptical reading), as my reading eventually accorded with and converged on these views. As for Andrei, if you worry about overvaluation, you simply cannot invest successfully. If you're seriously fretful about that, dca and call it a day. Or avoid. 7 years' neg returns for small-caps? That is amusing. It shows the most fundamental misunderstanding of what small companies are and do and how they work. Let us mark from tonight forward to xmas 2020 (hindsight!) and see how badly GABSX and DES have done by then ....
Doesn't seem all that radical. One is averaging in for 20 years, adjusting for 15 (probably 20 years realistically). Take the risks while you're young; might not have to take them later; and changing the investment pattern of the new money around 50 lets the earlier money continue working. Unless SS really does go bust, it represents a bond equivalent. Agree with the comment about small percentages of bonds offering little for young investors. Also agree that poor people have trouble finding money to invest. Might also get good results with 35 to 40 years of global high dividend fund or ETF. Represents value, international exposure, and many of the large companies are making money in emerging markets.
Reply to @davidrmoran: The comment was regarding his recommendation for a single basket all equities portfolio in this linked post not his diversified portfolios that you presumably used.
Consider the realistic scenario of a typical 20 something starting out with a very small portfolio and adding over time where a normal/bull market will also help grow it slowly.
If he was unlucky enough to face a bear market towards the end of the 20 year horizon with the same small only or value only single basket all equity portfolio, his draw down with such a portfolio would be horrendous and happen at a time when his portfolio had grown with contributions and gains to have a lot to lose.
The small or value 1-2% premium for the first 10 years or so on a smaller portfolio wouldn't make up for it and he would be left with a much worse situation than if he had used a diversified portfolio that didn't try to provide that premium but reduced drawdown.
In other words, the eventual outcome would be very sensitive to how the markets behaved in those 20 years. Or 30 or 40.
Merriman's radical recommendation works with a lot of assumptions - that the value and small premiums will continue for the next 20,years, and that the timing of a bear market in those 20 years will not be unfortunate as in the scenario above but will generally be a rising market with some corrections or that the portfolio will be large enough in the bull years relative to bear years and not skewed the other way.
There is no guarantee that these assumptions will hold or even a valid justification to say there is a good probability other than faith and looking in the back mirror. Simulations that ignore the reality of fat tails have seriously underestimated the probability and frequency of the previous bear markets.
Hence the value of diversification to reduce the volatility over most market scenarios with no assumptions on the thickness of tails. It will underperform in fortunate scenarios and over perform in unfortunate scenarios for that single basket recommendation.
There has been much MFO hot ink spilled over Paul Merriman’s purportedly controversial proposal for an all equity diversified portfolio during the accumulation phase prior to retirement.
This is not an entirely new idea or strategy. It has been long advocated by folks with a cast iron constitution who do not panic when adversity erodes their portfolios. These folks tend to not monitor their portfolios too closely and have a deep rooted faith in the equity market’s resiliency. They trust that volatility over the long haul is not worrisome, and that the superior returns of an all equity position outdistances untimely and unpredictable late-period disappointments. Is that trust warranted?
The MFO commentary over Merriman’s proposition has been mostly sensible, but contaminated just a little with nonsensical assertions and opinions.
Surely there is no shortage of assertions and opinions. Most are made of solid stuff, but some are composed of mirrors, smoke, misrepresentations, misunderstandings, and misinterpretations. But something has been completely missing from the exchange. What story does the data tell? Where are the analyses?
Here is my attempt to fill that void.
I ran a few Monte Carlo simulations using the Flexible Retirement Planner’s version of that useful tool. I surely do not claim that my analysis is exhaustive. It definitely is not. The entire sequence of calculations that I completed took about 15 minutes. That’s one of Monte Carlo’s most attractive powers. It enables a host of what-if scenarios and sensitivity analysis that permits the user to explore various aspects of the problem quickly. The code runs thousands of random simulations per case.
I hypothesized two alternate portfolios: an all equity portfolio, and a 60 % equity, 40 % fixed income mixed portfolio. For the all equity holdings, I postulated a reasonable 10 % annual average return with an 18 % standard deviation. For the mixed portfolio, I postulated a 7.5 % annual average return with a calculated 12 % standard deviation. I say “calculated” because I needed to assume a 0.4 correlation coefficient between equities and fixed income for the study period.
On the personal data level, I presumed a starting age 0f 35, a planned retirement age of 65, and a life expectancy (combined husband and wife) of 95. So there is a net wealth accumulation period of 30 years and a balancing net retirement phase of 30 years. For the retirement phase, I postulated a portfolio of only fixed income positions with a 4 % average annual return and a 6 % standard deviation. These are reasonable inputs and easily changed.
Initially, I assumed an annual accumulation phase savings rate (in non-taxable accounts) of $15,000 (15K) per year. You’ll see that that saving level is totally inadequate given that I parametrically explored portfolio survival likelihoods for 30K, 40K, and 50K yearly withdrawals during retirement. The Monte Carlo code adjusts these inputs internally for inflation. For the purposes of this analysis, I assumed an average inflation rate of 3 % with a 1 % standard deviation.
For the all equity portfolio, the survival probabilities were 55 %, 40 %, and 28 % for the 30K, 40K and 50K drawdowns respectively. None of these are acceptable and speak volumes for plan revision.
For the 60/40 mixed portfolio, the survival rates were only 22 %, 14 %, and 6 %, respectively for the same drawdowns. This finding is even less acceptable than the all equity portfolio.
With its enhanced net worth at the retirement date, the all equity portfolio delivered superior survival prospects during retirement when the retiree was assumed to convert to fixed income holdings.
The Monte Carlo simulator is a great tool to parametrically examine the impact of optional pathways.
For example, what happens to survival likelihoods if the savings rate is increased from the initial 15K to 20K per year? For the all equity portfolio survival rates increase to 71 %, 56 %, and 43 % for the 30K, 40K, and 50K withdrawal levels, respectively. That’s an improvement, but still far to risky for a comfortable retirement.
At this juncture, I said “forget about the 40K and 50K retirement withdrawal rates; they’re not realistic”. Focusing now on the 30K annual retirement spending requirement, I asked the following question: “How much annual pre-retirement savings is needed to reach a comforting 90 % retirement survival probability?” The retirement planner yielded a 31K per year reply.
You might not like the analysis or the resultant outcome numbers, but those are the hard numbers. They do not include any assertions or opinions. They are simply the output from thousands of calculations that did require a set of guesstimate inputs. Nothing new here when forecasting future outcomes.
The inputs can be easily changed to accommodate personal preferences and beliefs. Their influence on the robustness of the analytical findings becomes self-evident with additional calculations. Parametric analyses of this sort allow the pre-retiree to explore his options, and provide guidance for needed directional shifts in terms of time scale, savings level, and likely post-retirement spending limitations.
The Flexible Retirement Planner code does not model Fat Tails or Black Swan events, so it is slightly optimistic in its projections. I say “slightly” because I considered such limitations when I generated my own Monte Carlo simulator about 1990. I did include some Fat Tail modeling in my version of that tool to test sensitivity to that modeling shortfall.
The necessary program changes are relatively modest, only requiring a few additional lines of code. Basically, instead of using a single log-normal distribution for returns, two distributions are programmed with a break point at the extremes of what the user believes is the usefulness of the conventional log-normal distribution.
I tested break points at the 1.5 and 2.0 standard deviation levels. One obvious problem is that the choice of the second distribution is rather arbitrary given the paucity of real world data in this regime. I did examine a few Fat Tail distributions that I selected based on historical Black Swan events and outlier returns data. These did change the projected survival rates somewhat, but NOT in any decisive, decision reversing way, especially in the context of the overarching uncertainties of future market returns.
The Black Swans are rare. outlier events, and are statistically overwhelmed by the more common happenings. Waiting for Black Swans is a loser’s game. Nassim Nicholas Taleb discovered that when his earlier barbell investment style suffered weekly losses while waiting and waiting and waiting for the hammer to drop. His coworkers said it was like dying from a thousand small cuts.
It is my conclusion that Monte Carlo tools, even with their admitted shortcomings, are a superior way to address long term highly uncertain happenings. Many academic, military, and industry wizards who are tasked to predict the uncertain future would support me in that assessment.
I hope this post is helpful It is meant to be. I invested about 5 times more effort in writing this summary than I invested in actually doing the Monte Carlo number work.
I’ve posted this Link previously, but if you have an interest in pursuing the Monte Carlo tool, here is a Link to the simulator that I referenced and used:
Reply to @Mark: Even for 20 year olds, I think some amount (say 20%-30%) in bonds is good. From his own website http://www.merriman.com/PDFs/UltimateBuyAndHold.pdf returns in a relatively long recent period (1970-2012) are 8.5% annualized for 100% stock vs. 8.4% for 60:40 portlio with a little reduced risk. Younger investors are inexperienced and regardless of the advice they get, it is very likely they will sell at exactly the wrong time (when the market tanks) if they are 100% in equities. They also have the advantage of having a longer time till retirement, which means if they invest early enough in a steady balanced fund like FPACX, OAKBX or even a Vanguard balanced index fund, they can achieve their retirement goals more easily. Younger persons can also have some shorter term expenses (higher education, marriage, home purchase) which means a portfolio with reduced volatility (without sacrificing returns too much) would be better. Why take more risk when you don't need to? For my daughter, I created a brokerage account (including a Roth) when she started making little money working part-time during high school and college. She is invested in FPACX and ARTHX, and already has close to mid-five-digit portfolio at graduation. It also helped that she started investing closer to the bottom of the market.
Comments
Obviously Mr. Merriman has either too much money himself, which would allow him to be 100% in stocks (50% in international), or he has never advised real-life, ordinary investors. I have been in this business for almost 30 years, and I am looking at retiring in 5-7 years. I can tell you even I would not follow Mr. Merriman's advice, and I have a lot more risk tolerance than all of our retired clients.
What it doesn't address is helping that age group adopt a savings mentality when many in that group struggle to just make ends meet. That's a hard fight. I believe many in that age group are also woefully lacking in financial acumen, heck, I'd bet half of them couldn't even balance a check book. By the time they figure it out most will be far behind the 8-ball looking for that winning lottery ticket or worse, easy prey for all the shysters and pseudo experts out there promising plans and systems doubling their money.
I speak as a father to 4 in this age group. After 30-years I've finally gotten one to think beyond the end of his nose. Unfortunately he's the one who's in the best financial shape already.
I think we can also look at recent retiree's and the boomers coming up the ladder and see proof of same. You'll find many of these non-planners taking your order at Mac & Don's or similar. Just sad.
This is a good example of the point in my previous post that people start to confuse empirical evidence for natural law and use it for the future.
You can run this advice in most of the garbage-in-garbage-out Monte Carlo simulators and it will likely split out anywhere between 60% and 80% confidence (depending on the garbage-in it has been programmed with and the number of simulations) that it will be successful for anybody let alone 20 year olds.
Any 20 year old that follows this but unlucky enough to face an extended bear market in say the last 5 years of the next 20 years when his portfolio had reached its peak will be one sorry ass he followed this advise. Even if his Monte Carlo simulator had told him the likelihood of such a bear period was very small as divined by its programmers.
As for Andrei, if you worry about overvaluation, you simply cannot invest successfully. If you're seriously fretful about that, dca and call it a day. Or avoid. 7 years' neg returns for small-caps? That is amusing. It shows the most fundamental misunderstanding of what small companies are and do and how they work.
Let us mark from tonight forward to xmas 2020 (hindsight!) and see how badly GABSX and DES have done by then ....
Also agree that poor people have trouble finding money to invest.
Might also get good results with 35 to 40 years of global high dividend fund or ETF. Represents value, international exposure, and many of the large companies are making money in emerging markets.
Consider the realistic scenario of a typical 20 something starting out with a very small portfolio and adding over time where a normal/bull market will also help grow it slowly.
If he was unlucky enough to face a bear market towards the end of the 20 year horizon with the same small only or value only single basket all equity portfolio, his draw down with such a portfolio would be horrendous and happen at a time when his portfolio had grown with contributions and gains to have a lot to lose.
The small or value 1-2% premium for the first 10 years or so on a smaller portfolio wouldn't make up for it and he would be left with a much worse situation than if he had used a diversified portfolio that didn't try to provide that premium but reduced drawdown.
In other words, the eventual outcome would be very sensitive to how the markets behaved in those 20 years. Or 30 or 40.
Merriman's radical recommendation works with a lot of assumptions - that the value and small premiums will continue for the next 20,years, and that the timing of a bear market in those 20 years will not be unfortunate as in the scenario above but will generally be a rising market with some corrections or that the portfolio will be large enough in the bull years relative to bear years and not skewed the other way.
There is no guarantee that these assumptions will hold or even a valid justification to say there is a good probability other than faith and looking in the back mirror. Simulations that ignore the reality of fat tails have seriously underestimated the probability and frequency of the previous bear markets.
Hence the value of diversification to reduce the volatility over most market scenarios with no assumptions on the thickness of tails. It will underperform in fortunate scenarios and over perform in unfortunate scenarios for that single basket recommendation.
There has been much MFO hot ink spilled over Paul Merriman’s purportedly controversial proposal for an all equity diversified portfolio during the accumulation phase prior to retirement.
This is not an entirely new idea or strategy. It has been long advocated by folks with a cast iron constitution who do not panic when adversity erodes their portfolios. These folks tend to not monitor their portfolios too closely and have a deep rooted faith in the equity market’s resiliency. They trust that volatility over the long haul is not worrisome, and that the superior returns of an all equity position outdistances untimely and unpredictable late-period disappointments. Is that trust warranted?
The MFO commentary over Merriman’s proposition has been mostly sensible, but contaminated just a little with nonsensical assertions and opinions.
Surely there is no shortage of assertions and opinions. Most are made of solid stuff, but some are composed of mirrors, smoke, misrepresentations, misunderstandings, and misinterpretations. But something has been completely missing from the exchange. What story does the data tell? Where are the analyses?
Here is my attempt to fill that void.
I ran a few Monte Carlo simulations using the Flexible Retirement Planner’s version of that useful tool. I surely do not claim that my analysis is exhaustive. It definitely is not. The entire sequence of calculations that I completed took about 15 minutes. That’s one of Monte Carlo’s most attractive powers. It enables a host of what-if scenarios and sensitivity analysis that permits the user to explore various aspects of the problem quickly. The code runs thousands of random simulations per case.
I hypothesized two alternate portfolios: an all equity portfolio, and a 60 % equity, 40 % fixed income mixed portfolio. For the all equity holdings, I postulated a reasonable 10 % annual average return with an 18 % standard deviation. For the mixed portfolio, I postulated a 7.5 % annual average return with a calculated 12 % standard deviation. I say “calculated” because I needed to assume a 0.4 correlation coefficient between equities and fixed income for the study period.
On the personal data level, I presumed a starting age 0f 35, a planned retirement age of 65, and a life expectancy (combined husband and wife) of 95. So there is a net wealth accumulation period of 30 years and a balancing net retirement phase of 30 years. For the retirement phase, I postulated a portfolio of only fixed income positions with a 4 % average annual return and a 6 % standard deviation. These are reasonable inputs and easily changed.
Initially, I assumed an annual accumulation phase savings rate (in non-taxable accounts) of $15,000 (15K) per year. You’ll see that that saving level is totally inadequate given that I parametrically explored portfolio survival likelihoods for 30K, 40K, and 50K yearly withdrawals during retirement. The Monte Carlo code adjusts these inputs internally for inflation. For the purposes of this analysis, I assumed an average inflation rate of 3 % with a 1 % standard deviation.
For the all equity portfolio, the survival probabilities were 55 %, 40 %, and 28 % for the 30K, 40K and 50K drawdowns respectively. None of these are acceptable and speak volumes for plan revision.
For the 60/40 mixed portfolio, the survival rates were only 22 %, 14 %, and 6 %, respectively for the same drawdowns. This finding is even less acceptable than the all equity portfolio.
With its enhanced net worth at the retirement date, the all equity portfolio delivered superior survival prospects during retirement when the retiree was assumed to convert to fixed income holdings.
The Monte Carlo simulator is a great tool to parametrically examine the impact of optional pathways.
For example, what happens to survival likelihoods if the savings rate is increased from the initial 15K to 20K per year? For the all equity portfolio survival rates increase to 71 %, 56 %, and 43 % for the 30K, 40K, and 50K withdrawal levels, respectively. That’s an improvement, but still far to risky for a comfortable retirement.
At this juncture, I said “forget about the 40K and 50K retirement withdrawal rates; they’re not realistic”. Focusing now on the 30K annual retirement spending requirement, I asked the following question: “How much annual pre-retirement savings is needed to reach a comforting 90 % retirement survival probability?” The retirement planner yielded a 31K per year reply.
You might not like the analysis or the resultant outcome numbers, but those are the hard numbers. They do not include any assertions or opinions. They are simply the output from thousands of calculations that did require a set of guesstimate inputs. Nothing new here when forecasting future outcomes.
The inputs can be easily changed to accommodate personal preferences and beliefs. Their influence on the robustness of the analytical findings becomes self-evident with additional calculations. Parametric analyses of this sort allow the pre-retiree to explore his options, and provide guidance for needed directional shifts in terms of time scale, savings level, and likely post-retirement spending limitations.
The Flexible Retirement Planner code does not model Fat Tails or Black Swan events, so it is slightly optimistic in its projections. I say “slightly” because I considered such limitations when I generated my own Monte Carlo simulator about 1990. I did include some Fat Tail modeling in my version of that tool to test sensitivity to that modeling shortfall.
The necessary program changes are relatively modest, only requiring a few additional lines of code. Basically, instead of using a single log-normal distribution for returns, two distributions are programmed with a break point at the extremes of what the user believes is the usefulness of the conventional log-normal distribution.
I tested break points at the 1.5 and 2.0 standard deviation levels. One obvious problem is that the choice of the second distribution is rather arbitrary given the paucity of real world data in this regime. I did examine a few Fat Tail distributions that I selected based on historical Black Swan events and outlier returns data. These did change the projected survival rates somewhat, but NOT in any decisive, decision reversing way, especially in the context of the overarching uncertainties of future market returns.
The Black Swans are rare. outlier events, and are statistically overwhelmed by the more common happenings. Waiting for Black Swans is a loser’s game. Nassim Nicholas Taleb discovered that when his earlier barbell investment style suffered weekly losses while waiting and waiting and waiting for the hammer to drop. His coworkers said it was like dying from a thousand small cuts.
It is my conclusion that Monte Carlo tools, even with their admitted shortcomings, are a superior way to address long term highly uncertain happenings. Many academic, military, and industry wizards who are tasked to predict the uncertain future would support me in that assessment.
I hope this post is helpful It is meant to be. I invested about 5 times more effort in writing this summary than I invested in actually doing the Monte Carlo number work.
I’ve posted this Link previously, but if you have an interest in pursuing the Monte Carlo tool, here is a Link to the simulator that I referenced and used:
http://www.flexibleretirementplanner.com/wp/planner-launch-page/
Good luck. This retirement planning tool will reduce the need for luck, but you will still need a healthy dose of it.
Best Wishes and Merry Christmas.
Even for 20 year olds, I think some amount (say 20%-30%) in bonds is good.
From his own website
http://www.merriman.com/PDFs/UltimateBuyAndHold.pdf
returns in a relatively long recent period (1970-2012) are 8.5% annualized for 100% stock vs. 8.4% for 60:40 portlio with a little reduced risk. Younger investors
are inexperienced and regardless of the advice they get, it is very likely they will
sell at exactly the wrong time (when the market tanks) if they are 100% in equities.
They also have the advantage of having a longer time till retirement, which means
if they invest early enough in a steady balanced fund like FPACX, OAKBX or even
a Vanguard balanced index fund, they can achieve their retirement goals more easily. Younger persons can also have some shorter term expenses (higher
education, marriage, home purchase) which means a portfolio with reduced volatility (without sacrificing returns too much) would be better. Why take more risk when you don't need to? For my daughter, I created a brokerage account (including a Roth) when she started making little money working part-time during high school
and college. She is invested in FPACX and ARTHX, and already has close to
mid-five-digit portfolio at graduation. It also helped that she started investing
closer to the bottom of the market