Guest Blog by Steve Thorpe
Are you a do-it-yourself type seeking strategies to manage your retirement investments?
Thousands of books, magazines, web sites, and broadcast media sources promise help, however many publications are in fact cleverly designed to market expensive Wall Street products that pay for others’ retirements – not yours!
In contrast, Paul Merriman’s Live It Up Without Outliving Your Money! Getting The Most From Your Investments In Retirement is a great resource for investors researching techniques to effectively manage their retirement portfolios. Here I share a few chapter highlights that I hope will whet your appetite for more. Trust me, you will find many valuable tips in this book.
The Psychology of Successful Investing
Chapter 4 provides guidance on psychology, an extremely important aspect of becoming a successful investor. It covers managing your investment expectations, being clear about your goals and objectives and two extremely important points – watching out for what Wall Street preaches and the media reports (he shows you how these are closely related). Merriman emphasizes how the media is all about selling advertising-not helping the average investor. A couple of my favorite quotes are:
“The industry doesn’t want to talk about preparing you for the inevitable bad times, even though that is what you need”;
“The right way to deal with most broadcast financial journalism is to either change the station or turn off the radio or TV.”
What Are Your Goals?
The next chapter recommends that you estimate two target numbers:
(1) Your base retirement income, and
(2) Your “live-it-up” income.
The base target includes income for essential items that you must pay for during retirement: food, shelter, health care, clothing, taxes, utilities, and perhaps some for hobbies, entertainment, etc. The “live-it-up” target adds additional expenses that you’d like to have if possible, such as extra travel, a second home, etc. These two targets combined with advice from later in the book, can help an investor determine when (and whether) she can afford to retire (i.e., when a sufficient portfolio size is reached that would generate the base income); and when there’s really no reason to work anymore, except for non-financial reasons (i.e., she has accumulated enough to fund her live-it-up target).
Merriman also covers three competing goals for investors approaching retirement:
(1) Beating the market,
(2) Getting the highest return you can get within your risk tolerance, and
(3) Finding the lowest-risk way to meet your needs.
Merriman writes, “You can’t successfully pursue all three of these goals at once.” He wisely counsels that investors carefully consider their own risk tolerance when setting goals, and he gives several examples of risk-return tradeoffs.
Your Ideal Portfolio
The main chapters of the book (Chapters 6-10) present a fascinating discussion of diversification and asset allocation, and their potential effects on risks and returns.
Merriman walks the reader through asset allocation building blocks used to create a successful investment portfolio and advises on balancing risk vs. return using an appropriate allocation to fixed-income (bond) investments. These chapters build upon a key diversification benefit: “Smart diversification lets you mix two assets together and achieve a higher return, with less risk, than the average return of those two assets.”
Merriman develops a sequence of six portfolios, each with a base allocation of 60% equities and 40% fixed-income, and tracked during the 38-year period covering 1970 though 2007.
Portfolio #1 has 60% in an S&P 500 Index fund and 40% in a Bond Index fund. Portfolios 2 -6 gradually slice and dice the equity and fixed components into different sub-categories. Corporate bonds are removed, bond maturities are reduced, and inflation-protected bonds are added. In the examples presented, these changes alone reduced the volatility while maintaining the same return. Next, Real Estate Investment Trusts (REITS) then Micro Cap companies are added to the equity mix. Portfolio #5 adds Value (beaten-down, or “cheap”) stocks. Portfolio #6 adds additional diversification by splitting the equity slices between domestic and international.
Portfolio #1 achieved a 10.2% annualized return over the 38-year period, with an 11.2% risk (using standard deviation as a measure of risk). Portfolio #6 had a higher 12.7% return with a lower 10.8% risk. These differences may not seem large when viewed as annualized numbers, but when translated to dollars they are enormous: An initial $100,000 investment in Merriman’s sample portfolio #1 would have been worth $4,066,109 after the 38-year example period, while in portfolio #6 it would have grown to $9,507,765 – more than twice the return on your initial investment but with a less bumpy ride along the way!
Merriman suggests 50% equity/50% fixed-income as a starting point for investors to consider (adjusted for each individual’s circumstances). In the example shown, the 50/50 split attained more than three-quarters of the return of the 100 percent equity portfolio, while suffering only just over half of the risk. Not a bad tradeoff!
Where We Disagree
As with most books, I do not agree with every word. Two examples include:
1. Merriman expressed very positive views on funds from Dimensional Fund Advisors (DFA). Indeed, there are certain benefits, but I’m not convinced of Merriman’s statement that DFA “should have an advantage of at least one percentage point a year over Vanguard funds, even after the effect of a presumed 1 percent annual management fee”. Also I had small differences of opinion with the way Merriman’s DFA vs. Vanguard tables were presented – in my judgment, the comparisons were not always comparing apples to apples.
2. Personally, I’m a bit more conservative when projecting into the future. I’d tend to estimate lower expected returns and would suggest somewhat lower withdrawal rates in retirement, more along the lines recommended by Jim C. Otar in his Unveiling the Retirement Myth, another book I reviewed.
Despite these minor differences, I highly recommend this book.
The last few chapters of the book offer advice on reducing expenses and taxes, selecting the right funds for your portfolio, withdrawal strategies during retirement, hiring an investment adviser and building your own personal action plan (Merriman provides his own personal “500-Year Plan”). He also recaps Ten Lessons from John Bogle (founder of the Vanguard Group, Inc.) that are definitely worth reading, along with his pointers to additional websites and books.
I am confident applying Merriman’s techniques can benefit thousands of investors and perhaps it can help you to Live It Up Without Outliving Your Money! I paid Amazon $16.47 for my copy, and feel it was money well spent. At just over 200 pages, it’s an easy read that can pay for itself thousands of times over.
I love Merriman’s words from the end of Chapter 10:
“If you prudently choose to take lower risks and wind up with a lower return, you might have to work longer before you can retire. You might have to spend less (and save more) before retiring. You might have to spend less after you retire. But you’ll preserve your peace of mind. And in the end, peace of mind is priceless.”
In my opinion, this is great advice.
(Disclaimer: I am not compensated for writing this review, or if any copies are sold. I’m simply a satisfied reader who volunteered to write this blog entry for the Portfolioist.)
About the Author
Steve Thorpe is the founder of Pragmatic Portfolios, LLC, a fee-only Registered Investment Adviser based in Durham, North Carolina specializing in developing sensible investment plans integrated across all of a client’s investment accounts. He also chairs the Research Triangle Park, NC area chapter of the “Bogleheads” investment interest group. Observing conflict-of-interest laden behavior of various charlatans from Wall Street has always inspired Steve to help others navigate the sometimes-treacherous investment landscape.