“We’re Talking Millions”

Mark Meredith, CFP®

Originally published 08/22/2022

Last year financial author and educator, Paul Merriman, appeared for an interview on The Rational Reminder podcast (check it out here). During the interview, Merriman discussed his most recent book “We’re Talking Millions” which outlines 12 steps for investors, each of which has a potential million-dollar payoff.

Merriman states that if you can add 0.50% a year to your portfolio return, that could mean $1 – $1.5 million in long-term payoff for an investor currently in their 20s. Let’s see if that holds up.

Imagine a 22 year old making $50,000 annually at their first job. They contribute 10% to their 401k plan, while their employer matches 50% of their contributions. If they never once receive a pay raise, earn 8% each and every year on their 401k, and retire at age 62, they’ll have $2,181,879. If everything stays the same, but the return is changed to 8.5% annually, they’ll have $2,524,157, about $342,278 more.

That’s not quite a $1 million difference, but changing a few inputs would make it so, such as extending the timeline until age 72.

You may be wondering how it’s possible to increase the expected return by 0.50% annually. The answer might be simpler than you think.

The Flaw of Target Retirement Funds

Target Retirement Funds really are a wonderful thing. They automate portfolio management, and many of them come with low expense ratios. They have been a good product innovation for those who have no interest in financial markets.

What I have seen in many company retirement plans is that target retirement funds are the default investment choice, meaning if you do not handpick your investment elections you will be enrolled in a target retirement fund based on your age.

For someone entering the workforce today, they may be entered into a fund like the Vanguard Target Retirement 2065 Fund. Let’s look under the hood at the allocation (as of 07/31/2022):

  • Vanguard Total Stock Market Index = 54.30%
  • Vanguard Total International Stock Index = 36.20%
  • Vanguard Total Bond Market II Index = 6.50%
  • Vanguard Total International Bond Index = 3.00%

Someone scheduled to retirement 43 years from now (in 2065) currently has 9.50% of their portfolio in bonds, why? There is no serious risk reduction or diversification benefit by allocation 9.50% of your portfolio to bonds.

According to the DFA 2022 Matrix book we have seen US Stocks beat US Bonds by 5% annualized from 1976-2021 (12.1% vs. 7.1%). Moving a 10% allocation out of bonds into equities would increase your expected annual return by 0.50%.

For this reason, when I meet with younger investors I encourage them to divide the 401k across handpicked index funds with low costs, as opposed to the default target retirement option. The difference in ending wealth could be staggering from this one simple change.

Other Ways an Advisor Can Add Value, and How They Can’t

William Bernstein wrote in a 2003 article titled “The Probability of Success” that one needs four faculties to invest competently. Those are:

  • An interest in investing. It’s no different from cooking, gardening, or parenting.
    If you don’t enjoy it, you’ll do a lousy job. Most people enjoy finance about as
    much as Carmela Soprano enjoys her husband’s concept of marital fidelity.
  • The horsepower to do the math. As Scott Burns explained to me years ago,
    fractions are a stretch for 90% of the population. The Discounted Dividend
    Model, or at least the Gordon Equation? Geometric versus arithmetic return?
    Standard deviation? Correlation, for God’s sake? Fuggedaboudit!
  • The knowledge base—Fama, French, Malkiel, Thaler, Bogle, Shiller—all seven
    decades of evidence-based finance back to Cowles. Plus, the “database” itself—a
    working knowledge of financial history, from the South Sea Bubble to Yahoo!
  • The emotional discipline to execute faithfully, come hell, high water, or Bob
    Prechter. Mr. Bogle makes it sound almost easy: “Stay the course.” Alas, it is not.

Bernstein further suggests one must string all four of these together, which he estimates only about 0.01% of people can do. This is evidenced by numerous data points but most recently from Morningstar’s 2022 Mind The Gap Study, which showed that over the prior 10 years investors underperformed the very ETFs and mutual funds they were investing in by 1.70% annually.

How can an investor underperform the investments they are investing in? They chase returns by buying high and selling low, and feel the constant pressure to do something when markets aren’t going the way they want them to.

It is not terribly uncommon for someone to show me a fund with a track record of a very nice return, what they fail to show me is what the investors in the fund actually earned on average. The best example I know of this is Ken Heebner’s CGM Focus Fund, which was written about in Wes Gray’s book “Quantitative Value”.

The CGM Focus Fund was the best performing US Stock fund of the 2000 – 2009 decade, earning 18.2% annually. However, the average investor in the fund lost 11% annually. Heebner’s fund made 80% in 2007, and money poured into it. The following year it promptly fell 48% and investors withdrew their money.

Imagine if an advisor could just help the average investor close that gap found by Morningstar’s study, there’s another 1.70% annual value add. Unfortunately, many advisory firms charge high asset-based fees, which could get your right back to realizing the underperformance that you hired your advisor to help you avoid. I am an advocate of the flat advisory fee model, which does not compound with one’s portfolio.

This leads to me suggest Merriman is correct on his book title, we’re talking millions of dollars by creating and adhering to a well-crafted plan over the course of decades. Further value adds are tilting towards factors like small cap and value, providing tax planning recommendations, adopting a flat advisory fee (as opposed to asset-based), and instilling confidence in the plan throughout all market conditions.

We’ve covered what I think a good advisor can do, here is what they cannot do (credit on this goes to Nick Murray’s Simple Wealth, Inevitable Wealth):

  • With any consistency forecast the economy. No one can.
  • With any consistency forecast the market or time the entry and exit points. No one can.
  • With any consistency forecast the future relative performance of mutual funds or equity portfolios. No one can.

I believe this is the disconnect between the public and the advisory industry, which I will admit probably is not helped by the fact that some of the advisory industry claims they can do all three of the above. The sooner one accepts these things are not possible, the sooner they are on a better path to investment success and not having to worry about their portfolio.

Buffett once stated “Forecasts tell you nothing about where the economy is headed, but they tell you a lot about the individual who is making the forecast”. When I hear short-term market and economic forecasts, I stop listening. I propose you do as well.

Disclosure: This article is for informational purposes only and should not be considered a recommendation. Information contained in this article is obtained from third party resources that Meredith Wealth Planning deems to be reliable. Past performance does not guarantee future results.

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