Jim Lange Talks Investing With Nationally Recognized Expert and Author Paul Merriman

Episode: 199
Originally Aired: August 2, 2017
Topic: Jim Lange Talks Investing with Nationally Recognized Expert and Author Paul Merriman

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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  1. Introduction of Paul Merriman, Author of Financial Fitness Forever
  2. Educated Investors Are More Successful
  3. It’s Difficult to Change What Succeeded in the Past
  4. Balance Large and Small, Value and Growth, U.S. and Overseas
  5. Base Investments on Knowledge, Not Guesses
  6. Passion Made Jack Bogle and Vanguard a Success
  7. Small-Cap Assets Have Historically Outperformed S&P 500
  8. Rebalance Your Portfolio Every 12 to 18 Months
  9. Rebalancing Investments Can Seem Counterintuitive

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.

1. Introduction of Paul Merriman, Author of Financial Fitness Forever

Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and Attorney Jim Lange. This week, we welcome Paul Merriman back to the program. Paul is a nationally recognized authority on mutual funds, index investing, asset allocation and passive and active management strategies. He’s now retired from the Seattle-based investment advisory firm he founded in 1983, but he’s the author of several books on personal investing, including 101 Investment Decisions Guaranteed to Change Your Financial Future. Paul also writes columns for Marketwatch.com, and, in 2012, he created the Merriman Financial Education Foundation, which aims to help people get the most out of their investments without taking too much risk. This week, Jim and Paul will talk about various aspects of investing, including rebalancing your portfolio, how often should you do it, lessons that Paul learned from meeting with legendary Vanguard founder Jack Bogle, why small cap is underperforming this year, and is there a downside to index funds? So, a lot to cover, and let’s get right to it. Let’s welcome Jim Lange and Paul Merriman.

Jim Lange: Welcome to the show, Paul.

Paul Merriman: Well, it’s great to be back with you, Jim. Thanks for letting me come back.

Jim Lange: Well, as you know, you’ve been a very influential figure in my life. I used to be on your radio show when you were interested in educating some of your listeners on Roth IRA conversions and some estate-planning techniques, and you have followed my career, and you made some critical advice to me, gave me some critical advice years ago, is, as you know, I like to do the strategic part, the Roth part, the Social Security, educating grandchildren, estate planning, that type of thing, but I was never the person who actually wanted to manage the money. So, earlier in my career, I had worked out an arrangement with a very good active money manager, where I did the works that I did, I ran the numbers, did the Roth, et cetera, the money manager managed the money, and together, we charged kind of a standard fee, anywhere between, say, 50 basis points and 1 percent, and then the money manager and I split that fee, and you said, “Well gee, Jim, that’s a pretty good model, except you’re working with an active money manager. That’s not the way to do it, Jim! If you really care about your clients, what you will do is have that same arrangement, but instead of with an active money manager, with an index money manager, and preferably, even one who uses Dimensional Fund Advisors,” which is a great set of low-cost index funds.

After exploring the possibility of working with your firm, which didn’t work out because your firm was in Seattle and our firm was in Pittsburgh, I ended up choosing P.J. DiNuzzo, who also works with Dimensional Fund Advisors, and we have, together, just done phenomenally well and provided a great service to clients where we had that same model where our office runs the numbers, does the Roth, does the Social Security, tells people how much money they can spend, how to educate their grandchildren, what their estate plan should look like, et cetera, et cetera. P.J. and his crew actually manage the money, and then P.J. and I split, let’s say, a standard, or a slightly less than standard, fee. So, Paul, I owe an awful lot to you, and thank you so much for putting me in that right direction many years ago.


2. Educated Investors Are More Successful

Paul Merriman: You know, Jim, it’s great to hear that my teaching actually did some good, and here’s what I believe, and after reading your newsletter and the things you talk about, not just about investing, but about your life, I think that if we do a better job of educating our clients and taking care of our clients, the end result is they’re going to end up with more money to either live on and enjoy, or to leave to their children, or to leave to charities they care about, and here’s the bottom line: I really believe my conversations with you led to you not only in the end probably having a more successful business because I think you’re using a far superior investment vehicle, but it’s also leading to your clients making more money more than likely. You know, no guarantees, we always got to hide behind that, but the odds are, your folks are going to have more money to spend, leave to children and charities, and that, at the end of the day, is what my work is about, and I think that’s what your work is about, too.

Jim Lange: Well, you have always been a great educator. Even back when you were in practice, you used to give these literally legendary talks that I have seen on video, and actually, I will take the liberty of mentioning that you have a video of probably some of your finest information, and I’ll tell the audience a little bit about what you do for money and how your wife forbids you to make any, but you actually provide this wonderful two-and-a-half hour great information. Now, yes, it’s a little bit technical, and yes, it was done for a group of CPAs, but if people are really interested in getting the most out of what they have, I can’t give you a better recommendation than to go to www.paulmerriman.com and listen to this free two-and-a-half hour session, and I think you actually call it the same as my favorite book of yours, which is Financial Fitness Forever. Is that right, they both have the same name?

Paul Merriman: Yeah, that’s right, because it covers those same important topics that are in the book as well.

Jim Lange: Well, I know you have a lot of books out there, and I think that we had mentioned one in the introduction. Was it 101 or 1,001 Ways or something like that?

Paul Merriman: It probably feels like 1,001 to the reader, but it’s only 101, and it’s free!

Jim Lange: And it’s free! On the other hand, my favorite book of yours, and maybe you’ll come up with something else, but my favorite book, because I think it covers so much great information, is Financial Fitness Forever. So, before we get into the meat of the subject — and by the way, for whatever it’s worth, as you know, I order from you practically by the caseload and I give them out like candy because I think the information’s so valuable, which is Financial Fitness Forever, or, what I’m really going to recommend, is that our listeners go to www.paulmerriman.com and listen to the two-and-a-half hour, or watch the two-and-a-half hour, video, which has the same name, Financial Fitness Forever.

Paul Merriman: By the way, Jim, you mentioned the word “listen,” and there are really two ways that it’s offered. One is having to look at my face along with the outlines scrolling along on one screen, but that’s not going to work on a smartphone, and so we did another one where it’s simply me speaking the audio plus the outline scrolling over the smartphone. So, we’ve tried to make it available to different ways that people are likely to use it. But thank you very much for the kind mention. It is the heart of my educational work.

Jim Lange: Well, your educational work, which, literally, is what you have been doing all your life, and I found it very interesting. When you were in Pittsburgh, I went over to your hotel and we met for a while, and you told me something that I thought was very interesting, that I hope it’s OK to share with our listeners, which is that you said that your wife was happy to have you continue to be active, but she didn’t want you to make any money because she thought that you would just, like, get too much into it and you’d never see her. So, as I understand it, you guys have a rule that you’re allowed to write books, do podcasts, continue with your educational foundation, educating investors on how to get the most out of what they’ve got, but you’re not allowed to make any money. Is that accurate?

Paul Merriman: Basically, yes. I promised her I would never work for money again. I’m kind of a workaholic. It’s been hard on family. It’s been hard on my own physical self because I don’t take very good care of myself, and, of course, she thought that when I said I wouldn’t ever make any money again that I would actually retire. But I am, in fact, because of a special meeting I had less than two months ago, I’m even committed to working longer than I thought I was going to. So, I’m having a ball, and she actually is very supportive of the work, although, just like before, she wishes I didn’t work so many hours! Anyway, that’s life. When we love what we’re doing, you find that bliss in life that Joseph Campbell used to talk about, it’s hard to say no to something you just love to do.

Jim Lange: Well, you have always been a giver, and right now, you’re giving some information. So, why don’t we get down to some of the things that you have talked about? Now, I know that you have been very influential for me to get me and my clients into the index world, but I know that you have also, and so have I, had some interactions with Jack Bogle, who is the founding member and retired president and CEO of Vanguard. Can you tell us a little bit about some of the lessons that you learned from Jack Bogle?


3. It’s Difficult to Change What Succeeded in the Past

Paul Merriman: Well, it was kind of a life changer to me to be able to go to his office, sit down and talk with him, and I was given an hour to be there with him and I ended up spending 90 minutes with him, and that was one of the nice compliments I’ve ever gotten, or he just didn’t know how to get rid of me. One of the other! But it was fascinating because I sometimes wonder why does Jack Bogle believe the things that he believes compared to some of the things that you and I believe about what makes a successful long-term investment, and I never quite got it because there was just this huge difference between what the academics have actually discovered since the S&P 500 fund was even started back in 1976. But what I discovered, and this is so common, this is human nature, he got a lot of his motivation from work that was done by Paul Samuelson. I mean, Bogle was a bright guy, graduated from Princeton and all of that, very smart, and actually did his senior thesis on this active versus passive question, but when he went to his board of directors to propose this new fund, this S&P 500, he used the work of Paul Samuelson to help sell the directors. Now, that’s an important moment in time because if you look at it, it was from that piece of academic literature that he was able to end up being the kind of king, and not only king of indexing, but the king of the individual investor. He has shown a way of caring about the investor that, in a sense, nobody else ever showed in the way he showed it. But he did so well with that original research that to get him to change, to do something different, to take advantage of all the new research that’s been done since then, that’s not an easy thing for him to do. It’s kind of like, I know that you’ve worked with the professors there in the Pittsburgh area, lots of people from the education environment, and they had TIAA-CREF, and that’s what they invested in early on in their career, correct?

Jim Lange: That’s correct.

Paul Merriman: And what is it they believe? I mean, since TIAA-CREF got them to where they are today, how difficult is it to convince them, hey, there may be a better way? It’s hard, and it’s the same thing with Jack Bogle. He believes in the things that he believed in 40 years ago, and I, and you, we believe in things that we learned from, like, Dr. Fama and Dr. French, other academics that were kind of a step beyond Paul Samuelson, but it formed our belief system. So I now get it. I now get why it’s unlikely that Jack Bogle is ever going to be on the same page as I am because we’ve been motivated by two different sets of information, and that was important to me.

Jim Lange: Well, I’ve also interviewed Jack Bogle, actually twice, on the radio show, and I actually consider him one of the great American heroes, and if the average American, instead of investing in the 401(k) plan that they are likely invested in, instead have the opportunity to have a well-diversified portfolio of index funds in Vanguard, their lives would be much different. So, I am part of the Jack Bogle Mutual Admiration Society, but you did mention, hey, there’s some newer stuff out there that Jack Bogle doesn’t quite recognize or isn’t really part of his paradigm. Why don’t you talk a little bit about what French and Fama have said and how that might influence somebody’s choices and maybe not put everything in the S&P 500?


4. Balance Large and Small, Value and Growth, U.S. and Overseas

Paul Merriman: I’m happy to because I think it can be, and I have to use the words “can be,” so do you, it can be a life changer because what Fama and French did with tons of students who helped them uncover all of the past data regarding the returns of big companies and small companies and growth and value, they turned the return information upside down to find out how these asset classes did. Regardless of who the manager was, their view was, it wasn’t about the manager who was picking the stocks. It’s about what asset class you’re in, and not only that, but at the end of the day, if you put these different asset classes together, it turns out the unit of return per unit of risk is much higher than the S&P 500. It isn’t magic anymore. It was magic until people figured it out, but the work that Fama and French did was groundbreaking, and Fama has ended up being a Nobel Prize winner, and what they found was that there was this premium for value, a premium for small cap.

Now, we all know that today, but we didn’t know that when they did the research. In fact, people couldn’t figure out how does this guy at the price funds, the mutual series funds, how come he was making so much more money than other managers? It turns out it was no big deal. He was investing in value instead of growth, and there was a premium for that value, just as there is a long, long history of premium for small. You don’t have to invest all in value and small. In fact, the academics wouldn’t recommend that. They would recommend a different total-market index than Jack Bogle does because his is basically large-cap U.S. growth, and what Fama and French were recommending as a total-market index was a combination, a balance of large and small and value and growth, U.S., and, by the way, international, which Jack Bogle doesn’t really want people to be concerned about. He says you can get it all from the large growth companies, all the international that you need. Well, you and I, we have a big difference of opinion because of the work of Doctors Fama and French.

Jim Lange: Well, some of this isn’t just a theoretical academic paper. People actually have been getting better returns, and we have to be a little bit careful when we talk about better returns, but let’s say, for discussion’s sake, and you and I are on the same wavelength. I am a big believer in well-diversified portfolios, and I would say nine out of 10 clients or prospects that come to me, we have a process where, if it looks like we are a good fit and I like them and they like me, we take their portfolio, we put it into Morningstar, which is an objective reporting service, and we tell them where they are, and, at least, by my standards, and probably yours, they are pretty much universally overweighted in large U.S. companies, particularly growth, and underweighted in small companies. So one of the things that we try to do is to steer at least a portion of their portfolio towards small, and then, what happened? We had a year where small underperformed. So, they said, “Hey Jim, if you’re so smart and small’s so wonderful, how come I have less money than if I had just put all my money in the S&P 500?” How are you going to answer those people, Paul?


5. Base Investments on Knowledge, Not Guesses

Paul Merriman: Well, it’s with education. My wife and I went, this last weekend, to the Gottman Institute. It was Dr. and Mrs. Gottman’s husband-and-wife team, who talk about what you can do to make your life better as a couple, and I’m one of those believers that think we all need a tune up from time to time to kind of remind ourselves and see how we’re doing in terms of being a good husband or wife or whatever, or parent. But one of the things he mentioned that talked about his research, he said — and this is paraphrasing — “We want to make decisions that are based on what we know versus what we guess.” Most investors and most people who are recommending investments do that on the basis of predicting the future, what they guess is going to happen. The work of people like Dr. Fama and Dr. French and the work that I think we’re doing is based on what we know about the past, and here’s what we know if we get an education: We know that many of the years, small cap will underproduce large cap, but that’s the nature of the process that value will underproduce growth. In fact, this year, value is doing way less than large growth is doing. That is normal, and what investors need to understand is what is normal.

Was it normal in 1977 when small-cap value was up 22 percent and the S&P 500 was down 7 percent? Was it normal in 1998 when small-cap value was down 5.5 percent and the S&P 500 was up 28 percent? I could go through lots of years in the past, and what we need to be able to do, and it’s the hardest work that you and I have to do, I think, Jim, is to make sure that people understand that what just happened is not statistically meaningful. It’s actually meaningless because if we decide that what just happened was going to dictate the future of our portfolio, when the S&P 500, from 2000 to 2009, lost 1 percent a year, what would you conclude? “Well, you should never have your money in the S&P 500. It’s a bad place to invest.” Wrong! It’s a great place to invest, and you shouldn’t be making the decision based on what just happened, and, of course, human nature is that what just happened, particularly if it has to do with losing, either losing money or losing opportunity, that becomes such an important factor in how we look at our investments. What happens to us when we allow that to happen is Wall Street just comes rushing in: “Yes, Mr. Investor! We have some money in large growth. If you had been with us, you wouldn’t have lost that money that you lost in small-cap value,” or whatever it was. That’s how they make a living, swooping in, taking advantage of people when they’re thinking the wrong way, and if we educate people the right way, Wall Street is not going to have a shot at you, because you all know the difference between what we call the “courtship, the honeymoon and the reality.”

Jim Lange: I do want to give our listeners two sources of information that I highly recommend both. Particularly for the readers, my favorite Paul Merriman book is a book called Financial Fitness Forever, and for people who like video or audio, by the same name, Financial Fitness Forever, there is a two-and-a-half hour, I would call it gold, video and audio, which can be found at Paul’s website, which is www.paulmerriman.com.

I understand that you have some other Jack Bogle lessons that you would like to share with our audience?

Paul Merriman: You know, I would, Jim, because there are times as investors that we get frustrated because we’re just not getting there as quickly as we had hoped we would get there in terms of our expectations for returns and maybe even find out we have more volatility in our portfolio. There are a couple of things that came out of the conversation. It’s certainly well-known that his fund, the S&P 500 trust, the first index fund from 1976, that was the beginning. I knew it was a slow beginning, but I didn’t realize how close it came to even becoming the fund that it did, because it was supposed to be a $250 million underwriting by Dean Witter, and that was going to put that fund on the map and give it a chance to display whether it worked or not, and instead of raising $250 million, they raised $11 million. I mean, Jack said it was probably the worst underwriting in the history of the stock market! And I think I know why, and I’m going to find this out, and I’ll report back to you, Jim. I think it’s because they probably put a very small commission on it and Dean Witter brokers didn’t want to sell something with that small a commission because, after all, they come first. But anyway, the board of directors, or Dean Witter, I mean, he did not specify which, actually discussed the possibility of simply returning the money to the investors because the underwriting had been a failure, and Jack overcame.

I mean, he is one hard sale. I mean, he is a persistent guy. He’s tenacious. I mean, just being in the room with him and you can feel the passion and the tenacity that he would have in building. I mean, here he is at 88, he’s still got passion and a sense of that tenacity. But here’s the part that I find fascinating, and I didn’t realize it until, again, I was sitting there. Here’s a man who has become the king of the hill. He is the best in the business, and we honor him. As you have said, you honor him. He’s a hero of mine. He’s making money for people that they don’t even know they’re making money because the fund they own is charging less than they would be if Bogle and the Vanguard funds weren’t out there to keep the pressure on. But here’s the part that we need to understand: He got lucky. He got about as lucky as a person could get in this industry because he started that fund, as small as it was, and unsuccessful as it was, and it was called Bogle’s Folly. They laughed at him. “Well, who would want to buy a fund that produced average returns? This is ridiculous!” And it grew, and one of the reasons that it did well in terms of its performance had nothing to do with the beliefs of the public because the public didn’t even basically know about the fund. The fund really didn’t become the center of attention until the late ’90s, but by that time, it had compounded at over 16 percent a year. Can you imagine, as a salesperson, if all you wanted to do was make money by selling past performance, you would take that past performance, whether it’s real or hypothetical, and you would show this to people and say, “Look, you can invest in the 500 largest companies in America, and you can get a 16 percent compound rate of return, and, to top it off, oh, by the way, the last five years, from ’95 to ’99, it compounded at over 28 percent a year. Wouldn’t you like to have some money in that fund?”


6. Passion Made Jack Bogle and Vanguard a Success

That is the tailwind that Jack Bogle got to help make him the most famous man in our industry. He has done way more to help the individual investor than Warren Buffett, and Warren Buffett is considered to be a great man. So, what really made Jack Bogle great? A great idea, a passion to help others — by the way, he really is frugal. He himself, he’s about as frugal a guy as I’ve met in a long time, and a market where the market does what you want it to do, and that is to make more money than is normal for the people that you’re doing it for. I don’t care if you’re a full-commission salesperson at Merrill Lynch or a no-load investment advisor charging 1 percent or whatever they’re charging, we all want to make money for our clients because they thank us for it and it’s easy to find more clients. So I realize that luck had a lot to do with the success of Jack Bogle and the Vanguard funds, and we should remember, as investors, that just as we can have good luck in the market, unfortunately because since 2000 … let’s say you just started investing in 2000. Through the end of 2016, the compound rate of return of the same fund that put Jack Bogle on the map was about 4½ percent a year. How would that have been if he came public in 1999, and for the next 17 years, made less than government bonds? That would not have been a winner.

Jim Lange: And certainly not if we compare it to some of the other sectors that Jack is not as enthusiastic about, for example, small international. Getting back to small, I think what you were saying was just because it underperformed in one time period, let’s say relatively recently, that you’re saying that that’s part of the normal fluctuation, and if we look back to, say, some of the statistics that French and Fama are providing, let’s say, going back to 1928, that it might actually be 3 percent or 4 percent better than the S&P 500, and that, again, no guarantee for the future, but if you do have a sector, which is the smaller companies that have done that much better consistently, perhaps not consistently because, again, there’s years that are up and down, that at least a portion of your portfolio should be in some of these sectors like small.

Paul Merriman: Yeah, I absolutely agree, and to go back to that comment that Dr. Gottman said, it’s about what we know versus what we guess, and that we should make decisions on what we know. In that Financial Fitness Forever video, and in articles that I’ve written, I’ve got over 300 articles on the site …

Jim Lange: Is that all, Paul? You don’t sound like you’re very prolific! Just 300 articles.


7. Small-Cap Assets Have Historically Outperformed S&P 500

Paul Merriman: But here’s what I know: I know that if I go back and look at the market in the small-cap value-asset class, without picking a great manager, just own them all, as defined by Dimensional Funds, by the way, somebody else could define small-cap value a different way. So, that’s one of the interesting aspects about choosing the right small-cap value. There are differences. But looking back, and looking at every 40-year period, and the reason I focus on … well, I also show 15 years as well, for people my age, but then I show 40 years because I am focused on helping first-time investors coming right out of college, and that’s where I have the best access to them, show them how to invest for the future. Here’s what I know: I know if I look at every 40-year period, that the small-cap value makes more than 4 percent more a year than the S&P 500 on average, sometimes a lot more, sometimes a little less. But if you are in this process for the long-term, the evidence is overwhelming. The only problem with that evidence is, it isn’t proof, and if we could call it proof, we could put the word “guaranteed” on it, and I can’t put the word “guaranteed” that there’ll be a 4 percent advantage. But at least all of what we know allows me to, not predict, but to consider it likely that if you are in that asset class with part of your portfolio, that it will perform better than the S&P 500, and by the way, you want to be careful, both of us here, Jim. We don’t want to suggest that we want people to put all of their money in small-cap value. I understand why some people might do that, but we’re talking about that along with the S&P 500, and along with some large-cap value and other asset classes that also have a long history of outperformance.

Jim Lange: Well, let me ask your opinion on the way we do it in our office, again, with the association with P.J. DiNuzzo, who, by the way, is a great believer in the set of index funds that you mentioned, Dimensional Fund Advisors, that actually came from the Nobel Prize winners that you had mentioned, Fama and French. But what he likes to do, and, like you said, not everything in small cap because, to be fair, small cap is “riskier.” Now, what does risk mean? To me, risk is losing money in the long run. But the way it is traditionally measured is really standard deviation, meaning it’s much more volatile. So, what we like to do is say, OK, X percent, whether it’s 10 percent or 20 percent, and again, everybody’s a snowflake and you have to divide the portfolio according to individual needs, but what we do is, we take the small-cap section and we put it in, let’s call it, the long-term bucket, that is money that we’re not going to plan on spending for a long time, and that would be much different than, let’s say, the short-term bucket that might be cash and CDs and maturing bond ladders. And that way, if there is a downturn in the small-cap market, people say, “Well, I don’t care because my short-term needs are already taken care of. But if I can get an extra 4 percent in the long run for me, or maybe I won’t even be around that long, but for my kids, well, they’re going to get, ultimately, a higher rate of return.” So, that is the way that we handle it. We do it in different tranches or buckets, and then to add to the fun, we will have different tax buckets. So, for example, we will much prefer having, let’s say, a Roth IRA that you are likely to spend last, or probably even legacy money, and that could be invested for the long-term in, let’s say, small and some of the more volatile asset classes compared to money that will be spent in the short-term. I don’t know if that has any appeal to you.

Paul Merriman: First of all, I think this whole question of what I call, or the industry calls, asset-class allocation, where do you put different asset classes? I think you’re right on there, Jim, and this is a relatively new thing. When I go back to when I started my business back in the ’90s, we weren’t focused on making sure that we get every asset class in the right place tax-wise. Now, investment advisors do that, and that’s meaningful long-term, I think. The other question then is the bucket and do you leave small cap there by itself in that bucket that’s for the long-term? I think that’s a great solution. I happen to come from the part of the advisory community that believes that you have this asset allocation so much in small and large, and that you rebalance on a periodic basis because it maintains your exposure to risk, and if we don’t do that, what happens is the portfolio becomes more risky as you let things go. But I think they’re both legitimate ways to manage money. They’re both going to work in the long run as long as it works for the investor, because you and I both know, no strategy is any good if the investor won’t stay the course.

Jim Lange: Paul’s been giving us some great information, but for further information, I’m going to recommend a book that he wrote called Financial Fitness Forever, and a free two-and-a-half hour either video or audio on his website that just is filled with great information, and that can be found at www.paulmerriman.com.

We were talking about asset allocation and some of the tax strategies of putting some of the long-term, more volatile, but over a long-term, better performing asset classes like small caps, and the long-term bucket, and we just started to talk about rebalancing, that is, what to do as some of the asset classes do better and some of the asset classes do worse? So, Paul, why don’t you tell us a little bit about what you like to do in terms of rebalancing?


8. Rebalance Your Portfolio Every 12 to 18 Months

Paul Merriman: Well, rebalancing is one of the major challenges for individual investors. Most of my work, Jim, is basically do-it-yourself. I’m trying to help people who haven’t found a great advisor to work with them, and so I’m trying to help them with how could they do it in a way that they can maintain the discipline. So it’s very easy, theoretically, to tell people that once a year, or every 18 months, that you should rebalance your portfolio, or I could say that if you start out with 60/40, 60 equity and 40 fixed income, that when it gets to 70 percent equity and 30 percent fixed income, you should then rebalance back to your original risk-tolerance limits. So those are relatively easy do-it-yourself instructions. But when you’re working with an advisor, it really is a lot more complex, and the reason I’m worthless as an advisor because I can’t talk to people individually. I’m not allowed to. I’m no longer licensed. I’m trying to give information that could be used by lots of people, but the reality is, and you’ve seen this in your work, Jim, every client has their own set of variables that means that, for example, maybe they’re adding money to their portfolio each year. What a wonderful opportunity to rebalance. Maybe they’re taking distributions every year to live on because they’re whatever age they are. “I have to take money out.” OK, great opportunity to rebalance in that process of taking that minimum required distribution.

But when you do your best work for an investor, it’s when you take not only their risk tolerance, but you take their personal tax situation into consideration because sometimes, it isn’t just a matter of, if I’m an advisor, I might be managing a million dollars, but they could have another $400,000 someplace else. So, the work that I do in terms of rebalancing, it has to take into consideration the $1 million I’m helping to manage and the other $400,000 that is somewhere else, and I think, when I talked a while ago about this idea of asset-class location, that if we can manage both the 401(k), and I’m sure you’ve found this, too, and the taxable, we can create an overall portfolio that, if you have to take gains, you take it over into the tax-deferred part of your portfolio so that you don’t expose the investor to unnecessary taxes. That is both, I think, an art and a science, and I can’t do that for people. There’s no way. And I can’t even come up with a set of rules for all conditions. That’s the job of an advisor, and this is not an advertisement for you, Jim, because my belief is that every investor who’s got a reasonable amount of money to last them a lifetime ought to spend, at a minimum, one year in the trenches with a really great advisor to try to figure out who the heck you are, where you’re going, because most of us don’t do so well on our own. If I may reflect back on the weekend I just spent with my wife with Doctors Mrs. Gottman and Mr. Gottman, we will probably apply 10 percent to 20 percent of what we learned because that’s not our expertise! And it’s the same with money. Most of us just don’t have the time, the patience or the interest to do it right. That’s where a great advisor, and I mean great. There are so many bad advisors out there. You do need a great advisor who takes all of this into consideration, including taxes like you do, Jim, including risk tolerance, and not working for the house, for a set of funds that the company owns, but is doing it totally as a fiduciary in the best interest of the investor.


9. Rebalancing Investments Can Seem Counterintuitive

Jim Lange: And I think one area that you’re very well aware of, but you just didn’t happen to mention, is that we are working with human beings who often let their emotions run ahead of their brains. So, for example, what rebalancing is, if you actually think about the essence of it, you are selling what just did very well and you are buying what just did terribly. So this is the exact opposite of human nature. Normally, when we see a fire and we are afraid of getting burned, we don’t jump into the fire and put our hands even closer, we back away. Likewise, if we, let’s say, have something that is wonderful, we want more of it. We don’t want to sell it. So, for example, some of the behavioral, if you study the DALBAR studies, they will tell you that an S&P 500 investor does much worse than the S&P 500. Well, how can that be? Because the S&P 500 investor will typically sell when the investment is doing badly and will typically buy when the investment is doing well. So, therefore, the plain old S&P 500 does much better, and that’s really more of a behavioral issue.

Paul Merriman: You’re right. The human component is the largest component of all.

Jim Lange: So, what Murray sometimes says is he talks to a group of advisors and he says, “See the guy on your right? You should manage his portfolio, he should manage yours, and you’ll both be better off.”

Paul Merriman: Yes! Good idea, good idea.

Jim Lange: Well, anyway, Paul, you have been a great source of information. I fear we are running against the clock, but I do, before we close up, want to mention two wonderful resources, both free, that you are offering; I guess, actually one might cost a couple bucks. The book, my favorite book of yours, is Financial Fitness Forever. I know that there is a lot of other information on your website that is free, but again, my favorite book is Financial Fitness Forever, and then you also have a two-and-a-half hour video that can also be listened to as an audio file, and I know that you have actually made a special audio and a special video, and it goes by the same name, Financial Fitness Forever, and both of those can be found at your website, which is www.paulmerriman.com. Paul, thank you so much for agreeing to be a guest today.

Paul Merriman: Thank you, Jim. Keep up the great work.

Jim Lange: Well, thank you, and I think that it is fair to call you the elder statesman of personal finance.

Paul Merriman: I’ll go to bed with that thought tonight.

Dan Weinberg: All right, thanks, Paul, and thank you, Jim. Listeners, if you’d like a chance to meet with Jim Lange in person, you can give the Lange Financial Group a call at (412) 521-2732 to see if you qualify for the Lange Second Opinion service. That number again, (412) 521-2732. You can also connect with Jim’s office through his website at www.paytaxeslater.com. While you’re there at the website, you can check out some of our archived radio shows and get a free digital copy of Jim’s latest book, The Ultimate Retirement and Estate Plan for Your Million-Dollar IRA. For now, I’m Dan Weinberg. For Jim Lange, thanks so much for listening, and we will see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.