About Me 0060: Making Money Work

Investing legend Paul Merriman, shares the lessons learned and secrets discovered over more than 40 years as one of the world’s leading investment professionals.

John Nyaradi:

Hi, everyone, I’m John Nyaradi, publisher of Wall Street Sector Selector, a financial media site specializing in exchange traded funds and global financial and economic analysis. Today, I’m pleased to welcome our special guest, Paul Merriman. Paul, welcome to Wall Street Sector Selector.

Paul Merriman:

Thanks John, it’s great to be with you.

John Nyaradi:

Paul is one of the true giants of the investing and financial management business. He is founder of Merriman Incorporated, an investment advisory firm based in Seattle, Washington, that manages approximately $1.6 billion for thousands of families across the country.

Paul is a widely respected expert on mutual fund investing. He’s editor of the FundAdvice.com website and his podcast, “Sound Investing,” was named the best podcast in 2008 by Money Magazine. He’s author of a highly acclaimed book, “Live it Up Without Outliving Your Money: Getting the Most from Your Investments in Retirement,” by John Wiley and Sons and is widely quoted in major financial magazines and media.

Paul, let’s start out with your company’s motto, “Invest wisely and live fully.” I like that a lot. Can you give us a sense of what you mean by that, “Invest wisely and live fully?” How do you do that for people?

Paul Merriman:

My view of investing wisely is simply to do the smart, savvy things with our money to maximize our return without getting greedy. And I think one of the wisest things we can do is to invest within our risk limits. Investing wisely also means minimizing expenses and taxes. We believe in massive diversification. We believe that the more stocks you have in the portfolio, the better you will do, not the more average you will be.

The live fully aspect means that not only do you have enough money but that you are also able to enjoy it. Too many people have way more money than they need but find it difficult to enjoy it.

I just spoke with a client who’s down in Mexico. He’s been a client for over 20 years, and I know he’s got more money than he needs. He wants to buy a second house in Mexico. He must have talked to me five times about whether the purchase makes sense. And every time I spoke with him, his burning question was, “Now Paul, are you sure we have enough?” We convinced him, yes, he does have enough…and he’s making the offer, closing the deal, and that is what we think living fully is. Not just having enough, but feeling secure so you can spend it and enjoy it.

John Nyaradi:

That’s got to be a rewarding work especially in today’s environment after the post crash environment we’re in and the pain everybody went through.

Paul Merriman:

John, would you mind if I comment on what you just said?

John Nyaradi:

Please, go ahead.

Paul Merriman:

A lot of people complain about the emotional and financial pain of the 2007-2009 bear market. I think the problem was compounded by going through two big bear markets in 10 years, each of them about the same as the 73-74 decline. That much pain without an extended bull market in between is hard for people to digest and build confidence in the market. It has been one hell of a 10 year period.

John Nyaradi:

Yes, it really has been…you’re a unique animal, Paul, I think, because people tend to be either buy-and-hold people or market timing people, but you do both in your portfolios. I’ve read about what you call “the ultimate buy and hold strategy,” could you give us a little insight into that?

Paul Merriman:

Well, “the ultimate buy and hold strategy” is the title of one of my favorite articles to help people build a better buy and hold portfolio. The term “ultimate,” sounds like a big promise, but it simply means it’s the best I’ve been able to find.

As you know there are thousands of ways to build a portfolio using different asset classes. What we’re looking for are asset classes that have an absolute record of success, and a record of high units of return per unit of risk.

Now, obviously, I can’t know, nor do I try to predict, the future. But what I do have is 80 plus years of evidence that these asset classes have produced great returns. Sure, they don’t go up all the time, but not a one of them has ever failed. Not one has declared bankruptcy. Not one has ever experienced a permanent bear market.

John Nyaradi:

Right.

Paul Merriman:

All of these asset classes qualify as being survivors on a long term basis. So once we determine which asset classes qualify to be in the portfolio we have to decide how much we should invest in each one. I have tried to make that easy by giving people exact percentages in each asset class and funds that offer those asset classes.

John Nyaradi:

I think you said at one point that the choice of those assets is responsible for 95% of your return. How do you fine tune these allocations?

Paul Merriman:

For over 15 years we have recommended a very simple equity allocation. Half U.S., half international, half large, half small, half value and half growth. The equity part also includes REITS and emerging market asset classes.

Then it’s simply a matter of finding the right balance of fixed income to go along with exposure to the equity asset classes. I find most investors are unwilling to accept the risk of an all equity portfolio so we need to find the right balance of fixed income that produces the needed return within the risk limits of each investor. I am always looking for the combination that will produce peace of mind with a reasonable piece of the action.

John Nyaradi:

Sure.

Paul Merriman:

I’ve tried to help investors by building a tabIe of many combinations of fixed income and equity asset classes. The table is in, “Fine Tuning Your Asset Allocation,” at Fundadvice.com. And John, all my work comes with a guarantee. I guarantee if you follow my advice, you will lose money. That’s not the guarantee investors want to hear, but it’s the reality of any risk oriented investment.

John Nyaradi:

Sure.

Paul Merriman:

We should all know what level of risk we’re taking. And I don’t mean some generic risk that is indefinable. I’m looking for a number. The table covers over 40 years of data. It gives an investor a real time relationship between risk and return. If you’re willing to lose 5% to 50% of your money the table shows the likely return you will get over the long run.

John Nyaradi:

Could you talk a little about the market timing in your portfolios?

Paul Merriman:

To start with, I want to make sure that your audience understands that I’m not advocating timing over buy and hold. I know buy-and-hold is a lot easier emotionally. And it’s also a lot more tax efficient.

But there are a lot of people who will simply not accept the idea of holding equities without an exit strategy. Some advisors will tell investors, “You’ve got 50% of your money in bonds so why should you worry about stocks going down? They always come back.” And the investor’s response is, “Hey listen. This is my money, buddy, and I don’t want to sit and watch it decline without some way of protecting it.”

It’s really the catastrophic decline that most people are worried about, and so we use timing with almost the same view philosophically as we use for buy-and-hold. We market time funds in dozens of asset classes. We market time equity funds as well as bond funds. Each account is built to the same risk tolerance test as the buy and hold investors.

Most of the timing we do uses traditional trend following strategies. We never predict where the market is going, only follow the trends. A lot of timing critics think market timers are trying to predict the future. We believe there are trends and they stay in place one way or the other for long periods of time. Those trends can make you decent money on the upside but the most important work is protecting against some terrible losses on the downside.

John Nyaradi:

I hear the word “risk” over and over in our conversation. In your list of 18 mistakes people make, I thought it was really interesting that mistake number 3 is taking too much risk, and mistake number 4 is taking too little risk. That sounds like a conflict.

Paul Merriman:

Well, too much risk is normally a challenge for people who are over confident and think they have more control over their investments than they do. Also, people who take too much risk are not aware how much risk they need to take. If you found out that you could achieve all your financial goals with half as much risk as you’re taking right now, I’d have to challenge you to why are you taking all of that risk?

John Nyaradi:

Sure.

Paul Merriman:

For some the higher risk comes because the investor thinks their friend appears to doing better than they are. By the way, I’ve yet to find an honest amateur investor when it comes to reporting returns. And so we have to be so careful what our benchmark is and how we measure our success.

But then people can also be scared to death of almost any risk. I’ve met people with 10% of their portfolio in stocks, and when they’re down during a bad bear market, they jump to the conclusion that it’s happening to their whole portfolio.

I know it doesn’t sound reasonable to feel that way, but that’s the way a lot of peoples’ minds work. They hate losing money. The fascinating part is if we can just get those people to commit 20 or 30% of their money to stocks, they can literally double their return in retirement. Just a little bit of additional risk. They don’t have to go 50% or 60%. Just to get up to 20%, or 30% can make a huge, huge difference.

John Nyaradi:

Paul, we’re taking in July, 2011, and looking ahead over the next few months, what do you see is the biggest dangers for us as retail investors and the biggest opportunities?

Paul Merriman:

Well, it looks to me like the last 45 years. I have been a chicken for as long as I’ve been in the investment business. I call myself an aggressive chicken, but a chicken nonetheless.

But the fact is there’s always list A, the good news and there’s always list B, the bad news. Both of those lists exist at all times. I have always tended to look at the bad list and to be cautious, so I’ve probably been more defensive as an investor than I needed to be. But what I really worry about is not about me because I have found 100% peace of mind with my investments. I’ve saved enough that I can quit working anytime and have plenty of income in retirement. So that worry is behind me.

John Nyaradi:

Sure.

Paul Merriman:

But here’s what I worry about. I worry that people who have learned the right things, the smart things, the wise things about investing will somehow get spooked by the market and either jump to some ultra safe situation, and as you know, typically at the wrong time, they’ll be enticed into putting their money into something like a guaranteed equity index annuity or some other terrible security that will cost a fortune in fees and be difficult or expensive to liquidate.

John Nyaradi:

Well, folks, it has been a real honor today to have been talking with one of the real giants of the industry, Paul Merriman, founder of Merriman Incorporated in Seattle, Washington and editor of FundAdvice.com. To learn more about Paul and his work, just follow the link at the end of this interview, and that will take you to his website, Merriman.com.

Paul, thanks so much for joining us and we’re all looking forward to talking with you again soon.

Paul Merriman:

Thank you, John, very, very much.

Visit Merriman Incorporated.

(This interview edited for length and clarity)

We’re in business, so we don’t get to sit the tough seasons out and come back when it’s all better. Despite the economy, the small business owner still has serious management issues to address. We can tackle them head on, grow our businesses and ourselves–or we can ignore them, but that could eventually put us out of business. Success is the goal, and the better the team, the better the business.

Here are three suggestions to help you take care of your team, so that they can take care of your clients.

1. Focus on the little steps and everyday strategies.

Your team is no good if you can’t keep them focused. And you can’t keep them focused if you can’t keep yourself on track. Have you ever tried to build a business with your eyes glued to the television? It doesn’t work. In the same vein, jumping from one task to the next without focus and an ongoing sense of completion is just as unproductive. You’re busy, but so is a cat when he’s chasing his tail.

In “It’s All About the First Downs,” Diane Helbig gives some great tips to help you grow your business in “baby steps.” Instead of focusing on that big, amazing, and sometimes overwhelming plan, she has you shift your focus to the little steps. If we address the day-to-day details consistently, then we will eventually arrive at our big goals.

Diane says, “I’ve been confronted with people who are having trouble focusing.” She believes the “root cause is…an inability to see a big idea in small pieces.” I like what she says, because I believe your company’s future rests in your ability to manage the details of the dream, the day-to-day elements. In fact, the more focus you have on the daily strategies of your company, the more focus you can expect from your team.

Making the shift from the big idea to a daily grind that will get you where you want to be isn’t always easy. But Diane’s advice will get you started.

As you focus your team—and reap the benefits from it—you’ll probably want to find a way to reward them.

2. Try a new kind of raise: performance-based pay rewards.

You can’t grow your business without your team. So how do you take care of them if you are in a situation where you have just enough cash flowing to keep the doors open? Anita Campbell discusses performance-based raises in “Should You Pay for Employee Performance?”

You can’t give raises with money that you don’t have. So, if they make it, then you pay it. Anita explains, “A good pay-for-performance plan will focus on the aspects of employee performance that increase sales and profits. As a result, there will be more money available to pay employees for their performance.”

In the article, Anita tells you the type of employees that are most likely to appreciate this plan, as well as suggestions on how to implement pay-for-performance, including the advisors that can help you set it up.

Anita says, “When handled properly, a pay-for-performance program can motivate employees,” and that can move your business forward. Just keep in mind that your team needs to know the rules of engagement and it’s up to management to make that clear upfront and document it.

When it comes to performance, some people just don’t live up to it, and tough decisions have to be made. That brings us to point number three.

3. Fire what doesn’t work; hire what does.

In high school, college and the rest of life we try out for sports, audition for plays, interview for jobs, etc. We have to qualify for what we want, and the older we get, the higher the standards. We aren’t babies anymore—so we’re also long past being rewarded for being cute and cuddly. Everyone can’t or won’t perform at the level that your company needs and requires, and you have to do something about it.

In “3 Things to Consider When Hiring and Firing,” John Mariotti gives some well-balanced advice on firing team members without disrespecting them or breaking their will. He says, “Firing people is no fun at all—at least it shouldn’t be—but it is necessary.” John also advises us to “Always remember that it takes two errors to create a failed employee:

an employee who doesn’t perform in the job, and

the supervisor who put them in a position to fail.”

I try to remember that making the tough decisions can set us up to succeed where others fail.

From Small Business TrendsManaging Staff in a Tough Economy: Who Do You Fire, Who Gets That Raise?

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Friday 29 July 2011

Making Money Work

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