November 26,  2015

DiaDeMuertos

Thanksgiving Day is a national holiday celebrated in Canada and the United States as a day of giving thanks for the blessing of the harvest and of the preceding year.(Wikipedia)
Dear Friends,
The tradition of a special day to gather with family and friends in thanks and goodwill is a beautiful thing. Yet it strikes me that in Mexico, where my wife and I spend part of the year, there is a more-ancient annual family tradition of thanksgiving that reaches far beyond merely this year’s abundance, and who is physically present at the table, to celebrate the past, present and future.
At the end of October each year, Mexican families celebrate Dia de Los Muertos (Day of the Dead), to invite the return of the spirits of departed loved ones, honor their memory, acknowledge the cycle of life in which we are all connected and, I’m told, inoculate themselves for another year against the fear of death.
Altars are erected in homes, schools and other public places with photos and mementos of the deceased, along with their favorite food and drink and surrounded by sugar skulls (calaca) and bright orange marigolds, which bloom at this time of year. Children grow up knowing that death comes for everyone and they will surely be remembered after they are gone, hopefully for the good, honorable and loving things they did in their lifetime. Those living celebrate not only life but see the past, as well as the future, as a continuum.
In my work advocating strategic long-term diversified investments, I consider not only my lifetime but the historic evidence on which I base my recommendations, and with an eye for the welfare of my children and future generations. Next week I will share, in articles and a podcast, a wild but numerically verifiable process for turning $3,000 into $5 million over the course of a lifetime, leaving the gift of abundance for those who come after us.
Meanwhile, as I turn my attention today to celebrate the company of some of my most beloveds with turkey and fixin’s, I reflect on the many blessings of my life, like the opportunity in retirement to continue sharing my passion and expertise with you. This would not be possible without the help of my co-author Rich Buck, the coordination and marketing expertise of Aysha Griffin, the web maintenance and tech support ofMargie Baxley, the social media management ofBerenice Parra and the data research of Daryl Bahls. My thanks to each of them.
Below I include more Q&A’s from my readers. While I am grateful for your questions and try to answer as many as possible, I am constrained by time and woefully behind on the past few months. I hope you will search the “Ask Paul” Q&A archive at my website as well as podcasts, articles and recommendations that may answer your questions.
Wishing you a beautiful Thanksgiving Day and, as always,
To your success,
Paul
 
I recently spoke to the Personal Investing 216 class at Western Washington University. The following are my answers to a few of the questions asked by the students. To these students – and students everywhere – I suggest we never forget the wise words of Ben Franklin: “An investment in knowledge pays the best dividends.” I am thrilled to be part of your financial education.
 
Q: Why don’t target date funds include more small-cap value funds?
 
A: This question followed a discussion about the weaknesses of target date funds. While I am a great fan of target date funds, I estimate that a first time investor will make about 1.5% more per year with the addition of 25% in small cap value. Read this articlefor more on target date funds.
For the majority of target date fund owners, it is important that the equity portion of the funds’ returns track the market. If they hold the majority of their portfolio in large cap growth companies they will track the S&P 500 (the index that most often is considered the market) closely. If the manager invested more money in small-cap value companies, they will likely make their investors more money but there will be periods the returns don’t go up and down with the market. Target date fund managers know they are more likely to keep their clients happy by looking like the major market index. Even though the addition of small-cap value would create better long term returns, it comes with less predictable short-term returns and that makes investors uncomfortable. In other words, it’s about doing what’s in the best interest of the management company not the investors.
Q: Shouldn’t young investors have all of their investments in stocks?
 

A: (Along the same line as above, another student wanted to understand why a target date fund would have 10% in bond funds, as bonds make less than stocks.) Target date fund managers do a great disservice to young investors by holding about 10% in bonds. A 10% bond portion may make a young investor feel good during a declining market, but that’s the very time a young investor should be buying more cheap stocks. For every 10% in bonds, a balanced fund is expected to make .5% less per year. I think target date fund managers think investors feel more secure having some bonds in the portfolio. To make matters worse, if fund managers don’t hold any bonds their shareholders will have bigger losses in a bear market, compared to target date funds that do hold some bonds, and the managers will be criticized for not having some bonds to reduce portfolio risk.  Remember, young investors want to take advantage of lower prices in a bear market, not to sit safely in bonds.

Q: Have you ever lost money on an investment?
A: In all my years in the investment business I’ve never been asked this question. My first thought was to simply admit to making lots of mistakes in the early years of my investing career. In fact, I doubled my first speculation (a commodity trade) and on the following trade lost all my profits from the previous trade plus my initial investment.

Instead, I explained my portfolio has suffered lots of major losses as index funds hold some big losers along with many very successful companies. In fact, ENRON was one the 10 biggest public companies in the U.S., before it filed for bankruptcy. And I reminded my class ENRON was considered a great company up to a few months before it collapsed. Diversification is one of the smartest moves an investor can make.

Q: How can I save money when I am graduating with so much student debt?
 

A: It would be presumptuous to tell a student who’s about to graduate that they should be able to save 10% of their income, but I feel obligated to take that position. First of all, I encourage students to pay the minimum on their college debt and maximize their investments in their 401k. The first five years of 401k investments can account for over 1/3 of what they will have to retire at age 65. Plus, we all have the ability to live on a lot less than we want to and my hope is to get students to consider saving just as important as spending.  Many consider the smart move is to always pay yourself the first 10% of what you make. Plus, many companies match a part, or all, of the 10% saving.

Q: Where can I find information about University Street?
 
A: During the class I teach students about the best source of investment advice I know. I suggest we have to choose between Wall Street, Main Street and University Street. After making the case for University Street one student asked this good question.
My answer is that an internet search for Eugene Fama is a good start. He is the most cited finance professor. One of his papers has been cited in over 14,000 academic papers. My buy and hold equity investments are all invested in Dimensional Fund Advisor (DFA) funds. Their website (dfaus.com) has many articles, papers and videos on the work of Drs. Eugene Fama and Kenneth French, dedicated to finding the best ways to build a long term portfolio.
Q: What’s the difference between Fidelity and Vanguard target date funds?
 
Most of investors’ holdings in the Fidelity target date funds are in their expensive actively managed funds. The high costs of actively managed funds have lead to as much as a 1% lower rate of return than a comparable index fund at Vanguard. That’s 1% a year. Making 1% less than you should will likely lead to retiring later and/or retiring with less and leaving less to your heirs.
The good news is Fidelity has index funds, as well as index-based ETFs that are comparable to most Vanguard index funds. The key is being able to access them. Many 401k plans that are based on Fidelity funds allow self-direction within the Fidelity brokerage offerings. If they do, you can likely apply my Fidelity mutual funds or ETF recommendations found on my website.
If your plan does not offer self-direction then you probably won’t have access to more than the funds your trustees have offered. In a small company you might be able to convince the trustees to add Fidelity index funds, as well as Fidelity index based target date funds.

If your company is not matching any part of your contribution, and you are not saving more than allowed by a Roth IRA, you may be better off saving within an IRA, rather than a 401k. The Roth IRA allows your investments to compound tax free, as well as taking retirement distributions tax free.

Q: Why are small caps better than large caps?
 
A: I hope all the students in Personal Investing 216 will read the articles under the  “Performance Series” link. One of those articles is entitled, ” How to make money with small-cap  stocks . Within that article there is a link to a podcast on the subject: “10 things you should know about small cap funds.”

Most experts would simply say that small companies make more because they are more risky. The interesting part of history is there are many asset classes that do not appear to offer a higher return for more risk.

Q: Is there any benefit in investing in gold?
 
A: If you ask that question of people who sell gold for a living, they will always have a long list of reasons to “buy gold now”.  Try doing a search for the topic, “Why should I invest in gold?” Investopedia has an article entitled “8 reasons to own gold.”
I do not own any gold. Gold has high volatility and low expected returns. Over the last 50 years the return on gold is less than earned on U.S. Government Bonds that have much lower volatility. Also, the addition of gold means an investor will have less of the asset classes that have a history of making more than twice that in gold.

Here is what Warren Buffet says about gold: “If you took all the gold in the world, it would roughly make a cube 67 feet on a side… Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States… For $7 trillion… you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money… And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally… Call me crazy, but I’ll take the farmland and the Exxon Mobils.”

Q: If everyone invested in index funds what would happen to the stock market?
 
A: Keep in mind the value of stocks are set each day by the people who are buying and selling their holdings. The buy-and-holder has no impact on the price of securities until he or she decides to buy more or sell to meet financial obligations. When buy-and-holders buy index funds, they are reducing the number of shares available for future investors.  In theory that will drive the cost of future purchases higher.
Here is the reality: Most buy-and-holders are still subject to the strong emotions of the rise and fall of security prices. During bull markets (rising markets) investors become more confident and bid up the prices of securities.  During major bear markets many investors suffer the emotional and financial pain of loss and sell to move to something that is not going down. That is usually a move to money market funds or bonds.

As of the end of March 2015 approximately 20% of mutual fund holdings were in index funds.

Q: What books do you recommend for those of us who are just getting started?
 
A: Several years ago I suggested 4 books that I thought every investor should read.  Here is a link to the article: http://paulmerriman.com/4-best-books-retirement-investors/
At that time I had not written my “How-To Invest” series: “First Time Investor: Grow and Protect Your Money,” “101 Investment Decisions Guaranteed to Change Your Financial Future” and a third book for those working with, or considering working with, a professional advisor. “Get Smart or Get Screwed: How to Select The Best and Get The Most From Your Financial Advisor” includes important lists of services we should expect from an advisor and the questions that need to be asked before hiring an advisor. All three are available as free downloads.

Small-cap value is the gold ring of investing
I think I’m a fairly cautious, conservative investor. But today I’m here to talk about the most potent part of my portfolio; it’s so powerful that sometimes I wonder if I should own more of it.  More

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