Paul Merriman
Sound Investing For Every Stage of Life 

2 Funds For Life Q & A

By Chris Pedersen

NOTE: You can find all referenced resources at:

Q:  How much more would you have if you invested in 100% WW Ultimate Buy-and-Hold all-equity portfolio for 40 years instead of ramping risk down with the 1.5% X Age target-date plus SCV Two Funds for Life strategy?

A:  Not surprisingly, you’d have a lot more. Using the same assumptions of investing $10k/year on a monthly basis, increasing with inflation, the back-test says you’d have an average end balance of $17.1M, but you’d also have a worst-case drawdown of 58% at age 65.  That compares to an average end balance of $11.5M and 28% worst-case drawdown at age 65 for the Two Funds for Life approach. 

One could argue that the 30% additional drawdown risk is worth it because the balance is more than 30% higher, but I think the bigger question is how well will you sleep at night when you have no income and your net worth drops by more than 50%?

A better option might be the Merriman Aggressive Target Date Glide Path which back-tested with an average end balance of $18.2M and a 29% worst-case drawdown at age 65.  It’s more work, but probably easier to live with too.

Q:  Regarding the Two-Funds-For-Life strategy, I thought I’d only have to purchase two funds, but when I look at the glide path charts, it looks like I need to purchase many different funds – Do I need to buy 10+ funds and rebalance them annually?

A:   I think you’re getting confused by the fact that the glide paths are built with the Vanguard-like TDF plus a second fund, and the Vanguard-like TDF includes many asset classes. To invest similarly to the analyzed scenarios, you only need to purchase two funds (Vanguard-Like TDF and a second fund) and then rebalance annually. The resulting asset allocation will include many different asset classes, but most of them come from the TDF.  

Q:  How does adding small-cap value to a portfolio with a target date fund have such a huge impact, since small cap value performance does not seem to be spectacular?

A:  Small-cap value performance often looks poor for many years at a time, but when averaged over 40 years it’s past performance has been consistently significant.

Q:  In the Two Fund For Life portfolio analyses, are you using indexes for your historical returns since the majority of mutual funds do not beat indexes?

A:  Yes, I’m using index data, but I’m also subtracting expense ratios (0.16% for the TDF and 0.25% for the second fund) from the returns to make things more realistic.  You can see all the source indexes listed at the end of my article.

Q:  Is the performance you highlight for the Two Fund For Life Target Date Fund Strategies best case scenario?  

A:  No. The performance highlighted in the article, podcast and video is the average.  The best and worst cases are also shown in the tables. The only sense in which it is “best-case” is that it assumes an investor adopts the strategy and implements it perfectly for 40 years.

Q:  Can you give me an example to understand the Two-Fund-For-Life approach for a 38-year-old planning to retire at age 65?

A:  Sure, but it depends on whether you’re using the 1.5 X Age or 2.5 X Age in percent in TDF approach.  Here are the answers for each:

The 1.5% x 38 = 57% in the TDF  (+ 43% in SCV)

The 2.5% X (38 – 25) = 32.5% in TDF (+ 67.5% in SCV)

Q:  Which do you recommend: the 1.5 X Age or 2.5 X (Age – 25) Two-Fund-For-Life Strategy?

A:  We didn’t make a specific recommendation because we think it’s a personal choice.  Hopefully, we provided enough information in the resources for you to decide what’s best for you.  You should consider not just the higher end-balance for the more aggressive 2.5 X Age approach, but also the higher peak drawdowns. And, keep in mind that the difference in the approaches is smaller the older you are since they both go to 100% in the Target Date Fund near retirement.

Q:  For the Ultimate Buy-and-Hold Portfolio or Merriman Aggressive TDF Glide Path, would it be reasonable to carry the majority of the recommended fixed income and REIT positions in a tax-deferred account (e.g., an IRA) and carry the majority of the recommended stock ETFs in a taxable investment account? That would optimize the tax advantages afforded by the treatment of stock capital gains.

A:  Splitting the assets as you propose would make re-balancing difficult since there are limits on what can be contributed to the tax-deferred accounts and penalties for withdrawing from them. Over time, you’ll probably end up with some of all assets in both accounts. But yes, it would help reduce taxes to the extent that the asset class allocations don’t get too far out of line with the account balances.

Q:  Would it be reasonable to use the Merriman Target Date Portfolio Asset Allocations differently for different buckets of money that have different purposes (e.g. one fund using our retirement date for money we plan to use in retirement, and another fund using a later date for money we expect our children will inherit much later)?

A:  Yes, of course!  In the portion of funds you expect your children to inherit you could use their ages to determine how much to allocate to the different asset classes.

Q:  Can I implement the Two Funds for Life strategy at M1 Finance?

A:  Since M1 Finance only supports ETFs, you can’t use Vanguard’s Target Retirement mutual funds there, but M1 Finance does offer their own versions of TDF Pies. What’s really interesting is they are available as conservative, moderate and aggressive glide paths with early-year bond allocations of 2%, 6% and 16%. 

It would be relatively easy to setup a personal Pie at M1 Finance with a slice for one of their target retirement allocations plus a second slice for a small-cap-value ETF and update it annually to reflect the Two-Fund-for-Life approach. You could also implement the Merriman Aggressive Target Date Fund there. That involves updating a larger number of slices per year using the Google Sheet Calculator, but the expected return is quite a bit higher.

Q:  In the Two Fund for Life backtesting, you assumed monthly rebalancing, but since most people will probably only rebalance annually, what do you think that does to the results?

A:  It probably won’t make much difference. Backtesting suggests rebalancing annually instead of monthly increases the expected return and the drawdown exposure very slightly – by less than 0.20% in both cases. 

Q:  If I’m in my 20’s, and the glide paths of TDFs don’t change until you hit 40, why wouldn’t I just invest in a buy-and-hold portfolio until I’m 40?

A:  You could do that, and there’d be nothing wrong with it. There are a couple of reasons you might consider doing the TDF earlier though. If some of the investments you plan to eventually have in a TDF are in a taxable account, you’ll have to pay capital gains when you switch them.  Starting out in a TDF avoids that. The other reason might be familiarity and trust. The more years you spend with an investment, the more likely you are to feel comfortable with how it reacts to market changes and the more likely you are to trust that it will recover from a market downturn.

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