Save like mad for 5 years – Become a multi-millionaire

“Thank you for your work educating my wife and me and so many others. Specifically, thank you for your website, podcast, contributions through the Bainbridge Community Foundation and collaborations with other trusted resources like Tom Cock and Don McDonald.” — G.R. In This Edition 5 Years Can Make You a Multi-Millionaire Truth Teller: Dr. James Dahle […]

The post Save like mad for 5 years – Become a multi-millionaire appeared first on Paul Merriman.

“Thank you for your work educating my wife and me and so many others. Specifically, thank you for your website, podcast, contributions through the Bainbridge Community Foundation and collaborations with other trusted resources like Tom Cock and Don McDonald.” — G.R.

 

In This Edition

5 Years Can Make You a Multi-Millionaire
Truth Teller: Dr. James Dahle
Q&A
Corrections
Personal Story

Dear Friends, 

In striving to provide you with smart, accessible analyses of historical financial data, we are excited to keep finding new ways of presenting information to simplify investment strategies which make and keep more money in your pocket.

Recently, thanks to our Director of Research, Chris Pedersen, and Daryl Bahls, our Director of Analytics, we can offer young investors a different way to jumpstart, and likely ensure, their “more than enough” retirement. What we found is beautiful in its simplicity: $6,000 per year of contributions to a Roth IRA or Roth 401(k) for 5 years could yield between $38 and $50 million over 40 working and 30 retirement years.

Young investors might be able to save and invest $500 per month for the first five years of their working life (assuming 20-25 years old), or be helped by parents, grandparents or others who, by saving $25 a month for 21 years, can fund the 5 years of $6,000 investments. 

The three us got together to discuss this innovative strategy. Watch this week’s video or listen to our podcast, “5 years of investing and you can become a multi-millionaire.”

One of my great joys is teaching a class each semester at Western Washington University to students of Personal Investing 216, funded by our Foundation. I hope their exposure to “sound investing” strategies, like the 5-year plan, will inspire them to start saving, investing and stay the course for a lifetime.

Read “Save Like Mad for Five Years—Retire with Millions,” this week’s “MarketWatch” article by Rich Buck and me.

Watch video, “Portfolio Visualizer Monte Carlo Simulation Tutorial” by Chris Pedersen.

This table, “5 Years Can Make You a Multi-Millionaire,” shows the impact of an all-equity portfolio using Small Cap Value or a 50/50 balance of Small Cap Value and the S&P 500. 

Examine this new table which shows the percentage of time that Small Cap Value makes long-term returns of 12% to more than 14%. 

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Chris, who is author of 2 Funds for Life—A quest for simple & effective investing strategies, was interviewed recently on “The Money with Katie Show,” a weekly podcast for women, in which she and her guests “talk spending habits, smart investing, and tax strategies – without putting you to sleep.” Tune in to learn more about “How to Start Investing Successfully with Just Two Funds.”

   

Truth Teller: Dr. James Dahle

While Jim’s work at The White Coat Investor is geared toward physicians, his advice is not only sound but accessible to all investors and he addresses some issues that we do not, such as student loans, tax strategies, real estate and life insurance. Like us, all the information on his website is free and is intended is to help investors “avoid doing dumb things with our money.” I recommend you checkout his website for excellent financial education. He also sells classes, although I have never personally attended his classes.

I’ve had the pleasure of being interviewed by Jim and presenting at the White Coat Investor conference. He is author of The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing, written in response to thousands of comments and emails from medical students, residents, practicing physicians, dentists, and other high income professionals he received during more than two years blogging on his website. 

James M. Dahle, MD, FACEP, FAAEM is a practicing emergency physician and the founder of The White Coat Investor. After multiple run-ins with unscrupulous financial professionals early in his career, he embarked on his own self-study process to become financially literate. After seeing the benefits of financial literacy in his own life, he was inspired to start The White Coat Investor to assist his colleagues and is dedicated to “helping those who wear the white coat get a ‘fair shake’ on Wall Street.”

At the time, there was nobody providing unbiased financial education to doctors at any point in their training. Now, more than a decade later, financial wellness is widely recognized as a critical life skill for all physicians and similar professionals. Dr. Dahle currently serves as the CEO, a columnist, and the host of the podcast. He is a proud father of 4 children and spends his free time adventuring around the world or hiding in the mountains or desert of his home state of Utah.

Q&A by Chris Pedersen

Q:  I am a Canadian. This means that holding the recommended ETFs, I would lose a 15% withholding tax on the dividend payout if the stocks are not held in the limited space available in my registered retirement account. My current strategy is to hold more of the ETFs that you recommend, which are lower-dividend payers (IJR, RPV), in my personal account and only add the higher-dividend payers to my non-registered holdings after my retirement room has filled up. Do you think it would be worth finding Canadian based ETFs, even if they don’t align with the strategy?

A:  That sounds like a reasonable and sound approach. It may complicate rebalancing, but you might be able to address that by varying contributions to the different accounts as needed over time. I’d do a cost-benefit analysis before straying from your intended portfolio allocation. The practical historical return advantages of tilting to small and value are about 1% to 3% per year over the long term. In contrast, the tax drag on the account based on assuming a 2% annual dividend and 15% tax would only be 0.3%/year. I get not wanting to pay more taxes than needed, but this seems like a situation where the tax tail might be wagging the investment dog. 

Q:  For someone who isn’t interested in learning about investing, is there an all-in-one mutual fund or ETF that incorporates your ideas and does the yearly rebalancing? I imagine target date funds are more effective for younger folks than older.

A:  I’ve often heard Paul suggest the Vanguard Wellesley and Wellington funds for people looking for a one-fund solution.  It really depends on what you’re looking for.  

Target-date funds are relevant too. History suggests a young person that saves and invests 10% into a target-date fund is likely to have twice the lifetime purchasing power of someone who just spends or saves in the bank.  Similar analysis suggests retirees can improve their safe withdrawal rates and the amount their nest egg grows through retirement by investing in a combination of a target-date fund and a small-cap value fund.  That’s not to say these approaches will necessarily outperform the one-fund solutions, but none of these are complex, and all of them provide meaningful diversification.

Q:  I’ve recently changed employers, and their 401k plan offers a target-date fund but does not offer a small-cap value fund (only a mid-cap blend index fund).  I currently have all of my other retirement accounts consolidated into an IRA, where I use the two funds for life strategy.  Do you think it’s advantageous to contribute to this mid-cap blend fund and take advantage of dollar-cost averaging?  Or should I just contribute to the TDF in my 401k and rebalance my IRA each year to get the correct amount of small-cap value over my total retirement portfolio?

A:  A mid-cap blend fund has less exposure to the small part of the market and practically no exposure to the value part of the market. You’ll get more meaningful diversification and higher expected returns if you dollar-cost average into the TDF in the 401k and compensate by increasing your investment in small-cap value in the IRA.  When adjusting for your desired asset allocation, you’re right to look at assets across all accounts.

Q:  My question is about bonds. I’ve looked through the website and have been listening to the podcast since the beginning of the year and there is so much great discussion about equities, but I can’t find any specific discussions about what kind of bonds you recommend when it comes time to add them to a portfolio. I know lately you are more on the path of two-fund portfolio with target date funds, but for those of us that want to do-it-ourselves and follow more of the four-fund guide for equities, which types of bonds should we consider?  Treasury vs. corporate, short vs. long duration? Is there something I’m missing?  Is there is a post I’m not seeing?  

A:  If you look at the mutual fund and ETF portfolios on the website, you’ll see that Paul recommends a combination of 50% US Intermediate-Term Government Bonds, 30% US Short-Term Government Bonds, and 20% TIPS.  If you want to know more about this recommendation, I recommend referring back to Paul’s podcast from 2017, “What to do about bonds?”  Here’s the link:  https://paulmerriman.com/what-to-do-about-bonds/

Q:  What factors, conditions, considerations, etc. should one examine and balance when deciding whether to use your ETF Best-in-Class recommendation or the comparable mutual fund from a brokerage?

A:  The first thing to consider is what funds you have available.  I’d generally prioritize being able to automate an investing program over either the fund type (e.g., ETF vs. mutual fund) or the fund provider (e.g., Vanguard vs. Avantis).  Mutual funds are often preferred in automated retirement savings accounts because they allow fractional share purchases, but it’s increasingly possible to also do fractional share purchases of ETFs too.  Assuming you have a choice, the second thing I’d consider is whether the account is taxable or tax-advantaged.  ETFs are generally more tax-efficient and less likely to spin out unexpected capital gains based on trading of other fund investors which gives them an edge for taxable accounts.  Finally, I’d favor the Best-in-Class ETFs or equivalent mutual funds since they’ve been chosen to have the highest expected after-expense returns based on their historical exposure to the various risk factors.  Some investors may not agree with this last choice and instead, choose the funds with the lowest expense ratios since expenses are guaranteed and returns are not.  That may actually improve their expected returns if it also increases the chances of them sticking with their choice.  

Q:  Why should we invest in Global Ex-US stocks if, according to Portfolio Visualizer, their past returns from January 1986 through April 2022 have only been 6.74% compared to US stock market returns of 10.57%?

A: It’s an understandable question that points out how difficult it can be to be a data-driven investor when the available data is limited, in this case, to 37 years of history.  Here are the reasons I think it still makes sense to diversify internationally.  First, we don’t know what the future holds; second, there’s often a long-term reversion to the mean; third, holding some international stocks protects us from US country-specific idiosyncratic risk.  Here’s a chart from my book showing that you might have asked the opposite question if you looked at the period from 1952 to 1989.  I hope this helps you decide.

Q:  Daryl, What do you think about replacing SCB with MCB in the four fund US portfolio?  I ask this because there is overlap between the SCV and SCB funds.  And according to Portfolio Visualizer, between 2012 and 2022, MCB had an inflation adjusted CAGR of 11.9% and SCB had 11.7.  Of course, your SCB may contain smaller companies that those modeled by Portfolio Visualizer.

A: (from Daryl Bahls)  The US 4-Fund portfolio is all about holding the four corners of the US market, small vs large (basically, blend is large) and value vs. growth (again, basically blend is growth) of the ‘style box’.  Paul has always espoused 50% small/50% large (blend) and 50% value/50% growth (blend).  Ten or 20 years is not a very long time to assess the efficacy of an investment strategy (despite the fact I know it can seem that is a long time.) Also, 0.2% in a 20-yr CAGR is, in my opinion, in the noise and certainly not something I’d change my portfolio over.

Q:  Paul, After reading your article about the 4 fund portfolio, if you’re retired or have been investing 20+ years, isn’t it  kind of hard to switch up and start the 4-fund strategy?

A:  (from Paul)  If the money is in a tax-deferred or tax-free account it is simply a matter what asset classes you want in the future. One might have a very large position in the S&P 500 or the TMI. Since those indexes are basically driven by large cap growth one might wonder if it makes sense to diversify among more asset classes. Since we are only teachers, our “students” are left to decide what they find comfortable. My wife and I are 50/50 stocks and bonds, 50/50 large and small, 50/50 U.S. and international, 50/50 small blend and small value, 50/50 large blend and large value. No big bets. We will never get the returns of the latest hot asset class but we sleep well and have earned enough over the years. We have other investments that are not for us but for children and charities. Those are invested more aggressively.

By the way, if the money is in taxable accounts that requires dealing with tax questions. At a minimum, one could use dividends and capital gains to start broadening the exposure to the additional asset classes.

Correction

In our last newsletter, there was a broken link to our MarketWatch article, “This investment strategy is an extremely effective way to beat the S&P 500”. Thanks to Bob B. for bringing it to our attention. Here is the correct link: https://paulmerriman.com/this-investment-strategy-is-an-extremely-effective-way-to-beat-the-sp-500/

Personal Story

Thank you for your podcast and educational materials. I have learned so much in the past three years from your teaching. It seems like in recent podcasts you are moving away from the 10-fund Ultimate Buy and Hold and toward simplification. I understand the motivation for this with people who don’t have the time, motivation or interest in managing a larger portfolio. There is one thing that I would like to point out for those who do have the time.

I am in the sweet spot for Roth conversions between retirement and starting Social Security and RMDs. I am doing one conversion in each quarter (4 conversions per year) to try to convert funds at different market levels throughout the year. Although some of the 10 ETF categories seem to correlate to others, in terms of being in and out of favor, others are not so correlated.

The 10 ETF approach has allowed me to do my conversion from the categories that are most out of favor and therefore have the potential to gain the most once in the Roth. So far this strategy has worked wonderfully but I don’t think it would be as successful if I only had 2 or 4 funds to choose from when converting. I give Chris an A+ on his ETF recommendations. Thanks again for your wisdom and all you do for do-it-yourself investors. — Andy L.

Helping you build a better financial future,
Paul

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