Retirement plan decisions made easy
Drill Down: The Ultimate Buy and Hold Strategy
This allocation comes from my friend Paul Merriman, an investment advisor who runs the FundAdvice.com website. He calls this “The Ultimate Buy and Hold Strategy.”
He begins with a basic diversification upon which we all agree. Next, he deliberately overweights the asset classes that have a long-run track record of providing higher returns. For example, he overweights small cap stocks in the United States.
Value stocks are also overweighted. One way to look at stocks is to divide them into two categories: value and growth. Value stocks tend to be cheap because investors doubt their long run prospects are very strong. Growth stocks tend to be expensive because everyone sees their ultimate potential. A good deal of research suggests that in the long run, value stocks perform a little better than growth stocks. There’s no doubt that the growth stocks have great prospects, but you have to pay so much to buy a share, that you may not have a very high return when it comes time to sell. So Merriman overweights value stocks.
Merriman also overweights stocks in emerging countries. The small, fast growing countries tend to have stocks that grow at a faster rate than the global stock averages.
Why not just put all of our money into small caps, value stocks and emerging markets? They are very risky. Each, by itself, is riskier than the overall stock market. However, diversification reduces risk, so it’s not bad to have these stocks in your portfolio. Overweighting them does add risk, but that extra risk is probably justified by their higher average returns.
Finally, Merriman includes real estate through mutual funds that invest in Real Estate Investment Trusts (REITs). This is a diversification move. This is the only place where I disagree with Merriman. I concur fully that real estate is a good asset to own. However, if you own your own home (even with a mortgage on it), you probably have enough exposure to real estate. Unless your stock and bond investments are more than five times greater than the market value of your house, don’t add the REITs. (In looking at this test, use the market value of the house, not your equity in the house. When real estate goes up in value, your gain is proportional to your house’s total value, not your equity.)
So here is Paul Merriman’s Ultimate Buy and Hold Strategy, with my adjustment to delete REITs:
40% Short-intermediate bond funds
6.7% S&P 500 Index Fund
6.7% Micro cap index fund
6.7% Large cap value index fund
6.7% Small cap value index fund
6.7% Foreign large cap index fund
6.7% Foreign small cap index fund
6.7% Foreign large cap value index fund
6.7% Foreign small cap value index fund
6.7% Emerging market index fund.
You don’t have to follow these percentages exactly. Just get in the ballpark and don’t worry too much about the decimal points.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
» Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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