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In this update to one of the most important items in our article library, Paul Merriman shows how a series of simple but powerful concepts can put patient investors far ahead of the crowd. This 2007 update adds returns from 2006 plus a new portfolio.
If you are a serious investor, this article could be one of the most important things you'll ever read. I'm going to show you the very best investment strategy that we know, the strategy that's behind the way we manage the majority of the money we invest for clients.
Let’s start by looking at what’s new: First, we have added a new equity asset class, U.S. real estate funds. Second, we’ve refined our fixed-income recommendations. Third, we have updated all our returns with results from 2006.
This strategy is best understood with a brief history lesson. When I founded Merriman Capital Management in 1983, millions of investors had just suffered large market losses over a period of almost 20 years. In fact, from 1966 through 1982, the Standard & Poor’s 500 Index had produced negative returns after accounting for inflation.
We initially offered only strategies that used market timing systems to actively manage risk. The systems were designed to give investors a chance to participate in the equity market without the high risks of buying and holding no matter what.
In 1992, as we began helping clients with more and more of their money, it became increasingly clear that much of that money was invested without timing. We sought – and found – a buy-and-hold strategy that we believed would be worth recommending.
After all these years, we like this strategy so much that we call it the Ultimate Buy-and-Hold Strategy, as the title of this article indicates.
We don’t use that word “ultimate” casually. I don’t claim this is the best investment strategy in the world. But it is the best that we’ve found, and we are continuing to refine it. I believe almost every investor can use this strategy to increase returns and reduce risk.
This is suitable for do-it-yourself investors as well as those who want to hire professional money managers. It works in small portfolios (although not tiny ones) as well as large portfolios. It’s easy to understand and easy to apply using low-cost no-load mutual funds.
You should know that we did not invent this strategy. It has evolved from the work of many people over a long period, including some winners and nominees for the Nobel Prize in economics.
SETTING A HIGH STANDARD
In theory, a perfect investment strategy would be cheap, easy and risk-free. It would make you fabulously rich in about a week. Tax-free, of course. We haven’t found that combination, and we don’t expect to find it. But in the real world, this is the best substitute we know.
Over the long run, the Ultimate Buy-and-Hold Strategy produces higher returns than the investments most people hold. It does so at lower risk, with minimal transaction costs. It’s mechanical, so it doesn’t require investors to pore over investment newsletters, pick stocks, find a guru or understand the economy.
THIS STRATEGY IN A NUTSHELL
Even though this strategy is based on academic research, it’s really fairly simple. If I had to reduce it to a single sentence, here’s what I would say: The Ultimate Buy-and-Hold Strategy uses no-load mutual funds to create a sophisticated asset allocation model with worldwide diversification and the addition of value stocks, small company stocks and real estate funds to a traditional large-cap growth stock portfolio.
If you think you already know what that means and you’re tempted to skip the rest of this article, I hope you’ll resist that temptation. I have some compelling evidence to show you. If you apply this diligently, doing so could make a big difference in your future and your family’s future.
If there is a “catch” to this strategy, it’s availability. You cannot buy it in a single mutual fund. You can put it together approximately using Vanguard’s low-cost index funds; but Vanguard doesn’t offer every piece of it. You can get each of the individual pieces, but you may have to open more than a single account and you might have to pay more in expenses than I would regard as ideal.
In my view, the ultimate way to implement this ultimate strategy is to hire a professional money manager who has access to the institutional funds offered by Dimensional Fund Advisors. (More on that later.)
WHAT REALLY MATTERS
The Ultimate Buy-and-Hold Strategy is based on more than 50 years of research into the question: What really makes a difference to investment results? Some of the answers may surprise you. The people behind this research include Merton Miller, a 1990 Nobel laureate; Rex A. Sinquefield, who started the first index fund; and Eugene F. Fama, Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago graduate school of business.
Their expertise has been pooled in a company that Sinquefield started in 1981, Dimensional Fund Advisors, to give institutional investors a practical way to take advantage of their research. Today, Dimensional manages more than $120 billion of investments for pension funds, large corporations and a family of terrific mutual funds that are available to the public through a select group of investment advisors.
NOT FOR EVERYBODY
Before we get into the meat of this strategy, there are a few things you should know. Every investment and every investment strategy involves risks, both short-term and long-term. That means investors can always lose money. The Ultimate Buy-and-Hold Strategy is not suitable for every investment need. It is based on long-term returns. But it won’t necessarily do well in every week, every month, quarter or year. There will be times when it loses money. You have been warned.
Like most worthwhile ways to invest, this strategy requires investors to make a commitment. If you are the sort of investor who dabbles in a strategy to check it out for a quarter or two, don’t even bother with this. You will be disappointed, and you’ll be relying entirely on luck for such short-term results.
I am often asked how this strategy did last year or how it’s doing so far this year. Some people tell me they think investors should be in some particular asset over the next few months or the next year. Almost always, this is the result of something they have read or heard without checking it out thoroughly on their own. These people aren’t likely to succeed with this ultimate strategy because they are focused on the short term.
The Ultimate Buy-and-Hold Strategy is not based on anything that happened last year or last quarter. It’s not based on anything that is expected to happen next quarter or next year. It makes absolutely no attempt to identify what investments will be “hot” in the near future. If that’s what you want, you should look elsewhere, because you won’t find it here.
But if you want superior long-term performance that doesn’t require much maintenance once it is set in motion, you have come to the right place.
IT’S THE ASSETS THAT MAKE THE DIFFERENCE
The most important building block of this strategy is your choice of assets. Many investors think success lies in buying and selling at exactly the right times, in finding the right gurus or managers, the right stocks or mutual funds. In short, in being in the right place at the right time. Those are elements of luck, and they can work against you just as much as they can work for you.
Here’s the truth: Your choice of asset classes has far more impact on your results than any other investment decision you will make. I know this flies in the face of a lot of conventional wisdom and almost all the marketing hype on Wall Street, so I want to repeat it. Your choice of the right assets is far more important than exactly when you buy or sell those assets. And it’s much more important than finding the very “best” stocks, bonds or mutual funds.
Dimensional Fund Advisors studied the returns of 44 institutional pension funds with about $450 billion in assets over various time periods averaging nine years. The study concluded that more than 96 percent of the variation in returns could be attributed to the kinds of assets in the portfolios. Most of the remaining 4 percent was attributable to stock picking and the timing of purchases and sales.
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