Is Factor Investing Worth the Hassle in 2021? | Merriman Buy and Hold Portfolio Analysis

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Have you ever thought about how a few extra percentage points of investment returns might change the outcome of your financial goals? It might surprise you to learn that the difference between a few percentage points worth of returns can be literally millions of dollars. Today we are going to look at a portfolio that was created on the idea that every extra percentage point your portfolio can return is worth fighting for.

INTRODUCTION

Today we are going to analyze Paul Merriman’s Ultimate Buy & Hold Portfolio. If you watched our 2020 Portfolio challenge results video then you already know that this strategy didn’t do so well in 2020 but don’t let that deter you from considering this portfolio. Remember that in the life of an investment strategy, a single year is entirely meaningless.

Long term result are all that should matter and the logic behind Merriman’s strategy is sound and is backed up by years of academic research. This portfolio will be featured in my 2021 Portfolio Challenge so please consider subscribing if you want to keep up to date with how the portfolios in Season 2 are doing.

Please note that this portfolio’s results can be made much better by increasing the timeline to 100 years or so (for example, evaluating the results from 1920-2020). If you are unhappy with the results from todays analysis, no worries, just hold the portfolio for an additional 50-60 years and the results should improve.

Neal, Author of this post

PORTFOLIO GOALS

As I’ve tried to point out in all my analysis videos the goal when creating an investment plan should always be to generate the highest results with the lowest level of risk. We know that the S&P500 index will return around 8%-9% annually on average so if your goals can be met with that return then by all means please go watch my Simple Path to Wealth video and invest in that portfolio instead.

The Merriman Portfolio’s goal is to squeeze out a few extra points worth of return from the Simple Path strategy without having to take on higher levels of risk. The Merriman strategy is a long-term strategy and to get the alpha you want, it may take a few decades to show itself as a potentially superior choice.

FACTOR INVESTING

The Merriman strategy is all about factors or styles. Up to this point in all the portfolios we have analyzed the stocks have been represented as a single asset class. When we say stocks we are talking about the S&P500 index and we assume anyone buying stocks are going to get the same return as the index. You don’t have to use the S&P500 as your stocks asset class; you can use stock factors like value stocks or growth stocks or international stocks, or small cap or emerging markets or any number of other factors.

I think its best to walk through this process together so you can understand how Merriman creates his portfolios.

CREATING AN ‘ULTIMATE’ LIFELONG PORTFOLIO

Pension Funds

Pension Funds and general endowments typically all use a 60/40 portfolio. That is to say 60% US Stocks and 40% Aggregate US Bond Index. Historically that gives us a 9% annual return with a 9% standard deviation.

This is more or less the starting point. We need to construct a portfolio that exceeds an annualized 9% return and doesn’t exceed a 9% standard deviation.

Step #1: Get the Bonds Right

Merriman doesn’t generally like long-term US treasuries because their risk increases over time disproportionately to their returns. Merriman recommends we swap the 40% bond index with intermediate term bonds.

Step #2: Add Real Estate Stocks

Next we want to add real estate into the portfolio. Following Merriman’s guidance we split our allocation to 48% stocks, 40% intermediate term treasuries, and 12% REITs.

This small change has increased our return modestly by $3,000 or so. We also lowered our risk and our worst year was less bad than the 60/40.

Step #3: Add Some Small Cap Stocks

Next we want to add small cap stocks. Our new allocation is 36% stocks, 40% treasuries, 12% REITs, and 12% Micro-caps.

This change has increased our alpha by nearly $10,000. Our annual rate of return is now over 9% and our standard deviation is lower than 9% so that’s pretty good.

Step #4: Add Some Value Stocks

Next up we want to add some value stocks. Value stocks are stocks that have great looking financials but for whatever reason they are not popular with investors. The idea with value stocks is that eventually someone is going to realize these are great businesses and buy into them.

With the next mod the portfolio is now 12% US Stock Market, 40% treasuries, 12% REITs, 12% Micro-caps, 12% small-cap value, and 12% large-cap value.

With this change we increased our return over the 60/40 portfolio by $6,000 but this is $4000 lower than we got from adding small-caps. Standard deviation is still better than the 60/40 but its worse that the small caps version. Are we going backwards now?

Let’s keep going.

Step #5: Add Some International Stocks

Next we need to tweak the allocation to add international stocks. The new allocation is 6% US Stocks, 40% treasuries, 6% REITs, 6% US Small-Cap, 6% US Small Cap Value, 6% US Large Cap Value, 6% Emerging Markets, 6% Intl small cap value, 6% Intl large cap value, 6% Intl large caps, and 6% total intl stock market

With this its clear to me that we are moving backwards here. By adding these international asset classes we have somehow return $18,000 less than the 60-40 pension fund.

This is frankly terrible.

Well lets continue onward.

Step #6: Flatten Everything

The last step in Merriman’s process is to flatten everything out. We want to allocate our capital evenly across 10 asset classes. I’m going to use the all-stocks version of this portfolio since this is a retirement portfolio even though its not really a fair fight to compare a 100% stocks portfolio to one with 40% bonds.

Now you can see each of the factors split evenly in 10% positions.

Ah…. well, frankly I am shocked by these results. This is not at all what I expected to find. Its been probably 10 or more years since I last investigated this portfolio and at that time, this strategy was a big winner.

But that was then… as we currently stand here in the first quarter of 2021 we can clearly see that this portfolio is a loser. This portfolio has been resoundingly beaten by the most basic portfolio in history, the 60/40 pension fund.

FINAL THOUGHTS

Okay so what are my thoughts on the Merriman Ultimate Buy & Hold Strategy? Well it should be obvious to everyone how I feel. It really hurts me to say this because I’ve read all of Merriman’s books and I really admire his skill and tenacity. He’s a real great ambassador for the cause of financial independence and sound investing but as for his portfolio…. sadly I’m gonna have to pass on that.

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Published by nealosis