We recently hosted an event with Paul Merriman, which ended with a Q&A. There were so many great questions asked, we didn’t have time to respond to them all, but we hate to leave any question unanswered. Here are some of the questions we didn’t get to, with answers written by Merriman Advisor Michael Van Sant, and our Associate Advisor team.

question_markWhat factors should be considered in deciding if a couple has enough net worth to self-insure for long-term care?

There are a number of factors to consider in deciding whether to self-insure for long-term care:

Income streams and portfolio assets: Determine your income streams (including Social Security, pensions, and annuity distributions) and compare this value with your spending needs to maintain your desired lifestyle, plus the cost of long-term care. If a gap exists between income and needed funds, determine if your portfolio can be called upon to close the gap.

The most expensive long-term care facilities price out at an average of $300/day, with a typical stay in a nursing home lasting 3 years for a total of $328,500 per person. Taking the benefit of income streams into consideration, long-term care for a couple lasting 3 years would likely result in an out-of-pocket expense of $500,000. If your portfolio can handle that expense, it may be wise to self-insure. A general rule of thumb is that if a couple’s net worth is more than $2,000,000 they can likely afford to self-insure. Some people consider their home as part of their net worth when making this decision. Be sure to consider whether you are truly willing to sell your home and move if necessary. Many people envision receiving care in their homes and should not factor the value of their home into their net worth for these purposes.

Genworth offers useful tools and calculators to determine the costs of care in your area.

Bequest goals: Do you have a desire to leave your children an inheritance of a specific amount? Paying for long-term care out of pocket in the event you will need it could cause that desire to go unrealized. Purchasing long-term care insurance can provide for help in guaranteeing your heirs the inheritance you wish to leave them. Think of long-term care insurance as ensuring an inheritance floor for your survivors.

Sleep at night: Purchasing long-term care insurance, even if you could self-insure, can help you not to worry about the “what-ifs.”

Other care options: Who will care for you if you do not have coverage or the means to pay for long-term care? If your children are not close by or you can’t or don’t want to rely on them for care, long-term care insurance will provide for a caretaker.

Do you believe in the bucket strategy?

The bucket strategy is a financial planning concept that involves separating money into different buckets to achieve different goals. At a minimum there are two buckets. The first is for any expenses you are expecting in the next 2-3 years. The money in this bucket is always kept as cash or cash equivalent, with the belief that investing in the market is too risky and volatile in the short term. The second bucket is money you won’t need in the near term and is therefore invested in stocks and bonds. There can be multiple buckets and deeper planning involved, but this the basic description.

Back to the question, does Merriman believe in the bucket strategy? While we certainly weigh your short-term needs with your long-term goals, our strategy dives much deeper than the idea that everyone’s lives can fit into two buckets. We spend a lot of time up front covering all areas of your financial life to get a truly comprehensive understanding of your situation before we recommend an investment strategy. Only in this way can we ensure we are recommending an investment strategy designed to help you stay on track. We believe prudent asset allocation is the most powerful tool to align portfolios with client return objectives and risk tolerances. We also hold regularly scheduled reviews and make necessary adjustments to stay on track to meeting short and long-term goals.

What is the best investment to generate income and preserve principal?

At Merriman, we believe in a total return approach that is designed using academic research to achieve long-term growth. We do not use any specific investment to generate income. Rather, we use dividends, interest and appreciation to fund each client’s income needs.

We have two different core strategies (MarketWise and TrendWise) available for clients, and we build portfolios from those and other specialized securities, based on their risk tolerance

  • Our MarketWise portfolios, which are fully invested at all time, use low-cost mutual funds that are diversified among various asset classes.
  • TrendWise is an actively managed strategy that uses a trend-following discipline to limit downside potential.

When frequent withdrawals are needed from the portfolio, your advisor will help to preserve principal by being sensitive to costs associated with trading fees. If your advisor knows of an upcoming distribution, they will allow cash from dividends and interest to build up to reduce trading costs.
If you need to withdraw from the portfolio and there is not cash available, your advisor will use appreciation to trim from the asset class that is most overweight. This allows for a periodic rebalance to ensure your portfolio is in line with its target allocation. Using this approach, we are able to sell high while letting the underperforming investments recover.

How does Merriman add value to investment accounts?

Merriman adds value to the investment accounts in two ways:

First, we build our portfolios using an academic approach that is evidence-based. We recognize that markets are generally efficient and, through broad diversification and proper asset allocation, we create portfolios that meet each client’s risk tolerances and long-term objectives. The universe of investment products is very large and new products come out all the time; 95% percent of them are worthless, 5% of them are worth investigating, and 1% of them are actually worth investing in. Merriman’s research department culls through this vast and complex set of products to find those that will truly enhance investor returns and reduce their risk over the long-term. The average individual investor has neither the time, nor the expertise, nor the access to find the needles in the haystack. We provide portfolios that offer better value over the long run by combining carefully selected investments that have higher expected returns, like small companies and value companies, while including other assets classes that have a lower correlation to US equities, like reinsurance, international equities, global real estate, and peer-to-peer lending.

Second, as your Wealth Manager, we provide guidance and behavioral coaching through different market cycles. As an example, portfolios are regularly rebalanced to restore target allocations by trimming asset classes that have done well and adding to asset classes that have lagged – this is done with an objective perspective. This disciplined approach will help ensure your investments are still the right fit for your wealth management plan.

Is it reasonable to evaluate performance by comparing returns to appropriate index?

When evaluating performance, comparing returns to an appropriate index can be helpful, but an investor must also keep in mind the long-term goals of the portfolio. It should be stressed that comparing returns to an appropriate index is sometimes easier said than done. Typically, a well-diversified portfolio made up of many different asset classes will not compare accurately with some of the most commonly referenced indices – e.g. The Dow Jones Industrial Average, S&P 500 or the NASDAQ.

Your advisor should be able provide the most appropriate index that can be used for comparing returns. An investor should also be careful to recognize the long-term goals set forth when creating a portfolio. Often, short-term market volatility will not reflect the long-term objective of a portfolio, and typically comparisons made in the short run provide little to no help.

If Merriman can’t see the future or rely on past performance, how do you use research?

As stated in the question, past performance is unlikely to repeat exactly, and because of that, we’re not able to predict the future. However, over periods of time long enough to include multiple market cycles, there are trends that emerge with investing. By studying the past, research helps us identify strategies to improve client performance in the long run.

First, research helps create our asset allocations. History has shown that various asset classes (US stocks, international stocks, bonds, real estate, etc.) have rotated in and out of favor at different times. Research helps identify the correct amount to hold in each asset class to provide the greatest expected return for a given amount of risk.

Next, research helps identify appropriate times to rebalance portfolios. If a client’s appropriate portfolio is 50% stocks and 50% bonds, and stocks do very well over the next year, the client will have a portfolio with more risk than appropriate one year later. Research helps us identify how far the portfolio can drift from our original allocation before we need to rebalance and move back to the original allocation.

Third, research helps client performance by identifying the most tax-efficient ways to invest. There are some investments we only hold in taxable accounts, and some we only hold in tax-deferred accounts, like IRAs. We will also use Roth IRA conversions for some clients, and research helps us identify when that is appropriate and how much to convert.

While we believe that you can’t rely on past performance, as stated in the question, we use research to develop our best estimate for the expected return and volatility for a portfolio (such as a 50% stock portfolio that is rebalanced appropriately). These expected return and volatility numbers are used when we create a financial plan and help clients identify if they are on target for meeting their goals.

Finally, we rely on research to help identify the best investments to use when creating client portfolios, which takes us into our next question:

Do you still rely exclusively on Dimensional (DFA) funds?

Our research department looks at all investments to find the best options for our clients. We do use DFA for all of the stock and some of the bond holdings in our MarketWise portfolios, which make up about 80% of Merriman accounts. DFA has consistently proven to be the best option, and we use their funds much more than any other investment.

DFA’s funds are broadly diversified. Also, they don’t try to pick individual companies that are expected to outperform the market. However, because they are not index funds, they have some additional flexibility that helps to lower costs and increase returns.

DFA also relies on academic research to identify types of stocks that are likely to perform better over the long run – specifically value and small-cap stocks. DFA slightly overweights these stocks, and slightly underweights stocks with the opposite characteristics.

Our research department is constantly evaluating various investment options. For now, the combination of tilting toward small and value stocks, broad diversification without being tied to an index, and low fees have consistently made DFA the best option for many of our portfolios.