Paul Merriman is a household name in the investment space. This Wall Street ‘legend’ is also the author of the famous lazy portfolio, the Ultimate Buy-and-Hold Portfolio, which I have previously reviewed. But this time, we are exploring something new – the Paul Merriman 4 Fund Portfolio. As the name suggests, here is another relatively simple lazy portfolio with just four funds of equal allocation. It is another buy-and-hold portfolio that works for even the busiest and newest investors in the system.
If you consider adopting this portfolio, this review is just what you need. Stay with me on this exciting journey to unravel all you need to know before putting your money on this four-fund portfolio created by Paul Merriman.
Key Takeaways
I would have loved to read this to the end. But it’s understandable if you cannot, and that is why I have highlighted the key takeaways for your quick view below:
- Paul Merriman, a renowned financial advisor, author, and educator, is the creator of this famous four-fund portfolio.
- It is a buy-and-hold portfolio comprising only four index funds, each receiving an equal allocation of 25%.
- It allocates 25% each to large-cap blend stocks, large-cap value stocks, small-cap value stocks, and small-cap blend stocks.
- The investment strategy is 100% equity, meaning asset class diversification is non-existent.
- In terms of performance, the portfolio can hold its own against the S&P 500, thanks to its investments in assets that offer a higher risk premium.
- Not everyone should adopt the Paul Merriman 4 Fund portfolio. For example, it is unsuitable for older investors with a lower risk appetite.
- Like most lazy portfolios out there, you can recreate using ETFs and even tweak your choices to suit your individual investment goals and risk tolerance.
Paul Merriman 4 Fund Portfolio Overview
Paul Merriman is a name famously associated with lazy portfolios, asset allocation, index investing, and mutual funds. He is the founder of the Merriman Financial Education Foundation, an organization that has been offering quality financial education to investors since 2014. There are a few Paul Merriman portfolios out there, including the Target Date Funds Portfolio, the 2 Funds For Life Portfolio, the Ultimate Buy-and-Hold Portfolio, and of course, the 4 Fund Portfolio.
The 4 Fund Portfolio combines four index funds or exchange-traded funds to create a lazy portfolio. It comprises the large-cap blend stocks, large-cap value stocks, small-cap value stocks, and small-cap blend stocks. Each of these funds has an equal (25%) allocation in the portfolio. This makes the portfolio easy to create and manage.
A unique feature of this portfolio is that it is a 100% stocks portfolio. This means it does not consider asset class diversification in the United States stock market. There are no safe-haven assets in the mix. Therefore, the risks are slightly higher, considering there are no assets dedicated to limiting the possible offsets a bear market or similar correction may cause.
Despite its elevated risk, this portfolio has done well in terms of returns to investors. Past performance indicates excellent outings on multiple occasions, even against the S&P 500. This is expected considering the investments in this portfolio pay a considerable risk premium, i.e., riskier elements that offer higher potential gains. The elevated risk means investors with a low-risk tolerance may not find this portfolio suitable.
Let’s look at the investment strategy of this portfolio.
The Paul Merriman 4 Fund Portfolio Strategy
The Paul Merriman 4 Fund Portfolio adopts factor investing (also known as factoring) as its investment strategy. Like the Alexander Green Gone Fishin’ Portfolio, this portfolio advances the concept of index investing.
The usual indexing involves investing in a group of investment-grade funds tracking specific market indexes. However, in contrast, factor investment involves looking for factors that offer a risk premium, i.e., more potential gains even when the risk is higher.
So, it is unsurprising that three out of the four assets in this portfolio align with the factors that offer risk premiums. The only exception is the large-cap blend stocks, which is also the S&P 500.
The large-cap value stocks are chosen for their value factors; the small-cap value stocks are selected for their small-cap and value factors, while the small-cap blend stocks made the list because of their small-cap factor. We will expound on this further when we talk about asset allocation.
The Paul Merriman 4 Fund Portfolio Asset Allocation
The 4 Fund Portfolio by Paul Merriman’s asset allocation is simple. It is an all-equity portfolio that invests equally into four highly-diversified funds as follows;
- 25% in Small-Cap Blend Stocks
- 25% in Small-Cap Value Stocks
- 25% in the Large-Cap Value Stocks
- 25% in the S&P 500 Stocks
25% in Small-Cap Blend Stocks
The small-cap blended stocks ensure the portfolio is pretty exposed to smaller stocks across different sectors. These stocks are preferred for their blend of value, growth, and income. While the small companies’ stocks may be volatile, they offer better opportunities for growth than their larger and less volatile counterparts. This means they pay a risk premium and, ultimately, more potential gains.
25% in Small-Caps Value Stocks
Small-cap value stocks take up 25% of the portfolio. Yes, the smaller companies whose stocks this portfolio invests in are less stable than the larger companies. This means they are also riskier. However, investing in such small companies with high potential value characteristics guarantees risk premiums.
For instance, these smaller companies are relatively unknown and have yet to break into the market like their blue-chip counterparts. Therefore, they have a higher potential for lengthy growth, which translates to a premium. Similarly, these small-cap companies, through their value characteristics, have shown they are better performers than small-cap growth companies – this is also an added premium.
25% in Large-Cap Value Stocks
Large-cap value stocks are an exception to the traditional choice of large-cap growth stocks. These stocks are more likely to offer more significant returns in the long run; after all, the larger companies are more stable and thus provide more value factors. Choosing value stocks over growth stocks exposes the portfolio to possibly undervalued companies. However, the expected significant gains cancel out this offset in the long run.
25% in the S&P 500 Stocks
The inclusion of the S&P 500 has nothing to do with value or small-cap factors. Instead, they made the list because they expose the portfolio to the all-important large-cap titled groups of the U.S. stock market. With the S&P 500 in the mix, this portfolio offers investors exposure to more than half of the total market cap of the United States. Away from the asset allocation, next is the Paul Merriman 4 Fund Portfolio performance over the years.
The Paul Merriman 4 Fund Portfolio Performance
You will agree that a portfolio review without looking at the historical performance is incomplete. So, how has this portfolio fared over the years? Let’s find out together.
Capital Growth Since Inception
If you had invested $100 in the Paul Merriman 4-Fund Portfolio in 1928, you would have $4,024,753 in total portfolio value. That translates to an 11.9% CRR over 94 years. The best one-year return within this period is 96.0%\%, while the worst one-year return over the same period is -51.8%.
Now, let’s compare these numbers with that of the S&P 500. In the same period, a $100 investment in S&P 500 would have yielded $917,379 in total portfolio value. The CRR would be 10.2% over this period, with the best and worst one-year returns at 54.0% and -43.3%, respectively.
The four-fund combo has the worse one-year drawdown between both portfolios because the S&P 500 is the more stable of the two. That said, the difference is less pronounced, considering the volatility and risk of the four-fund portfolio.
Capital Growth – 15-Year Periods
We can get an even more precise view of the performance of this portfolio by considering the 15-year period. Between 1928 and 2021, the average 15-year growth of a $100 investment in the four-fund portfolio combo would be $652, which translates to a 13.3% average CRR.
In comparison, a $100 investment in the S&P 500 would have yielded an average of $460, equaling a 10.7% average 15-year CRR. The worst 15-year CRR of the S&P 500 is 0.6%, while that of the four-fund portfolio is 0.6%. On the other hand, the best 15-year CRR for both the four-fund and S&P 500 is 22.1% and 18.9%.
Again, the four-fund portfolio is the better performer if we consider the 15-year period’s performance. You can check out the table comparing the CRR and the best/worst one-year returns here.
Returns by Decade
Paul Merriman compared the performance of the popular asset class nominal returns by decade, and the findings were quite interesting. For example, the S&P 500 returned 13.6% over a decade, from 2010 to 2019 – just 1.4% higher than the 12.2% the 4-Fund Combo returned.
These are better numbers compared to what the low-cap value stocks (12.0%), small-cap blend stocks (12.0%), and small-cap value (11.0%) stocks returned. The story is very different in the preceding decade, i.e., 2000 to 2009. In this case, the S&P 500 performed worse than the 4-Fund Combo and far worse than the other asset classes.
The 4-Fund Portfolio returned 6.0%, compared to S&P 500’s -0.9%, which is worse than the low-cap value stocks (4.1%), small-cap blend stocks (7.9%), and small-cap value stocks (12.5%).
Notes:
- The Compound Rate of Return or Compound Return is the rate of return for capital over a cumulative period of time. They offer a more accurate estimation and a clearer picture of investment growth or decline compared to average returns.
- Abbreviations: LCB – US Large Cap Blend, LCV – US Large Cap Value, SCB – US Small Cap Blend, SCV – US Small Cap Value, CRR – Compound Rate of Return.
- The estimations above exclude advisor fees and other expenses.
Paul Merriman 4 Fund Portfolio: Positives and Negatives
Perfection is rare in life, and you will not find it in the Paul Merriman 4 Fund Portfolio. The portfolio sure has its positive notes, but not without the negatives.
Positives of the Paul Merriman 4 Fund Portfolio
Here are the reasons you should choose this 4 Fund Portfolio:
1. Historical performance is impressive
One of the vital reasons you should consider this portfolio is its impressive performance over the years. If you trace the records back to 1928, the portfolio has delivered impressive returns to investors, even better than the S&P 500. If you like higher returns – as most investors do – you are on the right track with this portfolio.
2. It is easy to create and manage
You are probably not reading this for the first time in this article. But I must reiterate that the simplicity of this portfolio is one of the key reasons you should adopt it. Lazy portfolios are easy to set up, but this portfolio takes it to another level. Choose your four assets as outlined in the strategy, and you are good to go. Everything is given in equal weight, so no stress!
3. Strong allocation to small-cap stocks
Most investors prefer portfolios that prioritize small-cap assets. The reason is simple – the assets in this class are known to have delivered impressive returns over the years. So, is it so surprising that everyone wants to invest in small companies that historically outperform their large counterparts? I do not think so.
4. Strong allocation to value stocks
This portfolio also tilts considerably towards value stocks. Investing in stocks with value characteristics increases the potential returns of the portfolio. How? Value stocks are better performers than growth-centric stocks, according to history.
Negatives of the Paul Merriman 4 Fund Portfolio
Let’s balance the equation by listing the reasons you may not want to consider this portfolio.
1. Asset class diversification is non-existent
There are four distinct types of index funds or exchange-traded funds (ETFs) in this portfolio, but they all invest in equities. Financial advisors often advise investors against this, considering the high volatility and risk of investing in 100% equities.
2. Factor investing means more risk
Although factor investing comes with a risk premium – potentially higher returns than the market’s average- there is even more risk when investing in high-risk, high-return equities. This portfolio has no safe-haven assets on its list, so there is nothing to balance things up in the event of a market shakedown.
3. There is no international exposure
If you are an investor who wants to get some exposure to international holdings, this portfolio cannot help you. Neither global stocks nor any other asset class exposes you to the ex-U.S. market. One would expect Merriman to introduce emerging market stocks, which have historically outperformed the domestic market. But he stuck with the domestic guns 100%.
Setting up the Paul Merriman 4 Fund Portfolio Using ETFS
You can replicate the traditional Paul Merriman four-fund portfolio using low-cost funds according to the list below;
- 25% in Small-Cap Blend Stocks – Vanguard Small-Cap Index Fund ETF (VB). VB exposes the portfolio to domestic small-cap stocks with value characteristics. The diversification is rich, considering these stocks are spread across different regions and sectors of the U.S. market.
- 25% in Small-Cap Value Stocks – Vanguard S&P Small-Cap Value Index Fund (VIOV). With VIOV, you get exposure to small-cap domestic stocks with a mix of value and high diversity across different regions and sectors.
- 25% in the Large-Cap Value Stocks – Invesco S&P 500 Pure Value ETF (RPV). RPV provides the overall portfolio with exposure to large-cap value investments. The fund invests in S&P 500-listed companies with value characteristics.
- 25% in the S&P 500 Stocks – Vanguard S&P 500 ETF (VOO). VOO is the fund offering large-cap blend exposure, including 500 of the largest U.S. companies (according to market cap). It is a cheap fund with an impressive track record.
Interestingly, you can tweak the above traditional setup to achieve international exposure via international small-cap blend funds. For example, you can cut down the allocation of VOO and VB by 50% and introduce 12.5% of Vanguard Total International Stock Index ETF (VXUS) and 12.5% of iShares MSCI Emerging Markets Small-Cap ETF (EEMS). The international exposure comes from the two international funds you have just introduced.
Conclusion – Should You Adopt the Paul Merriman 4 Fund Portfolio?
A lot has been revealed about the Paul Merriman 4 Fund Portfolio. It is a decent lazy portfolio with an impressive historical performance over the years by just combining four funds of the same asset class.
The investment strategy is sound – factor-based investing that seeks to amass as much risk premium as possible. It is also important to mention that this raises the risk levels of investing in this portfolio.
Therefore, if you are a young investor who ordinarily has the appetite for higher risks, or you are not young but still highly risk-tolerant, this portfolio may be the right fit for you. Young investors have enough time on their hands to absorb large drawdowns – a luxury old investors nearing retirement cannot afford.
This portfolio is also suitable for investors who are busy or too occupied to launch a hunt for better-performing assets in line with their risk appetite but have no problem taking considerable risks. Whatever category you fall into, ensure you do your due diligence and be sure to know what you are getting into before making that call.
Catch you on the next one!