Larry Swedroe had the "honor" of speaking dead last at this year's Inside ETFs conference near Miami. Still, his Feb. 13 talk drew a large crowd, who listened attentively as he explained ways of creating efficient portfolios that reduce the risk of "black swan" events.
About a dozen or more advisors, reporters with recording devices in hand and other fans hovered around Swedroe after his dense 40-minute presentation, despite the hubbub of meeting staff tearing down booths and removing equipment in the background. The post-talk groupies clearly were thrilled to meet this financial rockstar in person, ask him to sign a book or two, and probe his thinking on a variety of portfolio issues.
Swedroe, 67, is director of research for the Buckingham Family of Financial Services, which includes Buckingham Strategic Wealth and the BAM Alliance of RIAs. A native New Yorker, he's been with the St. Louis-based group since 1996. He published his latest tome, "Your Complete Guide to a Successful & Secure Retirement," with co-author Kevin Grogan a few months ago.
Though he isn't quite the household name that Warren Buffett is, he combines the Oracle of Omaha's humility with a deep knowledge of investing and an open approach to finance — sharing the secrets of his approach to portfolio building without hesitation.
"Larry knows more about investments research than most academics. He's a practitioner with a mind of a first-rate scholar, and it follows that his investment philosophy is based on a careful reading of the newest empirical studies on investment performance," said Michael Finke, chief academic officer of The American College of Financial Services.
"He's been a critic of fad investing practices that aren't based on sound evidence, and an equally strong proponent of strategies such as low beta and factor investing that have the most support among financial economists," Finke explained.
"Whenever Larry writes something about investing, I always make a point of reading it," he added. "It's one of the reasons we interviewed Larry, in addition to academics like Bill Sharpe, for our new wealth management designation (the WMCP) at the College. Larry knows how to build a real-world portfolio using the best science."
The Big Picture
Here's an innovative way Swedroe frames the complex process of portfolio diversification, for instance. "This is how I try to explain it," he said just after his talk at Inside ETFs. "You are taking a trip from New York to San Francisco, and each leg of the journey you are going to go halfway. In other words, the first leg you drive 1,500 miles, and the next leg 750 and so on. You get closer and closer, but you never really get there. Well, diversification works the same way."
In his view, you start the journey with a domestic equity portfolio "and then you add bonds, which gets you to St. Louis. Next is international diversification, which gets you to Kansas City. Then you add small and value, and you are in Denver. By the time you have added two or three others, you are on the Bay Bridge. You are probably at around 98% [diversification] … with five or six funds, and you do not need much more than that."
(Among the many funds Swedroe uses for diversification and that he lists in his latest book are the iShares S&P 600 Small Cap Value, SPDR S&P 600 Small Cap Value ETF and Vanguard Small Cap Value, along with funds from Bridgeway Funds and Dimensional Fund Advisors.)
In addition to the importance of portfolio diversification, Swedroe emphasizes the related topic of risk. "Nothing has really changed on that front, since I wrote my first book — 'The Only Guide to Winning Investment Strategy You'll Ever Need.' We had the same issues of the ability, willingness and need to take risk into account," he said in a recent phone interview.
"Then I helped write another book, 'The Only Guide You'll Ever Need for the Right Financial Plan,' and like the earlier one, this did not focus on retirement, but it did get into the same three issues involving risk," Swedroe explained.
"The one thing I think that may have changed somewhat is the fact that, let's say, the two pieces are tied together, which is why I talk about them in the latest book 'Your Complete Guide to a Successful and Secure Retirement' in a section of the introduction called 'The Four Horsemen of the Retirement Apocalypse.'"
The horsemen are historically high equity valuations and low bond yields, along with longevity and the expected need for long-term care due to Alzheimer's and other forms of dementia, with the latter two most impacting risk and retirement. (A fifth horseman is the failure of government to fully fund Social Security and Medicare.)
"We are living a lot longer, and so that means you need a bigger pot of money. Your money has to last longer," Swedroe said. "And the incidence of Alzheimer's and cognitive decline increases greatly, especially after age 85, and that can be very expensive."
Underestimating both the possible need for and cost of that care is risky. "Living in facility that deals with cognitive decline can cost you $100,000 or more a year in some cities. So, you have to consider this over a longer period, and you have to take into account the increased risk of very expensive care."
These and other issues, like elder abuse, are important in portfolio management, according to Swedroe. "They don't look like they have to do with investing per se, but they are related. It's not an investment strategy that we are talking about exclusively, but it is a strategy of dealing with these other risks. That's why the book really focuses on the need for integration of not only an investment plan but estate planning, taxes, withdrawal strategies, etc."
Risk Conundrum
With this outlook for both longevity and long-term care, do investors have the luxury of taking less portfolio risk as they age, as is generally argued?
"If someone has $30 million in the bank and spends $100,000 a year, they can just put their money in CDs and TIPs, take pretty much no risk at all and be fine. They won't likely run out of money," Swedroe said.
"But if you are the average person, you probably have to take some risk. This is why we go into this topic in the chapter on asset allocation and talk about the need to take risk," he explained. "What rate of return do you need from your portfolio to give you a good chance of not running out of money?"
When answering this question, don't use historical averages. "Stock prices today are much higher, and that means expected returns are lower. And certainly bond yields are much lower today than their historical average."
The idea that a traditional 60/40 portfolio of an S&P 500 stocks and five-year Treasuries will give investors 10% a year is no more, according to most financial economists. "There is no way that you are going to get 10%. It's probably going to be more like in the area of 4-5%. So, again, you need a bigger pot of money," he said.
As a result, investors "cannot load up on just fixed income" and need to consider using annuities, Swedroe says. "I like the idea of deferred annuities, because they help you overcome the psychological problem of giving up assets if you die early."
Buying a deferred-income annuity that pays $36,000 a year at age 85 might cost a 65-year-old male $100,000, for example. "But you would have to pay a lot more for one that starts to pay you at 65," he pointed out.
Swedroe describes insurance as a tool "to hedge the risks of the unexpected, not the expected." People buy car insurance, for instance, for major accidents and not to cover the costs of oil changes or fender benders — which you should budget for.
