2 Funds for Life: A Froogal Stoodent Review
2 Funds for Life: A Quest for Simple & Effective Investing Strategies by Chris Pedersen – Notes and Quotes
Tenth in a series of book reviews by The Froogal Stoodent
Every aspiring writer is told: “Know your audience.”
Exhibit A: Chris Pedersen’s 2 Funds for Life.
It’s very detailed, and definitely not for everybody. But for his intended audience, it works very well! Are you part of that audience? Let's find out!
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Chris Pedersen is a member of the Merriman Financial Education Foundation, which is a friend of this blog and a great resource for investors!
In this book, Pedersen provides a data-focused solution for long-term investors. Do you want to improve your returns over a low-fee target date fund, while still maintaining a straightforward approach?
Pedersen’s solution is simple: add small-cap value. Paul Merriman has long advocated small-cap value, which is the best-performing asset class for which we have long-term data (i.e., Bitcoin doesn’t count for our purposes here).
Depending on your goals, Pedersen has identified three main approaches:
Easy: 90% target-date fund (TDF), 10% US small-cap value index fund (SCV)
Moderate: take your years-to-retirement, multiply by 1.5, and that’s your percentage of SCV. The rest goes into a TDF.
Aggressive: take your years-to-retirement, multiply by 2.5, then add another 20% to that figure – that’s your allocation to SCV. The rest goes into a TDF.
The rest of the book dives into the details to investigate and justify these approaches.
Please note the “dives into the details” part. This book is very much aimed at stat-heads, personal finance nerds (ahem!), and people who want to know how the figurative sausage is made. A casual reader, however, will be lost within the first 15 pages.
For instance: near the beginning of the book (specifically, page 15), Pedersen uses such eye-glazing terms as “glide path,” “asset allocation,” and “sequence of returns”...in the same sentence!
When reading this book, it helps to have some exposure to personal finance ideas and terms already. Some exposure to statistical modeling, science, and/or finance will probably help as well.
Charts. Prepare yourself for lots of charts, and not always the straightforward kind. Pedersen revels in modeling, and these charts tend to cram in as much information as possible. He breaks down everything you need to know, but if you’re not already steeped in interpreting such figures, you could find yourself overwhelmed at first glance.
I harp on this because it’s important to know what you’re getting into when reading this book. Some writing styles are easier-to-digest than others. If you want a casual read with amusing stories, you might prefer a different book, such as JL Collins’ collection, Pathfinders (which even includes an entry by yours truly!). But if you want a work that’s long on technical detail, 2 Funds for Life just might be exactly the book you’re looking for!
Just don’t give it to a typical 17-year-old.
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Pedersen does a good job of detailing exactly how the sausage is made. He lifts the hood to reveal his underlying assumptions, as well as the specific modeling choices he made and why. This allows an interested reader to follow along, conduct their own tests, and make whichever changes they wish.
For readers with a certain inclination, that is an extremely useful – and rare – feature.
This makes 2 Funds for Life a very good guide for people who are interested in playing around with backtest simulators, such as portfoliovisualizer.com.
Pedersen recommends using Portfolio Visualizer; he also mentions further info available via the DFA Matrix book (a PDF issued annually by Dimensional Fund Advisors), the RAFI Smart Beta Interactive website, and the Credit Suisse Yearbook summary PDFs.
Some readers would enjoy diving deeper into these sources; some wouldn't. Caveat emptor.
Basically, readers of 2 Funds for Life need a certain attention span and a certain affinity for mathematical modeling. For the intellectually-inclined reader, this book is likely to be a great resource! But the reader who just wants to be told what to do – well, that reader need not apply here.
My recommendation here? First, know thyself. If you enjoy learning new things and getting into the figurative weeds with some modeling, you might well enjoy this book – and you’ll definitely learn something new!
Quotes:
“Even if someone had been saving only 10% per year, this $4.4M real benefit was more than the real $4M they would have earned in their lifetime. This reveals a shocking truth:
People who save and invest prudently across a lifetime
are likely to earn more money from investing than they do from working." (p. 22-23)
“There is no shortage of advertising money spent to encourage us to spend everything we earn and more because we deserve the good things in life today, but it’s a path to endless catch-up that never achieves financial freedom. To avoid it, we need to cultivate an attitude of gratitude instead of envy and learn to be generous to our future selves. If we can focus on what we have instead of what we don’t, it will help us defer some of today’s gratification so our future selves can have the security and freedom we deserve.” (p. 26)
“Perhaps the most surprising thing about this chart is that the highest 40-year safe withdrawal rate was for a 50|50 mix of the S&P 500 and US small-cap value, and it was 4.74%…Adding small-cap value to the S&P 500 produced higher safe withdrawal rates, suggesting it could be beneficial for retirees — especially those who retire early” (p. 62)
Froogal Stoodent note: a safe withdrawal rate of 4.74%?! That’s three-quarters of a percent higher than the standard advice! I’ve read numerous different posts and comments by people who are planning on a much more conservative 3% or even 2% withdrawal rate. Pedersen notes here that adding small-cap value to your portfolio can boost that by almost 1% per year!
“...many of the most impactful choices we’ll make happen in our teens and twenties. If we choose to learn more marketable skills or are lucky enough to find a calling we care so passionately about that we’ll move heaven and earth to make it happen, our resilience goes up…Choosing to establish frugal habits, saving early, and investing regularly are hugely important early steps to increasing our resilience. Conversely, spending too much, taking on debt, and delaying investing will lower our resilience. These choices are crucial because many will last a lifetime. It’s not that we can’t change, but most of us won’t.” (p. 71)
“Once we’re working, our resilience depends in large part on consistency. Consistently contributing to a retirement program. Consistently investing well. Consistently ignoring the ups and downs of the market to stay invested. And consistently working.” (p. 71)
“...unanticipated and unwanted years of unemployment…reduces our risk tolerance, but as long as it’s not too many of our working years, it won’t wipe it out altogether. There are things we can do to overcome these resilience-reducing events. We can work longer, plan better, economize, delay taking Social Security, or even change where we live.” (p. 72)
“If we invest $1 and get an 8% return for 40 years, it will be worth more than $20 in the end. Over 30 years, it only grows to $10. Over 20 years, it grows to less than $5. Over 10 years, it grows to just over $2.” (p. 72)
“This isn’t about putting off living today so we can live better tomorrow. It’s the opposite. It’s living every day like it matters so tomorrow is better. When we develop our talents, find ways to contribute that are valued, and live within our means while saving to be generous to our future selves, we thrive. For some, this is a culture they will have inherited from their parents. For others, it’s a culture they’ll need to pioneer.” (p. 73)
“Wouldn’t it be great if there was a single fund that included US and international stocks and a bond allocation that adjusts with age, so it’s appropriate all the way from our early investing years through retirement till death? There is. It’s the target-date fund.” (p. 78)
“In a 2020 study, Professors Mitchell and Utkus from The Wharton School of the University of Pennsylvania found that investors who invested solely in target-date funds had a 2.3% higher expected annual portfolio return than investors who didn’t use target-date funds. The reason was simple. Target-date funds nudged investors to hold more of their portfolio in stocks at younger ages.” (p. 78)
“Target-date funds provide a globally diversified, risk-adjusted portfolio in a single fund, but they tend to be conservative and are weakly diversified across equity risk factors such as size and value.” (p. 81)
“By combining conservative target-date funds with more aggressive and factor-diverse small-cap value funds, we can increase expected returns per unit of risk, control when that risk occurs, increase safe withdrawal rates, and decrease the chance of running out of money in retirement.” (p. 84)
Froogal Stoodent Note: And with this quote, near the beginning of Chapter 10, we come to the main thesis behind this book.
“Using 1.5 × YTR…outperformed the plain target-date fund in every respect except drawdowns, where it’s 5% worse in the early-year peak and 1% worse around retirement. Those slightly larger drawdowns produced a 30% higher median end balance, 23% higher median withdrawals, and a 26% chance of having a final end balance that beat the much riskier S&P 500.” (p. 91)
“In short, the 3-Fund portfolios delivered the same total financial benefit as the more complex portfolios, but with less time, less pain, and less risk.” (p. 114)
“If complexity is not required to get a good return per unit of risk, why do we hear about so many complex portfolios and investment strategies? One reason is regret avoidance. If you hold…a lot of different asset classes, you won’t feel as bad when you hear which one performed the best…Another reason is that it’s hard to sell simplicity. Who is going to pay an advisor or robo-advisor to manage two funds? Professional money managers and others in the financial services industry need to justify their fees and costs.” (p. 133)
“The Buffett approach, Vanguard-like target-date fund, and Easy 2 Funds for Life scenarios all had survival rates under 65% instead of the 98% to 100% we saw with the more ideal scenarios at the end of chapter 10…The big surprise is that the Aggressive 2 Funds for Life approaches had 100% 40-year survival rates regardless of the rebalancing approach.” (p. 137-138)
[While discussing the limitations of backtesting] “…it’s best to remember that we can never really know what the future holds.” (p. 150)
“…here are the steps if you haven’t already started:
1. Saving. If most of us start by saving what we can and increase it as quickly as practical until we’re saving 10% to 20% of our salary per year, we should have enough money to invest wisely and retire at a reasonable age…
2. Investing. As we’ve seen, investing strategies don’t have to be complex to be effective or long-lived. A 2 Funds for Life strategy is likely to perform every bit as well as a more complex portfolio. Combining a target-date fund and a small-cap value fund gives you broad and meaningful diversification….
3. Persisting. Whichever strategy you choose, it’s critical to stay the course…
4. Retiring. Deciding when to retire is a complex life decision, but knowing when you can afford to retire is a relatively straightforward financial calculation…
5. Taking comfort in the plan.”
“We live in amazing times. Investing has never been easier or cheaper. Automation abounds in the form of retirement account paycheck withdrawals, automatic investing, and self-adjusting target-date funds.” (p. 156)
“What if you already have a hodgepodge portfolio? Maybe it’s a collection of stocks. Maybe it’s a collection of mutual funds or ETFs. If it’s in a tax-deferred or tax-free account, there’s no tax penalty for changing it to what you want. If it’s in a taxable account, though, there could be tax consequences to selling…If it’s going to take a decade or more to see the new portfolio deliver enough of an advantage to pay for the cost of changing, just living with the existing portfolio might be the better option. Remember, even if there’s an expected advantage, there’s no guarantee you’ll get it. Taxes are immediate and certain. Expected returns are delayed and uncertain.” (p. 253, Appendix 11)
You can support this blog—at no cost to you—by buying it on Amazon here.
Or, check out my other book reviews in this series:
1. Debt: The First 5000 Years by David Graeber
2. Rich Dad Poor Dad by Robert Kiyosaki
3. The Clash of the Cultures by John C. Bogle
4. Principles (Life and Work) by Ray Dalio
5. When Genius Failed by Roger Lowenstein
6. The Practicing Stoic by Ward Farnsworth
7. Gold: The Once and Future Money by Nathan Lewis
10. 2 Funds for Life by Chris Pedersen
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