Bogleheads® 2022 Conference – Bogleheads Univ. - Principle 3: Never bear too much or too little risk
00:00:00.000 | (audience applauding)
00:00:03.160 | Our next speaker is Alan Roth, MBA, CPA, CFP.
00:00:10.440 | He has a lot more letters behind his name than I do.
00:00:12.440 | So he's at least four times smarter than me,
00:00:14.400 | I think is the way that what that means.
00:00:16.680 | He is the founder of a fee-only hourly
00:00:20.320 | financial advisory firm.
00:00:21.580 | He has 25 years of experience in corporate finance.
00:00:24.560 | He was the corporate finance officer
00:00:26.420 | of two multi-billion dollar companies,
00:00:28.960 | works as a consultant.
00:00:30.440 | He is the author of an investing book.
00:00:32.280 | He is an investment and financial columnist
00:00:34.240 | for the AARP, for etf.com, for Financial Planning Magazine.
00:00:38.720 | And most importantly, my favorite reason why I like Alan
00:00:42.280 | is something he hasn't done for quite some time,
00:00:44.420 | this role he had as a columnist called The Mole,
00:00:49.240 | where he went undercover in the financial planning industry
00:00:52.900 | and basically revealed all their secrets.
00:00:54.840 | So he hasn't done that for over a decade,
00:00:56.860 | but it's still my favorite role, Alan.
00:00:59.160 | And thank you for being here today.
00:01:01.160 | (audience applauds)
00:01:05.900 | - Wow, skies are opening up when I talk.
00:01:12.480 | Yeah, The Mole was the most fun I ever had writing.
00:01:17.000 | Bear the right amount of risk.
00:01:22.560 | How do we typically, holy crap.
00:01:27.100 | How do we typically determine the amount of risk to take?
00:01:31.340 | We take a risk profile questionnaire.
00:01:33.860 | And I know it doesn't seem like it today,
00:01:36.700 | but these are the returns of the total US in blue,
00:01:40.260 | total international in red, and total bond.
00:01:44.300 | And we are in the single worst nine months in bonds
00:01:50.460 | that has ever happened before.
00:01:55.500 | But still, bonds are a whole lot less risky than stocks.
00:01:59.900 | And by the way, there are some wonderful opportunities
00:02:02.680 | in this bond route.
00:02:05.460 | Something like TIPS a year ago,
00:02:07.100 | you could earn a negative 1.6 return, real return.
00:02:11.540 | Today it's a positive 1.7.
00:02:13.660 | So there are some really good things
00:02:15.540 | about this really bad bond market.
00:02:18.220 | How do we typically determine our risk?
00:02:22.540 | Raise your hand if you've ever taken
00:02:24.020 | a risk profile questionnaire.
00:02:25.740 | Vast majority of people, me too.
00:02:29.740 | Well, Jason Zweig of the Wall Street Journal,
00:02:32.460 | who'll be here tomorrow, says they're worthless.
00:02:35.540 | And I say, Jason, I completely disagree with you.
00:02:39.060 | They're not that good.
00:02:40.220 | They're actually dangerous.
00:02:41.940 | Why?
00:02:45.060 | Because the way we feel about risk is not stable.
00:02:48.620 | And the bigger one is they don't measure
00:02:52.380 | one's need to take risk.
00:02:55.180 | I've taken risk profile questionnaires.
00:02:57.660 | I love to take them.
00:02:58.940 | And I get, I should be 70% to 140% in stocks.
00:03:03.140 | I should have a margin account.
00:03:04.840 | By the way, what would have happened
00:03:06.300 | to that margin account in today's market?
00:03:08.160 | It would have been called.
00:03:09.460 | I'm 45% in stocks.
00:03:13.940 | Why?
00:03:14.780 | Because we've won the game.
00:03:16.500 | Our need to take risk is low.
00:03:19.660 | So there is a company that I think has
00:03:22.140 | the single best risk profile questionnaire out there.
00:03:25.660 | Not at liberty to mention their name,
00:03:27.300 | but it starts with a V.
00:03:28.560 | So here is an example of one question.
00:03:33.180 | In 2008, stocks lost over 31%.
00:03:38.100 | If this happened again, what would I do?
00:03:40.940 | And I answered it truthfully.
00:03:42.580 | I would buy more stocks, which is what I did in 2008.
00:03:47.100 | But one, it was really, really hard.
00:03:49.260 | And two, if I were 80% stocks,
00:03:54.260 | I never would have had the cash or the courage
00:03:56.740 | to buy more stocks back then.
00:03:59.000 | So feelings about risk.
00:04:02.460 | Beginning of this year, I'm hearing a lot of,
00:04:04.740 | I've got a long investment horizon,
00:04:06.900 | so I'm comfortable being 100% in stocks.
00:04:09.420 | Now I'm hearing, this has never happened before.
00:04:11.660 | Bonds and stocks at the same time,
00:04:13.540 | I'm going all to cash until things settle down.
00:04:16.300 | I'm not panicking.
00:04:17.340 | This is logical, rational.
00:04:19.060 | They're panicking.
00:04:21.100 | So I want to make someone in this audience
00:04:26.380 | a hundred billion dollar bet.
00:04:29.200 | And I'd rather have some diversity
00:04:30.780 | rather than a white male, okay.
00:04:33.700 | So who would take this bet
00:04:36.280 | where there's a 99% chance of winning?
00:04:42.360 | If I tell you that if you lose, you die.
00:04:46.140 | Your spouse dies, your children die.
00:04:50.960 | Probably wouldn't take that bet.
00:04:53.560 | So we want to look at probabilities and consequences.
00:04:58.000 | So we typically ask,
00:04:59.720 | how would you feel if your stocks lost 50%?
00:05:03.240 | Maybe the better question is,
00:05:04.880 | how would you feel if you couldn't send your daughter
00:05:08.360 | to that prestigious college
00:05:09.840 | that she worked so hard to get into?
00:05:12.840 | If you had to work another decade
00:05:15.280 | in that awful stressful job with that horrible boss,
00:05:19.240 | if you couldn't buy the lake house.
00:05:21.840 | So again, you have to think in terms of consequences.
00:05:26.700 | So willingness to take risk.
00:05:28.480 | I know from a guy,
00:05:30.200 | getting in touch with your feelings sounds a little weird,
00:05:32.600 | but you really have to imagine
00:05:34.900 | what it would be like if things don't work out.
00:05:37.760 | Test the ability to rebalance in a bear.
00:05:40.040 | The only good thing about this bear market
00:05:42.960 | is that with bonds and stocks going down,
00:05:44.840 | there's less of a need to rebalance.
00:05:46.840 | I'm so cheerful.
00:05:50.980 | So I had a lot of people that say to me,
00:05:55.920 | oh no, no, I don't panic in a bear market.
00:05:58.640 | Then they come to me as clients,
00:05:59.840 | and where did all these tax loss carry forwards come from?
00:06:03.920 | So in my opinion, the biggest predictor
00:06:08.000 | of how someone's gonna perform in the next bear market
00:06:11.040 | is what they did in the last bear market.
00:06:14.180 | So money and happiness.
00:06:16.200 | I'm really disappointed Jonathan Clements isn't here
00:06:18.840 | 'cause he taught me so much about money and happiness.
00:06:21.660 | I don't know, he put his family above me.
00:06:23.960 | I just don't understand that.
00:06:25.620 | But anyways, if Elon Musk makes another billion dollars,
00:06:32.600 | yes, he'll be happier, but when you lose money,
00:06:36.880 | you get roughly twice as much misery
00:06:39.900 | as happiness from making money.
00:06:41.800 | Daniel Kahneman won the Nobel Prize
00:06:44.520 | for Prospect Theory on that.
00:06:46.980 | So how much risk should you take?
00:06:49.100 | A 65-year-old with a $2 million portfolio
00:06:53.160 | needs $50,000 a year above Social Security,
00:06:57.360 | and the high willingness to take risk,
00:06:59.620 | they don't have much of a need, a conservative portfolio.
00:07:03.740 | The above with a million-dollar portfolio,
00:07:05.820 | they've gotta have it grow,
00:07:06.980 | so maybe take a little bit more risk.
00:07:09.100 | If they had a low willingness to take risk,
00:07:15.780 | probably shouldn't take much
00:07:16.980 | because they will sell when stocks go down.
00:07:20.460 | A 45-year-old saving for retirement
00:07:24.380 | with a high willingness can be aggressive.
00:07:26.020 | A low willingness, again, conservative
00:07:28.280 | because they're not gonna stay.
00:07:30.200 | A 25-year-old, I'm not a fan of 100 minus your age,
00:07:34.900 | if they're saving money that they need in two years,
00:07:37.720 | don't wanna take a lot of risk with it.
00:07:41.860 | A 25-year-old who just inherited two million,
00:07:44.380 | we don't know how he or she is gonna behave.
00:07:47.820 | So again, in concept of taking risk,
00:07:50.680 | the only one that should have an aggressive portfolio
00:07:56.180 | is someone that has the high need
00:07:58.300 | and as hard as it is to measure
00:08:00.920 | the high willingness to take risk.
00:08:03.700 | And Carl Richards has it right.
00:08:05.540 | We buy high, sell low, we repeat 'til broke.
00:08:07.900 | Never take uncompensated risk.
00:08:12.780 | 96% of stocks have earned, on average,
00:08:20.540 | the same amount as the Treasury bill.
00:08:23.900 | There's a handful of stocks that drive the return.
00:08:27.940 | And guess what?
00:08:28.840 | I don't know what those will be going forward.
00:08:31.340 | And I'm gonna brag, I owned Zoom
00:08:38.140 | before I even knew what Zoom was.
00:08:40.760 | Guess what?
00:08:41.660 | Vanguard Total Stock Index Fund.
00:08:44.460 | Okay.
00:08:45.420 | What about asset classes with low or negative correlations?
00:08:49.340 | Commodity futures, foreign currency futures, options.
00:08:53.140 | Can somebody tell me the one thing
00:08:54.420 | that all three of these have in common?
00:08:56.340 | In the aggregate, not a penny has ever been made
00:09:05.740 | before costs.
00:09:07.640 | There's someone on the other side of the trade.
00:09:10.440 | Inverse S&P 500 funds, triple inverse S&P 500 funds.
00:09:14.380 | And don't laugh, I've had really sophisticated clients
00:09:19.380 | that were private equity managers, mutual fund managers
00:09:22.500 | that owned both an S&P 500 index fund
00:09:25.500 | and an inverse S&P 500 index fund.
00:09:28.180 | That's like betting on both teams.
00:09:30.960 | You can't win through a bookie.
00:09:33.520 | Gambling half your net worth in Las Vegas,
00:09:35.580 | it'd be more fun than many of these other things.
00:09:38.560 | So low or negative correlations isn't enough.
00:09:41.340 | You also need a positive expected long run return.
00:09:45.820 | REITs sometimes have a negative correlation.
00:09:48.840 | Lately, as Christine Benz has pointed out,
00:09:51.420 | very positive correlation.
00:09:53.340 | Precious metals and mining funds, I think they're great,
00:09:57.820 | but you've got to have a stomach of lead
00:10:00.180 | to stay the course there.
00:10:01.940 | The penalty for not knowing your risk.
00:10:06.040 | I'm not at liberty to say the Chicago-based
00:10:09.940 | research company this came from.
00:10:11.920 | But overall, an individual investor underperforms the fund,
00:10:19.960 | not from fees, 'cause the fund has the fees baked in,
00:10:24.400 | by 1.73%, by either performance chasing,
00:10:28.080 | not knowing our risk, et cetera.
00:10:30.920 | So the old paradigm is unrisked.
00:10:33.800 | If you can't be right, at least be consistent.
00:10:36.400 | But these are the three, what I call
00:10:37.880 | the second-grader portfolios,
00:10:39.480 | or the three-fund portfolio from Taylor Larimer,
00:10:43.080 | total US, total international, total bond,
00:10:45.680 | and it's 90%, 60%, or 30% risky,
00:10:49.840 | and guess what, they all performed roughly the same.
00:10:53.960 | So pick an asset allocation that's gonna match
00:10:57.280 | your willingness and your need to take risk.
00:11:00.400 | Imagine the pain of if things don't work out.
00:11:04.680 | Think of asset allocation as a binding contract,
00:11:08.320 | and I tell my clients, I enforce based on guilt.
00:11:11.640 | You only wish a large New York law firm
00:11:14.360 | were out to ruin your life by comparison.
00:11:16.920 | And when I disagree with a client, I negotiate.
00:11:19.840 | For instance, in good times, the client might say,
00:11:22.520 | I wanna be 70% stocks, and I think 60% is more appropriate.
00:11:26.760 | I'll say, start with the 60, and then if stocks
00:11:31.760 | go down into 20% below where they are today,
00:11:35.000 | and your appetite is still there, then go to 70,
00:11:38.340 | I'm testing their resolve, I'm not timing the market.
00:11:42.920 | And guess what, how many clients come back to me
00:11:46.240 | in that bear market and say they wanna increase,
00:11:48.200 | it's hard enough to get them to rebalance.
00:11:51.280 | Thank you.
00:11:52.120 | - Thank you.
00:11:53.600 | (whooshing)
00:11:55.940 | [BLANK_AUDIO]