Bogleheads University 101 2023 - The Basics of Investing with Allan Roth
00:00:00.000 | [ Applause ]
00:00:06.920 | So, Alan, I bought us a little extra time here.
00:00:10.360 | Alan Roth is going to come up.
00:00:12.000 | I want to introduce Alan.
00:00:13.760 | He is a former board member for the John C. Bogle Center
00:00:17.720 | for Financial Literacy.
00:00:19.640 | He is an author.
00:00:20.920 | His book is called How a Second Grader Beats Wall Street.
00:00:26.000 | And it's a great Bogleheads book.
00:00:29.400 | I think Alan is going to be giving away a few of those books for people
00:00:32.840 | who will make a donation to the Bogle Center.
00:00:36.160 | Alan is a columnist in several places,
00:00:38.640 | AARP, etf.com, and financial planning.
00:00:43.080 | He is just such a generous and thoughtful person.
00:00:46.480 | And he has made huge contributions to Bogleheads over the years.
00:00:53.520 | And we're excited to have him here as part of this track talking
00:00:57.800 | about the basics of investing.
00:00:59.720 | So, Alan, come on up.
00:01:02.000 | [ Applause ]
00:01:10.200 | >> Thank you, Christine.
00:01:11.480 | That was incredibly nice.
00:01:13.400 | I'm thrilled to be here.
00:01:16.040 | I'm going to start with -- well, I was planning on starting
00:01:19.200 | with the two most important lessons in investing.
00:01:23.240 | But I've got to start with something very embarrassing.
00:01:26.680 | I need to borrow $1,000.
00:01:30.480 | I haven't managed my money very well.
00:01:34.080 | So I need to borrow $1,000.
00:01:35.760 | I'm going to return every penny a year from today, lots of witnesses.
00:01:41.200 | Who will lend me that $1,000?
00:01:44.520 | Christine, Mike, you're the nicest people in the world.
00:01:51.000 | You're not going to lend me the $1,000?
00:01:55.920 | Why would no -- somebody's nice back there.
00:01:59.120 | You would lend me the $1,000?
00:02:01.360 | Well, obviously, there's some really nice people in here.
00:02:06.320 | But who logically and rationally would lend me $1,000,
00:02:09.680 | and why would you not?
00:02:11.960 | No interest.
00:02:18.080 | You want to make money off of my misfortune, not being able
00:02:21.280 | to manage my own finances?
00:02:23.840 | That's pretty reasonable.
00:02:27.640 | You want to make more or less than inflation?
00:02:31.800 | More. Absolutely.
00:02:35.960 | Which gets me to the two most important lessons.
00:02:39.640 | Oh, by the way, if you lent me money
00:02:43.120 | versus lending the U.S. government money via Treasury,
00:02:47.560 | would you want to charge more or less me versus the U.S. government?
00:02:52.760 | More. I'm riskier.
00:02:55.400 | I'm a financial planner.
00:02:56.720 | That means I'm not very good with my money.
00:02:59.320 | So the two most important lessons
00:03:05.840 | in investing are you want to be compensated for taking on risk.
00:03:12.800 | The second is a dollar today is worth more
00:03:17.840 | than a dollar in the future.
00:03:20.320 | Has anyone noticed that things are costing more
00:03:22.640 | than they did a couple of years ago?
00:03:24.960 | Yeah. That's called inflation.
00:03:27.600 | So you want to make more than inflation.
00:03:30.920 | All right.
00:03:32.200 | The million-dollar coin flip.
00:03:34.920 | Is betting a million dollars even money investing?
00:03:38.960 | Is there an expectation of profit?
00:03:43.560 | No. What about betting a million dollars on a coin flip,
00:03:49.080 | whereas if you call heads and it's right, you get a $1,020,000?
00:03:54.680 | It is investing.
00:03:58.360 | I wouldn't take that bet.
00:03:59.640 | I would recommend that you not take that bet.
00:04:01.840 | There's a fellow by the name of Daniel Kahneman
00:04:03.880 | who won a Nobel Prize for prospect theory that shows we're going
00:04:07.880 | to get twice as much pain from losing money
00:04:10.280 | as pleasure from making money.
00:04:14.360 | But third is would you do a million one-dollar bets?
00:04:20.560 | What have I done?
00:04:21.880 | I think I heard a yes.
00:04:23.160 | I saw a yes back there.
00:04:24.480 | I would, because what I've diversified is
00:04:28.640 | over the number of coin flips.
00:04:31.840 | I should make $10,000 and a very,
00:04:34.600 | very low probability I would actually lose money.
00:04:37.480 | And even if I did, it would be very little.
00:04:41.000 | That's an example of diversification.
00:04:44.400 | So there are three types of risk.
00:04:49.800 | There's default risk.
00:04:52.360 | Let me just say lending money to Honest Al has huge default risk.
00:04:57.680 | There's interest rate risk.
00:05:00.480 | If you lent the U.S. government $100 for 10 years at 5%,
00:05:10.600 | then you're going to get $5 a year back.
00:05:13.440 | If interest rates went up to 7%,
00:05:16.800 | then that means you're getting a below market rate.
00:05:20.200 | Interest rates have gone up.
00:05:21.480 | The value of your bond has gone down.
00:05:24.800 | And holding it to maturity doesn't help.
00:05:27.680 | And then you have liquidity risk.
00:05:32.160 | It would be a lot easier to sell somebody your treasury
00:05:36.960 | than it would be to sell the $1,000 loan to Honest Al.
00:05:42.880 | So three questions.
00:05:44.320 | Why do people invest?
00:05:46.440 | Because they want to grow their money, obviously.
00:05:50.840 | How do people invest?
00:05:52.720 | We buy stocks, U.S., international, large companies,
00:05:57.200 | small companies, energy, tech.
00:06:00.920 | We buy bonds.
00:06:03.280 | We buy investment grade or one
00:06:06.080 | of the few terms the industry has gotten right.
00:06:09.960 | Junk bonds, high yield bonds.
00:06:13.360 | We buy gold.
00:06:14.520 | We buy bitcoin.
00:06:17.520 | We buy all sorts of things to invest.
00:06:21.360 | And where do we get investment advice?
00:06:24.160 | From our friends, from our neighbors, from TV, mad money.
00:06:30.680 | My personal favorite are newsletters.
00:06:33.440 | If I knew how to beat the market, do you think I would try
00:06:37.520 | to create a newsletter and try to sell it one
00:06:40.720 | by one for $299 a year?
00:06:45.360 | Jim Cramer, mad money.
00:06:47.280 | I'll let you in on a secret.
00:06:49.120 | The head of his foundation once shared their investment results
00:06:52.640 | with me.
00:06:53.920 | He earned half of the return of the U.S. stock market.
00:06:59.120 | So financial versus real assets.
00:07:06.200 | First of all, if you don't save, investing doesn't matter.
00:07:11.720 | So you've got to reduce current consumption today
00:07:15.760 | to have a better financial independence in the future.
00:07:20.400 | Or even a better thing to do is get the best deals
00:07:25.520 | on what you do consume.
00:07:27.320 | And I will say that Clark Howard is to savings
00:07:31.120 | as Jack Bogle was to investing.
00:07:34.160 | So I'm just absolutely thrilled.
00:07:36.120 | I've gotten to know him over the years.
00:07:37.680 | An absolutely wonderful guy.
00:07:40.760 | For planned consumption later.
00:07:44.880 | Real assets are used to produce goods and services.
00:07:49.040 | I could buy a new car so I could make money.
00:07:53.160 | I could invest in a new car to become an Uber driver.
00:07:56.360 | That's an investment in a real asset.
00:08:00.040 | Or financial assets which are claims to real assets.
00:08:04.080 | If I buy a stock, I have a claim on that company.
00:08:10.200 | So major classes of financial assets.
00:08:19.440 | There's debt.
00:08:20.760 | There's bonds.
00:08:22.040 | There's CDs.
00:08:23.360 | There are money markets.
00:08:26.160 | There's common stock.
00:08:27.560 | When we think of a stock, we generally think
00:08:30.160 | of a common stock.
00:08:32.360 | There are some stocks that have preferences known
00:08:36.240 | as preferred stock.
00:08:38.200 | And in spite of the name preferred,
00:08:41.600 | I recommend against them.
00:08:44.000 | And then there are derivative securities.
00:08:47.040 | Futures. Energy futures.
00:08:50.040 | Options. Puts.
00:08:51.560 | Calls. Anybody know how much has been made
00:08:55.080 | in the history of the futures
00:08:57.640 | and options market before costs?
00:09:03.360 | Zero. Was that you, Mike?
00:09:05.840 | Yeah. Well, Mike knows everything.
00:09:08.360 | Yeah. Absolutely.
00:09:09.800 | That is not investing.
00:09:11.640 | That is gambling.
00:09:13.920 | That's like betting on the Broncos.
00:09:15.800 | Oh, it's painful.
00:09:17.120 | So stocks and bonds are the two principal areas
00:09:24.560 | where people invest.
00:09:26.280 | If I buy a stock, I am one of the owners of that company.
00:09:32.840 | I have upside if it does well, NVIDIA.
00:09:37.360 | I have downside if it doesn't do very well.
00:09:40.880 | Like General Motors, it was at one time when I was small,
00:09:44.400 | viewed as safe as the U.S. government.
00:09:47.120 | I'm glad that wasn't true.
00:09:49.240 | So goes America.
00:09:50.560 | So goes GM goes America.
00:09:51.840 | I'm glad that wasn't true.
00:09:53.320 | And a bond is you're lending money to a company.
00:09:57.440 | And that company is going to pay you interest
00:10:02.360 | and the principal back.
00:10:04.480 | You've got no upside, no claim on how well the company does,
00:10:09.520 | but you have more protection
00:10:11.040 | than a common stock on the way down.
00:10:15.240 | Choices are asset allocation.
00:10:18.040 | Yes, in general, stocks are a lot riskier than bonds.
00:10:22.560 | You've got security selection.
00:10:26.960 | If I'm going to own some stocks, which ones should I buy?
00:10:30.600 | Is Exxon going to do better than Chevron?
00:10:33.320 | Is Amazon going to do better than Walmart?
00:10:36.160 | Those are the choices.
00:10:41.680 | So valuation.
00:10:44.840 | Why does Exxon Mobil, my first employer
00:10:47.080 | out of business school, by the way, why does it have value?
00:10:52.240 | Because it is going to pay us dividends and we hope
00:11:00.000 | that it will pay us more and more.
00:11:02.880 | And then we are also buying their cash flow.
00:11:07.120 | This is more, rather than investing 101,
00:11:09.560 | this is more investing PhD, but a stock buyback is a far more
00:11:16.520 | efficient way, tax-efficient way for a company to return money
00:11:21.240 | to shareholders, even though it has a terrible name
00:11:23.920 | in the press, in the media.
00:11:26.520 | Okay. Now, what I have here is a genuine, real,
00:11:34.960 | completely fake gold coin.
00:11:39.520 | Why does it have value?
00:11:41.840 | Because we say it does.
00:11:50.440 | It's rare and it's pretty.
00:11:54.480 | Belly button lint is pretty rare, but it's not so pretty.
00:12:01.160 | Bitcoin. Why does Bitcoin have value?
00:12:05.000 | A lot of value.
00:12:07.520 | There are actually some utilitarian uses for it,
00:12:11.240 | whether or not it's over or undervalued.
00:12:12.760 | I certainly wouldn't bet much on it, but that's why it has value.
00:12:18.800 | So what is riskier?
00:12:22.360 | A portfolio of 100% in one stock or a portfolio comprised
00:12:29.640 | of thousands of different companies?
00:12:32.440 | The latter.
00:12:36.360 | And by the way, does that mean a diversified index fund owning
00:12:43.000 | thousands of companies has no risk?
00:12:46.360 | No, it has risk.
00:12:48.320 | But it has a lot less risk than buying any one company.
00:12:52.840 | So I'm old.
00:12:55.160 | You know, back when I was in grad school, shortly afterward,
00:13:01.600 | the largest ten companies,
00:13:03.360 | the most valuable ten companies back then,
00:13:06.840 | versus the most valuable ten companies 40 years later.
00:13:10.280 | And by the way, things change.
00:13:12.280 | That list of 2020 is no longer valid.
00:13:15.200 | NVIDIA is in there.
00:13:17.960 | By the way, what do you notice about most of the companies,
00:13:21.320 | the most valuable companies today?
00:13:23.120 | Did they exist 40 years ago?
00:13:26.760 | They did not.
00:13:29.280 | So there's this big debate, active versus passive.
00:13:33.960 | Active is finding undervalued securities, timing the market,
00:13:39.760 | which by the way, I'm going to admit, I'm a market timer.
00:13:43.240 | Passive management, which Jack Bogle brought us,
00:13:48.080 | no attempt to find undervalued securities
00:13:52.000 | and no attempt to time the market.
00:13:56.320 | And then holding an efficient portfolio.
00:13:59.840 | What is the efficient portfolio?
00:14:02.760 | Which stocks should you buy?
00:14:05.520 | All of them.
00:14:08.640 | So there's this whole active/passive debate
00:14:10.960 | and efficient market hypothesis.
00:14:13.320 | Is the market efficient or not?
00:14:16.000 | And I argue, doesn't matter a bit.
00:14:20.200 | What matters is arithmetic.
00:14:23.360 | If the U.S. stock market earns 10%,
00:14:28.120 | the average investor is going
00:14:30.040 | to get 10% minus what they pay in fees.
00:14:34.680 | If the market loses 10%, the average investor is going
00:14:40.840 | to lose 10% minus what they pay in fees.
00:14:46.320 | So owning everything at the lowest cost.
00:14:51.800 | And by the way, this year, you may have heard of the term,
00:14:56.880 | the Magnificent Seven tech companies like Alphabet, Apple.
00:15:02.640 | They are .2% of the U.S. companies and maybe .1%
00:15:08.720 | of all companies, including international,
00:15:11.080 | and they have driven the entire return.
00:15:15.400 | Now, when it comes to market timing,
00:15:21.640 | when I was in business school,
00:15:23.960 | I was taught we couldn't time the market.
00:15:25.920 | But it turns out we're really, really good
00:15:27.760 | at timing the markets really, really poorly.
00:15:32.240 | And Morningstar's Mind the Gap does an amazing job of showing
00:15:37.680 | that shortfall year after year after year.
00:15:41.360 | If you look at fund flows into stock funds, rather, that,
00:15:47.360 | you know, we hit the .com bubble and people panic and sell.
00:15:51.320 | Then it goes back up and we buy.
00:15:53.120 | Then the financial crisis hits and we panic and sell.
00:15:56.480 | Then it goes back up and we buy.
00:15:58.800 | Then COVID hits.
00:16:00.080 | This has never happened before, a pandemic.
00:16:02.240 | We panic and sell.
00:16:03.520 | That was the shortest bear in the history
00:16:06.440 | of the U.S. stock market.
00:16:09.280 | But we are really, really good
00:16:10.840 | at timing markets really, really poorly.
00:16:14.200 | So what I do for myself and my clients is
00:16:16.960 | to set an overall asset allocation target.
00:16:20.520 | And guess what that means?
00:16:22.480 | When stocks go up, you have to sell.
00:16:27.200 | When stocks go down, you have to buy.
00:16:30.880 | Really, really simple and really, really hard to do.
00:16:34.080 | And let me tell you, when I bought stocks in March of 2020,
00:16:38.080 | when stocks fell 35% in 33 days, that was anything but easy.
00:16:43.840 | It took 10 minutes, but it was really hard.
00:16:47.560 | So, you know, in conclusion,
00:16:50.160 | investing is really, really simple.
00:16:52.720 | Taxes aren't, and Mike is really,
00:16:55.520 | Mike Piper is really an expert on helping there.
00:16:59.560 | It's simple, but not so easy,
00:17:01.520 | especially when money starts meaning more to us.
00:17:03.920 | And the older we get, by the way, the more money means to us
00:17:06.800 | because the less the human capital we have
00:17:08.800 | and the more the investment capital we have.
00:17:12.720 | Never take on uncompensated risk.
00:17:15.480 | Own every stock in proportion to the market.
00:17:20.360 | Now, nearly 15 years ago, I wrote this book,
00:17:23.200 | How a Second Grader Beat Wall Street.
00:17:25.720 | And cap-weighted investing, meaning that you buy more
00:17:30.320 | of the large, most valuable companies like Apple and Amazon
00:17:34.960 | and less of the smaller companies, was out of vogue.
00:17:38.040 | Everyone was factor investing, smart beta.
00:17:42.320 | It didn't work going forward.
00:17:45.000 | So, own every stock in proportion to value,
00:17:48.600 | and something like the Vanguard Total Stock Market Index Fund,
00:17:53.680 | we've got a great speaker who runs that fund,
00:17:57.840 | at a .03% expense ratio, does the trick.
00:18:02.760 | And then, when it comes to fixed income,
00:18:04.900 | take your risks with stocks.
00:18:08.020 | Your fixed income, you want to be very, very safe.
00:18:14.400 | So, in conclusion, investing is really simple.
00:18:18.560 | In eight words, anything that you do, ask,
00:18:21.400 | are you minimizing expenses and emotions?
00:18:24.640 | And are you maximizing diversification and discipline?
00:18:30.000 | Simple yes, easy no, and when you're eight years old
00:18:33.400 | and money doesn't mean anything to you, duh.
00:18:37.040 | The older we get, and like I said, I'd be lying
00:18:39.320 | through my teeth if I said it was easy to rebalance
00:18:42.360 | and buy more stocks in March of 2020 when our lives had changed
00:18:46.520 | and suddenly we weren't going to the office,
00:18:48.840 | we weren't socializing, who knew what was going to happen.
00:18:51.840 | It's really, really hard.
00:18:55.320 | So, anyways, that is investing.
00:18:58.480 | You know, I didn't know that we were going to -- oh, Christine,
00:19:00.240 | you're going to do introductions, wonderful.
00:19:02.760 | Thank you.
00:19:06.440 | [ Applause ]