Bogleheads® on Investing Podcast 012 – Larry Swedroe, host Rick Ferri (audio only)

00:00:00.000 | [MUSIC PLAYING]

00:00:10.460 | Welcome, everyone, to the 12th episode

00:00:12.620 | of "Bogleheads on Investing."

00:00:15.340 | Today, we have a special guest, Larry Suedro.

00:00:19.540 | Larry is the chief research officer

00:00:22.340 | of Buckingham Strategic Wealth and the author

00:00:26.220 | of 17 books on investing.

00:00:28.940 | [MUSIC PLAYING]

00:00:38.020 | Hi, everyone.

00:00:38.780 | My name is Rick Ferry, and I'm the host

00:00:40.860 | of "Bogleheads on Investing."

00:00:43.500 | This episode is brought to you by the John C. Bogle Center

00:00:47.220 | for Financial Literacy, a 501(c)(3) corporation.

00:00:52.780 | Today, we have a special guest, my friend, Larry Suedro.

00:00:57.980 | Larry and I have known each other for many years,

00:01:00.260 | and we've had a lot of healthy debates.

00:01:02.780 | So with no further ado, let's bring Larry in.

00:01:06.580 | We are pleased today to have Larry Suedro as our guest.

00:01:10.300 | Welcome, Larry.

00:01:11.780 | Great to be with you, Rick.

00:01:13.420 | I'm really excited to have you on the show, Larry.

00:01:15.540 | You and I have known each other for many years,

00:01:17.540 | and we've gone back and forth on the forum

00:01:20.460 | on many different topics.

00:01:22.100 | And everybody's got a different opinion and different view.

00:01:25.420 | And you and I have had our days.

00:01:28.700 | But it's always been very cordial,

00:01:30.140 | and I'm really excited to have you with me today.

00:01:32.700 | I'd like to start with you telling us,

00:01:36.700 | how did you get involved in this whole investing business?

00:01:40.700 | Give us some of your bio.

00:01:43.380 | My father did something very smart.

00:01:45.580 | He was a real stock junkie, would follow stocks daily

00:01:49.860 | and go to the Merrill Lynch office in the neighborhood

00:01:52.980 | and watch the ticker tape.

00:01:54.500 | And when I was born, he took, I think it was $500 in gifts,

00:01:59.980 | and he bought seven different individual stocks for me.

00:02:04.860 | And then when I turned 13, we had my bar mitzvah,

00:02:09.100 | and we got a little bit more cash.

00:02:11.420 | And then we sat down together, and we bought one stock.

00:02:15.500 | Because at that time, while other kids were reading

00:02:18.060 | the sports section, I was already

00:02:20.140 | following the Wall Street Journal and all these stock

00:02:22.660 | prices.

00:02:23.620 | So then you decided to make it a career,

00:02:26.500 | or at least go to school.

00:02:28.020 | I then went to school.

00:02:30.660 | My undergraduate degree is from City College, the Business

00:02:33.940 | School, Bernard Baruch in Finance and Investing.

00:02:37.380 | It really was just about the first finance degrees handed

00:02:42.060 | out anywhere, because there was no finance theory, as you know,

00:02:46.060 | until Bill Sharp and others created that CAPM.

00:02:51.180 | Before that, finance was hidden inside some accounting program

00:02:56.020 | or maybe an economics class.

00:02:58.140 | So Larry, while you were at college,

00:02:59.680 | I understand you were a pretty good basketball player.

00:03:01.980 | Is that true?

00:03:03.420 | That depends on your definition of a pretty good basketball

00:03:07.500 | player.

00:03:07.980 | I was pretty good for my neighborhood, but I was so

00:03:11.100 | short.

00:03:11.740 | When I got to high school, I was 5 foot 1 and 110 pounds,

00:03:16.460 | so I couldn't even make my high school basketball team.

00:03:19.720 | But I grew in my next two years.

00:03:22.540 | When I graduated high school, I was 5'10" and all of about 140,

00:03:28.300 | and I was still only 16.

00:03:30.540 | And I went to Baruch College, and I

00:03:32.860 | made their basketball team.

00:03:35.020 | You know, it's a D3 school, so it all

00:03:37.500 | depends upon your definition.

00:03:39.940 | Relatively speaking, I was good.

00:03:42.260 | So basically, you decided not to have a career in basketball,

00:03:45.900 | and so you went on and got your master's degree.

00:03:49.880 | Then went to NYU for my master's.

00:03:52.920 | And when I got out of school, Wall Street

00:03:55.480 | had collapsed, '73, '74, the crisis,

00:03:58.720 | in addition to which the end of the fixed commission era

00:04:03.240 | was over, and many firms were going bankrupt.

00:04:07.080 | Even Ross Perot lost a fortune trying to buy a brokerage firm.

00:04:12.420 | And so I ended up taking a job at CBS

00:04:15.640 | in their international finance department.

00:04:18.780 | And then I was going for my PhD in international finance

00:04:23.320 | and economics.

00:04:24.600 | Ultimately, unfortunately, the New York City subway system

00:04:28.600 | had gotten so bad and dangerous, I didn't quite finish my PhD,

00:04:34.980 | because I had to have my mother even literally drive down

00:04:37.880 | from the Bronx to pick me up the last semester.

00:04:40.880 | It had gotten so dangerous.

00:04:42.980 | So Larry, I understand from knowing you

00:04:44.600 | that you actually got not one MBA,

00:04:46.520 | but you got two MBAs in a way.

00:04:48.200 | Is that what you're talking about with the PhD?

00:04:50.360 | Yeah, in effect.

00:04:52.040 | So I don't really technically have two MBAs,

00:04:55.720 | but I have an MBA in finance and investing.

00:04:58.680 | And then going for my PhD, which would

00:05:01.440 | have been in international trade theory and economics,

00:05:04.480 | I have all of the required courses

00:05:08.440 | to have a master's in international finance

00:05:11.800 | and economics.

00:05:12.960 | So in effect, you could say I have two MBAs.

00:05:18.160 | So let's move on and start talking about your career

00:05:21.280 | on Wall Street.

00:05:22.680 | I really got lucky after that.

00:05:24.880 | It's one of those strange things.

00:05:27.000 | I feel like the Zelig character in Woody Allen's movie,

00:05:31.720 | where he's inserted in all these major events in history.

00:05:36.320 | I was involved in, I think, four of the biggest revolutions

00:05:40.960 | in finance, just happened to be at the right place

00:05:43.480 | in the right time.

00:05:44.800 | The first was when Brenton Woods broke down.

00:05:47.800 | All of a sudden, everyone had a deal

00:05:50.020 | with floating exchange rates and interest rates going crazy.

00:05:54.120 | And I was hired by CBS to be manager of international finance

00:05:59.000 | and helping them to manage those risks.

00:06:03.000 | So CBS, you're talking about the entertainment company.

00:06:05.720 | Yeah, exactly right.

00:06:08.040 | And there's actually an interesting story

00:06:10.400 | behind there, Rick.

00:06:11.320 | We could divert for a moment.

00:06:13.440 | So the only reason I interviewed with CBS,

00:06:16.040 | I was hoping to get a job with a Wall Street firm.

00:06:19.080 | And I did have one offer from IBM.

00:06:22.440 | But Wall Street, as I mentioned earlier, was in a sad shape.

00:06:25.680 | And they could hire somebody with 10 years of experience

00:06:28.960 | for about the same, or not much more than some young MBA.

00:06:34.360 | So I said, I've got to get a job.

00:06:37.400 | I'm getting married.

00:06:38.760 | And CBS happened to own the Yankees at that time.

00:06:42.200 | And so I said, I don't care if I drive a bus.

00:06:45.880 | I'll see if I can get a job with the Yankee organization.

00:06:49.200 | So I go to the interview.

00:06:50.640 | And on my way there, I pick up the newspaper.

00:06:53.440 | And the headline reads, CBS sells the Yankees.

00:06:57.720 | So I decided I'm dressed up in my suit anyway.

00:07:01.040 | I'm on the subway.

00:07:02.120 | I might as well go.

00:07:03.080 | I went, and ultimately, I did get a job there.

00:07:06.680 | And I had a good two years there.

00:07:09.280 | But then two years later, at the grand old age of 23,

00:07:15.000 | and with all of two years of experience,

00:07:17.480 | Citicorp and other banks were getting

00:07:21.560 | in the consulting business to help

00:07:23.480 | these big multinationals deal with foreign exchange risk.

00:07:27.440 | And they hired me to be a consultant.

00:07:30.240 | So I went and joined them.

00:07:32.000 | This was our new exciting area.

00:07:34.280 | And then two years later, Citicorp

00:07:37.520 | asked me to go set up a whole West Coast Investment

00:07:41.680 | Bank at the grand old age of 25.

00:07:45.560 | I had never run a foreign exchange trading room.

00:07:48.000 | I had never funded an offshore bank.

00:07:50.560 | I had never managed more than one person.

00:07:52.760 | And they sent me out to San Francisco

00:07:55.320 | to build an entire operation.

00:07:57.360 | And a second revolution was occurring around that time.

00:08:01.840 | Citicorp and Salomon Brothers were leading the way

00:08:07.040 | in creating what Buffett ultimately

00:08:09.240 | called these weapons of mass financial destruction,

00:08:13.360 | these derivatives.

00:08:14.480 | And they were more basic at that time, interest rate floors

00:08:18.960 | and ceilings and collars and foreign exchange floors

00:08:22.840 | and ceilings and collars to manage these risks.

00:08:25.960 | And so I was right there with that,

00:08:28.840 | and even helped design and create

00:08:30.960 | some of these derivatives.

00:08:32.760 | And then 10 years later, my boss at Citicorp

00:08:37.440 | left to join Prudential Home Mortgage.

00:08:40.240 | And that was a whole new revolution in mortgage banking,

00:08:44.480 | the first private mortgage-backed securities.

00:08:47.680 | So I got involved there.

00:08:49.880 | And with that big revolution, did that for eight years.

00:08:54.840 | And then we ultimately sold the company.

00:08:57.400 | And then I was going to look for something to do.

00:08:59.960 | I thought I'd go teach at something

00:09:01.840 | I'd always wanted to do.

00:09:03.440 | That's why I was originally going for my PhD.

00:09:06.760 | And friends of mine had started this RIA,

00:09:11.200 | a registered investment advisory firm in St. Louis.

00:09:14.480 | And they were good planners doing estate and tax

00:09:19.200 | type of work.

00:09:21.040 | But they didn't really know anything about investing.

00:09:23.720 | So I thought this would be a great fit.

00:09:26.560 | I told them I didn't want to have to do anything

00:09:28.600 | to do with running the company.

00:09:30.080 | But I would help set the investment strategy,

00:09:32.720 | teach them about managing all types of risk.

00:09:35.720 | So we joined forces.

00:09:37.960 | And right at that time, as you know,

00:09:40.760 | the early '90s, Fama and French write their groundbreaking

00:09:44.160 | paper.

00:09:45.040 | And we're now in this three-factor world

00:09:47.200 | that changed the way we thought about investing.

00:09:50.040 | And so that was our fourth revolution

00:09:53.520 | that now just happened to be at the right point in time.

00:09:58.120 | So I view myself as very lucky and had

00:10:01.000 | a lot of vast different experiences, which

00:10:04.040 | has helped me, I think, be a much better advisor,

00:10:07.640 | having lived through lots of financial crises.

00:10:11.160 | So the firm you're talking about is Buckingham Asset Management

00:10:14.680 | out of St. Louis.

00:10:15.880 | Well, now it's called--

00:10:17.040 | we changed the name about--

00:10:18.720 | I think it's now maybe two years ago.

00:10:20.480 | It's Buckingham Strategic Wealth,

00:10:22.840 | where just about a $17 billion RIA in now 35 cities.

00:10:29.080 | And then we have TAMP, which runs both BAM Advisor Services,

00:10:35.600 | helping other advisors, and a firm called Loring Ward.

00:10:39.640 | Together, we're about $52 billion, I believe.

00:10:43.600 | How many advisors are under the TAMP program, Larry?

00:10:46.600 | Do you have a basic number?

00:10:48.120 | Yeah, I can give you some general guidelines.

00:10:50.960 | At Buckingham, which is BAM Advisor Services,

00:10:54.160 | about 135 firms around the country with about, I think,

00:11:00.040 | $19 billion of assets.

00:11:03.000 | And Loring Ward has over 1,000 advisors, many of them

00:11:08.120 | small broker-dealers who really are nothing more

00:11:11.400 | than investment advisors.

00:11:13.720 | And then they have also about, I think,

00:11:16.840 | 100-plus advisory firms who are really more of the wealth

00:11:22.240 | management as well as investment advice.

00:11:25.840 | And they have, collectively, about $16 or $17 billion.

00:11:31.760 | So what helped this whole thing grow was your book,

00:11:35.400 | your very first book, correct?

00:11:36.920 | I mean, I recall when that book came out,

00:11:39.040 | just before I went to a DFA conference or right after that.

00:11:43.880 | Yeah, what happened was I got to Buckingham.

00:11:46.920 | And they had no marketing material at all.

00:11:50.160 | The firm had just been formed.

00:11:52.160 | And they had decided, like you did,

00:11:55.440 | to at least use some of DFA's funds.

00:11:58.400 | This was a DFA shop, if you will,

00:12:00.760 | in that it used DFA products exclusively in the early years.

00:12:05.280 | Today, we use many multiple advisors.

00:12:08.000 | But DFA clearly was the leader there.

00:12:11.040 | And I went to a DFA seminar, like you did,

00:12:14.560 | to learn everything about them.

00:12:17.280 | And they had, like, three slides at the time

00:12:20.360 | to explain what they did.

00:12:21.960 | So I said, we need to have a brochure to at least tell

00:12:25.960 | people what we're all about.

00:12:28.360 | So I took what I learned in those three days

00:12:31.800 | at the dimensional university, if you will,

00:12:34.920 | and put together a 40-page brochure.

00:12:37.740 | And then I said, what we really need is a book.

00:12:40.040 | And I had no intention of writing one.

00:12:43.000 | So I went and looked in the libraries and bookstores

00:12:46.400 | when there actually were bookstores.

00:12:49.000 | Well, there's still bookstores.

00:12:50.360 | You have to-- there are still bookstores out there.

00:12:52.680 | Yeah, there are a few, not many.

00:12:54.520 | I think we have one left in St. Louis, one major one.

00:12:58.000 | But at any rate, the only good book

00:13:02.440 | I thought out there at that time was "Random Walk Down

00:13:07.040 | Wall Street."

00:13:07.880 | And all it did really, although it was a great book,

00:13:10.680 | it told you the markets were pretty efficient

00:13:13.600 | and you should act as if they were.

00:13:15.840 | But it didn't really tell you what

00:13:17.240 | to do with it in the way, like, your book all about index funds

00:13:21.840 | did, or my book, or others like John Bogle's book.

00:13:27.000 | So I said, all right, I've got a 40-page outline.

00:13:30.320 | Let's see if I can put a book together.

00:13:32.680 | So I spent the next two years writing a book.

00:13:36.600 | And when I completed it, we got a publisher who liked it

00:13:41.760 | and decided to publish it.

00:13:43.240 | But the interesting story there was

00:13:45.480 | he hated my title, which was "What Wall Street Doesn't Want

00:13:49.440 | You to Know."

00:13:50.480 | So he said, Larry, go back and give me some other options.

00:13:53.760 | And I went to a bookstore and came up with, like, 15.

00:13:57.000 | He didn't really like any of them.

00:13:58.360 | And he pulled some things together.

00:14:00.680 | And he came up with the title, "The Only Guide You'll Ever

00:14:05.120 | Need to a Winning Investment Strategy."

00:14:07.600 | Now, the funny thing about that is, two years later,

00:14:11.960 | I wrote my second book.

00:14:13.600 | And I really liked that first title, "What Wall Street

00:14:16.480 | Doesn't Want You to Know."

00:14:18.120 | And I was obligated to show it to him,

00:14:21.640 | the writer of "First Refusal."

00:14:23.680 | And he read it and said, Larry, this is great.

00:14:25.660 | I love that title.

00:14:28.440 | Same guy who had rejected it two years earlier.

00:14:32.080 | Editors are strange people.

00:14:35.040 | I remember when I first saw that book,

00:14:36.660 | I can't remember where it was.

00:14:38.000 | It might have been at one of those bookstores that

00:14:40.080 | don't exist anymore.

00:14:41.440 | And I looked at the title.

00:14:42.600 | I said, oh, what is this?

00:14:46.560 | Whatever it was, "The Only Investment Guide You'll Ever

00:14:48.880 | Need."

00:14:49.380 | I looked at that and go, what the heck is this nonsense?

00:14:52.760 | But actually--

00:14:53.360 | That wasn't my choice.

00:14:54.960 | I started reading it.

00:14:55.840 | And I realized what it was.

00:14:56.960 | And I said, actually, this is pretty good.

00:14:58.920 | You've done really well.

00:14:59.920 | In fact, that book, if I'm not mistaken,

00:15:01.680 | has--

00:15:02.480 | you've done a couple of editions now, correct?

00:15:04.840 | I did one edition to that seven years later in 2005,

00:15:10.760 | updated that, and now I've written a total of 17 books,

00:15:16.040 | which four are originals and three of them are updates.

00:15:21.600 | I wrote in 2001, I think it was, "Irrational Investing

00:15:27.600 | in Irrational Times," which covered 52 investment

00:15:30.880 | mistakes.

00:15:31.480 | I thought people made.

00:15:33.840 | Several years later, I updated it and had 77 mistakes.

00:15:39.040 | That book was "Investment Mistakes Even Smart People

00:15:42.220 | Make."

00:15:43.000 | And then in 2000, I think, '15, I

00:15:46.200 | wrote "Reducing the Risk of Black Swans."

00:15:49.360 | In '18, we updated that.

00:15:52.080 | One of the books that I like--

00:15:54.280 | in fact, I think it's a great title--

00:15:55.720 | is "The Incredible Shrinking Alpha."

00:15:58.120 | And I've always been kind of fascinated with--

00:16:01.400 | could you talk about that and what's going on out there?

00:16:04.160 | The book itself is a nice little short book.

00:16:06.560 | I got that idea from Bill Bernstein

00:16:09.720 | to write these little short books that

00:16:11.720 | are really narrowly focused.

00:16:14.480 | So even a slow reader might read it in maybe three hours.

00:16:18.520 | So the idea is there are four big themes that

00:16:21.020 | are happening that are making it harder and harder

00:16:24.360 | for active managers to win.

00:16:26.840 | The first is that academics, simply really

00:16:31.120 | by studying the great active managers

00:16:35.800 | and seeing how they beat the market, could they identify,

00:16:41.880 | was it a unique skill that you can't replicate?

00:16:45.400 | Or are they buying certain types of stocks

00:16:48.120 | with certain traits or characteristics?

00:16:51.440 | And of course, as you well know, Thamer and French

00:16:55.040 | summarized a lot of other people's research.

00:16:57.960 | They didn't discover any of these factors

00:17:00.760 | themselves at all.

00:17:02.280 | But size and value--

00:17:04.880 | so prior to the publication of the cross-section of expected

00:17:09.080 | stock returns in '92, you could simply say,

00:17:12.680 | I'm beating the market.

00:17:14.160 | I'm generating alpha.

00:17:15.960 | And therefore, get away with charging high fees,

00:17:18.720 | because alpha is a very scarce resource.

00:17:21.760 | But after-- you could do it simply

00:17:23.960 | by tilting your portfolio to owning more small and value

00:17:28.960 | stocks in the market.

00:17:30.480 | You could claim out performance, and you'd be right.

00:17:33.640 | But after the publication of that paper

00:17:36.440 | and then index funds became available in these asset

00:17:41.120 | classes or giving you exposure to these factors,

00:17:44.640 | you can't claim out for any more.

00:17:46.440 | Either regression analysis or attributional analysis

00:17:50.600 | will show the alpha was nothing more than due to exposure

00:17:54.680 | to these factors.

00:17:56.400 | And then along comes Mark Carhart, '97.

00:18:01.320 | He adds a fourth factor, momentum.

00:18:04.640 | And so once again, alpha gets converted into beta.

00:18:08.520 | And then really in 2012, Robert Novy-Marks

00:18:13.360 | adds profitability, which gets expanded into quality.

00:18:17.560 | And what's important is these conversion of alpha into beta

00:18:23.000 | doesn't take anything away from all those great investors

00:18:27.000 | like the people from Graham and Doddsville

00:18:29.680 | who are buying value stocks that were highly

00:18:32.640 | profitable or quality, because they've

00:18:35.720 | discovered this 50 or 60 years before the academics.

00:18:39.560 | But if now we can replicate that and invest

00:18:43.320 | in exactly the same types of stocks,

00:18:46.560 | and there are two good studies showing that Warren Buffett's

00:18:50.640 | almost all, but not all, of his stock picking advantages.

00:18:56.760 | So not counting the benefits from the leverage

00:18:59.600 | he gets from his insurance company

00:19:01.840 | or not counting the benefit he gets

00:19:04.280 | from being able to give Goldman Sachs $10 billion

00:19:07.200 | at a much lower price than Goldman could have raised it

00:19:12.440 | if they had 30 days to go get the capital.

00:19:15.200 | But just looking at the public securities that he owned,

00:19:18.960 | most of it goes away if you simply

00:19:21.680 | bought an index of stocks that look like--

00:19:25.440 | meaning they have the same traits and characteristics.

00:19:28.760 | So that's the first thing.

00:19:29.920 | Today, every investor can invest in very similar manners.

00:19:35.360 | So alpha got converted to beta, which is nothing more

00:19:39.200 | than exposure to factors.

00:19:41.280 | So that's the first thing.

00:19:43.200 | Oh, we're still on the first one.

00:19:44.720 | You have three others?

00:19:45.960 | I got three out there real quick.

00:19:48.520 | We don't have like a day and a half.

00:19:50.280 | Yeah, I know.

00:19:51.000 | The others are real quick.

00:19:53.880 | Maybe you could sum her up a little.

00:19:56.120 | OK, so turn to the second one, which

00:19:58.480 | is in order to beat the market, you

00:20:00.280 | have to have victims to exploit.

00:20:02.400 | 70 years ago, 90% of all individual stocks

00:20:06.040 | were held directly by individuals

00:20:09.160 | in their brokerage accounts.

00:20:10.800 | Today, that may be closer to 10%.

00:20:14.120 | 90% plus of trading is done by big institutions.

00:20:18.000 | You just don't have those dumb retail investors

00:20:21.640 | who buy stocks that go on to underperform

00:20:25.080 | and sell stocks that go on to outperform,

00:20:27.840 | as the research shows.

00:20:29.880 | They're exploited by the more sophisticated

00:20:33.200 | institutional investors.

00:20:35.080 | But that pool of victims is shrinking dramatically.

00:20:39.080 | So today, when Goldman Sachs is trading,

00:20:41.720 | it's 90% chance it's SAC Capital or Renaissance Technology

00:20:47.240 | on the other side of the trade.

00:20:49.400 | The third thing is the quality of the competition

00:20:53.160 | has gone way up.

00:20:54.880 | When you and I got out of school, Rick,

00:20:57.600 | most of the people who were managing money, very few of them

00:21:01.080 | were world-class scientists with PhDs in finance,

00:21:05.080 | unaware of all this academic research.

00:21:08.040 | Today, everybody managing money is like a rocket scientist.

00:21:12.480 | DFA's CIO is an aeronautical engineer with a PhD.

00:21:18.480 | And Andy Berkin, my co-author of that incredible shrinking

00:21:22.440 | alpha, PhD in physics.

00:21:25.040 | So the competition is much tougher.

00:21:28.280 | And that makes it much harder to outperform those people.

00:21:32.240 | And the last thing is, 30 years ago or so,

00:21:35.600 | there was only about $300 billion in hedge funds

00:21:39.240 | out there chasing this limited amount of alpha, which

00:21:43.160 | is now a smaller pool and less victims to exploit.

00:21:47.160 | Today, we have 10 times that amount of money.

00:21:50.000 | So just not a lot of alpha to go around,

00:21:52.840 | and the pool is much bigger.

00:21:54.560 | So 20 years ago, when Charles Ellis wrote his famous book,

00:21:58.680 | Winning the Losers Game, about 20% of active managers

00:22:02.640 | were outperforming on a statistically significant

00:22:05.640 | basis.

00:22:06.520 | Today, several studies show that numbers less than 2%,

00:22:11.080 | and that's even before taxes.

00:22:13.480 | That's pretty lousy odds, which means passive investing

00:22:17.600 | is the winner's game.

00:22:19.360 | Well, I guess I know who that 1% is,

00:22:21.480 | because I hear it all the time, how they've outperformed.

00:22:23.840 | So anyway, yeah, I think the fifth one,

00:22:28.080 | if there's going to be a fifth one,

00:22:29.560 | is the speed at which information is disseminated now

00:22:33.000 | is just so much faster than it used to be.

00:22:35.240 | Yeah, no question that that's true as well.

00:22:37.560 | You could add that one, absolutely.

00:22:41.120 | Let's go ahead and then move on to the current book,

00:22:44.680 | the 17th book, which is Your Complete Guide

00:22:47.960 | to a Successful and Secure Retirement.

00:22:50.920 | And the forward is by Wade Pfau, good guy to write the forward.

00:22:55.960 | What motivated you to write this book?

00:22:58.720 | Well, I think the key here is that so many people, at least

00:23:03.800 | today, are at least beginning to focus on the need

00:23:06.640 | to have an investment plan.

00:23:08.600 | There are lots of good books on investment planning.

00:23:12.120 | You've yourself written several that really go a long way

00:23:16.400 | to helping people build an investment plan.

00:23:19.680 | But the key is that you can have the perfect investment plan,

00:23:25.840 | and it could blow up for reasons that have nothing

00:23:28.600 | to do with investing.

00:23:30.640 | You're a young man.

00:23:31.840 | You've got three kids, and you don't have enough life

00:23:34.960 | insurance.

00:23:35.560 | You die early.

00:23:36.880 | I don't care.

00:23:37.680 | Rick, you've got the perfect investment plan,

00:23:40.480 | but you don't live long enough to save and invest and watch

00:23:44.080 | it grow.

00:23:45.000 | You're a doctor, perform surgery,

00:23:47.080 | and you don't have a disability policy.

00:23:49.600 | And you're getting an accident, and you

00:23:52.320 | can't perform surgery anymore.

00:23:54.200 | You don't have an umbrella policy.

00:23:55.840 | You get in a car accident.

00:23:57.720 | You don't have long-term care, and you have dementia.

00:24:00.760 | There's all kinds of risks related to elder abuse.

00:24:04.080 | We even have a chapter on that.

00:24:06.240 | And there are so many ways that investors

00:24:08.800 | can make mistakes that lower their odds of success,

00:24:12.280 | like asset location, holding the right assets

00:24:16.400 | but in the wrong location, taking Social Security way

00:24:21.160 | too early, not using annuities where they are appropriate,

00:24:25.120 | and buying the right kind.

00:24:27.160 | So what I wanted to do was to create a book that

00:24:30.440 | looked at all of those things.

00:24:32.440 | And the first chapter is maybe the most important one,

00:24:35.600 | which is why we put it there, which

00:24:37.320 | has nothing to do with investing or other financial issues,

00:24:41.520 | but having a plan to have a meaningful and successful life

00:24:46.800 | in retirement.

00:24:48.200 | And that's so important.

00:24:49.840 | One, the highest suicide cohort in the United States,

00:24:54.360 | I would have guessed might be teenage girls.

00:24:56.720 | Unfortunately, I lost a sister at a very young age to that.

00:25:01.320 | But it's retired men, because they've

00:25:04.160 | lost the meaning and their purpose and sense

00:25:06.520 | of fulfillment and social connections, which

00:25:09.200 | they typically get at work.

00:25:11.520 | And the highest divorce cohort is

00:25:14.200 | what's called silver divorce.

00:25:16.320 | And my line about that is, well, I married you for better

00:25:19.120 | or worse, but not for lunch.

00:25:20.960 | And you have no plan to have a meaningful life.

00:25:24.040 | Did you come up with that?

00:25:25.120 | I married you for better or worse, but not for lunch?

00:25:27.640 | I don't know if I actually can take credit for that,

00:25:30.920 | but I steal it and use it all the time.

00:25:34.400 | Great.

00:25:35.040 | I'd like to add one more thing to your threat of elder

00:25:37.880 | financial abuse chapter.

00:25:39.720 | I wrote an article for Forbes about it.

00:25:42.640 | I called that article, "You May Never See Your Grandchildren

00:25:45.280 | Again," because I was invited to a local dinner

00:25:50.440 | seminar put on by a local advisor.

00:25:53.160 | I live in an over 55 community out here near Austin.

00:25:57.400 | And we just get hit with all of these dinner seminar things.

00:26:00.600 | Anyway, I decided to go to this one.

00:26:02.600 | There's no word of a lie.

00:26:03.640 | The advisor must have said three times,

00:26:06.360 | if you want to see your grandchildren again,

00:26:08.200 | talking to the woman in the audience,

00:26:10.560 | you want to come and see me, because I

00:26:13.080 | have had so many widows who didn't do it the right way

00:26:16.680 | when their husbands died.

00:26:18.960 | And by the time they came to see me,

00:26:20.560 | they didn't have any money, and they never

00:26:22.160 | got to see their grandchildren again after that.

00:26:24.240 | So if you ever want to see your grandchildren again,

00:26:26.440 | you need to come and talk with me.

00:26:27.800 | And the guy was a snake, because he

00:26:29.520 | was selling all kinds of high commission annuities

00:26:32.360 | and all this other stuff.

00:26:34.080 | I mean, he had a management fee that was something like 2%.

00:26:36.800 | He was a real snake.

00:26:37.720 | But this is what he was pitching to the people in this community.

00:26:42.400 | You know, we see that, unfortunately, all the time.

00:26:45.040 | Literally, you and I agree on lots of things,

00:26:48.640 | even though we've had some good debates about most of the stuff

00:26:52.280 | that's relatively minor.

00:26:54.000 | But this is a perfect one where I know we agree.

00:26:57.320 | I literally don't know how these people look themselves

00:27:00.320 | in the mirror when they get up in the morning

00:27:02.160 | and live with themselves.

00:27:04.080 | And unfortunately, it's not going to change.

00:27:07.080 | Tell me a few other highlights of the book,

00:27:09.840 | and then we're going to move on to some questions

00:27:11.920 | by the Bogleheads.

00:27:13.280 | Well, yeah, a couple of things I think are important.

00:27:17.080 | One, I think we really cover an incredibly broad spectrum.

00:27:20.680 | I don't believe there is any book that

00:27:23.120 | is as comprehensive as this.

00:27:25.440 | There are other good books on estate planning or investing,

00:27:28.760 | but none is comprehensive.

00:27:30.680 | Second thing I want to highlight is

00:27:32.520 | the book is filled with lists and checklists,

00:27:35.440 | action items for people to do.

00:27:37.520 | So I believe literally everyone who

00:27:39.760 | reads the book will walk away with some things

00:27:42.520 | that they can focus on.

00:27:44.760 | And I'll just touch on in the introduction,

00:27:47.120 | we talk about what I call the four horsemen of the retirement

00:27:51.280 | apocalypse.

00:27:52.240 | And I can take credit for that term.

00:27:55.560 | And the four horsemen here that are creating real threats

00:27:58.760 | to successful retirements are first equity valuations,

00:28:03.480 | at least in the US, are much higher

00:28:06.840 | than they have been historically.

00:28:09.720 | And bond yields are much lower.

00:28:12.560 | And unfortunately, so many people look at the past

00:28:16.120 | and automatically project them in the future.

00:28:18.840 | I meant to that.

00:28:19.600 | I tell you, the--

00:28:21.240 | and they're related, too.

00:28:22.280 | I mean, the high equity valuations that we have

00:28:25.200 | is related to the low bond yield.

00:28:27.360 | Yeah, exactly.

00:28:28.440 | The Fed, unfortunately, pushed a lot of people

00:28:30.880 | to take more risk because they can't live on that 2% bond

00:28:34.920 | yield.

00:28:35.600 | But here's an amazing stat.

00:28:37.760 | From 1982 through now, a typical 60/40 S&P 500

00:28:43.960 | intermediate treasury portfolio has earned 10%.

00:28:48.280 | Amazing.

00:28:48.780 | Most financial economists today would put that number maybe

00:28:52.720 | in the area of 5.

00:28:55.320 | I put it at like 4 and 1/2.

00:28:56.960 | Well, I won't disagree.

00:28:59.080 | And that's a real problem.

00:29:02.280 | If you're counting on 10 or anything near there,

00:29:05.640 | your plan is likely to blow up.

00:29:07.760 | So those are the first two horsemen.

00:29:10.640 | The third is we're now living much longer.

00:29:13.640 | When I was growing up, even as a teenager,

00:29:16.640 | I almost knew nobody who was 75 years old.

00:29:20.440 | And today, 65-year-old couple second to die

00:29:24.400 | is almost 25 years.

00:29:26.920 | And that means half the time, someone's going to live longer.

00:29:30.000 | So you really need to plan for at least 30 years, not 10

00:29:34.200 | or 15.

00:29:35.360 | So you got higher valuations, lower bond yields,

00:29:39.440 | lower expected returns, and the money

00:29:41.800 | has to last a lot longer.

00:29:44.080 | Fourth thing is the good news, of course, we're living longer.

00:29:48.120 | The bad news is the longer you live,

00:29:50.480 | the increased risk of dementia and long-term care

00:29:54.200 | needs, which could be very expensive.

00:29:56.640 | And that's where the risk to many people are.

00:30:00.200 | So that's got to be dealt with.

00:30:01.840 | We do have a chapter on long-term care,

00:30:04.840 | as well as annuities to help deal with that.

00:30:07.760 | And there is even a fifth horseman,

00:30:09.880 | which I mentioned, which is the risk of Social Security.

00:30:13.480 | If Congress doesn't act, and this

00:30:15.640 | looks like another do-nothing Congress,

00:30:18.280 | the estimate is in about 13 years,

00:30:20.440 | they'll only be able to pay out about 70%.

00:30:23.320 | It's not going bankrupt.

00:30:25.560 | So my advice is being conservative.

00:30:28.120 | Starting in 2032 or so, you should only

00:30:31.680 | plan on getting 70% of Social Security benefits.

00:30:36.000 | But then I remember that you and I, when we were growing up--

00:30:38.880 | I say we were growing up-- when we were 30 or 40 years old,

00:30:42.040 | I think we were saying we weren't

00:30:43.100 | going to get anything either.

00:30:44.300 | But we're going to get something.

00:30:46.000 | The question is, you may not get as much as you

00:30:47.640 | thought you were going to get.

00:30:48.920 | Exactly.

00:30:50.960 | And there are simple solutions here.

00:30:54.800 | Raise the amount of income that's taxed.

00:30:57.520 | You can raise the rate slightly.

00:31:00.600 | Those are two simple solutions that they could do.

00:31:06.680 | And then, of course, you can raise the age

00:31:09.360 | that you're retired.

00:31:10.880 | You can't expect to get 30 years of payments.

00:31:13.360 | It was designed maybe when people live 5 to 10 years.

00:31:17.320 | And so you're living longer, and people are working longer.

00:31:20.800 | Most of my friends are working till 68, 70, 72 now.

00:31:27.160 | They don't want to retire to, quote, "nothing," right?

00:31:31.640 | Well, I agree.

00:31:32.440 | In fact, this is my encore career

00:31:34.800 | doing what I'm doing now.

00:31:35.880 | As you know, I sold my company a couple of years ago.

00:31:38.960 | And now I'm just doing consulting

00:31:40.840 | and doing hourly advising.

00:31:43.880 | And it's an encore career.

00:31:45.280 | But I admit, I like the idea of continuing

00:31:47.940 | to get paid enough money so that I can pay all of my bills

00:31:51.040 | and travel and such and not have to touch my savings.

00:31:54.320 | The encore career is a good idea,

00:31:57.440 | and a lot of people are probably going to do that if they can.

00:32:00.280 | Yeah, and I would add one other thing on top

00:32:02.800 | of the points you made, which are critical,

00:32:05.160 | is it gives you that social connection.

00:32:07.800 | You stay engaged.

00:32:09.240 | And I'm sure you're just like me.

00:32:11.680 | You get great psychological joy out

00:32:14.800 | of helping people knowing you're increasing

00:32:17.680 | their odds of being them able to achieve

00:32:20.080 | their life and financial goals by putting them

00:32:22.720 | on the right path.

00:32:24.640 | Well, it's interesting from where we sit,

00:32:26.320 | because we get to pair into people's lives

00:32:28.880 | like most people can't.

00:32:31.600 | There's an old joke that if you really

00:32:33.240 | want to get to know someone, you either marry them

00:32:35.620 | or manage their money.

00:32:37.400 | And it's true.

00:32:39.120 | I mean, I'm talking with three or four people a day

00:32:43.560 | and really getting to know all about them

00:32:46.720 | and all about their finances and all

00:32:48.160 | about how they're planning things.

00:32:49.480 | And one thing you brought up, and I want to reiterate it,

00:32:51.920 | is this idea of disability insurance.

00:32:53.520 | I see a real, real lack of disability insurance

00:32:58.440 | out there, particularly among physicians

00:33:01.840 | and among people who are high wage earners.

00:33:04.280 | For some reason, it sort of passed them by.

00:33:06.880 | And I asked them, do you have disability?

00:33:09.160 | And they're making $500,000 a year.

00:33:12.240 | And they say, well, I think I've got a policy.

00:33:14.120 | I think I've got a policy.

00:33:15.480 | And I asked them, well, what would you make?

00:33:17.320 | And it turns out that somebody who's making $500,000 a year

00:33:20.920 | and has $300,000 a year in bills because they bought a new house

00:33:24.080 | and they want to send their kids to college

00:33:25.880 | and this and that and the other, if they became disabled

00:33:28.480 | and they couldn't work, they would be making about $100,000

00:33:31.320 | a year.

00:33:32.440 | That's a problem.

00:33:33.600 | Yeah, and it's a Pascal's wager bet, right?

00:33:37.560 | It's one of those things.

00:33:39.200 | It doesn't matter what you think the odds of your being

00:33:42.280 | disabled are, you're likely not willing to live

00:33:45.600 | with the consequences of being disabled

00:33:48.080 | without disability insurance.

00:33:50.360 | And I would add the other thing I

00:33:52.160 | would imagine you also look at, one of the first questions

00:33:55.880 | I ask somebody, because it's the cheapest insurance there is,

00:33:59.760 | and everybody should have it, is an umbrella policy.

00:34:03.720 | You can get a million bucks for something, I think,

00:34:05.760 | in the $300 to $400 range.

00:34:08.400 | And you should have at least as much, I think,

00:34:11.480 | as your financial assets, and maybe even most people up

00:34:15.480 | to about $10 million, because the lawsuits today

00:34:18.520 | are paying out such large amounts on claims.

00:34:22.840 | I personally carry a $10 million umbrella policy.

00:34:26.720 | Mine isn't quite that large, Larry,

00:34:28.180 | but I haven't written 17 books.

00:34:31.600 | Well, you and I know, you don't get rich writing books.

00:34:36.440 | I've got to move into the next area of our interview.

00:34:41.120 | You're very popular with the Boglehead community.

00:34:44.120 | I've always been for 20 years.

00:34:45.520 | Well, hopefully, we're going to get you out to a conference

00:34:47.980 | in one of these days.

00:34:49.080 | When your name comes up, and you're

00:34:50.640 | active on the Boglehead site, and a lot of people

00:34:54.640 | have read your books.

00:34:55.480 | And so when I went on the Boglehead,

00:34:58.060 | and I announced that I was going to be interviewing you,

00:35:02.240 | I got literally dozens and dozens and dozens of questions

00:35:06.440 | that people wanted to ask.

00:35:08.160 | So I have a printout here of several pages long of questions.

00:35:14.300 | Now, we're not going to be able to get to every question,

00:35:16.720 | but I want to get to as many as we can.

00:35:20.120 | So here we go with the first question.

00:35:23.600 | A Boglehead asked, what your thoughts are on the new Vanguard

00:35:29.360 | factor funds, and particularly the Vanguard multi-factor

00:35:33.920 | funds?

00:35:35.640 | These came out a little later on,

00:35:38.520 | and they don't seem to be publicized that much

00:35:40.600 | by Vanguard.

00:35:42.520 | But do you think that the way they're doing it

00:35:45.000 | is adequate?

00:35:48.080 | Well, I think a short answer would be this.

00:35:50.880 | Number one, virtually anything Vanguard does

00:35:54.960 | is likely to be done very well.

00:35:57.960 | One, highly ethical people.

00:36:00.520 | And number two, they do have good researchers there.

00:36:04.480 | Their funds, we did take a look at them, so I can comment.

00:36:08.040 | They're well-designed, and they're cheap.

00:36:11.480 | So those are all Vanguard traits, if you will.

00:36:15.640 | So somebody looking to add a little bit

00:36:17.960 | of further diversification in their portfolios

00:36:21.040 | away from a market-like portfolio,

00:36:23.920 | this is certainly worth looking into.

00:36:27.080 | The only negative, if you want to call it that,

00:36:30.060 | is they tend to have very low exposures

00:36:33.920 | to each of the factors.

00:36:35.400 | They're not a deep exposure to them.

00:36:38.840 | So one of the things you have to be careful about,

00:36:43.040 | people often, especially bogleheads,

00:36:45.320 | focus on expense ratios.

00:36:47.840 | I think the right way to focus on it

00:36:50.240 | is the expense ratio relative to the amount of exposure

00:36:55.040 | to these factors you're getting.

00:36:57.000 | So for argument's sake, just to make it simple,

00:36:59.600 | if you thought all of the factors

00:37:01.720 | would get you 2% a year, and you're

00:37:04.000 | getting 10% exposure to it, well, you're

00:37:06.960 | getting 20 basis points.

00:37:09.320 | And if you're paying 8% for it, and their implementation costs,

00:37:14.280 | you're probably not getting very much of any benefit.

00:37:17.080 | On the other hand, if you paid 20% for 30%, you're way ahead.

00:37:22.920 | Yeah, I call what you just talked about the cost

00:37:26.320 | per unit of risk.

00:37:28.800 | You could pay a lot of money for a small-cap value fund that

00:37:31.840 | basically has mostly beta and doesn't have much small cap

00:37:34.680 | and not much value.

00:37:37.000 | Exactly.

00:37:38.800 | You have to look at that.

00:37:40.000 | I'll give one very brief example.

00:37:43.080 | We used to use DFA Small Value Fund.

00:37:45.920 | We switched in 2011 to Bridgeway because it was much smaller

00:37:49.800 | and deeper value.

00:37:51.200 | It was 8 basis points more, but the market cap

00:37:54.720 | was half the size of DFA.

00:37:58.400 | And the price-to-book and earnings and cash flow

00:38:01.560 | were much lower.

00:38:02.760 | We estimated if the factors delivered what we expected,

00:38:08.480 | it would outperform by about 60 basis points.

00:38:11.360 | We were willing to pay 8 to get 60.

00:38:14.400 | I have a couple of people who asked about risk parity.

00:38:18.680 | So I'll let you go ahead and explain quickly

00:38:21.440 | what risk parity is, and you can give your opinion.

00:38:24.760 | Right.

00:38:25.240 | So here's the basic concept of risk parity

00:38:29.520 | or why people should at least be thinking about it.

00:38:32.880 | So a typical 60/40 portfolio, when

00:38:35.760 | I ask people if you have $1 million, $600,000 in stocks,

00:38:40.240 | and $400,000 in bonds, how much of your risk--

00:38:43.880 | not money, but risk-- is in stocks, they'll say 60%.

00:38:48.480 | But that's not true because stocks

00:38:50.760 | are so much more riskier than, say, a five-year treasury.

00:38:55.080 | They're about four times as volatile.

00:38:58.160 | So about 85% of your risk in that portfolio

00:39:03.160 | is in your equities.

00:39:05.120 | If you believe that, as you and I, I think,

00:39:08.120 | can agree, that markets are pretty highly efficient,

00:39:11.200 | then you should also believe it has to follow

00:39:14.320 | that all risky assets have very similar risk-adjusted returns.

00:39:20.160 | So small caps are riskier than large caps,

00:39:23.560 | so they should have higher expected returns.

00:39:26.160 | It doesn't make them a better investment.

00:39:28.120 | It means they're riskier.

00:39:29.520 | And once you adjust for the risk,

00:39:31.480 | their risk-adjusted return should be similar.

00:39:34.880 | Risk-adjusted returns are not just the Sharpe ratio.

00:39:38.160 | You have to think about liquidity and trading costs,

00:39:42.200 | et cetera.

00:39:43.120 | But that's the idea.

00:39:45.240 | So risk parity, the idea is to diversify

00:39:48.800 | across as many unique sources of risk

00:39:52.000 | as you can identify that provide premiums that

00:39:55.880 | have evidence, using my terms from my factor book,

00:39:59.280 | that they're persistent over very long periods of time.

00:40:04.040 | They're pervasive all over the globe.

00:40:06.480 | They're robust to various definitions,

00:40:08.840 | so you don't have likely data mining.

00:40:11.600 | So for value, PE, cash flow, EBITDA, all work.

00:40:16.000 | Momentum, you can have different formation and holding periods.

00:40:19.280 | They work.

00:40:20.120 | Has to survive transactions costs,

00:40:22.440 | meaning it's implementable.

00:40:24.320 | You don't want a 5% premium in micro caps.

00:40:27.160 | And of course, you're 6% to capture it.

00:40:30.000 | And lastly, it has to have intuitive reasons for you

00:40:32.640 | to believe it will likely persist.

00:40:35.520 | The idea of risk parity, then, is

00:40:38.240 | to put equal amounts of money in every one of the assets

00:40:43.040 | that you could identify, so you end up

00:40:46.160 | having an equal amount of risk.

00:40:48.240 | So that's the concept.

00:40:49.880 | Directionally, that makes perfect sense and logic.

00:40:54.160 | I would say, however, I don't have the same degree

00:40:57.520 | of confidence in all of these factors or asset classes.

00:41:03.120 | So I want to put more of my weight in my portfolio

00:41:07.640 | on things I have the most confidence in.

00:41:09.800 | Those are things that are risk-based solutions, things

00:41:14.440 | like small in value, where momentum is purely behavioral.

00:41:19.920 | So I don't want to ignore it because it

00:41:22.240 | has a lot of evidence that meet that criteria.

00:41:26.160 | So I just try to eliminate negative momentum,

00:41:28.680 | as an example.

00:41:29.800 | And then I invest in other assets,

00:41:31.760 | like reinsurance, quality, profitability, et cetera,

00:41:37.160 | putting more weight on the ones I have the most confidence in

00:41:40.760 | and less weight in the others.

00:41:42.640 | So each person should decide how much confidence

00:41:46.280 | do they have in each one, and then diversify.

00:41:49.560 | Logically, bottom line is risk parity is a good general idea.

00:41:55.160 | But I think it's not the right answer.

00:41:58.240 | You should not be looking to have

00:41:59.720 | exactly the same amount of risk in each of your assets.

00:42:03.840 | You should put more weight on the ones

00:42:05.760 | you personally have the most confidence in that

00:42:09.080 | will deliver above-market returns

00:42:12.160 | or have unique risks that are rewarding.

00:42:15.520 | Talking about risk, one of the Bogleheads

00:42:18.960 | asks, isn't a simple portfolio of a few index funds

00:42:24.080 | still the best way for the general public

00:42:26.520 | to grab their fair share of market return

00:42:29.000 | without breaking the bank on expenses?

00:42:31.480 | And if not, what can the general public

00:42:34.840 | do to try to take advantage of some of your ideas?

00:42:40.240 | First of all, I think you and I certainly

00:42:43.360 | can agree that a simple two-fund portfolio of a total US

00:42:49.440 | and a total international to the global market cap, which today

00:42:53.760 | is actually roughly 50/50, you want to tilt a little bit

00:42:57.480 | or, as Cliff Asness would say, sin a little bit.

00:43:01.040 | So you want to have a little more US

00:43:02.840 | or a little more international.

00:43:04.320 | That's fine.

00:43:05.440 | And that's a very low-cost, tax-efficient way to do it.

00:43:09.760 | The problem is you have all of your risk

00:43:11.760 | then in market beta, where correlations go very high,

00:43:15.800 | especially in crises.

00:43:17.680 | But even not in crises, you can go through very long periods.

00:43:21.480 | We happen to be one now.

00:43:22.840 | For the last 10 years, US small value

00:43:25.560 | has performed relatively poorly.

00:43:27.840 | From '66 to '82, on the other hand,

00:43:31.000 | a total US market fund would have underperformed

00:43:33.960 | totally riskless one-month Treasury bills for 17 years

00:43:38.360 | and underperformed small value by over 1,000%.

00:43:42.480 | To me, the right answer is you want

00:43:45.480 | to be low-cost, tax-efficient, and give yourself

00:43:50.760 | the chance to stay disciplined.

00:43:52.920 | And the right portfolio is the one

00:43:55.600 | that you are most likely to stay disciplined.

00:43:59.000 | So no matter what you invest in, whether it's

00:44:02.760 | total stock market funds, there are

00:44:04.920 | three periods where US total market has underperformed

00:44:09.120 | totally riskless T-bills for at least 13 years.

00:44:12.360 | That's cumulative 45 of the last 90 years.

00:44:16.920 | Obviously, in the other 45 years,

00:44:19.200 | it dramatically outperformed.

00:44:21.680 | We don't know which period you're going to get.

00:44:23.960 | Maybe the next 15 years, and you retire tomorrow,

00:44:27.840 | is one of those where US market beta does poorly.

00:44:32.000 | So to me, if you are able to deal with this tracking

00:44:36.080 | variance issue, that once you diversify,

00:44:39.160 | you know you're not going to look like the market,

00:44:42.400 | and you have to live with that.

00:44:45.280 | If you can't do that, well, then you

00:44:47.640 | shouldn't tilt into smaller value or own reinsurance

00:44:52.200 | or anything else.

00:44:53.440 | Because every risk asset guaranteed

00:44:56.680 | will go through long periods of underperformance.

00:44:59.680 | There is no such asset that doesn't.

00:45:02.400 | And that has to be the case, or there

00:45:04.760 | would be no risk for the long-term investor.

00:45:07.640 | On the other hand, if you do diversify--

00:45:10.400 | and diversification is difficult,

00:45:12.440 | because you're always going to own some things that

00:45:14.720 | are doing poorly, which is why so few people are good at it--

00:45:19.040 | then you increase your odds of getting

00:45:22.520 | a return that's expected.

00:45:24.400 | You're narrowing the dispersion of your outcomes,

00:45:27.640 | because you won't own all of the best,

00:45:30.360 | and you won't own all of the worst, if you will.

00:45:33.160 | And that actually goes a long way

00:45:35.240 | to giving you a better chance of getting

00:45:37.680 | the mean return expected out of a potential dispersion.

00:45:41.960 | When you run money Carlo analysis,

00:45:44.240 | diversified across asset classes or factors,

00:45:48.040 | unique sources of risk, will come up

00:45:50.600 | with much higher odds of success.

00:45:53.320 | But it doesn't do you any good if you can't stay disciplined.

00:45:56.440 | So don't do it if you're not going

00:45:58.600 | to be able to stay the course.

00:46:00.560 | And that means rebalancing along the way.

00:46:03.680 | I call it a lifelong investment strategy,

00:46:06.160 | because you really need to be in the thing lifelong.

00:46:08.840 | You've got to believe in it so strongly

00:46:11.640 | that you're willing to stick with it

00:46:13.680 | for the rest of your life.

00:46:14.920 | If you don't, odds are the time you jump out

00:46:18.240 | is going to be the worst time.

00:46:19.560 | And then looking backwards, you should have never

00:46:21.600 | done it to begin with.

00:46:22.520 | I completely agree.

00:46:23.880 | Exactly right.

00:46:25.000 | So let's get on to something that I

00:46:27.160 | think is really important right now.

00:46:29.280 | It's called recency bias.

00:46:31.160 | And somebody asks, do you think that investors

00:46:34.120 | are suffering from recency bias with the stock market going up

00:46:38.760 | over the last 10 years?

00:46:40.760 | Well, we know recency bias is prevalent to all investors,

00:46:47.640 | not just individuals.

00:46:49.920 | We spend more of our time managing people

00:46:53.280 | than we do managing money.

00:46:55.080 | Whatever is done well recently, they want to buy.

00:46:58.440 | I remember-- well, today, everyone,

00:47:01.320 | why we own international emerging markets

00:47:04.080 | are a small value.

00:47:05.640 | If you just go back to 2007 at the end of that year period,

00:47:11.400 | the prior five years, S&P had a great period.

00:47:16.720 | It was up 82%.

00:47:18.560 | EFI was up 162, call it double.

00:47:22.440 | And the DFA Emerging Market Fund was up 565%.

00:47:26.960 | And money was flowing in like crazy,

00:47:29.480 | as I'm sure you remember, into emerging markets.

00:47:32.080 | I do.

00:47:32.600 | It was all the rage.

00:47:34.040 | Yep.

00:47:34.520 | And then, of course, the reverse happens and then floods out.

00:47:38.440 | So the problem is people only buy after the good returns,

00:47:42.640 | and they panic and sell.

00:47:44.360 | So they hurt themselves.

00:47:45.680 | The best thing, as you said, and I completely agree,

00:47:48.760 | you've got to have this kind of lifelong approach.

00:47:52.360 | And you've got to stick with it.

00:47:54.640 | Now people are fleeing emerging markets.

00:47:57.360 | They're fleeing small value.

00:47:59.400 | And by the way, I'll point out one of the techniques

00:48:02.680 | I use when I talk to people.

00:48:04.640 | I point out value went through exactly the same period, even

00:48:08.120 | much worse performance, just not as long, in the late '90s.

00:48:12.520 | And Buffett, in many cases, is being ridiculed in the media

00:48:16.280 | as the time has passed him by.

00:48:19.400 | In the new dot-com era, you got to own Intel and all

00:48:23.640 | of these kinds of companies.

00:48:26.120 | But it is the same thing that happened in parts of the '80s

00:48:29.160 | when digital equipment and those stocks were there.

00:48:32.200 | And we're seeing now the same thing.

00:48:34.800 | Buffett didn't give up on value in the '90s.

00:48:38.000 | And then the next eight years were the biggest value premium

00:48:40.840 | ever by far.

00:48:42.360 | And right now, value relative to growth valuations

00:48:46.680 | are pretty much almost exactly where they were in '99.

00:48:50.680 | Now I'm not making any prediction.

00:48:53.480 | My crystal ball is cloudy.

00:48:55.200 | But valuations look really stretched.

00:48:59.800 | And value looks really cheap.

00:49:01.720 | And I ask people, what do you know that Warren Buffett

00:49:04.040 | doesn't know?

00:49:04.600 | He's not giving up on cheap value stocks.

00:49:08.360 | Why should you?

00:49:09.680 | It doesn't matter.

00:49:10.440 | Some people you can't protect from themselves.

00:49:13.600 | Larry, question from a Boglehead having

00:49:15.400 | to do with the 4% rule.

00:49:17.600 | And I'm referring to the idea that it's

00:49:19.640 | safe to withdraw 4% of your portfolio.

00:49:22.560 | Is there now a 3% rule instead of the 4% rule?

00:49:26.560 | Here's the way I would answer that.

00:49:28.160 | First of all, I don't believe people

00:49:29.960 | should use that as anything more than a guideline, number one.

00:49:35.200 | But the 4% rule is based on the historical evidence

00:49:38.680 | when valuations, of course, were much lower

00:49:41.560 | and expected returns much higher.

00:49:44.080 | And bond yields were much higher,

00:49:46.200 | which meant yields were much higher.

00:49:48.240 | Today, if you ran a Monte Carlo simulation using

00:49:53.000 | the same type of life expectancy and withdrawal rates,

00:49:56.800 | but now just projecting returns based on today's valuations,

00:50:01.660 | you get a number closer to about 3.3% to be safe.

00:50:07.240 | I think withdrawal rates like 4% or 3%

00:50:09.480 | or whatever you're going to use are fine

00:50:11.160 | when you're in your 40s and you're still working

00:50:14.720 | and you're looking toward retiring

00:50:16.960 | in your 60s or mid-60s.

00:50:19.920 | And when you're projecting out how much rate of return

00:50:23.200 | you might get on your portfolio and how much money

00:50:25.680 | you need to accumulate to get to a certain point.

00:50:28.800 | And then from there, if you took 4% or 3%,

00:50:31.680 | how much would that give you?

00:50:33.000 | I think that's where the 3% or 4% safe withdrawal rate works.

00:50:37.080 | But in retirement, when you're actually

00:50:39.000 | getting ready to retire, the withdrawal rate

00:50:43.000 | is the amount of cash flow that the portfolio creates, to me.

00:50:47.640 | So we're looking at dividends and interest income.

00:50:50.920 | And what amount of dividend and interest income

00:50:54.640 | and what amount of Social Security are you getting?

00:50:56.880 | And how much cash flow are you getting in?

00:50:59.080 | This is your sustainable amount.

00:51:00.800 | This is the sustainable amount that you can get out

00:51:02.920 | of the portfolio.

00:51:04.000 | If you go more than that, then you

00:51:05.720 | start cutting into principal.

00:51:07.400 | Then it becomes not as sustainable.

00:51:09.560 | So I think that this 3% or 4% withdrawal rate

00:51:13.240 | is good for planning purposes, long-term, long-range planning

00:51:17.480 | purposes.

00:51:17.960 | But you actually get into retirement, as you said.

00:51:21.080 | It's sort of year by year.

00:51:22.920 | And you're budgeting.

00:51:24.040 | And what are you going to do?

00:51:25.520 | And I know you use Monte Carlo simulation.

00:51:28.040 | I don't particularly use that.

00:51:30.680 | But I think we all get to the same spot.

00:51:33.680 | When you're actually in it and you're actually

00:51:35.800 | taking money out of the portfolio,

00:51:38.560 | you've got cash flow coming in.

00:51:39.920 | And then you've got things that are

00:51:41.380 | occurring on a year-over-year basis that

00:51:43.080 | might need to be looked at as they occur.

00:51:47.200 | I'll just add quickly, Rick.

00:51:49.400 | One, I certainly agree with the first half

00:51:52.000 | of completely what you're saying.

00:51:53.640 | 3% or 4% reasonable for long-term planning.

00:51:57.240 | In retirement, the only thing I would add to what you said

00:52:02.080 | is not drawing any principle, I think,

00:52:06.120 | becomes way too conservative.

00:52:07.680 | Because we know we are not going to live forever.

00:52:10.200 | So you can certainly dip into some amount of principle.

00:52:13.760 | Unless you have that, I'm going to want to bequeath desire

00:52:17.480 | there.

00:52:18.120 | So we don't want people not to be able to enjoy their life

00:52:21.680 | and spend money.

00:52:22.520 | So you want to at least consider you

00:52:24.360 | can dip into that portfolio a little bit every year,

00:52:28.600 | and just depending upon how far you're along.

00:52:31.160 | Certainly, at age 90, someone maybe

00:52:35.000 | got a 10-more-year horizon or most,

00:52:37.360 | they should be able to take out a lot more than 4%

00:52:40.400 | of their portfolio, right?

00:52:42.000 | Absolutely.

00:52:42.560 | Just like exactly what the required minimum distributions

00:52:46.200 | are on a retirement account, for sure.

00:52:49.520 | Now, if you could only spend it at age 90,

00:52:51.500 | that would be better, right?

00:52:52.680 | Right.

00:52:53.180 | That's the question, yes.

00:52:55.200 | All right.

00:52:56.160 | Somebody is asking, what about if you're

00:52:58.920 | in a situation where you have nobody who can take care

00:53:02.920 | of your affairs in retirement?

00:53:05.200 | You're unable to handle your own affairs.

00:53:07.240 | You're unable to manage your own portfolio at some point.

00:53:10.600 | What do you suggest for a person or a couple who

00:53:13.240 | is in that situation where there's nobody who can actually

00:53:16.680 | come in and help them and take over for them?

00:53:19.640 | What suggestions do you have for those folks?

00:53:22.160 | Yeah, well, first, I'm going to broaden the question

00:53:24.760 | because I think it's going to be helpful for every Boglehead.

00:53:28.160 | Just in my own particular case, we're all living longer.

00:53:31.440 | The risks of the dementia go up.

00:53:33.080 | And as we age, we become more susceptible.

00:53:36.080 | The con artists are most likely to prey on the elderly.

00:53:39.640 | And they know women are more susceptible.

00:53:42.880 | So they are targeted.

00:53:44.440 | I have a whole chapter on the book there.

00:53:46.680 | But one of the things that I did personally

00:53:49.160 | in creating my estate documents, my wife

00:53:52.560 | has a right, which I have a reciprocal right.

00:53:55.280 | If she believes I'm in cognitive decline

00:53:59.560 | and are unable to make sound financial decisions,

00:54:03.080 | she can request that I have or require

00:54:07.000 | that I have a cognitive test.

00:54:09.640 | And if I can't pass it, then I am

00:54:11.520 | to be removed from power of attorney over bank accounts,

00:54:15.720 | financial matters, brokerage statements, everything

00:54:19.480 | to protect myself and the family.

00:54:22.360 | And of course, I have the right to the same thing.

00:54:25.240 | And that's right in my estate documents.

00:54:27.920 | And obviously, if you're alone, you

00:54:31.120 | want to have that situation where

00:54:33.560 | some trusted family member or friend or whoever it might be.

00:54:41.240 | And I would prefer it not be some corporation like a bank

00:54:44.640 | trust that creates all kinds of problems with family members

00:54:49.200 | having difficulty accessing funds at times.

00:54:52.240 | But if you don't have that, then some trusted advisor

00:54:57.200 | could play that role.

00:54:58.240 | We do that for a select few of our clients.

00:55:02.000 | But you need absolutely to have somebody

00:55:05.000 | who you trust, the most trusted person in your life.

00:55:08.960 | I'll just add one other comment.

00:55:10.440 | Sadly, the person most likely to rip off the elderly

00:55:14.760 | is some family member who might be in trouble,

00:55:17.200 | either drug abuse, their business went south,

00:55:20.360 | they got a divorce and got in trouble,

00:55:22.800 | and often will, sadly, rip off the parents.

00:55:27.160 | I've seen people who were financially in trouble

00:55:30.560 | just ruin their parents' fortune by taking over

00:55:35.520 | and by convincing the parents to give them

00:55:38.540 | control over the assets.

00:55:39.800 | And very soon thereafter, there were no assets left.

00:55:43.520 | I've seen that happen.

00:55:44.960 | It's really unfortunate because these are unpleasant things

00:55:48.280 | to think about and contemplate.

00:55:50.920 | And therefore, people delay and don't do it.

00:55:54.000 | So I'm going to urge all the bogleheads who

00:55:56.160 | don't have a disability policy, don't have an umbrella policy,

00:56:01.840 | and don't have this request to have an exam where you could

00:56:08.200 | pass a cognitive test, if you don't

00:56:10.440 | have those in your documents, go out and get them tomorrow.

00:56:14.920 | Here's a couple of questions about different asset classes.

00:56:17.560 | You could just answer these very quickly

00:56:19.220 | because I have here, there, and everywhere.

00:56:21.760 | So one of them is, what role does cash

00:56:23.880 | play in an investor portfolio?

00:56:27.400 | Almost none because today, you can stick with short-term bonds

00:56:32.320 | just as highly liquid.

00:56:33.800 | So other than money in a checking account,

00:56:36.480 | you typically don't need much cash.

00:56:38.960 | As long as it's in a short-term bond fund,

00:56:42.400 | your volatility is going to be 1% or 2%,

00:56:45.120 | depending upon how short it is.

00:56:48.320 | So you want to keep maybe a couple of months'

00:56:52.240 | expenses in cash.

00:56:53.520 | And beyond that, there's no need to have a lot of cash around.

00:56:59.320 | That's one of the most common mistakes I see,

00:57:01.600 | is people sit with lots of cash.

00:57:04.440 | And what about peer-to-peer lending?

00:57:07.760 | Something new that I haven't heard you talk a lot about,

00:57:10.280 | but I know it's in your portfolios.

00:57:12.080 | Right.

00:57:12.600 | So this is a natural.

00:57:14.200 | The banks have been disintermediated

00:57:16.480 | by fintech providers.

00:57:18.840 | Partly, Dodd-Frank opened the doors for them.

00:57:22.360 | The banks were short of capital.

00:57:24.960 | And today, you can get a replacement for a 22% credit

00:57:29.320 | card if you're a good credit in the 13% to 14% kind of range.

00:57:34.440 | And if your credit isn't quite as good,

00:57:36.920 | the rates go up from there.

00:57:39.040 | After expenses, we think a well-run fund

00:57:42.920 | should be able to generate 4% to 5%, again, above T-bills.

00:57:50.240 | And you're getting compensated for credit risk.

00:57:53.040 | So last question, Larry.

00:57:54.600 | What is the most recent version, or the most up-to-date version,

00:57:58.600 | of the Larry Portfolio?

00:58:02.120 | So the Larry Portfolio phrase was coined by The New York

00:58:06.480 | Times.

00:58:07.040 | And it only referred to basically the equity

00:58:10.680 | portion of the portfolio.

00:58:12.680 | So it was US small value, international small value,

00:58:17.240 | emerging market value.

00:58:19.240 | So it's all in the highest expected return assets.

00:58:24.080 | Now, you could use that Larry Portfolio in one of two ways.

00:58:27.960 | I have investors who are young, willing to live

00:58:32.120 | with the tracking variance.

00:58:33.840 | And they're 100% equities and 100% the Larry Portfolio,

00:58:39.400 | trying to earn that extra premium.

00:58:42.200 | On the other hand, you have people like me

00:58:44.000 | who have won the game already.

00:58:46.000 | And I'm trying to protect my wealth.

00:58:48.320 | I'm trying to create more of that risk parity portfolio.

00:58:51.680 | I don't want a lot of market beta exposure.

00:58:54.680 | But I'm trying to keep my expected returns up.

00:58:57.960 | The equities I'm holding have higher expected returns.

00:59:03.000 | That allows me to own less market beta and then

00:59:06.080 | more safe bonds.

00:59:08.120 | So my portfolio was roughly, at the time,

00:59:12.160 | was 30% public equities, 70% safe bonds.

00:59:17.480 | It's a little more diversified today,

00:59:19.920 | adding things like reinsurance and alternative lending.

00:59:23.760 | I also happen to own something called the Variance Risk

00:59:27.200 | Premium Fund, or All Asset Variance Risk Premium.

00:59:30.680 | It's also one of the most studied research,

00:59:33.640 | well-documented premiums in all of finance,

00:59:36.640 | which is the Variance Risk Premium.

00:59:38.400 | So you're selling volatility insurance.

00:59:41.280 | We think that, again, has a 4% to 5%

00:59:44.880 | above T-bill expected return.

00:59:47.680 | And I also own AQR's Alternative Style Premium Fund,

00:59:52.600 | which is a long-short portfolio of four different factors

00:59:57.520 | across four different asset classes.

01:00:00.240 | So moving more towards risk parity.

01:00:02.440 | But each one of them is a few percent of my portfolio,

01:00:06.600 | because I want most of my portfolio in that safer bonds.

01:00:11.480 | Well, Larry, it's been very great having you on here.

01:00:13.800 | And as always, every time we talk, we are 99% correlated

01:00:19.600 | and only 1% uncorrelated.

01:00:21.600 | Yeah, and people love to focus on the 1%

01:00:25.000 | because that creates the tension, right?

01:00:28.200 | Well, thank you so much for being a guest on the Bogle

01:00:30.440 | Heads-On Investing Show.

01:00:31.880 | Great to have you.

01:00:32.520 | And hopefully, we'll have you back again soon.

01:00:34.480 | Yeah, my pleasure, Rick.

01:00:35.680 | And you can let the Bogle Heads know,

01:00:37.280 | if we didn't get to any of the questions,

01:00:39.320 | they can always shoot me an email

01:00:41.040 | at elswedro@bamadvisor.com.

01:00:45.720 | Always happy to answer questions.

01:00:47.520 | All right, thank you, Larry.

01:00:49.080 | Take care.

01:00:50.440 | This concludes the 12th episode of Bogle Heads-On Investing.

01:00:54.840 | I'm your host, Rick Ferry.

01:00:57.160 | Join us each month to hear a new special guest.

01:01:00.440 | In the meantime, visit bogleheads.org

01:01:03.800 | and the Bogle Heads Wiki.

01:01:05.600 | Participate in the forum, and help others find the forum.

01:01:09.840 | Thanks for listening.

01:01:12.040 | [MUSIC PLAYING]

01:01:15.400 | [MUSIC FADES OUT]

01:01:18.760 | you

Bogleheads® on Investing Podcast 012 – Larry Swedroe, host Rick Ferri (audio only)

Chapters