Bogleheads® on Investing Podcast 063: William Bernstein on TIPS, asset allocation, four deep risks
00:00:00.000 | [MUSIC PLAYING]
00:00:10.320 | Welcome, everyone, to the 63rd edition
00:00:13.120 | of "Bogleheads on Investing."
00:00:15.640 | Today, we're welcoming back to the program Dr. Bill Bernstein.
00:00:20.080 | He has written four books on personal finance
00:00:22.760 | and four books on economic history.
00:00:24.920 | Today, we're going to be talking about his current views
00:00:28.000 | on the markets and the economy and speaking
00:00:30.440 | about his updated book, "The Four Pillars of Investing."
00:00:33.360 | [MUSIC PLAYING]
00:00:44.320 | Hi, everyone.
00:00:45.040 | My name is Rick Ferry, and I am the host
00:00:47.200 | of "Bogleheads on Investing."
00:00:49.200 | This episode, as with all episodes,
00:00:51.760 | is brought to you by the John C. Bogle Center
00:00:54.280 | for Financial Literacy, a nonprofit organization that
00:00:57.880 | is building a world of well-informed, capable,
00:01:00.760 | and empowered investors.
00:01:02.440 | Visit the Bogle Center at boglecenter.net,
00:01:05.960 | where you will find a treasure trove of information,
00:01:08.760 | including transcripts of these podcasts.
00:01:11.800 | Before we get started today, I have a couple of items.
00:01:14.840 | First, I'd like to thank John Luskin for covering for me
00:01:18.400 | for five months as I went on a sabbatical up to Alaska.
00:01:23.040 | My wife and I dragged our camper from Texas for 20,000 miles
00:01:29.840 | all the way up through the US Rocky Mountains into Canada,
00:01:35.000 | through the Canadian Rockies, up to the Alcan Highway,
00:01:40.080 | to Dawson City in the Yukon, then across the Top of the World
00:01:46.640 | Highway over to a little town called Chicken, Alaska,
00:01:50.600 | and then spent two months touring around in Alaska,
00:01:54.000 | going everywhere where there were roads.
00:01:56.200 | And only about 1/4 of Alaska has roads.
00:02:00.200 | We made it all the way up to the Arctic Ocean
00:02:03.560 | and put our feet in the water, got to see the Alaska Pipeline.
00:02:08.560 | That went all the way up to Pudo Bay
00:02:10.840 | and stops at Dead Horse, which is
00:02:13.680 | where the oil facilities are.
00:02:15.920 | And I have to tell you that it is pristine up there.
00:02:18.520 | If you have this idea that somehow there's
00:02:20.880 | oil leaking all over the place, forget it.
00:02:23.600 | It is not true.
00:02:24.720 | The oil companies and the government
00:02:27.680 | and the Native Americans who own the land
00:02:30.040 | do an outstanding job of keeping the environment 100%.
00:02:36.240 | People have asked me, how was the trip?
00:02:38.760 | And the answer is, the beauty of this place
00:02:42.040 | is vast, the mountains, the forest, the tundra,
00:02:46.040 | snowfields, glaciers, thousands of waterfalls
00:02:50.040 | and thousands of square miles of wilderness
00:02:53.280 | where there are no roads and literally untouched.
00:02:56.600 | And it's not just Alaska.
00:02:57.760 | It's the Yukon Territory in Canada,
00:03:00.200 | Western British Columbia, and the Rocky Mountains in Alberta.
00:03:03.920 | It's just a beautiful part of the country,
00:03:06.040 | a beautiful part of the North American continent.
00:03:08.920 | Anytime you get an opportunity to go up there and take
00:03:11.320 | a look around, I definitely recommend it.
00:03:13.440 | And I also recommend going in the summertime
00:03:15.800 | because in the winter, it's 20 to 40 degrees below zero
00:03:20.040 | most of the time.
00:03:21.560 | We got back to my home in Texas at the end of September
00:03:25.800 | just in time for the annual Bogleheads Conference that
00:03:29.640 | was held in Bethesda, Maryland.
00:03:31.800 | And this was a huge success.
00:03:33.840 | It was the largest conference we've ever had.
00:03:36.160 | There were 510 attendees, 30 fantastic speakers.
00:03:40.560 | All of the speakers donated their time.
00:03:43.200 | No one was paid.
00:03:44.840 | Many people, including some speakers,
00:03:46.960 | bought tickets and donated them to people
00:03:50.040 | who otherwise would not have been able to attend.
00:03:53.600 | The committee chair this year, as was last year,
00:03:56.280 | was Christine Benz, who is also the current president
00:03:59.800 | of the Bogle Center.
00:04:01.280 | And she did a wonderful job.
00:04:03.280 | To name a few of the speakers, there
00:04:04.960 | was Howard Clark, Charlie Ellis, Jerry O'Reilly,
00:04:09.080 | Vanguard, who is responsible for managing about $4 trillion
00:04:13.880 | in equities, including the Vanguard Total Stock Market
00:04:16.640 | Index Fund, the largest mutual fund in the world,
00:04:19.520 | Washington Post columnist Michelle Singletary
00:04:21.960 | and her family, Jonathan Clements, and many others,
00:04:25.440 | including my podcast guest today, Bill Bernstein.
00:04:29.640 | All of these sessions were recorded.
00:04:32.440 | YouTube videos will be available soon on boglecenter.net.
00:04:37.560 | Next fall, around the same time, sometime in October,
00:04:40.880 | the date is yet to be announced, the conference
00:04:43.040 | will be held in Minneapolis, Minnesota,
00:04:45.720 | and I hope to see you all there.
00:04:48.040 | Our guest today is Dr. Bill Bernstein.
00:04:51.360 | Bill is not new to the Bogleheads or this podcast.
00:04:54.680 | He was a guest on this show about four years ago.
00:04:57.960 | And whenever John Bogle was around Bill,
00:05:00.680 | it would refer to him as the smartest guy in the room,
00:05:04.040 | and for good reason.
00:05:05.480 | Bill holds a PhD and an MD and has had a long career
00:05:10.160 | as a neurologist, now retired.
00:05:12.800 | When he was looking for the best way to invest his own money,
00:05:15.360 | he became disenchanted with the sales mentality
00:05:18.160 | of the financial industry and started a scientific quest
00:05:22.120 | into the markets and how they worked.
00:05:24.560 | That ultimately led Bill to low-cost indexing and Vanguard
00:05:29.400 | and co-founding an investment management firm called
00:05:32.640 | Efficient Frontier Advisors.
00:05:35.200 | Bill then began to write.
00:05:36.800 | First, he had a blog, and then he became a leading author.
00:05:39.520 | He's written eight books in total, four investment books,
00:05:42.880 | "The Intelligent Asset Allocator,"
00:05:44.800 | "The Four Pillars of Investing," now in its second edition,
00:05:48.080 | "The Investor's Manifesto," and "Rational Expectations."
00:05:51.800 | He's also written four economic history books,
00:05:54.560 | "The Birth of Plenty," "A Splendid Exchange,"
00:05:57.200 | "Masters of the Word," and "The Delusions of Crowds."
00:06:00.720 | I will also add that Bill has written several small,
00:06:04.440 | self-published books.
00:06:05.800 | Some of them are available for free on Amazon.
00:06:09.320 | He has also authored and co-authored
00:06:11.960 | numerous peer-reviewed articles for financial journals,
00:06:16.080 | and his work won him the prestigious James R. Verton
00:06:19.520 | Award from the CFA Institute in 2017.
00:06:23.240 | Today, we're going to talk about the past, the present,
00:06:26.320 | and what the future may hold.
00:06:29.280 | I remind listeners that the opinions given by Bill
00:06:32.440 | are his own.
00:06:33.600 | Each of us needs to look at our own goals
00:06:35.640 | and our own circumstances and determine
00:06:37.600 | which strategies and investments are right for us.
00:06:40.720 | With no further ado, let's welcome Bill Bernstein.
00:06:43.600 | Welcome to the podcast, Bill.
00:06:45.280 | I'm glad to be here, Rick.
00:06:47.280 | Thanks for everything you do for the Bogleheads.
00:06:49.240 | You were at the last conference.
00:06:50.720 | You were a big hit at the conference.
00:06:52.320 | You always are.
00:06:52.920 | You had a big, long line for people to sign your books.
00:06:56.040 | You've been going to the Bogleheads' conferences
00:06:58.040 | for many, many years.
00:07:00.160 | Jack Bogle attended almost every one.
00:07:02.560 | And the only one he couldn't attend,
00:07:04.680 | because he was in the hospital, he
00:07:06.400 | talked to the group from his hospital bed.
00:07:09.160 | We have a little different agenda now.
00:07:12.240 | Tell us a little bit about your experience
00:07:14.160 | at the new conference now that Jack is no longer with us.
00:07:18.160 | Well, one of the main reasons why I come to the conference
00:07:20.920 | is just because the Bogleheads are such nice people.
00:07:24.360 | It's just a very pleasant experience.
00:07:25.920 | That really doesn't change with the speakers.
00:07:28.960 | Now, obviously, everybody was concerned
00:07:30.880 | with the passing of Jack that the experience was
00:07:33.720 | going to change.
00:07:34.400 | And of course, it did.
00:07:36.480 | But thanks to you and to Christine and the big Rolodexes
00:07:41.680 | that you have, you were able to acquire
00:07:44.040 | some absolutely spectacular speakers and panelists.
00:07:48.680 | And almost every single one of them knocked it out of the park.
00:07:52.280 | So it was a very rewarding experience because of that.
00:07:56.000 | Thanks for saying that.
00:07:57.000 | It was certainly a team effort.
00:07:58.040 | A lot of people put in a lot of time
00:07:59.540 | to put these conferences together.
00:08:01.080 | And I appreciate your comments on that.
00:08:03.520 | One of the big items in the conference
00:08:05.640 | that seemed to be talked about in almost every session
00:08:10.080 | was inflation-protected securities, TIPS.
00:08:14.080 | And in fact, it was so popular that one of the panels
00:08:18.040 | decided that they weren't going to talk about TIPS,
00:08:20.200 | that it couldn't be mentioned.
00:08:21.120 | It was banned from the panel.
00:08:22.280 | That's how much this was mentioned.
00:08:24.960 | I know that you're a fan of TIPS.
00:08:27.400 | Could you tell me, number one, why you're a fan
00:08:29.840 | and also how one might implement TIPS into their portfolio?
00:08:34.840 | Well, because there's no other asset
00:08:38.520 | that matches your assets and your liabilities
00:08:42.120 | quite so precisely.
00:08:43.680 | So let's say that you decide that you need $30,000
00:08:48.640 | of real spending power in the year 2051, all right?
00:08:53.640 | However old you're going to be then,
00:08:56.720 | you can buy a TIPS that matures in 2031
00:09:01.520 | and know exactly how much spending power
00:09:04.320 | you're going to have when that bond matures.
00:09:08.160 | There is no other asset that you can say that about.
00:09:12.200 | You certainly can't say that about stocks,
00:09:14.480 | and you certainly can't say that about nominal bonds either,
00:09:19.160 | because if there's bad inflation,
00:09:21.480 | you're going to see the real value of that nominal bond
00:09:26.360 | turn basically into funny money.
00:09:29.320 | So that's the advantage.
00:09:30.880 | Now, until about a year and a half ago,
00:09:34.120 | TIPS weren't a very worthwhile proposition
00:09:36.760 | because their yields were so low.
00:09:38.440 | And in fact, there was a point about two years ago
00:09:40.880 | when the yields were strongly negative across the board.
00:09:43.280 | So if you bought $1,000 worth of TIPS at that point,
00:09:48.160 | and they were maturing in 10 or 20 years,
00:09:50.600 | you were guaranteed to get 80 to 90 cents
00:09:53.960 | on the dollar of spending power,
00:09:55.400 | which didn't seem to be a very good deal.
00:09:59.000 | Now, real yields are approaching 2.5%.
00:10:03.280 | So if you buy a 30-year TIPS,
00:10:06.800 | you are going to get $2 of spending power in 30 years
00:10:11.080 | for every dollar you put in now.
00:10:12.680 | And that's a heck of a deal.
00:10:13.840 | That's a near historically high yield.
00:10:17.520 | - So a lot of different ways to buy TIPS.
00:10:19.360 | You can buy individual securities.
00:10:21.480 | You could buy a TIPS fund, short-term or intermediate term.
00:10:26.480 | Or you could buy this new product
00:10:28.960 | that we've been hearing about
00:10:30.400 | called iShare Bullet Share TIPS,
00:10:33.560 | which basically are TIPS put into a portfolio
00:10:37.800 | or an ETF that mature in one year.
00:10:39.800 | And then there's another ETF for TIPS
00:10:41.480 | that mature in two years and so forth.
00:10:43.960 | So you could build this ladder of,
00:10:48.280 | instead of individual TIPS, bullet shares.
00:10:51.600 | How do you feel about these?
00:10:53.880 | - Well, the bullet shares, unless I misunderstand them,
00:10:56.120 | don't make a bit of sense to me.
00:10:57.760 | Why would you buy one or two bonds
00:11:00.520 | that mature in a given year?
00:11:03.760 | And I think beyond 2030 or 2032,
00:11:08.760 | there's only one maturing each year.
00:11:10.200 | So why would you buy a fund that only owns one bond
00:11:13.760 | when you can buy the bond yourself for zero expense?
00:11:17.120 | Doesn't make any sense.
00:11:18.520 | So there's basically two ways
00:11:20.440 | to defuse your retirement expenses with TIPS.
00:11:24.400 | One is simply to buy TIPS that mature
00:11:26.720 | in every single year that you're gonna be retired.
00:11:29.400 | That's not quite possible
00:11:31.920 | because there's a gap between 2034 and 2039.
00:11:36.240 | There are no TIPS that mature then.
00:11:37.760 | Now you can buy an excess amount of them in 2033 and in 2040,
00:11:42.760 | which pretty much does the same trick.
00:11:45.520 | And of course, you really don't have to own TIPS
00:11:48.760 | for all 25 of those years.
00:11:50.440 | You can skip a couple of years in between the TIPS.
00:11:53.640 | So you only have to own maybe six or seven or eight of them,
00:11:57.600 | but that's still a lot of work.
00:11:59.600 | The other way to do this is to buy a mix of TIPS funds.
00:12:03.060 | So let's say you think that your retirement
00:12:05.040 | is gonna last 30 years.
00:12:06.160 | Well, you want the average maturity of your TIPS funds
00:12:10.960 | to average out to about 15 years, half of that, all right?
00:12:14.840 | So you would buy a bit of a 20-year fund,
00:12:17.560 | and there's only one,
00:12:18.480 | and unfortunately that's offered by PIMCO,
00:12:20.280 | and it's got a 20 basis point expense.
00:12:23.000 | So that's just a little steep.
00:12:24.680 | Or, and then you could buy a short-term TIPS fund
00:12:26.880 | for a couple of basis points,
00:12:29.280 | or a couple of ETFs that do that,
00:12:30.800 | and you mix and match those two,
00:12:32.000 | and you try and average out,
00:12:34.080 | weight out the maturities to 15 years.
00:12:36.800 | And then, of course, you have to rebalance that
00:12:38.760 | once every couple of years to keep the maturity right.
00:12:41.840 | So neither way is perfect.
00:12:43.440 | Neither way requires a little bit of work.
00:12:45.560 | I prefer the latter, because that's fire and forget.
00:12:47.800 | You buy it, you lay it in,
00:12:49.460 | and even if you develop the bench up,
00:12:51.840 | you can tell your executors and your kids,
00:12:54.600 | "Hey, this is how you pay my expenses
00:12:56.640 | "when these TIPS mature."
00:12:57.600 | And they don't have to do anything
00:12:58.640 | except collect the principal when they mature.
00:13:01.640 | - Bill, you've recently released a second edition
00:13:03.960 | of "The Four Pillars of Investing,"
00:13:06.280 | probably one of your best-selling books.
00:13:08.480 | Could you review for us what those four pillars are?
00:13:13.100 | And perhaps, what the most important
00:13:16.040 | of the four pillars are?
00:13:17.480 | - Well, the four pillars are simply
00:13:19.560 | the theory of investing,
00:13:21.080 | so the connection between risk and return,
00:13:24.560 | and market efficiency, the knowledge
00:13:26.680 | that you're not going to be able to trade
00:13:28.960 | individual stocks and bonds particularly well,
00:13:31.080 | and the trick is not to trade,
00:13:32.440 | and you avoid trading by buying passively-managed funds,
00:13:36.040 | index funds, whatever you want to call them.
00:13:38.680 | So that's the first pillar.
00:13:40.080 | The second pillar is the history,
00:13:41.840 | and that's probably the most important pillar
00:13:44.380 | because markets become ebullient
00:13:47.180 | and euphoric from time to time,
00:13:48.900 | and markets, more importantly,
00:13:50.680 | become panicky from time to time.
00:13:53.460 | And it's important to know what that looks like,
00:13:55.580 | not necessarily so you can time the market
00:13:58.060 | because that's nearly impossible to do.
00:14:00.300 | You do that simply so you can keep your discipline
00:14:03.020 | and stay the course and say to yourself,
00:14:05.020 | "Yeah, you know, I've seen this movie before,
00:14:07.200 | "and I know how it ends,
00:14:08.380 | "either on the upside and the downside."
00:14:11.180 | The third pillar is your own psychology.
00:14:13.500 | The problem with human beings is we didn't evolve
00:14:17.260 | to deal with a 40- or a 50-year planning horizon.
00:14:22.060 | We evolved on the plains of the Serengeti
00:14:24.500 | dealing with a time horizon or a risk horizon
00:14:26.980 | that was measured sometimes in seconds,
00:14:30.220 | and so we are psychologically ill-equipped
00:14:33.580 | to deal with the long-term risks and returns
00:14:38.260 | that are involved with finance.
00:14:40.280 | So learning how to handle that is the third pillar.
00:14:42.500 | It's very important.
00:14:44.100 | And then finally, you have to learn how to deal
00:14:47.260 | with the financial services industry,
00:14:49.580 | which in many cases is the metaphorical equivalent
00:14:53.580 | of a war zone.
00:14:54.460 | There are people out there who are out to get you
00:14:56.660 | and transfer your wealth from your name to theirs,
00:14:59.980 | and you have to know how to deal
00:15:01.540 | with those people and those institutions.
00:15:04.220 | - In your book, you get into a detail
00:15:06.580 | about the equity risk premium,
00:15:08.980 | and this is the excess return for taking the risk
00:15:12.660 | in the stock market over the risk-free rate.
00:15:16.440 | And I'm assuming in your book,
00:15:17.460 | you're using T-bills as the risk-free rate?
00:15:21.340 | - Yeah, that's the classic one.
00:15:22.920 | You can also use longer bonds and especially TIPS
00:15:26.280 | as a risk-free rate as well,
00:15:28.460 | but most people use the 30-day Treasury bill.
00:15:32.180 | - And given that 30-day Treasury bills
00:15:33.880 | currently are yielding 5.3% at the moment,
00:15:38.880 | what would you suppose the equity risk premium is over that,
00:15:43.880 | say, over the next 20 or 30 years?
00:15:47.780 | - Well, you can calculate out
00:15:49.580 | what the expected return of stocks is,
00:15:52.660 | and you can also look at historical returns.
00:15:55.780 | And you can not only look in the United States,
00:15:58.120 | which is the winner, or just about the winner
00:16:01.940 | of all the 20 or 30 nations
00:16:03.700 | that we have long-term records for,
00:16:06.620 | and the equity risk premium seems to be,
00:16:08.540 | no matter how you look at it,
00:16:09.580 | either historically or calculated,
00:16:11.300 | somewhere in the vicinity of 4%,
00:16:13.220 | might be 3%, might be 5%.
00:16:15.500 | So if T-bills are yielding 5%,
00:16:18.340 | maybe you should expect perhaps 8% from stocks.
00:16:23.140 | Now, the problem with using the T-bill
00:16:24.700 | is that it's yielding 5.3% right now.
00:16:27.740 | I'm willing to bet that it won't be yielding
00:16:30.460 | that much three or four years from now.
00:16:32.620 | And so that may be an overestimate.
00:16:34.620 | A better estimate might be to think in real terms
00:16:37.660 | and say that, yeah, there's a 2.5% tips yield across,
00:16:41.220 | real tips yield across the yield curve.
00:16:44.180 | So maybe you should expect 5.5% or 6.5% real return
00:16:49.180 | from stocks, not nominal return,
00:16:50.700 | but after inflation return from stocks.
00:16:53.840 | - So if you were looking, say, for 5.5% to 6.5%
00:16:58.500 | real return from stocks,
00:17:00.100 | and you can get risk-free 2.5 in tips,
00:17:04.900 | then you're really talking a 2% to maybe 3%
00:17:08.460 | equity risk premium over real interest rates today?
00:17:13.460 | - Yeah, I'm saying 4%, in other words, 6.5% for bonds
00:17:18.260 | and tips and maybe 6.5% for stocks.
00:17:22.500 | So 6.5%, if it was 2.5% inflation, that's 9% nominal.
00:17:26.240 | - Oh, okay, so it's actually quite high.
00:17:29.880 | - Yeah, I think that's right.
00:17:31.020 | And one of the things that people kept asking me
00:17:34.700 | two years ago was, what do I do about low yields?
00:17:38.220 | And the answer is, you've got a great big loaded portfolio
00:17:41.620 | because yields are so low.
00:17:43.060 | Because when yields are low, asset prices rise.
00:17:46.420 | So be careful what you wish for.
00:17:47.900 | If you ever do get to the point
00:17:49.540 | where you have much higher yields,
00:17:51.700 | your portfolio is going to be considerably smaller,
00:17:53.880 | especially on an inflation-adjusted basis,
00:17:55.860 | indeed, which it is, okay?
00:17:57.620 | Stocks are down from where they were two years ago,
00:18:00.260 | and bonds, depending upon your duration,
00:18:02.660 | have gotten absolutely creamed over the past two years.
00:18:05.100 | I think the long treasury, the 30-year treasury,
00:18:07.700 | is down about half from where it was two years ago.
00:18:11.140 | - So let's talk about life in a 5% yield world.
00:18:16.140 | Some people would argue that stocks have not yet adjusted
00:18:20.620 | for a 5% yield on, say, the 10-year treasury.
00:18:25.620 | And real estate has not yet adjusted for this higher,
00:18:31.060 | for longer interest rate environment.
00:18:33.300 | - Well, that's certainly a possibility.
00:18:36.420 | But I also believe that the markets,
00:18:39.260 | the overwhelming majority of the time, are very efficient,
00:18:43.220 | and they reflect the proper level of prices.
00:18:47.260 | And I'm not willing to bet very often
00:18:49.860 | that the market is wrong about valuations
00:18:51.980 | and expected returns.
00:18:53.340 | And I'm certainly not willing to bet that right now.
00:18:55.580 | Now, the one thing that I think needs to be pointed out
00:18:58.420 | is that U.S. large-cap stocks are trading at multiples
00:19:03.420 | that are historically significantly higher than they have.
00:19:06.140 | So maybe their expected returns are lower.
00:19:09.220 | But there are other asset classes, equity asset classes,
00:19:13.220 | that are very reasonably priced.
00:19:15.340 | Small-value stocks are very reasonably priced right now.
00:19:18.620 | Foreign stocks are very reasonably priced.
00:19:20.660 | Emerging market stocks are very reasonably priced.
00:19:23.380 | And even real estate stocks,
00:19:25.620 | which have taken some real losses over the past year or so,
00:19:30.620 | are not unreasonably priced as well.
00:19:33.300 | So I think if you look beyond the S&P 500,
00:19:37.340 | I think that there are very reasonable places
00:19:39.220 | to get decent expected returns.
00:19:41.180 | And when you talk about expected returns,
00:19:42.740 | you have to realize there are very large error bars.
00:19:45.180 | You know, when I say 6.5%,
00:19:47.060 | when anybody says that there's a 6.5% expected return
00:19:50.500 | on stocks, over the next 30 years,
00:19:52.460 | it's quite possible we'll see a negative return,
00:19:54.660 | a negative real return,
00:19:55.660 | and it's quite possible we'll see an 11% real return.
00:19:58.900 | You just don't know.
00:20:00.060 | The best you can do is go with the central estimate.
00:20:02.780 | - There's been a lot of media bashing
00:20:04.940 | of the classic 60/40 portfolio,
00:20:09.020 | 60% in equity, 40% in fixed income.
00:20:12.900 | There was an article in the Wall Street Journal
00:20:15.540 | the other day that talked about how this
00:20:18.380 | had the worst year it's had in decades.
00:20:21.860 | And some people, primarily active managers,
00:20:26.180 | talk about how the 60/40 portfolio
00:20:29.700 | is not the right portfolio for today's environment.
00:20:33.300 | What's your take on it?
00:20:35.300 | - The person who wrote that article
00:20:37.940 | should wear a sandwich board that announces
00:20:40.380 | that they have risk aversion myopia.
00:20:43.020 | Because something has a bad return over a one-year period
00:20:47.100 | doesn't mean that it's a bad strategy.
00:20:50.260 | The 60/40 stock mine portfolio
00:20:52.460 | is a superb long-term investment strategy.
00:20:56.540 | And simply because it has a bad year
00:20:59.220 | is absolutely no reason to abandon it.
00:21:02.660 | In fact, one of the things that separates out
00:21:04.740 | the wheat from the chaff, if I can be sexist,
00:21:07.100 | the men from the boys or the women from the girls,
00:21:09.220 | if you will, in investing is how they respond
00:21:14.220 | to a bad year for their strategy.
00:21:16.460 | All strategies are gonna have bad years.
00:21:18.140 | And 2022 was a bad year for the 60/40 portfolio.
00:21:23.140 | But it was a superb 30 years.
00:21:26.020 | - And normally I tell people that the idea
00:21:29.860 | that a 60/40 portfolio will prevent a loss is wrong.
00:21:34.860 | That's never been what people have said
00:21:39.260 | about a 60/40 portfolio.
00:21:40.820 | They say that it reduces the probability of a large loss,
00:21:45.660 | but it doesn't eliminate the probability
00:21:47.620 | of a large loss.
00:21:48.460 | And I think that last year we saw that.
00:21:50.820 | Stay the course then with a 60/40 portfolio
00:21:53.220 | if you have one.
00:21:54.580 | - Yeah, you shouldn't give a rat's patootie
00:21:56.540 | about a bad year every now and then.
00:21:58.340 | What you care about is how you've done
00:21:59.660 | over the past 30 years.
00:22:01.900 | - There's a lot of terminology out there
00:22:04.700 | in the investment world that to me,
00:22:08.100 | I think is designed to confuse investors
00:22:10.860 | rather than help them.
00:22:12.460 | And one of them is called optimization.
00:22:16.100 | This idea that you can look back in history
00:22:18.660 | and look back at the markets historically,
00:22:21.180 | and you can optimize your portfolio
00:22:24.380 | with the correct percentages in each asset class
00:22:27.540 | so that going forward you have an optimal portfolio.
00:22:31.860 | How realistic is optimization going for looking forward?
00:22:36.100 | - It's beyond being impossible.
00:22:40.940 | It's almost a cruel joke.
00:22:43.220 | Probably the worst way to design a portfolio
00:22:46.700 | is to look at what's done the best,
00:22:49.540 | what asset allocation has done the best in the past,
00:22:52.780 | and then mimic that going forward.
00:22:56.060 | Warren Buffett, I think, very famously said
00:23:00.140 | that if you could get to future optimal portfolios
00:23:05.140 | from past results, then librarians
00:23:08.980 | would be the world's richest people.
00:23:12.860 | - There's another tool out there
00:23:15.140 | that's used by advisors a lot,
00:23:17.300 | and it creates a lot of squiggly lines on paper
00:23:22.220 | and puts a line through the middle of it all.
00:23:24.820 | It's called Monte Carlo simulation.
00:23:27.420 | And I'm skeptical on whether advisors
00:23:32.140 | should be using Monte Carlo simulations
00:23:34.540 | to determine the 5% probability
00:23:37.340 | that the clients will be living under a bridge
00:23:39.220 | and eating dog food.
00:23:40.860 | How do you feel about use or overuse
00:23:44.260 | of things like Monte Carlo simulation
00:23:46.140 | to determine what might be, again,
00:23:48.260 | an optimal portfolio for retirement?
00:23:51.460 | - Well, I would never use Monte Carlo simulations for that.
00:23:56.460 | What I would use them for is to try
00:24:00.100 | and get some sense of a probability
00:24:02.420 | of how likely you are to leave a request
00:24:05.180 | or, on the opposite end, how likely you are
00:24:08.100 | to run out of money.
00:24:09.540 | And even then, it's not a terribly useful tool.
00:24:13.220 | Financial economists have physics envy.
00:24:19.540 | They want to reduce financial systems
00:24:23.980 | to the accuracy and the precision
00:24:26.820 | of an airfoil or an electrical current,
00:24:29.500 | an electrical circuit.
00:24:30.740 | And you can't do that, all right?
00:24:32.700 | It's just an impossible thing to do.
00:24:36.060 | The systems are too dirty.
00:24:37.860 | Now, my favorite sort of hobby horse
00:24:40.900 | is when somebody looks at a Monte Carlo simulation
00:24:44.300 | and says that the odds of portfolio success
00:24:47.220 | are 95% or 98%, so there's a 2% or 5% chance of failure.
00:24:52.220 | Well, heck, if you look at human history
00:24:56.820 | over the past couple of millennia,
00:24:58.380 | you see that societies usually don't survive
00:25:01.340 | for more than 500 years.
00:25:02.660 | So if you have an 80-year lifespan,
00:25:04.660 | it means you have about a one in six chance
00:25:06.860 | of living through a catastrophic situation
00:25:10.420 | that is going to completely destroy your savings.
00:25:15.420 | So no one, no one in this quadrant of the galaxy
00:25:18.980 | can be guaranteed a 95% or 98% chance of success
00:25:23.020 | for simple historical reasons.
00:25:26.980 | There's really only one truism,
00:25:31.580 | which is that the more you save and the less you spend,
00:25:34.860 | the safer you're going to be,
00:25:36.380 | and you really can't say much beyond that.
00:25:40.380 | - You have several other small books that you wrote
00:25:44.860 | in addition to the eight big books, if you will.
00:25:48.020 | In fact, some of them are free on Amazon.
00:25:50.300 | People can download for free.
00:25:52.220 | One of these books that you wrote was called "Deep Risk,
00:25:56.940 | "How History Informs Portfolio Design."
00:26:00.580 | What did you mean by deep risk?
00:26:03.100 | - Well, to know what deep risk is,
00:26:05.180 | you have to know what shallow risk is.
00:26:07.580 | Shallow risk is the risk that everybody thinks about, okay?
00:26:10.500 | It's having a bad year.
00:26:12.340 | It's 2022.
00:26:13.460 | It's having a bad day.
00:26:14.780 | For example, you know, October 19th, 1987,
00:26:17.900 | when the markets lost almost a quarter of their value.
00:26:22.460 | That's shallow risk.
00:26:23.380 | Shallow risk almost always recovers,
00:26:26.420 | and that's not a risk that is going to get you.
00:26:28.740 | The risk that is going to get you as an investor
00:26:32.060 | is a prolonged period,
00:26:35.220 | lasting perhaps a generation of negative real returns,
00:26:39.020 | 'cause that's the sort of thing
00:26:40.580 | that can absolutely blast your retirement to smithereens.
00:26:45.460 | So let me give you an example of deep risk.
00:26:48.140 | Deep risk is the Japanese stock market
00:26:50.700 | over the past 33 years,
00:26:52.980 | which has lost something like 2/3 of its value
00:26:56.660 | in inflation-adjusted terms.
00:26:59.420 | A Japanese investor who depended on stocks
00:27:02.580 | for retirement beginning in 1990
00:27:05.460 | was probably eating cat food within 10 or 15 years.
00:27:09.460 | That's deep risk.
00:27:10.300 | Deep risk is what happened to bonds,
00:27:12.020 | U.S. bonds, between 1940 and 1980.
00:27:15.100 | Again, they lost, even with reinvested interest,
00:27:17.820 | about 2/3 or at least 60% of their value.
00:27:21.980 | That's enough to, you know,
00:27:23.740 | destroy anybody's retirement plans.
00:27:26.940 | And so what are the things that cause deep risk?
00:27:30.620 | It's not having a bad day or a bad year in the stock market.
00:27:33.300 | The things that cause deep risk
00:27:34.980 | are first and foremost, inflation, all right?
00:27:37.500 | So when you look at financial history,
00:27:39.740 | inflation is almost endemic.
00:27:42.140 | It is rare to see a nation
00:27:44.140 | that avoids hyperinflation at any point.
00:27:47.300 | We've more or less avoided it,
00:27:49.180 | although the '70s were a rough patch.
00:27:50.780 | The Swiss have avoided it, the Dutch avoided it.
00:27:53.220 | Very few other nations do that, avoid severe inflation.
00:27:58.220 | That's the most common deep risk,
00:28:00.140 | and it's also the one that is the easiest to mitigate,
00:28:04.020 | all right?
00:28:04.860 | And we'll talk about, perhaps,
00:28:06.020 | how to mitigate that in a minute.
00:28:07.820 | The next risk is deflation.
00:28:09.580 | Deflation is extremely rare, and it's easily curable.
00:28:13.020 | Printing presses, governments have printing presses,
00:28:15.380 | or at least, unless you're in the EU, you do.
00:28:17.980 | And so it's relatively easy to avoid deflation.
00:28:22.140 | Deflation rarely lasts a very long period of time.
00:28:25.580 | There's confiscation,
00:28:26.540 | the government coming and taking your assets,
00:28:28.220 | either through excessive taxation
00:28:30.540 | or through downright confiscation,
00:28:32.700 | as happened in the communist countries
00:28:36.020 | after their revolutions.
00:28:37.940 | And then finally, the fourth risk is destruction,
00:28:40.460 | which is more a civil disorder.
00:28:43.780 | So to take them in order,
00:28:45.620 | inflation is the one you can do the most about.
00:28:47.820 | Deflation is rare.
00:28:48.780 | You probably don't have to worry about it.
00:28:50.500 | Confiscation, you know, you have to flee the country,
00:28:53.380 | which is not an easy thing to do.
00:28:55.140 | And destruction, beyond, you know,
00:28:56.980 | having a good supply of canned goods and ammo,
00:28:58.980 | there's not a lot you can do about it.
00:29:00.980 | And even if you have the canned goods and the ammo,
00:29:02.980 | you may not be able to do anything about it.
00:29:05.740 | So the rational investor,
00:29:07.380 | I came to the conclusion in that book,
00:29:09.540 | tries to do the best that they can to mitigate inflation.
00:29:12.820 | - So here we are at a point in history
00:29:14.980 | where we have a $33 trillion national debt
00:29:19.340 | continue to rack up trillion dollars a year in excess debt.
00:29:24.340 | No end in sight for this.
00:29:27.860 | The only way we could possibly begin to pay this back
00:29:31.340 | is through some sort of confiscation.
00:29:33.220 | We have to pay more taxes.
00:29:35.060 | Would you agree with that?
00:29:36.740 | - Gosh, you did a really good job of channeling Ron Paul.
00:29:40.860 | - Okay.
00:29:42.420 | - How do you mitigate that, all right,
00:29:44.540 | if you're really worried about that risk?
00:29:46.220 | And there's several different strategies,
00:29:47.700 | which you can apply simultaneously.
00:29:51.380 | Number one is in the long-term,
00:29:53.100 | equities are not a bad hedge against inflation,
00:29:56.820 | not a perfect hedge against inflation.
00:29:58.940 | But when you look outside of the U.S.
00:30:01.140 | at the nations that have had the very worst inflation,
00:30:03.700 | places like Chile, places like Israel, even Weimar, Germany,
00:30:08.700 | stocks actually held up pretty well
00:30:11.700 | throughout those severe inflations.
00:30:13.500 | Why?
00:30:14.340 | Because stocks are a claim on real assets.
00:30:18.260 | They produce products that can be priced
00:30:21.220 | according to inflation.
00:30:23.060 | And in real currency,
00:30:24.380 | they have real assets that they can sell.
00:30:26.740 | So they're not a bad way to do that.
00:30:28.860 | Now, there are some kinds of stocks
00:30:30.500 | that do especially well with inflation.
00:30:32.500 | One of them is value stocks.
00:30:33.980 | Value stocks tend to be over leveraged,
00:30:37.380 | and that leverage melts away
00:30:39.060 | and goes straight to the bottom line with inflation.
00:30:42.380 | Commodities producing stocks do well.
00:30:44.500 | I'm not a big fan of owning commodities
00:30:46.380 | or commodities futures,
00:30:48.020 | but oil stocks, gold stocks, base metals producers
00:30:52.700 | all do very well with inflation.
00:30:55.580 | We've already talked about tips.
00:30:57.100 | Tips, by definition, are going to do well with inflation.
00:31:00.340 | The one asset class, interestingly,
00:31:02.060 | that really doesn't do that well with inflation
00:31:05.180 | when you look at it through a broad enough lens is gold.
00:31:08.660 | Gold did pretty well in the U.S. in the '70s with inflation,
00:31:11.900 | but in any other period in any other country
00:31:14.940 | that had severe inflation, it didn't do that well.
00:31:18.460 | And in fact, curiously, paradoxically,
00:31:21.660 | gold does best with deflation.
00:31:23.660 | And the reason for that, if you think about it,
00:31:26.100 | is fairly obvious, which is that financial panics,
00:31:29.020 | when people lose faith in the financial system,
00:31:31.740 | tend to be deflationary.
00:31:33.620 | And it's not that gold does well with deflation per se,
00:31:36.940 | but gold does well with financial panics,
00:31:38.820 | and financial panics tend to be deflationary.
00:31:42.260 | - Notice that during the COVID crisis
00:31:44.740 | that the price of gold went up significantly
00:31:47.460 | when that began.
00:31:49.140 | And then once we had the recovery from that
00:31:53.380 | and inflation started coming back,
00:31:55.140 | the price of gold did not continue up
00:31:58.860 | because it had already gone up.
00:32:00.860 | So just recently, your theory about gold is correct.
00:32:05.620 | Let's get onto another topic.
00:32:08.060 | You were speaking with Meb Faber recently on a podcast,
00:32:11.980 | and he was asking you what you thought
00:32:15.820 | you might start working on next.
00:32:17.500 | And one of the answers that you gave to him was
00:32:20.420 | you were very interested in why some countries
00:32:24.020 | became wealthy and some countries did not.
00:32:27.620 | What was the key factor of what you found
00:32:30.860 | in this research so far as to why some countries
00:32:33.940 | gain wealth and others do not?
00:32:37.220 | - Well, the question is why have the Northern Europeans
00:32:41.340 | done so well economically?
00:32:43.220 | And why, by the way, have their securities markets
00:32:46.620 | done generally much better than other countries?
00:32:51.180 | You know, when you look at the highest
00:32:52.660 | returning equity markets around the world
00:32:54.660 | in the past century and a quarter,
00:32:56.860 | you're looking at, you know, the United States,
00:33:00.140 | the UK, Australia, New Zealand, Canada,
00:33:02.820 | all being at or near the top of the list.
00:33:06.500 | Sweden and Switzerland have also done well.
00:33:09.340 | And what characterizes those countries?
00:33:11.500 | Well, it's, you know, the usual things,
00:33:13.060 | rule of law, independence of judiciary,
00:33:15.980 | but also it's what sociologists call radius of trust, okay?
00:33:20.980 | In other words, if, you know, you drop your wallet
00:33:24.500 | in the park or on the street,
00:33:27.540 | what are the odds of you getting it back?
00:33:30.580 | And it turns out that some cultures
00:33:32.660 | have a higher radius of trust than other cultures do.
00:33:37.660 | And the reasons for that are well beyond
00:33:40.020 | the ambit of this podcast.
00:33:45.020 | But it has to do with culture.
00:33:48.060 | And the other really interesting thing
00:33:49.860 | is it has to do with marriage proscriptions
00:33:52.900 | in Northern European countries.
00:33:55.420 | Because if you can't, you know,
00:33:58.220 | you can't marry your second or third or fourth cousin,
00:34:00.820 | it means that you have to leave the town
00:34:04.220 | that you were born to find a mate,
00:34:06.420 | as a lot of English people and Northern Europeans
00:34:09.820 | had to do at one point or another.
00:34:13.020 | And when you do that, you learn to trust other people,
00:34:14.780 | not just the people in your family and your clan.
00:34:17.220 | And that, you know, follows through
00:34:19.980 | in terms of economic growth.
00:34:21.860 | The higher the radius of trust,
00:34:23.220 | the longer the radius of trust in society,
00:34:26.060 | the more prosperous it is.
00:34:28.380 | I don't know that I'm gonna get to write that book,
00:34:29.900 | but it would be a fun book to write.
00:34:32.100 | - One of the things that you mentioned
00:34:33.860 | was things that break up that trust.
00:34:36.460 | You know, what causes that trust to erode over time?
00:34:41.060 | - Well, that's another interesting subject,
00:34:43.100 | and that would be the second part of the book,
00:34:45.140 | which is that societies that do become prosperous and stable
00:34:50.140 | tend also to acquire layers of special interests
00:34:56.740 | that tend to choke off the economy.
00:35:00.180 | So all you have to do in this country
00:35:02.220 | is look at the power of the medical-industrial complex
00:35:06.380 | that is resistant to any change or reform.
00:35:08.780 | And you see that we're spending
00:35:10.220 | close to 20% of our GDP on medical care,
00:35:13.580 | and yet our healthcare statistics are,
00:35:17.180 | if anything, a little worse than they are
00:35:19.700 | in countries that have, where the medical-industrial complex
00:35:23.300 | isn't quite as powerful.
00:35:24.940 | If you're an American diabetic,
00:35:26.940 | you are three times more likely to get an amputation
00:35:29.820 | as an English diabetic will,
00:35:31.500 | simply because our medical system is so dysfunctional.
00:35:35.420 | You know, you can also look
00:35:36.380 | at the military-industrial complex,
00:35:39.540 | and you can look at congressional privilege as well.
00:35:42.580 | One of the reasons why the Congress
00:35:45.260 | is so currently dysfunctional simply has to do
00:35:48.100 | with the capture of special interests
00:35:50.380 | of the legislative process.
00:35:52.700 | - One of the other things you mentioned
00:35:54.500 | is that as a country becomes wealthier,
00:35:58.500 | or the wealthier that society gets,
00:36:01.340 | there becomes more inequality,
00:36:04.180 | and that also leads to distrust.
00:36:07.580 | - Yeah, and we're seeing that right now.
00:36:09.260 | I mean, half of the people in this country,
00:36:12.860 | the United States, couldn't come up with $400
00:36:16.140 | for a car repair without going into debt.
00:36:19.420 | And that's the sort of, again,
00:36:21.660 | that's the sort of inequality that you see
00:36:24.180 | when special interests gain power.
00:36:28.500 | I mean, if you're a hedge fund,
00:36:30.060 | billionaire hedge fund manager,
00:36:32.020 | you're liable to have a marginal tax rate
00:36:34.460 | that is lower than legal secretaries.
00:36:36.900 | - You wrote a paper called "The Myth of Dynastic Wealth,
00:36:42.380 | "The Rich Get Poorer,"
00:36:43.820 | and the co-authors were Rob Barnett and Lillian Wu.
00:36:47.980 | Within society, people seem to wanna target
00:36:51.900 | very wealthy people.
00:36:55.100 | The rich don't pay enough in taxes,
00:36:57.380 | and they need to pay their fair share, and so forth,
00:37:01.580 | as if families are accumulating wealth,
00:37:06.300 | and that wealth will never go away.
00:37:08.900 | But in fact, I'd like you to talk about this paper.
00:37:12.220 | You wrote it some time ago, but I found it fascinating
00:37:15.340 | that wealth doesn't really stay with the same people
00:37:18.220 | generation after generation.
00:37:19.620 | It gets dispersed like sandcastles on a beach
00:37:22.740 | getting washed back out to the ocean after a few tides.
00:37:26.260 | - The paper looks over a time period
00:37:29.700 | that is not just a generation or two in length,
00:37:31.740 | but over several generations.
00:37:33.620 | So the classic example of that is the Vanderbilt family.
00:37:36.860 | There was a get-together of the Vanderbilts in 1970,
00:37:40.420 | and there was not one millionaire in the group,
00:37:43.540 | and how did that happen?
00:37:46.420 | So over the very long term,
00:37:48.340 | you're looking at centuries now,
00:37:50.420 | wealth tends to migrate out of the wealthiest families,
00:37:53.860 | and the reason is just, it's just simple exponential math.
00:37:57.340 | I mean, a very wealthy couple is going to have two children
00:38:01.300 | and four grandchildren and eight great-grandchildren,
00:38:06.260 | and by the time you get to the sixth or seventh generation,
00:38:08.500 | there just isn't enough wealth to go around,
00:38:10.580 | particularly as the successive generations
00:38:14.220 | get lazier and softer and tend to blow the money
00:38:17.940 | and sue each other over their inheritances.
00:38:21.860 | So over very long periods of time,
00:38:24.460 | their wealth does dissipate.
00:38:26.860 | We don't have any real dynastic wealth in this country.
00:38:29.540 | There are no families whose wealth goes back
00:38:32.420 | to the time of the Revolution,
00:38:33.620 | and very few families whose wealth goes back
00:38:35.940 | to, say, the time of the Civil War.
00:38:38.180 | Now, that said, there is enormous inequality
00:38:42.060 | from generation to generation.
00:38:44.380 | Perhaps I'm getting a little too political here.
00:38:46.340 | Whenever people complain about affirmative action,
00:38:48.940 | I remind them what affirmative action really looks like.
00:38:51.980 | Affirmative action is when your father
00:38:54.100 | is an investment banker and your mother is a radiologist
00:38:58.580 | and you've taken 14 advanced placement courses
00:39:01.780 | by the time you're in 11th grade or 12th grade, all right?
00:39:06.460 | And that's what real affirmative action looks like.
00:39:10.780 | And so from, you know, over one or two generations,
00:39:14.780 | we have real inequality
00:39:16.540 | and we have real lack of social mobility.
00:39:19.100 | But the one thing we don't have, and that's a real problem,
00:39:21.460 | the one thing we don't have to worry about, I think,
00:39:23.780 | is one or two families taking over the wealth
00:39:25.900 | of the entire country.
00:39:26.940 | That's not going to happen
00:39:27.860 | because that wealth does tend to dissipate
00:39:30.260 | over very long periods of time.
00:39:31.900 | But over periods of less than, say, 50 years or 60 years,
00:39:35.020 | I do worry about it.
00:39:36.580 | - Well, one of the things we have in this country
00:39:38.500 | is an estate tax to take 40% of wealth over,
00:39:43.500 | call it 25 million for a married couple.
00:39:47.620 | And basically the government takes it
00:39:50.180 | unless you give it to charity.
00:39:51.820 | So that also puts the money back into the system.
00:39:55.940 | It puts it back into other people's hands.
00:39:57.940 | And again, I always like to think of it as sandcastles
00:40:01.500 | that wash out to the sea over time.
00:40:05.780 | - I agree with you.
00:40:06.620 | I don't think we have to worry, you know,
00:40:08.780 | that 200 years Elon Musk's kids
00:40:11.260 | are going to be running the country.
00:40:13.460 | That's not the worry.
00:40:14.300 | The worry that I have
00:40:15.140 | are the short-term effects of inequality.
00:40:17.500 | I worry, for example, that in the United States,
00:40:20.020 | if you were born in the bottom quintile
00:40:22.300 | of socioeconomic status or wealth or income,
00:40:26.940 | the odds of you making it to the top quintile,
00:40:29.020 | from the bottom 20% to the top 20%,
00:40:31.580 | are about 5% or 6%, all right?
00:40:34.620 | Whereas in a perfectly mobile society, it should be 20%.
00:40:37.660 | Now in Scandinavia, Northern Europe, that's about 14%.
00:40:41.100 | In Arkansas, it's about 3% or 4%.
00:40:43.420 | In Silicon Valley, it's about 13%.
00:40:45.340 | It's almost, it's about at a European level.
00:40:47.980 | So I worry about our lack of social mobility,
00:40:51.460 | which is due to wealth inequality.
00:40:53.780 | - And is this all going to be the subject of a book?
00:40:56.420 | - Probably not.
00:40:57.260 | Other people have written about it far more eloquently
00:41:00.380 | than I'm ever going to be able to.
00:41:02.220 | The person who I pay attention to is Raj Chetty,
00:41:05.420 | who's at Harvard University, who's an economist.
00:41:08.020 | And Angus Deaton has written a very fine book
00:41:11.220 | on the subject.
00:41:12.340 | He's actually written two books.
00:41:13.940 | One is "Death of Despair," which touches on it.
00:41:16.700 | And the other is his more recent book,
00:41:18.220 | which is "Economics in America,"
00:41:19.660 | which is basically a biography,
00:41:21.580 | but he touches on a lot of these selfsame subjects.
00:41:24.580 | And he's well worth reading
00:41:25.700 | if you really want a deep dive into the issue.
00:41:28.380 | - I have one last question for you,
00:41:29.740 | and I'm doing it on behalf of Jonathan Clements,
00:41:32.140 | because he interviewed you at the conference
00:41:34.580 | and he did not get to ask this question
00:41:37.060 | because there were so many other questions.
00:41:39.580 | So I'm going to ask it on his behalf.
00:41:42.660 | You just jumped into an Uber.
00:41:45.060 | The driver is clearly both intelligent
00:41:49.220 | and uninformed about personal finance.
00:41:53.020 | He finds out that you're an expert in personal finance,
00:41:56.540 | and he asks you for advice.
00:41:59.740 | You have time to make five points
00:42:02.620 | before you get to your destination.
00:42:04.780 | What would you recommend to this Uber driver?
00:42:08.220 | - Well, I knew what those five points were a week ago
00:42:10.940 | when I was prepared for Jonathan to ask me that question.
00:42:15.260 | I'll do my best to recall five,
00:42:17.100 | but I may only get through the four.
00:42:18.900 | The first one is to save 15% of your before-tax salary,
00:42:23.900 | if you at all can.
00:42:28.660 | And the second is to keep your expenditures down.
00:42:32.220 | The third is to not trade stocks and bonds,
00:42:36.380 | to invest passively.
00:42:38.020 | When you trade stocks and bonds,
00:42:40.260 | to imagine that you're playing tennis
00:42:42.660 | against an invisible opponent, all right?
00:42:45.380 | And to realize that the person on the other side of the net
00:42:48.780 | isn't some dentist from Peoria
00:42:51.220 | who was put there for you to trade with and make you rich.
00:42:54.780 | That the person on the other side of the net
00:42:57.420 | more likely is Serena Williams
00:42:59.740 | or the investment partner of Serena Williams.
00:43:02.420 | The fourth thing that I would tell
00:43:04.380 | my metaphorical Uber driver
00:43:06.740 | is to ignore your friends and family
00:43:09.860 | because almost invariably,
00:43:11.500 | they're going to give you poor advice
00:43:13.460 | to stick to more reliable sources of information.
00:43:17.420 | And then the fifth thing is to avoid the headlines.
00:43:20.420 | The headlines are very useful.
00:43:22.420 | The economic headlines are very useful
00:43:24.060 | because if it's above the fold, if it's in the headline,
00:43:26.980 | it's already been impounded into the price.
00:43:29.100 | So it's worthless information.
00:43:30.940 | And if something's, in other words,
00:43:32.220 | if something is in a headline,
00:43:34.140 | then you don't have to worry about it
00:43:35.620 | because the prices have already reflected that.
00:43:38.780 | So I think I got five things.
00:43:40.260 | - You did.
00:43:41.500 | And I would say that the headlines are interesting
00:43:43.540 | because today, as I was reading the Wall Street Journal,
00:43:45.660 | the headlines were individual stock investors
00:43:47.860 | outperformed the market.
00:43:49.460 | I don't know if you caught that story or not,
00:43:51.380 | but it went in there and it talked about
00:43:52.740 | how many people own Apple stock and Google
00:43:56.420 | and Amazon in their own accounts
00:43:59.620 | and how they have outperformed.
00:44:00.860 | Now, I review literally hundreds of portfolios
00:44:04.500 | for individual clients every year.
00:44:06.380 | And I have to tell you, I have not seen this,
00:44:09.060 | but apparently the Wall Street Journal has.
00:44:11.740 | Did you read that article?
00:44:13.260 | - I saw the article and they quoted a research outfit
00:44:16.580 | that I have never heard of before.
00:44:19.420 | And we both are fairly familiar
00:44:21.700 | with the finance literature.
00:44:22.900 | There are literally hundreds of studies
00:44:25.260 | that show just how poorly individual investors do,
00:44:28.860 | whether they invest in individual stocks or mutual funds,
00:44:32.060 | they almost always underperform.
00:44:34.140 | And they underperform in direct proportion
00:44:36.460 | to how frequently they trade.
00:44:38.180 | So the fact that somebody somewhere
00:44:41.620 | came up with a study that shows the opposite,
00:44:43.820 | I would not just take a pinch of salt
00:44:46.340 | or even a thimbleful of salt,
00:44:47.620 | I would want a bucket of salt with that study.
00:44:49.580 | (laughs)
00:44:50.780 | - Well, thank you so much again
00:44:52.220 | for joining us on Bogle Heads On Investing.
00:44:53.900 | Your insights are always interesting.
00:44:55.820 | I have to go back and listen to this three or four times
00:44:57.780 | so I catch everything that you say.
00:44:59.780 | And thank you again also for speaking
00:45:01.860 | at the Bogle Heads conference
00:45:03.340 | and hope to see you there next year.
00:45:05.740 | - Rick, I hope to see you next year
00:45:07.900 | and I look forward to doing this again with you.
00:45:10.100 | - This concludes this episode of Bogle Heads On Investing.
00:45:14.180 | Join us each month as we interview a new guest
00:45:16.940 | on a new topic.
00:45:17.980 | In the meantime, visit boglecenter.net,
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00:45:32.060 | Join one of your local Bogle Heads chapters
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00:45:36.300 | Thanks for listening.
00:45:37.340 | (upbeat music)
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00:45:45.120 | you