If you're one of those who listens to the show every day when it comes out and if you're current with the show, then you're probably in vacation mode. As I record this here, it's Tuesday, November 24, 2015. I'm getting ready to pack up and head out of town for Thanksgiving.

However, let's not check out too early. I've got one more heavy lifting show for you. Today is going to be a heavy lifting show. We're going to get into some meat and potatoes of investing and talk about why index funds, fund investing, and passive investing is the only appropriate way for anybody to invest ever.

Welcome to the Radical Personal Finance Podcast. My name is Joshua Sheets and I'm your host. And welcome to the show. Yes, one more heavy lifting show. Let's dig into some meat on investing. My guest today is a man named Rick Ferry. Rick is a really awesome guy, a very knowledgeable investment manager and financial analyst.

He is also the founder of a company called Portfolio Solutions. And today, he's going to give us a master class on investing and asset allocation. I was able to connect with Rick recently while I was at the XYPN 15 conference. He was a sponsor of that conference in Charlotte, North Carolina a few months ago.

And while we were there, I connected with him and I was very impressed by him and I thought he would be a great resource for you on the show. So if you're in holiday mode and if for you it doesn't seem like fun to talk about investing and index funds and all that stuff, you might want to wait a few days and then check back with this next week.

Otherwise, here's one more heavy lifting show today and then tomorrow, we'll have a light and fun show for you as well. Playing interviews this week while I head out of town with my family heading over to Central Florida to hang out with family in Central Florida away from the coast.

But we'll be back after next week. So the show will be off on Thursday and Friday but we should be back on Monday of next week, 30th of November. So let's talk about sponsors right up here at the front and then we'll get to the interview and we will get you in and out today.

I'll do sponsors quickly. Sponsor of the day, number one today is Jay Fleischman. Jay is an awesome guy. He is a student loan and bankruptcy attorney. He is also the host of the Student Loan Show podcast and he is a past guest on Radical Personal Finance for two episodes, episodes number 214 and 258.

If you have student loans, you should call Jay. I was talking with somebody on the phone yesterday and he was mentioning that he had student loans and he was a listener of the show and I said, "Have you called Jay?" He said, "No, no, no. I hear you talk about that." I said, "Dude, what are you doing?

Call Jay." I really mean that because it's probably going to be – if you call Jay and/or go to studentloanshow.com/radical, sign up at least for Jay's $50 federal student loan review. Probably going to be one of the better 50 bucks that you're ever going to spend. He is a really knowledgeable guy and he – if there is a loophole that you can find that will help you in your student loan repayment plan to pay them off quicker and to pay them off with less money out of pocket to cut your interest expenses, things like that, Jay is the guy who will help you find that.

So if you have student loans, go to studentloanshow.com/radical. If you doubt that Jay is the guy who can be worth 50 bucks for a federal consultation – by the way, that's a $25 discount off of his normal rate for listeners of the show. If you doubt that, go and listen to episode 214 of the show and then listen to episode 258 of the show.

You'll find them on the website or in your feed and go ahead and listen there and I bet you you won't doubt why I say it's worth it at the end of that. Also make sure you subscribe to his podcast, Student Loan Show. You can find it in all the major podcast directories.

Which leads me to sponsor of the day number two is the sponsor that we introduced on yesterday's show, SoFi, Social Finance, S-O-F-I, SoFi. If you have student loans and one of the things that you want to look at is can you refinance them at a lower interest rate. The reason I led with Jay as a sponsor is you should first consult with Jay and if your option is in the back end to refinance it, he will tell you that and then you should investigate using SoFi.

You'll find a link, a referral link for me and for you at RadicalPersonalFinance.com/SoFi, RadicalPersonalFinance.com/SoFi, S-O-F-I, which is short for again, Social Finance. At that link, if you use that link and you refinance your student loans through them, you can put an application in line. It's very easy, very fast to do and you can find out what your rates would be, see if it would save you some money.

If you use that link, then I'll get a commission and you'll save 200 bucks. You'll get 200 bucks of credit back to your account. If you go through that and you want to check into their personal loan refinancing options, you can also find that at that link as well.

Just go to RadicalPersonalFinance.com/SoFi. Those are our sponsors of the day. With that, let's go to the interview. Please welcome Mr. Rick Ferry. Rick, welcome to Radical Personal Finance. Thank you, Joshua. It's great to be here. I owe you an interview on this show since I did my best the other day.

You were a sponsor of XYPN 15 and I did my best to eat you out of house and home at the Brazilian steakhouse dinner that you provided for us. I know. I got the bill and they said there was this big guy with a red beard. You thought the bill was going to be this, but we had to add another 15% just for him.

Exactly. Well, I quit eating carbohydrates a while ago. When you're at a conference like this, it's challenging to find food to do that. My strategy is I start by having a big breakfast. That day, I'd had a breakfast very early in the morning and then it was all day long.

We got to the Brazilian steakhouse and I did my best to eat about eight pounds of meat. I'm glad you enjoyed it. For dinner. Let's kick off. We're going to talk some finance today and talk about investing. You're a real expert. Don't be scared to make today a little bit heavy.

We're not talking necessarily to a mainstream audience here. We're talking to people who have an above average interest in finance. Start by just sharing with us a little bit about your story and a little bit about your company Portfolio Solutions and what you guys do. My story is back in the 1980s when I came into the field, I went into the traditional brokerage model and I started using the products that I was told to use.

What I did was I started analyzing the returns of those products. As I did that, I began to realize that the returns weren't matching the markets. I decided that I should go out and educate myself to find out how to manage money so that I could maybe better make better decisions for my clients.

Then I became a CFA, a charter financial analyst, and got my masters in science and finance. I created a lot of analytics to analyze the performance of money managers. Try not to hit the table. You're good. All good? All good. That's when I began to realize through my research that the money managers were not keeping up with the markets and that the best thing for my clients would be to just use index funds, which were beginning to grow.

That would have been about what year? That was in the mid-1990s. There wasn't the analytics out there. There wasn't the research that they have now. It was a lot of deep digging and actual experience using these products that got me to this point. How painful was that to be selling one thing and then doing your research and questioning that?

Before I went into finance, I was in the Marine Corps. I flew fighter aircraft. I used to land on aircraft carriers. When you do that, everything is very precise. It is what it is. There's no joking around about it. The facts are the facts and you react to that exactly as they are.

When I went into the finance industry, I thought that was the way it was. You were getting good, clean information and it was beneficial to you and you were able to do your job. That's exactly the opposite of that. That was a little bit of a reality check of what that was.

I realized that I had to do what the numbers said, what was reality. When I made that decision and had that epiphany, I didn't change my mind. I never went back. I got very angry about what I was seeing and that didn't make me feel good. The last few years I was in the brokerage industry, I was miserable.

I stayed because I had to figure out the plan for how I was going to use this information to help my clients. Where did you go from there? I actually started at Kidder Peabody. It's no longer with us and I went to Smith Barney who is no longer with us.

I was in it for 10 years. In the last three years, I was planning to start my company Portfolio Solutions which did low cost, index-based money management. There was nothing out there at the time and I was really one of the first ones, the first person who was going to put an RIA together that just did this.

Are you serving individual clients or are you serving advisors? For the past 15 years, we were serving individual investors. Mostly now, we're serving both individual investors and advisors. We're creating the channel to distribute through advisors. You are focusing on exclusively passive index funds? Okay, so we're getting into the technical aspect of it.

Let's talk about that if you mind. The first thing I do is look at, at one level, what is an asset class and isolate out different asset classes. By the way, this is all written in one of my books called All About Asset Allocation. This is all this information is in one of my books called All About Asset Allocation.

You start out at the asset class level determining what is an asset class and then which asset classes should you invest in because there are some that you wouldn't invest in because they don't give you a real return or maybe they're not investable. Once you come up with the asset classes that are investable, then you find the products that best represent the asset class in a low cost way.

Now most of the time that points to index funds, but there are times when you may not use an index fund because the asset class is best represented by something that's not an index fund. I don't know if they give specifics, but let's say high yield bond, part of the market, the best product out there is not an index fund.

It's actually a low cost actively managed fund. I can't get into for compliance purposes what one that is, but I think we all know which one and what big mammoth company out there has that. Let's start with answering that question. What is an asset class according to your definition?

Because it's a term that we throw around a lot of times and as financial advisors, we're great at throwing terms out that people don't actually understand and we're not great at supporting them. How do you answer the question? That's a good question. Again, two, there are asset classes and then there are the ones that you would want to invest in.

So, you have to look at it and you say, "Is there something unique about this asset class? Is it fundamentally different than another asset class?" For example, bonds are fundamentally different than equity. What backs the bonds, how bonds pay you a return, these are all fundamentally different than equity.

So, equities and bonds are two different asset classes. Then you look at something like commodities or precious metals and you say, "What about that?" Well, they're physical. The return you get from those is different than the return you get from bonds and the return you get from stocks. So you isolate these things out by, "Are they fundamentally different?

Do they have fundamentally different risks? How do you measure whether they're fundamentally different risks?" I do that through a rolling correlation analysis, not just a correlation analysis, but a rolling correlation analysis. What's the difference? Okay, correlation, for example, if you were going to take stocks and bonds and we were going to look back 50 years and we were going to say, "What's the correlation between stocks and bonds?" You did it as one flat 50-year number.

You would come up with something like .1, which means there's not much correlation between stocks and bonds. But in fact, the correlation between stocks and bonds is never .1. It goes through .1 on occasion, but it's never .1. So you have to do a rolling correlation where you're looking at three-year periods of time rolling forward over that 50-year period.

And then you can see how the correlation between two asset classes shifts. Sometimes it's negative, sometimes it's positive. And that shifting correlation, the variability of the correlation is telling you that there are different risks in stocks than there are in bonds because the correlation varies over time. You can do the same thing between common stocks and real estate.

And you can see that the correlation is sometimes negative and sometimes positive, but it shifts over time. And therefore, there are different risk factors within those asset classes. Same thing with commodities. And so you use this to determine, is the asset class fundamentally different? And one test to determine whether the asset class is fundamentally different is whether there are different risks in the asset class.

And you determine that or you validate that through a rolling correlation analysis. So the reason why this is important is from the scientific perspective, when we're constructing a portfolio, the correlation or the correlation coefficient is indicating, do these two asset classes tend to move together or do they tend to move in different directions?

So if you had a stock of Pepsi and a stock of Coca-Cola, those would be highly correlated. You would expect them in many ways to move together. There might be some variability between the companies, but they're both in similar markets. They're going to be subject to similar economic influences.

The idea of, say, stocks and bonds is, well, if stocks go up, do stocks go down? Bonds. Excuse me. Correct. Thank you. Do bonds go down? And when we're integrating a portfolio, a portfolio manager would love to have asset classes that were the exact opposite. That if asset class A goes up, asset class always B goes down by the same amount.

That is brought together mathematically that lowers the total variability, the total risk of the portfolio. The problem is those asset classes, there are no asset classes that are perfectly inversely correlated. They all have some coefficient between them that sometimes they go up, sometimes they go together. And so the goal of why this is important for the listener is you want to have asset classes that you need to understand the correlation between asset classes on this basis, on a year to year basis, or on a market to market basis, so that you can figure out how to construct them together in a portfolio to deliver the maximum return at the minimum level of risk.

Is that accurate? That's a perfect textbook explanation that doesn't actually exist in reality. Okay, but that's right. So let's talk about reality then. So the reality is, as you said, there are no negatively correlated asset classes, except if you went long the S&P and at the same time shorted the S&P, which gives you a zero return.

And you got to pay your premiums along the way. You have to pay fees. So it doesn't make any sense to do that. The best that you can find is asset classes that are randomly correlated with each other, and that at times may be negative and at times positive.

That's really the best you're going to find. The problem with that is that sometimes asset classes all go down together, and you can't get away from it unless you have a portion in cash. Not that I'm saying you should, but from a portfolio management standpoint, you can have contagion within all asset classes.

Let's take 2008, for example. International stocks, real estate, commodities, everything went down together. Stock bonds, high yield bonds, everything went down. Treasury bonds were the only thing that did well. So whatever portion you actually had in treasuries did well. So at that time, you should have had some in treasuries.

But you say, "Okay, well, I'll always have some in treasuries because they're negatively correlated with stocks." Well, no, not during the late 1990s. During the late 1990s, bonds went down and stocks went down. Why? Because it's a variable. That's why I say you have to look at a rolling correlation as opposed to a point correlation, because the rolling correlation will show you that there are times where this will occur.

It's important to not be seduced by modern portfolio theory into thinking that it's a safe way all the time. So back to the issue that you raised before we talked about correlation, about which funds do we choose. And by the way, throughout this interview, please correct me if I get anything wrong.

And feel any need to allow me to go on. But this is where I'm at currently with my own perspective on the question of active versus passive. You have to look at the actual market. So I could believe that for the most part, something like the stocks that are listed on the New York Stock Exchange, that's a highly efficient market.

There are a limited number of issues. There are a massive number of analysts looking at things. The companies that are involved are the most public companies in the world. They're the most highly regulated. Everything is conveyed in advance. All of the information is there. So I could believe that that market is very efficient and that it's very difficult for a manager to bring a lot of value in that marketplace.

However, when I look at something like the bond market, and we go from, if you know the numbers, a few thousand issues to many tens and tens of thousands of individual bond issues. Well, in this situation now, it's very hard for me to believe, well, I believe at the moment that underwriting is going to make a big difference.

Individually underwriting various bond issues. There are so many thousands of issues that are out in the marketplace that an analyst can bring some value, if for nothing else, then to provide some basic screens against municipalities that are bankrupt and getting ready to launch a multi-billion dollar stadium for a team that's defunct and has no fan base.

So something as simple as that, or moving from, say, large cap US stocks to a micro-cap area where underwriting now is going to make a much bigger difference. So I get annoyed when people paint with broad brush strokes and say, well, index investing and passive investing is always better than active investing.

And I say, well, wait a second, let's look and see, is it feasible that a manager can add some value? Real estate would be another example. A real estate index fund might have some place if you're just simply saying, I want to figure out how to factor the variability of interest rates and the market in general as it reacts to the economy in.

But any real estate investor knows that the actual underwriting of each rental property is of key importance because the property in your town that's in the ideal up and coming neighborhood versus the property on the outskirts of town that's in the neighborhood that's going to pot will make a massive difference in your returns.

So let me annoy you. Please, this is good. You are correct in some parts of what you say, but you're incorrect in most of what you just said. The data doesn't show that even in the bond market, the active managers are able to outperform the benchmarks, even though the benchmarks are cap weighted, which you think about it, companies that are in trouble and need to issue a lot of debt end up with a bigger part of the bond market.

So why would you want to buy more of them? But the fact is, the indexes actually outperform most of the active managers who are doing what you suggested, trying to find the inefficiencies and outperform. The same thing with emerging markets, the same thing with micro cap, the same thing with whatever market.

In the long run, when you look at the data of the active managers who are paid, the professionals who are paid to try to outperform those benchmarks, the data shows in every asset class, in every category that the benchmark outperforms most managers. Not all, but here's the problem. I can't figure out, and neither can most people, which managers I'm going to use and pay who will be the minority who will outperform.

You just can't tell in advance. So that's difficult. Most of the time, you're going to pick one who's going to underperform. But that's just one side of the coin. The other side of the coin is, and what's always kind of lost in the discussion, is the next derivative of this is, well, let's look at the managers who outperformed and let's see on average how much they outperformed by on an annualized basis.

And let's look at the managers who underperformed and let's see how much they underperformed by on an annualized basis. And here's the problem. A minority of managers outperform. So therefore, the probability of you finding one is low, and therefore, you would expect a huge risk premium for finding one, a very high excess return if you actually found a manager that outperformed.

But in fact, the alpha that they deliver is exceedingly low relative to the huge risks that you took going out trying to find that manager and by not using indexing. The average underperformance of active managers is two to three times the average alpha that the outperforming managers deliver. So even when you win, you lose, it's not a fair game.

You're not getting paid enough for the risks that you took. So it's a probability, there's a low probability you're going to find an active manager that outperforms ex ante, which means before they outperform. And then the payout that they're delivering on average isn't nearly enough to compensate you for what the average underperformance is of all the other managers.

And by the way, there's a lot of managers who don't even make it that far. They go out of business or they end up merging with another company. So this is all about probability and payout. For a portfolio that a person is going to put together for themselves or for their clients, if you put a portfolio together of only index funds and every single asset class, and let's say you're going to use 10 different asset classes and 10 different styles and you only use index funds, the probability that that portfolio of index funds will outperform any randomly selected portfolio of actively managed funds in the same asset classes is over 90%.

But there's no reason to select a randomly selected portfolio. So we can go into that. Exactly. I understand you. We can go into, well, we can just pick the ones that have low fees. So we look at the funds that have low fees that are actively managed, for example, because we know that fees matter.

And we find that a high percentage of the low fee actively managed funds track the indexes very closely. In other words, they're closet index funds. So you're paying more money for basically an index fund. It doesn't increase the probability by very much that those funds are going to outperform.

So you say, okay, what else can we do? Well, let's look at past performance. Well, we study after study after study shows that if you pick managers based on their past performance, there's a high probability you're going to underperform in the future. There's what's called persistent studies by S&P that are put out every six months.

And if you just say, we take a hundred funds and we say, okay, here are a hundred funds that outperformed or in the top quartile in the last three or five years. How did those hundred funds perform over the next three to five years? We find out that it doesn't even come up to a random number.

You would figure over 25% would stay in the top 25% over the next three or five years. And it's less than 25%. I mean, it's not even random. So it's extremely difficult to say that past performance gives you good future performance. You can't say that low fees give you good future performance.

So what is it that you're going to use that's going to determine what the performance of a fund is going to be going forward? And do you really even need to take that risk as an investor? So then why are you utilizing a managed bond fund of an unnamed origin in some of your investments?

Because again, looking at, I want to capture the risk and the return of the asset class in the most diversified, lowest cost way. Now indexing and index funds and ETFs are not to the point yet in every single asset class where they are the best representation of an asset class.

So this particular unnamed fund that I can't name for compliance reasons has 6,000 municipal bonds in it and the fee is, I think, 10 basis points and it's an actively managed fund. The best closest index fund has maybe 2,000 municipal bonds and the fee is 25 basis points. So my point is, well, the index fund is higher cost, has less diversification than the active fund.

And so if I want to get the best representation of an asset class, I'm going to use this fund even though technically the active fund, technically it's active, but it's a better index fund of municipal bonds than the actual municipal bond index funds out there. And that's what I mean by, you've got to look at what's in the fund.

What are you trying to capture? And most of the time, or a lot of times it's index funds, but other times it's not going to be. So do you think the management of that fund then is... No, they're not adding any value. I'm not buying them because they're adding value.

You're just buying them because they're a massive fund and they're cheap and they represent the broadest access to the market in a single security. Okay. Now, I don't generally... Yes, correct. But that was true about municipal bonds. But let's talk about, instead of representing a market, let's talk about representing a risk.

Okay. Okay. So if I do a portfolio asset allocation, it's really risk diversification. So you isolate out all the different risks in the marketplace and then you make a determination as to whether or not you're going to take a position in that risk. For example, in the bond market, there's two general risks.

There's term risk, which is longevity or maturity type risk, where you invest in long-term bonds, you get a higher return than investing in short-term bonds. Then there's credit risk, where if you get less quality bonds, you get a higher return than high quality bonds. So you have to determine where you want to fit those two risks, how much of those risks you want to have in your portfolio.

And then you go from there to seek out the best representation of those risks. And those are the funds that you buy to put in the portfolio, as long as they're well diversified and low cost. And same thing goes with factor investing. For example, if you believe in taking a bigger position to value stocks, and we can have a whole discussion about this, I mean, an hour long.

But if you decide that you want to take a position in value stocks, the question is, how do you determine value? Which factors do you use to determine value? How do you measure the cost per unit of risk in each of the funds that you're looking at? So if I want to get more value exposure in my portfolio, I just use a value index fund?

Well, it turns out, no, because they don't actually give you the best value exposure. You would use some other company that I can't name to get the best value exposure in your portfolio, even though it's a little more expensive. And even though it's quantitative or actively managed, it's the best way to get that value risk in your portfolio.

And it's not an index. So what's the proof that you have if you're constructing a portfolio? Let's walk through the process of constructing a portfolio. And I come in and I say, Rick, here's my retirement portfolio. It's got a million dollars in it. I need to invest it in such a way that it's going to provide for my family's financial security and retirement.

What's the first stage in that process? Okay, so you're talking now, what I've been talking so far, and all we've talked about now is my side, which is the academic side. Right, right. But where I want to go is I want to talk through the client side. But then I want to go back to the academic side and say, how do you construct the portfolio figuring out which proportion for value to measure the risk and goals of my portfolio?

This is a great question. So now I have to flip around and put my financial advisor hat on because I'm sitting in front of a client and I'm talking with the client. So we do the basic, who are you? What risks do you have in your life? Do you have job security?

What kind of income do you have? All the kind of basic financial planning issues to determine how much you're going to need at some retirement date, how much you're going to need to draw off that portfolio at a retirement date in order for you to achieve your life goals.

So we have that conversation. Build the financial plan. Exactly. That's all it is. And then from there, it'll come up with a stock and bond mix and maybe a portion carved out for emergency funds. But just leave that out for a while and just talk about how much of the portfolio should be in lower risk assets and how much can we put away for higher risk assets to have a greater return later on down the road.

Very basic stuff. Now again, I'm talking with a individual investor here. And we come up with not so much, well, first we come up with the number of the asset allocation. In my mind, I generate what kind of rate of return they're going to need and that in my mind generates what kind of a stock and bond mix they should have.

But that's not the end of it. I have to make sure that whatever that asset allocation is fits the client's emotional makeup so that they're not going to capitulate with that asset allocation in a bad market. So we don't do clients any good. Not so ever if we recommend asset allocations that they can't handle in a bad market.

And then a lot of times the clients have, they may have a high tolerance for risk, but they shouldn't be taking much risk based on where they are and what's going on. So we go through this whole process with them. So let's say we come up with a portfolio that's 50/50.

50 stocks, 50 bonds. Great. At that point, I say to them, oh by the way, also look at the tax side of it too. Is this taxable money, non-taxable money? So IRA, non-taxable. So the next thing is at that point, we basically stop with the client. Then we create the portfolio.

So the client's not involved in that side of it, but I'm putting together based on my academic work what has the highest probability of maximizing the risk and return within each asset class, stocks and bonds. And then I put together the 50/50 portfolio based on that. So you're looking at that and you come up with the idea, okay, of these stocks we want 35% weighted to large cap stocks.

Now within the 35%, what's your proof of what proportion should be designated into value versus other aspects of large cap stocks? Well let me make another plug for my book all about asset allocation because it's all in there. Nice. Of basically the efficient frontier of total market to value type investing.

And it shows you that somewhere around 30% seems to be a middle of the road number. And everything, by the way, with asset allocation when you're talking about these things is a sort of a middle of the road number. And I can give you a rule of thumb. If you take the risky equity asset class and the non-riskier large cap stocks versus small cap value, small cap value has higher risk and higher return expectation and large cap has lower risk and lower return.

So if you do an efficient frontier between those two, you come up with about 30% every time. Doesn't matter what the asset classes are. The efficient frontier ends up putting you somewhere around 30% roughly. Do you follow that, what I just said? Yeah. Yeah. That's how I build it.

I actually only use 25% go into these factor type funds. I don't even go to 30 and that's because of psychological. There's too much tracking error in the portfolio if you get much above 25% in these factor type strategies. Where the client may capitulate because the equity portfolio is underperforming the stock market by too much when those factors don't deliver.

I just threw a whole bunch of stuff in there by the way. A whole book can be written on that. Indeed. It gets pretty meaty. Instead of going deeper into that, I want to ask about the concept of risk, specifically with stocks versus bonds. When I was a practicing financial advisor speaking with clients with a responsibility on paper managing portfolios, I never could have made this statement nor could I have put it into practice because the firm has to protect itself based upon the need for the client's portfolio to match their stated risk tolerance on paper based upon standard investment industry norms.

If the client says, "I'm a balanced investor," or "I'm a moderately conservative investor," their portfolio needs to reflect that with an aspect of stocks versus bonds. However, since I no longer have that responsibility, I can make a statement like this. For me, I am persuaded that it is easier for me to modify my emotional makeup with regard to stocks and the variability of the market and also to plan appropriately in my personal finances to counter for the massive swings of up and down market risk.

Such that in my own personal portfolios, I would rather be in a 100% stock allocation in order to generate the highest long-term return. I get very concerned in working with clients and looking at client portfolios with the amount of assets that people have dedicated towards bonds based upon this concept of, "I'm a conservative investor." I get concerned because I look at the long-term return versus the risk that they face of the decrease in value of their money, the inflation risk.

I say, "It's easier for me," and if I had an iron fist over, say, my dad and mom's accounts, "It's easier for me to make a financial plan with enough cash on hand that I don't have to pull from the market if we get a down year. I want the 100% stock portfolio because I want the highest total maximum return." I don't personally buy for me or for my mom and dad, I don't buy the concept of, "Oh, we got to do a 60/40 split." Am I wrong?

No, not for you. You're not wrong because you understand it and because you're at the level of your knowledge where you understand that you can put money aside, which by the way is like a bond. So therefore, you actually do have a bond portfolio. So you are not 100% equity.

But the bottom line on that is that that's for you, absolutely. I am 58 years old and I have 100% equity. Wow, crazy. Why would a 58-year-old have 100% equity? Only because, well, I'm going to get a military pension. I've got a small pension coming in from Smith Barney.

I've got a small pension that's going to be coming in from Peter Peabody. I've got a small pension. I'll be getting Social Security. My wife's going to be getting Social Security. I have that. So I don't need bonds per se in my portfolio with the exception of the emergency fund that I have.

But everybody's different. You are at a much higher knowledge level than most of the people that you would be working with if you were an investment advisor or a financial planner. Everybody is brave in a bull market. The problem is if you take their bravery and you turn it into an asset allocation based on what they think their risk tolerance is after the market goes up 250%, you would be doing them a disservice because they would capitulate in the next bear market and there's no way they're going to get that back.

You would have really done a disservice to the client. Even though it's technically correct what you said, we want to get the best return for the clients. We would like them to know as much as we do, but I can't take my brain and put it in their head.

So I have to pull back and work on what is in their best interest. And sometimes even though having 100% equity is certainly in somebody's best interest, it isn't in their best interest because they're going to capitulate as soon as the market goes down. So it's not in their best interest.

And so the other side of the coin is the emotional reaction. And the hardest part about what we do as financial advisors isn't the asset allocation, technical, efficient frontier, whatever. It's all the same for every company. Yeah, 25% small value, some reach, so whatever it is. That's the easy part.

I can teach a 10-year-old how to do that. The hard part is reading the client and trying to figure out what is the best strategy for them, knowing the technical side, knowing what they need, but also knowing how people act. And that's the hard part. And I'm even personally, I'm a little unsure of my opinions in this area because I spent six years working with clients, the first three of which were focused on insurance, the last three of which I started to build my wealth management practice.

And during that time, I never walked with clients through a major downturn. And by the time even this, all the tiniest downturns a few months or so ago, I wasn't working with clients. I'm working with client portfolios. So I've not walked through a difficult time period. It's an intellectual exercise for me.

But looking at it intellectually, the concern that I have, and what I always felt when I was doing planning, is that as a financial planner, our major tool that we should be utilizing is not necessarily the asset classes within the IRA portfolio, but the asset classes that the client is more used to controlling.

So thinking, yes, could you keep $100,000 of cash in the checking account, and/or you could keep the $100,000 in cash or a short-term bond in the portfolio. And yes, it has the same effect, but the reality is that the cash in the checking account is accessible for the client, so I can point and say, "Look, ignore the portfolio over here and look at the $100,000 in the checking account during times when the market is down." And I look and I say, "Okay, a 60/40 portfolio versus 100/0, is the emotional mania driven by the actual numbers on the statement, or is the emotional mania driven by the newscaster on 5 o'clock saying, "Well, the Dow Jones Industrial Average dropped today by 487 points?" So it's both, because you can imagine when you see that the market's down 2% in one day, you don't need to look at your statements or get online to know that you're down.

You know that. So you're going to have that reaction anyway. But to your point about putting stocks in one fund, let's say your IRA or your personal fund, and just have all stocks there, and then your emergency money maybe being in a short-term bond fund or CDs. And so together you might have 70% stocks and 30% bonds when you put those two together.

In somebody's head, when the market is going down, they're only looking at the stock portfolio. And I'll give you a story. So I used to fly fighter aircraft in the military, and we have had situations where pilots are rolling in on targets, and they roll out, and they want to hit that target so bad, they get fixated on that target, and they drive the plane right into the ground.

They kill themselves. So what happens is the same thing here. The clients will fixate on just that equity portfolio, and they'll drive themselves into the ground and blow it up. So that's why I say, should you have a portfolio of just stocks over here, and maybe a portfolio of just bonds over there, or should you have a balanced portfolio on both sides?

And what I find is that psychologically, it's easier for people to, even though the same asset allocation is 70/30, to have a 70/30 over here in your personal savings account, and 70/30 over here in your IRA account, because you don't get so fixated on the dive, if you will, that's going on.

So what about this? What about the fact that clients are looking at a bond portfolio, and no matter what the numbers say, then it's very easy for the news mania to creep in and say, well, interest rates are going to rise, and your bond portfolio is going to plummet in value because interest rates are going to rise.

And yeah, the Federal Reserve, if they make this tiny rate hike, then all of a sudden, you're going to be down 40% of your value, and your bond mutual fund has an unlimited duration over time, because it's always got to be-- it doesn't. What I mean is that instead of looking at it and saying, OK, this individual bond issue that I have is going to mature, they can say, well, this mutual fund, yeah, it has a duration, but because they're always cycling new bonds in, maybe this bond portfolio can evaporate.

I've seen that mania, too. And so without data to come against that, it's so easy for us to be susceptible to even that, this fear of bonds. I agree. And we've probably had more bond fear than we've had stock fear in the last six years. But-- and we have had-- I was talking to-- I won't name them, but it's a-- I happen to be in the offices of one of the very large robo-advisor firms, because I know them all really well, so I go visit them.

This one happens to be in New York, but I won't mention their name for compliance reasons. Anyway, I'm there and talking with them, and they were trying to figure out how to answer questions from clients who call in and have fears. And the fellow who I won't mention his name said, we were thinking about having a dial-in number where it says, if you think interest rates are going to go up and the value of your bonds are going to go down, press one.

If you think the stock market is going to continue to fall, press two. And then get a recording, because it's the same answer. But yeah, these fears are difficult for people who don't have a lot of experience. And this is where the advisor comes in. This is where we make our money.

We make our money figuring these things out. Like I said, the technical side of this is easy. It's the emotional and the coaching side for the client that's hard. The therapy side that's hard for the client. But if we can do it, if we can keep them invested and keep them on track, stay the course, like John Bogle says, that's really a value added to the client.

Last question. So let's talk from your academic background and perspective. I've had a few portfolio managers or people who are on the show who talk about this. One of the most popular portfolios, and I've talked about it on the show, would be the permanent portfolio. The idea of 25% in each of four asset classes, including gold, including cash, and cash equivalents.

Academically that portfolio, depending on what you look at, often doesn't seem to perform when compared against other portfolios because of the underexposure to stocks. However, emotionally and psychologically, I believe it's powerful. Even for me, I still at times consider, I wonder if I should just be running the permanent portfolio.

It's so emotionally powerful that I wonder if it's not a better solution than we often give it credit because it fits that narrative and it allows you to look at the movements of the monetary system. It allows you to look at the government system and say, "Well, okay, I've got these protections in place." What's your perspective on that?

All right, I'm going to back up to a 10,000 foot level. There's a difference between investment philosophy and investment strategy. What you just talked about was a strategy. Philosophy is, I'm going to buy these four different asset classes. I'm going to do it in a low cost way. I'm going to buy a global stock index fund, a total bond market bond fund.

I'm going to put my money over here in, I don't know, one year of CDs and I'm going to buy a gold ETF. It's going to be passive. It's going to be low cost. It's going to be 25% in each and this is what I'm going to do for the rest of my life.

The idea of doing passive low cost is a philosophy. You and I, I believe, or I don't know, but maybe you and I have the same philosophy about low cost passive is the way to go. I don't know if you believe that or not, but I do. When I, all my clients do because that's the way they're investing.

That's philosophy. The other side of the philosophy is active management, try to pick managers who are going to outperform, try to time the market and all that. That's the other philosophy. I gave up on that years ago. I'm in this church here and I'm pretty far up the number of pews.

In fact, I'm probably at the altar. That's the philosophy. You're preaching from the pulpit. I'm in the choir anyway. John Bogle is the high priest. I'm in the choir. Everybody in the church has the same philosophy. No one in that church has the same strategy, which is what you were talking about.

How for me should I take this philosophy, divide it up into an asset allocation and different asset classes, implement it and maintain it? Everyone in that church is going to have a different strategy for how they do that and how they apply it to their life. Same philosophy, different strategy.

To get to your question is, if it works for you, great. That was a really fast answer after a really great intro. I like it. Rick, tell us about your service offerings for advisors and for individuals if anybody wants to work with you directly. Books, websites, materials. Let's have your commercial here for the ways that you can help the listeners of this show.

I appreciate that. You go to rickferry.com. I tried to make it simple even for myself. If I have my name on my website, I won't forget what it is. R-I-C-K-F-E-R-R-I. R-I. That's correct. F-E-R-R-I. There, I have my blog. I have my books. I have a link to our company website which is Portfolio Solutions.

There, we actually implement this philosophy for clients using various strategies based on their particular needs. We implement it through custodians such as Schwab and TD Ameritrade. We charge a low fee to help them determine what portfolios they should have. Then we do all of the back office administration and rebalancing, purchase everything, rebalance, report, and all this standard portfolio management stuff that we do.

We do it at a low fee. We've been doing it for 16 years. Recently, we've reached out to advisors and we said, "We will now do this for your clients directly where you have a portal and you're going to run that relationship with the client, but we're going to manage the portfolio using the same strategies." The fees for this are, for clients who come to us directly, it's 37 basis points.

That includes access to our CFPs to figure out what their investment needs are and so forth. If an advisor is in the picture and the advisor sends us a client, it's 25 basis points management fee. That's what Portfolio Solutions does. We have 1.4 billion under management. We've got a staff of 16.

We've been doing this a long time. We were the original low cost RIA out there. There's a lot of competition out there now that wasn't out there before. I'd like to believe that because we've been so successful, people have seen us and said, "Let's copy it." That would include that great big company out on the East Coast that we can't talk about, of course.

>> I just love, it's never been a better time to be an equity investor. As far as cost, lower than ever. Information access to information, lower than ever. It's better than a worst time probably to be an uneducated investor because the manias seem to get worse. It just seems to get tougher and tougher.

Rick Ferri, F-E-R-R-I.com. Thanks so much for coming on. You're welcome back anytime. >> Thank you. I appreciate it. Thank you very much. >> Those of you who are long time listeners to the show will have heard loud and clear my tongue in cheek at the beginning of the show when talking about that this is the only right way to invest.

Hopefully you've gained and learned a lot from Rick. He's a really great guy and extremely knowledgeable. He presents a strong case and I would encourage you to become knowledgeable about those options and make sure that you're using the information that he shared with you and also other information that you can find as well to figure out what is best and right for you.

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