Welcome, everyone, to the 86th edition of Bogle Heads on Investing. In this episode, we welcome back Joe Davis, Vanguard's global chief economist and global head of the Investment Strategy Group. Today, we'll be discussing Joe's new book, Coming into view, How AI and Other Megatrends Will Shape Your Investments. Hi, everyone.

My name is Rick Ferry, and I am the host of Bogle Heads on Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a nonprofit organization that is building a world of well-informed, capable, and empowered investors. Visit the Bogle Center at boglecenter.net, where you will find a treasure trove of information, including transcripts of these podcasts.

Before we begin today, I have three announcements. First, we lost an important voice in our community this month. Jonathan Clemens passed on after a valiant one-year battle with cancer. He left behind a long legacy that will not be forgotten. If you'd like to donate to Jonathan's charity called the Jonathan Clemens Getting Going on Savings Initiative.

You can learn about it on boglecenter.net, where contributions are being taken. I also did a podcast with Jonathan, Jason Zweig, and Christine Benz, episode number 82. You could go back and listen to that podcast and learn all about it. Rest in peace, Jonathan. You will be missed. Second announcement is after doing this podcast for seven years with occasional guest host, John Luskin, I have asked John to do half of the podcasts going forward.

So we're going to be switching back and forth. Last month, John did the podcast. This month, I did the podcast. Next month, John will do the podcast and so forth. John does a great job, and he is much more savvy about technology and getting the word out than I am.

And he's already got some great guests lined up. Last, our conference is coming up. We'll be kicking it off on October 17th with a Q&A. Christine Benz will be speaking with Salim Ramji, the CEO of Vanguard, Friday, October 17th, and it'll run straight through all the way till noontime on October 19th down in San Antonio.

There are still a few tickets available. We will have over 600 people there, which is an all-time record. The conference continues to grow. It's just going to be a phenomenal event. Hopefully, we'll see a lot of you there. My guest today is Joe Davis, Vanguard's Global Chief Economist and Global Head of the Investment Strategy Group.

He leads teams that are responsible for Vanguard's research and thought leadership agendas, as well as the development and oversight of the firm's investment methodologies and models. Joe chairs the firm's Strategic Asset Allocation Committee, which governs multi-asset class investment solutions. And he is a member of the senior portfolio management team of Vanguard's fixed income group.

Joe was first on the program back in December 2019, where we discussed economic conditions right before COVID. He recently wrote a book, Coming Into View, How AI and Other Megatrends Will Shape Your Investments. We're going to be discussing that book today. If you're going to the conference, you're going to get a free copy of this book, Compliments of Vanguard.

So, with no further ado, let's welcome back Joe Davis. Welcome back, Joe. Ah, thank you for having me. I tell you, economists rarely are invited back to a forum, so this is big news in and of itself. well, it's because we have short memories. Great book coming into view.

I've read it twice because I wanted to make sure I fully understood where you were going with it. We're going to dig into that in a minute. But I do have one question for you about the book. I actually found it unusual, maybe I'm wrong, that an employee of Vanguard was able to publish a book whose last name isn't Bogle.

First of all, we never set out to write a book. It was more of our conclusion and assessment of the potential risks that lay ahead that I felt compelled to write to a broad, smart audience, but is not reading economic, technical papers every day. So we reached out to Wiley, who had published many of Jack Bogle's books.

Now, Jack Bogle is in his own stratosphere, but it was a productive conversation. My only expectation is two things. One is I want all the proceeds donated to charity. And secondly, we're writing this, much like Jack did, the aspiration is to write it to a really intelligent audience, but let's try to take the technical jargon out of there.

And so that was the aspiration. What's the name of the charity? We're donating all the money to what we call Vanguard Strong Star for Kids, which is one of our charitable foundations to help children live in poverty. It's this one of the charitable organizations we support. In the beginning of the book, you talked about a conversation you had with Jack 20 years ago, where you said that was the beginning of writing this book.

And this has been a 20-year evolution. Describe that conversation and how this book was the outcome in part because of that conversation. Sure. Well, and to give the context, it was roughly the year 2004. So I've been working at Vanguard for about a year. I was hired out of graduate school to a new group that had just been founded, actually the group I lead today, Rick.

And so we were a small group and we were actually established to continue in our small way, the legacy, the profound legacy Jack Bogle had started, but he was getting older in his career. And so he would do speeches, but do we have a group that could articulate the wonderful scholarship that Jack had done and start doing it in, you know, other topics because they'd been so important to clients.

So that's the context. Jack was very supportive of even our group being established. So I had the audacity to reach out to him and say, hey, Mr. Bogle, do you mind meeting for lunch? I would love to just pick your brain on one thing. I'm a nobody, Rick. I'm a year out of grad school.

The fact that he even took time to have lunch with me speaks volumes of himself. So I have all my notes ready. We're going to have lunch in the galley. And I think he's going to quiz me on the Federal Reserve or what my GDP forecast is. I'm the first economist, by the way, hired at Vanguard.

And then I'm prepared for the question, why does Vanguard need an economist? Which, by the way, is a fair question. So we can get to that because he did, he would tease me on that. But he says, Joe, actually, I think Vanguard fundamentally needs an economist. And here's what I need you to do for me.

Now he goes, I have a decent framework for thinking about expected future returns for various investments, stocks, bonds, you know, the cornerstone of our portfolios. And he was actually being modest. I mean, his frameworks have been published. So you take dividends and earnings and some PE assumption, what P's are going to do.

I mean, some effectively some form mean reversion. And he goes, it's pretty good, but I could use some help. I need investors to have a better understanding of how some of these economic trends can affect the building blocks of returns, earnings for stocks and valuations and interest rates for bond investors.

So it was a really productive conversation. I'm listening just in one sense saying, oh my goodness, I'm having lunch with Jack Bogle. And then he's giving me homework assignments. And of course, I'm all happy. I'm like, I'm going to do this for Jack. I mean, the fact he even cares.

I could see the wisdom in his ask. I was not thinking of that. I was thinking more short term. You know, I was new to Vanguard. Most economists focus on GDP for the next six months. It's a cottage industry. You see them on the media all the time. That's usually the first question I'm asked.

But I think Jack was getting to important things for investors. Should we just assume the long run returns for the stock and bond market in constructing portfolios, right? Because then we have to assume returns, 4% for bonds, maybe 9% for stocks. Or are there times when you say, you know what, that's a little too high or a little too low, simply for planning purposes.

And so he was trying to create a line of sight saying, listen, I get questions on the time on globalization or tech, interest rates, deficits. Can you help me think through a framework? Now, this is 2004. So now I'm happy to say in the year 2025, so roughly 21 years later, we finally finished that framework.

That's work I had started 20 years ago. And we've been thinking about these matters in some degree. But it was in the past two years that I think we've taken a step forward respectfully for the entire industry. There is not a framework that exists that this book is utilizing simply to give probabilities and magnitudes for outcomes that investors can think about for risk management.

And and that's really the heart of the book. So it was an interesting book, not long. It is a fast read, if you don't mind me saying, but you do have to read it twice, some parts three times to really get a good idea of where you're going here.

And, and the second time I read it through, I really began to see the structure of where you were going. And in my own mind, this is how I see the outline of the book. Okay. Yeah, there's two parts to it. First part is about change, if you could put it that way, change.

Yes, you've explained change, the form of mega trends, and you list out what you have come up with is four mega trends. Now, that's not all the mega trends that are out there. But these are the four that you believe are probably the most prominent ones. And sure, and they are technology, especially AI.

Yes, globalization, basically, the miracle of modern commerce, which would include trade, and demographics, meaning the aging of the global population. Yes, government debt and deficits. So those are the mega trends. But then you want to look at them in the context of four different things. And there are many ways you could look at them.

But the four ways these mega trends could affect the following factors or topics, and they are GDP, which is the growth of the global economy. Yeah, growth, real growth. And then there's the stock market performance, inflation, and interest rates. So four mega trends, four economic and financial items that they could affect.

And then lastly, you did this across many countries. So it wasn't just the United States, you did it across China, UK, Germany, Japan, India, four other nations. And that's the first part of the book, very interesting analysis. The second part of the book, which we'll get to, is more along the lines of, okay, what do you do with this, now that you have it?

Yes, as an investor, right? Other than it's a nice economic seminar, right? A lot of a lot of good charts and graphs and pictures. And so you structured it along the lines of, can this have an impact on investment selection, and asset allocation? So we'll get to that in the second part of the talk today.

So Joe, is that a fair assessment of what the book is about? Yeah, and I, you know, I was a really good summary or decomposition, Rick, in terms of the book. And again, to give more context, I was actually looking for a book of somewhat this variety, just for my own consumption.

I have two roles at Vanguard in many ways, just for context, right? I'm, I'm the economist, I'm chief economist for the firm. But I also run our investment strategy group. So think about asset allocation, expector returns, a lot of stuff you and many others in Boglehead community talk a lot about, right?

Importantly, financial planning topics. I was looking for a book that bridged these two together in one part, because is a going to matter at all? Should I just have my head in the sand? Or are there a risk emerging? What about our deficit levels? Like that, is it never going to matter to the bond market?

I get these questions all the time. We spent three years doing this empirical, this is a data driven framework. This is not my opinion. This is not Joe Davis's thoughts on how the world may evolve. This is coming from a living, breathing system that I think thoughtfully having all these mega trends in a living system impact those four variables that you mentioned, these four, you know, big things that determine stock and bond returns.

And it keeps us honest, it does it in a probabilistic way, because we know the future is uncertain. And that's eye opening, because that is not done. Even in academia, in the leading institutions of the world, in the central banks, they are not doing it the way that we're doing it, because they have different problems to solve.

They either care just about the stock market, or they care just about GDP. But if I'm sitting at home, and I'm planning for my retirement, it's like, I don't know. They're talking about AI. All I know is, do I have enough money at the age 65? And so there was this gap.

But I had to break it down for the audience. First of all, let's demystify as best as I can. I tried really hard not to sound like an economist in this book. So like, I'm looking for like a B minus here, right? Because there's a lot of jargon. I go to my medical doctor for my annual physical.

I think I'm a decently smart person. But I don't know what they're talking about. They use all medical terms. So let's try to demystify it. But I don't want to take out the knowledge of the doctor in that, right? And that's what Jack Bogle would do all the time.

So it was channeling Jack in that in that regard. And so that's where we did. So the first half is really on the economic trends. And we look at each one of these, there could be others we could have looked at. But these are the four that will matter the most by far in the next several years.

So the first mega trend is technology with a focus on AI. Yes. If there's going to be one factor that matters most in a positive or a negative way, it's technology. We know this since the industrial revolution, right? Productivity or how efficient we are as workers, how creative we are in new products and businesses, ultimately is the lifeblood, the oxygen for economic growth and can keep inflation at bay.

Of course, it's always a difficult time trying to assess what future technological change will be. We're proud of the fact that, listen, we don't have some crystal ball like we already know what AI is going to become, but we collected data to be able to look at all past technologies.

I mean, back 150 years, particularly the ones that really are rare. They're called general purpose technologies. Think of electricity, internal combustion engine, the computer. They're rare, but when they happen, they really change trends and have some second order effects that affect interest rates in the stock market, sometimes very positively.

And so what our assessment was very eye-opening at the high level, it says that the general expectation that economists have today, if you ask most economists in the US, they say, oh, roughly stable growth, stable inflation, 2% and 2%, which by the way, that leads to 4% interest rates.

The probability of those happening in the next five years is very low, which was shocking to me. I mean, we're saying it's a very bold assessment on the future, but it's data-driven. Where the odds are tilting is that AI is going to lift growth more than some expect. It's going to be disruption.

So not it's everyone's happy and everyone can go about their business. There's significant labor market change ahead, but net-net, it will lead to greater all automation. Not all that will lead to job loss. We need to save some of our time. So much so that it will offset the aging of the baby boomers from here into the year 2032.

It'll save around 18 million workers. Now we're going to lose that in the labor force. It just so happens it will come at the right time. But I didn't know these answers until we did this data-driven framework. I mean, this is all around probabilities and magnitudes. And the biggest thing is that it will be augmentative for roughly 60% of the occupations.

For 20% of the occupations, we're doing this at the actual, at the every occupation in the world. So there's over 800 occupations. And this system is looking at AIs in what it could do five years from now. And I compare that in the book to the personal computer when it emerged.

There was winners and losers in occupations. But there will be some automation for sure. But the headline is that the greatest risk in the future is not necessary to inflation, it's actually to growth, which changes some of the economic assessment. The fact is, though, it better be transformational, because if it's not, we start to have deficit pressures built in the bond market, given the aging of society.

And so that's the heart of the book, is that it's tough to generate the sort of status quo view that I myself shared in the community for the past several years. That's unlikely to happen. A turning point is coming. The question is, which one? And most importantly, how do you navigate your portfolio, not to be tactical, but from a risk management perspective?

I read an article by MIT recently about how long it will take AI to be utilized in various industries, and some faster than others. Like we know, it's already being utilized quite a bit in the software development industry. But there are other industries that may never be utilized much service industries, like the people who are going to be ironing your shirts at the cleaners are not utilizing AI.

So in other words, it's going to hit different areas at different times. And so it's not just all at once. Interesting, though, you talked about GDP. I'd like you to comment on the other three factors, which would be inflation, interest rates, and government debt. So how will AI affect those other three factors?

Well, yeah. And again, just to quickly bring it back to that risk assessment, we have a tug of war. The book is about a tug of war that emerges. If AI is transformational and the odds are tilted, roughly 60% odds, it's more transformative for the economy than the personal computer and the internet.

That's a pretty bold statement. It is. So think about that. From an economist's perspective, you can get the 3% growth, even though immigration and demographics and aging have slowed the demographic pattern. You can still get it. However, if AI is not transformational, and I'll answer then your question, Rick, because we're in the early stages of this, we're in roughly the second or third inning, if you use baseball and nine innings as an analogy.

If it's not transformational, we all use it, but it doesn't lift growth because it doesn't change how I work. It's kind of then become social media. We all use it, but it hasn't made us really more productive. Then you get some of these negative, not dystopian negative, but you get low growth, but you have high debt levels.

And so that's a different outcome. So you can see the financial markets are not prepared for the latter. So this has implications from a risk management perspective. But I get two reactions to this forecast. I have presented this forecast up in Boston and in Cambridge. So I won't mention institutions, but they're pretty well known.

Those that are really smart. I mean, I'm talking Nobel prize winning individuals. They're more skeptical. Hey, AI is going to be more marginal than some people think. So they think they're all the risk is on the left-hand side, the downside. It's called deficits dominate, AI disappoints. I presented this out in Silicon Valley to the leading tech firms that are probably on CNBC right now.

And I get the other skepticism, why are the, we already know the odds of AI winning are a hundred percent. Why are they not a hundred percent? So I said, well, respectfully to both of those camps, you're making some strong assumptions. I see it very possible, but here, what has to happen for those outcomes to fully materialize?

And so part of the reason Rick gets to your question that AI has to lead to new industries. It can't just save us time. That's likely going to happen, but it has to be transformative and have knock on effects to other industries. And if that doesn't happen, now you can see the effects of the other factors.

If we don't have the lift on growth, like the late 1990s, we have a structural deficit or ongoing fiscal deficits. They're manageable, but they're six or 7% of GDP. That's the highest in peace time, by the way. It's not a political statement. This has been growing for about a bipartisan fashion for at least 10 years.

They will start to mostly push up interest rates. Meanwhile, you have growth levels generally coming down because demographics, aging of society, less in the labor force. It's a little bit Japan-like, right? If you think about Japan. And so it's not the end of the world, but it's certainly a scenario that the stock market in the United States is not prepared for.

You have an earnings growth that's half the current level. And so the risk, despite deficits dominating, is not to bond investors. You have higher interest rates, probably not 4%, maybe 5.5%, 6% on average. Again, we have projections in range, right? There's ranges. But the risk is then in the equity market that is not prepared for lower earnings.

And they go into this with high multiples expecting AI to be transformational, as if it's already happened. It's not nearly as likely as the AI wins, but neither of these outcomes are consensus. So the central bank's forecast, the Federal Reserve's forecast has only a 15% probability of being correct.

It assumes that the negative forces of demographics and debt balance exactly out with the positive potential effects of AI. It sounds like if it does even come out to the good side, the Silicon Valley side, that it's going to be choppy. It will be. I mean, when you read the East Coast version, the MIT version of it, it's very spotty.

It is. We take into account three types of technological change. Automation, which means save me time, and you may lose a job. Augmentation, make me better, like a power tool. A construction worker is better with a nail gun than without it, right? And then the third one is really the wild card, which is what new products emerge, not because of AI, but utilize AI.

Like in the internet, online shopping became a platform. The internet did not create online shopping, but it enabled it. Electricity enabled the motion picture and entertainment industry. It didn't create it, but it enabled it. So I don't know what that is. I point to some of the things, but that's the wild card to me.

The computer simulation shows that more likely than not, there's going to be a positive lift to that. That's the last thing to happen. If you want a year, that's like roughly the year 2029, 2030, plus or minus. I wish I knew what company that was. I don't. I try to identify for the reader, these are the areas that would be helpful to lift growth or reduce or increase scale because of high costs to serve unmet needs.

Healthcare is a great example. These are the characteristics. If we're talking about just AI being game-changing, tell me the new product or service. If it's healthcare, for example, so when I went to Silicon Valley, I did push back to them a little bit. Listen, I know you're all bulled up on AI, and I probably have the most optimistic economic assessment of AI in the asset management industry.

That said, I said, I'm still waiting for the new medical drug that's been enabled by AI because I'm still counting, and I'm still waiting for it. Yes, as everybody's hoping for it. Yeah. So the next mega trend you talk about is globalization. Yeah. You have a section in the book called Perception Versus Reality.

Yes. The perception is, at least in the United States, that, oh, we are now deglobalizing and this is going to be a bad thing. Trade will decrease. Oh, and tariffs are a bad thing and so forth. You're saying we can get over this. Yeah. And again, I think economists, myself included, have done a poor job explaining trade.

First of all, they need to be demystified. And secondly, these issues have been politicized across many countries. I travel outside the U.S. extensively. Same thing. So one thing is that all is equal. Free trade is in general beneficial for higher growth, lower inflation. But there's always been an asterisk to that.

That assumes there's a level playing field, and there are always winners and losers of free trade, including permanent job loss. That was always glossed over, by the way. It was always in the economic textbooks, but most economists didn't talk about that fairly. I've been in the deal mill towns that have never come back since the 1990s, and the playing field has never been level.

Now, you've seen some tariffs. This is not how I would necessarily attack some of these issues, but some of them are being used in the United States in particular to address what some would view as injustice or unbalanced playing field. The fact of the matter is, however, take the politics out of it.

Most of the job loss, say in manufacturing in the United States, has not been due to free trade. It's been due to automation. 90% of job loss has been due to automation. That's not my opinion. That's actually a lot of academic research. Now, how do we play this going forward?

If we raise tariffs, you will have some winners and losers. You will have greater fiscal revenue for the US government. You have slightly higher consumer prices for sure. Will we see a lot of on-shoring of those jobs? Unlikely. It depends on the industry. I'll give you a factoid, which I think helps.

The average automobile manufacturer worker in the United States makes roughly $25 an hour. In Mexico, it's $25 a day. Some countries, it's $25 a week. So the tariffs, if you're going to use that as an implement to bring them back, what it will do is likely change the location of where it is made in other parts of the world, less likely to be on-shoring onto the United States.

So I think this is a misunderstanding of where you can get new growth, which is new industries emerging. At the same time, however, there have been other countries that have done certain things in trade practices that have affected the US labor force in a negative way. And I can't say it more candidly than that.

So it's a mixed bag and there's a lot of emotion, I think, wrapped up in this topic. The fact is that globalization is not in retreat. That's the headline. And it's very hard to do so. We could throw up walls and have 200% tariff rates. It's still unlikely that you're going to have on-shoring of all these products, Rick.

The fact is, is that global supply chain, they may change from China to a different country. We will see some of that. So you'll see that where the products are coming from differ, but you're unlikely to see this massive launch shoring, unless they are in very specific industries that have related to national security.

So I'm seeing this conversation in Europe. So we're moving one from in free trade or globalization, one from a sole focus on efficiency, which generally drove you outside of the US simply for cost, even if it wasn't for quality. We're going to see more of a focus among many countries to a little bit more security in that conversation.

So we will see some modest on-shoring, but I think it'll be on products that have more security focus rather than just on any product. I think that's naive to think that. Rick Archer: In Texas, Samsung is creating a huge fab here, a gigantic building, just incredible, the size of the building, but it's just not going to employ that many people.

And the people that it employs are not going to be generally local, except for people to maybe clean that building and maintain the grounds. Rick Archer: An electrical vehicle, EV manufacturing company in China, the human workers, the Chinese workers there touched that automobile once. Human hands touched the automobile once over the entire assembly line.

Everything else is done by robots. So if the jobs do come back in the US, and there'll be some jobs, like some products that we should have, it shouldn't have a supply chain that that's long. That's more of my editorial comment. Maybe some security reasons, the industrial base of the defense industry, for example.

But will they come back with hundreds of thousands of jobs? Perhaps not. Maybe you have 10. I've been in manufacturing plants where they don't actually have light. You don't need lights because there's no human beings in the plant. That's automation. So free trade is blamed for the loss. However, more of the jobs have been lost because of the technology and automation.

Now, the key question is, if I was in that occupation, what can policymakers do? What can what can governments do to help that transition if you did lose your job? And I think the economist community waved their hand. Well, it's free trade. The market will clear. It'll work it out.

But there's communities that can be impacted for long periods of time with job loss. And that's what I think has been swept under the rug by the economist community writ large. And I think we'll hear more of that. And tariffs, maybe they're kind of directed at some kind of that sort of dimension.

They're trying to get back at that. But I think there's other ways you can think about in the coming years. So let's put this in the context of the four factors, GDP growth, the stock market, interest rates and inflation. Listen, globalization, what we're finding is that it's unlikely to have a material different different direction versus what it has been.

Maybe we'll flatline. It does not move the outcomes that drastically. And why I say that is where the product is made will switch from country A to country B. It'll switch from China to Vietnam. It's not going to change the fundamental properties of the US economy, 90% of which are not tied directly to trade.

So globalization is a mega trend, but not one that you see really moving the needle that much in one direction or the other going forward. What about the third one? What about demographics? In the economic community, I'm probably rattling a few cages because there's that phrase, demographics is destiny, right?

It's from the old French philosopher. So I title, of course, I'm ton in cheek. So I'm not a comedian. So the best I can do as an economist, I called it demographics are not destiny, but that's the fact. And from an investor standpoint, probably it's the one mega trend I would say steer clear of in forming an investment thesis on.

I've seen at investment conferences for 20 years, where in fact, it's assumed so much, it's so important that it's taken for granted, Rick. And so this is part of demystifying it. Now, what do I mean by that? Demographics such as population growth, which includes immigration, as well as the aging of society.

So percentage of the economy, that's a population that's over 65 or young, which gets the labor force participation rates. Those two are an ingredients of economic growth. So you mentioned GDP. By definition, they are a component of GDP. So they do matter. However, all of the changes in the trend over the next three, five or seven years and 10 years, virtually all of when the trend goes up and when the trend goes down is all correlated to technology and productivity growth, which is technology, how much it makes us more efficient.

Hardly any correlation and no causation to future economic outcomes. I'm not cheering for bad demographics. It's not like I want populations in decline, but people write off whole countries. Oh, we're the next Japan because we have a demographic profile. They're writing off China now. Yes, I saw that. And they'll have pessimistic stock market forecasts.

Well, we have poor population patterns. Where's the demand going to be? I'll give you this factoid and I put it as a footnote in the book. The following periods I'm going to list were associated with slowing population growth. You ready? The Renaissance, the Industrial Revolution, the Roar in 1920s, and the late 1990s.

Population growth slowed a little bit in Italy during the Renaissance. It slowed during the Enlightenment, by the way. But productivity just took off. My point being is that productivity is what's going to matter. And that's hence comes back to AI. How much could it lift? Now, if it doesn't lift our growth, then yeah, demographics is a little bit weaker and growth will be weaker.

But that's because technology failed, not because demographics was destiny. That's the big link. So again, it's not saying that demographics, we want to cheer for aging. But the fact is, the world and mankind has been aging in terms of life expectancy for 2,000 years. Now, the only way it's going to matter in the next five or seven years is that in the United States, we have tied our growing deficits, the gap between tax revenues and government spending, particularly around Medicare, Medicaid, and Social Security.

We have tied those spending commitments to an age when you turn 65 or roughly thereof. So we have linked the aging of society to our debt profiles. And so that's where demographics will come in. And that's been long talked about. But it's not aging per se. That means it's a it's a death knell for growth and hence high inflation and low economic outcomes.

I'm getting back to the conferences over the last 20 years. I don't know how many slides I see of people saying, well, the baby boomers are going to start spending money. They're going to start taking money out of the stock market. Yes. You need to get out of the stock market early because, you know, the value of stocks are going to go down.

I mean, it's just ridiculous. There's no correlation. I can tell you technology matters over demographics by a factor of 10 to one. So weight that appropriately. So as I'm saying throw out demographics, they don't matter at all. What I'm saying, though, is it should probably fit a low weight in your investment thesis if you're going to use that as an input for your financial plan.

So let's go to one that everybody worries about. And that is federal deficits. And your number four mega trend is government debt and deficit. It seems to me the number one thing that people I talk with are afraid about is this growing federal deficit where it doesn't matter who's in charge.

The common link between the two parties is just spend more money than we bring in. And where does that lead us? And it can't be good. I mean, this is the perception. There is some of that dynamic. And I don't want to be like end of the world. We're going to have a currency crisis.

The U.S. is going you know where in a handbasket. It's not that, but it's a serious issue. So yes, deficits are a problem. They do matter for the bond market. So I get two reactions to this, too. Like yourself, Rick, I get some serious concerns about the fiscal spending pattern.

In other words, it's not just spending. It's either revenue, lack of revenue, or too much spending, depending on your political stripes. Either way, there's a gap and there's deficits are building. And then I have others say, listen, deficits haven't mattered to the bond market in 30 years. I used to hear about crowding out.

It's never happened. Like, so deficits don't matter at all. But the truth is in between. They do matter. They're only having a small impact on the bond market, meaning borrowing costs today. All else equal, borrowing costs for U.S. Treasury Securities bond yields are a little bit higher today than they otherwise would be, in part because we know, underneath the surface, the deficits are starting to push them up a little bit.

Starting to put a little pressure on the U.S. currency, the value of the dollar. But I don't want to be alarmist. I'm just saying that those forces can modestly grow. And yes, if AI or some other technology does not really lift economic growth and tax revenues like it did in the late 90s, yeah, at some point you're probably going to have the bond vigilantes have a spike in interest rates, the 5.5%, maybe 6%.

Maybe we'll get a modest recession. Unfortunately, that's probably what it may take to get fiscal bipartisan reform. For long-run sustainability, for the record, for your listeners, I don't care what the deficit is today. What structural deficits are is 10 years from now, 15 years from now, 20 years from now, they're going to be growing.

And so it's the long-run, it's the compound interest in reverse that Jack Bogle used to talk about, right? It's that in reverse. And so you want to sort of bend that curve a little bit. But that's the tug of war that emerges. We don't grow out of the problem if AI turns out transformational.

Effectively, what it does, it's like the late 90s. There's no concern about that. In fact, we started running surpluses, but that's generally not what happens in our simulations. What happens is that the can is kicked. It doesn't emerge as a pressure, much like it wasn't in the early 2000s before COVID deficits were growing.

The bond market, we had zero bound on interest rates. So you can extend this and it seemed like it doesn't matter for a time. That's in the path that if AI becomes transformational. So that's what I'm saying. There's this tug of war. All the other factors matter less, but the deficit spending could be an issue.

If you want the good news, the good news is that the two scenarios, I think the knee-jerk reaction, and probably the reaction I would have had until we did the research. If I know for certain that AI is going to win, it's going to be transformational. I would have thought, well, I should overweight tech stocks that are doing great today.

Forget everything else. And if AI is a dud and deficits dominate, I should definitely get out of fixed income because we're going to have higher interest rates. So I shouldn't be in fixed income. Actually, the optimal portfolio, or the risk-managed portfolio does exactly the opposite. You would overweight fixed income strategically because you're going to have higher real returns.

And even if you think AI is transformational, you wouldn't overweight tech stocks because the effects start to spread to other parts of the market that have not participated. So from a risk management perspective, you would go against what the momentum or the alarmist crowds, I think, are suggesting at this moment on the CNBCs of the world.

So let's get into the investment side because that is the second half of the book. Yeah. And you divide this into two sections. The first section is the individual investments themselves. And here we have to have the active versus passive discussion. Okay. Discussion. I have to do a little history lesson here.

Yes. 50 years ago, Vanguard was formed. Happy anniversary. Yes. To that 50 great years. But you were not formed as a portfolio management company. Jack was fired by Wellington and recreated himself as Vanguard, which was an administrative company, basically doing the back office paperwork for Wellington. So they didn't have to do it.

Yes. Then he came up with the brilliant idea to create the first index fund, which they did not manage because S&P managed it. And thus Vanguard started to go down the road of managing and index funds and then eventually took on active management as well. But yes, fast forward to today, Vanguard, about 82% of your assets as of the end of last year were indexed assets and 18% were active funds.

You have to kind of bridge that. Yeah, sure. Together. I mean, that is your role at Vanguard. I mean, you're an economist, right? Yeah. Well, yeah, I'm actually part of the active process on our bond fund. So I talk about beta and index at the same time. I'm part of the alpha process too.

So talk about in the book that you view part of the solution to this as being a, call it core and satellite index plus active. And so give me your views on that. Yeah. Well, I think for your audience, I think there's two things going on. I wrote this book just as much full disclosure, dare I say, for all of us employees at Vanguard.

There's some, a lot of new employees. Some never have never met Jack Bogle. I'd say two things. One is to underscore that wonderful investment philosophy, broad diversification, long-term perspective, the power of compound interest and balance, right? So, cause some could be reading this book that have never heard of Vanguard and there's my son's just starting out investing, right?

He's a college grad. So, you know, he may not have had these lessons. And so we definitely start there and I don't take that for granted, Rick, right? And so I talk about that. I don't want to spend this whole book on financial planning. Really important. That's allocation topics.

Yourself and others in the Bogle community have done an amazing job, right? I don't want to give a short shrift, but I wanted to at least underscore for people, not at all, to say three things. One is the average actively managed fund should be sold, just like Jack said.

Bert Malkiel has said, I talked to him about this book and met with Bert. The zero-sum game still holds, which means 50% of dollars before costs underperformed, 50% outperformed. Then we got to subtract our costs. That hasn't changed regardless of what the mega trends do, past, present, and future.

And so that hasn't changed at all. And we, Vanguard always has believed in low cost. And if the average median active fund has no role in anyone's portfolio, regardless of the scenario. So I'm not dragging active management because indexing is somehow deficient in the future world. That's not it at all.

There was two things going on. One is I have long believed, and we have believed at Vanguard, that under certain assumptions, meaning you think you can pick the manager, that you have the odds a little bit tilted in your favor because of low cost, that this skilled manager can modestly outperform the benchmark, which means he or she is going to beat the other manager on the other side of the zero-sum game.

That's the only way this works. It's not a free lunch. And Jack was great. And Bill Sharp, you know, this whole podcast talks about that. So we haven't changed that in any way. What I'm saying though, what's been lost though, is saying that, oh, Vanguard doesn't believe in active management.

That has never been true. That's correct. But we've never believed in high cost. It's private investments, probably like, get out of here. In fact, if anyone owns an 80 basis point index fund, they should sell it. And they heard it from me at Vanguard. Like that's way too expensive.

So I was doing two things. One is just to say, hey, that has a modest share, but that's acyclical. That has nothing to do with the mega trends. I could have done an all index portfolio there. Totally. Which is a great place to start. If I was running this for a model portfolio for an advisory practice, I would start there saying, regardless of our economic scenarios and AI, Joe, do you think you can identify talented managers in this low cost decile?

You think that they're going to repeat? I'm willing to take some modest tracking error or risk. Maybe my parents aren't. But I would have a little active management, which I have my 401k Vanguard funds. But I'm mostly indexed as the core, but I'm willing to take on a little bit of that in the hopes that those managers are going to beat out the other active managers on the other side.

And they have a cost advantage in doing so. So they don't have to be as smart. Well, your parents are a little bit older than you are, maybe a little wiser. Yes. Okay. Yeah. But I think it's fair. I think it's a fair push. I just think that had been a little lost in the conversation.

I'm part of the active process of Vanguard. Yeah. It's so hard. This has been my domain, right? Totally. Trying to figure out who those people are that have skill. And what I found is, and I have to say this because I've got to throw out my two cents. Oh, please.

Is that the truly skilled active managers are not the lowest cost managers. It seemed to me that the research that I did is that the lowest cost active funds just get closer to the benchmark, but they don't surpass the benchmark. Because when you look at who the ones who you could say have skill and have surpassed the benchmark with skill, and then you look at their fees, they're modest fees.

They're not low fees. Yeah. No, that's fair. That's fair. In fact, our research would be similar to yours, Rick. It's not like go to the lowest cost that's all throwing everyone else. It's just that high costs are a hurdle. Yes. Because I've seen that in the private markets too.

Like you necessarily want the data would suggest the cheapest fund provider or private manager. There's a cost to skill. But again, so Jack Bogle's emphasis on low cost. This book has not changed that, uh, and shall never change it. It's core. I was just so you must take the active funds out of it.

My point being is just like, you could have some percentage of regardless of what AI does or not, regardless of what deficits do. Got it. So that, that was part one, the investments. And we kind of beat that horse to death. Yeah. The second part is, and you may not like this, is the asset allocation or how you divide between your stocks, bonds, cash, U S international, different types of fixed income in here.

You could do a static mix or you could do a tactical asset allocation, also called dynamic asset allocation, also called by some, maybe me market timing. Yeah. And here you fall. Well, you don't fall, but I mean, you do talk about whatever you wish to call it, uh, tactical dynamic.

I know you don't call it market timing because you're very specific about that in the book, but go ahead and talk about that. Yeah. I framed his risk management. It's funny that, uh, I mean, I, I appreciate the push, right? You know, we've known, no, we've known each other, but that's what's candy.

You gotta be, you gotta do, you have, I would hope you would ask that question for your listeners. I spent a lot of time we talked time thinking about this. I was very careful with the words. In fact, I reread some of Jack's books from the past. He, he would talk as well about dynamic allocation, but it's like, as if now most, when they do talk about it and I do not like if they talk about it, the way I'm going to say it, as if it's alpha, they're smarter than the market.

They're going to look around corners. Oh, the fed's going to go, they're going to cut rates six times, not three. And hence I'm going to go long. That's tactical dynamic, whatever the, they'll have the nomenclature. I just think the odds of those success are low because the information content's low.

Agreed. This I think is different. It's still is a form of active management, meaning I'm deviating from the market portfolio, but it's under the framework of modest risk management, but it's taking risk in the attempt to narrow outcomes. It is still a form of active risk because I could just say, let's say my benchmark is 60, 40.

And we talk about this in the book, right, Rick? Yes. If it's 60, 40, one way to interpret this. Oh, you know what? I'm better educated about the risks ahead. But I think either, either the market has these risks priced, which is one interpretation. That'd be Eugene Fama. The market's efficient.

Just kind of price them. And, or I really don't care. I don't know. I'm just going to invest 60, 40. I'm not going to engage. I'm not going to try to be cute. Fine. And I talked about that. That's one course of action. And the 60, 40 will fare okay in either scenario.

Like you're okay. Because I provide the expected returns in the ranges. However, if you're concerned about the one risk growing on the left-hand side, can you modestly make changes to your portfolio? Not in a timing perspective. I want to narrow the outcomes. Now, a market timer would say, no, I'm not going to increase the downside.

I'm just going to increase the upside. That's alpha. In this approach, you are not going to have higher returns. You're going to have a slightly narrower range of returns. And so there's no free lunch here. It's like a form of insurance. But I don't use that word because that's a, that's a loaded word.

But I'm saying either way is fine. There's two forms of staying the course. One is I'm 60, 40, and I'm staying it. And I say, fantastic. The other ones is you're a little concerned about deficits. You don't know what to think about AI. We've done the math. You're still close to the 60, 40, but the, the deficit dominate scenario is a little bit rocky.

So you could just be a little bit defensive. It is not from timing. I don't know when the timing would be on that, but it narrows the downside. It also narrows your upside a little bit. So it's not like, oh, I got alpha plus 100 basis points. That's, I think that's bogus.

If someone thinks they can do it, I tell you, I can't do it. And our framework was not designed to do it. Well, so a little pushback, if you don't mind. Please. Here's the problem from an investor's standpoint, not only on the picking the active managers who have skill, which how do you do that?

You know, you can't use past performance because funds change, managers change, funds get bigger, funds get small. I mean, things change. It's very difficult to figure out who has skill and who got lucky over there. But now on this side, this allocation side, dynamic asset allocation, let's call it, it's also difficult.

Who do you listen to? You have to listen to somebody. You have, I could listen to you and say, yes, what Joe says makes sense. I'm going to go with what Joe's tweaks are on his asset allocation. But I have to stay consistent with that for like my whole life.

Because let's say that I said in the past, 20 years ago, I'm going to go with GMO, right? GMO is Grantham, Mayo. Oh, yeah. Sure. Mean reversion. Yeah. A lot of mean reversion. Okay. They were spot on in the early 2000 and they hit the ball out of the park.

Then in 2010, their seven year prediction was for negative 4.9% real inflation adjusted returns from large cap US stocks. In fact, the S&P 500 real return over the next seven years was positive 12.9% annualized. So if I went with GMO's outlook and reduce my allocation to large cap US stocks, I missed out on huge gains.

So if I went with GMO, I got crushed during that seven year period of time. But let's say I decided to stick with them. What happened over the next seven years? In 2017, GMO's forecast for large cap was negative 3.8% real return over the next seven years. And through 2024, the S&P 500 real return was 13.6% annualized.

Here's my point on that. I have to pick a winning economist to follow. Is it going to be GMO? Is it going to be Joe Davis? Is it going to be Ed Yardeni? I mean, where am I going to get my information from? And what if I pick wrong?

Actually, Rick, we're in more agreement than you think. Believe me, I run the investment strategy group. So long term asset allocation, also an economist. So I know familiar with the names you mentioned, I'd say this, you know, first of all, what is a reasonable expected range of returns? That's the right at the heart of the book, depending upon how these forces emerge.

So this is for planning. Now, not even changing your allocation, just like, can I spend 4% of my portfolio eight? Yeah, this I haven't changed my benchmark. It's still 60-40. So I'm not saying touch it, right? Secondly, I'm saying is deviate from the 60-40 in any fashion from an index all 60-40 is by definition active risk, whether it's modest tilts for risk management, your market timing variant, or just active bottom-up active managers for a long cap growth manager or whatever.

It's all active risk. And by definition, the average person will underperform by definition. So if that is unpalatable to you, I don't want to, that's uncomfortable given my risk tolerance, 60-40, which is why in Vanguard, we default people if we don't know anything about them, generally all index solutions, because I can't assume that they're willing to take a modest probability of being wrong in trade-off for a modest upside higher return.

I can't make that assumption. And so we generally don't make that assumption from fiduciary. And I know many investors like, no, don't, I'm good. Like just 60-40, I know I'm going to get the market. And that's what Jack Bogle increasingly in his career would focus on. And so I'm with you with that.

I think what was lost though, no one talked more about the future expected returns and how they were varying through time and to modestly take risk mitigation measures. No one talked about that at Vanguard more vocally than Jack Bogle by a factor of 10. You think I speak a lot about it?

He was screaming from the pulpit in the 1990s to de-risk a little bit. Now what I think he meant, he was not being tactical, Rick. You know that. I would actually disagree with that quite frankly, because I know that Jack did do a few tactical things with his own portfolio.

And maybe he got talk, maybe he were being wrong, but I still think it was more risk. But it's around risk management. But risk management in this sense is still deviating from the market. So by definition, if I was managing some portfolios, I would say Mr. and Mrs. Smith, this is still a form of active risk.

We could be wrong in this. Are you willing to be a little bit wrong? But our attempt is to minimize the downside. That's the only reason for this. But as I said in the book, I was very clear, there's two to stay the courses, man. One is to just reduce risk as a form of act.

The other one is don't even involve in this, in this exercise and keep regardless. I think in both scenarios, the investor has got to do three things. I was, I was, I would hope and plead stay invested in the markets, stay investing in those long-term principles and try to tune out these, some of these noise.

We were trying to look over the news cycle and to say next three, five, seven years, and just try to bring some information. But I would hope investment committees are not making wholesale changes because to your point, Rick, if they listened to just valuations are high, they would have been out of the market three years ago.

I have more concerns today about market frothiness than I did three years ago, but thank goodness I didn't like sell my equities. I would have lost like four years of retirement in like four months. Right. So like that, that is not even on the table. The biggest part of the book is really around just education of the, of the, of the economic, try to demystify these economic trends.

And there are considerations at the margin, but believe me, this is not from some sort of market time or an alpha stuff. This is what these books do. These narratives, they don't have a data-driven framework, by the way. They're just talking, oh, we're going to have a crisis or we're going to, AI is going to be great.

I could say we're going to have this tug of war coming. Oh, by the way, good luck investing. And I don't even show what a representative portfolio would be if you want to modestly mitigate, it's mitigate risk, but it's a form of active management. Let's be very clear. So we know your group more than anyone else.

This, these listeners would know, okay, this is the proposition I would be getting into. And caveat emptor, as Jack would say, caveat emptor, if you're going to go there, because you got to be prepared for being wrong. And you do, in all fairness, you did say you could just do the 60-40.

Yeah. The Peter Bernstein. Oh, it's wonderful. He was a wonderful writer. 60-40 is the center of gravity, which I don't know if you ever read his article or not. I mean, it's kind of the starting point for investors as where you begin. And then you can go move up and down from there, but it's a fixed asset allocation.

So you're very clear about that in the book. Or you could decide to go this direction. But everything in moderation, everything in moderation. But you did say that if you do go in this direction of trying to pick active managers or trying to do some allocation adjustments based on what's going on, that it is adding risk to your portfolio.

Yes. Yes. It's not a free lunch. And that's unfortunate when some talk about, you know better than anyone else, the community. It's when all these things are talked about, active management, even private investments increasingly. It's, well, I'm going to get the public markets plus. Everything's plus. There's never a minus.

Like, well, it's plus or a minus. I'm part of this process. Like, I know the process. You and I know the data. Your listeners are really well-educated. So I'm just saying Vanguard has not changed. I can tell you, it's not changed our ways. We, our investment philosophy is core.

But some of the nuances are sometimes left out of the conversation. Believe me, I don't, I don't take this at all the wrong way, Rick. I love the push because it's important to tease out this. Hey, did, because you know, your listener goes, wait a minute, did he say what?

What did, he didn't mean that, did he? Like, I appreciate the push because most don't, they don't, they don't push or they don't ask those probing questions. I think it's fair of pushing your listeners on there because it's their money and it's their time they're giving you and the podcast.

Well, Joe, I'm going to end it there because you just gave me a wonderful compliment. So thank you. You're welcome. So thank you so much for being on. I really enjoyed the book. So much to think about. It just rattles your brain. But thank you so much for the work you're doing.

Continue the good work and hopefully we'll have you on again sometime. Oh, and I want to say seriously to you and to all the listeners, because maintaining and in fact, extending the legacy of Jack Bogle with this community is really important. And it's wonderful to see this community keeps his spirit alive and well.

Thank you. This concludes this episode of Bogleheads on Investing. Join us each month as we interview a new guest on a new topic. In the meantime, visit BogleCenter.net, Bogleheads.org, the Bogleheads Wiki, Bogleheads Twitter, the Bogleheads YouTube channel, Bogleheads Facebook, Bogleheads Reddit. Join one of your local Bogleheads chapters and get others to join.

Thanks for listening.