- Welcome back to Portfolio Rescue. Duncan, it feels like the markets need some rescuing these days. It's pretty bleak right now. Just day after day of drubbing. Speculative investments taken to the woodshed. I'm a glass-to-cephalic kind of guy, so I want to look at some positives of the drawdown before we get into some questions.

I think this whole episode just provides a great reminder that getting rich overnight is not easy and it's not normal. It shouldn't be like that, right? You shouldn't be able to put $10,000 into some token created on the internet that's a joke and make more money than people make in a lifetime.

- But if you had to pick one right now, which would you pick? - How many of them are gonna survive? I'm just saying most people can and should build wealth slowly. Get used to it. I think this is a good time to understand where all the cockroaches are.

All the charlatans who were pumping stuff and offering awful advice have been unmasked. And if you're still following these people, then I can't really help you. But now is the time to update your sources of advice to know where people were leading you astray. Here's one more. I put this out on Twitter yesterday.

Despite a global pandemic, the highest inflation rate in 40 years, two bear markets. I'm counting this as a bear market. We're 18 and changing it on the S&P. The S&P 500 is still, put this chart up, John, up 26% since the start of 2020. All this stuff that's going on.

The S&P is still actually up since the start of 2020. All this other stuff. Pandemic, inflation, all this stuff. One more. Stocks are getting cheaper. So, the market's up 26%-ish since 2020. Earnings are up 50%. The stock market is on sale. John, flip this next chart from Ed Yardeni.

This shows the forward PEs for large cap, small cap, mid cap. And large cap's still elevated a little bit. You can see mid cap now on a valuation basis for forward price-to-earnings ratios are below where we were in the 2018 bear market, fast approaching where we were in the March 2020 levels.

Stocks are getting cheaper. So, I don't know. Look, bear markets are never fun to live through, but sometimes you need to shake out the excesses a little bit. The fun times never last forever, but these terrible times don't last forever either. So, I don't know. Regarding that chart, the small cap ones being at a lower PE now, is that because they have a greater chance, people think, of going bankrupt or something?

What's the deal there? Because earnings are going up. Well, people are scared. The Russell 2000 has given up basically all their gains since the pandemic started. So, I don't know. Markets have survived much worse than this. My whole thinking is this too shall pass. We'll get through it. Duncan, your slacks the last few days have been keeping me going.

You're looking to move your whole portfolio into IBONs. Yeah. It's rough out there. Remember, if you have a question, email us at askthecompoundshow@gmail.com. Let's do the first one. Okay. "Up first, my portfolio has been aligned to a 60/40 allocation, but I'm seriously considering adding more equity exposure to position for a longer-term market rebound.

However, doing this would mean selling a portion of my bond allocation at the current woes. Am I overthinking things?" See, this person is trying to be Glass Ethyl as well. Just last week we were talking about, is 75/25 potentially the new 60/40? What you're really talking about here is over-rebalancing during a bear market.

So, bonds are down as well, but now stocks are down a lot more than bonds are. So, you're trying to figure out, "Should I just overweight the portfolio into stocks?" I think there's some questions you have to ask yourself when you're doing an asset allocation change like this. First of all, have my goals and circumstances changed enough to force me to change my portfolio?

Right? A change in expectations doesn't always require a change in strategy. So, doing nothing still is a decision. You can stick with your portfolio that you have as long as you're okay with that. I think you have to figure out whether you're looking at this through the lens of a long-term process or the short-term outcomes that you're overreacting to because the market's moved.

And then, I think you have to understand, if I started from scratch today, is this the same portfolio that I would build? So, of course, obviously you always have to take into account your risk profile and time horizon, but I think if you're okay with it, and the tax implications make sense, you could be selling bonds down today a little bit.

You're locking in some losses that you can use for taxes, depending on where your assets are located. But, I don't know, if you believe a stock-heavy portfolio is a better fit for your risk profile and time horizon, and you don't mind locking in some gains because you think the risk/reward in stocks is better than bonds right now, I have no problem with that.

The asset allocation is not easy, right? The perfect portfolio is only going to be known with hindsight. So, I think if you have a good reason to change, and you're going to stick with it for the long-term, you're not just going to do it, and then if stocks fall more, you're going to abandon the plan and go back to bonds.

As long as it's a long-term thing, I think that makes sense. Yeah. No, that sounds like good advice. I mean, it's also not, like you've talked about before, the emotions can kind of get in the way in a crash like this, and that doesn't always lead to great decision-making.

Right. Like, if you asked me, "Should I take 100% of my stock picks and move them to iBonds?" I don't know. I might be considering that, too. Let's do the next one. Okay. So, yeah, it's funny. We have all this advice, and you give all this great advice, and then I look at my Robin Hood, and I'm like, "Why didn't I take all this advice myself?" Okay.

So, our second question -- the first one, by the way, was from Scott. This question is from Badri. "I've heard of the 4% rule for retirement withdrawals and even the more conservative 3% rule, but I'm not interested in exhausting my retirement portfolio. Rather, I have two objectives. One, withdraw enough annually to live comfortably and within my lifestyle.

Two, grow my retirement portfolio so that I can leave a sizable amount to my children. I was planning on 2%, but is there a metric or a rule of thumb for this?" All right. So, William Bengen is a financial advisor who first put this out in a 1994 research paper called "Determining Withdrawal Rates Using Historical Data." So, he proposed a safe withdrawal rate of 4% using the portfolio's value in your first year of retire, and then you basically use that as a baseline, and you take the 4% and you increase it by inflation every year.

He'll call it 2%, 3%, whatever. I guess now it would be 8%. He uses a 50/50 stock bond portfolio, and here's some of the findings from his original paper. An absolute safe withdrawal rate based on historical market returns came out to 3%, given that insured portfolio longevity was never less than 50 years.

So, if you're a FIRE person, 3% is probably better than 4%. But, an initial withdrawal rate of 4% was considered safe because it never resulted in a portfolio being exhausted in less than 33 years. The worst case withdrawal for a 4.25% withdrawal rate was 28 years. He also said having too much in stocks is just as bad as having too little.

So, he found 50 to 75 was about right. So, that's probably where we get the 60/40 from. And 4% was not the baseline, but worst case. Right? Now, of course, he wrote this in 1994. Back then, you could get 7% or 8% in Treasuries. Not quite as easy today with 3%.

But, this is not an easy thing. We talk about retirement a lot here. Nobel Prize-winning economist William Sharpe once said that it's the nastiest, hardest problem in retirement. Because, like, there's a lot of Nobels. How long are you going to live? What are your spending habits going to look like years from now?

What's healthcare going to cost? You don't know these things. What are the returns going to be for financial markets? And then, what happens if you have a big, unexpected outlay? The other thing is, sequence of return risk is huge. So, John, put up the chart of the S&P here.

This is the S&P. I did this for my blog a couple years ago. Two years ago, maybe. So, this is the S&P 500. Annual returns from 2000 to 2020. Now, let's say you had a million bucks and you put it all on the S&P. This is not a very realistic example, but just go with me here, because I'm going to talk about sequence of return risk.

If you did it at the outset, do your 4% rule, and increased it by 2% for inflation, by 2020, you would have, like, $470,000 left. Now, let's say you reversed it. Instead of going in the order, because you can see those first three years, you had three down years in the S&P.

Down 9%, down 12%, down 22. What if your returns started in 2020 and worked backwards? So, it's the same exact returns. The annual return is exactly the same. It's 6.5%. But you just have those returns occur in a different order. If this were the case, starting with that same million-dollar portfolio, now you end up with $2.3 million after 21 years.

So, you have this sequence of return risk where you could have the same exact return over time. Let's say the market returns 8%. But if you have a nasty bear market that lasts three years at the outset of retirement, and you're depleting your portfolio, that could be hard for you.

Of course, that's just luck. It's good or bad, you know, whether you have a bull market or bear market at the outset. So, the answer here is that diversification helps. I used a portfolio with no bonds. And then, most retirement plans are going to require some flexibility, right? Listen, I think 2% is ultra-conservative.

If you started it today, that's 50 years' worth of expenses on day one, not including inflation. So, I think you're being very conservative there. One more thing, I think, yes, giving your children a big nest egg when you die is probably, I don't know, kind of a worthy goal.

But it's also nice if they see you spend it and enjoy it while you're here. So, watch them enjoy it a little. If you're not going to spend it, I'll watch them enjoy it a little. I think you could talk to them about it, even. Like, "Would you rather receive a bunch of money from me when I die and we have this really long time horizon and let it grow, or take some help now when you're younger and you probably need the money more?" So, it's probably going to be helpful when they're younger, anyway.

So, maybe that's a conversation worth having with them as well. O'Reilly: Yeah, it's true. Or, yeah, do some traveling as a family. You know, enjoy the money together, as opposed to, like you guys have talked about before, you know, just getting the money after you're dead. I think the inheritance thing is an older way of looking at things, I think.

I think that's another generation, and I think maybe we need an update on that. Do you think, will people be leaving, like, bored apes to their kids and grandkids? Michael's son is going to be receiving all his NFTs. Thanks a lot, Dad! Once AI takes over the world and those NFTs are worthless, then, you know, it's not good inheritance.

All right, let's move on. Okay, question three. So, this question is from Sean. "There are a lot of people calling for recessions in the coming months or years. Can this become self-fulfilling? If everyone says a recession is coming and people cut their spending, wouldn't that cause a recession?" I love this question.

This is a question I've had before, and it seems like it makes sense to me. Lewis: Yeah. This is more of a, instead of a macro data kind of thing, this is a psychological thing. So, let's bring in someone who's been writing about the psychology of markets for longer than I've been around.

Barry Rittholtz, our firm's namesake. Hey, guys. How's it going? Gardner: Hey, Barry. Lewis: So, Frederick Lewis Allen, who's one of my favorite financial historians, he once said that, he wrote a book about the 1920s, about the boom that led up to the Great Depression. He said, "Prosperity is more than an economic condition.

It is a state of mind." And I think there's a lot to this. So, what do you think? Let's say the Fed is shifting psychology right now. Can they throw us into a recession just by getting people to change the way they view their own finances? Gardner: So, the answer is kind of complicated.

And I'm going to try and work through the nuances. And I don't know if you guys remember, back in 2008, John McCain's economic advisor, Senator Phil Graham, warned that all this negative sentiment was trying to, people jawbone their way into a recession. It turned out, what caused the recession was just a collapse in the world's finances, between housing and derivatives and everything else.

So, I'm really kind of reluctant to embrace we can talk ourselves into a recession. Stop and think about what you spend money on each day. You get the kids ready for school, you pay your mortgage, you pay your iPhone bill, you got to shop for this, that. That's 80% of the economy right there.

So, are people really going to cut back on their discretionary spending so much? Are you not sending the kids to soccer or karate? Are you not taking them out occasionally for pizza or McDonald's or whatever your portion of choice is? Lewis: That is a good point. I was talking to Michael this week on our podcast, and I said, "I was out to dinner last week for my wife's birthday, and none of these people in the restaurant care that the stock market is in a bear market.

They're not paying attention to that. They're out there enjoying their lives, they're spending, they're going to concerts." So, I do think that probably us in the finance world probably think this is more of a thing than anyone outside of it. We're probably not paying as much attention as we are anyway.

Muckerman: Right. And the other aspect of this is it's the problem with all of these sentiment surveys. When you ask people things like, "How do you feel about the state of the economy? How much money are you going to spend for holiday shopping?" Anytime you ask them, what you're really asking them is, "Tell us about your future behavior." And it turns out we're terrible as a species at predicting what we're going to do off in the future.

You can give a momentary emotional thought, "Well, I'm nervous. My stocks are down. My bonds are down. My NFTs and cryptos are down. I'm probably going to throttle back." And then people go out and spend and spend anyway. The countryside is littered with the bodies of economists forecasting the demise of the American consumer.

That's a terrible bet to make. Lewis: Do you think that this wealth effect thing -- to me, when my stock portfolio is up or down, that's long-term capital for me, so that doesn't really determine how I spend money now, because that's future me, right? So that's the same thing.

The Fed seems really worried about this wealth effect, that they want to bring it down to bring down inflation. Do you think that can really do something? Muckerman: I think the Fed has gotten the wealth effect completely backwards. I wrote a column about this, I don't know, a decade ago.

The same things that caused the economy to go up caused the stock market to go up. And the Fed has it backwards. The Fed seems to think, "Hey, if the stock market is rising, people are going to go out and spend more. That's the wealth effect." When you look at the vast majority of the public has such a tiny investment portfolio -- you had a piece not too long ago about the top 1% have something like 20-30% of stocks, and the top 10% has, I think, substantially more than half -- that means 90% of the public, their portfolios, it's noise, it's on TV or in the newspapers, but it's not affecting their day-to-day life, it doesn't make a difference in their spending, it doesn't make a difference in a whole lot of, really, anything for most of the consuming public.

So, I think the Fed has the wealth effect exactly backwards. Good economy means good spending and good stock market, not the other way around. Yeah, I agree. Let's do another one, Duncan. Okay. Up next, we have a question from Mark. And Mark's question is, "Lately, we've been hearing the terms 'soft landing' and 'hard landing' regarding the Fed's actions.

Can you explain what these two phrases mean in market terms, and what are the implications?" I think everyone would prefer a soft landing right now, I guess. I put a little meat on the bones here. So, I'm going to call soft landing, "We don't go into recession, inflation comes under control." Hard landing, "Recession is required to bring everything under control." That's kind of been what's happening lately.

So, I looked. There have been, since 1928, 14 bear markets in or around a recession. The average drawdown for those 14 bear markets was almost 40% in the last 390 days, peak to trough, on average. If we go non-recessionary bears, which has happened more than you think, you know, 1987, 1990 was close to one.

There's been a couple times in the '40s around the war. I think there's been like 10 non-recessionary bears. So, fall close to 20% or more, but you don't go into recession. The average for those is 26% on average, and lasting 202 days. So, a nasty correction or bear market that happens if we don't get a recession.

I think for the stock market, that's probably a positive. It probably doesn't get worse. We have a recession, that makes it worse. Barry, what do you think? So, I've been flying Southwest since the airline started, and I have a vivid recollection. If you've ever flown into LaGuardia, it's kind of a short runway, and you're over water until you just land.

And looks like you're going to land on the water. Right, right. I have a vivid recollection of a plane. It felt like it slammed into the runway, and I just remember the stewardess say, "Welcome to New York's LaGuardia Airport. Please stay seated until the pilot taxis what's left of the aircraft to the gate." And really, that just sticks in my mind as, it wasn't a soft landing, and it wasn't a crash, it was a hard landing.

And it's a great metaphor to, we don't, I agree with you Ben, it's not a recession, the Fed doesn't tighten so much that the economy begins to contract extensively across all sectors, but things slow down enough, maybe we have flat or slightly negative growth for a couple of months or a quarter or longer, but it gets inflation under control, and then we could resume the rest of the cycle.

I think you got it exactly right. Do you think the Fed can actually thread that needle though? So you know, I've been wrong about inflation. I've thought it would be transitory, right? And transitory has proven to be far more transitory and taking much longer than expected. So when you look at, here's the challenge the Fed is facing.

When you look at all the inputs into inflation, almost none of them are caused by low rates or QE. The war in Ukraine obviously made anything associated with energy and a lot of things associated with food worse. Semiconductor constraints are affecting the car market. There's been a shortage of home building going back to the entire decade post-financial crisis.

The Fed raising rates isn't going to do a whole lot of that. And when you look at the number of home sales that are all cash, mortgage rates don't matter. So I kind of think Jerome Powell is in the transitory camp and they expect, believe, hope, or rooting for a lot of interest rates.

I'm sorry, a lot of inflation rates coming down on their own as things progress. And I hope they're right. They don't have to get a lot right for a soft landing to occur, but they're concerned that a few things go wrong and you can have a pretty hard landing and not have a bad recession.

But you know, a lot of these things are outside of their control. I just saw a piece today, maybe it was Charles Bolello, tweeted it, that showed inflation rates around the world. And it's not just the US. I don't know what the Fed can do to affect inflation in anywhere from Poland to China to, you know, to South America.

It's out of their control and has been for a long time. Right. They can't make the ships bring stuff over faster with supply chains. They can't put cars on the dealership lots, any of that stuff. Maybe they can, I guess they're trying to hope that they can slow demand, but that other supply stuff is out of their hands.

Right. And by the way, those giant container ships, they take three years to build and they cost hundreds of millions of dollars. And nobody wants to build more because the expectation is, hey, once the reopening process kind of works itself out, and we return to a service economy, remember, pre-pandemic, we were about 61% services, 39% goods.

That kind of flipped when you couldn't go out to restaurants, couldn't go to the gym, couldn't go on vacation. You bought stuff to do everything at home. That'll eventually reverse itself. It's sort of doing it already. If you look at what's going on with stocks like Peloton and you look at the airlines, how booked they are for the next couple of quarters, the return to services seems to be taking place.

That'll be a big driver of reducing inflation also. Yep. All right. Duncan, we got one more question. Okay. Ben, when you find out from your Fed colleagues if this is going to be a soft or hard landing, can you let us know? Somewhere in the middle, Duncan, is what I'm hoping for.

Okay. I dissented from the last vote, so. Also, we had a question in the chat. What do you mean when you say retail investor? I think the non-pros and non-institutions probably, right? A lot of institutions control a lot of the capital. Retail is more your individual 401(k) brokerage investor.

Okay. Household. Portfolios, not professionals. Yeah, not a professional portfolio manager, that kind of thing. That makes sense. All right. Up next, we have a question from Kim. There are a lot of new investors out there who might not have experienced a prolonged bear market like we're seeing right now.

What advice would you give those young investors? My thing with this is always for young people that your biggest asset when you're young is not money, because you probably don't have a lot of it. Your biggest asset is time and therefore human capital. So, how much you save is going to have a way bigger impact than your investment returns.

So, as long as you keep saving and then increase that savings rate a little bit each year, that's the only thing that matters. And bear markets are good for a young person. When I first started saving real money back in 2007, I got my second job and I finally had a 401(k) for the first time.

And all it did was go down for a year and a half. Those purchases are the best purchases I'll ever make in my career, right? I was buying throughout 2008 when it was falling. So, I think you just have to get used to it. I talked about it. So, there's been 15 bear markets since 1950.

The average loss is 30%. I think all-time highs, while they make you feel good, they're your enemy if you're a young person. If you have decades and decades ahead of you, you just have to expect these. And you're probably going to have, I don't know, 7 to 10 of them throughout your career if you're investing for 40 or 50 years.

So, part of it is just like get used to it, one. And two, keep saving because your savings rate matters way more than your investment return right now. Really, couldn't possibly agree more. The one thing I have to raise, I have to raise a couple of questions. The first is, what is this word prolonged in the question?

This is going on six months. '08-'09 was notorious as a short bear market, and it was 18 months. If you're a market historian and you look back at what things have been like, in 1966, we had just come off 20 years of amazing gains following the end of World War II.

And the markets hit a peak, the Dow just kind of kissed 1,000, and it literally spent the next 16 years sort of chopping up and down and unable to get over those 1966 highs. It wasn't until 1982, 16 years later, that all the major indices got above that 66 high.

So, if you're not happy with six months, imagine being a buyer during those 16 years. You're seeing no gains, and that's before you get to inflation, which was not only much, much higher than today, but persistent. It wasn't like a spike. And we're already, you know, if I had a guess, we're probably past peak inflation.

I mentioned this on our quarterly call earlier this month. But think about 16 years. Now, if you're in your 20s and 30s and you're contributing to a 401(k) regularly for 16 years, it's going to feel terrible for those 16 years. And then suddenly the market's going to explode upwards and everything you own is going to be worth 2 and 3x what you paid for it.

So, perfect example of this. So, 2000 to 2009 was a lost decade in the S&P. I had a friend who told me that was much older than me when I first started working. "I've been saving my 401(k) for 10 years. I now have less money in market value than I put in." And they thought this was a bad thing.

And then you have the explosion for the next 10 or 12 years of a bull market, but you just had 10 years to put in money at lower prices and higher dividend yields and lower valuations. Now, that 10 years of saving at lower prices all make sense because you get this explosion higher once things do get better.

So, yeah, you want that choppiness and volatility and lower prices occasionally because that's a good thing for you long term. Right. The way I like to explain this is the tail end of a bull market, right, and the era you're talking about, think about '96, 1996 when Alan Greenspan gave his irrational exuberant speech to 2000.

Not only did the market have this spectacular gain, what it effectively did was pull all these gains forward from the next decade or so. And the highs hit in 2000 were not surpassed until 2013. So very parallel to '66 to '82, you have 13 years of up and down and up and down.

In fact, the '08, '09 crisis, I think the market fell, was it 57%, which was identical to '73, '74, the market fell 56, 57%. And so, you have 13 years of it just feels awful. It goes up, it goes down, it goes up, it goes down, and your portfolio value is the same.

And then look at what happened from, you know, 2013 or the bottom in '09 forward. If you were making those contributions regularly over that long bear market, you know, the Nasdaq bottomed at around $1,100. The S&P 500 bottomed at $666. Even today, below $4,000, you're still 5X where you were.

It's an incredible. So when you're investing during a bear market, you have to think, "I'm investing for the next cycle, not this cycle." And that's hard to do. Yeah. The other thing I think that really helps as a young person, automate everything. So automate your saving, automate your investing, and go have drinks with a friend.

Go for a walk, go to the gym. Don't spend all your time paying attention to the market because for you right now, especially if you're saving for retirement, it doesn't really matter that much. So just take it out of your hands, take the emotions away, and go try to live your life if you can.

You don't have to spend as much time as we do paying attention to stuff. Let us care about it and you care about something else. Something I've tried to do on that note that you were just describing, I've been trying to look more at how many shares I have in my IRA instead of the amount.

You know, that way it's less depressing. If you're dollar cost averaging, you're buying more shares at a lower price. Then when markets are up, you buy fewer shares at a higher price. That's the way dollar cost averaging works. Psychologically, it feels better to see the share count going up, even if the price is going down.

Yeah. Also, we'll give a plug for Masters in Business. Barry just had Michael Lewis on a couple of weeks ago talking about people wanting to get into the finance world, if you haven't listened to that. Great show. Really good. Anyone coming up, Barry, on Masters in Business? Boaz Weinstein is this really fascinating investor and trader.

They do derivatives, well risk, Saba Capital is the name of the firm. He kind of became famous because do you remember the London whale that lost JPMorgan Chase like $6 billion? Boaz was on the other side of the trade. He didn't make $6 billion, but the Saba Capital made hundreds of millions of dollars.

And the ironic thing is that he gave a speech at a JPMorgan Chase conference like a year beforehand, warning about concentrated risk in commodity trading and how to hedge tail risk. He literally said, "You guys are about to get screwed, and I'm going to be on the other side of the trade, and here's how I'm going to do it." And pretty much that's what happened.

Nice. That'll be this weekend. Great. Okay. Remember, if you're watching on YouTube or my blog or something, you can listen to us in podcast form as well. Leave us a review so other people can find it. Keep those questions and comments coming. We've been getting a lot of really good questions lately.

Too many, right, Duncan? Yeah. We've seen a huge uptick in great questions with the market volatility. Yeah. Keep them coming. Askthecompoundshow@gmail.com. Remember, we're going to get through this, I promise. But stop paying attention so much to the market every day. Go for a walk. Go get a drink with friends.

Have some fun. And we'll see you next time. Thanks, everyone. Thanks, Barry.