Building an Investment Portfolio to Grow and Protect Your Wealth with Chris Doyle

00:00:00.000 | Everyone will tell you they lost money, even with a big sample set.

00:00:03.280 | If I look at the news, there's front pages saying more layoffs, bankruptcies,

00:00:08.480 | and that actually may be the best time to invest.

00:00:10.960 | How do I even think about why I should invest and how to invest?

00:00:14.080 | How would you start that conversation with them?

00:00:15.840 | A lot of it comes from what that person already knows about the markets, investing,

00:00:20.240 | trying to understand where they are. There are a few quite important decisions you need to make.

00:00:23.760 | There's the kind of risk you want to take on and the risks your financial

00:00:27.600 | situation will allow you to take on. When thinking about these types of questions,

00:00:31.360 | what is the maximum value going to tell you? And then there's, what should you actually do?

00:00:36.960 | If you don't want to be exposed to idiosyncratic things that happen in a country,

00:00:42.960 | you can diversify and say, "I'm going to invest some in the U.S.,

00:00:45.600 | I'm going to invest some in Europe, I'm going to invest some in Asia."

00:00:47.520 | It's certainly true that there's that opportunity for additional optimization.

00:00:50.640 | It's like, because things are taxed differently, then there's opportunity to optimize that.

00:00:54.240 | There was a study by this group of economists. They wrote this book called Triumph of the

00:00:58.240 | Optimists. They did this huge study over 20 countries and they found...

00:01:02.320 | Chris, thanks for being here.

00:01:05.680 | Thanks for having me in this lovely home studio you've built.

00:01:08.480 | Yeah. So we go way back. And the reason I wanted to have you join me today

00:01:13.200 | is because we get so many questions from people that are so confused about the process of investing.

00:01:20.080 | And I go back in time and think, "Gosh, when I had a lot of friends ask me how to invest,

00:01:24.640 | I would call you all the time." And that led to us starting a company together to

00:01:29.520 | help people figure out what to do with their money and invest.

00:01:32.160 | And so who better to join me for a conversation about how people should think about building

00:01:36.640 | their investment portfolio than the person that I called all the time and started a company with.

00:01:40.960 | So that's the goal is helping people understand how to think about their investment portfolio.

00:01:47.680 | And we did this a lot at Grove. And I'm curious if you were sitting in a meeting with a client

00:01:53.040 | and they said, "How do I even think about why I should invest and how to invest?"

00:01:57.680 | How would you start that conversation with them?

00:01:59.520 | I think a lot of it comes from what that person already knows about the markets,

00:02:08.720 | investing, trying to understand where they are. But I think there are a few quite important

00:02:16.880 | decisions you need to make when you're thinking about building a portfolio.

00:02:20.560 | There's the risk you want to take on and the risks your financial situation will allow you to take

00:02:26.720 | on. And then there's given that risk, what's the mix of investments that make sense to achieve your

00:02:38.960 | goals? Back up for one second and say, "The reason anyone should even do this is that their money

00:02:44.800 | wants to keep up with inflation." Is that the premise of why even invest your money in the

00:02:48.800 | first place? Well, I think most people want to invest their money to reach to spend it in the

00:02:53.200 | future. So I think beating inflation is a great goal. But I think people want to go beyond that

00:03:00.480 | and try to get as much out as they can. And the question is, well, how do you do that? What

00:03:07.040 | investments do you need to do that? Yeah. And the reason why you wouldn't just

00:03:11.120 | invest it in the riskiest thing in the world, as you said, is risk is very important. How much you

00:03:15.440 | can and are comfortable taking. And there are lots of questionnaires online to answer those things.

00:03:22.000 | And so I'd say someone could go get a risk score. One of the things that I think we noticed when we

00:03:27.280 | were talking with clients was people are a little bit maybe more optimistic about their own tolerance

00:03:33.360 | for risk than might actually happen. And depending on whether you've ever invested in the stock

00:03:40.400 | market or some investment that went down, the typical question is like, "If the market goes down

00:03:45.600 | 30%, what do you do? Do you buy more? Do you sell? Do you freak out?" Do you feel like those

00:03:50.720 | questions actually can gauge someone's risk? Yeah. I'm skeptical of the online risk scores.

00:03:59.200 | Some of them ask questions about what would you do if it was down 30%. Some of them ask questions,

00:04:04.480 | which are even worse, which are how much would you be willing to pay for a coin flip bet or

00:04:12.160 | something like that. They're trying to get at some fundamental characteristic of the person,

00:04:18.240 | but I think that's oversimplifies it. So I think you can try to take those questionnaires and see

00:04:24.960 | what they say as a general guide. But I think one of the exercises that we did with clients at Grove,

00:04:31.360 | which I think is the most helpful, is to really try to imagine yourself in your current situation

00:04:35.760 | with your brokerage account, with your retirement portfolio. And if the equity market were to go

00:04:48.080 | down 20%, 30%, 40%, how would you react? And is there a percentage loss or dollar loss that you

00:04:57.360 | say, "This would be extremely uncomfortable for me"? So I think playing out a scenario could

00:05:03.760 | actually be a really helpful way to understand what your risk tolerance is at this point for you.

00:05:09.760 | And I think not everyone that's an investor today was an investor four years ago. But I think you

00:05:16.880 | could ask yourself four years ago during the middle of the pandemic, when a lot of portfolios dropped,

00:05:22.560 | "How did you feel then?" These kind of major market corrections don't always happen

00:05:27.920 | so frequently that the average investor even sees multiple of them.

00:05:31.440 | In the last four years, we saw one. And yes, the recovery was quite quick, but I had friends that

00:05:38.320 | after a 20% loss were like, "I'm out." And then I had people that wrote it all the way to the bottom

00:05:42.400 | and wrote it all the way back up to the top and beyond. And so we have one data point that if you

00:05:47.360 | were an investor four years ago, you could maybe say, "How did I feel?" Yeah, I think that's really

00:05:51.920 | helpful. But as you point out, the recent drops have been pretty shallow and pretty quick recovery.

00:06:00.640 | It's helpful to look a little further back in history and say, "Okay, well, can you put yourself

00:06:07.040 | in the mind of if the drop had been 50% and was there for a little bit and the economic news was

00:06:14.480 | consistently bad for a long time, like it was in the 2008, 2009, where you had a lot of investors

00:06:21.680 | say, "What am I doing? I'm going to take a step back and sell." And I think from the trough over

00:06:27.840 | the next year, the market was up 65% or something. And I think a lot of people missed out on that.

00:06:34.480 | Yeah. And so the reason why this is important is because you want a portfolio that you're not

00:06:38.160 | going to sell out of when it's down, because if you do, you will often miss out on the ride back

00:06:43.920 | to the top. Yeah. I think that's one of the major mistakes that retail investors make.

00:06:48.480 | And it's a very easy mistake to make because all these signals are negative. And the market is a

00:06:55.760 | very different type of system than the ones we're used to dealing with. If you want a good restaurant

00:07:03.680 | to go to, then you need to ask your friends, "Hey, what was your experience at this restaurant?" If

00:07:08.480 | all your friends said they had a great experience or a terrible experience, that's a really good

00:07:12.640 | indication of how your experience will be. A different type of system that's maybe, if you're

00:07:25.840 | trying to buy a reliable car, you may ask your friends who have a similar car if their car breaks

00:07:30.880 | down, but it probably doesn't. But is that a signal that it's going to be a reliable car for you?

00:07:36.640 | Maybe, but you probably need a bigger sample set, right?

00:07:39.840 | You got to turn to Consumer Reports. Right. You go to the Consumer Reports,

00:07:42.480 | the reliability survey where they survey thousands of people. But for the market,

00:07:48.960 | either of those strategies in these downturns would not be a good one, right? Everyone will

00:07:54.960 | tell you they lost money, even with a big sample set. So you say, "Okay, well,

00:07:58.960 | not only have all my friends lost money, if I look at the news, the front page is saying

00:08:09.520 | more layoffs, bankruptcies. And that actually may be the best time to invest."

00:08:15.840 | Yeah. Yeah. I mean, if you invested all of your money at the bottom of the crash in '08 or the

00:08:22.400 | bottom of the crash, that would be great. But I think we could probably talk about it a little

00:08:26.720 | later. Waiting for that bottom might not actually be as good a strategy as just being invested now.

00:08:32.400 | I did an interview with a guy named Nick Majulie, who wrote a book that I believe

00:08:36.240 | is just "Just Keep Buying." And his argument was like, "Don't stop and wait. Just keep buying."

00:08:40.960 | We won't go down that path yet. So okay. So when we think about constructing a portfolio,

00:08:46.320 | I think before you start, you need to think about your risk and how much you can tolerate,

00:08:50.160 | because that's going to come into play. And how much you can emotionally tolerate and actually

00:08:55.600 | financially. If all the money you have is in the market, and you need it for lots of things

00:08:59.920 | in your life, you might be comfortable with a 50% drop, but you might not be able to financially

00:09:04.480 | afford it. So that's this other component that I think is often missed is can your financial

00:09:09.440 | situation tolerate? Yeah. And I think a lot of that is a function of what money do you need in

00:09:16.160 | the near future. If you're planning on buying a house in two months, then you probably shouldn't

00:09:22.320 | have that all in the equity market, because the market could easily drop and you could lose money

00:09:28.480 | and not be able to buy the house. So that affects your capacity to take risks, we would call it.

00:09:33.360 | Yeah. Okay. So now I've kind of understood, hopefully a little bit about my own personality,

00:09:38.080 | my own capacity and tolerance. But we actually have to build a portfolio. And so there are

00:09:43.840 | a seemingly unlimited number of things you can invest in. And I'm going to assume that most

00:09:49.840 | people here are looking to grow their money over time and beat inflation and earn more than just

00:09:56.640 | leaving their money in a bank account. How do you even begin to think about how to construct the

00:10:02.160 | portfolio? Yeah. So I think one principle would be diversification. And there's a lot of reasons

00:10:14.720 | for diversification. One is that you don't want necessarily a portfolio that's going to do well

00:10:19.520 | only in one set of conditions, because it's very hard to know what the future holds, right?

00:10:25.280 | So we think about asset class diversification as being important so that the portfolio can do well

00:10:31.760 | both in periods of high economic growth, and it doesn't totally fall apart in low economic growth,

00:10:42.000 | that it can withstand periods of high inflation and low inflation. So different asset classes

00:10:50.240 | can do well in different circumstances, right? So like stocks, in periods of high economic growth,

00:10:57.600 | stocks can do well. Low economic growth, you have government bonds can perform better.

00:11:02.640 | Periods of high inflation, you have TIPS, which are inflation-indexed government bonds.

00:11:07.520 | Those can do well, and also commodities, and in some circumstances, real estate.

00:11:12.240 | Yeah. So you're thinking about having a mix of asset classes that can benefit you a lot.

00:11:18.800 | And is it just asset classes, or is it geographies, size of the companies in those

00:11:23.680 | asset classes? How far can you go down the diversification path, and can you go too far?

00:11:29.280 | Yeah. So going further down the diversification, there are kind of two other axes I would think

00:11:36.480 | about the diversification. One is across geographies. If you don't want to be exposed to

00:11:45.680 | idiosyncratic things that happen in a country, you can diversify and say, "I'm going to invest

00:11:52.400 | some in the US, I'm going to invest some in Europe, and invest some in Asia."

00:11:55.040 | And you can also think about diversifying within a geography across companies. So

00:12:01.760 | you may not want to say, "Oh, I'm going to put all my money into one company in the US or in

00:12:10.960 | each country." There's benefits in owning a lot of different companies so that you're not exposed to.

00:12:21.120 | What if there's fraud or something that happened, or the company has a product that becomes less

00:12:27.920 | competitive? So yeah, I think there are benefits on those two axes too.

00:12:32.480 | Okay. So I think it's pretty agreed by most people that you want to diversify your portfolio.

00:12:36.960 | You want to diversify it, like you said, across asset classes, across geographies.

00:12:41.600 | How do you actually figure out what it is? So I'm thinking there's the old school portfolio,

00:12:48.400 | which is just like 60/40 stocks and bonds. Then you can go online and search these lazy

00:12:53.520 | portfolios and it's like, "Well, here's if you wanted three index funds, or four, or five."

00:12:58.160 | And you could build a portfolio of 50 index funds. Is there a principle or a guideline of how you

00:13:05.200 | find something that's going to do well for you, but isn't so complicated that you're either not

00:13:11.600 | getting any benefit for the level of work you're doing, or it's just too complicated that doesn't

00:13:16.240 | actually, you can't maintain it? Even with a simple two-fund, three-fund portfolio,

00:13:23.120 | there is a huge amount of diversification in that. If you look at some of these

00:13:29.600 | index funds, they have 3000 companies inside. If you're trying to think about all of these

00:13:37.520 | aspects to diversify upon, different types of companies, different geographies,

00:13:41.840 | different types of asset classes, at the end of the day, you have to pick something to put

00:13:46.160 | your money into. And you could go as far as you want and have all these asset classes.

00:13:51.840 | And we had a conversation years ago where it was like, "Well, if you want to add some China,

00:13:55.280 | but you want small cap and large cap China, and now all of a sudden you could build a portfolio

00:13:58.640 | with a lot of things." Or there are people out there who say, "You could just buy VTI,

00:14:04.320 | the total stock market, and then just call it a day." And you might miss out on international

00:14:10.240 | there. You might miss out on bonds, but that is unapproached. How do you think you find

00:14:14.960 | the place on that spectrum that makes sense? Yeah. So I think if you have your list of

00:14:21.040 | ways that you'd like to diversify your asset classes and geographies you'd like to hit,

00:14:25.440 | I would say almost the simpler, the better. If you can achieve all the ways you'd like to

00:14:35.040 | diversify with fewer funds, that's why I think the three fund portfolio is very popular in that

00:14:40.880 | people have their... A three fund portfolio can get you diversification across asset classes

00:14:49.760 | because it has bonds and domestic stocks and international stocks. And you get geographic

00:14:57.200 | diversification because it invests across a lot of countries and you get the company diversification.

00:15:00.800 | So I think the three fund portfolio is a great place to start because it seems to check all the

00:15:04.960 | boxes. I think if you wanted to go further and say, "Well, I'm actually concerned that

00:15:11.440 | this is not going to be... There's not enough exposure to assets that will do well in an

00:15:20.800 | inflationary environment." For example, it may not include things that are particularly exposed

00:15:25.360 | to commodities. It may not have enough real estate for your taste. It may not have enough

00:15:29.440 | inflation-indexed treasuries. Then you would look at expanding the set of

00:15:38.240 | funds that you need to include. Now, I'm imagining people might be

00:15:42.960 | thinking like I am right now, which is, "Well, I don't know. Do I need more inflationary protection

00:15:48.560 | in my portfolio? Do I need to have more real estate? Do I need..." I actually, even for myself,

00:15:55.680 | struggle with this. In a way, I would say over the years, I've done everything from three-fund

00:16:01.600 | to 12-fund to put money in an online investment advisor that you just give a risk score and they

00:16:07.440 | build the portfolio to then tweaking that portfolio. And I've never left feeling like,

00:16:12.880 | "I know this is the perfect portfolio for me because I don't know if my international exposure

00:16:18.640 | should be 40% or 30% or whether 40% or 30% even matters. I know I should have some."

00:16:24.480 | How do you even know which asset classes you might want to include?

00:16:29.360 | I think a lot of smart people disagree about this. I think if you surveyed recommended

00:16:37.040 | portfolios from professional investors, you could look at portfolios recommended by

00:16:41.840 | David Swenson, who's the former CIO of the Yale Endowment, or if you look at robo-advisors,

00:16:48.880 | Wealthfront, Betterment, they all, I think, have reasonable methodologies that get you to...

00:16:54.880 | You're checking the boxes, but there's different implementations of the things that check the

00:17:04.320 | boxes. And a lot of the difference comes from assumptions, beliefs of the person

00:17:09.920 | constructing the portfolio and different assumptions that go into the... about what

00:17:13.520 | the future will hold. Okay. So you could start as a baseline, go search for lazy portfolios,

00:17:20.960 | and there's this great Bogleheads wiki page with a bunch of options from three to six.

00:17:25.280 | You could go to Wealthfront or Betterment or any other online advisor and just say,

00:17:29.200 | "Here's my risk score. What portfolio do they give me?"

00:17:31.120 | At the end of the day, from a return standpoint, is there even going to be that much difference

00:17:37.120 | between, "Oh, well, one of them says 40% here and 60% here. One of them says 38 and 62."

00:17:43.120 | Should we even get caught up in these on-the-margin, single-digit changes to different

00:17:49.360 | allocations? Or is it kind of all who knows what the exact outcome will be, and they're all going

00:17:55.200 | to correlate with each other pretty well? Well, I think there are two parts to that

00:17:58.960 | question. This incremental changes to... If you're talking about, "Are you going to be 60%

00:18:08.080 | bonds or 60% stocks or 59% stocks?" That's not going to really matter.

00:18:13.680 | I think you do... If you look at the lazy portfolios, you'll see different...

00:18:24.240 | You'll see meaningfully different asset allocations. That will produce different

00:18:31.040 | returns. These things will not perform exactly the same. I think the problem that I don't know,

00:18:37.120 | no one knows, is what's going to do better. I think they all... I think that's the really hard

00:18:44.320 | question. What you could do is look at the rationale behind them and see which one makes

00:18:51.360 | the most sense to you. But yeah, I'm not going to say they're going to perform the same, but

00:18:58.320 | it's really hard to tell beforehand which one's going to be better. And you can have multiple

00:19:04.560 | reasonable approaches that you could decide from. What would the very sophisticated professional

00:19:12.640 | investor be doing that maybe isn't something we want to emulate, but might help us understand

00:19:17.920 | how anyone could come to the conclusion that 59 and 20 and 21, whatever combo of things,

00:19:25.680 | is actually correct? Yeah. Where do the numbers come from that a lot of these people will come up

00:19:29.920 | with? An approach that a lot of investors can use when building a portfolio is that they have some

00:19:41.600 | selection of assets and that from those assets, you can assign an expected return and you can

00:19:52.480 | try to predict what you think the average return is going to be of those assets over whatever time

00:19:59.360 | period you're looking at and what you think the correlation between returns are. And these are

00:20:04.240 | numbers that are hard to come up with. What's your expected equity returns? Again, a lot of smart

00:20:09.280 | people disagree about that. What's the correlation of equities going to be with bonds and real

00:20:14.640 | estate and commodities? Also very hard to predict. You can look at history, but correlations change

00:20:20.080 | over time just like returns do. So you can take this, then you can add further constraints on

00:20:27.120 | about, "Well, I don't want to have more than this type of exposure in this asset. I don't want to

00:20:31.040 | have more than this type of exposure in this asset." You can add complicated constraints.

00:20:36.560 | And then you put it through a big optimization algorithm where you ask the computer to say,

00:20:40.000 | "Okay, given a certain amount of risk that I'm willing to take or a certain potential loss that

00:20:46.080 | I can tolerate, what is the best combination?" So you can have an algorithm come up with that.

00:20:52.720 | Now, there's a long process of coming up with those expected returns, coming up with the

00:20:59.040 | correlations, putting the constraints on, building the optimization to solve it that

00:21:06.000 | get you those numbers. But that's a process a lot of professionals do follow.

00:21:10.320 | - Yeah. It seems complicated for someone like me to go build an optimization engine

00:21:15.200 | to do all of this. And at the end of the day, I'd probably be borrowing someone else's work

00:21:19.840 | on correlations and returns, which I could probably just borrow their assumption. If

00:21:24.000 | I'm going to use all of their assumptions for things, then optimizing that to the right portfolio

00:21:28.560 | is probably going to be easier to just say, "Well, what did they optimize to if I'm going to use all

00:21:32.080 | of their assumptions?" I think almost all of the portfolios out there that I've seen have some mix

00:21:40.080 | between equities and bonds and maybe some international. And so I think you're probably

00:21:48.880 | going to end up with a portfolio there. The things that there's probably more disagreement on is

00:21:53.760 | some have international and some break it out into developed and emerging market.

00:21:58.640 | Why break it out? Is it because the general international buckets of index funds you would

00:22:04.560 | buy just don't have the right balance? Or why do a lot of people add on this emerging market

00:22:11.280 | category to their portfolio? - So I guess, assuming we're talking

00:22:14.880 | about an international fund that includes some emerging market in it, the reason to break it out

00:22:19.280 | is, I guess, there are at least two reasons. One is that you may disagree with the total allocation

00:22:29.680 | to it. So you want to make it either higher or lower. Another is it gives you the opportunity to

00:22:38.240 | kind of rebalance in that if you say, "Okay, I want emerging markets to be 10% of my portfolio,"

00:22:47.760 | or whatever, then if emerging markets underperforms, then it may stay lower if it's

00:22:56.480 | indexed. Whereas if you had it broken out, you would potentially buy more and bring it back up

00:23:05.280 | to 10% of the portfolio. But again, the reason to do that, you need some type of opinion about

00:23:15.760 | whether you want more or less emerging markets in there.

00:23:18.480 | - Yeah. And I hear a lot of people say, "Okay, well, I live in the United States.

00:23:22.880 | If I buy a home and the US market is down, my home's going to be cheaper." Is the argument

00:23:30.640 | to include international because you want to do well even in a case when the American stock market

00:23:36.560 | does poorly? Or is there some other argument to being more globally diversified?

00:23:40.960 | - I think that's the primary one where you may not want your wealth only linked

00:23:51.760 | to the performance of the US stock market and that there are going to be years where

00:24:00.560 | the rest of the stock markets on average will do better than the US stock market.

00:24:08.480 | So to the extent you have that, then your portfolio as a whole will be less volatile.

00:24:13.440 | So that could potentially allow you to have a higher percentage of your assets in equities

00:24:20.560 | and get you to the same risk level.

00:24:24.000 | - Yeah, I think that's a really important point that I want to undermine. So

00:24:27.440 | by having more of your portfolio in equities, which have a typically higher return than

00:24:35.680 | fixed income bond, typically, historically at least, but you're taking on more risk.

00:24:41.040 | But if you diversify within that equities to say, "Well, in case the US stock market goes down,

00:24:45.120 | I can have a little bit of international in there, balance it out. It lets me take more

00:24:48.880 | overall risk in the portfolio." And so the, I guess the-

00:24:51.840 | - Or the same overall risk, but with more equities. A higher percentage of equities, yeah.

00:24:57.120 | - Okay. So we've got equities, we've got fixed income. We'll come back to,

00:25:03.760 | what are some of these other asset classes that you see on some portfolios and not?

00:25:08.880 | Maybe we'll talk first about real estate. Like someone listening might say, "Well,

00:25:14.320 | I already own a home, so I already have real estate exposure." What is the case for or against

00:25:19.840 | including real estate as part of your investment portfolio for someone who is not a professional

00:25:26.080 | real estate investor buying rental properties and commercial real estate and all that?

00:25:29.440 | - Yeah, so I guess the question is,

00:25:33.040 | including real estate in the portfolio being like buying REITs, so buying these publicly-

00:25:41.760 | - Yes, sorry.

00:25:42.000 | - Traded real estate trusts. And I guess one perspective on it is like, "Well, REITs are

00:25:47.920 | already in the S&P or sorry, these index funds to some extent." So there's a small amount of

00:25:53.040 | exposure that you're getting to these REITs already. And then there's a saying, "Well,

00:25:58.240 | do you want more than the default amount in the index fund?" And

00:26:03.920 | I think there's some historical evidence that the value of real estate moves differently than the

00:26:14.160 | value of the stock market. So you're potentially introducing more diversification into your

00:26:26.320 | portfolio, which again, allows you to potentially have a higher percentage of risky assets while

00:26:34.640 | keeping the same amount of total risk in the portfolio. And because of that, you expect

00:26:40.480 | that owning real estate is different than owning equity in a company.

00:26:46.000 | You'd expect it to perform well in different economic environments also.

00:26:52.240 | - Yeah, so I mean, 2008 is probably not the right example, but there were probably periods-

00:26:56.320 | - Yeah, not 2008.

00:26:57.760 | - But there were probably periods of time where real estate is doing well,

00:27:00.640 | the stock market is not doing well, and that would be a reason to dial it up. But an important thing,

00:27:04.960 | I think, to keep in mind is, okay, so you already have some exposure to real estate

00:27:08.880 | in your index funds. And the same thing is probably true, maybe not, about commodities?

00:27:15.600 | - So commodity-producing companies, yeah. Yeah, like Exxon and then miners, yeah.

00:27:21.040 | - So you probably have exposure to the commodity market maybe indirectly,

00:27:24.960 | but I've seen a lot of people talking about recently, energy has done well.

00:27:30.320 | Is there a case to put those commodities in your portfolio, the actual commodities? I'm sure,

00:27:38.880 | I think there are index funds that you can invest in energy or in timber or agriculture.

00:27:43.920 | Is there a reason to or not to add that on? Because I don't see it too often in most of

00:27:49.440 | the lazy portfolios, but I hear people talking about it.

00:27:53.040 | - Mm-hmm. So I think owning commodities themselves is challenging, right? You don't

00:28:04.880 | actually want to own a bunch of wood or oil. So the way that people can do this are through

00:28:15.600 | some of these funds that can trade commodity futures. And I think there's an argument among

00:28:23.040 | investors are like, "Well, what are you actually getting with commodity futures? How direct is that

00:28:30.400 | exposure to the underlying price of the commodity?" But I think there's some pass-through,

00:28:40.400 | it's not nothing. So I think one is the kind of the directness of the exposure.

00:28:44.720 | Another concern is of the management fees of some of these funds. So I think that would be worth

00:28:52.160 | taking a hard look at if they're charging 1% or more to manage this trading strategy of commodities

00:29:00.240 | futures, then that's something to be aware of that. It may give you additional diversification

00:29:06.160 | and that the commodities futures aren't going to behave the same as the rest of the assets

00:29:09.680 | of the portfolio, but you may pay for that in terms of management fees.

00:29:12.560 | - Yeah. Which I think is a overarching important theme, which is as you're picking ways to invest

00:29:18.560 | in various assets, there are a lot of ways to do it. If you want to invest in the stock market,

00:29:22.960 | you could invest in an actively managed index fund or mutual fund, you can invest in a passive one.

00:29:27.920 | What do you look for when you're trying to pick a way to invest in an asset class?

00:29:33.760 | - I think the two main ways are, what's a good index to track and try to find

00:29:43.600 | an asset that can track that index. If you're looking for the S&P 500, look for something that

00:29:51.840 | is tracking that. If you're looking for the, or maybe better the kind of the overall equity,

00:29:59.440 | the US equity market, look for funds that track the thing you're looking for. Then second is

00:30:04.560 | the fee that they charge on the management of the fund. You'll see this varies a huge amount.

00:30:16.800 | I mean, Vanguard has done an amazing job of offering these exceptionally low fees

00:30:23.200 | on a lot of index funds. I think those two things are basically what I would look for.

00:30:33.520 | - When you find these funds that, my buddy in college is in this fund and he says, "It's great.

00:30:38.960 | There's a great fund manager." You look at it and you're like, "Well, this fund is investing

00:30:42.080 | in the US stock market. It's got a 1.5% expense ratio." VTI, the Vanguard total stock market fund,

00:30:51.760 | I don't know what it is now, but it's probably like 0.03, 0.05, some minuscule amount.

00:30:57.200 | Is there any argument to be looking at these funds that are much more expensive,

00:31:02.320 | but managed by what I'm sure they would tell you are really smart investors that are making

00:31:07.520 | decisions that are supposed to outperform? - Yeah. This is an important distinction between

00:31:16.320 | these passively managed index funds, which their only goal is to track a defined index.

00:31:22.400 | Versus the active funds are frequently have an index that they're compared with,

00:31:36.800 | but they're trying to make investment decisions based on their analysis of companies or

00:31:44.720 | assets that are going to return more than others. They're trying to use some investment process to

00:31:51.600 | beat the index. They try to beat the index, but they also have to pay their managers to

00:31:57.360 | try to do that. They end up costing significantly more, a lot of times in the order of 1% or more.

00:32:06.640 | I think a helpful framing of that challenge is like, okay, well, it doesn't sound unreasonable

00:32:15.760 | that you put a bunch of smart people in a room and have them pick stocks and they're going to

00:32:20.480 | do better than the market. It doesn't sound unreasonable. But I think a framing that makes

00:32:25.840 | it harder is that, well, if you bucket all the people trying to beat the market together,

00:32:30.400 | and you call them the active investors, on average, they're going to have the same

00:32:35.120 | performance as the market. So that means there are going to be winners and losers to that.

00:32:38.880 | So you say, okay, well, maybe I can pick a fund in the winner half.

00:32:48.320 | Maybe, but all of those funds will also charge a management fee. So the question is,

00:32:58.560 | can you pick one that will win enough to overcome the 1% management fee? Because on average,

00:33:04.800 | they're not going to outperform because they have this management fee on top of it.

00:33:08.720 | Yeah, I remember looking and seeing this data. And it wasn't that people don't beat the market.

00:33:14.320 | They do all the time. It was that the person who beats the market in one year

00:33:18.160 | doesn't usually beat the market every other year. And so, it especially can be hard to pick

00:33:24.480 | someone. It's like, oh, they beat the market last year. Could be the worst indicator of whether

00:33:28.000 | they beat the market next year or not. And so, I think the data, and I don't know the exact stats,

00:33:35.680 | I will find an article, I'll link to it in the show notes. But the data is that net of fees,

00:33:40.480 | active investors don't beat the market. Would that be fair? In general, or even the average one?

00:33:46.320 | Net of fees. Yeah.

00:33:48.080 | Net of fees.

00:33:48.560 | I think that's probably true. Yeah.

00:33:52.800 | So, all of what, at least I'm investing in, is the only active management is anything that I'm

00:33:59.200 | doing myself, which is usually not beating the market. So, I've proven this point on myself.

00:34:05.040 | How do you think about newer assets like crypto fitting into a portfolio?

00:34:10.800 | I think with newer assets... So, let me take a step back and say, why do we have the confidence

00:34:19.440 | to include equities or something in the portfolio at all? And I think there are a few reasons that

00:34:25.280 | people feel comfortable with equities. A few reasons that people feel comfortable with equities.

00:34:31.600 | One is that there is a long historical record of them doing well. And it's not just,

00:34:40.240 | oh, in the US over the last 40 years, it's had a good return. It's that over... There was a study

00:34:48.000 | by this group of economists. They wrote this book called Triumph of the Optimists. And they did this

00:34:53.440 | huge study over 20 countries, over a hundred years of history. And they found

00:34:59.200 | over the hundred years, on average, global equities beat the market, but beat inflation

00:35:09.600 | by 5%. And some countries did better. The US, I think, was closer to six and a half percent

00:35:16.480 | overinflation over the hundred-year period they looked at. And some countries did worse.

00:35:23.360 | Even ones that faced a lot of hardship over that period, Germany, Japan,

00:35:31.280 | they had inflation war that caused a lot of destruction. And they still beat the market,

00:35:40.400 | or beat inflation by 3% over that period. So it's this kind of longstanding, consistent

00:35:47.040 | performance of history is one thing that makes it comfortable, people comfortable with it.

00:35:50.720 | Second is that you're getting ownership in a big, global, a lot of times profitable

00:36:01.120 | company when you buy a stock, or a group of them if you're buying an index. And that means you own

00:36:11.360 | a part of Apple, and Visa, and Johnson & Johnson, each of which has thousands of people trying to

00:36:16.800 | make new products, trying to be more efficient, make more money next year. And all the money they

00:36:20.960 | earn, they're going to reinvest in the business or distribute it to you. And a lot of these have

00:36:24.640 | big dividends they pay out every quarter. So you own something that is making money,

00:36:32.720 | and it has a long history of success. And so when you think about developing a long-term

00:36:38.000 | investment strategy, that's the type of thing that I would look to include. And you have an

00:36:42.960 | understanding of equities, and government bonds, and real estate, and these things you can get a

00:36:49.200 | handle around. When you think about including crypto in that strategy...

00:36:55.280 | - It's kind of missing both of them.

00:36:57.520 | - It's missing both the history and the unclear use of it.

00:37:06.560 | - It's certainly not an income-producing thing. You can't take it. I mean, sure,

00:37:13.520 | there are ways to stake it and earn income and all that, but it's effectively just a speculation

00:37:20.400 | that the reason it would go up is because people think it's more valuable, not because it tripled

00:37:28.320 | its revenue, built a new iPhone, those kinds of things, reasons that Apple stock might go up.

00:37:33.840 | It's going up because people think it's worth more because there's a limited supply of it,

00:37:37.600 | and more people want it, which is much more of a speculative bet than a kind of fundamental bet.

00:37:44.560 | - Yeah. I mean, to me, it's closer to a commodity that within maybe an unclear kind of

00:37:51.760 | total use of, or a currency, where there are reasons you don't include those directly in an

00:38:01.600 | investment portfolio traditionally. - Yeah. What about other alternative

00:38:07.760 | things? I want to invest in a friend of mine's company. I want to invest in a winery. I want

00:38:12.560 | to buy some art. Do those things fit in your investment portfolio?

00:38:16.800 | - I think it depends a lot on kind of what the purpose is. I think if you want to own a winery

00:38:26.720 | and/or art, there's probably a lot of value that you'll personally accrue from it other than the

00:38:32.640 | money. I imagine a winery, or a winery at least, it could be a very different approach of whether

00:38:40.800 | you're trying to run a winery to create a few bottles of wine for you and your friends, or

00:38:45.120 | as like a huge business venture that you're going to expect to make a lot of money on.

00:38:49.840 | - There are a lot of other ways people can invest their money, and there's a lot of platforms online

00:38:53.680 | that make it easier to buy art, to buy shares in private companies, to buy sneaker collections.

00:39:00.080 | I don't mean that you would own things that you can own a piece of as an investment. Those aren't

00:39:06.560 | things that necessarily have index funds. Those aren't things that you would traditionally see

00:39:10.160 | in an investment portfolio. But I think a lot of people that invest in companies and startups

00:39:15.360 | think of it as an investment. Do you think of that as something inside your investment portfolio,

00:39:20.720 | or do you like to carve a piece of your assets that you want to invest out, set them separately,

00:39:26.400 | and not call them part of your portfolio? - I would recommend thinking about them as

00:39:32.560 | different things. It's helpful to have a liquid investment portfolio with a defined strategy

00:39:39.680 | that you can manage. Then I think to the extent that you want to be involved with more speculative

00:39:47.520 | things with a much less clear risk and return profile than a traditional investment portfolio,

00:39:58.000 | it could be helpful to assign a pool of money that you're going to spend toward those things.

00:40:04.400 | - Yeah. I think I've often heard people say anywhere from 5% to 10% should be your cap.

00:40:10.320 | We're not going to tell people what they should do on this episode. This is not investment advice.

00:40:16.000 | It's a conversation. But when you think about these alternatives, I think the interesting thing

00:40:22.480 | is a lot of times there's not liquidity. You can't just sell them if you need the money. You might

00:40:26.080 | need to keep them locked up for years and years. I know in the case of angel investing, yes,

00:40:32.560 | you could make lots of money, but most of the time you make no money. I've always personally

00:40:39.120 | thought of them as a separate pool. But I guess in my mind, it's like, "Well, 10% of my investment

00:40:44.880 | portfolio is for this other stuff." It's not easy to track. It's not easy to value. So I keep it

00:40:51.760 | separate. But you might not even have them in your portfolio in the first place. There are a lot of

00:40:57.200 | sophisticated investors that probably don't also. But I think they're always so flashy. I think

00:41:03.440 | people are excited about all these opportunities. I think it's hard for people to figure out what to

00:41:07.200 | do with them. Yeah. I think either with illiquid, uncertain assets, or I think you have maybe a

00:41:17.840 | similar problem in a situation where, let's say, the market's going up a lot and there's an

00:41:26.560 | opportunity to invest in either a really promising stock or some other thing, and maybe your friends

00:41:34.080 | are telling you about it. And the question is, "Well, how do you make a good decision

00:41:37.120 | at that point?" And I think it comes back to having some investment philosophy that you

00:41:45.120 | understand and can stay in tune with. And then I think having a separate pool of money that you can

00:41:50.800 | be a little less restricted with. And if you're going to gain a lot of value or you think you

00:42:01.760 | really... I mean, you could be totally right about an angel investment opportunity.

00:42:05.120 | So I think it makes sense to carve out and say, "This is how much I'm willing to

00:42:09.520 | allocate to my other bets portfolios." Yeah. And in a conversation, I think with

00:42:18.400 | Andy Ratcliffe, he was like, "If you need to set aside money to satisfy your desire to be more

00:42:23.840 | active so that you can let all of the passive stuff to do its thing, go for it. Because it's

00:42:30.240 | better for you to put 5% and mess around than it is to put 0% and then mess around on the overall

00:42:37.200 | pool." And I think, unfortunately, and maybe fortunately, passive index fund investing is not

00:42:45.120 | sexy. It's not like you're in there making trades. For the most part, at least in my portfolio,

00:42:51.360 | it's just sitting there. I'm not even checking it every day. I'm just letting it do its thing

00:42:55.520 | over a long period of time. Yeah. That makes sense. Yeah. I mean, I think that's right.

00:43:00.640 | It's not something that is fun to talk about at a party.

00:43:04.960 | Yes. What are you doing? The market's up a ton. What are you doing? Oh, I'm waiting in my index

00:43:11.280 | fund. But I think for a lot of people, that's the... Well, I mean, there's a benefit in that,

00:43:19.360 | one, you're not spending a lot of time thinking about investing. You could spend it doing other

00:43:23.440 | things that maybe you like more. And you have the market working for you. So you're in it,

00:43:30.480 | you're benefiting from it. Yeah. Without a lot of effort. So we talked about almost all of these

00:43:35.600 | major asset classes, and we left off this big bucket that is really in a simple two-fund

00:43:40.640 | portfolio. It's your equities and your bonds or fixed income. You mentioned a few various types.

00:43:47.920 | But in today's market, how do you even think about the allocation to bonds and fixed income?

00:43:55.520 | I know in some portfolios, if you dial your risk score up, they don't even exist.

00:43:58.880 | And then you'll meet some people that are like, "Well, you need to have at least 30% or 40% of

00:44:03.200 | your portfolio in them." I feel like that bucket has the widest variation and lots of different

00:44:10.320 | opinions about how that fits in. And now, at least in 2024, with high interest rates,

00:44:17.440 | is cash fall in that bucket or not? So I guess, how do you think about it?

00:44:21.520 | Well, I think it's worth breaking down some of the arguments of why it's helpful to have in there.

00:44:28.720 | Because I think both the historical record and estimates of future returns are that,

00:44:37.600 | on average, bonds are going to return less than equities. That's historically,

00:44:42.480 | and that's I think what people are still projecting.

00:44:44.880 | So it's not to necessarily increase your return. What it can do is act as a bit of a ballast

00:44:56.320 | in your portfolio in that it can offer return if you don't want to dial the risk further up.

00:45:15.120 | But it also, in some economic situations, the price can move inversely with stocks.

00:45:26.800 | So there may be a situation where stocks go down if growth expectations are low,

00:45:33.360 | and the value of your fixed income increases. So it not only can offer...

00:45:43.120 | Yeah, so it can kind of lower the overall volatility in your portfolio in some circumstances.

00:45:48.320 | And that's a reason to have it.

00:45:49.680 | And if you go back in time and look at major market corrections, 2008, the dot-com bubble,

00:45:54.800 | before that, I would imagine that if your portfolio was a 50/50 portfolio in stocks and

00:46:01.040 | bonds versus 100% in equities, you probably would have not dropped as much.

00:46:05.760 | Right. Yeah. So I think there's a question, though, of...

00:46:11.040 | Okay, so let's say your risk... If you only said, "I'm going to hide some amount of my money under

00:46:18.240 | my mattress, and I'm going to put the rest in equities, then... And the amount I'm going to put

00:46:24.800 | in equities, I'm going to determine by my risk tolerance and capacity." Right? And let's say,

00:46:29.760 | "Okay, that means 50% of my money is in equities, and I'm going to put 50% under my mattress."

00:46:35.040 | Then the question is, "Well, what else can you do with it?" And what you find is if you

00:46:44.080 | assign some amount of diversification and actually negative correlation to the bonds,

00:46:50.720 | that means you may actually be able to put 55% or 60% of your portfolio in equities

00:46:55.360 | and the rest in bonds. Because if equities move down and bonds move up,

00:47:02.160 | then your total portfolio drop is going to be lower than if you just had 50% in equities and

00:47:08.240 | the rest under your mattress. So that's the difference. But instead of putting it on the

00:47:13.280 | mattress, you could have it in cash or in treasury bills, for example.

00:47:17.840 | So in a way... And this actually was the mattress example, really clarified things.

00:47:22.480 | You could think of your investment portfolio as all equities and then leave a large allocation

00:47:27.760 | to cash or outside of your portfolio to balance your risk. You've got $100,000. You don't want

00:47:34.720 | to lose it all. You only invest $50,000 and you leave $50,000 in cash. Not because you needed to

00:47:39.280 | buy a house, just because you don't want to invest all your money in the market and see it all go

00:47:42.480 | away. Or you could invest the full $100,000 in your portfolio, but just not have 100% of the

00:47:47.920 | portfolio in stocks and put them in some income-producing asset that isn't equities.

00:47:54.000 | And today, that could be cash at a high-yield savings account. It could be treasuries. It could

00:47:59.040 | be corporate bonds. How do you think about what to do with that pool of non-equity,

00:48:04.720 | I guess, fixed-income assets? So I think there are kind of two parts of that question. One is

00:48:12.800 | how much risks should you take in the other side of your portfolio, the bond side of your

00:48:20.320 | portfolio? And I think people disagree about this, but my perspective is take the market risk

00:48:30.240 | on the other side, on the equity side. So that means I don't really like for individuals investing

00:48:39.520 | in corporate bonds, high-yield bonds. I'd say I'd focus on government bonds, which

00:48:46.080 | consider to be risk-free, credit risk-free. And then the question is within government bonds,

00:48:53.840 | what's the duration that you want to take on? And what that means is how much exposure to

00:49:06.640 | interest rate risk do you have? Cash on one side or very short treasury bills?

00:49:13.120 | No matter, you're going to earn the amount on the bill and

00:49:19.440 | the price of that bill is not going to really go up or down if the rest of the interest rates move.

00:49:27.440 | You're just going to earn that amount. Versus a longer duration, if you buy a 30-year treasury

00:49:33.280 | bond or invest in a fund that has long treasury bonds, the value of that fund will go up and down

00:49:40.400 | as interest rates move. So if interest rates all go up, then let's say you want a 30-year treasury

00:49:48.960 | bond that yields 5%. If interest rates go up to 10% tomorrow and you own a 5% bond, then you could

00:49:57.280 | buy another bond at 10%. So your 5% bond is not worth nearly as much. So you're taking more interest

00:50:04.320 | rate risk. And that can be good or bad. I think in a down economic scenario where growth is low

00:50:12.160 | and the Fed cuts rates, long-term rates will probably drop. And that means the value of your

00:50:18.880 | longer-term bond holdings will go up. And it could go up at the exact point that the

00:50:24.240 | stocks may be falling. So longer duration means more interest rate risk, but potentially

00:50:30.880 | an offset to the equity risk. Which we saw over the last few years, after the recovery from the

00:50:36.720 | pandemic, the stock market heated up, it grew, inflation went up. And to combat that, we raised

00:50:42.640 | rates in the environment and your equity portfolio went up. But if you held a long-duration bond fund,

00:50:48.400 | it probably went down. And if that inverse happens, it could be a good hedge against that.

00:50:55.360 | And I think it's something interesting because if you hold a portfolio of bonds and you see,

00:50:59.200 | "Gosh, interest rates are rising on bonds. That's good, right?" Actually, it's good if you're about

00:51:04.560 | to buy the bond. It's not good if you already own the fund that has them. And I think a challenge

00:51:10.560 | here is you look at these long-term bonds and you see lower yields and you think, "Wouldn't my money

00:51:14.960 | just be better in a 5% high yield savings account?" And the answer is probably for the next week,

00:51:21.360 | yes. But as we've seen in the past, I think just in the last five years, I think we've seen interest

00:51:28.560 | rates go from 2%, 3% all the way down to zero, all the way back up to five. If right now interest

00:51:36.560 | rates in a high yield savings account are 5% and let's say next year, for whatever reason,

00:51:40.800 | they drop to zero, that 3% long-term bond is probably not going to be the price it is.

00:51:47.600 | You're not going to get the return you will get now on the long-term bond that you would then.

00:51:51.920 | So you might think, "Gosh, getting three now doesn't make sense because I'm getting five."

00:51:55.680 | But if the rate in your high yield savings account dropped to zero, you probably couldn't get three

00:52:00.400 | for 30 years anymore. Maybe it's one or one and a half. I don't know the right numbers.

00:52:04.160 | I think sometimes people look at these long-term things and think, "Well, the return's not as good

00:52:09.520 | as what I'm getting now, so I'll just stick with treasuries or I'll just stick with cash because

00:52:15.200 | it's a higher return." But if that return goes away, you can't get that seemingly higher long-term

00:52:23.040 | rate. So how could we compare a cash interest rate to a longer-term bond interest rate?

00:52:28.240 | Yeah. I think the comparison I would make is that if you have cash, let's say cash versus

00:52:39.600 | a 10-year treasury bond. If you own cash or a three-month treasury bill, then you're saying,

00:52:48.480 | "Okay, every day or every three months or whatever the amount of time you need to reinvest,

00:52:52.720 | that you're going to basically take the average interest rate over the next 10 years."

00:52:56.800 | If it's 5% today and then it goes to zero and stays there, then your average is going to be

00:53:03.120 | just above zero interest rate you'll have earned. Versus with a 10-year treasury bond,

00:53:08.160 | if you buy it and hold it, you're going to, if it's four point something percent,

00:53:14.880 | you're going to earn that four point something percent over the 10 years. So your average

00:53:20.880 | interest rate will be four something versus just above zero if interest rates go down tomorrow.

00:53:27.120 | So if you look at this 10-year bond, how is it priced? Is it just a bunch of really smart people

00:53:32.000 | trying to guess what the interest rates are going to do over the next 10 years and price it such

00:53:36.480 | that unless I disagree with a bunch of smart people who are all trading in the open market,

00:53:44.800 | presumably I don't have inside knowledge. The same reason I don't like picking stocks is there's a

00:53:49.120 | bunch of smart people pricing any individual stock. I don't think I can do better than them.

00:53:53.040 | Does the same principle apply to bonds in that if I want to get the best interest rate over 10 years,

00:53:59.120 | am I not just better buying the market than trying to pick and choose 5% now and something else

00:54:05.040 | later? So that's a big component of how that number comes about. Why does the 10-year bond

00:54:12.560 | trade it for something is because a lot of smart people have said, "Okay, well, I think the interest

00:54:17.840 | rate here is going to be here. At one year out, it's going to be this. Two years out, it's going

00:54:22.720 | to be this." And that's a market that is traded. You can trade these future prices. So a big part

00:54:30.720 | is people making an estimate of what the average short-term rate is going to be over that time.

00:54:36.240 | There's also this idea of a bond risk premium in that maybe you should be compensated additionally

00:54:44.080 | for the fact that you're buying a longer-term riskier security that can go up and down versus

00:54:50.640 | cash you have a guaranteed return. It's not the only component, but it's a major one that goes

00:54:55.200 | into it. In addition to potentially being compensated for having a riskier asset, there's

00:55:07.440 | also potential supply-demand factors as the Fed is going to be buying or selling these bonds that

00:55:16.640 | can also affect that rate. I guess it means depending on the economic climate, the Fed can

00:55:21.520 | make these actions to try to slow down or speed up the economy that will affect rates, and that'll

00:55:26.080 | affect all of these prices. We don't really know what they are. The Fed chose to do quantitative

00:55:31.360 | easing, which meant buying treasury bonds and mortgage bonds, which drove the yields lower.

00:55:39.680 | I think a lot of people believed lower than what that average rate would have been.

00:55:44.480 | Okay. That changed the assumptions people were making, and depending on which side you were on,

00:55:50.640 | you had a better or worse outcome. Right.

00:55:52.560 | Think about risk. Just to quickly recap building the portfolio, because I want to talk a lot about

00:55:59.360 | implementing it. First, you need to think about your risk, your tolerance for it, your capacity

00:56:03.920 | for it. You can go online. You can look at questionnaires. You can think about it internally.

00:56:09.840 | You can look at how you behaved in the past and come up with an idea of that. Then you have to

00:56:14.720 | build a portfolio. We talked about a lot of places you could get inspiration. We talked about some of

00:56:19.120 | the different asset classes. You can go look at the lazy portfolios online. You could use any one

00:56:23.680 | of these investment advisors like a Wealthfront or a Betterment to build a portfolio and see how

00:56:27.520 | it works and dial in what you want. Now we have a portfolio. You could potentially even have a

00:56:34.960 | conversation with ChatGPT to say, "Help me think about how to build this portfolio," if you want

00:56:40.160 | someone that's not a paid investment advisor, but a dialogue partner. We'll come back to that,

00:56:46.320 | because I think there are some challenges and some benefits to doing that.

00:56:49.360 | Let's assume that everyone listening has paused and created a portfolio, so they have something.

00:56:55.120 | How do you put that into place? I imagine some people will have already had this in place.

00:57:01.120 | First, let's talk about putting it into place. Then what happens if you realize that what you

00:57:05.600 | have now isn't what you necessarily want? For someone listening that has some money

00:57:11.120 | ready to invest and now has gone through this process, do you just pick your index funds,

00:57:17.040 | decide, "I'm going to do, for the sake of argument, 70/30 split and total global market in

00:57:24.560 | the 70 and total bond market in the 30," and you just dump it all in now? How do you think about

00:57:30.160 | whether it makes sense to slowly invest over time, invest all up front, or even potentially hold out

00:57:37.360 | and wait for the market to drop and try to buy at the bottom? I think a lot of the decisions...

00:57:43.840 | Thinking about these types of questions, there's what is the maximum theoretical value going to

00:57:53.680 | tell you? Then there's what should you actually do? What you should actually do is not necessarily

00:58:01.840 | the thing that's going to maximize to the scent of the expected value of your portfolio.

00:58:08.080 | You have to behave in a way that makes sense to you, that you're comfortable with.

00:58:14.800 | I think if you're sitting ready to invest, but you haven't invested a lot now,

00:58:18.160 | investing everything at once and then seeing the ups and downs in the portfolio as the market moves

00:58:30.000 | around, that may be a very painful experience if you're not used to seeing that. That would be an

00:58:38.560 | argument to step in a little bit at a time. Yeah. I remember this Vanguard study where it said,

00:58:45.200 | "Technically, lump sum investing was better." That makes sense because in the long run,

00:58:51.280 | the market goes up. If you assume that on average, the market goes up every day,

00:58:56.480 | not that it actually does, but if you assume on average, it always goes up,

00:58:59.280 | then you're better off putting it all in now than waiting. But in the circumstance, it goes down.

00:59:05.600 | If you're going to be able to not live with yourself for making the decision to put it all

00:59:10.560 | in the day before the market went down, you could invest over time. That might not have the highest

00:59:17.200 | expected value, but it might make you feel better. Yeah. If it's something that you can actually do

00:59:25.120 | and feel better about versus hesitate or not do or feel terrible about, that seems like a good

00:59:32.080 | approach to step in over time. Yeah. When a lot of these studies say the expected value is better

00:59:38.080 | to invest it all up front, it's not better 99.999% of the time. If it was, then the expected value

00:59:44.640 | would be so much higher. It's probably, and I'm making this number up, but it's probably better

00:59:51.040 | more closer to 60% or 70% of the time, or maybe even less than that, maybe like 55%.

00:59:56.640 | It's not like dollar-cost averaging versus investing all at once. The outcome is not,

01:00:03.600 | on average, five times better. It's probably marginally better. I think sometimes it's like,

01:00:09.760 | "Let's minimize the regrets I might have about the way I acted instead of get the best possible

01:00:15.760 | value." Yeah. That makes sense. I think if you had to put an order of magnitude,

01:00:20.160 | if I had to guess the order of magnitude of the benefit, it's like, "Okay, on average,

01:00:24.000 | if the global equity market has outperformed inflation by 5% and call inflation to be 2%,

01:00:37.120 | that's 7% gross return. If you average in over the course of a year, then on average,

01:00:44.880 | you're going to be half invested. That's 3.5% of expected return that you'd be missing out on."

01:00:50.480 | If that means that it's something that you're much more comfortable with,

01:00:55.040 | that may be a 3.5% you're happy to pay. Also, I don't even think you factored in in that math,

01:01:00.640 | the fact that while that money is all sitting in cash waiting for you to invest it right now,

01:01:04.320 | Oh, that's true.

01:01:05.040 | you're probably also earning 5% on that cash. The delta is really that 2%

01:01:11.200 | spread out over the year, and it just shrinks down a lot more.

01:01:15.200 | That's a good point with the higher interest rates currently.

01:01:17.520 | Yeah. Right now is actually a better time to dollar cost average than lump sum invest just

01:01:25.280 | because the money while you're not investing is actually earning a return. Whereas a handful of

01:01:32.160 | years ago, if it was earning zero, it might give you a little bit more angst about not investing.

01:01:36.160 | Maybe not investing, watching the market go up while your money earned zero would actually be

01:01:42.240 | the thing that stresses you out a lot, and it might push you in the other direction to actually

01:01:46.160 | want to invest everything right now. What do you think about if someone's thinking, "Gosh,

01:01:52.640 | I already have an investment portfolio. I've now gone through this process and realized it was

01:01:56.400 | either too complicated or it wasn't right for me, or I just want to simplify it and do something

01:02:00.240 | different." How do you think about that transition when it's already in the market, but you need to

01:02:04.880 | transition to something else? What are the ways you would decide when and how and over what period

01:02:10.720 | of time to migrate from one portfolio to the next? I think one thing that comes to mind

01:02:16.720 | is I guess a potential blocker to moving could be if you have a lot of gains that have unrealized

01:02:27.600 | gains in the portfolio, then if you were to sell those positions and buy other different ones,

01:02:36.800 | then you can actually realize those gains and then that can have an impact on your taxes,

01:02:41.840 | maybe a significant impact on your taxes. I think that would be a reason to think harder about what

01:02:50.160 | a change in strategy can look like. But yeah, if you're thinking about simplifying and you don't

01:02:58.880 | have that issue, yeah, I don't see what- You would just sell and buy something different.

01:03:05.680 | And buy something different. Yeah. What do you think would slow someone down or should?

01:03:12.640 | Yeah. I guess the taxes one for me has always been one because I had some old

01:03:17.280 | index funds that I was like, "I don't really want these," but they're at a low cost basis.

01:03:20.720 | I would say my one thing was at least wait till you've held them a year because you get better

01:03:26.880 | tax treatment in the US holding equities for a year and selling them than you do paying short

01:03:31.520 | term cap gains. I think sometimes there's an emotional hold up, which is like I meet a lot

01:03:38.880 | of people who, especially people that work at companies like tech companies that they own a

01:03:43.280 | piece of the company and say, "Gosh, my portfolio right now is 50% Google." And listening to this

01:03:49.200 | makes me think it's not very diversified. And I probably shouldn't hold 50% Google.

01:03:54.240 | And I remember we would always ask these clients this question of, "Okay, if you sold it all now

01:03:58.880 | by mistake and you sat on a pile of cash and you had to decide how to invest it, would you invest

01:04:04.720 | 50% of it back into Google?" And people are like, "No, no, I would never do that." And then we'd say,

01:04:09.840 | "Great. So then we agree you should sell the Google stock now and you should buy this new

01:04:14.320 | portfolio." And they're like, "Yeah, yeah. As soon as Google hits like 120..." I don't even know

01:04:18.720 | what Google's priced at right now, but it was always like, "As soon as it gets 20% more,

01:04:22.880 | then I'll sell it." And I feel like that, not necessarily because of taxes, but more about

01:04:27.920 | trying to time the sale of the asset they hold now and feeling like it's not where it should be

01:04:34.000 | has always hung up a lot of people. Yeah. Well, I think... I really like that framing,

01:04:39.760 | saying, "Okay, if you were all in cash today, what would your ideal investment portfolio be?"

01:04:46.720 | Because I think it's really clarifying to move away from where you are now, because

01:04:50.320 | putting aside the potential tax complications of actually moving it, it's a good framing to say,

01:04:56.560 | "Okay, where should I be?" And then you can move there either quickly or more slowly.

01:05:01.360 | And I think that's a really hard decision for people to make, to sell their company stock.

01:05:06.480 | They feel personally invested in it. In a lot of cases, people have, particularly Google,

01:05:12.720 | gained a lot of wealth by holding it. So it seems like maybe that's not the best decision to sell

01:05:19.760 | all this thing that's worked so well for them. But yeah, I think that framing is really helpful.

01:05:23.920 | I think one thing that I've also done, which I think is something not everyone does... I think

01:05:30.000 | you will probably lose if you compare Google to investing in the total stock market since Google's

01:05:35.200 | IPO. I think Google's probably outperformed the total stock market by a lot, but it won't look as

01:05:41.440 | good if you compare it to zero. And so I think sometimes people that are holding a stock for

01:05:46.320 | five years and they look at it and they're like, "Wow, my stock's up 100%." Well, if you had invested

01:05:53.040 | in the stock market for five years, I'm not saying it would have gone up 100%, but you want to make

01:05:58.160 | sure you're at least comparing things apples to apples. And so a lot of times I see people say,

01:06:02.800 | "Gosh, I don't want to sell this thing. It's been doing so great." And it's like,

01:06:05.440 | "Has the market also been doing so great?" Because the US stock market for the last

01:06:10.400 | century has been doing pretty great. There are windows of time it hasn't.

01:06:15.840 | So I think making sure you realize that by selling a few stocks and buying an index,

01:06:22.480 | well, one, you're still even holding those stocks. Google is a big chunk of the total stock market

01:06:26.640 | also. So you're not getting rid of all of it, or at least all the exposure. But also you're

01:06:31.280 | buying into a asset class that also goes up over time. And so you're not giving up all the returns.

01:06:38.560 | Okay. So we moved into this portfolio. A question that I've both gotten and thought about a lot is,

01:06:47.680 | well, it's easy to think about your investment portfolio and say, "Great. We want a 70/30 split

01:06:52.800 | of these two index funds. That's pretty simple." But I actually have between me and my partner,

01:06:58.480 | what if I have five accounts? What if I have my 401k, we've got a Roth IRA in both of our names,

01:07:04.400 | and then we've got this taxable brokerage account. Now I have five accounts. They have three different

01:07:10.160 | types of tax treatments. Do I just buy the same portfolio in all five? Or as I'm sure some people

01:07:18.240 | listening know, there is a case to be made for certain types of investments being really tax

01:07:24.800 | efficient or tax inefficient, and that putting them in different accounts could make the overall

01:07:30.560 | portfolio perform better. Yeah. It's certainly true that there's that opportunity for additional

01:07:37.920 | optimization. It's like, because assets are taxed differently and accounts have different tax

01:07:45.520 | treatment of the assets inside, then there's opportunity to optimize that. And I think there

01:07:54.560 | is additional value to doing that. The question is, how much value is there? And that depends on

01:08:00.960 | your tax situation and how much money you have invested, and also how complicated is it? And

01:08:09.120 | what's your appetite to do it yourself? And how much do you value your own time?

01:08:15.920 | So I think it's just like a rough ballpark way to think about the benefit of it. If you say

01:08:27.600 | you have, call it you're considering moving 20% of your portfolio to a tax-advantaged account,

01:08:35.840 | and that 20% that wasn't there, you're going to move somewhere else. And you say, okay, well,

01:08:40.720 | and that 20%, I expect to earn, let's say, 5%, have a 5% return. So then you're talking about,

01:08:51.920 | okay, how is that 1% of your portfolio return taxed? Because you're talking about the 5%

01:08:57.680 | return of 20% of the portfolio, 20% of- Yeah, so we're doing 1%, and we're saying,

01:09:03.120 | okay, we're going to optimize the taxation of that 1% return. And say, okay, well, in a

01:09:07.360 | high marginal tax rate of, let's say, call it 37%, in that one asset gets poor tax treatment,

01:09:18.720 | and one asset gets good tax treatment, and it's taxed at 15%. And you're saying,

01:09:22.800 | okay, what's the difference in that? It's like, that's 22% difference in the tax rate.

01:09:27.120 | So you're saying, okay, well, I'm going to have a 22% difference in the tax rate

01:09:31.200 | on that 1% of return. That ends up being 0.2% of your portfolio in additional return due to this

01:09:39.440 | tax optimization. And I would consider a pretty good scenario where you're doing 20% in the best

01:09:44.720 | tax treatment or the worst tax treatment. So 0.2%, that's something, that's not nothing.

01:09:51.520 | And depending on the size of your portfolio, that could be significant,

01:09:56.000 | and that could compound over time. But I think the implementation of it is usually not so

01:10:03.840 | straightforward. And I think it's something that I've done, maybe you've tried and done,

01:10:12.320 | that you need a spreadsheet, and you need to figure out what assets go where to make sure

01:10:17.520 | you have the right overall balance. So there is really a time and mental overhead of cost to doing

01:10:25.360 | it. Yeah, I think one thing that I learned trying to do this, because there's this great image that

01:10:30.560 | I'll link to in the show notes, or I'll overlay right here if you're watching on video, where

01:10:35.040 | it's like, what are the most to the least tax efficient things? And there's kind of two components

01:10:39.680 | to it. One is the tax treatment, and one is the expected growth. If your equities are going to

01:10:46.560 | grow at a rate that you expect to be higher than your bonds, then having your equities be in your

01:10:53.040 | Roth IRA that will not have any taxes in the future versus your bonds that will have a lower return,

01:10:59.200 | that could make sense. Your bonds also, though, might be taxed depending on whether they're

01:11:03.280 | qualified at higher rates. So maybe there's a counter argument there. There's a great story

01:11:09.440 | about a handful of people who have taken their Roth IRAs and invested in startups that have been

01:11:16.000 | the highest returning things. And because they had no future taxes in their Roth IRA,

01:11:20.320 | they got all those things tax free. The downside there would be obviously you're taking your

01:11:24.880 | retirement money and betting it on something that could go to zero, which is not a good

01:11:31.120 | retirement plan for most people. What I found doing this was there's another part that makes

01:11:38.240 | it complicated, which is it's unlikely that whatever your allocation to one asset is,

01:11:43.520 | is the exact balance of your 401(k). So in our circumstance, we had two Roth IRAs,

01:11:49.520 | two 401(k)s, and a taxable account. So we had five accounts. And if we decided that our perfect

01:11:55.280 | portfolio was even 70/30, which would be the easiest one, or a two fund portfolio, obviously

01:12:00.960 | 100% zero would be the easiest one. Then we're not doing any optimization. You're like, "Okay,

01:12:06.160 | well, I'm going to put these in here." One of the accounts is ultimately going to have

01:12:10.480 | two things in it. And as one account grows, it's going to grow faster or differently because they

01:12:16.880 | don't have the same thing in it. And now when you're trying to rebalance between them to stick

01:12:20.560 | to your core portfolio, I found myself being like, "Okay, in my 401(k), I need to sell a little bit

01:12:26.560 | of this to make up for this. And oh, wait, wait, wait, hold on. My 401(k) is all pre-tax. So even

01:12:33.040 | though there's 50 grand in my 401(k), 50 grand in my 401(k) isn't the same as 50 grand in my

01:12:37.920 | taxable account. So what should I actually count that at? And if I'm thinking about this overall

01:12:42.480 | portfolio, should I think about it after tax?" And then all of a sudden, I'm like, "Oh, wait.

01:12:45.760 | Well, these things are up and I'm going to have to pay long-term capital gains because they're in my

01:12:50.560 | taxable account. The Roth IRA, I'm going to pay no taxes." Even just figuring out how many dollars

01:12:55.200 | I had was so much headache that I couldn't actually manage it. It just didn't make sense.

01:13:02.000 | And I just couldn't figure out how to rebalance it. And I just stuck with it. And I just didn't

01:13:06.000 | make changes. And I was in a portfolio that wasn't the portfolio I wanted because it was too

01:13:10.400 | complicated to figure out how to get to the portfolio I wanted. And ultimately, I just switched

01:13:14.720 | and said, "I'm just going to have the same portfolio in all of them," because it was a little easier.

01:13:19.360 | Is it the most tax efficient? Absolutely not. Could I get that little extra return doing something?

01:13:25.520 | Probably. But would I actually manage it? No. And we'll get to some optimizations next,

01:13:33.520 | like tax loss harvesting or rebalancing. Is the expected value of being able to do those things

01:13:40.720 | higher than the expected value of the tax aware allocation? And if so, then you're actually better

01:13:47.520 | off making sure you can do that. However, if you are someone who loves to keep these spreadsheets,

01:13:52.240 | can value all of these balances appropriately and figure out what they're worth based on their future

01:13:56.720 | taxes, and do this and with ease, you're probably going to end up better in the long run in terms of

01:14:04.240 | returns by putting your most tax efficient things in one account and your least tax efficient things

01:14:10.080 | in another and your highest returning assets in another and balancing it. I just wasn't someone

01:14:14.720 | who could keep on top of it. And I think another thing to consider when considering a strategy like

01:14:22.320 | this, when you're kind of in your head, mixing together your retirement account and your brokerage

01:14:28.800 | account is that I think a lot of people may find it helpful to say, "Okay, this is my retirement

01:14:32.640 | money that you could think about investing. And this is my brokerage money. I'm going to set aside

01:14:40.720 | my retirement account money as something else." So a prerequisite to thinking about this tax aware

01:14:46.400 | application is that you really have to think about everything as the same thing, just with

01:14:51.360 | different features to it, which I don't think everyone's there. Yeah. Especially if you're

01:14:57.840 | thinking, "I'm a little bit younger. One day I'm going to buy a house. So the money in my investment

01:15:02.960 | portfolio might have a 10-year horizon, but the money in my retirement account might have a 40-year

01:15:07.040 | horizon." Those are very different. And we didn't talk about this at the outset, but I think because

01:15:12.960 | we both had this discussion for hours and years ago, the investment portfolio is for money that

01:15:19.840 | you don't need to touch in the short term. Now, we could debate whether the short term is three

01:15:24.000 | years or five years or 10 years, but the general principle was we're not going to take an investment.

01:15:29.680 | Our investment portfolio is money we don't need soon. It's not for the house we want in a few

01:15:34.000 | years. It's not for the company that we're going to start, or it's not to fund our life to take a

01:15:38.640 | sabbatical because we don't want to be in a circumstance where we need that money and the

01:15:43.360 | market's down and we have to sell while the market's down and we miss on the upswing because

01:15:47.680 | in the long run, the reason the market returns over 30, 40, 50 years or however many years your

01:15:52.800 | horizon is, is because it goes down and up and you need the down and the up.

01:15:56.480 | Yeah, I think that's a really good point in that this consistency of good returns for equities,

01:16:05.680 | it's always over a long time horizon. If you look at two or three-year chunks of equities,

01:16:11.360 | there are wild swings so that you want to give yourself the benefit if you're coming up with a

01:16:20.000 | investment strategy that has historical support for producing good returns over inflation,

01:16:27.200 | over long time periods. You want to give yourself that long time period to let it work.

01:16:30.400 | Yep. Let's talk about some of these other optimizations. Rebalancing. Unfortunately,

01:16:37.360 | it's not one thing to figure out, "Here's my portfolio and don't touch it for 30 years."

01:16:41.120 | Mm-hmm (affirmative).

01:16:43.120 | Because if you're in a portfolio of equities and bonds and the equities went up a lot and the

01:16:45.760 | bonds didn't, you're now at a different portfolio than you planned. If you wanted 70/30, maybe now

01:16:50.720 | you're at 75/25 or 80/20. How important is it to rebalance the portfolio and how often should

01:16:58.000 | people be thinking about when to do it? Yeah. I do think it's important because

01:17:07.040 | that asset allocation is important to keep the target risk that you're looking for

01:17:14.240 | in the portfolio. Rebalancing, make sure that you don't stray too far, either too low or too high

01:17:20.640 | from that target risk. In terms of when to rebalance, there's certainly a lot of diminishing

01:17:29.760 | returns to it. If you rebalance every day to make sure that you have the exact, you're not 70.01%,

01:17:39.280 | then that's going to take a lot of time and not provide a lot of value to you.

01:17:43.760 | If you rebalance once a year, I think that's going to get you the vast majority of the benefit.

01:17:50.000 | I'd say one other potential... You could say, "On one day a year, I'm going to go rebalance."

01:17:57.360 | That's a reasonable approach. Another way to augment that a little bit is that

01:18:04.400 | when there's a big market move, you may consider rebalancing. If there's a big move down or up,

01:18:09.200 | depending on the size of it, you may say, "Okay, well, I know it's not December 15th yet, but I'm

01:18:17.520 | going to take this time to say, 'Okay, well, now it's an opportunity to make sure I have the right

01:18:22.800 | amount of risk.'" What about tax-loss harvesting? How do you think about that as something worth

01:18:29.840 | doing or doing at a similar cadence or more frequently? For those who aren't familiar,

01:18:38.320 | I'll just give a quick overview, which is that when you have an asset, let's say you invest in

01:18:46.160 | the total stock market and it's down 20% because we're in the middle of a pandemic, you could

01:18:52.960 | leave it down. Let's say you bought it at $100, and now it's at $80. It's down. You could leave

01:18:58.960 | it there, or you could sell it at $80, spend that $80 to buy something very correlated and similar,

01:19:05.280 | but not exactly the same. Not the same VTI, but maybe a Schwab index fund that tracks the market.

01:19:12.400 | Now you'll have a lower cost basis. You'll have an $80 cost basis, but that $20 loss from that

01:19:18.640 | first purchase, you can actually use to offset some income up to $3,000 a year or other gains

01:19:25.680 | and continue to grow that other position over time. The more you collect these losses,

01:19:32.400 | I will say in some cases, the easier it is for you to change things in your portfolio that create

01:19:38.320 | taxable events. Do you think you can go overboard, or is it rebalancing? Once a year is probably

01:19:44.640 | enough. I think before you embark on the tax loss harvesting, there are a lot of rules that you need

01:19:57.360 | to follow, and there are some logistical challenges of doing it. You'd want to become familiar with

01:20:07.920 | what is a realized versus unrealized loss. What are the different types of these losses? Are there

01:20:15.200 | short-term losses, long-term losses? There's this complexity, because if you sell something and

01:20:28.160 | rebuy it, you can create a wash sale. None of this is tax advice. It's a way of saying that

01:20:37.520 | there are a lot of rules around how to actually achieve these realized losses

01:20:44.960 | that you need to be aware of before you start going down this road. If you want to go down the

01:20:52.000 | road, then I think you need a spreadsheet to approach it, because you need to track how much

01:21:04.240 | loss is in each of your positions, potentially each lot that you've bought of your positions,

01:21:13.120 | and then what are equivalent funds that you could sell one of and then buy more to get the right

01:21:20.000 | allocation. I think that's the minimum requirements to get started. The benefit of it is

01:21:34.080 | really dependent on your situation. If you're already in a portfolio that has a lot of gains in

01:21:38.480 | it, you may not really have a lot of opportunity to harvest tax losses, because the investments

01:21:47.840 | have already been going up. Yeah, yeah. If you bought the total stock market 10, 15, 20 years

01:21:52.640 | ago, your cost basis at this point is so low that even if the market crashed 20%, you probably

01:21:58.240 | wouldn't have a loss. Whereas if you just started investing last year and we have a market correction

01:22:04.960 | of 20% next week, you'll probably have losses in your portfolio. You can harvest the whole portfolio.

01:22:10.240 | Yeah. I think it's fair to say, one, yeah, you have to understand all these rules. These rules

01:22:16.320 | don't just apply in one account. If you are in five different accounts, your retirement account,

01:22:23.440 | your taxable account, and you're selling one thing and buying it in another, that can create

01:22:28.080 | an issue. I find that if you want to do tax loss harvesting on your own, you should really

01:22:34.880 | understand it. I know some people that even trade in different funds in all their different accounts

01:22:42.560 | because they want to make sure they're not mistakenly triggering any of these rules and

01:22:46.720 | causing taxes when they think they're saving money. Maybe not. Now, if you have two funds,

01:22:53.840 | right? If you have a two-fund portfolio and let's say you have no retirement accounts,

01:22:58.000 | you just have your taxable account, maybe you could make a case that it's a little easier.

01:23:04.080 | Who's going to benefit most from the tax loss harvesting? I think it's people who don't have

01:23:12.880 | investments that already have a lot of gains in them and that they're either adding money or

01:23:22.080 | they're adding money investing currently so that they can monitor if those investments go down and

01:23:26.880 | they could try to sell them and realize gains. Then I think there's, again, significantly

01:23:32.640 | diminishing returns from doing it more frequently. I think one of the big benefits of tax loss

01:23:41.200 | harvesting is that for some people, if they have a net realized loss in their account, they can

01:23:47.440 | offset their income with their capital losses. I will flag, we're talking about being able to

01:23:56.720 | take a loss that you would have been able to in the future offset your gains, which means

01:24:02.880 | maybe you could offset your long-term capital gains rate at 20 plus state taxes. Let's call it

01:24:08.880 | 25%. Instead, you can offset your income, which could be at 45%. You're getting a 20% arbitrage.

01:24:17.200 | The one that's like best case, and two, it's capped at $3,000 a year. You might think, "Well,

01:24:21.680 | $3,000 is a meaningful part, but if you're at a lower income, you're probably not at a high

01:24:25.360 | enough tax rate that it's going to do that much for you anyways." I think the real value where

01:24:29.920 | it comes into play is if you have a really substantial existing gains, let's say you've

01:24:37.280 | held that Google stock for many, many years and you want to trade it into your portfolio.

01:24:41.920 | If you're able over time to accumulate losses, it'll make the gains from selling that Google

01:24:47.120 | position much more tolerable because you might not have to pay those taxes. I know I needed to

01:24:53.040 | sell a lot of my portfolio sometime, I don't know, maybe two, three years ago. Because I had tax loss

01:25:01.520 | harvested in the middle of the pandemic, I was able to create a lot of losses. When I had to

01:25:06.960 | make that portfolio change, it didn't cost me any taxes because I'd been holding onto these losses.

01:25:12.240 | I felt good. I was not managing that myself. Our investments are at Wealthfront, they're automating

01:25:19.120 | all the tax loss harvesting, they've written some white papers about the value of tax loss harvesting.

01:25:24.400 | My personal non-advice belief is that there is value, probably more than the 0.25% fee,

01:25:33.360 | if you also factor that that fee means I don't have to think about it.

01:25:36.240 | But if I try to execute it on my own, it goes back to the tax aware allocation thing, which is like,

01:25:42.960 | I just, I'm not going to do it. I think it's possible to do on your own. I think it's not

01:25:48.080 | possible to do it at the level of sophistication that Wealthfront does it on their own, but you can

01:25:52.640 | capture a lot of the benefit. But like I said before, you have to know all the rules, have a

01:25:59.120 | plan, make your spreadsheet and do it. I think your points are exactly right in that if, well,

01:26:05.120 | I think, yeah, I think one, if you have some big sale of an asset with a gain, that makes it super

01:26:13.840 | helpful, but also in the rebalancing, if you imagine what rebalancing would look like from a

01:26:22.400 | tax perspective, right? It's like if equities go up, then you're going to be, if equities go up

01:26:28.960 | more than bonds, then you would sell some equities and invest that into bonds. So that's going to

01:26:36.080 | potentially produce a gain that if you have done tax loss harvesting and have been kind of in the

01:26:42.080 | right place, right time, and that you've invested money and it's gone down, you're able to realize

01:26:45.600 | that and you're able to offset that gain. So you wouldn't necessarily have to pay taxes on that.

01:26:50.000 | Yeah. One other downside I find of tax loss harvesting is just that

01:26:52.960 | depending on the times at which all of these things happen, your US stock market allocation

01:26:59.840 | might now have two or even three different index funds. And for some people, that's not a problem.

01:27:06.560 | For some people like me, it's like, I just want it to be simple. And now I find myself saying,

01:27:10.720 | well, now I just want to sell one of them so that I just have one of the same index fund. I don't

01:27:14.880 | want two or three. It's just easier for me to look at. And having to sell those things and pay taxes

01:27:21.040 | on them is like- Then you have gains in those.

01:27:22.640 | Yeah. Yeah. So I think if you want something simple, I would say either let someone else

01:27:28.240 | manage it or be excited about managing something complex or wait until very, very big moments,

01:27:36.800 | like the entire market's down 30% and those could be the times, but doing it regularly on your own

01:27:43.440 | seems like a nightmare. Yeah. And you still have to learn all the rules, even if you're doing it

01:27:47.760 | once at a time. Yes, you definitely do. What do you think about direct indexing? Because I know

01:27:54.080 | there's this company FRAC, which just launched, which is like direct indexing as a service.

01:27:58.720 | And the general idea is you could buy the S&P 500 index fund, but you could also just buy the

01:28:05.920 | 500 companies in the S&P and you could, one, avoid the expense ratio and two-

01:28:11.440 | 0.05%. Yeah. And to be clear, to pay for any-

01:28:17.200 | How much is that company? I think it's like 15 basis points. So

01:28:21.440 | you're not going to really avoid the expense ratio, I guess. The upside would be now that you

01:28:27.360 | own 500 companies, at any given point in time, there are companies that are failing in the U.S.

01:28:33.120 | stock market. And so if you own the whole stock market, on average, it goes up. If you own every

01:28:39.440 | company, then you can harvest the losses of the companies that fail while they're failing and

01:28:45.360 | capture more stock, obviously not something you'd want to do on your own, but you could capture more

01:28:49.520 | tax losses than you would otherwise. So I think the reason why I would not do that myself,

01:28:59.520 | are they a sponsor? No, I don't know. No sponsor.

01:29:03.920 | The reason I would not do that myself is I think the... I'm a little bit risk averse here,

01:29:13.280 | right? Imagine the circumstance where you have this company managing the 500 stocks for you,

01:29:18.800 | doing the tax loss harvesting. Okay, great. Sounds reasonable.

01:29:21.520 | What if they stop doing that? And they say, "Okay, we're not offering the service anymore.

01:29:28.720 | Here are your 500 stocks with gains in them." Because yeah, all the other ones have... They've

01:29:34.400 | sold all the ones with losses. What do you do then? Yeah, then you're managing a brokerage

01:29:39.760 | account with 500 individuals. Really, what would you do though?

01:29:42.960 | I don't know. I really don't know what I'd do in that circumstance.

01:29:49.280 | I guess at that point, you'd hope another company had started that you could say,

01:29:52.320 | "Can I transfer my 500 stocks to you so you can manage them?"

01:29:56.320 | Maybe try to find a company that Angel invest in that could manage it for you.

01:29:59.840 | Yeah. That is the biggest downside I've heard from people who use a service that does direct

01:30:09.120 | indexing, decide they don't want to use that service. And now they're stuck either managing

01:30:14.000 | 500 individual positions, which I can assure you rebalancing in between is going to be

01:30:19.440 | next to impossible on your own, or they're forced to sell out of them at probably a gain just because

01:30:26.960 | the market goes up over time. And so that would be the downside. If you are using a company for

01:30:32.960 | direct indexing, you are probably making a bet that that company or a company that can take over

01:30:41.280 | that portfolio will be around for a very long time, or you will be managing 500 or however

01:30:47.360 | many individual stocks, or you will be forced to sell them if that company stops operating.

01:30:51.520 | It sounds like for you, it's like, "Not a risk I want to take."

01:30:54.320 | It doesn't sound like a good trade to me.

01:30:56.400 | I'm still doing it, but I think maybe I'm-

01:31:02.960 | You may be too late now. Now you can't stop.

01:31:05.760 | Now I can't. I'm still doing it because I can't stop doing it.

01:31:08.000 | So another potential threat is what if they raise prices?

01:31:12.080 | Yeah. You're stuck paying those prices.

01:31:14.320 | Yeah. You're stuck paying those prices.

01:31:16.800 | Yeah. It's something that now that that portfolio is up, I'm like, "Well, I guess I'm-"

01:31:21.280 | I can either pay the prices or realize all the gains in these stocks.

01:31:24.480 | Yeah. So I guess I'm stuck in it. But because of it, I have harvested way more

01:31:30.720 | losses than I would have otherwise. So at least if I ever wanted to sell out of it-

01:31:34.400 | You'd be partially offset.

01:31:36.000 | I'd be partially offset. Other things along the lines of maintenance and ongoing stuff,

01:31:44.240 | when should people think about changing their portfolio?

01:31:46.560 | Because we talked about how to think about constructing it, but does it change over time?

01:31:51.280 | I think there are a couple of ways that the risk tolerance could change.

01:31:55.760 | One is become a more experienced investor where you become more familiar with how the market will

01:32:04.560 | move and you become more comfortable with seeing up and down in your portfolio.

01:32:12.800 | Another is your financial situation can change where you may have continued to save more money

01:32:18.400 | and say, "Oh, I'm actually comfortable putting more at risk." Or you could say, "I'm less

01:32:24.080 | comfortable putting more at risk because I don't expect to be earning as much or whatever in the

01:32:28.720 | future." And then I think an important way it could change is if you're combining finances with

01:32:35.040 | a partner. And then you're not only thinking about what your tolerance is, but you're thinking about

01:32:41.440 | what your combined tolerance is and what's the lowest tolerance of the combination of you.

01:32:47.440 | Yeah. Okay. And when that happens, it's like rebalancing. It's time to adjust things over time.

01:32:52.480 | How do you think about... Maybe we'll slot this earlier, Ben. When it comes to all of these

01:33:00.960 | changes, how do you think about doing them by buying and selling things, doing them as you're

01:33:06.800 | investing each month, doing them by reinvesting dividends? Are there easier ways to make the

01:33:12.960 | ongoing management work when it comes to ongoing investments and what you tell your

01:33:18.240 | brokerage firm to do with any dividends? I think it probably doesn't matter too much

01:33:23.520 | practically. The amounts you'll probably be changing are relatively small. I think

01:33:27.600 | the easier to manage is just have a reinvest dividends and you don't have to think about it

01:33:34.400 | if you let it go a little bit longer between rebalancing. But an approach that I use and I

01:33:43.360 | think some other people use is that you don't reinvest the dividends and you take the money

01:33:49.360 | that's spit off every month or quarter and use that to true up to the right allocation to the

01:33:55.200 | extent you can. And then you may have to make a bigger change if the market moves or something,

01:33:58.880 | and you may have to buy and sell. But that's a way of avoiding a little bit of the friction.

01:34:04.480 | And that strategy probably feels better right now when the money that's uninvested is probably in a

01:34:10.960 | money market fund earning 5%. Would you probably feel a little differently if the

01:34:15.600 | uninvested cash was earning 0% or is the headache it saves kind of?

01:34:21.200 | Well, I think the uninvested cash is only uninvested for a little bit because you can get

01:34:28.240 | the dividend either each month, maybe it's a bond fund or each quarter. And then you let all the

01:34:34.240 | dividends come in and then you can take those dividends and invest it. So they would only be

01:34:37.760 | sitting there for maybe a couple of weeks or a few weeks. So yeah, I mean, maybe it's not

01:34:42.560 | super optimal, but I don't know. It seems reasonable to me.

01:34:48.160 | Didn't stress you out.

01:34:48.800 | Yeah, it didn't stress me out.

01:34:49.680 | And let's talk about uninvested cash because I think we already talked about the portfolio and

01:34:56.080 | how you could leave cash outside to adjust your risk. But I remember when the pandemic was going

01:35:01.840 | on and we were down 30% and all I could think was, "Well, I'm pretty confident the market's

01:35:06.560 | going to go up over time. Really wish I had some of my money not invested." Not just because it

01:35:11.280 | wouldn't have been down. Obviously, anytime the market drops, it would be nice to have not been

01:35:16.320 | invested. But mostly because I was like, "Gosh, this seems like a once-in-a-decade buying

01:35:21.760 | opportunity right now. The market's down 30%, but I would have had to leave this money uninvested

01:35:29.600 | and had the market not gone down." So how do you think about leaving cash aside for opportunities,

01:35:36.080 | whether the market is down or some other thing happens? I know you used to call this

01:35:40.640 | your elephant hunting fund, but how do you think about that?

01:35:44.320 | I think on average, it's not going to be a good idea. On average, you're going to do better,

01:35:50.960 | I think, by having it invested. There could be a psychological benefit to having money set aside,

01:35:55.120 | but I don't think it's going to be on average better to wait for a downturn. You may feel

01:36:02.480 | very smart if you set the money aside and then a year later, there's a big downturn,

01:36:07.840 | you can invest it all and make 30% of the money. But yeah, I think on average, it's probably not

01:36:12.400 | going to work out. I also think it's incredibly hard to know when the market is at the bottom.

01:36:21.440 | Yes, yes.

01:36:22.720 | And I would say most people will get that number wrong. So it's one thing to say,

01:36:27.440 | "I wish I had money at the bottom of the pandemic to invest." It was another thing

01:36:31.520 | when the market was down 15% to either say, "Okay, now's the time." When is the time to

01:36:39.520 | actually do that is another challenge with that approach.

01:36:42.400 | Yeah. I think it's like, "What's your capability of timing the market?" Because timing the market

01:36:45.760 | is very, very hard to do.

01:36:48.160 | I will say maybe a slightly modified version is if your dollar cost averaging, if you're like,

01:36:54.400 | "I have $100,000 to put in the market over the next six months, and a month from now, the market

01:36:59.200 | is down 10%," well, maybe you can accelerate your strategy and just put the rest of it in the

01:37:04.800 | market. You're not necessarily keeping it all on the sidelines just for that purpose. But if you're

01:37:10.960 | already in the middle of deploying money, maybe that's a time you could accelerate how quickly

01:37:15.680 | you're doing it. I remember I had a chunk of money to invest, and my rule was like,

01:37:21.200 | "I'm going to put in X amount a month, but any time the market in any given day is down by more

01:37:28.480 | than 2%, I'm just going to rein in one of those months and do it today."

01:37:31.360 | Yeah. I think it's a lot about what can you do. You want a strategy that you can actually follow

01:37:39.120 | and that you feel good about. And if you feel good about getting a bargain by investing on down days

01:37:46.480 | or investing when the market goes down 10%, it's not going to hurt you, I think, unless you're

01:37:54.720 | having money out of the market for a long time, waiting for the crash that never comes.

01:38:00.400 | What would you say to someone who's listening to this conversation, is excited to dial things in,

01:38:04.400 | but just is an over-optimizer and is having analysis paralysis about picking the right,

01:38:10.000 | perfect portfolio? Yeah. I think once you can

01:38:16.080 | dial in what the appropriate risk is and what the right balance between

01:38:29.200 | equities and bonds and come to some basic asset allocation, then I would say there's

01:38:35.360 | always opportunity to add complexity on top of the strategy later.

01:38:40.560 | I think you don't want to put yourself in a situation where you're not confident in your

01:38:47.360 | investment strategy, which would cause you to potentially sell when it goes down because you

01:38:52.800 | don't really believe in it. But if you can get across that threshold where you think you're

01:38:57.840 | in something you can believe in, then starting simple sounds like a great way to get going.

01:39:05.440 | And then if you want to continue to do research about tax loss harvesting, tax aware allocation,

01:39:11.120 | and potentially add that complexity on later, that seems like a good approach.

01:39:16.960 | Yeah. I want to caution people not to make perfect the enemy of good here. I think that

01:39:24.080 | if you're on the fence between whether you should be in a 65/35 or a 70/30 portfolio

01:39:30.000 | and it takes you a year to dial in that decision, you probably would have been

01:39:34.000 | better off in either of them. Or start with the less risky one.

01:39:38.080 | If you think you may not have the tolerance for the 70%, start with the lower risk version of it.

01:39:47.840 | Yeah. My challenge has always just been there's no perfect answer. You could take a million risk

01:39:53.680 | scores and they'd give you a million different... Not a million, but you'd get a lot of different

01:39:57.680 | allocation amounts. At the end of the day, you just have to pick one that feels right,

01:40:03.360 | knowing that either direction for any of the assets in your portfolio could do better or worse.

01:40:10.240 | But a 70/30 and a 75/25 portfolio are going to be pretty correlated to each other.

01:40:18.880 | Even though they're not going to be perfectly correlated, they're going to be pretty correlated.

01:40:22.560 | And you will never know which one was actually the better one for a given period of time.

01:40:27.440 | Yeah. And you're making a choice by not being invested or being all in cash. You're making

01:40:32.560 | that your portfolio instead. Yeah, which is definitely not your portfolio.

01:40:36.960 | So it's also a choice you're making. And you're like, "Well, is that the right one?" Because

01:40:41.120 | you should think about what is the best one that you know now.

01:40:47.360 | Yeah. And to your point about complexity, even if that complexity... You can always

01:40:50.960 | add complexity. You can also always change it. If you decide you want to dial up the amount of

01:40:55.680 | equities you have, great. You can do that. You can change this over time. So finding something that

01:41:01.120 | feels good is great. For me, I think I have a four-fund portfolio. And I was like, "I just want

01:41:07.680 | them at 40/30/20/10." I felt really good about them all being very even numbers. No rationale

01:41:16.160 | there. It could have had 38, 40, whatever those numbers... I'm going to do the math right.

01:41:23.360 | I could have had 38, 22, 30, and 10. Those all would have also summed up to 100, I think.

01:41:30.720 | Double-check my math if you want. And I just feel good about it. I know it sounds crazy, but

01:41:37.440 | the difference between all these numbers got me caught up in thinking, "Gosh, I don't know if it

01:41:40.640 | should be this or this or this." So I just picked round numbers. And I was okay with that decision,

01:41:44.560 | even if it's not... Some other person's algorithm would have spit out a more optimal allocation.

01:41:49.600 | It just felt easy for me to look at and manage if I always knew that they were simple round numbers.

01:41:54.560 | Yeah. Makes sense. I think having something you can have confidence in and stick with

01:41:58.080 | if the market's down or up is probably one of the most important pieces.

01:42:02.880 | Yeah. And so if people do need someone to talk about it, and maybe they have a spouse that's

01:42:07.680 | not interested, I'm curious how you think about in light of the world now. When we were starting our

01:42:13.840 | company, there was no chat GPT. There were no other models you could have a conversation with

01:42:19.360 | about things like this. And so we built something that was a hybrid of software and human financial

01:42:24.240 | advisors. Human financial advisors still exist. If you're struggling to make these decisions,

01:42:29.200 | might make sense to work with one. I think the advice I would give, which is probably I assume

01:42:35.120 | is yours, is work with someone who has your best interest at heart. Work with a fiduciary.

01:42:40.320 | And understand that there is a difference between a financial planner who can help you think through

01:42:45.920 | planning and investing decisions and an investment manager. And so there are lots of people out there

01:42:51.040 | that can help you come up with a portfolio that can help you think about how much to invest,

01:42:56.080 | what to invest, that you don't need to pay an ongoing fee to manage your portfolio. You could

01:43:00.400 | pay a financial planning fee, but not a 1% of AUM assets under management fee on an ongoing basis.

01:43:06.960 | I don't know. Without going down a whole episode about picking a financial advisor in general,

01:43:12.240 | you could... Anything you would say about picking one?

01:43:15.360 | Yeah. I think picking advisors who's a fiduciary, who has experience working with clients in your

01:43:25.280 | general situation is a great place to start. And I think they're people with their own experiences.

01:43:33.920 | So I think interviewing them and interviewing a few of them and seeing this one you get along

01:43:39.360 | with, agree with their philosophy is the right thing to do if you want to work with someone.

01:43:44.000 | And what about AI here? Because I know you've been working on a lot of this in your lab and

01:43:48.240 | thinking about language models. Could you get a lot of what you get out of working with a financial

01:43:53.680 | advisor just by having a conversation about your portfolio with chat GPT, perplexity, whatever

01:44:00.000 | model you want? Maybe in the future. Right now, there's the hallucination problem where

01:44:09.600 | if you're relying on the model to give a good investment portfolio, it could just make up

01:44:19.040 | something. It could make up data. It could make up rationales. So I think there's a lot of...

01:44:27.120 | There's a lot of caution that would be needed. I think if you're

01:44:29.920 | using it to bounce around ideas and want feedback, but are not going to make any

01:44:35.040 | decisions based on it, maybe you could convince it to talk about it with you.

01:44:40.400 | But I think there are a lot of innovations that are happening on the model side themselves that'll

01:44:53.040 | be really interesting and lead to really interesting financial products in the future.

01:44:57.200 | For example, one of the approaches to improving the hallucination problem is this strategy called

01:45:04.960 | retrieval augmented generation or RAG, where the idea is given the question, can it integrate

01:45:17.280 | information from documents into what it analyzes and how it gives an answer?

01:45:23.040 | So maybe it could give a footnote about why it thinks this investment could be good or this

01:45:31.040 | portfolio could be good or why you should do something in this circumstance. There's also

01:45:35.760 | opportunity to not just have a one prompt. You send one message and it sends one message back.

01:45:45.440 | It's an opportunity to chain the outputs of the language model together and say, "Okay,

01:45:51.440 | well, the first prompt could be a set of ideas that it then goes and explores and then comes

01:45:59.680 | back and it writes a summary for you." I think there's a lot of innovations that will make these

01:46:04.960 | things more useful and more accurate in the future that I think is going to be a huge advantage for

01:46:13.120 | people who don't necessarily want to hire a financial advisor, but want to

01:46:18.160 | collect information in a lot better way than a Google search.

01:46:22.960 | Yeah. I'd push back a little and say, "I bet if you pull up any AI tool of choice right now and

01:46:29.600 | say, 'Hey, I'm trying to think about building an investment portfolio. Can you help me think about

01:46:33.520 | what my risk score could be?' You might be able to have a dialogue. Is the answer going to be the

01:46:38.160 | answer that I would say, trust it and execute it? No. Ask two or three different AIs a few different

01:46:44.160 | questions. If everything seems to get you to the same point and you look at other portfolios online

01:46:50.320 | that people show in lazy portfolios or whatever, and you look at what the portfolio wealth front

01:46:54.880 | or betterment would spit out and you're all in the same ballpark and you got something you feel

01:46:58.480 | good about, it could be a good thought partner as long as you're using other sources to check."

01:47:04.640 | Yeah. I think it can provide insight into what types of things you can be thinking about.

01:47:10.320 | But I think I'd be hesitant to rely on the output. Yeah. At this point.

01:47:18.480 | This has been awesome. I miss these conversations. Chris and I used to stay up late when we had no

01:47:24.480 | children and debate all of these things because we were thinking about how we build it for clients.

01:47:29.040 | So I'm really excited we got to do it again. Yeah. Thanks so much for having me.

Building an Investment Portfolio to Grow and Protect Your Wealth with Chris Doyle

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