Ep736: William Bernstein – Never Invest Based on the Headlines

Andrew Stotz 00:02
Hello fellow risk takers and welcome to my worst investment ever stories of loss to keep you winning in our community. We know that to win an investing, you must take risk but to win big, you've got to reduce it. Ladies and gentlemen, I'm on a mission to help 1 million people reduce risk in their lives. And I want to thank you for joining that mission today. Fellow risk takers this is your words podcast host Andrew Stotz, from a Stotz Academy, and I'm here with featured guests, William Bernstein, William or mill, I'll call you, Bill. Are you ready to join the mission?

William Bernstein 00:39
Sure, why not?

Andrew Stotz 00:42
I think you've been on a mission yourself. So let me introduce you to the audience about your mission. So William Bernstein is a neurologist, a co founder of efficient frontier advisors and investment management firm, and has written several titles on finance and economic history. He has contributed to the peer reviewed finance literature, and has written for several national publications including Money Magazine and the Wall Street Journal. He has produced several finance titles and also four volumes of history. The first one is the birth of plenty, the second a splendid exchange, the third masters of the Word, and the delusions of Clash of crowds, about respectively, the economic growth inflection of the 19, early 19 century, the history of world trade, the effects of access to technology on human relations and politics, and the history of social psychology of mass manias he has was also the 2017, winner of the CFA Institute's James R. Virgin award. Well, Bill, can you just take a minute and tell us about the unique value you're bringing to this wonderful world?

William Bernstein 02:00
Oh, well, I find that I get a lot of emails, a lot of people get back to me every week, thanking me for helping them out financially, in terms of their knowledge base that I gave you. They tell me that I give people the tools to invest successfully and have good retirements. And I also occasionally get emails and letters from financial professionals who thanked me for really redirecting their careers away from the senior aspects of the financial services industry to more productive and socially useful aspects of the financial services industry.

Andrew Stotz 02:49
Well, I'm one of those guys, I didn't send you an email over the years. But you know, for the listeners out there, there's, I'm gonna hold up three books that I, I was looking at these three books. And the first one I got was the intelligent asset allocator, that was 2001, how to build your portfolio to maximize returns and minimize risk. And that really helped me think about asset allocation, which I was mainly thinking about stocks initially, that really helped me to think about that. And then I got the four pillars of investing, which I got in 2010. And then I got the man, the investors manifesto. And that was also fascinating. But what's interesting also is that you've just come out with an update for the four pillars of investing the second edition, and maybe we could talk just briefly about that. And kind of, you know why someone should go out and get this if they don't have it in if they have the old version, like I did, why you think the updates that you've done in here is going to be valuable for people like myself and other financial professionals?

William Bernstein 03:58
Okay, well, I guess what I what I hear you asking me is, why did I write a second edition of the book, the first edition of the book came out in 2002. The version that you read is basically the 2002 edition with a little bit of a codicil at the end. And so the question is, is what what did I learn in the past 20 years that made me want to bring out a second edition? And the answer was twofold. The first part of the answer is that I learned that investing is one half math, and the other half is Shakespeare. And the first edition of the book emphasized the math. And what I've learned over the years is that that's all you focus on. And you don't focus on what I call the Shakespeare of investing, which is the social psychology, the neuro psychology and the history of India. I think you will have your head handed to you. If you if you think that the answer to doing better investing is just doing more better math, you're going to find yourself not doing very well. And the best example of that most salient example of that, of course, was long term capital management. These were the most brilliant mathematical economists in the world. But unfortunately, they didn't have a good working knowledge of financial history. And they didn't realize that once every 10 or 20 years, the wheels come completely off the wagon, and all of the correlations that they had dealt with all of a sudden go to 1.0, everything starts to correlate with each other. And so where they think they're going to be diversifying successfully, no, they don't. And I guess the way I would put it is that finance is not the same as an airfoil. Or an electrical circuit, there are no precise mathematical equations that actually well describe the system, you can come up with the precise academic, you can come up with precise equations, but it's kind of like you know, equals MC squared, for 10 or 15 years, then you wake up one morning, and you find out that this morning, he doesn't equal MC squared equals MC cube, and your portfolio blows up. And so that's the the first the first bit of wisdom that I wanted to impart in the book, or the first concept that I wanted to import in the book. The second reason is that I've really come to understand that how well you do over a lifetime, that investing really depends critically on how well you behave in the worst one or 2% of times. Because compounding is magic, you know, postwhat said that compounding is one of the greatest, the greatest force in the universe. He really didn't say that. But But it's true that compounding as we all know, is magic. And the first rule of compounding is to never interrupt. That's Charlie Munger, his first rule of compounding, and the way you avoid fatally. You know, impacting your lifetime and investing is to bail out during the worst of times, it's the bomb if the sell well. So how do you avoid doing that? Well, you avoid doing that by planning for the worst 2% of the time. And the way you do that is by holding more safe assets than You Think You Can you think you should be holding at times like these when the market is, you know, had 20 years of excellent returns. At the top of the market, everybody's a long term investor. But when the excrement hits ventilating system, people's risk tolerance suddenly changes. So the way I summarize that is by saying there is a reason why even Warren Buffett holds 20% of Berkshire in treasury bills and cash equivalents. Treasury bills, and short term Treasuries are elixir of equanimity. And they're the ones that allow you to sleep through the worst of times and enjoy the magic of compounding if you don't do that, you're going to probably Dale at the worst possible time.

Andrew Stotz 08:23
And one of the things about your books that I observed as I read them over the years is that you know, you come at it at you know, at from a scientific background, I think of, you know, a doctor type of background and neurologists, I think of also kind of an engineer background. And I see you kind of breaking it all down into, you know, you've got your graphics are great, and you've got really good tables explaining stuff. And I can see kind of how that and it's interesting to hear that transition to the Shakespeare aspect of it, which I can definitely, you know, see in this in this book, which has been kind of, for me, that was really helpful, because I was kind of structured in my thinking about it. So that helped me so if you think about who is the right person to read your book, who are other all the listeners out there. Let's say someone doesn't care anything about finance, someone's like a total finance nerd, like how would you describe is the right person to read your books?

William Bernstein 09:27
Realistically, my books are probably only aimed at about 10% of people. And these are people who are good at math, who don't necessarily enjoy the math but at least can do it and can understand have a at least a working knowledge of statistics, but also who enjoy reading about history, and neuro Psychology and Social Psychology. You know, there are a lot of really good personal finance writers out there, who aim at a very at a much lower level Ramit Sethi comes most easily to mind, I can't do Ramit Sethi and, you know, appeal to a popular mass audience the way he does. That's not who I am. So realistically, you know, I'm aiming my audience is basically someone who enjoys math is reasonably well educated, and enjoys reading about history and psychology as well. And that's best 10% of the population.

Andrew Stotz 10:35
Yeah, and I think if I think about the audience, I also think about CFA charterholders. As an example, I mean, being involved in CFA here in Thailand, I'm going to definitely share this episode with everybody and make sure that they, I'm sure many of them already have your books. There's an interesting chart in your book on page 85. And I'm just going to hold it up here. So you get a picture. And I just, I just found that as I haven't seen that chart, and it's looking at, it's a little bit of a complex thing, you know, it's Liniers or logs, and all that, but maybe you could just explain it's the title is figure 4.3 power law plot of daily Dow Jones Industrial Average price changes 2020 or 1926 to 2012. What are you trying to get across in that particular chart?

William Bernstein 11:26
Well, what I'm trying to get across, is to think critically and very skeptically about one of the foundations of modern finance, which is that returns are obey a strict random walk. Now, they do a beta random walk in terms of that being unpredictable. But you hear people say, for example, that if returns were normally distributed with a real random rock, then October 19 1987, would have never occurred, because that was a minus 23 standard deviation event. And, and that's, you know, that's computationally almost nonsensical. I mean, a minus 23 standard deviation event is kind of like all the molecules in my body decomposing, and then reassembling themselves and one of the moons of Saturn. That's how unlikely that's, that's how unlikely it is. But events like October 19 1987, do do happen, maybe not minus 23%, or 22%, which is what the Dow and the s&p fell on that day, but certainly minus 10% days are not at all unusual, which should be impossible as well. And it turns out that a couple of people realize that the returns weren't normally distributed, and one of them was a guy, but the million rent Mandelbrot, who's a famous mathematician who was one of the fathers of chaos theory, and even, you know, Jay, Eugene Fama, who is an apostle, that's efficient market hypothesis, and I think, would like to assume that returns are normally distributed, but they're not. All right. And so what that is, is a graph that shows just how non non normally distributed they are. And it turns out that the stock market returns follows roughly the same mathematical law. It's called a power law, which is also the same law that's followed by earthquakes and terrorist events, and a number of other natural and historical phenomenon as well, which makes events like October 19 1987, quite possible.

Andrew Stotz 13:44
There's so many things that I think about it that, you know, think about, you just mentioned earthquakes and think about the earthquake that happened in San Francisco, you know, 100 years or so ago, whenever that was, I can't remember the great San Francisco earthquake, but then

William Bernstein 13:57
they might be fixed. Yeah. Yeah. And yeah.

Andrew Stotz 14:01
And they changed the code. And they started to think more about how you construct a building that can sustain that type of thing. And all of that. And one of the questions you have I always have about the extreme event risk, which is what we're kind of talking about here is like, do you really prepare a portfolio for that? Or is the cost of preparing for that overwhelming the compounding that you're trying to capture? I don't understand how to think about that. And maybe you could help us think about these kinds of extreme events and do we plan for that? Do we build something in our portfolio like have 20% cash? Or what do you think about how to handle something like that?

William Bernstein 14:50
There are people who can tolerate 100% equity in their portfolio. Those people are few and far between in the real world, at times like this, everybody says yes, I can tolerate 100% in stocks, okay. But when push comes to shove in the really bad states of the world, those kinds of people, most of them tend to bail out people tend to be overconfident about their ability to pick stocks, they tend to be overconfident about their ability to pick successful money managers, mutual fund managers, hedge fund managers, what have you. But the most dangerous overconfidence of all, is the overconfidence that people have about their risk tolerance, there are people out there who think they can tolerate 70 or 80, or 90% stocks. But when the event actually happens when you get an October or November 2008, or on March 2009, or you get a tech bubble collapse, like happened between 2002 1002 Most of those people wind up selling out at the bottom. If they're too aggressively, they're too aggressively invested. One of the ways that the rich people get richer, and the basically rich people get richer, is because they're smart enough to own a lot of stocks. But they're also smart enough to know a lot of bonds. A rich person in my book is and who behaves like a rich person is somebody who has 20, or 30, or 40% of their money and T bills, which is enough for them to live on for five or 10 years. After a long or during a long period of stock market underperformance. Remember, stocks can have a zero real return for as long as 15 or 20 years, especially if you start at high valuations. And so if you don't have enough cash to see yourself through that, then you are going to wind up having to sell your stocks at the bottom. And so the truly wealthy people in the world are ones who have enough safe assets that they don't worry about the risky assets falling by 50%, or 60%, which has happened twice within about a seven or eight year span. Okay, stocks dropped about 50% between 2002 1002 If you weren't tech stocks, they fell by 90%. Right. And stocks fell, even the broad stock market fell by about 55%, between 2007 and 2009. So that's twice within eight years that we saw jaw dropping, stock market falls. And if you think you're going to see yourself through that owning 100% stocks, then I think you should take another look in the mirror.

Andrew Stotz 17:41
So let me ask you a question. You know, there's that saying if a tree falls in the woods, and nobody's there, you know, did it fall? You know, what, did we hear any noise from this? Let's just ask the question. If a person had a broad base index one, they were owning the market. And they went into a coma in let's say, October 1 of 1987. And they came out of that coma on October 31 of 1987. So the whole month of October, they were in a coma they had, I don't know 50,000 $100,000 In a broad base index. Did that event matter? To them?

William Bernstein 18:27
Not a bit. But that but you had to have, you know, endured a month of general anesthesia. And to have to have benefitted from that. Now there were I do know, people who slept right through that and did just fine, but they are the exception. And not the rule. Most people when they see their portfolio fall by 20% say to themselves, Oh my god, I'm not going to be able to retire. Okay, oh, my god, I just lost $100,000 or a half million dollars. I just that feels awful. I don't ever want that to happen to me. Again. All right. And, you know, I mean, we, in our, in our practice, we have very disciplined people who are used to holding lots of cash. And those kinds of falls don't bother them. But your typical investment advisor who has, you know, 300 clients who aren't used to that sort of thing and are too aggressively invested. They're going to be getting calls at 2am in the morning. I mean, I was getting phone calls myself, from other advisors saying, I can't do this anymore. You know, people are abusing me, they're calling me up at 3am in the morning yelling at me telling me I don't know what I'm dealing. I'm quitting this business. You know, I don't know if I can do this. And so that's, you know, most people, most people don't tolerate those kinds of stock market falls. And really, you know, the question, it gets to a broader question, which is sort of a parlor game that financial economists like to play, which is how riskier stocks do where it's the stocks become more or less risky, with increasing time horizon. Now the Orthodox answer to that is they become more risky with an increasing time horizon. But I think that that's a silly question to answer without first asking, Who are we talking about? How old is the investor, if you're 20 years old, if you're 30 years old, heck, if you're 45, or 50 years old, you should get down on your hands and knees and pray for an awful stock market for, you know, one bad series of bad returns after another you want to, you want to, you want to be saving all the way through 2000, the early 2000s and the late 2000s. So you can buy stocks, when they're cheap, because you got a job. All right, and you're saving, you're saving a stream of income. Now, on the other hand, the person you talked about, who was in a coma for October of 1987, that the font the functional financial equivalent of as the person who doesn't have any living expenses, all right, if you have no living expenses, and your portfolio falls by 20%, temporarily, big deal, okay. On the other hand, if you are a retiree, who just doesn't experience October of 1987, but who retires, and their first years of retirement are between 2002 1010. Or worst of all, if they retire in a year, like 1966, when stocks go forward with negative real returns for 15 years. And furthermore, your bonds also suffer grievous losses from inflation, then your portfolio doesn't survive. Yes, the event the market eventually turns around, but by the time the cavalry appears on the horizon, you're out of money. Because you're because you're spending for your living expenses to pay for living expenses. And because your stock returns have been so poor, if you have, if you had a 4% or 5%, burn rate, and you're retired, in 1966, you were toast within 15 years or so, you know, you were living out, you know, retired at age 65. And an age by times it by, by, by, by the time you were at You were lucky if you're if your kid had room for you in the, in the mother in law's apartment.

Andrew Stotz 22:34
It's fascinating. I mean, I dealt with my parents, my parents manage their money with the help. My dad worked for DuPont, all of his life, and they really helped a lot in those days. But then it was all kind of went to 401, k's and all that type of stuff. But in those days, you know, my dad has had a pension all of his life. And he also got, you know, DuPont stock at a discounted price, which he bought. He wasn't sophisticated in that. But in the end, they were able to live with 22 years of retirement. And when my dad passed away, and I brought my mom to Thailand, it's incredible the amount of money that they still had, you know, and the point that I'm making is that it's possible, you know, to get to build the wealth over time. And I just also want to compare that to my niece's. When each of my nieces was 18, I came back to America, and I gave me $3,000. And I said, we're going to set up a Vanguard account in this case, and I said, you're going to buy a Vanguard Index Fund. And my advice to you is contribute every month to this global Vanguard fund that owns every stock in the world and never sell.

William Bernstein 23:48
Yeah, well, I you know, the probably the, without, without a doubt, the most popular book I wrote, or the most popular thing that I wrote was a little pamphlet, called if you can which is still available for free, all you have to do is put my name into a search engine, put into quotes, if you can, and you'll download download the it's about a 10,000 word booklet or so. And it's aimed at people like you're nice young people like you're nice. And the message is, all you have to do is find you know is in your 401k Put all of your money into a target date retirement fund, and look at the statement at most once a year to make sure that your account hasn't been hacked. And otherwise pay no attention to your account whatsoever. And don't worry about it. Because you're saving money you don't you're not going to need that money for another 30 or 40 years and just forget about it. And by the time you're 6065 years old, you will probably be fine.

Andrew Stotz 24:47
One of my nieces out of the five that I did that with I was a little bit worried because she really was not interested in finance and you know her skills were in other areas whereas the others may have had a little bit more interest. So I was a bit nervous. about how she was going to handle that. And a couple of years later, when we got together, I asked them all to produce their, the results of where they were, as far as where did that? How did that money grow or not. And so they each, you know, said, Oh, I have this amount. Now in my account, I have this amount. And this one needs to mind. She had like, three to five times more than the others. And I was like, wait a minute, how can this be? And I said, what happened? What did you do? She says, Well, Uncle Andrew, you told me to contribute every month. So when I did my babysitting and stuff, I put the money in, and I bought it. And every month, I just kept contributing. And I was like, in fact, in one of my other nieces a couple of years after that. So she's, you know, investing in a tech fund. And she's investing in a startup. And I thought all Well, I think I lost her. And I, in the end, I think I kind of failed in this experiment, or this trying to give something because I wasn't able to convince them, that it's about constantly contributing and not getting distracted by all the different options out there. So it's just, you know, it's such a challenge. And sometimes when I read your work, I feel like, okay, it's getting simplified. And then sometimes I feel like, oh, but now it's complicated again. And it's such a difficult thing to manage. Because on the one hand, I want to simplify it by just saying just on that and forget about what's happening in the market. But then you come back and say, Andrew, you can't do that. Because of all of these emotional things. And you know, all of that other stuff. How do you balance simplicity with the complexity that's kind of necessary sometimes to get the best return over time?

William Bernstein 26:46
Well, what, what I like to say is that having a successful retirement portfolio is simple. All right. But simple doesn't mean easy. If you want to lose weight, losing weight is really simple, you eat less exercise more simple, but not easy. And finances the same way. Now what I need you what you may be referring to is, in all the books that I almost all the books that I write, I have some great simple portfolios, but I also have some very complex portfolios. And the complex portfolios are really aimed at people who are mathematically competent, who can write a spreadsheet, and who know how to, you know, read the spreadsheet and know how to know how to, to adjust their portfolio according to the spreadsheet parameters. But if you can't do the math, or you don't want to do the math, then really a target date fund is for you, or it most have free index funds, you know, total stock, total bond total International, and just contribute equal amounts to that every single month. And you'll do fine. All right. And, you know, theoretically, you should rebalance back to whatever your policy allocation is. But again, you have to be able to, you know, write a spreadsheet and adhere to it. And most people I found, don't know how to do that. I mean, one of my mentors in financial writing, is a guy named Scott burns, who's still writing for the Dallas Morning News. He's even, he's even older than I am. And one of the most important things he told me was Bill, for 90% of people fractions are a stretch, you know, don't expect people to be good at math. And you know, you're good at math, and pretty good at math. But it turns out that most people just can't handle the math. It's that simple.

Andrew Stotz 28:54
And even if let's just take an example of somebody that makes a very simple portfolio, like you've just described, you've said, total stocks, total bonds total International, and does some sort of, you know, contribution every month in some sort of weighting. And then if you compare that to the best guy, man or woman out there that digests your material learns it builds those spreadsheets takes advantage of some of those anomalies, maybe in small companies or in value stocks, or you know, they use some of those ETFs out there. Let's just say over that period of time, let's say the next 30 years, that the person that's relatively passive and simple, is getting a 10% return. What is the uptick if you were just to estimate that that more sophisticated investor is getting it or they're getting a 20% return or they're getting a 11% or 10.5% return when all costs and everything's figured into what they're doing

William Bernstein 29:53
with what they're getting between 10.5 and 11.0%? If you know value Loading in small loading. And, you know, adjusting your vet your your allocation, a little bit opposite big changes in valuation, that'll squeeze at best a percent of return out, it's for people that's sort of, you know, complexities for the kind of person who really enjoys the complexity and is really good with the math, and is also really, really disciplined. You know, over the past 1015 years value investing in small investing has been very discouraging, because, you know, returns have actually been slightly less than the market. Now, what I'm fond of pointing out to people about that is that that's true in the US, but abroad, both in developed markets, and in emerging markets value and small loading is done just fine, thank you, to the market, it's just the foreign investing in general hasn't done well, relative to us.

Andrew Stotz 30:58
I think that this is a super important message that you've just said. And that is that, if you do kind of a very simple, keep it simple, well diversified contributing on a regular basis, not freak out, when markets are up or down, that you'll be fine. And let's say that if you get tempted into I'm going to bring a lot of complexity into this. And if you find that hard or overwhelming, you're not missing much. If you just go back to the simplicity. In fact, maybe the best advice for some people is just built, get $100,000 into that simple methodology that you've just described. And then later, you know, if you feel like messing around, take, you know, five or 10% of it and see if you can build that complexity. And if you enjoy it, and if it returns,

William Bernstein 31:47
even the best bets in finance are best 5545 or 6040 in your favor. All right. So if you have an optimal if you have what looks to you to be an optimal asset allocation, and you follow it for 30 years, even 30 years, there's probably 40% chance, you'd still be better off using a simple three fund portfolio or a simple target date fund

Andrew Stotz 32:14
was one of the observation. You know, I was, I was reading one part and thinking about, you know, you're talking about the ethics of finance people. And we all, you know, concerned about that, in fact, I teach ethics and finance class at university. But over the last few years, I've kind of started questioning the ethics of a lot of different professions. And I've started, you know, looking at, for instance, let's take MediCal, I had to deal with my mother and my father in the US medical system. And I remember my mother, they had piled on a huge amount of medicine on top of my mom. And she had had a stroke. And then when I went to work with the doctor, and I said, Can we get her off with some of this? No, I can't. And I can't take her off that's another doctor. That's another doctor, that's another doctor. Okay, nobody's looking at it holistically. And I see my mom, actually, when I read the interactions, as well as the side effects, I see that those are really having a real impact on my mom. And I'm trying to get someone to pay attention, and you can't. And then I think about the ethics of then I go back in time, let's say when I was young, and my family doctor in our little town in Ohio, that guy was not influenced by the hospitals and the medical system and the insurance system and the government policies and the pharmaceutical companies and all that he was just, you know, pretty simple. But now I look at it, I think, I don't know, I started to question the ethics of a lot of different industries. Not that I'm giving a free ride to finance. But I there was a part of me that thought that when I was reading a portion of what you were talking about, I'm just curious, you know, what are your observations there when you compare across professions?

William Bernstein 33:57
Well, first of all, you heard me you heard me talk about the three big overconfidence in terms of being dangerous to you. But there's a fourth overconfidence that is dangerous to society at large, which is we all tend to be overconfident about our ethics, we all think they were happening. And I just read a marvelous, a marvelous book by a Harvard business professor by the name of Eugene solt has called why they did it. And it's about you know, all of these scamsters people who wound up getting evicted scamsters is the wrong word. Most of these almost all of these people did not start out wanting to scam people. They just slid into it in the classic sort of the paradigm of the person who steals $100 from the collection plate borrows it goes to the racetrack with the with the good intention to win money at the racetrack and put 150 bucks back in the next week. But of course that never happens. And they wind up feeling more and more money from the plate. as they as they double down on their bets. That's what happened to Bernie Madoff early May Rap started out in the 1960s with some very simple options based strategies that made money, all right, split strike conversion and a few other things as well. But by the 1970s, and particularly with the advent of Black Scholes, those arbitrage opportunities disappeared, he didn't understand what was happening. And so he couldn't understand why he wasn't making money any more than he was sure he's going to turn himself around. And that's when the Ponzi started when he started taking more people, taking more money from people and paying them back with the contributions of future fund fund investors. And so that's what tends to happen. Nobody thinks I mean, Adolf Hitler thought he was a great thought he was a good ethical person. So that's the problem that you deal with. Now, are there unethical doctors and dentists? Scott, you bet there are? I mean, I could tell you stories, but I probably get sued. So I won't. And, and, you know, but there's, there's a fundamental problem with finance, which is worse than other professions, which is, it's the Willie Sutton phenomenon, which is, you know, people, people, you know, Willie Sutton, famously is supposed to have said that, you know, when he when he was asked, Why do you rob banks? Well, that's where the money is. And let's be honest, people do not go into finance, for the same reasons that people become social workers, or Jesuit priests.

Andrew Stotz 36:31
Yeah. Yeah. And that's something I talk to my students about in my ethics class, like, why are you going into finance? And if your answer is, I want to get rich, you're going in for the wrong reason, your job is to make the client rich. And that's, you know, one of the things now, let's just highlight that book, why they did it inside the mind of the white collar criminal. And I think I'm gonna be listening to that on Audible. So that's an interesting one. One other thing I had a question about that I thought you would have a good perspective on is, many years ago, let's say 20 years ago, when a client would walk into an investment operation, they wouldn't ask them all of these kinds of behavioral questions. The behavioral questions came along, I don't know, 1015 years ago, when they started saying, you know, how would you handle a downturn and all that, and they came along, you know, at, they came along, and kind of trickle took the world or the finance industry by storm, people started asking these questions, and then they would adjust portfolios based upon those assessments. But as I look at those assessments, now, I start to think that those assessments are no longer for the purposes of protecting the client, they may be used to protect the institution or the bank or the investment firm. Because why am I saying that? Because it's easy to say, oh, yeah, well, you're, you're just, you know, you're a flaky guy, and you're going to sell out, I'm going to predict that you're going to sell out based upon your answers to this thing. So I'm going to put you in low risk stuff. It's not based upon the amount of money you had, or the time that you have, those are other factors, like, you know, if you're young or older, or you retired. And what's happening is that the financial professionals comforted to put people into lower risk portfolios, but then are bringing on shortfall risk at the end of their life, that they're not going to have enough money. And who's, you know, there's nobody to blame 30 or 40 or 50 years from now, when a guy retires, and they hadn't been exposed to enough of volatility of the market. I'm just curious what your thoughts are on that challenge or that dilemma?

William Bernstein 38:40
Well, I think what you're talking about is more likely to happen with an individual investor, who just can't wrap their arms around risk. You know, I'm sure that there are, you know, as you posit, there are investment advisors out there, who use these questionnaires and invest people too conservatively. For the long run, particularly young, young clients, young clients should be aggressively invested. But I think that must be relatively uncommon, far more common is the person who has a 401 K plan and just keeps it all in the money fund for 30 years. There's too much of it in the money fund for 30 years. So it's a problem, but I think it's more of a problem at the individual level. Now, I don't find these kinds of questionnaires to be at all useful in any dimension, just because someone puts down on a questionnaire that yes, I miss power and I can tolerate losing 40 or 50% of my money in a bad market doesn't mean they actually can. The most important, single most important question that we ask and probably, you know, it's what we base 80 to 90% of our asset allocation decisions on is how did you do during the last bear market? All right, and preferably their spouse is there to confirm the truth of what they're telling us? And if the answer is, you know, I'm only 30 years old, and I've really never invested through a bear market, I don't care what they tell me on a questionnaire, they're virgins, alright. And there's a wonderful quote that goes with that all in a moment that I have in the book. And so we put them at best 5015 stocks, and then we see how they do during the next bear market. If they do fine, then we up their allocation, there is a wonderful quote from a wonderful book that I'm sure you've read, called, where the customers yachts by French sweat. And the quote goes something like this, which is there are some things that cannot be explained to a virgin, either with words or with pictures, no words that I can, that I can write, where pictures that I can draw for you draw for you can convey exactly how it feels to lose a real chunk of money that you used to own.

Andrew Stotz 41:02
That is real pain. Yeah, that is real pain. And I think that that's a great. It's a great reminder. And it's that pain that causes us to make bad decisions, I want to wrap up this little section that we've had talking about it, your your book, and all that to recommend to anybody out there who really wants to get a deeper understanding about history, about markets, about the Shakespeare, you know, about the behavioral aspects, all of your books have been great for me as I've grown, but with the updating of the four pillars of investment to the of investing to the second edition, I've found it, you know, fantastic. So I'm gonna have links to all that in the show notes. But, you know, now it's time to share your worst investment ever. And nobody would believe that someone of your stature would have a worst investment after all the knowledge that you've gathered, so could you just tell us a story of one of your worst investments ever?

William Bernstein 41:58
Well, when I was much younger, I made every single mistake that you could possibly make trying to invest in individual stocks, trying to pick winning money, money managers. But easily, easily the worst investment that I've ever made, and it's sort of an object lesson was about 35 years ago, a couple of physicists, pons, and Fleischmann, I think were their names, announced that they had perfected cold fusion, they had been bedded, best, you know, they had basically perfected in a practical the, the technique of cold fusion, which enables you to take hydrogen atoms, smash them together, and get helium the same thing that that that goes on in a hydrogen bomb. And if that were the case, then we were, you know, we had a source of energy that was too cheap to meter. And the limiting factor in producing that in, in, in that technique was palladium. That was the catalyst. Right. So the price of palladium, I don't know went from like $100 an ounce, up to $400 an ounce, and I thought it would be a good idea to buy palladium futures. And of course, I lost my shirt, I probably lost, you know, low, low, low, five figures doing that. And that was a lesson, which is to never, ever invest, based on the news on the headlines, because it recalls a very famous statement by Bernard Baruch. It's something that everyone knows isn't worth knowing. So, you know, I don't worry at all the practical implication of that today is, is what's the Fed doing? You know, you know, what are the unemployment figures, you can ignore that, because it's something that everyone knows it's already been pounded into the market. It's one of those things that everyone knows that isn't worth knowing. And what I like to say about headlines, is that it's really good to read the headlines. Because if it's in a headline, you don't have to worry about it anymore, because everyone knows about it.

Andrew Stotz 44:01
Yeah, such that was such a great quote that I read in the book. And, you know, I mean, I was thinking about it when I was reading it like, Well, I mean, I want to know some general things that like his general knowledge, but if it's just the news out there, it's already in the price. And I've got to be thinking, you know, beyond that, or not being lured, let's say, by the seductiveness of those headlines. One of the things I'd love to do is just to get your thoughts on maybe a simple piece of advice for young person starting off. And let's just take two people, let's say someone that's not sophisticated at all, and doesn't want the complexity. And let's take someone that is a little bit more, you know, has willing to take on some of that complexity, and he's interested in it. What would be your general advice for them in their path? Let's say they're 25. They've got many years of investing ahead of them. What kind of advice after all that you've gathered in your knowledge would you give them?

William Bernstein 45:04
Well, what I would tell them is what comes out of financial theory comes something called the LDI. Or I think it's that I'm not even sure what LDI stands for. It's Merton Samuelson's model. And it basically says that young people should invest 100% in stocks, why 100% in stocks, because they only have a small amount of investment capital, right, but they've got all this human capital. And, and so even if they're 100%, heck, even after 200% in stocks, that's still very small compared to this massive amount of human capital they have. So they should invest all of their savings in stocks. All right. And that is conventional wisdom. That's what optimal investing looks like, theoretically. All right. So what I would tell them is, go 5050. All right, start investing every single month 5050 into stocks and bonds, and then see how you do during the first bear market. Okay. And if you can tolerate watching your stocks fall by 40, or 50%, then God bless you can up your stock bond allocation, maybe the 2575. And if you can go through the next bear market, and invest through that then sure. Put all of your money into stocks when you're young. Right now, when you're older. That's that's that's, that's, that's another story. So dusty, the advice I would give is to start slow, and see how you react to the bear market and find out what your actual risk tolerance is, in the real world, because there's a big gap between talking to talk and walking the walk

Andrew Stotz 46:46
LDI liability driven investment

William Bernstein 46:49
investing? Yes, yeah. Liability driven investing. Yeah, that's, that's, that's what he said yes.

Andrew Stotz 46:54
And if somebody is more sophisticated, and they see all the knowledge that you've got in your books and stuff, and they said, Okay, that's cool. But I'm really willing to take on a little bit more risk, or I'm willing to dig deeper, what would be the area that you would say, it's worth their time to spend on? Is it factors is it, you know, tilting with ETFs? Or what would you say, is a place that they could not, you know, where they wouldn't be wasting their time, if they spent time studying, learning, that type of thing.

William Bernstein 47:31
That would be the second daughter stuff they should learn, which is what's in the conventional finance literature. And about factor investing, maybe just maybe small value stocks and value stocks, in general have higher returns than growth stocks do? Maybe they do? Maybe they don't, I think they do. But I could be wrong. But the single most important thing that any investor should be spending a lot of their time on is investing history. And its financial history. Because if you don't have a working knowledge of that, you wind up like the poor guys have long term capital management.

Andrew Stotz 48:08
And you have four books that we talked about in the intro, and I'm just curious, out of all of the four of them, what would be the starting point that you would recommend from the birth of plenty as funded exchange masters of the word and the delusions of crowds? Were would be the starting point.

William Bernstein 48:24
I would start with a splendid Exchange, which is the history of world trade, simply because it was the book that was best received by the public it is a book that exceeded, it exceeded my wildest expectations in terms of its critical success. And because I think people just enjoyed the narrative flow of the book. It was it was, it was it was the book that purely by accident, I did the most things right in.

Andrew Stotz 48:54
So that's a great, you know, I mean, I read that and I can definitely confirm that. Also, it's a great name. Great name. Yeah.

William Bernstein 49:02
Yeah. Again, again, it was quite the one of the most painful processes in writing a book is getting a title that your both you and your publisher can agree on. There's a negotiation. Yeah. And Mike, my publisher was actually the one that came up with that.

Andrew Stotz 49:21
Yeah, that's a great one. All right. Last question. What is your number one goal for the next 12 months?

William Bernstein 49:28
Oh, here next 12 months, I've just come off of writing two books, two books, published in the past two years a lot of work. And I just want to read is follow my nose in terms of fiction and nonfiction reading, right, the odd book review when, when the fantasy strikes me and nothing more ambitious than that. I mean, there's the They're sort of the sort of the, you know, the bond bonds if you're if you're a nonfiction author, what's a bond bond is reading a good book and then writing a review of it. It's a simple, very satisfying process, it's much, much easier and much more and, and it's sort of like you know, spinach and vegetables are good for you. That's long form nonfiction writing it, it builds up your skills and your stamina. But there's nothing wrong with having the odd bom bom. And right now I'm just eating bonbons. I'm reading. I'm reading lots of good nonfiction books. I already mentioned one of them to the soul, this book. And I probably won't even wind up writing a review of that, but it's kind of fun to do.

Andrew Stotz 50:47
Yeah, it's, it's great exploring, you know, it's also great celebrating when someone's really written something, you know, well and written something unique. And I always love, love that. So it's not that common. I mean, there's, there are some great writers, but you know, there's a lot of stuff that's, you know, it's okay. But

William Bernstein 51:06
if you're serious about economics, I can't recommend the book that I just finished, which is economics in America by Angus Deaton, who, together with his wife, wife wrote depths of despair, and it's just a it's a meditation on a one on one political economy. And he's just a marvelous human being and as humanity comes, comes through with it, I mean, he, he describes, you know, what a what a rocket ride winning a Nobel prize is, and you wind up going to Stockholm with about a dozen people, because that's who they'll pay for. They'll pay for all your friends and your colleagues, your family. And you get squired around you have it. You have a limousine that's on call for you. But he said the best thing of all, was watching his nine year old grandson flirt outrageously on live TV with an interviewer. And that's the kind of book that says it's a marvelous book

Andrew Stotz 52:04
economics in America and immigrant economics investor,

William Bernstein 52:07
buy, buy, buy, buy economics in America by Angus Pete got it was the 2015 Nobel list. For, you know, his work on basically the health effects of inequality.

Andrew Stotz 52:21
Great, great advice. Well, listeners, there you have it another great discussion and story of loss to keep you winning. Remember, I'm on a mission to help 1 million people reduce risk in their lives. As we conclude, Bill, I want to thank you again for joining our mission and on behalf of a Stotz Academy, I hereby award you alumni status for turning your worst investment ever into your best teaching moment. Do you have any parting words for the immense audience?

William Bernstein 52:49
Just keep buying. And I'll tell you the pleasure was all mine.

Andrew Stotz 52:54
It was ours for sure. And that's a wrap on another great story to help us create, grow and protect our well fellow risk takers. Let's celebrate that today. We added one more person to our mission to help 1 million people reduce risk in their lives. This is your worst podcast host Andrew Stotz saying. I'll see you on the upside.