ISMS 29: Larry Swedroe – The Shiny Apple is Poisonous and Information is Not Knowledge

Andrew Stotz 00:02
Hello fellow risk takers, and welcome to my worst investment ever stories of loss to keep you winning. Today we continue our discussion with Larry swedroe. About investment mistakes even smart people make. We're moving into the second part of this particular book that you've written, which you've written so many Larry, it's incredible. This part is called part two, ignorance is bliss. And we've got two mistakes that we're gonna be talking about mistake 16 of your long list is Do you fail to see the poison inside the shiny apple? And Mistake number 17? Do you confuse information with knowledge? Larry, take it away.

Larry Swedroe 00:47
Yeah, so one of the things I learned long ago, somebody really smart taught me is if you tell some body of fact, they learn if you tell them a truth, they'll believe. But if you tell them a story, it lives in their heart forever. So I try to use lots of stories and allergies to things people are familiar with. And then you can understand the simple concept that you're trying to get across. And then you can understand hopefully, then, how it might apply to a more complex subject like investment. So I was trying to explain the problem with a lot of complex investments that are often sold to people or how brokerage firms take advantage of investors. So I thought of the story of Snow White, and the wicked witch with the poison apple. And the Evil Queen arrives at Snow White's cottage the skies as an old peddler. And despite being won by the Seven Dwarfs, to not open the door for anyone and don't accept any gifts, Snow White answers the door and then her naivete. The Evil Queen was no white into biting the apple, which of course, was poisoned. And she falls into a sleeping death that can only be way awakened by love's first kiss. Now fortunately, The Story Ends Well, unfortunately, when it comes to investing, there's lots of poisoned apples that are really hiding or poison hiding inside those shiny apples when it comes to investment products. So in the book, we described how brokers in effect, you know, enhance their wallets at the expense of the consumer as well as and simple ways by disguising or hiding the fees that they take. Unfortunately, in the United States anyway, the laws have given broken deal is great leeway in allowing fees to be charged that are not considered excessive. So for example, if you are buying a bond that was trading at par, say interest rates were 5% for double A bonds, and you're buying a double a bond of a certain maturity, and that yield should be 5%. So you should buy it and pour, that broker dealer could actually sell it to you, or 106 charges, six points for doing nothing more than executing an order. Right, there's no risk taking by the firm that is buying the bond, and hopefully they could sell it later. They're just going to the market, buying that bond and marking it up. And the courts amazing to me have found that 6% is not egregious, or whatever, a 1% fee maybe would be acceptable covering their costs and infrastructure and advice. So maybe 1% might be reasonable. But 6% is kind of crazy. So how do brokers take advantage of the naivete of the average investor, especially when lots of bonds don't have public pricing, or at least didn't use them? Today? There's more visibility today. So let's say Andrew, you want to buy a one year bond. Okay, yep. And the yield on that one year bond should be 3%. If I want to charge you a 1% fee, I've got to sell that bond to you at 101. And you're gonna look at his screen and say, oh my goodness, I just lost 1% I'm not getting 3% I'm getting 2% on that bond because I paid 101 On, and I'm getting only 3% interest. So what is the broker dealer do instead of selling you a one year bond, he sells you a 30 year bond. And now because the 1% costs is spread over 30 years, that costs might be seven basis points. So he sells it to you at 1.07. Or oh, oh seven. And you that gets it and he could add five points in there. And you'd only be adding 33/5 of a percent of the total cost of the bond. So the average consumer ends up buying much longer term bonds than they probably should be. But that allows the broker to disguise the fee, because it gets spread out over a much longer period.

Andrew Stotz 05:53
And that that spreading out is a theoretical spreading out because they're actually taking that fee right up front. Yeah. And so you're deprived of that money to compound over time. So it's just that's that is a brutal tactic. Yeah.

Larry Swedroe 06:09
So a second strategy is that you sell them a printer, a bond that's trading at a premium. Because the bond was issued at a time when interest rates were higher, and now rates are lower. So let's say you, the bond was sold when interest rates were 5%. And now, interest rates today on a 10 year bond are closer to four. So you're willing to pay above par for that bond, because you're getting 5%, when a new issue would be four. So let's say you charge your 1% spread. And now you know, you will own that bond. But the problem is, a lot of bonds have called features. And if it's in the period with a company can call a bond, you won't get the next maybe five years to get that full interest. Maybe it's callable, next month, or next year. And now,

Andrew Stotz 07:15
callable means that the company realizes we don't need to be paying this high interest rate, we're going to repay this and we're going to reissue a new bond at a lower rate Correct?

Larry Swedroe 07:25
Exactly right. So your cost of you know that you're paid a premium, you thought you would earn say, not higher rate for five more years. And maybe you only own it for one year. So instead, of course, the 20 basis points here, it costs you 1%. But they added two points to it, it was less. So that's a second way that the broker dealers screw the investor, they tend to try to sell callable bonds, which then get called and guess what, now they get a second chance to double dip because your bond got called. And now they can screw you again, by selling you another callable bond that might now if rates are now lower than they were now today, there aren't many callable bonds that are selling of premiums, because rates have obviously gone up. But, you know, the next cycle when that happens, we'll see this. And then there's a whole other category, which we didn't discuss in the book, because they weren't that popular yet in the US, when I wrote the book, something called structured notes.

Andrew Stotz 08:37
And before we get too structured notes, I want to go back and think about, you know, when you think about capitalism, what we want generally is less government regulation, and more price competition. The more price competition, we have, you know, the whether it's the iPhone, or your car, or whatever, the companies are really fighting it out with each other, to try to bring more value and lower prices. And it works very well. And so, why doesn't it work in the broker dealer world, because I can understand from a judge's perspective to say, salary, this is a free market. And if you know, if they can charge that price, and the investors are willing to buy it, and there's no fraud, right? If they send you a bill and say, you know, we charge you 1% when in fact they charge 5%. Okay, then you could say that there was a misrepresentation and fraud, but if there was no fraud, why isn't this correcting?

Larry Swedroe 09:38
Yeah, because the one the law is written that they're allowed to charge reasonable fees. What shocks me is if a firm were taking, you know, buying some illiquid security from you, and they can't sell it and they don't know where the price is, there's no liquid market for okay, you could charge a big spread and A big fee because you now have the risk, and maybe you can't even resell it, you might have to hold the bond for months or even longer, and you don't know where the market will be at that time. So maybe a five or a 6% fee might be applicable. But when you're just base in order taker, and you're taking no risk, you're entitled to a fee for giving advice and suggesting maybe to bind that bond. So maybe a 1% fee or something like that, or less might be appropriate. And I cannot understand how judges except they may be owned by the brokerage community, who is, you know, they're getting contributions

Andrew Stotz 10:40
that wouldn't happen in America, forever world countries?

Larry Swedroe 10:45
Yeah, well, they wouldn't be on the in that sense. But the brokerage firm could be supporting their political campaigns, they have a lot of chunky labor. In the US, they're not appointed. So that could be a problem. So let's talk a little bit about structure.

Andrew Stotz 11:04
Before we go there, I just want to highlight that in 2018, CFA Institute came out with a statement of investor rights, and you made me think about it. And I just was wanted to highlight a couple of those rights. One of them is, number three is my financial interests take precedence over those of the professional and the organization, this is your right when you go. And the other one is this one, which I like. On all this is number eight, all explanation have an explanation of all fees and costs charged to me, and information showing these expenses to be fair, and reasonable. In other words, I have a right to an explanation. And as I tell people, when I have taught and taught about these, and given some speeches about these, what I try to tell people is that it's not your responsibility to figure it out. If your financial adviser is give telling you something that's confusing, what you need to do is go back and ask them, please explain that in a more clear way. You have that right. And I just wanted to highlight that. And if they can't do that, you got to get out of there.

Larry Swedroe 12:21
Yeah, exactly. It's not only their right, in my view, it's their obligation, correct. Trust, but verify is always the basic principle. So let's move on to talk briefly about structured notes, which are sold and now in the 10s of billions, they actually are much bigger percentage of the market in Europe, for example. And a structured note is what we would call a derivative instrument it has, it's a creditor, if let's say, UBS, the big bank decides to issue debt, and the debt is tied to something like we'll return to you the return on the s&p 500. But it's on the index of price appreciation. So one way they screw you is not the total return will give you the price appreciation, which doesn't count the dividends. People forget that. And so they lose today, roughly 2% and not counting that. And then they might say something like, we'll guarantee that the losses can are capped at 10% or 5%. And the gains then in return are capped at 15% or 20%. Okay, now, that may sound attractive, my downside risk is protected. And but I'm getting giving up upside, but most people put much more weight on reducing the downside, because they tend to be risk averse. And that's where the big institutions take advantage of that fear and lack of knowledge of the investor on how to price these risks. So what the bank has basically done is sold you a debt instrument. Now that debt instrument has credit risk, so they should be paying more than the Treasury in the US, we would use the US Treasury, right. And let's say UBS for a, you know, one year note might pay 100 basis points over treasuries. That's not showing up in the numbers, right. It's, here's the note, we're gonna pay you this return on the s&p and there's nothing in there that says it's 1% More because our credit rating doesn't warrant the same as us. So that's the second thing that tends to happen there. The third thing is all they have done, they're not going to take the risk that let's say they kept gains at 20%. You know, they know that, you know they have in effect, you have sold them a call, they have the right to call it away for you if the s&p goes up more than 20%. They know what the cost of that call is. What are the odds? Do you think your average investor in Thailand knows what that call is? almost zero? Yeah, I would say it's virtually zero. And you have bought from you know, and you've also sold them a putt, because you've guaranteed them, they can't lose more than x. What are the odds that your client or a friend or an investor in Thailand knows what the cost of that put is? Again, it's probably close to zero. So what do we know is this, the research is done. There have been several papers that have analyzed these hundreds of securities, and take a guess, Andrew, how far overpriced these securities are, on average is at 1% 2%. What do you think it might be? I would say, one year instruments by the way,

Andrew Stotz 16:19
I would say three to five percentage points.

Larry Swedroe 16:22
And you're a fairly sophisticated knowledgeable, that's theirs for the year to love. The average number is higher, it's six or seven. And now, how do you know that you should never buy these things? I literally, almost never I've analyzed, when these first came out in the US I analyzed like 100 of them. And one of the first things before I did any analysis of them would be number one is I'd asked the firm that was the issuer say it was Morgan Stanley. I said, How much does the the brokers trying to offer me? How much do you or your grandmother or mother our own have that security? What do you think the answer is? Zero. Right?

Andrew Stotz 17:15
And you should never invest? My firm doesn't, doesn't allow me, you know, that

Larry Swedroe 17:21
firm allows them always to buy their own products, right? So, you know, one of the rules of investing is you should always ask an advisor do you put your money where your mouth is, I want to see your financial statement. And you may have a different asset allocation, because you have different risk appetite, but you should own the same types of investments that you want me to home? And if you don't, why should I trust it? So I have never once heard anyone tell me that they are their mother on a number two, I asked them how many institutional investors own the product institutions who could do the math, because they can calculate they'll call up somebody and ask them what the put in a call is worth. They can look at, you know, JP Morgan's credit spread, and figure that out, and then add it up and say, All right, here's I can replicate this myself at this costs. I could go buy treasury bonds, instead of JP Morgan or JP Morgan's debt, and then add a printer call on and see what happened. Take a guess how many institutions have ever bought any of

Andrew Stotz 18:34
these? I don't think they're designed for institutions, right

Larry Swedroe 18:37
was that designed to exploit naive investors, which is, in my mind criminal, I don't know how these people who mock at these things literally look themselves in the mirror in the morning, and are able to live with themselves. Now. I did see one product once from an insurance company was trying to gain market share. And it did have some worthwhile attributes. That's because it was probably designed by the marketing department and not the finance department. So it's not impossible, that it could be a good product, but let me explain why the all adds so greatly favor, you're getting screwed. And so and why the research has shown that the average excess cost is in Europe anyway, it's been 6% is the logic. Alright, so Andrew, you're the chief financial officer of JP Morgan. And you have a choice. You can issue the debt of JPMorgan as a straight debt instrument with no bells and whistles. And you have the alternative. You can issue some buffered note that has these caps on it, or you know, whatever. Which one are you going to issue

Andrew Stotz 20:01
I would say that

Larry Swedroe 20:05
with the lower costs,

Andrew Stotz 20:06
yeah, whichever I can get the lowest costs, and if I can damage those buffers to reduce

Larry Swedroe 20:12
the risks right there. And you know, so if you have the lowest costs by issuing a straight debt, that means the investor who is buying these structured notes gets what? A lower return. So therefore, it's pretty simple, the answer is easy, you should never buy a structured dump.

Andrew Stotz 20:36
And on that note, I want to just highlight that I've seen this in Asia, I think it's just a flood of structured notes. And I have some friends of mine that have invested in these things. And you know, when they invested it, they sound really smart. You know, it was something linked to the s&p, and to the Australian dollar relative to the US dollar. And I mean, I even had one of my friends call me and tell me, I can't really even explain what this is, but I bought it because I just sounds great. And, and they always lose on these things. And they can lose

Larry Swedroe 21:12
possible that you could make money because strange things happen. But you have to remember, the more complex it is, the harder it is for the investor to figure it out. And therefore they make it in complex, intentional.

Andrew Stotz 21:28
Yeah, and that's where the whole thing about the market is, you don't want to be trading against the most sophisticated players,

Larry Swedroe 21:35
that thing, investors, I've tried to teach, we've discussed this, whenever you're transacting in the market, you have to ask who's the sucker at the poker table, because it's always a zero sum game, before expenses, forget Commission's bid offer spread expense ratio for somebody to win, meaning they're gonna outperform somebody else to be on the other side of the ball. And since 90%, of all the trading is done by the biggest positions, the odds are pretty good. You're the sucker at the poker table, you're likely to be exploited and lose. And it's Warren Buffett, or some big institution. On the other side, you might win, you can get lucky, right? People win by buying lottery tickets and going to the casinos in Macau. But you know, the odds are not good.

Andrew Stotz 22:30
Well, and just to wrap this up, and go back to a lot of the other topics that we've talked about, what you've also taught us is that institutions do not outperform in aggregate. And that means if you're just if you're just trading in the market, and you're an individual investor, and you follow a systematic methodology, and your trading costs are low, and you want to own a portfolio of 20, stocks, let's just say for the next 30 or 40 years that you're building that, you know, you have certain advantages, because of not being driven by, you know, quarterly results and things like that necessarily like an institution. So when you're just kind of trading your skill into the general market, you have some potential to either get a market return, or maybe even a little bit higher, it's possible or a little bit lower, or a little bit lower, or a lot lower. But the point is, is that when you have the massive, most brilliant people lined up against you, you're going to lose. And so

Larry Swedroe 23:34
why, yeah, the odds are against

Andrew Stotz 23:39
your increasing your odds to win, you go one on one with the most sophisticated investors that are on average losing in the market, but they're designing a structured note guaranteed so they can win.

Larry Swedroe 23:54
And that case, your odds are literally close to zero. Yeah, congratulations.

Andrew Stotz 23:58
You've taken your odds from 5050. To you know, 595, which is let's talk about Mistake number 17, which is you confuse information with knowledge. I think some people may listening may think I didn't even really think about the difference between information and knowledge. So tell us more about this one. Yeah.

Larry Swedroe 24:18
So information is a fact could be an opinion. Whenever knowledge is information that can be used to generate alpha or outperformance getting an advantage. So we talked about in one of our early episodes, sports betting, right, if let's say the New York Jets had just acquired one of the great quarterbacks of all time a guy named Aaron Rodgers, and they're gonna play the first game. If you are the only person who knows that Aaron Rodgers just broke his ankle and is not going to be able to play you can pick up the phone call a bookie and bet against the Jets, and the odds are pretty good, you're going to win that bet. Now the bookie might if he found out, you knew that might send the hitman to take you out. But other than that, you know, that's an advantage. So that's inside information. But the example I like to use is this. I've accounted this, you know, 1000s of times over the 25 years, I've been advising investors actually, it's almost 30. Now. So, Andrew, have you ever bought an individual stock? Because you thought it would outperform at some point in your life? You did that stupid thing? Oh, yeah. So give me the example. We'll just use you as I

Andrew Stotz 25:51
can tell you one of my first investments in Thailand was buying a particular bank that was really bombed out, I was a bank endless, and I thought I was pretty smart. And that bank really, you know, went down quite a bit after I bought it.

Larry Swedroe 26:04
I had the same experience in the US, but we can talk about that later. But it's all let's use a simpler example. Let's say today, you've decided you're going to buy Apple Computer. And so when people asked me about that, I said, Okay, tell me why you think Apple is going to outperform because you're taking a lot of idiosyncratic risks. And I discuss with them the evidence that we have discussed before, that has showed that the average stock significantly underperformed the market, right? Because some stocks get 10,000% returns in the most you could lose as 1000. So the median stock return is well below the mean. In fact, only 4% of all stocks account for 100% of the excess return of the average credible number. Yeah, it's an amazing. So what the answer to that is, as we discussed, the more stocks you own, the odds favor you as you get closer and closer. From the median, you move towards the mean. And if you own the market, you're guaranteed to get the main return, get less very low expenses, a low tax, so owning individual stocks, unless you have a significant advantage, like inside information, which is illegal to trade on as Martha Stewart paid the price and found out right. You know, you shouldn't be buying an individual stock. So when I showed him that evidence, you can get rich, but the odds greatly favor, you're going to underperform. So tell me why given that evidence, you think you should buy Apple? So they'll tell me, Larry, you know, it's great new products, you know, this, you know, the cloud computing and AI on they give me 15 Good ring, great management and team is fabulous, their balance sheet is strong, they got a higher credit rating than the US government now sitting on huge amounts of cash, and on and on. And I say, Okay, let's assume for the moment, I completely agree with your analysis. And everything you said is true. Which may not be the case, but let's assume it's true. My I then asked him a very simple question. Let's say it's apple, and let's just make it up. It's trading at $100. And I asked him, so why are you buying it? You think it's worth 200? Right? Yeah, it's gonna go to 200. So I said, Okay, so we got all these facts. My simple question to you. Are you the only one who knows these facts? And, of course, the answer's no. I said, Do you think the smart guys at JPMorgan and, you know, every other investment firm and Warren Buffett and all these sophisticated hedge funds, like Renaissance technology, they are completely unaware of these issues? And if they thought Apple was worth 200? Would it be trading at 100? And they're sitting there on their hands and not buying the stock? If they thought it'd be worth 200? That's where it would be? Why is it trading? Only 100? That's because in their collective wisdom, the market thinks it's worth only 100. Right? So in the book, we just talk about this. So the story I use is your broker calls you up and said, we have this brilliant analyst, and here's what he's discovered about Amazon or Apple in this case, and here's the reasons why we think it's worth 200 But what they never said A is what should be said is the rest of the market, in their collective wisdom thinks it's only worth 100. But our guy, he's so much smarter than the market, he knows it's worth 200 We need to buy it. He's smarter than the Warren Buffett's the JP Morgan's or if that person said that you would hang up. That's why they never say that. So you have to ask the question. Give me the reasons why you are buying this stock? And then say, Are you the only one who knows it? Or do you think you're so much smarter than the really sophisticated guys with their PhDs, who spend 100% of their time analyzing these companies where you're maybe in your hot time at 10 to 11, at night on your computer and looking reading, some analysts report digging at the k one, which you're never going to read through their, you know, their disclosure documents, but since 1000, pages and stuff and finding that counting treatment of you know, accruals, and stuff like that, to discover something that maybe others have missed. And, you know, now with AI, you got all these powerful firms, having computers dredge the data, unless you have some advantage, which you almost certainly done. That's what you have to admit. And if you don't have an advantage, you shouldn't buy the stock because the odds are great, you're now going to underperform for all the reasons we discussed. That is

Andrew Stotz 31:43
a problem. There's so many paradoxes, circular references, tautologies, or whatever it would be, because, you know, we go back to the situation that if the market had no analysts, then the market would become super inefficient. If the market had all analysts, the market would be at peak efficiency. And somehow, the market needs to be somewhere in there in the middle of that. And I want to break down this mistake into two parts, right? The first part is new information comes out, and you think you're going to have some sort of advantage by trading on that information. This is just speed of dissemination of information. And now, you know, the pipes that the best traders have into the markets are in milliseconds. There's just

Larry Swedroe 32:41
one other really important thing. So there and this I wrote in my book 25 years ago, okay, not recently, this is research is that is that all, so a stock comes out. And let's say the earnings forecast is for 60 cents a share, and they come out at 50 cents a share. So you react and you want to sell. It's too late. The first trade incorporates almost all of the trading to get it to the right price instantly, on the very first trade, the market has reacted. And that's the right price. That's virtually the facts. And on average, of course, doesn't mean it can't drift lower or whatever, or come bounce back when new infamy. But on average, the first trade incorporates all that information. For the reasons we've already discussed. The swats sophisticated institutions have anticipated, alright, if the news comes out, and it's here or there, here's where we think it's worth.

Andrew Stotz 33:52
So the second one that I just wanted to touch on before we wrap up is the idea of the mosaic theory. And the mosaic theory is a theory that is used to justify the job of an analyst like myself, to tell people that the purpose of an analyst is to put together a lot of different pieces of a puzzle in a way that other people can't see, in a way that other people won't accept yet. And therefore, it's not in the market. So for instance, you know, I've done a lot of work on Tesla, let's say, I'm an analyst looking at Tesla, and I see something that I, you know, maybe I've been to China, and I've looked at their facility, and I've looked at what they're going to do, and maybe I've done a lot of work, research trying to pull together these pieces of a puzzle, and maybe the marketing. The Biden administration doesn't invite Tesla or Elon Musk to the electric vehicle launch and you think, okay, something's you know, I gotta put all the pieces together. And my conclusion is with all those pieces together, that this stock is worth something very different from what the market is got in that stock, whether it's higher or lower, let's forget about that. But something different from the market. Now, of course, some of those analysts, they come up with those mosaic theories and individuals are going to be terribly wrong, and some are going to be terribly right. And some are going to be in the middle. But my question is, is that, you know, that is what many investors think that they're doing, is creating a story. They're listening to Warren Buffett, and then listen to podcasts and listen to all these inventories to create a story around a stock and then own it because of that. What do you think about this, this

Larry Swedroe 35:45
effort, stoppage. And it's pretty simple, because that's exactly what all of the analysts are doing. They're trying to put this mosaic together, and then they say, We are smarter, I am smarter than the collective wisdom of the market. Now, that could be true, right? However, the evidence shows that there's no persistence of performance beyond the randomly expected, which means that, Andrew, you've been a great predictor in the past, so I'm gonna bet on you. But then there's no evidence that you are likely to get it right the next time. Now, there are a few handful of people have outperformed. But there's no way for you to identify them ahead of time, because there are other people who are outperform just like you, but then can went on to underperform. I gave the example in one of our sessions of Peter Lynch, generally considered the greatest mutual fund manager of all time, Peter Lynch was not the best manager in the 70s, when he had spectacular performance was the following David Baker ran 44, Wall Street, well, Lynch continue to have good returns in the 80s, from nowhere near as good as he had in the 70s, he still had a very good record, David Baker, in the next decade, turn $1 into 27 cents when the market skyrocketed. So you We only know today that Peter Lynch continues to do well, but why would you have chosen a number two guy and not the number one guy, but here's a more logical even way, if you're not convinced by the empirical evidence, what you're saying is there's somebody out there who can take all of this test disparate knowledge and weave it into a story to figure out, in effect, how to allocate resources. Ben, can you think of an analogy to that about how economies are run? Well,

Andrew Stotz 38:01
what would happen is that people would start copying that person?

Larry Swedroe 38:04
Well, the way I'm thinking the analogy is you have two types of economies centrally controlled, like Russia, North Korea, etc. And then Cuba, Venezuela, all right, and you're starting to get the message, you have capitalist society with a market is free to set prices and allocate resources based upon the signals it is given. Right, you know, that prices are rising in areas. So you have the signal is a shortage. So we should invest. If you set the prices and set the investments, then you're not getting market signals. And that's how Russia eventually went bankrupt. I think you meant USSR. Yeah, the USSR went back and disappeared. That's why North Korea is a disaster. And all centralized economies in the world have eventually blown up. And my view is China is now on the precipice of really turning in that direction unless they moved to a capitalist side. So give you just briefly. So how did China's succeed, right? So centralized economies are really good at harnessing resources to make something happen. So you come out of World War Two, and Russia is centralizing their autonomy and building steel plants and highways and airports and all the infrastructure and they can honest, the resources because they tell people if you don't go there, you're going to the Gulag, right, and so they can get that done. But once those things are in place, now you don't have the market signals. So they ended up producing, you know, millions of pairs of size 30 waist pants That's when they need more 30 twos and fours and six, because there are no signals. Right? China is now at the stage where they're going to lose all of the gains from their, you know, very young population, you get massive productivity gains like Russia did. When you move people off of farms to cities into manufacturing, and you don't have these small plots of land, you get big farms, more productive, right? And they built all these roads and highways. And now they've got a big problem, because the Chinese government is trying to decide whether quitter, this is why I think it's an absolute disaster with the Biden administration is now playing that same game, and deciding what industries should be winners just like Obama did. And we gave money to some solar panel company and lost hundreds of millions of

Andrew Stotz 40:55
Americans want this Americans want it. They want the government to do it. Capitalism,

Larry Swedroe 41:03
awful, there's no centralized economy in the history of the world has been able to execute once they get to that second stage. And I'm afraid that we are moving in that direction. On this fears of protectionism and stuff we're going backwards. That includes both parties, Democrats and Republicans,

Andrew Stotz 41:26
having made you know, at least 20 trips to China from Thailand. You know, one of the lessons I learned was it was capitalist thinking that got China combined with the industrialization. And you can say it was centralized and globalization, your favorite then? Yep. So there's a lot of factors that came together. But when I saw the level of capitalism, and the level of speed and the level of competition that was going on, it's incredible. It was incredible. What's happening now is, you know, there's there's a lot of other elements to that. But all I could think is America is moving away from capitalism in China is moving towards

Larry Swedroe 42:09
China is now in trouble. Let's talk about this very briefly. So the big Chinese reforms came, I think, in 79, or 80, right around there, after Mao was replaced. And it took a couple years to get those reforms going. And then Chinese growth soar from 80 to a, you know, Earl, mid till about 2010. So 30 odd years, Chinese growth and GDP was roughly 10%. Yeah, a little bit below that. But that's unbelievable. It's

Andrew Stotz 42:48
after inflation. That's real growth. Yeah, that's real growth.

Larry Swedroe 42:52
So that was enabled by a wall, these things we talked about the very youthful population, you don't have to support a lot of old people, right? Now, the social issues. There, you had the shift from the farms to big cities, which enhances productivity at building all these roads, and factories, which enhances productivity, right? You can, you don't have to take 30 hours to get from here to there, you can now go on some superhighway, and fast trains, all that stuff. But look what's happened since 2010, we've had a very sharply declining rate of real growth, and now it's maybe 5% or so. And a lot of people think that's exaggerated, and not real and likely going down. And now they're facing all the problems of an aging population, you know, the productivity increases are gone, because you don't have the movement from farms to city anymore. And you now have D globalization working against China, as well. So my own view is I wouldn't bet on Chinese growth, you know, helping the world economy, the engine, as it has for the last, you know, 30 years before that.

Andrew Stotz 44:13
And one of the things I would say, I mean, lived in Asia is that when I came to Thailand, it was 1992. We were in the middle of a 10 year, farms to factory, you know, movement that you've just described, which I call farms to factory and basic infrastructure. And we had that 10 year boom. And then in 1997, the bot collapsed, we had in 1998, we had 11%, negative GDP. And we went into a really brutal time for about five years until then things came back. And then same thing happened with Vietnam where they had a period of expansion and then boom, they couldn't produce at the same levels. And then China had the exact same thing. So they just lasted for 30 years, almost because He was also pumped up by the entry into WTO in 2002. So, you know, it's not uncommon to see the farms to factory and basic infrastructure give a huge push to an economy. And then at one point, it just stops.

Larry Swedroe 45:15
Well, the good news for the world as if India continues on the path using more capitalist economy, India has the exact opposite problem, they are still moving from farms to cities, they need to build all this infrastructure. They do have good education, people are very literate. They've got probably, you know, more engineers being graduated, and doctors them probably than the US is even, you know, has today, I would guess. But so I think in the end, they have an extremely young population, so they don't face that problem. So I think there is a chance that India could replace China as an engine for growth if they get it

Andrew Stotz 46:02
right. And I wouldn't write off China as easily as what you've said, because for a couple of reasons, the infrastructure is amazing. Number one, and so they have their arm benefits that are lasting benefits from that. The second thing is that they've built that say, the infrastructure for the iPhone as an example. You know, there's some real value in hubs in Thailand, we have like a car production hub. And it means that really, a lot of that expertise is right there that the car manufacturers can take advantage of. And so there is something to be said about that. The other thing, the other thing is that the education levels are very good and improving. They're moving from rote, to more original thinking. And I can see that because I attended one of the MIT of China, and I got to talk with so many young people that were coming up. There's still a lot of rote memorization and stuff. But I saw a lot of innovation happening. And you know what the other thing I would say that it's not, it's totally natural for an economy to move out of that phase and move into a consumption led phase, which is what the American has been in, and wages are rising. So prices of Chinese products are rising, and global markets is going to be harder to sell in global markets, but they have a standard of living that now, you know, is pretty strong. And my feeling is that there's a lot of consumer demand, even within China. So you know, I would say that, I don't see a collapse.

Larry Swedroe 47:39
Yeah, no, I'm just suggesting, here's some things on the other side of the coin, to think about, all those things you said are true. However, is China going to allow capital to be allocated with the market signals? Or are they going to force companies to you're going to spend here and you're well, we know the answer to that, at least now, is they are making decisions where they allocate capital, and then you get cronyism and bribes, and all the rest of the stuff that eventually, you know, destroys countries, right? That's why, you know, centralized economy in the world is everlasting. None, ever, and I don't think China is likely to break that mold. So that's a big bump. They can they make that transition? And maybe if they democracy were to take hold at some people hope, because you get economic freedom, then you want political freedom, then I would agree with you to have that ability. Well, only time will tell if that's likely to happen. That's the problem China faces though.

Andrew Stotz 48:51
Yeah. And I would say I'm not, you know, I can definitely see that central control has, you know, serious limits for sure. But I just want to go back to the last thing that we talked about, about the mosaic theory, and I just, I have to prove you wrong here. All of your knowledge and all of your wisdom. I'm just gonna like just knock that all out. Because I was recently at the bookstore and I bought this book. And I found out, I can read all of Buffett's newsletters, and he saw all of these mosaics and he put them all together, and he's the best investor of all time, and therefore, they know you can outperform through your mosaics, he explains his mosaic theories on every single year.

Larry Swedroe 49:39
So we actually discussed this in a prior session. I wrote a book called Think, Act and invest like Warren Buffett. So Warren Buffett for the first Oh 50 years of his investment career, far outperformed the market? And how did he do that? He told investors exactly how in his those letter or in the annual Berkshire, you know, letter to shareholders, and he said, I buy cheap companies that are hot profitable, have tend to have low financial and operating leverage. And again, I buy them cheap. And so guess what? Eventually, the world got smart enough and said, You know what, this guy must know something, why don't we reverse engineer what he's done? And is he this guy with skill? Where he can create that mosaic that enables him to identify which companies will outperform? Or did he just figure out what traits you need to have as a company to generate those high returns? If it's the former, then we can't replicate Warren Buffett's ability to create that mosaic, at least not yet. If it's the latter, I could buy an index of stocks that have these characteristics. So firms like dimensional fund advisors, Vontaze, BlackRock, others, went and recreated, you know, use that data in the high speed computers to find out and test and they have created mutual funds that buy the same types of stocks. And over the last 20 years or so Warren Buffett has no alpha.

Andrew Stotz 51:42
Larry Larry, in 2014, he outperformed the market in 2010. He outperformed the market. But look

Larry Swedroe 51:55
at His return of from 19 From around 2008 on. And you'll say he is not outperform once you adjust for risk.

Andrew Stotz 52:07
And in fact, when I looked at this part of the reason I bought this book of the shareholder newsletters is because I wanted to try to figure out what happened in 1976 and 1979. Because in 1976, he made a 129% return in his share price. He could never do that again, in 1979. He did 102%. And those two years, I would argue probably makes Warren Buffett if those two high performance years early in his career relative we had a

Larry Swedroe 52:41
small amount of money to manage relatively speaking, but but

Andrew Stotz 52:45
the compounding of the money that he made from those two periods, probably without those two periods, instead of having a 20% average annual return over the you know, since inception, maybe he would have had, I don't know 15 Or 14 Or 13. Or

Larry Swedroe 53:03
you look for something, all you have to do is read my book, Think Act and invest like Warren Buffett. It's all there. All right. You could also go to that website, we talked about portfolio visualizer. And you could run Berkshire Hathaway. Right. And you can see its returns. In fact, I'm going to do that right now. And we'll just run it against Vanguards, you know, s&p 500 fund.

Andrew Stotz 53:35
And this is portfolio optimization. Which section are you using now? Use

Larry Swedroe 53:39
the back test portfolio. Okay. Got it. And we'll run it from 2008 on just use that period because that was the and let's you know, I don't know what the answer is gonna be. So Berkshire earned 12.6. And Vanguard earned 13. Well, with and with significantly lower volatility.

Andrew Stotz 54:06
And that what was a period?

Larry Swedroe 54:08
Oh, eight through 2022.

Andrew Stotz 54:11
Oh, my goodness.

Larry Swedroe 54:13
Sorry. Oh, sorry. This is 11 because V Oh, was it was this is 2011. Yep. through July 2023. Okay, hold on. Let me let's run it using the Vanguard mutual funds, which has Yeah, that's the ETF. So we'll run it using the mutual fund. That'll give us hopefully,

Andrew Stotz 54:41
the ticker of that.

Larry Swedroe 54:43
That's a V f AIX and VFIA x. And here it's even worse. Now we're getting this is from January of oh eight to July 23 Berkshire earned 8.9 with an 18.2%, standard deviation, Vanguards s&p Admiral share or 9.8 with a 16.2 standard deviation. So Berkshire is underperformed by 80 basis points are so and has volatility that was about 13%, higher,

Andrew Stotz 55:25
boom, and Larry drops the boom, I got to take my Berkshire Hathaway letter to shareholders 1965 to 2014 book and return it to the bookstore.

Larry Swedroe 55:37
Know, there's a lot of good stuff in there, you want to invest like Buffett and buy the types of stocks that he buys. But you don't need to pick individual stocks. You can hire firms, like dimensional fund advisors, and advance this, and they're ETFs. And they will get you the same types of stocks. But instead of owning, say 20 or 30 stocks, it will own me, you know, depending upon the asset class, and small value it might own 1000. So you have a much safer portfolio, because you got rid of basically the idiosyncratic risks. Well, here's the evidence, you have to ask them, Warren Buffett, the greatest investor of all time, you know, he didn't get stupid in the last 18 years. You know,

Andrew Stotz 56:27
that's a great point, he should have actually improved his performance in the last, you know, couple decades as he learned and continue to learn.

Larry Swedroe 56:35
Yeah, but you know, and he hired lots of smart people out on Scott, Charlie Munger, who taught him lots of stuff. But the world has gotten much more sophisticated. And now the competition is much tougher, which is why Buffett can outperform it's not that he got dumb, the rest of the world caught up to him and figured out what he was telling people. So read my book, Think Act and invest like Warren Buffett. I'll have

Andrew Stotz 57:05
a link to that in the show notes. And I think this is a great way to end up the mistake number 17, which is do you confuse information with knowledge. And this is a great way of ending so Larry, thank you so much for sharing all of your wisdom on this. And ladies and gentlemen, I'll have the links to all of Larry's books and materials in the show notes. And this is your worst podcast host Andrew Stotz saying I'll see you on the upside.