In the 18th episode of Bogleheads® Live, Jon talks with Barry Ritholtz. Barry is the co-founder, chairman, and Chief Investment Officer of Ritholtz Wealth Management LLC, one of the fastest-growing investment advisors in the U.S.
Barry’s career focus has been on how behavioral economics and data affect investors. Jon and Barry discuss the behavioral side of investing, the relationship between greed and FOMO, the Bogle effect and the future of indexing, economic reflexivity, how to safely scratch that itch to actively manage an investment portfolio, the fallacy of low risk – high yield, portfolio allocation for younger investors, direct indexing to reduce taxes, and the importance of luck in investing.
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Jon Luskin: Bogleheads Live is a weekly Twitter Space where the Bogleheads community asks questions to financial experts live. You can ask your questions by joining us live on Twitter each week. Get the dates and times for the next Bogleheads Live by following the John C. Bogle Center for Financial Literacy on Twitter. That's @ bogleheads. twitter.
For those that can't make the live events, episodes are recorded and turned into a podcast. This is that podcast. Thank you for joining us for the 18th Bogleheads Live. My name is Jon Luskin and I'm your host. Our guest today is Barry Ritholtz. Today I'll rotate between asking Barry questions that I got beforehand from the Bogleheads Forum @ bogleheads.org and taking live audience questions from the folks here today. and taking live audience questions from the folks here today.
Let's start by talking about the Bogleheads, a community of investors who believe in keeping it simple, following a small number of tried and true investing principles. You can learn more at the John C. Bogle Center for Financial Literacy @boglecenter.net.
The annual Boglehead Conference is on October 12 through 14th in the Chicago area. Speakers include economist Burton Malkiel, Jason Zweig of the Wall Street Journal, Rick Ferri, host of the Bogleheads on Investing Podcast, Christine Benz, Director of Personal Finance at Morningstar, yours truly, and much more. You can find a link to register pinned to the top of the Investing Theory and News at the general forum at bogleheads.org.
Mark your calendar for future episodes of Bogleheads Live. Next week we'll have JL Collins, author of my favorite, The Simple Path to Wealth. You can see the full list of future guests at Boglehead Live. We're doing a call for volunteers. If you want to help turn this live episode into a podcast, we're looking for both podcast editors and transcribers and for help with proofing transcriptions, to help spread the message of low cost investing. Shoot me a DM at JonLuskin on Twitter.
Before we get started on today's show, a disclaimer. This is for informational and entertainment purposes only and should not be relied upon as a basis for investment, tax, or other financial planning decisions. Thank you to everyone from Bogleheads with questions ahead of time. We might not have time to answer all those questions.
Let's get started on today's show with Barry Ritholtz. Barry Ritholtz is an American author, newspaper columnist, blogger, equities analyst, and Chief Investment Officer at Ritholtz Wealth Management and guest commentator on Bloomberg Television. Ritholtz is the host of the Bloomberg's podcast Masters of Business, in which he interviews influential figures on markets, investing and business.
Barry, thank you for joining us today on Bogleheads Live. Beforehand, we exchanged emails and I mentioned what topic do you want to discuss? And you mentioned cognitive and behavioral sides of investing. What should Bogleheads know about the cognitive and behavioral side of investing?
Barry Ritholtz: Hey, Jon, thanks so much for having me. I've been looking forward to this. What should Bogleheads know? Well, let's go back to first principles and talk about some of the things that John Bogle referenced. And a quick definition. Sometimes people use cognitive finance and behavioral economics interchangeably. For our purposes let's define that as the behavioral side of investing, there is the behavior you can actually witness: the decisions people make with their money, how they invest, how they spend, how they save. That's behavioral. The cognitive side is more of the neuroeconomics that is going on internally. Adrenaline, dopamine, your heart rate, your respiration. We can't see it from the outside unless we slip you into an fMRI machine and see what parts of your brain are lighting up. So really there's a little bit of a distinction between the two and we sometimes conflate that.
But one of the great legacies of Jack Bogle is he very much realized how much of investing is just completely out of your control. What the Fed does, who the President is, what Congress does, what's going on in the economy, whether the market decides to open up the year down 20% for the first half of the year. You can't control any of those things.
But what you can control is your own behavior. How do you respond to inputs? How do you respond to stimulus, which could be thrilling, exciting, terrifying, nauseating. Do you give into it? Do you react to it? Are you greedy when the market is going higher? Do you panic when the market is going lower? And your limbic system, how well you control it, is going to have a much bigger impact on your long term success as an investor than whether or not you're picking this stock or that, or even this index fund or that. You could have the best set of holdings in the world, but if at the first sign of trouble you get panicked out of the markets, it's not going to do any good.
And I feel sort of silly saying this to the Bogleheads because if any group of investors has understood that and internalized that, and walk the walk--we have all the data from Vanguard and how Vanguard investors have behaved in 2020 and in ‘08-’09. I think people who follow the teachings of Jack Bogle very clearly have their behavioral side under control. What we're going to probably talk about today is fleshing out some of that and why some easy mistakes get made by people who either know better or should know better.
Jon Luskin: Absolutely can not control the market. Earlier today I was having a conversation with someone that they wanted to see if we would work well together. And one thing they mentioned was, “hey, if I can get 8% on my money, then I'm just going to stick with the index funds. I don't need to do all these other things.” So at that point I had to say, hey, you might not get 8%. It's very possible that's not going to be the case. Instead, let's focus on what you control, which is diversification, keeping those costs low. And to echo your point, Barry, stay the course – that is critical to investing success.
Audience member: I truly admire your podcast. I've listened for years. It's spectacular. So thank you so much for doing that. And given your expertise and your experience, the network you've developed over the years in terms of interviewing asset managers, people like Jack Bogle, where you think this industry is going to go over the next ten years, a book written recently called The Bogle Effect, where it paints a picture that the mutual ownership structure the Vanguard has developed. It's just very, very difficult to replicate, and it's just going to be increasingly difficult for the medium sized, smaller firms to survive in terms of product generation, advice, delivery, et cetera. Based on your experience, if you could just talk through where you see the industry progressing, let's say over the next decade. Thank you.
Barry Ritholtz: The Bogle Effect is by a friend of mine, Eric Bachunas, who I have coming on the podcast, I think next month--something like that--later this month or next month. And the book was really a lot of fun. It's horrifying to read a quote and start nodding your head in agreement and then at the bottom of the page find that, oh wait, that's my quote. Just like, oh my God, such confirmation bias. As someone who spends a lot of time looking at behavioral errors, to catch yourself vigorously agreeing with yourself, it's “oh, what an embarrassing moment” while I was reading the book.
So the industry has been going through all these really fascinating changes, and a lot of these changes have been a long time coming. They're just overwhelming trends that have been developing momentum for forever. It's the old joke from Hemingway. “How did you go bankrupt? Gradually at first, and then suddenly.” Indexing is one of those things that it just gradually, gradually, gradually was slowly gaining some ground and then boom, after ‘08 - ‘09, it just exploded.
My pet theory is that given all the scandals in the early 2000’s, the analyst scandal, the IPO scandal, the accounting scandals, people just finally said, “why are we playing this game? Let's just take our ball and go home.” And by ball, I mean money and home, I mean Vanguard. So that was how indexing went from this sort of interesting academically supported niche to now half of the mutual funds and half of ETFs--more than half are managed via passive indexes--which, by the way, is a very misleading data point because when you look at mutual funds and ETFs, they're actually a fraction of all the assets that are managed out there. The vast majority of assets, and let's just hold aside commodities and real estate, but the vast majority of stocks and bonds are still managed actively. It's just the mutual funds and ETFs where we see the passive approach really winning. You're starting to see more and more institutions move at least a portion of their portfolio in that direction. I think that's going to continue.
The thing that's really fascinating is some of the pushback to low cost, passive indexing as an approach. I did a couple of columns for Bloomberg where I got to mock the people who called it socialist, marxist, unamerican, a threat to the economy, a threat to the stability of the stock market, just every nonsensical thing you could come up with. My favorite bit of nonsense was the white paper by a bunch of law professors who used the airline industry to prove that, look, it's antitrust violation, having all this indexing going on. And talk about cherry picking data. Why are you using airlines, a notoriously small, frequently bankrupt, often consolidated industry, to show indexing is a problem? How about the giant technology space? Why don't you use that? That's because prices have been coming down and it's more competitive. How about finance? Same thing. How about industry? Same thing. And so you go through all these hired guns who have been retained, or at least motivated by higher cost active managers to take a swing at indexing. My concern is the relentless parade of slings and arrows eventually start to have an effect.
I don't want to talk politics, and I tend to be center / center left, socially progressive, but Bernie Sanders may have had the single stupidest tweet I've seen complaining that BlackRock, Vanguard, and State Street own 96% of stocks that are listed in America. And I think he got it backwards. He meant they own the stock of 96% of the companies. But so what? You look at Vanguard, BlackRock, and State Street, they're like 80, 65 and 61% indexing. They own everything. I wish somebody would sit Bernie down and say, do you have any idea how many trillions of dollars are managed this way and how many hundreds of billions of dollars have been saved by investors who index, to say nothing about how much there's been some academic studies showing index investors tend to be much more labor friendly than activist or active stockpickers.
So there's so many different ways to describe where the future of this industry is going. The red flag is that there's a lot of money at stake. And a lot of people who are very self interested and are not fiduciaries and don't care about the best interests of investors have been spending time and effort and money slagging indexing. And it's a danger out there that someone may talk a less intelligent legislator to do something that hurts our ability to buy cheap, easily traded index funds.
Jon Luskin: “Take my money and go home to Vanguard” – I love that Barry mentioned Eric Bulchanus, and he was on Episode Seven of Bogleheads Live where he talked about this exact subject, debunking many of the myths about the shortfalls of index investing. So you guys can check that out.
Audience member: Hey, Barry, great to speak to you. I've been a huge fan of your work. I listen to all the podcasts that come out of Ritholtz so this is something you'll probably hear again and again. My question to you is at what point does all passive indexing become counterproductive? Maybe we've talked about how it is such a great value added for the average mom and pop investor, but at what point do you say, “you know what, maybe everybody passively investing is not a good idea?”
Barry Ritholtz; Great question. I'll give you a two part answer. The first is over at MIT, Andrew Lo actually looked at this question to find out at what point does the lack of analyst community research stock picking, stock selection affect price discovery? And his conclusion was well over 90%. Once passive indexing gets well over 90%, you'll see a decrease in price discovery and market efficiency. So that's his guess, it’s much better than my guess. The second part is something I would point out, to borrow a term from George Soros, reflexivity. One of the fascinating things about markets, and one of the reasons it's so impossible to do any sort of long term forecasting, is that every print, every price, every day we get market numbers affects the subsequent reaction of other participants in the market.
So here we are. It's half of mutual funds and ETFs, but something like 7 or 9% – I don't remember the number I calculated some years ago when I wrote that piece of how much of stocks and bonds are actually managed across the board, not just limited to mutual funds and ETFs. So we're still a far way away from them. Maybe it's 12% or 15%. But whatever it is, think about how the dynamic around stock selection is going to change once 50, 60, 70% of the stock buyers are just blind index purchasers. One would think that if stock pickers, or maybe even market timers had any edge that they could gain over the broad index, it would be when there are fewer and fewer people competing in the stock picking world and more and more people just throwing money at the index. One would imagine that that would create an environment where stock pickers would do better.
Now, by the way, we've heard that stock pickers will do better in a downturn, or when the rally ends, or when the Fed starts raising rates. And all that has been shown to be foolishness. Maybe there's an uptick from 35% to 45% for a couple of quarters, then it'll come back down. But I saw something, I don't remember where I saw it the other day, they said almost half of all stock picking funds are beating their benchmark. It would have been over half, except the growth managers really crapped the bed. And it's like, why are you separating them from the rest of active managers? If – you're either active or passive, those are the dynamics. You don't get to carve out the worst performance and say, see, but for the people doing terrible, we're doing much better than average.
But when we go back to that concept of as there's less competition, as more and more people are buying passive, the theory is that there'll be more opportunities, there'll be more inefficiencies that will be easier to identify. And then what happens is all of a sudden a couple of years of active managers outperforming, net of fees, hey, maybe some money slides back from passive towards active, and maybe that's what stops the march upwards of ownership by passive indexing. But that's just a guess. It's impossible to project anything in a straight line because each day, each month, each year, the changes that take place within the market structure affect what subsequent market actors do.
And so I'm trying to guess two and three steps away, okay it’s 70%, maybe it's easier to pick stocks. Hey, maybe these guys put together a run of a couple of years. Maybe they outperform enough that it attracts money back to active from passive. But really that's just me guessing and spitballing. Maybe Andrew Lo of MIT is right that it's 90%. I suspect that change in the dynamic of stock selection once we pick the number 75%, maybe they get back in the game a little more than they have been, and we see where it goes from there. I just can't imagine we're going to march up to 95% 100% passive. People are so over optimistic. They love timing. They love stock picking. It's hard to imagine that no one is going to do that again. I think human nature is such that there's still going to be a bunch of people who think, “how hard can it be to beat the market. I think I could do this.”
Jon Luskin: You mentioned a great point there busting one of the myths about active management insofar as hey, and active managers are going to do better during down markets. Rick Ferri actually talks about this on the third episode of Bogleheads Live. That's just a function of style drift. They're just getting out of their style box. So they're not really investing geniuses. They were just sloppy with the investments that they picked for their particular fund. That's episode three of the Bogleheads Live for folks who want to check that out.
Audience member: I listened to your interview with Bill McNabb of Vanguard back in 2015. So you guys had a conversation about SIFI where big institutions play a role where they have to bail out any firm that are going down. Do you think that's still the case? Now Vanguard is about 14 trillion in AUM. So is that still the case?
Barry Ritholtz: So I think Vanguard is about 8 trillion to BlackRock’s 9 trillion. And the question is, are they a systemically important financial institution or SIFI. And while lots of the big asset managers are SIFIs, it's kind of hard to imagine Vanguard, that doesn't rely on leverage or derivatives or borrowed money or anything like that, is ever going to be in financial difficulty. The companies that run into that problem are the ones that use other people's money, they use a lot of leverage, they use derivatives, they engage in all sorts of aggressive trading, and their equity levels are relatively low compared to the total amount of risk and debt they have in their portfolio. So will some bank out there blow up and eventually need a bailout? I think history has taught us that that's been going on for decades and we shouldn't think it wouldn't go on.
I'd like to think that Bank America that merged with Merrill Lynch and JP Morgan Chase and maybe even Wells Fargo, despite all of their ethical issues, are sturdy enough that it can survive whatever the next couple of recessions throw its way. I can't say the same thing about hedge funds or any of the family offices or any entity that everything we saw with Archegos earlier this year--the crazy leverage, the wild pyramiding, the use of derivatives--those are the sort of things that get you into trouble.
Any institution, any bank, or any investor for that matter, if you're not using leverage or borrowed money or derivatives, it's hard to blow up. But the worst thing that happens is go to ‘08 - ‘09, your market is down 56%. Go to 2000 and in the Nasdaq – peak to trough – the Nasdaq 100 was down 81%. And it turns out if you held on, eventually you came back and you made a lot of money. But if you're doing it with borrowed money, if you're two to one and the market drops 50%, well, then you're wiped out. And two to one is the margin that an individual investor gets. Imagine some of these hedge funds that are ten to one. Or you look at Lehman was 40 to one, or Long Term Capital Management was 100 to one. Hey, at 100 to one, a 1% loss means your equity is gone and you're out of business. I don't care how many Nobel laureates you have, eventually you roll snake eyes and you're out of the game. And that's what happened to those guys.
: Absolutely. I don't think Vanguard is going to be creating any future financial crises. Let's bring it to a couple of questions that I got beforehand from the Bogleheads forums related to what you want to talk about Barry, which is the behavioral side of investing. DanFFA username writes, “what is Barry’s opinion on the risk of alternative investments, crypto, managed futures, trend-following, etc.?” And then User Er999 writes, “his podcast always has new interesting investment ideas each week. Assuming that he agrees with the idea of buy and hold and not often changing your portfolio is better for long term investors, how do you consume investment information without causing damage to your portfolio?
Barry Ritholtz: Two really good questions. Let's start with the crypto one, because that's easy. One of the things that relate to the idea of managing your own behavior is that fear and greed is a key underlying part of investing. It's human nature. You're not going to make FOMO [ Fear Of Missing Out] go away, and all FOMO is greed. Fear of missing out is just greed. You want what your neighbor has. “Hey, the guy down the street from me is an idiot. How is he making $6 million in crypto and driving a new Lambo and I got this crappy Honda coupe on my driveway?” That's FOMO. And really it's just greed described in a different way.
We always tell people, if you want to do whatever you want, trade crypto, day trade, play around with tech stocks, if you want to pull 5% or some other insignificant percentage of your assets aside, and diddle around with them, well, have at it. Have fun.
I'm not a big fan of managed futures because I'm aware that it's a different risk-reward set up than what you typically see. The futures market is much different than the stock or bond market. You're hiring someone as a managed futures trader to do the same thing for you. Theoretically, they're shielding you from all the downside. Listen, I know a bunch of commodity traders who are trend followers who have made tens of millions of dollars, but that's like saying, hey, this guy can hit a curveball and he's batting .295 in the major leagues. Doesn't mean that you can do it, doesn't mean that you're going to trade futures, or hit a hanging curve ball in the bigs. There are a handful of people who are astoundingly talented at these specific things. Most of us are not. Most of us are not going to be playing in the All Star game in the major leagues, and most of us are not going to be successfully trend following and making tens of millions of dollars.
It's always a challenge because discussing this, because there are examples of people who are amazing. Am I going to hit as many three pointers as Steph Curry? Of course not. It doesn't mean I shouldn't play pickup on the weekend. That just shouldn't be my career. And I think that's how you have to look at crypto, which to me is more like a commodity or a currency than something with a yield or discounted cash flow, like a stock or bond. Futures are speculative, and trend following is a form of speculation. So if you're an investor, that's not what you do.
The second question is really fascinating. Because I call Masters in Business the most fun I have each week. And I'm fortunate to draw from an amazing pool of people. And it's less about the specific investing idea and more about the thought process – how the person developed their philosophy and the methodology they employ then whether they're buying this stock or that mutual fund or this option.
Or someone like Scott Galloway, Professor Scott Galloway at NYU, who's built a number of companies successfully. The way he looks at data, the way he looks at opportunity and entrepreneurship, that's what I want to pull out from him. Not should I be long Facebook or not? Someone like Richard Thaler or Danny Kahneman. People who teach you about your own thinking process. Two Nobel laureates, both behavioral psychologists. Thaler happens to be an economist also. And so it's less about give me a fish, and more about teach me how to think about the process of fishing.
So when I consume information each morning, I put out a list of ten daily reads. And I've been doing this for just about 20 years. You can find that at ritholtz..com and sign up for it. Due to inflation, the cost doubled from free to now it's up to zero. But what I do is I used to print out all this reading material and read it on the way home from work when I was on a trading desk, because I didn't want to read it beforehand, because I didn't want it in my head. And what started to happen is I developed the ability to identify what's a good piece, what's an informative piece. Don't tell me why you like this stock. Give me an analysis for what makes stock selection worthwhile, or why you think the consensus is wrong on inflation or whatever. It's more about people teaching you how they think about the world, the economy, the market, than buy this-sell that.
And so I found all the guests, and we just did our 400th show. I find the guests are less intriguing for their stock recommendation. In fact, part of the idea for how the podcast came about--I'm flying back to New York from Vancouver. I have to change planes in, I think it was Chicago. And while I'm waiting for my plane, I'm in the lounge. One of the financial channels is on TV, and a well known hedge fund manager is on. And the interviewer is just asking him the worst question, what's your favorite stock? Where's the DOW going to be in a year? When's the Fed going to raise rates? And every question, the answer would have been stale by the time the guy walked out of the studio.
And as I'm watching and I'm thinking, no, don't ask for a fish. Find out how he fishes. Who are his mentors? How did he develop his philosophy, his methodology? What books does this person read? What mistakes did they make? What advice would they give somebody going into the field today? What do they know today they wish they knew 30 years ago? And that was the approach that ultimately led to the podcast. Just frustration with how bad a lot of television interviews were.
So to me, it's never about, here's my best idea and here's why you should buy it. It's always, let me tell you how I go about thinking about managing risk in my portfolio. How do I allocate assets? How do I look at the world? That's what matters. It's the process, not the outcome.
Jon Luskin: Gosh, you said so many wonderful gems in there. Firstly, the part about taking a small amount of your portfolio to play with. Absolutely. I couldn't possibly agree more. If we've got something, a small amount that can let us scratch the itch, then we'll leave the balance of our tried and true but boring investments alone. I can't help but think about Celsius today, which recently filed for bankruptcy. Me, personally, I put all of $200 in an account itself just to learn about it and see what happened. Now that $200 is probably gone for…
Barry Ritholtz: Let me jump in a second, because it's really such a perfect example. And as someone who not only lived through the financial crisis managing assets for clients, but wrote a book about it, you would think that if there was any lesson to be taken away from--and this wasn't 100 years ago, this was 15 years ago, ‘07 - ‘08. It's 2022. It's barely 15 years ago. What we learned is when someone says, hey, listen, these securitized subprime mortgages that we've repackaged into these CDOs, it's just as safe as Treasuries, but it's paying a much higher yield. My takeaway from that was either you're winning a Nobel Prize or someone should go to jail because it can't be just as safe with a higher yield. Either you're taking on a whole lot more risk, and that's where the improved yield comes from, or not, and it turns out you were taking a whole lot more risk.
So when we see a lot of these various companies making promises--at the time, the ten year bond was yielding one and a half percent--but we're going to give you 18%, you have to recognize that there's no guarantee there. They have to be taking on a massive amount of risk.
And that's what happens when we look at expected returns. Risk is what happens when you don't get the returns that you were expecting statistically, but are within the realm of fiscal probabilities. And anybody that's promising, I think we've seen 20% even a year risk free, clearly the risk is you will lose all your money because it's ten or 20 X what risk free Treasuries are offering. And maybe it's not just Celsius, I remember that exact number. But lots of the promises were made. You can only buy into that if you said, “hey, that great financial crisis, ‘08 - ‘09, yes, we're going to forget everything we learned from there. We can get 18% safely and not worry about losing all our money.” I don't remember whose quote I'm stealing, but it's one of the things that make the world of finance so unique, is our tendency to forget all of the lessons of history over and over again.
Jon Luskin: This one is from username AlwaysLearningMore, who writes “How would Mr. Ritholtz suggest that his children or grandchildren invest their IRA and 401(k) money for long-term investments?”
Barry Ritholtz: Another great question. I'm going to say something that I know a lot of people are going to disagree with, but you asked me to be honest. I'm going to give you the honest truth, when you're 20 years old, probably till the time you're 40, you should be 100% equity / 0% bonds. When you're 36 years old, you don't really need bonds. I would say the bulk of that should be low cost passive indexes. I prefer a global portfolio. Just look at the past 20 years. Global EM outperformed the US. Don't suffer from home country bias. So you want a global portfolio and you want to rebalance it every year. And if you want to take some percentage, 10, 20, 30% and make an active bet with it, hey, this technology thing seems to be working out. Let's put 10% of our index into the Nasdaq QQQs. Or I think India is a growth nation, let's put 5% into that. And I like value in small cap, and there's another 10%. I'm just making up things off the top of my head. But you go 80/20, passive/active or something like that, I think you're fine up until the time you're 40.
At the time you hit 40, and maybe for the decade after that, I would be very comfortable adding some venture capital funds to that, assuming you have access to the top quartile of VC’s. If you are overladen with technology on the equity side, well, then you probably don't need that. But if you're at a point where you're making enough money and you could throw a percentage into some venture, I think the potential upside is worth the illiquidity and the cost. And I don't really think you need to add bonds until you're 50 years old. If you want to add some REITs and real estate trust or farmlands, or maybe even some private equity at 50 and I'm talking, again, a couple of percent around the edge, it should never be the bulk of your portfolio, which should always be 5, 10, 15% at most. Again, if you're in the top decile private equity funds, they're fantastic.
All of the things that Jack Bogle hated, he was talking broadly. Private equity is expensive. Venture capital is expensive. Hedge funds are expensive and underperforming. However, if you can get some access to the top decile of these – I know a bunch of Bogleheads’ eyes are spinning in their heads – but if at 50 years old, you have a nice nest egg put aside and you want to pull a little bit of your investing into some of these alternatives, again, it's scratching that itch, I'm okay with that.
But the caveat is you have to watch your fees. I know Vanguard is talking about private equity 401(k)’s. Think about how the world has changed over the past 40 years, that that is actually a project that's being worked on. I'm okay with a 50 year old who has substantial money put away, peeling a little bit off, and if it scratches that itch and it gives them some potential upside, fine. But the core investment for the bulk of your life is going to be long term, globally diversified, passive.
Jon Luskin, [ Bogleheads Live Host jumping in for a podcast edit]: For those serious about investing in private equity, read David Swensen's Pioneering Portfolio Management. One challenge that Swensen notes is that finding that truly skilled money manager ahead of time is difficult. It's a bit of a catch 22. The really good managers have closed their funds to new dollars, and if a manager with a really good track record of past performance is still accepting new dollars, that makes it challenging for that same manager to provide superior performance going forward. To Barry’s point, whenever investing, be it public markets or private, keep those costs low. That's going to give the best odds of success.
Barry Ritholtz: You really don't need bonds in your twenties and thirties, arguably not even in your 40s. If it helps you sleep at night, OK, but especially at current prices. It's not a screaming buy and hasn't been for some time. That's how I would advise anyone who was in their teens or 20s or even thirties to be looking out over the course of the next 75 years. Keep in mind, if you're 15 to 25 years now, the odds of you making it into your 90s or beyond are much, much higher than they were 50 years ago.
Jon Luskin: For the Boglehead version of what you just shared, Rick Ferri talks about allocating to a small cap value fund as part of your portfolio in episode three of Bogleheads Live if folks want to check that out.
Audience member: When you are competing for the most sought after clients, high net worth individuals, how does Ritholtz Management separate itself from the likes of, say, a Goldman or a JPMorgan?
Barry Ritholtz: Wow. I don't think of us as competing with Goldman or JPMorgan. Our competitors are brokerage firms, other RIAs and to some degree self directed people. So our business model is a little different than the typical advisory firm, and I don't think I'm sharing any secrets. We launched in 2013. I pretty much-- and this is not how we manage money--but back in ‘06 - ‘07 I was screaming about derivatives in real estate. I had run an analysis published at thestreet.com. I remember it was the end of’ 06 or the beginning of ‘07, but it was called Cult of the Bear, and said, hey, Reinhardt Rogoff did a research paper that looked at five financial crises that eventually became the book years later, This Time is Different: 800 Years of Financial Folly. But at the time they looked at, I think it was Japan, Sweden, Mexico, the US,. I can't remember the fifth one, and they found that when you have a financial crisis, markets tend to fall about 50%, real estate tends to fall about 30%.
And everybody was so focused on the equity markets and I was watching in particular real estate, but I said, “let's assume Reinardt Rogoff is right and that real estate falls 30%, what does this do to the earnings picture of the Dow? And I literally spitballed all 30 Dow’s earnings in response to a 30% collapse. I think the time the Dow was 13 and change. And so I ended up calculating this earnings drops this much and that drops that much. And I ended up with a 9800 on the Dow. And then I said, “well, if we break 10,000 from over 13,980 it will cause a 3000 point panic. We'll end up at 6800.”
And that was the piece. Nobody wanted to talk about. the analysis, financial prices, any of this stuff back in ‘06 -’07. All anyone wanted to focus on was Dow 6800. And I was kind of pilloried for a solid year. And then the market starts rolling over. And at the time, this was an institutional firm, we were short a number of the big names that everybody knows about. And suddenly I had been a regular on CNBC for a while. Suddenly I'm on twice a week, three times, I'm practically on every day. It got to be too much.
And I said to a friend early in the process of the market rolling over, you see these jerks in 2000 who warned about the dot coms and then just doubled down the bottom? Do me a favor. If I do that, just slap me upside my head. Don't let me be that idiot. And I recall being on vacation and getting an email, “down 6800 what are you gonna do?” And I come back a week or so later and it had fallen to 6300. And I went on Yahoo news and said, ”hey, you can cover your shorts and buy them here.” You could have asked me the same question three months earlier. Three months later, I would have given you the same answer. It just turned out by dumb luck, that was the day before the market bottomed.
And as you can imagine, the next five years people just threw money at us. And so when we opened the firm, the challenge was saying to people, we don't manage money that way. We don't market time. We don't short stocks. It's big, broad, boring, low-cost. Here's how we do it. And ever since then, all of our clients come to us. We don't have people smiling and dialing. Yes, we have 55 employees, and I think we're up to 20 or 22 CFPs. We build financial planning into the process. But I've called it our exorbitant privilege that clients come to us. So we get to find people that they're a good fit for us. We're a good fit for them. We don't feel like we have to chase clients. We don't feel like we have to chase assets. I don't need someone coming in and saying, “hey, I want you or your partner Josh to pick stocks for me.” And then in six months, they leave in a huff. It's very disruptive. We put our clients and prospective clients through a fairly intensive process of educating them about markets, about behavior, about volatility. People are so upset to me, oh, your phones must be ringing off the hook. And it's always like, no, our office is nice and quiet. Our clients know that volatility is a feature, not a bug. And if you respond to volatility, you run the risk of losing a lot of money. If you ride out volatility and you have a long term perspective, volatility is the cost of admission in order to get the rewards, the long term returns.
I think our model is what makes us so different. Low cost, globally diversified, mostly index-like investing. I don't think there's anything particularly unique about that. We do have some interesting ornaments, that part of our behavioral training, is we have a tactical portfolio. It's rules based, and the purpose is not to beat the market, the purpose is to generate market returns. But to be able to have clients say, “oh, I've moved a portion of my portfolio out of stocks info bonds. Great, I'll leave the rest of my portfolio alone.” Similar to that 5% slug of “scratch the itch.”
This kind of lets people say, “oh, we've moved out. I think we moved out of equities”. And in that small portfolio, which is a small percentage of people's holdings, it's not to beat the market, it's to let people, “OK, I'm doing something, my guy's doing something. He's not just sitting on his hands, great.” When really, honestly, we're mostly sitting on our hands with their core holdings
So we do that. We've also been very aggressive in adopting new technology. We were one of the first users of Canvas, the direct indexing product from O’Shaughnessy, which is now part of Franklin Templeton. And the initial approach with direct indexing had nothing to do with ESG or concentrated portfolios like I thought it would. It had everything to do with tax loss, and in 2020 it had an incredible track record of reducing people's capital gains that they owed. This isn't for everybody. If you have a big pile of either founder’s stock or employee stock options, or inherited stock with a low cost basis, and you want to work out of that without paying capital gains, the beauty of direct indexing is you're not accessing the net losses, you're actually accessing the real losses.
If your portfolio is 10 -15 mutual funds, well, some are up, some are down. You take the net average. If you're down, you sell the ones that are down, you replace them with similar ones. Now you have a paper loss to offset your gains, but it's two, three, 4%. When you do it with individual stocks, that essentially you're mimicking an index, only instead of holding the Spiders or the Vanguard Total Market Index, you're holding all 3700 stocks. That's some of the ornaments that get a little fancy and a little complicated. For most people, that sort of stuff isn't useful. But for people who have highly appreciated stock that they want to work out and keep their capital gains to a minimum. That approach, which is really a software approach, not an investing approach, the software gives you access to all of the losses, which then can be replaced with identical or very similar companies. So your big broad index holdings look the same. We've been pretty cutting edge of that sort of stuff and those clients very much like that.
I think our model differs, separates us from everybody else because of we're not looking for clients. Clients find us because they see the philosophy, they see what we're writing. I think everybody who writes and publishes and speaks in the firm is super intelligent, really insightful, and has spent a lot of time thinking about how to do this right. And people hear somebody who they think is intelligent and finally a philosophy I like, and they want to participate with us. So that allows us the flexibility to focus on all this behavioral training and working with clients and not spending all day long chasing. The average adviser spends half their time chasing clients. It's our exorbitant privilege that we don't have to do that.
Jon Luskin: Barry, before I let you go, any final thoughts you’d like to share?
Barry Ritholtz: There was one question we didn't get to that I thought was really interesting, that I wanted to share my answer with you, and that was about the podcast. You had someone ask, hey, you've been lucky enough to interview some of the greatest minds in finance on Masters in Business podcasts. What have you taken away from that?
The biggest takeaway really has been a surprise to me and that was how often the concepts of luck and humility comes up when you have a Ray Dalio or Howard Martz tell you, I just got lucky. “Come on, you've been doing this for a long time. It's got to be more.” That aspect of humility and saying, you have to be aware of how serendipitous your success has been. And sometimes it's just a half an inch to the left and it all goes to hell. There are countless examples of people who--I just saw a fascinating thread on Twitter earlier today about FedEx-- and at one point in the ‘70s when gasoline prices had spiked, Fred Smith went to Vegas with the last $5,000 of the company because they were going to run out of money and played blackjack and came back with, I don’t remember it was 27 or 37,000. Whatever it was, he won enough money that bought them a couple of months and they eventually did a financing round and FedEx was off to the races.
You don't hear about all the millions of companies that tried those Hail Mary's and then died. The survivorship bias is a key factor. Everything is survivorship bias. And so we really need to be humble when we look at people who have achieved success. They tell you how much luck is involved and you have to realize how rare and fragile that sort of success is. The best investors I know are the ones who have tremendous humility. And to me, that's not only something I've learned, but something that genuinely surprised me.
Jon Luskin: I know you had Annie Duke on your show a few years back. Her book is phenomenal. That explains just that concept. Well, folks, that is going to be it for all the time that we have for today. Thank you, Barry, for joining us today. And thank you for everyone who joined us for today's Bogleheads Live. Our Bogleheads Live will have JL Collins, author of FIRE favorite, The Simple Path To Wealth. The week after that, we'll have Jim Dahle of the White Coat Investor.
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