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  • Bogleheads on Investing with Dr. William Bernstein: Episode 63

Bogleheads on Investing with Dr. William Bernstein: Episode 63

Post on: November 5, 2023 by Jon Luskin

Dr. William (Bill) Bernstein is a retired neurologist, author, investment adviser, and financial historian. His research is in the field of modern portfolio theory and economic history. Bill has published extensively on investing and economic history, including eight books and numerous articles. He holds a Ph.D. and an M.D. Bill is a repeat guest, first appearing in Episode 13. In this episode, we discuss Treasury Inflation Protected Securities (TIPS), asset allocation in today’s uncertain world, four deep risks, and the cost of income inequality.

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[00:00:10] Rick Ferri: Welcome everyone to the 63rd edition of Bogleheads® on Investing. Today, we’re welcoming back to the program Dr. Bill Bernstein. He has written four books on personal finance, and four books on economic history. Today, we’re going to be talking about his current views on the markets and the economy and speaking about his updated book, “The Four Pillars of Investing.”

Hi everyone. My name is Rick Ferri, and I am the host of Bogleheads® on Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a nonprofit organization that is building a world of well-informed, capable and empowered investors. Visit the Bogle Center at boglecenter.net, where you will find a treasure trove of information, including transcripts of these podcasts.

Before we get started today, I have a couple of items. First, I’d like to thank Jon Luskin for covering for me for five months as I went on a sabbatical up to Alaska. My wife and I dragged our camper from Texas for 20,000 miles all the way up through the US Rocky Mountains into Canada, through the Canadian Rockies, up to the Alcan Highway to Dawson City in the Yukon, then across the Top of the World Highway over to a little town called Chicken, Alaska. And then spent two months touring around in Alaska, going everywhere where there were roads – and only about 1/4 of Alaska has roads.

We made it all the way up to the Arctic Ocean and put our feet in the water. Got to see the Alaska pipeline that went all the way up to Prudhoe Bay and stops at Deadhorse, which is where the oil facilities are. And I have to tell you that it is pristine up there. If you have this idea that somehow there’s oil leaking all over the place, forget it. It is not true. The oil companies and the government and the Native Americans who own the land do an outstanding job of keeping the environment 100%.

People have asked me, “how was the trip?” And the answer is the beauty of this place is vast. The mountains, the forest, the tundra, snowfields, glaciers, thousands of waterfalls, and thousands of square miles of wilderness where there are no roads and literally untouched. And it’s not just Alaska. It’s the Yukon Territory in Canada, western British Columbia, and the Rocky Mountains in Alberta. It’s just a beautiful part of the country, a beautiful part of the North American continent. Anytime you get an opportunity to go up there and take a look around, I definitely recommend it. And I also recommend going in the summertime because in the winter, it’s 20 to 40 degrees below 0 most of the time.

We got back to my home in Texas at the end of September, just in time for the annual Bogleheads® Conference that was held in Bethesda, MD. And this was a huge success. It was the largest conference we’ve ever had. There were 500 attendees, 30 fantastic speakers. All of the speakers donated their time. No one was paid. Many people, including some speakers, bought tickets and donated them to people who otherwise would not have been able to attend. The committee chair this year, as was last year, was Christine Benz, who is also the current President of the Bogle Center. And she did a wonderful job.

To name a few of the speakers, there was Howard Clark, Charlie Ellis, Gerry O’Reilly of Vanguard who is responsible for managing about $4 trillion in equities, including the Vanguard Total Stock Market Index Fund, the largest mutual fund in the world, Washington Post columnist Michelle Singletary and her family, Jonathan Clements, and many others including my podcast guests today, Bill Bernstein. All of these sessions were recorded. YouTube videos will be available soon on boglecenter.net. Next fall, around the same time, sometime in October – the date is yet to be announced – the conference will be held in Minneapolis, MN. And I hope to see you all there.

Our guest today is Dr. Bill Bernstein. Bill is not new to the Bogleheads® or this podcast. He was a guest on the show about four years ago. And whenever John Bogle was around Bill, he would refer to him as the smartest guy in the room. And for good reason. Bill holds a Ph.D. and an MD and has had a long career as a neurologist. Now retired. When he was looking for the best way to invest his own money, he became disenchanted with the sales mentality of the financial industry, and he started a scientific quest into the markets and how they worked.

That ultimately led Bill to low-cost indexing and Vanguard and co-founding and investment management firm called Efficient Frontier Advisors. Bill then began to write. First he had a blog and then he became a leading author. He’s written eight books in total. Four investment books: “The Intelligent Asset Allocator,” “The Four Pillars of Investing” (now in its second edition), “The Investors Manifesto,” and “Rational Expectations.” He has also written for economic history books, “The Birth of Plenty, “A Splendid Exchange, “Masters of the Word,” and “The Delusions of Crowds.”

I will also add that Bill has written several small self-published books. Some of them are available for free on Amazon. He has also authored and co-authored numerous peer reviewed articles for financial journals, and his work won him the prestigious James R. Vertin Award from the CFA Institute in 2017. Today, we’re going to talk about the past, the present, and what the future may hold.

I remind listeners that the opinions given by Bill are his own. Each of us needs to look at our own goals and our own circumstances and determine which strategies and investments are right for us.

With no further ado, let’s welcome Bill Bernstein. Welcome to the podcast, Bill.

[00:06:45] Dr. William Bernstein: Glad to be back, Rick.

[00:06:47] Rick Ferri: Thanks for everything you do for the Bogleheads®. You were at the last conference. You were a big hit at the conference. You always are. You had a big, long line for people to sign your books. You’ve been going to the Bogleheads® Conferences for many, many years.

Jack Bogle attended almost every one, and the only one he couldn’t attend because he was in the hospital, he talked to the group from his hospital bed. We have a little different agenda. Now tell us a little bit about your experience at the new conference now that Jack is no longer with us.

[00:07:18] Dr. William Bernstein: Well, one of the main reasons why I come to the conference is just because Bogleheads are such nice people. It’s just a very pleasant experience that really doesn’t change with the speakers. Now obviously, everybody was concerned with the passing of Jack that the experience was going to change, and of course it did. But thanks to you and to Christine and the big rolodexes that you have, you were able to acquire some absolutely spectacular speakers and panelists, and almost every single one of them knocked it out of the park.

So, it was a very rewarding experience because of that.

[00:07:56] Rick Ferri: Thanks for saying that. It was certainly a team effort. A lot of people put in a lot of time to put these conferences together and appreciate your comments on that. One of the big items in the conference that seemed to be talked about in almost every session was inflation protected securities. TIPS.

And in fact, it was so popular that one of the panels decided that they weren’t going to talk about TIPS; that it couldn’t be mentioned. It was banned from the panel. That’s how much this was mentioned. I know that you’re a fan of TIPS. Can you tell me, number one, why you’re a fan and also how one might implement TIPS into their portfolio?

[00:08:36] Dr. William Bernstein: Well, because there’s no other asset that matches your assets and your liabilities quite so precisely. So, let’s say that you decide that you need $30,000 of real spending power in the year 2051. However old you’re going to be then, you can buy a TIPS that matures in 2031 and know exactly how much spending power you are going to have when that bond matures.

There is no other asset that you can say that about. You certainly can’t say that about stocks, and you certainly can’t say that about nominal bonds either because if there’s bad inflation, you’re going to see the real value of that nominal bond turned basically into funny money. So, that’s the advantage.

Now, until about a year and a half ago, TIPS weren’t a very worthwhile proposition because their yields were so low. And in fact, there was a point about two years ago when the yields were strongly negative across the board. So, if you bought $1,000 worth of TIPS at that point and they were maturing in 10 or 20 years, you were guaranteed to get 80 to 90 cents on the dollar of spending power, which didn’t seem to be a very good deal. Now, real yields are approaching 2.5%, so if you buy a 30-year TIPS, you are going to get $2 of spending power in 30 years for every dollar you put in now, and that’s a heck of a deal. That’s a near historically high yield.

[00:10:17] Rick Ferri: So, a lot of different ways to buy TIPS. You can buy individual securities. You could buy a TIPS fund – short term or intermediate term – or you could buy this new product that we’ve been hearing about called iShares BulletShares TIPS, which basically are TIPS put into a portfolio or an ETF that mature in one year. And then there’s another ETF of TIPS that mature in two years, and so forth. So, you could build this ladder of – instead of individual TIPS – BulletShares. How do you feel about these?

[00:10:53] Dr. William Bernstein: Well, the BulletShares, unless I misunderstand them, don’t make a bit of sense to me. Why would you buy one or two bonds that mature in a given year? And I think beyond 2030 or 2032, is only one maturing each year. So why would you buy a fund that only owns one bond when you can buy the bond yourself for zero expense? Doesn’t make any sense.

So, there’s basically two ways to defease your retirement expenses with TIPS. One is simply to buy TIPS that mature in every single year that you’re going to be retired. That’s not quite possible because there’s a gap between 2034 and 2039. There are no TIPS that mature then.

Now, you can buy an excess amount of them in 2033 and in 2040, which pretty much does the same trick. And of course, you really don’t have to own TIPS for all 25 of those years. You can skip years a couple of years in between the TIPS so you only have to own maybe six or seven or eight of them, but that’s still a lot of work.

The other way to do this is to buy a mix of TIPS funds. So, let’s say you think that your retirement is going to last 30 years. Well, you want the average maturity of your TIPS funds to average out to about 15 years. Half of that, alright. So, you would buy a bit of a 20-year fund and there’s only one and unfortunately that’s offered by PIMCO, and it’s got a 20-basis point expense. So that’s just a little steep.

Then you could buy a short-term TIPS fund for a couple of basis points – there are a couple of ETFs that do that – and you mix and match those two and you try to average out, weight out the maturities to 15 years. And then of course you have to rebalance that once every couple of years to keep the maturity right. So, neither way is perfect. Either way requires a little bit of work.

I prefer the ladder because that’s fire and forget. You buy it, you lay it in, and even if you develop dementia, you can tell your executors and your kids, “hey, this is how you pay my expenses when these TIPS mature.” And they don’t have to do anything except collect the principal when they mature.

[00:13:01] Rick Ferri: Bill, you’ve recently released the 2nd edition of “The Four Pillars of Investing,” probably one of your best-selling books. Could you review for us what those four pillars are, and perhaps what the most important of the four pillars are?

[00:13:18] Dr. William Bernstein: Well, the first pillar is simply the theory of investing. So, the connection between risk and return. And market efficiency, the knowledge that you’re not going to be able to trade individual stocks and bonds particularly well. And the trick is not to trade, and you avoid trading by buying passively managed funds, index funds, whatever you want to call them. So, that’s the first pillar.

The second pillar is the history, and that’s probably the most important pillar because markets become ebullient and euphoric from time to time, and markets more importantly become panicky from time to time. And it’s important to know what that looks like. Not necessarily so you can time the market because that’s nearly impossible to do.

You do that simply so you can keep your discipline and stay the course and say to yourself, yeah, you know, I’ve seen this movie before, and I know how it ends either on the upside or the downside.

The third pillar is your own psychology. The problem with human beings is we didn’t evolve to deal with a 40- or 50-year planning horizon. We evolved on the plains of the Serengeti, dealing with the time horizon or risk horizon that was measured sometimes in seconds. So, we are psychologically ill-equipped to deal with the long-term risks and returns that are involved with finance. So, learning how to handle that is the third pillar. It’s very important.

And then finally, you have to learn how to deal with the financial services industry, which in many cases is the metaphorical equivalent of a war zone. There are people out there who are out to get you and transfer your wealth from your name to theirs. And you have to know how to deal with those people and those institutions.

[00:15:04] Rick Ferri: In your book, you get into a detail about the equity risk premium, and this is the excess return for taking the risk in the stock market over the risk-free rate. And I’m assuming in your book you’re using T-bills as the risk-free rate.

[00:15:21] Dr. William Bernstein: Yeah, that’s the classic one. You can also use longer bonds and especially TIPS as a risk-free rate as well. But most people use the 30-day Treasury bill.

[00:15:32] Rick Ferri: And given that 30-day Treasury bills currently are yielding 5.3% at the moment, what would you suppose the equity risk premium is over that over the next 20 or 30 years?

[00:15:47] Dr. William Bernstein: Well, you can calculate what the expected return of stocks is, and you can also look at historical returns. And you can not only look in the United States, which is the winner or just about the winner of all the 20 or 30 nations that we have long-term records for, and the equity risk premium seems to be – no matter how you look at it, either historically or calculated – somewhere in the vicinity of 4%. It might be 3%, might be 5%.

So, if T-bills are yielding 5%, you should expect perhaps 8% from stocks. Now the problem with using the T-bill is that it’s yielding 5.3% right now. I’m willing to bet that it won’t be yielding that much three or four years from now, and so that may be an overestimate. A better estimate might be thinking in real terms and say that there’s a 2.5% TIPS yield, real TIPS yield, across the yield curve. So, maybe you should expect 5.5% or 6.5% real return from stocks. Not nominal return, but after inflation return from stocks.

[00:16:53] Rick Ferri: So, if you were looking say for 5.5% to 6% percent, 6.5% real return from stocks, and you can get risk-free 2.5% in TIPS, then you’re really talking a 2% to maybe 3% equity risk premium over real interest rates today?

[00:17:13] Dr. William Bernstein: Yeah, if I I’m saying 4%, in other words, 2.5% for bonds and TIPS and maybe 6.5% for stocks. So, 6.5%, if it’s 2.5% percent inflation, that’s 9% nominal.

[00:17:27] Rick Ferri: Oh, okay. So, it’s actually quite high.

[00:17:29] Dr. William Bernstein: Yeah, I think that’s right. And one of the things that people kept asking me two years ago was what do I do about low yields? And the answer is you’ve got a great big, bloated portfolio because yields are so low. Because when yields are low, asset prices rise. So be careful what you wish for. If you ever do get to the point where you have much higher yields, your portfolio is going to be considerably smaller, especially on an inflation adjusted basis.

Indeed, which it is. Okay. Stocks are down from where they were two years ago and bonds, depending upon your duration, have gotten absolutely creamed over the past two years. I think the long treasury or 30-year Treasury is down about half from where it was two years ago.

[00:18:11] Rick Ferri: So, let’s talk about life in a 5% yield world. Some people would argue that stocks have not yet adjusted for a 5% yield on the 10-year Treasury and real estate has not yet adjusted for this higher-for-longer interest rate environment.

[00:18:34] Dr. William Bernstein: Well, that’s certainly a possibility, but I also believe that the markets – the overwhelming majority of the time – are very efficient, and they reflect the proper level of prices. And I’m not willing to bet very often that the market is wrong about valuations and expected returns. And I’m certainly not willing to bet that right now.

Now, the one thing that I think needs to be pointed out is that US large cap stocks are trading at multiples that are historically significantly higher than they have, so maybe their expected returns are lower. But there are other asset classes, equity asset classes, that are very reasonably priced. Small value stocks are very reasonably priced right now. Foreign stocks are very reasonably priced, emerging market stocks are very reasonably priced and even real estate stocks which have taken some real losses over the past year or so are not unreasonably priced as well.

So, if you look beyond the S&P 500, I think that there are very reasonable places to get decent expected returns. When you talk about expected returns, you have to realize there are very large error bars. When I say 6.5% percent, when anybody says that there’s a 6.5% expected return on stocks over the next 30 years, it’s quite possible we’ll see a negative return, negative real return, and it’s quite possible we’ll see an 11% real return. You just don’t know. The best you can do is go with the central estimate.

[00:20:02] Rick Ferri: There’s been a lot of media bashing of the classic 60/40 portfolio, 60% in equity, 40% in fixed income. There was an article in the Wall Street Journal the other day that talked about how this had the worst year it’s had in decades. And some people, primarily active managers, talk about how the 60/40 portfolio is not the right portfolio for today’s environment. What’s your take on it?

[00:20:35] Dr. William Bernstein: The person who wrote that article should wear a sandwich board that announces that they have risk aversion myopia. Because something has a bad return over a one-year period doesn’t mean that it’s a bad strategy. A 60/40 stock bond portfolio is a superb long-term investment strategy and simply because it has a bad year is absolutely no reason to abandon it.

In fact, one of the things that separates out the wheat from the chaff – if I can be sexist, the men from the boys or the women from the girls, if you will – in investing is how they respond to a bad year for their strategy. All strategies are going to have bad years and 2022 was a bad year for the 60/40 portfolio. But it was a superb 30 years.

[00:21:26] Rick Ferri: And normally I tell people that the idea that a 60/40 portfolio will prevent a loss is wrong. That’s never been what people have said about a 60/40 portfolio. They say that it reduces the probability of a large loss, but it doesn’t eliminate the probability of a large loss. And I think that last year, we saw that. Stay the course then with the 60/40 portfolio, if you have one.

[00:21:54] Dr. William Bernstein: Yeah, you shouldn’t give a rats patootie about a bad year every now and then. What you care about is how you’ve done over the past 30 years.

[00:22:01] Rick Ferri: There’s a lot of terminology out there in the investment world that to me, I think is designed to confuse investors rather than help them. And one of them is called “optimization.” This idea that you can look back in history and look back at the markets historically and you can optimize your portfolio with the correct percentages in each asset class so that going forward, you have an optimal portfolio. How realistic is optimization going for looking forward.

[00:22:37] Dr. William Bernstein: It’s beyond being impossible. It’s almost a cruel joke. Probably the worst way to design a portfolio is to look at what’s done the best, what asset allocation has done the best in the past, and then mimic that going forward.

Warren Buffett, I think, very famously said that if you could get to future optimal portfolios from the past results that librarians would be the world’s richest people.

[00:23:12] Rick Ferri: Well, there’s another tool out there that’s used by advisors a lot and it creates a lot of squiggly lines on paper and puts a line through the middle of it all. It’s called Monte Carlo simulation, and I’m skeptical on whether advisors should be using Monte Carlo simulations to determine the 5% probability that their clients will be living under a bridge and eating dog food.

How do you feel about use or overuse of things like Monte Carlo simulation to determine what might be an optimal portfolio for retirement?

[00:23:51] Dr. William Bernstein: Well, I don’t use, I would never use Monte Carlo simulations for that. What I would use them for is to try and get some sensible probability of how likely you are to leave a bequest or in the opposite end how likely you are to run out of money. And even then, it’s not a terribly useful tool. The financial economists have physics envy. They want to reduce financial systems to the accuracy and the precision of an airfoil or electrical current, electrical circuit.

And you can’t do that. Alright? It’s just an impossible thing to do. The systems are too dirty. My favorite sort of hobby horse is when somebody looks at a Monte Carlo simulation and says that the odds of portfolio success are 95% or 98%. So, there’s a 2% or a 5% chance of failure.

Well, heck, if you look at human history over the past couple of millennia, you see that societies usually don’t survive for more than 500 years. So, if you have an 80-year lifespan, it means you have about a one in six chance of living through a catastrophic situation that is going to completely destroy your savings. So, no one in this quadrant of the galaxy can be guaranteed a 95% or 98% chance of success for simple historical reasons. There’s really only one truism, which is that the more you save and the less you spend, the safer you’re going to be. And you really can’t say much beyond that.

[00:25:41] Rick Ferri: You have several other small books that you wrote in addition to the 8 big books, if you will. In fact, some of them are free on Amazon. People can download for free. One of these books that you wrote was called, “Deep Risk: How History Informs Portfolio Design.” What did you mean by deep risk?

[00:26:03] Dr. William Bernstein: Well, to know a deep risk is you have to know what shallow risk is. Shallow risk is the risk that everybody thinks about. It’s having a bad year. It’s 2022. It’s having a bad day, for example. October 19th, 1987, when the markets lost almost 1/4 of their value.

That’s shallow risk. Shallow risk almost always recovers, and that’s not a risk that is going to get you. The risk that is going to get you as an investor is a prolonged period, lasting perhaps a generation, of negative real returns. Because that’s the sort of thing that can absolutely blast your retirement to smithereens.

So, let me give you an example of deep risk. Deep risk is the Japanese stock market over the past 33 years, which has lost something like 2/3 of its value in inflation adjusted terms. The Japanese investor who depended on stocks for a retirement beginning in 1990 was probably eating cat food within 10 or 15 years. That’s deep risk. Deep risk is what happened to bonds, US bonds, between 1940 and 1980. Again, they lost – even with reinvested interest – about 2/3 or at least 60% of their value. That’s enough to destroy anybody’s retirement plans.

And so, what are the things that cause deep risk? It’s not having a bad day or a bad year in the stock market. The things that cause deep risk are first and foremost, inflation. When you look at financial history, inflation is almost endemic. It is rare to see a nation that avoids hyperinflation at any point.

We’ve more or less avoided it, although the 70s were a rough patch. The Swiss have avoided it. The Dutch avoided it. Very few other nations avoid severe inflation. That’s the most common deep risk, and it’s also the one that is the easiest to mitigate. We’ll talk about perhaps how we mitigate that in a minute.

The next risk is deflation. Deflation is extremely rare, and it’s easily curable. Governments have printing presses, or at least unless you’re in the EU, you do. And so, it’s relatively easy to avoid deflation. Deflation rarely lasts a very long period of time.

There’s confiscation, the government coming and taking your assets, either through excessive taxation or through downright confiscation as happened in the Communist countries after their revolutions.

And then finally, the 4th risk is destruction. Which is war, civil disorder. So, to take them in order, inflation is the one you can do the most about. Deflation is rare. You probably don’t have to worry about it. Confiscation, you have to flee the country, which is not an easy thing to do. And destruction, beyond having your good supply of canned goods and ammo, there’s not a lot you can do about it. And even if you have the canned goods and ammo, you may not be able to do anything about it. So, the rational investor – I came to the conclusion in that book – tries to do the best that they can to mitigate inflation.

[00:29:12] Rick Ferri: So, here we are at a point in history where we have a $33 trillion national debt, continue to rack up a trillion dollars a year in excess debt. No end in sight for this. The only way we could possibly begin to pay this back is through some sort of confiscation. We have to pay more taxes. Would you agree with that?

[00:29:36] Dr. William Bernstein: Gosh, you did a really good job of channeling Ron Paul. How do you mitigate that? If you’re really worried about that risk and there’s several different strategies which you know you can apply simultaneously. Number one is in the long-term, equities are not a bad hedge against inflation. Not a perfect hedge against inflation.

But when you look outside of the US at the nations that have had the very worst inflation – places like Chile, places like Israel, even Weimar Germany – stocks actually held up pretty well throughout those severe inflations. Why? Because stocks are a claim on real assets. They produce products that can be priced according to inflation and in real currency. They have real assets that they can sell. So, they’re not a bad way to do that.

Now there are some kinds of stocks that do especially well with inflation. One of them is value stocks. Value stocks tend to be overleveraged and that leverage melts away. It goes straight to the bottom line with inflation. Commodities producing stocks do well. I’m not a big fan of owning commodities or commodities futures, but oil stocks, gold stocks, base metals producers all do very well with inflation. We’ve already talked about TIPS. TIPS, by definition, are going to do well with inflation.

The one asset class, interestingly, that really doesn’t do that well with inflation when you look at it through a broad enough lens, is gold. Gold did pretty well in the US in the 70s with inflation, but in any other period in any other country that had severe inflation it didn’t do that well. And in fact, curiously, or paradoxically, gold does best with deflation. And the reason for that, if you think about it, is fairly obvious. Which is that financial panics when people lose faith in the financial system tend to be deflationary. And it’s not that gold does well with deflation per se, but gold does well with financial panics and financial panics tend to be deflationary.

[00:31:42] Rick Ferri: I noticed during the COVID crisis that the price of gold went up significantly when that began, and then once we had the recovery from that and inflation started coming back, the price of gold did not continue up because it had already gone up. So just recently, your theory about gold is correct.

Let’s get on to another topic. You were speaking with Meb Faber recently on a podcast, and he was asking you what you thought you might start working on next. And one of the answers that you gave to him was you were very interested in why some countries became wealthy and some countries did not. What was the key factor of what you found in this research so far as to why some countries gain wealth and others do not?

[00:32:37] Dr. William Bernstein: Well, the question is why have the northern Europeans done so well economically? And why, by the way, have their securities markets done generally much better than other countries? When you look at the highest returning equity markets around the world in the past century and ¼, you’re looking at the United States, the UK, Australia, New Zealand, Canada, all being at or near the top of the list. Sweden and Switzerland have also done well.

And what characterizes those countries? Well, it’s the usual things. Rule of law and dependence of judiciary, but also it’s written what sociologists call radius of trust. Okay. In other words, if you drop your wallet in the park or on the street, what are the odds of your getting it back? And it turns out that some cultures have higher radius of trust than other cultures do.

And the reasons for that are well beyond the ambit of this podcast. But it has to do with culture and the other really interesting thing is it has to do with marriage proscriptions in northern European countries. Because if you can’t marry your second or third or fourth cousin, it means that you have to leave the town that you were born to find a mate as a lot of English people and northern Europeans had to do at one point or another. And when you do that, you learn to trust other people and not just the people in your family and your clan, and that follows through in terms of economic growth. The higher the radius of trust, the longer the radius of trust in the society, the more prosperous it is I don’t know that I’m going to get to write that book, but it would be a fun book to write.

[00:34:32] Rick Ferri: One of the things that you mentioned was things that break up that trust. You know what causes that trust to erode over time?

[00:34:41] Dr. William Bernstein: That’s another interesting subject, and that would be the second part of the book, which is that societies that do become prosperous and stable tend also to acquire layers of special interests that tend to choke off the economy. So, all you have to do in this country is look at the power of the medical industrial complex that is resistant to any change or reform and you see that we’re spending close to 20% of our GDP on medical care. And yet our healthcare statistics are, if anything, a little worse than they are in countries where the medical industrial complex isn’t quite as powerful.

If you’re an American diabetic, you are three times more likely to get an amputation as an English diabetic will simply because our medical system is so dysfunctional. You can also look at the military industrial complex, and you can look at congressional privilege as well. One of the reasons why the Congress is so currently dysfunctional simply has to do with the capture of special interests of the legislative process.

[00:35:52] Rick Ferri: One of the other things you mentioned is that as a country becomes wealthier, or the wealthier that society gets, there becomes more inequality and that also leads to distrust.

[00:36:07] Dr. William Bernstein: Yeah. And we’re seeing that right now. I mean half of the people in this country, in the United States, couldn’t come up with $400 for a car repair without going into debt. And that’s the sort of inequality when you see that, you see when special interests gain power. I mean, if you’re a billionaire hedge fund manager, you’re liable to have a marginal tax rate that is lower than the legal secretaries.

[00:36:37] Rick Ferri: You wrote a paper called, “The Myth of Dynastic Wealth: The Rich Get Poorer,” and the co-authors were Rob Arnott and Lillian Wu. Within society, people seem to want to target very wealthy people. Now the rich don’t pay enough in taxes, and they need to pay their fair share and so forth. As if families are accumulating wealth, and that wealth will never go to go away. But in fact, I’d like you to talk about this paper. You wrote it some time ago, but I found it fascinating, that wealth doesn’t really stay with the same people generation after generation. It gets dispersed like sandcastles on a beach get washed back out to the ocean after a few tides.

[00:37:26] Dr. William Bernstein: But the paper looks over a time period that is not just a generation or two in length, but over several generations. So, the classic example of that is the Vanderbilt family. There was a get together of the Vanderbilts in 1970. There was not one millionaire in the group. And how did that happen? So, over the very long term – you’re looking at centuries now – the wealth tends to migrate out of the wealthiest families.

And the reason is just, it’s just simple exponential math. I mean a very wealthy couple is going to have two children and four grandchildren and eight great grandchildren, and by the time you get to the 6th or 7th generation there just isn’t enough wealth to go around, particularly as the successive generations get lazier and softer and tend to blow the money and sue each other over their inheritances.

So, over very long periods of time, their wealth does dissipate. We don’t have any real dynastic wealth in this country. There are no families whose wealth goes back to the time of the revolution. And very few families whose wealth goes back to, say, the time of the Civil War. Now that said, there is enormous inequality from generation to generation. Perhaps I’m getting a little too political here.

Whenever people complain about affirmative action, I remind them of what affirmative action really looks like. Affirmative action is when your father is an investment banker and your mother is a radiologist and you’ve taken 14 Advanced Placement courses by the time you’re in 11th grade or 12th grade. And that’s what real affirmative action looks like.

And so over one or two generations, we have real inequality and we have real lack of social mobility. But the one thing we don’t have, and that’s a real problem, the one thing we don’t have to worry about I think is one or two families taking over the wealth of the entire country. That’s not going to happen because that wealth does tend to dissipate over very long periods of time. But over periods of less than, say, 50 years or 60 years, I do worry about it.

[00:39:36] Rick Ferri: Well, one of the things we have in this country is an estate tax to take 40% of wealth over call it $25,000,000 for a married couple and basically the government takes it unless you give it to charity. So, that also puts the money back into the system. It puts it back into other people’s hands. And again, I always like to think of it as that wash out to the sea overtime.

[00:40:05] Dr. William Bernstein: Yeah, I agree with you. I don’t think we have to worry that in 200 years Elon Musk’s kids are going to be running the country. That’s not the worry. The worries that I have are the short-term effects of inequality. I worry, for example, that in the United States, if you were born in the bottom quintile of socioeconomic status or wealth or of income, the odds of you making it to the top quintile from the bottom 20% to the top 20% are about 5% or 6%. Whereas in a perfectly mobile society it should be 20%. Now in Scandinavia and northern Europe, that’s about 14%.

In Arkansas, it’s about 3% or 4%. In Silicon Valley, it’s about 13%. It’s almost at about the European level, so I worry about our lack of social mobility, which is due to wealth inequality.

[00:40:53] Rick Ferri: And is this all going to be the subject of a book?

[00:40:56] Dr. William Bernstein: Probably not. Other people have written about it far more eloquently than I’m ever going to be able to. The person who I pay attention to is Raj Chetty, who is at Harvard University, who’s an economist, and Angus Deaton has written a very fine book on the subject. He’s actually written two books.

One is “Deaths of Despair,” which touches on it, and the other is his more recent book, which is, “Economics in America,” which is basically a biography. But he touches on a lot of these same subjects, and he’s well worth reading if you really want to deep dive into the issue.

[00:41:28] Rick Ferri: I have one last question for you and I’m doing it on behalf of Jonathan Clements because he interviewed you at the conference and he did not get to ask this question because there were so many other questions, so I’m going to ask it on his behalf. You just jumped into an Uber. The driver is clearly both intelligent and uninformed about personal finance. He finds out that you’re an expert in personal finance and he asks you for advice. You have time to make five points before you get to your destination. What would you recommend to this Uber driver?

[00:42:08] Dr. William Bernstein: Well, I knew what those five points were a week ago when I was prepared for Jonathan’s question. I’ll do my best to recall five, but I may only get three or four.

The first one is to save 15% of your before-tax salary, if you at all can. The second is to keep your expenditures down. The third is to not trade stocks and bonds. To invest passively. When you trade stocks and bonds, to imagine that you’re playing tennis against an invisible opponent, and to realize that the person on the other side of the net isn’t some dentist from Peoria who was put there for you to trade with and make you rich. That the person on the other side of the net more likely is Serena Williams or investment equivalent of Serena Williams.

The fourth thing that I would tell my metaphorical Uber driver is to ignore your friends and family because almost invariably they’re going to give you poor advice. To stick to more reliable sources of information. And then the fifth thing is to avoid the headlines. The headlines are very useful. The economic headlines are very useful. If it’s above the fold, if it’s in the headline, it’s already been impounded into the price, so it’s worthless information. And if something is, in other words, in a headline, then you don’t have to worry about it because the price is already have already reflected that. So, I think I got five things.

[00:43:40] Rick Ferri: You did. And I would say that the headlines are interesting because today, as I was reading the Wall Street Journal, the headlines were individual stock investors outperformed the market. I don’t know if you caught that story or not, but it went in there and it talked about how many people own Apple stock and Google and Amazon in their own accounts and how they have outperformed. Now, I review literally hundreds of portfolios for individual clients every year, and I have to tell you I have not seen this, but apparently the Wall Street Journal has. Did you read that article?

[00:44:13] Dr. William Bernstein: I saw the article and they quoted a research outfit that I have never heard of before, and we both are fairly familiar with the finest literature. There are literally hundreds of studies that show just how poorly individual investors do, whether they invest in individual stocks or mutual funds. They almost always underperform, and they underperform in direct proportion to how frequently they trade. So, the fact that somebody, somewhere came up with a study that shows the opposite, I would not just take a pinch of salt or even a thimble full of salt. I would want a bucket of salt with that story.

[00:44:51] Rick Ferri: Thank you so much again for joining us on Bogleheads® on Investing. Your insights are always interesting. I have to go back and listen to this three or four times so I catch everything that you say. And thank you again for also for speaking at the Bogleheads® Conference and hope to see you there next year.

[00:45:05] Dr. William Bernstein: Rick, I hope to see you next year and I look forward to doing this again with you.

[00:45:10] Rick Ferri: This concludes this episode of Bogleheads® on Investing. Join us each month as we interview a new guest on a new topic. In the meantime, visit boglecenter.net, Bogleheads.org, the Bogleheads® Wiki, Bogleheads® Twitter, listen live to Bogleheads® Live on Twitter Spaces, the Bogleheads® YouTube channel, Bogleheads® Facebook, Bogleheads® Reddit, join one of your local Bogleheads® chapters, and get others to join. Thanks for listening.

About the author 

Jon Luskin

Board member of the John C. Bogle Center for Financial Literacy


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