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Bogleheads Speaker Series with Bill Bernstein

Post on: April 16, 2021 by Rick Ferri

The John C. Bogle Center for Financial Literacy is pleased to present the fifth installment of the Bogleheads Speaker Series featuring Dr. Bill Bernstein discussing the markets, investing, and his new book, The Delusions of Crowds: Why People Go Mad in Groups, with CNBC senior markets correspondent, Bob Pisani.


Rick Ferri: My name is Rick Ferri and I’m the resident of the John C. Bogle Center for Financial Literacy. We are a non-profit organization, a 501c3 organization. You can go to boglecenter.net. That means your tax deductible contributions are greatly appreciated.

 And  today we feature Bob Pisani, as CNBC senior markets correspondent who has covered Wall Street for 25 years. Today he’ll be interviewing Dr.Bill Bernstein about his new book, The Delusions of Crowds. And if you missed this or can’t watch the whole thing, we are recording it and it will be available on bogleheads.org, as well as the Bogle Center site, boglecenter.net within a few days. So with no further ado, I’m going to turn it over to Bob.

Bob Pisani: I can’t tell you how honored I am to be here. I am correspondent, as you heard, I’ve been with CNBC for 31 years. I’ve been the markets  correspondent since 1997. I met Jack Bogle in 1997, at that time in a phone conversation with him, and was profoundly influenced by him. So much so, I opened a Vanguard account for my wife in that year, in 1997. 

I”m certainly a boglehead, maybe not officially a member. I’d like to be, but I have been for 24 or 25 years. So it’s a great honor, and I’m a big fan of Rick FerrI and William Bernstein. We’re going to try to keep to the time here. It’s a Saturday afternoon, it’s beautiful. Spend a lot of your time, we’re going to try to keep it to one hour.

Bill Bernstein, and when–I’ve known Jim [Wiandt] for many years–when Jim took this over and said I’m going to  do something with the bogleheads, I said I want in on this, and he said, well Bill Bernstein is doing–anything, I said.

 I’ve known Bill Bernstein’s work for years. The Birth Of Plenty is one of my favorite economics history books. And I read the new one, The Delusion Of Crowds And Why People Go Mad In Groups, and that’s what we want to at least start out talking about. I want to remind everyone if you have a question, you put it on the right side. I will do my very best to make sure Bill hears about it.

But Bill, tell us a little bit about the Delusion Of Crowds. Obviously Mackay’s book, and it’s not pronounced mckay–fixed that for us–but Extraordinary Popular Delusions And The Madness Of Crowds covered some of the stuff you covered before. But you felt the need to sort of, I don’t know if updated is the right word, but tell us a little bit, very briefly, about how, what’s the genesis of this new book. Why did you feel the need to to look at extraordinary popular delusions again.

Bill Bernstein: Well the genesis of the book was almost 30 years ago when I read Charles Mackay’s book, it’s makai if you’re Scotsman, if you’re American mckay–yeah if you’re an American you said it’s okay to say mckay. I read this book, Extraordinary Popular Delusions And The Madness Of Crowds. And the original version of this book was written in 1841 and it’s a remarkable book because it describes  many different mass delusions. Religious ones and also financial ones, and it’s most famous for its descriptions of the three great bubbles of the 17th and 18th centuries. The tulip mania, the famous tulip mania–he’s the one who actually coined that term  and brought it into the English language–as well as the twin bubbles in Paris and London in 1720. And the descriptions are absolutely remarkable of people just going absolutely nuts over stocks or tulips or what have you, and how it became society-wide mania. And then it all crashed down.

And at the time that I read this book in the early 1990s I thought it was kind of interesting, kind of like a b-movie about the Roman Empire, not terribly relevant to anything that I was seeing today. And then, lo and behold, before my very eyes, several years later the tech bubble blew and people began behaving in exactly the same way that Mackay described. And I thought to myself, gosh I’ve seen this movie before and I know just how it ends. And it certainly redounded to the bottom line of my portfolios. I was able to ignore the madness and stay away.

And it turns out that that’s not a unique experience. Mackay has been saving people’s bacon for the past 150 years. Most famously, Bernard Baruch read the book in 1907 and it saved his bacon back then. And he was so impressed with it that he actually wrote the forward to the 1932 version of the edition of the book. It’s been in print ever since.

So you know the book really impressed me and then  several years ago I observed, like all the rest of us, how the Islamic State was able to attract people from around the world to one of the worst places on the planet to fight and to die. And it turned out that they did that with a narrative. It was very similar to the one Mackay wrote about in his book about the Crusades and other religious manias.

And so I thought the time had come to write a new version of the book, an updated version of the book, and updated with some of the modern science behind it. Now I have a trigger warning about the book, which is more than half the book is about religious manias. And if that’s not your cup of tea, or if you’re a particularly devout follower of one religion or another, you may not want to read the book. But if you’re interested in financial manias, you’re interested in the psychology behind financial and religious manias, then proceed at your own pace.

Bob Pisani: Well I read every word of the book Bill in preparation for this. and I have to say I marveled at your stamina to go through so many hundreds of years of religious mania. The Anabaptist chapter was fascinating. It really was something. I want to get to the conclusions here, of the book, because even though there is some, I understand, modern challenges about Mackay’s interpretation of how severe anything was. As you know there’s some modern research that suggests it wasn’t as bad.

But I don’t think that really matters. I think there’s a whole point to all of this which is that the way human brains are structured people tend to keep behaving the same way over and over again. I wonder the core point about the book, the lesson from the book, is why humans tend to herd a bit, why they’re so susceptible of all types. Can you give us the conclusion here. What you, what the book concludes essentially?

Bill Bernstein: Well the book is really a meditation on human nature. First and foremost, we are running around  this planet with stone age brains. Brains that evolved during the stone age in the space age. So we’re navigating a space-age world with stone age minds. And the first thing that you have to know about human beings is that first and foremost we are the ape that imitates. We do what other people around us do. And the question is why do we do that. And the answer is pretty simple.

The best way to think about it is to think about the spread of humankind throughout North America and South America which took place over a very short period of time several thousand years from the Bering Strait down to the Tierra del Fuego maybe, at most, 10,000 years. And in the process human beings had to learn how to make kayaks and hunt whales and seals. And then hunt bison on the great plains and then to fashion palm leaves into blow guns in the Amazon.

And if you’ve never done any of those things before you’re never going to figure it out for yourself. So you have to find the one lucky person or people who gradually over time figure out how to do each of those things. And then you imitate them. So it turns out that imitation is an enormously valuable skill to the survival of our species and it served us very well during the stone age. But in a modern post-industrial society where you have to invest decades in advance it’s not so salutary.

Now the other characteristic is that we are the ape that tells stories. You know when stone age hunters went out to get and hunt a mastodon, they didn’t issue each other vectors or mathematical descriptions or geometric descriptions. They just one guy said to the other, hey you go right, I’ll go left and we’ll spear the beast from both sides.

Okay we tell stories, in other words, and so we are uniquely susceptible to narratives as opposed to hard facts. So those are the two basic characteristics of why we behave the way we do in the modern capital markets.

Bob Pisani: So narratives are essentially shortcuts to understanding the world, is that correct? And sometimes they can hijack the more rational center of the brain, is the very important point here about narratives that you’re trying to make.

Bill Bernstein: Yeah narratives it turns out are the way that we understand things and we respond much more to narratives than to dull facts. And I’ll give you an example of this, and it’s political, but I’m even going to mention Donald Trump’s name. But I think it’s pretty neutral. Which is that late 2015, during one of the republican  nominating  debates, the primary debates, somebody asked Ben Carson about vaccinating his children and whether we should be vaccinating children or not. And he gave a very good scientific answer. He’s a neurosurgeon after all and he said, look I’ve seen the data, and the data is that it doesn’t cause, vaccinations don’t cause autism, and you know we should vaccinate our children. Now you know he was a good republican so he said the government shouldn’t force us to do it. It was a pretty good answer, okay. And then Donald Trump broke in and said, you know I had an employee who had a child, a beautiful child, and she was vaccinated  and she got autism and this is turning into an epidemic. I tell you every single person, every single political talking head who saw that scored that in Trump’s favor.

Bob Pisani: Right. And that narrative, in that case that narrative appealed to the fear center in your brain, whatever. the amygdala, whatever part of your brain that went off, and so it had more than simply stating a dry fact which is the evidence that there is no problem with vaccination and autism.

Bill Bernstein: Yeah the message went straight to the amygdala and that pathway is very fast and it overwhelms the pathways to our higher thinking centers in the cortex which are very slow.

Bob PIsani: Right. Let me move on to bubbles. And now let’s try to make some conclusions about what bubbles–what one of the interesting things about bubbles is they all exhibit certain characteristics in common. A very interesting discussion about Minsky, who was a fairly obscure economist as far as I can tell, but is now widely cited for his study of bubbles and bubble conditions. And he noted there were two essential factors–I’m not sure there’s just two–but you  point out in the book  that in order to have a bubble you need to have very cheap money credit, and you need  revolutionary technology. Can you very briefly discuss that, and are there other factors that modern scholarship might have identified. They all have something in common, that’s my point, and we should all be able to recognize and say tulip mania bubble and you the dot-com bubble actually had something in common, and these are the common characteristics.

Bill Bernstein: Yeah the two driving characteristics of any financial bubble are cheap credit or low interest rates, which is another way of saying that, and a revolutionary technology that captures people’s imagination. So for example, right now what’s there to invest in. You know you can’t put your money into bonds because they have a near zero yield with any reasonable quality at all. You can’t put your money into traveling, you know you can’t go to restaurants.  It doesn’t make any sense to buy nice clothes as we both demonstrated right now.

So you put your money into stocks. Well this talks of what companies. Well you pick whatever is the most exciting technology you can find, whether it’s cryptocurrency or Tesla or whatever. And so the price gets driven up and that becomes a self-reinforcing phenomenon. The more prices rise the more money that people make. The more excited they get and eventually it reaches a breaking point where it explodes. But you can say what’s going to happen but you just can’t say when.

Bob Pisani: Yeah. There’s been some other studies that have done that add a few other things besides easy money and technology. So I guess financial innovations, I mean so the mortgage products that were introduced in the 1990s, for example, that helped lead to the financial crisis. Maybe some other things like supply demand imbalances and things like that. Let me ask you about a very specific bubble. Right now– I’m going to dive back to the book–but I want to divert and go right to this point, because I’ve had questions here about bitcoin. Is bitcoin a bubble, is it  a mania? ‘ I’m not asking you to pronounce long term what you think of cryptocurrencies, if you want to go ahead, but let me try to make it very immediate right now. Your thoughts on what’s going to happen to bitcoin.

Bill Bernstein: Well I’ll try not to be inflammatory. I will not use terms like coin apocalypse or cointastrophy.

Bob Pisani: Or coin tribulation. I will simply say that there’s, which is great, I don’t want to use apocalyptic terms but let me name them right now. Yeah, I’m just giving you…

Bill Bernstein: No, no, no. I deserve that. What I will say is there’s a lot of speculation by people who are less than well informed. And the history of how this falls out is not very encouraging. And that’s the whole point of reading the Mackay book, is you see not only the manias but how they ended. Now not all manias end in a bust. Maybe only 80 or 90 percent do.

There are, it’s been pointed out to me, that there were some manias that really didn’t result in a horrible bust, that released relatively obscure–for example there were three railway manias in England during the 19th century, and the second one really didn’t end in much of a bust. But the other nine or ten ones that you can easily name did.

So yeah, there’s no question in my mind that bitcoin is a mania. And the question is why do I say that. Because they fit Mackay’s descriptions. And the Mackay description of a mania as well as what we all observed during the housing crisis, during the housing bubble excuse me, or during the tech bubble of the late 90s, were four things.

And the first thing that you say is that speculation becomes a topic.  When everybody starts talking about a given investment at a party or when they meet casually, that is a bubble all right. When you see people who are quitting otherwise good jobs to trade assets, thinking they’re going to become fabulously rich and never have to work again, that is a bubble.

And then there are two other things which are not as commonly observed but are still characteristic. Which are when skepticism is met with vehemence. I can remember several times during the late 1990s when I expressed skepticism  about the tech bubble, being basically told that I was an idiot, uh if not seeing my  parentage insulted. That sort of vehemence you’re also seeing with bitcoin as well. People will get very angry at you if you express skepticism. You’re an old fogey, you just don’t get it. You don’t get it or you just don’t get it are five words that you hear very, very frequently at the top of a mania.

And then finally it’s extreme predictions. Bitcoin’s not going to go to a hundred thousand, it’ll go to 500,000 or a million or 10 million, because don’t you know they’re not making any more of them. When you start hearing those sorts of extreme predictions that’s the fourth factor, and we’re seeing all four of those things right now with bitcoin.

Bob Pisani: Yeah, I agree with your point. I would only point out, as you pointed out in the book,  dot com was a bubble, blew up, but the internet lasted.  Why can’t bitcoin blow up, the blockchain really does last. Does not seem like a lasting technology to you?

Bill Bernstein: Oh absolutely.  And this is one of the central points of the financial section of the book, which is that bubble investors turn out to be capitalism’s philanthropists. They wind up losing a lot of money in order to fund these technologies that last. So there’s no question that blockchain may turn out to be a very transformational technology in the way we do finance. It’s just that the people who are investing in the bitcoin related companies probably aren’t going to to benefit.

The best example of that I had in the fiber, right. Yeah it was Worldcom. I mean the people who invested in Worldcom got taken to the cleaners but the fiber that Worldcom laid still is something like 20% of today’s submarine traffic capability. So Worldcom and you know Gary Whittick, the guy who absolutely savaged his investors, but he was a real benefactor to society in the world at large.

Bob Pisani: Yeah I agree with your point. I have no idea whether bitcoin is worth five thousand or fifty thousand. I just  don’t have any idea whether it’s worth somebody spending 69 for a non-fungible token [NFT].

That just happened. I used to collect comic books in the 1960s. Somebody just had paid 3.25 million for the first superman action one the other day. Now you might say what idiot is going to spend 3.25 million for a comic book, but somebody did. So I’m very agnostic on prices. What I am excited about is blockchain is a long-term disruptive technology I think it’s going to last.

 I would pay very close attention to the Coinbase direct listing this week. That’s going to be, depending on how that thing prices, that could force another whole new wave of investment in crypto because that thing is so big we literally don’t know what it’s worth–50 billion, 100 billion–it’s literally not known. 

But I’ll give you an idea. if it goes at 50 billion dollars. Nasdaq is currently valued at 25 million.  The New York Stock Exchange with ICE [Inter Continental  Exchange], with the entire organization is 65 billion. So essentially there’s an exchange here, it’s really an exchange, Coinbase that is suddenly valued as much as the New York Stock Exchange and all the exchanges that are built around the NYSE. Yeah that’s pretty amazing. I don’t know if that is a sign of a bubble or mania but it’s a sign that a lot of people think there’s a lot of potential in blockchain technology, in general. And that’s what I think people should pay attention to.

 Let me just move on. You mentioned the bubble path, the physiology and diagnostic signs. You had the four “P’s”  that I liked very much. The promoters, so you need somebody out there and talk about the new technology. You need participants, you need buyers. You need the press.

You know one of the things Robert Shiller pointed out in Irrational Exuberance, another book that I got in the first three years going down the NYSE. I met Shiller, and when it came out in 2000–I think the Irrational Exuberance— I met him just after that he pointed out that one of the common characteristics of mania was bubbles first started appearing when the press started appearing in the 1600s. And he was very big, just as you were pointing out, the role of the press in helping  promote these manias. 

And politicians, of course, get involved in various ways and either in promoting them or changing the law. So I don’t have a question here Bill. I just want everyone to realize what are the characteristics of a bubble. Four things, the promoters, the participants, the press  and  the politicians. Is there anything to add to that at all? That’s doing a little learning thing here for everyone who hasn’t read them.

Bill Bernstein: Well yeah. What I do is I have this medical–I’m a doctor so I have this medical model of bubbles–so you know we already talked about the underlying pathophysiology, which is the Minsky criteria, you know, credit and technology, be it financial  or technological. To which I add two things, which are amnesia, and then particularly the fourth thing is the amnesia for traditional valuation criteria, which go down the drain during a bubble.

And then there’s the anatomy. And these forced locuses of the anatomy, which you just mentioned. There’s  the promoters, the participants, the press, and the politicians. And to me the most fascinating thing that I wrote about in the book were these promoters of the various  schemes involved with the bubble.

So starting with John Law with the Mississippi Company bubble, and then there was a guy in  London named John Blunt  who was a real scoundrel,  and then there was a man by the name of George Hudson who basically built out a lot of England’s rail network.  And a man named Samuel Insull in the 1920s, who built out the electrical utility infrastructure of a large part of the country. And both of these guys, both Hudson and Insull left us with very valuable infrastructure,  enormously valuable infrastructure. But they also became the capitalist heroes of their age, and eventually  wound up almost going to jail for fraud, because of their fraudulent financial  dealings. And the lesson here is that whenever you see somebody lionized in the press as being the capitalist genius of their time you have to really look out.

Okay we have two very recent examples of that. One of  them, which has already blown up, which is Adam Neumann with WeWork, who was this very charismatic guy who just went completely off the rails in terms of the way he managed WeWork— because he was so charismatic and got so little negative feedback, he went completely off the rails. And of course the one who’s still left standing is Elon Musk, who may wind up as a hero who will, you know, transform our transportation technology and other technologies as well. But he’s also showing some very worrisome characterological signs that you often see with these people who are the recipients of large amounts of adulation in the press.

Bob Pisani: Yeah, but he may be real. I mean honestly, the man has revived the space program. You know I grew up like you did in the 1960s.. I’m a science fiction fan.Ii grew up with Arthur C. Clarke and Isaac Asimov and  Arthur Clarke wrote 2001 a space odyssey in 1968. It was about 2001 going to Venus. I mean  my generation grew up with the whole where’s my jetpack crowd. Like what happened. Where did the future go? And I mean Musk has helped revive the space program.

I mean Thomas  Edison was real, he was a real person. He had his own problems, but there was a Thomas Edison who really was a genius. So I agree in terms of brain  characteristics and maybe some mental disorders. He exhibits some characteristics but so far he has remarkably delivered.

And I’m very close to the SEC, and I’m aware of how much agile he’s given the SEC, and I think he’s obviously circumvented the securities laws with his comments on twitter, but I think the guy is brilliant, and even if he stopped right now his contributions would be significant. I don’t know about the valuations of Tesla, at all. I tend to be very agnostic on those things,  but I  mean you do admit genius does exist right.

Bill Bernstein: Oh absolutely. And I agree with every single thing you said. And I make that point in the book. You know George Hudson and Samuel Insull transformed  England and the United States respectively in the way that we live. They were absolute geniuses but they did not come to good ends because of the hubris that evolved in the course of doing all the wonderful things they did.

So the question really is does Elon Musk wind up like Samuel Insulll,  which was not a good ending. Insull actually wound up dying penniless in Paris. Or does he wind up like Thomas Edison, who will you remember–I don’t know the answer to that. I would not be surprised either way.

Bob Pisani: Or Tesla himself. You know, look what happened to Tesla, a brilliant man who really essentially ended up with almost nothing. I want to move on because we’ve had some specific questions from the listeners and I want to try to address them. We’ve got a half an hour folks if you’ve got some questions let me know. But I try to get to a couple of them. There’s some very specific questions in general about investing. I don’t know how much you want to take them.

But I want to do something. I’m very interested in, which is what should we be advising people to be doing. Now I’m obviously a loyal disciple and I spend a lot of time, ETFs and index investing in general, do you feel–in my view, ETFs and index investing have generally triumphed. It is widely known now that almost all active management is not successful over long periods of time not that there isn’t–I know Jack would always correct me–it’s not that there isn’t any, we have very good active investors in Vanguard. And that funds, but they’re rare, and it’s hard to find them, and they cost too much. So with that said, how do you feel about the progress of a lack of a better word, the Jack Bogle ideology, the keeping costs low, generally index funds. Do you feel that that is winning the day, compared to say 20 years ago.

Bill Bernstein: Very, very slowly. And what I worry about is that the learning curve may be shallower than the birth rate. All right, I see it happening, and I certainly walk into a Bogleheads conference and you think that everybody has got religion and is doing things right, and within the confines of a bogleheads meeting, yes that’s very true.

But when I walk out into the wider world and I talk to people about investing, my sampling shows a very low incidence of bogleheads. You know for every person that I meet that’s read Bogle or Rick Ferri or Larry Swedroe, you know I meet 50 -100 who are still listening to their stock broker.

Bob Pisani: Right, Well isn’t this because literacy in general is not very good, financially isn’t very good. I mean the education system is failing us. What really disturbs me, you know I belong to the skeptical inquirer group and you’re not taught anymore n critical thinking in science, critical thinking, inductive reasoning. Why would you even be taught financial literacy, like what’s the Federal Reserve, what’s a stock and what’s a bond.

People come out of high school. It’s shocking how little they know. In high school, I graduated in ‘64. I had not a single course on finance. I learned how to type. I learned a little mathematics, trigonometry and geometry. A little science, a little history, but I literally didn’t know how to balance a checkbook when I was 18. literally. So yeah, so shocking that this happens.

Bill Bernstein: Yeah. No it’s not shocking at all. There’s the fact that emerged–very good at critical thinking–of course you know Europeans and Asians are even more enamored of active investing than we are here in this country. There’s almost, there’s very little of an indexing community outside of the United States maybe and Canada. So there’s that.

But there’s a more basic factor involved here, which is how compelling are the narratives. What my book is  really about, aside from disposition on human nature, is it’s also a story of compelling narratives.

Bob Pisani: Well right, so why– I’m sorry interrupted, right–this is a very important point, why is active management a more compelling narrative than indexing.

Bill Bernstein: Oh well, because indexing is a very,very dull and non-compelling narrative. It’s invest in three different index funds,  spend 15 minutes a year doing it and don’t even think about it beyond that. And go about and live your life. That’s a very dull uncompelling narrative. The real narrative is to turn on the financial media and watch Jim Cramer jump up and down on the desk in a gorilla suit and go boo.

That is what compels people to hear a corporate executive come and talk about what a great company he has. Or listen to a strategist, a market strategist from a large bank talk about where he thinks the market is going in the next six months. That’s much more compelling than buy three funds and rebalance it once a year and forget about it. It’s just that the boglehead narrative is so dull. Now where the boglehead narrative wins, of course, is on the data. But as we’ve already talked about, narrative always trumps data.

Bob Pisani: Yeah it’s funny. I spent a lot of time with the academic community. And of course the academic community has a very dim view of the active management community. But they’ve called them out. We know the numbers and the data. I covered the Spiva study– well they’re out twice a year, which is S&P–but that’s something I can get on the air every year, twice a year.

So the academic looks down on the active management community, and the active management community despises the academic community because they call them out on it. They think they’re a bunch of eggheads.

And the academic community also somewhat looks down on the financial press because they feel–that’s us folks, that’s me–we are  too complicit in going along with the active management narrative. Which you bring up in your book as well. So there’s a lot of competing forces that are going on here.

I will tell you I’m afraid I don’t agree with you, with your idea that indexing is not winning. I was a proponent of ETFs from 1997, and I’ve seen nothing but victory. Indexing forces–I know people in the act. I’m close to this community, the active management community. They’re terrified, they are really worried that indexing is sweeping the world. So I’ve agreed with everything you said but I really think  the bogleheads are winning and the active management community is terrified.

And you see it in their responses. In the last 10 years, fogies coming out and saying, oh wait for this, ETFs blow up because there’s not enough of the underlying stuff out there, it’s all going to blow up. It’s all a lot of nonsense. It hasn’t happened. Yet saying,  oh this is like communism, like brainless thinking. All nonsense. People know what high costs are. People have better understanding. The whole fund community is moving towards the ETFs. They’re moving towards lower cost. So am I crazy, Bill. I mean did anything I said make any sense there.

Bill Bernstein: No, no. I agree with you. Remember when you asked a question initially, I said yes, the bogleheads are winning. But what I’m saying is they’re winning very, very slowly. It’s a glacial process. And it could be that my sampling of people is skewed in the sense that I’m talking to relatively ordinary people but when I–you know just my acquaintances–you know to the extent that anybody who lives in Portland is ordinary, I suppose.

But what I’m getting at is that, what I guess I’m trying to say, is that the people who really matter, yes the people who are in the HR departments who are picking the funds. They’re picking Vanguard funds. It’s true, they’re picking  low-cost index funds now. Almost anybody in any kind of a decent–well let me phrase differently–20 years ago it was very hard to find a decent 401k plan–now you look at most 401k plans and most 401k plans have very good low cost choices. So that battle is being won, I think at that very high level.

But when you ask the average person on the street  about indexing  and you ask them about finance. To them finance is the guy on the TV who’s picking stocks and it’s their broker. It’s not the wisdom of Jack Bogle.

Bob Pisani: Yeah. Let me just move on here a bit and talk about the three fund portfolio because people ask me all the time what portfolio would I find compelling. And I said, you know investing should be simple, it shouldn’t be that hard. And I always bring up the three fund, the Bogleheads Three Fund Portfolio book which is basically some combination of total stock, total bond, and international.

I’m wondering if you feel that still is a valid look, and what I’d love to do is I constantly get people who send me 20 [fund] portfolios. Very impressive, many of them are indexing, they’re not quite crazy, and they say what do you think of this. And I say, well this is very interesting but I wonder how your 20 fund portfolio would stack up against the bogleheads three fund portfolio. And obviously it depends on the mix of the three fund portfolio, but even if you just take you know you know 60/20/ 20 or or 50/30/20, some combination. I wonder and maybe you can answer this, if we ever did anything that stacks up that three fund portfolio against a really comprehensive portfolio.

My point is, I think you can show simplicity would work. I think that three fund portfolio, and again it depends how you slice it up,  would probably perform as well as anybody’s decent broad portfolio that has 20 funds in it. Any thoughts about that.

Bill Bernstein: Well, yeah. First of all I would say one thing, it’s really important here, which is it really doesn’t matter whether you have a 20 fund portfolio or a three fund portfolio because in the end what is far more important than whether you’ve got 20 funds sliced and diced all these different ways, or three a simple three fund portfolio, what matters more is that you stick to whatever, your discipline is stick to whatever your allocation is. That is far more important than what your precise allocation is.

And that’s really what you should be training to do, is to have a portfolio that you can stick with through thick and thin. Now the second thing that I want to say is that I’m a big fan of the three fund portfolio and it has done particularly well over the past 15 or 20 years because this has been a particularly bad period for pretty much every other asset class you’d want to look at. Whether it’s value stocks or small stocks or more of a weight to foreign stocks. If you did those things you’re not going to do as well as you would have done with a three fund portfolio.

I’m not sure that that’s going to be true going forward. But again that’s angels on the head of a pin. What’s far more important is that you pick an allocation. now there’s something that in my mind may even be better than a three fund portfolio and that’s a one fund portfolio.

Okay if you’ve got a good target date fund  in your 401k that’s really all you need. And the advantage of a one fund portfolio is because you’re not going to see the international or the foreign stock part of that portfolio get horribly creamed. It won’t be as visible even though you own it. When you own a target date fund you’re not going to see that in the pricing. You’re not going to see that oh my god one of my components lost 55 percent over the trailing 15-month period, as has happened a couple times in the past couple of decades.

Bob Pisani: Yeah  I’ll give you one. Vanguard Wellington. People ask me all the time if you ever had to one fund. I’d say, that’s a hard one but I picked Vanguard Wellington myself.

Bill Bernstein: I think I agree with that. I actually–Wellington is the one non-indexed fund that I do recommend happily to people.

Bob Pisani: Yeah. Just move on in terms of factors. There’s been a lot of debate about what factors matter and Fama French models. And I’ve had a lot of discussions with other people about this. Is there any evidence that you should continue to have a value, small cap tilt to your portfolio, or does that matter at all. It certainly hasn’t worked in the last decade, but does this– I’m just asking generically–does the factor debate matter to you at all?

Bill Bernstein: Well it matters to me because that’s how we invest. We are factor loaded and we’re quite happy with our results over the past 20 years. We were extremely happy with our results from 2000 to 2010, not so happy with our results in the past 10 years. Over the past 20 years we’re quite happy with our results, but that’s the hard part. In other words we do believe that there is a premium to investing, certainly in value stocks, maybe even to small stocks, although that’s less certain.

But that premium, if there is a premium, doesn’t come for free. That premium comes at a cost, which is a period like the past 10 years. Now you know I’m not going to get into the weeds about whether value stocks have gotten uh much cheaper than growth stocks have. I think that they have, and I continue to believe that, but you know there are no certainties in investing. I could easily be wrong, but if I had a bet one way or the other, I would bet that over the next 10 or 20 years value stocks will outperform growth stocks. But I have no certainty about that.

Bob Pisani: Well if you believe in reversion to the mean, that would certainly make some sense. And we’ve seen that recently with small cap value being the biggest outperformer this year. I want to hit you on–we’ve got another 20 minutes left–I want to hit you on six or seven questions the  listeners are writing in. Keep the answers relatively short so I can get a number of questions in.

Here’s one that I think is a good one. Why is it that so many institutional investors endowments and foundations in particular continue to be such firm believers in alternatives, in active management, even though they know, or should know, the evidence on all of this.

Bill Bernstein: Two reasons. To be very fast, number one is they are facing horrible constraints in terms of traditional assets. So if every day playing vanilla stocks and bonds aren’t going to enable you to fund your participants’ liabilities or your spending, then gosh we should try something else, and that something else is alternatives.

And then the second dance, the second reason is consultants. There’s an entire consultant industry out there whose rice bowl is basically shouldering responsibility when things go bad. So you know the consultant industry is, the consultant is, the person you blame when things half sell. And you know a consultant isn’t making a very good living if he recommends a three fund indexed portfolio.

Bob Pisani: Yeah that’s a very good answer. I completely agree with that. Let me move on. The current Bill Miller of state of the day is Kathy Wood over at ARK Investing.  She has attracted in nine days 500 million dollars to her Space ETF even though she has almost nothing to buy there. And here it’s considered a space investment. But  let me just ask you any particular thoughts on Kathy. What is the new current superstar?

Bill Bernstein: Well if you know anything about mutual fund history she’s an easily recognizable type. She’s the superstar who makes three or four hundred percent over a couple of year  period and then flames out. My favorite was Ryan Jacob, which is an interesting story. Ryan Jacob ran the Internet Fund  back in the late ‘90s, and then he ran the switch to the Ryan–excuse me in the Jacob Internet Fund–I think it was after that. And that fund posted returns of I think 300% one year, 200% the next year, and then proceeded to fall in price by 95% between 2000 and 2002.

Now what’s interesting is that fund is still around and if you string together all of his results, he actually beats the S&P 500. But I don’t think there are any sentient beings in this quadrant of the galaxy that actually held on with him for 22 years or 23 years. And so he’s a perfect example. So do I think that Kathy Woods portfolios are going to crash and burn. I think it’s highly likely because you could name not just Ryan Jacobs but Garrett Van Wagoner,  Helen Young Hayes, Bill Miller, all people who did very well for a very short, relatively short period of time, except Bill Miller. He did well for 15 years and then imploded. That’s the history.

Bob Pisani: Yeah. I mean I think that’s a great point. The first conversation I ever had with Jack Bogle, that’s exactly what he said to me in 1997, and it was about Bill Miller. He said, he’s a very decent fellow but you understand how rare they are. So in a sense I don’t–I hate bringing up somebody’s going to be a superstar just by the sheer numbers of people that are out there picking stocks, somebody’s going to hit it, right. And so we’re going to anoint them as geniuses even when, as the academics would say, it’s a statistical probability that someone is going to be correct. So I always go back and forth between should we ignore anybody that’s successful. No I say, you’re just a statistical anomaly therefore you’re not important. I don’t think so, but I think people should be very aware of the point that you’re making.

Bill Bernstein: Let me interrupt and just add one fast thing, which is that, you know, if you’re going to run a stock picking, you enter a stock picking contest like the ones that get done at the high school level, you don’t invest in the S&P 500. You pick the hairiest, riskiest tech stocks you can find and you hope that you hit lucky. That’s how you win that contest, right. And it’s the same thing with superstar fund managers. That’s what they do. They have very concentrated portfolios in very hot areas, and that is a recipe, in the long term, for failure.

Bob Pisani: Yeah. By the way, I forgot to ask you what do you own. I know that’s– I don’t want to be personal too much. But people always ask me the question and I’m always amazed how rarely anybody ever asks people in private what actually do you own. I’ve owned about a dozen funds. They’re all Vanguard funds, and almost all index funds, but you know, I  tried paring it down over the years and I’m getting better at it. But I don’t know what generically, what do you want…

Bill Bernstein: Well on the bond side it’s very simple. I own pretty much almost exclusively treasuries, with a bit of munis in my taxable portfolio. And on the stock side I use Vanguard for you know, total stock market or large market  in the stock space. And for the small and value tilt I use Dimensional.

Bob Pisani: Yeah wonderful organization. I think very highly of Dimensional, and there’s another organization that’s transitioning to an ETF platform. And, you know, obviously with Eugene Fama there on the board, a big thing. Let me get to some more specific questions here. There are people who actually want your investment advice. Here you asked Bill about buying corporate bonds through ETFs. I understand he said not to do that. Is there a specific recommendation?  There seems to be a lot of interest in bonds here.

Bill Bernstein: Well I don’t like corporate bonds in general. This is, I guess, where I part company with Jack Bogle because what you’re doing is you’re getting extra yield but you’re doing it by taking equity like risk. And I’m a big believer in having a risky part of the portfolio which is long term, and then a riskless part of the portfolio safe.

You know if you invested in corporate bonds, for example in 2008, you had the experience of watching what you thought was a safe asset lose 5% or 10% or 15% of its capital value, and that’s the money you’re going to live on when you lose your job, that’s the money you’re going to use to buy stocks, the fire sale. And it is very discouraging to see that head south during the real financial crisis.

I’m not overly fond, on top of that, of ETFs because of the spreads that open up. Now you can have this–there’s this philosophical argument– so what’s the real price. Is the real price the open end fund price at the end of the day? Is the real price the ETF price? Because quite a gap can open up between those two prices. But there’s no question that the open end price functions better. So if you’re going to own corporate bonds in a fund, you’re probably better off in an open end fund.

Bob Pisani: In open and fund, correct, as opposed to an ETF.

Bill Bernstein: Yeah, and I’m not a big, as I said, I’m not a big believer in owning corporate bonds anyway.

Bob Pisani: So you in your personal fund, in your tax account, you own all treasuries.

Bill Bernstein: Treasuries and a bit of munis.

Bob Pisani: Yeah, okay.  And you don’t  like corporate bonds in general. Some people don’t like bond funds themselves because they keep rolling over and having new funds. There’s a lot of people who are owning individual bonds, whether corporate bonds or treasuries or muni’s. You’re not making that distinction between the funds versus owning them individually. You don’t like corporate bonds in general.

Bill Bernstein: But I–and again, you’ve asked another question– which is, what about owning individual corporates versus owning a corporate bond fund. And owning individual corporates is not a game that individual investors should play. Those are relatively opaque, mark very high spreads. Leave that to the person at the fund company who knows what they’re doing.

Bob Pisani: Yeah. Some questions on international investing.  You know, I remember talking to Jack in 2006. I actually called him and said I’ll show you mine if you show me yours. Tell me what you own. And he declined to do that. I think his biggest son  ran a hedge fund at the time. He had some money in the hedge fund with his son. But he made it very clear, he largely, it was total stock and total bond and I was surprised he didn’t seem very big on international investing. I understand he kind of changed that as time went on. How do you feel about international investing right now as a percentage of the portfolio? Where does it fit in and if you can give me a percentage, maybe that’s tying you down too much, but should it be ten percent, twenty percent.

Bill Bernstein: Well here’s the way I look at it, which is that very, very roughly– and I haven’t looked at it recently, I’ll admit–you know the world stock market is roughly half foreign and half US. All right, so efficient markets would tell you that’s about what you should be. You should have an equal amount of the two.

Now having said that, there are good reasons to tilt toward the US. Number one is especially in a sheltered account  you lose the foreign tax advantage that you have by owning it in a taxable account. So that’s number one. Number two, you’re going to be spending US dollars in your retirement unless you’re moving to Europe and you’ll be spending euros. So you want to take a little bit of that currency risk out.

So you should certainly tilt more heavily towards US stocks. So if your portfolio is 50/50, there’s nothing wrong with being 30/20 or 35/15. In other words my set point is somewhere between 30% and 40% of your stock portfolio being foreign.

Bob Pisani: Do you have any problem with, for example, China where some viewers call in and say, you know for every Alibaba that’s supposedly privately owned, a very large part of the Chinese stock market is largely–particularly the older school, industrial banks–largely controlled by the government. Nominally they may seem private, but in fact the government  controls them. Does that figure into your calculation? Does it matter, do political systems matter?  Even when China  has capitalistic characteristics, where does that fit in the political situation in terms of investing.

Bill Bernstein: Well Chinese equity has a much much bigger problem than what you just talked about, which is dilution.  And all you have to do is step back and look at things from Chinese market at 50,000 feet and what you see is that over the past, I don’t know, 28 years or so that data has been kept, the return on Chinese stocks in US dollars has been paltry, a couple of percent at most. And that’s only been very recently that it’s actually nudged into positive nominal territory with the results of the past couple of years. And the reason for that is equity dilution. It doesn’t do you any good at all if an economy is growing at eight or ten percent a year if the stock pool is being diluted at twenty percent per year. Which is what’s happening in China.

To give you the opposite example of a very long term, the Swedish market  has had about the highest returns over the past 120 years of any developed market. Why is that? Because the Swedes don’t dilute their stocks, their stock pool. Okay so that’s a good reason to be wary of emerging markets, and it is a problem with emerging markets index funds because they are now very heavily weighted  towards China. And I might add parenthetically, it’s why I prefer DFA’s emerging markets funds to Vanguard funds because they’re less exposed to China than the Vanguard fund is.

Bob Pisani: Yeah that’s a very good point. A couple of more specific questions, We had several people ask about insurance, a couple people asked about long-term care and life insurance policies. I don’t know if you want to comment on that. We feel strongly about that. Had a couple questions on annuities. In general, I know annuities have changed in the last 10 years, but any thoughts on any of this.

Bill Bernstein: Yeah, I’m going to pass on long term care insurance. that is just well beyond my field of expertise. My strategy for  long-term care insurance is to acquire enough assets so that you don’t need it. And I have to admit I don’t have a lot of advice to offer to the person who can’t do that.

And then your second question is annuities .I have nothing against fixed immediate annuities, the simplest, cheapest possible product. The SPIA, a single premium immediate annuity is a fine product with one caveat, which is don’t even think about buying one until you’ve figured out how you’re going to delay Social Security until 70 because that is effectively the cheapest annuity and the best annuity that money can buy. 

Bob Pisani: Yeah, so rather than maximum Social Security, well full source score is 66 years and four months, right.

Bill Bernstein: It depends upon your age.

Bob Pisani: Yeah, and so if you stay till 70 you get about 30 percent more, right. I believe so per year somebody who at 64 months would get 3,000 a month would get a thousand more if they stay till 70, I think.

Bill Bernstein: In other words if you take a hundred thousand dollars to cover your residual living expenses between the time you’re 66 and four months to age 70, okay, that is the same as buying an annuity that not only yields close to eight percent, or about eight percent, but is also an inflation protected annuity which you can’t buy for love or money now anywhere else.

Bob Pisani: Yeah, and of course  a lot depends on when you’re guessing how long you’re going to live. I mean if you think you’re going to die at 73, obviously getting…

Bill Bernstein: And your spouse, yeah. In other words it’s a joint problem. So if you’re convinced that both you and your spouse are going to be pushing up the daisies long before your time then yes don’t buy it, don’t do that. But for ninety percent of people it’s a good choice.

Bob Pisani: We only have two or three minutes and I appreciate everyone. We get out on time, but let me just ask you about the debate about the 60/40 portfolio, which never made a lot of sense to me particularly, and seems to be under assault for the obvious  reason we’re all living a lot longer and bonds aren’t returning much. But can you give us two minutes on that whole debate? The 60/40 portfolio, is that even useful to discuss anymore?

Bill Bernstein: I have nothing wrong, I have no problem with a 60/40 portfolio. I mean it really depends upon your own personal circumstances and particularly your burn rate. Okay, if you’re 60, if you’re retiring at age 60 and you’ve got a five percent  burn rate  a 60/40 portfolio may very well put you in a bad place if you have a bad initial sequence. On the other hand, if your burn rate is two or three percent it almost doesn’t matter what your asset allocation is, as long as you have at least a reasonable amount of money in stocks.

But one thing I might add is that you hear this every five years, the 60/40 portfolio was dead and I’ve heard that in one form or another for the past 30 years. It’s wrong.

Bob Pisani: Yeah, agreed. Folks it is precisely two o’clock. This has been a wonderful stimulating–it’s a great honor to be with the bogleheads–I hope to be back with you again. And Bill, thank you so much for joining us. I’ve been a great admirer of your work for many, many years. Rick Ferri is back with us, and Rick I admire your work too.

And I really would like to get on the air the boglehead three portfolio and I’d like to talk about it versus a wider portfolio because I think that’s a useful way of educating people more about the value of it. Part of the problem is with what–and I think this goes to Bill’s point about neuropsychology–is people think if I have 20 funds, that this activates my brain, plays the dopamine more than three funds. So I think Bill’s right, there’s nothing wrong with 20 funds, but do you really need it. Well I don’t know, but I feel more like I’m more important, or I’m activating my brain cells more if I  have 20 funds instead of three funds. And if we can show them here’s your funds since 1999, and here’s to your three funds since 1999. I think that would go a long way towards telling people all right, calm down. You really don’t need 20 funds.

Rick Ferri: A psychologist would call that 20 fund portfolio the illusion of control. Thank you. Okay maybe we can collaborate and do something on that. Well thank you and  publicity is the greatest genius, correct. Make something that’s complicated and make it  simple, and that’s that’s a greater genius than having 20 funds in a portfolio.

But thank you, Bob and Bill. I mean that was a fascinating discussion. Everybody agrees, that was listening, to go on for a couple more hours. So greatly appreciate both of you being on today. A wonderful discussion and we hope everyone who joined today enjoyed this presentation. It was recorded and it will be available on bogleheads.com and on the boglecenter.net website.

Our next Boglehead Speaker event will be in May with a guest to be announced soon. So thanks for joining us and see you next time. And thanks Jim for hosting this.

About the author 

Rick Ferri

Investment adviser, analyst, author and industry consultant


Bogleheads Speaker Series

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