Hear the entire interview at BogleHeads Live
My name is John Luskin. I’m your host. Our guest today is Barry Ritholtz. Today. I’ll rotate between asking very questions that I got beforehand from the Forum at Bogleheads.org and taking live audience question from the folks here today.
Let’s start by talking about the Bogleheads, a community of investors who believe in keeping it simple, following a small number of tried and true investing principles. You can learn more at the John C Bogle Center for Financial Literacy at Boglecenter.net.
On today’s show with Barry Ritholtz, an American author, blogger, newspaper columnist, market analyst, and chief investment officer at RWM, and the host of Bloomberg’s Masters in Business podcast.
Hey, John. Thanks so much for having me. I’ve been looking forward to this.
What should Bogle heads know about the cognitive and behavioral side of investing?
What should Bogle heads know? Well, well, let’s go back to first principles and talk about some of the things that John Bogle recognized so early.
He very much realized how much of investing is just completely out of your control. What the Fed does, who the president is, what Congress does, what’s going on in the economy, whether the market decides to go down 20% for the first half of the year, you can’t control any of those things.
But what you can control is your own behavior. How do you respond to inputs? How do you respond to stimulus? Which could be thrilling, exciting, terrifying, or nauseating you? Are you greedy when the market’s going higher? Do you panic when the market’s going low, lower? Does your limbic system control you or do you control it?
Those are going to have a much bigger impact on your long-term success as an investor then whether or not you’re picking this stock or that, or even this index fund or that. You could have the best set of holdings in the world, but if at the first sign of trouble, you get panicked out of the markets, it’s not going to do you any good.
And I feel sort of silly saying this to the Bogleheads because if any group of investors has understood this, internalized it, and walked the walk — it’s you guys. We have all the data from Vanguard about how their investors behaved in 2020 and in 08-09. People who follow the teachings of Jack Bogle very clearly have their behavioral side under control.
And David, you are live to ask your question.
Thank you very much. I truly admire your podcast. I’ve listened to for, for years. It’s spectacular. So thank you so much for doing that. And, you know, given your expertise and your experience in the network you’ve developed over the years in terms of interviewing you asset managers. You know, people like JackBogle. I’m wondering where you think this industry is going to go over the next 10 years. And I’ll tell you, what kind of got me thinking about this more deeply was a book called The Bogle Effect, where it kind of paints a picture that the mutual ownership structure that Vanguard uses it’s just very, very difficult to replicate.
Thank you. Sure. Very fair question. Although a lot of it is speculation on my part, the book, The Bogle Effect is by a friend of mine, Eric Balchunas, who I have him coming on the podcast. I think next month. The book was really a lot of fun.
So the industry has been going through all these really fascinating changes. And a lot of these changes have been a long time coming there, just overwhelming trends that have been developing momentum for forever. And, sometimes, it’s the old joke from Hemingway: “How did you go bankrupt? Gradually at first, and then all at once.”
Indexing is one of those things that it just gradually, gradually, gradually was slowly gaining ground and then boom, after oh 08-09 it just exploded.
My pet theory is that given all the scandals in the early two thousands, the analyst scandal, the IPO scandal, the accounting scandals. People just finally said, “Why are we playing this game? Let’s just, you know, take our ball and go home.” And, and by ball, I mean money and home, I mean, Vanguard.
That’s how indexing went from this sort of interesting academically supported niche to now half of the mutual funds and half of the ETFs more than half are managed via passive indexes. Which by the way is a very misleading, misleading datapoint, because when you look at mutual funds and ETFs, they’re actually a fraction of all the assets that are managed out there. The vast majority of assets, and let’s just hold aside commodities and real estate. But the vast majority of stocks and bonds are still managed actively. It’s just the mutual funds and ETFs where we see the passive approach really winning. You’re starting to see more and more institutions move at least a portion of their portfolio in that direction. I think that’s going to continue.
The thing that’s really fascinating is some of the pushback to low-cost, passive indexing as an approach. I did a couple of columns with Bloomberg, where I got to mock the people who called Indexing Socialist Marxist UnAmerican, a threat to the economy, a threat to the stability of the stock market, just every nonsensical thing you could come up with. My favorite bit of nonsense was the white paper by a bunch of law professors who used the airline industry to prove that “Look, it’s an antitrust violation having all this indexing going on!” Talk about cherry-picking data! Why use airlines — a notoriously small, frequently bankrupt, often consolidated industry? To show indexing as a problem, how about the giant technology space? Why don’t you use that? Is it because prices have been coming down for all of their products + it’s more competitive? How about finance? Same thing. How about the manufacturing industry? Same thing.
And so you, you go through all these hired guns either retained or motivated by a higher cost active managers to take a swing at indexing. My concern is that you start to see the relentless parade of slings and arrows eventually start to have an effect.
Hey, Barry. Great to speak to you. I’ve been a huge fan, I listen to all the podcasts. My question to you is, at what point does passive indexing become counter-productive ?
It is such a great value add for the average mom and pop investor. At what point do you say everybody passively investing is not a good idea. Or do you reach that point?
Great, great question. I’ll give you a two-part answer. The first is over at MIT. Andrew Lo actually looked at this question to find out at what point does the lack of analysts community, research, stock picking effort, stock selection affect price discovery. And his conclusion was “Well over 90%. Once passive indexing gets over 90%, we can see a decrease in price discovery and market efficiency.” So that’s his guess — and his guess is much better than my guess.
The second part is something I would borrow from George Soros, the idea of reflexivity. One of the fascinating things about markets and one of the reasons it’s so impossible to do any sort of long-term forecasting is that every print, every price, every day we get market numbers and that affects subsequent reactions of other participants in the market.
So, so here we are, it’s half of mutual funds and ETFs or something like 12% or 15% of all equities, but whatever it is, think about how the dynamic around stock selection is going to change once 50, 60, 70% of the stock buyers are just blind index purchasers. One would think then the stock pickers or maybe even market timers had an edge that they could gain over the broad index.
When there are fewer and fewer people competing in the stock picking world and more and more people just throwing money at the index, one would imagine that that would create an environment where stock pickers do better.
That concept of there’s less competition as more and more people are buying passive. The theory is that there’ll be more opportunities, there’ll be more inefficiencies, and they’ll be easier to identify. And then what happens, all of a sudden for a couple of years, active managers are outperforming net of fees.
Hey, maybe some money slides back from passive towards active and maybe that’s what stops the March upwards of ownership by passive indexing. But that’s just a guess, it’s impossible to project anything in a straight line because each day, each month, each year, the changes that take place within the market structure affect what subsequent market actors do.
So I’m trying to guess two and three steps away. Okay, so is it at 70%, maybe it’s easier to pick stocks? Hey, maybe these active guys put together a run of a couple of years. Maybe they outperform enough that it attracts money back to active from passive, but really that’s just me spit-balling. Hey, maybe Andrew Lo of MIT is right. That it’s 90%. I suspect that that changes the dynamic of stock selection.
It’s not like we are going to 100%; No one is going to do that! Again, I think human nature is such that there’s always going to be a bunch of people who think: “How hard could it be to beat the market? I think I could do this!”
On your podcast you always have new interesting investment ideas each week. Assuming you agree with buying & holding, how do you consume investment information without causing damage to your portfolio?
I call Masters in Business the most fun I have each week. And I’m fortunate to draw from an amazing pool of people. But its less about the specific investing idea, and more about the thought process. The how this person developed their philosophy and methodology than whether they’re buying this stock or that mutual fund or this option.
When you have someone like professor Scott Galloway of NYU Stern, who’s built a number of companies successfully. The way he looks at data, the way he looks at opportunity and entrepreneurship. That’s what I want to pull out from him. Not should I be long Facebook or not?
Or Richard Thaler and Danny Kahneman. These are people who can teach you about your own thinking process! Two Nobel laureates, Behavioral psychologists, and Thaler is an economist also. And so it’s less about “Give me a fish” and more about “Teach me how to think about the process of fishing.”
I find the guests much less intriguing for their stock recommendation. In fact, part of the idea for how the podcast came about, I’m flying back to New York from Vancouver. I have to change planes in I think it was Chicago. And while I’m waiting for my plane, I’m in the lounge one of the financial channels is on TV and a well-known Hedge fund manager is on and the interviewer’s just asking him the worst questions: What’s your favorite stock? Where’s the Dow going to be in a year? When’s the fed going to raise rates? And every question, the answer would have been stale by the time the guy walked out of the studio…
And as I’m watching and I’m thinking, No! Don’t ask for a fish! Find out how he fishes. You know, who were his mentors? How did he develop his philosophy, his methodology? What books does this person read? What mistakes did they make? What advice would they give somebody going into the field today? What do they know today they wish they knew 30 years ago?
And that was the approach that ultimately led to the podcast. Just frustration with how bad a lot of television interviews were.
So to me, it’s never about, here’s my best idea, and here’s why you should buy it. It’s always, let me tell you how I go about thinking about managing risk in my portfolio. How do I allocate assets? How do I look at the world?
That’s what matters; It’s the process, not the outcome.
How would you suggest your children or grandchildren invest money for long-term investments?
Another great question. Um, so, I’m going to say something that I know a lot of people are going to disagree with, but you asked me to be honest, so I’m going to give you the honest truth.
When you’re 20 years old, probably till the time you’re 40, you should be a hundred percent equity. 0% bonds. When you’re 36 years old, you don’t really need bonds. I would also say the bulk of that should be a portfolio of low-cost, passive global indexes. Just look at the past 20 years – Globally, EM outperformed the U.S, so don’t suffer from home country bias. So you want a global portfolio and you want to rebalance it every year.
And if you want to take some percentage 10, 20, 30% and make an active bet with it, Hey, this technology thing seems to be working out. Let’s put 10% of our index into the NASDAQ QQQS, or I think India is a growth nation, let’s put 5% into that and I like small cap value and there’s another 10%. I’m just making up these things off the top of my head.
But if you go 80/20, Passive/Active or something like that. I think you’re fine up until the time you’re 40ish.
By the time you hit 40 and maybe for the decade after that, I would be very comfortable adding some venture capital funds to that. Assuming you have access to the top quartile of VCs (if you are overladen with technology on the equity side, well, then you probably don’t need that). But if you’re at a point where you’re making enough money and you could throw a percentage into some venture, I think the potential upside is worth the illiquidity and the cost.
I don’t really think you need to add bonds until you’re 50 years old, if you want to add some REITs and real estate trust or farmlands, or maybe even some private equity at 50, go ahead.
And again, I’m talking a couple of percent around the edge. It should never be the bulk of your portfolio, it should always be no more than 5, 10, 15% at most. Again, if you’re in the top decile, private equity funds. They’re fantastic. You know, all of the things that Jack Bogle hated, he was talking broadly. Private equity’s expensive, venture capital is expensive, hedge funds are expensive AND underperforming. However, if you can get some access to the top decile of these — I know a bunch of Bogleheads eyes are spinning in their heads, but if at 50 years old you have a nice nest egg put aside and you want to pull a little bit of your investing into some of these alternatives, go ahead. Again, it’s scratching that itch. I’m okay with that.
But the caveat is you have to watch your fees. I know Vanguard is talking about private equity for a 401k’s — think about how the world has changed over the past 40 years. That is actually a project that’s being worked on. I’m okay with a 50-year-old, who has a substantial amount of money put away, peeling a little bit off, and if it scratches that itch and it gives them some potential upside fine, but the core investment for the bulk of your life is going to be long-term globally, diversified, passive index.
You know, you really don’t need bonds in your twenties and thirties, arguably not even in your forties, But if it helps you sleep at night. Okay. Bonds, especially with current prices, are not a screaming buy and haven’t been for some time.
That’s how I would advise, anyone who was in their teens or twenties or even thirties. To be looking out over the course of the next, you know, 75 years. Keep in mind if you’re 15 to 25 years old today, the odds of you making into your nineties or beyond are much, much higher than they were 50 years ago.
Hear the rest of the interview at BogleHeads Live