At the Money: The Right And Wrong Way to Invest, with Dave Nadig, Vetta Fi (Oct 25, 2023)
Investing can be complicated. But what if there was a simple solution? On this episode of ‘At the Money,’ I speak with Dave Nadig about investing as a problem that has been solved.
Full transcript below.
~~~
About this week’s guest:
Dave Nadig is an industry pioneer with over 30 years of ETF experience. Most recently, he was Financial Futurist for Vetta Fi, and Chief Investment Officer and Director of Research of ETF Trends and ETF Database. Dave previously served as the CEO and CIO of ETF.com. As a Managing Director at Barclays Global Investors, Dave helped design and market some of the first exchange-traded funds. He is the author of “A Comprehensive Guide to Exchange-Traded Funds” for the CFA Institute.
For more info, see:
~~~
Find all of the previous At the Money episodes in the MiB feed on Apple Podcasts, YouTube, Spotify, and Bloomberg.
Transcript:
Investing is a complicated problem. What if I told you a beautiful solution has been found? Investing is not easy. How do you pick the correct asset class? Which sectors do you buy? How do you know which are the right stocks or bonds to own? Do you use leverage? Do you hedge? Do you time? What about private equity, hedge funds, venture capital?
It’s really complicated. Or is it? I’m Barry Ritholtz. And on today’s edition of at the money, we’re going to discuss investing as a problem that’s been solved to help us unpack all of this and what it means for your portfolio. Let’s bring in Dave Nadig. He is financial futurist at Vetta Fi and a well known ETF industry pioneer.
Barry Ritholtz: So I love this quote of yours. Investing is a problem that’s been solved.
Dave Nadig: Well, what I mean by that quote, Barry, is that I think a lot of people spend a lot of time and energy and frankly, emotion caught up in the idea that they have to figure out investing, right? They have 10,000. They have 100,000. They want to grow that from scratch for some purpose, 5, 10, 100 years out, whatever it is. And they feel like their job is to solve this puzzle and get all those pieces just right. And if they get it right, they win. And if they get it wrong, they’re destitute. And I think that’s the wrong approach. The core of investing is in fact, a solved problem.
Mathematically, if you’ve got a, a set of assets you can invest in for almost 60, 80 years, we’ve understood the fundamental math of how you put that portfolio together. to get a certain pattern of returns for a certain level of risk. There’s nothing really all that interesting or complicated about that.
You can do all the math on your phone. There’s a hundred different apps you could download that will make a model portfolio for you. That’s not the part people should be focusing on. I. I contrast that to advice, the knowing what to do, when to do it, how to do it. That’s the really hard problem. That’s where people should be putting their energy.
Barry Ritholtz: So let’s, let’s break this up into a couple of different pieces. If I say to the average lay person, investing is a problem that’s been solved, they’re going to say, great. What’s the solution?
Dave Nadig: Well, the problem with your question is that an advisor then would turn around and say, great, how much money do you have to invest? When do you need it back? What’s your tolerance for risk? There’s another 50 questions you have to ask before you get to the investment part. Once you’ve gotten to the end of that chain of questions, you know, Oh, this, I have a hundred thousand dollars. I need this in 15 years because that’s when my kids are going to go to college.
I understand my tax situation and, oh, I can put some of that in a 529 or I can’t. Once you answer all of those questions, then constructing that portfolio, what do I own to get a pattern of returns that delivers me the maximum chance of being able to put my kids through college in 15 years? Honestly, you can do that in a target date fund and that’s most of the math baked in for you.
Anything you do other than that is trying to get a different pattern of returns that is inherently going to have more risk associated with it. So a target date fund, for listeners who may not be familiar with this, these typically are the default settings for 401ks. They’re managed by big fund managers, Fidelity, Vanguard, et cetera, and they start out with a certain percentage of equities and a certain percentage of bonds, um, depending on how far out, 80 whatever, and as time goes by, they gradually lower the risk by raising the percentage of bonds and lowering the percentage of equity.
Barry Ritholtz: Fair enough statement, absolutely. And it’s very easy to criticize those things. They’re very naive, right? I buy a 2030 fund. Okay. Well, how much is precisely in cash? How much is precisely in international equities? There is a decent amount of variation between the vanguard and black rock. And everybody’s got a version of these things.
Dave Nadig: Um, so there are differences between them, but the point is they’re all trying to do the same thing and they’re all basing it on the same. Fundamental understanding of how asset classes interact with each other. So that part of the problem is not actually the difficult one. Making the decision to do that and then sticking with it is the difficult part.
Barry Ritholtz: Let’s stick with the portfolio part because when I hear you say investing is a problem that’s solved and knowing your background working in the ETF industry and what you’ve done for so many decades. I think of a low cost, diversified portfolio of ETFs consisting of broad indices, rebalanced once a year – You’re done. Am I making it too simple?
Dave Nadig: No, I think it’s actually that simple. I think that the value of going further than that is fine tuning it to your individual needs. Is rebalancing that once a year the best answer is rebalancing it once a quarter the right answer. There’s a different answer for different people is the honest answer there, but the math about how you do it very straightforward for most people.
As you said, a diversified portfolio of low cost index ETFs is going to get you 90 percent of the way there. That last 10% you know, do you get an active manager to run your bond fund? Do you put a little bit of money in? Commodities or crypto or real estate or something that’s a little spicy. Those things are really all about getting that last 10%, those last three miles of the marathon and having some energy there.
That’s what that’s all about. But the base of it, the 80 90 percent of your returns is just about getting your money in the market and not making any dumb mistakes. Big, low cost ETFs are really good at keeping you from making dumb mistakes.
Barry Ritholtz: So I’m glad you brought it up that way because Charlie Ellis wrote a wonderful book years ago, “Winning the Loser’s Game,” where he makes the analogy to tennis. And when you look at professional tennis players, they win by scoring points. Sounds obvious, right? Now you compare the professionals to the amateurs. And they don’t win by scoring points, they lose by all these unforced errors.
And what you’re describing is, don’t worry about the points, just avoid the big mistakes, you’re ahead of most people.
Dave Nadig: Absolutely, and it has nothing to do with how smart you are. I think this is the other thing people sometimes get upset about is when you say something like this, they’re like, well, but I’m smarter than that. I can figure out something better than just buying a target date fund. It has nothing to do with being smart.
It has to do with whether or not you’re actually going to be doing this every single day. So it’s those unforced errors. It’s the panicking because the market went down, so you sell out of everything. It’s the, uh, thinking the markets are a little bit too pricey, so you stay out for six months and you miss a rally.
Those unforced errors really suck most of the returns out of individual investor portfolios. And even at the institutional level, even the folks that get paid to play the game, their hit rates on these things are like measured in the 51 to 49 percent rate. Nobody hits home runs over and over again, really good institutional active managers hit singles more reliably than they should, and that’s considered magic.
Barry Ritholtz: So the idea that an individual investor is going to somehow do better than that is ridiculous. And I’m always fascinated by the concept of intelligence, because my experience, almost 30 years in the markets, Intelligence is table stakes, just to sit down at the table.
Hey, everybody doing this is really smart, and some people are really, really smart. But if it was just intellectual horsepower that mattered and nothing else did, well, then long term capital management wouldn’t have blown up as spectacularly as it did, nor any of the past dozen funds that blew up. These are filled with MIT and Harvard whiz kids who are brilliant.
Dave Nadig: Right. But it’s not just about intelligence. Well, it’s not because there’s so much luck involved, right? And I think people in the business are very reluctant to point out how uncertain finance is. I’m not saying that it’s luck, whether Tesla stock goes up or down. There’s always a reason. Right. And gosh, the financial media is really good at telling you the reason whatever happened in the market happened.
They’ll tell you why, even if they’re just making it up. Well, that’s the narrative fallacy writ large. Right. Hey, here, let me explain to you what just happened, that I was unable to warn you about in advance because I had no idea. Right, so, so something as simple as market timing, like, Oh gosh, the market seems expensive.
Maybe I should take some off the table. A very common sort of retail investor reaction to seeing a lot of headlines. Whether you get that right, and the math proves this over and over again, is blind luck. Whether or not you actually time the market correctly is a coin flip, and generally you’re going to get it wrong because you’re going to be on the wrong side of sentiment.
So that uncertainty is the reason why intelligence only gets you so far. Because the way you mitigate uncertainty is not by being smarter, it’s by being unemotional and managing risk really well. And for most investors, the way you do that is you give the money to a giant index fund and don’t think about it for as long as you can.
Barry Ritholtz: That’s really fascinating. And, you know, when you speak to certain. Uh, people like Annie Duke who, who wrote the book Thinking in Bets, one of the things that Uh, poker players, where there’s an unbelievable amount of luck involved. One of the things that Annie Duke talks about all the time is avoiding resulting, meaning looking at the outcome, looking at the results, and trying to extrapolate backwards.
What you need to do is focus on the process, and sometimes a really good hitter is going to strike out, and sometimes wood gets hit on the on the ball, and you get a double triple home run. And that’s good. But a good swing, with a, a well thought out strategy at the plate doesn’t guarantee anything. And people seem to lose track of that.
Dave Nadig: Yeah. And I, one of my favorite books, I think she has a whole thing in there about learning to deal with bad beats, right? How do you deal emotionally with, you know, again and again, doing the right thing, having the right hand and somebody who’s just an idiot just hits it out of the park and you lose and then you lose again.
And that is a very common story in investing. And I think that people, particularly folks who who think about investing, who are attracted to individual investing, they think about stocks and performance and fundamentals. I think those types of folks are the ones that are most in danger of making bad mistakes because you can be wrong on fundamentals for a very long time, even if you were right on the underlying truth, right?
The market cannot reward you for a very long time. Your brilliant stock can go from a PE of 20 to a PE of 8 for reasons you don’t understand.
Barry Ritholtz: There’s an old expression, never confuse a bull market with brains. The flip side of that is a rampaging bull market covers up a lot of errors. I love the way the book Thinking in Bets starts.
I don’t remember which team it was and whether it was a Super Bowl or I think it was a conference game where the coach goes on, goes for it on fourth and one. Stopped at the goal line, the other team gets the ball and scores, and the coach is excoriated wanting to go for it, not go for a field goal, but she defends that decision as, statistically speaking, this is your best process but a bad outcome.
Hey, you’re down by seven. If you’re not going to get the ball in now, what makes you think you can get a field goal and then march all the way down the field and score again? It was the right process, and unfortunately, it’s not guaranteed. You had a bad outcome, you have to work past that and stick with the good process.
Dave Nadig: And you have no alternative as an investor, right? I mean, the insurance industry would try to sell you a lot of products that guarantee you things. But there are no free lunches and you certainly cannot guarantee market returns. If you’re going to be an investor and you’re going to do something other than just clip coupons on your 30 year treasuries for the rest of your life, you have to be willing to accept some level of uncertain.
And that’s just the way it is. And investing is a probabilistic exercise using imperfect information, uh, to make decisions about an unknowable future. That. That sounds to me like the definition of uncertainty. Exactly. And, and when I say it’s a solved problem, I mean, the, the overlaps with quantum physics are endless, right?
We are working, living in a probabilistic world. Investors have to get comfortable with that. That’s why it’s a solved problem. We understand the parameters. We understand how historically things have reacted alongside of each other, but that doesn’t mean that’s how they’re going to react tomorrow. So let’s sum this up.
Barry Ritholtz: Okay. Investing is complicated, especially if we make it complicated, but if we want to take a simple solution, it’s not that difficult. Own a globally diversified set. of low cost index ETFs, rebalance those ETFs once a year, have a good night. That’s all that’s necessary. Sure, we can make it more complicated, we can think about lots of other aspects to this, but that solution will work for the vast majority And as Dave suggested, that solution isn’t even the most important aspect of your investing.
It’s why are you investing? What are your goals? What are your risk tolerances? And how does this portfolio fit in to what you hope to accomplish? That’s the variables that are complicated. But investing itself? It’s a problem that’s been solved.
You can listen to at the money every week, find it in our masters and business feed at Apple podcasts. Each week, we’ll be here to discuss the issues that matter most to you as an investor. I’m Barry Ritholtz. You’ve been listening to at the money on Bloomberg radio.
A Comprehensive Guide to Exchange-Traded Funds (ETFs) by Joanne M. Hill, Dave Nadig, Matt Hougan, Deborah Fuhr
