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Episode #592 - Process Over Panic - Investing with Charles Ellis

“Real risk is simple, not enough cash when money is really needed, like running out of gas in the desert. “

-Charles Ellis

Roger: Welcome to the show dedicated to helping you not just survive retirement, but to have the confidence you're not going to run out of gas in the desert so you can lean in and create a great life. Today on the show we're going to continue this month long theme on process over panic and we're going to focus on investing. We have three things on deck today.

Number one, we're going to talk about the controllables. What can you control when you're building a retirement portfolio? What can you not control and why? It's important to understand this.

Two, we're going to have a conversation with Charles Ellis who is a legend in the investment management industry. His book Winning the Losers Game was pivotal in the industry, but also in my life. You’ll hear a great conversation with him. He's a wonderful dude.

Then lastly, we're going to answer some of your questions related to the pie cake to indexing and rebalancing.

Now, before we get started, in relation to the pie cake, that is my phrase for how a proper portfolio should be constructed to give you confidence to fund retirement. The problem is I create these little phrases, pie cake, et cetera, because they help me make sense of the world. But you don't live in my head and that's a good thing. So, in this week's noodle, our weekly email comes out every Saturday morning. I created a video, I took some things from the retirement masterclass that are going to explain the fundamentals of constructing a retirement portfolio, then I'm going to go through an example, John and Betty, of how you actually do it to get a portfolio allocation that can give you confidence. That will be in this week's Noodle. So, you can expect that. If you're not signed up for the noodle, you can go to thenoodle.me. Enjoy thousands of others hanging out on Saturday morning working on our retirement chops. I'm going to share the agenda for the Rock Retirement Club Conference, which is the last weekend of September, only available to RRC members. We have Wade Pfau coming, we have Christine Benz hanging out for a couple days and over 200 people. So, we'll share that agenda because we just got that published and we would love for you to join us if you join the club.

All right, let's get this party started.

PRACTICAL PLANNING SEGMENT

Today we're going to talk about investing. What can we control and what can't we control so we can build a process that can keep us strong when we're getting a little bit too greedy or when we're getting a little bit too fearful. I want to give a quick update first that's related to this in a way, so I think it's worth noting.

About a month or so ago we had Peter Lazaroff, chief investment officer of Plancorp, on and we were talking about private investments and whether there was a case for them or not. He mentioned that he had been in conversations with high level executives at Vanguard and some other firms and that they were going to be coming out with alternative investments, private investments in some of their portfolios. Well, I was just reading the other day that Vanguard is working with, I think BlackRock to do exactly this, bring private investments to you and me via the Vanguard products and other firms are doing this as well. That is interesting to me. But I want to just give an opinion here on this trend because I think it's important when we're focused on what we can control and what we can’t control.

Number one is these investment firms, Vanguard or Fidelity or just name anyone that builds portfolios that you can buy, whether it's an ETF or otherwise. At their core from a business perspective, they are a distribution company. They create products and they distribute them, then the more they can get into people's hands, the more money everybody makes and hopefully the investors as well. At the core, that's the business case. When I look at private investments coming into portfolios, it's not like you and I are asking for this. It's not like there's settled science or theory that adding private investments is really going to do anything helpful to us. But all of these firms are trying to get more distribution for these products outside of the ultra-wealthy. I actually don't think this is a good thing. I think it overcomplicates things and it sets things up for worse outcomes potentially. So just my thoughts on it, I don't think it's a good idea

All right, let's talk about building a retirement portfolio because this is related to things we can control and things we can't. Now, what is the intent in building a portfolio for retirement? It's always a good question to answer as clearly as you can. What am I trying to accomplish here? I can think of a couple things that are probably universal for most of us.

One, I need to have money available when I need it. I need cash when money is really needed. To go back to Charles Ellis’s quote, I need to have cash when it's really needed, and that is managing sequence of return risk or markets going down. That's number one.

Number two is I also need to manage inflation. I need to have money grow over time, hopefully, so I don’t lose the value of my money as I get older because inflation is the other risk. Plus, I need money to grow for potential spending shocks later in life. These are typically the two core intents of investing. I have to have my money grow so I can manage inflation risk and I have to have cash when I need money so I can pay my paycheck. That's the core intent. So, then the question is, what is the simplest way to achieve this? If we're investing well, we know cash is safe on the short term. It doesn't have any sequence of return risk. Very short term bonds have very small sequence of return risks and they will give us some yield, but they're horrible for inflation. In the near term, we probably need more cash and more individual bonds to fund life. Then on the long term, equities, Jeremy Siegel would say, is the perfect inflation hedge if given enough time. So, we're going to have to have a mix of these two things, and that's the tension.

As we're trying to build a portfolio with that backdrop, let's start off with what things can we not control? Well, we can't control market performance. We can't control how bonds do or stocks do or international stocks do. Totally uncontrollable. We can't control market volatility in whatever market we're talking about. Sometimes they're going to be really volatile as of lately with equities, and sometimes they won't. We cannot control geopolitical events. We can't control interest rates. We can't control economic cycles. We can't control what investments will be winners or losers. Read Charles L's book to get a really good primer on this. Those are things that we can't control. If the markets are going down, we can't control whether they go back up or not. More importantly or just as importantly, you can't predict these things either. No one can. That's where we and professionals get ourselves into trouble. Markets are going down. I'm worried. I predict that this is going to continue. So, I'm going to sell. Well, you're just making a guess about the future, which is fundamentally unknowable.

We all thought markets would go down and down and down. I'm saying all. I don't mean all of us. A lot of people thought markets will go down and down and down because of tariffs and all the other stuff. We've had this big rebound. It doesn’t matter. None of it was predictable. Nobody can. Your investment professional can't. The smartest person on TV cannot predict these things. The problem when you try to predict these things, let's say which direction the market's going to go. If you sell, you open up all of these decisions that you have to make about predicting the future again. So, if you sell all those assets, then what? Well, yes, you've protected it on the short term, but you've taken on inflation risk and you've blown up your plan. Then what? When do you get back in? How much do you get back in? What do you get back into? You create all these what then questions that get you down the rabbit hole of trying to predict and predict and predict and predict. It is a way of just driving yourself batty as well as not having a sound investment approach. You can't control all those things and you can't predict all those things. Any advantage that there might be is negated. Then the cost is in trying to hire all these smart people which generally negates any value they might be able to add if they're successful. It's just not a good investment process. The best investment process, in my opinion, is focusing on things you can control. So now let's switch.

What can you control? Well, you can control expenses, right? You can control the money you pay to go into an S&P 500 index ETF or into an international fund or into a bond. Investments are real dollars or investment expenses are real dollars that come out of your pocket. Those are controllable.

Number two is you can control your asset allocation. An asset allocation is simply diversifying your assets so you don't have all your eggs in one basket to manage volatility and in an optimal way. We'll do a primer on that in the future. I'm going to focus on doing lots of primers here going forward. You can focus on being diversified so you're not putting all your eggs in one company in one sector of the economy, in one asset class like small cap or large cap or international. Because if you put all your money in one sector, then that you're going to live and die by whether, say, technology does really well or utilities do really well. You can diversify around that. You can control these things. You can control matching your assets to the spending that you want to do in order to rock retirement. That is controllable. When you're reallocating or constructing a retirement portfolio, you can manage one of the most important things, which is the time horizon for each investment you make. Time horizons are really important. Essentially it goes to that quote from Charles Ellis is, hey, real risk is really simple, real risk. We don't need to talk about volatility. I got to make sure I have cash when it's really needed. The risk is I don't want to run out of gas in the desert. Time horizon and investment choice is pretty straightforward. If we focus on that, we can control how we build out the time horizons a la, portfolio construction that's easily controlled. Then we can control rebalancing when we rebalance this to get back to what makes sense given our resources and our spending plans.

Then lastly, we can control the things we do to be very tax efficient in the portfolio so we can minimize taxes, which is minimizing expenses. This is where the serious professional plays the game in retirement planning is focusing on these controllable things and minimizing all the non-controllables that we talked about. This is what a professional does. An amateur or someone without a process is going to try to predict the future, put in sophisticated strategies that promise that they can predict the future because they're super smart. By doing all of those uncontrollable things and thinking you can do those things, you waste a lot of time, you waste a lot of energy to build something sound so you can go create a great life. It's as simple as that. That's boring. It doesn't feel awesome when things are bad and when things are really good, we feel like we're missing out a little bit. But that's what a professional does so that the people he works with can actually create a great life.

All right, I'm going to put that sermon away for now. You can check out the primer video in the noodle email this weekend. Let's go chat with Dr. Charles Ellis.

INTERVIEW WITH CHARLES ELLIS

So, Mr. Ellis or Charlie, what would you prefer I call you?

Charles Ellis: Charlie by a long shot. Charlie.

Roger: Charlie, by a long shot. You came into my life, wow, I want to say 15 years ago with a book that I don't know if you're best known for. You've written like 21 of them. Winning the Losers Game. It definitely had an influence on my life, and I want to talk a little bit about that, but I also want to talk about your life. You just published a new book this year. Why are you still publishing books? What was the drive to publish this latest one?

Charles Ellis: It's going to be a long answer, Roger. You know, I've had what has to be described easily as one of the luckiest lives anybody ever had. Start with born in this era of time in this country. I had wonderful parents and terrific opportunities. Education, elementary school in communities where the teachers were given a choice in their lives. They could either be a nurse or a stenographer or a teacher. If they were really bright, they naturally chose teaching. So, we had some really wonderful people teaching us in elementary school then. It wasn’t fair to them, candidly, but it was wonderful for the kids growing up. Then I went to Phillips Excellent Academy and had four years there and enjoyed it enormously. Then I had four years at Yale College, and then I had two years at Harvard Business School. Then I had 14 years getting a PhD.

Roger: The long route.

Charles Ellis: Well, you know, I was starting a new company at the same time that I was trying to do the PhD. Candidly, that's not a smart move, but, it turned out to be a great educational opportunity. Harvard Business School in the early 1960s did not have a course on investment management. Shortly after I left in 1964, an extraordinary professor named Collier Crumb created a Tadai for course on investing. That became the most popular course that the school had. He needed somebody to help him teach that course. He would do two sections, but he needed to have at least somebody else to two of the other sections. A section is 80 students, okay? All smart, all opinionated, all full of beans, and all interested in making a good showing. So, he drafted me, and five years out of business school, I was teaching investment management. I was scrambling to learn as much as I could. Then, I had a very long and extended career with the CFA Institute, which you would know very well. Then wound up as chair of that group, which was also a terrific learning experience. Then my career, same sort of experience. Learning, learning, learning, learning. I was in a consulting firm called Greenwich Associates. I had the privilege of starting that firm. So, I got a chance to influence the design quite a lot. We did something that was really very effective. We'd interview a thousand of the most important customers for a professional Financial Service Group, interview them for an hour apiece. It's amazing how much you can ask in the way of questioning. Then we would present that data showing exactly what every firm got, their score, to our clients, so that they could see what the competition situation was and where they were losing ground or gaining ground and where they were strong or where they were weak. It made the consulting that we did really very cost effective, cost being in time, because we were saying that's what the data says. It's not our opinion; it's the opinion of your most important clients. Then they would have to say, well, I guess that's the real truth. Then, I did that for 30 years. Boy, I'll tell you, you'll learn a lot working with firms on their internal strategy, what they're trying to do. Then at the same time, I did more teaching at the Harvard Business School and also teaching at the Yale School of Management. Face to face with bright students and face to face with bright clients, you'd be amazed how much you can wind up learning. Then, as you know, I did get involved in writing over 100 articles over the years and then writing, which I now have 22 books. About half are on investing and about half run financial organizations. When you're trying to write something and get it clear so it would be well received by the public, you really learn a lot.

Roger: The same thing with teaching. You're learning a lot by teaching it.

Charles Ellis: You bet.

Roger: So, the people listening are all in their 50s or 60s, and they're either getting ready to retire or they're living in retirement. They're thinking about, obviously, the financial part of it. How do I create my paycheck? They're also thinking about, who am I? What am I going to do with the rest of my life now that my normal career has been retired? So, let's start on the investing end.

Charlie, what was an article that became the book Winning the Losers Game was, I think, in 1975, that you wrote.

Charles Ellis: That's a long time ago.

Roger: Where the idea of passive index type investing wasn't really a thing back then. How do you view that now that indexing and passive investing is pretty much the norm?

Charles Ellis: Well, I never use the term passive investing because I think people misunderstand. If you have time for a little footnote, who did the original work on index investing? Groups of engineers. What kind of engineers? Well, there were some mechanical engineers. But actually, most of them were electrical engineers. Okay, so what if you're an electrical engineer, what does passive mean to you? It's a two hole or three hole wall socket. That is the passive part, and it's a two pronged or three prong active part which is at the end of a cord. The active part goes into the passive part. What's the emotional impact of using the term passive and active? None, it's just descriptive. Well, if you're not an electrical engineer, what if you majored in liberal arts instead or business or something else? Well, then you'd have a pretty strong view. You would have a view that passive is for jerks and guys are willing to quit and active is what you ought to be and everybody wants to be active. Can you imagine introducing someone and saying this is our next President of the United States. He's passive, be a killer. Or introducing, this is my beloved. She is passive. She'd slap you.

Roger: So, when I think of index based investing, I'll use that phrase. What I think of it's less about the index. The index is the active part that gets implemented efficiently. One of the biggest advantages is my understanding, and you're the expert of this is cost and tax efficiency.

Charles Ellis: Oh no, no, that's. Those are second and third.

Roger: Why am I even trying to explain this to you? You're the gentleman that talked about this.

Charles Ellis: You're doing a really good job of articulating what the right questions are. Just my job is to try to give you useful answers and sometimes tease you a little bit.

Roger: I love it.

Charles Ellis: The benefits of index investing, number one, everybody knows. Oh yeah, much lower fees. And they are much lower fees. Second, okay, lower taxes because there's less turnover. It's roughly 5 or 6% turnover instead of 35, 40, 50% turnover. That is worth keeping in mind. Anything else? There are lower operating costs. Candidly, it's such a small matter that most people say forget it, this doesn't come. But it's worth thinking about. Then there's a fourth thing that is really pretty exciting. Most people who are clients of investment managers would describe what they're looking for as a top quartile investment manager. Well, okay, how about indexing? How does that come up? Indexing turns out to be in the top half of the top quartile over a 20 year period. The data coming in and saying the same thing and the nice thing to pay attention to is yes, indexing is in the top half of the top quartile, which is terrific. But what's really worth paying attention to is it's not in the bottom half, because those who are in the bottom half tend to way underperform. So granted, indexing only slightly outperforms the market, the competition over time. But the guys who get in trouble then do a hail Mary effort to get out of trouble. They usually either do make it for a while or they make a mistake and they make it even worse. So, the actual results of those who are not indexing are much worse than, than just they didn't quite make it. They really clobbered their results. Those are all really nice advantages. But if you take those advantages and add them up, they don't come out to more than roughly 2% of your return per year. Wait a minute, 2%? That's a lot. Why are you so excited about it? 2%. If you think the market's going to return to 7%, 8%, let's be optimistic. Say 8%, which I think is way too optimistic, but it makes the numbers easy. 2% as a fraction of 8% is not 2%. It's 25% of the returns. So, if you look at it that way, it's pretty serious. You say, wait a minute, wait a minute, wait a minute. 8% is before inflation. Inflation drops things down to. If we're very, very successful at controlling inflation, 6% might be worse than that. But let's take with 6% because it makes the numbers easy. You lose 2% of 6%. That's third. That's 33%. That's starting to become really quite significant.

Now. The big slammer is what's called behavioral economics. And every investor really ought to sit down and read Daniel Kahneman's extraordinary book, Thinking Fast and Thinking Slow. It's probably the most useful book, not intended to be for investment management, but most investors would get more benefit from reading that book than any other investment book they could read because he makes it clear the behavior mistakes that we as individual human beings, imperfect as we are, and we make them all the time, and we make them in predictable magnitude. They cost the average investor in an average year, two full percentage. So, you go back to my 2% of costs against 6% return, add another 2% and you're really getting clobbered. That's the reality that most of us don't recognize. Thank goodness we don't, because if we did, we'd really be upset. But if we don't recognize it, even in the abstract, we're making a terrible mistake in not recognizing the benefit of indexing. Why is indexing so valuable? Because it's so darned boring. There's nothing exciting about indexing. So, we leave it alone. If I were to unroll my sleeve, you'd see. Oh, I see you have a scab, where you got a cut the other day. Pretty long one. It's 4 inches long. Do you ever scratch it? No. Why not? My mother taught me to leave it alone, it will take care of itself. The same thing is true for most of us with regard to investing. If we leave it alone, we'll get better results.

What's the secret to leaving it alone? Well, the best secret is indexing, because it is candidly boring. We don't pay much attention to it, and we assume, like the plumbing and the electrical system, both of which are very important, they don't work out pretty well. So that's my story. Boy, I can promise you I'm sticking to it, if you ask me. Well, do you do indexing yourself, Charlie? You're darn right I do. I'm not entirely indexed. I have to confess. I have one active investment. That active investment is so close to an index fund on steroids that I'm very comfortable staying with it.

Roger: The analogy that you have used is, I think you use tennis in that original article, and then book is working to minimize unforced errors rather than being better, which is sort of. Which is really changing the whole game.

Charles Ellis: About how it is.

Roger: Yeah, how about how to think about it?

Charles Ellis: The reason I called the first article The Losers Game is because Simon Ramo, who was one of America's great brilliant minds, he was chairman chief executive officer of TRW when the space program was just getting started. Then he, more than anyone else, shaped the space program as a civilian. He happened to be a gifted musician. He played with three professionals out of this Los Angeles Symphony in public and did it fairly often. He was also a very good athlete, and he figured out in tennis there are really two games. One is the kind of game that the Williams sisters played and a couple of the really outstanding tennis players of all time play all the time. It is beautiful. Shots right next to the line, hard serves, and, very, very fast game, and they win points, and that determines the outcome. The game of tennis that I play and everybody that I know plays is more controlled in terms of outcome by making mistakes or avoiding making mistakes. They're two completely different games. But they have the same rules, same scoring. You wear the same clothes, you play on the same court, and you use the same balls and rackets. But one game is all about winning points, and one game is all about let the other guy lose the points, keep it in play, and not being clever serving right next to the line. Don't hit it harder than you know how to handle. Don't do the things that make mistakes. Let the other guy make mistakes, and you will be the winner. But actually, you're not the winner. He was the loser.

Roger: To follow that analogy, if we index, it takes away a lot of the opportunity for trying to be better and just minimizing unforced errors. Then from a behavioral aspect, then we can focus our efforts on minimizing unforced behavioral errors. If we can do those two things somewhat consistently, we really set ourselves up for success.

Charles Ellis: Yes, and all you have to do is, like my mother's advice on scabs, leave it alone and it'll work its way out. If you leave it alone and let the market and the economy and all the people that are working terribly hard in all those different companies do what they do best, you're going to have a very, very happy, positive outcome.

Roger: So, when I think of my son, who's 28, Charlie, and this definitely fits to a T for him because of his time frame, how does that change when you're in retirement and you need to draw from your assets to fund your paycheck?

Charles Ellis: Well, now we're getting into my most recent book, but because I'm a little bit advanced beyond the we're getting into retirement.

Roger: Well, you have a good perspective.

Charles Ellis: I'm 87 years old, 87 and a half. I still work because people still need investment advice, and I love it. I love doing it. I think I've got a perspective that's reasonably sensible for the people that have got the kind of question you just asked. Hey, I'm retiring. Should I do something different? This may surprise you, but I do not own any bonds, and I have not owned any bonds since I was in my early 20s. Now, in fairness, I've got bond equivalence. I've got a stable asset in that I own our home, and that's a substantial and stable asset. For most people, it's a surprise that they would think of that as being part of their investments. But it is part of their investments. They say, well, I'd never sell the house. My wife and I like living there. Yes, you won't, but your children might or their children might. Someday somebody is going to realize it by sale and you should at least recognize that it is a real asset and it is an awful lot like a bond and it's a stable asset. It rises about at the rate of inflation.

Anything else? Yes, darn right there is. Social Security. The Social Security benefits that an individual is entitled to receive in this country are fabulous partly because the best credit in the world is behind them. Secondly, the government is quite willing to adjust for any impact of inflation. So, it's inflation protected then. There's no other bond that I know of that is inflation protected pretty good. And that is a substantial fixed asset. So, when people say I've got 40% in bonds, what they really should be saying is I've got 75 or 80% in bonds. People who didn't mean to be shortchanging the equity side are doing so already. I get Social Security and I own my own home. So, when I say I'm all in equities, that's not really true because I've got two fixed asset equivalents, sitting right there.

Roger: How does it come into play in your mind if you're needing to still draw from your assets over and above Social Security or pension in order to fund your paycheck? The fact that if you're 60 years old, you have that sequence of return risk that could impair the rest of your plan.

Charles Ellis: Well, there are two parts of that.

First, most people at that stage of development have got a retirement plan that's going to pay out. So, I have for an example, a required minimum distribution from an IRA. I can't control that. I can do more than that, but I have to do at least that amount or get penalized. So that's one part of it, steady flow that comes. the second part is what Yale, Harvard, Stanford, MIT and most other major universities do have a spending rule that spreads the distribution over time. Easy way to do that. Pick a day, your birthday for an example. Each year on your birthday, what is the value of the market in your portfolio? Mark it down, add it up for the last nine years and you've got a 10 year, because 10 is easy to divide by fine and add 10 numbers up, divide by 10, and that gives you a smoothing that's pretty stabilizing as to how much you can distribute. That really does get your attention to the part that you really ought to pay attention to, which is the normal average trend of Your experience, not what happened last month because of the Trump fiasco. fine. Leave that aside. You're going to smooth it out so that you don't have any moment in time making an impact that will do very well for you.

Roger: Is that a process that you've used in your retirement?

Charles Ellis: It is. But in all fairness, the required minimum distribution gives my wife and me as much as we need for our living expenses for, and I'm going to.

Roger: Say for normal people. Whatever that is, the concept of having all of their financial assets and equities and the standard deviation that that's going to bring to your life, it's like being on a roller coaster. Is that something because of your background and understanding, you're just comfortable with, or what advice would you give to someone who doesn't quite understand the financial concepts of the kind of volatility that that kind of portfolio would have?

Charles Ellis: Well, let's lay it on a little bit. I'm trained as an economist. I've spent most of my career working in the investments world or with people who are in the investments world. I've seen an awful lot of terrible moments and wonderful moments come and go. I've got a huge database to work with, and therefore, it's easy for me to say, hey, you know, after all these years of spending long days every day, and I've worked weekends, too, paying attention to the smartest people in the world in the investment world. I've really been immersed in it. Do I have a competitive advantage compared to other people? Absolutely. No doubt about it. But the ability to add 10 numbers and divide by 10 is not a very sophisticated ability. All you have to do is think carefully about the realities of life over time instead of what happened this week. What happened this week? Oh, did you see what happened this week? No. This week doesn't matter in the sweep of time any more than when you've got teenage children. Do they behave correctly at all times? No. Do they sometimes upset you and get your goat? Sure. Do you sometimes wonder, how could I have let them down? I didn't do the right thing as a parent. Sure. But on average, they're adorable and they are going to be wonderful adults. Well, the same thing is true of the market. The economy is one of the great engines of all time. Again, back to Warren Buffett, who says “the most powerful, wonderful thing in the world is compound interest”. With an economy like the American economy, it is large, diverse, complex, and dynamic.

Roger: I'm sure you've heard this countless times, Charlie, of yes, but it's different whether it's the administration or the debt or pick your poison.

Charles Ellis: Sure.

Roger: So right now, for a lot of people it feels different this time. How do we avoid, I don't know if those are unforced errors that come from the 24/7 news cycle and what seems like an increasing pace of change. My perception is, and you have a better perspective, is these kinds of worries are always around. They're just different. They're just different names. But how do we avoid the unforced errors when we're so human?

Charles Ellis: I do think that we have an unusually challenging federal administration. But as much as I'm terribly uncomfortable with the decision making process and most of the people who are making the decisions and the decisions themselves, when I look at them, I'm really just speaking as an economist. I don't think the folks at Washington know what they're doing well enough to be making decisions that big and for everybody else to be paying attention to. I think they're making mistakes. Okay, how do you factor that in? Because you're really kind of glum about it. Well, I was around when the McCarthy era came through. I was around when Vietnam was causing rioting on campuses. I've seen a lot of difficult times and I've seen a lot of absolutely wonderful times. The wonderful times don't last and the dreadful times don't last and this nation kind of wobbles its way along. The economy is not the administration and the economy is not our foreign policy. The economy is a profound engine of creative energy and economic gains and I wouldn't want to live without it. I just think we're very, very fortunate and I'm very comfortable betting in the long term these things work them their way out. I do hope that people are able to look at it.

There have been really terrible times in the past. We had 14% inflation. That is a killer and it caused a lot of harm, but it didn't last. The disillusionment that the Vietnam War brought forth didn't last. Racism didn't last. And a lot of terrible things have happened, but a lot of wonderful things were going on at the same time. I think if you're an investor, if you put aside politics and public affairs and concentrate on what's going on in terms of business management, business leadership, business capabilities, you'd say, you know, the American market is a terrific place to generate all kinds of really successful companies. I'd like to have a piece of that action, but I don't know which companies to invest in. That's one of the benefits of indexing.

Roger: I was talking to Meir Statman the other day, a friend of yours. Wonderful man.

Charles Ellis: Yes, and very, very bright.

Roger: Very bright. I asked him, I said, I'm going to be talking to Charlie. He said, oh, you're going to love Charlie. I said, “Well, what should I ask him?” He says, well, you can talk about the indexing stuff and the investment stuff, but he did say Charlie is much more advanced in age than I am and he has a perspective. Talk to him about life and retirement. He has not ever really retired but talk to him about the life part of it. So, I want to do that for a second. If you're open to it.

Charles Ellis: Sure.

Roger: I'm 58, you're 87. A lot of people who listen are in the 50s and 60s. You've never actually retired. Was that an intentional choice?

Charles Ellis: It was, but you could also argue it was accidental. if I had been working for a major corporation, it wouldn't have been my decision to retire. It would have been carved in stone. At 65, you are retired. I was working basically as an individual practitioner. I promised myself if I ever felt that I wasn't making a real contribution, I would stop. Not that I would retire, but I would stop.

Roger: Why not that you would retire?

Charles Ellis: Well, because to retire suggests that you might do something part time. I didn't want too if I was not really helping people, I didn't want to do that 50% of the time or 60% or something like that. So that was just me talking to myself. Part of it was if I couldn't write something that was important enough in the opinion of somebody else that they would publish it, then I would think that it was important information. Fact is that as we talked about before, what I think may be my most useful book, certainly in terms of its only 100 pages long, so it doesn't take very long for anybody to read it. The title really gets to it. Rethinking Investing. It's not a very zippy title, but it's one that causes people to say well, well, well, maybe I ought to do that, because I'm at an age where I want to pay attention to what's going on. It's a short little book and 100 pages. I can read that in two hours easily. I could probably read it in two hours with a couple glasses of wine just to be sure I didn't lose the two hours. it's got a very. There are no complicated equations. There's no mathematics, there's no Greek symbols. It's all very straightforward. But it does present a very different way of thinking about investing than most people have the privilege of thinking through. I had the privilege. How did you have the privilege, Charlie? I've served on the investment committee with David Swensen for 17 years. I watched one of the most capable original thinkers who was really disciplined in his actions and behaviors, watched him work his way through one market after another market after another market. The two of us became quite good friends. We really worked hard at, trying to understand what was going on and what we should do about it, if anything. And the usual answer is do nothing. But once in a while, once in a while, there would be something to be done. Basically, the privilege of working with a brilliant person who was very open and candid with what he was saying about and what he was doing over a long period of time. What a terrific opportunity that was.

Roger: It makes me think of a quote that I used the other day that came from a movie producer, I think, in the 30s, and it was, “Don't just do something. Stand there.”

Charles Ellis: Right. That's been around for quite a while.

Roger: It has; it has. The fact, one thing I like about it, and this is something that I battle, Charlie, especially in our industry, is there is this natural urge to complicate things. When we see something that's a hundred pages, I mean, just what you just described right there, it's very simple, but it's not simplistic. There's a lot that is underneath it like an iceberg that, you know, that's the beauty of it. It's easy to dismiss choice.

Charles Ellis: Seven years to get there. Amen.

Roger: It's easy to dismiss short, simple things as simplistic when that's the farthest from the truth. Because there's a lot.

Charles Ellis: I could not have written this book 20 years ago. Just couldn't have done it. Came close, but it's not quite the same thing.

Roger: So, let's move away from money for a second. I'm 58, Charlie, and listeners are in their 50s or 60s. On a personal level, we're looking forward to retirement or working in a different domain and we're thinking about our identity. What am I going to do all day? What advice would you give me so I don't have regrets when I'm 87?

Charles Ellis: Well, number one is recognize that you don't have forever. So, make a list of things you want to be darn sure you get to do in the time that's available. For me, travel is very important part of that. So, there are lots of different places that I would like to go and I've worked my way through that list. I need a couple more years yet. Travel is something that I've always enjoyed. The learning experience, the opportunity to get to know new food, new visual experiences, new cultures, new friends. So that would be one.

Second, I want to be sure that I've had enough time to say thank you to the people who've made a real difference to me in my life. There are candidly quite a few of them. So that's another sort of thing on your checklist of things you want to be sure you do. I think most people find themselves able to go back and say, yeah, you know, there are some people. I had a friend who's on the Yale faculty just a couple days ago, and said to me, I got the most wonderful letter. It wasn’t very long; it was fairly short from a student that I had 35 years ago. H wrote to me just to say thank you. It didn't just make my day, it made my year to have one student, after all those years, feel like he would like to sit down and write me a personal letter. It wasn't very long, and his handwriting was perfectly okay. but he wanted to say thank you and how much that really meant to me because I worked hard to be a teacher, as every other teacher has, and wouldn't. As I think back on it, I wish I'd written more letters of that kind to people that made a difference to me in my life. And it's a little corny and you don't want to write a sappy letter, so keep it brief, but just say, hey, I've been thinking about you. I was smiling because I thought what you did was pretty good and it was very good for me. so that would be part of it. Then I think most people would recommend that you find something that you really, really, really like to learn and try to learn it. candidly, I have not gotten to that stage yet.

Roger: Well, you're still learning in your Domain.

Charles Ellis: I'm still trying to figure out the investment side, and to carry the message that I've had the privilege of seeing firsthand to as many people as possible. But that's on my list of I, ought to find something that I could say, you know, now that I've got control over my own time travel isn't going to take it all over. You know, my wife and I've got four different trips this year that we're looking forward to, and they are going to be wonderful fun. I know for sure that they're going to be very enjoyable. Okay. Is there anything that I could do that would be risky and, looking around for something that I could say, you know, that wouldn't be easy for me to do, but it would be good for me to do.

Roger: Why do you think that's important?

Charles Ellis: Well, I've read enough articles about the retirement that if you don't have a sense of mission or purpose, you might very well find yourself just sort of flopping around and kind of lost. I do have one purpose. That may be goofy, but it's me. When I was in college, I had the privilege of being an art history major. And if you think about, there are a lot of really wonderful artists, and I would like to just make the time to study maybe 50 different artists, maybe 25 different artists in the books that are available and then at the museums that are accessible to see and try to gain a closer understanding of what those artists were all about. I'm very likely to make that my commitment.

Roger: One thing I like about that. One, well, two things. One, it's goofy and it's specific to you. Two, it's a great example of it doesn't have to be about changing the world. It's a personal thing, and it's not expensive.

One other perspective I would love to get from you, Charlie, is, and this is true regardless of politics or economies and all that is being afraid of the future when you leave earning income. What I have observed in all the journeys I've walked with people, and I feel it with myself sometimes, is it's easy to delay because we're worried about the future, and it's easy to deny ourselves doing the, you know, doing the things that we want to do because we're worried about. Just fill in the blank. How should we feel about that when it feels like there's a big fog ahead of us between my age and your age? Should we worry so much?

Charles Ellis: I would not worry very much because your problem is not how do you find what you're going to do. Your real problem. It's going to be how do you find enough time to be able to do it and do it well. You would see yourself as having lots of time. I look at myself and say, “I don’t have much time. and, if I don't have much time, then you don't have lots of time.” You probably ought to be focusing on how you make the best use of the time. One of the things that we all get advice about, and I think it's true, be sure that you nurture friendships and loving relationships. I have a sister who's in her early 90s, and she shows that pretty clearly. I took the time to drive three hours to see where she is, spend an hour and a half with her, and then drive three hours back. I don't have six or seven hours to spend driving around, but to spend the time I did with my sister. She was so pleased and so appreciative, and I'm glad I did it. My two brothers have said, because they heard about it, they said, good for you. Well done. That was the right thing to do. Then I've got a cousin who has just learned that she's got a terminal cancer, and I wish I had spent more time with her. That's the kind of thing that clarifies, when you see it in real terms, you realize more time with those people you really like, more time with those people you really love, more time with those people you really admire are times well spent. The other people seem to enjoy it, too.

Roger: Well, if they're hanging out with you, I can understand. Charlie, we've never met before.

Charles Ellis: No, but this has been very, very enjoyable.

Roger: But I have been a student of yours from afar and your work. So, think of this as that oral letter, your work has had a profound impact on my entire trajectory as a practitioner and helping me guide countless other people. I'm very thankful that you came into my life via your writings.

Charles Ellis: Well, I'm very glad to hear that, Roger. But I'm also delighted that you're taking it, reshaping it, rethinking it, and then distributing it to large numbers of people in your lovely personal and gracious way. It's just. It's terrific. Thank you.

Roger: Well, I will work to make you proud. Thank you so much for your time.

Charles Ellis: I've enjoyed it greatly. Thank you, Roger.

LISTENER QUESTIONS

Roger: Now it's time to answer some of your questions. Today we're going to focus on investing questions given the theme. But if you have a question for a future show, you can go to askroger.com and I'll do my best to help you on a future show.

KEVIN HAS A QUESTION ABOUT THE PIE CAKE

So, our first two questions are related to the allocation pie cake. And the first one comes from Kevin.

Kevin says,

“I am still planning and don’t intuitively understand a pie cake, but I've been taking seriously the need to preserve the first three to four years of income given the recent downturn.”

Well, Kevin, I can understand why you don't understand the term pie cake. It is specific to me. It comes from inside my head as what I labeled to better understand the process that we use, and you don't want to live inside my head, trust me. We're going to provide an explainer video in this week's Noodle to understand what I mean by pie cake, which is how to allocate your resources to fund your life. I think that video is going to help you understand it and see why I call it a pie cake, and maybe you can live a little bit in my head. But it sounds like from what you're doing in terms of preserving the first three to four years of income, you're getting the gist of it. That's the important part.

Check out that video in our weekly newsletter, the Noodle that comes out on Saturday. If you're not signed up for it, you can go to thenoodle.me and sign up.

VINCE’S AUDIO QUESTION ABOUT THE RETIREMENT FLOOR

Our second question is related to this, and this comes from Vince. My question revolves around your retirement floor

Vince: Hi Roger. I started listening to your podcast pre Covid and have enjoyed listening to each episode.

My wife and I are 64, she's retired and I'm winding down. Currently on the RRC waiting list for June open enrollment. My question revolves around your retirement floor. For simplicity's sake, say you live on $100,000 a year and want a five year guaranteed income floor equaling $500,000. If you put 200,000 into money marketer T bills, should you have the balance of $300,000 in fixed income or would you need fixed income to generate $300,000 over the course of 5 years? So, you would need 1.2 million in fixed income, which would approximately generate 60k annually. Appreciate your insight.

Thank you very much.

Roger: Great question, Vince. I'm excited to meet you. When you join the club and join the cohort on June 5th, we'll have that live event coming up June 5th. We're going to do some teaching for everybody but also invite people to join the Rock Retirement Club to build their retirement plan of record.

In the video, Vince, that I'm going to share this Saturday in the email, I'm going to be using the Excel Planner, which is part of the masterclass, which walks through building out your allocation. My default method, Vince, is not to have a bond portfolio throwing off that amount of income to cover years three through four, five in your example, but you have individual investments, typically an individual bond or CD that matures at the beginning of the year that you need the money. So, in your example, if you needed $300,000 in year three, you would have a bond or something maturing at the beginning of that year that provided you with your $100,000 to fund your paycheck that's not coming from other income sources. Now, you could get a little bit more optimal in this and calculate the interest that you're going to receive over those three years.

In theory, you could say, well, that means I only have to buy a $90,000 bond, as an example, and I'll get my $90,000 plus $10,000 in total interest, which will give me my $100,000. I don't do it that way. And the reason I don't do it that way is I like to have built in buffers, and that would be a buffer, that extra interest that's coming in. So, I would prefer just to buy $100,000 bond knowing that this interest is going to come in, but not really account for it. That gives us some margin for higher than average inflation, for bad assumptions, for things, the unknown, unknowns that popped up, et cetera. I like to build a little bit of those buffers. But you'll get a sampling of how to do this. But I definitely, as a default, don't use a bond portfolio just simply to throw off that interest.

JOHN ASKS ABOUT ROGERS THOUGHTS ON INVESTING IN MULTIPLE INDEX FUNDS AND WHAT THE DIFFERENCE BETWEEN A MUTUAL FUND AND AN INDEX IS

All right, our next question is much more complicated to answer than it first appears, and it comes from John. This really relates to a lot of Dr. Ellis's work. Charles Ellis. I would definitely suggest reading Winning the Losers Game when it comes to investing. It was a pivotal book in my investment career, and it's related to John's question.

John says,

“What are your thoughts on investing in multiple index funds versus one? For example, investing in multiple amounts in 10 different funds versus all-in-one funds to possibly have a better average return overall and have less losses if some perform better during the market downturn.

Additionally, I hear Dave Ramsey talk about mutual funds a lot. What's the difference between a mutual fund and an index? What are your thoughts on investing in both?

Thank you for your time.”

John, this is actually a more difficult question to answer than it appears. Let me explain why.

There are layers to this that need to be explained to answer it. So, let's go to just the simple answer. Does it make sense to invest in multiple index funds, say 10 versus 1? Does that get you more diversification? Does that increase the possibility that you're going to have better returns? Not necessarily.

Is the answer because if you buy 10 different mutual funds that are all index funds, let's say that all invest in the S&P 500 index or a different index that is almost identical to the S&P 500 index. 10 doesn't get you more diversification because you're all investing in the same thing. It's like when I like the color green and blue, so I end up buying multiple shirts that all sort of look like each other. That's not how you build out a wardrobe. They are all basically the same thing with slight variation. That doesn't necessarily help you. The goal is to have an asset allocation that may have different investments that perform differently.

An example might be, let's assume you want to have a U.S. stock portfolio. You could buy a mutual fund that invests in the S&P 500 index, which has 500 stocks that all reside in the United States that are meant to represent the United States market. So, if you have one fund that owns that, you don't need to have others that are identical. But you could add a mutual fund that invested in small companies which are, we could argue, underrepresented in the S&P 500. Now, small companies are generally faster growing but can be more volatile and they'll perform differently than large companies. So, by adding those two, you may have more diversification and they might help offset each other to some extent. I'm doing this and trying not to go down the asset allocation rabbit hole. The key is what they're investing in and there's a degree of, is it worth the extra complexity to add more investments? So, I would be careful about just thinking more investments are better. I see that strategy all the time, not just by individuals, but by program run, asset allocation programs, and it drives me nuts. More is not necessarily better, John. It's about diversification.

Now, I want to get to your Dave Ramsey comment and the difference between mutual funds and indexes. To be clear, you actually can't invest in an index. All an index is, is a model that someone has created. You could create an index, John, in the case of the S&P 500 index, Standard and Poor's company created this index and has a methodology of what 500 companies go into the index and how they're weighted because they're not equally weighted. And each year they manage and reconstitute the index to take some companies out of the index and put some companies in the index with the intent of trying to provide a basket of stocks that represent the United States stock market. So that's just a mathematical model. You actually can't buy that index. But what you can buy, and there are a lot of providers of, are mutual funds that try to mirror that index. I'll just say one, let's say the Vanguard S&P 500 Index Mutual Fund. Its only goal is to mirror that model that Standard and Poor's has created as closely as possible. That's how they grade themselves, which means that they're just buying the basket of stocks in whatever percentages the model says to buy. When the model changes, they try to change as quickly as possible to match the model. So, they track themselves on, being close to the model. That means you don't have rock star managers trying to figure out where the economy's going or what stocks are going to be great and what sectors are going to be great. No, it's basically just a computer program that tries to match the model. As a result, a mutual fund that matches The S&P 500 index generally doesn't have much cost involved because there's not a lot of people involved relative to an active managed fund, which means they're less expensive and they trade a lot less so they can be more tax efficient, so they cost a lot less. You're just buying a basket of stocks that's following a model.

Now let's go back to the Vanguard S&P 500 mutual fund. I’m just saying Vanguard just to say it. I'm not saying it's better, worse than anything else. You can buy it in two different structures. This sort of relates to the Dave Ramsey question. You can buy a mutual fund as an exchange traded fund which trades on a stock exchange that typically is very efficient, or you can buy it as an open end mutual fund. These are the things I think Dave Ramsey generally refers to, which is a traditional mutual fund. They both have their quirks that we don't need to get into here. So, we, I just want to make sure we get our terms correct. You can't invest in an index. There are mutual funds that will follow particular indexes. Indices and mutual funds come in two primary wrappers, exchange traded fund or open end mutual funds. Those are the building blocks of building an asset allocation. That goes back to your 10 better than one. Not necessarily.

We do a whole training on this in the Rock Retirement Club in the masterclass of what asset allocation is. okay, last comment. Related mutual funds, since we're going down this rabbit hole a little bit, is mutual funds come in two basic styles, obviously ETF and open end, or the structure. But the strategies come in two basic flavors, passive strategies, which are those that try to just track an index as we've described, or actively managed funds where there is a manager and a team of analysts who are trying to do better than a passive basket of stocks. I think this is more of what Dave Ramsey refers to, not that I watch his show very often. And this is Charles Ellis's work, Winning the Losers Game. Pivotal book talks about winning the losers game in that. The studies are pretty overwhelming that actively managed mutual funds, because you have to pay all these analysts and they have to pay rockstar investment managers typically cost more and when they get it wrong, that can hurt their returns. Generally, that doesn't exceed the extra cost involved in trying to find the captain of the boat rather than just buying the basket of stocks.

Hopefully, John, that answer gave you some better understanding. I think you have some research, basic research to do on portfolio construction before you go just buying multiple investments because it may actually not help you, it might actually hurt you.

BEN’S QUESTION ON REBALANCING WITH THE CURRENT MARKET CONDITIONS

Let's get to one more question related to investing and this comes from Ben.

“Hey, Roger and team, thank you so much for the show and all the great information you provide. My wife and I are 55 and a year away from retiring. We have a 60/40 portfolio with five years in cash to fund the cash flow goal. We have been rebalancing every six months and are, due again this month. I know we should not try to time the market, but with current market conditions, is it best to wait until it is a bit less volatile?”

All the research that I've read, Ben, shows minimal value in rebalancing more than once a year from a 60/40. What we're talking about here, for those of that might know, let's say you want 60% in stocks, 40% in bonds and bonds stay constant and stocks go down. Now we may have a 55% in stocks and 45% in bonds. Rebalancing to a target allocation is essentially getting back to the initial allocation that you wanted, which was 60/40 in this example. That means we would have to sell some of our bonds and buy some of our stocks to get back to a target portfolio that we determined fit us. This again, the video that I'm going to share on Saturday, it's better be a good video I think is going to help explain some of this a little bit.

Number one, my approach and recommendations are to back into what your target portfolio is based on putting a purpose for every dollar in terms of funding your life. My default and what we teach in the Rock Retirement Club and what I do in my practice is we look at rebalancing once per year. Typically, that's in the third quarter. Regardless of what's going on in the world and in the markets third quarter we're reconstructing our pie cake or allocation and how life is going to work focused on the year coming up. So, we do that once a year in the third quarter. Can you do that every six months? Is that bad? No, not necessarily. It just creates a little bit more work. It creates a little bit more friction in terms of having to place the trades, perhaps tax consequences, etc. So, there's nothing wrong with doing it. There's that way it just creates more work. Again, the video hopefully will help explain from an asset allocation standpoint.

Now I want to talk about your last comment of should we try. I don't want to try to time the market, but with current market conditions, is it best to wait?

I would argue no, it is not best to wait. One of the quirks of asset allocation, if you're going to follow it, if you set a target that you're supposed to be 60/40 and you're supposed to rebalance and let's say stocks are down a lot and that you know, to rebalance, what do you have to do? You have to sell some of your bonds and buy some of your stocks. When stocks are down, that feels hard, right? Just like when stocks are doing really well and they're going up and you’re rebalancing, that means you have to sell some of the stocks that are doing well and buy some of the bonds that are not performing, as well as stocks. If you believe in asset allocation as a portfolio strategy, you will always, in your rebalancing, have to sell the things that feel safe or that you maybe want to buy more and buy the things that you are afraid to buy. That is not a bug, that is a feature. You're buying things that are low and doing poorly and selling things that haven't done as poorly to get back to your allocation in small amounts, typically and overtime. That actually is a great strategy. But it's going to require you to sort of plug your nose and do things that are intuitively, in the moment, not that comfortable. So hopefully that gave you some explanation and hopefully the video on in Saturday's email, we'll do the same.

With that said, let's go to a smart sprint.

TODAY’S SMART SPRINT SEGMENT

On your marks, get set, and we're off to take a little baby step you can take in the next seven days to not just rock retirement, but rock life.

All right, in the next seven days, let's take an assessment of the process you use when investing your assets for retirement and identify two things.

Number one, are you focused on time horizons so you have confidence on the money that you will need within the next five years?

Number two, is your process focused on things you can control or things that you can't?

This is important. I don't know if you're using an advisor or not. The more you can focus on things you can control and control expenses, and the more you can get the time horizons right, I think the more confidence you'll have in rocking retirement.

Before we get to my grandfather's mission, I want to say thank you. I received, oh, Lord. 20, 30, 40 emails, all encouraging me and the team in our noodle email last week. We got some not so nice emails related to this process over panic. I wasn't expecting that. But man, the replies that we got from you, way too many to read here. we’re heartening. I say that those rough emails don't bother me, but you know, I'm human, they do, right? We're dedicated to focusing on helping you, empowering you to make better decisions so you can create a great life. But I just want to say thank you. It had brought me to tears.

BONUS

All right, mission number 46 and 47 for my grandfather's flight flights in a B-17 in World War II.

“Ship number 868. September 10th sortie 31 first visited our old pal Vienna, Austria today and it was anything but friendly on both sides. We hit the oil refinery and really pounded it, and they pounded us in turn. They pounded us with black hammer and plastic type of flak here. Lost some planes on this mission. Still lucky. Carry 12,500 pound bombs. mission flight time 7 hours and 30 minutes. Altitude 25,000ft.

P.S. my buddy Red, our radio operator, finished his 50 missions today. Good deal. Four down, six to go.”

That's, I'm assuming he's saying of his crew, you lose planes, you lose people, just like the people on the ground. So, matter of fact, life's precious.

The opinions voiced in this podcast are for general information only and not intended to provide specific civic advice or recommendations for any individual. All, performance reference is historical and does not guarantee future results. All indices are unmanaged and cannot be invested in directly. Make sure you consult your legal, tax or financial advisor before making any decisions.