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welcome to the best interest podcast where we believe Benjamin Franklin's advice that an investment in knowledge
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pays the best interest both in finances and in your life every episode teaches you personal finance and investing in
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simple terms now here's your host Jesse Kramer hello everybody and welcome to
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episode 58 of the best interest podcast my name is Jesse pramer today we're starting the episode actually by
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alluding to a different podcast this one is by a man named Malcolm Gladwell you might have heard of him he's a pretty
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famous author his podcast is called revisionist history I was recently listening to an episode of his podcast
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and I learned about something called the Minnesota starvation experiment Malcolm
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Gladwell calls his podcast episode the department of physical hygiene I'll include a link in the show notes and yes
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it's all about something called the Minnesota starvation experiment right around world War II I actually think it
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was during World War II there were a group of young men who for one reason or another couldn't fight in the war they
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wanted to participate in some other way and a very famous scientist named anel Keys convinced them to participate in
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this experiment where for about 3 months the men had their diets and exercise slightly adjusted so that they would hit
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some sort of they call it like a balanced weight so the men who were maybe a little overweight were
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encouraged to lose a few pounds The Men Who were a little underweight were encouraged to gain a few pounds until
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they kind of hit this median normal weight for their height and then commenced a starvation period for 6
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months these men were fed what is called a starvation diet barely enough calories
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to survive the goal of the experiment was for over the six-month period for the men to lose 25% of their weight so
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for someone who's maybe 6 feet tall and weighs 190 PB the goal of the experiment
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was for that man to lose 47 lb and drop down to a weight of 143 from 190 to 143 in 6 months now the
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long-term goal of the study was to help people all over the world who are dealing with some sort of starvation to
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understand how to prevent starvation in the first place to understand how to best cure starvation what nutrients are
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most important how the body reacts to a reg diet again how to best put on weight
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what organs are most damaged by starvation and what organs need to be carefully looked at when reintroducing
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nutrients to the body all that sort of thing now that experiment probably couldn't take place today it's just a
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bit too gruesome and a bit too painful to starve someone for 6 months to get them to the point where the real study
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could begin one of the things in the podcast that most caught my eye and caught my mind's attention is how the
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men in the experiment how their mental States changed one of the biggest ones for example many of the men developed
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food Obsession during their starvation period it's all they could think about
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they really didn't think about interpersonal relationships they didn't care too much for the kind of things
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that we occupy our normal days with they would just think about food during the experiment the men had to walk in pairs
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around the city of Minnesota they had to walk 22 miles a week as part of the exercise to help them lose the weight
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during the starvation period and they'd often walk to restaurants or diners and
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simply sit there and watch people eat that was part of their entertainment or at the very least that's what their
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brains wanted them to do was to watch people eat some of the men started collecting cookbooks during the
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experiment and interestingly some of the men never stopped collecting cookbooks they had this food Obsession for the
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rest of their lives quick sidebar listening to Malcolm gladwell's episode I thought of my dog Sadie who we got as
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a starving and nursing mother dog she was found on the streets of Houston severely malnourished and she's now a
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perfectly healthy dog she is also the most food motivated dog I've ever met she has an obsession with food she likes
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to watch me eat dinner she you know any little hint that she might be getting fed she gets excited for not every dog
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does that but a dog who starved on the streets develops that kind of food Obsession and similarly as we learned in
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this podcast people who are starved develop that food Obsession too and for some of them it never leaves towards the
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end of the podcast episode one audio clip in particular really struck a chord with me it was some testimony given
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later in life by one of the studies participants and and this was from a man who according to testimony from the many
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participants in the study this one man was someone that the rest of the participants looked up to they saw him
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as as Noble they saw him as righteous he was well educated he was well put together they saw him as as a person
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worth emulating but I want you to listen to this man's testimony right now or you
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could put it in another way his confession to how his mindset and how his brain chemistry changed over the
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course of the study I'll tell you a a a nasty moment I was walking along and I
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obviously had a buddy but I don't know who it was and um it was deep into the semi
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starvation and um we were tired when they crossed the street they didn't have the energy to
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take the half step up onto the sidewalk we were tired uh and and weak and so we were
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standing at a corner waiting for a light or something and a kid came along on a bicycle and he was really moving pumping
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away and going I said wonder where he's going and then I said said to myself I know where
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he's going he's going home for supper and I'm not and then for a very brief I hope it
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was brief moment I suddenly hated that that boy and that I hate at this point to tell you this
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because uh it doesn't speak very well for me um but I I remembered it with I guess
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horor that that I could feel such a thing so utterly irrational but but there it was and uh
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you ask an experience that I remember I sure remember that is there anything that we haven't
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talked about or that I should have asked you or you'd like to to add that seems
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relevant you should have asked me why I'm missing fingers on my left hand okay I keep saying to myself that this
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was because I um was so weak and I was chopping wood and I got the um axe caught up in the TR
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and I didn't have a a rapid enough reaction time to pull my hand away so I removed some
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fingers he was at the house of two elderly ladies in Minneapolis who had befriended some of the subjects leg and
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his buddy would go and watch the women eat then go outside to split wood to steal themselves against the temptation
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to take any of the women's food I recognize that a human being can go through a period of mental illness
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I think I was mentally ill was I mentally ill at the time that I removed the fingers I don't know I like to think
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that I wasn't I like to think it was an accident I'm not going to sit here and
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categorically say that I didn't do it on purpose severe trauma severe anxiety
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severe pain mental pain or physical pain these can make us think in a rational ways clearly this guy who's been
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starving for months and then sees a strong young boy riding a bicycle he thinks irrationally in this moment when
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he wants to reach out when he wants to harm the boy when he feels like he hates that boy that's an irrational thought
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and now he's giving a confession as an old man he feels guilty for it I don't
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think he should because he he realizes that it was an irrational thought and it's interesting a little bit scary to
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think that you and I and everyone we know we have that side of our brain we might not like to admit it but it's
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there that you or I or any other human we know when we're put in dire scenarios
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we think differently we act differently we know what's not rational or at least
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in hindsight we know it's not rational but in the moment it feels like that's
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the right thing to do and that right there is a powerful investing lesson so let's switch gears Let's Travel to
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Johnsonburg Johnsonburg is a quiet town in the alagan National Forest that's in
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Northwest Pennsylvania here in the USA now Johnsonburg is best known at least regionally for their Lumber industry and
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the the associated paper mill that's in the town of Johnsonburg but Johnsonburg
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made national news in the spring of 2022 for a very different and somewhat disturbing reason there was uh a
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recently constructed iway bypass in Johnsonburg and now a bypass is a a bridge that's built above or around
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usually some combination of both built above or around a village or town you've
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probably driven over thousands of bypasses in your life even if you didn't know it it's a highway bridge over a
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residential area the bypass in Johnsonburg made national news because dozens of deer were leaping off of the
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bypass not all at the same time but over the course of days and weeks they were leaping off the bypass and dropping to
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their death onto populated parts of the town so these deer they walk out onto the miles long bypass but they aren't
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quite smart enough unfortunately to find their way back off the bypass and eventually they get spooked perhaps by
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traffic or perhaps by some Panic from their predicament they're stuck out there and a certain survival mechanism
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kicks in the deer they think well I can either stay trapped on this bypass and surely die or maybe I can jump and maybe
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I'll survive it's easy for us big brained humans to say well how about a
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third option where you just walk off the bypass but deer aren't equipped to understand traffic patterns or Bridge
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construction or probability theory in there plight In Their Fear they rely on Instinct and the only sliver of survival
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they think will come from jumping even though it's clearly a self-destructive
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Behavior so when zoomed out of course it's stupid when zoomed in at least into
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the deer's brain it appears like it's the rational thing to do and so the deer
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jump so let's keep that story in mind a reader on my blog on the best interest
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his name was Phil maybe he was from patani Pennsylvania he wrote in and he said Jesse I don't understand why you
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hold any Bonds in your portfolio to be honest with you I don't know why anyone
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holds bonds so can you please explain the problem with a 100% stock portfolio it's a great question Phil you're not
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the first to ask you won't be the last to ask we know that over time stocks outperform bonds so why hold any bonds
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at all and I'll start by saying that some people do recommend 100% stock port
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folios their rationale is pretty simple a 100% stock portfolio has always outperformed any portfolio with bonds as
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long as you zoom out to a long enough time span but the key word there is over the long run as long as you zoom out
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long enough all stocks make sense so if you're young enough to invest your money
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and you know pull a rip vanwinkle go to sleep for 30 years investing in 100% stocks might be the right allocation for
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you some people are fine with a multi-decade hibernation of kind of avoiding their account statements and
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and not getting spooked by the concept of losing money or the prospect of losing money but most people don't live
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in that world an important question to ask in portfolio construction is what is your risk tolerance or in plain English
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how much money can you lose before you get nauseous we each have a unique answer to that question and more
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importantly our answer in theory might be different than our answers in practice so I'm going to say that again
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because it's pretty important your risk tolerance in theory might be different
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than your risk tolerance in practice take Sally for example Sally believes in theory based on paper based
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on what she's heard she thinks she can stomach a 20% loss to her portfolio before feeling even a hint of stress she
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knows that the market has dropped before she knows that bare markets happen and she's aware of the fact fact that a 20%
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drop in her portfolio is not only a probability it's almost an inevitability
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over the course of her investing career 20% no worries once 30% down she'd probably lose some sleep and if she ever
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got 40% down off her all-time high she'd begin to fight that urge to panic and to
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sell completely so something near a 7030 portfolio is a good starting point for sality that's 70% stocks and 30% bonds
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the reason why is because we can just look back at history and say how has a 7030 portfolio performed over time 7030
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portfolio's worst full year occurred in 1931 that's during the Great Depression
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and it suffered a 31% loss that year the 100% stock portfolio that the question asker Phil is interested in that
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suffered a 43% loss in 1931 and actually up to an 89% Peak to trough draw down so again 43% that was
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over the course of a full year when there was some time to recover but the actual High to the low the peak to the
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trough of a 100% stock portfolio was 89% that occurred in 1929 now in order to reduce the
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volatility in Sally's portfolio we add bonds to the stocks or some other lowrisk asset maybe cash could work too
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now that ballasts out Sally's portfolio to meet her specific risk tolerance it's
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still possible that she'll lose money in a 7030 portfolio but not as much as she
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would in a 100% stock portfolio now in theory that 7030 portfolio for Sally makes sense but what if she finds
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herself in a year like 2022 and at one point during the year her 7030 portfolio was down 20% not the 30% that she
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thought would make her Panic only 20% but what if she actually starts panicking at 20% down you know Warren
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Buffett said only when the tide goes out do you discover who who's been swimming
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naked that's one of his most famous quotes the tide going out of course is a
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metaphor for the market dropping and swimming naked is a metaphor for someone being unprepared for that eventuality to
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happen only in Market downturns does theory get put to the test can you stomach what you said you could stomach
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can Sally stomach what she thought she could stomach she might only be down 20% in a year like 2022 but she could be
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freaking out and what do we do how do we help well if we need to hopefully we can
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educate her and then if needed reallocate her assets we need to learn about Sally why is she freaking out can
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we teach her enough about the long-term trends of the stock market to help her feel at ease that's actually a really
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good place to start we could remind Sally that if she zooms out enough here's what a 7030 portfolio does over
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fiveyear time spans over 10 year over 20 year time spans yes this one year is a bit chaotic and a bit painful but it was
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one of the possibilities that we knew about when we began investing in a 7030 portfolio if you stick with it here's
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where you'll end up in the long run we can educate Sally and oftentimes education makes investors feel a lot
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better about where they stand if the education doesn't really work if it doesn't sink in and if Sally says yeah I
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hear the words you're saying I still can't handle it well then we might need
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to reallocate Sally's assets maybe 7030 wasn't right for her in the first place
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and she needs to be in something more like a 60/40 or 50/50 portfolio maybe she needs to diversify even further into
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alternative assets or something like that simply to kind of detangle and uncorrelated the Assets in her portfolio
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even more no matter what we need to avoid a situation avoid a scenario where Sally sells completely there's this
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quote that lots of investors use they say the only people who get get hurt on the roller coaster are those who jump
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off now this quote begs the question just how scary is a roller coaster that impels someone into jumping off of it
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and more importantly though how do we reduce that scariness how can we prevent people from jumping off their portfolios
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how do we preempt the survival mechanism that says if I don't sell right now I
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might never get another chance this portfolio is headed to zero and I am jumping off of the ship before it goes
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there mammal brains are similar to one another we share the same amydala that controls
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our fight or flight response the same impulse that pushes say a deer to jump from a bypass it also pushes Sally to
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panic sell her portfolio Sally sells out of fear not stupidity that fear is a survival
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mechanism fear's goal much like Pain's goal is to motivate us into an action
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that remedies the fear if you're scared well you run or you fight if you touch a
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hot stove you reflexively pull your hand away to intentionally endure such pain it does seem inhuman requiring some
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level of mental fortitude to bypass the very brain circuitry that makes us alive
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in the first place in that context Sally selling her portfolio or a deer jumping
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off of a bypass it seems kind of rational is it also nearsighted and myopic of course it is it's easy for us
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to see that shortsightedness on the outside looking in but it doesn't feel myopic for Sally In the Heat of the
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Moment or for those dear they say it's hard to see the picture when you're
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standing inside the frame when your portfolio is down 20% you are standing inside that frame it's hard to see the
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full picture similarly for the deer they just see the frame of them stuck on a bypass Big Friend of the best interest
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Howard Marx who's a very famous investor he has his own appropriate quote quote
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on the topic Howard says we have to practice defensive investing since many of the outcomes are likely to go against
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us it's more important to ensure survival under negative outcomes than it is to guarantee maximum returns under
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favorable ones it's more important to ensure survival under negative outcomes than it
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is to guarantee maximum returns under favorable ones while Marx is referring to avoiding too much risk we can also
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applied his idea to avoiding self-destructive behaviors for a deer to avoid self-destruction we'd say don't
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walk out on a bypass in the first place if only they'd listen to us and to Sally
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or to any other investor we'd say don't take on so much risk that you'll Panic
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sell when markets aren't Cooperative history tells us time and again that the
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survival Instinct to panic sell is a self-destructive instinct when zoomed out Panic selling is stupid of course it
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is just look at the market history why would you ever sell knowing that we'd
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get to where we are today but when you zoom in in that moment when the markets have dropped 30% off their all-time high
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and you don't know what the future holds selling Panic selling it might feel
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rational in that moment we'd all do better to remind ourselves that humans are frequently irrational and because
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humans are frequently irrational it begs the question not if Sally will Panic cell but when Sally will Panic sell and
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that brings us back to Phil's original question that brings us back to bonds or
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to any other lower risk asset class the rationale for holding bonds or for holding cash for alternatives for
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diversification the rationale for these non-stock asset classes is to prevent self-destructive Panic selling it's one
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thing to admonish investors and say don't be stupid don't sell your stocks
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the market will eventually recover but good luck looking a panicked investor in the eye and accusing them of stupidity
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for selling your accusation simply won't work their amydala the most irrational
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part of their brain is in control in that moment and it's begging them to pull their hand off the stove can you
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blame them for listening our best and only option as investors is to prevent panic in the first place some pain is
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okay but Panic is not they say the true cost of long-term investing is a psychological cost because you need to
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endure some pain but you need to prevent that Panic you need to build a portfolio
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that meets your goals in the good times but won't mentally break you in the bad
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times I must not fear fear is the mind killer fear is The Little Death that brings total
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obliteration I will face my fear I will permit him to pass over me and through me
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and when it has gone past I will turn the inner eye to see its path where the fear has gone there will
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be nothing only I will remain some of you might recognize that Morgan Freeman impression as the litany
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against fear from the famous book and now movie Dune while perhaps a bit dramatic for a
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personal finance podcast it is actually a pretty interesting quote fear is the mind killer fear really does mess with
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our brains and another part of that quote is once the fear is pass me I will look at its path and only I will remain
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and similarly if you let a market Panic or a bare Market or a market crash when those bad times have gone passed you can
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turn your eye to your Vanguard your Fidelity your Schwab accounts and only you and your portfolio fully intact will
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remain changing gears a little bit here now some of you know that by day I work for a fiduciary Financial Planning and
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wealth management firm in Rochester you know we we help people we help individuals we help families plan their
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financial Futures and explaining that previous concept is extremely important explaining how we design portfolios to
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ensure that they can stuck with for the long run to explain why we diversify in order to keep risk
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lower that's a really important part of the job and sometimes what that means is
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that there are big headlines in the news that we're worried about things like
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debt ceilings or interest rate hikes and all that kind of stuff and as investment
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managers we have to decide whether to take action or not in the portfolio and often times because of the work done
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beforehand because of the diversification present the correct answer the rational answer is we're not
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going to do anything right now we designed the portfolio for this it's meant to withstand this and it will
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withstand this and once we get one or two or 5 years out from now we're going
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to look back on this time and realize that doing nothing was the right thing to do now one quote that I I recently
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heard and I'm adopting it myself because I think it's a terrific quote to explain
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that though is that inaction is not the same as inactivity by choosing not to act from
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an investment point of view by choosing not to make any changes that's not the
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same as sitting idly twiddling your thumbs doing nothing at all you know humans like all creatures great and
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small we're biased towards action it's so ingrained in Us in fact that occasionally our brain brains override
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conscious thought and and force us to act we talked about that before with the stove when you touch a hot stove your
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brain instinctively and impulsively screams out to you act right now remove yourself from the source of that pain it
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doesn't even really it's just instantaneous it's not even screaming at
00:26:16
you you don't have a choice impulse takes over and you act now that same bias that helps us survive run from the
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tiger block that projectile that's heading towards your face that instinct that bias it is purely
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harmful to the long-term investor as an investor in action in action is your friend but it's important paradoxically
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that we differentiate in action from inactivity now John Bogel the founder of Vanguard he famously quipped the the
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rule for the investor should be all think about and in effect the financial system has built on this and when
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something monstrous happens big noisy uh affects the market greatly on a very shortterm basis the answer is don't just
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stand there do something but the real answer is don't do something just stand
00:27:08
there or don't get captivated by the emotions of the moment you heard him right don't do something don't bias
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yourself towards action just stand there actively choose not to act to understand
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why we simply have to consult historical precedent first why might an investor want to take drastic action we know that
00:27:30
by now to avoid pain and what's the cause of that pain well of course it's a
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downward bare Market where we see our account values dropping by 10 or 20 or 30% or more and our brains instinctively
00:27:42
think do something avoid that pain you're exposing yourself to the painful stock market so stop that sell your
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investments before the pain gets worse that's the normal human response identify the cause of the pain and reel
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back from it but stock Market history shows us how harmful that behavior is to your long-term portfolio performance
00:28:03
selling because of losses it serves to lock in those losses that's bad and then
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you like the rest of us humans won't have the gumption to buy back into the market to participate in its eventual
00:28:15
recovery in the eventual rally action during a bare Market is an investors's enemy inaction is our friend
00:28:25
but inaction isn't the same as inactivity it takes conscious effort to choose in action it takes conscious
00:28:33
effort to rebalance your portfolio maintaining a predetermined asset allocation even during turbulent markets
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it's boring and simple but you have to do it you need to actively choose to keep your cool The Secret of great
00:28:46
investing is temperament it's hard to stay calm during a bare Market our brains want the Panic we want to sell to
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survive we want to jump off that bridge like the deer you need to actively choose not to it's a bit like meditation
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you're choosing when you meditate to sit there and do nothing you are paradoxically actively choosing in
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action the metaphor gets even better though because as anyone who's ever meditated will tell you meditation is
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hard it's really challenging to quiet your brain and be still after all we're
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all biologically wired for Action we're wired to think to worry to plan everything except to sit and be still
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investors choosing in action it works exactly the same way we must quiet that worried voice in our heads my retirement
00:29:37
account just drop by how much we need to quiet that voice we need to choose to wait out the markets storm calm Waters
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do await us if only we wait for them day after day we must choose to wait to stay
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calm to be patient don't do something just sit there but don't confuse use
00:29:57
that in action with [Music] inactivity thanks for tuning in to this episode of the bestest podcast if you
00:30:07
have a question for Jesse to answer on a future episode send him an email at Jesse bestin interest. blog again that's
00:30:15
Jesse at bestter interest. blog did you enjoy the show subscribe rate and review
00:30:20
the podcast wherever you listen this helps others find the show and invest in knowledge themselves and we appreciate
00:30:28
it we'll catch you on the next episode of the best interest [Music] podcast the best interest podcast is a
00:30:36
personal podcast meant for education and entertainment it should not be taken as
00:30:41
Financial advice and is not prescriptive of your financial situation
