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Welcome to personal finance for long-term investors, where we believe Benjamin Franklin's advice that an
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investment in knowledge pays the best interest both in finances and in your life. Every episode teaches you personal
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finance and long-term investing in simple terms. Now, here's your host, Jesse Kramer. Welcome to Personal
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Finance for Long-Term Investors, episode 133. My name is Jesse Kramer. By day, I
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work at a fiduciary wealth management firm helping clients nationwide. You can learn more at bestinterest.blog/work.
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The link is in the show notes. And by night, I write the bestinterest blog and I host this podcast. I also put out a
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weekly email newsletter. And all of those projects help busy professionals and retirees avoid mistakes and grow
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their wealth by hopefully simplifying their investing, their taxes, and their retirement planning. And Ruben Miller,
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Ruben Miller is going to be joining me today. Before introducing Reuben, we're
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going to do a quick review of the week. This one is from uh NC Palmat, who says uh five-star review. Great listen. Jesse
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is very relatable and easy to follow. I always leave having learned something new. Well, NC Palmat, thank you very
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much for those kind words. You could shoot me an email to jesse at bestinterest.blog and I'll get you
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hooked up with a supersoft podcast t-shirt. And you know what? After after sitting down and and recording this
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conversation with Reuben, I've decided to skip any sort of uh traditional opening monologue today from from me. I
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think Ruben has a lot of interesting thoughts to share and he's got this great teaching approach with how he
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shares his thoughts and I'm happy just to you know give the stage to him as it
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were. An introduction for Ruben for those of you who don't know Ruben. Ruben
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Miller is an investor, a writer, a teacher and also interestingly enough a chess master. He's the the founder and
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chief investment officer of Peltoma Capital Partners. He founded Peltoma in 2023 to show people that there's a
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better way to invest. In addition to being a Forbes contributor, uh, Rubin is also the acclaimed writer of the
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Fortunes and Frictions blog, uh, and he's frequently quoted as well in the Wall Street Journal. He's a relentless
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advocate for financial literacy and a founding committee member of the USC, that's University of Southern California
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Financial Literacy Festival. And yes, uh, Reuben, a native of my very own Rochester, New York, earned a national
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chess master title at the age of 15. So without further ado, here is Ruben Miller on personal finance for long-term
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investors. All right, Ruben, you know, one one thing I I hope to lean on today is your
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experience as what I would call an insider in the investment management industry due to your experience at the
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highly regarded Dimensional Funds. And I'm sure listeners have heard of Vanguard, Fidelity, etc., but but maybe
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not Dimensional or at least fewer have heard of Dimensional. And I know personally, I know sometimes I can
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think, boy, if I've never heard of them. I bet they're annuity slingers, active
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management slop, something like that. But you and I know Dimensional is pretty different. So, do you mind actually just
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starting with a little bit of background on on Dimensional and maybe some of your
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experiences there? >> I think the first thing I would say is that I find when I talk to investors,
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there's often a misunderstanding of like what lane do all these people swim in?
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There are custodians like Schwab and Fidelity who also have funds who might also have financial advisors and so they
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swim in a lot of lanes. >> Mhm. >> One cool thing about dimensional fund
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advisors is there's just one lane. All they do is make funds and there's only
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one investment philosophy. And so when you think about even if you're just in
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fund land like you're at Vanguard, sorry, Vanguard does a few things, but Vanguard funds, let's talk about a
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second, there's different breeds and colors and tastes of Vanguard funds. >> Yeah,
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>> they tend to have a lowcost bent to all of them, but if you want to go pick
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someone a manager that's going to pick stocks for you, Vanguard does active management. If you want to go buy an
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index fund, Vanguard does passive management. You have to sort of know what you want to match it to your tastes
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and preferences. M >> they have it for you, but it's like a grocery store. You got to pick what you
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want. The cool thing about a working at Dimensional, which I loved those years, I was there from 2015 to 2022, is so
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much of wholesaling, which is selling funds, for me, I was selling them to financial advisors, is trying to get
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these products into like model portfolios at a financial advisor firm. >> Yeah.
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>> So, if you go to a financial advisor's office and they say, "Hey, we're looking
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for, you know, the best emerging market small cap manager." You're like, great.
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This is my emerging small cap fund. Is this Do you Do you want it? Do you want to buy it? Well, Dimensional is very
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different in the sense that they don't really like I wasn't taught to talk
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about funds that way. I don't lead with products. You lead with the philosophy.
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So, back in the I mean, this is now the 50s and 60s basically early research coming out of the University of Chicago
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that led to the eventual creation of dimensional fund advisors. But basically these professors who started doing the
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early work in finance and security pricing and built these models around how we think assets should behave
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through time and why and economic intuition and rationale and things like that led to this belief that was almost
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antithetical to the way people had always invested which was find some smart person to pick stocks for you. And
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as we started having the computing power to look at how do people do that do that
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especially after fees. It's not a very good value proposition to charge a meaningful fee and try to pick stocks
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for people. It's a distribution of course like all things in life. It's a
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distribution. You're always going to find some people that look great. Now can you prove they're skillful and
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talented instead of lucky? That's a lot harder from a stat statistical perspective. But it's always going to be
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a distribution. So people might say but what about this manager? It's like maybe
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I don't know but on average active management has not been a great value proposition for investors. Dimensional
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only sells passive funds. What's different about Dimensional being a passive fund manager and what everyone
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associates with passive management which is index funds is index funds have a third party involved which is whoever
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creates the index list. So we'll use S&P 500. That's what >> standard employes. They're sitting
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around a table and saying what goes on the list of 500 this year, this quarter, whatever it might be, and they change it
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through time. So the index reconstitutes, but the S&P 500 is just the largest 500
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stocks in the US. Sometimes it's like 506, which is kind of weird, but it's
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basically the top 500, not top, sorry, the largest 500 company. >> So Dementia would ask the question sort
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of like, why is standard for got to be involved? >> Let's say I want to go own 500 stocks
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and I manage hundreds of billions of dollars. Why am I outsourcing this list to stand for just because they have the
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S&P 500? So that's basically the question dimensional positive was sure passive investing makes sense from an
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empirical data perspective. We want to invest that way, but I'm not sure I want
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index funds. If I want to go buy 500 or 3,000 stocks or whatever it is, why don't I just go do it and then have the
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flexibility to if I want to make a modification, I don't have to wait for some committee to meet every quarter or
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6 months or year and say, "Great, the 5004 is now 498 and these are the six
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additions and subtraction, but like why do I want a third party involved?" So
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index funds are really cool because they're going to be cheaper on average than dimensional because they're more
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offtheshelf. like they are literally a static list for a period of time that you're just tracking. There's really no
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humans really needed that much besides some small trading or whatever. But there's there's very it's rigid and
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there's not that much thinking that goes on once you create the list. Dimensional
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is going to look at this additional research and say, "Wow, there's certain
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ways to not only design portfolios, but implement day after day that we think we
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can improve on indexing." So that's the general dimensional spiel. They're
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they're about a trillion dollar company now. I mean they're a massive global
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powerhouse in the investment world. They have this one philosophy which is very unique in the investment landscape. A
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couple other companies I'd say that do that well would be Avantis which is a
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competitor of Dimensional sort of offshoot. A lot of people left Dimensional go create Avantis. Very
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similar in that vein. They also would say well we're not going to we don't
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pick stocks like we just do one thing and we do it really well. So if I'm similar on the other end, there's also
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some fun companies that are just active management and I love that to be honest because at least they stand for
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something. >> Sure. >> Something I learned at Dimensional was how to sort of sell against everything
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that wasn't >> and we would we would basically refer these places as grocery stores. Like you
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got something for everybody. You're kind of nothing to everyone, right? If you
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want to be everything to everyone. So like American Funds, Capital Group is a fantastic example of a company whose
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investment philosophy I don't care for, but whose sort of culture and business
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philosophy I really like. They stand for something and they're not trying to just
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create products that they think people will buy. You're not going to see Capital Group create index funds. They
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don't like passive management and so I might not want to buy their funds, but I
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at least respect the way they do business. I will say that many of these active managers have had I mean the
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tailwinds of passive management are very obvious to any of us in the industry and
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so like it or not it's where the industry has is going and has been going. So a place like American Funds
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Capital Group they have hedged their bets a little bit I'd say they have some
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partnerships with Vanguard where they sort of have model portfolios where you can get some passive get some active.
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American Century is a great example oldtime legacy active manager. They are actually the ones that have Avantis
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underneath. They basically helped launch Avantis within them. So it's like a
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massive fun company that's like a brainchild of the American Century complex that my good friend Eduardo
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Repetter left Dimensional Go create and he did it sort of with with American Century. So American Century hedged a
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little bit that way. So I would say everybody knows where the industry is going and has been going and so some
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fund companies sort of stepped up to bat and made some of these hedges. It's
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obviously great for the cash inflows at places like Vanguard or Dimensional which are heavily lowcost passive. But
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the last thing I'll say and I'll pause is it has its own challenges which is
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that it is seen as a fairly commoditized investment approach especially index funds. So if you're Fidelity and you
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have a Fidelity S&P 500 fund and then you got Vanguard who has an S&P 500
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fund, mostly what you're competing on is you say, "Well, what do you cost and
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what do you cost because it's basically the damn same thing." So the fee
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compression is very hard. I mean, I felt that in my career at Dimensional, which
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Dimensional would market against saying we're not a commodity and I would say
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they are they are very unique, but the world sees these passive investments mostly as commoditized. And so it's hard
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to know if you want to hang your hat professionally at a passive investment manager for the next 10, 20 years, which
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are decisions I had to make uh in my career, when you see them lower in fees almost every year. Yesterday, Vanguard
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announced another 52 funds lowering their fees. And so that makes sense. Definitely index funds are very
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commoditized. So there's nothing else to compete on. It's a fascinating dynamic
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in the industry that people, a lot of people probably don't appreciate that it's the best time ever to be a Vanguard
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investor or dimensional investor. Less clear if someone said, "Hey, where should I try to go get a job?" But I
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would say, "Oh, go work at a passive manager for the next 20 years." Not so
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sure. >> Yeah, that's really interesting. I I use the comparison when you say
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commoditized. I mean, I I literally use the comparison of a gas station where you say, "Is Mobile's gas any different
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than Synokco's gas?" And pardon me if those are like regional gas stations,
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but right, it's gasoline. It's just a commodity. And what are these gas stations, you know, how do they compete?
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Well, they compete on price and maybe some other amenities, but it really is the same product underneath the hood.
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But, but going back to dimensional just I could hear a couple listeners there saying, "So, wait a second. You know,
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they don't follow the standard and pores dictates of 500 stocks. They come up
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with their own." And that sounds like putting your finger on the scale and that sounds like active management. So
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do you mind just peeling back the onion one little layer to say like what what rules is dimensional following in their
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passive strategies? >> Great question. So passive is is my word. It's also the it's also the way
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Gene FMA who Nobel Prize winner that is associated with dimensional would describe how they invest it.
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>> The industry classifies dimensional as active. >> So it is worth delineating because it's
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kind of confusing. It's just people that don't work in the industry. But when I
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think about active management, what I'm really referring to is traditional security selection. Do you build a model
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to pick stocks and say that's a good stock and that's a bad stock whatever.
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That is what Dimensional does not do based on traditional metrics of I think forward earnings are going to go up and
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blah blah blah on this specific company. What Dimensional does do is they they design really thoughtful portfolios
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based on the information they have. But the information they have are things like price. They look at the stock
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market, they see price. They're going to design a portfolio so that you don't
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have the same amount as of Apple stock as you do Frontier Airlines stock. That's a very active decision. One's
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obviously a much larger, more robust company. One's much smaller, deserves a
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smaller weight in your portfolio. But they're not going to say, I think Apple
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is going to outperform Frontier this year. That is a much harder argument to make. Obviously, Apple's going to be
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relatively more expensive company. It's big and successful and robust. And Frontier Airlines, I'm assuming, is a
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piece of crap company. like it's just like it's a budget airline. Like doesn't
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mean the stock can't do really well, but I know where I'd rather be be an
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executive and work at where my comp would be better. I know what a better company is. So, Dimensional A is going
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to look at every single stock in the universe and because they're passive and
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they say, "Hey, look, prices are probably going to adjust for the information we have at the time.
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Frontier is going to be cheap and Apple's going to be expensive." That makes sense to us in this world. It's
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easy to pick when you go bet on a sports game. It's easy to pick the winner in a
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lot of games. much harder to beat the spread. That's what passive management
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is all about, which is that I am not going to try to outguess prices. That can lead you to buying the S&P 500. That
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could also lead you to saying 500 stocks in the US, but wait, there's almost
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3,500 stocks in the US. Why wouldn't I want to own all of them? Why don't I
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want to own midcaps and small cap stocks and all that? So, dimension would start
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with a much larger opportunity set. Then the sort of special sauce I would say is
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that not all stocks are probably created equal that should be somewhat intuitive
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to us that if we believe that you know thoughtfully taking risk we should expect to get rewarded for that. If I go
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if I have $100 and I go buy Frontier Airlines stock and or Apple stock let's
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say I have two options. You're like well most people are gonna be like I'd rather
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have Apple stock. That's it. That means that Frontier Airlines should have a
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higher expected return. Otherwise, why the heck would anybody buy, >> right? I sleep way better at night
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knowing Apple stock than I would Frontier Airlines or whatever budget company you want to pick. So, there's
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this research that was formalized in the 1992 academic paper called the cross-section of expected returns, which
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is by Gene FMA and this other gentleman at Dartmouth, Ken French. And the p the paper basically it's one of the most
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cited papers in finance but it basically says like expected returns are different
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for various characteristics of stocks and the three big ones would be small cap stocks companies that we don't know
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that probably struggle more in economic downturns compared to large cap stocks. That it's pretty intuitive to me that
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that would have to be the case. Like it wouldn't make any sense to me if someone
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could go buy the biggest most successful companies and expect the best return >> and make the most money. Yeah. that that
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doesn't really make sense. Then value stocks, which is small cap versus large
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cap is an outright measure. You say, "What is the market capitalization? This
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is a $200 million company or a $500 million company." Value versus growth stocks. That's a relative measure. You
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say, "What's the price of this company for how much it earns each year?" Or,
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some measure like that. You're going to now have a a division, a fraction that
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you're going to look at. So, it's a relative value. It turns out that stocks
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that have sort of depressed relative prices, we call value stocks, so they trade at low prices for how much they
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earn, those have also outperformed historically tends to be nobody wants to work at a value stock company. If you go
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look at a list of value stock companies, it's the opposite of the growth, which
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is Meta, Amazon, Google. Now, also tend to be not the shiny companies. The big shiny ones are the easiest to buy. Those
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are the growth stocks. And over time, those have underperformed. And then the last third sort of data cut that I'd say
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came on I think the paper was written in 2013 but it's this it's this relative
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measure called relative profitability and it's the opposite side of value. It's actually by by Robert Novi Marx
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who's at Rochester and this is the idea that it's the opposite side of a coin
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from value. If value says there's two lemonade stands and you want to say you
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look at them and they both make $100 a summer. Two lemonade have the same idea and you say your profits are $100 a
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summer. The only question you have to ask if they're basically the same thing
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is great, what do you cost and what do you cost? Because if one costs 70 bucks to buy and one cost 30 bucks to buy, I'm
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going to buy the $30 one lower price per earnings. That's value. Profitability
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puts that on its head and says, "Okay, now I'm going to standardize the price.
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I am going to buy a lemonade stand for $100." Now, the question you ask is,
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great, who makes more money every summer? So, let's tie this all together. the US market has, you know, as I said,
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almost 3,500 stocks. Now, you say, I'm going to own the whole market. I obviously want a diversified portfolio.
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I'm going to start the whole market. Dimensional is going to do that. Then they're going to say, okay, I want to
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slightly overweight the small cap stocks. Those have higher expected returns. I believe they're riskier and
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so I expect to do better. Now, if I just like buy a t build a tiny portfolio and
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just buy Frontier Airlines or a few things like that, one could go bankrupt and disrupt my entire life, right? like
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my entire financial life could be exploed by a small b like that. So what you really want to do if you want to
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capture a premium like a small cap premium the expectation and historical realization that small caps would do
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better than large caps is you got to basically buy all of them to accommodate that some of them might go bankrupt
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right and some of them are going to shoot to the moon and you don't know which but historically small caps have
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done better I have no reason to think it wouldn't be true in the future makes
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economic sense to me so we're going to overweight small caps then we're going
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to slightly overweight value stocks and the third one is going to be okay let's
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overweight high relative profitability companies. So you take this portfolio, the whole market, and just sort of tilt
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it towards these premiums. The deeper you tilt, the higher, we would say, expected return you can have, but the
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more tracking error you're going to have to the 6:00 news when your client sees
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the S&P 500 did 1% today. Well, if you own a bunch of small and value stocks,
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like you don't own the S&P 500. So a decision an investor, allocator, adviser
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like us has to make is if I believe all this stuff, how much do I want to tilt toward these premiums knowing that the
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tradeoff is going to be tracking error? The other crazy thing that I feel so many so few people grasp like how
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vicious this is is investments are so noisy over horizons that were very uncomfortable with. So small value
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stocks, they basically stunk for like 15 years, like the most recent 15 years. Like the S&P 500 and QQQs, NAS, those
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things have shot out the lights. Those are basically the Q's are like large growth stocks, high tech. They trade at
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very high prices, often for very little earnings. People are basically betting on the future. They don't need to see
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earnings today. And they smoke small value stocks for a while. So when we say there's a small value premium that's
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almost a hundred years of data looking for statistical significance knowing that there are periods of like 10 15
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years where you underperform. So we know that ahead of time. So we have to sort of set expectations to ourselves if
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we're DIY or with our advisor has to make sure we know like hey this this might not work for a long time which is
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an argument probably to not deviate too much away from the market itself. So, it
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sounds like you're saying that Dimensional has a a set of rules in place, right? It's these value rules and
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small rules and profitability rules. And once the rules are in place, that helps
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define the quote unquote index, right? It's not like midyear, they're saying
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like, you know what, we decide we're not going to go with value tilts anymore.
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Like, the rules define the index. And now just like, hey, S&P defines their rules for 500 stocks a certain way and
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Dimensional defines their rules for these tilts a certain way and then once you have the rules in place, you're just
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passively following along. Is that more or less? >> It's pretty close. I would say there's
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some day-to-day management. What they're trying to say is there's going to be
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drift in the portfolio. Let's say we buy the market, we tilt a small value and
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profitability, and now one stock that was small in value is kind of becoming midcap and growthy. Dimensional has the
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ability to go trade that stock out of the portfolio, especially if it's a mandate. If you go buy Dimensional's
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small cap value fund and a security drifts out of that definition, >> you kind of want you'd want to say,
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well, at least you're thinking about selling that thing, right? It doesn't
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fit why what I hired you for. >> Index funds don't do that. Index funds
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don't do anything until they reconstitute and the list changes. So you can own securities that don't fit a
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small value index anymore in a small value index because they drifted higher, you know, like uh GameStop would be the
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perfect example. GameStop when it become a meme stock, you go from small value to
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large growth potentially overnight. But if you're an index fund, you might not
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trade, you might not reconstitute for another four to six months. So dementia would say having the flexibility to do
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trading like that. Avantis similar, they would say that's a big benefit. Again,
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price matters. You and I can be like, "Hey, look how look how amazing adviserss we are. Like everybody should
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hire us." No way. Not everybody should hire us. Like because we would have to
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adjust our prices, right? Like everything has to have a price that clears and so everything has to be a
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good value for the price. So on for you and me, obviously, if we're really good,
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we should charge higher fees as an adviser. That's going to make us not a great hire for some people who maybe
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don't have that complex of lives. For investment funds, active management is
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just hard because you're constantly wanting to charge more for this expertise you have on how to pick stocks
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and the majority of active funds don't outperform. For index funds versus dimensional, that's a fascinating
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conversation because I would say and my friend David Booth would say who started
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a company that they wouldn't have a business if they couldn't beat index
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funds. Why the hell would anyone buy their funds which are going to be more expensive because they have to pay
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portfolio managers to trade every day? they wouldn't have a business that didn't beat index funds over the long
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run. They've done a very good job of beating index funds. Obviously, not every single fund, but amazing track
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record that Dimensional has and to design and and implement portfolios like that,
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>> but they cost more. And so, in a handful of years where the S&P 500 index does
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amazing, even a comparable fund, maybe a dimensional that owns some larger stock
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like that, like you might easily underperform for a while. So advisers like us or investors have to say gosh do
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I want to keep doing this dimensional thing that's similar but has a higher expense ratio every year. So that's
00:22:50
hard. It's a very competitive landscape like you I'm out of it now like you and
00:22:55
I are in in the financial advisory world. We get to choose which funds to own for our clients. But I look at you
00:23:00
know the inner workings of these fund companies. It's a tough business. >> We're all long-term investors here
00:23:06
right? And we have to internalize these ideas that whatever decisions we make in
00:23:10
our portfolios. Hopefully, we're making them with the long-term in mind or at
00:23:15
the very least maybe what we're saying maybe in equities especially, right? If
00:23:18
you want to own one-year Treasury treasuries because that's what's going
00:23:22
to fund your next year of retirement. I I get it. That's not a long-term decision. I think it's a very prudent
00:23:26
decision, but that's not a long-term decision. But especially on the equity side, whatever we're choosing to do,
00:23:31
whether it's all S&P 500, whether it's a 50-50 mix of domestic and international,
00:23:36
whether it's tilting towards what dimensional tilts towards, I mean, we have to have some internal faith that
00:23:40
we're making these decisions because over the next not 5 years, I would argue
00:23:44
maybe not even 10 years. I'm talking over the next 20 or 30 or 40 years, we think we're going to see some sort of
00:23:50
pattern play out. Here's a quick ad and then we'll get back to the show. Did you
00:23:54
know my written blog, The Best Interest, was nominated for 2022 personal finance
00:23:59
blog of the year, and it's been highlighted in the Wall Street Journal, Yahoo Finance, and on CNBC. I love
00:24:05
writing, especially when that writing is to share financial education. And I usually write one or two articles per
00:24:11
week. You can read them all at bestinterest.blog. Again, the web address is bestinterest.blog.
00:24:20
Check it out. And I suppose let's let's pivot now, Ruben, to some of the
00:24:24
individual advice that we give or or just some of the things that our individual listeners can take away
00:24:28
today. I think of sometimes I chat with people who maybe are they're just 100%
00:24:33
in the S&P 500 index fund. It might be their whole portfolio. It's certainly
00:24:36
their whole equity strategy. And it's simple. It's what we would maybe lovingly call a lazy portfolio. That's a
00:24:43
bogalhead lazy portfolio. >> And oh, it's probably going to work out, too. As long as they don't get in their
00:24:48
own way, I would say it's not a terrible portfolio by any means. >> Exactly. Exactly. And there is this line
00:24:54
though where you might say, "Yeah, it's it's not terrible. Might be a little
00:24:59
incomplete." And at some point there's a line where I I've said this before. I
00:25:04
think people are much more likely to go wrong in complexity than they are in simplicity. But there still comes a line
00:25:10
where something is so so so simple it might have some negative ramifications. So when we're talking about dimensional
00:25:17
or just when we talk about your investment strategy, where do you kind of draw that line to say like, hey,
00:25:22
okay, let's let's just start with that example 100% S&P 500. >> Yeah.
00:25:26
>> What would you say to this >> hypothetical investor say, you know
00:25:29
what, you might want to make a few tweaks here or there? >> I'd go back to where we kind of started,
00:25:33
which is like, what is your philosophy around prices? And for me, when I look at prices, I say, gosh, there's a lot of
00:25:40
smart people trying to buy every stock out there. There's a lot of smart people
00:25:44
trying to sell it. it comes this equilibrium and that's the price we see on our phone ticker app or on CNBC or
00:25:49
wherever you look at stock prices there's so much information in a price because it's an equilibrium of all these
00:25:56
traders millions of people every day so to me a lot of people overlook like the beauty in that is like prices are
00:26:03
probably pretty efficient there's a lot of smart people out there incentivized
00:26:06
to make a lot of money in the stock market so it's going to stress it to get
00:26:10
to a pretty fair price so okay so let's say someone's with me so far and say I
00:26:14
get it. Prices are probably fair. Then I'd say, okay, do you think that international stock markets or small cap
00:26:23
stocks in the US move the same as the S&P 500? And I can show some on the charts. And the answer is they do not.
00:26:30
>> Some years small caps beat large cap, some year large caps beat small cap.
00:26:33
Sometimes by wide variety, like right now, this year alone, we're like not even two weeks into the year. I think
00:26:38
small value stocks are up like eight or nine% over the S&P 500. the large rate
00:26:42
in just just a very short period of time. Again, tough 15 years before last year. So, like not to read into the
00:26:48
thing I want you to know is they're just different for a moment, not better, nor
00:26:51
worse, but they're just different. So, now we can say we want to own stocks.
00:26:56
Stocks behave differently and prices are probably pretty fair. So, I don't know
00:27:00
why someone would only own 500 of them because the math works out that if you buy a little bit of every stock across
00:27:06
the whole world, you should expect lower volatility than an S&P 500. We can't
00:27:12
guess which stocks are better. We said prices are fair. Lower volatility is going to lead to higher realized returns
00:27:18
if that's how it plays out because volatility erodess returns, right? Like if we have a portfolio and we go up 10%
00:27:27
and then down 10%. We're not back to where we started. $100 up 10 then down 10 goes to 99. Bigger volatility spreads
00:27:35
larger decrease over time. So volatility will will erode your portfolio even if it's like the same numbers and they
00:27:41
arithmetically net out. All else equal. We want the same return with the lowest volatility possible. I would tell you
00:27:46
you want to do that through owning all 13,000 stocks across the whole world. if prices are generally fair than you would
00:27:52
just the S&P 500. All said, not a terrible portfolio from what you and I see out there, right? Like I see a lot
00:27:58
worse than that. You are betting on large stocks in the US. Obviously, some of them have international businesses
00:28:04
and so you might get some international exposure and the US is about 65% of the world and the S&P I think is about 85%
00:28:11
of the US. So you own about 50% of the global stock market in those 500 stocks because they're such large stocks. So
00:28:19
there's 13,000 in the world, but the top 500 in the US make up about half of the
00:28:24
market capitalization. So I would say like if you can really hang on like you're probably going to be just fine.
00:28:29
Is that really the investment journey I'd want someone to sign up for though?
00:28:32
>> Yeah, that's fair. Well, let's let's pivot to that then. And and I'm thinking
00:28:35
about if you could design the the default investment approach for a long-term investor, maybe this is your
00:28:42
own default long-term approach. Not that you have to give away your your own holdings or the secret sauce for for
00:28:48
Peltoma clients, but let me just ask you this, like what principles would be non-negotiable? I know you've already
00:28:54
covered a bunch of really good ones and I don't want to make you have to to restate everything, but but what do you
00:28:59
what do you do when you're designing a portfolio in that way? >> It's such a good question. And I'm going
00:29:04
to deflect it for a second just to say that the most important part of us allowing clients to realize the outcomes
00:29:12
that we've aligned on them with and to to live a bigger life and get what they
00:29:16
want is that we design a journey that they can stay on with us. The answer is first sort of like
00:29:25
how can I build some guard rails so this person stays in their seat. There's a
00:29:29
lot of ways to do it. One is going to be they're probably not going to own 100%
00:29:32
stocks, right? no matter who they are because that's a that's a really whippy
00:29:36
ride. So, they're probably going to own some bonds or something more conservative. Then, we're probably not
00:29:40
going to just put it all in one country like I was saying, the US example, but maybe you're an you're an international
00:29:45
investor and you live in France and you want a lot of French French stocks. I mean, I know Canada, there's some
00:29:50
studies about Canada, you know, that average home bias in Canada is over 50%. People in Canada have over 50% of their
00:29:55
stock portfolio in Canadian stocks. Canada's 4% of the world. That doesn't
00:30:00
make much sense given how the world looks and what prices have told us. That's a very heavy home bias. So I
00:30:06
would I would first and say, "Hey, I could probably use a bunch of different
00:30:10
tools. Vanguard, Dimensional, probably even American funds, active management. I don't even maybe like is you can stay
00:30:16
in your seat and I can get decent funds. I can get you where you need to go."
00:30:21
Then we're going to start again, we're going to have to pick how many stocks
00:30:24
and how many bonds. That's a decision that's going to get updated every year
00:30:27
through the planning work that firms like ours do, right? Like people's goals
00:30:30
change, their retirement hopes, spending, things like that. So that's another one of the outsized drivers of
00:30:36
your outcomes is just going to be how many stocks do you own, how many bonds you own because over time very different
00:30:40
expected outcomes and journeys. Then this is where I sort of having a career at Dimensional pivot a little bit from
00:30:47
the way I think a lot of people that work at a quantity eggy place like that is like I don't care that much about the
00:30:53
factors we just talked about. They make sense to me. It makes economic intuition
00:30:58
that small caps should do better than large caps. That said, like I've seen how noisy the data is and I got to make
00:31:05
sure this client is going to stay in their seat if I tell them, hey, look at this super smart firm Dimensional and
00:31:10
Gene FMA and we're going to overrate small caps blah blah blah and now all of
00:31:12
a sudden small caps suck for 15 years. That's a pretty tough investment journey. So the idea of tilting a
00:31:18
portfolio towards anything away from what clients see on the six o'clock news, you got to be very thoughtful that
00:31:24
if you stretch it too far and it doesn't work, you've introduced this probability
00:31:28
that they might not stay on this journey with you. So, what I'm always interested
00:31:33
in with clients, like I'll give you a great example in a second, but I am interested in ensuring that I do what I
00:31:39
can to decrease the probability that they will get off the bus with me. That means often I'm willing to sacrifice
00:31:47
expected returns, maybe own less value stocks or something because I'm afraid
00:31:51
that the tracking error towards what they see on the news or hear from their friends at the country club or something
00:31:56
like that might lead them to fire me and go buy an annuity from someone. That is
00:32:00
the most important thing. Here's here's the interesting thing about our firm and
00:32:02
where my partner Rachel Lavine and I almost disagree. Anytime a client has a lump sum of cash, I've never not
00:32:09
suggested dollar cost averaging for a meaningful amount of money. Yeah. So, we just brought this client Northern
00:32:14
California at $6 million and first thing I walked through was like, hey, I suggest you dollar cost average this.
00:32:20
All the spreadsheets say don't do it. If you Google it, it'll say higher return
00:32:22
if you just put it all in the market. I am telling you take your lower expected return because dollar cost averaging you
00:32:28
know you know if you have $6 million maybe you put in a million dollar every year for six years slowly get in we we
00:32:34
we wouldn't do it over six years we're doing it over about two years but a
00:32:37
little bit over time as opposed to all on day one if you look at the spreadsheet the spreadsheet answer
00:32:44
markets go up over time so it looks like most people would be better off looking
00:32:49
backward just having put it all in on day one but I don't like March and April
00:32:53
of last year. I know that the stock market can go down 5 to 10% in a single day. I was on a trading desk in 2008. I
00:33:01
have seen a lot of crazy stuff. I do not want any investor to experience what I've seen the day after they just put $6
00:33:10
million in the market or whatever it might be, whatever is a lot of money to you. That is a journey where I've
00:33:16
increased the probability that someone might get off the bus with me. With this client for instance, like I have
00:33:21
embraced a lower expected return because I know it increases the probability that we'll at least get to
00:33:29
where I want to get to with them. My partner Rachel, who's smarter than I am,
00:33:34
disagrees, not disagrees, I would say she likes to push back and remind clients, just so you know, you're
00:33:40
probably going to be better off if you just do this all at once. She likes to take, hey, why don't we coach them maybe
00:33:45
to be able to do it? I am just not comfortable with that because most of our investment lives are going to be
00:33:52
driven to the positive and the negative by 15 or 20 days. >> Mhm. >> Right. Like that is it. I mean back in
00:34:00
April the S&P went up 10% in one day. That is bonkers. >> It's that eight sigma event you wrote
00:34:08
about, right? >> Yeah. The eight sigma um on Friday, silver was down 30% in one day. A metal
00:34:14
that people have probably traded for thousands of years changes price 30% in one day. So we have these inflection
00:34:20
points 911 COVID great financial crisis tariff last March April where a handful of days drive such crazy outsized
00:34:30
outcomes in our life. So, a lot of times too, whether I'm trying to figure out,
00:34:33
do we dollar cost average this or do we own a little bit more small caps, some of these decisions to me are already
00:34:40
noisy, but also small in magnitude compared to what I know is going to happen in a journey with an investor,
00:34:46
which is we're going to see some crazy the next 20, 30 years together. And the more I can communicate that to them,
00:34:53
like we're doing, you're probably doing this too, like reviews for last year
00:34:56
right now and like client returns look amazing because Mark's doing really well
00:34:59
and like blah blah. And I'm just like telling everybody like do not expect this every year, right? This is three
00:35:04
years in a row now. >> I launched my firm three years ago. So I have like I couldn't have had more
00:35:09
serendipitous timing. I got to keep telling people, you know, set expectations that it's not always going
00:35:13
to be this way. We can't control risky assets. So I went off a little tangent
00:35:17
there, but let me tie back to the the comment I was making about factors, which is I think it's much more
00:35:22
important people build a portfolio they can stick with. You keep your fees low and your diversification high. I don't
00:35:28
really need to go much beyond that. We do tilt our portfolios a little bit. Most of our clients don't care. They
00:35:34
they just don't care. It's just not really what drives a lot of our conversations. But I think you cannot
00:35:39
argue with someone who just owns the market itself and really care more about what's the right weight of owning the
00:35:45
market, the stocks in my portfolio versus someone like bonds or real estate, whatever you're going to do.
00:35:49
Like be very thoughtful about the split between different profiles of risk assets. But whether you tilt with DFA or
00:35:56
Avantis or something like that versus Vanguard, that to me is less interesting because it's so noisy and we've just
00:36:02
seen it be so noisy the last few decades. So still love I love Vanguard and and Dimensional Anontis like they
00:36:07
all they all are great. I'm less interested by that than most people that work in our industry that like this kind
00:36:11
of quantity stuff. >> Going back to dollar cost averaging versus lump sum. I mean it's it's at one
00:36:17
point, you know, I'm an engineer originally, right? I'm a spreadsheet guy
00:36:20
and I'm show me the numbers and the first time that I went through the the whole lump sum math myself and I was
00:36:25
like well this is easy you always lump sum but then yes it's funny like if if
00:36:30
you only think like a calculator then you will come to the answers that a calculator comes to when you start
00:36:35
thinking like a human who's got this sometimes irrational brain in our head you realize that you can make decisions
00:36:41
that appear right on paper >> and maybe 70% of the time they work out in reality but that other 30% of the
00:36:47
time is really really painful I Conorman would call that loss aversion or some version of that. Something I've adopted
00:36:53
maybe like 80% of client scenarios that I've adopted is I explain to them the
00:36:57
the math of lumpsum versus dollar cost averaging. Maybe they already know it and I say I would propose this following
00:37:04
scenario where no matter what you're going to look back 12 months from now with about 50% regret because we're
00:37:11
going to lump sum 50% on day one and then we're going to take the other 50% and we're going to dollar cost average
00:37:16
it over >> Yeah. four, a six, a 12 month time span, depending on their preference. And 12
00:37:22
months from now, you'll look back and either say, "Oh, I wish I just lump
00:37:25
summed it all on day one." Or you're going to say, "Boy, I wish I dollar cost
00:37:29
averaged it all over 12 months or whatever." You might look back 5 years from now and be like, "Oh, now I see."
00:37:36
Cuz that's the other thing. It's it's hard to make a decision in the stock
00:37:38
market and then only 12 or 18 months later know whether it was smart or not. As we said before, these these are multi
00:37:44
multi multi-year decisions. So, it's a very interesting topic >> and they're they're binary, right? Like
00:37:50
binary financial decisions are so complex because as you described perfectly, >> we are going to look back and one of
00:37:56
these will have worked out better. How do I work on the the art side of you're
00:38:00
in my job to communicate the behavioral side of this which is that we have got to be comfortable with being wrong. But
00:38:06
you just have to get comfortable with it. We we just have to do the to make the best decisions we can with the
00:38:11
information we have at the time. And it's hard. Everybody wants everything. >> Here's a quick ad and then we'll get
00:38:18
back to the show. Serious question. Why do podcasters constantly ask for ratings
00:38:23
and reviews? Yes, they do help highlight our shows to new listeners. They help strangers find us on Apple Podcast and
00:38:30
Spotify. It's totally true and a good reason to ask for ratings and reviews.
00:38:34
But I have something more important, at least more important to me. I want to know if you like this stuff. I want to
00:38:40
know if you like my podcast episodes, my monologues, my guests, the information I
00:38:45
share with you and the stories I tell. I want to improve and make your listening
00:38:48
more enjoyable in the process. So yeah, I would love to read your reviews. And sure, if you throw a rating in there,
00:38:54
too, that's great. If you like what I'm doing, please share it with me. It's
00:38:58
such a great feeling to read your feedback. I'd love to read your review or see a rating on Apple Podcast or
00:39:05
Spotify. Thank you. I told myself I wouldn't turn this into an interview about chess, Ruben. But it is funny as
00:39:11
part of your introduction, I I mentioned your chess background. You're a very
00:39:13
accomplished chess player. It's so ironic that chess is this game where you can always look back and say, "Oh yeah,
00:39:21
boy, knight f7 was a pretty bad move there. I I miss I blundered. I missed something obvious like it is so black
00:39:27
and white. You can always look back and know whether you were right or wrong or or maybe you know in advance that you
00:39:32
were right or wrong when you make a move." But the world of investing and financial planning just doesn't work out
00:39:37
that way. There there's so much about the future that is unknown and there's
00:39:40
so much about the current problem quote unquote that is not solvable in the traditional sense. We just have to make
00:39:47
a probabilistic bet. And like all probabilistic bets, you you you try to make the one where the odds are in your
00:39:53
favor, the decision where the odds are in your favor, but you have to accept the fact that some percentage of the
00:39:58
time you'll be wrong. It's hard. It's not easy. It's one of the perils of the
00:40:03
last this meme mania we've kind of gone through is that you can't really assess
00:40:08
the quality of your decisions in investing by your outcomes. And that's sounds crazy to people, but you have to
00:40:16
assess decision quality rather than did I make or lose money, right? Like you can go to a poker table and be a
00:40:22
complete jackass and sweet poker is similar. You're per like you're spot on
00:40:28
that chess is different. I'll give a comment. It's it's probably better to
00:40:31
say like chess amongst good chess players is different. Obviously, you get bad feedback loop because the person
00:40:37
doesn't know how to how to make the right move and show you why you made an an error that that m. But if you look at
00:40:43
I wrote this post gosh probably three years ago on my blog called do chess players make good investors? I would
00:40:48
love to say yes. As you know like I grew up where where you are now. Rochester has an amazing chess center chess
00:40:53
center. I cut my teeth there. I was like a young chess master traveling the country and stuff. I owe it all to that
00:40:59
roster chess center. And when you play chess against good players, you learn very quickly. In a lot of things, you
00:41:07
have to take a lot of lessons. You get you need a coach. It helps obviously at some level to get a coach. But the
00:41:11
reality is if you have a quick feedback loop in anything life, you know, you got
00:41:14
to change directions. And if you good chess players play each other, you use quick feedback loop. You goof up, you're
00:41:19
going to get taught a lesson. my article that I wrote basically I just looked at
00:41:24
different sports and games like poker and back gammon and scrabble and chess and one way you can know how much luck
00:41:32
is involved is simply by how persistent is the world champion every year back in
00:41:37
like the 1880s this guy was world champion for 30 years in a row Magnus Carlson was present day
00:41:45
he's been world champion he's been best friend for like 10 15 years depending
00:41:48
you know tournaments are kind of weird how you get labeled, but like he's by
00:41:51
far like the best player in the world for 10, 15 years. There's information in
00:41:54
that. There's not that much randomness in if you see that. In chess, there's no
00:41:59
randomness. All the information is on the board. You might not know what to do with it, but there's no dice that get
00:42:04
pulled. There's no cards that get flopped, whatever. In poker, it varies a little bit, but if you look at like the
00:42:09
15 years like trailing, I believe like a few times the same person pops up. So, you say, "Okay, there's got to be some
00:42:15
randomness or luck, but you got to be pretty good at some point to be able to do that." So it can't be all luck. It's
00:42:20
not like the whole world's shooting dice, right? That's going to be a different. So it was really interesting
00:42:25
to look at that. And then back gammon has like a little bit of luck. Scrabble was fascinating because Scrabble to me
00:42:30
has so much luck. >> Yeah. >> But it's also so hard. Like you know,
00:42:34
you see Scrabble, it's ridiculous. So it was there's some persistency like maybe
00:42:38
somebody was like the last 15 years was like was world champion like four times and you're like okay. So they like got
00:42:43
good enough tiles and they're also just dirty. >> They know a lot of words I guess, right?
00:42:46
They just know words. >> Yeah. So the reality is like investing is so noisy that like chess players probably
00:42:54
don't make good investors. They expect that if they do the right thing then they get the outcome that they wanted.
00:43:00
If I play a really good game of chess, I will win. That does not work in investing, right?
00:43:06
That's why you need a really long time horizon. And like you were talking, I
00:43:09
need a I need a long time I need to be a long-term investor because I need some of this noise to net out. One great line
00:43:17
that my friend David Booth says is in in the long run, it's all about expected
00:43:21
returns. So, design the best portfolio you can and stick with it. Your expected returns over long periods should be
00:43:30
similar to your realized returns. So, if stocks do 8 to 10% on average per year and you have a 30-year horizon, you're
00:43:37
probably going to get close to 8 to 10% per year. In the short run, returns are really dominated by unexpected returns.
00:43:44
It's >> the stuff we don't expect to happen on the one-year basis. New news that pops
00:43:48
up or whatever. We have these drastic changes. I mean, last year emerging market stops were up 37% last year,
00:43:54
right? Like, who would have guessed that in the beginning of the year? Now, in the long run, these historical returns
00:43:59
that we can analyze, it's very uncommon that over even a 15-year period or longer that people haven't gotten around
00:44:06
10% every 15ear period. It's just been way more consistent than you would ever
00:44:11
guess. things just tend to net out where that is the price for doing business. If
00:44:15
you're going to go own other people's companies in a diversified way, you've
00:44:18
returned about 10% per year and that tends to make sense for the risk you're
00:44:21
taking. Super noisy in the short run. Short run is driven by unexpected returns, but in the long run driven by a
00:44:27
well-c calibrated expected return. >> That's awesome. Ruben, I feel like
00:44:31
you're more of a podcast pro than maybe you let on. I Well, you're you're the
00:44:35
way you explain these thoughts is just so crystal clear, at least to me. I I I appreciate the way you speak. I really
00:44:42
like the way you write and and so maybe can you just real quick tell the reader or tell the listeners, I'm sorry, a
00:44:46
little bit about Fortunes and Frictions >> and tell the listeners a little bit more
00:44:50
about Peltoma and and how they can reach out to you. >> Sure. Well, one of the other things
00:44:54
about investment managers like Vanguard or Dimensional or things we talking about is they have a lot of compliance.
00:45:01
So, if you work there, >> it's very hard to also maybe have a public presence. if you want to have a
00:45:07
podcast or have a blog, it's not their problem. It is just there's a lot of
00:45:11
regulation. Obviously, different fund companies might be more or less strict on it. But when I was working at
00:45:15
Dimensional, I've always had this creative itch and it was hard for me to use it while working at this sort of
00:45:21
very white collar, highbrow fund company. Not their fault. It was just a bit of a mismatch from personalitywise
00:45:26
eventually. So, when I left, I knew I wanted to do something creative and it was probably going to be a blog. And so,
00:45:32
I launched Fortunes and Frictions, I guess about four years ago. It's just fortunat.com.
00:45:38
I tend to just frankly I write about whatever the hell I want to write about. That's actually the best way to describe
00:45:42
it. What I care about and so what I write about tends to be some it's the art and science of what we do and the
00:45:48
things that investors face. I sometimes write about literature that's sort of
00:45:53
whatever whatever's on my mind. If I'm reading something cool, I'll find a way
00:45:56
to tie about. I'm writing something about prediction markets right now and Taylor Swift and whether Taylor Swift's
00:46:01
going to get married at the end of the year. just like by the end of the year just dropped precipitously
00:46:06
and I noticed when I saw that I was like I bet you everybody sees that and says oh my gosh what happened
00:46:12
>> right like what that's where our brain goes >> sure >> somehow in the stock market people don't
00:46:17
do that people all of a sudden think oh that's a that's that's cheap now or I
00:46:21
want to sell it or buy it it's like no something happened and now the price is
00:46:24
reset again and like so like I I have been working on this noodling it so nobody steal it but so I I I write about
00:46:31
just stuff that comes mind. I I've been lucky that some, you know, prominent
00:46:36
people in our industry have cared and shared it with others. And so, it's been
00:46:39
a really fun outlet for me. It's funny. Podcasts are I kind of wish I'd done a
00:46:45
podcast at this point. I really love writing, but podcasts are a little bit you just come and shoot like we're doing
00:46:50
today and then you hit publish. Some of these blogs might take me 15, 20 hours. And so, and I sometimes I'm like I think
00:46:57
a podcast probably have bigger reach anyway. Like I listen to more podcasts than I do read blogs. I enjoy writing
00:47:03
the audience. I mean I think maybe one unique thing about my blog is it's not
00:47:07
targeted to anyone. So to anyone that I'm trying to get to be a client and that comes across there's no ads on it.
00:47:13
Like no fault to anybody else but like it's an approachable blog because you
00:47:17
can tell I'm not spamming you with stuff. I'm literally like you're just
00:47:20
getting in my brain with me for a while. And so that's fun. And so it's it's sort
00:47:24
of intended as a as a gift to to people who maybe want to learn about investing in a different way than a textbook. So a
00:47:30
lot of the things just kind of teaching basic investment concepts through a lens
00:47:33
of whether it's pop culture or literature or something like that. So that's that part. I'm very active on
00:47:37
LinkedIn. That's sort of been my platform where I also write. I'm a little bit more playful on there and I
00:47:43
just kind of goof around. I always say kind of treat LinkedIn like it's Twitter. And as long as I'm the only one
00:47:48
doing that, which so far in our world I sort of am, that works pretty well. Someday people will catch on and realize
00:47:53
that's not a bad way to do it. So I'll lose uh my head start, but yeah, that's
00:47:57
mostly where people can find me. Then the firm Peltoma, we're a boutique raa
00:48:01
out of I live most of the year in Austin, Texas. And I have a business partner, Rachel Lavine. She also worked
00:48:05
at Dimensional and we have a third colleague Emily Moran. She also worked at Dimensional. We basically at
00:48:10
Dimensional when we were wholesalers, we saw hundreds of advisory firms across the US, across the world. And Rachel and
00:48:16
I just kind of said like, I kind of know what firm I'd want to be a client of.
00:48:20
let's go build it. And so that's what we've done. We worked for about se just
00:48:25
over 70 families and a couple institutional clients. Rachel and Emily are both I mean Rachel especially is
00:48:31
just a fantastic financial planner and Emily is quickly rising to do so as well. I focus a little bit more on the
00:48:35
investments and some of the business development, but we're you know people have this idea that you need this an
00:48:42
enormous firm. There's a lot of benefits to big firms like I don't have everything. If you want to be my client,
00:48:49
I can't prep your taxes. I got to outsource trust stuff. If we need some estate planning, I know how I know how
00:48:54
to do it. I know who to call like I can get it done. But definitely, you know, firms that wrap everything up for you.
00:48:59
I'm sure your firm has more robust capacities than mine. Just to trade-offs, right? Like how much how
00:49:04
much you want the person like how much you want to work with Ruben or Rachel versus like how much you really want
00:49:08
your tax prep tied in with your with your financial planner. So, we're really
00:49:12
we're a great firm for people that want to work with us, but boutiques have their trade-offs. At the same time,
00:49:16
large firms have their trade-offs where what you hear is always, you know, gosh,
00:49:20
I was working with Bobby last year and my dad worked with him and then Bobby passed me to Mary and now I don't even
00:49:24
know who my advisor is anymore. Like when you come to us, everybody knows kind of who your adviser is. And um it's
00:49:29
been a really fun run. It's a really fantastic business. And as you know, Jesse, like you get these emails from
00:49:36
people that are just like, "You've changed my life. I I don't know what we
00:49:40
were thinking on hiring you before or like what do we even do before you?" The
00:49:44
cool part about this job is that we get to serve people meaningfully. It's not
00:49:49
rocket science. You can make a really nice living and your clients love on you, you know. And so for us, what I've
00:49:56
really enjoyed the last couple years with our growth is that our clients are really rooting for it
00:50:01
>> and that's fun. Like I'm sure, you know, you have these relationship people and
00:50:04
they're really rooting for Jesse's success, right? >> And I see that in our clients that
00:50:08
they're excited about this this next phase of where our firm goes. It's not
00:50:12
cheap to run these businesses. So like it's a very premium product that we deliver. And for me, I think something I
00:50:18
think about a lot as a as a business owner is making sure that if someone else takes a meeting with one of my
00:50:24
clients, like someone else in my firm, like my clients are impressed. Thankfully, Rachel and Emily are both
00:50:28
smarter than I am. So that works for us. But as we grow, I do think about like how do we keep wowing people with the
00:50:35
caliber of people here. like any business like eventually we'll grow and have some turnover something like that
00:50:41
but for now the threesome of us is working really well. >> Thanks for sharing that story with us
00:50:46
Ruben and thank you for sharing everything with us today. Listeners we will throw all the relevant links into
00:50:51
the show notes and Ruben Miller thank you for joining us on Personal Finance for Long-Term Investors.
00:50:56
>> Thanks so much. >> Thanks for tuning in to this episode of Personal Finance for Long-Term
00:51:01
Investors. If you have a question for Jesse to answer on a future episode, send him an email over at his blog, The
00:51:07
Bestinest. His email address is [email protected]. Again, that's jessevestinterest.blog.
00:51:15
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00:51:26
on the next episode of Personal Finance for Long-Term Investors. Personal Finance for Long-Term Investors is a
00:51:33
personal podcast meant for education and entertainment. It should not be taken as
00:51:37
financial advice and it's not prescriptive of your financial situation.