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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. Hello and welcome to
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Personal Finance for Long-Term Investors, episode 130. My name is Jesse Kramer. By day, I work at a fiduciary
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wealth management firm helping clients nationwide. You can learn more at bestinterest.blog. blog/work. The link
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is in the show notes. By night, I write the best interest blog and I host this podcast. I also put out a weekly email
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newsletter. And all of those projects help busy professionals and help retirees avoid mistakes and grow their
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wealth by simplifying their investing, taxes, and their retirement planning. Later on in today's episode, Cullen Ro
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will be joining me. Cullen is a a plain spoken systemsoriented financial thinker, and I'd say he focuses on how
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money actually works rather than how people wish it worked. Unlike many, you know, maybe macroeconomic commentators,
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though, Cullen's lens is very much grounded in portfolio management and real world investing that applies to
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individual investors like us. He's concerned with how narratives about money can mislead investors into bad
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decisions. And I'm excited to share some of his latest thoughts with you all
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today. But first, we'll do a quick review of the week. This one comes from BAB3546,
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who says, "Excellent financial guidance, relevant, and transparent. This is the
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only financial podcast I listen to. Jesse is great at explaining difficult financial topics and his guidance aligns
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with what I believe helps the majority of investors. Also, I appreciate how transparent he is about any incentives
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he has related to his podcast or newsletter. I recommend signing up for the weekly email. Thank you, Jesse.
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Well, thank you, bab. I'd be happy to send you a supersoft podcast t-shirt. Just shoot me an email
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to [email protected] with your shirt size and address and I will get that t-shirt mailed off to you.
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And before Cullen joins us today, I wanted to share a couple thoughts about the intellectual side of investing in
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portfolio management. I think there's a funny conundrum that I found in the world of personal investing. You know,
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usually investors who overthink what it takes to build a portfolio, they usually
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end up underperforming in some way or at the very least they find that all that effort earned them essentially zero
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marginal gain. It was just wasted effort. And then again, investors who don't think at all about investing can
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actually, you know, do reasonably well, I would argue. But also, they they tend to float through the investing world
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with these really big misconceptions. And at times, those misconceptions can cause them massive damage. Personally, I
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think there's a Goldilock zone, though. I do think there's a Goldilock zone. I
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think it's important to to learn about investing and to keep learning about it.
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And you don't have to spend every moment thinking about it. you don't have to
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update your your spreadsheets on a daily basis and and rebalance on a weekly basis. But I think there are lessons
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that these eternal lessons that you can build upon and and keep learning about. I've built one upon the other and it's
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provided me with this I'm going to use the word steelier, right? The steely reserve against the the slings and arrow
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that the market can throw my way. So, we're not necessarily reinventing the wheel here with our investing thoughts
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or with being intellectual about the investing pursuit, but we are building up this framework of really solid ideas.
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And even if it doesn't make our investing complex, I still think learning more and more about it can only
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help us out. So, first I'm going to read to you guys from an article today that I
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titled Buffett's Way versus Index Funds. And it was inspired by a reader question. This reader wrote in and said,
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"Jesse, I appreciate everything you have to say on stock investing and lowcost
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diversified index funds. I also love all the Warren Buffett wisdom you share, but
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at least when it comes to investing, isn't Buffett a counter example to diversified indexing? How do we square
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that circle? An amazing question. And it's amazing question. And I I kind of
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think of this question. It's like that young eager dad walking up placing a baseball sitting on top of a tea. So
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that little Timmy, you know, that's me. I can step up with my $29 Walmart aluminum bat and hit a double out to
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left center field. Bam. So, thank you for that very nice setup. But this reader has a great point because the
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long-term investing, the long-term kind of passively based, lowcost diversified investing that we talk about here on the
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podcast that I write about on the Best Interest blog, that is not how Warren Buffett has invested over his long
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career. And I would actually argue that the last 10 or 15 years of financial media has basically misrepresented
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Warren Buffett's investment approach. I can go into that story a little bit, but
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basically it has started to say and and you will often find things that say things like Warren Buffett has all his
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money in an S&P 500 index fund. That's not exactly true, but if you follow me
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today, you'll see that there is a lot of common ground between Warren Buffett's
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investment approach and the kind of stuff we talk about here. You'll also see where the divergences exist and why
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they exist. And I'll present maybe some sort of unified theory of stock investing that connects diversified
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index investing with some sort of more individualized stock picking and business picking and it it unifies them
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with some same core logic. So anyway, let's talk about a couple of the core commonalities up front. Whether picking
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individual stocks or buying an index fund, investors ultimately buy ownership in real businesses. That's what we're
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doing here, right? Stocks are not lottery tickets. They are shares of companies. They are fractional ownership
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of those companies, of their current earnings, of their future earnings, of their future cash flows, of all their
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assets. That's what you are buying when you're buying a stock. And both Buffett
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style investing and indexing rely on the idea that a company is worth the present
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value of its future cash flows. I'll say that again. A company is worth the present value, the value today, of all
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of its future cash flows. We added up all the company's profits from now until
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judgment day, as Warren Buffett would say, and then we discounted those dollars back to today. That's what a
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business's intrinsic value is worth. But does a stock's price always match that
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stock's value or the company's value as we just described it 30 seconds ago?
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Well, that's where some of today's contention and confusion exists. I'd
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answer that question this way. I'd say that investors vote with their dollars.
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They'll buy or sell a stock if they perceive it as undervalued or overvalued. And on average over time,
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yes, we expect a stock's price to be somewhat correlated with the company's
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value, right? That's clearly the expectation. You wouldn't expect a stock's price to always be wildly
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different and uncorrelated to the value of the company itself. But there are periods periods of time when a stock
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price is disjointed from its underlying value. This is especially recognizable in retrospect, right? It's very very
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hard to recognize it in the moment. It can be very hard to recognize it with any sort of foresight, but given enough
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time in retrospect, that's when you can start to see it. This idea called the
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efficient market hypothesis or EMH. The efficient market hypothesis is the idea that all the buyers and all the sellers
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and all the traders on the in the stock market, they use all available information as best as they can to hone
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in on the proper price for a given stock. Now, it doesn't mean that today's
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price is guaranteed to be correct or perfect, per se, but instead it suggests that poor schmucks like me, and I'd
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argue like you, can't possibly know enough to know whether the market is right or wrong. Or put another way, the
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market, all those buyers and sellers and traders, the market has all the information about any given company,
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while you and I only have some of that information. Over time, there's no way
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that you and I can consistently outsmart the market or consistently beat the market's prices or just be more accurate
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than the assessments that the market is bringing to us. That idea, that is the pillar of index investing. You can't
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beat the market. So, why bother trying? Just buy everything at the market's given prices and then hold on for the
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long run. Now, let's pivot and talk about more specifically how Warren Buffett invests his money or how he has
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always invested his money because the efficient market hypothesis is is just one example of where Warren Buffett and
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his famous business partner Charlie Mer would very much disagree. They don't
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need to outsmart the market all the time. And they're not sure that they could outsmart the market all the time
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for what it's worth. But what they do argue is that they need to outsmart the
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market sometimes. They'd also say that they don't need to make really smart
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decisions about every single stock, but instead they should make very few investment decisions, but when they do
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make those decisions, they are smarter than the market. And sometimes they suggest that the stock market loses its
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mind. Basically, there's some sort of temporary insanity, some sort of ex irrational exuberance or some sort of
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panic. It could be widespread. It could be relatively narrow. Maybe most of the market is behaving efficiently, but this
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small corner over here is acting kind of berserk. But either way, Warren Buffett
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would say that there are times when the market is not efficient, is certainly not accurate in its pricing, does not
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give appropriate prices to particular stocks. And earlier I I mentioned, you know, this poor schmucks like me and you
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not having enough info to know whether the market was right or wrong on any given day. Well, Warren Buffett would
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say, I'm different than that. I do have enough info at times to know whether the
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market is right or wrong about a particular stock. And when Warren Buffett identifies one of those
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opportunities and if that opportunity has a sufficient margin for error around it just in case his math ends up a
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little too optimistic, well, that's when he pounces. And that's the method by
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which Warren Buffett has built his investing legend. Now, I really like this story. When faced with the idea
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that an investor could skillfully pick individual stocks like Warren Buffett did, and I will say for those who are um
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who really want to know, Warren Buffett did a lot less stockpicking than he did of buying individual private companies
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almost maybe like a private equity company would nowadays. Yes, he did some stock picking, but but a lot of his
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empire involved um you know buying the Nebraska furniture mart for example. It was a private furniture company in
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Nebraska. wildly successful business that Warren bought for a pretty reasonable price and now he's owned it
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for 40 years or something like that. Or Se's Candies is another one. If you're
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out on the West Coast, you know Se's Candies. I think Warren Buffett bought it in the '7s, I want to say. And it's
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just been this wildly successful investment that he bought an entire private candy company and he's owned
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that for the last 50 years. So anyway, that's how most of Buffett's success has
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been has been buying individual businesses, but yeah, he's picked some stocks, too. Anyway, back to what I was
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saying before. When when faced with the idea that an investor could skillfully pick individual stocks, the hardline
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index fund investor, the efficient market acolyte would invoke the famous coin flipping metaphor. And in fact,
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there's a famous debate where a business school professor, it was 1984 at Columbia University, and a University of
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Rochester, my alma mater, a University of Rochester finance professor named Michael Jensen challenged Buffett's
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investing record. And Jensen said, "If a large group of monkeys flipped coins and
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predicted if the coins would land heads or tails over time, a small number of those monkeys would by random chance or
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luck correctly predict the outcome of a lengthy series of flips." And and in
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essence, that metaphor is saying that Buffett's record, his stock picking record, his investing record is nothing
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more than Warren Buffett being the one lucky monkey, right? It's just a a lucky
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series of flips. But Buffett in his Midwestern folksy way, he took that metaphor and ran with it. What if he
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postulated, you follow Jensen's monkey metaphor and you get down to the best
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coin flipping chimpanzees in the world, only to find out that all of the best coin flipping chimps were raised in the
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same zoo? Well, it would beg the question, how could coin flipping be pure luck if all the best coin flipping
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chimps are from the same zoo? Surely, there must be something in the water at that zoo. There must be some sort of
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special training from the zookeeper. There must be some non-luck skill-based reason connecting all these winning
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chimpanzees. Buffett then laid out nine individual investors who not only beat the market but crushed the market for
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multi-deade periods between the late 1950s and the early 1980s. They weren't
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nine random or cherrypicked investors. Instead, all nine investors were students of Benjamin Graham and David
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Dodd, the two founding fathers of value investing. Ben Graham famously wrote the
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intelligent investor. He was Warren Buffett's kind of mentor and idol uh when Buffett was in grad school. But
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anyway, th those nine investors were all quote unquote raised in the same zoo, right? That is they all followed very
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similar value investing philosophies all from Graham and Dodd. And clearly Buffett would argue there must be some
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skill in their common investing approach. And that parable came to be known as the super investors of Graham
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and Dodsville. But there are some important caveats here too. Buffett does recognize that many people can't or
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won't invest the way he does. So, he's on the record recommending index funds
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to most investors. And that's where that story comes from where he has instructed
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that 90% of his estate be invested in an S&P 500 index fund for his heirs and for
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you know charitable giving in the future. So, basically what he's saying there is I can be smarter than an index
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fund, right? Buffett can be smarter than an index fund, but he recognizes that not everybody can be. I I think that's
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kind of a fair assessment. Also, another caveat. Buffett started investing in an
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era with basically no computer power, way less instant data, far fewer active investors looking for opportunities. The
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market was less efficient when he started investing. I think that's hard to argue with. But the real question for
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you listening at home is, can you follow that same path? It's not that the market
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is infallible. All you have to do is look at daily price movements to realize that the market is constantly wrong. But
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it is rapid to amend its previous mistakes. If it was perfect, why are the prices moving so much? How can it be off
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by multiple percentage points in a given day? The bigger question is whether you
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possess the insight and the information to recognize the market's mistakes, whether you have the patience to wait
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for the big mistakes and whether you have the fortitude to pounce on those mistakes when you recognize them. You
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know, do you want to invest that way? Most people don't. In fact, the data is
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clear that even most professionals who attempt to consistently outperform the market will fail to do so. It's really
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hard to do. Instead, most people should accept the returns of their diversified portfolio, build a financial plan around
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those returns, and then just move on. In other words, the efficient market hypothesis is probably wrong, or at
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least it has some clear flaws, but 99% of people should act as if it's perfectly right. Here's a quick ad, and
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then we'll get back to the show. Did you know my written blog, The Best Interest,
00:14:20
was nominated for 2022 Personal Finance Blog of the Year, and it's been highlighted in the Wall Street Journal,
00:14:26
Yahoo Finance, and on CNBC. I love writing, especially when that writing is to share financial education. And I
00:14:33
usually write one or two articles per week. You can read them all at bestinterest.blog.
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Again, the web address is bestinterest.blog. Check it out. And with that, let's bring
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Cullen Ro on to the show. Cullen is the founder and chief investment officer of Discipline Funds. And through his
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writing and research, he brings this rigor and nuance and realworld perspective to topics that are often
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either overly simplified or completely misunderstood. And Cullen recently published a book called Your Perfect
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Portfolio, which explores over 20 different investment strategies in a quest to find the best way for you to
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invest. All right, Colin, thanks for uh thanks for stopping by the podcast, man. And uh
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let's start with this cool term that I I've kind of uh previewed for the
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audience a little bit. You call it define duration and and just reading some of your research. It's almost like
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taking some sort of almost fixed income concepts of duration and applying it to stocks in order to maybe level the
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playing field when it comes to building the portfolio. But I thought if you could maybe you can start with just
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reminding the audience what duration really means especially kind of from a fixed income world. But then could you
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pivot and explain this term you use the point of indifference and how to apply the concept of duration to stocks. In
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the fixed income world the concept of duration basically means interest rate risk. It's really you're trying to apply
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a time horizon over which the instrument has principal risk. And so you can actually understand that for instance a
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a bond with a duration of five basically means that if the interest rate relative
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to that fixed income instrument moves by 1% in either direction the duration being five means the principal will
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change by 5%. So if interest rates go up by 1% the bond's principal value will
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fall by 5% inside of that period inside of like a one-year period. And so you have this very strict understanding of
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the the way the principle is related to the the time horizon over which the instrument might have a certain sequence
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of returns risk. And that's really the the kicker is that you can think of bonds in terms of a sequence of return
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risk outcome where when something bad happens you kind of know mathematically well what is my break even point in the
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long run? How long is it going to take me for for the interest that this bond is paying for me to get back to my break
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even point? And so you have this very quantifiable concept of risk across certain time horizons when you
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understand things like duration inside of bonds. And in the stock market, we don't really know how to apply that. We
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really don't even nobody even really applies time horizons at all to the stock market for the in a quantifiable
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way. And so when I talk about defined duration, I'm kind of trying to extend
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the the idea of bond duration to all instruments. And so when I'm defining the duration of the stock market for
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instance, what I'm basically doing is we're taking an assumed max draw down
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and an expected future real return and we're trying to to sort of estimate what
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is a reasonable time horizon over which this instrument might generate a real return, a real break even. And that's
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what William Bernstein has called your it's your point of indifference. It's
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where you become indifferent to the principal change of the instrument in real terms. And so this is basically a
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quantified way of applying the same principle where you're applying a sequence of returns to the instrument.
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So for instance, if the stock market fell like 50% and you had a certain expected real return, you could quantify
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what is the time horizon over which that instrument would generate a real return
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where you kind of break even. And the the historical defined duration of the global stock market has typically come
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out to like 15 to 20 years. And so if you apply this sort of a a reasonable max draw down, something like a 50% draw
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down and then an expected average annual return, the real return break even point
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is about 15 to 20 years on average applying that sort of a methodology. And so this allows you to start to apply a
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time horizon to the the stock market. In essence, you're applying a sequence of
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returns risk expectation to the stock market because this is what every especially retirees, it's what every
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retiree worries about is am I going to retire into 2008? The stock market falls 50%. I I'm undergoing a 4% withdrawal
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rate, which suddenly turns into an 8 to 10% withdrawal rate when my portfolio gets cut in half or something like that.
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It's every investor's worst nightmare. And when you can start to quantify this
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out, what it allows you to do is it allows you to start doing what's called more of a an asset liability matching
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methodology where just for background, I I worked with banks after the the financial crisis because I did a lot of
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wonky sort of macroeconomic analysis on quantitative easing and what was the impact of interest rates and whatnot on
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on bank balance sheets and bond portfolios primarily. And I realized working with banks that all my retail
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investors that I work with have the same problem, the same temporal mismatch cuz
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bonds banks borrow short and they lend long. They have an asset liability mismatch in their and they have they
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have to be very very conservative about how much that mismatch is actually differentiated because if you're not
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careful about it, you end up like Silicon Valley. >> Silicon Valley. Sure. But the funny
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thing is that retail investors have the exact same issue. I realize when a retail investor sells into a bare
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market, what's really happening psychologically is they're selling stocks, they're selling a long duration
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instrument because they want the certainty of a short duration instrument. They're buying cash, selling
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stock because they're realizing that hey, they don't have enough certainty in
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their portfolio. they don't have enough safe assets to give them the certainty
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to ride out the volatility of the stock market. And so when you can begin to then build in sort of an asset liability
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matching process to a retail investor's investing methodology, you can start to
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build what is basically like a I mean it's kind of like a bucketing strategy
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or like a a structured ladder portfolio, but you're embedding the stock market
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into all of this now where you know, for instance, you can build out a let's say
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a 0 to 10year bond ladder that is pure fixed income and you just have this rolling ladder and then if you're able
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to quantify the defined duration of the stock market, you can actually start layering other assets in where you can
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sort of quantify the sequence of returns out to like 30 or 40 years in theory. So, and then you can start thinking
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about everything and reframing everything in time horizons rather than the way we currently do asset management
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for the most part is basically like okay here's a diversified portfolio of let's
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say 60 40 stocks and bonds and I've run your retirement analysis through 10 million Monte Carlo simulations and you
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have a 99% odds of success and not running out of money and that's great. It's a good process, but it doesn't give
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people an understanding of what they really want, which is when am I going to have money at certain times in my life.
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Am I going to have $50,000 to buy a car in 2 years? Am I going to have $150,000 to send my four-year-old to college in
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15 years? Am I going to have $2 million in 20 years when I'm 65? And that's what
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people want to know. And when you can start to sort of reframe everything in time horizons and then quantify it, you
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know, there's still there's guesswork that goes into all of this obviously
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because you're guessing, you know, you're assuming max draw downs, you're
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assuming expected future returns, but you're beginning to quantify this in a
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way where it becomes much more rigorously sort of attached to a quantifiable process rather than the the
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guesswork that goes into just saying here's a diversified portfolio. I understand your risk profile to some
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degree. And we're pretty sure that you're going to have enough money, but
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we're not really sure if you're going to have the money in certain buckets when
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you really need it. It's just a fantastically deep answer. But let me play a devil's advocate on behalf of
00:23:00
some listeners because I skew maybe a little more conservative than some of my listeners and they give me some grief.
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And some of the numbers when you just mentioned that 15 to 20 year duration for stocks, I bet you you perked up a
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few ears. So a few of the quite a number of listeners maybe they come from that the FIRE background maybe they're bogal
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heads they've seen some data that says like well in twothirds of years stocks
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outperform bonds or maybe in twothirds of years stocks have a positive nominal return. So that's one baseline. Another
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way of thinking about it is if I look at all fiveyear periods over stock market history stocks are positive 88% of the
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time. If I look at all 10ear periods stocks are positive 93% of the time. I know those numbers might not be precise,
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but the point is that I would wager a lot of people if you just describe asset liability matching to them, which is a a
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terrific topic. I've I've brought it up a couple times before, even I sometimes
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when I'm describing it say, "Yeah, once you're 8, 10, 12 years out, time to
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start sprinkling in stocks." Mhm. >> When you said that 15 to 20 year
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duration, does that mean that typically when you might be doing a financial plan, you're going to wait until year 15
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before sprinkling in stocks or what exactly does that look like? And and maybe also where does that 15-year
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number 15 to 20-year number where does that actually come from? Yeah. So you're
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actually running the math on the I mean it's basically just the assume a max
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draw down and then assume an expected real return and that that will you can then quantify what is the defined
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duration based on the math there. So that's where the actual figure comes from and and I'm extrapolating this from
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for instance in the current environment it's kind of a nice time to to be articulating this because there's this
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really big disparity in valuations for instance across the tech world uh even the the domestic United States has you
00:24:49
know a huge disparity in valuations but the global uh stock market especially where you know US cape ratios are like
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40 and foreign markets for the most part are something like the low 20s and this
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is It's a gigantic unheard of sort of disparity. And when you extrapolate that
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out, what the one of the things that we know is that the expected future risk adjusted returns of stocks, they're
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pretty highly correlated to cape ratios cuz cape ratios reflect basically expectations. When expectations are
00:25:19
really high, stocks tend to generate not necessarily lower returns. I think this
00:25:23
is the mistake some people make. >> It's not that stocks necessarily have to
00:25:27
generate lower returns. it's that they're likely to generate more volatile
00:25:31
returns, meaning that your sequence risk is higher. So, if you bought the very tippy top of the NASDAQ bubble back in
00:25:39
2001, you generated an 8% return since then, but you had to go through what was it 15 years of absolute trauma to even
00:25:50
break even in real terms. And so you went through a not necessarily a lower return, but you went through a much more
00:25:58
volatile period of returns. And so that's part of what we're trying to extrapolate out here. And so the I think
00:26:04
what we're we're doing to some degree is we're trying to communicate the
00:26:08
potential risks here. And the you know that 15 to 20 year number what it does is it gives you kind of a baseline for
00:26:14
understanding well what is a reasonable time horizon over which to judge the stock market. We we say things like, you
00:26:21
know, stocks for the long run or, you know, whatever it might be, but rarely is that number ever quantified or put
00:26:27
into some sort of context. You know, you're framing it nicely in s terms of like the the probability of certain
00:26:33
outcomes over certain periods. And yeah, you're right. It with the stock market,
00:26:38
you know, over rolling 5, 10, and 20 year periods, the stock returns are something like 88 to 95 to 99% positive.
00:26:46
And but what that 15 to 20 year number does is it it gives you a baseline number for understanding where the stock
00:26:53
market fits into a portfolio. And then you can start to blend things. And that's what's that's where this whole
00:26:58
process gets kind of cool for me at least is that you can start blending instruments. You create multi-asset
00:27:04
instruments inside of a portfolio where for instance a 60/40 portfolio right now
00:27:09
has roughly like a a 14-year this is a global 6040 has roughly like a 14-year defined duration. So and if you did
00:27:19
something that was like a you know an 8515 bond stock portfolio that might have more of like a 5-year defined
00:27:26
duration. And so when you blend things, you can start building multi-asset instruments that or embedding time
00:27:33
horizons into the portfolio methodology where you can communicate to somebody that hey in my Roth IRA, which I'm not
00:27:40
going to touch for 40 years, I'm loaded to the gills with AI stocks, technology,
00:27:47
I'm actually loaded to the gills with VTI or like the the absolute riskiest stuff in a portfolio that you could
00:27:54
possibly have because I know that the time horizon of that is extraordinarily long. I don't have to worry about the
00:28:00
sequence of returns risk. Whereas, you know, if someone's got a taxable account
00:28:04
where let's say they're they're drawing it down every month and they're living
00:28:08
off of the portfolio, they need a lot more certainty in there, you probably need something that has an average
00:28:14
defined duration in there that is much shorter on average because you're probably frontloading it with who knows
00:28:19
like treasury bill ladders or CDs or something like that. It's much more front-loaded. So, you've got liquidity
00:28:24
in there. you can start to build this out in a way where you're communicating
00:28:28
the time horizons over which all of this is certain serving very specific financial purposes. And so that's kind
00:28:35
of the the goal of trying to quantify this to some degree is to communicate it better to the client so that they can
00:28:42
kind of compartmentalize things and see and understand okay I know the role of the T bills in my portfolio. And this is
00:28:49
the other kicker is that it actually gets you away from per performance chasing because when you look at it
00:28:55
through the lens of the time horizons, you sort of know, well, I don't care that my my T bills are going to
00:29:02
underperform. Of course, they are. My taxable account that's loaded to the gills with short duration stuff, it's
00:29:06
going to underperform the S&P 500. I know that it's designed to do that.
00:29:11
Whereas, you know, maybe my Roth IRA that's loaded to the gills with technology and, you know, growth stuff.
00:29:17
That's where you can get sort of the sexy high performance from a portfolio.
00:29:21
But you segment things in a way where it's communicated very clearly that hey,
00:29:26
each bucket or each portfolio is sort of serving a very specific role as it pertains to my financial plan. I think
00:29:33
if I can summarize part of your answer, it's that the defined duration of 100%
00:29:38
global stocks, yeah, that's 15 to 20 years. But the defined duration of 30% stocks, 70% treasuries, well, that might
00:29:47
have a defined duration of 8 years. So if I'm matching that future liability in
00:29:52
2035 of my retirement, eight or nine years from now, to a particular asset, maybe that what did I just say? 30%
00:30:00
stock, 70% bonds. maybe that's the right asset to match to that future liability.
00:30:04
And so in that way, as I'm building my asset liability ladder, stocks do enter
00:30:09
the picture before year 15. It's just in a muted way. It's not dissimilar to what
00:30:14
target date funds do to some degree where a target date fund, you know, a 2060, it was funny actually, somebody
00:30:20
asked me this. They sent me an email the other day about Van, one of Vanguard's
00:30:23
2060 target date funds. And it's like 9010 stocks bonds. And I thought about
00:30:28
that through the lens of a defined duration process and I said gosh that thing's got a 35 year time horizon that
00:30:35
10% bonds are serving zero purpose. They that portfolio should be probably 100% equities. It might even need to be
00:30:44
there's an argument that it could be just growth stocks and like or like you
00:30:48
know higher growth stuff because it's d defined duration would be so long. But
00:30:52
target date funds are a good sort of corlary to this because what I'm really
00:30:56
trying to do is I'm almost trying to like break down target date funds into components where you can now take the
00:31:03
same sort of concept of a target date fund but apply it to your portfolio in a way where okay I have a target date fund
00:31:11
for the car purchase that I'm making in two years. I have a target date fund for
00:31:16
my daughter's college in 15 years. I have a target date fund I'm applying to,
00:31:21
you know, my retirement in 30 years or whatever. And you can customize this and blend it though in ways where the
00:31:28
portfolio is very temporally weighted in this more structured manner. Here's a
00:31:34
quick ad and then we'll get back to the show. I send a free weekly email to thousands of readers that shares two
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00:32:24
One thing you said multiple times, Colin, is real returns, right? Everything you're talking about today is
00:32:27
real returns, inflation adjusted returns, which brings up inflation risk. So for our audience of kind of DIYers,
00:32:33
retire, retirees, people thinking about retirement largely on their own, inflation risk is definitely a scary
00:32:39
one. How do you tend to incorporate inflation risk into I'd say your your research writ large and and your
00:32:46
financial planning thoughts writ large? >> Yeah, I mean it's hard because you you
00:32:51
have to predict inflation in a financial plan. Anytime anyone goes through financial planning software, we all have
00:32:59
to sort of embed you know an assumption about what is the future inflation rate going to be. So you know this sort of
00:33:05
macroeconomic analysis comes into all of this to some degree. don't want to get
00:33:09
like too deep in the weeds about like how to do that or you know a a very simple way is sort of a what's called
00:33:15
like an extrapolative expectations process where you're you're basically
00:33:18
just extrapolating the past into the future you know that probably comes out to what like three 3 and a half%
00:33:24
something like that you know that's not a bad approach I think that the you know
00:33:29
going forward I've made arguments that the probability of kind of returning to
00:33:34
like a precoid type of inflation environment is relatively high just cuz I think that the two big trends that are
00:33:41
going on presently the basically the demographic trends where the United States is just we're not producing as
00:33:47
many people and the population itself is getting older that's a recipe for kind
00:33:51
of lower demand and that's been something that's kind of been in progress for basically 40 years and but
00:33:58
the other big one is technology technology and especially AI once the robots really come online and they start
00:34:05
to really ramp up production of everything, you know, because the robots will never stop working. They'll never
00:34:10
stop making stuff. We really are in a world of abundance there where you get this potentially lower rate of inflation
00:34:17
because the supply problem is just solved across so many different sectors of the economy. But that creates a
00:34:23
paradox also where inequality is probably much higher and you probably have more demand for something like a
00:34:30
universal basic income. government fiscal policy is probably much more important, much larger in that sort of a
00:34:37
world and you potentially get inflation from that. So I wrote in a you know a recent sort of blog post the 2026
00:34:44
financial planners outlook that something in that 3 to 3 1/2% range is probably pretty reasonable because even
00:34:51
if we get a return to like 2 2 1/2% inflation you should expect sort of co-l like shocks along the way and that could
00:34:59
come from a recession in which the the Fed and the Treasury respond with big time stimulus and you get these sort of
00:35:07
a bumpy sort of inflation where you maybe not a COVID, you know, style jump in inflation, but you get a response
00:35:14
mechanism that results in say, you know, a shock of four to 5% temporary inflation that then, you know, those big
00:35:21
tailwinds they or those big inflation headwinds that I talked about before, they ultimately operate like a magnet.
00:35:26
They suck the inflation rate back down because they're such they're just huge
00:35:31
secular headwinds to inflation in the long run that they're going to they're
00:35:34
going to continue to sort of pull the inflation rate back down to, you know, say 2 to 3%. But I think that's a pretty
00:35:40
reasonable expectation, but it's a it's something that we all have to estimate
00:35:45
and it's a hugely important part of the equation. I think it's typically better
00:35:50
to be a little more conservative about the estimate. So even if the Fed has a 2% target or something or let's say that
00:35:57
inflation over the last 15 years has averaged like 2 and a.5%. I still think it's reasonable to sort of air on the
00:36:04
more cautious side. And so that's just typically how I operate as an adviser
00:36:09
anyway is I you know like part of why I use a I use a 50% max draw down in the defined duration concept because I'm
00:36:15
assuming almost like a sort of a worst case scenario you know or a realistic large draw down that's not uncommon
00:36:23
especially in in real terms and so it's sort of plan for the worst and hope for
00:36:28
the best approach and yeah if you cover those bases then you know you really do have a much higher probability of
00:36:35
actually understanding what are the likely outcomes across even you know the worst sort of scary types of
00:36:41
environments. >> You mentioned uh fiscal stimulus in there. You said you know it's possible
00:36:45
that inflation might rear its head if there's a a recessionary shock and the
00:36:50
government responds with a big injection of fiscal stimulus. This doesn't come up
00:36:54
every day but I think there's a pretty good subsegment of maybe the American
00:36:58
populace and retirees too who look at government stimulus. They might not know what the modern monetary system is, but
00:37:06
that's kind of part of it. They worry about fiscal policy. They worry about increasing levels of government debt in
00:37:13
and how that might affect long-term market outcomes, long-term inflation, and therefore how those things might
00:37:18
affect their retirements. What are your thoughts again kind of from some of your
00:37:22
macro research, from some of this long-term research you do? I mean, should retirees be concerned about those
00:37:27
things? Gosh, I mean I I feel a ton of questions about like is social security going to be a thing, you know, in 20 in
00:37:35
five years? You know, I have people who worry it's going to go away tomorrow.
00:37:39
It's weird from a sort of understanding the principles of the monetary system.
00:37:43
The I think a lot of people think of the government as something that is going to
00:37:47
run out of money, which is also it's a weird narrative because most people also
00:37:51
understand that the government has a printing press. And so the whole idea of the government running out of money is
00:37:56
sort of nonsensical. It's the thing that makes the government unique is that they
00:38:01
they don't run out of a line of credit. They can run into an inflation problem
00:38:07
where they're creating so much money that the demand is functionally falling
00:38:12
for that money because they're just creating so much more of it that the amount of money relative to the supply
00:38:16
of goods and services out there is shrinking and that results in higher consumer prices for instance. But the
00:38:23
government doesn't run out of money. And so the the capacity for us to afford
00:38:28
things like social security or Medicare is theoretically infinite. It's just a
00:38:34
it's a balancing act to the for the especially for the United States where we're such a productive economy that
00:38:41
that's the thing that really matters is it's it's how much are we producing
00:38:45
relative to the amount of money we're also creating. And so it's a balancing
00:38:49
act for the government to to balance that out. But it's a big part of why we
00:38:54
haven't had high inflation in the United States over the last 40 years is because
00:38:59
we are the wealthiest, most productive economy in all of human history, basically. And so there's that's another
00:39:06
sort of big headwind to high inflation ever taking off is that part of that assumption that we're going to encounter
00:39:13
something like a return to the 1970s or a you know a huge high inflation rate a hyperinflation sort of event is that
00:39:23
most Americans are going to wake up and suddenly start being like I don't like
00:39:26
making money. I don't like making stuff. I don't want to be rich. Uh I don't want
00:39:30
to be productive. which is just there's something in our DNA that sort of seems
00:39:34
antithetical to that for better or worse. I don't know if that's even necessarily a good thing, but it's it's
00:39:40
a certainly a good thing in terms of being able to produce lots of stuff. And being able to produce lots of stuff
00:39:46
means that it's very hard to produce very high inflation because the government just can't create enough
00:39:52
money. And so it's an important thing to understand I think especially I don't
00:39:55
like to get too sort of deep in the weeds about monetary dynamics with especially with clients and people like
00:40:03
that because it's it can be counterproductive to a large degree because it's just not a it's not
00:40:09
something that I think most people really need to worry about. It's worthwhile understanding the dynamic so
00:40:15
you're comfortable with it so that you feel comfortable enough to sort of you
00:40:19
know like I feel this question with bonds a lot like are the you know are interest rates going to surge because
00:40:24
you know the government is going to run out of money and then the you know all the credit instruments are going to go
00:40:29
to zero or something and it's like well no that's not functionally possible. So,
00:40:34
you know that you could have a high inflation in which the Fed has to reset interest rates and stuff and that will
00:40:40
obviously have a big impact on the bond market, but that's a totally different
00:40:43
dynamic than a company running out of money and experiencing a credit event. So, it's a very different dynamic and
00:40:49
it's it's important to understand that stuff, but you don't want to get too
00:40:54
deep in the weeds on that because then you you get into the, you know, the Zimbabwe rabbit holes that become sort
00:41:00
of counterproductive. >> No, it is funny. I think there's a a totally un understandable kind of human
00:41:06
psychology trap which is you know we take the rules and regulations that apply to us as individuals and we try to
00:41:13
apply those rules and regulations to other circumstances in life thinking that there's a parallel. Unfortunately
00:41:19
the rule that as an individual you probably shouldn't spend more than you earn and you certainly shouldn't spend
00:41:24
more than you earn for a really really long time and go further and further into debt. It's a great rule in personal
00:41:29
finance. Yeah. But it very much legitimately does not apply to the way that the US government works. As weird
00:41:35
as that is to think about. >> Well, that's weird, too, cuz the government should try to nudge us to be
00:41:42
productive and they should incentivize us to do things that are productive in the long run and whatnot. But at the
00:41:48
same time, the government is a weird instrument or a weird entity because they're in a lot of ways they're like a
00:41:53
nonprofit. They don't have to generate a profit, but in a lot of ways, they have
00:41:57
to actually do a lot of the things that capitalists don't want to do or the things that capitalists actually are not
00:42:04
very good at making money at or can't make money at. For instance, like running a military, building things that
00:42:09
you're going to destroy, you know, like armaments or bombs or whatever, and then
00:42:13
having a workforce that you might literally see get killed is a really bad way to run a business. And so, you know,
00:42:21
running a military is obviously not a profitable endeavor from the government perspective and it's not designed to be,
00:42:26
you know, so the government to some degree, not just in terms of running the military, but also running like a safety
00:42:32
net and, you know, trying to take care of some of the people who can't take care of themselves in society and
00:42:37
whatnot. You know, those are functions that are not going to be profitable. And so it to for the rest of us out there,
00:42:43
there is a certain degree of sort of like loss acceptance involved in that that we're going to say, okay, well
00:42:48
maybe we accept a lowish rate of inflation, understanding that well, every retiree is getting social security
00:42:55
and that's a good thing or you know, we have a military that can defend us and
00:42:59
that's a good thing even if there's an inflation impact from the costs that are
00:43:02
incurred along the way. Well, I know we've kind of gotten into a couple more
00:43:06
complex subjects there, Colin, but uh one thing I think about is how to find that balance between, yes, understanding
00:43:13
the complex things and in some cases tackling the complex things inside our financial plans, inside our retirement
00:43:18
plans, but still balancing enough simplicity so that we can actually function within our retirement plan. or
00:43:26
you know I think about you know how does a DIY investor for example balance simplicity of like indexing with some
00:43:32
sort of tactical risk management not necessarily chasing returns like you know how much juice is worth the squeeze
00:43:39
in terms of these this financial planning exercise that we're doing so I'm just curious because like I said you
00:43:44
you get into some really interesting complex topics but then you distill it down into some pretty simple outcomes
00:43:50
and and pretty simple takeaways so I just I'm looking for any tips or tricks
00:43:53
that our listeners can walk away with today of of how to find that balance. >> It's hard. You know, Christine Benz from
00:43:59
Morning Star wrote a a great article. Uh it was about a month ago, I think, about
00:44:04
optimizers versus what she calls satisficers. And you know, and it's the that balancing act between, you know,
00:44:10
trying to optimize and tinker with every aspect of your portfolio versus the just
00:44:14
defaulting to something really really simple. And it's hard. Everyone's different. That's the thing that is
00:44:21
really important to understand about especially portfolio management. I actually am in New York right now in a
00:44:26
hotel room because I'm promoting a book called Your Perfect Portfolio. And the
00:44:30
whole gist of the book is basically that your portfolio needs to be perfect for you. It can't be what somebody else is
00:44:37
selling. You know, don't listen to the guy talking about defined duration and
00:44:41
be like, "Oh, I need to buy that because it's he seems smart or he, you know,
00:44:45
seems smart enough and, you know, seems like a good strategy or I read this risk
00:44:49
parity strategy from Ray Dalio. He sounds he's he runs the biggest hedge fund in the world. I got to buy that
00:44:54
one. You know, you got to find what works for you. And that is very much like the analogy I use in the book is
00:45:00
it's very much like finding a spouse in life. You have to find someone who works
00:45:04
for you. And you have to understand that there's going to be ups and downs and
00:45:08
you have to stay loyal and committed. You know, I I interviewed William Bernstein in the book and he wrote about
00:45:13
how the the suboptimal portfolio that you can stick with is going to be better than the op the theoretical optimal
00:45:19
portfolio that you can't stick with. And he's trying to communicate that, you
00:45:23
know, you might have this theoretically optimal portfolio where you've back tested it. You looked at all the numbers
00:45:28
on it and that thing whipsaws you once and you say, "I can't do this." So you
00:45:32
sell it into a bare market. And when you do that, that theoretically optimal portfolio is serving you worse than
00:45:38
something that, you know, if you just gone out and bought like a, you know, a 60/40 portfolio or, you know, I also
00:45:45
interviewed Taylor Laramore who came up with the three the bogalhead three fund portfolio in the book and that's like
00:45:50
the simplest portfolio that exists out there. So it's but it's a balancing act
00:45:54
too cuz like I wrote in the book that the bogalhead three fund portfolio is brilliant in so many ways but arguably
00:46:02
the biggest flaw in it is that it might be too simple because it's basically
00:46:06
just two buckets. It's you know in inside of my framework I would say well he's really only constructed two time
00:46:12
horizons. And so what happens in a 2022 when both of those buckets go down a lot
00:46:19
and does that scare you? I think for a lot of people it does. Or does it make you question it to a point where you
00:46:25
say, you know what, I only own stocks and bonds. I don't even have a lot of temporal diversification in here. I kind
00:46:32
of wish I had bought gold or I wish I had bought, you know, managed futures or some sort of something that was truly
00:46:38
uncorrelated. And so it's a process that everybody has to go through for themselves and sort of understand, you
00:46:45
know, the the risks and the, you know, the different ways that all these instruments and strategies work. And you
00:46:51
have to find something that works for you. And that's part of also being a a
00:46:56
decent financial advisor is that you can help people sort of understand how to do
00:47:02
that. And you can most importantly even if the process is imperfect which is it's always going to appear imperfect at
00:47:09
sometimes in fact that's part of the benefit of diversification is that Brian
00:47:13
Portoi says that diversification is learning to hate some part of your portfolio all the time and weirdly
00:47:21
that's exactly right because when everything's operating the exact same way it probably means that when things
00:47:28
go haywire they're going to be operating all the same way and that means you
00:47:32
maybe you're not diversified enough. And so learning to hate some part of your
00:47:36
portfolio that is down is weirdly sort of a good thing because it means that your portfolio is oper it's operating
00:47:42
the way that it should be in a diversified strategy and so but at the same time everyone has to find you know
00:47:48
the right balance of that and you know you have to mix in things like taxes and fees and it can get very very complex
00:47:56
very very quickly. So I I don't know if I would describe myself as an optimizer
00:48:01
or a satisficer. I think I'm kind of in the middle to some degree where I've
00:48:06
tried to sort of distill a strategy that is can be very very simple but is still
00:48:12
optimized to a specific financial plan. But that's just me. There's a lot of
00:48:17
people who will hear terms like define duration and sequence of returns and be like, "Oh, okay. This is this is just
00:48:24
nonsense jargon." And you know, I need something that boglehead three fund portfolio sounds really nice to me. And
00:48:30
if you can stick with it, I mean, that's great. That's, you know, that's the
00:48:33
whole Bill Bernstein thing is if you can you build something that's simple, lowcost, tax efficient, and you can
00:48:38
stick with it through thick and thin, you know, like that's really hard to beat. That's awesome. So, it sounds like
00:48:44
on the spectrum of optimizing to satisficing, you have found an asset mix that is perfect for you, Colin. And
00:48:52
that's the name of the game. You have found your perfect portfolio. >> Yeah. With perfect for me. Yeah.
00:48:58
>> Perfect for you. If listeners are curious and they want to I mean you're a
00:49:02
prolific writer. You mentioned your blog. I've read your white papers and now with this book I mean let's let's
00:49:07
talk about the book cuz in case listeners want to pick up a copy, but then also if people just want to start
00:49:12
following your work more closely, where can people find you? >> Uh so the book is called Your Perfect
00:49:16
Portfolio. And the book I wrote 10 years ago, Pragmatic Capitalism is sort of wonky and macroeconomics and frankly
00:49:25
like I was reading parts of it. I was like, man, this book is terrible, just boring. But this one's a lot more
00:49:31
fun and it's it's explorative. I basically I write about some principles
00:49:34
of portfolio construction and then I write very specifically about 20 or so different strategies and, you know, they
00:49:41
range from very simple to much more complex, but for the most part, it's all
00:49:45
very approachable. And I wrote it in uh, you know, sort of I'm a dad now. That
00:49:50
was the biggest difference between now and writing my my first book. And so I write lots of terrible dad jokes in
00:49:55
there. So I tried to be a little more playful. I try to not dumb it down, but I try to write it in a very approachable
00:50:02
and understandable way, but also I write a a sort of bloggy newsletter called Discipline Alerts or from the the
00:50:08
Discipline Funds website. And I sometimes they're more wonky, sometimes they're, you know, they're just sort of
00:50:15
weekend thoughts of kind of my ruminations about what's going on in the world, why tariffs are good or bad or
00:50:22
why, you know, the debt ceiling is another nonsense, you know, conversation that we're having once every 3 months or
00:50:28
so. And this is why it's a nonsense conversation. And so I get into a little
00:50:34
bit of politics, a little bit of just, you know, everyday life, and a lot of sort of, you know, important investing
00:50:40
concepts. >> Well, we'll link to all those resources in the show notes, Cullen. And, uh,
00:50:44
thank you so much, Cullen Rosh, for joining us here on Personal Finance for Long-Term Investors.
00:50:49
>> Thanks, Jesse. Great talking to you. >> Thanks for tuning in to this episode of
00:50:53
Personal Finance for Long-Term Investors. If you have a question for Jesse to answer on a future episode,
00:50:59
send him an email over at his blog, The Bestinest. His email address is [email protected].
00:51:06
Again, that's jessevestinterest.blog. Did you enjoy the show? Subscribe, rate,
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and review the podcast wherever you listen. This helps others find the show and invest in knowledge themselves. And
00:51:18
we really appreciate it. We'll catch you on the next episode of Personal Finance
00:51:22
for Long-Term Investors. Personal Finance for Long-Term Investors is a personal podcast meant for education and
00:51:29
entertainment. It should not be taken as financial advice and it's not prescriptive of your financial
00:51:34
situation.