510: Managing Investment Risk When You've Already Won The Game with William Bernstein

[INTRODUCTION]

Casey Weade: You've probably heard the saying, "If you've won the game, stop playing.” You may not know who said that. Well, today you're going to find out. Welcome to the show. My name is Casey Weade. This is Retire With Purpose Podcast, where it is my mission to deliver clarity and purpose and elevate meaning in your life. Now, if you're not sure what that means or maybe you're new to the show, I want you to know what to expect. We have both financial and non-financial conversations here on the show. This will be a little bit more financially oriented today as we're going to be having a conversation with William Bernstein. However, if you're looking for those non-financial conversations, I encourage you to look out for those Freedom After 50 episodes, they're labeled as such. You can go on in there and listen to our great conversations that really focus around the purpose and meaning that you seek in this phase of your life.

Today, I would like to introduce your guest. This is William, also known as Bill Bernstein. He's a leading voice in personal finance, asset allocation, and retirement strategy, also retired neurologist and co-founder of Efficient Frontier Advisors. He's the author of many acclaimed books, three of which I'll point out for you. One will be the focus for our conversation today. That is The Four Pillars of Investing, The Intelligent Asset Allocator, and The Investor's Manifesto. There are many credentials that we could rattle off with Bill, but I want you to know what to expect today. He's going to be here with us as we will be delving into risk management, safe withdrawal strategies, how behavioral finance plays into retirement success, and more lessons from that book, The Four Pillars of Investing.

We also partnered up with Bill to give that book away for free to you right now. We're going to make it really easy to do that as well. All you have to do is go on over to iTunes and write an honest rating or review of the podcast and then shoot us a text with the key letters ‘BOOK’ to 888-599-4491. We will then verify your iTunes username and send you your copy of The Four Pillars of Investing. With that, I would love to welcome our guest, Bill, to the podcast.

[INTERVIEW]

Casey Weade: Bill, welcome.

William Bernstein: Happy to be here.

Casey Weade: Bill, I'm excited to have this conversation with you. This is a conversation I've wanted to have for some time. I've used this quote of yours for as long as I can remember in this business, and I want to kick our conversation off with that. You said, "If you've won the game, stop playing.” Now, to dig a little bit deeper and deconstruct this quote of yours, I think it makes sense to start with, what is the game?

William Bernstein: The game is meeting your basic living expenses in retirement. So, for example, let's say you need $40,000 a year in addition to your Social Security in order to meet your living expenses in retirement. Well, if you use the 4% rule, which is not a bad rule of thumb, it's not perfect, but it's pretty good, that means you need $1 million because 4% of a million dollars is $40,000 a year. Or another way of putting that is you need 25 years of residual living expenses. That is expenses in addition to your Social Security in order to pay your living expenses and your taxes. And so, once you've made that, over that finish line, you need to be very careful. Yes. Over the next 30 years or so, the odds are that stocks will do better than bonds, but that is not a slam dunk. Five times out of six, sure stocks are going to do better than bonds over that period of time.

But it's also true that five out of six times you play Russian roulette, you win, alright? And the consequences are asymmetric. So, if you invest too conservatively and stocks do well, okay, you didn't get to buy the beamer or you didn't get to fly first class as often as you would like. But if you're wrong in the other direction, the consequences are far more dire. It doesn't mean sell all your stocks, it just means take some of those winnings off the table and put them into conservative assets.

Casey Weade: When I think about this question, I think about a lot of the families we work with that are very overfunded. There's a lot of families that are listening to this podcast, and they're overfunded in their retirement. Let's take, for instance, someone that they need $40,000 to fund their retirement and they've saved $5 million and we know that they could probably bury that money in the backyard. And if they drew a good map, they could pull out enough to meet their expenses for the rest of their life. They could invest it at 1% a year, and they would have $50,000 a year to cover their expenses. So, do they stop playing the game altogether or are you saying just take it to cash? You don't need to take any risk whatsoever. Do we only take as much risk as we need to take? How do we really answer that question?

William Bernstein: Well, we're not talking to those people. And we're not talking, or I should say we're not talking about those people. Let me give you a more extreme case than the one you've just given me. Let's take someone who has only $100,000, but they have enough Social Security and they have enough pension income to pay all of their living expenses. Well, that $100,000 portfolio that they have, modest as it may seem, doesn't really belong to them. It belongs to their heirs and to their charities. So, the rule, that particular rule, stop playing the game doesn't apply to them either because they don't need a penny of that money aside from perhaps for emergencies. The case you've given is another case like that as well.

Let me give you another case. Let's take somebody who has found out over the past 40 or 50 years that they have very high risk tolerance and they can invest in 100% stocks and sleep like a baby during periods like the last month or like ’07 to ’09. If that person has a burn rate of only 1% or 2%, they could meet that out of the dividend stream of their stocks. And even during the worst of times, that dividend stream in dollar amounts doesn't really decrease by very much, temporarily decreased by about 25% during ’07, ‘09, during the Great Depression. In real terms, it fell by about 50%, but only very, very briefly. So, as long as that person has enough money for emergencies and to meet brief periods like that, they're fine too.

Now, how many people have a burn rate of 1% or 2% and can tolerate 100% stocks? Well, there aren't very many people like that in this quadrant of the galaxy, but at least it's a theoretical case where that rule doesn't apply either. The rule applies to someone who's got a burn rate of 4% or 5%. That person has to be very careful because if you have a 5% burn rate and you have a 10-year period with very low or negative stock returns, and let me tell you, those periods of time do happen, then you need to be much more conservative. You need to stop playing the game and not be too stock-heavy when you enter retirement.

Casey Weade: Yeah. I think when I hear this quote, I often think of something I heard my dad say over and over again as an advisor himself. And then he stepped into retirement several years ago and he always said, "Just make me 4% or 5% and don't lose my money and I'll be okay the rest of my life. Why would I ever take any more risk than that? I just need to make a decent rate of return and I'll be okay.” I think what you're saying is, and I think I see this even with some of what I saw my father do over the years is he would kind of impart his own position or his own philosophy on others.

And it's hard to understand someone that's on the other side of that table when you’re, like my father, a very conservative investor, “I don't want to lose. I never want to lose. I've got enough money. Just make me a decent rate of return and I'll be okay the rest of my life.” Then meeting with someone that's maybe in the same position, but they have a much higher risk tolerance, it's hard to come over to the other side of that table and really understand that person.

William Bernstein: You have to be very careful and have a long historical perspective. Jason Zweig wrote a really excellent article just a few days ago about a concept that was formulated by Peter Bernstein, who's no relation to me, unfortunately, or was no relation to me. And it's the concept of memory banks. Our memory banks, mine and particularly yours, have been formed over the past 30 or 40 years with very high returns and that influences our thinking. You have to be very careful that you have a longer historical perspective. Now, the opposite of that perspective was your father's, and he probably is more in tune with Will Rogers’ perspective, which was, “I don't care about the return of my capital. I care about…” No, I don't. Okay. I screwed it up. “I don't care about the return on my capital. I care about the return of my capital.”

Casey Weade: Yes.

William Bernstein: You have to realize that he was speaking in the environment of the 30s when simply getting the return of your capital was no mean feat.

Casey Weade: Yeah. He often said it, and my grandfather as well, "It's not the return on your money, it's the return of your money that really matters.” And I heard that time and time again. There are some other individuals that have really viewed this, I think, calling it a game. There are some risks in calling it a game in and of itself. And because for many of the families we've worked with over their lifetime, it's kind of become a game. And the value of their assets that they've accumulated over their lifetime, their net worth has become a scorecard. And it's hard to kind of get off of that position of, well, it always has to be growing or I'm not doing a good enough job even when I don't need it to grow. What do you say to those people?

William Bernstein: Well, we are the, you know, human beings are the ape that seek status. And one of the ways we seek status is by keeping score, especially relative to other people. And so, it becomes a game. And the game, like all games, is somewhat enjoyable. I have to admit, I fall foul of that myself. I enjoy the game of investing. It is fun. And you have to resist that because investing shouldn't be fun. It should be boring. And the more fun you make it, the more you're likely to have your head handed to you.

Casey Weade: Is there some carry-over here to the way we think about work as well, or retirement, where we don't need to continue working? We're 60 years old. We've saved more than enough money. We need the rest for life. And you should just quit. You should quit the game. You've won. Go do something more fulfilling.

William Bernstein: Well, you have to… There's an assumption embedded in that statement, which is that there is something that you find more fulfilling than work. There are people out there who despise their jobs, who hate their jobs. It's an apocryphal saying among physicians and I think there's some basis to it that most physicians over the age of 50 would retire. Only they could afford it. Because it's a fairly brutal game when you get to be that age, 50 or 60 years old. But there are probably about 30%, 40% of doctors who are going to get carried out feet first because they enjoy medicine so much. So, it really depends upon which of those two baskets you fall into. If you love your work, you're crazy to quit it. You're not going to find anything more fulfilling or more enjoyable than work.

I like to say that golf is, when it comes to retirement, golf is an awful four-letter word. If that's all you've got to look forward to, you're going to have a rough retirement. On the other hand, if you hate your job, maybe it's not such a bad four-letter word. I love what I do and I'm not going to the beach anytime soon.

Casey Weade: Yeah. Well, I can see that and I think we all can and we see that show up in your most recent book, The Four Pillars of Investing. So, to transition over to some of the content around that book, this book was first published back in 2002. It was re-released in 2023, so about 20 years later. Now, what do you view as some of the most important additions to the latest book that you put out here from 2002 to 2023? What changed over 20 years where it required an updated version?

William Bernstein: Nothing changed in the financial markets at all. The markets don't look very different in 2023 than they did in, well, 2000, 2001, 2002 when the book was written, which was the US growth stocks were very overvalued. Everything else was relatively reasonably priced and fixed-income assets offered a reasonable rate of return. Now, that certainly wasn't true even four or five years ago, but that's true now. What has changed is me, is my learning process. You learn a few things over a 20-year period. And I learned two things over 20 years.

Number one is that the riskiness with stocks depends almost entirely on how old you are and where you are in the lifecycle. So, if you are a young person, your net worth consists almost entirely of your human capital. If you're 25 years old and have a typical median job, you've got a couple of million dollars of human capital in your bank, okay? That's future salary and savings. And that looks like a bond. So, it's almost impossible, theoretically, to own too much in the way of stocks when you are young. If you've got $2 million in human capital and $20,000 of investment capital in your 401(k), then you have a stock exposure of 1%. So, you can't own too much stocks. Now, that's assuming that you have the risk tolerance, which to own 100% stocks.

In fact, there are people who say you should invest 200% or 300% in stocks and leverage yourself, which for most people is unwise. There's almost no one in the world who can tolerate a 200% stock portfolio or should tolerate it for that matter. Whereas when you're older, that is exactly reversed. You have no more human capital left, and hopefully, if you've done it right, you've got a couple million dollars or at least several hundred thousand dollars of investment capital. There you have to be very conservative for the reasons that I explained before, which is that occasionally stocks have very low returns, and if you retire into one of those periods, you're in a world of hurt.

The second thing that I understood that I learned that I wanted to write about is analogous to that, which is that when I started writing the book, and certainly over the past couple of years, it is now possible to the fees to pay for your living expenses in real inflation adjusted returns and protect yourself against inflation with this wonderful instrument that our Uncle Sam makes available, which is the Treasury Inflation-Protected Security, which added 20 or 30 years now yields close to 2.5%. A 2.5% guaranteed real return is nothing to sneeze at. And I suspect that the odds are pretty good. There are going to be people who are going to be kicking themselves for not buying these things when they retired. They're not appropriate for the pre-retiree, but they're certainly appropriate for people who are retired.

Casey Weade: Okay. We’re going to get a little bit deeper into those things here in just a moment. But I want to talk about the foreword that was written by Jonathan Clements. He had two key investing realities that he pointed out in that foreword. One of those was that more things can happen than will happen. And let's stop there for just a moment. How do we get a clearer picture of the real risks that we face when we're bombarded with all these things that can happen on a daily basis?

William Bernstein: Yeah. Who was it? Donald Rumsfeld made a lot of intellectual capital and got himself a bit of memeship by talking about unknown unknowns. He was probably channeling Frank Knight who talked about uncertainty, which is the same thing. The difference between risk and uncertainty, risks are the things that you know can happen. Uncertainty is the things that you don't know can happen. And that's unfortunately the world of finance. I mean, who knew that we were going to have a pandemic that was going to absolutely cripple the world economy very briefly in 2020? Who knew that the horrific events of 9/11 were going to occur? Who knew that we were going to get a US president who appears hell-bent on destroying the international economic system?

None of those things were predictable. And yet if you're an investor, you have to plan for them. What people have been saying the past couple of months was, "We're in a new world. We've never seen anything like this before. How do you deal with it? Everything's changed. Maybe we need a new investment strategy.” And the trick is you need an investment strategy that can survive unknown unknowns like that, uncertainty like that. So, the next financial crisis, most likely, more likely than not, will not be recognizable in any form or shape. It will be something that will be totally out of the loan you can't ever plan for, but you still have to plan for it.

Casey Weade: Yeah. I think that's challenging. When you feel like everything's going so well, you believe in the economy, maybe you believe in our political environment, the global economy. You're so positive about the future. However, we have to recognize that there's always unknown unknowns lurking out there that we need to be prepared for.

William Bernstein: Yeah. You don't look old enough to have been around in 1990 or at least managing money in 1990.

Casey Weade: I wasn't managing money. No.

William Bernstein: Yeah.

Casey Weade: But I was around.

William Bernstein: You were around. I was around and I was managing at least my own money back then. And gosh, the world looked just absolutely wonderful. We had defeated communism. There were no geopolitical rivals. It looked like a century of Pax Americana. Okay. That turned out not to be the case. So, it goes in both directions. You can wind up being overly too historically optimistic. When that happens, look out. Alright? And the reason why you should look out is because finance theory tells us that you are rewarded for bearing uncertainty. Well, when there's not a lot of uncertainty out there, you shouldn't expect security returns to be high.

And as the 1990s progressed, that's what happened. The world looked absolutely even more wonderful in 1990 and 2000 than it did in 1990 because you take the political euphoria of the end of communism in 1991, let's say, and then you go out another eight or nine years and the internet is going to change everything. And it's going to be wonderful. It bleeds over into politics. Bill Clinton left the presidency in 2001 with the highest rating and the highest approval rating of any president in US history. And that was simply because he exited the presidency at exactly the right time.

Casey Weade: Yeah. Now, this next one that Jonathan pointed out might be a known unknown, I would presume, but it might be an unknown unknown for many of our listeners. He says, "We get just one shot at making the financial journey from here to retirement and we can't afford to fail.” And my question there is, what about the people such as yourself even that they say, “I don't ever plan on retiring. I'm not going to retire at all”? They're maybe in their sixties or seventies and they say, “I have plenty of human capital left. I'm going to continue to earn money for a very long period of time.” However, that known unknown might be that we know that we will inevitably retire, and it may happen sooner than we planned.

William Bernstein: Yeah. Well, that's something that you have to plan for as well. A very relatively small percentage of people will wind up getting whacked by circumstances: illness, injury, legal judgment, who knows what. And you have to plan for that. That's why you have an emergency fund. I like to say that there are two kinds of riskless assets. The first kind of riskless asset is the riskless asset of the system one of the brain. It's the logical, rational planning brain, which says, “I have certain real living expenses that are going to be coming up when I'm retired in 10 or 20 or 30 years.”

And the riskless asset for that frame of mind is the TIPS bond, okay? Because you are guaranteed at maturity to have a certain amount of spending power. If you're buying a bond that yields 2.5% and you hold it a real 2.5%, you hold it for 30 years, then you know that if you spend $0.50 on that bond now, in 30 years, you're going to have a dollar's worth of real consumption power, today's consumption power. So, you'll double your consumption power. So, that is the riskless asset of the mind. But the riskless asset of the gut is the treasury bill. And it is certainly not riskless in the long term because you never know what your reinvestment rate is going to be.

But at times like that, that is the money that will see you through when, excuse my French, the excrement hits the ventilating system. Alright? There is a reason why Warren Buffett holds 20% of Berkshire in treasury bills, in cash equivalents. Why does he do that? Because he knows that with a heavy investment in insurance companies, there are going to be insurance events. They're going to wipe out other insurance companies, and he doesn't want Berkshire's holdings to be wiped out. So, he holds that 20% reserve. It reduces his long-term returns. But in order to get those long-term returns, you have to survive. Now, the most interesting thing lately about Berkshire is, at least as of four or five months ago as of their last report, it held 30% in treasury bills. Gosh, kind of spooky. Maybe he knew something, you know.

Casey Weade: Yeah. Or maybe he is just aging and he’s changing his…

William Bernstein: Or maybe, or I don't think that it's his aging. He's managing capital for the eons. He's not managing capital for the 90-year-old Warren Buffett. He's managing capital for the widows and orphans that owned Berkshire. He owned 30% treasury bill simply because he just didn't see any buying opportunities out there at current prices. It's simple bean counting for Warren.

Casey Weade: Yeah. Being a bit facetious there, but you talk about your view on risk and aging as a big part that you then incorporate into this book. As you talk about the two major determinants of the level of equity risk or stock risk, the risk that we should be taking, and those two major determinants being age and burn rate. So, as we age, we should maybe be turning down our level of equity risk is kind of what is implied there. Now, I know there are two different factors to this.

What I wanted to ask you about is some of the research that, say, Dr. Wade Pfau for one put out not that long ago, kind of challenging this age-old wisdom that we automatically decrease our equity risk over time arguing that we are going to get better results if we actually increase that equity risk over time. Where we should create a bond 10, if you will, or a fixed income 10 as we approach retirement age, spend down at fixed income, increase our equity allocation so that maybe when we're 60 we actually have lower risk than when we're 80 because we have less of a timeframe remaining.

William Bernstein: Yeah. Well, there are several things about that. You’re talking about a paper that Wade wrote with Mike Kitces, and it's a marvelous paper. I quote it all the time, and I find the paper to be very intuitively understandable and obvious because let's say you're 60 years old and you have a retirement timeframe with an excess probably of 30 years. I mean, actuarially, if you look at a married couple at age 60, the median joint survival is somewhere into the early nineties for that couple. So, they're looking at 30 years plus. The worst thing that could happen to them is that they have a bad sequence of returns early on, as I just discussed.

Now, the trick is that as they get older, let's say they're no longer 60 years old, let's say they're now 75 years old, well, now they're looking at maybe 15 or 20 years of survival. So, they don't have to have as much in riskless assets. Let's say they're 90 years old. Well, they've only got at most 10 years or so ahead of them. So, of course, they have to own less bonds to defease that. So, what happens is you have a stock-bond portfolio and you start burning your bonds when you're young. And so, your level of equity exposure naturally rises. Now, the other thing about that paper is when you look at it, you dig into it and you look at the numbers, it's really not that dramatic.

The success rate for a reverse glide slope in there, at least in their work, is not that much higher than a regular glide slope. You're talking about maybe several percent difference in success rate between the two strategies. So, the results aren't all that dramatic, but they still do point in the direction that, yeah, as you get older, your stock, your equity allocation is going to increase simply because you're burning off your riskless assets first. And as you get to be much old, as you get to be closer and closer to be pushing up the daisies, but you don't have that much left to defease so you can buy more stocks.

Casey Weade: I mean, it's like into investing like a Warren Buffett. You're 85 or 90, you're no longer investing for yourself. You're investing for your heirs, your children, your children's children, or charities, for that matter.

William Bernstein: Yeah. There's a wonderful quote that I can't resist interjecting here, which is Gloria Steinem, which is, "The rich plan three generations ahead and the poor plan for Saturday night.” And that's basically, hopefully, I suspect most of your listeners fall into the former category.

Casey Weade: Yes, absolutely. And so, you have two different determinants of the level of risk or equity risk we should be taking. Age. We discussed age here. There's also this burn rate factor and you share that the higher your withdrawal rate is, the less equity risk you should be taking. However, at some point, doesn't it become a necessity? Now, I want to withdraw 7%, 8%, 9% per year. And now at what point do we say, "Okay. I'm just going to have to do this because I can't dial down that risk.” So, there's an acronym that we often use and it's, "Can I take the risk? Do I have the capacity for the risk? Do I have the attitude for the risk? Do I have the need for the risk?” The question being, how do we weigh these three different things? When does the need take precedence over the can or attitude?

William Bernstein: Here's how I think about those two things. Okay. You're talking about need and capacity and tolerance, which is the way I put it. It's not as pretty an acronym but it's the same basic idea. And the problem is, is that two of those things pull in the opposite direction. If you have the need to take risk, that is you have a high burn rate, then you do not have the capacity to take risk. Because if you have a high need to take risk and you don't have enough assets, then if you get a bad sequence of events, you're going to have a really catastrophic outcome. On the other hand, if you have so much assets, you're the person with the 1% burn rate, that person has a very high capacity to take risks. But they have zero need to take risk because they have so much assets.

So, when I think about that paradigm, I just pair away those other two things because they pull in opposite directions. They cancel each other out, needed capacity, cancel each other out in that sense. And all you're left with is tolerance, risk tolerance. And that's really what it boils down to.

Casey Weade: Yeah. I had a guest not long ago. I can't remember who it was, but I asked a very similar question and they viewed it as a three-legged stool: capacity, attitude, and need. And you don't want one of those things to be lopsided, right? So, if your attitude piece is a little short, work on lengthening that, or if your need is a little short in that leg, just work on lengthening that. I thought that was an interesting way of looking at it.

William Bernstein: Yeah. It's a good way of thinking it but what it means in practical terms is if you're someone with a burn rate of 10%, you're going to have to shorten that 10% leg. Ten percent is way too much of a burn rate unless you have metastatic cancer.

Casey Weade: Yeah. Well, and let's just stay on that for a second because I'm sure there's somebody listening and they're going, "Yeah, but I've made 10% a year for 10 years.” Why can't I pull out 10% if I'm averaging 10%?

William Bernstein: Yeah, because you're living in a fool's paradise. You're falling or if you want to put a more academic gloss on it, you're suffering from the availability heuristic, which is what you see as all there is. It's a famous phrase of Danny Kahneman, which is that we tend to overweight recent experience, the recency bias. So, you've got the attitude of the past 20 years of very high-security returns. I've made all this money in stocks, I'll continue to do it in the future. That's historically toxic. That's dangerous because you very may wind up in Will Rogers's frame of mind of the 1930s.

Casey Weade: Yeah, I think that’s hard. As you said, we have this recency bias. We think about what’s happened in the last 10 or 15 years. We don’t have that historical perspective, which you say is just so vital for us to have. And I want to talk about that historical perspective in just a moment. But before we get off of this risk piece, a way that you explain the two main different types of risks that we face that I think people will find a value that is shallow risk and deep risk. And let me let you explain the difference between these two things.

William Bernstein: Well, shallow risk is the risk that we feel in our gut. We evolve in a state of nature with a very top of a very short risk horizon. You have to be able to respond in a state of nature instantaneously. So, if you see some yellow and black stripes near peripheral vision, or you hear the hiss of a snake, you better respond and respond to it very quickly. So, that is why we are so attuned to shallow risk. Seeing the market fall 2% in a day is something that gets headlines. That’s shallow risk. Okay? To the long-term investor, that’s totally irrelevant.

I lived through October 19th, 1987 when my stock assets fell by a quarter on a single day. Now, is that even a blip in my financial life? No, not even close. Okay? Maybe I held on, I bought more. Even if I had sold but not sold very much, I’d still have been fine. It wouldn’t have mattered one single bit. What mattered the most to my current financial situation is returns of the past 30 or 40 years. So, deep risk are periods of 30 or 40 years, which are much, much more important because those returns compound. What matters is periods of 30 or 40 years when real returns were very low or negative, that I said, does that ever happen? You bet your BP it happens. Okay?

For example, let me give you a perfect example of deep risk, which is being an owner of Japanese stocks in 1990. The real return, the real total return of Japanese stocks from 1990 to today is a loss of more than 50%, all right, in terms of spending power. Let me give you an example, in the United States, which is owning the long bond between 1940 and 1980, the real value of the long bond with reinvested interest between 1940 and 1980 was similar. It was about minus 55 or minus 60% in real compounding terms. That’s deep risk. It’s when if the real value of your assets has a significantly negative return for decades.

So, one of the things that cause those really bad events, the deep risk, well, the first thing that causes it and the most common thing that causes it is inflation. All right? So, that’s the thing you have to protect against. The second thing that can do it is deflation. That’s rare, rarely lasts for very long. The third thing that can cause it is confiscation, which is taxes. Now, I’m not one of these people who believes at all, taxation is theft, but you can certainly have your assets taxed away from you.

And then, finally, there’s destruction, okay, which is really bad geopolitical events. We’re all living under the sort of shroud of nuclear weapons, and we seem to have forgotten about that over the past 20 or 30 years. Inflation is the only thing you can really do something about. Okay? And we’ll talk about that in a bit. Deflation is rare, doesn’t occur. It’s not a big worry. Confiscation, there’s not an awful lot you can do about confiscation unless you’re willing to get on a plane with a suitcase full of gold and jewels. And then, finally, there’s not an awful lot you can do about the fourth thing, which is destruction. So, deep risk, the deep risk that most people should worry the most about is inflation. And there are ways protecting against it. Not completely, but you can at least mitigate the damage that gets done by it.

Casey Weade: Let’s take a little bit deeper dive into each, let’s start with shallow risk. So, shallow risk, and what we’re trying to avoid with shallow risk is panic selling during these short periods of selloffs in the markets? Is liability matching your core solution to that? Or what is our solution to avoidance of panic selling?

William Bernstein: The solution to panic selling is psychological training and historical knowledge. So, it is knowing that the best fishing is done in the most troubled waters. Okay? And there’s a wonderful quote. I wish I had it in front of me, so I have to, I’m going to mangle it a little bit because it’s from memory, but it’s from John Templeton. And what Templeton said was that bull markets are born in despair, grow with time, mature more with time, and then die in euphoria. Okay? I’ve just horribly mangled the quote.

And then the key thing is the end of the quote, which is that the best time to buy is at the point of maximum pessimism, and the best time to sell is at the point of maximum optimism. All right? So, it’s knowing enough history to know the truth of that quote which is that the very best time to buy and certainly to hold on is when things look the worst, and the very best time to lighten up is when things look the best. And so, it’s a combination of training yourself psychologically to know that and to act on it accordingly. And really, that comes with historical knowledge, but really it comes with experience. All right?

There’s a wonderful article, I think from about 1982 from BusinessWeek, which was The Death of Equities, which is an article that’s very well known and its description of what equities looked like in 1982 which was that the only people buying equities in 1982 were older people. Okay? And the explanation that was given in the article is they were stupid old geezers who didn’t understand the new paradigm of investing. Well, in fact, the old geezers knew that bear markets turned around and they were the ones who did the best.

Casey Weade: Yeah. One of the things that retirees will often hear is they get to retirement and they say, “Yeah, I need out of the market. I can’t take the risk anymore.” So, well, why can’t you take the risk? And you’re still going to be investing for the next 20, 30 years. You go, “Well, I have needs. I have income. I need the money now.” You don’t need all the money now. And you point this out in your book and you suggest that retirees have at least 10 years’ worth of their basic expenses covered. And I want to deconstruct this a little bit.

And one, we need to know what does it mean to have them covered? And number two, we need to know the significance around a decade or 10 years where what we’re really doing to circle back to what I said is we’re buying retirees’ time to continue to invest in the markets with other dollars and go through that inevitable volatility that ultimately results in larger returns over time.

William Bernstein: Yeah. I mean, what I like to say is I think that instead of saying pay your living expenses for 10 years, I would say pay your basic living expenses for a period of 20 or 30 years. I’m not talking about flying first class, owning a Beamer, or traveling to see your grandkids three times a year. I’m talking about being able to pay for your rent and your groceries or to pay for the maintenance on your paid off house and groceries. And you should have 25 or 30 years of that saved up, so you don’t wind up bunking with your kids or eating cat food when you’re old.

Being old is not a walk in the park. And the only thing that’s worse than being old is being old and poor, and you want to avoid that at all costs. The consequences of being old and poor are very asymmetric. So, I like to say 20, 30 years of basic living expenses because you never know. There had been 20-year periods, almost 20-year periods in the US stock market when real returns were negative. And you don’t want to risk encountering a period like that. Chances are you’ll be all right. You’ll be all right if you invest in stocks when you’re old, but there’s a one in six chance that you won’t, just like there’s a one in six chance when you play Russian roulette, you lose. You don’t want to play Russian roulette.

Casey Weade: You’ve spoken a lot about treasuries as the kind of core solution for covering those expenses. And I recently read an article not long ago. I think it was released last week that was discussing the recent volatility that we’ve seen in treasuries. And it was ultimately suggesting that we should further diversify this bucket and not just have those safe dollars be treasuries. What is your view on the current state of treasuries in diversifying that, I don’t know, “safe money bucket”?

William Bernstein: Yeah. If there’s anything safer at a 30-year or a 20-year or a 10-year horizon, then a TIPS bond at maturity. I’d like to know what it is, all right? Do you want to invest in foreign bonds? Well, then, you’re taking currency risk. Okay? Because otherwise, I mean, you can hedge it, but then there’s not a lot of difference between a hedged foreign bond and a US dollar bond. They’re going to behave pretty much the same way.

Do you think that the stocks are less risky? Yes, again, if you think that gold is less risky over a 30-year time horizon, then let me show you what gold returns looked like between 1980 and 2011. Okay? They were awful. And could the government fiddle with the inflation adjustment? Yeah, they could, but I can’t imagine anything that is less risky than a TIPS when held to mature.

Casey Weade: Yeah. And the only way that some of these major risks show up and that treasury safe, for instance, would be impacted, would be shifting over to that deep risk piece. That’s really some of those unknown unknowns. And you’ve said inflation is really the only thing we can put guardrails against. But I think, as advisors, we’re often challenged with figuring out how we help someone let go of some of those fears that might be the unknown unknowns. It might be some of those things you discussed earlier. It might be confiscation, might be World War III, might be global financial collapse. How do we help people past those barriers?

William Bernstein: You try and teach them the history. But I don’t mean to be terribly cynical about this. Very few people have the temperament to invest for the long term. We’re too much captives of our evolution at our evolutionary environment. It’s a really hard thing to do, and the best you can do is to teach the history. I mean, I would even go so far as to say, if you have someone, a client who is 60 or 70 years old and they haven’t learned that stocks are generally recovered from severe bear markets and they haven’t learned that stocks generally have the highest returns in the long run. Then the odds, if you’re going to be able to teach them that at age 70, when they haven’t learned it over the past four years, are pretty low. I mean, good luck with that. I don’t mean to be unduly pessimistic, but you’re not going to be able to teach a 70-year-old to hold stocks for the long run if they haven’t figured that out over the past 40 years.

Casey Weade: Yeah, you talk a lot about the knowledge of history being one of the most important pieces that investors need to be armed with in order to be successful. And one of the things you say in that pillar too is that the worst time to invest in an asset class is right after it’s had a long run of strong returns. Some look at the US economy as that, as a whole, and they look over very long periods of time, decades upon decades today, and they’re calling for the fall of the US, right?

But then there’s others. We can zoom in a little bit closer and say, look at the last 15 years, this has been one of the greatest bull markets we’ve seen. And they say, well, should we still be investing in US stocks, because this asset class has had a very long period of strong returns? Would you view that as a current risk? And if so, how would you mitigate against it?

William Bernstein: Well, I think we’ve just seen what the risk of it is. And I really don’t like it when people quote short-term returns. But boy, I’m going to do that right now, which is that year to date foreign stocks have been the place to be. The question is, has the juice already been squeezed out of that lemon? I don’t know. But there is nothing wrong with holding a highly diversified portfolio of US and international stocks. A global stock index fund, such as the Vanguard, All-World ETF/VT or the similar product that you’re going to get from BlackRock or Schwab or Fidelity, there’s nothing wrong with that as being a single stock fund for the average investor, especially now that it’s 60/40 domestic/foreign.

Ten years ago, the World Stock Index was overweighted to foreign stocks. It was 60/40 foreign to domestic or 40/60 domestic to foreign. And that was probably too much foreign exposure. But right now, a World Stock Index looks mighty prudent to me.

Casey Weade: Yeah. And we’re in a period of time where, yes, US stocks have outperformed, international has underperformed. Maybe it makes sense to be a little bit more globally diversified. That’s what I hear you saying.

William Bernstein: Yeah. Here’s another way to look at that, which is that until very recently, US stocks were selling at twice the multiple of foreign stocks. Okay? Well, what that is saying is that for every dollar or every penny, let’s say, of earnings you get from a dollar of US stocks, you’re getting twice as many pennies from the foreign stocks in earnings. Okay? You’re getting twice the earnings yield.

So, for that to actually even out, what would have to happen is that US stock earnings would have to grow to be twice as big as they are now, relative to foreign stocks. You’re going to have to, in other words, US stock earnings are going to have to double relative to foreign earnings for that debt to pay off. All right? And one of the things that history teaches you is that people tend to be over-optimistic about growth prospects. So, when you buy a market that has a P/E of 30, you’re generally not going to do as well as when you buy another index that has a P/E of 15.

Casey Weade: Yeah. I love that you dedicated a whole pillar there in the book on the business of investing. And you said something in there that I think is going to stand out to many. You said that you believe that many advisors and brokers are shockingly ignorant of the fundamentals of investment theory. My question around that is, I’ve said in the past that the barriers of entry to this business are disgustingly low. I’m curious, how would you adjust the barriers of entry into our business to elevate the standard? And I kind of want to ask that in the context of, you’re a past physician, you dealt with some very serious ailments, and that wasn’t an easy position to get yourself into. You couldn’t get into that position in 60 days.

William Bernstein: No. And it’s interesting. I don’t know how you do that. You can have educational requirements, but then you get into credentialism. And there’s a problem with that, too. I don’t know how to solve the problem. I see a much bigger problem than the barrier to entry problem and the shockingly low standards in the industry. I see the problem being that we expect the average person to be able to save and invest on their own because we don’t have a decent social safety net.

I mean, one of my favorite sort of memes is the Scandinavian crime film or crime series where the bad guy has a suitcase full of cash that he’s secreting for one occasion or another, and it opens up and the criminal says, “Oh, my God, I’ve got a million kroner in here.” Okay? Well, a million kroner is $100,000, which, if you’re a Swede is all you need to retire because your retirement and your healthcare expenses and your kids’ and your grandkids’ education is already paid for. In an American crime film, that Halliburton case has $2 million in it because that’s what you need to retire. So, we expect people to be able to accumulate that much money and then to invest it.

And it’s kind of why you get onto the airliner and instead of turning right to go to your seat when you come in to the door of the airplane, the flight attendant says, “Oh, no, no, you’re turning left, you’re flying the airplane to Chicago.” I mean, I’ve got a pilot’s license. And I can tell you that investing is a whole lot harder than flying an airplane. And yet, we expect people to be able to do it. It makes no sense to me.

Casey Weade: I first saw that you said that on a CNN interview back in 2012. So, we’re 13 years later. Is it getting easier or harder?

William Bernstein: It’s getting a little easier. I have to admit that making the target date retirement fund, the default for many DC plans, for many 401(k) plans is a positive event, but still, the average person is in no way intellectually or emotionally equipped to invest on their own. Now, I suppose, to get back to your original question, how do you solve the problem of advisor malfeasance and incompetence? I supposed you could have a tougher regulatory environment from the SEC’s perspective. You can have the SEC coming in and looking at people’s portfolios and looking at advisor’s portfolios and say, you’re turning over this portfolio 200% a year or 100% a year, you’re out of the game. Okay? Or you’re investing in a mutual fund for your clients that’s actively managed and has an expense ratio of 2% and is paying you a 12b-1 fee, you’re out of the game. Okay? But we’re not moving in that direction. We are moving in the direction of less and less financial regulation, at least in this administration.

And the damage is not going to be done with stocks and bonds. The damage is going to be done with crazy crypto. I mean, to my way of thinking, the increased enthusiasm for crypto investing coupled with the decreased regulatory oversight of crypto is a disaster waiting to happen. It’s a perfect storm waiting to happen.

Casey Weade: Yeah. I was just speaking with a gentleman that was working on my car. The guy that works on cars, talked to him two days ago and he told me a story, “I lost $865,000 in crypto in the blink of an eye.” That was his life savings. With less and less regulation, I have similar fears for individuals like that. And now, you’re saying we shouldn’t go this alone. We’re a do-it-yourselfer. Maybe we shouldn’t go it alone. We need to partner with someone. And you’re also simultaneously saying that most advisors and brokers are shockingly ignorant of the fundamentals of investment theory. How can an investor know, if they want to partner with someone, how can they know if the advisor that they’re looking to work with actually knows what they’re doing?

William Bernstein: Here’s the 30-second acid test. You go to a prospective advisor and you show them, this is what I’ve invested in now. I’ve got one third of my money in a total US stock market fund and a one third of my money in a total foreign fund and one third of my money in a bond index fund. How should I be investing? How should I be investing with you?

And if the guy or the gal looks at you and says, “Oh, my God, you’re doing it all wrong. You need to be investing in this stock and that stock, and this actively managed fund and that actively managed fund. Here’s how you need to be tied to the market.” You make a 180-degree back turn, and you run as fast as you can away from that person. If, on the other hand, the advisor looks at you and says, “You know, this doesn’t look bad to me. I might tweak it a little this way. Maybe instead of being one third, one third, one third, I’d be 40/40/20 or I’d be 30/30/40. I might use the Schwab fund instead of the Vanguard fund. Or I might use this ETF instead of this mutual fund.” But you pretty much got the right idea, that’s the person you hire.

Casey Weade: That’s great. I expect that people are going to use that, and some advisors are going to hear that question, so I’m sure many appreciate that. As we bring things to a close, I want to bring you back to about six years ago. In 2019, you had a Morningstar podcast episode, and you said, “When you think about your tombstone, investment advisor is not one of the things that you want to see up there.” What do you want it to say?

William Bernstein: I wanted to say that his adult children still enjoyed talking to him when he was old.

Casey Weade: And I have to ask, what do you do intentionally to ensure that that’s what’s there someday?

William Bernstein: God, now, you’re asking me about parenting advice. And that’s the last thing I would ever want to do. I’m not sure I was ever the world’s greatest parent. My wife was much better at that than I ever was. But be nice to your kids. Be nice, and when they’re very young, they need an appropriate amount of discipline, but just be nice to your kids and foster their development. I mean it’s not rocket science.

Casey Weade: I love that. Love solves a lot of the world’s problems. You’re on the Retire with Purpose Podcast, so I would be remiss if I didn’t ask you this question, what does that term mean to you? What does the phrase “Retire with Purpose” mean to you?

William Bernstein: It means always wake up in the morning and look forward to what you’ve got planned for your day. Okay? And if that’s writing or volunteering or getting out and having a walk with your spouse or God forbid, golf, then God bless.

Casey Weade: And what would you say to someone that’s listening and saying, “I don’t have that today. I don’t have those things that I’m looking forward to every morning”? What kind of advice would you give them?

William Bernstein: Well, I mean, are they still working? Maybe they want to look for another job that’s not as stressful or not as unenjoyable. And if it means making less money, then that’s a price well worth paying. I mean, the biggest risk that older people have is loneliness and not having enough connection. So, for God’s sake, keep contact with your friends and your family and do as much as you can to spend time with them. That’s probably the single most important thing.

Casey Weade: I mean, I love that we’ve talked about money for about an hour, and then we wrap it up with what really matters, what money is supposed to help you accomplish. I can see you’re really intentionally focused on money as a tool to really help you accomplish the most meaningful things.

William Bernstein: Yeah. I mean, to put, again, I guess I tend to cast things in terms of negative normatives a little bit too much. But if you think that the purpose of money is to buy you things, then you’ve lost the game. The purpose of money is to buy you time and autonomy.

Casey Weade: I love that. Well, if you’re listening and you want to dive deeper into Bill’s book, The Four Pillars of Investing, and learn more, this is a great book, you have to get it in your hands. And that’s why we partnered up with Bill to get this book to you for free. So, again, if you want a free copy of Bill’s book, The Four Pillars of Investing, all you have to do, super easy, go to iTunes, write an honest rating and review of the podcast, and then shoot us a text with the keyword “Book” to 888-599-4491. We’ll send you a link, verify your username, and get you signed up. Bill, thank you so much for joining us. It’s been an honor.

William Bernstein: Pleasure was all mine. You have a good one.

Casey Weade: Thanks, Bill.

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