Latest / Masters in Business / Replay Interview With Burt Malkiel: Masters in Business (Audio)

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Replay Interview With Burt Malkiel: Masters in Business (Audio) · Masters in Business

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Speaker 1: I PC. This is Master's in Business with Barry Ridholds
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Speaker 1: on Bloomberg Radio this week on Masters in Business. I
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Speaker 1: have a very special guest. His name is Professor Burton Malkiel.
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Speaker 1: And when I say I have a special guest man,
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Speaker 1: I am not kidding this week. Professor Malkiel is perhaps
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Speaker 1: best known for writing one of the most seminal books
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Speaker 1: on investing, A Random Walk down Wall Street. It's now
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Speaker 1: and it's eleventh edition, having sold more than a million
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Speaker 1: and a half copies. UH Professor of Economics at Princeton,
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Speaker 1: twice Chairman of the department there. He ran the Hell
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Speaker 1: School of Management for about eight years, and over the
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Speaker 1: course of that period he was for twenty eight years
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Speaker 1: on the board UH Vanguard. He is currently the chief
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Speaker 1: investment officer of Wealth Front Friends with other guests of
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Speaker 1: the show like Jack Bogel and Charlie ellis really Professor
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Speaker 1: Malkiel is unique um in the annals of of investing.
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Speaker 1: He's a rock star. And I don't know if there
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Speaker 1: are many people who are more knowledgeable and more influential
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Speaker 1: uh than he is. So the man who pretty much
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Speaker 1: invented the blindfolded monkey throwing darts, the person who suggested
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Speaker 1: that Wall Street created an index fund so that investors
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Speaker 1: could make low cost indexed investments. What else can I say?
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Speaker 1: Why don't I say nothing else? And with out any
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Speaker 1: further ado my conversation with Bert Malkiel. This is Masters
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Speaker 1: in Business with Barry Ridholts on Bloomberg Radio. My special
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Speaker 1: guest today. And I know you make fun of me
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Speaker 1: when I say that, but my special guest today is
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Speaker 1: truly a special guest and a legend in the world
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Speaker 1: of finance. Let me read just a short version of
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Speaker 1: his curriculum vitae. His name is Professor Burton Malkiel. He
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Speaker 1: used to be the Chemical Bank Professor of Economics at
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Speaker 1: the Princeton UH At Princeton University. He is a two
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Speaker 1: time chairman of the Economics Department, served as a member
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Speaker 1: of the Council of Economic Advisors from to nineteen seventy seven,
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Speaker 1: became president of the American Finance Association. After that, he
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Speaker 1: was dean of the Yale School of Management in the
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Speaker 1: eighties and spent twenty eight years as a director of
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Speaker 1: the Vanguard Group. He's probably best known for authoring the
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Speaker 1: book A Random Walk Down Wall Street. It's now and
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Speaker 1: it's eleventh edition. The paperback came out again, updated and revised.
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Speaker 1: It's sold one point five million copies, and a number
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Speaker 1: of people have said, if you read only one book
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Speaker 1: about investing, Random Walk Down Wall Street is the one
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Speaker 1: to read. Professor Malkiel, Welcome to Bloomberg. Thank you very
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Speaker 1: enjoy being here, and I am am thrilled to have you.
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Speaker 1: By the way, I left out so much from your CV.
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Speaker 1: UM bachelor's and NBA from Harvard and fifty three and
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Speaker 1: fifty five doctorate from Princeton in sixty four. You're currently
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Speaker 1: Chief investment Officer for wealth Front, which is a software
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Speaker 1: based financial advisor. UM. The list goes on and on.
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Speaker 1: I'm gonna stop that because if I keep discussing your
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Speaker 1: CV will run out of time for questions. You're probably
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Speaker 1: best known as someone who who was early in the
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Speaker 1: history of recognizing that quote markets are efficient. Why are
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Speaker 1: markets efficient? First of all, sometimes people get wrong what
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Speaker 1: efficient markets mean, so giving a definition, so let me
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Speaker 1: let me tell you the way I define it. There
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Speaker 1: are two parts to uh, the idea of efficient markets,
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Speaker 1: and one part that many people associate with it that's wrong.
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Speaker 1: The parts that are right are one that information gets
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Speaker 1: reflected very quickly into stock prices. If there's some favorable
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Speaker 1: news about a company, uh that's going to increase at
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Speaker 1: stock price ten percent, the stock price tends to go
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Speaker 1: up ten percent right away because anybody who uh waits
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Speaker 1: uh to uh get take advantage of it will find
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Speaker 1: that quicker people have come in beforehand. So one information
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Speaker 1: gets reflected right away. Now, what efficient markets is often
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Speaker 1: associated with, which is wrong, is that efficient markets mean
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Speaker 1: the price is always right. The price is exactly the
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Speaker 1: present value of all of the dividends and earnings that
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Speaker 1: are going to come in the future, and the price
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Speaker 1: is perfectly right. That's wrong. The price is never right.
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Speaker 1: In fact, prices are always wrong. What's right is that
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Speaker 1: nobody knows for sure whether they're too high or too low,
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Speaker 1: and that leads to the second point about efficient markets.
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Speaker 1: It's not that the prices are always right. It's that
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Speaker 1: it's never clear that they are wrong. There's nothing systematically
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Speaker 1: wrong about them. Therefore there are no arbitrage opportunities, and
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Speaker 1: therefore the market is really very very difficult to beat,
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Speaker 1: and so information gets reflected. The market's tough to beat.
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Speaker 1: But prices are not always right. We know perfectly well
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Speaker 1: they're always wrong, but nobody knows for sure whether they're
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Speaker 1: too high or too low. We were recently having a
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Speaker 1: discussion about fair value when people were complaining, well, the
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Speaker 1: market is not at fair value, and my my response was, well,
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Speaker 1: you just briefly pass fair value as you crean too
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Speaker 1: much to the upside of too much to the downside.
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Speaker 1: You're saying, even when you go by fair value, we
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Speaker 1: don't really know exactly what it is. We don't know,
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Speaker 1: we don't know for sure. Look, we know perfectly well
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Speaker 1: that in March of two thousand there was a bubble
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Speaker 1: in the stock market. UH. We had internet companies selling
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Speaker 1: a triple multiples. We had companies changing their name UH
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Speaker 1: to put dot com at the end of it, and
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Speaker 1: the price would double. We know that there were crazy
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Speaker 1: things going on but the problem is the people who
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Speaker 1: are associated with the view I told you so I
7:19
Speaker 1: knew that. The problem is they knew it in and
7:26
Speaker 1: that's the problem. After the fact, we know perfectly well
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Speaker 1: the prices were wrong, But the difficulty was the people
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Speaker 1: who said we knew it, knew it early in the
7:37
Speaker 1: nineteen nineties and missed one of the best bull markets
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Speaker 1: we've ever had. I very famously remember Lewis Rukaiser's his
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Speaker 1: elves saying these things in nine six. He ended up
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Speaker 1: demoting a few of them because they were right. Stocks
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Speaker 1: were of valued. But so you missed four years of
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Speaker 1: double digit gains this last collapse. I recall, in real time,
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Speaker 1: very very few people were warning about credit, about derivatives,
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Speaker 1: about housing. These days, I have meant more people who
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Speaker 1: claim to have seen that collapse coming, and that would
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Speaker 1: be a little bit of hindsight bias. Now exactly, and
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Speaker 1: that's precisely the thing that happens uh before the fact,
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Speaker 1: we really don't know, and we don't know today. Are
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Speaker 1: the is the stock market too high or too low?
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Speaker 1: It's high now, there's no question valuations are stretched. But
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Speaker 1: it's also the case that the short term government interest
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Speaker 1: rate is zero, and the long term interest rate after
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Speaker 1: inflation is probably zero or below zero. So in that environment,
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Speaker 1: everything is going to be more highly priced. I'm Barry Hults.
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Speaker 1: You're listening to Masters in Business on Bloomberg Radio. My
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Speaker 1: special guest is Professor Burton Malkiel of Princeton and Vanguard
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Speaker 1: and the author of A Random Walk Down Wall Street.
9:07
Speaker 1: The paperback is now and it's eleventh edition and it's
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Speaker 1: sold a million and a half copies. Um, let's talk
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Speaker 1: a little bit about indexing versus active management. Uh. There
9:20
Speaker 1: was a quote from the book that I've always enjoyed
9:23
Speaker 1: this number of quotes from the book, but you had
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Speaker 1: said back in nine seventy three. Fund spokesman are quick
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Speaker 1: to point out that you can't buy the market averages.
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Speaker 1: It's time the public could so explain your role in
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Speaker 1: the development of the index funds. Well, basically I said
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Speaker 1: that in nineteen seventy three, and the first index fund
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Speaker 1: was not started until seventy six. Now. Uh, you know,
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Speaker 1: I want to give Jack Bogel all the credit in
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Speaker 1: the world, because it's one thing for an academic to say, hey,
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Speaker 1: there ought to be index funds. It's another thing for
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Speaker 1: somebody to bet his company on starting an index fund,
10:12
Speaker 1: and let me tell you, it wasn't easy. At the beginning.
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Speaker 1: They had an underwriting where they were hoping to do
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Speaker 1: a hundred million or more in the index fund, and
10:24
Speaker 1: in fact the book wasn't oversubscribed. They sold eleven million.
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Speaker 1: And sometimes I used to joke, because uh I then
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Speaker 1: was on the Vanguard board that Jack Bogle and I
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Speaker 1: were about the only people I knew who actually owned
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Speaker 1: shares in the index fund. It was very, very slow
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Speaker 1: to catch on, but it did catch on, UH And
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Speaker 1: in fact, last year, hundreds of millions of dollars moved
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Speaker 1: from actively managed funds into index funds, and index funds
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Speaker 1: now now have maybe somewhere between thirty and thirty five
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Speaker 1: percent of people's money of individuals or institutions, more institutional
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Speaker 1: than individual. Uh. Individuals are slower to catch onto this,
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Speaker 1: so with the institutions it's maybe thirty five or more.
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Speaker 1: With individuals it's probably a bit less than thirty. But
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Speaker 1: the point is the market is catching up to the idea,
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Speaker 1: and UH I am obviously simply delighted since I've basically
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Speaker 1: been an evangelist for index funds all my life. So
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Speaker 1: Vanguard you. You mentioned your you you served with Jack Bogel.
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Speaker 1: You were on the board for twenty eight years. They're
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Speaker 1: now over three trillion, that's trillion, with of which two
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Speaker 1: thirds are actively are actually passive indexes are actually they
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Speaker 1: still have about a third that are active management. But
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Speaker 1: that leads to a really interesting question. What's more significant
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Speaker 1: the low cost aspect of it or the passive aspect
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Speaker 1: of it of index Well, I think they're both both
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Speaker 1: are important. Clearly, the low cost is important in that Uh,
12:18
Speaker 1: you know, let me tell you, any of us who
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Speaker 1: talk about financial markets need to be very modest about
12:27
Speaker 1: what we know and don't know. But let me tell
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Speaker 1: you the one thing I'm absolutely sure about with respect
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Speaker 1: to financial markets, and that is the lower the fee
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Speaker 1: I pay to the purveyor of the investment service, the
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Speaker 1: more that's going to be for me. And the problem
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Speaker 1: is for active managers, it is still the case that
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Speaker 1: probably a hundred basis points one percentage point a year
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Speaker 1: is what they are charging, and the index fund or
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Speaker 1: e t F, the exchange traded index fund, charges five
13:03
Speaker 1: or four basis points. Uh. And that difference is basically
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Speaker 1: a difference that comes to the investor. It's also the
13:15
Speaker 1: case that trading is not free. There are bitass spreads,
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Speaker 1: there are market impact costs. Uh, it's not free. So
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Speaker 1: there's an extract cost uh, including what I think people
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Speaker 1: do not appreciate, and that's the tax cost of the
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Speaker 1: active trading. When you have an actively managed fund, you've
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Speaker 1: got a ten ninety nine at the end of the year.
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Speaker 1: Very often and they will say, hey, we realize some
13:44
Speaker 1: short term and long term capital gains on your behalf
13:47
Speaker 1: and you've got to report those on your income tax.
13:49
Speaker 1: You have a partner named Uncle Sam, and he's going
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Speaker 1: to take exactly that. That's that's quite astonishing. So how
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Speaker 1: do I'm curio is, how did you find your way
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Speaker 1: to Vanguard from Princeton. Well, I think Vanguard found its
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Speaker 1: way to me in that people knew uh that I
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Speaker 1: had been a proselytizer for index funds. I believed in
14:19
Speaker 1: low cost uh, and so it was such a very
14:23
Speaker 1: natural fit. And Vanguard came to me. I didn't come
14:27
Speaker 1: to them. So let me throw another of your quotes
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Speaker 1: from the book out that that I adore. And I'm
14:33
Speaker 1: curious as to the sort of pushback this generates. But
14:36
Speaker 1: by the way we take this quote for granted, and
14:39
Speaker 1: I have found a number of quotes that are yours
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Speaker 1: that a number of other people have have taken credit for.
14:47
Speaker 1: But in a random walkdown Wall Street, you wrote, a
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Speaker 1: blindfolded monkey throwing darts at a newspaper's financial pages could
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Speaker 1: select a portfolio that would do just as well, one
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Speaker 1: selected carefully by the experts. What was the response to that. Oh,
15:05
Speaker 1: the response was really uh, definitely bad. Uh. The former
15:16
Speaker 1: Bloomberg business Week was just Business Week, And my book
15:21
Speaker 1: when it first came out, was reviewed by an investment
15:24
Speaker 1: professional in Business Week, and it was probably the worst
15:28
Speaker 1: review I've ever had in my life. The reviewers said,
15:32
Speaker 1: this is the biggest piece of garbage that you could
15:34
Speaker 1: possibly imagine, because professional, uh, investment people really don't like
15:42
Speaker 1: to be compared to a blind to blindfolded chimpanzee. So
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Speaker 1: I remember, for a long time the Wall Street maybe
15:53
Speaker 1: it was fifteen years they were doing this, The Wall
15:55
Speaker 1: Street Journal was literally throwing darts at stock pages and
15:59
Speaker 1: compared to an absolutely and in fact, they had invited
16:03
Speaker 1: me to throw out the first darts when they did this.
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Speaker 1: And basically what they found was there was a little
16:15
Speaker 1: bit of an effect because when the Wall Street Journal
16:18
Speaker 1: put the column out. The column had five picks of
16:22
Speaker 1: the experts, and the expert picks, Uh, maybe got a
16:26
Speaker 1: little bit for a day, the price went up a bit,
16:29
Speaker 1: but generally, after the fifteen years of doing this, it
16:34
Speaker 1: came out basically pretty even. And you know, that really
16:37
Speaker 1: leads to a very very important point about indexing. You know,
16:43
Speaker 1: we talked about the markets being reasonably efficient. Suppose they
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Speaker 1: weren't efficient. It doesn't matter when you think of it.
16:51
Speaker 1: All the stocks in the United States have to be
16:54
Speaker 1: held by somebody. Every share of General Motors is held
16:58
Speaker 1: by somebody. Every share of Facebook is held by somebody.
17:03
Speaker 1: Any every share of Salesforce is held by somebody. So
17:08
Speaker 1: what that means is if you, as a professional investor,
17:15
Speaker 1: hold just a few of the stocks, what that means
17:22
Speaker 1: is and say that they're the good ones, the ones
17:25
Speaker 1: that went up more than the market. What that has
17:29
Speaker 1: to mean is that somebody else is holding the stocks
17:34
Speaker 1: that went up less than the market. It it must
17:37
Speaker 1: follow that investing has to be a zero sum game.
17:42
Speaker 1: If somebody is outperforming, then somebody else has got to
17:47
Speaker 1: be underperforming because the index holds everything. And the reason
17:52
Speaker 1: the index fund wins is the index fund is holding
17:56
Speaker 1: everything and essentially charging a zero the and the active
18:02
Speaker 1: manager is holding some of the stocks and charging a
18:06
Speaker 1: one percent fee. So even if before fees, the active
18:12
Speaker 1: managers balance each other out, after fees, they're going to underperform.
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Speaker 1: And what we know, we know so clearly is year
18:24
Speaker 1: after year after year, the active funds are underperforming. Every year.
18:31
Speaker 1: I always read columns, this is going to be a
18:34
Speaker 1: stock pickers market year, you know, every year people are
18:37
Speaker 1: going to say that, or beginning of this year, there's
18:40
Speaker 1: going to be more of volatility. This year, the unactive
18:42
Speaker 1: managers will be able to outperform. And Standard in Pores
18:47
Speaker 1: does a so called SPIVA report each year Standard and
18:50
Speaker 1: Poor's indices versus active, and every year we get the
18:54
Speaker 1: same thing. Two thirds of the actively managed mutual funds
19:01
Speaker 1: underperformed the index, and the third that outperform in one
19:06
Speaker 1: year aren't the same as the third that outperformed in
19:09
Speaker 1: the next year. So that uh uh, you know, it's
19:13
Speaker 1: not that it's impossible to outperform, and in fact, there
19:18
Speaker 1: are a few outperformers, but when you go active, you're
19:23
Speaker 1: much more likely to be in the bottom end of
19:26
Speaker 1: the distribution and index investing isn't mediocre investing, it isn't
19:31
Speaker 1: average investing. It's actually above average investing. I'm Barry Riults.
19:37
Speaker 1: You're listening to Masters in Business on Bloomberg Radio. My
19:41
Speaker 1: special guest today is Princeton Emeritus Professor Burton Malkiol. He
19:46
Speaker 1: is probably best known for his book A Random Walk
19:50
Speaker 1: Down Wall Street. The paperback is now in its eleventh edition.
19:54
Speaker 1: It's already sold over a million and a half copies
19:58
Speaker 1: and is widely regarded as the one book to read
20:01
Speaker 1: on investing if you're only going to read one. Uh.
20:04
Speaker 1: He is also, in addition to a long and glorious
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Speaker 1: uh academic career, he is also the chief investment officer
20:14
Speaker 1: of wealth Front, which is one of the larger new
20:18
Speaker 1: software driven asset management firms, which is running about three
20:22
Speaker 1: billion dollars. Is that about right? So how did you
20:26
Speaker 1: get involved with something like a robo advised or something
20:30
Speaker 1: like Wealthfront? Well, again, they just as with Vanguard, they
20:34
Speaker 1: found they came to me rather than vice versa. Uh.
20:41
Speaker 1: And again it was just such a natural fit because
20:46
Speaker 1: a they use only index funds, and as you know, UH,
20:51
Speaker 1: that's what I have believed in all of my life.
20:55
Speaker 1: And secondly, uh, they are charging very low fees. They
21:04
Speaker 1: charge nothing for the first fifteen thousand dollars under management,
21:09
Speaker 1: and then they charge twenty five basis points a quarter
21:14
Speaker 1: of one percent on anything over there versus a traditional
21:19
Speaker 1: investment advisor that will put together a portfolio for you
21:24
Speaker 1: and charge probably at least one percent uh and sometimes
21:31
Speaker 1: even more. And the problem I think with many professional
21:36
Speaker 1: investment advisors is that we ought to recognize that they
21:41
Speaker 1: often have a conflict of interest. What I think is
21:46
Speaker 1: not as well known as it should be, is that
21:50
Speaker 1: if you go to an investment advisor who sits down
21:53
Speaker 1: with you and says, okay, uh, we'll put together a
21:57
Speaker 1: portfolio for you, that that advisor gets paid for selling
22:04
Speaker 1: you an actively managed fund. It's not only that the
22:08
Speaker 1: fund itself is charging you maybe one but there's a
22:13
Speaker 1: conflict of interests the advisor. Uh. In fact, that's one
22:17
Speaker 1: of the reasons why there's such a battle now about
22:20
Speaker 1: the so called fiduciary standard. And again, what this advisor, uh,
22:26
Speaker 1: this automated advisor, we have no conflict of interests. We
22:31
Speaker 1: just use In fact, uh, we use a lot of
22:34
Speaker 1: Vanguard ETFs. But if Charles Schwab has a cheaper e
22:37
Speaker 1: t F. H we will use that and we are
22:41
Speaker 1: able to automatically rebalance the portfolio to keep it within
22:47
Speaker 1: the risk level that the client wants. If it's a
22:52
Speaker 1: taxable account, uh, we do uh tax loss harvesting. I mean,
22:58
Speaker 1: for example, last year, we had a bit of the
23:03
Speaker 1: portfolio in emerging markets. Emerging markets were terrible last year,
23:09
Speaker 1: so that if you bought an emerging market e t
23:12
Speaker 1: F you had a loss. What we will then do
23:16
Speaker 1: is we will then sell that e t F keep
23:22
Speaker 1: your position in emerging markets by buying another one that's
23:28
Speaker 1: similar but not identical. And the reason you can do
23:31
Speaker 1: that and have it not be a wash sale is
23:35
Speaker 1: say you sell an M S c I Emerging market
23:39
Speaker 1: e t F and you buy a Vanguard one. They
23:43
Speaker 1: are index to two different indices, so it's not a
23:47
Speaker 1: wash sale. And so we're able to do all the
23:51
Speaker 1: things that a sophisticated investment advisor will do for you
23:57
Speaker 1: and do it at a fraction of the cost. And again,
24:01
Speaker 1: as I said before, the thing I'm sure about is
24:05
Speaker 1: the lower the costs that I pay, the more that's
24:08
Speaker 1: gonna be for me. And UH, I think it's been
24:13
Speaker 1: very effective and in fact, in a lousy year like
24:18
Speaker 1: last year, we were able to realize for various accounts
24:25
Speaker 1: between two and three percentage points of tax losses, so
24:31
Speaker 1: that even in a year when markets were pretty darn
24:34
Speaker 1: flat and did very little, we were able to, UH,
24:38
Speaker 1: I think benefit the people who are our clients. So
24:42
Speaker 1: so within this and I find the term robo adviser
24:46
Speaker 1: to be a little misleading. But well, I don't like
24:49
Speaker 1: it because it suggests that, in fact, you know, there's
24:53
Speaker 1: some senseless robot who's doing it. And since I'm the
24:58
Speaker 1: chief Investment Office, I can tell you that, in fact,
25:03
Speaker 1: there are a lot of smart people behind what we
25:06
Speaker 1: are doing. I'm Barry Rich Hults. You're listening to Masters
25:09
Speaker 1: in Business on Bloomberg Radio. My special guest today is
25:13
Speaker 1: Professor Burton Malkiel, formerly of Princeton where he is still
25:19
Speaker 1: UH professor emeritus, a former board member of Vanguard for
25:24
Speaker 1: twenty eight years, and author, now in its eleventh edition,
25:29
Speaker 1: A Random Walk Down Wall Street. UH. The book has
25:32
Speaker 1: sold over a million and a half copies. UH. Let's
25:35
Speaker 1: talk a little bit about UM. Some other guests I've
25:38
Speaker 1: had on the show that that you know, so you
25:42
Speaker 1: worked with Jack Bogel for a number of years. He
25:45
Speaker 1: was a guest on the show a few months ago.
25:48
Speaker 1: What can you tell us about Jack that that we
25:50
Speaker 1: probably don't know? Well, I don't know whether you know.
25:54
Speaker 1: Jack is very well known, and I think the some
25:57
Speaker 1: of his habits are uh probably better known than the
26:04
Speaker 1: habits of some of your other guests. But one of
26:07
Speaker 1: the things about Jack is that maybe people don't know,
26:11
Speaker 1: is this idea of low cost uh is really into
26:17
Speaker 1: his DNA. This is a guy who will go to
26:21
Speaker 1: a hotel uh and when they say, well, we've got
26:26
Speaker 1: a very good room, and we've got a bargain, uh
26:29
Speaker 1: it's a hundred and fifty dollars a night, Jack will
26:32
Speaker 1: go and say, well, do you have anything at a
26:34
Speaker 1: hundred dollars a night? Jack has this sort of calvinist
26:39
Speaker 1: streak uh that uh uh he uh as much money
26:46
Speaker 1: as he has, and he's certainly been very successful financially,
26:50
Speaker 1: just lives his life as frugally as you can imagine.
26:58
Speaker 1: And of course I think that's really what has gotten
27:01
Speaker 1: into his company. A vanguard that uh that's really into
27:07
Speaker 1: Jack's uh d n A. And you know the interesting thing,
27:12
Speaker 1: I'll tell you one other little funny story about Jack Vogel.
27:19
Speaker 1: So many Wall Street people, uh have you know the
27:24
Speaker 1: eight thousand dollar watch on and uh the Italian Uh,
27:30
Speaker 1: the Italian suits and so forth. Uh. Jack is always
27:34
Speaker 1: sort of in a rumpled suit. And interestingly enough, when
27:39
Speaker 1: he first met Warren Buffett, uh, they were actually at
27:44
Speaker 1: a hotel together, and Jack recognized Warren went up and
27:49
Speaker 1: introduced himself, and he said to Warren, you know the
27:53
Speaker 1: thing I really like about you is you have rumpled
27:56
Speaker 1: suits just the same as uh I do. And Jack
28:01
Speaker 1: and Warren have become very very good friends. And as
28:04
Speaker 1: you probably know, because Warren is the sort of exception
28:08
Speaker 1: to indexing that everybody mentions that, Warren has said, I've
28:12
Speaker 1: got told my widow when I'm gone, I just want
28:18
Speaker 1: you to own index funds. So there's a couple of
28:21
Speaker 1: things about Jack. He's been a lifelong friend and uh,
28:27
Speaker 1: just a wonderful guy. But Buffett has said publicly most
28:31
Speaker 1: people should be in indexes. That absolutely what what the
28:35
Speaker 1: average person should be doing. But so let's talk a
28:39
Speaker 1: second about Buffett, because when we talk about the efficient
28:44
Speaker 1: the concept about the efficient market hypothesis, the name that
28:49
Speaker 1: always comes up is Warren Buffett? Is is he an outlier?
28:54
Speaker 1: Is he lucky? Or is he uniquely skilled? Look? I
28:57
Speaker 1: think he is enormously is skilled. I wouldn't take anything
29:01
Speaker 1: away from him. But he's also a very good businessman.
29:07
Speaker 1: Let me tell you a little story. At one point,
29:10
Speaker 1: when I was the dean of the Yale Management School,
29:14
Speaker 1: we had Katherine Graham come to speak to our class,
29:21
Speaker 1: and uh, she fortunately got the time wrong, but not
29:26
Speaker 1: to come an hour later an hour earlier. So I
29:29
Speaker 1: was able to sit down with her for about an hour.
29:32
Speaker 1: And of course, the first thing I wanted to ask
29:34
Speaker 1: her was, look, I know that one of Warren Buffett's
29:38
Speaker 1: first great investments was the Washington Post. And tell me
29:43
Speaker 1: about Buffett, because Buffett generally buys companies, are huge stakes
29:50
Speaker 1: in companies. And she said, uh. I said, what was
29:54
Speaker 1: it like working with him? She said, you know, when
29:57
Speaker 1: I had learned that he had bought a steak in
30:01
Speaker 1: our company, I was just scared to death. I thought
30:04
Speaker 1: he clearly wanted to take over the company. Uh, and
30:07
Speaker 1: I would be out in my ear. So I called
30:10
Speaker 1: him and he said, no, really, I just did this
30:13
Speaker 1: as an investment. And she said, I really sort of
30:16
Speaker 1: liked him. He seemed very honest and straightforward. And I
30:20
Speaker 1: then confided at him, we're going bankrupt. We're really in
30:24
Speaker 1: terrible shape. Would you please come join my board and
30:29
Speaker 1: help me right this company? Buffett joined the board. Buffett
30:35
Speaker 1: actually was to Catherine Graham enormously helpful as a business person,
30:42
Speaker 1: moving the thing around and making it finally successful. And
30:46
Speaker 1: so when you think of Warren Buffett, I don't think
30:50
Speaker 1: it's just that he read Graham and Dodd bought a
30:54
Speaker 1: value stock uh and uh and it was good. He's
30:58
Speaker 1: also made sure not himself, but he's put good management
31:03
Speaker 1: in and has helped managements. And I think that's been
31:07
Speaker 1: the genius of Warren Buffett as opposed to Uh No,
31:13
Speaker 1: it's very easy. You just read Graham and Dodd and
31:16
Speaker 1: run a good portfolio. Let me also say about Buffett
31:19
Speaker 1: that given the size that Berkshire Hathaway is now, it's
31:24
Speaker 1: virtually impossible for him to do the kinds of things
31:29
Speaker 1: that he has done in the past. He does um
31:34
Speaker 1: bring a certain good housekeeping stamp of approval. And he
31:39
Speaker 1: is also and I recall the most recent addition you
31:42
Speaker 1: referenced him, he gets access and creates deals that the
31:48
Speaker 1: average stock picker is just never going to have access to. Oh, absolutely,
31:53
Speaker 1: and he's got the capital that during the financial crisis, UH,
31:57
Speaker 1: he was able to go to financial institutions, get a
32:02
Speaker 1: ten percent coupon, get an equity participation, and do what
32:08
Speaker 1: other people were not able to do. So let's last
32:11
Speaker 1: word about Buffett. He made a tremendous investment in Goldman Sachs,
32:15
Speaker 1: which turns out to be hugely usually successful. Most people
32:21
Speaker 1: probably don't realize that he had offered Dick Fold of
32:24
Speaker 1: Lehman Brothers an investment and Fold turned them down, which
32:29
Speaker 1: is stop and think about how how brilliant and insight
32:32
Speaker 1: that was. So, so let me go back to UM
32:36
Speaker 1: some of some of my favorite quotes from the book.
32:40
Speaker 1: I recall hearing this way back when, and then when
32:43
Speaker 1: I started researching UM things for this conversation, I was
32:49
Speaker 1: shocked to see that this was a quote of yours
32:53
Speaker 1: you had written in or said in some interview. Tip
32:57
Speaker 1: of the week if you bought a thousand dollars worth
33:00
Speaker 1: of Nortel stock one year ago. By the way, this
33:02
Speaker 1: was in the late nineties when Nortel UH symbol NT
33:06
Speaker 1: was a house of fire. UM if you had board
33:10
Speaker 1: a thousand dollars worth of Nortel a year ago, today,
33:13
Speaker 1: it's worth forty nine dollars. But if instead you went
33:16
Speaker 1: out and bought a thousand dollars worth of Budweiser, the
33:20
Speaker 1: beer not Anheuser bush stock a year ago, if you
33:25
Speaker 1: drank all the beer and traded in all the cans
33:28
Speaker 1: for the nickel deposit, it'd be worth seventy nine dollars
33:32
Speaker 1: more than Nortel. My advice to you start drinking heavily.
33:36
Speaker 1: I remember seeing that in the late nineties, and it
33:39
Speaker 1: was never attributed to you. Is that really a quote
33:43
Speaker 1: from burton Mouth? Hiel, Oh, yes, it definitely is. But
33:46
Speaker 1: you know, my feeling is imitation is the best form
33:49
Speaker 1: of flattery. I'm you know, I'd obviously prefer uh that
33:55
Speaker 1: someone gave me credit for it, but uh, the imitation
33:59
Speaker 1: is fine. And the point about the book, and I
34:02
Speaker 1: think one of the reasons that the book has done
34:04
Speaker 1: well is that it is written in a rather lighthearted fashion,
34:09
Speaker 1: because a lot of people's eyes glaze over when they're
34:13
Speaker 1: talking about facts and figures and numbers. So I've really
34:17
Speaker 1: tried as hard as I could to make it as
34:21
Speaker 1: interesting as possible. Well, you certainly you're certainly succeeded. There
34:25
Speaker 1: Another book that that I've been a fan of, uh
34:29
Speaker 1: is The Winning the Loser's Game by Charlie Ellis. He
34:32
Speaker 1: was also on the board of Vanguard for a long
34:36
Speaker 1: time and uh on the Yale Advisement, Yale Endowment Advisory Board,
34:42
Speaker 1: where where you were um chairman of the School of Management.
34:46
Speaker 1: I assume you and Charlie know each other fairly well.
34:48
Speaker 1: We do know each other fairly well. And uh, Charlie
34:52
Speaker 1: and I have actually written things together. And and again
34:58
Speaker 1: I think one of the things Charlie and I want
35:01
Speaker 1: to give him credit, this is his Charlie has I
35:04
Speaker 1: think uh uh just uh this wonderful analogy about investing
35:12
Speaker 1: that is just so true. Uh. And it's one of
35:16
Speaker 1: the things he's best known for. He says, Listen, suppose
35:20
Speaker 1: you're a tennis player, but you're not a professional. Now.
35:24
Speaker 1: Professionals win points by some uh you know, huge fast serve, uh,
35:33
Speaker 1: some drop shot, some superb shot uh that the other
35:39
Speaker 1: player can't get. But when you think of ordinary people
35:44
Speaker 1: playing tennis, the people who win are the people who
35:48
Speaker 1: have just made the fewer errors that trying to do
35:52
Speaker 1: something extra is a loser's game, and uh, that of
35:57
Speaker 1: course is what Charlie is best known for. Obviously, Charlie
36:02
Speaker 1: and I are Kendred Spirits in that we both believe
36:06
Speaker 1: in indexing. Charlie, for example, started his career and started
36:12
Speaker 1: a company, Granite Associates, where they were helping to choose
36:17
Speaker 1: the best investment advisors. Charlie believed in active management, and
36:23
Speaker 1: only after experience with it he now realizes that he
36:28
Speaker 1: is a convert. And Uh, there is no better person
36:34
Speaker 1: uh to sing the praises of indexing than Charlie Ellis. Uh.
36:39
Speaker 1: He's a great guy and a very good writer. So
36:43
Speaker 1: if people want to find more of your writings other
36:46
Speaker 1: than the book, and this isn't the only book you've
36:49
Speaker 1: written a number of them, where else would they go
36:51
Speaker 1: to to learn more about the works of Burton Malkiel. Well,
36:56
Speaker 1: I've done other things, uh, such as and maybe this,
37:02
Speaker 1: you know, gets into a different subject. I've written about
37:07
Speaker 1: emerging markets and a book called Global Bargain Hunting. I've
37:10
Speaker 1: written about China in a book called From Wall Street
37:14
Speaker 1: to the Great Wall. Uh. And I think in general today, uh,
37:21
Speaker 1: probably if I have any investment advice for a long
37:28
Speaker 1: run portfolio. I suspect that people are smitten with what
37:36
Speaker 1: we call the home country bias, that they just have
37:41
Speaker 1: US stocks uh to the detriment to their own detriment,
37:48
Speaker 1: and they are ignoring some of the fastest growing parts
37:52
Speaker 1: of the world. Emerging markets now have about half of
37:56
Speaker 1: the world's GDP. Emerging markets have eighty five percent of
37:59
Speaker 1: the world else population. Emerging markets have about of the
38:04
Speaker 1: world's capitalization. And today emerging markets are very unpopular, which
38:13
Speaker 1: means attractively priced, which means that they are probably the
38:17
Speaker 1: most attractively priced markets in the world. Now that doesn't
38:21
Speaker 1: mean the next month or the next year they're going
38:24
Speaker 1: to do well, but we can look at very long
38:33
Speaker 1: run rates of return and get some idea as to
38:38
Speaker 1: whether they're going to be high or low by looking
38:41
Speaker 1: at valuations and look, valuations in the United States are high.
38:47
Speaker 1: They're higher than average. Because emerging markets have been so unpopular,
38:53
Speaker 1: valuations are well below normal. Emerging markets are still growing.
38:59
Speaker 1: China is slowing down. Yeah, China is probably only growing
39:03
Speaker 1: at six six and a half percent now rather than ten.
39:07
Speaker 1: And everybody says China is crashing and burning. I wish
39:10
Speaker 1: we were growing at six for sure, So I think
39:14
Speaker 1: there's a lot of growth there. Valuations are better, and
39:17
Speaker 1: I just think that if somebody has a portfolio and
39:23
Speaker 1: has nothing in emerging markets, you ought to take a look.
39:28
Speaker 1: And of course I would say you take a look
39:31
Speaker 1: by indexing, because a lot of people say, oh, emerging
39:35
Speaker 1: markets are very inefficient, you don't want to index there.
39:39
Speaker 1: In fact, of emerging market active managers are outperformed by
39:44
Speaker 1: the index in part because of the inefficiency of emerging markets.
39:49
Speaker 1: So that asks spreads are high market impact costs when
39:53
Speaker 1: you buy and sell, there are stamp taxes and emerging
39:56
Speaker 1: markets you really want to be more passive there. And
40:00
Speaker 1: my advice for investors is take a look and at
40:04
Speaker 1: least a small piece of the portfolio should be put there,
40:08
Speaker 1: and I think over the next decade people will be
40:11
Speaker 1: well served. This puts you a little bit at odds
40:14
Speaker 1: with Jack Bogel, who is not a fan of investing overseas.
40:18
Speaker 1: He's concerned about the currency risk, and he says, hey,
40:21
Speaker 1: half of the S and P five hundred uh revenue
40:25
Speaker 1: comes from overseas. How do you respond to jile? Absolutely, Uh,
40:29
Speaker 1: there's no question you get some of it with us multinationals.
40:34
Speaker 1: But my feeling is, uh, you will also get some
40:39
Speaker 1: good portfolio effects because emerging markets are not totally correlated
40:45
Speaker 1: with the US market. I think that you're missing something.
40:50
Speaker 1: And even though Jack is one of my absolutely best
40:55
Speaker 1: friends and we agree on ent of things, Jack also
40:58
Speaker 1: doesn't like a t f S and I think are
41:01
Speaker 1: a great uh, are a great invention and uh great
41:07
Speaker 1: for people. So a little Burton Malkiel, Jack Bogel Trivia,
41:11
Speaker 1: my head of research and I were putting these questions
41:14
Speaker 1: together and we noticed that Jack Bogel was born at
41:19
Speaker 1: the peak of the market and you were born at
41:23
Speaker 1: the depth of the crash. Uh huh. That's very interesting.
41:27
Speaker 1: That's fascinating, a little bit of fascinating, a bit of
41:31
Speaker 1: information and uh uh uh. I was a depression baby
41:38
Speaker 1: and so is so is Jack. Um. Professor Malkiel, you
41:42
Speaker 1: can hang around a little bit. We'll we'll continue chatting
41:44
Speaker 1: for a while. So h and if I forget to
41:47
Speaker 1: say this later, thank you so much for doing this
41:49
Speaker 1: and being so generous with your time. We have been
41:53
Speaker 1: speaking with Professor Burton Malkiel of Princeton University, author of
41:58
Speaker 1: A Random Walk down Wall Street Now and it's eleventh edition.
42:02
Speaker 1: If you enjoy this conversation, be sure and stick around
42:05
Speaker 1: for our podcast extras, where we keep the digital tape
42:08
Speaker 1: rolling and continue chatting about all things investing. Be sure
42:13
Speaker 1: and check out my daily column on Bloomberg View dot com.
42:17
Speaker 1: You can sign up for my Daily Reads also at
42:20
Speaker 1: Bloomberg dot com, or follow me on Twitter at Rit Halts.
42:24
Speaker 1: I'm Barry Rit Halts. You're listening to Masters in Business
42:28
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42:31
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42:41
Speaker 1: offered by Merrill Lynch Pierce feder Smith incorporatedor Register Broker
42:43
Speaker 1: Dealer remember s I PC. Welcome to the podcast extras. Bert,
42:47
Speaker 1: Thank you so much for doing this. This is really fascinating.
42:50
Speaker 1: I'm a fan of yours for forever. You could tell
42:53
Speaker 1: by the other folks I've had on the show, Jack Bogel,
42:57
Speaker 1: Charlie Ellis, Bill McNab, Jack and in you are you
43:03
Speaker 1: are right in the same circle of of excellence as
43:08
Speaker 1: these folks. There's so many questions I want to get
43:11
Speaker 1: to you get through. Let's let's see how many of
43:14
Speaker 1: these we can we can click through. Let let me
43:16
Speaker 1: start with a softball. Why is stock picking so difficult? Basically,
43:25
Speaker 1: it's partly difficult. Is that partly the reason is that
43:31
Speaker 1: there are so many people doing it and that they
43:35
Speaker 1: are so professional in doing it. You know, if you
43:41
Speaker 1: have a market where say ten percent of the people
43:48
Speaker 1: in the market or professional and n are individuals who
43:54
Speaker 1: don't know anything, and they will pick a stock because
43:59
Speaker 1: they like the name, or they will pick a stock
44:04
Speaker 1: because uh uh, they drive a Fiat so they'll buy
44:10
Speaker 1: Fiat Chrysler. They'll do it that way. That gives the
44:15
Speaker 1: professionals a possibility of finding things that may be improperly priced.
44:25
Speaker 1: But when you have a market now that is ninety
44:28
Speaker 1: percent professional and probably of the trading is done professionally,
44:37
Speaker 1: that competition means that if somebody has got a good idea,
44:41
Speaker 1: they act on it and the price reflects that good idea.
44:45
Speaker 1: And that's I think the problem. When you've got a
44:48
Speaker 1: market that you have individuals who are buying stocks for
44:53
Speaker 1: different reasons other than do they represent good value. Maybe
45:00
Speaker 1: there's a chance of doing it, and maybe this worked
45:03
Speaker 1: fifty years ago. But the problem is as the market
45:07
Speaker 1: gets more and more professional, when people are better trained,
45:11
Speaker 1: when people have better sources of information, when people can
45:15
Speaker 1: go to their Bloomberg terminals and the information gets disseminated
45:21
Speaker 1: immediately to all the professionals, it's then harder and harder
45:28
Speaker 1: to actually beat the market. So that raises another question
45:32
Speaker 1: that raises a number of other questions. Uh, why are
45:37
Speaker 1: so many people still so involved in chasing alpha? Why
45:43
Speaker 1: is it that the majority of market participants seem to
45:48
Speaker 1: be spending so much time chasing uh that the dream
45:53
Speaker 1: about performance. Let me give you two reasons. One is, uh,
45:59
Speaker 1: that they get paid for doing it. This is and
46:03
Speaker 1: well paid at that this is a very well paid profession.
46:08
Speaker 1: Uh so, uh, they do get paid for it. The
46:12
Speaker 1: second is, and this goes to the work of Danny Kahneman,
46:19
Speaker 1: who was one of my colleagues at Princeton, that there
46:23
Speaker 1: does seem to be in our d n a a
46:28
Speaker 1: feeling of over optimism. These people who are chasing alpha. Yeah,
46:33
Speaker 1: they do it because they get paid to do it.
46:35
Speaker 1: But I think they honestly, you know, it's it's not
46:38
Speaker 1: that they're bad people and that they're lying. They really
46:42
Speaker 1: believe something. Yeah, they're direct and the and and this
46:46
Speaker 1: is I think the problem that this over optimism is
46:53
Speaker 1: just a part of our human nature. Uh and uh
46:59
Speaker 1: even though they think it's difficult, uh, they think I
47:02
Speaker 1: can do it. You know we uh we and uh
47:07
Speaker 1: we now is myself and Danny Kahneman, because I've done
47:10
Speaker 1: these experiments. You ask a group of students. I've got
47:14
Speaker 1: two hundred students in the room, and I give them
47:18
Speaker 1: some questionnaires and one of them is are you a
47:23
Speaker 1: better driver or the worst driver than all the other
47:28
Speaker 1: students in the room. And of them say that they're
47:32
Speaker 1: better than averages like like will be gone. Yes, you know,
47:35
Speaker 1: we're all better, we're all better than average. And I
47:39
Speaker 1: think that there's a lot of that in uh uh
47:42
Speaker 1: in this that you know, you just uh you you
47:48
Speaker 1: you you hope uh and you think that yeah, it's
47:52
Speaker 1: hard to do, but I can do it. You know.
47:54
Speaker 1: The joke story about this being in our DNA is
47:59
Speaker 1: a few hundred thousand years ago there were two groups
48:03
Speaker 1: of cave men, and one group of cavemen saw some
48:06
Speaker 1: mammoth down on the plains and said, I have an idea.
48:09
Speaker 1: Let's take sharpened sticks and see if we could go
48:12
Speaker 1: bring down this three ton mammoth. And the other group
48:15
Speaker 1: of people weren't optimistic, and they stayed in the cave. Well,
48:19
Speaker 1: the first cave might have lost a few participants, but
48:22
Speaker 1: they had mammoth meat all winter and they made it
48:24
Speaker 1: through to the spring. The risk of us group, they
48:27
Speaker 1: didn't have anything to eat, and therefore we we have
48:30
Speaker 1: tend to be over optimistic. We may lose a few
48:33
Speaker 1: people along the way, but as a group, the tribal
48:36
Speaker 1: will survive. And I always thought that was an amusing
48:39
Speaker 1: I think I think that's right, because I really do
48:42
Speaker 1: think it's in our d n A. So this raises
48:46
Speaker 1: another question. I mentioned. Vanguard is now up to three
48:50
Speaker 1: trillion with a TU charging an average of something like
48:54
Speaker 1: eleven basis points across all their funds. But at the
48:57
Speaker 1: same time, the hedge fund community is also up to
49:01
Speaker 1: three trillion, and they charged two hundred basis points plus
49:06
Speaker 1: another of the profits. Some people have described hedge funds
49:12
Speaker 1: as a fee transfer mechanism UH disguised as a asset class.
49:18
Speaker 1: How do we explain the simultaneous success of really low
49:24
Speaker 1: cost indexing and really expensive active private management. Well, I
49:31
Speaker 1: don't think the hedge fund fees are going to continue.
49:36
Speaker 1: I think there's already uh some pressure on the fees,
49:40
Speaker 1: and there are some institutional investors, such as CalPERS, who
49:44
Speaker 1: have in fact realized that this may not be as
49:49
Speaker 1: good a deal as they had hoped. Hedge funds worked
49:53
Speaker 1: for a while, and you know, again this goes back
49:56
Speaker 1: to the paradox of professional advice. At the beginning, there
50:03
Speaker 1: were hedge funds who made a lot of money and
50:07
Speaker 1: who actually did find arbitrage opportunities. Let me give you
50:12
Speaker 1: an example. Uh, we have standard and Poor's futures. We
50:17
Speaker 1: have standard and Poor's e t fs. Sometimes those futures
50:24
Speaker 1: and the e t F sold at prices that were
50:27
Speaker 1: different from the prices of the underlying and when you
50:32
Speaker 1: were able to do efficiently a program trade, you might
50:37
Speaker 1: be able to get an arbitrage where the future is
50:42
Speaker 1: too high, so you short the future and by the
50:44
Speaker 1: underlying or vice versa, a relatively low risk transaction. There
50:49
Speaker 1: were some arbitrages, and some hedge funds, like Citadel was
50:54
Speaker 1: one example of a hedge fund that got built up
50:58
Speaker 1: that way. Did very very well. Those opportunities now have
51:02
Speaker 1: basically been arbitraged away. That's the idea of efficiency that
51:08
Speaker 1: has more and more good people get into something, the
51:11
Speaker 1: opportunity goes away. It's like, you know, suppose there was
51:16
Speaker 1: a Christmas rally that the market goes up between Christmas
51:20
Speaker 1: and New Year's. Well, then if you know about it,
51:24
Speaker 1: then what you do is you buy the day before
51:27
Speaker 1: the Christmas holiday and you sell the day before New
51:29
Speaker 1: Year's UH, in order to take advantage of it. But
51:33
Speaker 1: then you realize you've got to go two days before
51:35
Speaker 1: and sell two days before the end. And then of
51:38
Speaker 1: course it disappears. And so I think what's happened is
51:43
Speaker 1: that worked for a while, it does not work now.
51:47
Speaker 1: And the hedge fund returns have been just terrible over
51:52
Speaker 1: the last five years. And I think what you are
51:55
Speaker 1: seeing slowly, these things don't happen overnight, but slow you
52:00
Speaker 1: were seeing pressure on fees and more and more institutions questioning, UH,
52:07
Speaker 1: the idea of hedge funds. And and again let me
52:11
Speaker 1: talk about another person. I don't know if you've ever
52:13
Speaker 1: had him on your show, UH, David Swenson, who wrote
52:17
Speaker 1: the book on institutional management of using hedge funds, and
52:22
Speaker 1: David was then going to write a book for individuals.
52:25
Speaker 1: He then looked at the situation today and said, oh
52:28
Speaker 1: my god, you can't do it anymore by index funds.
52:33
Speaker 1: I haven't had Swenson on, but i'd absolutely love to.
52:37
Speaker 1: You know, you mentioned uh some years ago the hedge
52:40
Speaker 1: funds were making money. Jim Chenos, who runs kind of
52:43
Speaker 1: Coast Associates, said, twenty five years ago when he or
52:47
Speaker 1: thirty years ago when he launched his hedge funds, they
52:50
Speaker 1: were about a hundred hundred hedge funds and they were
52:53
Speaker 1: all making alpha. They were all actually making money. Now
52:57
Speaker 1: there's ten thousand hedge funds, and the same hundred hedge
53:00
Speaker 1: funds are still uh making creating alpha, and none of
53:04
Speaker 1: the rest are. So you're right, is a handful of
53:07
Speaker 1: them that did, and some of whom still are. Uh.
53:11
Speaker 1: Look at look at Renaissance Technologies and Jim Simons um
53:16
Speaker 1: hand uh, David Tepper and Appalouse Associates. There's a small
53:21
Speaker 1: run of folks that seem to be making money. I
53:24
Speaker 1: don't want to quite say consistently, although when you look
53:28
Speaker 1: at Bridgewater and you look at Renaissance, some of them
53:30
Speaker 1: have been fairly consistent over the years, but it sounds
53:34
Speaker 1: like the you're you're of the opinion the bulk of
53:37
Speaker 1: them just don't get it. I think the bulk of
53:40
Speaker 1: them don't, and I think it's getting harder and harder
53:42
Speaker 1: and the paradox of professional advice. Uh, if it works,
53:48
Speaker 1: it's going to destroy the alpha's. And I'm very suspicious.
53:54
Speaker 1: I don't think that supposed there even is some alpha around. Uh,
54:00
Speaker 1: the two and twenty means the alpha's all gonna go
54:04
Speaker 1: to the purveyor of the service. I think they'll be
54:08
Speaker 1: less and less of it. And again, when we talk
54:11
Speaker 1: about the things that Yale University did that my own
54:17
Speaker 1: university did, remember also that a lot of these things,
54:22
Speaker 1: it's less well known, would cut their own deals with
54:25
Speaker 1: these people, and they wouldn't necessarily pay two and twenty.
54:29
Speaker 1: The alpha's that are around, if there are any, are
54:33
Speaker 1: not going to justify two and twenty for the buyer
54:38
Speaker 1: of the fund. So let me throw another quote at yours,
54:41
Speaker 1: the of you. Let me know, throw another quote at
54:45
Speaker 1: you of yours that that I really like. It's not
54:49
Speaker 1: that stock prices are capricious, it's that the news is capricious.
54:54
Speaker 1: Explain what you meant by that, Well, look, if there
54:58
Speaker 1: is a headline UH that comes out tomorrow, UH, and
55:08
Speaker 1: it says, uh, men's stores are gearing up for a
55:16
Speaker 1: Father's Day buying season, that's not news. I could have
55:22
Speaker 1: written that six months ago the calendar, you know, Christmas exactly. Uh.
55:30
Speaker 1: What's news is something that you can't predict from the past.
55:37
Speaker 1: What's news is uh, for example, today it looks like
55:43
Speaker 1: an Egyptian airliner was taken down by terrorists. That's news.
55:49
Speaker 1: You couldn't predict that yesterday. You couldn't predict that the
55:52
Speaker 1: day before. And so news is in some sense random,
55:58
Speaker 1: and by random I mean unpredictable. And it's the unpredictable
56:04
Speaker 1: things that move prices. And what I am suggesting is
56:09
Speaker 1: that to the extent that they mean that prices should
56:13
Speaker 1: be higher or lower, the prices changed right away. So
56:19
Speaker 1: I like the way you describe that. Let's talk a
56:22
Speaker 1: little bit about what's become one of the hottest bud
56:25
Speaker 1: buzzwords and investing, smart Beta, which you actually added a
56:30
Speaker 1: whole section in the in the whole Champion. So, so
56:36
Speaker 1: is smart beta just smart marketing or does it have
56:39
Speaker 1: some real I believe that smart beta is mainly smart marketing,
56:44
Speaker 1: and it's not smart investing. Now, what smart beta is
56:48
Speaker 1: is the following. What we know from history is that
56:54
Speaker 1: there are certain factors that have been associated did with
57:01
Speaker 1: somewhat higher stock returns. Example, we know over time the
57:09
Speaker 1: returns from smaller companies have been generally a little bit
57:14
Speaker 1: higher than the return from larger companies. Now, my sense
57:19
Speaker 1: is that's probably right, it probably will continue. But in fact,
57:25
Speaker 1: smaller companies are riskier than larger companies, so that if
57:30
Speaker 1: you get a somewhat higher rate of return for taking
57:35
Speaker 1: on more risk, that doesn't mean the market is inefficient,
57:39
Speaker 1: that doesn't mean it's a real alpha. That just means
57:43
Speaker 1: you took on more risk. Uh. Junk bonds yield more
57:48
Speaker 1: than triple A bonds, of the of which there are
57:51
Speaker 1: only a few now. But the point is, yes, you
57:55
Speaker 1: can get a higher rate of return for taking on
57:57
Speaker 1: more risk. UH. So what smart beta says is, let's
58:03
Speaker 1: put the portfolio together with some of these factors that
58:07
Speaker 1: have been associated with higher returns. And my sense is
58:13
Speaker 1: that either you get the higher rate of return because
58:16
Speaker 1: you've taken on more risk, or that the factor isn't
58:21
Speaker 1: nearly as dependable as it's been in the past. For example,
58:28
Speaker 1: value has generally done a little better than growth over
58:33
Speaker 1: the years. I think largely because of the situation UH
58:40
Speaker 1: in the year two thousand when growth stocks sold a
58:44
Speaker 1: triple digit multiples, and I remember my own public service
58:49
Speaker 1: of New Jersey sold at a multiple not too much
58:52
Speaker 1: over ten. So obviously the growth stocks went way down,
58:57
Speaker 1: the value stocks did well. Not depend endable though year
59:01
Speaker 1: to year. In fact, the last few years value stocks
59:04
Speaker 1: have been a trap. They haven't been good. So my
59:07
Speaker 1: sense is it's really an excuse to charge instead of
59:13
Speaker 1: five basis points, seventy five or a hundred basis points,
59:17
Speaker 1: And if you do get a higher rate of return,
59:20
Speaker 1: it's only because you've taken on more risk. And these
59:23
Speaker 1: other factors are really not nearly as dependable as the
59:29
Speaker 1: proselytizers for smart beta suggests. So let's hold smart beta
59:34
Speaker 1: side for second and talk about the French Fama three
59:38
Speaker 1: factor model, which since has been expanded. So I think
59:41
Speaker 1: five factors. So small cap is one, value is the
59:47
Speaker 1: three factor, and the regular beta. The regular volatility is
59:51
Speaker 1: the third one of the Fama French three factor model.
59:54
Speaker 1: Now now there's also two additional factors. One is quality
59:58
Speaker 1: where you're avoiding heavily indebted or some other quantitatively way
1:00:04
Speaker 1: to to eliminate names and momentum on top of it.
1:00:11
Speaker 1: How do we adjust those sort of models that seem
1:00:15
Speaker 1: to do somewhat better than the actual um benchmark? Is
1:00:21
Speaker 1: it that there are inefficiencies and it's too challenging to
1:00:26
Speaker 1: to sift through. When you look at the Wall Street coverage,
1:00:29
Speaker 1: for example, the analysts coverage of big cap stocks Apple, Walmart, Google,
1:00:35
Speaker 1: there's a hundred analysts covering them. You look at any
1:00:38
Speaker 1: of the mid size or even small cap stocks, there's
1:00:42
Speaker 1: a dearth of coverage. There's a dearth of banking services.
1:00:45
Speaker 1: It seems like there's not a lot of information about that.
1:00:49
Speaker 1: Is that potentially an inefficiency that that could contribute to
1:00:54
Speaker 1: small cap so called premium It's possible, But I would
1:00:58
Speaker 1: also say, uh, since there are a lot of small
1:01:03
Speaker 1: camps uh that really can lose half or three quarters
1:01:09
Speaker 1: of their value. Uh, they're also I think, in my view,
1:01:14
Speaker 1: intrinsically risk ear And I think that's the other point
1:01:17
Speaker 1: about this. Let's take momentum, which is one of the
1:01:20
Speaker 1: ones that there's been a lot of recent work on.
1:01:23
Speaker 1: There is a little bit of past evidence that there
1:01:27
Speaker 1: is some momentum in the market. There are also what
1:01:33
Speaker 1: is called momentum crashes. But sometimes you get a momentum
1:01:38
Speaker 1: stock and uh it works fine, uh until uh uh
1:01:45
Speaker 1: until it doesn't. I mean again, you know that uh
1:01:49
Speaker 1: this uh fellow on a different network who will be nameless,
1:01:56
Speaker 1: would talk about the fang stocks Facebook. You know, all
1:02:00
Speaker 1: of these were just doing well. There was a lot
1:02:03
Speaker 1: of momentum, and then all of a sudden, uh, it crashed.
1:02:07
Speaker 1: And so while there might be something there, I think
1:02:12
Speaker 1: there's also an inherent risk in following some of those factors.
1:02:19
Speaker 1: So again my view is that they're not nearly as
1:02:24
Speaker 1: dependable as people argue they are. They probably are associated
1:02:30
Speaker 1: with larger risk. And as I've looked at all the
1:02:34
Speaker 1: smart beta ETFs over the last five years, I do
1:02:40
Speaker 1: not find that as a group, after expenses, that they
1:02:46
Speaker 1: have in fact been a good deal for investors. So
1:02:50
Speaker 1: my view is plain vanilla capitalization waited indexing is still,
1:02:57
Speaker 1: in my view, the way to go. So given the
1:03:00
Speaker 1: success of indexing and the success of Vanguard and a
1:03:05
Speaker 1: host of other advisory firms that advocate indexing, that leads
1:03:11
Speaker 1: to an obvious question, when does indexing get to be
1:03:16
Speaker 1: too big? Can we ever reach a point where too
1:03:19
Speaker 1: many people are in are in indexes and that creates
1:03:22
Speaker 1: opportunities for the active managers. Well, you know, when indexing
1:03:28
Speaker 1: is of the total, I might start to worry about that,
1:03:33
Speaker 1: But I think with the indexingt pent of the total,
1:03:37
Speaker 1: there are still plenty of active managers out there to
1:03:42
Speaker 1: make sure that information gets reflected quickly. And in fact,
1:03:46
Speaker 1: I think it'll always be the case. Suppose indexing was
1:03:51
Speaker 1: so great that, in fact, the market wasn't reflecting the news,
1:03:58
Speaker 1: then it will pay somebody to jump into the market.
1:04:02
Speaker 1: And you know, that's the wonderful thing about capitalism. Uh,
1:04:06
Speaker 1: if you have free markets and somebody can jump into
1:04:09
Speaker 1: a market, if there is an opportunity, you can count
1:04:13
Speaker 1: on the fact that somebody will. So I'm not worried
1:04:16
Speaker 1: about it. Uh. If in fact it was the case
1:04:20
Speaker 1: that markets were getting less and less efficient in reflecting information,
1:04:25
Speaker 1: believe me, that'd be a profit motive for somebody to
1:04:28
Speaker 1: jump in. Because if there's a chance to make money
1:04:33
Speaker 1: in this world. Uh, that's the beauty of capitalism. Somebody
1:04:37
Speaker 1: will find a way to do it. So I mentioned
1:04:41
Speaker 1: to a friend that I was speaking with you today
1:04:44
Speaker 1: and Uh. This person is an active manager, and he said,
1:04:50
Speaker 1: ask him what his problem is with market timing. If
1:04:54
Speaker 1: I see a train coming down the tracks, don't I
1:04:58
Speaker 1: want to jump out of the way. So I know
1:05:01
Speaker 1: what the answer is, but let's hear it directly from Well, look, absolutely,
1:05:06
Speaker 1: you want to jump out of the way. The problem is, UH,
1:05:09
Speaker 1: it just isn't that obvious that there's the train uh coming?
1:05:14
Speaker 1: You know, maybe maybe it's a light at the end
1:05:16
Speaker 1: of the tunnel rather than the train coming in the
1:05:19
Speaker 1: opposite direction. And I think the people who have tried
1:05:23
Speaker 1: to do market timing, uh have I think, uh really
1:05:28
Speaker 1: not been successful. I have never known. Look, I remember
1:05:33
Speaker 1: I've been uh on boards like Vanguard where we had
1:05:41
Speaker 1: some people trying to do market timing, because Vanguard, as
1:05:45
Speaker 1: you pointed out earlier, has some actively managed funds. I've
1:05:49
Speaker 1: been a long term director of Prudential Financial. We had
1:05:53
Speaker 1: people trying to I have never known anyone who could
1:05:57
Speaker 1: consistently time the market. And in fact, I've never known
1:06:02
Speaker 1: anyone who knows anyone who was able to consistently time
1:06:05
Speaker 1: the market. Sure, jump out of the tracks of a
1:06:09
Speaker 1: train is coming. But it isn't that obvious. So let's
1:06:14
Speaker 1: talk a little bit about the behavioral side. We've alluded
1:06:18
Speaker 1: to it throughout the conversation. Behavioral economics today is widely understood,
1:06:23
Speaker 1: widely followed back a few a decade or two ago,
1:06:27
Speaker 1: it really wasn't understood. Here's a quote from you, and
1:06:33
Speaker 1: this is directly from the book. There are four factors
1:06:37
Speaker 1: that create a rational market behavior over confidence, biased judgments,
1:06:44
Speaker 1: herd mentality, and loss aversion. What does that mean to
1:06:48
Speaker 1: the to the average investor, Well, I think when you
1:06:51
Speaker 1: actually look at how this works with what people do,
1:06:57
Speaker 1: let me tell you what I think. The main lesson
1:06:59
Speaker 1: is one of the things that we know is that
1:07:05
Speaker 1: people tend to sell out when things are looking grim
1:07:13
Speaker 1: and to buy when everybody is optimistic. We we have
1:07:17
Speaker 1: very good data on the flow of money from individuals
1:07:23
Speaker 1: into equity mutual funds, and what we know from those data,
1:07:28
Speaker 1: uh is the following fact that money flows into the
1:07:33
Speaker 1: market when everyone's optimistic. In the first quarter of two thousand,
1:07:39
Speaker 1: at the top of what it clearly in retrospect was
1:07:43
Speaker 1: a bubble, more money came into equity mutual funds than
1:07:49
Speaker 1: ever before that that quarter Q one two thousand, Q
1:07:53
Speaker 1: one two thousand. That's when the money came in right
1:07:56
Speaker 1: at the top and in fact went into the growth funds,
1:08:01
Speaker 1: went into probably the most overpriced part of the market.
1:08:05
Speaker 1: We used to have a sick joke at Vanguard at
1:08:11
Speaker 1: that period because value funds, which were actually cheap had outflows.
1:08:20
Speaker 1: We uh we at Vanguard. The flagship value fund that
1:08:25
Speaker 1: we had was called the Windsor Funds, was run by
1:08:28
Speaker 1: a man by the name of John f a great
1:08:30
Speaker 1: money manager. He was losing money all the time. Now,
1:08:35
Speaker 1: you don't know in a mutual fund complex exactly where
1:08:41
Speaker 1: those flows were going, because when you redeem in a
1:08:45
Speaker 1: complex like Vanguard, you just redeem the fund and it
1:08:50
Speaker 1: goes into the money market fund. So you have to
1:08:53
Speaker 1: look at where the checks were written. So we looked
1:08:57
Speaker 1: at where the checks were written, and in fact, the
1:09:00
Speaker 1: checks were being written to this company in Denver called
1:09:04
Speaker 1: Jens Janice. Oh sure, and the Janie Fund had something
1:09:07
Speaker 1: called the Janie twenty the twenty best ideas that they had.
1:09:11
Speaker 1: They were all internet companies. And the sick joke that
1:09:15
Speaker 1: we had is, you know what, why do we have
1:09:18
Speaker 1: to go and do the accounting of having the money
1:09:21
Speaker 1: go from Windsor into the money fund and then to Janice.
1:09:25
Speaker 1: Why don't we just package up the money and send
1:09:27
Speaker 1: it to Denver right away. Well, you know what happened.
1:09:32
Speaker 1: The Janie fund lost eight percent of its value. Uh.
1:09:36
Speaker 1: In fact, value funds did very well after the market crashed.
1:09:41
Speaker 1: So here is the problem. People are putting their money
1:09:44
Speaker 1: in when they're optimistic, they're going into this these momentum
1:09:48
Speaker 1: types of things. The money then came out when the
1:09:52
Speaker 1: market was low in two thousand and two, and when
1:09:55
Speaker 1: did most of the money come out of the stock market,
1:10:00
Speaker 1: out of equity mutual funds? Individuals took out scores and
1:10:05
Speaker 1: scores of dollars in the third quarter of two thousand
1:10:11
Speaker 1: and eight, which turned out that was one of the
1:10:13
Speaker 1: mark that when the world was collapsed, and when we
1:10:15
Speaker 1: we saw the first quarter of two thousand nine, the
1:10:18
Speaker 1: flows actually accelerated and there was just a huge get
1:10:23
Speaker 1: me out at any price exactly. And of course what
1:10:26
Speaker 1: we know is that was precisely the time to get
1:10:30
Speaker 1: in rather than going out. And in fact, this is
1:10:35
Speaker 1: where our emotions get ahold of us. And in fact,
1:10:40
Speaker 1: if it's the best thing that an investment advisor can do,
1:10:45
Speaker 1: whether it's a regular investment advisor or one of the
1:10:48
Speaker 1: automated advisors that I work with, is to keep people
1:10:52
Speaker 1: on an even keel. That's the best lesson that we
1:10:57
Speaker 1: can have is, for heaven's sakes, uh, don't let your
1:11:03
Speaker 1: emotions get ahold of you. Be a regular investor for retirement.
1:11:10
Speaker 1: Put money in every pay period every quarter you'll get
1:11:15
Speaker 1: take the advantage of dollar cost averaging, which in a
1:11:19
Speaker 1: volatile market will actually help you because you buy more
1:11:23
Speaker 1: shares when the price is down that when the price
1:11:26
Speaker 1: is up. Don't try to time the market, because it's
1:11:30
Speaker 1: not that you don't it's even worse than that you
1:11:32
Speaker 1: don't know how to do it. It's that when you
1:11:35
Speaker 1: do it, you're much more likely to be wrong rather
1:11:38
Speaker 1: than right. One of the things I noticed in the
1:11:42
Speaker 1: O eight oh nine collapse was even the people who
1:11:46
Speaker 1: saw the train coming and got off the tracks when
1:11:49
Speaker 1: the market bottomed in March O nine, they refuse to
1:11:53
Speaker 1: believe it. They stayed in cash. And we watched people
1:11:57
Speaker 1: sit in cash oh nine in two thousand ten and
1:12:01
Speaker 1: two thousand eleven, and all we heard about for a
1:12:04
Speaker 1: couple of years was this is just a head fake.
1:12:08
Speaker 1: This is a temporary rally. It's gonna go even lower.
1:12:11
Speaker 1: And what are we two hundred and six percent higher
1:12:14
Speaker 1: from then? It's amazing. Lesson about timing is uh, not
1:12:18
Speaker 1: only do you not know when to get in, you
1:12:22
Speaker 1: don't know when to get out and when you market time.
1:12:24
Speaker 1: You gotta be right twice. You gotta know when to
1:12:27
Speaker 1: get out and when to get in. And nobody and
1:12:32
Speaker 1: I really believe this, nobody, but nobody can do that.
1:12:36
Speaker 1: So you mentioned the behavioral counseling for financial advisors as
1:12:40
Speaker 1: well as the software um advisors. Let me let me
1:12:45
Speaker 1: ask a question a little differently. What is it that
1:12:49
Speaker 1: the financial services industry actually gets right for their customers
1:12:56
Speaker 1: to the extent that they get their customers to diversify,
1:13:03
Speaker 1: to have some safe parts of the portfolio, to keep
1:13:09
Speaker 1: an on an even keel uh two tax uh manage
1:13:16
Speaker 1: that is, to the extent that you have H an
1:13:20
Speaker 1: I R A or a four oh one K. To
1:13:23
Speaker 1: the extent that you have that and have some fixed
1:13:27
Speaker 1: rate instruments, Uh, they ought to go into that part
1:13:32
Speaker 1: of the portfolio. Uh. And to the extent that you're
1:13:37
Speaker 1: in the taxable portfolio, maybe that's when you put some
1:13:41
Speaker 1: municipal bonds in if you want some bonds. And you know,
1:13:44
Speaker 1: this may seem very obvious, but that's something that individuals
1:13:49
Speaker 1: don't obviously think about. So there's a lot that financial
1:13:53
Speaker 1: advisors can do UH. And what I think is particularly
1:14:01
Speaker 1: useful in terms of what I'm doing with this automated
1:14:05
Speaker 1: advisor is if we can do it more efficiently, if
1:14:11
Speaker 1: we can do it at lower cost, it's going to
1:14:15
Speaker 1: be much better for the individual. So we have about
1:14:20
Speaker 1: thirty minutes left before I have to send you off
1:14:22
Speaker 1: to chat with Arthur Levitt. Before I do that, let
1:14:26
Speaker 1: me run through some of my favorite questions I asked
1:14:31
Speaker 1: all of my guests. UM, it didn't look like you
1:14:35
Speaker 1: were gonna go into finance when you came out of
1:14:38
Speaker 1: school with an m b a. I from what I read,
1:14:42
Speaker 1: you were thinking about going into business rather than finance.
1:14:46
Speaker 1: How did you make that transition? What what shifted your
1:14:51
Speaker 1: focus more towards investing asset management and finance rather than
1:14:56
Speaker 1: working with UH corporate entity. Well, I was always interested
1:15:02
Speaker 1: in finance. I mean I grew up a poor kid
1:15:06
Speaker 1: in Roxbury, Massachusetts, which is part of Boston, and I UH,
1:15:12
Speaker 1: we lived in a tenement house. We had no money,
1:15:16
Speaker 1: but I was just sort of fascinated with numbers. I
1:15:18
Speaker 1: was fascinated with the stock market. I had no UH
1:15:21
Speaker 1: money in the stock market, but I knew the price
1:15:25
Speaker 1: of General Motors stock as well as I knew Ted
1:15:28
Speaker 1: Williams batting average. UH. And when I was in college,
1:15:32
Speaker 1: I was a good economic student. And my professors in
1:15:36
Speaker 1: college said you ought to go to graduate school and
1:15:38
Speaker 1: be an economist. And I said, no, no, look, and
1:15:41
Speaker 1: I grew up poor. I want to go and make
1:15:43
Speaker 1: some money. So I did go into UH. I did
1:15:46
Speaker 1: go to business school. I did UH then go into
1:15:49
Speaker 1: Wall Street. I worked for Smith Barney for almost three years.
1:15:54
Speaker 1: I was an investment banker. But what I found was
1:15:59
Speaker 1: I was thinking I really did like economics. I was
1:16:04
Speaker 1: trying to go to n y U UH and get
1:16:08
Speaker 1: a PhD. At the same time that I worked for
1:16:11
Speaker 1: Smith Barney. But I was an investment banker, I was traveling,
1:16:16
Speaker 1: I was missing more of my classes. And what finally
1:16:20
Speaker 1: happened was I finally did make enough money so that
1:16:24
Speaker 1: I didn't feel poor anymore, and I took a leave
1:16:27
Speaker 1: of absence to go to Princeton UH get a PhD.
1:16:36
Speaker 1: I expected to go back into Wall Street. I still
1:16:39
Speaker 1: liking finance, but an interesting thing happened. Uh. They said
1:16:44
Speaker 1: to me, hey, you've been a pretty good student, come
1:16:48
Speaker 1: and stay and teach. Really and so two things happened.
1:16:54
Speaker 1: I said, all right, I'll try it for a year
1:16:55
Speaker 1: and see if I like it. And secondly, Prudential Financial
1:17:04
Speaker 1: had had a scandal at one point where the chairman
1:17:09
Speaker 1: was having Prudential lend to some of the entities that
1:17:13
Speaker 1: the chairman UH controlled, and the legislature decided that there
1:17:18
Speaker 1: had to be six public directors of Prudential, chosen by
1:17:25
Speaker 1: the UH Supreme the Chief Justice of the New Jersey
1:17:31
Speaker 1: Supreme Court. The Chief Justice interviewed a number of people
1:17:35
Speaker 1: for this, including me, put me on the Prudential board,
1:17:40
Speaker 1: and again came to the point and said, you know,
1:17:43
Speaker 1: I could be a professor and still be a business.
1:17:46
Speaker 1: You know, I sort of never decided when I he
1:17:51
Speaker 1: gave me both options. I then was on the Prudential
1:17:53
Speaker 1: board uh for uh longer actually than even on the
1:17:58
Speaker 1: Vanguard board, so that I uh then being on the
1:18:03
Speaker 1: Prudential board and knowing other people got on other boards
1:18:08
Speaker 1: and basically became uh someone who could live in both
1:18:14
Speaker 1: worlds and who could make a good living from being
1:18:18
Speaker 1: in the business world. Uh, and UH did the writing
1:18:23
Speaker 1: Uh and teaching that I enjoyed. I enjoyed teaching. It's
1:18:27
Speaker 1: one of the reasons why I wrote random Walk. Oh really,
1:18:30
Speaker 1: that's interesting. So basically that was kind of my career
1:18:35
Speaker 1: of not deciding what I wanted to be when I
1:18:37
Speaker 1: grew up, Uh, and in fact thinking well, maybe I
1:18:41
Speaker 1: can do both things. And I have you told it
1:18:43
Speaker 1: at Princeton? Am I right? And saying almost forty years
1:18:46
Speaker 1: is right? Well, I I was at Princeton, as you
1:18:51
Speaker 1: pointed out in your introduction. I worked for the government
1:18:54
Speaker 1: for a couple of years on the President's Council of
1:18:57
Speaker 1: Economic Advisors. I was a management school old dean at
1:19:00
Speaker 1: Yale for seven years. So I've done a lot of
1:19:03
Speaker 1: different things, and I've enjoyed that because I think life
1:19:07
Speaker 1: is richer to the extent that you get more and
1:19:11
Speaker 1: more experiences, always always keep it fresh, always always mix
1:19:15
Speaker 1: it up. So let me ask you, uh this fascinating question.
1:19:19
Speaker 1: Who were your early mentors? Who who was giving you
1:19:23
Speaker 1: advice and insight as to what to do with your career? Well,
1:19:28
Speaker 1: as I said, I think I had a couple of
1:19:32
Speaker 1: professors who were very influential who really did want me
1:19:36
Speaker 1: to be uh an academic, who in fact, UH were
1:19:44
Speaker 1: very disappointed uh when uh I first went into business.
1:19:53
Speaker 1: Within the UH business community, I guess UH people UH
1:20:03
Speaker 1: like Jack Bogel, who we've talked about before, who I
1:20:11
Speaker 1: liked particularly both because he and I did see eye
1:20:16
Speaker 1: to eye on of the things about investing, and who
1:20:21
Speaker 1: also had a social conscience. Uh. This was a business
1:20:27
Speaker 1: person who showed you that you could actually do well
1:20:32
Speaker 1: financially by doing well for your client. And I guess
1:20:36
Speaker 1: that was a particular influence for me in the things
1:20:40
Speaker 1: that I had done. UH. And look, finance is fascinating uh.
1:20:47
Speaker 1: You know, as I said, it interested me before I
1:20:50
Speaker 1: had any money and could do anything with it. So
1:20:55
Speaker 1: finance is fascinating and I do think that UH. While
1:21:00
Speaker 1: a lot of people are very angry about finance because
1:21:06
Speaker 1: finance did practically bring the world down in the financial crisis, UH,
1:21:11
Speaker 1: finance is also absolutely essential UH and UH can help
1:21:17
Speaker 1: people uh more than it can hurt them. What what's
1:21:21
Speaker 1: a financial crisis or two amongst friends? Right? It's um
1:21:24
Speaker 1: so so you mentioned and I'm only kidding before you
1:21:29
Speaker 1: people start sending the emails. Um, you mentioned the mentors
1:21:33
Speaker 1: you previously mentioned David Swenson of Yale and Warren Buffett,
1:21:37
Speaker 1: any other investors stand out as influencing your thought process
1:21:42
Speaker 1: or affecting the way you looked at markets? Now, I
1:21:47
Speaker 1: think that, uh, clearly those are the main names in
1:21:53
Speaker 1: terms of my own career, in my own life of
1:21:58
Speaker 1: people who have been influential. So let's talk about some books, uh,
1:22:05
Speaker 1: in addition to the eleventh edition of a random of
1:22:08
Speaker 1: Down Wall Street. UH, tell us about some books that
1:22:12
Speaker 1: you found influential. They could be fiction, non fiction, they
1:22:17
Speaker 1: don't have to have anything to do with finance. What
1:22:20
Speaker 1: are some of the books that that very much influenced
1:22:23
Speaker 1: your thought process? Well, let me give you one in
1:22:27
Speaker 1: the finance, uh academic area, and umh one uh part
1:22:36
Speaker 1: of uh, you know, my own career. You know, sometimes
1:22:42
Speaker 1: I think it would be nice to have eight or
1:22:45
Speaker 1: nine lives because there are a lot of different things,
1:22:51
Speaker 1: uh that would be fun to do. I mean, we
1:22:53
Speaker 1: haven't talked about this, but I was in the Army
1:22:55
Speaker 1: for three years and the Army Finance Corps. I actually
1:22:59
Speaker 1: liked the Army. What did you do for for the
1:23:01
Speaker 1: in the Army. Actually, what I did was we uh
1:23:07
Speaker 1: can I did this right after business school. Uh. There
1:23:11
Speaker 1: was a colonel in the Army who was the commandant
1:23:14
Speaker 1: of the Army Finance Corps and we were putting in
1:23:18
Speaker 1: a computerized pay an accounting system. And this colonel decided,
1:23:24
Speaker 1: what we need are well trained people to go into
1:23:27
Speaker 1: various posts to do it. And so I was a
1:23:31
Speaker 1: direct commissioned into the U. S. Army Finance Corps did
1:23:36
Speaker 1: uh uh did the conversion of our pay and accounting
1:23:44
Speaker 1: system into a computerized one. And at the age of
1:23:48
Speaker 1: twenty two, I had more responsibility than anybody could possibly
1:23:52
Speaker 1: have had at that in the private sector. For sure,
1:23:58
Speaker 1: certainly more than you'd ever out in the private sector.
1:24:01
Speaker 1: And I loved my experience. In fact. Uh you know,
1:24:06
Speaker 1: while as I told you, I grew up poor and
1:24:09
Speaker 1: I did want to get out and earn some money.
1:24:11
Speaker 1: The army is not a place to earn a lot
1:24:14
Speaker 1: of money. But I actually thought, gee, you know, this
1:24:16
Speaker 1: wouldn't have been a bad career. The other possible career
1:24:21
Speaker 1: that I would have loved is I am a frustrated
1:24:24
Speaker 1: Shakespearean actor. Uh. In that uh, I uh as a
1:24:31
Speaker 1: with a lean and hungry. Look, I was a wonderful
1:24:34
Speaker 1: Cassius and a high school play. I would have loved
1:24:37
Speaker 1: to have done that. And I love reading Shakespeare. I
1:24:40
Speaker 1: love theater. Uh. And actually a lot of the things,
1:24:43
Speaker 1: the so called fiction things that I read, are plays,
1:24:49
Speaker 1: because it would have been a wonderful career to have
1:24:53
Speaker 1: had uh. And other than thinking that it meant a
1:24:58
Speaker 1: life of being poor, I might have actually done that.
1:25:02
Speaker 1: With respect to other books that I think are very
1:25:05
Speaker 1: very influential, I would point out Danny Kahneman's book Thinking
1:25:10
Speaker 1: Fast and Slow Again. I think that the insights of
1:25:16
Speaker 1: you know, it's like the old Pogo line, We've met
1:25:18
Speaker 1: the enemy and it's us. Uh. This is I think
1:25:21
Speaker 1: the biggest problem that we have and investing and the
1:25:27
Speaker 1: insights uh in that book, which is a wonderful summary
1:25:32
Speaker 1: of what we know about behavioralism. Uh. This is uh.
1:25:38
Speaker 1: I think you you ought to read my book, But boy,
1:25:43
Speaker 1: I would definitely read that book. It's a terrific book.
1:25:47
Speaker 1: I've read it. And I'm gonna tell you most of
1:25:49
Speaker 1: our listeners, or or at least many of our listeners,
1:25:53
Speaker 1: most of our listeners are familiar with the book, and
1:25:55
Speaker 1: I would bet many of them have read Danny Khneman's work.
1:25:59
Speaker 1: It's it's just seminal um in the space. And so
1:26:03
Speaker 1: that's the the non fiction non finance book. What what
1:26:08
Speaker 1: else do you, uh do you want to mention in
1:26:10
Speaker 1: terms of books? Well, I think those are you know
1:26:14
Speaker 1: as um again we've talked about it and it's very
1:26:19
Speaker 1: well written. Charlie Ellis's book Show on Winning the Losers Game,
1:26:27
Speaker 1: uh is I think very uh important. And uh you know,
1:26:33
Speaker 1: Jack Boggle has um written some great books. In fact,
1:26:38
Speaker 1: I think uh probably uh one of his uh best
1:26:45
Speaker 1: books uh is not directly about finance, and as uh
1:26:52
Speaker 1: says a lot about Jack Bogel. The book is called
1:26:55
Speaker 1: Enough and it comes from uh this uh h idea
1:27:02
Speaker 1: uh that there was a discussion with a writer and
1:27:13
Speaker 1: who had sold a lot of books, and the vellow
1:27:17
Speaker 1: pointed out to a hedge fund guy who had made
1:27:20
Speaker 1: billions of dollars and said to the writer, ah, gee,
1:27:27
Speaker 1: you know you've sold a lot of copies of books,
1:27:31
Speaker 1: but you have got a pittance relative to this hedge
1:27:37
Speaker 1: fund guy. And the writer said, yeah, but I have
1:27:41
Speaker 1: got something uh that that fellow will never have, and
1:27:47
Speaker 1: that's enough. Uh. And again this is an idea that's uh,
1:27:51
Speaker 1: it's it's actually a wonderful book of Jack Buggles UH
1:27:56
Speaker 1: that I recommend warmly to people, a philosophical perspective on
1:28:02
Speaker 1: what you need to be happy as opposed to never
1:28:05
Speaker 1: never achieving that. So you've been watching the finance industry
1:28:11
Speaker 1: for a good long time. UM, what do you think
1:28:15
Speaker 1: are the most significant changes that we've witnessed? And we
1:28:20
Speaker 1: could probably talk for hours just about what's changed, But
1:28:23
Speaker 1: what is it that stands out as this is really
1:28:27
Speaker 1: something that's going to have a lasting effect, uh, decades
1:28:30
Speaker 1: into the future. Well for me, because as you know,
1:28:35
Speaker 1: I wrote there auto be index funds three years before
1:28:40
Speaker 1: the first index fund was put into effect. What I
1:28:45
Speaker 1: am so pleased about is that indexing finally has taken off, uh,
1:28:52
Speaker 1: that money is flowing in. I think the E t
1:28:56
Speaker 1: F revolution uh is a terrific big thing. While there
1:29:01
Speaker 1: are some ETFs, and here I would agree with Jack Bogel,
1:29:05
Speaker 1: there are some E t F that I think are terrible.
1:29:07
Speaker 1: I don't think people should buy the E t F
1:29:11
Speaker 1: gives you three times the of the S and P.
1:29:16
Speaker 1: There are some of them that are terrible. But the
1:29:18
Speaker 1: plane Vanilla ones allow people to basically buy the market
1:29:25
Speaker 1: at close to a zero cost. I think this is
1:29:30
Speaker 1: a revolution, and I think it's uh just extremely important.
1:29:36
Speaker 1: I think that one of the big mistakes also that
1:29:42
Speaker 1: people make is that they don't save enough. I think
1:29:48
Speaker 1: that we do have a crisis in this country that
1:29:53
Speaker 1: as we are aging, many people are woefully unprepared for retirement.
1:30:00
Speaker 1: One of the things that I wish we had done
1:30:04
Speaker 1: as a nation. When George Bush was hoping to privatize
1:30:09
Speaker 1: social Security, what I would have preferred that he do
1:30:16
Speaker 1: is do a private add on to the regular Social
1:30:21
Speaker 1: Security where you would have another percentage or so that
1:30:26
Speaker 1: would come out of your salary, and this would be
1:30:29
Speaker 1: yours that could have been invested in index funds. I
1:30:35
Speaker 1: think if he had proposed that, it would have passed
1:30:39
Speaker 1: as opposed to trying to redo the whole system. I
1:30:44
Speaker 1: still would like to see something like that because I
1:30:48
Speaker 1: think as a nation, we are not saving enough, uh
1:30:53
Speaker 1: and many people are unprepared for retirement. That that's Charlie
1:30:58
Speaker 1: Ellis's most recent That's arl A Ellis's most recent book,
1:31:01
Speaker 1: exactly the coming coming retirement Crisis. Let me before I forget,
1:31:05
Speaker 1: let me just make a note, don't buy triple leveraged
1:31:10
Speaker 1: inverse funds. Got it. I don't think anyone's going to
1:31:13
Speaker 1: take that as a news flash from you know, but
1:31:16
Speaker 1: but it's always good hearing it, uh, straight from the
1:31:20
Speaker 1: horse's mouth. Alright, So you mentioned indexing as the most
1:31:24
Speaker 1: index funds as the most significant shifts since you joined
1:31:28
Speaker 1: the industry. Looking forward, what do you think are the
1:31:32
Speaker 1: next changes that are going to take place? Well, being
1:31:36
Speaker 1: UH in the vanguard of automated UH investment advisories and
1:31:44
Speaker 1: trying to build that business up. I do believe that
1:31:53
Speaker 1: this will become increasingly important, and we will be able
1:32:00
Speaker 1: to automate investment advice because by doing so, we can
1:32:07
Speaker 1: charge less. And as I've said many times, I'm very
1:32:12
Speaker 1: modest about what I know or don't know about finance.
1:32:15
Speaker 1: But what I'm just absolutely sure about is if we
1:32:19
Speaker 1: can provide services at lower cost. UH, that's a win
1:32:26
Speaker 1: win for people, because the lower the price I pay
1:32:31
Speaker 1: to the purveyor of any service, the more that's going
1:32:35
Speaker 1: to be for me, especially if you're going to compound
1:32:37
Speaker 1: that over decades, you bet you, because costs again, UH,
1:32:43
Speaker 1: my friend Jack Boggle would call it just as Einstein
1:32:48
Speaker 1: said at one point that compound interest is one of
1:32:52
Speaker 1: the greatest forces in the world. Well, the costs compound two,
1:32:57
Speaker 1: which Jack calls the tyranny of the compounding of costs.
1:33:02
Speaker 1: So we're down to our last two questions. These are
1:33:06
Speaker 1: two of my favorite questions. I ask all of my guests.
1:33:11
Speaker 1: If somebody who is just graduating college um as a
1:33:16
Speaker 1: millennial as they're referred to these days, came to you
1:33:21
Speaker 1: when asked, said they're interested in a career in finance,
1:33:25
Speaker 1: what sort of advice would you give them. I would
1:33:28
Speaker 1: tell them that while finance sometimes has a a very
1:33:33
Speaker 1: bad name, I mean, after all, we've had uh people uh,
1:33:38
Speaker 1: and they're really very very similar Bernie in this campaign,
1:33:44
Speaker 1: Bernie Sanders says all the problems in the world are
1:33:48
Speaker 1: because of Wall Street and uh uh and break up
1:33:52
Speaker 1: the banks and everything's gonna be fine. And Donald Trump
1:33:55
Speaker 1: has not been very different from Bernie sand really uh
1:33:59
Speaker 1: in say sing that Wall Street is all bad, don't
1:34:03
Speaker 1: believe it. Uh, it's a fascinating career. Uh and uh uh.
1:34:12
Speaker 1: Finance has in fact been extremely important in improving welfare.
1:34:23
Speaker 1: And we were talking about books. There's a book by
1:34:26
Speaker 1: Getsman which has just come out about how money has
1:34:33
Speaker 1: in fact been absolutely essential in improving people's standard of living.
1:34:41
Speaker 1: What what's the name of the Getsman book? Uh, it's
1:34:44
Speaker 1: money and uh uh you might be able to find it.
1:34:50
Speaker 1: I don't think I've got the other part of it.
1:34:52
Speaker 1: Exact money changes every Money changes everything. Fine, Yeah, I
1:34:57
Speaker 1: give credit to Google for that money changes everything. How
1:35:00
Speaker 1: finance made civilization possible? By William oh And I recognized
1:35:06
Speaker 1: this pyramid on the on the cover of the book. Um.
1:35:11
Speaker 1: And our final question, God, I have like a million
1:35:14
Speaker 1: other things to talk to you about, but I can't
1:35:17
Speaker 1: keep you here forever. What is it that you know about?
1:35:20
Speaker 1: And I know the answer to this, but I have
1:35:21
Speaker 1: to ask it. What is it that you know about
1:35:25
Speaker 1: investing today that you wish you knew forty years ago
1:35:29
Speaker 1: when you started your career. Well, I didn't know about indexing. Uh.
1:35:36
Speaker 1: In fact, when I worked at Smith Barney, I spent
1:35:41
Speaker 1: a lot of time with the research people. I Uh,
1:35:46
Speaker 1: I had drunk that kool ai that at that point
1:35:49
Speaker 1: I believed it could be done. And actually one of
1:35:54
Speaker 1: the things that I just found absolutely fascinating was it
1:36:01
Speaker 1: wasn't necessarily because people weren't good at it. UH. My
1:36:08
Speaker 1: mentors at that time where people by the name of Bill, Grant, Nelson, Shannon, Uh.
1:36:16
Speaker 1: They were very good at it. But I began to realize,
1:36:21
Speaker 1: which I didn't know at the beginning, was the paradox
1:36:25
Speaker 1: that the more the talented people are in this game,
1:36:34
Speaker 1: the less they can profit from it. Because the more
1:36:37
Speaker 1: the talented people work and invest and make market prices change,
1:36:47
Speaker 1: the better the market becomes, and the better off people
1:36:53
Speaker 1: are just accepting the tableau of market prices that are
1:36:57
Speaker 1: out there and buying an index fund. And it was
1:37:00
Speaker 1: that kind of experience that finally led to this view
1:37:07
Speaker 1: that indexing was the way to go. Professor Malkiel, thank
1:37:11
Speaker 1: you so much for being so generous with your time.
1:37:15
Speaker 1: This has been an utterly fascinating UH tour to force
1:37:19
Speaker 1: conversation about the everything you've learned and the proper way
1:37:25
Speaker 1: for most people UH to invest. I hope all the
1:37:29
Speaker 1: listeners have have enjoyed this conversation. If you have to
1:37:33
Speaker 1: be sure and look up an inch or down an
1:37:35
Speaker 1: inch on Apple iTunes, you can see the other ninety
1:37:38
Speaker 1: two or so such conversations we've had. I would be
1:37:43
Speaker 1: remiss if I did not thank Taylor Riggs, our booker
1:37:47
Speaker 1: for for scheduling these UH conversations and staying on top
1:37:52
Speaker 1: of all of our very various guests. My engineer is
1:37:56
Speaker 1: Charlie Volmer and my head of research is Mike at Nick.
1:38:01
Speaker 1: You've been listening to Masters in Business on Bloomberg Radio.
1:38:07
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1:38:09
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1:38:15
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