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

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