Dr William Bernstein And John Rekenthaler In Conversation

All right, well, as we all know, it's much better to be lucky than smart, and I was lucky with at least three people 30 years ago. One of them you've already seen, Scott Burns, who 30 years ago told me, young man, keep at it, you'll do well. And then the second person who you also heard about was Jonathan Clements, who was just unbelievably generous and forthcoming with encouragement and advice. And the third person who I came across almost at exactly the same time is this guy sitting here, who not only provided me with encouragement and advice, but also with a very interesting connection, which was that we were, John's also a very lucky guy, by the way, starting with Morningstar in 1988. And then he was also very lucky because Morningstar is in Chicago, and he got connected up with Richard Thaler, Nobel Prize winning economist, probably the most famous behavioral economist around. And I don't know whether it was Dick or you who forwarded me the syllabus from the course you took, I can still see it, I can't find it anymore, but it's this big brown syllabus that connected me up with the behavioral economics literature, which was enormously valuable. So I'll start off with a question, which is that in 19, well, which is in 2017, excuse me, you wrote a column entitled, Most Stocks Stink. It was one of my better titles, yes. Yeah, exactly. So why don't you explain to, you've already heard a little bit about this work reference, but it's such an important piece of work that I think that John would do well to explain it to you. Yeah, I ran across an article by an academic with a fine name of Hendrik Bessembinder. So I got a chance to practice my high school German a little bit. And you know, I think pretty much everybody here has heard the story about a few stocks end up leading the portfolio or end up leading the index. And if you don't own those stocks, I mean, that's an argument for diversification, right? If you don't own those stocks and they're not in your portfolio, you miss out. Well, Dr. Bessembinder put his research to work on this and went back and looked through the history of the stock market, at least the last hundred years or so. He looked at 26,000 US companies and tracked them from when they went public to either now if they're still alive, but most are not because there aren't 26,000 publicly traded companies. There's about 20 less, there's about 4,000 or 3,500 now, or when they were purchased or when they went bankrupt or whatever. And he found that 51% of them had negative returns for the entire history of the company. So only 49% of companies managed to turn, or stocks managed to turn a profit during their existence. And this is nominal return. It's not real return. This is nominal return. When you look at the real performance, it's worse. He found that 86 companies out of those 26,000, 86 companies, which is 0.33%, one third of one percent, were responsible for half of the stock market's growth when you market cap weight their results. And 930 companies or something like that, I think it was 933 companies, were responsible for 100% of the growth. Basically 900 companies gave you everything and the other 25,000 were net zero. Some made a little money, some lost a little money. So that was a, I mean, I found those numbers to be fascinating and they certainly backed up the idea that, and we'll probably touch on this some more because I've been looking at some other recent numbers, that in a portfolio, it's very often, if you've got 20 stocks in the portfolio, it's one or two that are doing all the lifting for you. And you've got 10 that aren't really doing much one way or the other, and then a few more that you really regret. Yeah. That's the academic heft behind the famous Bogle-ism, which is don't look for the needles in the haystack, own the whole haystack, which is certainly an incredible piece of wisdom. Can I open with a question for you? Absolutely. This is my first conference here, and I've been led to understand that you used to do this with Jack Bogle. Indeed. Scared the pants out of me. So I'm sitting in Jack's seat. Indeed you are. How the world has declined. Yeah, and I'm not getting any better. So you're scared. What about me? I'm not getting any better either. All right. Okay. Well, here's something that you and I go round and round about. We're going to have fun with this one, which is, are tech stocks overvalued? Is the Magnificent Seven overvalued? Should we still be owning the S&P 500, or maybe should we just be owning the S&P 493? Okay. That's a big question for you. Well, one, I think we've both learned over time that in most cases, if we think we're smarter than the market, the market's smarter than us. That certainly would have been the case. Because these discussions were going on 10 years ago, should we be out of these. There was still a version of the Magnificent Seven. And the answer, as it turned out, was it was definitely right to be in the Magnificent Seven 10 years ago. We had talked before this discussion a little bit about, historically, it's been a bad idea to buy, say, the 10 biggest stocks in the U.S. Because their business success, this is kind of the Tom Peters excellence story. You look at the companies that people think are excellent in hindsight, they had the best business results. Well, there's a lot of expectations built into their stock, plus their businesses also are likely to reverse to the mean. So you get a double hit. One, the businesses aren't quite as spectacular going forward in terms of the operating performance and the earnings. And two, there's disappointment from investors because they had bid up those businesses. So the stocks take a double hit. If you look back 20 years ago, that was absolutely true. If you look back 20 years ago, and you bought an asset-weighted basket of the 10 largest U.S. stocks, that made 3% over the last 20 years, that basket. And the market was up 11. That was exactly what you were saying. It's a mistake to go buy the previous winners. But if you look 10 years ago, and you bought a basket of the 10 largest stocks, they're up 17%, and the market was up 14. And if you bought the 10 largest technology stocks, they were up 21%. The big got bigger. Apple and Microsoft were the biggest back then, and they did great in the last 10 years. So I'm of a mixed mind on this. While I understand the adage and the general principle, there has been something different going on because this is not all multiple expansion. In fact, some of these companies, their price-earnings ratios are, Apple's has gone up a lot, but Microsoft's is not much different than it was 10 years ago. Facebook's has gone down a lot. Some of the others. So, I mean, there's just been tremendously good operating performance. You've used the word moat as well in this regard, and I'm wondering if you can expand on that. Well, yeah. I mean, the idea of a moat, this is a big Morningstar thing, right? And we still borrowed it from Warren Buffett. A lot of people borrow from Warren Buffett, so I don't feel too guilty about that. I think we use our own term. But the idea is, you know, businesses that have a protection or some sort of... They're not a commodity business. It's hard to get in there and compete with them. And it certainly seems that Microsoft and Apple, with the way that they're embedded into so many technology products and metas, I keep wanting to call it Facebook, but it is a meta platform. And others have, not just U.S. moats, but global moats. So there's some sense that I have that these businesses are different. I realize it's a dangerous thing to say this time it's different. It has been different the last 10 years. Multiples on these stocks are up more than they were before, overall, even though some of them are not. So overall, I'm at a mixed point. These businesses have been better businesses than anybody forecasted, really, they have been. They've outdone expectations. It's not just, you know, crazy investors throwing money or index funds causing bubbles and all this stuff that other people have written about. At the same time, the expectations are really high with these companies. I would be surprised if the top 10 stocks outperformed the rest of the market over the next 10 years. I sounded like Paul Merriman a little bit here now. But I don't think it's going to be a disaster. I mean, most of these companies, here I have a little bit of a list, Broadcom, Tesla, Oracle, and Palantir have price earnings ratios over 60. I don't like over 60. Maybe that's because 60 was the number for the Japanese market in 1989. But that's my magic bad number. And Nasdaq, the ones that had earnings were something, well, even a little higher in 1999. But a lot of the others, as I mentioned, Microsoft, Apple, Alphabet, Amazon, Meta, and such are quite a bit below that level. I think those companies' performances could disappoint some. And maybe probably will if they don't quite meet expectations. But they're not going to tank. That's a long-winded answer, but I have a lot of them. Yeah, I would agree with that. I mean, the problem that I have with the term moat is that in the moment, everybody seems to have a moat. Had you gone back 70 years ago, 80 years ago, you would have said Pennsylvania Railroad has a moat. How do you compete with Pennsylvania Railroad? And it would have been the same thing, of course. It's a moat stock until it's a commodity stock. Exactly. The same thing you could have said. I mean, IBM. IBM, 40 years ago, looked absolutely unbeatable. How could you possibly compete with IBM? They weren't even selling their machines. They were renting them for a king's ransom. How do you compete with that, with IBM? Well, I worked at IBM in 1985, by the way. I was the lowest person on the rung at IBM, the single lowest. I was an assistant, a product support assistant. I can tell you that everybody, I say we, I was only there briefly, we thought nobody was ever going to catch up with us. Somebody came in once to a presentation to look at an IBM little mini-frame that they were selling. And after he left, the salesman said dismissively, with disgust, he wanted an apple. We don't sell to those kind of people. He was like an apple customer. I had the same experience 40 years ago. The most overconfident person I ever met in my community, in my local community, was the local IBM salesman. Yeah, well, there were about 100,000 of them out there then. Yeah. All right. Well, you wrote a brilliant column in, it was your, I believe it was your, well, it wasn't a valedictory column, this was in 2020, it was an absolutely brilliant column. You said that long bonds are for fools. And I believe that, and you believe that, and I bring this up because there was a, probably the most popular thread on the Bogleheads forum at that point was a thread that was entitled, put the first 20% of your portfolio in long bonds, okay, and people had a lot of, a lot of fun with that, particularly in retrospect. So go ahead and elaborate on that one, if you could. Yeah. You had mentioned to me that you thought my reasoning was more sophisticated than yours, but I don't think it was. I looked and said, 1%, because I hit 1%, who on earth would want to get a 1% return for the next 30 years, you know, nominal return? And then I backed up and I did, and so then I, so then I thought, well, I tried to answer my question. Who would want this? Because I know the answer was, it wasn't me, but somebody did because bonds were trading at 1%. So somebody was willing to own them. And then I went through and that's how it came to the title because my argument was, okay, maybe it's somebody who doesn't really think, I don't know who would want to own an asset making 1% for 30 years, but maybe you're thinking yields are going to continue to drop and you're going to sell it to somebody who's willing to take half a percent, a greater fool. So that's why I said long bonds are for fools to sell to a greater fool. So maybe, okay, maybe there's a logic in that, that's speculation, I think more than an investment, but that's a possibility. And then I talked a bit about central banks and there might be other buyers that are really not economic buyers. I suppose you could say somebody who has locked in, they're going to invest 20% in long bonds kind of no matter what the price, if you have an asset allocation that locked in, then you're not an economic buyer either. So I do have a concern a little bit about this thought that if you have an asset allocation, you should stick with it for life and stick to your discipline. I don't think if your asset allocation is to own 20% of your portfolio in long bonds that you wanted to do that at 1%. You might say, well, this is the time to make an exception and just, I'll hold some cash there instead or something shorter. It's always fun in retrospect to look at what's the conventional wisdom at the time. And one of the conventional wisdoms at the time was an idea put forth by Ken Rogoff, famous Harvard economist, brilliant guy, who said, let's take all the cash out of the system. No one can use cash anymore. And if you take the cash out of the system, then the government can debase the currency and people can't put the cash in the mattress to get a positive real return if you have negative real returns. And so the idea was that bonds were going to have soon enough negative returns, negative nominal returns. And that prompted Ed Chancellor, brilliant observer, economic historian, to say what it appears people are doing now is they're buying bonds for capital appreciation and stocks for the yield, which of course is not the way that it worked out. I think that in general, that's almost, that column is almost like a once in a generation type column. Because I don't see pricing anomalies very often that seem obvious. You know, when you talked about 1966 to 1982, I was an adult by the end of that period, but I wasn't really following the markets. In hindsight, I think if I had been following the markets, I would have said, well, 15% long bond return in the early 80s, even with inflation being high, was a pretty good signal that you might want to be in a long bond. Certainly Japan, with a PE ratio of 60, US technology stocks in 1999, I don't think we're quite there yet now. I would not say we're at that period because I just said that I don't think we're at that period. We're there. But, you know, it doesn't happen very often. So I don't, the vast majority of time I've seen people say, this is too much. They were wrong. So I'm very, I want to be very careful with that. And I admit that some of the things I've said are also somewhat in hindsight with me. So don't take anybody, including me, too seriously when they say, I've figured out that this is the top or near the top. Yeah. I'm longer in the tooth than you are. And I actually did buy long bonds back then. I should have bought stocks. Okay. I'd have done better in stocks. And it's the same thing that people look back to, you know, the late 90s when TIPS first came on the market, people didn't know how to price them. And you look and you say, God, I should have bought all those, those TIPS at 4%. Guess what? You'd have been, you'd have done, still would have done better buying stocks. We talked in the late 90s, or email talked is the case maybe, and you were talking about REITs. Yeah. Get out of tech and get into REITs. And I'm like, who's this doctor guy out in Oregon and what's he talking about? And three years later, I was like, okay, I need to keep, keep in touch with him. Because REITs did fantastically well. And believe me, in 1990, well, REITs, nobody likes them now either. It was the same kind of mindset. They were just, in 1999, if you had a list of 97 investments, REITs would be either 96th or 97th on the Glamour list. Yeah. Two, two things, two things made me decide back then that REITs were a good deal. One of them was that, was the yields, of course, that they were almost double digit yields back then. But the other thing was we all have our personal contrary indicators, people who we, we, you know, who always get things wrong and you go opposite to. And one of them was a physician colleague of mine, actually, another neurologist, who when I talked to him about REITs, and he actually had written about them and he'd read my article and he called me up, it was about a 15 second phone call. He said, I read your article about REITs. I've done nothing but lose money on them, hung up the phone. Well, he was right about that part. Yeah, exactly. And that, and that, and that, you know, that rang the bell for, for me. Well, on the same subject. John Luskin here from the John C. Bogle Center for Financial Literacy. We're able to provide these videos from the BogleLabs conference for free, thanks to generous donors like you. Consider making a tax deductible donation at boglecenter.net slash donate. Your contribution helps us continue our mission, building a world of well-informed, capable and empowered investors. And now back to the conference. You know, your, your valedictory column said that, you know, this was not too long ago. It was about last year, I believe. November. Yeah. And you said that bonds are still too expensive. But gosh, these tips, their, their, their yields look pretty good. So how do you resolve, you know, with, with nominal yields not being all that impressive, but real yields being impressive? I'm guessing what you're saying is that you expect there to be big time inflation. Well, bigger than, than the breakeven inflation rate on tips, which is the breakeven inflation rate means, effectively, if inflation is over that level that, that is calculated, then you're better off being in an inflation protected bond for tips. And if it's below that level, you're better off at being in a nominal bond. And that's about, it's 2.25% right now for a 30 year. I can do the show of hands things, but I doubt there's anybody here that's really comfortable saying, you know, wow. For 30 years, I'm going to, I'm going to absolutely, you know, without worry, lock in and expect inflation to be less than 2.25% by owning a nominal bond rather than owning a treasury inflated bond. You might think, okay, inflation might be 2% or 1.5% average over 30 years and I'll make money. But I think you have to concede there's some sort of possibility of, as was talked about yesterday, a debt spiral of the Fed or the, you know, of the government trying to inflate its way out of this monstrous debt that we do have. That has to be considered a possibility. And if it is, you're getting clocked in those nominal bonds compared to tips. It just, it doesn't seem like the bet is in the favor of the nominal bond. I would want something more like 6% as opposed to 4.5% to 5%, which is the range now. I think you're right. It's, it's, it's, it's all about asymmetric consequences. I mean, you, you can see even a bigger word than I use. If you want to concede that the market is usually right, these things, and that's the best central estimate that the break, you know, 2.25% inflation over the next 30 years. And you know, and if you make the bet that, that, that, you know, that you think it's going to be higher than that and you're wrong, inflation's only 1.5%, well, you've lost three quarters of a percent of yield. Big deal. Okay. Whereas if you're wrong in the other direction, you can be wrong by a lot more than 1.5% by investing in nominals. Yeah, that's framed very well, Bill. That's exactly what I was trying to say. If you're right on one end, how right are you going to be? It's not a, it's not that big a deal. It's not going to make or break or anything remotely your, your, your investment results or your retirement, you know, your retirement lifestyle. But if you have quite a bit in nominal bonds and you're wrong, that's, that's real pain. And what's the point of doing that? I mean, what we're supposed to, aren't we supposed to be avoiding risks of, of very bad events during retirement when we can't work and make up for them? Yeah. One of the other voices that, that was very loud at that point was Dick Sillas, who was here last year, Dean of American Financial Historians, who pointed out that yields were at a 5,000 year low. You know, that sort of gets your, yeah, you were the historian. Yeah. I didn't go back that far. Yeah. Talk, talk about the long view. You know, it's what I've always loved about, about professors. Whenever you, whenever you contact Bill, he'll always give you the 5,000 year number. Whether it's gold prices or trading history or whatever, it all, it's somewhere back in Sumeria is where he is. Okay. Well, before I turn the questioning over to you, John, you wrote one column that, that is very salient to this audience, which is, has Vanguard lost its way? What do you think? Yeah, I wrote this column a few years back and, and until my final retirement column where I got more emails and they were very nice. Maybe somebody here sent me one, thank you. That was the most popular column that I had ever written, had a lot of people read it For since I started at Morningstar in 1988 until I wrote this, which I think was 2021, 2022. Anyway, a little while ago. Yeah. December of 21. Okay. I had so consistently been, said positive things about Vanguard, the fund company, about Vanguard funds, about Bogle-ism that I had been accused by other journalists sometimes of being, you know, Vanguard's lapdog. That was actually a phrase that was used. Shill. Yeah. I had somebody once call me a hedge fund shill, which is funny by the way, because I've never said a single positive word about hedge funds ever. So that was not a close reader. But anyway, so, but I started hearing troubling things and this won't come as news to anybody here about Vanguard's customer service and technology. And I was getting notes from people explaining that the problems they had and, you know, looked into it more, wrote that it seemed pretty clear that Vanguard had a problem with customer service. And they used to have such a great customer service back in the day, Jack Bogle famously would get on the, man, the phones when they got too busy and that whole pitch. And in fact, Morningstar, to an extent, modeled itself after what Vanguard did and our CEO would be down there picking up the phones when we got busy too and all that sort of thing. And at the same time, Vanguard announced its relationship with private equity provider, which seemed not quite traditional Vanguard, since private equity is illiquid, expensive, blah, blah, blah. And worst of all, to me, was at the time Vanguard had announced, if you entered into its private advisory service, I think is the name of it, where you get an advisor and it's 30 basis points or something like that, and you get advice, you would have access to special funds that nobody else could get to. This was a pure, you know, Dean Witter, Merrill Lynch, old school, 30 years ago kind of thing, load fund. We have secret funds that you can't get to unless you're our customer. It seemed just bizarre to me that Vanguard would do that. So I wrote this column, I guess it was a, you know, a warning shot, like I'm concerned. And I got 51 emails and 50 of them were darn right, cranky people, mostly about the customer service. And one told me I had no right to criticize Vanguard. I feel better about things since then. I know that the technology and customer service is still imperfect, I hear about it, but they're certainly aware of the issues. And I haven't seen any sort of further steps with our product lines that concerned me back then. So I would say, I wouldn't say that Vanguard has lost its way. It was a question at the time, I didn't make a statement, has Vanguard lost its way? You know, I do think it's natural that these, that Vanguard, Schwarm, iShares, you know, these biggest firms, in some ways do start to look more like each other as they all become giants. They, for one thing, you know, Fidelity, they've mimicked a lot of what Vanguard does. So even if Vanguard doesn't change, they look a lot more like Vanguard than they did 30 years ago. So it's, you know, Vanguard, to me, still stands out as being different, but it's not as different as it was 25 or 30 years ago. It's inevitable. One of the fundamental features of American late financial capitalism is people who are well-informed taking advantage of people who aren't well-informed, okay? So you know, if you get free checking, you're subsidized by the people who do the overdrafts. Same thing if you pay off your credit card, you're being subsidized, you know, every month you're being subsidized by the people who don't. One thing that will warm the cockles of almost everybody in this audience, which is if you're flying coach, you are being subsidized by the people who are flying first class, thank you. And the problem that Vanguard has when they compete with Fidelity and Schwarm is that Vanguard doesn't have any suckers to subsidize the people who are getting low fees. I wouldn't say suckers, but clearly the personal advisory service is a service that brings in a higher fee level and helps to. Yeah, that may be the service that saves them. But you know, I sure wouldn't want to compete with, you know, Schwarm's ability to only pay out, you know, 50 basis points on cash. That's a cash cow. I think that Alan pointed out that in one year, 130% of Schwarm's profit came from charging so little, from paying so little on their cash. How do you get 130% of profits? It means that the rest of Schwarm is losing money. All right. Beyond that. All right. Well, I'll turn it over to you now. Okay. I'll ask, what advice that you received when you started investing, when you first became Well, the best advice that I, of course, got was from Jack Bogle, which is, I mean, I don't have to say anything more than that was, you know, you know, just to not try to predict the future. And, you know, if I wanted academic backup from that, it's my favorite psychology and economics author, who was Phil Tetlock, who basically, you know, pointed out that no one forecasts at all, well, least of all experts. So, you know, if it's a, you know, and if I had to, you know, distill it down even further, it's a piece of advice I got from Ken Fisher, bless his soul, who said that, you know, he pays close attention to the headlines, because if it's above the fold, he doesn't have to worry about it. It's already in the price. All right. If it's in the paper, it's in the price. The worst advice, my God, there's so much awful advice out there. I mean, almost... Well, there's the rest of our session. Yeah. I mean, almost anything you hear from Morgan Stanley is going to be bad advice. So, next question. Let's talk a little bit about the international stocks. We've done that already. But the international markets have, you know, last 15 years or so disappointed, until this year have disappointed, relative to U.S. market, although they've made money in real terms. Yeah. International equities. But what's your take on the prognosis, why that happened and prognosis going forward? Well, what happened was tech, and it has to do with improved corporate profits and profitability. The best analysis that I've seen was done by Cliff Asness at AQR. And he did some very fancy regressions and came up that came with the fact that maybe 20% of the outperformance of international was due to improved profitability and earnings, and the other 80% was due to increased valuation. The way I look at it is that, you know, foreign PEs are not much more than half of U.S. profitability. So you have to pay, you know, to get... So if you pay $1 or $100, you're getting, you know, maybe $3 of earnings here, and you're getting $6 of earnings abroad. Well, what that tells you is that for the U.S. stocks, that $3 from the U.S. to come up to $6 from the foreign stocks, the U.S. is going to have to grow their earnings to be twice as big as they are now, relative to foreign stocks. That's not a bet I'm willing to make, okay? So I'm not saying I... Now, the really nice thing about that, though, is that the valuations have driven up the market cap of U.S. stocks relative to the world cap. So it, for the very first time, makes an all-world, all-cap index, an attractive index that's now 60-40 foreign U.S., whereas, you know, years ago, it was the other way around, which didn't make any sense for a U.S. investor. I mean, I'm, you know, all against home country bias, but owning 60% of foreign stocks is too much. And now it's the other way around. So it makes VT a darn fine choice. I'm going to push back, although I don't entirely... Well, the first part I believe more, the second part, I'm not so sure. But a counter-argument might be, one, okay, Bill, but U.S. is exceptional. One, technology. Clearly, the U.S. is the world technology leader. Of the companies that I met, I mean, U.S. has seven of the ten largest, most valuable companies in the world. And it's not all multiples. If you look at earnings, it's not that much different. And the second is the doctrine of shareholder value that is taken over in the United States. The notion that for a company, what matters first, second, third, and fourth is getting the stock price higher, not necessarily making your employees happy or being a good community servant or all those sorts of things, as Milton Friedman would say, those are beside the point. Your job is to increase the price of your shares, and you can, if you set aside your shareholder hat and put on a political hat, you can like that or not like that. But from the point of view of an investor, one could say, well, that's a benefit for investors in U.S. stocks that maybe they don't get from other countries that have, say, strict labor laws where you can't lay somebody off. If you're overstaffed, you can't lay people off without giving them a year's notice and so forth. And it makes these other companies less nimble and less competitive than the United States. Yeah. I mean, I don't disagree with that at all. Institutions matter. If you look at the Dimson, Marsh, and Staunton database and you look at their graph, all of the countries off to the right of their bar graph that have the highest returns of looking at now, almost all of them are English-speaking nations. It's not Shakespeare. It's not the language of Shakespeare that causes returns. It's the English common law that does the sorts of things that John is talking about. And I think where that really comes into play is in emerging markets. I do not buy emerging market stocks unless they are selling at a significant discount, which they are now, to U.S. stocks. Because a country that does not protect its children against contaminated milk and seismically unsafe schools is not going to pay too much attention to the minority rights of foreign shareholders either. So I've never been a fan of Chinese stocks, for example, for that reason. So I'll grant you that. Institutions are important. Now the one thing that maybe we'll get to in a bit, which I think is one or two more of the downstream questions, is that the economic return to capital in this country is increasing and the economic return to labor is decreasing. So shareholders are doing well, workers not so much. And I don't think I have to offend too many people politically when I say that we are a polarized country. And if there's one thing that's driving that polarization, it's that. And I don't think, you know, eventually we're going to get to the point where you can't get to the point where, you know, capital takes 100% of the pie. That's pitchfork territory. It's trying though. I mean, that's the job of capital, right? Yeah, that's true. That's true. And the trouble is that capital doesn't do such a good job of looking after itself as well as, you know, for example, Boeing demonstrated very nicely. I mean, I have the same view with you on emerging market stocks, and it's related, but coming at it from a slightly different angle. Starting in 2013, that was the first time I ran this study, and I've repeated it a couple times since then. I looked at the relationship between a nation's corruption. There's a corruption index that's put out by a nonprofit organization, and they rank them, you know, with perceptions of people of how corrupt is this country and doing business in there. And like, you know, Norway and Denmark and such are the least corrupt and very near the top of the list, and, you know, Sudan and Russia are down at the bottom, and U.S. is about number 20 or so, but it's not in the top 10. And when you do a correlation between the level of corruption and the performance of stocks, you'll find that there is one, that the companies that show up as less corrupt have tended to have better stock market returns. Just another way of measuring the same thing that we've been talking about, which is, is this business that's being conducted, is the money flowing through to investors, or is it being leaked out somewhere, is it being leaked out to government officials, or is management feathering its pockets, or whatever it is that is preventing investors from getting their money? It's something to take into consideration, because as you know, we heard so much when emerging markets were presented to the public in the 1990s, or early 90s was the biggest time, came in as mutual funds, about the growth rates of these countries, and you could get countries that were growing at 5, 6% GDP rate, and U.S. was, you know, 2% GDP in developed markets. That's where you wanted to be to make the money. Well, it hasn't worked out that way, even though the growth has been there. It's an example where they were growth countries, but they weren't growth stocks, for these reasons. The wedge there is theft and dilution. You look at share dilution in China, it is absolutely astronomical. That's right. Dilution, that's a good point. I mean, there's a... It's related to theft. Theft to shareholders. Yeah. Exactly. Same thing. I mean, what I like to say is that there's a test that I apply to any country that you want to invest in, which is, if you are robbed in broad daylight by a known assailant in the presence of witnesses, who do you go to? If you go to the police, that's the country you want to invest in. If the answer is you go to your cousins, you don't want to invest in that country. I guess you invest with your cousins then. Exactly, yeah. So Bill, say the last 25 years or so, this is a discussion that Jack and I used to actually have a bit, and we didn't fully agree. Do you think the fund industry, speaking broadly, mutual funds and ETFs, is improving or not? Do you think investor experiences are improving? Do you think we're in a better place? The central tendency is obviously improvement, okay? Jack, I wasn't so sure it was obvious, but that's in part because he disliked ETFs so much. Yeah, but if you look at the asset-weighted expense ratios, they're clearly decreasing, and people are getting smart about indexing. ETFs, I have to admit, have helped with that, but at the fringes, my God, you're seeing all sorts of mishigas. Yes. Okay? That's Yiddish. That's a technical term? That's a technical term. It's Yiddish for craziness. Janky funds is another technical term. Janky. That's an investment term. That's more of a WASP thing. Yeah. Okay. Yeah. Well, there you go. Yeah. So I mean, what can you say about the triple-leveraged strategy fund, which is a fund that invests in one stock, 200% leverage, which is strategy, which is a fund which itself is a leveraged holding of Bitcoin. So it's a ... I mean, people- Yeah, that's worse than any mutual fund we have, I think. Yeah. People ... Well, it is a mutual fund. Oh, okay. It's an ETF. Well, but that's not a ... I'm old school. Not a plain- Open-end. I'm an open-end person. You're an open-end person. There we go. Yeah. I've long since lost that. Lost that distinction. I think that Jack tells the story of ... Gus Sauter was finally able to convince Vanguard that the ETFs were a thing, and they had real theoretical advantages, to say nothing of financial advantages. And he was ... Jack wanted nothing to do with it, and he saw Jack, and he saw Gus going out of the cafeteria, and he yelled at him across like 100 people, well, you finally got your way, Gus. Another new type of fund that's been out since you were talking about new funds are these buffer funds, the funds that will say they'll cap your gains, but they'll protect you on the downside. There's 50 ... I mean, it's not a huge number by VTI standards, but there's been 50 billion that's come into them pretty quickly. Do you have any thoughts on funds like that? Yeah. They're not a strategy. They're a compensation scheme. Basically, there is ... He has thoughts. Yeah. Aside from that, they're a pretty good idea. No. I mean, theoretically, if you want to reduce your downside, you sell stocks, and you buy cash or bonds. Okay? Yeah. And, in fact, I'm not a good enough mathematician to do this, but I'm reasonably sure that you can prove mathematically that that will always be superior to a buffer strategy. Well, especially since a buffer strategy is coming in with 80 basis points of expenses. Expenses. Yeah. You can get your stock fund with two or three basis points in your cash with nothing, so. Yeah. I had a back and forth with a salesman from one of these companies that's producing it, and I basically very nicely demonstrated to him that, given I was able to reverse engineer what their algorithm was, and then I showed him that it was grossly inferior to cash and bonds, and he very pointedly asked me to please not show that to anybody else. Should we open it up to questions? Sure. Did anybody have ... Okay. He's got ... I'm afraid I've got several questions. You'll read the questions, right, Rick? I have questions. Okay, good. Make him do the work. Yeah. All right. Here we go. Several questions, and a lot of great questions, but let's start with something down your alley of the stock market. What should we think about investing in Intel and other companies that the government takes a stake in? Go ahead, John. I'll do the next one. Well, so far, I think the government's only taken a stake in Intel at 10%, so I don't know how much that affects the stock price, except pretty clearly, I guess that stock price is not going to zero, since the government seems to be interested in having it around and wants to protect its stake, so this seems more theoretical to me at this stage. It's a head-scratching move for me. It's different. On the one hand, I see the argument of national security and protection of technology and so forth. On the other hand, that's not private enterprise. I wouldn't want the government owning 10% of Morningstar, which is where I worked for forever and ever, and it's not what I was raised to believe in, so I don't know. Yeah. I mean, it's too bad it's only one stock, because that's not terribly well-diversified, but if it was a nice, big, fat portfolio of them, then that would be a good portfolio to short. Okay, so here's another question on the stock side, and this comes up a lot. What do you think about planning to live on stock dividends in retirement? In other words, buying high-dividend-yield stocks, which, if you remember, Jack years ago said there's growth and there's value, and the value is for retirement because it pays higher dividends. I mean, how do you feel about that strategy for getting income in retirement from dividends? Oh, it's a dividend fallacy. I mean, what's the difference between having a 4% dividend and hiving off 4% of your capital value? You know, the Modigliani theory was—what's the—MM-something-Modigliani—Merton—no. Yeah. Miller? No. Yeah, Merton Miller. Modigliani Miller. Yeah, that's 20M's. Yeah, 20M's, yeah. And it's basically that it doesn't, you know, a stock that yields 4%—all that the market's telling you is it's going to grow 3% less than the stock that's yielding 1%. That's what theory tells you, so it's not a rational strategy. I'm slightly more sympathetic to that than Bill, in the sense that, obviously, people get a psychological comfort from the idea of that they're not touching their principal and they're spending this, the dividends. The danger with dividend strategies is they can become concentrated. Like 20 years ago, there were a lot of financials that were high dividend stock. You could, there were dividend funds and dividend indexes that were 40, 50% financials, bank stocks, and those have not done well. So that would not have been a good thing. You have to be careful in getting diversification and making sure you're getting companies that are viable and have some moderate growth prospects as opposed to ones that are paying a high dividend because they're just going nowhere and sinking. It's not a path that I actually use in my own retirement. I'm more on bills. I have, I'm mostly in equities and I sell equity shares to, as a general rule. I mean, I get some dividends, but not as, that's not enough for me to sustain me in my retirement, but I'm planning on the equity shares. Selling the equity shares. But I realized, you know, I've been involved with investing for a long time. And so the idea of touching capital doesn't bother me because over time that capital grows and I'm not actually depleting capital in a long enough term. But not everybody would be up for that, I don't think. I mean, I know not everybody's up for that. That's why dividend strategies are popular for one reason why. Yeah, well, you almost stole my favorite line, one of my favorite lines, which is that a suboptimal portfolio that you can execute is better than an optimal one you can't. Yes, yes. Or don't let a great idea get in the way of a good idea. That's the Morningstarism. That's our founder. So we're gonna go over to the fixed income side now and we're going to speak about tips. And the question is, paraphrasing, how reliable is the CPI data used to price tips? And what does it mean if it's not reliable? Yeah, we talked about that. Yeah, I mean, this audience must be hardly sick of hearing about tips. But the short answer which I gave yesterday is that it's even before the bond market would scream bloody murder if that happened. But even before the bond market screams bloody murder, 75 million people, social security recipients who are seeing their benefits obviously debased will hit that kill switch even before the bond markets do. Retirees do have a lot of power. That's one of the themes that we didn't discuss here. And we didn't talk about retirement issues, which we can do for another time. But I absolutely, was it Sean, I think, yesterday, I was talking about the power of retirees in millennia, whatever it is. Anyway, I've done quite a bit of work on this. And the long story over the last 50 years is the group that has fared the best relative to they were 50 years ago financially are retirees. And the ones that have been the worst are young people. And my theory is it's because they don't vote. And people don't, and politicians don't watch out for them because it doesn't hurt. You don't lose votes by doing things that don't help young people. You do lose votes if you do things that hurt retirees because they notice and they vote. Okay, sticking on the topic of tips, we have the three fund portfolio, which is U.S. stocks, international stocks, and a total bond fund. But the total bond index does not include tips. So should it be a core four portfolio, which would be U.S. international, total bond, and tips? Yes. That's it? Okay, I gotta find another question. Well, it says 30 seconds. It says 28 seconds, so we were trying to be. All right. So I'll find another question. Okay, so here's one about direct indexing. How do you feel about direct indexing? Do you think it's useful or a valuable way to invest and harvest losses? Yeah, go ahead. Well, I've written quite a bit about direct indexing. The short version of this story, since it says zero seconds now. You can take another 30 seconds. All right. Well, the short version of this story is direct indexing, which is buying an index of stocks directly rather than through a fund so that you can time or you can sell off the losing positions and use that to negate gains in your portfolio. It's a good strategy for a small percentage of people who have quite a bit of money in a concentrated position and need to work that off as a general retail strategy. And there are people out there offering direct indexing, get in for $50,000 or $100,000 or something like that. You're not getting any, there's a cost associated with it and the benefit matches or is less. The cost matches or exceeds the benefit. So if you're the sort that's looking into the credit investor, more than just a normal in credit investor, high-end in credit investor, looking into a bunch of sophisticated strategies, you wanna look at direct indexing, fine. Most people, no, no. It's an extra complication without, it's not gonna get you anywhere better. Alan Roth did an excellent analysis of that and came to pretty much the same conclusion and found that the benefit very rapidly tails off and becomes a negative after several years. I'm actually friends with one of the leaders in the direct indexing industry. And he's, I mean, he's been out there openly saying this stuff is being way oversold. It's, this is, you know, we developed this for an institutional, very high-end audience and it makes sense for these applications. But this is another thing that's, that, okay, it may be a good idea for some people under some circumstances at a, but a small number of people. Hey, let's take it to retail. Everybody can do it. Yeah. All right, well, thank you, Bill. Thank you, John. That's been a fantastic discussion. If you enjoyed this video, we have dozens more on personal finance and investing available on this channel. Hit that subscribe button to get notified when we release new content, including our monthly podcast, Vogelheads on Investing, and more conference sessions like this one. To watch more right now, click the video card on your screen.