For this episode of the Rational Reminder Podcast, we review our year by playing back and discussing a collection of the most impactful moments of the show from 2020. This has been a drastic year filled with many learnings for us all, and in today’s show, we cover topics of happiness, decision making, dealing with uncertainty, and the connection that financial planning and investing have to all of this. We collect some amazing gems of wisdom from guests like Annie Duke, Ken French, Michael Kitces, Patricia Lovett-Reid, and a whole lot more, whittling down an original list of over one hundred of this year’s finest moments to a collection of just 45. The show starts out exploring themes of the connection between wealth and happiness, keeping cool in stressful times, and the transformations that crises kickstart. From there, we talk about the importance of models and systems for informing investing and behaviour in general, and the idea that unexpected outcomes swamp expected ones in the short term. We also look at what market history has to say about staying in your seat rather than market timing when things look bleak. Next up, we cover themes of the value of a flexible approach to retirement spending, how families should think about financial planning, whether 60/40 portfolios are dead, and why stock market returns in the U.S. are higher under Democratic presidents. Moving onto the subject of decision making, we explore some of our guests’ thoughts on evaluating decisions, outcomes bias and the role of luck, and more. We also consider the topic of human capital, how it relates to investing, and what we should really be spending our time on. The subject of the convergence of brokerage firms and financial advisors then leads to a great exploration of the role of financial advisors. We wrap up with some extra special perspectives on how optimal financial planning should be geared around the person that you want to be rather than maximizing wealth for the sake of it. Tune in today for an amazing overview of the year and to hear all the ways we have changed and grown thanks to our incredible guests.

Key Points From This Episode:

• Looking back on the year: Pandemic adjustments and how this podcast has grown. [0:00:15]

• Shoutouts and Cameron’s method of putting past clips together for today’s show. [0:06:20]

• Dr. Brian Portnoy and Andrew Hallam on wealth and happiness. [0:09:15]

• Dealing with stress and volatility with Dr. Moira Somers and Dave Goetsch. [0:13:48]  

• Craig Alexander on market volatility and Jim Stanford on crisis and revolution. [0:18:27]

• Dave Goetsch and Greg Zuckerman on the benefit of models and systems. [0:23:11]

• The role of unexpected returns in outcomes and how to deal with this. [0:27:04]

• Small and value stocks relative to the market with Dr. William Bernstein. [0:33:09]

• Ken French and Cliff Asness on whether ‘this time is different’. [0:35:29]

• Enduring tracking error with Cliff Asness and Andrew Hallam. [0:38:37]

• Cliff Asness on whether 60/40 is dead and Lubos Pastor on why stock market returns in the US are higher under Democratic presidents. [0:41:00]

• Changing your risk portfolio when the market is dropping with Ken French. [0:45:25]

• Market timing versus awareness of investing history with Mark Hebner and Dr. Bernstein. [0:48:20]

• Wade Pfau on how expected returns fit into financial planning and the ‘safety first’ approach. [0:52:15]

• Moshe Milevsky on retirement spending and Pattie Lovett Reid on addressing one’s financial situation. [0:56:13]

• Annie Duke, Ken French, and Victor Ricciardi on making and evaluating decisions. [1:00:05]

• Greg Zuckerman on the role of luck in decisions leading to positive outcomes. [1:08:15]

• Forecasting as a way of knowing the range of outcomes with Craig Alexander. [1:11:15]

• Moshe Milevsky and Dr. Bernstein on human capital, financial planning, investing and asset allocation. [1:13:34]

• Josh Brown on what to spend your time on and Fred Vettesse on when to start saving. [01:16:28]

• Michael Kitces on the convergence of brokerage firms and financial advisors. [01:19:20]

• Dennis Mosey Williams and Ken French on financial advice for gaining wealth and being content. [01:20:57]

• Allison Schrager on the role of financial advisors for mitigating systematic risk. [01:25:00]

• Mark Hebner on the role of financial advisors for explaining a range of outcomes. [01:26:38]

• Scott Rieckens and Dennis Mosey Williams on what finding happiness means. [01:30:03]

Read The Transcript:

Ben Felix: This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision-making for Canadians. We are hosted by me, Benjamin Felix, and Cameron Passmore.

Cameron Passmore: And welcome to episode 130, if you can believe it. This is going to be our second annual year in review show. And we thought we'd try it again this year. It seemed to have good reception last year.

Ben Felix: And what a year to review.

Cameron Passmore: It really is unbelievable. I spend a fair amount of time going through the clips. And when you go through and listen to what we learned from our guests this past year, and put that beside what kind of year it has been, from what we've all lived through at home, what the world has gone through with a pandemic, the horrible effect it's had on businesses, it has just been unbelievable experience. Does any particular jump out at you, like what you and your family have gone through?

Ben Felix: I don't know. I think people in general are pretty resilient. And I think that this pandemic is shown that for my family. I think we've adapted really quite well. And sometimes I feel bad saying that, because I know for a lot of people, depending on what they do for work, that may not be the case, like a restaurant worker or a frontline medical worker. They're obviously in a different situation. We're able to work from home, so we're lucky in that sense. And we've got the kids at home, we didn't send them back to school. And that's been fantastic. The kids are loving it. My wife's really taken charge of doing some pretty serious educational work with them. And as far as we can tell, they're advancing a ton academically, which is pretty cool to watch.

We ditched our dining room, got rid of the dining room table, and put down a big turf field in there. So instead of hardwood floor, it's all turf now, grass, fake grass. And built a big play structure with a rock climbing wall and a big slide coming down off one side. So even in the winter, we should be in pretty good shape to keep the kids moving.

So I don't know, people can adapt, people are resilient. And in my house, this has been evidence of that.

Cameron Passmore: That's great.

Ben Felix: What about you?

Cameron Passmore: Yeah, the kids and I've been at home. So James, as people know, works in our team. So he's been upstairs in his office. I've been here in the living room office and Anna's been studying at school. So we've adapted quite well. I actually enjoy working at home, although, I do miss the team a lot and all the random collisions of the team. And we will get back to normal at some point, and some sort of different modified office environment. But yeah, I think we've done fairly well. I do feel horrible for a lot of the small businesses. And we're doing our best to try to do more takeout and do Christmas shopping locally to do a little bit that we can. But it just shows that the difference in parts of the economy and how they're affected, it's, it's been amazing. And you think back, we were weeks away from likely signing onto more office space. Well, that didn't happen. That may not happen. That's serious impact. You take that multiplied thousands or millions of times over, it's a big deal?

Ben Felix: Yep. Yep. It's true. We were even talking about in the podcast, we were going to have a whole fancy studio to record the podcast from, inside of our office. And that'll change very quickly. And it was just dumb luck that we hadn't signed any leases.

Cameron Passmore: So before we get to the episode, a lot of people ask, how many people listen to this podcast? So I thought we'd share a few data points. So in 2020, we will likely end with about 900000 downloads, this calendar year, compared to 229000, 2019, which is incredible. We started 2020 averaging about 56000 downloads a month. And ended the year, just under 100000 in December. When you and I started this crazy thing, two and a half years ago, we didn't even know what kind of objectives to set. And we don't focus on the numbers. We just try to do the best content we can. But never ever would we have considered, I don't think, something like this.

Ben Felix: No, in terms of this reach, absolutely not. And like you said, it was never the intention. People know the story, the intention of this podcast was to help our clients keep up to date with how we're thinking about different issues. And what's going on in our world, as portfolio managers and financial planners. Apparently there's a wider appeal for that type of information.

Cameron Passmore: And someone commented on the community board that we should take the Canadians part out of the intro line that you use every time. And more than half of the downloads are actually from Canada. And about a quarter from the US and the rest from around the world. Next up is Australia, UK, Germany, each around 5%. And even the YouTube channel, which I find amazing is now up to 20000 views per month, out of [crosstalk 00:05:06] basically nothing in the past year, since we started putting the video over there.

Ben Felix: And now, we've got some pretty high quality video feed going up there, which I think is neat.

Cameron Passmore: Can you give an update on the community board?

Ben Felix: Yeah, so it's getting close to 1000 users, which is again, when we rolled that out, I was not expecting that much engagement. And it just keeps on growing. We got to 600 pretty quickly, but more and more people have been drawn. Other than listening to the podcast, I guess, I don't really know where the people that are logging in there are coming from. How are they finding the... Must just be podcasts listeners that are going over there. Because we don't announce it anywhere. I guess there's a link on the website too. So if people are going there to read the transcripts and stuff, they might find the community.

Yeah, and I've said this, so I'm repeating it again, but the discussions that go on over there are just mind-blowing. So many smart, engaged people that are really interested in this stuff, with varying levels of knowledge and expertise in the field. And the conversations are unbelievable. As an observer, but also to participate in, it's really a neat little community.

Cameron Passmore: So before we jump into our take of what 2020 meant to us, we should give a shout out to the great people that are behind or with us in this endeavor. So shout out to Angelica Montagano who's our really extraordinary marketing specialist at PWL. She brings us great ideas, great insights, and pulls together a ton of stuff behind the scenes, like coordinating YouTube, working with compliance, the community board, the merch shop, just to name a few things. There's so much work that goes on that is behind the scenes. And we appreciate Angelica's effort as well as her boss, Martin Dallaire very much for his support. Matthew Passy, who is also known as the podcast consultant and his team. He takes care of all the audio production, cleaning up, taking out the mistakes that we make, and also the show notes and puts it on the platforms that people get to download it from. Matt is terrific to work with. And we really appreciate Matt's effort.

Shout out to Brenda Bartlett, the CEO at PWL Capital, who we appreciate her support of this venture as well, she's the one that does our weekly compliance review to make sure it's all okay before it goes out. We get all of our merch from a company called Northern Craft. So shout out to Jen Belden for her great ideas and production of the merchandise you see in the online store. And also, want to thank Trevor May, who, as people know, is the musician behind the music that we changed part of way through 2020. So thanks, Trevor, for the music.

So just to set up this episode, and again, this is the second time we've done this. Something I heard a long time ago, and I forget who his quote this is, but you really only change by the books you read and the people you meet. So that's the framework I took to assembling these clips for this show. Because we have learned so much from the books and the papers and these academic journals that you've dug up, this past year. You combine that learning along with the amazing people, we've had a chance... very fortunate to get a chance to interview some phenomenal guests. So I've tried to bring this all together to tell a story for the years. We're going to go through clip by clip that we've chose. And to try to paint a picture of how we view 2020. And it's actually a pretty interesting collection of thinking and stories in what was an unbelievable year.

Ben Felix: Well, when you combine the events of the year with the people that we've been fortunate enough to speak about or speak with on the podcast, I think it'd be hard to make it not interesting.

Cameron Passmore: Yeah, it was actually very hard. We got it down to 45 clips, and I had over 100. And it was really hard to cut it down to 45. But we had to make it, at least, somewhat manageable. But anything else to add before we go into the episode?

Ben Felix: No, I think that's good. Let's jump into it and review the year.

Welcome to episode 130 of the Rational Reminder podcast and thinking through the year and the themes and how we changed, one of the big ones was that it's really easy to get wrapped up in tweaking a model portfolio for the right factor tilts and getting higher expected returns and more tax efficiency. But returns or higher expected returns, don't necessarily result in a better life. They can because rationally more wealth is always better than less. And more wealth does give you more flexibility to do things. But more wealth for the sake of more wealth is not always a good thing. Another way of saying that more basis points for the sake of more basis points is not always a good thing. And I think in episode 102 with Brian Portnoy, Dr. Portnoy really told us how to think about the difference between being rich, which I think is sort of the matter of basis points and dollars, versus being wealthy, which is a much bigger definition.

Cameron Passmore: And I think this clip perfectly sets up the big picture for the year.

Brian Portnoy: I establish a fork in the road that I think is important for people who think about having a healthy relationship with money and want to achieve financial wellness. And that fork is between being rich and being wealthy. We tend to think of money in quantitative terms, back to Ben's questions about emotions and why is it such a triggering topic. We're taught to think of it quantitatively, but it's very much qualitative experience. So we think about accumulating more money and the things that money buys. And perhaps, something we can talk about is, is an important observation or finding from the social psychology literature, which is that the accumulation of more doesn't necessarily make us as happy as we think we're going to be. And so, what I wanted to do in this project and how I developed my thoughts was distinguished that quest for more with the achievement of what's really important to you.

And so, I define true wealth as the ability to underwrite a meaningful life. Now that's a deliberately loaded phrase, and we can talk about what's a meaningful life, and what does it mean to underwrite that life. This phrase, funded contentment, hopefully, focuses people on the idea that, let's think about what makes for a contented, joyful, meaningful, purposeful life. And then, recognize that money is an absolutely unavoidable topic on a day-to-day basis. And we should think constructively. It's not always comfortable, but we should try to think constructively about how we go ahead and fund that contentment. And maybe, divert our attention a little bit... it can't be perfect, and it won't be a 100 percent all the way. But divert our attention from that quest to be rich, which is the equivalent to a quest for more, which is ultimately quite unsatisfying.

Cameron Passmore: Yeah. So when Brian talks about distinguishing between the quest for more, with the achievement of what is important to you, that really spoke to me in a big way. And ultimately, this is all about happiness. And what a year to consider what makes you happy. And you realize that it's not just about accumulating stuff. And I thought our guest Andrew Hallam, who joined us in episode 99, had a great definition of happiness and what really should matter to you.

Andrew Hallam: It's a really good question that you're asking. Because I think that many people will pursue certain things, believing that it will make them happier, like a new car or a bigger house. But when we look at happiness studies... and this is what I love, that there are people in universities that study happiness full-time. And it's really cool to look at what is it that they're actually finding. And what they've found is that, say a car, you buy a brand new car, you buy a brand new car, and for a moment, it's like a sugar fix. You feel really good about it. You feel happy about it. Or a brand new phone, you're jazzed. You've got the greatest, latest iPhone 11 or iPhone 55 or whatever it may happen to be. But after a really short period of time, it becomes just another phone. It becomes just another car.

Ben Felix: Even with the best laid plan and rational thinking before the fact, our brains run into a whole bunch of problems, when we're faced with scary circumstances, like a pandemic.

Cameron Passmore: Yeah, so we invited Dr. Moira Somers back on the show. And that was right at the worst point in March, when the markets were rough. And it really wasn't clear how the pandemic was going to go. And we were all living in a very confused state, so she came on. And I thought, gave some very insightful information about how we make decisions when we're under stress.

Moira Somers: There is a tendency when people are under stress to really hyper-focus, to rally all of their neurological resources, to try and figure out solutions to the problem. When they're in the grip of fear, you may have heard of this phrase, [inaudible 00:14:27], that the higher order centers of the brain go off line for a while, while people are in the midst of a fear response. But as they try to get into problem solving, what happens is that the high-order centers of the brain do come back online. But they sometimes come back online in this hyper-focused way, that does a really good job of dealing with what's in the spotlight at the moment. But fails to see what's going on in the broader environment, or what are some of the other sources of input that should be considered. So even when we're out of an immediate fear response, we may not be accessing our best thinking, even so.

Ben Felix: Writing out a plan, not just for finances, but also for our actions more generally, that that takes uncertainty into account. Making that plan when we're rational, when things are calm, is one of the best ways to deal with uncertain situations, or the fact that the future will always be uncertain. And Dave Goetsch really drove that home, when he joined us, right in the depth of the uncertainty of the pandemic in March.

Dave Goetsch: And so, I got to this point where I found out that there was a different way to invest. There was a different way to have the best chance of having a successful outcome, without trying to predict the future of where the stock market was going to go. And it involved having a financial advisor. And I ended up writing a pledge to myself. And I looked up what that pledge was this morning. And it's, I know that life is uncertain, but I'm not powerless. I can control what I can control. That's why I'm a long-term investor, because I believe in the power of markets. It all just boils down to that one point on the investing side. And then, when I start to think about the health and the jobs and the other stuff that's worrying about me, I go back to that same thing. I know that life is uncertain. We really don't know what's going to happen in any facet of our lives. But you're not powerless.

And that's the moment for me that really changed, when I understood this stuff, which is uncertainty used to make me powerless. Because there are things you can do. So just as you can build a portfolio that is going to be reflective of your age, your risk levels, your goals. You can also approach this in terms of what are the things that I can do in this crisis, when I'm worried about my job and how much money I have. What are the drivers and spending and things that I can do to try and monitor that?

And then, this last line about being a long-term investor, because you believe in the power of markets. If you believe in the power of markets, you believe in the power of people. You believe that we are , a globe full of people, going to try to innovate and solve problems and make things better. And this kind of investing all comes from a science-based place anyway. And when I read all the articles that I'm reading, I do feel like the solution to this problem is a science-based solution. It's a vaccine. It's a strategy. It's about taking temperatures and vectoring or doing the things in South Korea. And I do believe that we will figure this out. I just don't know exactly when. And identifying it like that as, oh, I just feel like this absolute weight of anxiety that's on top of me. Being able to slice it up and parse it out and say, "Oh, that's what I think I'm feeling." That way because of this and his way, because of that, ends up, for me, being really helpful.

Cameron Passmore: Okay, so Dave gave us some perspective in terms of how he deals with volatility and uncertainty. And we had Craig Alexander, who was the Chief Economist from Deloitte Canada, joined us on episode 110. And he talked about how the market has to also figure out what is going on when these kinds of extreme events occur.

Ben Felix: Yeah, I think it's easy to lose sight of what volatility in the market is actually telling us. And Craig did a great job, just doing a pretty general overview of that. I think one of the most interesting points that I heard early in the pandemic was from Jeremy Siegel, from Columbia, who talked about the fact that if you use a regular stock valuation model and assumed earnings went to zero for a year, and then came back to normal afterwards, you would have about a 5% drop.

And Craig really did a great job describing why that's the case, but also more generally, why we would see such high volatility when things were as uncertain as they were.

Cameron Passmore: Well, you just think of what's going on at that time, investors are trying to figure out how much money they want to have in the markets, portfolio managers are deciding what stocks are actually worth. Companies are deciding what their customers are going to be buying, how much raw materials they need. Suppliers of these companies are also... like the amount of figuring out [inaudible 00:19:46] at the same time, is unbelievable. And it's all happening all the time in real time.

Ben Felix: Yeah, and because prices change and are publicly listed and available all the time, we get to live through and see that volatility.

Craig Alexander: And I think that that's why you're currently getting the volatility in the market. Because if the health risks are managed, then I think the economic recovery proceeds, and the market will continue to make up the ground it lost. If on the other hand, it looks like the reopening is going to be very protracted, or we're going to have setbacks, or there's going to be a second round of infection, these are all the things that are going to cause the market to reevaluate valuations for stocks. Because the stock is nothing but the discounted present value of all the future earnings of the company. And actually, what the market's trying to do is figure out what that earnings forecast looks like.

Cameron Passmore: So I've been through a bunch of market crises over time, like the tech crisis, and the 9/11 crisis, and of course, the housing market issues in 2008, 2009. So I was never really worried about the markets per se. And I know you weren't. But I think for the first time ever, I was worried about the health of people. And I've never really felt that before. So that was totally new for me. But we had economist Jim Stanford join us for a really interesting interview, very thoughtful, thoughtful guy. And he talked about the lessons that will be learned, that can improve our , going forward. And he talked to me about just in time delivery, the impact of globalization, and things that, perhaps weren't perceived as risk before really did end up being risky.

Ben Felix: Yeah. One of the things Carlota Perez talks about as well, which relates directly to what Jim told us, is that in many cases, a crisis kicks off the deployment phase of a technological revolution. Well, I guess we won't know until we can look back on this in 20 years or whatever, but this sure seems like that happening, where everyone, all of a sudden realized, oh, you can work from home and it's not so bad. And oh, every business has to be online. This situation has made all of those things front and center, or even obvious when they weren't before.

Cameron Passmore: But those perspectives, as talked Dr. Somers said, are easy to, not so much to ignore, but not to be aware of when you're in the middle of a crisis. You don't get that broader perspective, the opportunity that might come out of this.

Jim Stanford: I think so. In my line of work, I have to be sometimes mindlessly optimistic, even though economists are known as the dismal science. I have to be hopeful. Otherwise, I'd give up this job and do something else. And I think there could be a silver lining to this pandemic. And I say silver lining carefully. I don't want to minimize the horrors of what's going on, especially for families that have lost a loved one. But I do think it's going to force us to question some of the ways we were doing things before. My specialty is in the area of work and labor markets. I think the pandemic is going to force us to very, very seriously re-examine the whole phenomenon of precarious work and how we've constructed this kind of just-in-time on demand workforce, in many sectors of our economy. And apart from that being very unfair for those who are in those jobs...

Cameron Passmore: For sure.

Jim Stanford: We never have hope of a permanent job with benefits, where you could take out a mortgage and buy a house.

Cameron Passmore: So how can you deal with an event like this, knowing that if you're striving for funded contentment, as Brian Portnoy said, when the world around you is really coming apart. How do you keep your head in times like these? And we've talked endlessly about models and the benefit they give you. That may not be reality, but at least they're frameworks of reality that allow you to keep calm and keep focused on what your ultimate objectives are. So they do help explain the world, so that you can make informed decisions and stick to those decisions. So I thought Dave Goetsch had a great description of the benefit of models.

Dave Goetsch: The other thing that's I see in this moment is, if you're a financial advisor, or if you're interested in investing, you talk a lot about models. In the last 10 years, the topic of quants has been huge and they all have models and those models have a range of outcomes. And people have been talking about data mining and back testing. And does your model hold up or not? And the more people have familiarity with this idea of models and the limitations of models, I think the more helpful this moment can be, because what you see is that models, when you hear David Booth, Eugene Fama talk about models, they're not designed to predict the future.

They're designed to help us understand how things are working and gain insights from that. And I feel like there's this big disconnect right now about looking at all these models of how many people are going to get sick and what's going to happen. And people are so frustrated, genuinely, understandably, because there's no number. How can a number be between X and 30 X? And it's because of all the variables, it's because of all the range of outcomes, it's because of the things we don't know, but rather than trying to get a number from them, what are the insights you can gain from that?

Ben Felix: Looking back, one of the... The single most important things that anyone could have done through the pandemic is, now keeping in mind that there's a bit of an outcome bias here where things didn't end up being as bad as some people thought they could have gotten, and maybe they still could get that bad. We don't really know. But in this case, looking back, one of the most important things that anyone could have done is stick to the plans and the systems and the rules that they made in calmer times. And Greg Zuckerman, in episode 97, talked about that being one of his big takeaways from the work that he did, researching Renaissance technologies.

Greg Zuckerman: I guess what I took away from my experience, from the Renaissance experience, is the importance of having a system, having set of rules. And that's true if you're an investor, but that's true in life, I think. So again, they are a systematic investor. They have a group of rules and systems and they defer to them and they don't use gut intuition judgment. One thing we've learned is that we humans are susceptible to all the behavioral mistakes, greed, fear, panic, just dumb stuff that we do time and time again. You want to fight that as much as possible. So I'm not saying that everybody has to be a quant. Not everybody can, and not everybody should, but we should have a set of rules. And it's true in any walk of life, you can look at surgeons, you look at pilots, they have these checklists over the last few years that even though a veteran pilot's like, "I've done this a million times, I don't need no checklist." Yeah, they've learned surgeons too, that just forcing to do these checks, yes, I've done this. Yes, I've done that, before you take off.

Cameron Passmore: So humans are susceptible to all behavioral mistakes and I totally agree. And this is why I think that models are so important to have. Probably my favorite clip from the whole year is this next one and it's come up in so many conversations with clients since we heard Professor Ken French say this. Unexpected returns will swamp you. If you don't have a model to understand what the expected return is, the unexpected return may cause you to abandon your strategy.

Ben Felix: Absolutely. Outcomes are dominated by unexpected returns. We spend so much time talking about expected returns, which matter, and from the perspective of having a model and thinking about what gives you the best expected outcome, knowing what your expected returns are is very important. But the actual outcome is going to be dominated by the unexpected return, especially over short periods of time.

Prof. Kenneth French: What Fama and I show is almost 8% of the time, 8% of the universe, if we have 100,000 parallel universes, if we look over the next 20 years, you will not get a positive equity premium. So people will look at that and say, "Aha, there is no positive expected equity premium." In fact there is, but the realization can be quite different from the expectation The realized return, that's the expected return plus the unexpected return. And the trouble with equity is the unexpected return, as we're living through the coronavirus right now, the unexpected return can totally dominate the expected return. Almost your complete performance over some, any reasonable short run period, is going to be determined by the unexpected, not the expected, return. And even 20 years, 8% of the time, you won't get a positive equity premium. If the world looks exactly like it did from 63 to 2016.

Ben Felix: Even though unexpected returns can dominate outcomes in the short run, it still makes a lot of sense. Like I was saying before we heard Professor French speaking there, it can still make a lot of sense to build a portfolio to capture higher expected returns. Give yourself the best expected outcome, even on understanding that the unexpected outcome is going to play a big role in it. But like stocks in general, like owning stocks instead of owning bonds or GICs, you have to be able to deal with that unexpected portion of the outcome. And when we start talking about factors, it's not just the stock market's unexpected outcome, all of a sudden you introduce values unexpected outcome, which sure showed up in this pandemic.

Marlena Lee: Let me back up a second, because I do think that depending on your goal, the market portfolio could be a great portfolio. It is well-diversified, tends to be low turnover, typically low expense ratio. But to your point, if your goal is to outperform the market, then over weighting those areas of the market with higher expected returns. So smaller cap securities value or companies with higher profitability is a good way to do that. And when I say good, I mean there's a lot of theoretical and empirical evidence to suggest that those are robust drivers of returns and that you're tilting the odds in your favor of outperformance by pursuing a performance using that method. Investors have to be able to tolerate differences from the market because those premiums are never going to be a certainty. We can't guarantee those premiums are going to be positive over any period of time. If they were certain, then there really isn't a good reason to expect the premium. They are volatile so being able to cope with that tracking error and periods of under-performance is part of the deal.

Ben Felix: Even though we know that the unexpected return is going to play a big role in outcomes, one of the best ways to deal with that fact, with the fact that we know there's going to be a big contribution of the unexpected return, is to diversify across sources of expected return because the unexpected portion of the expected outcome is likely to be different for your different sources of expected returns.

Cameron Passmore: And what a year to be aware of that and not abandon strategy, because a lot of the under-performance of for example, a value factor, yes, it's partly due to the value factor, but it's also due to the growth factor doing so well. And there's been some staggering returns on those large cap growth stocks that we've talked about so many times, that, I think, and caused a lot of people to abandon... Believe the value is dead and the future is in these growth stocks. But as Professor French said, so much of what they earned was unexpected, why would you expect the unexpected again?

Marlena Lee: It's a great question in that we do think that if you have information about expected returns, wouldn't you want to use all of it? And we think that different variables, so market capitalization, or price to book, or profitability, or asset growth, momentum, all of those different variables, they bring different information to you about expected returns. So it doesn't matter if you're pursuing a market wide portfolio or a segment of the portfolio, let's just say Canadian equities, wouldn't you want to use all of the information available to you as opposed to just pursuing only value or only small caps? That certainly is true that if you have an integrated approach to using all of the available information, that does improve the reliability of outperformance, meaning that even if you have the same level of expected outperformance, that by having an integrated approach, that there'll be more periods, even holding the expected out performance constant, that you would actually outperform your market benchmark.

Cameron Passmore: So despite value's ugly run, we had Dr. William Bernstein joined us on episode 108, and he told us about the relative valuations of small and value and how they do look attractive today.

Ben Felix: You can say what you want about, whether you think the expected returns of value or small cap value or growth are higher in the future, but just using valuation like Dr. Bernstein says, just using valuation as one proxy for expected returns, small value and value are so cheap that it would be hard, really hard, to expect them to have lower returns than growth, which is as expensive as it's ever been in history. Maybe not quite, but pretty darn close. To think that their expected returns are going to be... That gross expected returns are going to be higher, or even that small and value are going to have the same expected returns as growth going forward. I just don't know how you can theoretically justify that.

Cameron Passmore: But if you weren't aware of the factors, you wouldn't even know that there's this dichotomy going on.

Ben Felix: Yeah. And I guess if you weren't aware of valuations, you'd have the same issue, which is why having the data is so important. But when you look at the valuation spread between large growth and small value it's as wide as it's ever been. It's really hard, for me anyway, to look at that and reason that large growth can continue to increase in price relative to the rest of the market. That's really hard to think about.

Dr. William Bernstein: I don't think it's going to be as large to the extent that I believe that some of it is still due to risk, I think that it's still there. And I think we've seen the evidence for that just during the past 5 or 10 years. If you're a value investor, you've been very discouraged by the past 5 or 10 years. And a lot of people have given up on it. And a lot of people had said value is dead. Whenever I hear from anybody that a certain approach is dead or a certain asset class is dead, I perk up my ears because that means that all of the weak hands have sold out of it. And I think that's what's happening with value now. I do think, and to answer to your questions, at least some of the value and small premiums are still there. And the main reason why I believe it is because the valuations now of small and value stocks relative to the market are much more attractive than they were 10 years ago.

Cameron Passmore: So the question we get a lot, and we certainly read a lot, is it different this time? So that's a question we pose to Cliff Asness in episode 93. So you have to listen to what he has to say about, is it different this time?

Ben Felix: Well, Cliff's perspective, and he wrote a great paper that we talked about in a past podcast episode, it was more of a blog post, I guess, than it was a paper, but he looked at what is causing this? What is causing this divergence in returns and valuations for small value, value and large growth? And one of the things that he looked at was how did these companies look relative to each other fundamentally? And what he found is that value in small value or value, I think is what he was looking at, I don't know if he looked at small value specifically, but value looks about as good as it has in terms of business fundamentals in relative to history. It's not like the value companies are getting worse. And similarly, it's not like the growth companies are getting better. So his perspective on this was really good.

Cliff Asness: So I do think, if anything, the evidence is value has lost for the last couple of years, at least, not because it's broken, not because it's different this time, but because it's the same thing as before people, are going a little crazy. And I do think many of the other factors not picking up value in these last couple of years and the value spread widening at the same time is pretty strong evidence for that theory.

Ben Felix: But when we asked Professor Ken French what he thinks about this time being different, and if we're in a winner take all economy, he told us that this isn't the first time that he's heard that this time is different, but this is where, and I think Cameron, you mentioned this earlier in this review episode. Basically you can't extrapolate realized returns into expected returns.

Cameron Passmore: At any time you hear someone like Professor Ken French say that it may not be so different, you have to pay attention.

Prof. Kenneth French: I'm not a big fan of this notion that it's a winner take all economy, this time is different. Anytime somebody tells me this time is different, I'm skeptical. I guess I'm old enough to have heard that many times. And every time it turned out, well, it really wasn't different. When I think about Amazon and Microsoft and Facebook, the companies where people are saying, "Oh, it's a winner take all economy." It's not plausible to me that the expected return on Amazon or Microsoft or Facebook is equal to what their realized return has been. I keep coming back to this theme that the realized return is the expected return plus the unexpected return. The astronomical performance of those high tech companies, to my mind, that was unexpected. Things turned out to be phenomenally great for them, but there's no reason to think, oh, now when I do my calculation, what should the expected return going forward for Amazon or Microsoft or Facebook be? It's not going to be what the average return for those stocks have been for the last 15 years.

Cameron Passmore: So living through tracking error is something we've talked about many times and you have to live through it to be successful as an investor. And you have to know what your expected outcomes can be. So we asked Cliff Asness what you have to do to live through a tracking error and what his experience has been like.

Ben Felix: And his comments are awesome and you can feel it living through it is that it's not easy. And I'm not going to sit here and say, I've lived through as many value draw-downs as Cliff has because I haven't. This is my first one. But you can imagine that there's always, always, always just like market downturns, there's always going to be a narrative for why this is happening. And people always try and rationalize outcomes. They try and find explanations for results, as opposed to looking back at what the theory would have predicted and what the theory predicts going forward. I think it's really easy to rationalize outcomes and say why this time is different. And it's much harder to stick with a strategy that was devised based on theory and evidence.

Cameron Passmore: Absolutely.

Cliff Asness: That want to be here three years from now to say, "Oh, thank God we stuck with that." I think it's probably a little easier for me having had that experience several times. Doesn't make it easy. I actually sometimes tell friends it's astounding how hard this still is. Even though I've seen this movie multiple times before, but when you see it your first time that's harrowing.

Cameron Passmore: And then Andrew Hallam, who was back in episode 99, had some additional insights into the idea of staying in your seat when you do suffer some tracking error.

Ben Felix: And this is... It speaks to so many different things. You mix between stocks and bonds, how much tracking error you can handle. One of the things that comes up in the community fairly often is okay, well, if small and value of higher expected returns, why wouldn't I just go all small cap value? Well, can you really stick with it? Would you have stuck with it for the last 15 years? Because a lot of people haven't.

Andrew Hallam: The bottom line isn't how the asset classes perform. The bottom line is how well can you perform? Can you harness your emotions, such that, and what kind of portfolio would allow you to stay in the game and not end up doing something silly? And the studies do show that most investors do end up shooting themselves in the feet. It's very easy when the market's going up, but markets don't always go up.

Ben Felix: With valuations where they are, large growth being such a big part of the market, the market itself is expensive, particularly in the US. And at the same time, interest rates are low and therefore bond expected returns are low. So one of the things that we asked Cliff Asness about was whether or not the 60 40 classic stock bond split is dead.

Cliff Asness: The funny part is I am certainly one of the people who thinks you could do better than a passive cap weight at 60 40. Yet, I feel an incredible desire to take the other side of any argument that anyone ever makes. If you tilt towards value, small momentum, low beta, you're differing from a pure 60 40 portfolio. If you're a believer in what's called risk parody, you are not 60 40. You have more bonds and fewer stocks because 60 40 is very dominated by stocks.

I do believe those are long-term edges. I believe in international diversification. So is 60 40 domestic, or is it global? Every single one of the things I mentioned, some have done okay. Some have done poorly. Nothing has been quite as good as long and strong US stocks for quite a long time. So I was joking in the beginning when I said it's not dead because it's kicking the hell out of everyone, kicking the hell out of everyone for a long time also makes you expensive. We are in the camp that both stocks and bonds, not a disaster, we're not trying to time a crash, but have lower long-term returns from here than they normally do. And that's a fairly simple argument. Price to any fundamental for stocks for the market-wide is quite high. And you might've noticed bond yields are quite low.

Cameron Passmore: And of course, in addition to the pandemic, this is also an election year in the US and there was a ton of questions around that. And you did some amazing research for that, was it one or two episodes? We talked about the US election, which I think blew a lot of people's minds, what the data show. And then you connected us with Professor Lubos Pastor from University of Chicago Booth School. And he talked to us about the research that he and others have done in the past on this subject.

Ben Felix: His research on this is phenomenal. He basically debunked what was previously viewed as a puzzle about why stock markets tend to do better under Democratic leadership than Republicans. But we'll let Lubos tell you about it, but I find these points to be absolutely fascinating, which is why we also talked about it on the podcast before getting Lubos to come on and speak about it himself.

Lubos Pastor: Yeah, sure. So the puzzle is that stock market insurance in the US are higher under Democratic presidents than under Republican presidents. And I mean much higher, the difference is about 11% per year since 1927 when good quality stock data began. In fact, the whole of the equity premium since 1927 has been earned under Democratic presidents. And we're not the first ones to discover this, we're the ones who try to explain this. And how do we explain this? You might be tempted to find an explanation that's based on different economic policies of the two parties. You would have to argue, though, that Democratic policies are good for the stock market and Republican policies are bad. At first sight, it's not obvious. We tend to think of Republicans as being the pro-business party that cuts taxes and regulations. And moreover, that explanation would have required a lot of irrationality because investors would have to somehow ignore this information.

So our explanation is different. And our explanation is that it's not about what presidents do, but it's about when they get elected. We argue that Democrats tend to get elected in times of trouble when expected future returns are high. And Republicans tend to win in good times when expected returns are low. 

We argue that when people are highly risk-averse, two things happen. We are more likely to elect Democrats. And on top of that, because risk-aversion is high, expected returns are also high going forward. In crises, stock prices are low and expected returns going forward are high and that's creating both of these two things. So it's not that Democrats are somehow causing stock returns to be high. It's high risk-aversion that's causing those returns to be high, and Democrats to get elected. That's our story.

Cameron Passmore: So you have the perfect storm of an election, a pandemic, fear, which really is the perfect set of criteria to possibly cause someone to bail on their investment plan. So we asked Professor Ken French if the market's going to keep falling, why should I not just go to cash? Why should I not just change my risk profile?

Ben Felix: And his answer makes you realize how silly that question is.

Prof. Kenneth French: You said it seems intuitive when you know the market's going to keep dropping. Yes, absolutely. If you know, the markets are going to keep dropping, get the hell out. But if you know the market's going to keep dropping and you're not special with respect to that information, so does everybody else, and it's already impounded in prices. So it's not logical to say "Everybody knows the market's going to keep dropping." The reason one might want to adjust his or her portfolio at this point is because they've learned something about themselves. They've discovered that their tolerance for risk like this is lower than they thought. If that's really the case, then fine. With this level of volatility, if this is way more painful than you anticipated, then adjust your portfolio. But you probably should think of that as your new permanent portfolio.

It wouldn't make sense to say, "Okay, I used to think I was just like the market, like all the other investors in the market, I want my fair share of the market. Now I'm thinking, oh no, I am more timid than the typical investor. I better reduce my allocation to stock." Now that you've discovered you're more timid, you probably ought to use that information later on when you're building your portfolio. So what I'm getting into here is my general way of thinking about portfolio allocations. I'm thinking about how people should construct their portfolios. And I always frame it by saying, "I know the average dollar invested holds the market portfolio. How do I differ from the average dollar invested? If I look like absolutely the typical investor out there, then the market portfolio seems perfectly sensible for me as my portfolio."

Ben Felix: Professor French's comments really make you realize how really ridiculous it is to make the statement that well, I'm going to do X because the market's going to keep falling. Like Professor French said, yes, if you know that, then you should absolutely get out. But I think that Mark Hebner did a really good job explaining why that doesn't make a whole lot of sense because the market is pricing in current expectations at any point in time. So for you to say that the market's going to keep falling is essentially saying that you have better information than the market, because you know it's going to keep falling despite what current prices are telling us.

Cameron Passmore: And I would argue that 2020 is the perfect year to prove that market timing is likely not to lead to optimal results.

Ben Felix: Oh, well, this one was in some ways unique because of how quick the downturn and recovery were. That itself was a historic event. But even strategies like trend following, which systematically try and exploit trend momentum to help mitigate the pain of market drops, those strategies didn't do so well because this happened so quickly. There wasn't a whole lot of time to get out at the right time, or to get back in at the right time.

And if you missed the days, we had some of the biggest up and down days in history in 2020. And if you missed them... Well, if you missed the down days, you're okay, I guess. But if you missed the up days after taking the down days, not so good.

Cameron Passmore: But it's also, you're aware, if you did cash out sometime back in March, that was one decision. But you have to make the other side, as well. When do you get back in? And can you imagine, someone got out then, and now they have to decide to get back in? You could ride the elevator down again. It's no joke.

Ben Felix: No, it's no joke. There was a, and I have not independently verified this number yet, but Larry Swedroe tweeted that small cap value was up 94% from its bottom. That's tough if you timed it imperfectly, as imperfectly as possible. If you got out at the bottom and miss the ride back up, that's hard to recover from.

Mark Hebner: What's the job of a free market is to set prices so investors will be positioned to earn a fair return given the risk they have in their portfolio. So, in an inverse way, the price is set inversely proportional to the uncertainty of your expected return. And that price is set by 10 million buyers and sellers every day around the world, roughly. And because of so many active participants in price setting, and price discovery, really, we think that prices are fair all the time. And so, the prices are changing so that the expected returns remain essentially constant.

Cameron Passmore: So we asked Dr. William Bernstein how important it is to be aware of investing history. And this goes back to what we were saying earlier. If you don't know that these kinds of market movements are possible, and have happened often in the past, you are setting yourself up to possibly make decisions that are not great for your portfolio.

Dr. William Bernstein: Well, again, it's one of the essential pillars of being able to invest. And understanding market history means understanding several things. First and foremost, it means that in the very long run, both stocks and bonds can have periods of very poor returns. About once a generation, and sometimes twice a generation, stocks lose about 50% of their value.

In the past 20 years, stocks lost about 45% of their value. In the early 2000s, more than 50% of their value during the financial crisis of 12, 13 years ago. And very recently, they lost about a third of their value very quickly before recovering. So that's the first thing you have to understand.

The second thing you have to understand is that there's an inverse correlation between how good the economy looks and what future returns are going to look like. If you are compensated for taking risk, then you have to be compensated the most when the risks look most frightening.

So, the best fishing is done in the most troubled waters, the most stormy waters. The very best time in US history to buy stocks was in the early 1930s, when they were practically being given away. And if you mentioned buying stocks to someone, they'd either laugh at you or try to slug you. And the same thing was true in the early '80s, as well. And most recently, in March 2009, most people got visibly sick when they thought about the stocks in their portfolio. Those are the very best times to buy stocks, and that's one of the things that history teaches you.

Ben Felix: So we've heard from some of the best thinkers in finance about the importance of having a model and rules in a system. The importance of understanding your expected outcome, but also the fact that the unexpected outcome can swamp that, especially over short periods of time. We need to understand what market history says, because that helps to keep you in your seat. And I guess, more generally, you need to stay in your seat because if you don't, you're almost certainly not going to get a good outcome.

But one of the things that we haven't talked about yet is what all of this actually means when the rubber hits the road, so to speak. And this is one of the things we asked Wade Pfau about. How should investors think about expected returns? Understanding all of this uncertainty, and understanding the unexpected return, and even understanding that history won't necessarily repeat itself. We asked Wade Pfau how expected returns fit into financial planning.

Wade Pfau: Well, the key to a lot of that is to just recognize that when interest rates are lower, you shouldn't just base things on historical averages. And unfortunately, that's still what a lot of the simple planning software does where they, based on the market returns going back to the 1920s, they may say that, "Okay, assets are volatile, but on average bonds might give you a five or 6% return, and then stocks with some sort of equity premium above that." Well, when you start from such a low interest rate environment, it's really mathematically impossible to get those kinds of higher returns. And so, you need to make adjustments so that your average returns are going to be more reflective of the lower interest rate environment. And it has a big impact. When you just plug in historical average-type numbers to run your simulations, you can see that something like the 4% rule of thumb works 95% of the time. But when you update that for more realistic market return assumptions in a lower interest rate environment, that 95% success could drop to somewhere between 60 or 70%.

Cameron Passmore: So that comment leads to another comment from Wade Pfau, where we asked him about a different approach, given all this uncertainty, to retirement planning. So he talked about a safety-first approach that you can use for your main core retirement expenses, and the benefit of taking that kind of approach with your foundational income needs.

Wade Pfau: So the probabilistic framework in some sense is really newer because it's not really based on any sort of academic model. But the probabilistic approach is more of a total returns investment strategy, where you are just spending from your investment portfolio. And generally, you're seeking market upside so that you can try to spend more than bonds would otherwise support, hoping that stocks will outperform bonds. And so, you're just spending more than otherwise possible with fixed income.

And that can be contrasted with the safety-first approach, which really is more like that academic approach in terms of, use some sort of contractual protection, and bring in the power of risk pooling to help manage that longevity and market risk for the basic expenses.

But it's not only thinking about risk pooling and insurance, it's just using that for core retirement expenses, and then using the total returns investment portfolio for the more discretionary types of expenses. So that you take the stock market risk for expenses that are... There's some more flexibility for that, but you otherwise are focused on contractual protections for the basics.

Ben Felix: Building on what Wade Pfau said, we talked to Moshe Milevsky a lot about retirement spending. And one of the things that he was able to drive home for us, and for the listeners as well, I believe, is that it's ridiculous to have a rigid spending plan in retirement. To think that you're going to pick a dollar amount at age 65 and then spend that same dollar amount adjusted for inflation, like the 4% rule would suggest, is just silly.

And flexibility in spending, from a risky asset throughout retirement, is really important. And this is something that we within our team have been spending a lot of time researching, and hope to have some interesting findings for papers, and podcast discussions, and financial planning tools in the future. Just how do you take this idea of flexibility and implement it systematically with rules in a model like we've been talking about, in the financial planning process? So, Moshe really does a great job explaining why that idea of flexibility is so sensible.

Moshe Milevsky: The idea of a spending rule, and I want to be very careful here. The idea of picking a spending rate at the age of 65, and sticking to that spending rate for the rest of your life no matter what happens, it is ridiculous. It should sound ridiculous once it's properly explained.

So obviously you have to be flexible and you have to adapt to what's happening in the market. So the intelligent approach to spending is, "You know what? My portfolio is down 10%, how much should I adjust my spending?" That's the intelligent approach. "The markets have been up very strongly. I'm thinking I could probably withdraw a bit more. How do I adjust my spending? Markets are up 30%. Can I adjust my spending 30%?" No, no, no, no, no, you need a reserve.

Versus in the other direction. " Markets are down 20%. Should I reduce my spending 20%?" No, you don't have to because there should be a reserve built in there. So then, obviously you have to adjust, and it has to be dynamic. But to stick to a particular percentage and say, "Well, no matter what, we're going to continue to withdraw that percentage for the rest of my life as long as I live," I don't even know why we continue to push back against it. But to answer your question, Cameron, absolutely flexibility is important.

Cameron Passmore: So Patricia Lovett-Reid of CTV News was a guest. And you asked her a question, and her answer caught you off guard. You asked her, "What are some of the other things that people can control that can help them address the current situation in their financial planning, their investments, given the pandemic?" And I think you were expecting more of an answer along the lines of, what can you practically do with your portfolio? What can you do with your spending? Anyways, her answer was not what you were expecting, so have a listen.

Ben Felix: Not what I was expecting, but she knocked it out of the park. She gave the right answer. I was probably thinking about it the wrong way when I asked the question, and she gave a great answer.

Patti Lovett-Reid: I think they can understand their own financial situation. I think a lot of people are accepting the fact if they have lost a job, any job is a good job right now because it will help to pay the bills. The government programs are going to start to be unwound. People who have benefited by way of mortgage deferrals, or maybe even their credit card hasn't come knocking, a credit card company come knocking right now because they know this is a period of difficulty for a lot of families.

But I think families have come together. They're a lot more forthright in terms of what their financial situation is. I think there are families out there who in the past could afford to say yes to their children, for example, and they're not in that position right now. And so, I think a dialogue around each individual or family financial situation is something that you can control. And I think it goes a long way.

Ben Felix: With all the information that we're talking about, and thinking about what Patti Lovett-Reid just told us, there's a really big question that I think everyone needs to think about. And this is always true, maybe particularly true this year, but what actually constitutes a good decision?

I think there are a lot of different components, but one of the big considerations is whether a good decision for you is the same as a good decision for somebody else. And in most cases, it's probably not. And then the other piece of it is, again to tie it back to what we were talking about earlier, how important it is to have rules, and systems, and models to make decisions, as opposed to just going from the gut.

Annie Duke: Essentially a good decision involves a process that works toward allowing you to get a better forecast of the future, allows you to get closer to what you would call ground truth. Meaning, what is actually true of the world, in order to decide what options that you have available to you will actually be more likely to advance you towards your goals than retreat away from it.

Now, let me be clear. That means that what is a good decision for me maybe not be a good decision for somebody else, because it's all about advancing you towards your goals, what your values are, what your resources are. And this all needs to be informed by beliefs. One of the key ways to spot a good decision process is that you can examine it, that you can explain what the process was that you went through, and that you can repeat it. In other words, if I repeat the same process over time applied to the same decision, I should expect to get similar results over the long run applying that same decision.

And that's where we can see there's a real breakdown in terms of good decisions. I think first of all, people don't really know what the definition of a good decision is. And second of all, when you start to get into things like deciding by intuition or gut, you can see where that's problematic in terms of what a good decision process would be. Particularly when we think about this repeatability, or the ability to examine it, and pull it apart, and analyze it, and think about how close it's getting you to the truth

Cameron Passmore: And the other interesting part about making decisions to me, and you think back to the very first clip we had from Brian Portnoy about finding contentment is, you can set a goal and your goal can migrate over time, because people adapt to what their new realities are.

So we talked to Annie Duke again about how your preferences can change over time, and how you need to be clear that this might happen. And your decisions now will affect future decisions as you decide what's important to you over time. So again, it's about flexibility and knowing that this will evolve as time goes by.

Annie Duke: There are places where your preferences will be extremely clear. But when we start getting into these things of personal taste, and what brings us happiness, and what makes our life meaningful and things like that, those do evolve over time, and I think we don't know them very well.

So the idea, like with everything, is I'm going to make my best guess right now, because that's the information that I have, and those are the beliefs that I hold, and that's what I think I know about myself. But I'm going to do some work to imagine, first of all, the future, where maybe it turns out that I didn't like this choice so much, and think about why that might be.

Ben Felix: Keeping in mind what Annie Duke just told us about what constitutes a good decision, the other side of that is how you evaluate your decisions. I think one of the traps that it's really easy to fall into is evaluating decisions based on the outcome that you get.

If you invested a lump sum of cash right before we had this pretty substantial market downturn, or even if you happened to get out before things got really bad and that feels like a good decision, it probably wasn't. In both cases, evaluating the decision based on the outcome is probably not the best way to think about it. And again, back in episode 100, Ken French did a really good job thinking about how he evaluates his investment decisions, keeping in mind how much uncertainty there is in stock market outcomes.

Prof. Kenneth French: When I think about the quality of the decisions I've made, I have spent most of my life studying empirical data. And what I know is volatility, the uncertainty, the unexpected part dominates most outcomes. Not all of them, but most outcomes in my life are dominated by the unexpected part.

So when I want to judge, let's focus on investing because that's what I know well, when I want to judge the quality of an investment decision I've made, I don't pay much attention to the outcome. I pay attention to, "Did I make a good decision based on the information I had at the time?" The outcome, that's dominated by things I can't forecast. So it would be crazy for me to say, "Oh, great, look at this. I made a great decision," or, "Oh, darn, I made a stupid decision here." No. Presumably I made a great decision based on the information I had when I made the decision. But the realization, what actually happens is going to be dominated in most situations by the part of the information I never had.

The coronavirus, I keep coming back to that because it's dominating the news these days. But it doesn't dominate the way I evaluate my investment portfolio. I certainly regret the fact that I'm a lot poorer today than I was three weeks ago. That's too bad, but I don't say, "Oh, wow, how crazy could I have been to invest in that portfolio?" I look back and I say, "No, that was a perfectly sensible portfolio I had invested in three weeks ago. It's too bad that we got all these bad data over the course of the last three weeks."

It's not my fault. I didn't know anything. I don't have to excuse myself to anybody else, but I do have to look at myself and say, "Is there something I want to change here?" No. For my money, there's nothing I want to change here. And I try to extend that throughout my life. I try to evaluate all of my decisions in exactly that way. Did I make the best decision I could based on the information I had at the time I made the decision?

Cameron Passmore: So in terms of decision-making, we had Professor Victor Ricciardi join us in episode 118. And we asked him about whether or not investors should try to make rational decisions.

Ben Felix: I think this came up again when we spoke with Brian Portnoy and Josh Brown. It comes back to, what is a good decision, and how does that tie in with your values? Josh and Brian wrote this book where they interviewed well-known investment professionals, and showed that they're not behaving what the orthodoxy, as they call it, would call rationally. And that conversation gave us a lot of time to reflect on what is actually a rational decision, and does it make sense to think that way?

And I think what I still come back to, and this is personal for me, what resonates with me is it's really important, and I think this is what Victor Ricciardi's getting at, it's really important for people to have the information that would allow them to make a rational decision, a theoretically rational decision. And then work your way away from that based on your specific views and values. But if we start with the views and values, and ignore what's rational, I don't see how that puts you in a good position to make a good decision.

Victor Ricciardi: Yes. And what I think behavioral finance does is actually understanding what your biases are. Are you overconfident, do you trade too much, are you a worrier, do you feel stress? What are your trigger points when you invest money? When you spend money? And so, if you're actually sitting down with a financial advisor or a planner, hopefully they help you develop a non-emotional strategy, things that you're comfortable with.

And when the market has a massive correction, if you're in the proper risk profile, if you also have a idea, within a financial planning context, of saying, "I'm 80% towards my goal, the market came back a little bit. Let me keep on that path to reaching my financial goal and my financial plan."

Ben Felix: When we're talking about outcomes and evaluating decisions, the role of luck can't be understated. Greg Zuckerman, in episode 97, talks about his view on the role of luck, and how it potentially affected the outcome of Jim Simons and Renaissance Technologies. But if you think back to that book that Greg Zuckerman wrote, and some of the stories in there, there were so many little things that Jim Simons, who's the quintessential stock market genius who's gotten everything right. Not everything, but 51% with a lot of leverage.

But that there are so many stories in that book, or at least a few stories in that book, of instances where Simons strayed from the model based on his intuition. Boom, broke from process, got lucky. And the point Greg makes in the book is that there were lots of other potential Renaissance Technologies that got unlucky in those instances where they strayed from the model.

Cameron Passmore: And he talked about a lot of the books he's written are about the people that have been successful. So you've got this massive outcome bias that he talked about in that pool that he's researching.

Ben Felix: Yeah, it is fascinating to think about. Morgan Housel talks about this in his book, The Psychology of Money, as well, where we have a, I can't remember what he calls it in the book, a tails problem, or an outcome problems, something like that, where you see the outcomes, usually the good ones. Those are the ones that you hear about, the Buffets, and the Dalios, and the Jim Simons. But those are such a tiny, tiny, tiny segment of the overall sample of investment outcomes. But we focus on those and try to replicate them.

Cameron Passmore: And in a world where results are so noisy, it's very hard for an individual with all the emotional biases to pick through that and have a set of rules that make sense going forward, if that's what you're going to follow. If you're not going to have the model as an anchor, a theoretical underpinning for your decisions, how can you not be swayed by some story of the day?

Ben Felix: Outcomes are so attractive. Theory and evidence, not so attractive. Outcomes? We ascribe wisdom to outcomes, which I don't think is the best thing to do.

Greg Zuckerman: A lot of what I do for a living, in my books and at the Wall Street Journal as well, I write about the winners. And it's a self-selecting group. For everyone who wins, or everybody like Jim Simons and his colleagues who make history, there's maybe 10 other people who maybe had the same kind of approach and didn't have the same luck.

So you need good fortune, I'd call it, as much as skill. And in life, that's one thing I've learned since I get up there, at least 50% of success in life is good fortune, and counting your lucky stars, or thanking some being, whoever you are, however you deal with that kind of stuff. You need health, that's part of the good fortune. There's just so much you can do to increase your chances, but you need a lot of the good fortune.

Ben Felix: One of the things that we saw a lot of throughout the pandemic, and in general, were economic forecasts. And when we had Craig Alexander, Deloitte Canada's chief economist, on episode 110, we asked him, who is an economist, who does economic forecasting, "If we know economic forecasting tends to be wrong, which is a fact, what is the value in economic forecasts? And his answer was really phenomenal. And I think applies to financial planning as much as it does to business, which is that you need to know your range of outcomes. You don't need to know that your forecast is going to be right. You don't need to predict the future. You need to know your range of outcomes and be prepared for all of them.

Craig Alexander: And while nobody has an accurate crystal ball, businesses still need forecasts to develop business plans. And in the current environment, in normal times we do... Here's our base case forecast for businesses to use for planning exercises. And then we do stress testing and we come up with bad scenarios and businesses will often stress test their business. The issue is we're currently living through a stress test. If you think of the magnitude of the shock that we're just experienced, it's as bad as the worst stress test I ever generated for the bank I worked for. And given that we're in that environment, you have to think about scenarios. So right now, one of the strongest themes I have in our economic commentary is the fact that we need to think about things as scenarios. And the way... Conceptually you think about it like a tree diagram and with probabilities associated with each branch of the tree and what you're trying to predict is which path your economy is going to take.

Cameron Passmore: Another big theme for us, and we've been learning a lot in our team lately. Is all of the different types of capital that we have in addition to financial capital and a big one is human capital. And especially the younger you are, the more human capital you have, and this can have serious implications in how you could decide to invest. So this is something we talked to Professor Moshe Milevsky in 122 about, and I thought his description of human capital and how it applies to financial planning and investing was brilliant.

Moshe Milevsky: Human capital is the present value of all the earnings that you're going to be receiving over the course of your life. And you graduate from a business school these days, it can be in the millions of dollars. COVID aside, what area of the business school, but it's the present value of what you're going to earn. I call it a gold mine. It's an oil well. And if you actually quantified it, today's low interest rate environment really is in the millions of dollars. And that has to be taken into account when you build your investment portfolio. So when you're young, you have millions of dollars in human capital, relatively safe, depending on what your job is. So it's got to be taken into account. What do I mean by taking into account? So, I'm a university professor. I have a decent pension from the university. If I add up my tenured position and my pension and I present value that I'm looking at, a couple of million dollars in bonds. So I don't own bonds. I haven't owned bonds for many years.

Ben Felix: We also talked to Dr. William Bernstein in episode 108, about the role of human capital in asset allocation and some of his commentary around this was fascinating. Where in some cases, times like the coronavirus market downturn are actually what you want if you have stable, valuable human capital. I remember I was taken aback when I was reading one of Dr. Bernstein's books, where he said that some young people should actually be getting down on their knees and praying for long protracted bear markets.

Cameron Passmore: That's what I told my son who has been aggressively saving because he saw the drop in his savings during March and April. And I said, this is exactly what you want. You want to be able to buy more cheaper. So he didn't change a thing. He kept doing his regular savings plan, and now he's been rewarded sooner than perhaps he might have liked. He might've wanted a longer bear market, but he saw the results of sticking to the plan.

Dr. William Bernstein: Exactly, and that's an important time to think about it, is this business of human capital. If you have more human capital than investment capital, you want that returns. And the opposite is true. If you work for the government or the post office, then you can invest in the riskiest kinds of value stocks. On the other hand, if you're tied to the financial services industry, you want to be much more conservative in the way you invest.

Cameron Passmore: So we had Josh Brown on in episode 126 just a few weeks ago. And I thought this clip that he shared with us really brings the whole thing home in terms of what's important to you. What should you really be focusing on in your life? And as you mentioned earlier, it's not necessarily squeezing all the extra basis points out of different factor tilts.

Ben Felix: We can't forget what the basis points either. I like basis points. I completely agree with Josh. I think it's important to put the other stuff first and foremost, but that doesn't always mean we don't need to think about the basis points. I think if the basis points start to get in the way of the other stuff, if someone's spending all their time rebalancing and tweaking, and maybe this is going to alienate the entire rational reminder community discussion board, because everyone is in there doing that. I think if it gets in the way of that, it's a problem, but it doesn't mean we should ignore the basis points either.

Cameron Passmore: And I'm not, and he did not suggest that either he talked about you want to have low cost tax efficient, highly diversified portfolios, but it is about perspective.

Josh Brown: So what should you spend time on? I think human capital and social capital should occupy almost all of your time of your working life. Making relationships, meeting people, getting smarter, becoming useful to the people around you. That's what you should spend your time on. Not what percent gold, what percent treasuries. It's not going to matter. It's all going to even out. So how can you really elevate yourself? Build your career, build your network, make people happy around you, be productive. It's not a secret, but that's the secret.

Ben Felix: Keeping in mind the importance of human capital in asset allocation, we asked Fred Vettese what his advice is for people who are entering the workforce today. And he had some really interesting insights.

Fred Vettese: I'd say live within your means. I would say have some flexibility when it comes to saving for retirement. Maybe you still want to keep your savings rate of ...you still want to be saving, putting aside 10% of your money every year on average. But there will be times in your life when you just can't do that. Your second child is on the way, you have daycare expenses. You have other expenses, which you have never had to face before. Maybe for a few years, you just can't. And when I looked at the modeling and people consumption patterns in their lifetimes, there are period in your 30s is the hardest time to be saving.

And it's fine for 60-year-olds who have a six figure income to be falling people to be saving 10 or 20% per year. But when you're 32 and you got those two kids in daycare expenses and other expenses, you just can't do that. But I'd say if that's the reason, then maybe you do give yourself a bit of a break. You do have to start by 35. And if the reason why you're not saving is because you're trying to get a better lifestyle than you should, and that would be a bad reason.

Cameron Passmore: We also had the chance to talk about the business of financial advice with advisor and industry guru, Michael Kitces. And he has an unbelievable, almost encyclopedic knowledge of our industry and the rules and laws, particularly in the United States, but a lot of the principles apply in Canada. And he talked about this great convergence that's going on between brokerage firms which would typically be in raising capital for companies. The brokerage, the independent advisory businesses, technology, robo-advisors and this is all basically being mashed in together right now. And we're living in this great transition and it has implications for the advice part of the business.

Michael Kitces: The challenge now that's happened around the world is the broker capital formation side of the industry has largely vergence the advice side of the industry while the actual advice side of the industry is still doing advice as well. And the two are mashing together because technology forced them to converge. And it's creating on the one hand, an absurd amount of consumer confusion. People that write financial advisor on their business card and some are literally in the business of advice. And some are legally in the business of product sales and happen to figure it out that advice is good at selling products, but it's not objective advice because it's there to sell a product. And now we're even seeing a regulatory backlash of regulators that are coming forth in one country after another and saying, wait, wait, wait, wait, wait. If you all are going to call yourselves advisors and give advice regardless of what portion of the industry you're in, we're going to regulate you like advisors, regardless of what portion of the industry you're in.

Ben Felix: Something that we think a lot about keeping in mind, what Michael Kitces just told us is what should we be thinking about? What should we be focusing on and what direction should we be going in to be doing the best possible thing for our clients? A lot of the things that a portfolio manager used to have to spend time on has changed. As an example, for our portfolio management process, we work very closely with dimensional fund advisors which takes away a lot of the administrative and execution related portion of managing a portfolio. So what should we be focusing on?

We asked this question to Dennis Mosley Williams, who has expertise in answering exactly that question. And we've been approaching this by working very closely for the past year with past podcast guests. So you may recognize Dr. Moira Somers, who we've heard from and Dr. Brian Portnoy, who we've also heard from. We've been working with them to help us think about the ways that we can help our clients move toward that idea of funded contentment, helping them think about what money actually means to them. And what is that connection between this money that you have, and these basis points that you're trying to get and living a content life.

Dennis Mosley Williams: For sure. I mean, at the end of the day, there will always be investments and advice within the financial services industry. But where clients find value is increasingly has to do with more than returns, all investments have become commoditized. So generally speaking, everybody has access to the same things. So really what they're looking for, I think increasingly the question that advise investors are asking is who is this company helping me become in addition to wealthy? What else am I learning? How am I transforming? And that word transformation, you see more and more, not just in the investment world, but in all businesses really.

Cameron Passmore: I think a lot of people were surprised with the next clip. So yes, our role is shifting with technology and with skillsets being developed. But with professor Ken French, we asked him, because I've heard him talk about this before. We asked him about the benefit he gets from working with a financial advisor, because a lot of people think, you're Professor French. How can you need an advisor? And that's when you realize there is so much more to the business of advice and just managing the portfolio.

Ben Felix: His comments aligns so well with what we just heard from Dennis, which is that Ken, he says that he does take care of the portfolios. Ken decides how much of a value tilt he wants.

Cameron Passmore: Right.

Ben Felix: But when it comes to executing the portfolio and dealing with bigger picture planning, and Ken says this, dealing with what we are trying to accomplish. And I think that's one of the biggest ones. Helping people think about that relationship between what do you actually want to accomplish? Who do you actually want to become? And what is the relationship between that and your financial wealth? That's one of the most challenging probably, but most important roles that a financial advisor can play in someone's life.

Prof. Kenneth French: My relationship with my financial advisor is enormously valuable, both to my wife and myself. I often say it's the most valuable check my wife writes. I don't write any of the checks. So it's the most valuable check my wife writes for lots and lots of reasons. I take care of the portfolio in terms of deciding what we want to do, but actually doing it. My financial advisor does that. My financial advisor is enormously helpful on dealing with our taxes, dealing with our estate planning, dealing with even what are we trying to accomplish with whatever wealth we do have. Helping us think through that, helping us think about the charities we want to be involved with. It's just, somebody can act as a sounding board for lots of the questions and lots of the issues and clarifying lots of the trade-offs that we encounter in lots of different dimensions of our lives.

Ben Felix: With the rise of index funds, it's getting increasingly common for people to believe. And we have these conversations too to believe that there's no role for financial advice and investing has become so easy and democratized. And cheap that paying someone to manage a portfolio doesn't make a whole lot of sense. And we asked Alison Schrager about this in episode 87. And her commentary was fascinating. She explained that index funds only solve one problem. If you're worried about idiosyncratic risk, if you're worried about the risk of the individual companies in the market, and you want to make that go away, index funds solve that problem. They give you systematic risk. But if you're worried about systematic risk and the relationship between that and your actual outcome and how your wealth relates to meeting your objectives, that's a much harder problem to solve. That's systematic risk. And that's where she believes that financial advisors can start to play a role.

Allison Schrager: Well, and he said there are two very different sources of risks that have two very different strategies. Certainly, I mean, my theory is, especially again with financial planners is that there's no real benefit in to using a financial planner. If you're concerned about idiosyncratic risk, it's super easy to buy an index fund and get rid of all your idiosyncratic risks. The systematic risk is a lot harder and that's what takes expertise. And that's what takes actual risk management still, and that's where I feel like advisors have a lot of value at. I mean, I see this a lot in media saying, Oh, you can just buy an index fund. Why pay for advice? Well, it's because they've only identified idiosyncratic risk. They haven't thought about systematic risk, which is where it was and management options. All these things come in.

Cameron Passmore: And to carry on with what Allison Schrager talked about, we interviewed Mark Hebner, who was the founder of Index Fund Advisors, which is as we said in the interview with him, one of the leaders of information and a lot of data, rich presentations on his website and as an incredible collection of stats and data points and articles on this whole index fund revolution. So we asked him about what's the role of an advisor and he really highlighted how it's really to explain the range of outcomes. And even though you can explain it, a lot of people just don't understand statistically the range and the distribution of these potential outcomes.

Mark Hebner: None of these people understand the distribution. This is the problem. Or do they accept the fact that all returns are starting with the same expectation. Listen Fama  once told an advisor group at a DFA conference, he sees the primary job of advisors is to teach clients about the distribution of returns that they're in for in essence. And that's the great thing about something like this is you have an expected return up here, but down here you have a realized return. And there's a very wide range of realized returns relative to that expected. And that is such a hard concept to get in people's heads. First of all, they don't accept randomness. They don't accept efficient markets, which sets a fair price, which positions these expected returns to be essentially constant over time. Everybody wants to argue with that, but I don't see anybody really profiting. I saw your thing about Cliff Asness, but even he says, that's not a good idea to try to time these factors.

Ben Felix: Beyond just explaining the range of outcomes which is important, and it's one of the most important aspect of investors staying in their seats, Mark Hebner also talked about how financial advice... And financial advice I think it's important to point out it doesn't necessarily mean dealing with a firm like PWL. It can be a fee-only financial planner. It can be subscribing to a planning service like the one that Robb Engen who's been on the podcast has.

So it's not about... We're not trying to promote our business or people who are doing what we're doing. But Mark Hebner does a great job of explaining the other aspects of financial advice that aren't necessarily related to the portfolio, which as we've mentioned a few times now are arguably some of the most important aspects of this process.

Mark Hebner: I would like to say that financial planning is a very difficult topic and a very difficult result that you end up with in this process in terms of interpreting it. I really think the real value of financial planning is the process of doing it. Making the client more aware of all of these elements that I just talked about, collecting that information for them, and then giving them the snapshot in time. But that's all it is because things are going to change for them and they're involved in a random walk through life. The market is a random walk. And there's going to be changes in their situation on an ongoing basis. And so these things have to be revisited and it just gives you a nice format to go back and update all of these aspects with the client on some routine basis.

Cameron Passmore: So there's two clips left we wanted to share with you. And this is where I think it all comes home after you're like this, when you realize what's important in your life. And again, Dennis Mosley Williams, who was so much fun to interview and he's got such great perspectives. But he talked about what is happiness to him and what is guiding him now, and I just thought, even though it was a short clip, it was very, very pointed, very well put.

Dennis Mosley Williams: And I'm not judging beautiful cars and I still really love beautiful cars and all that great stuff. It's just in terms of where we are at, what I want, funded contentment. That ship is... There's no happiness in there for me with that. I'm guided by other stars now that are much more meaningful to me. Time and thinking, and all those other good things that are just about me.

Ben Felix: When you start thinking down this path, one of the things that you realize is that as much as we've spoken ill of the fire movement in the past, one of the things that the fire movement has gotten right, is this idea of finding the things that make you happy. What are the most impactful changes that you could make in your life financially that will necessarily affect your happiness? And we were very fortunate to have Scott Rieckens in episode 95, where he explained the changes that his family made as they started a very aggressive pursuit of financial independence retire early a goal.

Cameron Passmore: I remember after we interviewed Scott, it was an incredible experience. And you and I both looked at each other afterwards and said, this is the episode you should probably listen to first and for all the other ones, just to get perspective on what does make you happy and what's important in your life.

Scott Rieckens: The most impactful changes we knew we could make were housing, cars and food, the big three. But really the most impactful change to our lifestyle was really the mental shift to a more stoic stance. Becoming more grateful for the things that we have and not just the materialistic side of gratefulness, but also taking a look at something like a simple cup of coffee and being more grateful and aware of how that cup of coffee is delivered to your lips. The fact that somebody is farming this bean and then it's being shipped across the world, and then it's being roasted by a professional and somebody has to take the time to invest in all of this and take a chance so that you can walk in and have somebody make you the most amazing pour over in the world. And it's all for six packs. I think that's incredible.

But when you're doing that without that thoughtful loop, you're just, Oh, this wasn't as good as yesterday. That's a really bad place to be. So I think the most impactful change that we made was really the mental shift into understanding how lucky we were, not only just in life, but like to be able to pursue this at all. That is an incredible privilege. So we felt we had to go through that because that was not where our head space was.

Cameron Passmore: It's there, you have it, 2020 in review. At least the way we looked at it was quite a year, learned a lot, went through a lot, affirmed a lot.

Ben Felix: Yeah. And we've really, I think changed in a lot of ways throughout the year, just in openness to different ideas and thinking about the bigger, bigger picture. Moving one level up above the portfolio and the optimal financial planning decisions, and really trying to think about how do those things actually feed into the person that you want to be and where you want your family to be. It really comes back to this idea of what a rational agent who wants to maximize wealth for the sake of wealth. That's not a human and we know that. And I think getting more toward that human angle of wealth is something that we're going to continue to pursue.

And you'll see that as you see the podcast guests that start coming up in 2021 and the themes and the conversations. I think it's a much more important area to be exploring than the small cap value tilt, but don't worry. We're still going to talk about the small cap value tilt.

Cameron Passmore: I agree with you and well-put. We're very grateful for the incredible guests we've had. They've been phenomenal, so gracious with their time, and it's really fun to try to meet more people that get to add to this story as we go forward. Obviously, we're incredibly grateful for all the listeners. This has been incredible to get the feedback. We get both on YouTube as well as on the community board. And I don't know about you Ben, because you're not as active on Twitter, but I get lots of DMs on Twitter. So it is very gratifying to know that we're having a little bit of an impact in the world. Anything else to add?

Ben Felix: No, I think that's good. We'll see everybody next year or I guess you'll hear us and you'll see us.

Cameron Passmore: We have an amazing guest. The surprise guest coming up on January 7th. So with that, we wish you a good couple of weeks. We're taking next week off. So with that Happy New Year, and we'll see you on January 7th.

Book From Today’s Episode:

The Psychology of Money — https://amzn.to/3npH7G6

Links From Today’s Episode:

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/ 

Shop Merch — https://shop.rationalreminder.ca/

Join the Community — https://community.rationalreminder.ca/

Follow us on Twitter — https://twitter.com/RationalRemind

Follow us on Instagram — @rationalreminder

Benjamin on Twitter — https://twitter.com/benjaminwfelix

Cameron on Twitter — https://twitter.com/CameronPassmore

Episode 102 with Dr. Brian Portnoy — https://rationalreminder.ca/podcast/102

Episode 99 with Andrew Hallam — https://rationalreminder.ca/podcast/99

Episode 110 with Craig Alexander — https://www.pwlcapital.com/the-rational-reminder-podcast-110-craig-alexander-no-crisis-should-ever-go-to-waste/

Episode 106 with Jim Stanford — https://rationalreminder.ca/podcast/106

Episode 97 with Greg Zuckerman — https://rationalreminder.ca/podcast/97

Episode 100 with Professor Ken French — https://rationalreminder.ca/podcast/100

Episode 108 with Dr. William Bernstein — https://rationalreminder.ca/podcast/108

Episode 93 with Cliff Asness — https://rationalreminder.ca/podcast/93

Episode 116 with Mark Hebner — https://rationalreminder.ca/podcast/116

Episode 112 with Professor Moshe Milevsky — https://rationalreminder.ca/podcast/122

Episode 114 with Patricia Lovett-Reid — https://www.pwlcapital.com/the-rational-reminder-podcast-episode-114-patricia-lovett-reid-financial-wellness-in-a-crisis/

Episode 120 with Annie Duke — https://rationalreminder.ca/podcast/120

Episode 112 with Michael Kitces — https://rationalreminder.ca/podcast/112

Episode 118 with Professor Victor Ricciardi — https://rationalreminder.ca/podcast/118

Episode 104 with Fred Vettese — https://rationalreminder.ca/podcast/104

Episode 87 with Allison Schrager — https://rationalreminder.ca/podcast/87

Episode 116 with Mark Hebner — https://rationalreminder.ca/podcast/116

Episode 95 with Scott Rieckens — https://rationalreminder.ca/podcast/95