September 9, 2021

Episode 166: Lessons from 100+ Years of Global Stock Returns

September 9, 2021

In this week’s episode, Cameron and Benjamin share what’s on their mind and delve into listener questions on subjects ranging from the CAPE ratio to how to go about changing someone’s mind. Tuning in you’ll get a preview of some of the formidable guests featured on future episodes, like John Cochrane and Hersh Shefrin. We also cover book recommendations and unpack the concept of libertarian paternalism from the highly influential best-seller, Nudge: The Final Edition by Richard Thaler and Cass Sunstein, and how it can be a force for good. We cover various facets of passive investing and index funds including how, despite its proven effectiveness, many people continue to take a dim view of it. Learn why certain personality types may be more drawn to active investing and why. We also share tips for reasoning with skeptics, including some useful questions to ask when things get heated. Next, we take an in-depth look at index funds and global returns over the last century based on the research of Dimson, Marsh, and Staunton and their book Triumph of the Optimists. We also answer questions from our Talking Cents Cards and take a look at the best bad advice from the previous week. This episode is packed with fascinating anecdotes and excellent recommendations that you won’t want to miss! Tune in today!

Key Points From This Episode:

We reflect on some of the reviews and feedback we’ve received over the past week. [0:03:00.7]
An overview of the guests that listeners can look forward to on future episodes. [0:06:15.8]
Talking Cents Cards and how they can introduce your family to conversations about money. [0:07:01.2]
Introducing Nudge: The Final Edition by Richard Thaler and Cass Sunstein, and the concept of libertarian paternalism. [0:08:50.0]
Cameron shares his story of the week, an article from Magnify Money on how emotions can influence investor decisions. [0:13:53.3]
An update on our response to a listener question on the CAPE ratio by discussing the work of John Cochrane on determining predictability. [0:17:24.2]
We unpack a listener question on whether one should be looking to convert family members who fit into the average, active investor archetype. [0:21:47.6]
What Benjamin has learned from Think Again by Adam Grant, about how to talk to people you disagree with. [0:24:15]
How Benjamin experienced a revelation on index funds. [0:29:28.5]
An examination of index funds and global returns over the last century based on the research of Dimson, Marsh, and Staunton and their book Triumph of the Optimists. [0:36:30.3]
An in-depth look at how global events factor into Dimson, Marsh, and Staunton’s data. [0:39:35.9]
How dictatorships, civil troubles, wars, unsuccessful economic and monetary policies, and communism have prevented countries from transitioning from emerging to developed. [0:42:43]
Cameron and Benjamin answer a Talking Cents card question by sharing the first big purchases that they saved up for. [0:50:47.6]
Cameron and Benjamin answer a second card question: What is a creative way to save money in today’s digital era? [0:52:53.8]
Hear this week’s bad advice from an Entrepreneur article titled: 7 Downsides to Passive Investing and Why it Can Be Bad for Your Portfolio. [0:54:09.2]

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 were hosted by me, Benjamin Felix, and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore: Episode 166. Welcome. And as people have seen, I think from a couple of weeks ago podcast, I'm back in the office and you've got your new home office set up. Unfortunately, we don't have live Oscar, but we do have Oscar here, for those on YouTube, over my right shoulders. We have Oscar painted on my wall in the office. So he is here in spirit, even though you won't see him, as in the past, jumping up on the chair beside me.

Ben Felix: I love that wall.

Cameron Passmore: Yeah. It's pretty cool actually, so maybe we'll post a picture of it on our Instagram page.

Ben Felix: That's a good idea.

Cameron Passmore: Anyways, did I tell you that my daughter Anna moved out, got her own place?

Ben Felix: Wow.

Cameron Passmore: Nice new place. It's a nice condo in the south end of Ottawa, so she's pretty happy, pretty proud. So I'm halfway to being an empty nester. Just James and I at home now with Oscar.

Ben Felix: Wow.

Cameron Passmore: For those that don't know, James works on our team. So we're both, when we're working at home, working away. So I'm coming into the office most of the time. I think most of the time you're going to be at your home office, right?

Ben Felix: That's the plan.

Cameron Passmore: Excellent. And it looks like a pretty sweet setup, for those who can see.

Ben Felix: Yeah. I like my home office a lot. Nice place to work.

Cameron Passmore: It's amazing. I think we're both, for example, yesterday, we're recording this on Friday the third, but yesterday I had too much work to come to the office to do. I mean, it's so efficient and effective working from home, I find. Just get up and you jump right into it.

Ben Felix: What an interesting comment. Imagine what that means about the efficiency of pre-pandemic work life.

Cameron Passmore: Yeah. I mean, it's different work, right? At the office, you have much more interaction, so it's a different ... But yesterday I just had to put my head down and get a lot done. So stay home and you just crank it out.

Ben Felix: Right.

Cameron Passmore: We've mentioned this before, but we love hearing from listeners, and I know you and I get lots of reach outs either by email, or mainly email, I guess, and also on other platforms like LinkedIn, especially. We've met all kinds of people, people looking to get into the industry. How do they break in? Looking for feedback on what courses to take. We've also had a number of people that are in the industry, looking for guidance of how do they make a change? We've had a number of people join our team that we've met that way, which has been incredible.

A lot of firms that are in our industry grow by buying books of business or acquiring other firms, and that's not really how we operate. However, if you are an advisor and you want to talk and you kind of think you might be a good fit ... If you've listened to the podcast, you know how we invest, you kind of know how we operate, how we think about planning. If you think you might be a fit, reach out. We'd be happy to talk. We're not aggressively looking to grow with new advisors, but hey, we're open to talking to you if you think it might work out.

Ben Felix: Definitely. There's enough people out there that think and operate the way that we do, and we're doing fine in terms of growth on our own, but I do love the idea of becoming sort of the hub for the advisors in Canada that think and operate and the way that we do.

Cameron Passmore: Yeah. Especially if you appreciate being on a team. We have one approach, one philosophy. We have redundancy in all the different roles. We have decentralized things like trading, and operations, and service and whatnot. So if that seems appealing to you, drop us a line. A lot of new, recent reviews we've had, which is great. I just checked and we've up to almost 700 reviews in iTunes, and we try to highlight every one of them here.

So Holly says, "Great podcasts. Learned a lot about finance," and she especially enjoys the episodes about money and wellbeing, which is great data. We've had a lot of people say that, and, "great content." Defacts in Great Britain reached out to say they, "particularly appreciate the hosts' evidence-based critical thinking, not only when sharing their expertise in finance, but also in discussing topics such as human biases, psychology, and even search for meaning and happiness." Again, thanks for reaching out. Also from Shambolic Dingo in Germany, "Thank you both for providing such insightful content. The podcast introduced my entire family to the world of evidence-based investing." And the other bonus from this one is I got to learn what shambolic means. That actually means chaotic, disorganized or mismanaged. Did you know that?

Ben Felix: Nope. I would have guessed that was a made up word.

Cameron Passmore: That's why I thought you're going to laugh at it like you normally do.

"Just finished a play through every episode from the beginning, and I'm sold." We present information and the evidence to back it up. "The only downside is once you've listened to every episode you want more, and no other podcast I've found has quite this academic and practical rooting." That's very, very kind. On that note, did you know that on average 10 people a day listen to our very first episode?

Ben Felix: No. That's crazy. That review, though, I find that personally, there are some other podcasts that I listen to, not a ton, but I hope this doesn't sound self-serving or weird in some way. I love listening to our own podcast. Not necessarily the ones where it's you and I talking, but when we have like a guest episode that's really good, going back and listening to those, I enjoy that thoroughly. And there are not a ton of podcasts out there that I'll go and re-listen to episodes.

Cameron Passmore: Yeah. I'm trying to listen to one past guest episode a week just to keep it fresh, because it's an unbelievable collection, but there's so many now.

Ben Felix: This ties in, though, to the new comprehensive overview that we released as a sort of a pilot a couple of weeks ago. I think it was very successful. I mean, it was one of our most downloaded episodes really quickly, and just the feedback on YouTube in the comments and in the community was extremely positive. So definitely we'll continue with that series probably quarterly-ish. I don't know.

Cameron Passmore: Did you find it easier to prepare? Because that one, you did pull it all together. I took the easy road in that one.

Ben Felix: That one specifically was okay. But I started looking at doing inflation, government debt, and quantitative easing as another comprehensive overview. I just started poking around and seeing what was out there, and that one will be much more challenging to prepare, but I think it's also going to be a great episode. But anyway, there's a ton of topics that I think we can pull out of past guest episodes like that. So yeah. I appreciate everybody's feedback on that, but it's definitely an idea that is going to continue going in the future.

Cameron Passmore: Also to highlight the AMA coming up September 15, at 3:00 PM, with Jack Vogel. Should be very good. And upcoming guests, man, we've got some good guests coming up. So economist Hersh Shefrin is coming up next week. Two weeks after that, John Cochrane, The Grumpy Economist. So we talked to him earlier this week, and that was an amazing conversation. And then two weeks after that will be economist and author Campbell Harvey. You got Campbell Harvey to come on.

Ben Felix: Yeah. I don't know how many people look at that lineup and they're starstruck, but they should be, because those three people, they're pillars of modern finance. Yeah. It's no joke.

Cameron Passmore: And they come up back to back to back. I mean, and the people before this are no joke, and we got some great guests lined up after that. It's pretty amazing. I wanted to highlight in the store, the Talking Cents cards, just to remind everybody they're in stock. These are the cards that are from the University of Chicago Financial Education Initiative. They're professionally done. They're professionally written. They're designed for families just to get conversations going about money, ideally for ages seven and older. Just have them by your kitchen table and pull out a card or two every once in a while. So $30 per deck. Angelica set it up on the store, such that if you buy any other item over $15, you get 20% off the cards. And also you get a free pair of socks with it, the Rational Reminder socks, and free shipping in North America. So if you have family members at home, kids at home, I would argue you really should get a deck. It's cheap, and they really do work and do get conversations going.

Ben Felix: I haven't used them with my kids a ton. My oldest is six. He probably would get it, but we haven't done a ton of it. But I had a friend of mine over the other day, and we pulled the cards out like two grown men. I guess kind of how we do it on the podcast. We were cooking some steaks outside, and we took out the talking sense cards, and it's actually pretty fun, and it's an interesting way to pass the time with somebody.

Cameron Passmore: As always, stay in touch. Love to hear from listeners, as we mentioned earlier. So we're on LinkedIn. You can check out Rational Reminder on Instagram, connect on Goodreads. We're both on Twitter. I'm on Peloton at CP313. There's also hashtag #RationalReminder on Peloton. So that community is growing as well. Anything else?

Ben Felix: No. Let's go ahead to the episode.

***

Ben Felix: Welcome to episode 166 of the Rational Reminder Podcast.

Cameron Passmore: So we'll kick it off quickly with a book, which frankly this book could be an entire podcast series on its own. But the book is called Nudge: The Final Edition by Richard Thaler and Cass Sunstein. So they wrote the original book, I think it was back in 2008, I believe. So this is newly revised and updated. I'm sure many listeners have read the book or heard about it, and it's kind of become a business classic. And since we talked about the book Noise back in episode 154, that Cass Sunstein was a co-author of, I decided to check this out because it just was released and it showed up on my Kindle. So I thought, "Well, we'll talk about this book and give it a reread."

So it has been completely updated, but the basic proposition of the book, if you don't know, is that people make choices all the time, and how choices are presented or framed can greatly impact how people do make decisions. So in their words, the authors' words, they say, "Choice architecture matters." It's interesting, they call it in their words, "libertarian paternalism," which they say marries a freedom of libertarianism along with the guidance and oversight of paternalism but without the force. It's all about giving a guide to help you make things that are likely to help you without harming you.

I mean, the classic example that I think many people have heard of is food displayed in a cafeteria line. If you put healthier food earlier in the line, the consumption of healthier food increases, right? They also talk about how so many decisions that people make are automatic, based on heuristics or rules of thumb. And frankly, we have to do that, otherwise you'd never get through your day. Because we make so many decisions every day that that's the way it has to be, and they give countless examples in this book.

And some are current examples, like they talk about the pandemic and how easily humans are nudged by other people. People like to conform, and if people see others behaving in a certain way, they will follow. And if you're in a community, whether it's a real physical community or it's a digital community, people will behave like the norm of that community.

Ben Felix: Wow.

Cameron Passmore: And they talk about this with mask wearing. I'm not being political, but depending on what community you're in, you'll have an opinion or a tendency in terms of behavior with masks. Another good one they talk about, especially now with return to school, back to school time, they talk about how college students' academic effort is affected by their roommate. So if you end up getting a studious roommate or someone that performs well at school, your marks will go up. So that is pretty cool.

Ben Felix: I can see that.

Cameron Passmore: Again, you conform to people around you. Well, we see it in our office, right? We have a culture of pursuing further education. So a lot of people are doing all kinds of different credentials here in the office. They talk about having issues with self-control, and we often make choices that after the fact, we might regret, especially when the time between making the decision and experiencing the consequence might be long. Something like between eating dessert and having it show up in your waistline might be a long time. Or retirement savings. So you can always put off decisions. So again, another nudge is having members in a defined contribution plan, have an automatic enrollment so you actually have to opt out of the plan as opposed to opt-in to the plan. Well, if you have a default opt-in to the plan, there's much greater levels of participation.

So they give some examples of how to improve your own decision-making. Things like the checklist manifesto, which we've talked about. You'll have a forced checklist to go through things. They talk about how if you make big decisions, break them down into smaller ones to try to get them down to kind of a rule of thumb level, so that you can make a decision. They give examples of, one example they gave was talking about, "Should I take a new job that's in another city?" That's a big decision. "Do I move? Do I sell? Do I buy? Do I rent? Do I like the city? What sort of neighbors do I want?" There's all kinds of things that you can go through and decide on each of those micro-decisions that add up to the big decision.

And they also talk about, this is interesting, talk about elimination by aspects. Take all the things that you would eliminate. "I would only move if I'm making X." So any jobs that are below X, they're off the table, without even being ... Otherwise, you get into, "Well, it's a cool company. It's a good city." No, no. You said you got to make X before you make the decision. Or, "I will not take a job that is more than two hours away from where my kid's grandparents live." So all the interesting jobs, no matter what the pay level is, how interesting it is. They're just off the table.

Anyways, you could talk about this book forever. There's so many, so many examples in there. I highly recommend it. It's a super easy read. A little comical too, in places. They actually seem to be pretty funny people.

Ben Felix: Sounds excellent. Maybe I'll read it.

Cameron Passmore: It is. And you think back to the past guests we've had that talk about making decisions, be it Annie Duke, or Ashley Whillans, and the list goes on, right? So it's a really interesting book. Highly recommend it. Do you want to go on to the one story of the week?

Ben Felix: Sure. Yup.

Cameron Passmore: This was a story that, you found it or I found it, but an article from Magnify Money, is a survey they did of 1,116 US consumers that had an investment account conducted the last week of June of this year, and they sought to determine if investors let their emotions influence their investment decisions. Interesting kind of talking about this after talking about Nudge, but they're trying to determine the quality of decisions that, what was the quality of the decisions or what behavior was going on when they made those decisions.

So get this, were some of these key findings. 66% of the investors have made an impulsive or emotionally charged investing decision they later regretted. Now, one thing about the participants in this. It would be nice to know how many people were, say, on the Robinhood type platform. 32% of investors have traded while drunk.

Ben Felix: Yeah. That's the headline of the story.

Cameron Passmore: This includes 59% of Gen Z, which are age 18 to 24, investors who have bought or sold an investment while inebriated. More than any other age group.

Ben Felix: Now, this is interesting, because when we talked to Hersh Shefrin, to record that episode, I'm pretty sure it was a conversation with Hersh, he said ... I asked something about making some kind of decision, and he specifically said not to do it after you've had a couple of drinks. Do you remember that?

Cameron Passmore: Yeah.

Ben Felix: There's another paper that's somewhat related to this, that I found after our conversation with Hersh. I went and dug this paper up. It was a 2009 study, but Hersh talks about thrill-seeking in your conversation with him, and its relationship to stock trading. So that comes from, I think, this paper. It's a 2009 paper, Sensation Seeking, Overconfidence and Trading Activity. And they had this Finnish, from Finland, dataset where they had ... I can't remember all the data points, but a whole bunch of data points where they could really build out a psychological profile of a person, including their driving record. I can't remember what else, but they were able to build a profile of thrill-seeking individuals, and then look at how those people traded in their investment accounts. Crazy access to that kind of data, but this is the study. And they found that the most thrill seeking people are the most overconfident and trade the most in their brokerage accounts.

Cameron Passmore: Wow. Wow.

Ben Felix: Isn't that crazy?

Cameron Passmore: And he talked about the link that it's somewhat like having dopamine in your system.

Ben Felix: It is. It is. He said it is like having dopamine, and it's the same effect as when someone first starts to use opiates.

Cameron Passmore: Yup. So coming up later this year, we have Dr. Anna Lembke from Stanford coming out, who just released a book called Dopamine. So she'll be on later to talk exactly about that. So other things they find, those that self-manage their investments report higher rates of lost sleep, and regrettable decisions than those who use an advisor. Most investors, 58%, agree their portfolio performs better when emotions are left out of the equation, but that's easier said than done. 37% of investors have lost sleep worrying about the stock market, and 30% have cried over investing. Top reason for tears includes losing money in the stock market, feeling overwhelmed, and get this, selling too early. On a more positive note, 44% of investors say they feel excited about investing, the most popular sentiment. Is that good, feeling excited about investing? Not so sure.

Ben Felix: I don't know.

Cameron Passmore: Stress followed closely behind with 41% of investors tensing up at the starting bell.

Ben Felix: I think there's actually a quote somewhere, I can't remember exactly what it is, but if you feel excited about your investments, you're doing something wrong.

Cameron Passmore: Yeah.

Ben Felix: Something like that. Listener questions?

Cameron Passmore: Fire away.

Ben Felix: So we did, the listener question we did recently was on CAPE, and I went through this whole long thing about how CAPE's completely useless. Not how it's completely useless, but why it's difficult to use to predict returns. And then I prepared for our conversation with John Cochrane, and John has done a lot of work on predictability, which is great.

And I've read his paper-ish, and actually just a side note, the preface to his book, he talks about how there are so many important papers in economics that have formed what has become his fiscal theory of the price level, which is his current big, huge work that he's writing a book about. How there's so many important papers that he had skimmed through along the way. But he says reading academic papers is hard, so he hadn't really read them, and then as he went along through time, trying to figure out this theory, he would talk to other economists and they would say, "Oh, you got to read my paper on this." And it was one of the papers that he'd skimmed over. So he'd finally go after that push and read the paper in detail. And then there were a bunch of breakthroughs that he had through that type of experience.

So anyway, there's the same kind of thing for me with this, where I read John's paper, but not thoroughly enough, clearly. And then I guess my kick in the pants to really read it properly was to prepare for the interview that we had with him. So John says in his paper that the Goyal and Welch study and the Dimson study, the Dimson, Marsh, and Staunton study that we talked about that sort of disproved predictability, he says that that's a diagnostic, but it's not a test. And he says the low out of sample explanatory power findings from those papers, they're an important caution about market timing? You can't use those forecasts to build an aggressive market timing portfolio, but they're not a statistical test of predictability. So he says the present value logic implies that if both returns and dividends ... And this is going to melt people's brains.

Cameron Passmore: I was going to say.

Ben Felix: If you're listening on 2X speed, you should slow down now. Slow it down now.

Cameron Passmore: Slow down now.

Ben Felix: Present value logic implies that if both returns and dividend growth are unforecastable, the price-dividend ratio is constant. So if both returns and dividend growth are unforecastable the price dividend ratio is a constant. Empirically, we know that's not true, because the price-dividend ratio is extremely volatile. So then the question that Cochrane asks is, "How much of dividend growth or returns is forecastable rather than just looking at returns?" And historically, we know that high prices have been resolved by low subsequent returns, not by higher dividend growth, which implies that returns are indeed forecastable. All those other studies really just showed us that we can't time the market, but that doesn't mean that returns are not predictable.

And it's kind of weird, right? What does predictability mean if we can't use it to time the market? And from our conversation with John, which people will hear coming up in a future episode, it's basically like we can build really wide parameters around how expected returns are different based on predictability, based on valuation metrics, but they're nowhere near precise enough, not even close to being precise enough to use them to time the market.

And he actually says that in our conversation with him, that he personally does not use this information to try and time the market, because it's too noisy. But if you're developing return expectations, maybe you would include some of it. And we actually, we're done that paper now on expected returns. It's just being cleaned up and we're putting all the proper references and table numbers in, and what we ended up doing in the end is using 25% predictability contribution to the model and 75% historical for stocks, and then the inverse of that, 75% predictability contribution for bonds, 25% historical average. So that paper will come out probably in the next few weeks and we can talk more about it then.

But that's very different from what I said when we talked about CAPE last time, so I'm always happy to learn, and people will hear more about that, because the very first question that I asked John in our interview with him is about that. And we talk about it pretty extensively. And the thing that I found really amazing is how important that piece of information is to all of the other theory on portfolios that John has done throughout his career. Because you kind of look at the timeline of all the work that he's done and where he is now on his thinking, and all of it stems from return predictability and cashflow unpredictability.

Cameron Passmore: He's up in three weeks, episode 169.

Ben Felix: So that was an update on the previous listener question. The actual listener question, Jeremy G asks, "Should evidence-based investors, read: listeners of the podcast, be looking to convert family members who fit into the average, a.k.a. active investor archetype? If yes, how?"

Cameron Passmore: Such a great question.

Ben Felix: Great question. It's a touchy subject. Money's very emotional. Investors are myopic. They evaluate stuff over short time intervals, even if it's a long-term decision. I think one of the challenges with this is that if you do manage to convince someone to switch to index investing, and then the market declines, or they go and check how their previous active fund or stocks are doing two years later, and they realize that they're underperforming by using index funds instead of what they were doing before, it could create tension. Obviously that's highly relationship dependent. People really need to arrive at this decision on their own, and that's one of the things that for us at PWL has been such an important part of our experience, is that there was a time where we would get referrals from existing clients, or we used to do ... Remember we used to do a radio show, Cameron?

Cameron Passmore: Yeah.

Ben Felix: Before the podcast, Cameron and I did a weekend radio show on the local radio in Ottawa.

Cameron Passmore: A phone-in show. Yeah.

Ben Felix: A phone-in show. And we would get people that were interested in working with us, but they wouldn't know what indexing was, and we have to go through this whole education process, and it was really difficult, and now it's the opposite, where people are coming to us having been already educated, and like, "I want this. I want exactly what you do." So we don't try to convince people. We put the information out there, and people who are ready to consume it can do so.

Cameron Passmore: Well, it's such a polarizing topic, right? So many people are so set in their ways, and the default everywhere in your life is that you can be better. You can be above average. So it just naturally becomes part of what you might seek in this profession, or from this profession.

Ben Felix: It's like what people used to say about Bogle, that index funds are un-American. The same kind of idea. There's a quote from Kahneman he gave it a CFA conference about ... I can't remember the exact quote, but it's something along the lines of, "This is not a field where you can build intuition, because there's not enough ... It's too random. You can't build intuition because of all the randomness. It's not a field in which you can learn," which is pretty interesting, in terms of predicting the market. You can learn, just not about how to outperform.

So this question was, it came at a time when I was ... Or I read it at least at a time when I was reading, which I still am, the book, Cameron, that you mentioned in episode 136, which is Think Again by Adam Grant. So I do take your book recommendations eventually. It takes me a while. The book is about thinking like a scientist rather than preaching, prosecuting, and politicking with your beliefs, having humility over pride in how you think, having more doubt rather than certainty and more curiosity rather than closure in your thinking and in your beliefs.

There's a chapter in the book on how to talk to other people when you want to help them change their mind or help them think more like a scientist. So I wanted to mention a couple of points there, because I think it's maybe useful for the type of conversations that people might have with family or friends or whatever, if they want to talk to them about this. The other weird thing about this is that once you get your head into it, you become passionate about it, because you realize how much sense it makes and how right it is, which makes you want to help other people in your life. But it's not always that easy.

So the first big one is, don't be a logic bully. If you go and bombard somebody who doesn't share your beliefs with all of the facts and figures and data for why you hold your beliefs, that's one of the worst things that you can do. Adam Grant says that trying to change someone's mind is a negotiation where you're trying to reach an agreement about the truth. And if you just bombard them with information, it can end up backfiring pretty hard. He says that you should find things that you do agree on, and I just wrote examples like, "I think we can agree that it's the returns after fees and taxes that we care about." You could agree with anybody on that. No one's going to disagree with you on that, I don't think.

Cameron Passmore: It's not very disagreeable.

Ben Felix: Oh, another I wrote is, "I think we can agree that there are fewer examples of successful active managers than ones who failed to beat the market." I think most people would agree with that. Another one is, "Define things that you're willing to change your mind about in the discussion." I had trouble thinking of one for that, but I had the example of saying that you're impressed with this fund that someone's invested in and how strong the track record is. You can be impressed with that without sacrificing your beliefs. Even if it's a random outcome, it's still impressive.

Cameron Passmore: That's the part you don't say in your argument, I'm guessing.

Ben Felix: Oh, yeah, right. Do I say that out loud? Focus on fewer strong arguments rather than too many, than a whole bunch of not as strong arguments, and the reason for that one is that if your negotiation partner is able to reject one of your arguments, then they'll dismiss the whole case, and they won't be interested in listening to you anymore.

Cameron Passmore: So often you get the whataboutism, right? Like, "Well, what about Renaissance Technologies? What about Warren Buffet?" That's what you always get, right?

Ben Felix: Yup. If people don't care much about the issue, if they're open to your argument, and if they're not strong-willed, then giving more reasons can actually be helpful. So if someone comes to you and says, "Hey, I'm interested in index investing. Can you tell me about it?" Then dumping all the facts and data maybe is a little bit more useful, but if somebody has a stake in the issue, if they're skeptical of review, and if they're stubborn, then piling on the logic is more likely to backfire. So that's when you don't want to be a logic bully.

I'll ask questions about the position of the other party. These ones I think are pretty interesting. So my example of questions are, "Do you see any merit to the concept of index investing? What would cause you to reconsider your position on active management?"

Cameron Passmore: Exactly.

Ben Felix: "What evidence would change your mind?" What Adam Grant says in the book is that if you ask that question, "What evidence would change your mind?" Or, "What would change your mind on this?" If the answer to the question is nothing, then you're done. That's it. There's nothing you can do. So you just end the conversation and move on.

And then another interesting suggestion is to have a conversation about the conversation. So if it gets uncomfortable for whatever reason, you can discuss the discussion. So you can say, "I don't think this conversation is going that well. How do you feel about it? I was kind of hoping that you might see this information or these ideas of sensible. Am I correct that you don't see any merit in them at all?" And he says that that can really change the tone or shift the direction to be more favorable and kind of calm people down if a discussion gets heated. I mean, is that really going to happen about index funds versus active funds, a heated discussion? I guess it could happen. People do get pretty passionate about it.

Then another big one is to not have really strong opinions. That one's kind of counterintuitive, but having a little bit of uncertainty, a little bit of confident humility, according to Adam Grant, makes the whole discussion, more palatable for the person on the other side of the argument or discussion. So my example is, "Indexing is a pretty good idea for most people. It's not perfect, and it's not for everybody."

Cameron Passmore: No. There's a certain personality profile that it's really appealing to as well. If you're out for excitement, or as you've said many times, skewness, you want that lottery payoff, that's not for you.

Ben Felix: Right.

Cameron Passmore: It isn't. If you have other things that are important to you in your life, you don't want to get into the minutia of a portfolio and you don't enjoy necessarily doing day-to-day research on things, makes a lot of sense.

Ben Felix: Yeah.

Cameron Passmore: Remember the time when the light went off for you

Ben Felix: On index investing?

Cameron Passmore: Yeah.

Ben Felix: You know this story. You just make me retell it to-

Cameron Passmore: I know, but do you remember what was the tipping ... Was it the article, was it a tipping point?

Ben Felix: I think so. I think so. I've told this story before I'm sure, but before I met Cameron, I was doing my MBA, selling mutual funds, which is a job that I had gotten through an internship program through my MBA school. I did an internship where I was working for an advisor doing financial planning analysis and building PowerPoints to make cases about different financial planning things. And then after that, the firm was like, "Do you want to continue to work here?" And I'm like, "Great. A job. Yeah. Definitely." And then it was like, "Cool. Go do your mutual fund scores. We'll pay for it. Go do your insurance course. We'll pay for it, if you pass." And then it was all commissioned selling. I was like, "Oh, geez."

And the crazy part is that they indoctrinate you. And it's nothing against any of the guys that I used to work with, but they have people come in from fund companies for the lunch and learn once a week or once every couple of weeks, and they're talking about what they're doing in portfolios and why their managers are the best, and their track record, and all this stuff. And you just kind of learn that's what's right. And there's a presentation going around from Fidelity about ... It was like a smoking PowerPoint from a cigarette company. It's showing all the Fidelity funds that have beat the index. Why would anybody index? And this is back in 2011 or '12, I guess. Probably 2012. It's crazy to think back then that fund companies were putting out disinformation about index investing.

Anyway, so I had managed to get an interview in with the Globe and Mail. I guess I was hustling my media presence even back then. So I managed to get this article in the Globe and Mail, and it was about some fund, some Fidelity fund that I was told was a good product. And it got absolutely obliterated in the comments.

Cameron Passmore: Let me see if it's still online.

Ben Felix: That was the first real big light bulb for me, where I went and started doing my own deep research, which led me to find Dimensional, and led me to find PWL, and then all that stuff got connected. I called Dimensional and talked to somebody there, and then a few months later Dimensional called me back and said, "There's this from in Ottawa that was looking for somebody." And then that closed the loop with Cameron, but I'd already found PWL and thought it was the coolest firm ever, because they're they're securities licensed as opposed to mutual funds licensed, when they're portfolio managers and they're using index funds. It's the coolest place ever that I would love to work. And then Dimensional closed the loop on the whole thing. It's was pretty crazy.

Cameron Passmore: Yeah.

Ben Felix: But that was the light bulb. The light bulb was the article, that I just got blasted by a bunch of people on the internet.

Cameron Passmore: I just looked quickly. I can't see the article in the first page of Google, but it's worth hunting down if you can find it.

Ben Felix: That's good. The rest of my life since then, doing stuff on the internet, has just been to push that search result further down on Google.

Cameron Passmore: I remember I was 15 years ahead of you. Of course, I remember we used to be trained to defend ourselves against index funds, and it was all crazy. And as soon as we went fee-based, we joined the company in '97, it was all over. And then we hung onto one active manager, I forget the name of it, a value manager from California, and they left the company. They were sub-advisors through the company, and they left, and it was just a mess. The performance was terrible. So I said, "What are the MERs?" The MERs were over 3%. It was just completely crazy in hindsight.

Ben Felix: Wow.

Cameron Passmore: This is like '95 to '97, right? A long time ago. ETFs were just getting going. So anyways, we should roll on to the main topic. You wanted to talk about the lessons from 100 plus years of global stock returns.

Ben Felix: Yeah, so I had this idea. We'll see how it goes. Hopefully it's useful, but I've read a lot of work from professors Dimson, Marsh, and Staunton, who they had their book Triumph of the Optimists back in 2002, which sort of transformed into the Global Investment Returns Yearbook that they do every year with the Credit Suisse Research Institute now. I often go back and reference past summary reports. They publish summary reports for free online. It's a small section of the full yearbook they produce. The actual yearbook, they only produce in hard copy, and you have to be a customer of Credit Suisse, I think, to access it. But the summary of those is pretty great. It has a lot of good information.

I was doing research on something recently and was reading one of the reports, and just thought to myself, "You know, I've read most of these, and there's all these really cool little bits of analysis across all of them." So I thought it would be interesting to try and take a cross-section of the most interesting findings that Dimson, Marsh, and Staunton have found. I didn't mention yet the unique aspect of their research is that they have this proprietary data series that they created. You can purchase access to it. We have a license for it, but it's not widely available to the public. So it goes back to 1900. It currently has 23 countries, 21 countries with continuous histories, because Russia and China don't have continuous histories, but they're still in the database. Yeah. So they use this data to answer all sorts of interesting questions that are relevant to investors.

So one of the biggest ones, and we've talked about this in the podcast, I think, many times, is the US stock market returns have been an anomaly. It's interesting to think back, though. In 2002, people didn't really know that. That wasn't a widely held fact, that US stocks have performed the best in the world, because we didn't have really good data for the rest of the world. From 1900 through 2020, US stocks have delivered an annualized 6.6% per year, adjusted for inflation. Inflation over that period is 3%. That's a 9.9% nominal return over the full period. The rest of the world, excluding the US, has delivered an annualized 4.5% over the same period.

Cameron Passmore: Wow.

Ben Felix: So more than 200 basis points of negative tracking for the rest of the world, excluding the US, relative to the US. So expecting the US experience to repeat is probably not the best idea, especially considering how ... And we just talked about CAPE. It does have some predictive power probably, or at least evaluations do in general. So expected returns in the US are probably lower. I mean, you look at how expensive the US market is right now compared to the past, it's pretty expensive right now. Almost scarily so. Not that I'm predicting anything.

Cameron Passmore: I was going to say, put the caveat.

Ben Felix: Yeah. It could go higher, and it can always go higher, or it can stay at this level and earnings can catch up. Even though that's not typically what happens, it could happen. Anyway, the point is, though, that looking at the US 10% historical return, which many people do, and assuming that's going to be your future return, probably not the smartest idea.

In the 2009 yearbook, which is the earliest one that they post the summary of online, think about the timing. This is, the global financial crisis, 2008 had just happened. Their objective in the 2009 yearbook was to restore people's confidence in stocks, because the other thing was happening is that 2008 happened, but that decade had not been so great even before the financial crisis, in terms of total market stock returns. And not just for the US. There was a lot of the countries in the database had negative real returns for that decade.

Cameron Passmore: So-called lost decade.

Ben Felix: Right. But it's not just the US, right? I often hear that quoted for the US lost decade, but it was bad for most of the countries. Actually most countries, of the 19 countries in the database at the time, most of the countries had negative real returns for the full period. And the other tricky thing about that is that the 1990s had just happened, where stock returns were really good. So it's like, "What's going on?" And then you step back, of course, and from 1900 through 2008 at the time, returns were nice and positive everywhere. And then even that's still true now, bringing the data up to 2020.

So the point that they wanted to make in their analysis here was that, "This bad period just happened, this bad decade, and this bad crash just happened. The long term has been pretty good, and look what else has happened in the long term." So they go through all these major world events from 1900. So from 1914 to 1918, which is World War I period, global stocks had a cumulative loss. This is not annualized. It's cumulative for the full period. A cumulative loss of -31% over the four-year period. From 1929 to '31, global stocks had a -54% cumulative return, which was kicked off by the stock market crash in 1929. 1939 to '48, global stocks lost a cumulative 12% coincident with World War II. Some countries did a lot worse, and I'll mention those in a second. Global stocks lost a cumulative 47% from 1973 to '74, with the oil shock. Lost 44% from 2000 to 2002 with the internet bust.

Cameron Passmore: Yup. I remember it well.

Ben Felix: Right. It lost 41% in 2008 with the financial crisis. Now, individual countries, this is crazy. So from 1939 to 1948, Japanese stocks lost a cumulative 96% of their value.

Cameron Passmore: Wow.

Ben Felix: The US stock market lost 61% from 1929 to '31, and the UK lost 71% from 1973 to '74. So it kind of speaks to the need for diversification, I would say, a little bit. Then the big takeaway is that there have been these bad periods, but there have also been offsetting good periods. They talk about 1919 to 1928, after World War I, stocks returned 168% cumulative. From 1949 to '59,. They returned a cumulative 395%. 1980s, they delivered a 257% return, 111% through the '90s. So bad times, there are also good times. Nets out to be not so bad, but there are really bad times. It's probably not news to anybody that's investing in stocks, but I think it is important for everybody to understand.

One of the things that I found interesting in looking at these data is that they're using annual data. COVID last year would not have shown up. If you're using daily data, it probably would have, but using annual data-

Cameron Passmore: Of course.

Ben Felix: Last year, there was a 16.8% return for the world index. Crazy.

Cameron Passmore: True, but the draw down in March was huge.

Ben Felix: Right. But if you're using calendar year returns, which is what they're using, then it doesn't show up.

Cameron Passmore: It gets washed out. Wow.

Ben Felix: Yeah. I wonder what other intra-year craziness is not included in their data.

Cameron Passmore: Yeah.

Ben Felix: Another big one for ... Okay, we have these crashes. We did a video on bear markets and market crashes, and how stuff tends to come back pretty quickly, and those videos ended up kind of coinciding with the bottom, which was kind of fun in hindsight, that markets bounce right back, but that doesn't always happen. Global stocks returned to cumulative negative 8%, in real terms, from 1910 to 1931. Germany, France, and Japan have all experienced periods where real stock returns were negative for more than 50 years. People talk about Japan's 30-year flat, real return period. But yeah, it can go longer than that, and it has historically. So that's kind of that for that piece.

I mentioned the importance of sort of separating, "How have global stocks done?" From, "How have US stocks done?" In terms of forming expectations about the future. One of the other things that they do in one of the yearbooks that's really interesting is decompose the historical risk premium. "Where have the returns actually come from?" Because we can kind of say, "Hey, this segment of returns, we might expect to repeat. Can't guarantee it, but it might repeat. But this piece of returns, there's no reason to expect that to repeat." So they break it down into geometric mean, dividend yield, net of the risk-free rate, the annualized growth rate on real dividends,. And the annualized change in the price dividend ratio over time.

The single biggest driver of returns in this sample is dividend yield. And we talked about this with John Cochrane, that companies have to pay dividends eventually. And theoretically, that has to be true for them to have value. It doesn't mean you have to own dividend-paying stocks, but it must be true that companies will eventually distribute their earnings as dividends. And in historical data, that's exactly what has happened, is in the long run, companies pay dividends, and that's where a big chunk of returns comes from. So that makes sense.

The other big drivers of returns were the growth rate of real dividends and the change in the price to dividend ratio. So Dimson, Marsh, and Staunton kind of say that in the second half of the 20th century, decreasing risk probably boosted price multiples, but probably permanently. Risk decreases. Prices increase. But if risk is lower forever, because regulations are better, property rights are stronger, all that kind of stuff, you wouldn't expect that to change. So that component of returns, you wouldn't necessarily expect it to repeat. And they also make the point that dividend growth over the second half of the 20th century was, again, better than anybody would have expected at the beginning of the period, and therefore we shouldn't count on the full amount repeating again.

So I gave the XUS, global XUS returns a few minutes ago. The global return on average was 5.2% from 1900 to 2020. So still much lower than the US, but the point Dimson, Marsh, and Staunton are making is that even that is probably too much to expect. And that's 5.2%. Inflation, again, was 3% over that period, so that's an 8.2% return. I don't think most people are expecting returns to be that high. It's still a good lesson.

In the 2010 yearbook, they introduced analysis on emerging markets, which they can do with their historical data set using GDP per capita to define an emerging market, and they kind of ran that analysis today and said, "Does that describe emerging markets?" Yes, it does. The 30th percentile of GDP per capita captures most emerging markets today, so they use that to measure emerging markets in the past, going back to 1900.

One of the observations and make that I thought was pretty interesting is that even over 110 year, at the time, time span, not very many countries moved from emerging to developed, and likewise not many moved from developed to emerging, which is interesting, because you would expect emerging markets to eventually become developed, and that's kind of partially what you're betting on as an investor. The reasons they give is that there were dictatorships, corruptions, civil troubles, wars, unsuccessful economic, and monetary policies and communism. Those are the reasons for most of the emerging countries that stayed emerging throughout the full period.

And then the other points that they make about emerging markets are that you kind of need them in portfolios, because they make up a big chunk of the global capitalization. They have been diversifiers, but betting or assuming that they're going to have exceptionally higher returns because of their economic growth, and we've talked about this on the podcast and in a YouTube video in the past, probably doesn't make sense. Economic growth doesn't tend to correlate with stock market returns. In fact, a lot of literature documents a negative correlation. A stock market can grow for a lot of reasons that don't result in returns to existing investors in that market. Now, because of risk, they do actually say that they expect higher returns for emerging markets, because they are riskier, the prices are lower, but not for the reason that people tend to think. It's not the economic growth that you're betting on.

In the 2015 yearbook, they extended that thinking to industries, so it's kind of like, "Okay, economic growth doesn't predict returns in emerging markets. What about industries?" So they look at the dispersion of industries over time, which is pretty interesting analysis. One of the things that they kind of state going into this is that, and Ilmanen, in his 2011 book, on Expected Returns, says the same thing, that industry portfolios are not priced factors, or they're explained by it. They are fully explained by priced factors, so any difference is just going to be kind of random. So Dimson, Marsh, and Staunton find that across the annual cross-sectional dispersion for all US industries is 22%, but the average spread between the best and worst industries was 108%. That's in the US data going back to 1900 through 2014.

So the question they're asking, "Okay, there's this huge dispersion in industry returns. Can we pick industries?" And they give the example that we've talked about before, of railroads, which ended up outperforming road travel, like vehicle-related stocks and air travel stocks, and the market, railroads beat all that stuff despite being a declining industry by market capitalization relative to the rest of the market. But then they also make the point that technology, a growth industry, has actually performed really well. So they kind of step back and say, "It's not so much industry shrinking or growing that is going to dictate differences in expected returns. It's prices." So kind of what you'd expect. It's the relative price, not the industry growth that is going to explain differences in returns. And they find that, they find that doing a rotation strategy reinvest in the cheapest industries adds value to returns, and Dimensional does this a little bit. They allow for some industry rotation by not capping industries at their cap weights. So the cheapest industry will be allowed to have, I think it's a 5% or 10% over-allocation relative to the market without making a full industry bet.

And then the other one that they did is they tested a momentum strategy. So it's like, "Okay, let's take the cheapest industries and sort by that." That leased out performance, but they also said, "Let's take the previous year's best performing industry and invest in that one every following year." And that also led to excess returns. So they did observe both a value effect and a momentum effect within industries. I thought that was pretty interesting.

Okay. I think I just have a couple more. Another big one they looked at was US bonds. This one is really interesting. US government bonds, and have they really been safe assets historically? Bond prices are pretty high. Yields are pretty low. Bond returns have been insanely good for the last few decades. What does the longterm data look like? The US bond market has had two periods of major under-performance in the historical data. They reached a peak in 1915, and had a big decline until June 1920. They had lost 51% in real terms by June 1920 and did not recover their real value until 1927.

Cameron Passmore: Wow.

Ben Felix: Pretty ugly. And these are long-term government bonds that we're talking about.

The 1940 bond bear market was even worse for investors. It started in December 1940. US government bonds lost 67% of their value, and didn't recover in real terms until 1991. Talk about an ouch. Pretty crazy. So it's kind of a 50-year bond bear market in that case. One of the points they make is that in real terms, in inflation-adjusted returns, if we see a high inflation, bonds can be just as risky or more risky than stocks.

Cameron Passmore: For sure.

Ben Felix: But I think one of the really interesting questions that they pose is, "We don't really care about bonds on their own. Everyone knows you think about bonds in a portfolio with stocks. So how have bonds performed relative to stocks? It's the timing, the correlation that matters of stocks done historically, when bonds have done poorly."

So we know they've been less volatile and they've historically had imperfect correlation. Everyone thinks they're a good diversifying asset. That's been true around the world. Recently, though, and this point I found really interesting, especially given all the conversations in the community and with Dave Pleca about negative correlations, and Dave mentioned this too when we asked him about it. But the recent correlations in between stocks and bonds have been negative. Some people think like, "Cool, this is going to persist. We're going to have negative correlations forever." But when you look at the long term data, there have been times where correlations have been like 0.4, 0.5 kind of thing. Globally positive. And in the full period, 1900 to 2020, it's been a slightly positive long-term annual correlation. I thought that was pretty useful information. If you look back long enough, there's been a positive correlation between stocks and bonds.

In the 2012 yearbook, they look at how stocks and bonds have performed under various inflation regimes. This is another one that I think is probably on a lot of people's minds. High inflation is also generally volatile. So not only is it high, it tends to be volatile at the same time, and that results in a higher inflation risk premium for bond holders. And the other thing that's interesting about high inflation, or scary about it, is that it historically increases the correlation between stocks and bonds. Very high inflation is bad for both stock holders and bond holders, which affects the diversification benefit of bonds in the portfolio.

One of the things they do that is pretty interesting is they sort stock and bond returns by contemporaneous inflation, and that shows that in extreme periods of deflation, bonds are killers. Average a real 20%-

Cameron Passmore: For sure.

Ben Felix: …annualized return in the most severe periods of deflation, while over the same period, stocks returned an average of 11%. And then as you go across their chart that they made, stocks increasingly beat bonds under less extreme deflation and moderate inflation. But then when inflation starts to get high again, stock returns start to get a little lower, bond returns start to get negative, and then in the highest periods of inflation, both stock and bond returns are negative, but bonds more so. A lot lot more so than stocks.

All right. I'm going to stop. That's it.

Cameron Passmore: That's it?

Ben Felix: There's so much more. There's a bit on mean reversion, but I'm going to skip it because we talked about most of the research that they cover in this, we talked about in a recent episode. So I don't think we need to ... We don't need to rehash it.

Cameron Passmore: Okay. So let's go into the Talking Cents. I left my other cards at home, so this may be a duplicate. We'll see, but you and I have not seen these cards yet. I think we've had that one before. I think we've had that one before. Let's try this again. "What is the first thing you ever purchased?" I don't think we've had that one. I'll answer that. I remember the first thing I saved up for, I remember going to the mall. I grew up in Lennoxville, Quebec. We used to go to the mall. There was a big new mall that ... This was back in the, gosh, '70s. We'd go to the mall, and that's when I was ... I used to have a little worm farm. I was like six years old and used to raise worms. So my parents taught me about how to ... This was probably the first purchase I bought, what's called Buzz Bedding. You ever bought Buzz Bedding before? So it's what you use when you want to raise worms. It's a special bedding for worms.

So I remember going, I'm like, "Okay, I have to buy buzz bedding to build a worm farm. And I'm in the hole," whatever it was, $20, let's say, "and I don't make any money until I sell the worms, but then it'll be weeks until I find enough worms to put in the farm." So that's the first thing I remember purchasing, but then I saved up that first summer selling worms to buy a stereo. I remember going to the store every Friday night, we'd go to the store, and I'd idolized this Lloyd stereo. That's the first thing I ever bought. How about you?

Ben Felix: I bought a bike by doing chores. And I remember my mom had this whole chart that she made, and I would do certain chores, and that would earn me notional money or whatever. And eventually I got to buy a bike. So I remember that.

I used to buy gas for my boat, I remember that, when I was like 10 years old. We lived on a lake, and I had an aluminum boat, and we lived on the campus of a boarding school that my dad taught at, and I would give tours, 10 or 11 years old, I would give tours to prospective families that were interested in sending their kids to the school. They would put the family in my hands, this kid, but I knew the campus really well, and I would walk them around, and show them the different dorms and where the cafeteria was, and all that kind of stuff.

Cameron Passmore: Yup.

Ben Felix: And I would get $20 per tour, and I would almost always take it and use it to fill my red plastic gas can with gas so I could go riffing around the lake for the rest of the day, or the weekend, or whatever. Those are some of the earliest ones I can remember.

Cameron Passmore: Here's another one. I must have been kind of stumped. "What is a creative way to save money?" Creative? Not the traditional dollar cost average, "Pay yourself first," in today's digital era. What's a creative way to save money?

Ben Felix: Does it mean to reduce your expenses, or to put money into a savings account?

Cameron Passmore: "What is a creative way to save money?" I don't know if it's to reduce spending. I don't know.

Easier as I get older, as I get older, there's less stuff I want. So I'm completely out of the want kind of phase, so saving gets easier for me as I get older. Until you go to a really nice furniture store. There's a beautiful new furniture store in Ottawa that we went into a couple of weeks ago. You come home after that, and it's like, "Wow. Our furniture is garbage in the house."

Ben Felix: Oh, don't come to my house. You should see my furniture. I've got a pretty ratty Ikea couch.

Cameron Passmore: Well, you've got kids, right? It's not worth it.

Ben Felix: I'll tell you how I save money.

Cameron Passmore: Okay. Fire away.

Ben Felix: Our coach was, I find that uncomfortable. It was pretty low coach, like Ikea couch. I'm tall, right? So sitting on this low couch for hurt my back and my hips. So I 3D printed new legs for the couch that raise it up to a level that's comfortable for me. That was cheaper than buying a new couch. That's a creative way to save money.

Cameron Passmore: That saved money. There you go. That's a better answer. Okay. We have a phenomenal bad advice of the week this week. This one's a Lulu. Anyways, as always, if you send us bad advice of the week, we're happy to send you a Rash Reminder hoodie, kind of like Ben and I are wearing today, with the Christmas colors going on here. Anyways, so Mitchell is a longtime YouTube follower of yours, and he told us that he's worked his way through the entire library of our episodes. And we've covered lists like this before, but this one was just too good to pass up on.

So this is an article from Entrepreneur Magazine, August 18, of the Summer Edition. And it was originally on the Market Beat site, whatever that is, on the same day. Anyways, the title of the article is, Seven Downsides to Passive Investing and Why it Can Be Bad for Your Portfolio.

Ben Felix: Uh-oh.

Cameron Passmore: Anyways, the article starts out nicely by saying, "Studies show that while many active funds outperformed passive funds in the short term, they don't in the long run." Okay. So far, so good. "Only a small percentage of actively managed mutual funds actually performed better than passive index funds. Investors are attracted by ease of investment, low cost, and less effort." So far, so good. "Passive investing typically takes the buy and hold approach," but uh-oh, it heads south pretty quickly. "But this passive investing has limitations." You bet. "Let's take a look at a few reasons." They come up with seven reasons why passive investing can hurt your portfolio. So let's rip through these.

"Downside number one: They have preset limits. They lock you into a predetermined set of investments." I would argue that is a good thing, so that it reduces emotion, keeps you in your seat, keeps you invested, and low fees. "Active funds can ..." This is still part of downside number one.

Ben Felix: You know what, though? Sorry to interrupt.

Cameron Passmore: Fire away.

Ben Felix: I met with someone years ago that had sold a business, and they found us, and I had a conversation with them, and it was a couple. And I thought we had a pretty good meeting, but they ended up going elsewhere. And I inquired what happened, and one of the pair of the couple, it was actually exactly this. They didn't like that it was set in an allocation that was going to be locked in, and it wasn't going to be able to change as the market changed. So I can see why someone would ... I can't see why. I have seen someone consider this a downside.

Cameron Passmore: Yes. Still under downside one. So this is the preset limit thing. "Active funds can deviate. They can take advantage of short-term trading opportunities." I guess that means that they're smarter than the market. "Passive investments don't follow a broad portfolio." I don't get that one. They are pretty broad.

Ben Felix: There was no reason behind it? It was just a bullet point?

Cameron Passmore: No. I'm just giving you the bullet points.

Ben Felix: Okay.

Cameron Passmore: "Sometimes it's not all good to track the S&P 500 instead of the wide gamut of available securities." So we agree on that. You want more diversification than the S&P 500.

"Downside number two: You have less control over your investments. You can't make changes if you see certain sectors or companies underperforming." Again, why is that bad? "You fall when the market declines." This is the classic. It's still number two here. "You fall when the market declines." So is there evidence that active managers don't?

Ben Felix: There's not. There's not. The most recent one was Lou Bosch Pastore, which we talked to him about.

Cameron Passmore: Yup. "You cannot avoid companies you may dislike." That is true. If there's companies you don't want to profit from, you're right. It's hard to exclude those in an index portfolio. "You can't react to the markets." Okay, true. But is that bad? You may not in hindsight want to have reacted to the markets. "If you know," get this one. You're going to love this one. "If you know a particular stock is overvalued or undervalued, your hands are tied." True, but do you really know?

Ben Felix: You do tend to overweight naturally the larger, more expensive companies in the cap weighted index. So I wouldn't call it undervalued or overvalued, but-

Cameron Passmore: Okay. This goes back to the argument you talked about with Adam Grant. "If you feel constricted by lack of control, passive investing isn't for you. Pick your own stocks." Is that really the best reason you should become a stock picker?

Anyways, "Downside number three: Holdings are overvalued." So this is what you alluded to with the S&P 500 or BTI. They all have similar type holdings. So yes, you should be more diversified.

Ben Felix: I'd say they have lower expected returns. I don't know if I'd say they're overvalued, but-

Cameron Passmore: I didn't. I'm just saying that's what the author's argument is.

Ben Felix: Oh, I know. I know.

Cameron Passmore: "Downside number four: They might not track the index exactly." Quote, "If you expect an index fund to be a duplicate of a sector, think again. Fund managers make adjustments to individual funds, which causes differences between the fund and the index." I've never heard of that before.

Ben Felix: Seems like a bit of a straw man argument there, but anyway.

Cameron Passmore: Keep going here. "Downside number five: You won't get above market returns. Just remember, average stays average. You can't outperform the market if you only keep pace with it."

Ben Felix: In one of Larry's books, he talks about the easiest way to be an above average investor, and it's by owning index funds, because the average investor dramatically underperforms the index.

Cameron Passmore: Exactly. So that's number five. "Number six: Passive investments limit your investing knowledge and growth. So can passive investing and turn you into a slack-jawed automaton? Possibly." So does that mean we have to change the name of this podcast to Slack-Jawed Automaton Reminder or something? "When you stick your money in index funds, you rob yourself of a chance to research and learn more about investing in the market." So I guess the 166 episodes have been a robbery of our time. "Any investing knowledge you could have gained goes by the wayside when you choose an index fund over picking individual stocks. You don't learn how to develop skills, such as determining asset allocation." Really? "Risk management." Really? "Or valuing individual companies." Okay. Give you that one. "Investing can be a lifelong journey and an exciting process. Why limit your opportunities?"

Ben Felix: I find this one really interesting, because I think it is a common perception that if you learn how to invest in individual stocks and do individual security evaluation, that you're going to become a better investor, but it comes back to my comment about Kahneman earlier, that it's not a field that you can learn that way, but it doesn't mean that there's not a lot of learning that can be done. It's just not that kind of learning.

Cameron Passmore: And there's so many people doing that, that that's who you're up against. You're up against pros on every trade. And to assume that you're smarter than everybody else in this adopted system, not likely. "Number seven downside: Sectors can limit your diversification. Some ETFs only track specific sectors. You may think your portfolio is diversified because you own ETS from different fund companies. However, a lot of them on the same stocks. For example, growth-focused funds may only expose you to large cap tech."

Ben Felix: I don't know how the sector diversification ends up getting included in the discussion about active versus passive.

Cameron Passmore: Anyways, "You might need to pay attention to the sectors and concentrations in various funds. For example, if you have large cap holdings, you may need to balance those and that particular ETF with small cap stocks."

Ben Felix: That's true whether you're using active funds or ... It's not false.

Cameron Passmore: No.

Ben Felix: But it's not an argument against.

Cameron Passmore: Anyways, so the bottom line, the author says, is, "Think carefully before you choose passive investing. Bogle warned investors in January, 2019 that there may be too many shares in too few hands. He said that index funds could one day control the US stock market, and he said that he didn't believe that such concentration was served in the national interest." Yikes. The quote goes on, "If the indexing pioneer says you should think carefully about your passive investing approach, you should." So that's the first time I read Bogle this overtly as an argument against indexing.

Ben Felix: Oh, yeah. No, that's definitely a thing. That's something that people were quite worried about a couple of years ago.

Cameron Passmore: Well, I get the argument, but I'm saying, to spin Bogle back on index funds?

Ben Felix: Yeah, yeah. Pretty crazy.

Cameron Passmore: Pretty crazy.

Ben Felix: And they're totally different arguments. Bogle is rightly concerned about concentration of control of companies in the big asset managers, but that's got nothing at all to do with whether or not an individual should choose to invest in index funds, unless they're trying to serve the public good by reducing concentration of control in those managers.

Cameron Passmore: Exactly. Pretty good bad advice of the week. Again, if you have some ideas on that or you find one, send them our way, and we'll send you a hoodie.

Ben Felix: Yup. That was good bad advice. I agree.

Cameron Passmore: Good bad advice. All right. Last call. Anything to add?

Ben Felix: No. We always appreciate the reviews. Keep them coming, and something I say in my YouTube videos, but never really say on the podcast, is that one of the best things that you can do to help us out is share the podcast. Share with someone who you think would find it useful. And with the comprehensive overview episodes, we'll have an increasing amount of, I think, easier to share content. Someone listening to this episode for the first time, I don't know how easy it is to kind of jump into it and-

Cameron Passmore: And embrace it.

Ben Felix: ...and embrace it. Yeah.

Cameron Passmore: Excellent. Okay. As always, thanks for listening.