February 27, 2020

Episode 87: Allison Schrager: Risk is Everywhere

February 27, 2020

You can’t get anything good out of life without taking a risk, and this holds true in the world of investing too. Depending on the situation, people are willing to either pay more for high-risk or risk-free, and matters become more complex because the term 'risk-free' means a different thing to everybody. Today’s guest is economist Allison Schrager, Senior Fellow at the Manhattan Institute, author of An Economist Walks into a Brothel, and long time collaborator with Nobel laureate, Bob Merton. Allison is an expert on risk and she joins us in this episode to speak about this topic in relation to retirement and retirement finance. We talk about the idea that while risk has been given conventionally bad associations, it can be more accurately understood as a probability distribution between the future occurrence of both potentially good and potentially bad things. Allison shares her opinions about how both young and old people should approach risk, and stresses the importance of having clearly defined goals and a good financial advisor. She shares her thoughts on managing systematic vs idiosyncratic risk, why the retirement crisis is not all doom and gloom, and the laddered bond portfolio she developed with Bob Merton. Joining this episode, you’ll also hear Allison speak about how misinformation causes people to be hesitant about annuities, the connection between risk management in surfing and investing, and why investing in education is smarter than investing in a house. Allison covers a whole lot more risk-related topics in this episode too, so don’t miss out on it.

Key Points From This Episode:

Allison’s definition of risk: as a probability distribution. [0:02:54.0]
The idea that the word risk pertains to both good and bad things. [0:03:57.2]
Relativity of the term ‘risk-free’ and its fundamental connection to price. [0:04:20.0]
Probability of, and skill in, taking risks depending on how they are presented. [0:05:11.0]
The value of having a clear goal in mind as far as managing risk. [0:07:19.0]
Strategies for managing systematic vs idiosyncratic risk. [0:09:20.0]
Value adds advisors can give for managing systematic risk. [0:10:01.0]
Retirement goals in the current crisis and Allison’s work with Bob Merton. [0:11:51.0]
The retirement problem as a problem of income, not wealth. [0:12:17.0]
A duration matching laddered bond portfolio as a risk-free retirement plan. [0:13:18.0]
Why 401(k)s are wealth focused compared to defined benefit plans. [0:14:43.0]
Statistics around retirement age casting the retirement crisis in less of a bad light. [0:15:19.0]
Why people are scared of putting their retirements into annuities. [0:17:08.0]
Misinformation that people are given that make them bad at retirement planning. [0:17:53.0]
Similarities between risk and mitigation in surfing and market investing. [0:19:39.0]
Idiosyncratic and systemic risks faced upon purchasing a house. [0:21:26.0]
An argument for investing in education over homeownership. [0:22:24.0]
Why time diversification is a fallacy in Allison’s opinion. [0:24:00.0]
Pros and cons of investing in mostly bonds or mostly equities. [0:24:52.0]
The ultimate riskiness of 60/40 portfolios and other products too. [0:27:04.0]
Thoughts on the new trend of adding private equity to portfolios. [0:28:40.0]
How the global shortage of safe assets could have an economic impact. [0:30:31.0]
Advice for pre-retirees: have goals, have a good financial advisor, and plan. [0:32:12.0]

Read the Transcript:

I'm super excited to have this conversation after seeing you present last fall at a conference that I was at, and I thought your presentation was excellent. So off the top, my question for you is how do you describe risk?

Well, I said the technical definition of risk certainly in finance is it's like a probability distribution. Anytime you make a decision and you don't know what the future holds, which is pretty much all the time, it's the whole range of things that could happen, both good and bad, and how probable each of them are.

I think risk gets characterized as a bad thing. Is risk bad?

No, I mean, we do say that and I said the origins of the word are certainly like something dangerous. And I mean, naturally, we're going to focus on downside because we tend to be risk averse. But technically, risk is good things too. You don't get anything good out of life without taking a risk. Certainly you know that in finance, you get a higher return, if you take the best interest of your assets or you hope you do, or that's why you would invest in them. So it's both the good and the bad, even if we tend to focus more on the bad. And when we say something as risky, usually refer to something that's going to be a bad outcome.

And because it comes from the title of your book, and your book, by the way, I thought it was terrific.

Thank you.

And you spent a lot of time studying risk. And you talk about what you learned in studying risk in a fringe market like sex work.

Well, on one hand, you learn that it's really all the same that markets have a way of pricing risk that's fairly uniform. But on the other hand, when you go into these fringe markets, you tend to see subtleties that you don't always see elsewhere. Certainly, with sex work, one thing that I think is probably the hardest concept to grasp in finance, that I see people gloss over a lot and I still struggle with it anyway, I've been educated on it a lot is what is risk-free mean? And what is the meaning of risk-free because it's not always the same. It depends on the problem you're solving. And I think we also forget that risk-free comes at a price. But this was really apparent in a brothel because first of all, you realize people are paying a lot for it's effectively as risk-free sex transaction.

And also, even that the service that has the highest premium on it, it's a bit called the girlfriend experience, which is this illusion of intimacy without any risk of rejection. And I said, you pay more for risk-free, but what is risk-free to people, isn't always what you'd anticipate. I didn't expect I'd go to a brothel and be like, "Wow, there's a risk-free transaction all around me." For some people, I wouldn't call it risk free, but for a lot of people, it is. And I think it shows, one, how fundamental risk free is to price, and two, how risk free isn't the same for everyone.

Do you think people understand the risks that they're taking, in general?

Sometimes, I think people are better at risks and they get credit for it. It's really popular to say that we're these doomed, flawed creatures who can't make sense of risk. But certainly something I saw in my research is that people, no matter what their education is, take risks repeatedly in the same area, tend to be very good at it, very competent, very thoughtful. It's just people tend to be bad at taking risks when information is presented to them strangely, or it's a problem they've never solved before. It's like investing for retirement, which is actually a very hard risk problem. I've said it multiple Nobel prize winners are working on this and they don't have the answer. We throw this problem on everyday people with no training whatsoever. And then if they're not great at it, we assume somehow, they're the ones coming up short.

In your answer there, you talked about when presented strangely, we are in a risk management business, you could argue how investors are presented with risks, certainly leads to different amounts of risk being taken on. Can you talk about how important, how the risk is presented is to the ultimate outcome or decision by the investor?

Yeah. And I mean, then there's two different schools of thought on this. I mean, certainly there's the behavioralist school that says that we're somehow flawed that if we see, say, a probability versus natural frequency, so a probability to be like 50%, natural frequency would be like 50 times out of 100, we might make a different decision. But there's another school psychologists who think, well, we just evolve to think of risk or to assess risk in one way. We came up with probabilities fairly later, much later, and our brains just haven't caught up, but that doesn't mean that we can't be trained in the same way we're trained in how to read. But yeah, you do see a lot of very differences in behavior. In fact, when you see natural frequencies, people actually behave more like economists predict they should. So, that speaks to, one, the fact there's a lot of room for, to manipulate people. And two, it also says that we need to think more carefully about how we communicate risks because people actually make very good decisions if they really can understand and internalize what risk means.

I think something that stems from that question is people understanding why they're taking risks in the first place, which I know I already asked about. But how important do you think it is to know what your intended outcome is before you take some risks?

Incredibly important. I think in fact of all the risk management techniques that I have ever studied, and some of them are quite complex, fancy derivatives and whatnot. I think being clear on what your goals are and what you're taking a risk for is the single most effective strategy. For instance, with retirement, we tend to have people focus on wealth, like say have a magic number, like a million dollars by the time you retire, but that doesn't really help you with the riskiest part of retirement, which is knowing how much to spend each year. But if you think about your retirement savings, your retirement goals in terms of income, you'd be solving a very different risk problem. You'd probably even have a very different investment strategy. So you might think that like, "All right, I had that million dollars. I've locked it in. I've completely taken risk off the table for retirement." But in terms of making that money last a lifetime, you really are actually very much exposed.

So let me give you a real scenario on that example. Let's assume that you have stock options and you reached your goal monetarily for the income you want for the rest of your life a year ago. And since then, you did not sell, but the options have doubled in value. So, now you have an even greater lifestyle locked in for the rest of your life. And you might be in your mid 30s, how would you advise someone to think about the risk in that decision? Because next year, it could be double again or it could be half again.

I mean, that's the thing. I mean, you could think of it this way. I mean, you're always giving up upside, so it's a hedge to take the risk off the table, but you're always giving up upside when that happens. So I think that's why it's important to have a goal. The odds of meeting your goal are much, much higher if you take risk off the table once you need it, because there's always a chance the market will turn. You could get lucky this year. You could get unlucky the next year. But I mean, you have to be comfortable with giving up that extra upside, which is again, why it's important to have a goal and just be comfortable with reaching your goal.

On the concept of upside Cameron was talking about stock option on like an individual security position versus selling and diversifying. How do you think investors should be thinking about that difference between... When we're thinking about upside, the potential upside, how should they be thinking about that difference between systematic and idiosyncratic?

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 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 skill. And that's where I feel like advisors have a lot of value add. I mean, I see this a lot in media of saying, "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, is it where was management options, all these things come in.

Yeah.

Can you talk about the value adds, you see that advisors can give around systematic risk?

Well, as I said, like you were talking about an options' strategy or it could just be helping you set your goals and then de-risking, it could honestly, I think a lot of value added through advisors comes from just honestly sitting down with people and helping them think through their goals, identifying potential risks. Certainly when it comes to retirement, thinking about risks like being capacitated, how estate planning, all of these things. But it's a fool's errand to think an advisor is going to beat the market. I think that's where a lot of people go wrong is expecting their advisors going to get them extraordinary returns. Instead, as I said, this value add is systematic risk because if the stock market into completely craps out, having an index fund doesn't do you much good, but having a really solid risk management strategy and having someone to talk to is really what's invaluable.

If we assume someone has identified their goals and they put a plan in place to try and achieve them, how do you think people should go about staying true to those objectives? The original objectives that they set that define the types of risks they decided to take, how should they stay true to those objectives, when we are bombarded with so many external influences?

I said, it's tempting, especially when you've reached your goal, you've locked it in and your neighbor's stock portfolio went up. I mean, I think this is again, why advisors play an important role to say, "Hey, you've reached your goal. If you're comfortable risking some, maybe we'll set a new goal. Maybe we'll take more risks that comes with setting a new goal." And I think that requires a conversation with an expert because you could also say, "Hey, if you are comfortable with this and you're complaining about your neighbor or getting a higher return because he's still markets, you have to understand he's going to lose a lot of that if the market changes tomorrow." We don't know if it will.

I read your excellent article in courts on the looming retirement crisis, given that as a backdrop, do you think it's realistic that most people can reach their own retirement goals without taking on any risk at all?

Probably not. Certainly not where interest rates right now. I mean, you can if you want to save a ton. But I think most people it's not worth the sort of huge drop in their current lifestyle, save that much. And nor is it probably efficient or optimal to do that.

Stemming off of that, you've done some work on retirement finance with Robert C. Martin, who's a Nobel prize winner. Can you just talk a little bit about the work that you've done or are doing with him?

We haven't worked together in a couple of years now, but initially, we worked together at a startup where we were developing an investment strategies for 401k plans that managed everyone's 401k as if it was a little mini defined benefit plan. And this really changed how I saw finance because I'd worked in the retirement space before and on industry, but in academia. And it was really Bob who helped me really reframe the problem as an income problem rather than a wealth problem. This is where a lot of people get it wrong. And this is just speaks the way Bob thinks about everything, which is how do you define risk-free. The first step in any time you're falling risk problem is what are your goals and what is the risk-free asset? And that is, as he says, your numeraire, because he's smart guy. But for the rest of us would just be like, what terms do you put your goals? We did that for a while, and then eventually we were acquired by DFA. And so, we continued to develop the model there and eventually developed a post retirement income strategy.

What does that risk-free mean to an individual planning for their retirement? Can you elaborate on that a bit?

Well, I mean, I guess technically it would be an annuity price or a laddered bond portfolio that would give you a stable income for a certain amount of years or in annuity case, it would be your entire lifetime. Annuity might not be right for everyone, but it does give you a risk-free price on retirement income. This is important because as a much longer duration than like a T-Bill, and your average target date fund defines risk-free as a T-Bill. so really it's specifying a problem, and this is leading, I think, most American households to be short duration in their retirement portfolio.

Can you just touch on what... I didn't realize that the startup had been acquired by Dimensional, which is interesting, what is that post-retirement product doing, that's different from just a regular target date fund or a long-only portfolio?

As I said, it would be... I mean, I think they abandoned it in the last couple of years. I've been working on it since on my own, is it's just as said in a strategy that is effectively like a laddered bond portfolio, but it's a lot cheaper because we just do duration matching with bond funds.

Interesting.

So what it actually does is you put out an income goal and it could actually, as I said, simulate a laddered bond portfolio, only doing duration matching, and as well, there's also scope to be in a riskier portfolio and not just be all in bonds because with rates being what they are, a lot of people can't afford to even be risk-free even after they retired, they have to take some risks.

Fascinating. So it's like a liability matching product that people can use. Is that the idea?

Yeah. I mean, and that's the core of what we did pre and post retirement is that assuming they were well-funded, which they very rarely were, defined benefit plans of did have at least the asset strategy right. And they were income-focused. Why have we need 401k so wealth-focused instead of just taking what we know work for defined benefit plan?

Yeah. That is really interesting.

Some of the numbers in your retirement crisis article are absolutely staggering, like $400 trillion shortfall estimated by 2050. This is way beyond the value of like the entire stock market, for example, how do you frame this issue and how severe is it?

Well, I don't think it's quite as severe. I mean, I throw out that number, but I think those are World Economic Forum number. And then they also are assuming everyone retires at 65, with the 70% replacement rate. And you know what, that's probably just not going to happen for most people. First of all, there's a lot of controversy about whether a 70% replacement rate is appropriate. It's probably even less realistic a lot of people are going to retire at 65. Most people are probably going to have to work at least part-time into their 70s.

So that certainly makes it a little bit less bad. And as bad as it all looks, we have to remember that people actually, probably the average household is going into retirement with more wealth than other than before. And that's in part because of 401ks and the take off a 401k type plans. Everyone gives them a lot of flack because they don't think they're as good as defined benefit plans, but they have much wider coverage of 50% of people have access to workplace retirement accounts, only, was it like 30 something percent did at the peak of DB plans. So in part, because they're cheaper, they're also more widely available, which overall has increased retirement savings.

Makes sense.

So it's not all doom and gloom?

It's not, but there's still problems. There's a retirement crisis school. And then there's been nothing-to-see-here at school. I'm probably somewhere in the middle of, I think it's not as bad as people think, in some ways people have more wealth than other before. But there's still a huge shortcomings in this market. For instance, we don't have a good post-retirement option. I mean, I think a lot of people and policymakers are relying on annuities and I'm skeptical that the market will ever really take off. And also, I mean, the long-term care market is very scary. I mean, it's really hard for insurance companies to offer reasonably priced long-term care insurance, which is why a lot of them are not offering it. And that's leaving people exposed to a huge source of risk. Certainly their entire families are exposed to that risk because often children or spouses end up being caregivers.

What makes you skeptical that an annuity market will take off?

People don't like annuities. I love annuities. I'm the retirement economist. No one else does. I think people are skeptical or just scared to take their life savings and hand it over to an insurance company. Even if it means they're reducing risk, even if it means they get more money because they're pulling longevity risks with the [inaudible 00:17:26]. And I think that is in part because of fears about long-term care expenses and also just the scariness of having a big financial firm and have all your money.

Makes me think of another question that, when we talk about people not wanting to buy annuities and maybe not understanding the risk they're taking by not doing so, do you think that... And actually another example is maybe people thinking that stocks are risky even for a long-term goal and bonds are safe, even though it probably isn't true. Do you think people are good at thinking about how to measure risk?

I mean, again, if they're experts in it, no, they're very good at it. If they're not, they're not. But the thing is it doesn't help that when it comes to the retirement problem or personal finance, we complain people are terrible at it, but we also get a lot of really mixed messages. This isn't like, think of the, was it some financial company focusing on what is your magic number? What is the amount of number you need to have when you retire? Well, that sets people up for failure because it gets them thinking about the day they retire, but not anything afterward, when afterward is the hard part. It also would make them more skeptical to annuitize because you're like, "I work so hard. I have all this wealth," but now you're going to hand it over to insurance company. So I mean, to some extent, yeah, people are bad at measuring risk and understanding the risks in retirement, but they also get a lot of really mixed messages that I think are leading them astray.

And there's also a lot of bad behavior too, that goes on.

Yeah, for sure.

And would you have any recommendations for people as to how they might be able to behave better and behave more rationally?

Well, I mean, I think a lot of it is tuning it out, put money in your 401k and just don't look at it. I personally, my various 401ks over the years have no idea how much money is in them. I do roughly have a ballpark figure because that way, I don't sweat what happens to the stock market with it because I'm in it for the longterm. And also, I'm not looking at it and thinking if I want to buy something, this is money I have available to me. It's just there, and I don't think about it. So I think you've just have to try to tune it out. I know a lot of people don't have that option. It's their only form of saving, which is another issue people have in personal finance. But if you can, I think what you want to do is put as much money as you feel you can into your retirement savings, and then just don't look at it.

We've been talking a lot about risk, which we can measure and quantify to an extent and maybe plan around. What about uncertainty?

Well, that's the other one. I mean, risk is, they said, what can be measured and uncertainty is what can't. And in my book, I talk about the surfers who have all of this and we certainly see this in finance too, fancy risk mitigation technology, just like we do in finance. Their tools are a lot like stock options in a lot of ways, but the fact is no matter how good your risk management strategy is, you're still in an 80 foot wave and there's no way that's going to be safe. And I think the same is true of investing in markets. There's no way you're going to get a higher return than the risk-free rate and have a risk free experience. There's always risk involved.

I think that was the lesson I took away from Bob Martin's experience in LTCM. It's like, "Yeah, they had a lot of stuff going on, but you know what? They had a 21 [inaudible 00:20:26] leverage ratio," and nothing in the world is ever going to make that safe. So I think that's where uncertainty comes in because you're in the water and something's always going to come upon that you just can't anticipate. And I think the only way to really deal with that is liquidity. But liquidity is expensive, obviously, it's getting money on the sidelines. So you have to think about how much liquidity do you need. And again, that's a hard thing, but that's the only real hedge against the uncertainty.

Did Bob talk a lot about LTCM?

Yeah, he likes to talk about it, but usually the stories are actually more fun. Like the good times they had. It was actually fun. I went to his [speche 00:20:59] shift, which is the 75th birthday party honoring his work. And a lot of LTCM people were there and someone now from there, it makes a wine called convexity wines. So I was given this bottle of wine called convexity wine. So I was pretty excited about. We're all fixed income geeks.

In a recent podcast, I thought you gave a really interesting framing about the risks we take on when we make a house purchase. Can you talk about that? Especially since we have so many listeners that live in really hot real estate markets.

Yeah, for sure. I mean, housing is always sort of a fraught purchase, I think because it is both what people live in and people like to see it as an investment. But it's fascinating to me. I have a friend who bought an apartment in New York and I was having dinner with her. It was around the time I was writing the book and everyone was just like, "Well, of course you got to buy this apartment. It's always a good investment to buy an apartment in New York." And as a financial person, like there's no always good investment, obviously depends on what you're paying, but people tend to assume prices can only go up.

But obviously, we learned in the financial crisis, one, that's not true, and two, you face different sources of risk with a house. There could be an idiosyncratic risk. It could just be like a really cool house with cool features or something trendy. Or there's also this larger systematic risk if the whole market could collapse. And I think when you're buying a house, you have to be aware of each, especially if it's idiosyncratic. Something quirky about that house, you can always recreate that elsewhere.

Do you have thoughts from an economist perspective on the rent versus buy discussion?

It depends. It depends what you're paying. I personally have never owned a house and I have no mixed feelings about that. I'm 42 and I don't feel like I'm a personal failure. Although if I read stories in the Atlantic, I was told I am, that I haven't achieved this major marker of adulthood. Anyway. I'm like middle-aged. But I think home ownership personally is overrated, but it makes sense for some people. It really just depends on, one, what you're paying; two, what the rental market is. I live in new York, it's a very vigorous rental market.

And three, what your lifestyle is and what your liquidity needs are. But I find it odd that people are so fixated on millennials not owning homes, but having student debt. Because as a lifecycle economist, I look at student debt as an investment in your long-term earnings. If not only does it mean you've got higher earnings when you finish college, because sometimes you don't, it puts you in a higher steeper wage path throughout your lifetime. And also, it is just the risk of unemployment, which is a significant investment that pays off over 30 years. And why people think home ownership is a better investment than an education sort of baffling to me.

Do you have any thoughts on, because you mentioned lifecycle investing, there was a paper from Ian Ayres and Barry Nalebuff a few years ago, where they recommended using leverage to get to your lifetime equity exposure as soon as possible. Do you have any thoughts on young people using leverage to invest?

So, I'm not familiar with this paper. Is the idea is as a young person, you have a lot of human capital ahead of you that spawn like?

Yeah.

And that's why you should take leverage because it's negative bonds to get you earlier?

It's effectively that, and the reason being to gain time, diversification, diversification across time, with your equities.

Well, I partially agree with that. I agree that... I mean, I'm not going to go out and tell everyone to take leverage because it's very risky. But in theory, yes, there's an optimal debt equity split, and young people, having almost all their assets in their future earnings, which are bond-like or probably overexposed to bonds. Whether or not they should take on leverage and all the risks associated with that, I'd be wary to go there, but in theory, yes. But I do part ways with them on the whole time diversification issue, because I believe that's a fallacy. Yeah. Like over on average, over time, you have a lower volatility, but you also have a much bigger tail risk, right? I mean, there's no reason why we couldn't have 40 years of really bad stock market returns and you're taking on that risk. So there is a fallacy of time diversification there, but in theory, yeah. I mean, if you have the average young person, even if they have almost no savings is totally overexposed to bonds.

Interesting. So do you think most investors should have an allocation to bonds?

I mean, I guess in theory, if you're a young person and you already have all your earnings in front of you, no. But it also depends on your individual risk tolerance. I don't think anyone's risk tolerant is necessarily wrong. It just depends on you what risks you're comfortable taking. Even if you are a young person, you've got years of your earnings ahead of you. So in theory, you've got a ton of bonds in your portfolio. If you're just someone who can not handle losing a sense of money and that's just you and you're 25, then maybe you shouldn't be mostly in bonds.

What about the other extreme where your retirement is like you're wealthy and you have way more money than you will ever need. What do you think about the argument that a person like that should be all in equities?

All in equities? Well, I mean, again, if they're comfortable with that, but as I said, that does seem a little risky to me. But it depends on that person and what their goals are, and certainly how they plan to use that money in the future. And if they plan to leave it to their heirs and what their heirs needs are. Again, I think this is the big challenge for personal finance, is that, people's needs traditionally after they retire are so idiosyncratic. And there's so many people who don't get the advice they need.

It's tricky too. If we can tie it back to that, we were talking about where people that give financial advice can add value. And we were talking about the framing of risk. I think we ended up seeing a lot of young people who have a lot of bonds in their portfolio because they think that's safe and they think that's the right way to be risk averse when you're young. But I don't know if that's always necessarily true. It's probably not.

Yeah. Well, also it depends on the duration of those bonds.

Right, that's very true.

And also I'm seeing more and more. I see this a lot of financial firms that because the risk-free rate has gotten so low, they keep pushing fixed income assets with a lot of risk associated with them as risk-free. Well not, they don't say they're risk free, but they're like, "This should be like..." Like in this breakdown of 60/40, everyone's like, "You know this, you should have high yield debt or REITs in your 40% fixed income portfolio." Well, it's like, "Yeah, it's fixed income. But that 60/40 split was supposed to be risky, non-risky, not just risky fixed income." So I think people are also being misled about fixed income being risk-free when a lot of it is very risky.

I've got to ask since you brought it up, is the 60/40 portfolio dead?

Well, I mean, I never, I'm sure, I believed in it to begin with. I mean, the idea that there's one portfolio for everyone, but the extent if you believe that risky, non-risky should be 60% risky, 40% risk-free and you have a good reason for that, then no. I mean, that shouldn't change with what happens to market. You might need to reassess can I afford to do this anymore? Is 60/40 just a luxury I can't afford? But if you really believe that this is the right split between risky and no risk, then that shouldn't change.

We often hear that well stock your silver value, you can't buy stocks now, and then bonds are just overvalue, you can't buy bonds anymore. So there's so many articles that we've talked about on the podcast over the past two years, that suggests that 60/40 is dead, therefore, you need us as advisors to go and find you alpha products or hedge funds or liquid alts or whatever it is.

Yeah. And I see those roo, and it's like, all they're doing is putting you in rather risky assets.

Correct.

There's no free lunch here. I wouldn't say there's anything... I mean, I don't know, I'm not an active market person, but there's anything that's really undervalued, you maybe can get a higher return going and something more exotic, but you're also taking on more risk. And there's really no way around that.

And knowing not a free lunch, there's often higher fees involved with those products.

Yeah, for sure. But I guess that's how they justify the fee is that, I saw a presentation where they were like, "These are all the things we think should be in your 40% portfolio." And I was like, "What's the ball on this?" And they're like, "20%." I'm like, "Then what's it doing in the 40% portfolio?"

Interesting. Another question I had for you, one of your articles talked about how much private equity is being added to portfolios, like pension funds and things like that. Any comment on that?

Well, I mean, again, when the risk-free rate is low, people need to find risk elsewhere. And I think private equity is very attractive. Certainly for pension funds because they have a certain rate of return. They have to claim they're getting each year. And private equity, no one really knows what this stuff is worth. You've got to... If you look at these, the financial reports from pension funds from year to year, they always say our private equity fund returns, I don't know, 16%, and every year, it's the exact same because who knows what that number means.

If you have something liquid that's hard to value, it sort of makes it a pension fund that's very attractive for them to just... I think Cliff Asness calls it the illiquidity premium, that you have something and you can claim whatever. I don't know if he defines it this way, but this is my understanding of it that you can just claim whatever attorney you want, which, if you're a pension fund or a certainly a lot of institutional investors who don't need their money immediately, but do have to prove that they're out-earning the market, can be very attractive. But you're also taking on tremendous amount of risks because none of this is going to be realized for years and no one knows what this stuff is really worth.

And it's certainly gone mainstream this week with Vanguard announcing a product in the private equity space.

Yeah. I mean, I feel like it's one of those things. We go from, "All these bad actors doing all these fancy things, stay away to 'Gee, we need to let the little guy in on this."

It is interesting. The whole private equity thing is fascinating because you've got the smoothing of returns too like you're talking about, which makes it look compelling on paper to, for example, a pension manager to add in.

Which is, they were just whirring in of itself because it leaves taxpayers exposed. But the idea is that we're going to open this up to everyday retail investors, said it is a little scary. And if this all goes bad, you know what the narrative is going to be, which is everyone got duped into this. And I mean, I'm not even against private equity. I think it could be a very valuable asset class. And there's a lot of evidence that it actually can make markets more efficient, but you can have too much of a good thing.

You wrote an article recently that I read about the global shortage of safe assets and how that might have an economic impact. Can you talk a little bit about that?

Yeah. Isn't it because the foundation of everything is risk-free and I mean, shortage is an odd term because on the one hand, there's this huge demand for safe assets, that only a couple of countries can produce them, which creates an actual shortage that there's really no way around. And it's made the cost of low risk very low, historically low. And I don't think we really know what the consequences of that are going to be. I mean, on the one hand, I'm hesitant to call it a bubble. One, because I don't believe in bubbles and two, because it's like a bubble I guess if you believe in them, it's an asset that speculators have driven up to the point where it's so overvalued and it's going to pop.

And that doesn't really make sense for low response. Or an investors might lose their appetite for them. The government regulations might change or institutions stop buying them, so prices would fall eventually. But I don't see it being like one day, it just crashes like the tech bubble. On the other hand, it's the systemic, it's so important because it's everywhere. Think about the risk-free rates in almost every asset pricing formula, it's everywhere. So, if interest rates or... It certainly is driving how much leverage on a lot of corporate balance sheets. So if you think about it, if there is a big change in the bond market, it could cause a lot of dislocations.

How did you become so interested in risk?

Bob. I always had an interest, obviously, I studied retirement finance as an economist, so that is a risk problem. I never realized that was central to it. But I think Bob is such an exciting, inspiring thinker, and he's just so passionate about risk and being risk at the center of it all. I think anyone who'd spend as much time with him as I did, would walk away kind of obsessed with it.

If we think about the concept of the global retirement shortfall, if anything, what do you think people could be doing differently now, pre-retirees, to address that for themselves?

Well, I think, as I said, working hopefully with a good planner, setting very clear goals, and having a plan for post retirement, having a plan for long-term care. And as I said, being realistic about the risks involved and what it costs to reach your goals. Like my own mother, she has a DFA advisor who, I have a lot of faith in, so I don't like to get involved with her finances. But yeah, I mean, she is very obsessed with having this certain number of when she retires, but it hasn't really as well thought through exactly what her plans are for retirement.

My last question for you, Alison, and it's always my last question. Can you define success in your life?

Well, I think it's different for everyone. I mean, for some people, it's their family. For other people, is having a certain amount of money. For me, I think it's being really intellectually fulfilled, and meeting new people and finding new ideas every day.

And it appears that risk is giving you endless opportunities to explore.

It's great topic.

So Alison, this has been great. So happy you could join us. This has been an incredible interview and I think you've added a ton of value. So thanks for your time.

Thanks for having me. It was fun.