Many IPOs start with a bang, resulting in high first-day closing prices that attract retail investors. Today we unpack new and established research to explore how the hottest IPOs compare with average market returns. We open our conversation by first sharing community updates and details about the book and news of the week. After reflecting on how 2020 was one of the biggest IPO years since 2000, we talk about why IPOs tend to release in waves. We then chat about where IPO allocation usually goes and why most investors aren’t given access to huge early returns. A key insight this episode, we dive into how retail investors impact IPO pricing and why IPO buy and hold returns often trail the market. Following this, we discuss the factors that skew IPO prices, why IPOs resemble lotteries, and whether there is an optimal model for when companies make an IPO. From IPOs we jump into our planning topic on well-being and behavioural coaching. We start by looking into the differences between financial well-being and funded contentment. Linked to this, we talk about other forms of capital that range from human and social capital to temporal capital. We examine the factors that impact your well-being before touching on why you should make decisions while considering all your forms of capital. Later, we debut a new feature and then offer our bad advice of the week. Tune in for another informative conversation on rational investing.
Key Points From This Episode:
From building battlebots to what they’ve been watching, hosts Benjamin and Cameron catch-up with listeners. [0:00:23]
Rational Reminder community updates and added features. [0:02:53]
Being a generalist over a specialist? Hear about the book of the week. [0:06:23]
Hear our news roundup for the week. [0:09:14]
Introducing today’s portfolio topic: investing in IPOs. [0:15:30]
Exploring IPO waves, pricing, and why only high-value investors are given IPO offerings. [0:19:54]
How institutions and retail investors impact IPO pricing. [0:23:00]
Examining the historical buy and hold returns for IPO stocks. [0:25:37]
Why IPO stocks might be the “worst of all worlds.” [0:29:31]
Research that shows why IPOs are like lotteries. [0:30:48]
How ‘skewness factors’ hype up the value of IPOs. [0:34:01]
Why waves of companies tend to make IPOs near the same time. [0:37:11]
Benjamin summarizes his arguments for and against IPOs. [0:42:54]
Introducing today’s planning topic: your well-being. [0:44:22]
Financial well-being versus funded contentment and the different forms of capital. [0:47:11]
The importance of weighing your other forms of capital when making decisions. [0:51:12]
Why high-income doesn’t correlate with higher well-being. [0:53:28]
How nationality and social factors affect self-reported well-being. [0:56:54]
Consequences from people being generally bad at predicting what will make us happy. [01:00:37]
Setting financial goals that consider your well-being and sense of purpose. [01:02:58]
How unemployment can affect your well-being. [01:04:26]
Why you should consider other forms of capital when saving for retirement. [01:06:30]
We answer a conversation card from the University of Chicago Financial Education Initiative. [01:09:30]
Hear our bad advice of the week, courtesy of TikTok. [01:12:20]
Read the Transcript:
Ben Felix: This is The Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making for Canadians. We are hosted by me, Benjamin Felix, and Cameron Passmore.
Cameron Passmore: Oh has it been a long time since it's been an Us episode, what we call an Us episode. It's been a well over a month since we recorded one.
Ben Felix: Yeah. Wow.
Cameron Passmore: So of course, the big burning question you got to show us your new BattleBot.
Ben Felix: I'm skeptical that anybody was wondering about that, but in case they were, I did have it sitting next to me. This is our current iteration of the BattleBot. One of the things we discovered is that tungsten is one of the densest metals that exists, and you can actually buy pieces of tungsten. So in the tips of this piece of plastic here.
Cameron Passmore: As we do a shameless plug for our YouTube channel for this.
Ben Felix: Are in case, the big pieces of tungsten.
Cameron Passmore: Really?
Ben Felix: So the weight of that spinning object is a, I don't know what you call it unsafe maybe, or fun, one of the two, possibly both.
Cameron Passmore: But it could do some serious damage to another BattleBot.
Ben Felix: To anything really. You should hear it. Oh, maybe we can do it. I'll make a video. It's nuts. It sounds like a turbine or something when it's going at full speed.
Cameron Passmore: Wow. Very cool. So I got a Spark amp for Christmas. You heard of a Spark amp?
Ben Felix: Nope.
Cameron Passmore: There's a huge community online talking about this. It's an app you buy for your guitar, it's I don't know $250 or something. So as far as amps go is very affordable, but it's an amazing digital device that links with your smartphone and pretty much any song you want. You load it up, it'll play the song, the video of the song and all the chords for it and play the music through the app. It's just a brilliant piece of technology to practice with. And it's so much fun.
And the sound of the app, and you can also download all kinds of different, well, it's got all kinds of built-in pedal sounds automatically. But then there's a whole, I guess, or their business model is to sell you more pedals so you can buy all these pedals sounds, whatever sound you want, any artists, any guitars, any song you can buy that sound. So it's very cool.
Ben Felix: Wow.
Cameron Passmore: One show a little bit different than what we normally talk about, which are often a little more gruesome shows, but have you seen Somebody Feed Phil on Netflix?
Ben Felix: No.
Cameron Passmore (00:02:31):
So we discovered this weekend being cold in Ottawa and the pandemic, so we're inside. Anyways, so Phil Rosenthal is the former co-producer of Everybody Loves Raymond. He does this travel food show that is fabulous. Travels the world, and really gets into the culture and hangs out with local people and how they cook and eat, we just loved it.
Ben Felix: Wow.
Cameron Passmore: It's a real good news, happy, pleasant, amazing photography. So it's on Netflix. Yeah. Quick update. The merch store is obviously wide open. We've lots of hoodies available and there's still some of the free socks available. Anything you want update on the community?
Ben Felix: No, it's pretty crazy over there in terms of the amount of content it's being generated, which makes me very happy that we switched to the new platform because it's all searchable and easy for people to find.
Cameron Passmore: So what are some of the new features that are up now that we've upgraded the platform? There's you can rank or vote.
Ben Felix: The new features, they weren't well received by the community. So I don't know how much I'm going to say about them because they might go away, but you're able to vote on topics, which was cool. But the way the discourse has it set up is that everyone's got a limited number of votes. So we made it so that old posts would close so that people would get their votes back, but people weren't happy about posts closing. So Angelica is going to rejig everything to make it closer to what everybody thinks it should be like. But anyway, it's edging up on 2000 users in the community now, which is pretty cool. I mean, there's still tons of really good thoughtful discussion going on in there. So, I mean, if anybody enjoys listening to the podcast, I would encourage them to check out the community because the quality of the discussions there are really, really high.
Cameron Passmore: Yep. I agree. We have a new segment in the podcast that we're going to try out called Talking Sense. So for those on YouTube, you can see we've discovered these really cool, almost like playing cards that came out from the University of Chicago Financial Education Initiative. So this is basically cards with interesting questions, just to prompt discussions around financial education and they're available for $20 US directly from the education initiative. Order them, they ship within a week or so. And they're not right or wrong type questions. They're just questions to stimulate your thinking. So we're going to ask each other, or just pick a couple of cards each episode and see how it goes. Today's were a little tough, but.
Ben Felix: I think conceptually, I think it's a really cool idea. It would maybe feel tacky if we'd pick these cards up from the dollar store, but because they've come from the University of Chicago, I think it's pretty cool. And as an initiative, I think it makes a lot of sense. I mean, their suggestion is that you kind of have these conversations around the dinner table sort of thing with kids, they recommend the age of seven and up. So we thought it would be kind of neat for us to do the same thing, but geez, the questions were harder than I was expecting. And not hard like analytically hard. It's not that kind of question. It's like, how do you even think about this? I mean, you'll hear it at the end of the episode.
Cameron Passmore: Yeah. But we decided not to script it ahead of time because we didn't want some sort of perfect pollers to answer because it's not the point of that. Right. Is to get you to think about these questions.
Ben Felix: Our hope is that we'll add this to the episode discussion. We'll put the question in there. So people that are in the online community can discuss how they would answer the question. That's kind of our idea is to get that conversation going. And then if people don't want to go buy the cards, they can take the weekly question from the episode and take it home to the dinner table and talk about it with their family. And I don't know, hopefully it starts some good discussion around money.
Cameron Passmore: Exactly. And with that, we hope you enjoy episode 134, the first Us episode of 2021. Thanks for listening.
So we kick off episode 134 with a quick, very quick book review. So a very good friend of mine posted on Twitter at the end of last year. His favorite nonfiction book of 2020 was a book called Range: Why Generalists Triumph in a Specialized World. So I dug into it. I'm about two thirds of the way through it over Christmas. And it's so interesting. So it's written by David Epstein and the basic premise that the author makes is that specializing early on in life is unwarranted, be it in school or other activities. And he argues that it's even more true in a tech driven world where figuring out how to solve problems matters more than a specific set of tools. And it kind of flies in the face of the old, you need 10,000 hours at some something to become a master of your domain. This basically blows that up. However, he does qualify that point saying that if you're interested in an endeavor, that there is immediate feedback and he gives examples like guitar, golf, tennis, where there's no nuance in how well you do.
Like if you're not good at guitar, as I can tell you is the way I play. It shows up pretty quickly. Same with golf or tennis. So you need specialization and to get those shots like Tiger Woods famously shot back in 2000 to 2008, you need years and years and years of practice. But he says, if your world is 'wicked' where rules and score keeping is unclear, and the feedback is not immediate than a broader experience set, maybe a greater value to you. And the author actually researched many successful people and found that generalists are as he quotes, 'prime to excel' and people who fail often quite often and try different things often end up with very fulfilling and rewarding careers and end up with a certain level of resilience to help them through life. So really enjoying the book, highly recommend it.
Ben Felix: Oh, it makes sense.
Cameron Passmore: Yeah. I found it interesting because it is such a different perspective from the 10,000 hours argument. Right? So, I mean, I think of when we raised our kids, Ana didn't like dance, she went on to piano and it's okay to kind of bounce around and try different things and see what you like as opposed to being forced to stick with something. And that giving up on it is quitting. That is not necessarily a bad thing.
Ben Felix: I remember that was one of the things that attracted me to engineering. Was it's not so much having one specific skill set. It's more about solving problems.
Cameron Passmore: But it's also something where the answers in engineering aren't exactly nuanced. I mean, there's immediate feedback whether you're right or wrong.
Ben Felix: Not always, I think problems can be more complex than that. If it's physics specifically, that's true.
Cameron Passmore: Interesting. Onto the news of the week, going again quickly because we have lots of material. So I had a lot of people on Twitter reach out to me about this article. It was in Bloomberg on January 13th, entitled Index-Fund Trillions Are Distorting Prices in the S&P 500. So the article argue that large fund flows into the S&P 500 index are disproportionately raising prices of large cap stocks, mainly in the US. And the article talks about researchers from Michigan State, along with London School of Economics and the University of California at Irvine analyzed data from 2000 to 2019 and found that, "Noise traders were pushing up the prices of the big companies as they enter the S&P 500. Plus they end up with a larger weight in the index and distorted prices mean fund flows and devaluate indexes exacerbate that situation." And then they argue that this will pave the way for the outperformance of the smaller companies in the S&P 500 when the price gap normalizes. Any thoughts on that?
Ben Felix: It's kind of like the Michael Burry article that we talked about, not that long ago, where he didn't have the analysis like this to back it up, but he said basically the same thing that he thinks that these prices are getting distorted. Then we can argue about that, but the result, and this was kind of the conclusion that we had last time we talked about this, is that if it does result in large cap growth being overpriced and small value being underpriced, then, hey, great.
Cameron Passmore: Interesting to note the recent price performance difference between the US small cap value index and the S&P 500 index. These are just snapshots in time. I'm not predicting anything, but the IJS index is small cap, the US small cap value index is up 43% for the past six months to today, which is Friday, January 22nd. So 43% for the past six months, the S&P 500 same time period, six months up 19%. So you are seeing a big difference in recent returns. And the one-year returns are actually quite similar, small cap value one year 15%, S&P 500 one year, 18%.
Ben Felix: It's crazy how close they are.
Cameron Passmore: Yeah. The next piece of news, the Tesla evaluation. Saw a tweet earlier this year that compared the evaluation of Tesla to the entire Canadian market. So get this, Tesla's now worth 800 billion or so US, which is roughly a trillion Canadian. The total value of all 1,572 companies on the TSX is 3.2 trillion Canadian. Can you imagine Tesla that produces half a million cars a year, it's worth a third of the entire TSX market. It's also interesting to note that Tesla is now worth $75 billion more than the entire S&P 500 energy sub-index which is made up of 25 energy companies starting with Exxon, Chevron, ConocoPhillips, and all the way down.
Just think, it's incredible comparisons. As we know, Tesla joined S&P 500 index in December, and there was another tweet that came out that a lot of people tweeted at me over the holidays of a 39 year old software engineer and Tesla investor, who recently retired as $12 million US of Tesla shares. Made 900k at one day, and it was, "Not selling shares for the foreseeable future." And I think he was going to use margin to fund his lifestyle.
Ben Felix: Isn't that what, I can't remember the list, but Robert Shiller has a sort of checklist for what constitutes a bubble. And I'm pretty sure stories like this are one of the things like specifically stories about people who've become extremely wealthy in the bubble asset are one of the checklist items for whether or not a thing is a bubble. Not saying it is.
Cameron Passmore: Next little piece of quick news, psychedelic mushroom ETF is coming. So if you're into psychedelic mushrooms as an investment, there's a new ETF coming on the NEO Exchange in Canada, under the symbol PSYK from Horizons ETFs. Supposed to start trading this week. So news flash is...
Ben Felix: Is that Rational Reminder, appropriate news?
Cameron Passmore: I don't know. I'm just telling you that you never know what's going to come out in this marketplace. Maybe that's a sign of a bubble. I just, it's amazing to me, these kind of products you throw at the wall and see what sticks.
Ben Felix: I mean, Horizons, that's part of their business. They're the first one to launch the marijuana ETF, the HMMJ, which didn't do so well.
Cameron Passmore: Okay. At least the next story. The quick fourth story does have some data in it. So cash is king in TFSAs. This was an online survey sponsored by BIMO that was conducted by the Pollara Strategic Insights of 1500 Canadians in late November last year that found the average amount held into TFSA increased 9% in 2020 to just under 31, 000. 53% of respondents said they contributed the amount they expected to in 2020. Who would have guessed, right? I guess, decreased spending enabled you to save more. However, and this is what I thought was interesting. Only 49% were aware that a TFSA can hold both cash and at least one other type of investment. However, cash is the primary investment making up 38% of respondents TFSA balances on average. And I remember when they came out, the tax-free savings account, there's a lot of debate around whether having savings in the name would mislead people in terms of what could be held inside.
Ben Felix: I think it probably does. I don't think it's a very good name. Yeah, a lot of people don't realize that you can hold and should hold or not. That's not necessarily always true. In an optimal scenario you would want to hold long-term investments in TFSA, not cash, but I don't know how common that knowledge is.
Cameron Passmore: Maybe it should be tax-free investment account.
Ben Felix: But we also know from Adriana Robertson and from Josh, Josh Brown and Brian Portnoy, that people tend to hold more cash than a rational model would predict.
Cameron Passmore: Right. It's just interesting they would hold it into the account that for many people is the last account they'll ever touch.
Ben Felix: But a lot of people don't have enough investments to max out their RSPs and TFSAs.
Cameron Passmore: True. I agree. So under our portfolio topic this week, something you've spent a lot of time digging into.
Ben Felix: Spent a lot of time on it a while ago, and then rediscovered my notes and they became relevant again. We've covered the topic once before on the podcast, but there was a bunch of new research, I guess, that I put together for a question that somebody asked me. Anyway, I thought it was worthwhile to revisit it because there's enough new content. And because 2020 was one of the biggest IPO years since 2000 in terms of the number of IPOs and the aggregate IPO proceeds so big IPO year, last year. And obviously we all heard about a lot of the big ones. Now that phenomenon of IPOs happening in waves. That's not a new thing. '99, 2000, that was a wave that people probably remember. But as early as 1975, that's the first paper that I could find documenting this, the idea that IPOs happen in waves called hot markets have been documented.
That was a 1975 paper by Ibbotson in Joffe in Journal of Finance called Hot Issue Markets. So 1960s, there was a big IPO wave with electronics related companies and in a random walk down Wall Street, Burton Malkiel refers to that as the tronics boom. I don't know if that's what everybody called it, but I think it's a pretty good name. And then 1983, there was another big explosion of IPOs and that was microelectronics and biotechnology. And then we had the dot-com that I mentioned in the late 1990s. Now, when it comes to IPOs and this same thing happened last year. I mean, it probably always happens the same way. I don't know. You can speak to the historical context more than I can Cameron, but people talk so much about the first day returns of the IPO. And when it comes to fear of missing out and people wanting to get in on the IPO action.
I think that they're often thinking about those first day of returns, but the single most important takeaway on this topic of investing in IPOs is that, I mean, you probably won't be able to partake in that first day return. Because when the media reports on that number, they're typically reporting on the difference between the IPO offer price and maybe the first trade, or maybe the closing price on the first day of trading. But that difference that's called the IPO pop colloquially. That difference is not something that most investors can access because most investors don't get in on the IPO allocation.
Cameron Passmore: That's right.
Ben Felix: IPO allocations go to institutional investors for the most part. And for any allocation that does go to retail investors, it goes to... Wealthy is not even the right term.
Cameron Passmore: Active. Active and wealthy, some combination of the two.
Ben Felix: High value, like high value brokerage clients. So if you're through some combination of broker services and other services that the firm provides. Maybe you took your company public through this firm or whatever, but if you've generated a large amount of revenue for the financial institution that's part of the underwriting of the IPO, you're more likely to get an allocation. Most other people, especially for these hot IPOs, the ones that are oversubscribed the average person's probably not going to be able to get any, and if they can, it's not going to be as much as they want to get.
Cameron Passmore: Yeah. Highly, highly unlikely to get it.
Ben Felix: Now, those first day returns were importantly saying that you can't access them. But the reason they're so exciting is because they're so big and they are. The difference between the IPO offer price and the closing price on the first day of trading. So what the market actually values the shares at relative to the price that they sold in the IPO is a huge jump. So Jay Ritter has the data on this. He's a professor. He's actually coming on the podcast in the next few months, but he's got all this data on his website available for free kind of like Ken French data sort of idea, but for IPOs. So he shows for 2020, the average first day pop was almost 50%.
Cameron Passmore: That is wild.
Ben Felix: It's interesting when you look back historically, there's been the IPO waves where a lot of IPOs happen at once, but those pops tend to be bigger during those waves. So you look back at how big the pops were in 2020. The last time they were that big if I remember correctly was in '99, 2000, which is also kind of scary to think about. And one of the important things about that is that it's money left on the table for the company, because the company like the actual, what they get for selling their equity is the IPO offer price. So if a company has a 50% pop in the first day, they left that much on the table because they don't get that money. [crosstalk 00:20:35].
Right. And we look back from 1980 through 2020, the first day pop has been about 20%. So 50% is in 2020, 20% from 1980 through 2020. So you can see the pop, the average first day pop in 2020 was huge even compared to history. But regardless over the full period, 20%, if you got in, on all the IPO allocations and you're getting hit with 20% first day of returns, that's pretty awesome, but you can't, or you probably can't get access to it. Fidelity actually has on their website like I mentioned, the high value brokerage clients, they actually publish on their website their process. So they say each customer who wants to participate in an IPO offering is evaluated and ranked based on his or her assets and the revenue they generate for the brokerage firm. Typically, customers with significant long-term relationships with a brokerage firm will receive higher priority than those with smaller or new relationships.
Cameron Passmore: That's how the world works.
Ben Felix: Right. There's a paper, an academic paper in the Journal of Finance that actually looked at this issue from an academic perspective. So they had a broader data set than obviously just Fidelity's statement. But the paper was called Quid Pro Quo? What Factors Influence IPO Allocations to Investors? And they looked at 220 IPOs from January 2010 to May 2015. And they were trying to find what are the determinants of IPO allocations? So what characteristics of the investor determine who's going to get a hot IPO allocation specifically? And they found like what Fidelity says, they found strong support for brokerage revenues associated with the client being a significant determinant. And they found that that effect is stronger in hotter IPOs. So if an IPO is more oversubscribed, more people wanted to access it, the higher value clients getting access, that that effect is stronger.
Which if you think about the other side of that, if an IPO is not hot, if nobody wants it, that one's going to be easier to get if you're not a high value client. But it's the hot ones that everybody wants that tend to have the big first day pops. So there's a bit of a adverse selection there where the ones with the biggest expected pops, the hottest IPOs are harder to access, unless you're a high value brokerage client.
Cameron Passmore: I still think about that 50% pop in 2020 and what's the cause behind it. I mean, you would think the underwriters would have seen the demand coming and may have been able to better price it. Or do you think in the end just to have that kind of excitement is good for all the IPOs in general?
Ben Felix: I just sort of tangentially notice this as I was doing this research, I didn't dig into it though, but there's a whole body of research on why institutions allow for these underpricings, because everybody knows about it. It's not a secret. Actually I do touch on it a little bit in these notes so we can come back to it, but I'll mention it briefly now, actually, just because you brought it up. One of the papers mentions that retail investors may have a preference for skewness. They may have a preference for lottery like outcomes. So they're getting bad outcomes most of the time with a smaller chance of getting a really good outcome and institutions don't. So this paper empirically tested if there's a skewness preference.
So they found institutions don't have that, retail investors do. So on the first day of trading, when their shares changed hands from institutions to retail investors, the skewness preference that retail investors have results in a big price pop. And institutions don't tend to take that skewness preference into account because they don't have it when they're valuing the shares. So who knows if that is the answer, but it's an interesting observation.
Cameron Passmore: I think what you're basically saying is a lot of individual investors may not know the metrics of the company, the evaluation metrics, but they're willing to take a shot that this company is going to change whatever space it's in.
Ben Felix: So, I mean, it's even, it's more mathematical than that even. If they have a preference for skewness, they'll pay more for it than somebody with standard risk preferences would pay for the same share. Like the valuation in their eyes, because they don't have standard risk aversion preferences, because they've got the skewness preference. Their valuation is going to be different than somebody who does have the more normal, I guess, approach.
Cameron Passmore: But we've heard people say they want to buy X company because it is going to change, pick a company in the past year. It doesn't matter which one, but they don't have any idea what the valuation metrics are around the company.
Ben Felix: Yeah. It could be a similar effect. I mean, it could relate also to what we learned with Adriana Robertson, that a lot of what academic theory suggests drive people's decisions is very different from what people actually say is driving their decision. It could be a similar thing. It could show up in the data as a preference for skewness. But in reality, it's just people YOLOing because they think the company is going to do well.
If we come back to Jay Ritter data, and this is now, we're going to start differentiating here for the rest of the conversation. We're going to focus on IPO returns, excluding the first day pop, because like we've just been describing you can't actually access that. So from our perspective, looking at this, it doesn't make a whole... I mean, how many IPO allocations have we seen people get? Not a lot practically speaking. But on the first day of trading though, that's when people tend to get the shares.
I mean, if it's like a junior mining company on the TSXV then maybe you can probably get the first day allocation, but for Airbnb or whatever, it's very, very unlikely and less likely we've been saying you're a large client of one of the firms that's part of the underwriting syndicate for that IPO. Okay. So coming back to Jay Ritter data from 1980 through 2018, the average three-year buy and hold return for IPOs measures from the closing price on the day of trading, which is the relevant price to those of us who cannot access the IPO price. Trail the market by 17.5% in total. And they trail a style adjusted benchmark by 6.6% in total. So that's all IPOs from 198O through 2018.
Cameron Passmore: For three years, yeah.
Ben Felix: A three-year buy and hold returns for that time period. So pretty bad. And there's more data we'll talk about in a sec related to the same thing. Now, tech is the one that gets all the today. Anyway I mean, I guess all the ones we talked about, historically going back to 1960, they're all tech related, which is actually kind of interesting in itself. So for the tech industry, specifically from 1980 through 2018, but excluding '99, 2000, because that must make the data look funny or something. Jay Ritter data shows that IPOs beat their style adjusted benchmark by a cumulative 17.2%. So that's cumulative, not annualized, but trailed the market by 2.7%. Now this starts to touch on and we're going to touch on it more, but it starts to edge up on one of the interesting characteristics of IPOs, which is that they tend to behave like small cap growth stocks that have weak profitability and invest aggressively. Which as we know from like an, I guess with theoretically and empirically, those are the worst stocks.
So we see them in this case with the Jay Ritter data, we see that they beat their style adjusted benchmark, which is probably more like a small cap growth type benchmark. So they did a little bit better than that, but trailed the market, which is kind of what you'd expect if it were a small cap growth portfolio. So then if we look at another data source, so we've been talking about the Jay Ritter data, and now we're going to look at a paper titled The Long-Term Performance of IPOs, Revisited. This is a 2017 paper. So in this case, they looked at 7,487 IPOs after the first day of trading from 1975 through 2014. And similar to what we just saw with Jay Ritter data, they find that IPO firms tend to underperform for the first two years, even when we account for common risk factors.
So that's actually a little bit different from what we just mentioned with Jay Ritter. They underperformed even when we account for size, relative price and momentum is what they looked at in this paper. Now, the underperformance, this is another interesting point. The underperformance relative to the proper risk factor benchmark, the underperformance gradually declines with longer time periods. And after two years, this paper found that the underperformance relative to a style appropriate benchmark becomes statistically insignificant.
Cameron Passmore: Interesting.
Ben Felix: So in that data series, the IPOs, even when you account for the common risk factors, they get to worse than that, but that only lasted for two years. Now why is that? I don't know if I have the answer there. Dimensional did a paper on this in 2019, and they again looked at a pretty big data series of 6,362 US IPOs from 1991 to 2018. And the approach that they took in this case was that they built a hypothetical cap weighted IPO portfolio. So they included IPOs issued over the preceding 12 month period and they rebalanced the portfolio monthly. They excluded first day returns like we've been talking about you should. And they found that over the full period, the IPO portfolio trailed the market by about 2% while also being much more volatile.
And they found in their sample that the IPO returns were well explained by the factors in the Fama-French five-factor model. So the previous one was using Carhart four-factor. And now we're talking about Fama-French five-factor. And then their data this is where I got the idea that IPO firms on average behave like small cap growth stocks with weak profitability that invest aggressively, the fatal combination.
Cameron Passmore: The worst of all worlds.
Ben Felix: Yeah. The worst. The worst of all worlds. And the other interesting piece about that is that stocks within that category, not only did they perform poorly as an asset class, but they also have lottery like returns. And so we're going to touch more on this idea of lottery like returns, because it becomes potentially important from a pricing perspective. But it's just this idea that you have a small chance. It's like the story you told Cameron, where people might want to buy this thing because they think it could be the next whatever. So they're willing to take the gamble. That is a plain English description of a preference for skewness.
So we basically know that excluding that first day pop, which makes it makes things look really good, but once it's excluded, the performance of IPOs is quite poor for sure, for the first two or so years. One study found after two years, the underperformance becomes statistically insignificant. But yeah, for some amount of time after a company goes Public, there seems to be excess negative performance. And in any case, the firms are behaving like small cap growth slope, I think is what Dimensional calls it, small growth, low profitability, aggressive investment.
Once that's excluded, IPOs not so good. So then the next question we kind of touched on were the skewness preference, but the next question is why, why does that happen? So there's a paper and this is where I got the skewness idea. There's a 2011 paper titled IPOs as Lotteries: Skewness Preference and First-Day Returns. So in this case, the authors explain and this is really interesting. They explain that IPOs with high expected skewness and had a bunch of proxies for expected skewness, which they tested as predictors of actual skewness. It's kind of crazy to think about it, I guess. So the IPOs with the highest expected skewness experienced significantly larger first day pops. So these lottery like stocks are the ones that have the biggest pops.
Cameron Passmore: That's really interesting. So the business model has skewness, is that what you're saying?
Ben Felix: There were a bunch of different skewness metrics, not business model. It was probably industry-related and things like that. And market condition related. I'd have to dig back into the paper to see what their-
Cameron Passmore: Super interesting. I'm just imagining it could be like a potential winner take all type company.
Ben Felix: That's the idea behind the preference for skewness is that you're willing to overpay for that possibility, even though there's a very low chance of it actually coming to fruition the way that you expect it to. So then the other piece where this gets interesting when we're talking about that negative abnormal returns is that the IPOs with the highest expected skewness. So they get the biggest first day pop. They also earn the most or more negative abnormal returns in the one to five years after the IPO.
Cameron Passmore: Negative abnormal returns.
Ben Felix: Correct. So more expected skewness leads to higher pop, also leads to, and then I don't know if they don't fall in a chain, but higher skewness also leads to more negative abnormal performance.
Cameron Passmore: Fascinating.
Ben Felix: Yes. Now here's another one where it gets really interesting. The higher expected skewness is also associated with a higher fraction of small sized trades on the first day of trading. So the authors suggest that this is consistent with a greater shift in holdings from institutions who, like I mentioned earlier, they found empirically don't seem to prefer skewness to individuals who seem to be willing to pay a premium for skewness. So now we've got these bigger first day pops being related to higher expected skewness, to the more lottery like the payoff, the bigger the pop, but also the more negative the average returns.
And this seems to be related to a change of hands from institutions to retail investors. But you just think about this phenomenon of meme stocks like Tesla, although Tesla did an IPO last year, obviously. But just this concept of the stocks have become so popular in social media world, that fits so well with this narrative of people preferring skewness and being willing to pay a lot for it. And I don't know, maybe I'm just being historically ignorant to think that there was no such thing as a meme stock in the past, but I don't know Cameron, was there or is this a new thing?
Cameron Passmore: Well, it's nothing like today, right? You think of the ones that have gone lately, DoorDash, Airbnb, Slack. It's wild.
Ben Felix: Yeah. And now stepping back and thinking about this rationally for someone with standard risk preferences, the lottery like payoff is not what you want. I mean, just like buying lottery tickets is not a good financial decision. Like you're going to lose money, except there's a tiny chance you won't.
Cameron Passmore: I guess you're buying hope. What's hope worth to you?
Ben Felix: Yeah. Yeah. I find the effect of the changing of hands from institutions to retail investors and that being related to skewness, which is related to bigger first day pops, which is related to more negative returns. I find that to just be absolutely fascinating. And you could, I think the paper is even making the argument that retail investors are driving this, they're driving the bigger pop because they have such a strong student's preference and they're therefore driving the significantly negative returns.
Cameron Passmore: Yeah. And you wonder if access to technology like Robinhood and other online trading platforms accelerates this too, because it's so easy now to do it.
Ben Felix: It would be difficult to argue that that is not the case. And that's kind of, I guess, related to my question about meme stocks historically. And if that was a thing, I mean, people still have ways to communicate. I don't know. And people have been day trading for a while. Like that technology has existed for quite a long time.
Cameron Passmore: I think back to '99, 2000, everyone knew everyone. Market participants knew that there was a lot of hot stocks that were coming, but you had to get a brokerage account and it wasn't that obvious to set up an online account back then. You had to go to the bank, you had to get the signatures done. You had to go through a process. It wasn't all online back then.
Ben Felix: And keeping in mind that paper, I don't know if I had, it was a 2011 paper. I didn't know what data set that they were looking at, but it would be interesting to look at that skewness effect over time and in 2020 as well. It'd be fascinating to see that data series extended. Okay. So just based on the skewness preference, it seems like a pretty compelling reason to avoid hot IPOs. IPOs in general don't do well. Hotter ones do worse, arguably because retail investors are willing to overpay to do to their preference for skewness, which doesn't make any sense, but neither does buying lottery tickets. And we know there's a market for that too, but that's not even the worst part when we're talking about IPO waves anyway. So a year like 2021 there's a big wave of IPOs.
What we just described doesn't answer the question of why that happens. That's a different thing. You get the big IPO pops, you can argue that's a skewness preference, but why do we get these big waves of IPOs? Like I mentioned, '60s, '83, '99, 2020 big waves of IPOs. Why does that happen? My favorite paper, I don't know if you should have favorite papers or not, but my favorite one on this topic was from Lubos Pastor, who we obviously had in the podcast. And we didn't talk about this topic with him and I think it could almost be like a whole separate episode having him back on again, to talk about his research on technological revolutions and IPO waves. Anyway, so he's got a 2005 paper titled Rational IPO Waves, and similar to what we've talked about with Pastor's past research, he takes what seems like it should be an obvious irrational explanation. So IPOs happen. I mean, the irrational narrative is that IPOs happen because of mispricing.
So companies go public because they realize it's basically an arbitrage opportunity where they can sell their equity for more than it's worth. But Pastor in this paper gives the rational case for why IPOs could happen in waves. So they create a model and then they test the model to see how well it matches up with what's happened historically. And they find that the model's predictions are very close in line with what we've seen in the past. So in their model, private firms are attracted to capital markets when market conditions are favorable. Which makes sense in the sense that expected market returns are low. So expected returns are low, meaning prices are high that attracts firms to the market, which sounds pretty similar to the mispricing story, except we're talking about low expected returns instead of an arbitrage opportunity.
Also unexpected aggregate profitability is high. So again, if we're in a good place in the business cycle, if things are good, everyone's optimistic. That means expected profits are high, which means prices are going be higher. Although that's not an expected return component, that's a cashflow expectations component. And then the last one is taking those together. Private firms will wait for an improvement in market conditions before going public. So if market conditions are not good, private firms aren't going to go public. And then as market conditions improve, private firms will go public. So once they've improved sufficiently, a wave of private companies will exercise their option to go public. And so that's why you get these IPO waves.
Now, from the perspective of investing in IPOs, I think that a couple of the conditions and their model are particularly important. So the one that we just mentioned with expected returns, if expected returns are low, dumping a bunch of money into a company that went public because expected returns were low, probably doesn't lead to high expected returns, which should be somewhat obvious. And they observed this to be true where after IPO waves there tend to be high market returns proceeding IPO waves, and low market returns following IPO waves, which makes sense.
And then the other one, and we talked about this in our technological revolutions discussions is that IPO waves based on high prior uncertainty about the post IPO average profitability in excessive market profitability for the companies going public, should result in high prices for the IPOs because of relationship between profitability and prices convex. So I'm not going to go into detail because we dug into this pretty deep in the previous episode, but it's the whole Jensen's inequality thing where uncertainty about profitability increases price all else equal. Now, technically there's no impact on expected returns in that case because it's not affecting the discount rate mechanism on price. But as uncertainty decreases based again on Jensen's inequality, prices should fall all else equal.
So, Pastor in the paper specifically references technological revolutions and says that that can be one of the things that plays into an IPO wave. And if you think about the prior uncertainty, from the perspective of the companies going public, it makes a ton of sense for them to do so. And again, it's not a mispricing condition, but if there's a ton of uncertainty about the expected profitability of companies in a certain type of industry, and that makes their prices high rationally, because they could do really well. It makes sense for them to go public, which is great. But once they go public and the market learns about their actual profitability, good or bad prices should decline all else equal.
I mean, again, from the perspective of investing in IPOs especially around IPO waves. I don't think it bodes very well for, I can't use expected returns in that case because it's not an expected returns mechanism, but it doesn't bode well for realized returns, I guess. And there's an expected return piece in there where market conditions have to be favorable with high prices, which again, relating to 2020, we absolutely had. Now I do want to make it clear that I'm not saying IPOs are bad. We're not saying IPOs are bad. They are important to the economy. Now we can get into a whole debate about whether the IPO path or the direct listing or the SPAC is better, but whatever, raising capital is an important part of a capitalist economy. So it's not bad from that perspective, but from the perspective of investors accessing the secondary market, I mean, empirically IPOs are brutal. And I think the theory around the skewness preference, and then you take the prior uncertainty piece and the low expected returns piece.
You mash all that together. And I mean, the bigger the IPO pops are, and the more IPOs that are happening in the market, the worst the prospects for investing in IPOs seem to get. But a year like last year, that was the thing to do because there were so many hot IPOs.
Cameron Passmore: It's absolutely fascinating. Onto our planning topic. So we kind of have a theme going of late, where we're looking at more, the non-financial type things in planning, and this week is no different. We're going to talk about wellbeing. We're saying it's such an interesting topic for us to get into, and you've done some fabulous research on this, but it all stems from financial advice typically focuses just on portfolio management, number crunching, quantitative financial planning, all the things that we normally cover in this podcast. But there's a whole concept of behavioral coaching that while it does get some acknowledgement, it is becoming more and more important role for anyone, either advising clients on their financial issues, or if you're advising yourself, you're self-managing your household finances. And when you think about finance, it's linked is directly tied to so many aspects of our lives.
Ben Felix: I think the behavioral coaching piece. I think this extends beyond that. I think when people think about behavioral coaching as one of the things that a financial advisor or someone managing the household finances does. They're talking about staying invested and sticking with your asset allocation and sticking to your savings plan and all that kind of stuff. But I think that what we're going to talk about here is quite a bit bigger than that, where it's, instead of just looking at financial wellbeing and how do we make sure that the right behaviors are taking place to achieve that? This is more about what are the other decisions that people should be thinking about that are related to finances, but not related directly to financial wellbeing?
And so it's like stepping further away from finance in a way relative to behavioral coaching, which is like, I've said, how do you stay invested in your portfolio? And looking at what are the non-financial impacts of financial decisions and what are the financial impacts of non-financial decisions? And how do you make all those decisions together within a framework that maximizes overall wellbeing, as opposed to just financial?
Cameron Passmore: Because financial well-being is not simply a number, it's more about having enough. It's not most people typically want more all the time, right? We're wired to want more, but that does not necessarily lead to a higher level of wellbeing. And this goes back to things we've talked to many times with Brian Portnoy. The whole notion of funded contentment is not a number. It's a mindset. It's a frame of mind. Financial wellbeing is often just about getting more. This is more than that.
Ben Felix: Yeah. It's that delineating financial wellbeing, which like you said, can be just about getting more like you're financially better off the more that you have, but separating that from wellbeing broadly speaking, which is about having enough. So financial wellbeing, the more you have the better, from a strictly financial perspective, but wellbeing is about having enough money to fund a meaningful life. It's what Brian calls funded contentment. Now we start talking about wellbeing, we can still use words like capital, which I think are important. And Brian Portnoy actually, the way that he defines capital for this purpose is anything that you can spend in order to achieve something that you want. So financial capital is what we give so much attention to, and it is important. And it's intertwined with all the different types of capital, but we also have human capital to allocate, social capital, so relationships and your network. And temporal capital, which is just your time and how you allocate your time.
Now what we're realizing, and we're going through a process to educate ourselves on this. But what we're realizing is that to give really good financial advice or alternatively to make really good financial decisions, you can't just look at one type of capital in isolation. Financial capital, and human capital we have historically given attention to. But you start getting into the other types of capital and it can materially change the advice that you would give or the decisions that you would make, which is why we think it's important to start talking about it. Just to use one example with philanthropy and how the different types of capital are related to each other. You can give financial capital and you can donate money to charitable causes. You can allocate your human capital by donating your expertise.
You can allocate social capital by speaking with your network about the cause that's important to you, or you can allocate temporal capital by volunteering your time. Now all of those things are related to each other, because if you donate your time, you might have less financial capital. And if you ask your network to donate to a cause that's important to you every day, you're going to, I guess, decrease your social capital. Anyway, so all of these decisions are recursive. It's a sort of closed system, but advising on financial capital without considering the other types of capital. I think what we're realizing is, I mean, when you start getting into it and the data behind what actually makes people live meaningful lives and what makes people feel good about themselves. You can almost start to argue that it's irresponsible to give financial advice without taking consideration of all the other things.
Cameron Passmore: Well, that's exactly the argument that Meir Statman who's the finance prof at Santa Clara University makes in that article that we've been sharing back and forth. That advisors should be wellbeing advisors in enhancing their client's wellbeing in all of these domains. And the reason that this is sensible for anyone managing overseeing household's finances is that all decisions are in some way, capital allocation decisions. That's the argument he's making. And that the financial capital allocation decisions underpins most other capital allocation decisions because so many decisions have a financial component to them. So whether you're as a financial advisor giving advice or self-managing your things, you should be considering these various aspects of your wellbeing when managing your finances. 55% of people surveyed ranked money as the most important source of stress followed by quite a distance behind stress over work, health, family, and social life. So that was a BlackRock survey, a recent BlackRock survey.
Ben Felix: And that drew on I think, four countries of data. So Meir Statman in the paper that you mentioned, he draws on that survey data and then also on a whole bunch of different academic studies to explain why considering all these different facets is so important. I love the way that he framed, what do we get from capital and how we allocate our capital. And Statman gives three main benefits and he actually uses money in the paper, but I think you can easily apply it to capital more generally speaking. So he says that you get utilitarian benefits, which is that that's the basics. And actually, Brian, I think I had some notes on this from Brian Portnoy too. Brian says that financial well-being in his definition has four components getting by, which is utilitarian benefits, feeling safe, achieving goals and then funding contentment is the sort of pinnacle of financial wellbeing.
So that was Brian Portnoy. I look back to Meir Statman. We've got utilitarian benefits, expressive benefits. So that's how you convey your values and tastes and social status using money. Now, people who listen to this podcast might sort of turn their nose up and say, "Well, I don't need those things." But when we start getting into the data, the academic literature on why those things are important, it may potentially change the way people think about it.
Cameron Passmore: And he gave some good examples. So a couple of examples of expressive benefits, buying a luxury watch can express prestige, reservations at a fancy restaurant can express social status.
Ben Felix: And again, we're going to touch on the literature about why those things can be more important than you would maybe expect. And then the third one that Statman touches on is emotional benefits. That's how the things that capital affords us makes us feel. So again, with the luxury watch that can make you feel proud, you can feel special having a nice meal, paying an insurance policy premium can make you feel safe, lottery tickets, or IPO stocks can give us hope.
Cameron Passmore: But it's interesting like that luxury watch one. I mean, I often would think that was a signaling for many people. I hadn't thought about the pride part of it. It could be different needs that are being fulfilled.
Ben Felix: Yeah. One of the things from this paper that reflecting on it seems like of course I should have known this, but I'd never really thought about it, I guess. So this was new for me, but the distinction between happiness and wellbeing and they're often used interchangeably, but there was actually a paper by Kahneman and Deaton where they specifically explained how they're not the same thing. Happiness is like an emotion that you feel in a short, intense burst. Wellbeing is something that requires reflection. So this was in the Kahneman, Deaton paper was high-income improves evaluation of life, but not emotional wellbeing. Was a 2010 paper. And then this other piece was another new thing for me, which was the Cantril Ladder. Had you heard about this, Cameron?
Cameron Passmore: I had not.
Ben Felix: Yeah. So this is a whole new domain for us to explore. So the Cantril Ladder is a question that asks, please imagine a ladder with steps numbered from zero at the bottom to 10 at the top. The top of the ladder represents the best possible life for you. And the bottom ladder represents the worst possible life for you. On which step of the ladder would you say you personally stand at this time? I think it's, I mean, it's a pretty cool question to think about. And then it gets into that, the stat that we've all heard, or I'm sure many of us have heard. Which is that people with incomes below, insert number, but in this study is $75,000 are less happy and they do report less happiness yesterday, less enjoyment, less frequent smiling, and less laughter.
That's people with incomes below $75,000. They're less happy. They also report more worries and greater sadness. So what you can draw from that is, okay, well, it's diminishing returns if my income goes up above 75,000. But yeah, and it's not.
Cameron Passmore: It's not. People whose annual incomes exceed 75,000 by a wide margin don't report greater happiness than people whose annual incomes only exceed 75,000 by a narrow margin. So it's clearly diminishing returns to happiness with increasing income.
Ben Felix: To happiness. And that's the one that everyone kind of we've all heard that. So there are diminishing returns to happiness, but this is why that delineation between happiness and well-being becomes important. So except from the same study, the people whose annual income exceed $100,000 report substantially higher wellbeing, wellbeing now, not happiness. So the evaluation of where you stand on the Cantril Ladder than people whose annual income is 75,000. And the people whose annual income is $150,000 report substantially higher wellbeing than people whose annual income is &100,000. So we see that diminishing returns concept disappear when we switch the framing from happiness, which is a fleeting emotion to wellbeing, which is more of a reflective evaluation of how good is your life?
Cameron Passmore: So well-being reflects all possible benefits of income and wealth, including, as you said earlier, the utilitarian benefits of the goods and services you're able to buy as well as the expressive benefits of social status and the emotional benefits of pride.
Ben Felix: Yeah. So fascinating. So there's another paper by Deaton 2018 paper titled, What does Self-Reports of Wellbeing Say about Life-Cycle Theory and Policy? So he found that on average people in different countries place themselves on different steps of the Cantril Ladder. And it was a four on average in African countries in between seven and eight for the rich countries of Europe and the English speaking world, women placed themselves somewhat higher on the ladder than men, except in Africa. And people in rich countries tend to fall down the ladder during the transition from youth to midlife and then ascended again as they grow older, that one, I had heard that one. It's pretty, pretty interesting.
Cameron Passmore: Yeah. There's a bunch of other crazy statistics that you dug up. So get this on, while it seems unfortunate, social comparison does play a huge role in wellbeing. So a paper you discovered called Neighbors and Negatives: Relative Earnings and Well-Being found that an increase in neighbor's income reduces a person's wellbeing as much as an equal reduction in their own income. If that doesn't blow your mind. But an increase in the neighbor's income does not affect the well-being of people who do not socialize with their neighbors. So if you hang out with your neighbors and they get a pay increase and you don't, that affects your wellbeing.
Ben Felix: It affects your wellbeing as much as if you had your own pay decrease by the same amount.
Cameron Passmore: Yeah.
Ben Felix: I didn't dig these up by the way, I did sort of, but it's all from the Meir Statman. He had a really, really long paper in one of the journals I subscribed to, I can't remember which one. But yeah, he had all of these papers cited to make his case.
Cameron Passmore: Another one, 2012 paper entitled Inequality at Work: The Effect of Peer Salaries on Job Satisfaction studied a group of university employees who were told about a new website that listed the salary of all university employees. The employees then surveyed about their current job satisfaction and job search intentions. So employees with salaries below the median for their pay unit and occupation reported lower satisfaction with their jobs and pay and a significant increase in the likelihood of looking for a new job. Which is wild.
Ben Felix: It is wild. So there's this idea of social comparison and status symbols starts to become... Again, my comment earlier about people listening to this saying, "Well that's not rational to think that." I mean, I guess there are ways to think your way out of it, like practicing stoicism maybe would be one example. But the reality is we have a natural inclination to do these things and it really does affect our wellbeing. There was another one, another point here is on elite education, which when you talk about the different benefits that you can get from allocating capital, lead education gives utilitarian benefits. And there was a paper that Statman sites showing that the IRR on elite colleges is higher, but then it also delivers expressive and emotional benefits like saying you went to Harvard or whatever.
So again, just touching on and thinking about it practically, these are real decisions that a family might make about where to go to school or where to send the kids to school or where the kids should apply to school. And that's a financial decision in a way, or in an important way. I mean, I remember I looked at going to Princeton when I was choosing where to go and play basketball. And the cost was prohibitive and Ivy Leagues don't do scholarships, they only do financial aid. But I have often thought for no rational reason. And this is a completely, I even feel kind of embarrassed to say it, but I've often thought that it would be cool to have a degree from Princeton instead of Northeastern. There's nothing wrong with Northeastern. It's a very good school.
Cameron Passmore: It's just be an AB test you could have done.
Ben Felix: Yeah. If I could go back. So one of the other big things that plays into all of this is that humans are bad. And this is again, empirically true, bad at effective forecasting, we're really bad at predicting what will make us happy in the future. And this is one of the fundamental problems with goal setting, which again, when we think back to Brian Portnoy's framework, one of the components is achieving goals, but that's not the pinnacle. Funded contentment is what you're really trying to achieve. And that's a difference between more achieving goals. You always need more and enough, knowing when enough is enough and that relates to effective forecasting, because we don't really know. We might set a goal and an ambitious financial goal thinking that when we get there we're going to be happy. But the data show that that doesn't tend to be the case. And what stems from that is that you should be doing things that make you happy now, not things that make you happy later or increase your wellbeing now. I'd be careful with my language.
Cameron Passmore: Yeah. Another aspect of well-being has to do with community and family and finances, believe it or not are linked to that. So the ability to spend more time with family and friends usually comes or often comes with having a larger balance sheet. And then you have to start to consider the trade-off between time and the value of time. So do you want to work harder now to have more free time later, or it's more important for you to take time now at the expense of a bigger balance sheet later, which will be better for your wellbeing?
Ben Felix: And these are financial decisions. We have these conversations with people all the time. Just, I don't know if we've been... We're hoping to improve accounting for all of these different aspects, but it's very easy to have a conversation about how much someone can save or how much they should save to reach a retirement goal, but that doesn't take into account whether that goal should be the goal. And that's the piece where I think we have some work to do. And I think people in general, whether they're getting financial advice or making their own financial decisions, those are the components that need a lot more attention.
Cameron Passmore: Because setting that plan in motion now may be terrible for your current well-being.
Ben Felix: Exactly. Exactly. And my comment earlier about it being, the more you go down this rabbit hole, you can make the argument that it's irresponsible to coach somebody on financial decisions without taking all of these other aspects into account. To sit down and do a financial plan and say, "Okay, you want to retire at 55. Okay. Well, here's what you have to do." So when you think about what we were just talking about with savings and what's the optimal saving amount, what are you saving for? Are you saving to stop working? And then I think that question of, is that the right goal? Again, becomes important when you start looking at what the literature says about the relationship between work and wellbeing. And you think about work, and I know you can debate whether people like their jobs or not.
I know some people don't, but the work, when you think again, back to those benefits of allocating, the different types of capital. Work provides utilitarian benefits through the earnings that we're all familiar with and spend most of our time talking about in relation to human capital. But work also provides or can provide expressive and emotional benefits. People express their identity through their work and take pride in doing their job. Work often contributes to membership in a community. Losing a job takes away the income piece, obviously, but it can also take away identity, pride, accomplishments, and membership in the community.
Cameron Passmore: And purpose.
Ben Felix: Yeah, there's a 2011 paper that looked at the impact of unemployment. This is a scarring or scaring, the psychological impact of past unemployment and future unemployment risk. 2011 paper, they found that unemployment remains a scar on wellbeing long after regaining employment. Now you can argue that's different because that's not talking about retirement. It's talking about probably an unplanned job loss, but it does show that relationship in the data between work and wellbeing. We've touched a little bit on temporal capital time and the importance of community and family and things like that. So again, we think about work and there's this recursive interaction where all aspects of wellbeing are effected. So work is fulfilling and provides utilitarian benefits like we just mentioned, but working long hours can reduce time with family and friends. And stressful work can decrease the quality of time spent with family and friends and stress with family can make work more difficult.
All of those things can be related back to different financial decisions that people might make over time, whether it's financial capital or temporal capital allocation decisions. And you step back and think about all of this in the context of retirement planning, which again, the quantitative and tax aspects of that we'd beat to death and spend so much time on. But things like creating a vision for retirement are arguably as important as all of the other financial stuff like financial security, which is critically important to a successful retirement. But financial security is only one of the many elements required to maintain a high level of wellbeing throughout retirement.
Cameron Passmore: Makes you realize why retirement is so hard. So many of those other benefits, there's a chance that they just disappear.
Ben Felix: And there are like Larry Swedroe's book, Your Complete Guide to a Successful and Secure Retirement, I think it's called. In that book he has a bunch of thought exercises that he got from different experts in the fields of psychology that people can do to prepare for all of those other aspects of retirement. But again, the recursiveness in this overall model comes back into play because the financial aspects will facilitate the non-financial aspects. But the non-financial aspects are critical to maintain a high level of wellbeing. Even if the financial aspects are taken care of, it all needs to be considered jointly. Now, why is this an important topic to talk about? And it does kind of feel like we're rambling a bit because there's a lot to talk about here. And it's somewhat outside of our usual discussions about risk and expected returns.
But you think about what good is expertise, whether that's expertise with a third party like what PWL does, or if it's a person trying to take ownership of the household finances. Basically what we've been talking about through this segment is base rates. What are the things that increase wellbeing? So you think about what are expert's good for more generally? It's that. It's knowing base rates. They can't predict the future, but they understand base rates. So I think incorporating wellbeing evidence broadly speaking into financial decisions is extremely, extremely important. And I'm not alone here saying this. The Loonie Doctor who was on this podcast in episode 73, he has realized this and built himself a holistic wealth framework, which he discussed in the episode.
And he has a post on his website as well. But I'm realizing more and more that all of these other aspects and making sure that they're informing financial decisions. And making sure that the impact of financial decisions on these other aspects of wellbeing are taken into account is more important, or at least as important as the optimal factor tilt or whether you should have a concentrated portfolio or an aggressive portfolio.
Yeah. I mean, in terms of impact on wellbeing. And again, I guess that's what it comes down to is that concept of wellbeing. If the goal changes from optimizing financial health or financial wellbeing, which is that concept of more, how do we get more? Just switching the framing to maximizing for wellbeing, broadly speaking has a potential to materially change a lot of the decisions that people would make, important decisions, like big life altering decisions. So I think talking about how much you need to save for retirement without talking about why do you want to retire? Or what would you rather be doing? I think it might completely miss the mark.
Cameron Passmore: So you're ready to try our new feature?
Ben Felix: Yep. You're pulling the card.
Cameron Passmore: I will pull a card. I'll let you pick right-hand or left-hand, for those on?
Ben Felix: Right-hand.
Cameron Passmore: All right. Imagine that you have a factory that can make anything. What would you make and why?
Ben Felix: Oh, geez.
Cameron Passmore: We kick it off with an easy one. Oh my gosh.
Ben Felix: That is a brutally difficult question to answer. Factory that can make anything. And it's costless? The production is costless?
Cameron Passmore: What would you make and why?
Ben Felix: Wow. These are hard. I mean, it can't be money or any financial resources because you would just de-value them. What could the world use an infinite amount of?
Cameron Passmore: First time thinking about do you want to be that good person, do you want to make something that interests you?
Ben Felix: And what would the good person make?
Cameron Passmore: Exactly. That's what I'm trying. I know I'd love to make like, it I'd love to own a guitar factory and to be super cool, but that doesn't necessarily improve humanity.
Ben Felix: I'm imagining infinite production. You're going to infinitely produce guitars. And the world's just going to be full of guitars.
Cameron Passmore: Full of guitars. Well, it'd be high quality limited running guitars.
Ben Felix: Fresh water or something?
Cameron Passmore: Or nets.
Ben Felix: What does the world need? They have mosquito nets?
Cameron Passmore: Mosquito nets protection, carbon sequestration.
Ben Felix: Let's do one more. This one is too weird. Yeah. Carbon sequestration could be. You could infinitely print carbon credits.
Cameron Passmore: All right. What is something that is priceless to you?
Ben Felix: Oh, geez. These are hard. What did we get ourselves into? I mean, my family, for sure. My mind probably. Well, I mean, absolutely. But the tricky thing about the mind is that if it goes, you probably won't even realize it. Although I do think like my grandmother has Alzheimer's and one of the worst parts is when, although I think she's past this now, she doesn't come out of it so much. But when it was less advanced, she would come out of it and be able to recognize how far she'd gone. That was pretty brutal. Anyway, family, my mind.
Cameron Passmore: Yeah. I mean, clearly family of course. And all the relationships we have at least and the girls. But to me, something that is so priceless to me is that aha moment when you learn something for the first time, something changes your mind or gets you to think differently. And this is something that it honestly, it happens probably every morning. Now that I've become pretty aggressive at reading, is that the light bulb goes off like that is priceless to me. Those are two cards for this week. And you could tell they were not rehearsed ahead of time.
Bad advice of the week, this is a TikTok and it will likely be our last TikTok I know. This TikTok came from Ahmad. So been getting lots of bad advice ideas that have TikTok on it. This one was particularly special. I think I chose it because it had the Homer Simpson emoji built into it. So let's go ahead and run it. We'll come back on the other side.
Bad Advice of the Week - Tik Tok Video: What's one thing that just makes you extremely upset and you can't explain why?
The fact that we were told that stock trading isn't for everybody and that you'll never be able to win from the stock market. But here I can explain how that is possible by providing you some of the basics. First, go to TradingView and select a company you like. You will see a chart like this full of candles. Each candle that you see here represents a day in the stock market. The green candle is known as the bullish candle. The bottom of the candle is the opening price and the top is the closing price. Say the price opened at $10 and closed 11, the red candle is known as the bearish candle. The top of the candle is opening price and the bottom is the closing price. Now we can look at trends. Here we buy low and sell high. Here we like to sell high and buy low. In situations like this where it's neither up or down, this is called consolidation. And now most importantly as a beginner, add a stop loss to minimize your losses.
Cameron Passmore: Okay. I don't know what else to say. That to me is completely insane. How this advice could possibly be good for you is beyond me. Stock trading you've been told stock trading is not for you and candles, technical analysis, candles window buy low here, sell high there, sell high here, buy low here. It's so easy to make money. To me the whole thing is just completely absurd. I couldn't tell how many times this video has been downloaded, but I'm guessing a fair number.
Ben Felix: I often wonder if they're just jokes. Like this is satire, right? This isn't real.
Cameron Passmore: People tell me they're not jokes. I asked that question as well as they're tweeting me saying, "No, they're not jokes, they are serious." Anyways, there's your bad advice of the week. Anything else to add?
Ben Felix: Nope.
Cameron Passmore: All right. Thanks for listening.
Book From Today’s Episode:
Range: Why Generalists Triumph in a Specialized World — https://amzn.to/36hnU39
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Benjamin on Twitter — https://twitter.com/benjaminwfelix
Cameron on Twitter — https://twitter.com/CameronPassmore
'Index Fund Trillions Are Distorting Prices in the S&P 500' — https://www.bloomberg.com/news/articles/2021-01-13/trillions-of-dollars-in-index-funds-are-distorting-the-s-p-500
'Quid Pro Quo: What Factors Influence IPO Allocations to Investors' — https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12703
'The Long-Term Performance of IPOs, Revisited' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2929733
'Initial Public Offerings as Lotteries: Skewness Preference and First-Day Returns' — https://pubsonline.informs.org/doi/abs/10.1287/mnsc.1110.1431?journalCode=mnsc
'Rational IPO Waves' — https://www.jstor.org/stable/3694852
'High income improves evaluation of life but not emotional well-being' — https://www.pnas.org/content/107/38/16489
'What do Self-Reports of Wellbeing Say about Life-Cycle Theory and Policy?' — https://www.nber.org/papers/w24369
'Neighbors as Negatives: Relative Earnings and Well-Being' — https://www.nber.org/papers/w10667
'Inequality at Work: The Effect of Pure Salaries on Job Satisfaction' — https://www.nber.org/papers/w10667
'Scarring or Scaring? The Psychological Impact of Past Unemployment and Future Unemployment Risk' — https://www.jstor.org/stable/41236648