In today’s episode, we pull relevant quotes from past guests (namely John Cochrane, Gene Fama, and Jonathan Berk) to extricate who should own market cap funds. We look at the variable risks of value stocks and factor investing and hear counter-views on owning the market. We also delve into the hot topic of tax loss selling, with an overview of a recent Financial Analyst Journal paper on loss harvesting outcomes, sorted by investor profiles. This episode will get you up to date on the biggest finance news of the week, from crypto collapses to Amazon’s catapulting gains and losses. Tune in to hear all of this and more, including a recap of our conversation with Dave Goetsch and our Financial Literacy Month book reviews.
Key Points From This Episode:
A neat way to keep track of the value of your purchases over time. (0:00:33)
The results of the Rational Reminder financial literacy survey. (0:02:44)
An overview of this episode’s topics. (0:05:45)
Who should invest in market cap-weighted index funds. (0:07:28)
How to determine whether you’re different from the average investor. (0:16:13)
Gene Fama’s take on the possibility of identifying state factors. (0:22:13)
The variable risks of value stocks. (0:23:25)
What drives people to increase their value tilts over time. (0:25:11)
The risks of factor investing, and trading in general. (0:28:26)
Jonathan Berk’s take on owning the market. (0:31:53)
A summary of who should invest in total market index funds. (0:33:20)
The big crypto news of the week! (0:38:21)
Other significant market news. (0:42:17)
An overview of a recent Financial Analyst Journal paper on loss harvesting outcomes, sorted by investor profiles. (0:44:59)
Our book reviews for Financial Literacy Month. (0:55:15)
A recap of our conversation with Dave Goetsch. (1:01:47)
A few of our listeners’ reviews. (1:02:50)
Read the Transcript:
Ben Felix: This is the Rational Reminder Podcast. a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.
Cameron Passmore: Welcome to Episode 227. It's funny, Ben. We were just saying before we started recording, you never really know what's going to get the attention. Lately, your hair and your trampoline have been getting lots of attention.
Ben Felix: Yup. People are very interested in my hair.
Cameron Passmore: You don't know what to say to that. Anyway, so I got a story to share with you. I was in line last week with my buddy, Dave, from Edmonton at a conference. We're in the coffee line and he says to me – Dave and I ride our Peloton many Saturday mornings together. He says, “I got an idea for you that might be of interest.” He's pretty nerdy on numbers. He was saying that what they do in their family, so him and his wife and his kids, anytime to do a large purchase, they will take the label maker and put the amount they paid for that item and the date they bought it, put it on a label and then put it discreetly on the item.
Us being Peloton riders he says, “I looked at the date. Looked at my Peloton, looked at the date and the price I paid.” He's got it now down to below like, 2,50 per ride. He does this. Now, arguably this is really geeky. I’m not suggesting people do this, but it's interesting to keep track of the value you get out of an item that you choose to buy. He's even broken down the Peloton cents per calorie. You can go to extremes, of course. But he said, it ends up becoming a good discussion with particularly your kids, who say they really want something. They buy it. You go back three years later, nobody remembers when they got it, what they paid for it. At least, you have a record of that and say, okay, in hindsight, was that item worth what you paid for it? He said, it has an impression on his family. Thought it was a cool idea.
Ben Felix: That is a cool idea. I have that conversation with my kids all the time. They wanted a new toy recently that all the other kids at school had. I reminded them, “Guys, go look in your room. All of the toys that you really wanted, they end up in the same box within two weeks or something like that.” That is a cool idea, though.
Cameron Passmore: Would you ever go as far as labelling it?
Ben Felix: I don't know if I would. Is he calculating the opportunity cost of not investing the money that could have been invested, instead of buying the Peloton, though? I don't know if that cost-per-ride number is accurate.
Cameron Passmore: Oh, this is just straight line. We're not doing – not comparing it to had it been invested. No, it's true. There are so many people you hear, “I bought one. Now, it's just an expensive drying rack for my clothes.”
Ben Felix: Yeah. No, it's a neat idea to keep track of your purchases. It's a way to audit. We talked to Andrew Hallam about that a while ago, to take your credit card statement and go through your purchases and see if it made you happy or whatever. This is a way of doing that, but keeping track of it over long periods of time by putting the costs on a physical object. It's a neat idea.
Cameron Passmore: You wanted to talk about the financial literacy survey.
Ben Felix: Oh, yeah. We have the Rational Reminder newsletter that we send out, I think, once a month, I think.
Cameron Passmore: True.
Ben Felix: Not sure how many people it goes out to, but maybe a 1,000-ish.
Cameron Passmore: I think so.
Ben Felix: Something like that. So, we included — We didn't do it Angelica and Sandra and the team did put the S&P FinLit quiz in the newsletter with a Microsoft forms link so that people could go and take it. And 137 people responded. Just cool to see the results. Of course, these people responding to a quiz in the Rational Reminder newsletter are a little bit finance geekier than average. The unsurprising average score was 92% on the quiz, which is a lot higher than the average in Canada, which is 68%. I wasn't surprised just based on the sample. The lowest score of all the four question categories was question one, which was 82% average score, across the 137 people that took the quiz.
That question is suppose over the next 10 years, the prices of the things you buy double, if your income also doubles, would you be able to buy less than you can buy today, more than you can buy today, or the same as you can buy today? We got at least one comment back on this question. I've heard this before, the first time we talked about this, maybe in a YouTube comment, or something. People say that the question is flawed because if your income doubles and prices double your, after-tax income will have fallen due to the progressive tax system. That's a really good thought. A lot of progressive tax systems, including Canada, they actually – I don't think the question was even going for this level of complexity.
Cameron Passmore: It's overthinking.
Ben Felix: It's overthinking the question for sure. Let's say, we're going to overthink it. If you do overthink it, progressive tax systems typically increase their tax brackets with the consumer price index. Canada does that once per year. Anyway, I don't know if that's why that was the lowest-scoring question, because maybe it's somewhat unclear. It was just interesting to see, though.
Cameron Passmore: There's also some feedback on question number two regarding interest rates on a debt. I think, arguably, that question could have been clearer, put some time variance in that question.
Ben Felix: Arguably.
Cameron Passmore: Again, it's overthinking.
Ben Felix: We had this conversation. I think that question, it didn't include time in the question, or the answers, which implies a single time period of undetermined time. I think that question is fine. Anyway.
Cameron Passmore: They get us overthinking, which may be typical of our audience, too.
Ben Felix: I don't know if we've said this yet. We have Professor Annamaria Lusardi, who designed that global FinLet quiz and is the authority on financial literacy. She's going to be a guest on the podcast coming up pretty soon. Maybe we can ask her.
Cameron Passmore: Excellent. Speaking of financial literacy for November, which is Canada's Financial Literacy Month, the November sale in the merchandise store continues. You spend $30 and you get 50% off Talking Sense cards. Oddly enough, Talking Sense cards are $30. Basically, you can buy the cards for half price. Free shipping in North America and free socks and a beverage cozy. That goes until the end of November, so you have another week or so from the time this releases.
All right, so coming up today, Ben, you're diving into who should own market cap funds, and you wanted to talk about tax loss selling, which is a pretty hot topic. Then we'll review for Financial Literacy Month, five more books. I actually added a sixth, which is a book I read this week. Another one snuck in. I'll take another crack at the 60-second episode review, see if I can keep it under a minute this time. This one's our episode with Dave Goetsch. At the end, we'll just chat and talk about reviews and letters and connections and stuff.
Ben Felix: I think we added some news items, since you wrote these bullet points, right?
Cameron Passmore: Yes, but they’re in the middle. Yeah.
Ben Felix: Still. There's no one in there.
Cameron Passmore: I’m not stealing all the candy in the lobby here. We got to have some surprises. Yes, there are some new stories. This is a big day in the markets, maybe talk a bit about that, too. Not that we wanted to be that current, but it's interesting to observe what's been happening.
Ben Felix: One of the things that I'll say now, as opposed to later is that we're thinking about a project where we take most episodes and turn them into continuing education courses, where we would build a five, or 10-question quiz. If you listen to the episode, you can fill out the quiz. We would get those quizzes accredited by probably, FP Canada and IRAC, if you're in Canada, for CEU credits. If you listen to episode and you require those types of credits, you could go and take these quizzes. We would charge some amount of money to get a certificate for taking those quizzes.
We're going to put a poll in the Rational Reminder community, just to see if you're an advisor in Canada, and those CEU credits would be useful to you, if you can, please let us know, that'd be great.
Cameron Passmore: Beautiful. With that, let's go to the episode. All right, let’s jump into episode 227. Ben, take it off.
Ben Felix: All right, so I want to talk about who should invest in market cap-weighted index funds? I think it’s a pretty interesting topic. We're going to throw some clips in here from past guest episodes because it was really the Jonathan Berk and Jules van Binsbergen conversation when they talked about if you don't think you have any information, you should just own the market. That was a pretty interesting argument for owning the market. Then I started thinking back through past conversations we've had and there's a whole bunch of really good clips, I guess, from literally the best people in the world that you could ask this question to, explaining who should just own the market. I wanted to talk through that. Then like I said, insert some those clips in there.
Okay, so I've said and we’ve said countless times that owning low-cost total market index funds is the most sensible way to invest for most people. I think that's a true statement. Most people, whatever that means, and maybe we'll talk more about that. While that is a true statement, a true general statement, it's not actually that useful. Because how do you know if you're like most people? If you're not like most people, how do you identify if you're different? If you do identify that you're different from most people, how does that change how you should invest? This really answer that question, who should just own the market and who should do something a little bit different?
Cameron Passmore: You've been thinking about this.
Ben Felix: Well, yeah. Because we've talked a – I mean, you go through the clips that I want to throw in here and we've got some – a bit of Fama, a bit of John Cochrane, Berk and van Binsbergen. I don't know who else is in those. Sebastien Betermier. All these fascinating tidbits of those conversations that answer pieces of this question. Yeah, I have been. I have been thinking about it. You go back to Harry Markowitz's portfolio theory in the 1950s. His modern portfolio theory concept is built on the basis that investors seek to minimize the variance in their portfolios for a given level of expected return, or maximise their expected return for a given level of variance. Pretty standard portfolio theory stuff.
The optimal set of risky portfolios are mean variance efficient, and the risky portfolio with the highest Sharpe ratio is called the tangency portfolio. This is stuff we've talked about before. Anyone that's taken any level of finance classes has heard this. In this theory, all investors optimally hold the tangency portfolio combined with a long, or short position in the risk-free asset. Now, then we go to the CAPM. That's Markowitz's portfolio theory in the 1950s. CAPM in 1964, at least Sharpe’s iteration of it, the CAPM model turns Markowitz’s portfolio theory into a testable prediction about the relationship between risk and expected return.
In the CAPM, each asset’s price is based on its contribution to the risk and expected return of the market portfolio. In an efficient market, where investors are mean-variance optimisers, all assets must be priced such that the market portfolio is the tangency portfolio. Under the assumptions of the CAPM, the market portfolio is the tangency portfolio. Remember, in Markowitz’s portfolio theory, all investors should want to own the tangency portfolio. In CAPM, if CAPM describes expected returns, the market portfolio is the tangency portfolio. Therefore, everyone should just own the market. Well, sort of.
The theoretical market portfolio includes all assets, but the argument for index investing is well, public stock and bond markets are a pretty good proxy for the market portfolio, even if they're not the true theoretical market portfolio. We can stop there. This is like Bogleheads. We're done. This is where Bogleheads stopped. Everyone should own the market. There's no other risk premiums. Mean-variance is optimal. At least this is the theoretical justification to be a Boglehead. Bogleheads, I'm sure have other reasons, like simplicity and costs, which we will talk about.
The advice at this point of the theory is just own total market stock and bond index funds, you're done. Now, the CAPM, of course, was a huge breakthrough in financial economics. It was the first model we had to elate risk and expected return. It's a beautiful theory. I think, Fama talked about how much he likes it and how he wishes that the other factors could be disproved, so we could just use the CAPM. Of course, they haven't been disproved, and it's been the other way around where the CAPM has a whole bunch of empirical flaws.
If, in addition to portfolio variance, investors also care about how their portfolio behaves relative to other states of the world, it's reasonable to believe that expected returns would deviate from their CAPM predictions. That brings us to the ICAPM. That's where Robert Merton had his 1973 paper. The ICAPM considers a multi-period investor. I didn't mention that for the CAPM. The CAPM considers a single-period investor. The ICAPM considers a multi-period investor, who in addition to mean and variance is concerned with the covariance of their portfolio with other stuff, like labour income, the prices of consumption goods and future expected returns. Because now we're worrying about multiple periods, instead of a single period.
If your returns in one period affect your returns in the next period, that matters to multi-period, or long-term investors, which is different from CAPM. ICAPM investors still care about optimizing for the mean and variance of their portfolios, but they're willing to accept a little bit more variance, or a little bit less expected return. ICAPM investors are still concerned with optimizing mean and variance, but they're willing to accept a little more variance, or a little less expected return if their portfolio is not sensitive to states of the world that they're concerned about. That's that covariance thing.
Now, the existence of multiple price risks materially changes the logic of market cap-weighted index funds being universally optimal for all investors. Remember, with CAPM pricing, the market portfolio is the tangency portfolio and we can all go home. In the ICAPM, the market portfolio is no longer the tangency portfolio. The market portfolio in the ICAPM is the multi-factor efficient portfolio. Hopefully, people understand what that means. It's like, it’s got the right combination of mean-variance and covariance exposure to other states of the world for the average investor.
If you're the mean-variance investor, you can't just buy the market anymore. In the case of the ICAPM, rather than a single, theoretically optimal portfolio for all investors, there's literally infinite optimal portfolios, where optimal is different for each investor, based on how the characteristics of the investor match up with the characteristics of the portfolio, we can no longer say there's an objectively optimal portfolio. It depends on the investor. That's ICAPM thinking.
Now, investors can differ in their willingness and ability to accept covariance with bad states of the world. The market portfolio is still totally logically optimal for the average investor. It has to be, but it's sub-optimal for everyone else. This is where it gets tricky, right? If you're not the average investor, you shouldn't do own the market portfolio. The market portfolio with ICAPM pricing combines the mean-variance efficient portfolio with – this is what I was talking about with multifactor efficient. It combines the mean-variance efficient portfolio with the portfolios that tend to perform well in bad states of the world that most investors are worried about.
The hedge portfolios trade off lower expected returns for lower covariance in bad states of the world. Now, that's good for the average investor, because it hedges against just to the right amount. Hedges against the risks that the average investor is concerned about. The problem for some investors is that multifactor efficiency of the market portfolio means that the market portfolio delivers the perfect mix of the mean-variance optimal portfolio and the multifactor hedge portfolios for the average investor. Again, I think I'm repeating myself here.
If you're not the average investor, those exposures to hedge portfolios may not be optimal. Maybe there's not enough. Maybe there's too much. Then one of the big takeaways from that whole thing is that if you're the mean-variance investor because they can still exist, if you're an investor that doesn't care about covariances with other states of the world, you can still be a mean-variance investor. Again, if that is you, if you're not exposed to the risks that the average investor is worried about, owning the market portfolio is suboptimal. Because it's multifactor efficient, the mean-variance portfolio is still in there, but it's mixed in with a bunch of hedge portfolios that you may not want to own if your goal is mean-variance efficiency.
Okay, so just to reiterate a little bit. If you are the average investor, if you're sensitive to the same common risks as the average investor, which is probably a better way to say it. Who's the average investor, who knows? If you're sensitive to the same common risks as the average investor, or you have the same sensitivities to those risks, you should hold the market portfolio. If you have more or less sensitivity to the risk that most investors are worried about, and your portfolio should be different, at least in the theory, John Cochrane gave us a nice explanation of this back in episode 169, given that the market portfolio is optimal for the average investor, how do you decide if you are different from average? We'll go to a clip from him talking about that for a few minutes.
John Cochrane: Now, finally, I think I'll answer your question. Why should you with this great insight, do something different from everybody else? Well, you might be genuinely smarter than everybody else. You might be genuinely better informed than other people. Good luck to you on that one. You certainly might have a different ability to take risk. You might want to be an insurance company and simply say, “Well, the average investor is somebody who has started a business and made a lot of money in it.” But they still own a business. If they're doing their jobs right, they're thinking hard about integrating their business risk and the portfolio risk. In a time when the average person, like December 2009, or I guess, March 2009, was the all-time buying opportunity that I didn't take. I can tell, you guys didn't take either, because you're still working for a living, or whatever.
If you can spot that everybody else is they are really worried about the risk to their business, and so they're dumping, even though they understand this is probably a good time to buy, then that's – But you're a tenured professor, or you're retired, you can afford to take a risk, if you understand other people want to get rid of, you're probably going to get paid a premium to do it. Actually, March 1934. If you can get a time machine, go back to March 1934. That was the all-time bottom of the Great Depression. That was the greatest single month in stock returns ever. You want to buy February 1934. Go back and tell great-grandfather to buy.
It was the depths of the Great Depression. You're still taking risk. There was a good chance that America turned fascist and socialist and communist in the middle of the Great Depression. There was a good chance that we lost World War II. There's all sorts of risks there. It was a bet. I think the best one is if you can identify your ability to take risk as different from other people, that justifies buying. Most importantly, here's where we get a little fluffy, which stocks do you buy? Do you buy value stocks, growth stocks, momentum stocks? Which industries do you invest in? How do you avoid the good stock versus good company fallacy?
I think if you could understand what risks are in different categories of stocks, who is buying them? Who is better served to taking them? I think that is probably the great – the market timing happens slowly, but the sector allocation, the style allocation, that's something that you can do at different times. I think, understanding your risk-bearing capacity relative to various sector styles and factors would be really the way to think about that. I don't have good answers about that. No one has good answers about that.
The one I would say is, don't invest in your own company. Don’t invest in your own industry, which is one of the biggest mistakes people make. They load up on their own company, even the geniuses at long-term capital management had borrowed money to invest in their own company. Come on, guys. You don't want to do that. That is just multiplying risks. We can always start with don't pay too many taxes and risk management. Those are completely free. You don't need to chase alpha for that. It's not a zero-sum game.
One of the aspects of risk management is even though everybody thinks their own industry is the industry of the future, even the coal people thought that. Keeping enough money out of the wonderful rewards of your own industry in your own company, so that if things go bad, you can survive. That's a classic example of this thinking about heterogeneity. Even if your company is a great company, and you think it's a great return opportunity, it might not work out. The FTC could decide that you're a monopoly and destroy it. Or, the SEC could decide, you contribute too much to climate change and destroy it.
Even if you think it's a great opportunity, you should be investing less in it than the average person, because you're exposed to that risk. If we can make that case more generally for factor risks, I think we would have a much better framework for understanding who should invest in factor risks and who shouldn’t.
Ben Felix: That was a great clip from John. I also want to go to quickly, a very concise version of that answer to a similar question from Gene Fama in episode 200.
Gene Fama: Taste, new attitudes towards different dimensions. I think of them as different dimensions of risk, but attitudes to different dimensions of risk are what do it. In Merton's perspective, it's basically our attitude towards whatever these underlying state variables are that generate premiums in various dimensions.
Ben Felix: Okay, so if you're not exposed to any common risks outside of your portfolio, that is you don't depend on labour income, you don't own a business, or otherwise have sensitivity to economic risks outside of your portfolio returns, or if you're willing to load up more on the risks that you're already exposed to, that's another important thing there, you might be a mean-variance investor. But it's important to remember and again, I'm repeating myself. I get a little bit too excited about mean-variance efficiency.
Cameron Passmore: There's a sentence that has never been said before in the history of finance.
Ben Felix: I'm sure Bill Sharpe has said that before.
Cameron Passmore: Oh, maybe.
Ben Felix: Or, Harry Markowitz.
Cameron Passmore: It’s still funny.
Ben Felix: Yeah, right. The market portfolio is not mean-variance efficient, multifactor efficient. I think I've said that enough times. A mean-variance investor who only cares about risk and expected return as the tilt toward the multifactor hedge, they’ll tilt away from the multifactor hedge portfolios in the market portfolio. Now the ICAPM, of course, does not define the states of the world that most investors are concerned about. It refers to them just as unknown state variables.
I loved the comment that Fama gave us when I tried to dig into that. Is there any way we can know what those state variables are? I just want to play that real quick. It's less than a minute.
Gene Fama: Well, possible in what sense though? I mean, can you go into their minds and take out what dimensions of returns, or special interests, or disinterest? What things do they have positive tastes for and what things do they have negative tastes for, and are those things general? I mean, because everybody have positive tastes for one thing and negative tastes for another. It's not that easy. Bob Merton was one of the smartest guys, if not the smartest guy I've ever known, and he didn't even attempt to do it. He did not even take a crack at it. He just gave us the mathematical framework and said, “Run with it, guys.”
Ben Felix: All right, so the state variables are unknowable, again, with Fama’s version of humour there. This is where Fama and French's 1993 paper, Common Risk Factors on the Returns on Stocks and Bonds is important. That's when they took the empirical evidence that small-cap and low-priced stocks are unexplained by market risk using the CAPM as the model. They suggest that these stocks may reflect sensitivity to unknown state variables that produce non-diversifiable risk. They're basically saying, we don't know what the state variables are people are worried about are, but these portfolios seem to be sensitive to those things, whatever it is that they may be.
Now, if we look at some of Sebastien Betermier’s stuff, and well, this is actually not even him yet. These are other empirical papers on whether value stocks are riskier in different times. If you look at the empirical data, value stocks tend to be under distress, have high financial leverage, face substantial uncertainty in future earnings. They also tend to be riskier than growth stocks in bad economic times, and only slightly less risky in good times. They deliver low returns when labour income and consumption fall.
From an ICAPM perspective, you can see a pretty good argument for why we would call value stocks risky, or why we call them sensitive to state to the world that a lot of people are worried about. Based on that, we might expect as the theory predicts that investors with high human capital and high exposure to macroeconomic risk would tilt their portfolios toward growth stocks, which act as a hedge portfolio based on what we were just talking about. Then, this is where the Sebastien Betermier stuff comes in, in their paper, Who are the Value and Growth Investors? They find in a representative sample of approximately 70,000 Swedish households, that households progressively shift from growth stocks to value stocks as they become older and their balance sheets improve.
It's like, you couldn't ask for better empirical evidence supporting just the ICAPM version of why we see differences in returns. They also find in their research that investors with high human capital and high exposure to macroeconomic risk tilt their portfolios away from value stocks, and then again, of course, that's consistent with the greater hedging demands of younger and less wealthy investors and older wealthier investors tending to look more like the theoretical mean-variance investor.
Now, I do want to just go quickly to a clip where Sebastien explains their results to us back in episode 196. We had asked him what causes people in their sample to increase their value tilts over time.
Sebastien Betermier: We think it's a mix of effects. It's a strong result. Oftentimes, when you have strong result like that, you have multiple drivers coming up. To tease apart the multiple possible channels that could explain that migration, we create an econometric model, where we are going to regress, or see how that value tilt corresponds, or can be explained by a number of characteristics, like age, the balance sheet strength, gender, human capital, and so forth. What we'll find is that in general, age explains about 60% of the migration.
Here, financial theory says that growth stocks, they may be risky in the short run, but they tend to be safer over the long run. A lot of their risk comes from transitory price shocks, which you may not face as much over the long run. They make more sense for younger folks with a long horizon. As they age, well, that benefit diminishes as the horizon gets closer. That can explain part of the shifts toward the value tilt.
Another driver is human capital. We believe that human capital explains about 20% of the migration. That's 60%, 20%, or 80% here. Here, financial theory says something else as well. It says that value stocks, in addition to the horizon effect, which are stocked, value stocks and that being more exposed to bad recessions. These are stocks with low market value relative to book. There's few growth options left in them. They tend to have more leverage. They tend to have more operating leverage, more fixed costs, so they have a harder time adjusting their production model during bad times. They may be more exposed to default in times of bad recessions.
When you're looking at the cross-section of individuals, you have younger folks, older folks. The younger folks have the bulk of their wealth invested in human capital. Little financial wealth. Whereas, among retirees, it tends to be primarily financial wealth. The younger folks may want to hedge away from that risk. Part of that means, well, not tilt as much toward the stocks as some of the other investors.
Then the third driver, which we believe explains about 20% of the migration. we're at 60, 20, 20, we’re at 100 now. The remaining 20% is the strength of your balance sheet. Again, going back to the concept of the composition of wealth, when you're young, we find that the bulk of your wealth is in your human capital. It's in real estate, but it's very levered at that point. You have some financial wealth, but your cushion is fairly small. There's also a lot of liabilities. There's the mortgage. You may have liabilities through your kids and other types of student loans that might remain. Whereas, when you're more mature, you tend to have accumulated more financial wealth, and you don't have as much liabilities.
By the time you're 60, 65, typically the mortgage is being paid. These individuals have more bandwidth to take some of those risks, and they're not as exposed to those bad recessions as the younger folks. Again, it makes sense to tilt toward value if you have a stronger balance sheet and you can afford to bear the shocks.
Ben Felix: Okay, so as a theory, the ICAPM solves a lot of empirical problems that the CAPM suffers from. One of the big takeaways is that if you are not the average investor, the market portfolio which again, we can easily proxy with low-cost total market index funds is not the theoretically optimal portfolio for you. Investors who are more willing, or more able to take on the risks that the average investor wants to avoid should theoretically, tilt their portfolios away from the multifactor hedge portfolios and toward the assets more exposed to, or more sensitive to the risks that the average investor wants to avoid. Cool, that's ICAPM theory. You should be different from the market.
Your portfolio should look different from the market if you're different from the average investor. That's where we get this idea of, hey, there are other priced risks out there. If you want higher expected returns on a risk-adjusted basis, if you want to be the mean-variance investor, you should be tilting toward these riskier securities. That's the whole idea. That doesn't mean everyone should be doing it.
We did that episode a while ago on, is factor investing worth it? I don't think we talked much about this theoretical side. We just talked about differences in expected returns. That was like, given that you are a mean-variance investor, is factor investing worth it? It's not given that you are a mean-variance investor. I think, that's one of the things that gets lost when people start talking about factor investing. Everyone wants to act like they're a mean-variance investor, but not everybody is and not everybody should be.
Okay, so we got the ICAPM theory. I think, as much as that's cool theoretically, and as much as what I just said makes sense. If you want to be a mean-variance investor, you have to be different from the market. In practice, it's not quite as clean as it sounds. There's something there, but it's not as clean as it sounds. Fama and French, they gave their handful of risk factors. They've got their five-factor model now, which is an empirical model, as Fama told us when he was on our podcast. What did he say? It's got a very, very light theoretical touch to it, but it's an empirical model. There's no consensus on what the true pricing factors are. What variables really proxy for the states of the world that most investors are concerned about? We don't really know. There are hundreds of factors in the literature.
I think, given that uncertainty, and are we targeting the right stuff, every time that you trade, you could be losing to a skilled active manager. This is what I mentioned, Jonathan Bern and Jules van Binsbergen. This is what they got me thinking about on this topic. There's always someone on the other side of the trade. If it turns out that what we thought were riskier stocks are really just noise in the data, or we're using the wrong variable, or whatever, you could end up on the wrong side of the trade.
I mean, I think we have enough information to target higher expected returns, obviously, maybe. This is still an interesting angle to think about. Owning the market, just owning the whole market is a hedge against being misinformed. You buy it once and you forget it. Tilting toward riskier stocks requires more trading, because the relative riskiness of stocks changes over time. A more targeted index, or a more targeted fund, like a Dimensional, or an Avantis, they've got to trade more often, they've got to reconstitute more often. If you'd look at the turnover in those types of portfolios compared to a total market index, the turnover is going to be higher for anything targeting riskier securities. Each trade is an opportunity to be misinformed. I want to go to the clip of Jonathan Berk giving us his thoughts on this in Episode 220.
Jonathan Berk: Yeah. This is, I think, a very important point. I mean, we obviously emphasize when we teach finance. But I think that in general, this is not emphasized enough, which is if you are trading, anytime you trade, and you don't have information, if the other side of the person has information, you lose. That's the nature of the game. If somebody has more information than you, and you trade with him, you're on the losing side. The extent to which if you know you don't have information, and you know there is information out there, what you want to do is don't trade.
The way you don't trade is you buy the market portfolio. You buy it once, you hold it, and you sell it. Actually, it's more subtle than that. It's not just don't trade. Why the market? Why not just any portfolio? The reason why the market is particularly good is you're buying it in the economy-wide weight. You're not emphasizing any stock. Somebody with information is going to emphasize some stock over another stock. If you're on the other side of that trade, that means you have the opposite. You're doing exactly the opposite to them, and you will lose. What you want to make sure is you're never exactly opposite of somebody with information. How do you do that? You just buy the market. Because the market, you're not opposite to anything. You’re in the weight of the whole economy.
Ben Felix: Okay. I think that's an important counterargument to being different from the market. Like I said before we went to the clip with Jonathan, while there are hundreds of documented risk factors out there, there's at least one paper, there's the 2022 paper that we've talked about before, is there a replication crisis in finance? They find that all those many, many factors that are out there, they really boil down to 13 main themes. The majority in this paper, the majority they find are significant parts of the tangency portfolio. I mean, we don't have perfect information. We can't, because, well, I mean, the state variables are unknowable, like Fama made me laugh about. We don't have perfect information about differences in expected returns, or how to proxy sensitivity to risks or whatever. I think we've pretty good information. Pretty good.
Even then, even if we have pretty good information, being different from the market also introduces monitoring costs. The market portfolio is what it is. It's easy to see if you're getting what you paid for it when you invest in a total market ETF. When you see this too, with if you buy a total market fund from iShares, or Vanguard, the returns are going to be the same, basically. If you buy a value fund from iShares, or Vanguard, or Dimensional, or Avantis, vastly different. Vastly different characteristics, vastly different returns, ex-post. It's a whole different situation.
When you're tilting toward riskier stocks, there's more oversight required to know whether the fund is delivering what you expected. Doing so efficiently, and to know whether you're targeting the right risks, which of course is not knowable ex-ante, which adds to the whole monitoring problem. Your life is just a lot easier when you just own the market through low-cost index funds. Even if it is theoretically sub-optimal. Even if you said, “I can identify myself as a mean-variance investor.” Whether that's through preferences for risk, or your financial situation, or whatever, it's still not crazy to say, “I don't want to risk being wrong. I don't want to have the monitoring costs. I'm just going to own total market index funds.” The monitoring cost, that was another argument from Jonathan and Jules.
Okay, so to summarise, who should invest in total market index funds? The market portfolio, which again, we can proxy with total market index funds, is optimal for the average investor. It’s multifactor efficient. If you are the average investor, which of course, we can't know, but you can decide. You can decide, “You know what? I think I am the average investor.” Maybe that's the best way to identify – self-identify as the average investor.
Cameron Passmore: Self-identify as average. Yes.
Ben Felix: Yeah. If you’re average, you can rest easy, knowing that the best portfolio for you is total market index funds and that's it. If you're different from average, which I mean, most people have to be, not everybody can be average. That's not how it works. The theoretically optimal portfolio requires tilting the theoretically optimal portfolio. Doesn't mean it’s what you should do. If you're following portfolio theory, the theoretically optimal portfolio requires tilting toward or away from the securities in the market that hedge against bad states of the world.
An investor who wants to achieve the highest Sharpe ratio, while ignoring portfolio covariance with bad states of the world, the investor that wants to be a mean variance investor. There are a lot of those out there. I think everybody wants to be a mean-variance investor. Maybe they need to hear about the ICAPM. ICAPM is not nearly as exciting as mean-variance optimization, I don't think. An investor who wants that, who wants to have the highest Sharpe ratio possible, they can't just invest in the market. You can't invest in the market and expect mean-variance efficiency, because the market portfolio is multifactor efficient, but it is not mean-variance efficient.
Now, again, I'm repeating myself here. Even if you know how you're different from average, which of course is very difficult to do and difficult to measure, we don't have precise information about which assets are truly sensitive to the unknown state variables that you may, or may not be concerned about. Even then, even if you had a way to say, “I'm this much different from average,” okay, now, what do you tilt toward, or away from? We don't have perfect information there.
If you want to minimize the risk of trading on bad information, owning the total market portfolio accomplishes that. That's the hedge against being misinformed. I think, there are worse positions to take than just saying, “I'm going to own the market.” I also think that we have a lot of pretty good information about differences and expected returns. It's maybe worth thinking about it and building a portfolio.
Then the last thing to consider is if you don't want to spend time monitoring your portfolio, monitoring the performance of your portfolio and the managers that you're choosing, like if you're choosing a Dimensional or an Avantis, or a Vanguard, or an iShares, or whatever, to get exposure to value stocks, or whatever it may be, there's a lot more oversight required ongoing for that. There's a cost there somewhere. I don't know how you measure it, but there's a cost in there. If you don't want to do that and worry about it, then total market index funds are hard to argue against, even if they're identifiably theoretically optimal on other measures, or for other reasons.
Cameron Passmore: That was great.
Ben Felix: Did that answer that question? Do we know who should invest in total market index funds?
Cameron Passmore: Certainly, gave a framework. That was great. Jump to the news of the week? Boy, there’s a lot going on this week. I mean, you and I exchange stories often in the evening. This week, you can hardly keep up with what's going on.
Ben Felix: Yeah, I know. Crazy.
Cameron Passmore: This crypto stuff with FTX, that's where you wanted to start. It's incredible.
Ben Felix: Yeah. This was at the time of recording this week, at the time of this episode airing last week, yeah, one of the largest crypto exchanges, FTX, they had some liquidity problems. I'm not going to try and dig into the whole story, but they had some liquidity problems. They tried to do a deal to sell to Binance, which is the largest crypto exchange. That alone was crazy because these guys are like arch rivals, Sam Bankman-Fried and CZ. I don’t know if that’s how you pronounce it. That’s how he writes his name.
Cameron Passmore: That’s the spell, yeah.
Ben Felix: Yeah. They were having this ongoing rivalry. Then Sam Bankman-Fried says he's going to sell to Binance. It’s like, “What?” That was nuts. Then, Binance decided not to do the deal. I can't say that I predicted this, but when you see the tweets going back and forth between the two guys, I thought to myself like, “Oh, my goodness. I bet you, they're going to do due diligence.” Because it said, pending due diligence. I was like, I bet they're going to go to due diligence and they're not going to do the deal.
Then sure enough, the next day, or a couple days later, Binance comes out and said, they're not going to do the deal after going through FTX’s financials. Now FTX is in big, big trouble. Watching it unfold is going to be fascinating. I mean, maybe by the time this episode is out, maybe we'll know more. We don't know a ton at the moment. Sam Bankman-Fried, the owner of FTX was previously a billionaire and getting all sorts of titles like the next Warren Buffett and stuff like that.
Cameron Passmore: Well, he said in an interview, I think, it was relayed somewhere that he wanted to buy Goldman. He's speculating, he might buy Goldman Sachs at some point in the future. Something like that. There’s all kinds of hopes like that.
Ben Felix: Whole lot of confidence going on there. Maybe it was justified in whatever.
Cameron Passmore: He also owns a big chunk of Robinhood.
Ben Felix: Yeah. He's big in crypto, like FTX was the exchange that he had, but he also had Alameda Research, which was a derivatives trading entity. Yeah, so big deal in crypto. Anyway, so my understanding is that he was previously worth 16 or 17 billion dollars. Now, he's no longer a billionaire. I don't know how accurate that is, but that's what I've been seeing. A big, big mess. There's been a bunch of very good articles written on what happened step by step, or what we think happened. We're not going to go into that here, but it's fascinating to read about this. It's fascinating to watch. It's just like the, I don't know, the type of finance drama that happens in unregulated markets, I guess.
Then the other thing crypto that happened is that the US Department of Justice recovered 50,676 bitcoins that were stolen from the Silk Road by a hacker in 2012. Hackers stole bitcoins in 2012. According to the Department of Justice post about this, the hacker did a whole bunch of complex transactions to try and cover their tracks. The details of how they tracked them down aren't there, but they did. It's just interesting to see that – when nobody is under the illusion that at this point, I don't think that Bitcoin’s anonymous, everybody understands that's not how it works. The fact that they are able to link this guy's wallet address to him as an individual and sees all of his assets, his crypto assets and his non-crypto assets, because they were ill-gotten is, I don't know.
Cameron Passmore: Are these the ones that were found in the popcorn can?
Ben Felix: Yeah. Some of them were, yeah, there was a floor safe and the bottom of popcorn tin. That's where, I guess, the hard drives must have been, or the cold storage wallets.
Cameron Passmore: Cold storage. Yeah.
Ben Felix: Yeah. This is what happens, right? Law enforcement catches up with stuff. That's what happens. Yeah. Very interesting week for crypto.
Cameron Passmore: Then you want to talk about Amazon. Interesting observation. Amazon became the first company to lose, or drop by a trillion dollars in market cap.
Ben Felix: Yeah. I remember, it was, I don't know, a year ago or something that we were talking about Microsoft and Amazon on the race to a trillion dollars. Who's going to be the first to get to a trillion-dollar market cap? Now, Amazon's made history as the first company to lose a trillion dollars, which speaks of the size of the company, right?
Cameron Passmore: You put these notes in before today's market moves. We're recording this the afternoon of November 10th, so the market’s about to close here. Amazon today, just as an observation is up almost 12%. It's now approaching a market cap of a trillion dollars again, which you’re talking about a loss drop of a trillion dollars.
Ben Felix: Yeah. Also, interesting to look at Facebook, or Meta. It seems like, it's solidly a value stock at this point. I was looking at the holdings of the Dimensional US vector and the Avantis US large-value products. Meta is a pretty sizable holding in both of those. I think it's become a value stock.
Cameron Passmore: Yesterday, announced layoffs. Was it yesterday, or today that are coming up? The markets seem to be reacting positively to that. Up 11% as of right now. I think, they’ve seen some people say that the PE ratios in the seven, eight range, I believe.
Ben Felix: Crazy.
Cameron Passmore: Crazy.
Ben Felix: I remember again, it wasn't that long ago that we were talking about the Fang stocks and then these seemingly invincible companies that just kept going up in price and debating amongst ourselves and with our listeners, whether it was a winner-take-all market, where these companies due to their network effects were just going to keep getting bigger and the returns were going to keep being higher and higher. We were saying, probably not. There you go.
Cameron Passmore: Now, the big move today is in fixed income. I don't know if you've seen this or not, Ben. I guess, the CPI numbers came out today and inflation was less than expected. Therefore, the market, I guess, the story I read is that they figured the interest rates increase in the future may not be as great. Therefore, bonds prices have gone up, yields have come down. We have a 2% move right now in the bond universe in Canada, in the SBB ETF. This shows it can happen so fast.
Ben Felix: Yeah. We were talking before we started recording about how we're glad to be in our seats. We're glad to be in the market on a day like today. Imagine trying to have timed everything going on in the market right now. It's that whole thing about if you missed that best day or whatever, you completely blow up your return. I think, this is one of those days.
Cameron Passmore: Small value right now is up five and a half percent. You miss that, that's AN expensive miss right? Even the Dow is at three and a half.
Ben Felix: Incredibly expensive.
Cameron Passmore: TSX is up three and a half. A lot of names are up a lot more than that.
Ben Felix: Yup. Got to stay invested to capture premiums.
Cameron Passmore: Be there to capture the premiums.
Ben Felix: Same thing for fixed income.
Cameron Passmore: Absolutely. All right, tax loss harvesting.
Ben Felix: Yeah. We already did our main topic, kind of, but there's this paper in the Financial Analyst Journal. It was 2021 paper on loss harvesting, but it takes a different approach. We talked about a paper back in episode 158. That was a 2020 paper in the Financial Analyst Journal. I came across this one and I just thought it was interesting enough to talk about on the podcast. They mostly look at loss harvesting through the lens of direct indexing programs, but they also touch on using funds as an alternative.
Then, this is what made this paper unique. They're looking at loss harvesting outcomes sorted by investor profiles, and they base those profiles on the US survey of consumer finances. They sort investors into types based on a handful of variables, which I'll talk through. Loss offsetting income to taxable equity, which they stayed as a ratio, LOI over EQ. That's a very important metric to sort investors on because you need to have capital gains to use to offset your capital losses. If you do a loss harvest, and you have no taxable gains in Canada, in that year, or the previous three years, there's no point to doing the loss, or harvest, or at least there's no immediate benefit to doing it.
If there's a cost to loss harvesting, you probably wouldn't do it, unless you had those gains available. In the US, it's a bit different. You can use losses to offset $3,000 of regular income per year. In Canada, you generally can't do that. There are some cases for small business corporations where you can, but that's not super relevant for this. Then they grouped people by, or investors by quarterly new cash flows into the portfolio. When you're contributing, you're always buying new shares, which affects your adjusted cost base. If you invest a lump sum and walk away, after, I don't know, a year or two years or something, there might be no losses in the portfolio. Again, there's no point in, or there's no ability to do loss harvesting.
Whereas, if you're contributing 10% the portfolio value per year or something like that, you're always resetting your adjusted cost base and potentially creating loss harvesting opportunities. Then they looked at the 15-year liquidation of the portfolio. They arranged that from 75% liquidation in the type one investor, which is supposed to be representative of a massive fluent investor to 0% for a type four investor, which is the ultra-high-net worth in their archetypes.
The idea is that at a lower net worth, the investor is more likely to need to liquidate more of their portfolio for consumption. Whereas, an ultra-high-net worth investor is not going to have to liquidate. Then the last thing they sorted by were the tax rates. The harvest tax rate and the spread between the harvest and the liquidation tax rate. If you can harvest at a very high tax rate today, which decreases your adjusted cost basis, so you're saving tax at a higher rate today, but you're also increasing your – or decreasing your adjusted cost basis, which increases your future tax liability, and then you sell at a much lower tax rate in the future, that's the best possible outcome for tax loss harvesting.
Cameron Passmore: For sure.
Ben Felix: If the current tax rates not very high, then there's not a whole lot of immediate benefit. If the spread between current and future tax rates is not very large, then a lot of the deferral benefit goes away. You get less of a bonus on the tax rate spread, I guess, if the spread is small. In a base case estimate using standard assumptions, like the same assumptions that other papers have used, which is no limit on offsetting income, so they assume that you always have capital gains to offset with the losses, and they assume no liquidation in this base case. In that case, they find a 104 basis point tax alpha, which is similar to other papers and very similar to the paper that we talked about in episode 158.
Then by group, so in the type one group, which is the mass affluent group, they find the estimate at 24 basis points, which is less than the fee on most direct indexing programs. Then at the type four group, which is the ultra-high-net worth group, they find a much larger 191 basis point tax alpha. But a big input there is the spread between current and future tax rates, which they had at 17%. They also had a higher initial tax rate.
For a US investor and maybe this is super relevant. In Canada, a high-net-worth investor is going to have a tax spread of zero, assuming no major changes in tax rate on harvest and liquidation. You're always going to be at the highest marginal tax rate and the capital gains rate is always the same. There's no spread. In Canada, the initial tax rate is also lower than what they're using in their model.
Then they looked at the effect of the return environment, or what actually the old paper that we discussed, the 2020 paper, but they refer to this as generational luck. Depending on the sequence of returns that you happen to get over your investment period, there's going to be an effect on the efficacy of tax loss harvesting of this strategy. We call it generational luck. A big portion of the tax loss harvesting alpha in this sample is explained by that, by the return environment, that you happen to get, which is completely outside of your control. Then the last thing they did their analysis here, they use boosted regression trees, which I'm not going to try to explain, but they use that to find the relative importance of loss harvesting of the loss harvesting alpha drivers.
They find that investor characteristics, like the tax spread, the harvest tax rate, the availability of loss offsetting income, the liquidation strategy, and the cash flows into the portfolio, those things together explain about 60% of the difference in tax loss harvesting alphas. While the return environment explains about 40%, which is significant. That's one of my takeaways is even if you can identify as the best possible candidate for loss harvesting, 40% of the outcome is going to be explained by the return environment that you happen to get.
Cameron Passmore: It’s wild.
Ben Felix: Completely outside your control. They find that their sample that when average returns were 6% or lower, there was a lot of tax alpha available. But when returns were higher, it was much more difficult to generate tax alpha. This is empirical using US data. They also find that to achieve a high tax loss harvesting alpha, investors needed to have an average volatility of at least 17% within the first 12 months, after making cash contributions to their taxable equity portfolio. That's part of that 40%. Which is like, a lot of stuff has to go right. You have to be making contributions, but the right sequence of returns has to happen after you make the contributions to get the high alpha.
In the end, they find that the ability to tax loss harvest in all return environments with direct indexing was of the clearest added value to investors with loss offsetting income to taxable equity ratio above 5%. At least 5% of the value of your taxable portfolio, you have that much per year, in taxable capital gains, which you can offset with losses. Then that includes in the US, the $3,000, of regular income that can be offset with losses. You have to have a meaningful, anticipated tax spread. To reiterate, that will not never be a thing, and at least currently won't be a thing in Canada.
The only thing we ever hear about is on that, on the spread is that it might get negative. Might go the wrong way, if the capital gains inclusion rate increases. I don't think we've ever had a discussion in Canada that I've heard on long-term and short-term capital gains, like lowering the rate on long-term gains, or anything like that.
Cameron Passmore: If we have, I've missed it also.
Ben Felix: Yeah. You have to have a sufficiently high harvest tax rate. Again, in their high tax rate case, in this paper, the tax rate is quite a bit higher than the highest tax rate on capital gains in Canada. For other investor types that don't meet those criteria, the authors of this paper suggest that the cost of direct indexing is likely not worth it. Investors may still want to engage in tax loss harvesting using funds, since the costs are much lower.
They find lower tax alpha for loss harvesting with funds, but they still do find a tax alpha, but with all the same problems. It doesn't work for every investor and it depends on the return environment and all that stuff. The big takeaway, and I already mentioned this, for me, and this is similar to last time I looked at this actually, is that the spread and the tax rates, and the availability of offsetting income are huge inputs to the equation. If you don't have those, you wouldn't do this.
I think it makes that case for when does tax loss harvesting as a strategy makes sense, have a very specific niche case in this be considered carefully. Then the other really eye-opening thing was that the 40% of the outcome was explained by factors totally outside anyone's control. Even if you identify as the perfect candidate for loss harvesting, there's no guarantee of a good outcome and you're paying an additional 30 or 40 basis points, in the case of direct indexing, at least. In the case of using funds, the cost is having to choose the loss-selling pair that may be sub-optimal relative to what you wanted to own.
If you're using total market index funds, not as bad, because like I mentioned earlier, the tracking error between two total market funds can be pretty low. If you try to use even Dimensional and Avantis small-cap value funds, for example, for a loss-selling pair, there can be meaningful tracking error over a short period of time. They can blow up any loss-harvesting alpha. They do make an interesting point in favour of direct indexing, which is that the probability of getting a good outcome increases because during bull markets, when time series volatility is low, which is what you'd care about if you're loss harvesting with funds, cross-sectional volatility is really the only way to get tax loss harvesting alpha.
If you happen to invest in a regime where time series volatility is low, and it's a bull market, where prices are going up, up up, you just won't be able to loss harvest. Whereas, if you're in a direct indexing program over that period, you may still be able to get some loss servicing alpha. It’s less effective in those periods, much less effective, but at least you might get something. I guess, it's not a new argument. It's a reasonably good argument for direct indexing though, but is it worth the 30 or 40 basis points? I'm still fairly unconvinced, especially for a Canadian.
Cameron Passmore: Fantastic. You'll be happy to know before I go to the book reviews that Oscar just barged into my room. I think I told you, I got my printer and little table here beside me. It's only about maybe eight inches off the floor, so he wedges hidden underneath this table and he gets so caught in there that if something happens in the house that he wants to get to, like someone comes to the door, he has a tripping over the printer cable and pulls off the – he's down here now.
Ben Felix: That just happened?
Cameron Passmore: He's just wedged on, it was to my legs and wedges down underneath this printer. I don't understand what he's doing. Anyways, he's here for the book reviews. You're good to go with that, book reviews?
Ben Felix: Ready to go. Yeah.
Cameron Passmore: All right, here's some six book reviews for you for financial literacy month. The first one, Geometry of Wealth: How to Shape a Life of Money and Meaning by our good friend, Brian Portnoy. Brian is a two-time guest, episode 102 and 126, and founder of the company Shaping Wealth. Brian's got amazing industry experience, many years doing mutual fund research at Morningstar, and also worked extensively in the hedge fund world. This book came out in 2018. It's really a book about the relationship between money and meaning. Until you define the purpose of your savings, you're not able to really formulate your priorities. Only once you have priorities, can you actually create a strategy for your investments.
Once these steps are in place, you can then start your journey towards what he calls, and this is such a great pairing of words, funded contentment. For me, Ben, this is the first book that I read. It really drove home that concept of having enough and what is the difference between being wealthy and rich. As Brian says, wealth truly defined as only achievable in the context of a life in which purpose and practice are thoughtfully calibrated. That's book number one.
Book number two, past guest as well, Fred Vetesse, Retirement Income for Life: Getting More Without Saving More, Second Edition. I wanted to include a book that was for people closer, or perhaps into retirement. Fred was a terrific guest on episode 104. Seems so long ago, 104. Widely regarded as Canada's leading pension expert. This book was released in 2020 as an update to his original 2018 one. He dives into topics really practically, such as early retirement planning, estate planning, what's the impact of low interest rates. Why would you want to defer your CPP, how to think about annuities and how to draw down your assets in retirement. Excellent resource, lots of practical ideas and an easy read. Highly recommend Fred's book.
The next one, Paul Merriman, another good friend of ours. He co-wrote a book with Richard Buck called We're Talking Millions!: 12 Simple Ways to Supercharge Your Retirement. Paul was an excellent guest and is a good friend of ours, back in episode 147. Although retired, there's a very large wealth management firm with his name on it out in the Seattle area that he founded many years ago.
This is a 160-page book that is widely available, including a free PDF online. In fact, at the front end of his PDF, there's links to lots of other free downloads. If you go to paulmerriman.com, you'll see it there. Or, if you just Google, We're Talking Millions, a PDF pops up right away. Paul is truly out to help people, and that came through in our conversation with him. This book has been dubbed as a simple blueprint for a favourable financial future. Goes through many the similar points we've talked about before, such as saving, starting early, owning equities, diversification, cut your expenses, index funds, factors, dollar cost averaging, and of course, rebalancing. Another great and again, free resource.
Next one from John Bogle, Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor. I'm sure, vast majority of listeners know John Bogle, legendary force behind Vanguard. We discussed the amazing mark that he's left on our industry in our conversation with Robin Wigglesworth in Episode 184. Also, I don't know couple months ago with Gus Sauter, in Episode 216. To me, the best testament for this book came from William Bernstein, who called Bogle’s common sense of mutual funds, perhaps, “The best introduction to basic finance that ever has been written.” I'm not sure we need any more reason to read it than that.
The original version of this book was written in 1999. Then this one was updated in 2010, with an intro from David Swensen. It's a great intro. David Swensen of BL Fame. Bogle’s lifetime message was always twofold, low-cost index funds are simply a sensible way to invest for most investors, and that the industry is basically to convince you otherwise. Legendary messages from Vanguard. The book goes through classic topics such as investment strategy, selection performance, tax and efficiency of many funds, time in the market and cost matter.
Ben Felix: Were we the bad guys earlier, convincing people otherwise? We might have been.
Cameron Passmore: Just expanding on the argument. Didn't say they're bad necessarily. Number five, The Investment Answer: Learn to Manage Your Money and Protect Your Financial Future by Dan Goldie and Gordon Murray. Dan Goldie is a registered investment advisor in California. His co-author, Gordon Murray chose to co-write this book in the remaining time he had while he was suffering from glioblastoma. He passed away about the time the book was released back in 2011. The book is 96 pages long. Extremely readable. Basically, breaks down an investor's decision into five steps. Do you do it yourself, or with an advisor? What is an appropriate asset allocation for you? How to diversify your assets, invest actively or passively and how to rebalance. This is by luck that we included this book, as was mentioned by our past guest, David Goetsch, which is what I'll be doing a 60-second review of in a little bit.
The last book I wanted to sneak in, because I read it this week, I thought it was great and it's very Canadian-centric, was a book by Erica Alini called Money Like You Mean It: Personal Finance Tactics for the Real World. I discovered this book earlier this week, devoured it in a few mornings. Erica is the personal finance reporter with The Global Mail. I think, Ben, you've done work with her, correct?
Ben Felix: Yeah. When she was global news, we talked for a bunch of stories, and she put me on TV surprisingly, once or twice.
Cameron Passmore: Yeah, so this is a super fresh book, targeting Gen Z's. Like I said, Canadian-centric, Canadian rules, easy to read. Covers up all the big parts of financial planning for managing credit, your credit score, buying a house, retirement planning, investment options, believes in indexing. Just a really great, well-written, readable package for Gen Zs. Had to add it in. I know it's number six. We had five two weeks ago, six this week. That's a great set of resources. All of them are available, all are affordable, some are free. There you go.
Ben Felix: Awesome. Good books.
Cameron Passmore: We're going to try another one episode in 60 seconds. I failed by 10 seconds two weeks ago.
Ben Felix: Oh, did you?
Cameron Passmore: I did. It was 70 seconds. Ben will do a clock somewhere. I don't know when the clock is going to be here, but ready to start the timer?
Ben Felix: Hold on. I’m going to time you.
Cameron Passmore: Time it.
Ben Felix: Ready?
Cameron Passmore: Yup.
Ben Felix: Go.
Cameron Passmore: Okay, so sitcom writer, Dave Goetsch, was our guest in Episode 26. His story is one of true transformation. Dave grew up worrying about economic uncertainty. Ironically, he ended up with a career in the economically volatile entertainment industry in LA area. Dave was always searching for a solution to shield himself from worry that he discovered the book I mentioned earlier, The Investment Answer. The book is full of great ideas and new ideas to him. This led him to find a great advisor. The advisor implemented a philosophy that gave him the confidence that he craved. Huge dramatic impact on Dave. He became a transformed investor. He emphasized to us in the episode, if you can stop worrying, you can be better at living the life you want to live. Think about how good that must have felt. Now, he wants his friends to have that same feeling.
Ben Felix: Nice. 47 seconds.
Cameron Passmore: Wow. Here we go. That was better. Okay.
Ben Felix: That's a cool episode with Dave. I like Dave.
Cameron Passmore: Yeah. The line I should have mentioned as well is his famous line to me that I use a lot is you learn to hug uncertainty, hug volatility. He was great. It's been a great –
Ben Felix: You could. You had 13 seconds. You could have fit that in.
Cameron Passmore: Yeah. Maybe I went too fast. Anyways, now we're at the low-pressure part of the episode for the three of us that still remain. Okay, I don’t know if we're going to call it, but we'll call today the close. You put a note here, about how many times it's been reviewed. We mentioned this, I don't know, month or so ago. It would be cool to get above 1,000. We're up to 907 reviews on Apple podcasts, which is pretty cool. When you poke around at other podcasts, there's not a lot that have that many.
Ben Felix: Yeah. Well, yeah. I mean, we've been doing the podcast for a while. A few people listen. I guess, some people left reviews over the last few years. It’s crazy. We've been doing the podcast four years.
Cameron Passmore: Four and a half years.
Ben Felix: Man. Crazy.
Cameron Passmore: Yeah. Very nice reviews. Casey Jain are on Apple Podcasts from the States, called this, “Favourite pod. I love this podcast. I'm a nerd, but half the time, okay, more. I'm so confused what they're talking about, but the cadence is so simple. So calm, so geeky. It's the perfect tone to relax to. After hours of listening, you'll start to learn! I'm starting to really enjoy the financial content now, as well as so really happy to leave a review.” Thank you.
Ben Felix: Very nice.
Cameron Passmore: So simple, so calm, so geeky.
Ben Felix: I'll take it. I’ll take it.
Cameron Passmore: All right, you to the next one.
Ben Felix: Billy VL in Canada said, “Great show for people interested in personal finance and investing. Great show. Got to say, one of my favourites. One ask for the team, can you put the names of the book view review in the show notes?” Do we not do that?
Cameron Passmore: Angelica said, we're going to make sure we do it.
Ben Felix: I think, we usually do. Maybe the episode Billy listened we haven’t.
Cameron Passmore: There's also a book list on our site of all the books.
Ben Felix: Yeah. A lot of books, though.
Cameron Passmore: It’s a lot of books. It’s a lot of books.
Ben Felix: What do you do with that list? You go, “Oh, I heard about a book,” and he goes like, “200 books in there or something.”
Cameron Passmore: Oh, it’s way more than 200.
Ben Felix: Is there?
Cameron Passmore: There's a way more than 200.
Ben Felix: We should organize that some hours. What do you even do with that at that point? They listen to podcasts while driving, so they don't have a chance to write the books down, but they want to somewhere to – I thought they were in the show notes. If it wasn't, sorry.
Cameron Passmore: The next one, I'm happy. I want to talk about this. Lut666 on Apple in Canada, “Amazing interview style. I've been listening for a couple years. I love your focus on happiness and living a good life. Your interview style is the best of any podcast. You effectively ask open-ended questions and you let the guests speak. Your talking points are concise and well-presented. It's too common in most other podcasts that the host rambles on with compounding leading questions, which hinder the guest’s ability to speak about the important or most relevant points. Keep up the good work. You're a shining example of how to execute a podcast.”
This is something that we talked about this that your style, and you go back and listen to old episodes, you can tell the questions get shorter, shorter, shorter. Now, I'm not sure we ever butt in. You can listen to other podcasts and this listener is right. You often get that preamble and compound questions. Then you wonder, as a listener, how is the person going to answer – these are two separate questions that have been bundled. It's like, just keep it short and let them speak. We're very deliberate about that.
Ben Felix: Yup. That's something that we always try and make the questions as short as possible. No compound questions. Open-ended questions. Those are all things we try to do. We've also gotten feedback in the opposite direction, saying that some people wish we would interrupt sometimes, but I always find those are somewhat a very, very specific point of view on something as like, “Why didn't you push back on this thing?” I don’t know, man. I don't share your point of view. That's why. How about that?
The ticker on Apple Podcast Canada, we should just send this to John Cochrane. This is for him. Not for us. “What an excellent review of economic theory. John delivers outstanding insight to economics. What a learning opportunity for anyone who's looking to understand modern economics.” Yes, we agree.
Cameron Passmore: We agree. I got a nice email. I've been pondering this message for a while, but my three-month-old has been keeping me busy. I'm an RR listener and a fan since late 2018. In all modesty, I think I didn't claim to be part of the early audience. This past summer, you guys shared some negative feedback you received in the podcast. For me, it was a trigger to decide to write you a message. It seems like, you read and appreciate the message you get. Here it goes. “To be honest, I don't get any of the negative feedback. The crypto series, for example, I don't know how much more transparent and clear you could have made this. If you're not interested, just skip it.”
Ben Felix: Hold on. Hold on. Okay. I mean, I think some people just don't pay attention to what's happening maybe, and then form opinions based on that. Every now and then, I see our podcast show up in Reddit threads where someone's – this happens. It's like, once every couple months, someone posts on Reddit, what are your favourite financial podcasts? Everyone suggests these threads. It's like, there should only be one of those. Why do you need to have a new one every few months? Anyway, they come up frequently enough. I'm always grateful that our podcast is often mentioned.
In the most recent one of these that I saw on Personal Finance Canada, that happened. Someone says, Rational Reminder. Then someone else says, that it's gone downhill in the last year. Then someone else is like, “What do you mean it's gone downhill? I didn't notice anything.” The person who had said that initially said, “Well, half their episodes are on crypto now.” Then someone was like, “Yeah, but they started a separate series. It's not related to the podcast. You can just skip those episodes.” Anyway, it's funny that people got upset about that.
Cameron Passmore: This person carries on. This is clearly labelled in the podcast feed and other criticisms you seem to have gotten is that not every episode is on hardcore, finance topic, but honestly, I can't imagine a better mix of subjects and guests. For me, all the evolutions in subjects have been without friction. I guess I'm just evolving together with the flow of the podcast. Okay, occasionally, there's a guest or subject, which is not my favourite episode. I suppose that's just life.
Ben Felix: Yeah, it is.
Cameron Passmore: I've been thinking about how to express how much I value the podcast and I've sold on the following. I would pay a subscription fee to get access and exchange for my Netflix account. I'm not sure my wife would agree. However, I hope you don't try and monetize the content, because new listeners might find it harder to discover. Just illustrate the impact of your content in my quest for a good life. We've hired a cleaning person, buying time, gone to one car, and I've taken up kayaking this spring to tilt towards more outdoors and healthy factors. I hope I don't come off too strong of a fanboy, but I just wanted to express my gratitude for all the content you created. If I’m a terrible if, but I'm sure can't be more than a vocal minority would cause you to stop the RR podcast. That's from MH in Brussels. We have no plans to monetize the podcast. We're not going to put up a paywall. That's not in the cards.
Ben Felix: No paywall. We've tossed around the idea of a Patreon because that's not the first time someone has said that. I want to give you guys money. That's not why we're doing the podcast, but if it makes people feel good, maybe it's interesting. I don't know. Anyway, so that's something we've talked about. Not monetizing the podcast, not making a paywall, not even making any special Patreon content, but just setting up a Patreon.
Cameron Passmore: People want to kick in. Because it does cost money. It's a pretty big organization now to pull it off. Who knows where that will go?
Ben Felix: Yeah. The cost of producing the podcast is no joke and maintaining the community and all that stuff around it, it's quite the thing.
Cameron Passmore: As always, connect with us. We're both on LinkedIn. I'm probably more active and connected on LinkedIn. Feel free to reach out, drop me a note anytime. We're both on Twitter as @rationalreminder. CP313 on Peloton and also, #rationalreminder on Peloton. Rational Reminder is on Instagram. There’s a lot more reels coming out now, too, which are pretty cool, if you're into reels.
Ben Felix: If you're into that kind of thing.
Cameron Passmore: If you’re into that kind of thing. Ben, anything else this week?
Ben Felix: No, I don't think so. I don't think so. I have some cool ideas for future episodes. I've been doing this financial planning course for Quebec. It's like, in Canada, one province, Quebec has real proper, tight regulation over professional financial planning. Because I moved to Quebec, I wanted to, I don't know, I don't have to do this, but I'm doing the financial planning certification course in Quebec. They have phenomenally good, well-developed content on what the financial planning process should look like. Anyway, so doing this study has given me tons of good ideas for future episodes with more financial planning focus. I think that should be fun. I don't know if that's this year or early next year, but they'll be coming.
Cameron Passmore: Yeah, we're taking on ideas around the goals survey as well, which is so cool. All right, as always, everybody, thanks for listening.
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Books From Today’s Episode:
The Geometry of Wealth: How to shape a life of money and meaning — https://amzn.to/3Od9J3N
Retirement Income for Life: Getting More without Saving More — https://amzn.to/3GpkHRN
We're Talking Millions!: 12 Simple Ways to Supercharge Your Retirement — https://amzn.to/3UI3uaE
Common Sense on Mutual Funds — https://amzn.to/3AjUsIM
The Investment Answer: Learn to Manage Your Money and Protect Your Financial Future — https://amzn.to/3UWeSPM
Money Like You Mean It: Personal Finance Tactics for the Real World — https://amzn.to/3g9bT7Q
Links From Today’s Episode:
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/
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Follow us on Twitter — https://twitter.com/RationalRemind
Follow us on Instagram — @rationalreminder
Benjamin on Twitter — https://twitter.com/benjaminwfelix
Cameron on Twitter — https://twitter.com/CameronPassmore
'An Intertemporal Capital Asset Pricing Model' — https://www.jstor.org/stable/1913811
'Risk and Return of Value Stocks' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=112553
'The Value Premium' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=351060
'A Consumption-Based Explanation of Expected Stock Returns' — https://repository.upenn.edu/cgi/viewcontent.cgi?article=1146&context=fnce_papers
'Who Are the Value and Growth Investors?' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2426823
'Is There a Replication Crisis in Finance?' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3774514
'Amazon Becomes World’s First Public Company to Lose $1 Trillion in Market Value' — https://www.bloomberg.com/news/articles/2022-11-09/amazon-hits-unwelcome-milestone-with-1-trillion-in-value-lost?leadSource=uverify%20wall