Angelica Montagano

December 10, 2020

Decision Making, Financial Literacy, Financial Planning, Goal Setting, Happiness

Episode 128: Morgan Housel: The Psychology of Money

Angelica Montagano

December 10, 2020

Decision Making, Financial Literacy, Financial Planning, Goal Setting, Happiness

Morgan Housel is a partner at The Collaborative Fund and a former columnist at The Motley Fool and The Wall Street Journal.

He is a two-time winner of the Best in Business Award from the Society of American Business Editors and Writers, winner of the New York Times Sidney Award, and a two-time finalist for the Gerald Loeb Award for Distinguished Business and Financial Journalism.

As author and financial expert Morgan Housel explains this episode, “people don't make financial decisions on a spreadsheet. They make financial decisions at the dinner table.” Today we chat to Morgan about his key insights into financial decision-making — many of which are captured in his book, The Psychology of Money. Our conversation opens with an exploration of how investing success has less to do with what you know and more to do with how you manage your behaviour. We then look into the dangers of emulating top investors and how luck can fuel success. Reflecting the theme that people invest according to their unique circumstances, Morgan shares why he prioritizes endurance as an investor by minimizing his debt and having high cash reserves. After hearing his take on debt and whether young people should use leverage, we dive into how financial expectations impact investing and the importance of deciding what ‘enough’ means to you. We discuss the virtues of saving like a pessimist and investing like an optimist before looking into the role that financial advisors play in guiding their clients. In the latter part of the end of the episode, Morgan touches on active versus passive investing, the purpose that bonds serve in your portfolio, his top lesson from 2020, and why he’s empathetic toward people who sell their portfolios during a downturn. Throughout our discussion, Morgan shares his clear understanding of how our psychology affects our relationship to money. Tune in and benefit from his incredible perspective.

Key Points From This Episode:

Introducing today’s guest, financial author Morgan Housel. [0:00:15]
Morgan shares his view that succeeding in investing has little to do with how you behave. [0:02:31]
Hear about the problems that can arise from trying to emulate top investors. [0:05:02]
Exploring the impact of luck on your success. [0:07:37]
The differences between being conservative and having a margin of safety. [0:08:35]
Insights into Morgan’s personal investing strategy. [0:09:48]
Morgan’s thoughts on leverage and how debt impacts behaviour and peace of mind. [0:10:31]
Stepping off the hedonic treadmill and the importance of defining your financial expectations. [0:14:02]
The link between money, independence, and having a high quality of life. [0:16:44]
What it means to be wealthy and what motivates the drive to be rich. [0:19:18]
Morgan’s advice to save like a pessimist and invest like an optimist. [0:21:34]
Why no one makes perfectly rational investing decisions. [0:23:54]
The role of financial advisors in guiding clients towards their investing decisions. [0:26:22]
Why Morgan has embraced the simplest investing strategy available to him. [0:29:02]
How you should be thinking about fixed income in your portfolios. [0:31:20]
Why financial advisors can be priceless when understanding your finances and goals. [0:33:44]
Life is surprising; hear why this is Morgan’s top takeaway from 2020. [0:36:29]
Morgan’s thoughts on the FIRE Movement and retiring early in life. [0:38:53]
Hear Morgan’s predictions on the next big financial innovation. [0:41:49]
Why Morgan is empathetic towards people who sell their portfolios during a downturn. [0:43:50]
The tendency for people to embrace more extremist views during times of financial crisis. [0:47:34]
We ask Morgan how he defines success in his life. [0:50:25]

Read the Transcript:

A line you wrote in the book, The Psychology of Money, when you're talking about the field of finance and you said, "At no other field can someone with zero experience do better than someone who has spent a career studying finance." Can you talk about the implications of this statement and what that means for the average investor?

We know the notion that you can have someone who has never worked in finance, does not have any financial training or background, but still let's just say hypothetically they dollar cost average into index funds and they leave it alone for 40 years. That person will probably do very well as an investor. They might literally be in the top decile of all investors over the course of their life, without any training, any skill, any background. They didn't work at Goldman Sachs, they didn't go to Harvard Business School, and they can still do very well. There aren't many other fields where it's like that.

Can you imagine a world where someone who did not go to medical school and had no medical training ended up in the top decile of heart surgeons? It would never happen. It would be impossible to consider that. But it does happen in investing, and there's two explanations for that. One, you could say that there's a lot of luck involved in investing. People who don't know what they're doing per se do well. Maybe there's an element of luck. And I think that could be one answer, and I talk a little bit about that in the book.

But to me the bigger answer and explanation and takeaway from this is that doing well at investing is not about what you know. It's not about how smart you are. It's not about where you went to school or how sophisticated you are. It's not about the amount of information that you have. Doing well at investing is by and large how you behave. It's whether you can keep your head on straight when the world feels like it's falling apart. It's things like your relationship with greed and fear and who you trust, who you seek information from.

And all those things have virtually nothing to do with where you went to school or what you got on your SATs. It doesn't have to do anything with that. It's much more about your behavior, your psychology, which can vary from person to person and is really not correlated to your intelligence. You can have someone, and we write about this in the book, people who did go to Harvard Business School and are textbook geniuses who fail miserably at money because they don't have the behavioral side. So I think the behavioral side is important because it has the ability to neutralize any of the analytical intelligence that you bring to the table in investing. And I think that's why the psychology of investing, the psychology of money is so fundamentally important in this endeavor.

People often look at great investors, sort of people that have had a good outcome through history like Buffett and Dahlia would come to mind, or maybe people like Ben Graham; and individual investors who want to try and emulate people like that, the people that have had really good outcomes. Can you talk about some of the problems that that raises?

I mean, so much of the issue with trying to copy other great investors, it's not that you shouldn't do it. It's not that it's a problem. I've done it myself. I continue to do it myself. I tend to think that the lessons that we learned from them are way too specific. And the more specific the lesson that you learned from those people are, the less likely that you will be able to copy it and emulate it yourself. And rather than looking for specific lessons, I think we should be looking for the big, broad 30,000 foot takeaways that we can learn from these people.

If you look at Warren Buffett or Benjamin Graham and your takeaway is you should buy stocks that trade for less than 1.2X of their networking capital, if that's your takeaway, that's probably not going to be that helpful for you because we live in a different era. Maybe that worked in 1960, it might not work today. So like if it's really specific, it might not help. But if your takeaway from Warren Buffett is, hey, he has been compounding for 80 years, and that has been the main driver of his net worth over time, just the fact that he's been a consistent investor for 80 years, that's a good takeaway. A really big, broad takeaway is something that I think that we can emulate.

There's another chapter in the book that I write about Bill Gates. There's so much that we can and should learn from Bill Gates about the power of hard work and putting and taking risks. There's a lot to learn from Bill Gates. But if your takeaway from Bill Gates is really specific about how to build a software company and whatnot, that might be much less. That's something that you won't be able to copy as much as people think.

There's also this element of luck that takes place in the big successes, people who are extremely successful, who are the people who we tend to look up to, who we want to emulate. The more successful that someone is, the more likely it is that a degree of luck fueled their success. Not 100%. I'm not saying Bill Gates and Warren Buffett were just lucky. But is there an element of luck involved in it? Yes, of course. There's a very big element of luck involved. And therefore the ability for me or you or anyone else to copy their success is substantially hindered because you cannot emulate luck. That's why, again, it's just important to pull from those stories the biggest broadest lessons about behavior, rather than the technical specific takeaways from what they've done.

One of Bill Gates best friend in high school was a guy named Kent Evans. And by Bill's recollection, Kent was smarter than Bill Gates, harder working than Bill Gates, had a better business mind than Bill Gates and Kent and Bill's plan was that they would go to college together and go and start a company together. So you could easily imagine a world where Kent Evans was the founder of Microsoft, maybe the bigger person in Microsoft than Bill Gates was. But he tragically died in a mountaineering accident when he was 18 or 19 years old and that ended it right there. So you have this one kind of just crazy stroke of bad luck of risk that sent things in the other direction.

Can you talk about the difference between being conservative and having a margin of safety which you talked about in the book?

If you look at my personal finances, people might think that I'm conservative because I have a reasonably high percentage of my net worth in cash. I don't have any debt. People might look at that and say, "I just don't want to take a lot of risk. I'm kind of scared. I don't want to take risks." I don't think that's the right way to look at it. I don't think I'm conservative. What I want to have is endurance. I want to be so unbreakable financially in the short run to increase the odds that I will be able to stick around as an investor for the stocks that I do own to compound for the longest period of time. If you understand the math of compounding, you know that the big gains come at the end of the period.

If you're investing for 30 years, the biggest gains in dollar terms are going to come in the last couple of years. That's how the math of compounding works. It just gets exponentially higher as time goes on. So to me, the number one thing that I want to do, and I think this is true for a lot of investors, is just maximize my endurance, maximize my durability as an investor. And I do that by having a reasonably high percentage of cash and having no debt. It's not that I don't want to take a lot of risk, it's that I want to maximize for endurance.

So I think a lot of conservative investing strategies are kind of mislabeled and a lot of really aggressive investing strategies might be mislabeled as well. If you're someone who is really swinging for the fences, but by swinging for the fences you are dramatically increasing the odds that you're going to get kicked out of the game, either financially or psychologically you're going to get scared out, or you're going to get kicked out because you get a margin call, you have too much debt, whatever it is. That might work, but that's just not the game that I want to play. The game that I want to play is acknowledging how ridiculously powerful compounding is and therefore increasing the odds that I will be able to stick around long enough for compounding to work. That's the game that I want to play. And it might look conservative, but to me it's actually the opposite.

Can you expand a little bit more on the concept of debt? Can you just talk a little bit more about your thoughts on the use of leverage?

I mean, here's one way I think about it. There's this really interesting study from Yale probably 10 or 12 years ago that came out and the study showed that historically if you back test this, that most investors should use 2X leverage, 2X margin in their investing account. And they basically showed that even if you get wiped out, as you will once every 30 years or so, even if you get wiped out, as long as you start investing the next day, again with 2X leverage, over the course of your life, you will end up ahead. You'll end up dramatically ahead. That's what the data shows. Like everyone should be 2X margined in their investing accounts. And that was the end of the study. That was the point that they made.

And to me it just seemed ridiculous because it ignored the idea that if you are investing in your retirement account and let's say at age 45 you get wiped out, you lose everything, what are the odds that you are going to wake up the next morning and say, "Okay, let's get back in the game. Let's keep investing at two." The odds of you doing that are zero. If you get wiped out, you're going to say, "Screw this. I'm never doing this again. This has been a scam. I'm out of here." So to me the math of leverage, even when it works, if it ignored the psychology of enhanced drawdowns or catastrophic drawdowns, you're missing the big picture here. So I think that's one element of debt.

To me, the other element of debt that gets a little bit more philosophical, I guess, is that my financial goal, and this is my goal. It doesn't have to be everyone else's goal. But my goal financially is independence. I want to control my time. I want to wake up every morning and just say, "Whatever I want to do today, that's what I'm going to do. I don't want to be beholden to anyone else. I want independence." And what debt does is it takes your future income and it gives it to someone else. It's just making you beholden to someone else.

So that's why I write in the book, my wife and I paid off our mortgage a couple of years ago, which I read in the book was the worst financial decision we've ever made. You'd be like, "I cannot justify it on a spreadsheet. It makes no sense whatsoever. It's not rational." When people ask me to justify it, I say, "I can't. I can't justify. It doesn't make any sense whatsoever." But I think it was the best money decision that we ever made because it dramatically increased at least our perception, our feeling of independence. This idea that this is our house, no one's going to take this away from me. Our monthly expenses now are ridiculously low because we have no housing.

It just increased our independence, even if it made no sense on paper. So that's another element of debt that I think goes misunderstood. And a lot of that for both of those points is this idea that people don't make financial decisions on a spreadsheet. They don't make them in Excel. They make financial decisions at the dinner table. That's where they're talking about their goals and their own different personalities and their own unique fears and their own unique skills and whatnot. So that's why I kind of push people to say like, it's okay to make financial decisions that don't make any sense on paper if they work for you, if they check the boxes of your psychology and your goals that makes sense for you. And for me, extreme aversion, what looks like an irrational aversion today, and I would say is an irrational aversion to debt, is what works for me and what makes me happy, so that's why I've done it.

This makes me think of chapter three of your book called Never Enough where you had some pretty powerful stories about people with lots of money who lost it because they wanted more. Maybe can you define what enough is?

Well, I think the most important financial skill for anyone is just getting the goalpost to stop moving. Like if you are lucky enough to have a rising income and a rising net worth over time, but your expectations increase in lockstep with your net worth, with your income, you're not going to feel that much better off. It's a classic hedonic treadmill that everyone knows about. And so for me, we spend so much time in this industry talking about how to raise your income, how to grow your wealth, how to increase your investment returns, which is great. That's obviously an important part of the equation. But I think we almost need to spend just as much effort managing our expectations because if we don't, then we're just going to be on this treadmill over time of wondering what the purpose of this is and wondering why we are not happier than we assumed we would when we had X amount of dollars or X higher income.

Why aren't we happier than we assumed we would? And I think the answer is most of the time, because your expectations grew at the same amount if not faster than your income. We can quantify some of this at the macro level. If you look at the median household income adjusted for inflation in the 1950s, it is about twice as high today as it was back then. The median income adjusted for inflation double what it is today than it was in the 1950s. But we look at the 1950s by and large as this nostalgic period of middle-class wealth and prosperity. Like that was the era of middle-class prosperity, but we're twice as rich today in median terms than we were back then.

Why is that? To me I think the answer is because our expectations of what people expect out of a material life have more than doubled since the 1950s. So even though our incomes have doubled, if our expectations have more than doubled, we feel like we're worse off. And that is something too that you can quantify. The median square footage of a new house in the 1950s was less than 1,000 square feet. It was 950 some odd square feet. Today it's about 2,400 square feet of a median new house in the United States.

So there again is even if our incomes have doubled, if our expectations of what we want out of life materially have more than doubled, we feel like we're worse off. And that just gets to this idea of having a concept of enough, which is going to be different for everyone. And I'm not saying live like a monk and don't expect anything good out of life. That's not the point either. But if you don't have a sense of what enough is, and if you don't go out of your way to manage your expectations and keep your expectations lower than they might otherwise want to be, you're never going to be that happy with the money that you have, especially if you're lucky enough, again, to have a rising income and rising net worth over time.

Can you talk about money’s greatest intrinsic value?

I had touched on this a little bit earlier, but to me the greatest intrinsic value is independence. And look, it's not that I don't like stuff. I like nice cars, I like nice homes as much as anyone else. But to me, what money really does for you that can really increase your quality of life, more than any of the material stuff, is giving you independence and control and being able to do what you want when you want with who you want for as long as you want. That to me is something that I think you will never get accustomed to, that every morning that you have independence. You will wake up and say, "This is great."

You will get accustomed to the Ferrari, you will get accustomed to the mansion to where its benefit to you will be diminished over time. But independence is something that I think you'll never get over. Or more to the point, not having independence is something that will always hurt if you don't have it. If you don't like your job, you don't like what you do but you're forced to do it because you have to do it to pay your bills, that level of lack of independence is something that will lead to a less happy life for most people most of the time.

I always just want to use savings and wealth that I can save and build over time as just increasing my independence, like decreasing my dependence on other people and being able to do the work that I want when I want to do it for as long as I want to do it. And one day just retire when I want to do it. And just waking up one day and saying, "Look, I've had a good career as a writer, I've had fun, but my time is up. I'm going to bow out here gracefully when I want to, rather than when I'm forced out to do it," that is something that's really important to me.

I've always really looked up to people like Jerry Seinfeld who quit on top. Seinfeld show was the top of the world and when he was going to renew in I think 1998 or 1999, NBC was going to offer him $100 million for one season. And the show was the biggest thing in the world and he said, "Nah, I'm good. I've had enough. Thanks for everything." And he mentioned at one point that the reason that he wanted to quit on top is because he had no desire to experience the downside.

He didn't want to quit when the show's ratings fell off a cliff and then he was forced out. He didn't want to experience that. He said, "Look, I'm quitting on top because of that, because it's just like I've had enough and this is good and I'm going to bow out here." I've always had so much respect for people who can manage their careers in that way. And I think if I can have, and if other people can have, a level of financial independence that lets them do something similar to that, to quit on their own terms when they want to rather than being forced out, is something that's really important to a quality life.

So is independence or the drive for independence what someone is really seeking when they say they want to be a millionaire?

I think the first thing is that it's different for everyone. There are some people that really genuinely want to work until the day that they die. And that might be me as well. I'm not discounting that either. So it's different for other people. But there is a thing when people say, this is something that I observed many years ago, that particularly young people, particularly young men to single them out, when they say they want to be a millionaire, what they really mean is I want to spend a million dollars, which I'd read a book is literally the opposite of being a millionaire; which gets to this point of like, what is wealth?

And to me, wealth is what you have not spent. That's what wealth is, is money that you've saved, that you've invested, that you have not spent yet. And what's important about that is that that makes it so that wealth is invisible. Because I can see your clothes, I can see your car, I can see your house. I can not see your bank account. I can not see your brokerage statement. I have no idea how wealthy you are. You have no idea how wealthy I am because you can't see that. So what is visible to us is like the opposite of wealth in the world.

And so we go through a lot of life without any clue how wealthy or poor some people are. It's a very deceiving thing. It's almost the opposite of physical fitness. Because if someone is physically fit or someone is obese, you can see that, it's visible. Therefore you can say, "I want to look more like this person. Here's someone whose physique I admire. Maybe I should go work out because I want to look like that as well." It's visible and you can see it, but it's not how it works in finance. Since we have no idea by and large how wealthy most people are or the opposite of how buried in debt some people who look like they're wealthy are, we go through life with I think a lot of false role models.

It makes it very difficult to really look up to the right people and emulate the right people. And by and large, the people who look wealthy because they're driving a fancy car, they live in a nice house, whatever they give the appearance of wealth, a pretty shockingly high percentage of those people are not people who you would actually consider wealthy if you saw their finances. There are people who are leasing Ferrari's and they're buried in debt with huge mortgages that they can barely pay every month. And it just makes the appearance of wealth much more difficult to grasp than I think people imagined.

One of the big things in committing to a long-term investing strategy using low cost index funds, that kind of thing, is optimism. But when you look at the news and when you just look around anywhere, there's so many reasons to be pessimistic. Can you talk a little bit about some of the ways that people can deal with the pessimism that's so hard to escape?

I mean, to me I think the big philosophy that I have for my own money, and I think it would work for a lot of other people too is save like a pessimist and invest like an optimist. You need to save like a pessimist with the idea that if you look historically, bad news is the default. Like in any given year, any given month, all around the world, things are breaking. Things are breaking all the time. If you look at the economy, the history of economics is kind of a constant chain of recessions and bear markets and companies going out of business and missed expectations. It's a lot of bad news. So you need to save like a pessimist so that you can survive that gauntlet, the never ending short-term gauntlet that is always going to be the case. And that's why for me it's having a reasonable amount of cash and no debt so I can survive that gauntlet.

But on the other hand, you want to invest like an optimist because if you also know economic history, you know that in any given decade, in any given generation, for almost everyone almost everywhere, there's a lot of progress. And if you understand the power of compounding over the course of your lifetime, there could be a ridiculous amount of progress that's going to accrue to you as an investor, make you very wealthy. Those two skills seem like they're conflicting; save like a pessimist, invest like an optimist.

But I think the way that I phrase in the book is there's a difference between getting rich and staying rich. Getting rich requires being an optimist, swinging for the fences, taking a risk, being really optimistic about humanity and people's ability to solve problems. Staying rich requires almost the opposite. It requires a certain degree of paranoia about uncertainty and things that you don't know and not wanting to take a lot of risks so that you don't get wiped out. And you need to nurture both of those skills at the same time. They need to be nurtured separately.

And I think it's hard to do that because they seem like they're conflicting. It's much more intuitive to think that you should either be an optimist or a pessimist. You should either be like the dewy eyed, everything's going to be great; or you should be the bunker living, things are going to fall to pieces. It's more intuitive that you should be one of those, but I think you need to have elements of both to do well for the longest period of time.

Great answer. This is the Rational Reminder Podcast. Do you think people should try to be rational?

I write in the book that no, I don't. And it's not that I don't think people should be rational. It's that I think that, again, people don't make financial decisions on a spreadsheet where all the numbers match up and think of investing like it's physics or math where two plus two equals four for me and you and everyone else. It's all just a clean equation that gives you an answer and then you follow the answer. I just don't think that's what finance is. Since everyone has different personalities, different histories, different goals, different family dynamics, different expenses, different views about politics in the world; equally intelligent informed people are going to come to different decisions and what I do with my money might not make any sense for you and that's okay. It doesn't mean that we disagree, it just means that this is different.

It's very similar to how people date and find spouses. Everyone has a little bit different view of what they're looking for. You cannot summarize what makes a good spouse into a math equation. It's just not how it works. It's a very nuanced and personal thing. What works for you might be different for me, but that's fine. We're like, if it works that's great. So I think for financial decisions, aiming to be reasonable instead of rational is probably the better goal for people. And just like I mentioned earlier with my mortgage, that's not rational.

Whenever I mention that, there's always someone who tries to walk me through the math and I shut them down and I'm like, no, no, no, no, no. You're right. The math makes no sense. It's not rational. I know it doesn't make any sense, but it's reasonable for me. It's what I wanted to do and it made us happier, so that's why we did it. And I think if more people kind of embrace that, that being reasonable is the best you can do, that's great.

I mean, one other example is the well-documented home bias in investing where people who live in the United States by and large only own US stocks, people who live in Germany only own German stocks, et cetera. There's a home bias to investing. It's not rational at all. There's no reason to think that the companies based closest to your house are going to perform the best. There's no ration to that, but it's pretty reasonable if owning companies that you are familiar with because you drive past them every day.

If that helps you take the leap of faith of being able to stick with a company for a long period of time because you're familiar with it. It's not just some company you've never heard of, you've never seen their logo, you have no idea what they do. But if you're owning companies that you're familiar with because they are based in your hometown, that's actually a pretty reasonable thing to do. If it's going to help you stay in the game and stay motivated, then that's a reasonable thing even if it's not rational.

Where do you see the role of financial advice fitting into all this? If we're saying it's good for people to make reasonable decisions, does it also make sense to have a sort of rational voice in your ear for some people to find a balance between what's rational and what's reasonable?

Yeah. I think one good analogy here is a doctor because if you go to see the doctor and let's say you have a very serious terminal illness, what most doctors will tell you, and I'm not a doctor, this is just my impression. What most doctors will say is, "This is what's happening. These are your options. Here's what I can do." And then they will say, "What do you want to do?" And the reason that they do that is because let's say someone has terminal cancer. One patient might say, "I want surgery. I want chemotherapy. I want everything" Another patient might say, "I just want morphine and palliative care and I'm just going to go home and let nature take its toll." And both of those answers could be right for that person.

So the role of the doctor is basically to lay out the options and lay out the science and then let the patient do what they want to do. And I think financial advising is very similar. Luckily the stakes are usually not quite as high as that, but if you're a financial advisor and you can say, "This is how the economy works, this is how investing historically works. These are our options. Now let me ask you, what do you want to do? What makes the most sense to you?" Because different clients who are the same age, same income, everything, might come to completely different conclusions, and that's fine.

So I think the less that we can view finance as a one-size-fits-all endeavor and the more that we can view it as a personal endeavor. There's a great quote from a financial advisor named Tim Maurer who says personal finance is more personal than it is finance. I think the more that financial advisors can embrace that, the better they're going to end up doing.

And I think what that means is that a financial advisor views themselves less as a gatekeeper of knowledge and information, and more as a personal financial psychologist who's just laying out the options and then helping you make the decision among the options that you have in front of you, and realizing that everyone's going to be different rather than like an engineer. You're paying the engineer to get the information from them. I think that's not what a financial advisor should do. It's much more about helping you contextualize your own life and how you can use a financial plan to help that.

I think it's really important and it's hard for people because a lot of people want to think that finance is like math where two plus two equals four for everyone. And I just think it's not. It's much closer to something maybe even like medicine or like relationships where equally smart people come to very different conclusions.

Can you talk about a scenario where it might be better off being active when trying to beat the market?

Well, look, I'm a pretty passive investor. There's a chapter in the book where I lay out my household finances. There's no numbers but I just show you, here's everything that we do with our money. I'm a passive investor. My entire net worth is a house, a checking account and some Vanguard funds. That's everything we have. But I'm not a passive zealot. I'm not one of the people who say you can't beat the market, don't even try, no one should try to do it. Everyone who tries is just trying to scrape fees off. I'm not that person at all.

I know that there are investors who will outperform the market and I'm friends with some of them, but I still don't invest in their funds. Why? Does that seem hypocritical? I don't think it is because to me, again, what I'm really trying to maximize for is endurance. And if I can stay invested in my index funds for another 30, 40, 50 years, I'm going to check every financial goal that I have and then some. I'll probably end up literally in the top decile of all investors if I can do that. But that's a big if.

My strategy for investing, again, is increasing my endurance and I'm going to do that if I can have the simplest investing approach possible. If I can have the fewest knobs to fiddle with, the fewest levers to pull in my investing life, that will increase my ability to leave it alone. The fewer decisions that I have to make, the more endurance I'm going to have. So that's why I want the simplest strategy. It's not because I don't think people can beat the market. It's that if I invested in those funds, if I employ those strategies, it would decrease my endurance. The more decisions I have to make, the more odds are to make a decision that's going to screw everything up.

Charlie Munger has a great quote where he says, "The first rule of compounding is to never interrupt it unnecessarily." And that to me is like, that's what I want written on my investing tomb. That to me is all of investing summarized. The simple approach that I have is hopefully going to increase my endurance. But I understand that my personality and my goals won't be for everyone. So if you are an investor who know what is really important to you is that you beat the market this year over the next five or 10 years, I think there are investors out there who can do that. And I would recommend some of them to you, even if it doesn't necessarily work for me.

You talked about the maybe misconceptions around what it means to be a conservative versus an aggressive investor and you talked about your personal large cash allocation. How do you think people should be thinking about fixed income in portfolios?

I think the biggest thing about fixed income is that we had a 40 year period now with falling interest rates where you could earn great returns on bonds. If you own long-term treasury bonds for the last 30 or 40 years, they probably did better than your stock portfolio by and large. And I think it's important to realize that now that we live in this zero interest rate environment where that doesn't occur anymore, it was the 40 year period where you could earn 10% a year on your bonds, that was the anomaly. What we're dealing with today is not the anomaly where bonds don't give you that much real return. That's kind of par for the course. It was a period from 1980 to 2010 where bonds were just incredible return generators. That was the historical fluke.

So I think it's important to shift our expectations from something that generated wealth to you towards what I think is the real purpose of bonds, which is providing an airbag to your psychology to make sure that you do not get scared out of the stocks that you do own. So if you have a 60/40 portfolio, the 40% that you have in bonds, the sole purpose of that is to make sure that you can leave the 60% you have in stocks alone. That's its purpose. That you don't get scared out, that you don't get pushed out financially or psychologically. And that's a really important part of a portfolio.

If having 20, 30, 40% of your assets in bonds will keep you from selling your stocks in March of 2020 or in 2008, then the 0% return that you're going to earn on your bonds is well worth it because the amount of damage that would be inflicted if you panicked in March of this year is something that you're never going to be able to make up for. So really it's still a very valuable part of your portfolio and it's easy to look at your bonds and say, "Oh, my bonds are yielding 0.3%. That's the return I'm getting."

And I think I would caution against that. I would say, "No, the real return you're getting is actually very high because if they can prevent you from panic selling your stocks, then the return, the hidden return on your bonds is actually through the roof and it's going to make all the difference in the world to your lifetime investing returns." So it just has to do with shifting your perspective on what the purpose of bonds is.

Can you talk about the importance of an advisor in that relationship and the impact of so many popular robo-advisors and do-it-yourself investment resources out there?

I think, again, to use an analogy of doctors, most doctors have their own doctors that they go see. If you are a family doctor, you have your own family doctor that you see for your own health. And it's not that going to another doctor because they have more information than you. Like if you are a doctor yourself, you have all of the medical knowledge that someone else has, but you still go to another doctor because you need someone else who does not have the emotional baggage that you do that can look at your life with a clean unbiased set of eyes and can identify parts of your life that might be unhealthy, that you might have a higher propensity to overlook because they're uncomfortable to talk about, whatever it is.

I think investors should have the same. And even if you are a very smart, sophisticated investor and you know everything, it's still important to have some sort of advisor who you go and talk with, like you can bounce stuff off of. I didn't speak with a financial advisor at all until about a year ago, until I had a good friend of mine who is a financial advisor. I just opened the kimono into our personal finances and he had a lot of insight that I never would have considered. And it was really eye-opening to me in terms of my ego at the time of saying, "I know a lot about investing. This is what I do for as a profession. I don't need a financial advisor." And then my friend brought up 10 points that I had never in a million years considered that we were doing. So that was really eye-opening to me.

And a lot of the points that he brought up, I won't go into details about them, but there were probably things that I was overlooking because they were a little bit too painful to consider. Maybe they were too boring to consider. But they were so obvious when he brought up, which is just to say that I think the purpose of a financial advisor is, again, it's not necessarily being a gatekeeper of information. It's being an unbiased set of eyes to people to uncover and discuss topics that someone else would not consider because they're too painful to consider or too boring to consider in their own lives.

Again, it's much more closer, I think, to being a financial psychologist, which was not the case 20 or 30 years ago when back before the internet era, a financial advisor was an information gatekeeper. If you wanted to learn about what the best funds were, if you wanted them to learn about the new rules in the tax code, you had to go to your advisor at Merrill Lynch because there was no other way to get that information. Not the case anymore. All that information is for free for everyone online. You can get custom portfolios from Vanguard and Betterment. You don't need an advisor. But the value of an advisor is still incredibly important in that ability to really analyze someone's life in a way that they would not analyze on their own.

Are there any lessons that we can take away from a year like this?

I think that the biggest lesson, this was well before COVID, this was maybe 2017. I went to a large dinner with Daniel Kahneman. And Kahneman is a psychologist who won the Nobel Prize in economics. And he mentioned something that I love. He's so quotable. He said, "When you are surprised, the biggest lesson that you should take away from that is that the world is surprising." It's not that, "Oh, I was missing this bit of information and now I should incorporate that into my forecasting model." The lesson from surprises is that the world is surprising. I think that's the lesson from 2020.

To me, the biggest risk in any given year is usually what no one is talking about until it happens. It's not what's in the news, it's not what we've been predicting for months, it's not trade wars, it's not the election, it's not the pending legislation on the tax code. It's under those things that are not risky but we know about them. They're in the news, we know about them. The biggest risk is always something like COVID-19 or September 11th or Pearl Harbor, something that no one was talking about until the moment it happens.

And I think that's going to be the case in the future as well. I think we can confidently say here today that the most important news story of 2021 is something that no one is talking about today. It's impossible to talk about because it hasn't occurred or there's information that no one has yet. And I can confidently make that prediction because that's how it works every year. The biggest news story in every year is something that was a surprise, and COVID-19 is like a blunt force in your face example of that that completely changed the world.

But that's always going to be the case. And the longer the time horizon, the bigger that's the case as well. If we talk about what's going to be the biggest news story of the next 50 years, 100% chance that it is something that you and I or no one else is talking about today. It's going to be a complete surprise. The surprising aspect of it is what makes it a big deal because no one's prepared for it. So it completely upends their plans, people get completely wiped out overnight because something happened that they weren't expecting. I think that's always the case. It's the classic Taleb Black Swan idea that the biggest things that move the needle in history is what no one is prepared for that have these outsized consequences.

You mentioned earlier that you place a high value on independence and that's an important part of money, and I completely agree. What do you think about the maybe extreme end of that with the Financial Independence, Retire Early movement?

I think it's by and large great. If there's something that I might, not disagree because everyone's different, but if I raise a skeptical eyebrow to a part of it is that actually quitting work when you're 25 or 35, whatever it is, I think most people are going to lose a degree of identity and their place in the world if they're truly doing nothing. Now, most people in the FIRE movement if you brought that up to them, they would say, "It's not that I'm going to quit work. It's that I'm going to just do the work that I like doing. I'm going to take the job that I really enjoy." That's great. I think that's great.

But there are a subset of people that I think are doing this so that they can retire and play golf when they're 25. And in my view, the majority of those people, not all of them, but the majority, after doing that for about two months will say, "This isn't what I expected. I'm not happy." They're not happy because they're not providing value in the world. They're not tied in with a group of coworkers that they love. They're not being productive in the world. Not all of them, I'm painting such a broad brush here, but if there's one part of the movement that I think a lot of people will look back with skepticism of, it's that.

The other part that is a little bit concerning to me is that the FIRE movement really picked up steam during a giant bull market. It kind of came into fruition like 2011/2012, and then it took off from there. That was a period where the market was going up 15, 20% per year. Is it different this year now that the market lost 35% of its value in March. Maybe, but then we've already had this big rebound. What is the FIRE movement going to look like if we have something more analogous to 2008 where it took several years to recover, or the 1970s and '80s where you had a 20 year period with no real returns.

What does the FIRE movement look like in that world versus a world where it's been relatively easy to make money in the market over the last decade? That's another aspect of it that I think will be interesting, particularly for the people in the FIRE movement who when you read the numbers of it are really skimming the edges pretty close, retiring with 3 or 400 grand and they're living off of that. Well, if you have a 50% market decline that stays there for 10 years and you're trying to live off of 300 grand, that gets dicey.

The 4% rule is designed historically, it's tested historically during periods like the '70s and '80s. It's not that you can't withstand it in technical terms. To me it's more like, can you stand it in psychological terms? Can you have a pretty tight financial situation and then watch your net worth decline 50% and still wake up and say, "I'm fine and I'm okay. I'm independent." Can you still maintain that? I don't know. Maybe some people can, but I think a lot of people won't be able to do.

Do you have any sense or opinions or thoughts on what the next big financial innovation is going to be that's going to help individual investors?

I don't know. That's a great question. To me I think the big missing element in terms of what's missing in the world is we've been able to robotize, if that's a word, portfolios and we've kind of cracked the code on portfolio management and fees have fallen to basically zero-one portfolio management. We figured that part out. We've not been able to robotize or systematize financial advice. And I don't know if we can because it's different for everyone. It's one thing if you are Betterment and you can say, "Here's an allocation based off of your age that probably works for you." But it's totally different than when you get into people's individual personalities, their goals, their expenses, their marriage situations. Are you getting divorced?

There's all these other messy elements of providing a holistic financial plan that we have not been able to use technology very well to scale that up and bring costs down, and which is why by and large the financial advice industry kind of still has a similar fee structure and fee amount that it did 10, 20 years ago. The fee for mutual funds and index funds have fallen 90%, but the fees for financial advisors have not. And I don't know if we will ever crack that code. I don't know if you can, but I think that's kind of the missing element. If I were a really ambitious FinTech entrepreneur, that's the missing element where you can add a tremendous amount of value that hasn't really been disrupted yet. To me, I have no idea how you would disrupt that, but I think if there is a potential to be a huge innovation that really moves the needle in the financial space, it's that.

Someone called you on March 23rd, the depths of the crash this past March, what would you have told someone who said they're thinking of selling their portfolio and going to cash?

I'm actually fairly empathetic to these situations. The right answer is of course don't, that's the right answer, right? But the purpose of money is to give you a good life. That's why we're doing this. And if the amount of financial uncertainty of watching your portfolio decline, if that's giving you a bad life, if you're losing sleep, if you're talking to your kids in at night and you're saying to yourself, "I don't know whether I'm going to be able to afford college for you now," if that's grating on your life so much that bailing out is going to relieve that pressure, I'm empathetic to that even if I think it's the wrong answer. It depends on the person. It depends on the amount of stress that they have.

Obviously you want to deal with those problems before March of 2020. You want to really look historically at the odds of decline, at the odds of market volatility historically, and be able to try to predict how you're going to react to that before it happens. But for people who don't, I'm empathetic to that. I think it's, let's say someone goes to law school and they go into $200,000 of debt and they grind through three years of law school, and they've devoted their life to it. And then they get a job as a big attorney at a big New York law firm and they hate it. They hate every second of it and they say, "I don't want to do this anymore."

I think most people in that situation would say, "Hey, some costs, don't worry about it. Live the life you want to live. If you want to quit and go be a school teacher, do it. Do what you want to do." And I think there is some analogy to that with investments as well. Even if it's such a painful answer to say, "Look, you're bailing out the wrong time that's going to devastate your finances for the rest of your life." But if it's what you want to do, I can be empathetic to that.

I think there also was a thing about in March of this year where the cause of the decline was so unprecedented for all of us. It wasn't a financial crisis. It wasn't manufacturing numbers had declined or were having a run in the middle of recession. It was, this is the pandemic that is shutting down the world in a way that we have not seen. And even if you look at the Great Depression, even if you use that as your analogy, during the Great Depression you had industry volumes and incomes where revenues would be down 25%, 30%. And that was the guts of Great Depression.

In March of this year, you had things like airlines where revenue was down 90%. This was a totally different dimension than anything we had dealt with before. I have really smart, sophisticated friends who I admire in this industry where I was talking to them in March and they were saying, forget about buying stocks, I'm buying guns and ammunition right now. Like it's easy to look back at that and see and think that that was ridiculous and that was really extreme. But I think both in 2008 and in March of 2020, it probably should have turned out worse than it did. I think in both 2008 and March of this year, we got lucky.

You can imagine a situation in 2008 where there was no TARP and the federal reserve sat on its hands. And we got a financial collapse similar that we did in the early 1930s. You can imagine a situation in March of this year, particularly in an election year, where there was no CARES Act and we would have been looking at Great Depression 2. I think those things were not only possible, I think those things were probable. And the fact that we ended where we did is I think something that we ended up fairly fortunate, which is just to say back in... If I think about my own view as in March of this year, I didn't sell, I didn't panic, but I was scared. I was really scared about the state of the world as I think we all were. And it just increases the odds that you're going to make a decision that you never imagined you would when you're in that heat of the moment.

I mean, it's really interesting too during the Great Depression. That was another situation where it probably should have turned out worse than it did. I mean, a lot of European nations in the 1930s, their response to financial collapse was to embrace fascism. That was the rise of Hitler, the rise of the Muslims. It turned out worse in a lot of other nations than it did in the United States. And there was actually a very big push in the 1930s to embrace something closer to European style fascism in the 1930s that didn't happen but it was pushed heavily. In the heat of the moment when everything is collapsing around you, people start embracing ideas that they never would have thought possible when the economy is strong.

And there's a thing in the 1930s that people should read about. I think it's one of those fascinating stories of American history. It's called the Business Plot, and it was in I think 1933 where a group of very wealthy businessmen and military leaders came together and they started planning a coup to overthrow FDR and install a military leader named Smedley Butler as the new fascist leader of the United States. And they were very serious and organized. It's easy to read that and say, "Ha ha ha. That never happened." But that happened in Germany, that happened in Italy, that happened other places around the world at the same time. It's just crazy to me to think of what world history would have been like if that happened.

Your comments about being empathetic to people that want to go to cash, they lined up really well. We had Professor Ken French on in episode 100 of this podcast a few weeks back and he said you shouldn't try to time the market, but if you feel really, really, really bad in a crash, you've got a new data point. You might have learned something about yourself and maybe you should change your portfolio.

Yeah, I think that's right. We're all just trying to learn about ourselves, not just learn about the economy. But I think 2020 and 2008 is a good time to be introspective about yourselves. And you really start realizing what your own goals are, similar to if you have a near death experience a lot of times that will push people to saying, "Look, after my near death experience, that's when I quit my job to spend more time with my family." I think in a less dramatic way, 2008 and 2020 does that for our finances. Once you're looking down the pit of despair, that's when you really realize like, okay, what is my risk tolerance? Do I actually have this risk tolerance that I thought I did one year ago? Maybe I don't, and therefore I should embrace that with both hands and do things a little bit differently than I was before this.

How do you define success in your life?

It's different for everyone, but for me success in life is, I mean, what matters to me more than anything else and I think a lot of people will relate to this of course is my wife and my kids. That's everything. I love my job, I love my career, but I feel like I'm doing it for them. Not because I'm suffering through it, but I feel like that's just everything for me. So to me it doesn't matter how much money you make, it doesn't matter what career you're in, it doesn't matter where you went to school, if you're working hard to support your family, you've checked 95% of the boxes that you can check for me.

Different for everyone but that's who I really respect in life are people who are just waking up and working hard to support their families. That's my kind of person. That's what I like. So to me, that's a lot of what success is in life is working hard out of devotion and support to other people. Like even for you who are not married, who don't have kids, if you're working hard out of devotion and support to other people as well, that's success to me.