YouTube Transcript:
investing for idiots

welcome to investing for idiots yes
you've come to the right place this is a
video for the Libra bag holder option
day trader the Wall Street bets
afficianado I'm making this video for
the people for the victims who find the
scams they're in featured on my videos
and today we're doing something a bit
different this is a series where we have
real experts on the show and a perennial
topic of this series is investing given
that so much of my work is investing
gone wrong we've had Patrick Boo the
playing bagel and today we're joined by
Ben Felix the whole point of this series
is to point people toward channels which
give a sound theoretical understanding
to finance and moving them away from
gambling and financial nihilism and
towards basic Common Sense investing
welcome to the show Ben I appreciate you
coming on if you don't mind I want to
start at the end in mind for those who
just watch you know the first minute
what is the optimal strategy for most
people not considering individual
circumstance for most people to put
their to allocate their money and then
we'll back up to why that is the case I
think you've said that inv investing is
a solved issue what do you mean by that
yeah I I call it a solved problem
because we have these tools called index
funds which is what you're I think
referring to in the question which are
funds that give you really lowcost tax
efficient exposure to an entire stock
market so the S&P 500 is an index that a
lot of people have heard of that's I'm
not saying that's the index people
should be investing in we can talk more
about that later but an index is a
representation of a stock market so the
S&P 500 it the way that they describe it
that S&P describes it is that it
represents 500 leading companies in the
US Stock Market and it's a
capitalization weighted index which
means that larger companies measured by
their size by their market
capitalization have more weight in the
index and smaller companies have less
weight so we have these things called
indexes we have these things called
index funds that all they do when you
invest your money in the index fund is
they invest your money in the stocks in
the index and that's a really efficient
way to get exposure to the stock market
and so I mentioned not just the S&P 500
there are indexes representing stock
markets all all over the world and so
you can use these tools to build a
portfolio that's going to give you
exposure to Global stock markets which
is kind of all most people need uh in
terms of building a really high quality
portfolio yeah so there's this so now I
want to thank you for that I think that
is the answer that basically I was like
looking for and I've heard so many
people say so many experts say but now I
want to back up to sort of the beginning
let's just start with a bit about you
and then I want to talk about why it is
kind of counterintuitive that in experts
would tell you sort of not to go with
experts there are active financial
advisors things like that and we'll get
into why you and I think I also think
that that is not the most prudent
strategy for you know uh most people not
to get into individual situations but um
start with a bit about yourself what is
your back I think your engineering to
start right like just like me I did
chemical engineering I did nothing with
it and uh I think you are the same
mechanical right yeah that's right you
you know yeah mechanical engineering at
at nor Eastern I'm I'm Canadian I live
in Canada but I went to North Eastern
University in Boston did mechanical
engineer engineering there and then I
came back to Canada and did an MBA in
finance after that and that's how I got
into into finance and like you I never
used my engineering degree went straight
to the NBA yeah why did you what made
you interested in finance why why were
you you kind of taken by the idea of
investing and I wasn't at all I I was I
was not taken by the by the idea of
engineering I I knew I I probably didn't
want to work as a mechanical engineer
but uh I I was playing basketball that's
why I was at nor Eastern I'm I'm 6 foot1
people don't often realize that because
they see me sitting down on my YouTube
channel uh so that's re really are you
joking no I'm dead serious like actually
610 I'm listed at 611 for like if you go
on the North Eastern website you can see
it from when I played uh oh man yeah wow
yeah so I played basketball that's why I
was at nor Eastern and then I came back
to Canada primarily for basketball I
came to play at a Carlton University
which is like I don't know what to
compare it to um the best basketball
school in Canada by far uh so I came
back to play there and I had to choose a
program an academic program so I went
there for basketball but it's like okay
I probably don't want to do a masters in
engineering uh maybe I'll do an NBA
because you know that's pretty flexible
with what I can do with it afterwards
and then I picked Finance for the same a
concentration of Finance for the same
reason that I picked an engineering
degree in the first place was that it
was kind of the hardest program I was
told mechanical engineering is the
hardest thing you can do and I was like
all right I kind of like mechanical
stuff I'll just I'll do that and then
same thing for finance like of all the
streams you can pick in the NBA Finance
is the hardest one so all right let's do
it and that's that's it but I was never
like I love investing or I love finance
that no I do now yeah no no I was going
to say that really bleeds through a lot
of your videos that actually you are
very interested in the research side of
Finance that's how I found your videos
is I was looking for somebody who talked
about not just like their opinion about
stocks but what the research actually
said and you'll often cite you know
journals and articles in your videos
which I really appreciate but it's
interesting so the counterintuitive
thing that I want to get at in this
video why I'm calling it investing for
idiots be besides the Prov of title is
that I think it is interesting and
deeply counterintuitive that in most
Industries expertise is how you get the
superior advantage in the field so if
you would want you know something done
right you hire an expert to do it for
you that is the intuition that is at the
heart of almost everything we do in the
world and there's like a saying you get
what you pay for right um there's a
reverse saying in Finance now which is
popularized by I think Jack Bogle which
the the founder of Vanguard where he
says in finance you get what you don't
pay for meaning that it's the reverse
and that often times hiring the best
wealth manag manager in the world will
lead to worse outcomes than doing the
very at this point now simple and dumb
thing and the idio like it almost feels
too dumb which is hold a very Broad
Diversified Index Fund not choose stocks
not choose timing not choose any of the
things that you would think you would
have to do if you want to achieve a kind
of
a above average is a bit misleading
because actually you're getting the
average but the getting the average is
in finance weirdly above average can you
break down why this is the case that
that that is deeply
counterintuitive so I think the average
return piece there that you just
mentioned is actually really important
that with with index funds I've heard
people say like well why would just
settle for the average return why
wouldn't I try and do better by by
picking stocks or timing the market but
I think if you look at what are average
returns like what are what are the
average returns of investors or what are
the average returns of actively managed
mutual funds they're way below index
fund returns so I think what you said is
not incorrect that you're getting
relative to other investors you're
getting above ad average returns using
index funds you're getting the market
return which is the average but if you
compare yourselves to yourself to other
investors uh or or other types of funds
I think you're getting an above average
return with index funds why is that the
case expertise is weird in financial
markets I think it's because financial
markets are competitive they're a
competition now if you have one skilled
person and nobody else is doing anything
to price stocks St stocks are priced
based on trading so if I think a stock
is worth more and you think it's worth
uh and you think it's worth less we
might have a transaction and and every
time that that happens it puts
information into stock prices now
everybody wants to make a profit if
there's one person pricing assets and
nobody else is there they they could
make a lot of money because there'd be a
bunch of mispriced assets and they could
go decide what to pay for them and and
they' they'd be become very wealthy very
quickly but that's obviously not the
reality there's a bunch of people
competing to be the one putting their
information into the price to try and
make a profit and that competition is
what sets stock prices but it also
results in a situation where you've got
if you've got two extremely skilled
traders to and like you know we talk
about active manager underperformance
and I think a lot of the times it almost
becomes pejorative where active managers
are dumb and I don't think that's the
case I think they're some of the
smartest people in the world like
finances become this brain drain for all
the other smart Fields so it's really
smart people and but they're competing
with each other to be the ones to to
make a profit and when you get that you
you get this thing called the Paradox of
skill where when the the players playing
against each other in a game are
increasingly skilled the outcome is
increasingly determined by luck rather
than skill take like NBA games for
example uh you take two NBA players that
are equally skilled and make them play
oneon-one against each other and they
play 100 games like the winners is going
to be determined by luck assuming
they're equally matched right uh yeah so
I think that's it there's there's a
paradox of skill and it creates a
situation where being skilled does not
lead to better outcomes and then for
investors the the you get what you don't
pay for comment is because for the
service of hiring someone to try and do
that for you you're going to pay a high
fee you're also going to have high
transaction costs because every time
they trade a there's a cost implicit or
explicit or or usually both and so net
of fees and costs trying to beat the
market on average is going to be a
losing game so you got those two pieces
one the outcomes are determined by luck
because all the players are so highly
skilled and two you're paying a cost to
participate in that game to try and beat
the market and so net of costs on
average you're going to lose it's a it's
a losing
game when you say it it it sounds simple
but it it is uh hard to get your head
around and I have you know I have a
bunch of uh you know family members for
example who will tell me like yeah I've
got this active manager he's charging me
you know sort of 1% and uh and I want to
like I want to shake them I want to just
tell them like this is gonna be horrible
for you but they just always tell me
like no no no this guy's a smart guy
he's a smart you know he's a smart guy
and
um and I've I've said something in the
past and and my wife has told me like
hey you got to stop this you got to stop
it's not you're not you don't need to
evangelize about this because for some
people they need this get they wouldn't
save the money if not for the fact that
somebody's holding on like if they if
they were in charge of these decisions
they wouldn't act as rationally as you
think they would act which is they would
just put it in you know an index fund
and just hold it can you there also is
this piece which I think is hard to expl
understand and wrap your head around
when you think about it in terms of like
textbook Math versus there's a
behavioral side of this too um how do
you think about Behavior behaviors as
they impact returns and how
do people work against themselves so to
speak I think there's like a saying like
we've met the enemy and the enemy is us
um that I think is true of most people
who are
investing yeah for sure I mean you look
at the data on how do investors perform
relative to the assets that they invest
in so you can look at that for indexes
you can look at for mutual funds
investors pretty much always
underperform so you take the a stock
index fund for example or a stock index
and and the index returns whatever 8% a
year or something like that investors
typically would earn uh less 7% or 6% or
something like that depending on what
asset class we're talking about explain
by
what that's the the difference what's
the explanation for the behavior no no
what what is causing that
underperformance are they just trading
it because they trade at the bottom and
they buy at the top it's it's bad
timeing decisions yeah so that's it's
it's really comparing money weighted and
time weighted returns I mean Finance
terms I guess but there's this Gap if uh
if people are investing at the top and
selling uh at the bottom there's going
to be a difference between the money
weighted and the time waited return the
mechanics that don't really matter but
that's why we see those those gaps it's
poor poor timing decisions and that's
really it's it's really everywhere and
it's been around for a long time but I I
think your your comment about the person
needing handholding is important because
there's a separation between
the investment strategy and the fact
that somebody may need investment advice
I'm I'm biased here because I'm the
chief investment officer of a wealth
management firm we use lowcost funds to
build portfolios like we believe all the
stuff that I'm saying on the investment
management side but I still do think
that there's room for handholding as you
called it but also other things like
Financial Planning and tax advice that
people need so I don't think those two
things have to be combined someone who's
giving Financial advice doesn't have to
be selling you crappy High fee
investment funds unfortunately that has
been the synonym for a while where
Financial advice has become synonymous
with like this self-dealing that is
happening where they're selling often
tools that they are getting kickbacks
from selling um so that is just an
unfortunate like you know I think
well-deserved reputation of the
financial it is well deserved yeah I
industry industry but um you touched on
something thing which I think is worth
talking about which is uh market
efficiency where you said you know as
the players get better then the outcome
is increasingly determined by luck which
brings me to a question which H are
markets getting more efficient as
information gets faster and the players
become more
sophisticated market efficiency is a
really really hard question to answer uh
whenever I ask academics about this on
my podcast they kind of laugh and like
how how are you defining market
efficiency how do you want me toine
market to Define market efficiency
market efficiency is is technically is
kind of the plain English definition it
means that prices reflect all available
information stock prices reflect all
available information now how do you
actually test for that to check like our
Market's getting more efficient there
are a lot of different ways none of them
are completely conclusive uh but if you
look at something like information
production so is is there is information
about individual stocks
uh being produced at at a higher rate or
or a lower rate than than the past uh I
think from measures like that markets
are at least as efficient as they've
been in the past possibly getting more
efficient but that's not the only thing
that that uh that matters like another
big one is active manager performance so
we talked about can active managers beat
the market and that's been pretty stable
for a very long time very few active
managers are able to beat the market if
markets were getting less efficient we
might see we might expect to see that
reverse the other thing so yes
information is more available yes
technolog is getting better the other
thing that we're seeing though as a big
trend is that a lot of people are moving
to index funds which means there are
fewer dollars invested with active
managers and the way that prices got
right in the first place is because the
active managers were trading on
information trying to make a profit so
this is a thing called the Grossman
stiglets Paradox it's basically the
Paradox is basically that markets can
never be perfectly efficient because if
they were there would be no more
information production it's kind of like
an equilibrium though in reality where
if if the pendulum ever swings too far
toward passive there will be
opportunities for active managers then
at least in theory they'll come back
make a profit for a bit and then markets
will be efficient again yeah because
fundamentally Index Fund investors are
sort of getting a free lunch of the work
of pass of active managers to determine
the price of stock the fair price of
stocks uh talk to me about about
diversification and what a type of risk
is that you can diversify away and
things that you can't diversify away
because I I think this is also something
that's counterintuitive where you go why
would I buy a basket of stocks when that
basket of stocks is for sure going to
have a bunch of losers like stocks that
are going to be terrible why would I not
just pick the stocks that I know are
going to be good you know I know hey I
believe in Tesla right I believe paler
Alex C whatever his name is uh that that
guy you know he's got he's got Big Ideas
Ben why don't I just invest in that
instead of your dumb idea where I you
know invest in these losers what is what
is the answer to that
yeah it's really easy to identify past
winners like we can say hey that guy's
really smart or hey this company's doing
really really well that's reflected in
the price and so I think that's a bit of
a trap that people get can get caught in
where people can end up paying a really
high price to invest in an objectively
good company but because you paid a high
price for it your investment returns are
going to suck we've seen that happen uh
throughout the course of financial
Market history again and again like it's
it's a again back to investor Behavior
it's something that people kind of love
to do they love to overpay
for exciting companies more generally
though the problem is most stocks
perform poorly they perform poorly
relative to treasury bills they perform
poorly relative to the market a few
stocks perform really really well so I
mean to your question can we identify
those winners ahead of time that's
really really hard to do and because
most stocks perform poorly you're much
more likely to pick losers than to pick
uh winners so if you look at people
building concentrated portfolios there's
a study that looks at this if you build
concentrated portfolios of stocks you're
much more likely to underperform the
market than to uh to outperform it so
that that's concentration uh the risks
that you can diversify away are company
specific risks or industry specific
risks so that's like take two companies
that are otherwise identical they're
exposed to the same uh the same big
picture risks but one Company CEO starts
doing some crazy stuff that the market
really doesn't like that company is
going to do relatively poorly its
returns are going to be relatively poor
compared to the other company uh because
of what the COO is doing not because of
anything that's going on in the overall
market so that that's company specific
risk that can be Diversified Away by
owning all of the companies in that
industry or or uh or sector okay right
and then when you diversify all the
risks away like company specific risk
you've got industry risk which you can
diversify Away by investing in other
Industries you've got country specific
risk which to an extent you can
diversify a way by investing in other
countries and then you roll all that up
you're left with what's called Market
risk the reason this matters is that
market risk is priced that means you
expect compensation for taking on Market
risk you do not expect compensation for
taking on individual company risk or
industry
risk is this that is this why they say
like diversification is the free lunch
in finance or like there there's some
saying about that because you're
actually getting above average or you're
getting extra expected return for not
having uh for not taking on more risk
where most of the time taking on getting
more return means taking on more risk
yeah yeah so if if you diversify with a
bunch of risky assets those stocks are
risky if you have a whole bunch of them
you're reducing your risk without
decreasing your expected return whereas
typically in finance if you want to take
less risk you have to expect lower
returns so why do all these people pick
stocks I think it's exciting I think
people think they're smart I think
there's a lot of overom confidence in
investing uh whenever I make a video
smart I I'm no that's why this video is
investing for that that is like the
whole premise is that kind of the most
genius thing to do as an investor is to
know what you don't know and sort of and
kind of take the counterintuitive
position of
of realizing that average returns are
really easy to get and above average
return slightly above average returns
are incredibly hard to get and almost no
one gets them that is like the very odd
thing at play here yeah and you're
introducing a whole bunch of risk that
you're going to get below average
returns by trying to get above average
returns and you're much more likely to
get below average
returns I think it's the overconfidence
uh people want to believe that that
there's a smart person out there or that
they're the smart person that can give
them a out performance but yeah it's uh
not not very well
supported okay so I got another another
question for you which is I hear about
AI Hot Topic robots Hot Topic I want to
screw you know Screw the total market
index I want to put my money in the uh
roll the dice in the AI funds in the you
know whatever uh why is that a bad idea
or a good idea is it a good idea so I
got a lot of questions about this when
Arc Kathy Woods fund or funds were doing
really really well like there were a
couple years or a few years where they
were just crazy rocket ships crushing
and so I started getting questions like
why would we invest because her
narrative was the index has all these
old boring companies that really suck
and they're not Innovative and we're
going to pick the Innovative ones they
going to do really well so I started
getting questions from clients like why
why wouldn't we why would we want to
invest in these old companies why
wouldn't we want to invest in the new
economy so I did a lot of work digging
into that I made a couple videos on it
on investing in technological
revolutions I did one on uh Superstar
fund managers or something like that too
uh which those two things of go hand
inand so what tends to happen why is
investing in Revolutionary Technologies
or or or new economy stocks historically
a losing a losing game it comes back to
asset pricing so when something's really
exciting so AI for example I think
crypto went through this too marijuana
stocks went through it too electric
vehicles I mean it's just recent history
but this is a this is something that
happens throughout history Railway
stocks went through this too so what
happens is people people realize this
thing is exciting they realize it's
going to be impactful and ass prices
start to reflect that and so the asset
prices shoot up and what happens when
asset prices shoot up more people hear
about this thing oh AI it's going to be
really big and the stock prices just
went up a bunch so more people invest in
it and the price keeps going up and that
cycle carries on for a while and you see
asset prices go up up up investors tend
to buy after they've gone up and then
they tend to come back down because
nothing nothing tends to be as as
revolutionary as quickly as I think
people expect
and you have a dilutive
factor don't you like the companies also
are issuing a bunch of new shares
they're also you're not capturing the
full um profits of that sector that you
think you are yeah that's one of my
favorite pieces of this whole thing so
you get high asset prices and one of the
reasons that they're high I've heard
someone called this the big Market
delusion which is basically that every
stock is priced as if they're going to
capture all of the market share of that
new industry but that's never what
happened so even if there is a massive
amount of new earnings that are going to
be available for an industry to capture
when it's a new exciting industry like
you said a lot of companies are going to
issue new stock a lot of new companies
are going to be created and so there's
this huge earnings pie but it's not one
company capturing it and the more
companies that go after that huge
earnings pie the lower the earnings per
share which is what matters to investors
which is what matters for stock prices
is going to be and so you can end up
with massive earnings growth for a new
industry and really bad earnings per
share growth for all the companies that
are issuing stock to try and try and
capture that that new opportunity and so
investors end up just kind of getting
getting hosed and this is like you go
back through history this happens again
and again and again High stock prices
exciting technology investors buy at the
peak and they get
smoked this this is what is so
interesting to me
about um finances there are all
these traps for otherwise smart people
to make catastrophic mistakes with their
finances because of things that seem
intuitive until you like know a bit more
of the picture like um you're not I have
a guy I won't say his name but a very
you know popular Finance guy on YouTube
and he was he's telling me behind the
scenes oh you got to invest you know
this smart you know industry and da d d
d da and he was making the case so
strongly to me that I was like what is
the like research on emerging market
like like some of these like really you
know interesting Industries and that's
when I found your video on I was like oh
this is not the easy buy that I thought
it was where it's like yeah just buy a
few of these you know hot AI stocks or
hot robot look it's going to be the
future it's not as simple as I
identified as if not as if everyone
can't see that Ai and robots are going
to be an important part of the the
future anyway to say nothing of that um
I want to touch on an interesting piece
which is that even though we all know
past performance is no indicator of
future you know results we all kind of
behave a little bit differently than
that everyone sort of behaves as if the
opposite is true and I want to talk
about us versus International right this
is a big
conversation um where the US has sort of
especially in the past decade or so has
sort of crushed um and so there is a
narrative that crops up every time
something like this happens which is
well I just want to abandon this loser
which is everybody else but the US US
number one we're the Kings sorry Canada
you guys are you know you guys
are sorry I'm just it's you're not
performing I'm dumping the loser for my
portfolio in theory intuitively like if
you just didn't know anything else it
kind of there's some tendenc to believe
that idea can you explain why this might
be a problem and explain the trend of us
assets that have become higher priced PE
wise relative to other International
assets AKA is investing in international
stocks a dumb
idea yeah so the the US market has been
wild for for the last 15 years it's been
just I mean incredible insane like
anyone that was not investing in the US
over that period like you you you you
missed out on a lot of returns and you
don't get those back like that's it uh
which which is one of the reasons that
you know even though we're about to talk
about us expected returns maybe being a
little lower than the past I don't think
that means anybody should get out of the
US market because I could have sent I
could have said the same thing five
years ago and here we are the US market
has been
incredible uh so what has happened over
the last 15 years but really over the
last 30 or so years years is that us
stock prices have gotten higher relative
to their
fundamentals and that the fundamentals
have been they' been good um like
there's no question there the US market
is objectively strong economically uh
but but the other thing that's happened
is the valuations of US Stocks have
gotten Higher and Higher and Higher and
right now if you look at the the the
Schiller price earnings ratio which is
one way to measure stock market
valuations it's you know it's not as
high as it was in the year 2000 but it's
really high Ben it's really high it's
about as close as it's been since since
then since the 20 year 2000 and you know
it's not conclusive by any means but
typically when stock prices are high
expected future returns are low and
realized future returns are are low like
if you go and sort historical US market
returns by their starting Cape they're
starting cyclically adjusted price
earnings ratio higher starting capes are
ass explain what you just said what's a
what's a cape I'm sorry sorry sorry
cyclically adjusted price earnings ratio
so it's a way of measuring stock market
valuations it's the 10year smoothed real
earnings of companies yeah so you're
measuring the prices relative to that
smooth earnings figure and that just
helps to balance out big changes in
earnings from year to year and so that
that measures really high right now
meaning meaning buying a dollar of
earnings of us company earnings is
really expensive right now compared to
history and historically that has led
had been associated with lower future
returns now what does this mean for for
does international investing make sense
if you look back to 1980 or so up until
now a huge portion us has completely
obliterated International stocks over
that period and a huge portion of that
difference has come from rising
valuations and so if we think about is
the same thing going to happen for the
next 20 years for the next 30 years it's
it's really hard to say that valuations
us valuations are going to keep going up
the way that they have over the last 15
or so years to deliver the type of
returns that people might expect when
they say oh I'm only going to invest in
US Stocks so I think that's a little bit
of a trap uh currently expected returns
are low uh they're low partially because
past returns have been high which has
led to increasing valuations and so
people see the past returns and they
project that into the future but in
reality they should probably probably if
anything be expecting the opposite lower
returns now if we look at uh US versus
International stocks throughout history
I looked at this a while ago I looked at
10year rolling periods from I think 1900
to 2023 or something like that and it
was about 60% of the time that us beat
International which is like it it won
most of the time but it wasn't all the
time by any means it wasn't what you'd
expect if you were only alive from 2010
or something that's right that's right
so yeah like I I I think International
divers diversification makes sense I
made a video on it I I diversify
internationally the US is only one part
of the world it currently makes makes up
about 65% of the global stock market
which is a lot uh it's increased each
year partially because valuations have
been going up and up uh but there's a
huge portion of the global stock market
that is not the US and the US I don't
think will perform the way it has in
recent history forever and historically
when the US has faltered when it's had
lower returns International returns have
been better relatively speaking and
that's diversification it's like basic
this is another way to diversify it's
just interesting because people who talk
about diversification especially in the
US are usually talking about us Equity
diversification they're not actually
they don't want to diversify to the rest
of the world they're like they actually
want to bet on their country there's a
bit of a country preference of you know
and and and we have uh historical
returns we look back and we go see look
we proved it we're we're the best we
want to but it is interesting like the
same I I I find this because I follow
some of these um there's this community
called the bogleheads have you heard of
these guys oh I've heard of them yep
these bogleheads uh they're they're like
people who kind more or less subscribe
to the the theories of Jack Bogle the
Vanguard kind of father of uh index
investing they and to some I don't want
to treat them all as a monolith but some
of them have issues with this idea of
international like most of them are like
look even people who in theory
completely subscribe to the idea of
diversification sort of half subscribed
to it cuz they go look I don't want to
really hold that much you know I back
tested this and I'm a little smart I
backed and I found out that you know
International is not worth holding so
I'm fully us and then Jack Bogle even
himself is like I don't hold any
International I I hold like and Max 20%
something like that
so
do if we are looking at this from what I
wanted to give my audience is no advice
just a theoretic
understanding a framework for how to
think about this in my mind this is an
irrational side of both Jack bogle's
philosophy and in the philosophy of a
lot of people who even subscribe to
diversification if you really subscribe
to it you kind of have to subscribe full
send unless you're making arguments
about like tax efficiency of
international like I guess I guess but
uh what what is your thought about that
do you think that the the most sound
theoretical framework is just buy
everything
and if that's true do you buy more than
just equities do you buy every like
Commodities you buy oil yeah yeah yeah
what what is your answer yeah so I I
think on the international
diversification piece if someone wanted
to be only us
Equity it's it's probably not the end of
the world I don't think it's a good
decision but there are worse countries
to invest 100% of your wealth in like
the US is 6 it's 65% of the global
market and it it it has companies that
do have exposure to markets all around
the world right it's not it's not quite
globally Diversified because us
companies that sell overseas are going
to perform differently than companies
overseas so it's not perfect but again
if if you wanted to invest in one
country the US is probably the way the
way to do it I do also think for us
investors like you mentioned tax there's
also currency issues costs there are
reasons to have Home Country bias if
you're in the US or elsewhere like in
Canada many people have a home country
bias and I think to an extent that can
make sense
just because of of the frictions of
owning foreign stocks there's other
weird stuff too that you can start
thinking about like the risk of
expropriation by Foreign governments in
times of conflict like those are real
things that are worth considering and
thinking about
diversification uh so I you know I don't
think it's the end of the world if a
us-based investor said I'm going to
invest everything in US Stocks I'm not
recommending that or suggesting it and
I've argued against that including with
the bogleheads community many times
every time I make a video on
International diversification they lose
their
minds
yeah by the way I like this guy I like
that I'm not I'm not hating I I I think
uh they're one of the more sound you
know um Financial groups out there
actually but and and they have you know
interesting discussions but it is
something that's cropped up that I think
is interesting because I'm like wow this
uh knowing the theoretical underpinnings
and actually believing in it when you
have all this data that that kind of
pushes you towards well the US seems so
good um is is hard
to it's kind of hard to argue against
the past performance of a guy who's like
I invested in the US in the last 40
years and I you know everyone who
invested in Fe you know International is
an idiot compared to me and like the
yeah you know in theory no yeah not not
in theory but I guess in practice he's
right in those 40 years he was right you
know correct just like if you invested
in Nvidia for the last 10 years and I'm
going to come to you and say hey you
shouldn't have shouldn't have done that
and they would say well in theory you're
right in practice you know you're wrong
yeah I think be there there's a little
bit of rear viw mirror bi bias because
the US market has done so well on recent
history but you go back like from 2000
to 2010 US Stocks returned
zero for 10 years it's like those those
those periods happen and over that
period uh other other St elsewhere did
did better I mean even in the US I don't
know if we're going to talk about this
but even in the US the US market which
is what everybody sees the past
performance of right now was flat us
small cap value stocks over that 20120
period did incredibly well that's not
quite diversification that's not like an
appropriate term for it um but investing
in something other than the US market
capitalization weighted index can make a
lot of sense in some cases the theory
piece of that is is pretty simple if
markets are efficient uh the global
portfolio of assets is the theoretically
optimal portfolio and that like that's
the it's pretty simple that's the basic
argument for why you should be globally
Diversified okay question on top of that
because you say that Ben you say that
but you don't do that you don't do that
in your own life you do a little thing
called the slice and the factor tilt
yeah what are the uh you know see I've
done my research I've done my homework
what are the
factors uh in the F French model what is
the F let's back up what's who's
fam and does he know French and what are
these things I think we have to back up
even further actually I think we have to
go back one step further to this is for
idiots B yeah we're going for going for
idiots yeah I'm G to I'm going to do my
best here so we talked about Market risk
earlier you can diversify everything
away uh and you end up with Market risk
and that's the one priced risk that's
the risk you expect compensation for for
taking okay uh that's you get that by
owning a an index fund a total market
index fund so that idea really comes
from a 1964 paper in the Journal of
Finance by a guy named Bill Sharp who he
won the Nobel Memorial prize in economic
Sciences for this this work he came up
with this thing called the capital asset
pricing model the capm and this model
basically predicts I hope this is not
too nerdy but it basically predict
predicts that uh expected returns are
explained by exposure to Market risk so
you you take on Market risk you get you
get an expected return if you take on
more Market Risk by taking by owning
stocks that have a higher Market beta
that's pretty Nery what talk but riskier
stocks should have higher expected
returns in his in his model uh but it's
a single Factor model meaning Market
risk is the only risk that explains
expected returns so that's 1964
from then until the '90s there were a
whole bunch of things that were
violating that that model so there were
a whole bunch of types of stocks where
if you looked at their capm if if you
analyze them through the lens of the
capm it looked like they had higher
returns that were too high for the
amount of Market risk that they were
exposed to so that could mean two things
it could mean markets are inefficient
and that there are all these profit
opportunities these risk-free profit
opportunities for people to take or it
could mean that the capital asset
pricing model was not the best model to
to to explain how assets are priced to
explain what risks are incorporated into
stock prices so this is where F and
French f is the guy who came up with the
idea of market efficiency in the 1960s
and 70s and his co-author Ken French uh
they came up with the idea that maybe
there are more than the one market risk
maybe there's more than one risk that
investors care about when they price
assets because the the capam was
empirically wrong meaning you could find
lots of way lots of places where it was
not not working yeah so they they came
up with this uh a three Factor model
where they said it looks like investors
probably care about Market risk but also
the specific risk of small stocks and
the specific risk of of value stocks and
those were two of those empirical
irregularities is this dumb enough I
don't know like we be no yeah this is
fine no you want to explain value versus
growth real quick yeah yeah okay so
value the way that F and French measure
it they they measure price relative to
book value so the book value is like the
just the value of a company's assets and
then its price is the value of its
assets plus the discounted value of
future cash flows so basically if if
people think a company's going to do
really badly in the future it might
trade at its Book value like this
company's going to generate no profits
it really sucks right if a company's
going to do really well it's going to
have a really high price relative to its
Book value so a growth stock would be a
high price relative to book value stock
a value stock is a cheap stock it's got
a low price relative to its Book value
so they had observed that value stocks
tended to beat grow stocks
over time likewise they'd observed that
small companies measured by their market
capitalization had tended to outperform
big companies so they added these two
independent factors to the asset pricing
model and all of a sudden a lot of those
empirical irregularities that the capm
was failing to explain they kind of went
away so from that paper this whole field
of of financial economics was born
called uh multiactor asset pricing which
is really the study of like how are
assets priced like what what information
goes into the price of a stock what do
investors car about uh so they had that
three Factor model and they later in
2015 came out with a five Factor model
let's not talk about the five let's just
let's just do let's stick with the okay
for now for now yeah that's that the
three Factor model is really the it
explains the the the capm explained like
two-thirds of the differences in returns
between Diversified portfolios the three
Factor model brought that up to about
90% that means like if you take two
actively managed portfolios for example
and ask why are their returns different
the capm is going to explain about 2/3
of it the the three Factor model is
going to explain about 90% of it the
five Factor model explains about 95% so
there's definitely some diminishing
returns that is to
say their returns are explainable as a
function of the amount of risk they're
taking on that is fundamentally their
the whole idea is exactly that yeah
so because this is something that was
con that was confusing me when I first
learned about this is I was like oh are
the factors like another way like
diversification to get sort of this uh
free lunch like I just buy more small
cap index funds and I buy more value
stocks and I just get better returns as
opposed to people who buy the whole
market index is that what you're
saying well theoretically there are
independent risks that a lot of
investors probably should not be taking
and that is why they're compensated so
the market portfolio in theory the the
market capitalization weighted like you
go and buy the market index fund that's
the optimal portfolio for the average
investor now if you're not the average
investor if you're in a position to take
more risk than than the average investor
and take more risks that show up at
really bad times than the average
investor like risks that will show up at
the same time that you might lose your
job somebody who has a job that's
exposed to those types of risks they
maybe shouldn't be investing in value
stocks someone who's retired for example
and doesn't depend on their income at
all Maybe they can take a little bit
more Risk by tilting toward toward value
stocks but they're they're not for
everybody and they are risk at least in
in the F French thinking they're risk
premiums which means like no it's not a
free lunch it's an additional risk that
you're taking and doing it can suck like
if you were investing in value or small
cap value stocks over this recent period
where the US Market's been going nuts it
hurt like I I have a value tilt in my
portfolio and it sucks yeah because
growth actually has been value doesn't
always beat growth and growth has been
killing yeah um so anyway I wanted to
kind of uh bring that up because it's an
interesting you know um Deep dive on the
specifics of you know diversification
people talk about these Factor tilts
they're not talking about the same thing
as diversification where you get sort of
an increase in expect expected returns
for no additional risk you are getting
an increase in expected returns for
taking more risk just like if you were
to have you know 100% equities versus
having 80 20 bonds or something like
that you would get an expect more return
but you're taking on more total risk um
I think probably we should touch on
bonds a little bit everyone kind of is
bored to death by bonds but for the
first time ever they've become a little
bit interesting well at least the first
time in sort of my investing lifetime um
where they're actually paying something
how do you think about Bonds in
somebody's portfolio so far we've just
been talking about equities but that is
not sort of the uh the commonly
understood way to invest because if you
want to diversify you should also be
thinking about diversifying away from
just pure Market risk as well depending
on how much risk you want to take what
is the kind of theory behind why someone
should consider Bonds in their portfolio
what are they maybe just jump into that
sure so stocks pieces of equity
ownership in a company you're
participating in in the expected future
earnings of a business and because of
that earnings are they can fluctuate a
lot businesses can have bad times and so
stock investors are exposed to a lot of
risk so that's investing in a company's
stock there are also these things called
bonds which is another way for companies
to raise Capital if they don't want to
issue stock they can issue bonds and
that's they're effectively borrowing
money so if you buy a bond you're kind
of lending money to a company or to a
government or whatever and they're going
to pay you interest they're called
coupon payments and then at the end of
the when it when it matures they're
going to give you your principle back
the the other interesting thing is that
if a company goes bust stockholders
usually get zero but Bond holders often
have some claim on assets so there's a
couple different reasons there like
you've got guaranteed payments you've
got principal at maturity and you've got
potential claim on assets in a worst
case scenario so all of that together
suggests that bonds are a little bit
safer than stocks which you know it's
more complicated than that but that's
kind of step one they're a little bit
safer yeah want to talk about what is
risk later if you have if you have time
I I don't want to take too much of your
time but
um okay the point is a little bit lower
downside in the in theory bonds have a
lower uh downside risk of losing money
especially when you talk about what a
lot of people are thinking of when they
think of bonds at least for their
Investment Portfolio is some type of
government bonds or highgrade bonds um
for a while the us especially has been
in an odd position I don't know the
interest rate situation around the world
but the US was in the interesting
position of paying very little for bonds
so there was you know the what's
sometimes known as like the risk-free
rate for the least risky thing we can
think of is like sort of what the
government going bust um so the closest
thing to risk-free as you can get was
basically nil I mean nearly nil um so
how should people think of bonds and and
there's long-term bonds there's
short-term bonds there's medium-term
bonds I
ironically these are have different
types of risk because when I first
understood bonds I was like oh well the
longterm seem the safest get a 30-year
Bond you're guaranteed to have that
payment for like what's the risk can you
explain the different types of risk of
short medium long-term bonds yeah really
question no it's it's a great it's great
question it's it's not an investing for
uh idiots question but but I love it but
I love the
question okay so shorter maturity bonds
are going to be really low in volatility
so volatility is like the price can
change if you buy a a short or treasury
bill for example like it's basically
like cash like you're going to earn some
interest it's not going to move around
the price is not going to move around as
you go longer out in maturity the price
is going to move around more and more uh
day-to-day based on changes and things
like interest rates break that down
because if I buy a 30-year Bond today at
5% just so everyone's
clear I will if I wait the full 30 years
the price doesn't fluctuate and the
interest rates don't fluctuate so why
are you saying that the price
fluctuates it if all of a sudden
tomorrow so you've got a bond that's
paying you 5% if all of a sudden
tomorrow I can go and get a bond for 6%
your bond is going to be worth
relatively Less in the in the market so
it'll be repriced based on what the new
what the new rates are and if you went
to sell it you're not going to get your
principal back so and because because
assets are priced daily you're going to
see a price fluctuation the longer you
go out and maturity the more extreme
those price fluctuations are going to be
so at like the 30-year Mark you they can
be extremely volatile but now back to
your question what is risk so for short
maturity bonds uh you're not going to
have any volatility which is one way to
think about risk you're also going to
have a relatively low interest rate uh
and if you look in the in the data
around the world for how to bills like
short very short-term government debt
obligations how do they perform they're
there's a pretty good chance you're
going to lose money in real terms
holding very short-term debt so they're
not
volatile but there's a good chance they
won't keep up with inflation so you're
not taking on volatility risk but you're
taking on the risk of losing your
purchasing power if we go to the other
end of the spectrum uh it's nominal
bonds what we're talking about so bonds
that don't adjust for inflation there
are also real bonds or tips in the in
the states that do adjust for inflation
it's this is an idiot's class it's hard
it's hard to ignore them so I I'll talk
though about long long-term bonds like
you mentioned earlier if you if you have
a a nominal liability and that's
important it's frustratingly complicated
but it's important if you have a nominal
so it's $100,000 but it's a $100,000
nominal so it's not going to change in
in real terms like there's no inflation
on this liability that you have right
and you buy a bond for that you're going
to get your interest over time and
you're going to get your principal back
at maturity and even the price
fluctuations in the inter term are not
going to matter to you because you have
this 30-year liability that you need to
fund and you don't care about the end
term so it's not it's going to be
volatile uh but it's going to hedge your
future
liability the problem is most
liabilities are not nominal like I don't
think an individual house like you or I
do not have nominal liabilities I don't
think in in any anything like there's no
nothing that I'm going to want to buy in
the future that's not exposed to
inflation insurance companies have
nominal liabilities because someone buys
a million dollar insurance policy it's
going to be a million dollar insurance
policy in 30 years or whatever uh but we
we households people want to buy stuff
food whatever those are real liabilities
so a nominal Bond even if it perfectly
Hedges a nominal liability can be
extremely risky in real terms and so
this gets to the the really interest
interesting thing about now you can buy
you can buy an inflation protected bond
to hedge that real liability um but
bonds more generally nominal bonds how
do they fit into portfolios they reduce
your volatility for sure bonds to your
stocks reduces your
volatility but they probably decrease
your ability to maintain purchasing
power in the long
run and so we should yeah we yeah we
should
first we need to we need to probably
Define what volatility is even though
we've been talking about it for a while
because most of us myself included we I
usually think of risk in just in terms
of volatility like you know the the risk
that price will go up or down and the
the size of those swings um but that is
not all that risk is risk is actually
very hard to Define anyway go ahead
what's
volatility uh it's the price how much
the magnitude of price changes I guess
is one way to think about it so a stock
is going to be volatile it's going to be
worth you know $10 today but it might be
worth $15 tomorrow or $5 Bitcoin is
volatile you know Bitcoin one day it's
worth you 10,000 one day it's worth
100,000
um and then as compared to that we talk
about bonds as being less risky what do
we mean by that we mean they are going
to be subject to lower price
fluctuations but that as you say is not
the only risk a huge risk that we you
know all are concerned with is okay
in 30 50 80 years when you know when I
need to fund some retirement do I have
enough money at relative to uh my
standard of living and infl the
inflation that has happened during that
period of time that is a huge risk that
and there is an argument maybe you could
give it that equities having equities as
part of your portfolio actually Dr risks
that yeah so equities are very risky in
the sense that they're volatile and they
do have an uncertain long-term outcome
like there there's no sane world where I
would say that investing in stocks is
going to give you a guaranteed
inflation adjusted return the long
there's still a chance you lose money
but relative to nominal
bonds uh Bond stocks have historically
been much safer there's a paper on this
that's not published yet it's going
through like the conference uh cycle and
stuff and it's it's getting interesting
comments I've been talking to the author
about it the whole time but it's uh the
paper's called challenging the status
quo it's basically saying that the
status quo is that people think they
should start out investing in stocks
when they younger and then add bonds as
they get older because bonds are safer
and that's like you know Common Sense
textbook and so their paper basically
shows if you go and look at the they use
global data going back to 1870 and they
did something called bootstrap
simulations basically they they created
a whole bunch of hypothetical scenarios
using actual historical data but it gave
them way more potential hypothetical
scenarios based on historical data than
we actually have historical data right
and what they found in those simulations
is that the optimal portfolio for the
whole life cycle is 100% stocks now this
is like it's pretty controversial
because while their data show that like
a lot of people get really upset that
anybody would possibly say that but it's
at very at the very least it's a very
interesting finding and it's driven by
the fact that stocks are still very
risky and they emphasize this in the
paper stocks are still super risky at
long Horizons but bonds nominal bonds
are a lot riskier you're much more
likely to lose money in bonds and so
adding them to your portfolio crazy
right adding them to your portfolio
makes it riskier it makes it less
volatile which is great if you're really
worried about volatility but it makes it
riskier from the perspect perspective of
funding your future
consumption okay that that being said
one thing that always freaks me out
about things like that and maybe this is
the you know
the slightly risk averse volatility wise
guy in me which is that every Financial
investor can read all the theory till
they're kind of blew in the face but
they only get one shot at the financial
markets and they can't predict
beforehand what their ride is going to
be so they have they have all this
history but they're guaranteed a
different ride than the historically was
the case so saying historically we had
all this you know evidence that you know
stocks or whatever um stocks don't
always beat bonds now they beat bonds
over if you take a long enough time
frame you could say that they you know
they they beat them over you know this
many if you take this many years but we
also don't know that that's even a
guarantee that that will continue to be
the case so what always you know freaks
me out about that is like you have to
plan for what historically didn't happen
to happen and that is like to me the
basis of a lot of a sound framework for
investing is you have
to build a portfolio
where yes you want us stocks to rip a
100 like for the rest of time but you
have to plan for the event that doesn't
happen because you only have one shot at
the your investing time period does that
make sense it does it does make sense
and I mean there there are different
ways that people have tried to express
that I've seen some pretty crazy
portfolios that take what you're saying
to the extreme where it's like we're
going to have 10% gold 10% stocks 10%
Bitcoin like every possible thing that's
going to perform potentially differently
from the other stuff so I I don't
disagree with you and bonds are a pretty
tame example of of diversification
obviously and I I'm not advocating for
100% stock portfolios we have not very
many clients that are firmed that are
actually invested that way I I think
it's an interesting idea um yeah I mean
there there are limits to that thinking
I I we don't know the distribution of
all future asset returns and because of
that we don't know which assets are
going to be good diversifiers I think
looking at historical data is one
interesting lens but I agree with you
like if you look at just the theory and
forget about that empirical paper yeah
of course bonds makes sense but then you
look at the empirical paper and it's
like well yeah okay this gets me to
actually where I want to um where I want
to sort of try to start wrapping things
up which is
through listening to the boggles to the
Ben Felix's of the world to all you
smart guys who are reading all these
papers
I've sort of come to an
interesting
um place
where the fundamentals are sort of
Undisputed in a lot of these circles
where it's like okay passive investing
you get what you don't pay for most
active investors will lose so the
average makes sense and then it's almost
like when you get into like the basics
of fitness and then you get into
advanced Fitness where there's all the
these new papers that come out and
people excitedly rush into these like
new theories about like how to optimize
the you know the little tidbits of this
or that but they are sort of
making tiny little I would say like a
like uh you know
theoretical I don't know bets is the
right word I guess in finance it's a
little bit more of bets uh because you
don't know the outcome But
ultimately when you do think about
people who are not plugged in
what do you think about this is I guess
where we're going to end where we
started which is what should most
investors okay that they're not reading
journals they don't want to pay
attention to any of this stuff they
don't want to be worried about um you
know sort of what the latest paper says
about allocation what are their what is
like the basics and then we can't tell
them what portfolio to build because
obviously they need to make their own
decision based on that but let's get
back to ignoring like the daily trends
of or I get it's not I know it's not
daily but like the year-to-year decade
to deade trends of you know we think
this is interesting this is you know a
slightly better way to do it what is the
ad not advice but framework for most
people to think about investing going
back to for idiots so let me give you an
interesting example we talked about
factors we talked about the F French
three Factor model we didn't get to the
five Factor model and that's okay but
there's a there's this term that's
that's uh been created in acad Finance
called the factor zoo and that term was
created because there were so many
documented factors there were so many
they're called pricing anomal anomalies
like so many observations that this type
of stock or that type of stock did
better than other models would predict
and for the exact reason that you're
saying that is that is a problem for
someone who's trying to optimize down to
the most recent paper so I I I don't
think that anybody should be doing that
the problem that creates for people who
want to pursue Factor investing is that
there's always competing models so the F
and F and French have a model but
there's a ton of other models out there
and a lot of people say now that while
the F French model is no longer relevant
because of this this and this so if
you're a f French value investor it's
really hard to stick with your value
portfolio when it's underperforming and
people are saying well no F and French
are wrong now because of this this and
this you should be using this Factor
model so for most people who don't want
to get into the details of why they
think F and French are still right uh
they should probably not that type of
investing now some some people can do it
like I have we have an online community
for our podcast called the rational
reminder Community named after our
podcast and there's a bunch of people in
there that like it it blows my mind
honestly I I love that community and I
interact in there often but there are
people in there that literally nerd out
all day spend hours in there talking
about you know value should be defined
this way no it should be this way or
like momentum is a good Factor no it's
not uh so some people love that and I
mean I think that those people probably
treat it like a hobby that is not most
people the rational minor Community is
not most people so I think for someone
who's listening for the uh Investing For
idiotes listener the intended consumer
of this podcast they should probably be
using lowcost index funds that just
track the market now whether that's us
or globally Diversified I don't know man
like there there's funds like VT that's
a that's not a recommendation but that's
an all stock Global portfolio that's a
that's a pretty nice security as a
starting point at least on the equity
side of a portfolio one thing you don't
have to think about it you have to worry
about it in Canada we have similar
products called asset allocation ETFs
they're not quite like V VT because
they're not they give an overweight to
Canadian stocks they're not market cap
weight but same same idea one thing and
you buy that and that's your portfolio I
think that level of Simplicity like we
talked about investor Behavior earlier
too uh when you look at the data on that
funds that are self-contained that
rebalance themselves they tend to have
much lower Behavior gaps investors tend
to behave much better in those products
so for for the typical person that's
listening to this podcast that's like
trying to learn about investing and they
want to just make good decisions uh
total market index funds market
capitalization weights are a great
starting point and the more simple you
can make it the better you're going to
be in the long
run and if I could humbly add one tiny
thing to your great wrapup there low
fees we didn't really Touch Too Much on
like because ETFs and and mutual funds
have their own set of fees involved you
need to pay attention of that and keep
it as low as low as possible um Ben
Felix you have been a uh fascinating
character for me to to learn from and I
really appreciate you coming on the show
where can people find you obviously you
have the rational reminder podcast and
you have the YouTube channel is that
your main two outlets where people can
discover your work yeah those are I
release videos every two weeks on my
YouTube channel and then I just search
Ben Felix I guess on YouTube and you'll
you'll find my channel and then rational
reminder we post an episode every week
those are like they're pretty nerdy I
mean if people want to be like really
get into the weeds I guess that they can
listen but I mean yeah investing for
idiots is not is not rational reminders
intended
audience yeah that's not a bad that's
that's fine these are our meme coin
investors our our our Wall Street bets
guys uh okay thank you for watching
we'll see you next time