Speaker 1: Bloomberg Audio Studios, podcasts, radio news. This is Masters in
Speaker 1: Business with Barry Ritholts on Bloomberg Radio.
Speaker 2: This week on the podcast, I have an extra extra
Speaker 2: special guest. Charlie Ellis is just a legend in the
Speaker 2: world of investing. He started for the Rockefeller Family Office
Speaker 2: before going to DLJ and eventually ended up launching Greenwich Associates.
Speaker 2: He's published twenty one books. He's won every award you
Speaker 2: can win in the world of finance. He was a
Speaker 2: member of Vanguard's Board of Director, he was chairman of
Speaker 2: the Yales Endowment Investment Committee. And his not only did
Speaker 2: he write twenty one books, his new book, Rethinking Investing
Speaker 2: is just a delightful snack. It's only one hundred pages
Speaker 2: and it distills sixty years of investing women wisdom into
Speaker 2: a very very short read. I found the book excellent
Speaker 2: and Charlie as delightful as always. I really enjoyed our
Speaker 2: conversation and I think you will also with no further ado,
Speaker 2: my discussion with Charlie. Alie, thank you Berry, Well, thank
Speaker 2: you for being here. First of all, we're going to
Speaker 2: talk a lot about the book in a bit which
Speaker 2: I really just devoured over a cup of tea. It
Speaker 2: was that short and very delightful. But before we do that,
Speaker 2: I want people to fully understand what a fascinating background
Speaker 2: you've had and how really interesting your career is. Where
Speaker 2: you began and where you ended up. You get a
Speaker 2: master's in business from Harvard Business School, a PhD from
Speaker 2: New York University, and then you sort of happen onto
Speaker 2: Rockefeller Foundation. How did you get that first job? How
Speaker 2: did you discover your calling?
Speaker 3: Friend of mine and schools said if you got a
Speaker 3: job yet? I said, no, not yet, got a couple
Speaker 3: of things, and I'm working towards He said, well, I've
Speaker 3: got a friend, and I thought he meant the Rockefeller Foundation.
Speaker 3: Actually he meant the Rockefeller family in their investment office.
Speaker 3: And very very bright guy came up from New York
Speaker 3: to Cambridge, Massachusetts, climbed to the third floor of my
Speaker 3: apartment building, and we did an interview in what I
Speaker 3: would have to describe as shabby graduate student facility. And
Speaker 3: at the end of half an hour, I realized it
Speaker 3: isn't the Foundation that he's talking about. He's doing about
Speaker 3: something else, and I got to figure out what that is.
Speaker 3: The end of the second half an hour, I knew
Speaker 3: he was trying about investing where there were no courses
Speaker 3: at that time at the Harvard Business School on investment management.
Speaker 2: And he's really describing the Rockefeller family office. Yes, not
Speaker 2: necessarily the foundation. So what were they doing at that time?
Speaker 2: What were their investments like, Well.
Speaker 3: They invested the family's fortune, and at that time, relative
Speaker 3: to other family fortunes, it was the large major, so
Speaker 3: on and so on. They were also because they'd been
Speaker 3: generous philanthropically for years, managing several charitable organizations endowments. So
Speaker 3: the combination made us a consequential investment client for Wall
Speaker 3: Street as Wall Street was just coming into doing serious
Speaker 3: research on individual companies and industries. So it was takeoff
Speaker 3: time for what became institutional investing.
Speaker 2: So give us some context as to that era. This
Speaker 2: is the nineteen seventies and eighties essentially.
Speaker 3: Went when I was in the nineteen sixties.
Speaker 2: So late sixties, not a lot of data available on
Speaker 2: a regular basis, and modern portfolio theory was kind of
Speaker 2: just coming around.
Speaker 3: Oh, it was just an academic curiosity. Nobody's right mind
Speaker 3: thought it had a chance to be proven. But you know,
Speaker 3: if you go back to those days. If we came
Speaker 3: back to it, we would all of us agree with
Speaker 3: the people who said, no, it's nothing, it's not going
Speaker 3: to happen. The transformation of the whole investment management world,
Speaker 3: information availability, legislation, who's participating in, what's the trading volume,
Speaker 3: what kind of information is available? How fast can you
Speaker 3: get it? Wow, every one of those dimensions has changed
Speaker 3: and changed and changed. The world is completely different today.
Speaker 2: You detail that in the book. We'll talk about that
Speaker 2: a little bit. That if you just go back fifty years,
Speaker 2: completely different world, as you mentioned the volume, but who
Speaker 2: the players are, how technology allows us to do things
Speaker 2: that we couldn't do before, and that we've also learned
Speaker 2: a lot since then.
Speaker 3: We sure have. It's hard to remember, but I do
Speaker 3: because I was new and fresh and submitting impression. Trading
Speaker 3: volume three million shares in New York Stock Exchange listed
Speaker 3: Now it's six seven eight billion. That's a huge change
Speaker 3: order of magnitude. The amount of research that was available
Speaker 3: was virtually zero.
Speaker 2: That's amazing.
Speaker 3: Now.
Speaker 2: I recall, well, the CCH binders used to get updates
Speaker 2: on a regular basis, the clearing house binders, and then
Speaker 2: it was essentially Zax and a whole bunch of different companies.
Speaker 2: But that's really late eighties, right, Like when did the
Speaker 2: research explosion will really happen?
Speaker 3: Research explosion happened in the seventies and then into the eighties.
Speaker 3: But the documents that you were looking at are thinking
Speaker 3: about we're all looking.
Speaker 2: Backwards, right, that's right.
Speaker 3: Give you the plane vanilla facts of what's happened in
Speaker 3: the last five years in a standardized format with no
Speaker 3: analytical or insight available. Now everything research is a future
Speaker 3: and it's full of factual information and careful interpretation. It's
Speaker 3: really different.
Speaker 2: That's really interesting. So how long are you at Rockefeller
Speaker 2: before you launched Greenwich Associates in nineteen seventy two.
Speaker 3: Well, I was there for two and a half years.
Speaker 3: Then I went to Wall Street with Donaldson, Lufkin and
Speaker 3: General at for six and then I started Greenwich Associates.
Speaker 2: So what led you after less than a decade to
Speaker 2: say I'm going to hang my own shingle. It seems
Speaker 2: kind of bold at that point you're barely thirty years old.
Speaker 3: It was a little nervy, I have to graduate. There
Speaker 3: are a couple of different parts. One is that I
Speaker 3: knew from my own personal experience, I had no ability
Speaker 3: to get my clients to tell me what I was
Speaker 3: doing right or wrong. They'd always say, oh, you're doing fine,
Speaker 3: just keep it up, You're doing fine. Then no idea
Speaker 3: what my competition was doing. You know, if we could
Speaker 3: give factual information on exactly how well each firm is
Speaker 3: doing and how every one of their competitors are doing,
Speaker 3: we could interpret that in ways that clients would find
Speaker 3: really useful, and then we could advise them on specific
Speaker 3: recommendations based on the facts, really undeniable facts, based on
Speaker 3: three hundred, five hundred, six hundred interviews with people who
Speaker 3: made the decisions, and it worked well.
Speaker 2: I can't imagine they're happy with the outcome, because what
Speaker 2: you eventually end up learning is that a lot of
Speaker 2: people who charge high fees for supposedly expert stockpicking, expert
Speaker 2: market timing, expert allocation, they're not doing so well, And
Speaker 2: it turns out, at least on the academic side, it
Speaker 2: appears that the overall market is beating them.
Speaker 3: I wouldn't quite say it that way, So I wouldn't
Speaker 3: deny what you're saying, but I would say it differently. Now,
Speaker 3: when the purpose of any market a grocery store, a
Speaker 3: drug store, filling station. The purpose of any market is
Speaker 3: really to find what's the right price that people will
Speaker 3: buy and trade at, and the securities industry is a
Speaker 3: very strong illustration of that. Lots of buyers, lots of sellers,
Speaker 3: what do they think is the right price to do
Speaker 3: a transaction, and they put real money behind it. So
Speaker 3: that purpose of a market gets better and better and
Speaker 3: better when the participants are more skillful, when the participants
Speaker 3: have more information, when the information is really accessible, and
Speaker 3: that's what's happened to the securities markets. The ability to
Speaker 3: get information from a Bloomberg terminal. You don't mind using mitame,
Speaker 3: but seriously, Bloomberg terminal will spew out so much in
Speaker 3: the way of factual information. And there are hundreds of
Speaker 3: thousands of these terminals all over the world, so everybody
Speaker 3: in his right mind has them and uses them. Everybody's
Speaker 3: right mind has computing power that would knock the socks
Speaker 3: off Anybody who came from nineteen seventy got dropped into
Speaker 3: the current period that would just be amazed at the
Speaker 3: computing power. And they don't use slide rules anymore. You know,
Speaker 3: back in the early seventies, everybody used a slide rule. Wow,
Speaker 3: and we were proud of it, and we're pretty skilled
Speaker 3: at it. But it's nothing like having computing power behind you.
Speaker 3: In those days, there were very few in the way
Speaker 3: of federal regulations. Now it's against the law for a
Speaker 3: company to have a private luncheon with someone who's in
Speaker 3: the investment world.
Speaker 2: Right reg FD said it has to be disclosed to
Speaker 2: everybody at once, so it is just whisper it to.
Speaker 3: And everybody gets the same information at the same time.
Speaker 3: So basically what you've got is everybody in the game
Speaker 3: is competing with everybody knowing everything that everybody else knows
Speaker 3: at exactly this right same time. You can be terribly
Speaker 3: creative and wonderfully bright and very original, but if everybody
Speaker 3: knows exactly what you know, then they've got computing power,
Speaker 3: so they can do all kinds of analytics. Then they've
Speaker 3: got Bloomberg terminals, so they can do any backgrounding that
Speaker 3: they want to find. It's really hard to see how
Speaker 3: you're going to be able to beat them by much,
Speaker 3: if anything. And the truth is that people who are
Speaker 3: actively investing are usually making They don't mean to, but
Speaker 3: they are making mistakes. Then those mistakes put them a
Speaker 3: little bit behind, a little bit behind, a little bit
Speaker 3: behind the market. And then of course they charge fees
Speaker 3: that are high enough, so trying to recover those fees
Speaker 3: while trading. And you can only trade successfully by beating
Speaker 3: the other guy when he's just as good as you are.
Speaker 3: He's got just as big a computer as you have,
Speaker 3: got just the same factual information you have. Then all
Speaker 3: those other different dimensions, there's no way that you could think, oh, yeah,
Speaker 3: this is a good opportunity to do well. That's why
Speaker 3: people increasingly, in my view, sensibly turned index funds to
Speaker 3: cut down on the cost.
Speaker 2: So it's interesting how well you express that, because sometime
Speaker 2: in the nineteen seventies you start writing your thoughts down
Speaker 2: and publishing them. Not long after, in nineteen seventy seven,
Speaker 2: you win a Gram and DoD Award. Tell us what
Speaker 2: you were writing about back in the nineteen seventies and
Speaker 2: what were you using for a data series when there
Speaker 2: really wasn't a lot of data.
Speaker 3: Well, the data did come, but it came later, and
Speaker 3: fortunately it proved out to be very strong confirmation for
Speaker 3: what I've been thinking. But I was in institutional sales
Speaker 3: and I would go around from one investor to another,
Speaker 3: to another, to another to another, and I knew pretty
Speaker 3: quickly they're all really bright guys. They're all very competitive,
Speaker 3: they're all very well informed. They're all very serious students
Speaker 3: trying to get better and better and better. Their job
Speaker 3: is to beat the other guys. But the other guys
Speaker 3: are getting better and better and better all the time,
Speaker 3: striving to be best informed. They get up early, they
Speaker 3: study on through the night, they take work home on weekends.
Speaker 3: Competition competition, competition, competition. How are you going to do
Speaker 3: better than those other guys when there's so much in
Speaker 3: the way of raw input is the same and the
Speaker 3: answer is no, you can't.
Speaker 2: Michael Mobison calls that the paradox of skill. As all
Speaker 2: the players in a specific area get more and more skillful,
Speaker 2: outcomes tend to be determined more by random luck because
Speaker 2: everybody playing is so good at the game.
Speaker 3: Absolutely true.
Speaker 2: So I'm fascinated by this quote. We've been talking about
Speaker 2: errors and making mistakes. One of the things from your
Speaker 2: book that really resonated is quote, we are surrounded by
Speaker 2: temptations to be wrong in both investing and in life.
Speaker 3: Explain well, we all know about life that were tempted
Speaker 3: by beautiful men beautiful women who are tempted by whiskey,
Speaker 3: gin other drinks, where some of us get tempted by
Speaker 3: drugs and other things like that. So there are lots
Speaker 3: of temptations out and around. You think about all of
Speaker 3: us in the investment world are striving to be rational,
Speaker 3: which is a terribly difficult thing to do. Warren Buffett
Speaker 3: is rational and is brilliantly rational. He also does an
Speaker 3: enormous amount of homework. He also has terrific ability to
Speaker 3: remember things that he studied, and he spends most of
Speaker 3: his time reading, studying, memorizing, and reusing. Very few people
Speaker 3: have that kind of ability natural ability that he has.
Speaker 3: But most of us now have equipment that will damn
Speaker 3: near do the same thing, and you could call up
Speaker 3: things from the historical record anytime you want to. It
Speaker 3: puts everybody in a position of being able to compete
Speaker 3: more and more skillfully all the time. And therefore, candidly
Speaker 3: I think the fees are a big problem. And then
Speaker 3: the second problem is, yes, we've got opportunities to be
Speaker 3: born more skillful and more and more effective, but actually
Speaker 3: what we also have, which really drives anybody who seares
Speaker 3: about examining the data drives some nuts. And anybody who
Speaker 3: is an investor wants to deny it. And that is
Speaker 3: that we make mistakes. We get scared by the market
Speaker 3: after it's gone down, we get excited about the market
Speaker 3: positively after it's gone up, and we interpret and make
Speaker 3: mistakes in our judgment. Now, it's a wonderful section in
Speaker 3: this little bitty book that I've just finished, wonderful section
Speaker 3: on behavioral economics. Terrific book by Daniel Konnaman Thinking Fast,
Speaker 3: Thinking Slow, several hundred pages, and anybody in the investment
Speaker 3: world or to read it because it tells you all
Speaker 3: about what we need to know about ourselves. And I've
Speaker 3: got one chapter that just ticks off a whole bunch
Speaker 3: of things, Like eighty percent of people think they're above
Speaker 3: average dancers, eighty percent of people think they're above average drivers.
Speaker 3: If you ask men a question, are you really above
Speaker 3: average various kinds of skills, they get up to pretty
Speaker 3: ninety ninety five percent saying they're very, very very good. Now,
Speaker 3: if you look at a college group, are you going
Speaker 3: to have happier life than your classmates? Yes, by far
Speaker 3: are you going to get divorced as much as your classmates?
Speaker 3: Oh no, that won't happen to me. Then all kinds
Speaker 3: of other things that anybody looking at it objectively would say,
Speaker 3: you know, Barry, that just isn't the way it's going
Speaker 3: to happen. These guys aren't that much better drivers than
Speaker 3: the normal crowd. In fact, they are part of the
Speaker 3: normal crowd.
Speaker 2: You know, we all that we're separate from the crowd.
Speaker 2: I love the expression I'm stuck in traffic, when the
Speaker 2: reality is, if you're near a major urban center during
Speaker 2: rush hour on workday, you're not stuck in traffic. You
Speaker 2: are traffic. And we all tend to think of ourselves
Speaker 2: as separate. Really really fascinating stuff. I'm fascinated by the
Speaker 2: evolution of your investing philosophy. You start with Rockefeller Family Office.
Speaker 2: I assume back in the nineteen sixties that was a
Speaker 2: fairly active form of investing. Tell us a little bit
Speaker 2: about how you began, what sort of strategies you were using,
Speaker 2: and then how you evolved.
Speaker 3: Whoa boy. That's a complicated question. First of all, In
Speaker 3: the early sixties, when I was working for the Rockeviller family,
Speaker 3: that was the old world. All kinds of changes have
Speaker 3: taken place since then and virtually turned every single dimension
Speaker 3: of what was the right description of the investment world
Speaker 3: into a very different, opposite version. And it changed like
Speaker 3: that makes it almost a waste of time to talk
Speaker 3: about what was it like. But just for instance, I
Speaker 3: did some analysis of a company called DuPont, which was
Speaker 3: one of the blue blue trips of all time. And
Speaker 3: I had also been studying IBM, which was a wonderful company,
Speaker 3: and I've realized, you know, IBM has got an ability
Speaker 3: to generate its own growth because it is creating one
Speaker 3: after another advancement in computing power, and they've got a
Speaker 3: terrific organization behind it, and they are able to create
Speaker 3: their own growth. IBM is a true growth company. DuPont
Speaker 3: needs to invent something that other people will really want,
Speaker 3: and it has to be something that's really new, and
Speaker 3: then they get patent protection for a certain period of time,
Speaker 3: and then they lose the patent protection because it's completed.
Speaker 3: They've got a different situation. Both companies were selling at
Speaker 3: thirty thirty two times earnings. One company I thought was
Speaker 3: sure to continue growing and the other I wasn't so sure.
Speaker 3: So I got permission to go down to Wilmington, Delaware,
Speaker 3: and for three days I had nothing but one interview
Speaker 3: after another after another, where the senior executive of the
Speaker 3: DuPont organization, and they were very candid, and they told
Speaker 3: me about their problems. They told me about their opportunities.
Speaker 3: They told me about their financial policies. Their first level
Speaker 3: financial policies were that they would always pay out half
Speaker 3: their earnings and dividends the long established and that was
Speaker 3: the way they did things. The second thing is they
Speaker 3: had a major commitment to nylon, but nylon was no
Speaker 3: longer patent protected, and so the profit margins of nylon
Speaker 3: were going to come down, for sure, and come down
Speaker 3: rather rapidly because competition was building up pretty quickly. They
Speaker 3: hoped to build one terrific business in a leather substitute
Speaker 3: called Corefam. But as I talked to the executives, they
Speaker 3: talk to me about we're having difficulty getting people to
Speaker 3: use core fam. We're getting people who make shoes to
Speaker 3: think about using core Fam. We can't get sales outside
Speaker 3: the United States to really get going, and we're having
Speaker 3: a difficult time getting sales inside the United States. And
Speaker 3: candidly it doesn't look like this is going to turn
Speaker 3: out to be the bonanza we had all thought it
Speaker 3: was going to be just a year or so ago. Well,
Speaker 3: it doesn't take a genius, then it doesn't take a
Speaker 3: very experienced person. And I was not a genius, and
Speaker 3: I was not an experienced person, but I could see
Speaker 3: the handwriting. Wait a minute. If you only reinvest half
Speaker 3: your earnings each year and your major business is going
Speaker 3: to be more and more commoditized, and your major new
Speaker 3: business is not taking off, you got a real problem here,
Speaker 3: and you're gonna have a tough time keeping up the
Speaker 3: kind of growth that would justify selling for thirty plus
Speaker 3: times earnings, whereas IBM was guaranteed to be virtually guaranteed
Speaker 3: to be able to do that because they didn't have
Speaker 3: very much the way of competition, and they really knew
Speaker 3: what they were doing, and they kept cranking it out.
Speaker 3: So what do you do? I came back and said,
Speaker 3: I know that the family, the Rockefeller family, has many
Speaker 3: friends in the DuPont organization, but they also have many
Speaker 3: friends in the Watson family of IBM. I think it
Speaker 3: would be a great thing if we would sell off
Speaker 3: the holdings in DuPont and use the money to buy
Speaker 3: into IBM, go out of one family friends into another
Speaker 3: family friends. They would all understand it, and that was
Speaker 3: what was done, and of course it involved a substantial
Speaker 3: amount of ownership being shifted. And I've always thought to myself, Wow,
Speaker 3: in that one specific recommendation, I earned my cape for
Speaker 3: several years.
Speaker 2: Huh. Really interesting, And it's fascinating because that's what was
Speaker 2: being done in every institutional investor and every endowment. People
Speaker 2: were making active choices.
Speaker 3: But they also were making lots of mistakes. Right if
Speaker 3: you looked at what happened in the two years after
Speaker 3: my recommendation, IBM doubled and DuPont almost got cut in half.
Speaker 2: Wow, So that worked out really well. So it's kind
Speaker 2: of fascinating that you've evolved into really thinking about indexing
Speaker 2: because when you were chairman of the Yale Endowment Investment Committee,
Speaker 2: David Swinson was famously the creator of the Yale model,
Speaker 2: and he had a lot of focus on private investment,
Speaker 2: on alternatives, on venture capital, hedge funds, as well as commodities.
Speaker 2: What made that era so different where those investments were
Speaker 2: so attractive then and apparently less attractive to you today.
Speaker 3: First, you have to understand that David Swinson was a
Speaker 3: remarkably talented guy. He was the best PhD student that
Speaker 3: Jim Tobin Nobel Prize winner ever had. He was the
Speaker 3: first person to do an interest rate swamp, which is
Speaker 3: the first derivative transaction that took place in this country
Speaker 3: between IBM and the World Bank, which just show you
Speaker 3: everybody had told him you'll never be able to do that, David.
Speaker 3: So we're talking about a very unusual guy, and he
Speaker 3: was creative and disciplined in a remarkable combination. And he
Speaker 3: was the first person of size to get involved in
Speaker 3: a series of different types of investing, and then he
Speaker 3: very carefully chose the very best people in each of
Speaker 3: those different types. One day I was thinking, you know,
Speaker 3: he's really done some very creative work. I wonder what's
Speaker 3: his average length of relationship because the average length of
Speaker 3: relationship with most institutions was somewhere between two and a
Speaker 3: half and three and a half years. High turnover of
Speaker 3: managers the calculation was fourteen years on average, and they
Speaker 3: were still running, so it'd probably be something like twenty
Speaker 3: years of typical relationship duration. Many of these managers when
Speaker 3: they were just getting started. So it's the most dicey
Speaker 3: period in any investment organization. Very very unusual and creative.
Speaker 3: Guy said to me after he'd been doing this for
Speaker 3: quite a long time. You know the nature of creativity
Speaker 3: payoff is getting less and less and less because of
Speaker 3: everybody else is doing what I've been doing. It's not
Speaker 3: as rewarding as it used to be. And because I've
Speaker 3: been choosing managers and other people are trying to get
Speaker 3: into those same managers, they're not as differentiated as they
Speaker 3: used to be. The rate of return magnitude that I
Speaker 3: have been able to accomplish ten years ago, fifteen years ago,
Speaker 3: I'm not going to be able to do in ten
Speaker 3: or fifteen years into the future. And I think he
Speaker 3: was right.
Speaker 2: Huh really interesting. So how do you end up from
Speaker 2: going from the Yell Endowment to the Vanguard Board of Directors?
Speaker 2: Tell us where that relationship.
Speaker 3: Came completely different. Each one was doing what they were
Speaker 3: capable of doing really well. Vanguard was focused on minimizing
Speaker 3: cost and they really systematic at it. Different orientation. The
Speaker 3: orientation of the Yale Endowment was to find managers and
Speaker 3: investment opportunities that were so different that you might get
Speaker 3: a higher rate of return. So attacking to the reaching
Speaker 3: for higher and higher rate of return, Vanguard was reaching
Speaker 3: for lower and lower cost of executing a plain vanilla
Speaker 3: proposition index funds Canes once had somebody say, you seem
Speaker 3: to have changed your mind. He said, yes, when the
Speaker 3: facts changed, I do change my judgment. What do you
Speaker 3: do when the facts changed? And the reality is we've
Speaker 3: been looking at a market that has changed and changed
Speaker 3: and changed and changed, and the right way to deal
Speaker 3: with that market has therefore changed and changed and changed
Speaker 3: and changed. Then what you could have done in the
Speaker 3: early nineteen sixties you can't do today. And what you
Speaker 3: should have done in the early sixties was go find
Speaker 3: an active manager who could knock the socks off at
Speaker 3: the competition. But it just the competition is so damned
Speaker 3: good today that there isn't a manager that can knock
Speaker 3: the sox off.
Speaker 2: And a quote from your book is the grim reality
Speaker 2: is clear active investing is not able to keep up with,
Speaker 2: let alone outperform the market index. That's the biggest change
Speaker 2: in the past fifty years is that it's become pretty
Speaker 2: obvious that the deck is to be in favor of
Speaker 2: active managers. Now it seems to be very much stacked against.
Speaker 3: Them because they're so very good. It's ironic, ironic, ironic.
Speaker 2: The paradox of skill. Yep, huh, really fascinating. You reference
Speaker 2: some really interesting research in the book. One of the
Speaker 2: things I found fascinating is that research from morning Star
Speaker 2: and Dalbar show that not only do investors tend to
Speaker 2: underperform the market, they underperform their own investments.
Speaker 3: Tell us about that, because we're human beings, as any
Speaker 3: behavioral economists would point out to you, we have certain beliefs,
Speaker 3: and those beliefs tend to be very very optimistic about
Speaker 3: our skills, and we think we can help ourselves get
Speaker 3: better results, or at least to minimize the negative experiences.
Speaker 3: And the reality is that over time just doesn't work
Speaker 3: out to be true. The average investor in an average
Speaker 3: year loses two full percent by making mistakes. With the
Speaker 3: best of intentions, trying to do something really good for themselves,
Speaker 3: they make mistakes that are costly and that cost you.
Speaker 3: Think about it, if you think the market's going to
Speaker 3: return something like six or seven percent, you lose two percent,
Speaker 3: maybe two and a half, maybe three for inflation, call
Speaker 3: it two and a half. Whoop, that's something down. Then
Speaker 3: you've got fees and costs. Jeez, who is add on
Speaker 3: to that? If you did add on another two percent
Speaker 3: that you've made mistakes, you're talking about a major transformation
Speaker 3: to the negative of what could have been your rate
Speaker 3: of return.
Speaker 2: Let's put some numbers, some meat on that bone. You
Speaker 2: cite a UC Davis study that looked at sixty six
Speaker 2: thousand investor accounts from nineteen ninety one to nineteen ninety six.
Speaker 2: Over the that period, the market gained just under eighteen
Speaker 2: percent a year, seventeen point nine percent a year. Investors
Speaker 2: had underperformed by six point five percent a year. They
Speaker 2: gave up a third of gains through mistakes, taxes, and costs.
Speaker 2: And then Dalbar does the same thing. That's where the
Speaker 2: two to three percent in a low return environment is.
Speaker 2: So how should investors think about this tendency to do
Speaker 2: worse than what the market does well?
Speaker 3: In my view, and it's part of the rethinking investing
Speaker 3: concept of the book is if you find a problem,
Speaker 3: it's a repetitive problem. In this sure is attack the
Speaker 3: problem and try to reduce it. So what could you
Speaker 3: do to reduce the cost of behavioral economics, and the
Speaker 3: answer is index or ETF. And the reason why you
Speaker 3: would index where ETF would help is because it's boring.
Speaker 3: You know, if you own an index fund, you don't
Speaker 3: get excited about what happened in the market is anything
Speaker 3: like you would get excited about it if you had
Speaker 3: just had five stocks, or if you had two or
Speaker 3: three mutual funds and you were tracking those mutual funds
Speaker 3: because they change more. The market as a whole, it
Speaker 3: kind of goes along in its own lumbering way, a slow,
Speaker 3: wide river of flow over time, and you, yeah, there's
Speaker 3: nothing to get excited about, so you leave it alone.
Speaker 3: You leave it alone, and you leave it alone. And
Speaker 3: it's a little bit like when your mother said, don't
Speaker 3: pick it that scab, let it heal by itself. Well,
Speaker 3: but mom, it itches. You'd just be a little bit
Speaker 3: tolerant and don't itch it or don't scratch it. Then
Speaker 3: it'll heal faster. And sure enough, mother was right. In
Speaker 3: the same way, if you index, you won't be excited
Speaker 3: by the same things that other people get excited by,
Speaker 3: and you just sort of steadily flow through and have
Speaker 3: all the good results come your way. That's it.
Speaker 2: Huh. Really interesting. So, first of all, I have to
Speaker 2: tell you I love this book. It's totally digestible. It's
Speaker 2: barely one hundred pages. I literally read it over a
Speaker 2: cup of tea. And you've published twenty books before this. What,
Speaker 2: first of all, what led to this very short format?
Speaker 2: Why go so brief? I'm curious.
Speaker 3: It's really an interesting experience for me. I love helping
Speaker 3: people with investing, and I keep trying to think of
Speaker 3: how can I be helpful and what are the lessons
Speaker 3: that my children, grandchildren ought to learn, What are the
Speaker 3: lessons that my favorite institutions ought to learn, my local church,
Speaker 3: whatever it is now, what could I offer that would
Speaker 3: be helpful? And I thought to myself, you know, the
Speaker 3: world has changed a lot, and some rethinking of what's
Speaker 3: the right way to invest might turn out to be
Speaker 3: a good idea. I should try penciling that out. And
Speaker 3: the more I've tried to scratch it out for the
Speaker 3: Church Investment Committee, I realized this is something that could
Speaker 3: easily be used by virtually everybody else. There are some
Speaker 3: major changes that have taken place, and the world of
Speaker 3: investing is very different than it used to be, and
Speaker 3: the right way to deal with the world is really
Speaker 3: different than it used to be. And I owe it
Speaker 3: to other people because I've been blessed with this wonderful
Speaker 3: privilege of being able to learn from all kinds of
Speaker 3: people what's going on in the investment world and how
Speaker 3: to deal with it and add it all together. I
Speaker 3: should put this together in one last short book. And
Speaker 3: my wife laughed, you never get this down to only
Speaker 3: one hundred pages. I think that's all it takes.
Speaker 2: Yeah, pretty close. I think it's like one hundred and something,
Speaker 2: one hundred and two, one hundred and four.
Speaker 3: And one of those pages is blank, and that there
Speaker 3: are several pages that are half blanks of.
Speaker 2: Well, it's barely one hundred pages. So I love this
Speaker 2: quote from the book. Over the twenty years ending in
Speaker 2: mid twenty twenty three, investing in a broad based US
Speaker 2: total market equity fund produced net returns better than more
Speaker 2: than ninety percent of professionally managed stock funds that promise
Speaker 2: to beat the market. Really, that's the heart of the
Speaker 2: book is that if you invest for twenty plus years,
Speaker 2: passive indexing and we'll talk about passive the phrase in
Speaker 2: a minute, but basic indexing ends up in the top decile.
Speaker 3: Yeah, And you're talking about twenty years, and many people say,
Speaker 3: oh gee, that's a long time. Wait a minute, Wait
Speaker 3: a minute, wait a minute. You start investing in your twenties,
Speaker 3: you'll still be investing in your eighties. That's a sixty
Speaker 3: year horizon. And if you're lucky enough to do well enough,
Speaker 3: you might leave some to your children and grandchildren. So
Speaker 3: it might not be sixty years, it might be eighty
Speaker 3: one hundred hundred and twenty years. Try to think about
Speaker 3: that long term, because that is a marvelous privilege to
Speaker 3: have that long a time to be able to be
Speaker 3: an investor.
Speaker 2: And you cite the S and P Research Group SPIVA,
Speaker 2: the average annual return of broad indexes was one point
Speaker 2: eight percentage points better than the average actively managed funds.
Speaker 2: That's nearly two percent compounding over time. That really adds up,
Speaker 2: doesn't it.
Speaker 3: It sure does, And compounding is really important for all
Speaker 3: of us to recognize. Some people call it snowball, and
Speaker 3: I think that's perfectly fine, because as you roll a snowball,
Speaker 3: every time you roll it over, it gets much thicker,
Speaker 3: not just a little bit, much thicker, and you do
Speaker 3: compounding it one two four eight, sixteen thirty two sixty four,
Speaker 3: one hundred and twenty eight. Those last rounds of compounding
Speaker 3: are really important. So for goodness sake, think about how
Speaker 3: can you get there so you'll have those compoundings work
Speaker 3: for you.
Speaker 2: So we mentioned the phrase passive, which has.
Speaker 3: Come oh please don't do that, which comes.
Speaker 2: With some baggage. But you describe what a historical anomaly
Speaker 2: the phrase passive? Is it? Really? Why don't I let
Speaker 2: you explain? It really just comes from an odd legal usage.
Speaker 2: To tell us a little bit about where the word
Speaker 2: passive came to be when it came glad.
Speaker 3: To indexing is to me the right word to use.
Speaker 3: Passive has such a negative connotation. I don't know about you, Berry,
Speaker 3: but I wouldn't want anybody to describe me as passive.
Speaker 3: Now I'm going to vote for so and so as
Speaker 3: president of the United States, It's not going to be because
Speaker 3: he's passive. Passive is a negative term. However, if you're
Speaker 3: an electrical engineer, it's not a pejorative. There's two parts,
Speaker 3: two prongs or three prongs on the end of a wire,
Speaker 3: and there's a wall socket that's got either two holes
Speaker 3: or three holes, depending on which electric system is. The
Speaker 3: one that has the prongs is called the active part.
Speaker 3: The one that has the holes is called the passive part.
Speaker 3: And because indexing was created by a group of electrical
Speaker 3: engineers and mechanical engineers, they just used what they thought
Speaker 3: was the sensible terminology, and then other people who had
Speaker 3: not realized where it came from, saw it as being
Speaker 3: a negative. I don't want to be passive. I want
Speaker 3: to have an active manager who go out there and
Speaker 3: really do something for me. That is a complete misunderstanding,
Speaker 3: and it really did a terrible harm for indexing vest
Speaker 3: to be called passive.
Speaker 2: Let's talk about some of the other things that index
Speaker 2: investing has been called. And I put together a short
Speaker 2: list because there's been so much pushback to indexing. It's
Speaker 2: been called Marxist, communist, socialist. It's devouring capitalism, it's a mania,
Speaker 2: it's creating frightening risk for markets. It's lobottomized investing, a
Speaker 2: danger to the economy, a systemic risk, a bubble waiting
Speaker 2: to burst. It's terrible for our economy. Why so much
Speaker 2: hate for indexing.
Speaker 3: Well, if you were an active manager and you were
Speaker 3: life threatened by something that was a better product to
Speaker 3: the lower cost, you might have some negative commentary too.
Speaker 2: It's just as simple as their livelihood is dependent on
Speaker 2: flows into active and that's where all the animals.
Speaker 3: And it's partly livelihood, it's partly religious faith, it's partly
Speaker 3: cultural conviction, it's partly what I've done for most of
Speaker 3: these people would say, have been doing it for twenty
Speaker 3: five years, and I want to keep doing it for
Speaker 3: twenty five years. Oh, by the way, I get paid
Speaker 3: really well to do.
Speaker 2: It, and I liked that job to continue. Sure you
Speaker 2: mentioned we talked earlier about the temptation that we're surrounded
Speaker 2: by temptations to be wrong. I want to talk about
Speaker 2: some data in the book about what happens if you're
Speaker 2: wrong and out of the market during some of the
Speaker 2: best days. And the data point you use was ten
Speaker 2: thousand trading days over twenty six years on average, that's
Speaker 2: about eleven point two percent returns. So if you have
Speaker 2: money in broad market indices over twenty six years, ten
Speaker 2: thousand trading sections, you're averaging eleven point two percent annually.
Speaker 2: If you miss only the ten best days, not a year,
Speaker 2: but over those ten thousand trading days, that eleven point
Speaker 2: two percent drops to nine point two percent twenty days
Speaker 2: down seven point to seven point seven percent a year,
Speaker 2: and if you miss the thirty best days out of
Speaker 2: ten thousand, the return goes from eleven point two to
Speaker 2: six point four, almost a five hundred bases point drop.
Speaker 2: That's amazing. Tell us about that.
Speaker 3: Oh, First of all, you have to recognize when you
Speaker 3: select out the most extreme days, it does have a
Speaker 3: really big impact. The second thing is when do those
Speaker 3: days come? And the best days usually come shortly after
Speaker 3: the worst days, the bounce, the hey, wait a minute,
Speaker 3: this market is not as bad as everybody's saying. It
Speaker 3: really does have a terrific opportunity, and that's when the
Speaker 3: best days typically come. So the time that we all
Speaker 3: get frightened and all of us get unnervou is the
Speaker 3: is the most wrong time to be taking action.
Speaker 2: And the statistical basis is those ten days are only
Speaker 2: zero point one percent of total training sessions, but you're
Speaker 2: giving up one fifth of the games. That's an amazing asymmetry.
Speaker 3: And it's a hell of a great lesson to learn.
Speaker 3: Hang in there, steady aety does pay off.
Speaker 2: Another quote from the book, why should investors care about
Speaker 2: the day to day or even month to month fluctuations
Speaker 2: in prices if they have no plans to sell any
Speaker 2: time sooned. That sounds so perfectly obvious when you hear it.
Speaker 2: Why are people so drawn into the noise?
Speaker 3: Well, when I advise people on investing, I always start
Speaker 3: with what do you most want to accomplish? And then
Speaker 3: the second question is when do you plan to sell
Speaker 3: your securities? And most people say, well, what do you
Speaker 3: mean when do I plan to sell? Well, when are
Speaker 3: you most likely to say? I need money out of
Speaker 3: my securities? Investment for life spending, probably in retirement. Oh yeah,
Speaker 3: And then they'll give you a date, and then you say,
Speaker 3: and how far out into the future is that? And
Speaker 3: then really want to be difficult for somebody to say, Okay,
Speaker 3: it's forty three years out into the future. Let's go
Speaker 3: back forty three years. Tell me what you think was
Speaker 3: happening forty three years ago. Today's date, forty three years ago.
Speaker 2: I have no idea.
Speaker 3: Why do you ask? Well? Asking because you have no idea,
Speaker 3: and you have no idea forty three years out into
Speaker 3: the future. And the reason for that is because you
Speaker 3: don't care. It's the long term trend that you care about,
Speaker 3: and you care greatly about that, but you don't care
Speaker 3: about the day to day to day fluctuations.
Speaker 2: So you sum up the book by pointing out every
Speaker 2: investor today has three great gifts time compounding and ETF
Speaker 2: and indexing.
Speaker 3: Discuss time to be able to have the experience of compounding,
Speaker 3: where you each compounding round you double what you had. Boy,
Speaker 3: does it really pay off to be in it for
Speaker 3: the long term and have saved early enough so that
Speaker 3: you compound a larger amount. But that leap from one
Speaker 3: to two it's not very exciting. Two to four is
Speaker 3: not much, Four to eight is not really all that much,
Speaker 3: Eight to sixteen starts to attract your attention. Sixteen to
Speaker 3: thirty two that's really something. Thirty two to sixty four
Speaker 3: and to one hundred and twenty eight, Holy smokes, I
Speaker 3: want that last doubling. That's really a payoff. Only way
Speaker 3: you get there is start early and stay on course
Speaker 3: compounding away as best you can.
Speaker 2: You know, people have points it out, and I think
Speaker 2: you reference this in the book that as successful as
Speaker 2: Warren Buffett has been over his whole career because of
Speaker 2: the doubling. It depends on the rule of seventy two.
Speaker 2: But let's say every seven or eight years. Half of
Speaker 2: your gains have come in the most recent seven and
Speaker 2: a half eight year era, and Warren's now in his nineties,
Speaker 2: and the vast majority of his wealth have only happened
Speaker 2: in the past ten fifteen years. It's kind of fascinating.
Speaker 3: Well, he's a brilliant and wonderful human being, and all
Speaker 3: of us can learn great lessons from paying attention to
Speaker 3: what Warren says or has said in his annual meetings
Speaker 3: are a treasure chest of opportunities to learn. He did
Speaker 3: start as a teenager, not in his mid twenties, but
Speaker 3: in his early teens, and then he is not stopping
Speaker 3: at sixty five. He's roaring right past that. And when
Speaker 3: you bolt on those extra years, it gives him a
Speaker 3: much larger playing field in which to double and double
Speaker 3: and redouble and redouble. And all of us ought to
Speaker 3: pay attention to that one most powerful lesson. If you've
Speaker 3: got the time, the impact of compounding really is terrific.
Speaker 3: And the only way you get to be have the
Speaker 3: time is to do it yourself, save enough, early enough,
Speaker 3: and stay with it long enough to let the compounding
Speaker 3: take place. But it's inevitable power of compounding is just
Speaker 3: wonderful to have on your side.
Speaker 2: So three of the things I want to talk about
Speaker 2: from the book. First, as alpha became harder and harder
Speaker 2: to achieve, as it became more difficult to be very
Speaker 2: good competition, the aspect of reducing costs, reducing fees, reducing
Speaker 2: taxes became another way of generating better returns. Tell us
Speaker 2: a little bit about what led you to that conclusion
Speaker 2: and what firms like black Rock and Vanguard have done
Speaker 2: to further that belief system.
Speaker 3: Parents really candidly just been pay attention to what the
Speaker 3: numbers say, and pay attention to the data, and the
Speaker 3: data is so powerfully, consistently strong that active investing is
Speaker 3: an exciting idea. And in the right time and circumstance
Speaker 3: the nineteen sixties, it worked beautifully. But the circumstances now
Speaker 3: are so different that it doesn't work beautifully. It works
Speaker 3: candidly negatively.
Speaker 2: Two other things I want to go over, what is
Speaker 2: the concept of total financial portfolio, Meaning, when you're looking
Speaker 2: at your allocation, you should include the present value of
Speaker 2: your future social security payments and the equity value of
Speaker 2: your home has sort of unlike and that should help
Speaker 2: you shift your allocation a little away from bonds, a
Speaker 2: little more into equities. Tell us about that now.
Speaker 3: I think it's one of those ideas that once it
Speaker 3: pops into your mind, you'll never walk away from it.
Speaker 3: Most of us have no idea what the total value
Speaker 3: of our future stream of payouts from Social Security are,
Speaker 3: but you can do the calculation fairly simply. Most of
Speaker 3: us would be really impressed if we've realized how much
Speaker 3: is the real value of that future stream of payments
Speaker 3: that are coming from the best credit in the world,
Speaker 3: federal government, and that's inflation protected, so it's even better
Speaker 3: than most people would imagine. That's the single most valuable
Speaker 3: asset for most people. The second most valuable asset for
Speaker 3: most people is the value of their home. And I
Speaker 3: know people would say that first reactions, but I'm not
Speaker 3: going to sell my home. I'm going to continue to
Speaker 3: live there. Fine. True, But someday either your children or
Speaker 3: your grandchildren will say, we don't really want to live
Speaker 3: in that same house, so we're going to sell it.
Speaker 3: So it does have an economic value, and it will
Speaker 3: be realized at some point down the line. Take those
Speaker 3: two and put them side by side with your securities
Speaker 3: and most people would say, my god, I've got more
Speaker 3: in the way of fixed income and fixed in bond
Speaker 3: equivalents than I had ever imagined. I think I ought
Speaker 3: to be careful in my securities part of the portfolio,
Speaker 3: to rethink things and probably be substantially more committed to
Speaker 3: equities in my securities portfolio because I've got these other
Speaker 3: things that I was never counting on before, but now
Speaker 3: that I've been told about it, I really want to
Speaker 3: include that as my understanding to the total picture.
Speaker 2: And I like the concept of outside the market decisions
Speaker 2: versus inside the market decisions. Explain the difference between the two, well.
Speaker 3: Outside market decisions have to do with what's changed in
Speaker 3: your life, most obvious being when you retire, but sometimes
Speaker 3: it's when you get a better job, higher pay, or
Speaker 3: even you get a significant bonus because of the wonderful
Speaker 3: achievement that you've had during the particular year, when your
Speaker 3: circumstances get changed. Oh and getting married is another real change.
Speaker 3: When the circumstances changed, you really ought to rethink your
Speaker 3: investment program just to be sure that it's really right
Speaker 3: for your present total picture.
Speaker 2: Makes a lot of sense. I know I only have
Speaker 2: you for a few more minutes, let me jump to
Speaker 2: three of my favorite questions that I ask all my guests,
Speaker 2: starting with what are some of your favorite books? What
Speaker 2: are you reading right now?
Speaker 3: My favorite books tend to be history, and the one
Speaker 3: that I have most recently he read is a wonderful
Speaker 3: biography of Jack Kennedy as president and the things that
Speaker 3: he did that made America the most popular country in
Speaker 3: the world.
Speaker 2: And our last two questions, what advice would you give
Speaker 2: to a recent college grad interested in a career in investing.
Speaker 3: Think about what really motivates you to be interested in investing.
Speaker 3: If it's because it's a high income field, that's okay,
Speaker 3: But candidly, it's not an inspiration. And you only have
Speaker 3: one life to lead. Is it your desire to lead
Speaker 3: your life making money or doing something that you would
Speaker 3: say was at the end of your life, I'm so
Speaker 3: proud of what I did, or I'm so glad I
Speaker 3: did what I did. If you're thinking about investing because
Speaker 3: it's a profession where you help people be more successful
Speaker 3: in achieving their objectives, then candidly you could have a
Speaker 3: fabulous time. It won't come because you beat the market,
Speaker 3: but that's not the problem. For most people. For most people,
Speaker 3: beating the market is very clearly secondary to what's their
Speaker 3: real need, which is to think through what are their objectives,
Speaker 3: what are their financial resources, and how can they put
Speaker 3: those together into the best for them investment program. And
Speaker 3: the same thing is true for every college, every hospital,
Speaker 3: every church, every organization has an endowment needs to think
Speaker 3: carefully about what is the real purpose of the money
Speaker 3: and how can we do the best for our long
Speaker 3: term success by the structure of the portfolio that we have.
Speaker 2: And our final question, what do you know about the
Speaker 2: world of investing today that would have been really useful
Speaker 2: back in the nineteen sixties when you were working for
Speaker 2: the Rockefellers.
Speaker 3: Oh boy, First that the whole world is going to
Speaker 3: be changed. So don't stay with what you think is
Speaker 3: really great about the early nineteen sixties, because all of
Speaker 3: that is going to be upended, and all the lessons
Speaker 3: that you would think were just great about how to
Speaker 3: do things in the early nineteen sixties will work against you.
Speaker 3: And by the time you get to the this time
Speaker 3: of the year, you will be making mistakes one after
Speaker 3: another after another after another by doing things that are
Speaker 3: just completely out of date. And the world of investing
Speaker 3: will change more than most fields will change. Computer technology
Speaker 3: will change more, airplane travel will change more. But candidly,
Speaker 3: investing is going to change so much that if you
Speaker 3: take the lessons that you're learning for how to do
Speaker 3: it in the sixties and try to transport those into
Speaker 3: the twenty twenties, you're going to pay a terrible price.
Speaker 3: Don't do it. Don't do it.
Speaker 2: Thank you Charlie for sharing all of your wisdom and insights.
Speaker 2: I really appreciate it. We have been speaking with Charlie
Speaker 2: Ellis talking about his new book, Rethinking Investing, a very
Speaker 2: short guide to very long term investing. If you enjoyed
Speaker 2: this conversation, check out any of the five hundred or
Speaker 2: so we've done over the past ten years. You can
Speaker 2: find those at Bloomberg, iTunes, Spotify, YouTube, wherever you find
Speaker 2: your favorite podcast, and be sure and check out my
Speaker 2: new book, How Not to Invest The bad ideas, numbers,
Speaker 2: and behavior that destroys wealth. I would be remiss if
Speaker 2: I did not thank the Crack team that helps put
Speaker 2: these conversations together each week. Andrew Davin is my audio engineer.
Speaker 2: Anna Luke is my producer. Sean Russo is my researcher.
Speaker 2: Sage Bauman is the head of Podcasts at Bloomberg. I'm
Speaker 2: Barry Ritults. You've been listening to Masters in Business on
Speaker 2: Bloomberg Radio.