Speaker 1: This is Masters in Business with Barry Ridholts on Bloomberg Radio. Hi,
Speaker 1: this is Barry Ridholts. You're listening to Masters in Business
Speaker 1: on Bloomberg Radio. Welcome to our season. We're very excited.
Speaker 1: We have a lot of fantastic shows coming your way.
Speaker 1: Before I tell you about this week's guests, let me
Speaker 1: just give you a little update. We've been on hiatus
Speaker 1: over the holidays, running a few repeats if you missed them.
Speaker 1: We had Jeff Glenlock, Jim Chainos, Mark Cuban, and now
Speaker 1: we're starting with a whole new run of new shows
Speaker 1: beginning uh this weekend, which is January. Before I tell
Speaker 1: you the details about this week's guest, let me just
Speaker 1: tell you a little bit about what we have in
Speaker 1: store for you some fantastic shows. Recording next weekend is
Speaker 1: some guy named William Gross, formally of Pimco. Now with Janice,
Speaker 1: we spoke, or we by the time you hear this,
Speaker 1: we will have spoken for a couple of hours. We've
Speaker 1: been going back and forth about this show. A lot
Speaker 1: of really interesting stuff, enough material that it might even
Speaker 1: end up being a two hour show. So that's fascinating stuff.
Speaker 1: Check out that next week I'm heading out to Seattle
Speaker 1: to interview Howard Marks of oak Tree Capital, really a
Speaker 1: super value investor, and another phenomenal fixed income investor. Uh
Speaker 1: Cliff Fastness of a q R is on our schedule,
Speaker 1: as is Jim McCann of eight hundred Flowers, which in
Speaker 1: response to a lot of requests. Hey, I love the
Speaker 1: interviews and I'm learning a lot about finance and investing,
Speaker 1: but what about things in non financial business. So Jim
Speaker 1: is somebody we've known for a couple of years, and
Speaker 1: he's a really fascinating character who essentially took a single
Speaker 1: flowers shop and turn them into this fantastic, successful, publicly
Speaker 1: traded company. We have a lot of other people queued
Speaker 1: up from outside the world of finance. I think that's
Speaker 1: going to be really interesting, including people from the arts
Speaker 1: and and that could be a really intriguing conversation. Before
Speaker 1: I babbled too long, let me tell you about this
Speaker 1: week's guest. It's a special youth edition of Masters in Business.
Speaker 1: Patrick O'Shaughnessy, author of Millennial Money, all about how young
Speaker 1: people can make a fortune courtesy of their fifty year
Speaker 1: investment horizon. You know, we tend to think of the
Speaker 1: youth today as being really disadvantaged. They came of age
Speaker 1: in the midst of a horrible financial crisis that burdened
Speaker 1: with lots of student loans and and college debt. There
Speaker 1: aren't that many great job opportunities. Patrick takes a very
Speaker 1: contrarian position, which is the youth have the single greatest
Speaker 1: advantage on their side, and that's time you get to
Speaker 1: compound returns for fourty or fifty years. Most people don't
Speaker 1: really start investing seriously into their forties or fifties, or
Speaker 1: at least that's what Patrick says. And by that time,
Speaker 1: you've given up so many decades of compounding, you've missed
Speaker 1: out on so much that you're actually at a disadvantage.
Speaker 1: Even if you're making very little money and putting very
Speaker 1: little aside, you should still do it, says Patrick in
Speaker 1: his book Millennial Investing, because of the miracle of of compounding,
Speaker 1: and one it does two your returns. Essentially, you can
Speaker 1: start later and put more money away, and you'll end
Speaker 1: up with about as half as much as someone who
Speaker 1: starts early, someone who starts in their twenties. So be
Speaker 1: sure and check that out. Uh, with no further ado,
Speaker 1: let me introduce Patrick O'schalnessy, principal at O'Shaughnessy Asset Management
Speaker 1: and author of the book Millennial Money. This is Masters
Speaker 1: in Business with Barry Ridholts on Bloomberg Radio. This week.
Speaker 1: I have a special guest who is unique in two ways. First,
Speaker 1: his name is Patrick O'Shaughnessy. He's the author of Millennial Money,
Speaker 1: How Young Investors Can Build a Fortune. So this is
Speaker 1: a special youth oriented version of Masters in Business. But
Speaker 1: we have a couple of first with Patrick uh Patrick
Speaker 1: is you're born in eighty five, right I was. You're
Speaker 1: thirty yet almost thirty, just about to turn thirty in April,
Speaker 1: so by far you are our youngest guest ever on
Speaker 1: the show. And second, you're the first guest who is
Speaker 1: the offspring of a previous guests co We we had
Speaker 1: um Yale Hirsch and his son Jeff, but they were
Speaker 1: on together, So you're the first um, first official progeny
Speaker 1: of a prior prior guest, so that that makes you unique.
Speaker 1: A little background about pat Rick um obviously born in
Speaker 1: n five, not quite thirty, undergraduate at Notre Dame, surprisingly
Speaker 1: degree in philosophy, not finance, but you ended up becoming
Speaker 1: a chartered financial analyst. How did you find your way
Speaker 1: to finance? So my interest in markets in general, and
Speaker 1: finance even more generally really comes through human psychology. I
Speaker 1: studied philosophy with sort of an unofficial minor in psychology,
Speaker 1: just because I'm interested in how people act and how
Speaker 1: people think. And I think that the stock market represents
Speaker 1: probably the most interesting intersection of all the most interesting disciplines.
Speaker 1: So I sort of backed into it through psychology. UM,
Speaker 1: and that's what got me interested. And then from there
Speaker 1: I went to, you know, the more traditional route studying
Speaker 1: accounting through the c FA, etcetera. But it's people that
Speaker 1: got me interested in marketing. And it certainly doesn't hurt
Speaker 1: that your father is James O'shawna See, who wrote a
Speaker 1: highly regarded book What Works on Wall Street and runs
Speaker 1: the firm um Oceana Csset Management where or a principle,
Speaker 1: I've been extremely fortunate UM. And I say that not
Speaker 1: so much because I have a father who is a
Speaker 1: well known investor, but more because of how he encouraged
Speaker 1: me as a young person really just to love learning. UM.
Speaker 1: It was never about this ratio or that ratio is
Speaker 1: really just about loving to read, loving to investigate. So
Speaker 1: that's the reason I'm so lucky, but lucky for a
Speaker 1: lot of reasons. So let's talk about you as a
Speaker 1: young person, because the theme today is going to be
Speaker 1: the advantages of youth, the things that young people have
Speaker 1: that they may not even realize that works so strongly
Speaker 1: in their benefit. And who better to discuss it than
Speaker 1: it's someone who is a not quite thirty and b
Speaker 1: wrote a book about what millennials should be doing with
Speaker 1: their money. And the funny thing about that is when
Speaker 1: people think about this generation, the thought processes, they're living
Speaker 1: in their parents basement. They don't have a lot of
Speaker 1: economic opportunity. Jobs aren't plentiful, it's tough to get by.
Speaker 1: And you took an extremely contrarian position and you basically said, hey,
Speaker 1: you'll never have a better time to invest in your
Speaker 1: life than when you're in your twenties and thirties, and
Speaker 1: I'm going to write a book about it. Yeah. You know,
Speaker 1: this is true of young people in general, but even
Speaker 1: more so of the millennial generation, just because of what
Speaker 1: they've witnessed. Three catastrophic collapses in the housing market, in
Speaker 1: the stock market, um and we are as people tend
Speaker 1: to be once burned, twice shy, and so we've got
Speaker 1: this very negative view of the stock market. My goal
Speaker 1: with the book was to sort of reverse how people
Speaker 1: think about risk and make them realize that if you've
Speaker 1: got forty years ahead of you, you have huge potential.
Speaker 1: If you start very young, and dollar might turn into
Speaker 1: seventeen dollars, whereas if you wait till forty, like most
Speaker 1: people do, that same dollar on average turns into just
Speaker 1: about five dollars. So, so let's talk about those three crises.
Speaker 1: The dot com crisis, you have the housing collapse, then
Speaker 1: we have the financial crisis. How has that impacted the
Speaker 1: psychology of of your peer group, of the millennials. Well,
Speaker 1: it's really part of our biological heritage. There's one of
Speaker 1: my favorite writers is the anthropologist Diamond, who spent a
Speaker 1: lot of time with indigenous people in Papua New Guinea.
Speaker 1: And when he was traveling with them, one night they
Speaker 1: were setting up camp and he wanted to set up
Speaker 1: a camp below a tree, and they said, absolutely not,
Speaker 1: we won't do it. And he was surprised because the
Speaker 1: tree was fine, it was alive, it hadn't begun to
Speaker 1: rot or anything. But they wouldn't do it. And he
Speaker 1: realized that they take all sorts of extreme precautions against
Speaker 1: even very low probability events, and he called this tendency
Speaker 1: constructive paranoia. Human beings are very sensitive to even low
Speaker 1: probability losses because negative things have a big impact on
Speaker 1: our survival. Now that's great in a primitive setting, but
Speaker 1: in the markets, the exact opposite is true. We say
Speaker 1: better safe than sorry, which is how we tend to
Speaker 1: act biologically, but in markets, typically the safer you feel,
Speaker 1: the sorry you will be in the future. So what
Speaker 1: works on the savannah doesn't work on the Wall Street. Absolutely,
Speaker 1: and and that's just the way we're programming. We've seen
Speaker 1: three catastrophic things that signal to us danger when you
Speaker 1: look at markets, So that makes millennials more risk averse,
Speaker 1: and they tend to run very low stock expo oosure
Speaker 1: and absurd levels of cash in the portfolios they do.
Speaker 1: And some of the most recent surveys show fifty or
Speaker 1: more in cash for twenty five year olds, which is
Speaker 1: just insane because of the power of inflation, you know
Speaker 1: that the value that cash will slowly get stripped away
Speaker 1: over time. Whereas they have very little in stocks, which
Speaker 1: over the long, over four decades, have always been you know,
Speaker 1: the most renuwerative successful asset class. Never never a negative
Speaker 1: UM twenty year rolling period of equities in the US. UM,
Speaker 1: you look at Japan. That's really the exception, isn't it. Yeah?
Speaker 1: Internationally and there's some there's some extreme examples like Japan, Germany,
Speaker 1: some of the World War two countries, But equities over
Speaker 1: the longer term after inflation have been safer than the
Speaker 1: more traditional bonds. In cash compounding, use the famous example
Speaker 1: of the grain of rice on a chessboard. Describe the
Speaker 1: advantage that twenty five year old has if they're looking
Speaker 1: at a forty or even fifty year investment horizon. Well,
Speaker 1: the thing about compounding that makes it hard to take
Speaker 1: advantage of is all the great benefit happens at the
Speaker 1: tail end of life, not in the beginning. So if
Speaker 1: you're investing a thousand dollars now, you might only make
Speaker 1: a few hundred dollars in returns, but the same rate
Speaker 1: of return way later in life represents much bigger sums.
Speaker 1: My favorite example of this is Warren Buffett. Everyone knows
Speaker 1: him as the most successful investor out there. Um, you
Speaker 1: know sixty billion dollar net worth. He was not a
Speaker 1: billionaire until he turned sixty years old, and his superpower
Speaker 1: was that he started when he was eleven years old
Speaker 1: buying shares and the power of compounding. Now, he was
Speaker 1: a great investor, but the power of compounding was what
Speaker 1: led to his great results through time. The same is
Speaker 1: true for young people today. Small a bounds invested now
Speaker 1: can result in huge sums in our fifties and sixties. Patrick,
Speaker 1: in the book, you discussed three factors that are required
Speaker 1: in order for any young investor to succeed, and those
Speaker 1: factors are be different, go global, and get out of
Speaker 1: your own way. Let's let's discuss those in reverse order.
Speaker 1: Let's start with get out of your own way. Sure,
Speaker 1: I think this is actually probably the most important of
Speaker 1: the three because strategy is one thing, but if you
Speaker 1: don't stick to your strategy, you will be in trouble
Speaker 1: in the long term. Investors tend to be their own
Speaker 1: worst enemy, reacting emotionally at exactly the wrong times, both
Speaker 1: in times agreed and in times of panic. So the key, really,
Speaker 1: I think, is to get out of your own way
Speaker 1: by making your investing program as automatic as possible, meaning
Speaker 1: money from your paycheck or bank account is just automatically invested,
Speaker 1: whether it be in your four oh one K retirement
Speaker 1: account or just regular brokerage account, and invested for you
Speaker 1: without you having to take action. Because the more opportunity
Speaker 1: we have to interceed in the portfolio, the worst our
Speaker 1: results are are likely to be. There's been a and
Speaker 1: may have even been your dad who on the show
Speaker 1: told the story that when Fidelity did a review of accounts,
Speaker 1: the accounts that had been the most successful, ones that
Speaker 1: people essentially had forgotten about, just left to the left
Speaker 1: them alone, and those were the highest returning portfolios in
Speaker 1: their whole book of business. There's an amazing you can
Speaker 1: you can overcome all this by just making your investments automatic,
Speaker 1: and for most people that's the easy solution. So four
Speaker 1: O one K, it's really easy. Is there a way
Speaker 1: to make it automatic with just a regular brokerage account? Sure,
Speaker 1: you can set up with almost every company with whom
Speaker 1: you might have an account, you can set up set
Speaker 1: up an automatic transfer from your bank checking account into
Speaker 1: your brokerage account pretty easily, and and that's probably the
Speaker 1: most basic and effective way to do it. So once
Speaker 1: the money hits how does that get disposed into a portfolio.
Speaker 1: So there are certain services that do it for you. Um,
Speaker 1: this is kind of the cutting edge of the meeting
Speaker 1: of Silicon Valley and Wall Street where their software that
Speaker 1: they've built that just automatically handles it all for you.
Speaker 1: There's a number of companies that do it. The biggest
Speaker 1: of them is a company called wealth front Um. There
Speaker 1: there are a number of other great options that people
Speaker 1: can research, but they handle everything for you once the
Speaker 1: money is there, and then you don't have to do anything.
Speaker 1: That's that's great. I know Bennements is a competitor. There's
Speaker 1: personal Capital. There's about a dozen of those. We have
Speaker 1: our own version of it. There. There's a lot of
Speaker 1: different monies that do that. By taking the human element
Speaker 1: out of it, you're removing the emotion, you're moving the
Speaker 1: people being in the way of their own interests. Yes,
Speaker 1: an emotionless investing process will always be better than one
Speaker 1: that involves too much people. So now let's go to
Speaker 1: the second point, which is go global. Obviously referring to
Speaker 1: the home country bias that we see all all over
Speaker 1: the entire investing world. Yeah, I call it portfolio patriotism.
Speaker 1: It's this it's this tendency to prefer companies whose CEO
Speaker 1: as we know, whose products and services we use and
Speaker 1: so on. We just like the familiar, and we don't
Speaker 1: like investing in companies that we've never heard of. Unfortunately,
Speaker 1: that ignores a wealth of opportunities abroad, and very often
Speaker 1: some of the best opportunities and the cheapest opportunities are
Speaker 1: outside of the US. So I encourage investors to build
Speaker 1: a very global diversified portfolio because there are countless examples
Speaker 1: of individual country stock markets. Japan is probably the most
Speaker 1: current and extreme example, having law long periods of time
Speaker 1: where they do badly, but an equal weight to balance
Speaker 1: global portfolio has has really never had a twenty or
Speaker 1: thirty year run of negative performance, even after inflation. Um So,
Speaker 1: I think that a balanced global approach is better than
Speaker 1: just buying stocks in the country in which you live.
Speaker 1: We're speaking with Patrick O'Shaughnessy, author of Millennial Money. Now,
Speaker 1: the third points, or really the first one in your
Speaker 1: list is probably the most challenging one, which is similar
Speaker 1: to the Apple slogan think different. You're saying be different, yes,
Speaker 1: and and this is really a point that is addressed
Speaker 1: specifically at those trying to outperform the market. It's a
Speaker 1: hard task to do and for most investors. If I
Speaker 1: met one on the street, I would say that simple
Speaker 1: index funds are a very good option to get started
Speaker 1: for those that are interested in in owning individual stocks
Speaker 1: rather than just owning the entire market. I think that
Speaker 1: there are certain ways that if you are consistently different
Speaker 1: in these key ways, you can outperform the market over
Speaker 1: the long term. These are things like buying stocks at
Speaker 1: very cheap valuations, buying higher quality companies that themselves earn
Speaker 1: strong returns on their investments, Buying companies that are definitely
Speaker 1: not meddling with the books, that have real cash earnings,
Speaker 1: not quality earnings, high quality earnings um. And it's also
Speaker 1: important to look at recent trends in the market over
Speaker 1: the last say, three to nine months. Companies that are
Speaker 1: the falling daggers sometimes are best avoided. So if you
Speaker 1: can buy high quality, cheap companies that the market is
Speaker 1: just beginning to notice, and do that very consistently through time,
Speaker 1: that has been a strategy that historically speaking, has worked
Speaker 1: very well better than the overall market. The key is
Speaker 1: that you have to be different, and we're gonna come
Speaker 1: back to the checklist that you've created in order to
Speaker 1: be different. But when you end up taking these three
Speaker 1: bullet points, um, get out of your own way, go global,
Speaker 1: and be different, what are those portfolios end up looking like?
Speaker 1: So depending on whether or not the investor is is
Speaker 1: choosing to be very different than the market, it'll end
Speaker 1: up looking quite distinct. You might have always global holding,
Speaker 1: because that's a key part of it. But typically if
Speaker 1: you're a young person the vast majority in equities, you
Speaker 1: might have imbalances in terms of the market sectors. You
Speaker 1: might own a lot of consumer stocks but no energy stocks,
Speaker 1: something like that. You have to have a willingness to
Speaker 1: look very different and not care what's going on in
Speaker 1: the market. Only care what's going on obviously to the
Speaker 1: benchmark or the SMP five hundred exactly. And you know,
Speaker 1: two thousand fourteen it was a hard year. The SMP
Speaker 1: five beat everything else. Um, So you really have to
Speaker 1: have that intestinal fortitude to ignore when you're losing to
Speaker 1: the overall market. But but the combinator, the combined portfolio
Speaker 1: will still be well diversified globally and within the US
Speaker 1: side of things. What sort of names we do you
Speaker 1: tend to look at I know they rotate on a
Speaker 1: regular basis, but you're really talking about high quality companies
Speaker 1: at a relatively low valuation. Yeah, one of I'll give
Speaker 1: one example that's pretty representative of these ideas, which is
Speaker 1: Cgate Technology. It's a hard drive manufacturer. Um, we've owned
Speaker 1: it for about five years and it's been one of
Speaker 1: the best performing hold in our firm's history. It was
Speaker 1: a classic value story where everyone said it's going out
Speaker 1: of business. Hard drives is dinosaur technology, it's all moving
Speaker 1: to the cloud. Um, this industry is going out of business.
Speaker 1: Super cheap valuations, high quality earnings, they were aggressively repurchasing
Speaker 1: their own shares, they were investing in themselves. Um. Those
Speaker 1: are all great things to look for in a company,
Speaker 1: and that would be a kind of a common profile
Speaker 1: the name that that we like. Let's talk about one
Speaker 1: of the biggest trends in investing today, the idea of
Speaker 1: active versus passive indexing. In the book, you start out
Speaker 1: by saying, you know, if nothing else, passive indexing is fine,
Speaker 1: but I think you could do better address that if
Speaker 1: you would. Sure, I think that you know all the
Speaker 1: all the original arguments in the book trying to compel
Speaker 1: young investors to get going are all based on just
Speaker 1: owning the overall market simple passive indexes that you don't
Speaker 1: have to do anything, you just own a slice of
Speaker 1: global business. I think that that is a great way
Speaker 1: to get started, and for the average investor, that's probably
Speaker 1: the best solution. They don't have to think about it much,
Speaker 1: they don't have to spend time researching companies anything like that.
Speaker 1: I do think that for the sort of the second
Speaker 1: level investor that wants to get deeper into the weeds,
Speaker 1: that there are ways to beat the market. You just
Speaker 1: have to do your research and do your work and
Speaker 1: stick to some really proven key principles. So my my
Speaker 1: opinion is kind of twofold. It depends on the individual investor.
Speaker 1: For most people I know that aren't in this business,
Speaker 1: I advocate simple passive index funds because they're cheap. We know,
Speaker 1: they do very well over time, they have good tax
Speaker 1: friendly returns um and you don't have to know much
Speaker 1: about the markets to participate in their growth. You're just
Speaker 1: buying into the global business universe and letting it do
Speaker 1: its thing and getting out of the way. Yeah, all
Speaker 1: of a sudden you've got millions of people working for
Speaker 1: you effectively, and that's that's kind of a powerful concept
Speaker 1: and not trying to pick which the winners will be,
Speaker 1: just participating in the entire thing. But there are some
Speaker 1: issues you have with passive investing, which is similar to
Speaker 1: issues that Rob are not has raised, and um your
Speaker 1: dad has raised and other people. And it has to
Speaker 1: do with the problem with selecting stocks based on market
Speaker 1: cap waving. Yeah, so we we think of market cap
Speaker 1: as a factor like any others, like price to earnings
Speaker 1: or something simple like that. This is an interesting study
Speaker 1: if you broke the market into ten groups equal groups
Speaker 1: of names. So let's say there's three thousand stocks or
Speaker 1: so in the market, three names in each group, and
Speaker 1: the division was based solely on their size. So the
Speaker 1: number one group was the three d biggest stocks, Number
Speaker 1: ten the three hundred smallest, and you ran that simulation
Speaker 1: over the last fifty years. The only really interesting thing
Speaker 1: you would find is that the biggest group, the three
Speaker 1: hundred largest stocks or so, have underperformed the rest of
Speaker 1: stocks by between two and three percent per year on
Speaker 1: an annualized basis. So names that have done the best
Speaker 1: over the long term go on to actually underperform. We
Speaker 1: would argue that the index based strategy is just to
Speaker 1: buy big cap stocks, and then that doesn't make much
Speaker 1: sense that you can do better from a strategy perspective.
Speaker 1: Where indexes have it right is how disciplined and consistent are.
Speaker 1: Talk a little bit about this. Something in the book
Speaker 1: I found fascinating, which is only buy stocks with the
Speaker 1: letter C as an example of what one of the
Speaker 1: flaws in cap weighted indexes yees. So if all you
Speaker 1: did every year was by every name in the market
Speaker 1: that started with the letter C, honestly, you could do
Speaker 1: it just about any letter and the result would be
Speaker 1: the same. You would outperform the market on paper. And
Speaker 1: the reason for that is that it excuse you away
Speaker 1: from just the biggest names and just create sort of
Speaker 1: a random sample of companies that that tended to actually
Speaker 1: do better than the biggest stocks overall. So kind of
Speaker 1: a funny exercise, it is, certainly wouldn't advocate anyone do that,
Speaker 1: but but it's it's powerful to show that just a
Speaker 1: random sampling will do better, an equal weighted random sampling
Speaker 1: than than just a market index on paper. I suspect
Speaker 1: we're going to see an E T F in the
Speaker 1: not two different future called E T F B E
Speaker 1: D f C E t F D just just stocks
Speaker 1: of those letters because someone will someone will end up
Speaker 1: um buying it. So so now let's talk a little
Speaker 1: bit about when you're not buying indexes, when you're putting
Speaker 1: together a portfolio, how do you deal with the behavioral
Speaker 1: issues that you mentioned throughout the books throughout the book
Speaker 1: in terms of how investors get in their own way. So, really,
Speaker 1: we think the solution is to make your approach completely
Speaker 1: model based, meaning you design a model that selects stocks
Speaker 1: for you based on proving key ideas, attributes the common
Speaker 1: stocks that have been successful share and then you stick
Speaker 1: to that model through thick and thin. And I can
Speaker 1: promise you because value stocks are a big component of
Speaker 1: what we do that very often you'll look at the
Speaker 1: names coming out of your model and say, wait a minute,
Speaker 1: this can't be right. This stock is terrible. It's the
Speaker 1: cgate technology of five years ago. Uh, you know, it's
Speaker 1: the leisure stocks of five years ago when people said,
Speaker 1: no one's ever gonna do anything for fun again. They're
Speaker 1: just battening down the hatches. So it forces you to
Speaker 1: own some uncomfortable stocks, which is why we think you
Speaker 1: just need to take humans out of it, make it
Speaker 1: a model based approach. Only that's so funny. My my
Speaker 1: favorite war story about reaction to stocks when the first
Speaker 1: Apple iPod came out. I've been a Mac fan boy
Speaker 1: for forever. I got my hands literally the first week
Speaker 1: the iPod came out, and oh, I get it. The
Speaker 1: Sony Walkman for the digital era. This is gonna be huge.
Speaker 1: Apple at the time was fifteen bucks, thirteen cash. I
Speaker 1: showed this to a dozen people. The reaction was uniformly, dude,
Speaker 1: what are you talking about? Things? Out of business? Ah?
Speaker 1: And I learned that when you get that oh reaction,
Speaker 1: pay attention because it means all the worst part of
Speaker 1: the stock is out of the price, and all that's
Speaker 1: left is either out of business or a lot of upside.
Speaker 1: With Apple turned out to be a lot of upside.
Speaker 1: I love the phrase the cave you fear to enter
Speaker 1: holds the treasure you seek, and that is often true
Speaker 1: in the stock market, as it was with Apple. In
Speaker 1: our earlier segment, we discussed a variety of different factors
Speaker 1: that go into approaching markets correctly as a young investor.
Speaker 1: But you took it a step further. What you said
Speaker 1: second level investing beyond indexing, and you created a checklist
Speaker 1: for identifying stocks that have five key characteristics that you
Speaker 1: think make for the best sort of portfolio that people
Speaker 1: can in fact do themselves. Yes. Yes, So so we
Speaker 1: can go through each of the five, which I think
Speaker 1: I have very compelling reasons each. The first is that
Speaker 1: you want companies that are very oriented towards their shareholders.
Speaker 1: What I mean by that is they send lots of
Speaker 1: cash back to equity and debt stakeholders in the company there,
Speaker 1: So that means retiring debt, buying back shares, an issuing dividends,
Speaker 1: paying dividends. Yes, and so you want to favor those stocks.
Speaker 1: And you want to avoid stocks that are just issuing
Speaker 1: a ton or raising a ton of new capital. So
Speaker 1: secondary equity offerings, you know a lot of new debt,
Speaker 1: those tend to be bad science historic. What about the
Speaker 1: companies that generate a lot of stock options and have
Speaker 1: to issue stocks to cover that. How does that fit
Speaker 1: into that? So you've got to make sure you look
Speaker 1: at the net number. So you want to look at
Speaker 1: total buybacks and total issuance and net those numbers out
Speaker 1: against one of other to account for any sort of
Speaker 1: issuance that's for stock options, that would be a bad
Speaker 1: thing issuance for stock. So shareholder yields greater than five percent?
Speaker 1: Is uh? The first bullet point. Second bullet point return
Speaker 1: on invested capital. Yeah. So the key idea here is
Speaker 1: that this is sort of a measure of a company's quality.
Speaker 1: You want to invest in company whose own investments are
Speaker 1: are yielding great returns. So if a company takes its
Speaker 1: cash that it's raised through equity and debt, makes investments
Speaker 1: in property, plan, equipment, whatever its investments are, depending on
Speaker 1: its business. You want businesses that are great at earning
Speaker 1: high returns because those filter through two investors. So a
Speaker 1: return on invested capital that's very high relative to competitors
Speaker 1: has historically been a good sign. So you want to
Speaker 1: focus on companies with good return on capital. All right,
Speaker 1: And the third bullet point operating cash flow greater then
Speaker 1: reported profits. Yes. So the bottom line number that everyone
Speaker 1: still pays attention to is earnings EPs. That's the number
Speaker 1: that makes headlines. Far fewer investors are focused on real
Speaker 1: operating cash flows. We want real, not manipulated earnings, and
Speaker 1: there are a lot of ways to make earnings look
Speaker 1: better than they are. Maybe it's growing your accounts receivables,
Speaker 1: or messing with your inventories, or just blowing up your
Speaker 1: asset base. There's lots of ways to do it. We
Speaker 1: want to focus on companies that have real, strong, consistent
Speaker 1: operating cash flows that are at least as high as
Speaker 1: their earnings, hopefully a lot higher. So how are you
Speaker 1: measuring that? How are you looking at actual cash flows?
Speaker 1: So it's very simple. On the statement of cash flows,
Speaker 1: there's three different kinds. You just look at the operating ones,
Speaker 1: ones that are coming in on a net basis as
Speaker 1: a result of the company's normal business activities, and you
Speaker 1: compare that with the company's reported net income. A simple
Speaker 1: check is just to say we want companies cash flow
Speaker 1: higher than their earnings. This would help you miss the
Speaker 1: endrons of the world, the adelphia's the world comes, all
Speaker 1: of which would have would not have passed this does
Speaker 1: It doesn't make sense to have earnings higher than cash flow.
Speaker 1: It doesn't make sense because that means it's coming from
Speaker 1: something like accounts receivable. You your earn engineered. It may
Speaker 1: not be fully engineered, but it means that the earnings
Speaker 1: are not coming from real cash. It's coming from cash
Speaker 1: that you think you'll receive in the future. All right,
Speaker 1: So that was bullet point checklist number three. Number four
Speaker 1: enterprise value to free cash flow less than ten x.
Speaker 1: How does that work. Yeah, it's a fancy way of
Speaker 1: saying you want to buy cheap stocks. You want to
Speaker 1: buy companies trading at low multiples. I like free cash flow.
Speaker 1: You can use earnings, you can use book value, you
Speaker 1: can use sales. They all work. The important point is
Speaker 1: that the less you pay for stocks, the more you
Speaker 1: will earn from them in the long term. Very easy
Speaker 1: to say, much harder to do in practice because it
Speaker 1: often points you towards some contrary bets places that the
Speaker 1: market is worried about. But value is key. If there's
Speaker 1: anyone lesson from this list that people take away is
Speaker 1: to focus on paying as little as possible for earnings,
Speaker 1: for cash flow, for sales, etcetera. Let's look at the
Speaker 1: last factor, which is really kind of interesting. You describe
Speaker 1: it as a momentum factor, but I'm gonna say it's
Speaker 1: not a momentum factor. It's really a avoid dogs factor.
Speaker 1: Because what you your bullet point is your checklist point
Speaker 1: is s x month momentum that's in the top three
Speaker 1: quarters of the market, which is a polite way of saying, hey,
Speaker 1: avoid that bottom quarter. Yeah, there's there's honestly no special
Speaker 1: magic to that particular cut off point. The real key
Speaker 1: is that we know from market history companies that have
Speaker 1: been doing the absolute worst over the last six months
Speaker 1: or so tend to continue to be dogs for the
Speaker 1: next year, and that by avoiding those companies you can
Speaker 1: avoid what people often call value traps um things like
Speaker 1: that wait for the wait for the trend to be
Speaker 1: established a little bit more before buying in. That can
Speaker 1: be a nice addition to just about any strategy. We're
Speaker 1: speaking with Patrick O'Shaughnessy, author of Millennial Money, describing the
Speaker 1: checklist that young investors should use in order to put
Speaker 1: together their own active portfolios if they already have a
Speaker 1: passive portfolio and want to take it to the next level.
Speaker 1: So let's let's go overall five of these shareholder yields
Speaker 1: greater than five, return on invested capital greater than operating cash,
Speaker 1: greater than earnings, enterprise value to cash flow as less
Speaker 1: than ten x um, and then six month momentum in
Speaker 1: the top three quarters. This is really a version of
Speaker 1: the great Warren Buffett quote, which is I'd rather buy
Speaker 1: a wonderful business at a fair price than a fair
Speaker 1: business at a wonderful price. This isn't rocket science. These
Speaker 1: are common known, common sense investing principles just put into
Speaker 1: a rigorous model, and they work very well together. You're
Speaker 1: buying shareholder friendly companies, high quality earnings, very attractive prices
Speaker 1: in this case, and the market isn't selling them off,
Speaker 1: you know, in droves over the in the recent past.
Speaker 1: So let me push back a little bit of this.
Speaker 1: So this sounds a little complicated, although you're saying, if
Speaker 1: if I subscribe to a AII, I could have most
Speaker 1: of this automated. What does this generate? What sort of output?
Speaker 1: How often do I have to change this? Is? This
Speaker 1: is not exactly a set and forget portfolio. How much
Speaker 1: work is involved in managing this? It is not set
Speaker 1: and forget And that's why really I highlight that it's
Speaker 1: for that second level investor that wants to do a
Speaker 1: little more. You can still manage it with as little
Speaker 1: as one to two times per year touching the portfolio.
Speaker 1: So it's not going to require that you trade all
Speaker 1: that often. In fact, every stock you bi should be
Speaker 1: held for at least a year for tax purposes. So
Speaker 1: it's a slow moving strategy. If you want to just
Speaker 1: rebalance every December thirty one, you could do that quite effectively,
Speaker 1: and it wouldn't require all that much work, maybe half
Speaker 1: an hour at the computer with your with your brokerage
Speaker 1: account open. So what do you get for all this work?
Speaker 1: What's the net long term returns of this sort of portfolio?
Speaker 1: So the returns have been outstanding in the past, and
Speaker 1: of course you know you can never expect the past
Speaker 1: to repeat itself exactly. But this sort of concentrated portfolio
Speaker 1: I recommend about twenty five stocks or so by these
Speaker 1: different measures, UM has yielded honestly crazy results. It's it's
Speaker 1: performed by about n outperformed the market by about nine
Speaker 1: percent on an annualized basis over the last fifty years. Now,
Speaker 1: of course that doesn't include trading frictions or or taxes
Speaker 1: or anything like that, so you need to reduce that
Speaker 1: number in your mind. But this combination has been powerful.
Speaker 1: Now buffets out performed by significantly more than that on
Speaker 1: an on an annualized basis. But that that that number
Speaker 1: is a pretty good starting point a year for fifty years.
Speaker 1: That's compounded obviously in an O eight oh nine. A
Speaker 1: portfolio like this is does this get shell act as
Speaker 1: bad as the market or are you buying cheap and
Speaker 1: it doesn't fall as much? It's it gets shell act.
Speaker 1: It's a long only portfolio. It's a stock portfolio, so
Speaker 1: you can expect it to be more volatile. It's not
Speaker 1: some magic bullet. It will have long it can have
Speaker 1: a five year period when it's underperforming the market. The
Speaker 1: key is really sticking with it. Of course, we've had
Speaker 1: a pretty remarkable fifty year periods in US actually markets,
Speaker 1: and yeah, it's been it's been a great sample in
Speaker 1: which to test a strategy like this. Um So, my
Speaker 1: goal is not to anchor people on which is a
Speaker 1: tremendous return, but rather to show them that it's possible,
Speaker 1: through a rules based strategy to outperform a market based
Speaker 1: on some you know, well proven principles. And the advantage
Speaker 1: about performing isn't just a couple of percent a year.
Speaker 1: It's it's talking about youth. We're talking about millennials who
Speaker 1: have a multi decade UH time horizon. How does that
Speaker 1: compound over thirty or forty If you get ten percent
Speaker 1: or nine percent, just out performing by three or four percent,
Speaker 1: what does that do for you over thirty years. I mean,
Speaker 1: if you're investing, let's say you're maxing out your four
Speaker 1: O one K or putting some similar amount dollars a year,
Speaker 1: which is hard, very hard for for many young people.
Speaker 1: Let's say you're putting five thousand dollars a year away
Speaker 1: that the difference in two or even two or three
Speaker 1: percent out performance can literally mean millions of dollars by
Speaker 1: the time you're sixty five or seventy years years down
Speaker 1: the road, forty years down the road, because it's peanuts
Speaker 1: in any given year two or three percent, but that compounds,
Speaker 1: like the rice doubling on the chessboard that you mentioned earlier,
Speaker 1: to significant sums and big gaps over the term. So
Speaker 1: it's it can be very renumerative. We've been speaking with
Speaker 1: Patrick O'Shaughnessy, author of Millennial Money and principle at O'Shaughnessy
Speaker 1: Asset Management. If you want to hear more of this conversation,
Speaker 1: be sure and check out our podcast extras there at
Speaker 1: Bloomberg dot com and at Apple iTunes. My regular daily
Speaker 1: column is at Bloomberg View. You can follow me on
Speaker 1: Twitter at Ridholts or check out my blogged at Ridholts
Speaker 1: dot com. I'm Barry Ridholts. You're listening to Masters in
Speaker 1: Business on Bloomberg Radio. All right, welcome back to the podcast.
Speaker 1: This is the fun part of our show where we
Speaker 1: let our hairs down and have a little bit of
Speaker 1: a drink and discuss things that we can't talk about
Speaker 1: on the radio. Um for those of you who are
Speaker 1: joining us for some strange reason. Halfway through the podcast,
Speaker 1: I'm Barry Riholts. My guest is Patrick O'Shaughnessy. A little
Speaker 1: background about how Patrick and I know each other. I
Speaker 1: actually know Pat's dad for I don't know. It's got
Speaker 1: to be like ten years true story. I don't know
Speaker 1: if he ever told you this. Our old office, I
Speaker 1: want to say ten years ago was like Park and
Speaker 1: fifty was right diagonally across from the Walldorf and I'm
Speaker 1: in a Starbucks on Park, right near the old bear
Speaker 1: Sterns building. And it was right as he was extricating
Speaker 1: himself from bear Sterns a few years before the clap.
Speaker 1: So I want to say that's like oh five, oh six,
Speaker 1: it was seven when it was all said and done. Okay,
Speaker 1: it was the machinations had begun. So it was it
Speaker 1: was literally about nine or ten years ago, and we're saying,
Speaker 1: I'm having coffee with a friends and he's at the
Speaker 1: next table having coffee. At that time, we had both
Speaker 1: been doing Bloomberg's c NBC, Fox whatever and had seen
Speaker 1: each other around and we just kind of looked at
Speaker 1: each other and he goes, you're and I go, you're
Speaker 1: And so we just started schmoozing, and we were very
Speaker 1: sympatical about a lot of things UM, evidence based, rule
Speaker 1: driven investing, looking at data, looking and so we just
Speaker 1: struck up a conversation and started emailing and stayed in
Speaker 1: touch over the years, and I've had him speak at
Speaker 1: our conference. We've we actually have some UM money with
Speaker 1: with your dad, and so when you've came along and
Speaker 1: he introduced us, it was kind of interesting, was like, well,
Speaker 1: what's this young turk gonna do. This young punk having
Speaker 1: to follow a dad who wrote one of the most
Speaker 1: seminal books on quantitative investing. And I gotta tell you,
Speaker 1: you did a really nice job first book. This is
Speaker 1: really you know, I have a blur full disclosure. I
Speaker 1: have a blurb on the book and I say, if
Speaker 1: someone gave me this book when I was in my twenties,
Speaker 1: I'd be a billionaire today. Yeah, maybe a little bit
Speaker 1: of hyperbole. Maybe not. Um, someone that starts very young
Speaker 1: might have might have those lucky results. But yeah, it's
Speaker 1: it's been. It's been a great relationship. And I'd say
Speaker 1: the other thing that we really share. What I've enjoyed
Speaker 1: about your writing is the psychology aspect of it of markets.
Speaker 1: I think think that really at its base, that's what
Speaker 1: this is all about, is figuring out what incentivizes people,
Speaker 1: what motivates people, and in many cases, trying to do
Speaker 1: the opposite and do that consistently. So you know, it's
Speaker 1: funny because I began my career on Wall Street as
Speaker 1: a trader. I didn't go to business school and went
Speaker 1: to law school. Love law school, hated being a lawyer,
Speaker 1: and when the opportunity came in the early nineties to
Speaker 1: jump into finance, I jumped at it. And the training
Speaker 1: essentially consisted of being shoved in the deep end of
Speaker 1: pool and being yelled yelled at all, right, swim and
Speaker 1: either you learned to swim or you drowned. It was
Speaker 1: that sort of training process. But I had a different
Speaker 1: background like you. Um, I had a philosophy background, but
Speaker 1: I also had a lot of math and science, and
Speaker 1: so I was always looking at wealth. Here's the hypothesis,
Speaker 1: let's either validated or disprove it. And all the stuff
Speaker 1: you hear on trading desks, most of it is just
Speaker 1: nonsensical myths that don't end up to close scrutiny. Why
Speaker 1: is this stock going up more buyers and sellers? That's
Speaker 1: sort of nonsense, and you talk about a number of these,
Speaker 1: but that's what led me down that path of Uh,
Speaker 1: the explanations I'm being told make no sense whatsoever. There's
Speaker 1: got to be a better reason why humans behave this way. Yeah.
Speaker 1: I think really the only persistent advantage in markets is
Speaker 1: understanding investor of psychology, because that's not going to change.
Speaker 1: That's kind of the one factor that just doesn't change
Speaker 1: through time. We always react the same way to similar stimuli,
Speaker 1: and if you understand that, you can do really well.
Speaker 1: You can build a successful strategy. And so I think
Speaker 1: the background in psychology, like when we're interviewing people, my
Speaker 1: I always sit up a little taller when someone's got
Speaker 1: an interesting background like that, because it brings a unique
Speaker 1: perspective to markets that's evergreen, that will always work. UM.
Speaker 1: So I'm fascinated by the you know, million studies that
Speaker 1: show just how terrible we are, how we're just finding
Speaker 1: fake patterns all over the place all the time and
Speaker 1: chasing them around. Um. You know, we're concer instantly foolish
Speaker 1: with our money. And the good news is that for
Speaker 1: some active investors that creates persistent opportunities to exploit UM.
Speaker 1: And you know, that's why, that's why we had that
Speaker 1: model based approach, because we can hope to consistently exploit
Speaker 1: you know, behavioral misspricings. It's fascinating it It's almost gotten
Speaker 1: to the point where behavioral finance and and behavioral economics
Speaker 1: has become too accepted because when I first started exploring this,
Speaker 1: I want to say, twenty years ago, there wasn't a
Speaker 1: lot of writings that were out there. Dick Faler had
Speaker 1: a couple of books, Um, Thomas Gilgovich up in Cornell.
Speaker 1: You know, it was before the commons of the world
Speaker 1: and the Shillers of the world had won their nobels.
Speaker 1: So early on you had a hunt for information that
Speaker 1: explains why people were irrational. And the funny part about
Speaker 1: that is the fundamental premise of economic I am loath
Speaker 1: to use the word science, is that humans are rational
Speaker 1: if it maximizing economic actors when they're not not even close. Right.
Speaker 1: And you mentioned Kenneman who who wrote my favorite, probably
Speaker 1: my favorite psychology book, Thinking Fast and Slow, which isn't
Speaker 1: just about investing, but it's a great investing book without
Speaker 1: really meaning to be. He has a term called cognitive mirages,
Speaker 1: which means even though you might be aware of all
Speaker 1: these ways you're being irrational, that doesn't stop you from
Speaker 1: being irrational in the future. It's very, very hard to
Speaker 1: overcome our biological imperative. Anyone that thinks otherwise should try
Speaker 1: buying some value stocks because it's very hard to do so.
Speaker 1: So psychology is it's very hard to overcome. It's you know,
Speaker 1: if you understand that, you at least have a shot
Speaker 1: of saying, hey, am I doing something wrong here? What
Speaker 1: what should I be doing? Instead of what I'm actually doing? Yeah? Sometimes,
Speaker 1: you know, I I often wonder if some sociopaths would
Speaker 1: be better investors in the average human. There's a studies
Speaker 1: that show that. Yeah. An awesome, awesome study called Lessons
Speaker 1: from the Brain Damaged Investor where a research or at
Speaker 1: Stanford by the name of but Shiv had two groups
Speaker 1: play a very similar the same investing game twenty rounds
Speaker 1: single dollar bills. Every round was you can choose to
Speaker 1: invest your dollar, hand it over and I flip a
Speaker 1: coin that comes up heads, you get two dollars and
Speaker 1: fifty cents that comes up tails. I keep your dollar.
Speaker 1: The other option is you just hold on to your
Speaker 1: dollar and wait two fifty versus the Well, no, why
Speaker 1: wouldn't you give a dollar every round? Well, of course, right,
Speaker 1: so they explained to the participants, the math is basic.
Speaker 1: The expected value of each coin flip is a dollar
Speaker 1: twenty five. You should play every single time. That would
Speaker 1: be the smartest strategy. So the two groups were these
Speaker 1: a normal group of everyday people and the second group
Speaker 1: who all had brain damage to a very specific part
Speaker 1: of their brain, the limbic system that controls emotions, specifically
Speaker 1: fear um, and so these people couldn't feel fear like
Speaker 1: the average person could. So they had them played this
Speaker 1: game and they tabulated the results, and here's what they found.
Speaker 1: The brain damaged players played of the time. They weren't perfect,
Speaker 1: they didn't do the pent which would be the best strategy,
Speaker 1: but they played of the time. The normal brain patients
Speaker 1: only played fifty seven percent of the time, and the
Speaker 1: reason for that was just one thing after a loss,
Speaker 1: meaning after they invested their dollar, they lost the coin
Speaker 1: flip and lost their dollar the next round, which wasn't
Speaker 1: shouldn't be it's a coin flip, it's not influenced by
Speaker 1: the previous round. They only played of the time. So
Speaker 1: after a loss again we talked about it on the
Speaker 1: earlier part of the show. After a loss is when
Speaker 1: we get extra sensitive, which is which is exactly backwards, right,
Speaker 1: classic risk aversion is that you feel losses twice as
Speaker 1: much as you feel the benefit of a game. And
Speaker 1: this is this is a this is a in you know,
Speaker 1: a study example showing exactly that that when you take
Speaker 1: the emotional part of our brain out, we don't make
Speaker 1: these same mistakes. And there's countless ow there's examples, but
Speaker 1: I love that one because it's it's amazing that we
Speaker 1: make such a clearly irrational decision. The researcher told him,
Speaker 1: that's in irrational, wrong decision and they still they still
Speaker 1: did it, so pretty amazing stuff. That's fascinating. We talked
Speaker 1: a little bit about automated investing, well front benement, lift off,
Speaker 1: personal capital. There's so many of them. Uh, there's still
Speaker 1: a teeny tiny percentage. They get a lot of press,
Speaker 1: but there are tiny percentage of of the investable assets.
Speaker 1: Do you think this is gonna expand into something more significant?
Speaker 1: Is this a millennial sort of thing or is this
Speaker 1: the sort of situation that um, it's gonna be a
Speaker 1: little niche and it's not gonna go anywhere beyond that. UM,
Speaker 1: I think that it will probably consolidate there. As you mentioned,
Speaker 1: there's a lot of them out there, and they do
Speaker 1: different things and they have different strengths and weaknesses. But
Speaker 1: I think the core idea here, which is make investing
Speaker 1: automatic and extremely easy, and use software to do all
Speaker 1: the things that we say we should do but then
Speaker 1: don't actually do. Manage our taxes, make regular investments, don't
Speaker 1: monkey with our portfolios. It just does it all for
Speaker 1: you for for fairly affordable fees. I think that concept
Speaker 1: is here to stay UM and and some of these
Speaker 1: companies will be wildly successful and their software companies. Uh,
Speaker 1: they've got a course strong financial people at the companies.
Speaker 1: But you know, I know Adam Nash, who's the CEO
Speaker 1: of Wealth One pretty well. I've I've spoken to him
Speaker 1: a number of times, and the guy is is a smart,
Speaker 1: shrewd software guy with a sort of finance as a
Speaker 1: secondary skill set. And it's They've built a pretty incredible product.
Speaker 1: And I think that those sorts of automated solutions will
Speaker 1: stick around, and they will be very good for millennial
Speaker 1: investors because that solution is way better than you know,
Speaker 1: calling your broker looking for a tip um like you know,
Speaker 1: say my dad's generation did more commonly, That's just not
Speaker 1: a great way to invest. This is smarter and I
Speaker 1: think it will last makes a lot of sense. Let's
Speaker 1: talk a little bit about bubbles and global investing. We
Speaker 1: hinted and alluded to the Japanese situation, but it seems
Speaker 1: that bubbles are a function of our post War War
Speaker 1: two era. We've had We've had the nifty fifty in
Speaker 1: the late sixties that ended a twenty year run from
Speaker 1: forty six to sixty six. We've had the dot com bubbles.
Speaker 1: We've obviously seen problems in Europe we've We've seen the
Speaker 1: Japanese bubble in eighty nine, then the housing boom and
Speaker 1: bust in the US. Is this just the nature of
Speaker 1: capital markets? They go through these sorts of periods. It is,
Speaker 1: And again I think it's rooted in psychology. You've got
Speaker 1: these melt ups towards the end of these major bubbles,
Speaker 1: you know, the famous ones like the Tulips, the Dutch
Speaker 1: Tulips mania and south Sea crisis, etcetera. It happens over
Speaker 1: and over again, and the charts all look the same, right,
Speaker 1: and you can take away the stories and you've got
Speaker 1: all identical charts. Japan is probably my favorite. I was
Speaker 1: a big Michael Crichton fan growing up, and he wrote
Speaker 1: a book about the Japanese corporate takeover of America, which,
Speaker 1: in hindsight sounds so silly Sun. What was the Land
Speaker 1: of the Rising Sun or something something like that, and
Speaker 1: Rising Sun maybe just maybe just that shorter title. And
Speaker 1: so when I dug into the history of the Japanese market,
Speaker 1: I was just fascinated. What was going on just blew
Speaker 1: me away. In the whole markets trading at ninety times earnings,
Speaker 1: there were certain industries trading at two hundred and fifty
Speaker 1: times earnings. I love using the example that if you
Speaker 1: apply that multiple to you know, an enterprising youngster in
Speaker 1: your life who makes who has lemonade stand and makes
Speaker 1: fifty dollars a day every year, Well, by that math,
Speaker 1: that that little lemonade stand would be worth about six
Speaker 1: million dollars with a similar valuation. And so there was
Speaker 1: just crazy stuff going on. Uh, and everyone was terrified
Speaker 1: that in America that the Japanese were going to take over.
Speaker 1: They bought Rockefeller Center, they were taking all the crown
Speaker 1: jewels of America back to Japan. And and and there was
Speaker 1: even one potentially apocryphal story of them overpaying by two
Speaker 1: hundred million for a big landmark. It might have been
Speaker 1: the Exxon Building or something like that, just to set
Speaker 1: the record for the highest price paid. That's a good
Speaker 1: use of shareholds of money, is to say we set
Speaker 1: the record. We we overpaid the most for a building. Yeah,
Speaker 1: I think. I think the bottom line is that bubbles happened. Um,
Speaker 1: they happen in large part because of human psychology, which
Speaker 1: won't change. And then in the future, when something feels
Speaker 1: really enticing and you want to be a part of it,
Speaker 1: like you know you might have, or in real estate
Speaker 1: or whatever. The more recent examples are just stay out
Speaker 1: of it. Yeah, you might miss out on some great
Speaker 1: short term gains, but we know how bubbles end. They
Speaker 1: all burst, So just ignore your emotions as much as
Speaker 1: you can. You know, when we started seeing chatter of
Speaker 1: China taking over the world, I'm old enough to recall
Speaker 1: the Japanese taking over the world, and like, geez, this
Speaker 1: sounds awfully familiar. That Chinese have been around for five
Speaker 1: thousand years there, they've perennially been a threat. Why would
Speaker 1: we think that this time they're gonna be any more
Speaker 1: successful than they've previously been. It just felt so similar
Speaker 1: to the sort of oh, the Japanese were taking over.
Speaker 1: It really felt the same. My favorite history book Market
Speaker 1: history books a book called Devil Take the Hindmost, which
Speaker 1: chronicles kind of all these ones that we've mentioned. There's
Speaker 1: a great chapter on Japan. It goes through tool Mania,
Speaker 1: tons of other examples. But it is amazing that it's
Speaker 1: just the same pattern over and over again, never learning
Speaker 1: from history, uh, always making the same mistakes as those
Speaker 1: before us, because we can't help ourselves. Well, some people can,
Speaker 1: and some people can but to be honest, the vast
Speaker 1: majority of people, when when the animal spirits are running,
Speaker 1: they're they're joining the herd. It's it's the example I
Speaker 1: love to give and in a presentation is now. I
Speaker 1: don't know if you in your youth this was on television,
Speaker 1: but when I was a kid, Sunday Night's Channel seven,
Speaker 1: Mutual of Omaha's Wild Kingdom, I mean, that's today it's
Speaker 1: the Discovery Channel and Animal Planet. But back in the
Speaker 1: days of broadcast TV, when Marconi had just recently invented radio,
Speaker 1: that's all we had. Animal Planet didn't exist. Mutual of
Speaker 1: Omaha's Wild Kingdom was the closest thing, and every show
Speaker 1: began the same way. It's a vast sea of of
Speaker 1: meat on the hoof over the Savannah's million you'd see
Speaker 1: these and they zoom in from the aerial shot and
Speaker 1: you'd go from the earth black with will to best
Speaker 1: I mean just and you'd eventually get to our heard
Speaker 1: of a small herd of a few thousand whatever it
Speaker 1: was Zebras gazelles. So usually the gazelle and invariably one
Speaker 1: gazelle wanders off from the herd, and then they show
Speaker 1: you the picture of the lions and the tall grass,
Speaker 1: and who gets eaten but the gazelle that's not part
Speaker 1: of the herd. And I think that is the evolutionary
Speaker 1: basis for why there is safety in numbers, why there
Speaker 1: is comfort in doing what everybody else does, even when
Speaker 1: we know it's not right for us. There's good reason
Speaker 1: we're programming the way we are because it's it's we
Speaker 1: survived right. And the unfortunate thing is that culture and
Speaker 1: cultural constructs like markets just evolve a lot faster than
Speaker 1: our biology. So we can't evolve to keep up um
Speaker 1: with the evolution in culture, and that puts us out
Speaker 1: a disadvantage. And so that my my suggestion is if
Speaker 1: you just remove yourself from the equation, all of those
Speaker 1: problems will go away. If you don't, you're gonna spot
Speaker 1: fake patterns, you're gonna see things that aren't really there,
Speaker 1: and you're going to create all sorts of problems. So
Speaker 1: just get out of just get out of the way
Speaker 1: and remove yourself from the equation. You talk about the
Speaker 1: difference between human software and human hardware, and you alluded
Speaker 1: it to that, and that this last statement, the repeat
Speaker 1: the quote that you actually had in the book about that. Yeah. So,
Speaker 1: so my point was that human hardware, our biology and
Speaker 1: all the reactions that we have because of our biology,
Speaker 1: evolves a lot slower than our software, which is our culture.
Speaker 1: Things like markets are are the best examples economies, things
Speaker 1: like that. Um you might have heard of the term meme,
Speaker 1: the cultural units of cultural evolution that can just move
Speaker 1: a lot faster because it doesn't require you wait from
Speaker 1: generation to generation to make incremental changes. The problem is
Speaker 1: they're at an imbalance today. We're not designed to survive
Speaker 1: and thrive in our current environment. We're designed to We're
Speaker 1: kind of stuck in the Stone Age, if you will.
Speaker 1: We're optimized for that environment in most ways, and we
Speaker 1: did really well. Obviously you can see the result to that.
Speaker 1: We just haven't changed much, even though the world has
Speaker 1: changed a great deal, and now often it does us
Speaker 1: a disservice because we make all these crazy, irrational decisions.
Speaker 1: You mentioned a book Devil Takes the Hindmost. The book
Speaker 1: I'm reading right now is called Last ape Standing, and
Speaker 1: it's about the evolutionary process. At one point in time.
Speaker 1: Over the past let's call it four million years, there
Speaker 1: have been approximately at least that we have a fossil
Speaker 1: record of sixteen various species of humans, and why did
Speaker 1: we as a group of humans survive when others didn't
Speaker 1: make it? And had to do with our adaptability and
Speaker 1: our big brains and and our ability to walk up right,
Speaker 1: and a lot of other factors that are great for
Speaker 1: surviving in an ever changing world that requires adaptation on
Speaker 1: the fly, The ability to work with tools, the ability
Speaker 1: to adapt to changing conditions. All those things are great.
Speaker 1: All those survival traits are great, but they have nothing
Speaker 1: to do with making you know, intelligent capital allocation decisions
Speaker 1: in a system like the capital markets and the big
Speaker 1: I think the biggest of those tendencies is this loss
Speaker 1: of version that we've we've referred to a few times
Speaker 1: that were twice as sensitive to losses. If you think
Speaker 1: about the kinds of errors that we could make ten
Speaker 1: thousand years ago, Let's say we were walking we saw,
Speaker 1: you know, a russell at a russell in the grass
Speaker 1: or something. One type of error is we could get
Speaker 1: alarmed and and and overly defensive and it could turn
Speaker 1: out to be nothing. Call that a little insurance policy
Speaker 1: that you take heed you didn't need to, but you did. Anyway.
Speaker 1: The second mistake you can make is that you say, oh,
Speaker 1: it's nothing and it's alliance. Right, And guess which one
Speaker 1: of those two people survived. Well, it's not who survived.
Speaker 1: It's of those two people, only one of them are
Speaker 1: passing their jeans along the risk aversion. Hey, they managed
Speaker 1: to be around long enough fifteen or twenty years back
Speaker 1: then to to actually have progeny. The people who ignored it,
Speaker 1: who didn't have that risk aversion, they were lunch, Yeah,
Speaker 1: and it makes perfect sense, and it just doesn't work,
Speaker 1: and Mark it's and that's too bad. But if we
Speaker 1: know about it, at least we can adjust to it.
Speaker 1: So I would be remiss if I did not address
Speaker 1: something that you spend a long time talking about in
Speaker 1: the book, which is inflation and the erosion of purchasing power.
Speaker 1: We didn't get to it on the on the broadcast portion.
Speaker 1: Let's let's you had a quote that I really liked
Speaker 1: in the book. You know, when the Ford Model T
Speaker 1: first came out, it costs two hundred and sixty dollars
Speaker 1: that today buys you a single tire. Yeah, a nice tire,
Speaker 1: but a single tire. And and that just shows the
Speaker 1: power over time. It's sort of like death by a
Speaker 1: thousand cuts. In any given year, Inflation is is hardly
Speaker 1: ever massive, other than say the nineties seventies when it
Speaker 1: got to double digits. But even if inflation is two
Speaker 1: percent per year or three percent per year, it's sort
Speaker 1: of a hidden tax acting on you behind the scenes
Speaker 1: that you never really realize until you look back over
Speaker 1: a lifetime. We mentioned I'm twenty nine years old. Since
Speaker 1: I was born, the purchasing power of the dollar back
Speaker 1: then has about been cut in half. So inflation has
Speaker 1: slowly eroded the value of a dollar just in my
Speaker 1: shorter lifetime, I will continue to do so. So the
Speaker 1: key is to position yourself in assets that do well
Speaker 1: on top of inflation, inflation plus inflation plus and And
Speaker 1: the problem is that all of the assets, especially for millennials,
Speaker 1: that we think of as the safest, that will take
Speaker 1: cash as bonds, sure T builds, whatever, whatever you want
Speaker 1: to look at, are in fact the most dangerous over
Speaker 1: the long term because inflation kills their return. So cash,
Speaker 1: let's take T bills net negative real return. Let's take
Speaker 1: T bills for example. Once you get to ten twenty
Speaker 1: thirty year holding periods, and you look back over the
Speaker 1: last hundred years or so. About of those twenty or
Speaker 1: thirty year holding periods, cash actually has a negative real return,
Speaker 1: meaning after you take inflation out of the equation, you
Speaker 1: lose purchasing power, and that's what people think of as
Speaker 1: the safe asset. There was occasions when over those long
Speaker 1: term periods, long term bonds again some make people think
Speaker 1: of as safe on a real basis loss more than
Speaker 1: forty per cent over a thirty year period, and that's crazy,
Speaker 1: that is not that is not a safe place for
Speaker 1: your money because inflation was slowly working against it. Meanwhile, stocks,
Speaker 1: even after inflation, have never even had in the US
Speaker 1: a twenty year period of negative real return. So even
Speaker 1: if you had invested on the eve of the crash
Speaker 1: in ninety nine and then done nothing and came back
Speaker 1: twenty years later, you still would have eked out a
Speaker 1: positive six percent return. It's not a great return, but
Speaker 1: it's positive, and the same cannot be The same cannot
Speaker 1: be said of cash and bonds over the longer term.
Speaker 1: So inflation is key to pay attention to, and we're
Speaker 1: talking about the pernicious compounding effects of even something as
Speaker 1: low as two percent over the course of thirty or
Speaker 1: forty years. You know, we as kids, we used to
Speaker 1: make fun of my father and our parents, who always
Speaker 1: used to give us the story. Listen, when I was
Speaker 1: your age, for a nickel, we could go to the
Speaker 1: movies for a quarter, we could go to the beach.
Speaker 1: We could get two hot dogs, fries, a soda and
Speaker 1: still have money left over for a matten ae. And
Speaker 1: today all that stuff is fill in the blank. And
Speaker 1: the joke is, as you hit a certain age and
Speaker 1: you're not there yet, and I'm just about there yet,
Speaker 1: you could look back twenty thirty years and say, I
Speaker 1: remember when you know movies were a dollar fifteen bucks
Speaker 1: from a movie. That's crazy, it's it's but this is
Speaker 1: really a pernicious drag on returns that are not achieving
Speaker 1: any sort of nominal I'm sorry, any sort of real return. Yeah.
Speaker 1: Most of the time you hear the stock marketing long
Speaker 1: term returns ten percent, Well not really. Once you take
Speaker 1: inflation out of there, it's more like six and a
Speaker 1: half or seven percent, And that's a huge difference over
Speaker 1: the term. And and same thing with with cash or
Speaker 1: you hear maybe three percent, well not when inflation is
Speaker 1: four percent per year. For thirty years. Um, so it's
Speaker 1: it's behind the scenes, it's hidden, but you need to
Speaker 1: pay attention to how how does the fact that we're
Speaker 1: living in a deflationary era impact that? Or is this
Speaker 1: merely a temporary phenomena. Um. I am certainly no expert
Speaker 1: on on, you know, the drivers of inflation, and a
Speaker 1: little suspect that that anyone is. I don't know that
Speaker 1: anyone has a complete picture of what drives inflation over
Speaker 1: the longer term. I do know that once once we've
Speaker 1: left the gold standards and has been kind of moved
Speaker 1: to a global fiat money system, inflation has been the
Speaker 1: norm over longer periods of time because there's no real control.
Speaker 1: And I'm not an advocate of a gold standard or
Speaker 1: anything like that. Well, it made sense at one time.
Speaker 1: I can't imagine anyone really believing it makes sense to
Speaker 1: anyone without large gold holdings believing that going back to
Speaker 1: the gold standard makes any sense today. Right, But I
Speaker 1: think there's some compelling evidence that explosion in the supply
Speaker 1: of money can can lead to inflation over time. And
Speaker 1: I don't think we're going back to a gold standard.
Speaker 1: I don't think we should. But but with a fiat
Speaker 1: money system I think comes long term real inflation that
Speaker 1: will will be important for millennials. It's something that you
Speaker 1: have to recognize his reality, even two percent as a
Speaker 1: drag and have to plan around. And that means having
Speaker 1: a substantial slug of your investment portfolio in a equities
Speaker 1: and be global equities that meet the characteristics that that
Speaker 1: you described earlier. And that's doubly true for young people
Speaker 1: who have a long time ahead of them. They don't
Speaker 1: need this money anytime soon. That should be the goal
Speaker 1: as they're setting it aside and forgetting about it um
Speaker 1: and so that's doubly true for young people. Anything else
Speaker 1: you want to touch on that we haven't gotten to
Speaker 1: before I released you out into the Wild? This has
Speaker 1: been really great. I appreciate I appreciate the opportunity to
Speaker 1: come on the show. I love the show. I think
Speaker 1: we've covered good ground. I'm glad we had a the
Speaker 1: opportunity to talk about things that apply to millennials. You know,
Speaker 1: a lot of what we do on this show seems
Speaker 1: to be geared to people who are either professionals or
Speaker 1: have been investing for a while, or fifty something or
Speaker 1: sixty something year old and you know that blurb was
Speaker 1: was heartfelt. It's the sort of thing that I wish
Speaker 1: I knew about in my twenties. My four oh one
Speaker 1: K would be substantially large, or my investment portfolio would
Speaker 1: be substantially larger had I started even ten years earlier.
Speaker 1: This is the major bummer about investing is that everyone
Speaker 1: that's interested in it has squandered the advantage of youth typically,
Speaker 1: and that young people just aren't worried about it. They're
Speaker 1: not thinking about it. It's not in their minds. It's
Speaker 1: not a pressing concern. It's very hard to think a
Speaker 1: year ahead, let alone forty years ahead. Uh. The sad
Speaker 1: paradox is that the most potent time to start is
Speaker 1: when you're young. That's the time when people tend to
Speaker 1: care the least. What one last psychological study which is
Speaker 1: really fascinating, So people have a real hard time understanding
Speaker 1: time understanding their own mortality, understanding you have a finite window.
Speaker 1: They did a study I'm trying to remember the economists,
Speaker 1: last psychologist who did the study where they explained essential,
Speaker 1: here's what it's gonna cost to live, and here's your income,
Speaker 1: and they explained all these things logically and try to
Speaker 1: get people to say, hey, I'm willing to put this
Speaker 1: much money away every um month, and they ended up
Speaker 1: getting a relatively small amount. Then they use the software
Speaker 1: where they took a picture of their face and digitally
Speaker 1: aged it to show here, by the way, here's what
Speaker 1: you're gonna look like when you're seventy to eighty years old.
Speaker 1: The photo vastly more effective than logically explaining, and they
Speaker 1: would get people to commit far more monthly savings because
Speaker 1: suddenly it becomes real, Oh, I'm gonna be old one
Speaker 1: day in that working and I need to have some
Speaker 1: income to live on and not rely on Social Security.
Speaker 1: And it just goes to show you how easy we
Speaker 1: are to be fooled, manipulated, or nudged into doing the
Speaker 1: right thing. That was amazing. I had not encountered that study,
Speaker 1: and it's always fun to hear about a new one,
Speaker 1: and I think again highlights what we've been saying, which
Speaker 1: is appealed to emotion more than anything that you can
Speaker 1: get people to act. You know, show them a bunch
Speaker 1: of abstractions and numbers and software. It's not all that compelling,
Speaker 1: but say hey, here's what you're gonna have to gonna
Speaker 1: look like this is what you're really going to be
Speaker 1: dealing with, and all of a sudden they act that's
Speaker 1: an amazing study. Well, Patrick, thank you so much for
Speaker 1: coming by. It's been a pleasure having you. UM. We'll
Speaker 1: get this edited together and out on the weekend. For
Speaker 1: those of you, UM who want to check out the
Speaker 1: rest of the series, you can go to Apple iTunes
Speaker 1: all O. All previous Masters in Business are posted there.
Speaker 1: We have a great line up coming up with the
Speaker 1: rest of the year. I'm really excited about some of
Speaker 1: the names that that you'll see. Uh. In fact, coming
Speaker 1: up next week we have our interview with Bill Gross
Speaker 1: UH that will be posted in one or two parts
Speaker 1: starting I want to say January. UM. Check out my
Speaker 1: daily column on Bloomberg View. The blog is at Ridholtz
Speaker 1: dot com. Follow me on Twitter at rid Halts. I'm
Speaker 1: Barry Ridhults. You've been listening to Masters in Business on
Speaker 1: Bloomberg Radio.