Podcast #107 Show Notes: The Four Pillars of Investing with William J. Bernstein, MD

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I first met Bill Bernstein at the Bogleheads Conference in 2008. I was a Bernsteinhead before I was ever a Boglehead. The Four Pillars of Investing was certainly one of the first good books on investing I ever read and had a huge influence on my financial outlook.

This interview with Dr. Bernstein is chock-full of so much financial wisdom that every investor should know. Are you an “investing adult” or still an “investing infant” or “investing teenager”? If you find that you are an investing infant or teenager Dr. Bernstein provides a roadmap towards becoming an investing adult.

He feels the reason why physicians are such lousy investors is that they don’t take finance and investing as seriously as they take medicine. Finance and investing is a very serious subject, just as serious as medicine is and just as involved and you wouldn’t think of practicing medicine without understanding the basics: anatomy, physiology, pathology, and pharmacology. In the same way, you shouldn’t be doing finance unless you understand those equivalents in finance. The equivalents of those four subjects in finance are the four pillars of investing that we discuss in this episode.

Laurel Road has helped thousands of medical professionals across the country refinance federal and private school loans. In addition to offering a $300 bonus for WCI readers and listeners who refinance student loans with Laurel Road, Laurel Road also offers those in residency or fellowship the ability to make reduced payments throughout their training and up to six months after. Terms and conditions apply. For more information and to submit an application, simply visit Laurel Road. 

The Four Pillars of Investing

When Dr. Bernstein completed residency he realized that the country we live in didn’t have a functioning social welfare system so he was going to have to save and invest on his own. He said,

“I approached it the way I thought anyone with scientific training would do, which is peer-reviewed literature and I collected data, I built models. When I was all done, I realized that I had done something that not all physicians had done, and it was of value to all small investors, not just other physicians.”

He started publishing his work and says, “basically once you publish books about finance, reporters start calling you up, you start getting quoted in the national media and then people start asking you to manage money.” That is how he got into money management. He started a financial advisory firm, Efficient Frontier Advisors, LLC in 1998 with a financial advisor by the name of Susan Sharon, who already had an established practice and they’ve been in business ever since but are no longer taking new clients. I asked him what was the main reason he wanted to start the firm. He said he just enjoys managing money.

He started a blog the Efficient Frontier a number of years ago as part of his initial writing process. We are talking about a couple of years after the invention of the World Wide Web! He learned how to code html and set up a website and started publishing small articles. Today there are lots and lots of blogs but in the late 90s, that was not the case. A blog was a pretty rare thing. Dr. Bernstein said, “the name wasn’t even invented for another decade when I started doing it. It was only in the mid 2000s that I realized, ‘Oh, I’m blogging’.”

Investing for Beginners

I stress the importance of continuing financial education and encourage everyone to read at least one good financial book a year. Dr. Bernstein’s books are among the best.  I divided them into four categories. I called them investing for beginners, investing for adults, the history books, and then I broke If You Can, out into its own category.

These first three were The Intelligent Asset Allocator in 2001, The Four Pillars of Investing in 2002 and The Investors Manifesto in 2010. He says that each of these was an improvement and a simplification of the same message.

“The message of the first three books, especially for physicians, was really pretty simple. The reason why physicians are such lousy investors is because they don’t take finance and investing as seriously as they take medicine. Our finances and investing is a very serious subject, just as serious as medicine is and just as involved and you wouldn’t think of practicing medicine without understanding the basics, anatomy and physiology and pathology and pharmacology. In the same way you shouldn’t be doing finance unless you understand those equivalents in finance and the equivalents of those four subjects in finance are the theory of investing, the history of investing in finance, the psychology of finance and last and not least, the business of finance, the people you’re going to be dealing with on the other side of your trades and the people providing you with your products.”

He feels like learning these pillars takes a little bit of effort. We’re talking about hours of reading and you shouldn’t invest one dollar with anyone until you’ve mastered these subjects.

I asked him which of those books would he recommend to someone who has never read any of his books?

He says it depends upon what your math skills are. The history of the three books was that the first one, The Intelligent Asset Allocator, he thought he was writing a book for the average investor and it turned out that what he had written was a book that was really for the average engineer, because there was a lot of math in it. So he simplified it into The Four Pillars of Investing, but even a lot of people found that one to be overly complex. His neurology partner, has a PhD in Molecular Biology, so she’s a pretty smart lady, and even she told me, “Hey, you know, this stopped me cold in a couple of places”. So that was the genesis of the last book, which was The Investors Manifesto, which is basically strips out all the math and is pretty descriptive.

So it really depends upon who you are. If you’re a math whiz and you enjoy statistics and you enjoy higher level math, then read The Intelligent Asset Allocator. If on the other hand you despise math and you don’t think you’re good at it, go for the last book, The Investors Manifesto. I think that the most rounded out book though is the middle one, the Four Pillars of Investing. If you can ignore the math in it, you’re still going to be pretty well rewarded.

Now the four pillars of investing are:

  1. The Theory of Investing
  2. The History of Investing
  3. The Psychology of Investing
  4. The Business of Investing

Now, of those four pillars, which would he say is the most important?

“That’s a very hard question, but I would say the psychology of investing. It turns out that human beings are just not wired for finance and the way I explain that is that we evolved in a state of nature where the risks that we faced were second to second. The flash of yellow and black in your peripheral vision, the hiss of the snake, and it’s a second to second thing, whereas the risks that we face in the modern world stretching out over decades and we’re just not wired to deal with them and that’s really what destroys most people’s ability to execute finance in the long run. So you have to understand just what those reactions are and how to overcome them.”

Investing for Adults

He wrote an investing for adults series in 2012 to 2014. These are shorter books that assumed a basic knowledge of investing on the part of the readers. These included The Ages of the Investor, Skating to Where The Puck Was, Deep Risk and Rational Expectations. I asked him what he was trying to accomplish with these books and should we expect to ever see another in the series?

“Probably not. The way it started was I had developed some things that I wanted to say about lifecycle investing, which I had thought some more about after I’d written my books. I had thought about what is the real nature of risk in the long run and then I wanted to write a book for professionals that warn them about hurting and about a lot of trends that I saw in investing at the professional and institutional level that bothered me. I realized after I had written those three books, which are respectively The Ages of the Investor, Deep Risk, and the Skating Where the Puck Was, that basically they could be folded into a successor book to the Intelligent Asset Allocator.

The Intelligent Asset Allocator is now almost 20 years old and I decided at that point that it was time to write another version of the book. So I folded all of those three subjects plus the subject matter of The Intelligent Asset Allocator into a full length book, called Rational Expectations. So those four books are basically aimed at what I call investing adults, which are people who have mastered the four subjects that I talk about and it’s really aimed at more professional investors than individual investors. The term investing adults is a bit sardonic because I’ve met some 15 year olds who are investing adults and I’ve met a ton of 75 year olds who were investing infants. When I say investing adults, I’m talking somebody who has an adult approach to investing.”

How can someone assess whether they’re an investing infant or an investing teenager or an investing adult?

“Well, that gets to the very last book that you mentioned that I wrote, which is If You Can. If You Can, is available for free. It’s about 10,000 words. It’ll take you at most an hour or two to read. If the subject matter that is written about in that little pamphlet is familiar to you, you’re an adult. If the subject matter isn’t familiar to you, you’re not an adult and the booklet provides a roadmap towards becoming an adult.”

I recommend that book all the time, not only because it’s free and very accessible, but anybody can get through 16 pages. If you can’t get through that, you have no business whatsoever having anything to do with managing your own money, including employing someone else to manage your money for you.

History of Finance

His next three books deal with history. There is A Splendid Exchange, The Birth of Plenty, and Masters of The Word, I’ve only read two of the three. I’ve read A Splendid Exchange and The Birth of Plenty and I think they’re excellent at helping develop one of those four pillars of investing: knowledge of the history of finance and markets. I asked Dr. Bernstein to tell us more about these books.

“Now, the reason I wrote Masters of The Word, was because when I wrote Splendid Exchange, I came across a fascinating story about the repeal of the Corn Laws in 1846 in England. This was a legislative action in the House of Commons that basically destroyed a lot of the wealth and the power of the land gentry in England. It benefited greatly the other 99% of the population who had to eat the grain that was produced on that land, basically reduced tariffs on imported grain, which protected the aristocracy. The way that it happened was that Richard Cobden was able to muster public support for the repeal of the Corn Laws, these tariffs by using the Penny Post, the new postage system that the English government had just set up.

I realized that in a world where only the wealthy can communicate and travel, everybody else is disempowered and if you go through the history of mankind, you find that that is a recurrent story. So, for example, you go back thousands of years when literacy rates were extremely low, and you find that there’s this very small elite group of scribes in Egypt and Mesopotamia who basically ran everything. What happens in Greece, and the reason why democracy develops in Greece, is because the Greeks invented this very simple alphabet, just 22 letters with consonants and vowels that six year olds could learn. So the literacy rate in Greece among male citizens was probably in excess of 30 or 50%, which was just sky high for that period of history. Well, where does democracy develop?  So it’s the story of that interplay between communications, technology, and power and there are lots of other very important examples of that throughout history. I decided to write about that.”

Future Stock and Bond Returns

At this point in the interview, we turn to more controversial topics in finance. I wanted to give listeners the opportunity to hear his opinions on these topics. He is a firm believer that future stock and bond returns are likely to be lower in the future than they have been in the past. In fact, in the forward he wrote for my first book, he said,

“The bad news is that today’s young physicians, Jim included, won’t be as fortunate. Well, I’ve just told you that it’s impossible to make financial forecasts, this is true only in the short term. It’s actually pretty easy to estimate the future returns of both stocks and bonds in the long run, say over the next 20 to 30 years. For bonds, it’s very simple. They’re expected return is the interest rate, which as we all know, is very low at the moment and for stocks, it’s only slightly more difficult. Simply add the stock market dividend rate, currently about 2%, to the longterm average per share dividend growth of 5% to give an expected return of 7%. Neither of these unfortunately is going to match the double digit returns by investors in previous decades.”

That was about five years ago and over the last five years, the Vanguard total stock market funds returned 10.3% and the total bond market fund returned 2.7%. I asked him if he was surprised by those returns.

“Not at all. What you have to realize is just how much uncertainty there is incorporated into that estimate and the easiest way to talk about it is to imagine you think that the longterm returns of stocks are 7%. Well, the thing that I haven’t told you is that the standard deviation of those stock returns of 7% is about 15%. So if you go two standard deviations up, two standard deviations down, which is the 95% confidence limits, then you’ve got a possible return over one year of plus two standard deviations, which is 37% or minus two standard deviations which is minus 23%. That’s why it’s a fool’s errand to try and estimate stock returns next year or next month.

Now the longer the period of time you go out, the more certain that becomes. So for example, let’s take a 49 year period, why 49 years? Because the square root of 49 is seven and the way you do the math, is you take that 15% and you divided standard deviation and you divided by seven, so now you’ve got 2%. So now you’ve got plus or minus two standard deviations over almost a 50 year period, which gets you to a possible high of 11% or a possible low of about 3%, all right? Which gives you a lot more certainty, but certainly over a five year period, a return of 10.3% which is barely double digits, shouldn’t surprise you at all.”

Allocation to Gold Mining Stocks

Now, in The Four Pillars of Investing, some of his sample portfolios included tiny allocations to gold and or gold mining stocks. I asked him does he think that is an asset class worthy of inclusion in a portfolio today and if so, which investors should consider it?

“It’s really appropriate only for a very small subset of investors. You have to realize that the return of precious metals equities, I don’t recommend investing in gold, I recommend investing in precious metals equities, and the reason for that is it’s horribly volatile. So it means that if you have it as a constant percent of your portfolio, then you’re fairly often going to be selling high and buying low. If you say you make it 2% of your portfolio, then it’s going to move very wildly with respect to the other 95% of the portfolio. So to keep it a 2% when it does really, really well, which is a lot of the time, you’re going to be selling a lot of it and when it does really, really poorly, you’re buying a lot of it and that sounds very attractive and very salutary. It’s emotionally very hard to do because this is an asset class which at least two or three times in the past 50 years has lost three quarters of its value. To be constantly rebalancing and buying feels like throwing money down a rat hole.

In the long run, it works, but it requires an enormous amount of discipline and, quite frankly, the benefit of owning just 2% of it in your portfolio is not that great. So I only recommend it for people who meet two criteria. One is they’re really interested in finance and they’re really into spread-sheeting their investments and rebalancing very, very clinically and technically and number two, people who have the emotional discipline to deal with that kind of volatility, which quite frankly not a lot of people qualify on.”

Factor Investing

What are his thoughts on factor investing? For example, does he believe the small and value stocks are likely to outperform the overall market over the next 30 to 50 years?

“Yes. The problem is that this is one of those things that everyone now knows about and so the prices of value stocks and in small stocks had been bit up a bit and so I think that the rewards for doing it in the long run are not going to be as great as they were in the past. I think that for the average physician, you’re probably better off just sticking with the total stock market.”

What about some of these other factors out there, like low volatility or momentum? At what point do these dozens or hundreds of factors just become artifacts of data mining?

“There’s an enacted finance academic by the name of John Cochrane at the University of Chicago who very famously labeled all of these newly identified factors as the factor zoo, and I think he identified something like 500 of them and most of them are due to data mining. The most famous example of data mining was a fellow by the name of David Leinweber who basically mined the OECD database and found that butter production in Bangladesh was very predictive of the movements of the S&P 500. All right, well that was purely an accident and I don’t think anyone in their right mind would base their investment decisions on that. I think that a lot of returns to factor investing are in that category. If you mine enough factors, you’re going to find something that worked.”

But obviously, it won’t carry forward since it was only luck that it was a factor in the past. But he did mention about momentum.

“One of them that, I don’t recommend investors pursue, but I think is a real factor is momentum. So stocks that have done well in the past six months or a year tend to do better going forward. The problem with that is the premium you get from doing that is it’s an enormously expensive one to mine because you’re turning over your portfolio very rapidly, and that carries costs, not only transactional costs, but if it’s in a taxable account, you’re also generating huge amounts of capital gains.”

 

Low Cost Actively Managed Funds

What are his thoughts about low cost actively managed mutual funds such as those available from Vanguard?

“If you’re going to invest in actively managed funds, then you should be investing in the ones with the lowest expense ratios. The problem is that even the cheapest actively managed funds are more expensive than passively managed funds. So I’m not wild about that, but if you have to, if someone put a gun to my head and said, “You’ve got to invest in actively managed funds”, I would pick the ones with number one, the lowest fees, the lowest expenses and number two, the lowest turnover.”

Real Estate Investing

Does he see a role in a portfolio for real estate above and beyond a simple REIT index fund?

“What I like to say about investing, and I presume you’re talking about commercial or residential rental real estate, is that it’s not an investment. It’s a job. So if you enjoy dealing with drug addled and potentially heavily armed tenants and fixing toilets, then I say go do it. You can probably make a lot of money doing it and it’d be a good diversifier in your portfolio, but I don’t think most normal people want to be landlords.”

What does he think about some of these opportunities that are somewhat more passive than that, but not quite an index fund? For example, these opportunities available to accredited investors to buy syndicated apartment complexes with a hundred other investors or to buy into a private real estate fund. What are his thoughts on those investments?

 

“I think that those are products that are sold, not bought. I think they’re usually pretty opaque, they’re not liquid and the long term overall experience for people in those kinds of vehicles is poor.”

 

Jack Bogle

I asked Dr. Bernstein to describe the influence Jack Bogle had on him personally and on the industry?

“That question is kind of like you’re asking about the influence of Charles Darwin on the study of evolution. I mean, he basically, he didn’t invent the efficient market hypothesis, but he’s the one who put it into practical use. So I guess the proper analogy would be the Wright Brothers didn’t invent the internal combustion engine, but they applied it to powered flight and that’s exactly what Jack Bogle did. He took the concept of passive investing, which to that point, had been a theoretical construct of people like Paul Samuelson and Gene Fama and Burton Malkiel and he brought it to the general public and for that, he deserves to be remembered forever.”

 

Financial Services Industry Fees and Conflicts of Interest

Dr. Bernstein has always been somewhat critical on the financial services industry and particularly its fees and conflicts of interest. He has said in the past.

 

“99% of fund managers demonstrate no evidence of skill whatsoever and you were engaged in a life and death struggle with the financial services industry. If you act on the assumption that every broker, insurance salesman and financial adviser you encounter is a hardened criminal, you will do just fine.”

 

I asked him if he thinks the industry is improving or getting worse in this regard over his career?

“I think it’s getting better. Not much better, but I think it’s getting better. You’re not seeing quite the frequency of overt abuses, the day of the stockbroker who is cold calling clients and taking their existing clients and having them trade actively in and out of stocks on the basis of really no useful information, is slowly fading. It’s still there. You still see those kinds of practices, but they’re not nearly as frequent. People are investing more in passive investments in low cost mutual funds, even the ones that are actively managed, and so I think things are slowly improving.”

 

Managing Your Own Money

Now, despite the problems of the industry, he has said,

“No one in his right mind would walk into the cockpit of an airplane and try to fly it or into an operating theater and open a belly and yet they think nothing of managing their retirement assets. I’ve done all three and I’m here to tell you that managing money is in its most critical elements, the quota of emotional discipline and quantitative ability required even more demanding than the first two.”

And he said,

 

“A decade ago, I really did believe that the average investor could do it himself. I was wrong. I’ve come to the sad conclusion that only a tiny minority at most 1% are capable of pulling it off. Heck if Helen Young Hayes, Robert Sanborn, Julian Robertson and the nation’s largest pension funds can’t get it right, what chance does John Q. Investor have?”

Does he still feel the same way? Does he think the vast majority should have a financial advisor and if so, what can an investor who feels capable and has his own written financial plan do to know if he’s in that 1% or not?

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He says everyone should endeavor to get into the 1%. If everyone tried to get into that 1% than the figure may be more like 10-20%.  There is no reason why someone who’s smart enough to get into medical school can’t master the Four Pillars of Investing as he described them. The average physician is certainly capable of doing it for him or herself. The trick is, it’s going to require a lot of effort.

But he feels like when you broaden out that question to the general population,

“I think that our entire system of retirement savings is colossally stupid. I think that it’s just a fool’s errand to expect the average person who is flipping our burgers or taking care of our kids or pressing our coffee at Starbucks to be able to invest competently in their 401(k) plan is about as logical and about as sensible as expecting him to fly their own airplanes or open their own belly.

Bitcoin Bubble

We discussed the bitcoin bubble a bit and what lessons we can learn from that. He gives four criteria for identifying bubbles.

  1. It becomes a topic of everyday conversation. When you go to a party or a social engagement and people are talking about how wealthy they are getting trading bitcoin or tech stocks or real estate, that’s a sign that you’re in a bubble.
  2. When people quit perfectly good professions to day trade.
  3. When you express skepticism about a particular investment and you get really angry responses. When skepticism has met with vehemence, that’s a sign.
  4. When you start seeing extreme price predictions. So when people say that the price of something’s not just going to go up or down by 20%, which is the typical sort of prediction you have for the stock market, but the prices are going to quadruple or fall by a factor of four.

Bitcoin had all four of these criteria.  It was amazing how quickly it happened. It was like watching the tech boom and burst in rapid time. I thought it was absolutely fascinating and what was amazing to me is that most people didn’t seem to recognize it. They didn’t seem to think that it was bizarre at all that the value of something had quadrupled in eight weeks.

Not Following His Own Advice

At this point in the interview, we had a few questions from readers and listeners. One wanted to know a personal example of when Dr. Bernstein didn’t follow his own advice?

“A better way of phrasing that question, at least in terms of my experience, is what stupid things did I learn from that I did. I invested in palladium futures. I at a very early stage in my career, I invested in mutual funds based on their prior performance and in every single case I had my head handed to me. When didn’t I follow my own advice? Probably not being rigorous enough in my process, not being mathematical enough in my process in my own personal investments. I do have to admit that when I invest client money we’re extremely rigorous. We’re very mathematical, we’re very rules based about it. I’m not quite as rules base in my own personal investing and I probably should be more rules based.”

 

Breakdown of His Investments by Asset Class

Dr. Bernstein says because he is older and doesn’t have a lot of human capital ahead of him his investments are less than 50/50 stock and bond.

“Right now they are 45/55 stocks and bonds and they’re very heavily valued in small based and I’m a little overweight in foreign stocks because I think that they are cheaper, which is precisely what we do for clients.”

Student Loan Debt and Forgiveness

A couple of listeners asked questions about student loan debt. What does he think about debt forgiveness and the magnitude of student debt? He thinks it is a national scandal. He came out of medical school with $300 in debt. There is this enormous generational injustice we are currently dealing with.

“If you have users like me who benefited greatly from the system to say nothing of low security prices and high subsequent returns and then you’ve got this generation of younger people coming out of school who are essentially indentured servants and who have no prayer of discharging that debt. We have to rectify that, which gets to Elizabeth Warren’s proposal, which I think has a lot of merit and I think needs to be seriously considered. If I can get into a little bit of politics, there are a lot of truly scandalous things about this particular presidential administration. But I think that Betsy DeVos is the poster child for exactly what we’re talking about. As far as I can tell, she is in the back pocket of the private universities and the debt services and really does not have the interest of the nation’s young people at heart.”

Safe Withdrawal Rate

His opinion on a safe withdrawal rate?

“The old safe withdrawal rate was 4%, and it really depends upon your age. Let’s take two extreme examples. Let’s take the person who is say, 30 years old who’s just inherited or come into a huge amount of money and who wasn’t going to be working. Well, that person safe withdrawal rate is probably not much north of 2%. Whereas if you take someone at my age, probably who is just starting to withdraw and I’m 70. The safe withdrawal rate is probably about four and a half percent or so. I think for the average retiree, the person who wants to retire at age 60, I think it’s somewhere around three or three and a half percent. The old answer was 4% and the only way that that worked was because security returns going forward were so high. I don’t think they’re going to be high enough to sustain that from now on.”

 

What’s Been a Change in His Thinking Lately?

He said how he thinks about the long term risk of stocks has changed. People in finance have a consensus of opinion that stocks actually become riskier over time and there are a number of reasons why you should believe that. But to him, it is really a stupid question unless you qualify it by asking what’s the age of the investor or at what point in the life cycle of the investor are you. If you’re a young person, you look at your capital, almost all of your capital is human capital. It’s your future earnings and your investment capital’s going to be relatively small.

“So the risks of owning stocks and purchasing stocks periodically as part of a saving plan are relatively small. In fact, if you are a young investor, you should get down on your knees and pray for a lot of volatility and lousy returns so you can accumulate the stocks in your portfolio for your retirement at low prices. So for a young person, stocks aren’t particularly risky and they should not be afraid if they can tolerate it emotionally to invest nearly 100% of their savings into stocks. On the other hand, you have a person in my position who is not going to have a lot of future earnings, who’s going to be living off their investment capital and that person has to be a lot more cautious about stocks. If a person who is 70 years old, has 100% of their assets in stocks, and then stocks lose 50% over a 10 year period and you’re withdrawing 3% or 4%, after 10 years you may be living under a bridge.”

 

Ending

Dr Bernstein’s parting words of wisdom, “treat finance as a serious field of study just as you would treat medicine.  The roadmap you should follow for doing that is in If You Can . If you aren’t familiar with finance, if you’re not treating finance as seriously as you treat medicine, you shouldn’t be doing it.”

 

Full Transcription

Intro: This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high income professionals stop doing dumb things with their money since 2011.
Intro: Here’s your host, Dr. Jim Dahle.

Dr. Jim Dahle: Welcome to White Coat Investor Podcast number 107, an interview with William Bernstein, MD.

Cindy: Hello, White Coat Investor readers. This is Cindy here back again to thank this episode’s sponsor, Laurel Road. Laurel Road has helped thousands of medical professionals across the country refinance federal and private school loans, including my husband and I. They gave us the lower rate, and we were able to pay off our loans quickly. Of course, we took advantage of the $300 bonus they offer White Coat Investor readers and listeners to refinance student loans with Laurel Road. Laurel Road also offers those in residency or fellowship the ability to make reduced payments throughout their training and out of six months after. Terms and conditions apply. For more information and to submit an application, simply visit www.laurelroad.com/wcipodcast.

Dr. Jim Dahle: Thanks so much for what you do. You’re work is not appreciated enough. I know you’re on your way into work, maybe your way home from work, maybe you’re out running or you’re at the gym on a treadmill or something, maybe you’re preparing food in the kitchen, I don’t know, however you listen to these podcasts. But I know you probably had a hard day at work in the last day or two, and probably nobody told you thank you while you were there. So, let me be the one who thanks you for your patients. Sometimes, they just don’t thank you because they’re too worried about the medical condition they have, or they’re too frustrated at the system that you and I both have to deal with, and they do as well, so let me be the one to tell you thank you for them, for everything that you’re doing, and all the years of education and training you did, all the thankless nights that you did, all those calls you’ve taken. I appreciate what you’re doing.

Dr. Jim Dahle: Be sure to check out our list of disability insurance agents. If you are in need of disability or term life insurance, this is a carefully curated list. It’s not only curated by me, but by your fellow white coat investors. When they have a bad experience or particular good experience, they let me hear about it, and I use that to mold the list over the years. So, these people that are listed on my Recommended Insurance Agents page on the website are truly, truly good people that are doing disability insurance policies for hundreds of you every year. They really know their stuff. So, rather than going and trying to find your own agent, use these people and save yourself a lot of worry.

Dr. Jim Dahle: Be sure to also check out our Facebook group. If you haven’t yet, there are a ton of people in there. I think last count was well over 18,000. They are mostly physicians, dentists and their trainees. I think that’s about 71% of the group, but there are other professionals in there both attorneys and APCs, pharmacists, etc., and some spouses of high income professionals. So, it’s a broad group, but I’m amazed at how many people there are in there and the quality of the questions and the answers being given to the questions is continually rising. So, if you haven’t checked that out, it’s called White Coat Investors. It’s a private Facebook group. You do have to answer three questions to get into it, one of which says, “Yes, I’ve read the rules.” But if you are a high income professional and not a financial professional, we’ll let you right into the group. If you’re a financial professional, we’d like you to sponsor the group, of course.

Dr. Jim Dahle: Our special guest today I am totally honored to have. William Bernstein Ph.D., MD, is a chemist, a physician, a financial theorist, a blogger, the author of 11 financial books, and even a financial advisor. I first met Bill in person at the Bogleheads Conference in 2008 in Dallas, Fort Worth. Now, at that particular conference, Jack Bogle was sick in the hospital, he was having some sort of issue with his heart, and so he didn’t actually make it to the conference. I think he spoke to use very briefly by video at the conference, but that was it, but it didn’t even disappoint me because I was a Bernsteinhead long before I was a Boglehead, and so was perfectly honored just fine to be able to meet Bill Bernstein while I was there.

Dr. Jim Dahle: One of his books, The Four Pillars of Investing, was certainly one of the first good books on investing that I ever read. I totally lucked into it at the used bookstore next to my house, and it has had a huge influence on my financial outlook. Now, whether that’s his best book or not, I’ll leave for you to decide, but it was the one that most impacted my life. So, I wanted to bring Bill on the show and he graciously agreed, just as he agreed to speak at the Physician Wellness and Financial Literacy Conference last year in Park City, and so I’m glad to have him here.

Dr. Jim Dahle: All right, welcome to the show, Dr. Bernstein.

Dr. Bernstein: Pleasure to be here.

Dr. Jim Dahle: All right. I’ve read a lot of your writing, and we had you out to the White Coat Investor Conference in Park City, but I have never actually heard your story. So I’d like to start with you telling us your story, your upbringing, your education and training, your career as a physician, and the circumstances around you leaving medicine.

Dr. Bernstein: Well, the story, which is that I began after completing my residency, I very quickly realized that I live in a country that didn’t have a functioning social welfare system, so I was going to have to save and invest on my own. I approached it the way I thought anyone with scientific training would do, which is peer-reviewed literature and the basic text, I collected data, I built models. When I was all done, I realized that I had done something that not all physicians had done, and it was of value to small investors, not just other physicians. That’s a long shaggy dog story, which you probably don’t need to hear, but basically, once you publish books about finance, reporters start calling you up and you start getting calls and then people start asking you to manage money.

Dr. Bernstein: So that’s how I got into the money management business and when I started writing about finance, when you publish books and when you start getting quoted in the national media, people will naturally enough ask you to start managing money, which I did and one of the other things that I found is that when you write about finance, it is necessary to write about financial history and economic history and…

Dr. Jim Dahle: Let’s talk a little bit about the blog. You started a blog, the Efficient Frontier a number of years ago. Can you tell us about the origin of that and what you hope to accomplish with it?

Dr. Bernstein: Well, that was part of my initial writing process. This gets to around 1995 when I decided that I wanted to write a book about what I had found in my research. So I wrote a book called The Intelligent Asset Allocator, which eventually did get published five years later. But, of course, it didn’t get published right away. I sent away proposals to 30 different publishers and of course, I got rejected in every single case. So one of the people I was in contact with was a financial advisor by the name of Frank Armstrong in Florida, who was a pioneer on putting financial data and information on the web. He had done it probably earlier than almost anybody else. We’re only talking about a couple of years after the invention of the World Wide Web by Berners-Lee and he said, “Why don’t you, you know, put your things on the web”, and so I learned how to code html and I set up a website and I started publishing small articles that were basically formulated on the book that I had written and by and by, I put the whole book on the web and I found that I enjoyed writing short articles as well.

Dr. Bernstein: For a while, I would say between 1996 and say 2003 or 2004 for about 10 years, I was putting out about one article a month on the website and that got a fair amount of attention in the press.

Dr. Jim Dahle: Yeah, I imagine it would. I mean, now there’s lots and lots of blogs and certainly lots of financial blogs. I think there’s even about 80 physician financial blogs that had been started at this point, but in the late 90s, that was not the case. A blog was a pretty rare thing and so I think if you’re willing to be out there, you were a pretty rare commodity, I imagine.

Dr. Bernstein: The name wasn’t even invented for another decade when I started doing it. It was only in the mid 2000s that I realized, “Oh, I’m blogging”.

Dr. Jim Dahle: Yeah, and all these tools that we use to blog now, it didn’t exist. You had to do your own coding at the time too. I’m sure that was a little bit challenging, I imagine. You couldn’t just go read another blog on how to blog and learn how to do it.

Dr. Bernstein: Yeah. It’s an illustration of the barrier to entry problem, which is you don’t want to do something where the barrier to entry is very low and back in the day, 20 years ago, the barrier to entry on the web was high enough that if you could do it, you were a fairly rare commodity.

Dr. Jim Dahle: So let’s turn now to your books. I count 11 books that you’ve written. Did I miss any? Is that the right count?

Dr. Bernstein: I’ve lost count, but that sounds about right.

Dr. Jim Dahle: So I kind of divided them into four categories. I called them investing for beginners, investing for adults, the history books, and then I broke If You Can, out into its own category. I’d like to take each of those categories in turn and talk about the books. These first three were The Intelligent Asset Allocator in 2001, The Four Pillars of Investing in 2002 and The Investors Manifesto in 2010. Now, I think I’ve heard you say that each of these was an improvement and a simplification of the same message. What would you say that message is and which of these books do you recommend to someone new to your writing?

Dr. Bernstein: Well, the message of the first three books, especially for physicians was really pretty simple and actually directed really towards physicians in particular, although I didn’t realize it at the time. The reason why physicians are such lousy investors is because they don’t take finance and investing as seriously as they take medicine. Our finance and investing is a very serious subject, just as serious as medicine is and just as involved and you wouldn’t think of practicing medicine without understanding the basics, anatomy and physiology and pathology and pharmacology. In the same way you shouldn’t be doing finance unless you understand those equivalents in finance and the equivalents of those four subjects in finance are the theory of investing and we’ll get to what that means in a minute. The history of investing in finance, the psychology of finance and last and not least, the business of finance, the people you’re going to be dealing with on the other side of your trades and the people providing you with your products.

Dr. Bernstein: That takes a little bit of effort. We’re talking about dozens if not scores of hours of reading and you shouldn’t invest dollar one with anybody until you’ve mastered those subjects.

Dr. Jim Dahle: So, which of those books would you recommend to someone who has never read any of your books?

Dr. Bernstein: Well, it depends upon what your math skills are. The history of the three books was I wrote the first one, Intelligent Invest… The Intelligent Asset Allocator, because I thought I was writing a book for the average investor and it turned out that what I had written was a book that was really for the average engineer, because there was a lot of math in it. So I simplified it into The Four Pillars of Investing, but even a lot of people found that one to be overly complex. I mean, my neurology partner, has a PhD in Molecular Biology, so she’s a pretty smart lady and even she told me, “Hey, you know, this stopped me cold in a couple of places”. So that’s was the genesis of the last book, which was The Investors Manifesto, which is basically strips out all the math and is pretty descriptive.

Dr. Bernstein: So it really depends upon who you are. If you’re a math whiz and you enjoy statistics and you enjoy higher level math, then read The Intelligent Asset Allocator. If on the other hand you despise math and you don’t think you’re good at it, go for the last book, The Investors Manifesto. I think that the most rounded out book though is the middle one, the Four Pillars of Investing. If you can ignore the math in it, you’re still going to be pretty well rewarded.

Dr. Jim Dahle: Now, of those four pillars, which would you say is the most important?

Dr. Bernstein: That’s a very hard question, but I would say the psychology of investing. It turns out that human beings are just not wired for finance and the way I explain that is that we evolved in a state of nature where the risks that we faced were second to second. The flash of yellow and black in your peripheral vision, the hiss of the snake, and it’s a second to second thing, whereas the risks that we face in the modern world stretching out over decades and we’re just not wired to deal with them and that’s really what destroys most people’s ability to execute finance in the long run. So you have to understand just what those reactions are and how to overcome them.

Dr. Jim Dahle: Now the next four books I want to talk about, not necessarily the next four you wrote. But the next four, I think breaking these up into a reasonable order are the investing for adults series that you wrote from 2012 to 2014. These are shorter books that assumed a basic knowledge of investing on the part of the readers. These included Ages of The Investor, Skating to Where The Puck Was, Deep Risk and Rational Expectations. What were you trying to accomplish with these books and should we expect to ever see another in the series?

Dr. Bernstein: Probably not. What I was doing was playing with self publishing and trying to figure it out. It’s a very rewarding way to write about finance. But, I probably won’t be using that particular platform unless I decide to write another big finance book. The way it started was I had developed some things that I wanted to say and I wanted to talk about lifecycle investing, which I had thought some more about after I’d written my books. I had thought about what is the real nature of risk in the long run and then I wanted to write a book for professionals that warn them about hurting and about a lot of trends that I saw in investing at the professional and institutional level that bothered me. I realized after I had written those three books which are respectively The Ages of the Investor and Deep Risk and the Skating Where the Puck Was, that basically they were… they could be folded into a successor book to the Intelligent Asset Allocator.

Dr. Bernstein: The Intelligent Asset Allocator is now almost 20 years old and I decided at that point that it was time to write another version of the book. So I folded all of those three subjects plus the subject matter of The Intelligent Asset Allocator into a full length book, which I also sell online called Rational Expectations. So those four books are basically aimed at what I call investing adults, which are people who have mastered the four subjects that I talk about and it’s really aimed more professional investors than individual investors. The term investing adults is a bit sardonic because I’ve met some 15 year olds who are investing adults and I’ve met a ton of 75 year olds who were investing infants. It really when I say investing adults, I’m talking somebody who has an adult approach to investing.

Dr. Jim Dahle: Now, how do you think the best way for somebody to assess whether they’re an investing infant or an investing teenager or investing adult is? I mean, how can you know?

Dr. Bernstein: Well, that gets to the very last book that you mentioned that I wrote, which is If You Can. If You Can, is available for free. You just have to put that in quotes into Google, put my name and you’ll be able to download it. It’s about 10,000 words. It’ll take you at most an hour or two to read and if the subject matter that’s written about in that little pamphlet is familiar to you, you’re an adult. If the subject matter isn’t familiar to you, you’re not an adult and the booklet provides a roadmap towards becoming an adult.

Dr. Jim Dahle: That’s very helpful and actually a book I recommend all the time, not only because it’s free and very accessible, but anybody can get through 16 pages. If you can’t get through that, you have no business whatsoever having anything to do with managing your own money.

Dr. Bernstein: Yeah, including employing somebody else to manage your own money for you. If you can’t comprehend and grasp that particular pamphlet, then you’re a walking patsy.

Dr. Jim Dahle: Yup. There’s a lot of truth to that. Now the next three books deal with history. There’s 2008, A Splendid Exchange, The Birth of Plenty that came out in 2010 and Masters of The Word, in 2013. Now I confess, I’ve only read two of these three. I’ve read A Splendid Exchange and The Birth of Plenty and I think they’re excellent at helping develop one of those four pillars of investing and knowledge of the history of finance and markets. But tell us a little bit about Masters of The Word, how media shaped history and why you thought it was important to write.

Dr. Bernstein: Well, I’m at that point in my life when I only do things that are fun and one of the things that I’ve found is fun… that I find is fun that very few other people find is fun, is I enjoy writing long form nonfiction and really long form nonfiction is about organizing your own reading. If you enjoy leisure time reading than the way most people do it and it’s partially how I do it is you read book reviews, you get recommendations from friends and it’s sort of aimless. All right. You’re not really org… It’s really you’re not really reading in an organized fashion. I find that it’s much more rewarding to explore a single subject in depth.

Dr. Bernstein: Now, the reason I wrote Masters of The Word, was because when I wrote Splendid Exchange, I came across a fascinating story about the repeal of the Corn Laws in 1846 in England and this was a legislative action in the House of Commons does that basically destroyed a lot of the wealth and the power of the landed gentry in England and it benefited greatly the other 99% of the population who had to eat the grain that was produced on that land, basically reduced tariffs on imported grain, which protected the aristocracy. The way that it happened was the man who affected was a man by the name of Richard Cobden, and he was able to muster public support for the repeal of the Corn Laws, these tariffs by using the Penny Post, the new postage system that the English government had just set up and he also was able to use the railroads which was also what was behind the Penny Post to travel around and organized.

Dr. Bernstein: So I realized that in a world where only the wealthy can communicate and travel, everybody else is disempowered and if you go through the history of mankind, you find that that is a recurrent story. So, for example, you go back thousands of years when literacy rates were extremely low, a percent or two and you find that there’s this very small elite of scribes in Egypt and Mesopotamia who basically run everything. What happens in Greece and the reason why democracy develops in Greece is because the Greeks invented this very simple alphabet, just 22 letters with consonants and vowels that six year old could learn. So the literacy rate in Greece among male citizens was probably in excess of 30 or 50%, which was just sky high. All right? For that period of history. Well, where does democracy develop? All right. So it’s the story of that interplay between communications, technology and power and there are lots of other very important examples of that throughout history. I decided to write about that.

Dr. Jim Dahle: Yeah. I’m looking forward to picking up that one. That is the kind of book I would enjoy reading. Now let’s turn a little bit away from your books. You started a financial advisory firm, Efficient Frontier Advisors, LLC. When did you start that?

Dr. Bernstein: 1998. That was about the time I had gotten onto the internet and I was starting to develop a media presence and when you write books about finance, when you start publishing articles, when you have a website, when you start getting quoted in the Wall Street Journal or money magazine, people will naturally ask you to manage money and one of the people I encountered on the Internet was a financial advisor by the name of Susan Sharon, who already had an established practice and we got together and we’ve been in business ever since for the past 20 years.

Dr. Jim Dahle: So are you still working as a financial advisor? Is the firm’s still in business?
Dr. Bernstein: Oh, yes.

Dr. Jim Dahle: Okay. Now I don’t think you’ve accepted new clients for a long time and I was on the website a couple of days ago and it said the minimum investment is 25 million, which would certainly preclude most of my listeners from hiring the firm anyway. But what was the main reason you wanted to start the firm and what were you hoping to accomplish with it?

Dr. Bernstein: Well, in the first place our minimum is no longer 25 million. It’s infinity. We’re not taking new clients. But I enjoy managing money and it’s nice to be able to make a living doing it. It’s just that simple.

Dr. Jim Dahle: Let’s turn now to some of the more controversial topics in finance. I want to give listeners the opportunity to hear your opinions on these topics. You’re a firm believer that future stock and bond returns are likely to be lower in the future than they have been in the past. In fact, in the forward you wrote for my first book, you said “The bad news is that today’s young physicians, Jim included, won’t be as fortunate. Well, I’ve just told you that it’s impossible to make financial forecasts, this is true only in the short term. It’s actually pretty easy to estimate the future returns of both stocks and bonds in the long run, say over the next 20 to 30 years. For bonds, it’s very simple. They’re expected return is the interest rate, which as we all know, is very low at the moment and for stocks, it’s only slightly more difficult. Simply add the stock market dividend rate currently about 2% to the longterm average per share dividend growth of 5% to give an expected return of 7%. Neither of these, unfortunately, is going to match the double digit returns are in by investors in previous decades.”

Dr. Jim Dahle: Now that was about five years ago and over the last five years, the vanguard total stock market funds returned 10.3% and the total bond market fund is returned 2.7% and we’ll walk five years is hardly the longterm, stocks did provide double digit returns. Were you surprised by that?

Dr. Bernstein: Not at all. What you have to realize is just how much uncertainty there is incorporated into that estimate and easiest way to talk about it is to imagine you think that the long-term returns of stocks are 7%. Well, the thing that I haven’t told you is that the standard deviation of those stock returns of 7% is about 15%. So if you go two standard deviations up, two standard deviations down, which is the 95% confidence limits, then you’ve got a possible return over one year of plus two standard deviations, which is 37% or minus two standard deviations which is minus 23%. That’s why it’s a fool’s errand to try and estimate stock returns next year or next month.

Dr. Bernstein: Now the longer the period of time you go out, the more certain net becomes. So for example, let’s take a 49 year period, why 49 years? Because the square root of 49 is seven and the way you do the math, is you take that 15% and you divided standard deviation and you divided by seven, so now you’ve got 2%. All right? So now you’ve got plus or minus two standard deviations over almost a 50 year period, which gets you to a possible high of 11% or a possible low of about 3%, all right? Which gives you a lot more certainty, but certainly over a five year period, a return of 10.353 point… 10.3% which is barely double digits, shouldn’t surprise you at all.

Dr. Jim Dahle: Now, your prediction for bond returns was spot on. It was basically exactly what the yield was five years ago.

Dr. Bernstein: Yeah, and again it’s two, two things. Number one is money returns were a lot less noisy than stock returns are. Number two, you’re looking at the dumb luck. All right. A lot of people who make predictions that are wildly accurate or wildly inaccurate are for that reason. It’s really due to the uncertainty and how lucky you are in your guess.

Dr. Jim Dahle: Now, in Four Pillars of Investing, some of your sample portfolios included tiny allocation to gold and or gold mining stocks. Do you think that’s an asset class worthy of inclusion in a portfolio today and if so, which investors should consider it?

Dr. Bernstein: It’s really appropriate only for a very small subset of investors. You have to realize that the return of precious metals equities, I don’t recommend investing in gold. I recommend investing in precious metals equities and the reason for that is it’s horribly volatile. So it means that if you have it as a constant percent of your portfolio, then you’re fairly often going to be selling high and buying low. If you say you make it 2% of your portfolio, then it’s going to move very wildly with respect to the other 95% of the portfolio. So to keep it a 2% when it does really, really well, which is a lot of the time, you’re going to be selling a lot of it and when it does really, really well, your buying a lot of it and there’s sort of an… that sounds very attractive and very salutary. It’s emotionally very hard to do because this is an asset class which at least two or three times in the past 50 years has lost three quarters of its value. All right, and to be constantly rebalancing and buying feels like throwing money down a rat hole.

Dr. Bernstein: In the long run, it works, but it requires enormous amount of discipline and quite frankly, the benefit of owning just 2% of it in your portfolio is not that great. So I only recommended for two kind for people who meet two criteria. One is they’re really interested in finance and they’re really into spread-sheeting their investments and rebalancing very, very clinically and technically and number two, people who have the emotional discipline to deal with that kind of volatility, which quite frankly not a lot of people qualify on.

Dr. Jim Dahle: Let’s talk for a minute about factor investing. What are your thoughts on factor investing? For example, do you believe the small and value stocks are likely to outperform the overall market over the next 30 to 50 years?

Dr. Bernstein: I think the answer to both of those questions is probably yes. The problem is that this is one of those things that everyone now knows about and so the prices of value stocks and in small stocks had been bit up a bit and so I think that the rewards for doing it, in the long run, are not going to be as great as they were in the past. I think that for the average physician, you’re probably better off just sticking with the total stock market.

Dr. Jim Dahle: What about some of these other factors out there, like low volatility or momentum? At what point do these dozens or hundreds of factors just become artifacts of data mining?

Dr. Bernstein: Well, that’s… you’ve put your thumb right on it. There’s an enacted finance academic by the name of John Cochrane at the University of Chicago who very famously labeled all of these newly identified factors as the factor zoo, and I think he identified something like 500 of them and most of them are due to data mining. The most famous example of data mining was a fellow by the name of David Leinweber who basically mined the OECD database and found that butter production in Bangladesh was very predictive of the movements of the S&P 500. All right, well that was purely an accident and I don’t think anyone in their right mind would base their investment decisions on that. But, and I think that a lot of returns to factor investing are in that category. If you mine enough factors, you’re going to find something that worked.

Dr. Jim Dahle: Yeah and obviously won’t carry forward since it was only luck that it was a factor in the past.

Dr. Bernstein: Exactly.

Dr. Jim Dahle: What are your thoughts

Dr. Bernstein: Now momentum-

Dr. Jim Dahle: Go ahead.

Dr. Bernstein: Let me talk about the one last one, the one of them that I think that I don’t recommend investors pursue but I think is a real factor is momentum. So stocks that have done well in the past six months or a year tend to do better going forward. The problem with that the premium you get from doing that is it’s an enormously expensive one to mine because you’re turning over your portfolio very rapidly, and that carries costs not only transactional costs, but if it’s in a taxable account and you’re also generating huge amounts of capital gains.

Dr. Jim Dahle: What are your thoughts about low cost actively managed mutual funds such as those available from vanguard?

Dr. Bernstein: Well, I think that if you’re going to invest in actively managed funds, then you should be investing in the ones with the lowest expense ratios. The problem is that even the cheapest actively managed funds are more expensive than passively managed funds. So I’m not wild about that, but if you have to, if someone put a gun to my head and said, “You’ve got to invest in actively managed funds”, I would pick the ones with number one, the lowest fees, the lowest expenses and number two, the lowest turnover.

Dr. Jim Dahle: Let’s talk about real estate for a minute. Do you see a role in a portfolio for real estate above and beyond a simple REIT index fund?

Dr. Bernstein: What I like to say about investing and I presume you’re talking about commercial or residential rental real estate, is that it’s not an investment. It’s a job. So if you enjoy dealing with drug addled and potentially heavily armed tenants on fixing toilets, then I say go do it. You’re probably, you can probably make a lot of money doing it and it’d be a good diversifier in your portfolio, but I don’t think most normal people want to be landlords.

Dr. Jim Dahle: What do you think about some of these opportunities that are somewhat more passive than that, but not quite an index fund? For example, these opportunities available to accredited investors to buy syndicated apartment complexes with a hundred other investors or to buy into a privately private real estate fund. What are your thoughts on those investments?

Dr. Bernstein: I think that those are products that are sold, not bought. I think they’re usually pretty opaque, they’re not liquid and the overall experience, long term overall experience in people in those kinds of vehicles is poor.

Dr. Jim Dahle: Do you think there’s a premium there for being willing to be illiquid?

Dr. Bernstein: No, not really. I mean, theoretically, there’s an illiquidity premium. But I think that in the real world, the track record of these things is pretty miserable.
Dr. Jim Dahle: Jack Bogle passed away recently. Can you describe his influence on you personally and on the industry?

Dr. Bernstein: Yeah, I mean, it’s sort of like that question is kind of like you’re asking about the influence of Charles Darwin on the study of evolution. I mean, he basically, he didn’t invent the efficient market hypothesis, but he’s the one who put it into practical use. So I guess the proper analogy would be the Wright Brothers didn’t invent the internal combustion engine, but they applied it to powered flight and that’s exactly what Jack Bogle did. He took the concept of passive investing, which to that point, had been a theoretical construct of people like Paul Samuelson and Gene Fama and Burton Malkiel and he brought it to the general public and for that, he deserves to be remembered forever.

Dr. Jim Dahle: Now, you’ve always been somewhat critical, the financial services industry and particularly its fees and conflicts of interest. Let me read back two quotes here from you. “99% of fund managers demonstrate no evidence of skill whatsoever and you were engaged in a life and death struggle with the financial services industry. If you act on the assumption that every broker, insurance salesman and financial advisor you encounter is a hardened criminal, you will do just fine.” Do you think the industry is improving or getting worse in this regard over your career?

Dr. Bernstein: I think it’s getting better. Not much better, but I think it’s getting better. You’re not seeing quite the frequency of overt abuses, the day of the stockbroker who is cold calling clients and having taking their existing clients and having them trade actively in and out of stocks on the basis of really no useful information, is slowly fading. It’s still there. You still see those kinds of practices, but they’re not nearly as frequent. People are investing more in passive investments in low cost mutual funds, even the ones that are actively managed, and so I think things are slowly improving. So the answer to your question is yes, a bit.

Dr. Jim Dahle: Now, despite the problems of the industry, you’ve also said this, and I’ve got two other quotes here. “No one in his right mind would walk into the cockpit of an airplane and try to fly it or into an operating theater and open a belly and yet they think nothing of managing their retirement assets. I’ve done all three and I’m here to tell you that managing money is in its most critical elements, the quota of emotional discipline and quantitative ability required even more demanding than the first two.” The second quote, “A decade ago, I really did believe that the average investor could do it himself. I was wrong. I’ve come to the sad conclusion that only a tiny minority at most 1% are capable of pulling it off. Heck of Helen Young Hayes, Robert Sanborn, Julian Robertson and the nation’s largest pension funds can’t get it right, what chance does John Q. Investor have?”

Dr. Jim Dahle: Do you feel the same way? Do you think the vast majority should have a financial advisor and if so, what can investor feels capable and has his own written financial plan due to know if he’s in that 1% or not?

Dr. Bernstein: Well, the trick is everybody should endeavor to get into that 1% and if everybody endeavored to get into that 1%, the figure might be more like 10 or 20%. So I look at the problem on two different levels. Number one is particularly for this audience, there’s no reason why someone who’s smart enough to get into medical school can’t master the Four Pillars of Investing as I described them. That’s not a plug for my book by the way. In If You Can, I describe what the four pillars are and I don’t recommend one of my books because I think it’s cheesy to recommend your own books. So you don’t have to read any of my books to understand how to do this. So I think that the average physician is certainly capable of doing it for him or herself. The trick is, it’s going to require a lot of effort.

Dr. Bernstein: Now, when you broaden out that question to the general population, I think that our entire system of retirement savings is colossally stupid. I think that it’s just a fool’s errand to expect the average person who is flipping our burgers or taking care of our kids or pressing our coffee at Starbucks to be able to invest competently in their 401 plan is about as logical and about as sensible as expecting him to fly their own airplanes or open their own belly.

Dr. Jim Dahle: Let’s turn a little bit to a kind of a relatively recent market event that I thought was absolutely fascinating to watch. In October, 2017 you told CNBC that you didn’t think bitcoin was yet in a classic bubble. Over the eight weeks after that, it quadrupled in value only to burst and then provided investors with a minus 83% return in 2018. Truly it was the closest thing to a Tulip mania or South Seas Bubble that has existed in my short 15 year investing career. What lessons can we learn from the bitcoin bubble?

Dr. Bernstein: Well, first of all, I plead bad luck. If they’d asked me four or eight weeks later, I probably would have given, or at least I hope I would’ve given a very different answer. That was… I was asked that question just at the point where it was about to take off and when I said that, I basically posited four criteria that I had for identifying bubbles. Number one is when something becomes a topic of everyday conversation. When you go to a party or a social engagement and people are talking about how wealthy they are getting trading bitcoin or tech stocks or real estate, that’s a sign that you’re in a bubble. The second sign that you’re in a bubble is when people quit perfectly good professions to today trade or to trade mortgages or securities and we saw that of course during the late 90s when I saw medical doctors and lawyers quit what they were doing to a today trade.

Dr. Bernstein: Number three is when you express skepticism about a particular investment and you get really angry responses when skepticism has met with vehemence, that’s a third sign. So the most famous example of that with bitcoin was a little later when the very famous tech entrepreneur said that if bitcoin didn’t go to $500,000, he would perform an act on national television for which he’d probably be arrested. Then finally, number four is when you start seeing extreme price predictions. So when people say that the price of something’s not just going to go up or down by 20%, which is the typical sort of prediction you have for the stock market, but the prices are going to quadruple or fall by a factor of four. That is the sign of a bubble and the point that I was asked that question, none of those four criteria were present but they certainly were present four to eight weeks later.

Dr. Jim Dahle: Yeah. It was amazing how quickly it happened. It was like watching the tech boom and burst in rapid time. I thought it was absolutely, absolutely fascinating and what was amazing to me is that most people didn’t seem to recognize it. They didn’t think, seem to think that was bizarre at all. That the value of something had quadrupled in eight weeks.

Dr. Bernstein: Yeah. You know, a few weeks after, I was at your conference in Park City. I was down in San Francisco. I had a conference of high school teachers on financial education for young people and one of the questions I got asked at that point was about bitcoin and the teacher who asked the question just happened to remark that their students were speculating in bitcoin and both my jaw dropped and Jonathan Clements, who was sitting next to me who was also at the Park City conference, his jaws dropped two and one of us asked, I forget which one of us asked, “Well, you know, show of hands how many of your students are investing in bitcoin” and probably two thirds of the teachers in that room raised their hand. That’s a pretty sure sign.

Dr. Jim Dahle: Wow. Speaking of that Park City conference, what’d you think of that experience coming out and speaking to a bunch of doctors?

Dr. Bernstein: It was great fun. I was very impressed with the other speakers that you had, particularly the young radiologist who talked about burnout. I wished I had heard that talk 30 years ago, particularly her advice for dealing with the MBA from hell.

Dr. Jim Dahle: Yeah. You’re talking about Dr. Nisha Mehta, I think. I think that was her you’re referring to.

Dr. Bernstein: Yeah, very impressive young woman. Yeah.

Dr. Jim Dahle: So I’ve got a few questions that I put out a call on Twitter to people that wanted me to ask you questions. So I’ve got a handful of these I’m going to give you without any preparation whatsoever, but I think they’re most of them are pretty softball. One was, what’s a personal example of when you didn’t follow your own advice?

Dr. Bernstein: Well, really what’s that… really a better way of phrasing that question, at least in terms of my experience is what stupid things did I learn from that I did and I invested in palladium futures. I at a very early stage in my career, I invested in mutual funds based on their prior performance and in every single case I had my head handed to me. When didn’t I follow my own advice? Probably not being rigorous enough in my process, not being mathematical enough in my process in my own personal investments. I do have to admit that when I invest client money we’re extremely rigorous. We’re very mathematical, we’re very rules based about it. I’m not quite as rules base in my own personal investing and I probably should be more rules base.

Dr. Jim Dahle: That brings us up to the next question. This one comes from Dusty on Twitter who asks, “What is the breakdown of your investments by asset class?”

Dr. Bernstein: Well, I’m a geezer and so I don’t have a lot of human capital ahead of me. I had a fair amount of investment capital, so I’m less than 50/50 stock bond. I think at the present time, my own personal investments are 45/55 stocks and bonds and they’re very heavily value in small based and I’m a little overweight in foreign because, I have foreign stocks because I think that they are cheaper, which is precisely what we do for clients.

Dr. Jim Dahle: Now we’ve got a couple of questions on a relatively current event that’s in the news, particularly with the Democratic primary starting to ramp up a little bit. Vaughn asks, “I’d love his perspective on student debt and loan forgiveness” and I have another similar one about your opinion on the student education debt funding model and if that’s our next debt bubble and what you think of Elizabeth Warren’s solution to the crisis.

Dr. Bernstein: Okay. Well, let’s deal with those question by question, because I hear three or four questions there. The first question I think I heard, and correct me if I’m mistaken, is what do I think generally of debt forgiveness and of the magnitude of student debt, is that? I think that’s the first question I was asked.
Dr. Jim Dahle: I think that’s a fair summary. Yes.

Dr. Bernstein: Yeah, and I think that it’s a national scandal. My medical school tuition was $1,550 a year and I came out of medical school with virtually no debt. I think I had $300 worth of student debt, not 300,000, $300 of student debt. So there’s this enormous generational injustice that we’re dealing with. If you have users like me who benefited greatly from the system to say nothing of low security prices and high subsequent returns and then you’ve got this generation of younger people coming out of school who are essentially in ventured servants and who have no pray of discharging that debt. I mean, they can’t… you can’t as you well know, you can’t declare bankruptcy and get out of the problem the way you can with most debt.

Dr. Bernstein: So I think we have to rectify that, which gets to Elizabeth Warren’s proposal, which I think has a lot of merit and I think needs to be seriously considered. If I can get into a little bit of politics, there are a lot of truly scandalous things about this particular presidential administration. But I think that Betsy DeVos is the poster child for exactly what we’re talking about. As far as I can tell, she is in the back pocket of the private universities and the debt services and really does not have the interest of the nation’s young people at heart.

Dr. Jim Dahle: Now let’s turn a little bit away from politics and we’ll take another question. This one from Patrick who asked your opinion on a safe withdrawal rate.

Dr. Bernstein: Well, the old safe withdrawal rate was 4%, and it really depends upon your age. Let’s take two extreme examples. Let’s take the person who is say, 30 years old who’s just inherited or come into a huge amount of money and who wasn’t going to be working. Well, that person safe withdrawal rate is probably not much north of 2%. All right? Whereas if you take someone at my age, probably who is just starting to withdraw and I’m 70. The safe withdrawal rate is probably about four and a half percent or so. I think for the average retiree, the person who wants to retire at age 60, I think it’s somewhere around three or three and a half percent. The old answer was 4% and the only way that worked was because security returns going forward were so high. I don’t think they’re going to be high enough to sustain that from now on.

Dr. Jim Dahle: All right, one last one of Twitter. This one from Gary who asks, “What’s been a change in your thinking in the last few years?”

Dr. Bernstein: The biggest change that I have is how I’ve thought about the long-term risk of stocks. People in finance and particularly finance academics play this parlor game of do stocks become more or less risky with time and I’m not going to bore you with all of the pros and cons of that. But the consensus of opinion is the stocks actually become riskier over time and there are a number of fear radical reasons why you should believe that. But to me it’s really, it’s a stupid question unless you qualify it by asking what’s the age of the investor or at what point in the life cycle of the investor are you. So, if you’re a young person, you look at your capital, almost all of your capital is human capital. It’s your future earnings and your investment capital’s going to be relatively small.

Dr. Bernstein: So the risks of owning stocks and purchasing stocks periodically as part of a saving plan are relatively small. In fact, if you are a young investor, you should get down on your knees and pray for a lot of volatility and lousy returns so you can accumulate the stocks in your portfolio for your retirement at low prices. All right. So for a young person, stocks aren’t particularly risky and they should not be afraid if they can tolerate it emotionally to invest nearly 100% of their savings into stocks. On the other hand, you have a person in my position who is not going to have a lot of future earnings, who’s going to be living off their investment capital and that person has to be a lot more cautious about stocks. If a person who is 70 years old, has 100% of their assets and stocks, and then stocks lose 50% over a 10 year period and you’re withdrawing 3% or 4%, after 10 years you may be living under a bridge.

Dr. Jim Dahle: Now, I think we’re starting to push an hour here, so we’re going to have to wrap this up soon. But I wanted to give you the chance, I mean, I presume this podcast is probably going to be listened to by somewhere between 20,000 and 30,000 high income professionals like doctors. This is your opportunity to tell them anything else you think they ought to know about their investments, careers, finances, et cetera.

Dr. Bernstein: Well, I would just reinforce what I said a couple times throughout the podcast. It’s to an audience of physicians, it’s extremely important which is that somebody else said to me very recently. If you went into a doctor’s office and you saw general hospital playing, you would run out yelling and screaming from that doctor’s waiting room and it’s the same way with finance. If you are getting your finance information from the Wall Street Journal or Kiplinger’s or CNBC, that’s like getting your medical information, your medical background from USA Today. All right. Treat finance as seriously as a serious field of study as you would treat medicine and this roadmap for doing that, which I put out in If You Can, that you should follow. If you aren’t familiar with finance, if you’re not treating finance as seriously as you treat medicine, you shouldn’t be doing it.

Dr. Jim Dahle: Thank you so much and we’ll have links to all of his books as well as that free pamphlet, If You Can, on the podcast notes. So be sure to check those out. Dr. Bernstein, thank you so much for your time and for coming on the podcast today.

Dr. Bernstein: It was my pleasure Jim.

Dr. Jim Dahle: All right, that was wonderful having Bill on the podcast. I cannot recommend his books more highly. If you haven’t read his books or if you only read one or two of them, there’s still a lot of great information out there that is worth your time to read. I liked him so much that I included one of his books in the swag bag for the White Coat Investor conference in Park City. We gave everybody the Investors Manifesto that showed up to the conference and so be sure to check those resources out. We’ll have links to them in the show notes.

Dr. Jim Dahle: If you’re still looking for disability insurance or you just need a second opinion on whether your policies are any good, check out our list of recommended insurance agents. You can find it on the main website, whitecoatinvestor.com under the recommended tab. Most of them will give you a second opinion for free and if you find out that you’re really inadequately covered, they can help you get the policy that’s perfect for you.

Cindy: We want to thank Laurel Road for sponsoring this podcast. Laurel Road has helped thousands of medical professionals across the country, refinance federal and private school loans. In addition to offering a $300 bonus for WCI readers and listeners who refinance student loans with Laurel Road, Laurel Road also offers those in residency or fellowship the ability to make reduced payments throughout their training and up to six months after. Terms and conditions apply. For more information and to submit an application, simply visit www.laurelroad.com/wcipodcast.

Dr. Jim Dahle: Head up, shoulders back. You’ve got this. We can help. We’ll see you next time on the White Coat Investor podcast.

Disclaimer: My Dad, your host, Dr. Dahle is a practicing emergency physician, blogger, author, and podcaster. He’s not licensed to countenance attorney or financial advisor. So this podcast is for your entertainment and information only and should not be considered official personalized financial advice.