William Bernstein: If You've Won the Game, Stop Playing

Our guest this week is noted author and advisor, William Bernstein. Bill’s background and entree to finance is unique—a neurologist by training, Bill self-taught himself the principles of investing and asset allocation, eventually parlaying that knowledge into a successful financial advisory practice and a series of influential, critically acclaimed books such as "The Intelligent Asset Allocator." In this conversation, we explore Bill’s background and how it shaped his development and thinking as an investor and how he applies those lessons in working with clients who are trying to meet goals like a comfortable, secure retirement. “I had to figure out how to save and invest on my own”: Bill’s crash course into investing and constructing a portfolio (1:29) “I had to figure out how to save and invest on my own”: Bill’s crash course into investing and constructing a portfolio (1:29) • “I had to figure out how to save and invest on my own”: Bill’s crash course into investing and constructing a portfolio (1:29) • Separating the wheat from the chaff: How Bill decides what investing research matters and what doesn’t (4:30) • Top of the list: Books that profoundly influenced Bill’s investment philosophy and approach (5:45) • “The overwhelming science of investing does not speak well of active management”: Bill on why empirical data ought to settle most questions (and why active-share doesn’t hold up to scrutiny) (7:02) • “You approach it with extreme caution”: Bill explains why investors should be skeptical of most factors they encounter in the “factor zoo”, save a few (9:27) • A question that’s giving Bill pause: Is value too crowded a trade? (10:33) • Is low-volatility the most attractive factor from a behavioral standpoint? Bill worries it’s gotten too expensive. (12:02) • Fingers (and toes) crossed: Bill thinks value is cheap enough to stick with (12:55) • “Really, not very much”: Bill on how his approach to asset allocation has evolved over time (13:43) • “The riskiness of stocks is not an intrinsic characteristic of stocks; it’s more a characteristic of the investor”: Why stocks’ volatility doesn’t fluster younger investors, but freaks out older investors (14:38) • On how we tend to overrate our risk tolerance: “The difference between being able to see (losses) in a spreadsheet and actually manage (through losses) in real time is the difference between crashing an airplane in a flight simulator and in the real world” (15:38) • “If you’ve won the game, stop playing”: How to shake older investors out of their complacency with equity risk and recency bias (16:53) • “The very best physicians are consumed by self-doubt”: How a high ratio of “rumination-to-celebration” can help investors constructively reckon with shortcomings in their approach and improve (19:26) • Getting it wrong and therefore right: Bill explains how advisors can use their own fallibility and uncertainty to fortify their relationship with clients (versus scaring them to death) (21:12) • An argument with Jack Bogle: How a debate with the Vanguard founder about foreign-stock investing became an object lesson in how reality intrudes on theory (and how that informs Bill’s approach to managing clients) (22:56) • “You don’t appreciate it until bad things happen”: On whether the rally in riskier bonds has changed Bill’s tune on limiting fixed-income investments to short-term, high-grade fare (24:25) • “Investment is a process that transfers wealth to people that have a strategy and can execute it from those who don’t and can’t” (26:22) • “A reasonable hypothesis, but it got tested” (and failed): Bill on the argument for active bond investing (27:02) • Earthquakes and execrable returns: Why the best investing and economic gains have been realized in English-speaking countries. (Hint: It’s the law.) (27:48) • Emerging-markets stocks: Why they’re only a bargain when they’re cheap relative to their own history and developed markets (and still might not be inexpensive even in that case) (30:23) • Potential hazards: “The US markets are significantly overvalued relative to the rest of the world” (31:36) • “You’d have your head handed to you”: On the impermanence of investment measures, why it’s dangerous to extrapolate, and the implications for investors (32:54) • “When I think about my tombstone, ‘investment adviser’ is not one of the things I want to see up there” (34:00) • “We’re extremely choosy in who we take on. So we have a very enjoyable practice as a result of that” (35:49) • On retirement preparedness: “A slow-moving and fairly impressive disaster” (37:13) • “I don’t think the system needs nudges. I think the system needs dynamite”: Steps to radically redefine the retirement system (39:20) • “It would be nice if we had a system where people didn’t have to save quite so much, because that’s an unattainable goal for probably 80% of the population” (40:41) • The skunk-in-the-suburb analogy: We’re evolved to avoid the snake or the tiger, not to plan for retirement fifty years into the future (41:24) • What to do for investors who aren’t interested in finance or good with numbers: Limit investor autonomy, provide a generous match, offer a low-cost menu, default them into a target-date fund (43:03) • “One of the most important people in my life”: Remembering Jack Bogle (44:32) • “Something that everyone knows isn’t worth knowing”: Bill on the under-appreciated importance of corporate governance to security returns (46:46) • How Bill navigates ESG with his clients: He discourages them from pursuing it (49:25) • Principled but “bending”: How humility should make room for other ideas or priorities within a portfolio or plan (51:05)   • William Bernstein bio (CFA Institute) https://blogs.cfainstitute.org/investor/author/williamjbernstein/ • William Bernstein’s “Efficient Frontier” website http://www.efficientfrontier.com/ • Mean-variance optimization: Explainer https://www.effisols.com/basics/MVO.htm • William Bernstein’s reading list http://www.efficientfrontier.com/reading.htm • Fama and French research papers https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=1455 • “A Random Walk Down Wall Street” by Burton G. Malkiel https://www.amazon.com/Random-Walk-Down-Wall-Street/dp/0393081435/ref=sr_1_1?s=books&ie=UTF8&qid=1324493412&sr=1-1 • “Bogle on Mutual Funds” by Jack Bogle https://www.amazon.com/gp/product/111908833X/ref=dbs_a_def_rwt_bibl_vppi_i4 • “The Intelligent Investor” by Benjamin Graham https://www.amazon.com/Intelligent-Investor-Definitive-Investing-Practical/dp/0060555661/ref=sr_1_1?s=books&ie=UTF8&qid=1324493602&sr=1-1 • “The Theory of Interest” by Irving Fisher https://www.amazon.com/Theory-Interest-Illustrated-Irving-Fisher-ebook/dp/B00CR32KGK • “The Arithmetic of Active Management” by William F. Sharpe • https://web.stanford.edu/~wfsharpe/art/active/active.htm • Active Share website https://activeshare.nd.edu/ • “Presidential Address: Discount Rates” by John H. Cochrane https://faculty.chicagobooth.edu/john.cochrane/research/papers/discount_rates_jf.pdf • Value (aka “book-to-market”) factor http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_form_btm.html • Momentum factor http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_mom_factor.html • Profitability factor http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/tw_5_ports_beme_op.html • “Your Complete Guide to Factor-based Investing” by Andrew L. Berkin and Larry E. Swedroe • https://www.amazon.com/dp/B01N7FCW2D/ref=dp-kindle-redirect?_encoding=UTF8&btkr=1 • Factor performance http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html#Research • Berkshire Hathaway 2018 shareholder letter http://www.berkshirehathaway.com/letters/2018ltr.pdf • “Betting Against Beta” by Andrea Frazzini and Lasse Heje Pedersen http://pages.stern.nyu.edu/~lpederse/papers/BettingAgainstBeta.pdf • “Betting Against Beta” factor vs. value factor performance (10 years ended Feb. 2019) https://www.portfoliovisualizer.com/factor-statistics?s=y&factorDataSet=-1&marketArea=0&__checkbox_ffmkt=true&__checkbox_ffsmb=true&__checkbox_ffsmb5=true&ffhml=true&__checkbox_ffhml=true&__checkbox_ffmom=true&__checkbox_ffrmw=true&__checkbox_ffcma=true&__checkbox_ffstrev=true&__checkbox_ffltrev=true&__checkbox_aqrmkt=true&__checkbox_aqrsmb=true&__checkbox_aqrhml=true&__checkbox_aqrhmldev=true&__checkbox_aqrmom=true&__checkbox_aqrqmj=true&aqrbab=true&__checkbox_aqrbab=true&__checkbox_trm=true&__checkbox_cdt=true&startDate=03%2F01%2F2009&endDate=03%2F31%2F2019 • “The Intelligent Asset Allocator” by William J. Bernstein https://www.amazon.com/gp/product/0071385290/ref=s9_simz_gw_s0_p14_i1?pf_rd_m=ATVPDKIKX0DER&pf_rd_s=center-2&pf_rd_r=1NNWXTETT62HJ8QM9ZM6&pf_rd_t=101&pf_rd_p=470938631&pf_rd_i=507846 • “Availability” heuristic https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/availability-heuristic/ • Dunning-Kruger effect https://www.ncbi.nlm.nih.gov/pubmed/10626367 • “Why Jack Bogle Doesn’t Own Non-U.S. Stocks” with Christine Benz and Jack Bogle (Oct. 22, 2018) https://www.youtube.com/watch?v=P54trh0Rre8 • “Will Active Stock Funds Save Your Bacon in a Downturn?” by Jeffrey Ptak https://www.morningstar.com/articles/852864/will-active-stock-funds-save-your-bacon-in-a-downt.html • “Global Stock Markets in the Twentieth Century” by Philippe Jorion and William N. Goetzmann, Journal of Finance https://onlinelibrary.wiley.com/doi/abs/10.1111/0022-1082.00133 • “Legal Determinants of External Finance” by Rafael La Porta, Florencio Lopez-de-Silane, Andrei Shleifer, Robert W. Vishny, NBER Working Paper https://www.nber.org/papers/w5879 • Online Data Robert Shiller http://www.econ.yale.edu/~shiller/data.htm • S&P 500 Shiller PE Ratio https://www.multpl.com/shiller-pe • S&P 500 Price/earnings ratio https://www.multpl.com/s-p-500-pe-ratio • S&P 500 Price/book ratio https://www.multpl.com/s-p-500-price-to-book • National Retirement Risk Index, Center for Retirement Research at Boston College https://crr.bc.edu/special-projects/national-retirement-risk-index/ • “National Retirement Risk Index Shows Modest Improvements in 2016” by Alicia H. Munnell, Wenliang Hou, Geoffrey T. Sanzenbacher, Center for Retirement Research at Boston College https://crr.bc.edu/wp-content/uploads/2017/12/IB_18-1.pdf • “In Memoriam”, William J. Bernstein, Efficient Frontier http://efficientfrontier.com/ef/0adhoc/RIP-JCB.html • David Yermack, Albert Fingerhut Professor of Finance and Business Transformation, NYU Sterm, Publications https://its.law.nyu.edu/facultyprofiles/index.cfm?fuseaction=profile.publications&personid=20547