Original subtitles

welcome to investing for idiots yes

you've come to the right place this is a

video for the Libra bag holder option

day trader the Wall Street bets

afficianado I'm making this video for

the people for the victims who find the

scams they're in featured on my videos

and today we're doing something a bit

different this is a series where we have

real experts on the show and a perennial

topic of this series is investing given

that so much of my work is investing

gone wrong we've had Patrick Boo the

playing bagel and today we're joined by

Ben Felix the whole point of this series

is to point people toward channels which

give a sound theoretical understanding

to finance and moving them away from

gambling and financial nihilism and

towards basic Common Sense investing

welcome to the show Ben I appreciate you

coming on if you don't mind I want to

start at the end in mind for those who

just watch you know the first minute

what is the optimal strategy for most

people not considering individual

circumstance for most people to put

their to allocate their money and then

we'll back up to why that is the case I

think you've said that inv investing is

a solved issue what do you mean by that

yeah I I call it a solved problem

because we have these tools called index

funds which is what you're I think

referring to in the question which are

funds that give you really lowcost tax

efficient exposure to an entire stock

market so the S&P 500 is an index that a

lot of people have heard of that's I'm

not saying that's the index people

should be investing in we can talk more

about that later but an index is a

representation of a stock market so the

S&P 500 it the way that they describe it

that S&P describes it is that it

represents 500 leading companies in the

US Stock Market and it's a

capitalization weighted index which

means that larger companies measured by

their size by their market

capitalization have more weight in the

index and smaller companies have less

weight so we have these things called

indexes we have these things called

index funds that all they do when you

invest your money in the index fund is

they invest your money in the stocks in

the index and that's a really efficient

way to get exposure to the stock market

and so I mentioned not just the S&P 500

there are indexes representing stock

markets all all over the world and so

you can use these tools to build a

portfolio that's going to give you

exposure to Global stock markets which

is kind of all most people need uh in

terms of building a really high quality

portfolio yeah so there's this so now I

want to thank you for that I think that

is the answer that basically I was like

looking for and I've heard so many

people say so many experts say but now I

want to back up to sort of the beginning

let's just start with a bit about you

and then I want to talk about why it is

kind of counterintuitive that in experts

would tell you sort of not to go with

experts there are active financial

advisors things like that and we'll get

into why you and I think I also think

that that is not the most prudent

strategy for you know uh most people not

to get into individual situations but um

start with a bit about yourself what is

your back I think your engineering to

start right like just like me I did

chemical engineering I did nothing with

it and uh I think you are the same

mechanical right yeah that's right you

you know yeah mechanical engineering at

at nor Eastern I'm I'm Canadian I live

in Canada but I went to North Eastern

University in Boston did mechanical

engineer engineering there and then I

came back to Canada and did an MBA in

finance after that and that's how I got

into into finance and like you I never

used my engineering degree went straight

to the NBA yeah why did you what made

you interested in finance why why were

you you kind of taken by the idea of

investing and I wasn't at all I I was I

was not taken by the by the idea of

engineering I I knew I I probably didn't

want to work as a mechanical engineer

but uh I I was playing basketball that's

why I was at nor Eastern I'm I'm 6 foot1

people don't often realize that because

they see me sitting down on my YouTube

channel uh so that's re really are you

joking no I'm dead serious like actually

610 I'm listed at 611 for like if you go

on the North Eastern website you can see

it from when I played uh oh man yeah wow

yeah so I played basketball that's why I

was at nor Eastern and then I came back

to Canada primarily for basketball I

came to play at a Carlton University

which is like I don't know what to

compare it to um the best basketball

school in Canada by far uh so I came

back to play there and I had to choose a

program an academic program so I went

there for basketball but it's like okay

I probably don't want to do a masters in

engineering uh maybe I'll do an NBA

because you know that's pretty flexible

with what I can do with it afterwards

and then I picked Finance for the same a

concentration of Finance for the same

reason that I picked an engineering

degree in the first place was that it

was kind of the hardest program I was

told mechanical engineering is the

hardest thing you can do and I was like

all right I kind of like mechanical

stuff I'll just I'll do that and then

same thing for finance like of all the

streams you can pick in the NBA Finance

is the hardest one so all right let's do

it and that's that's it but I was never

like I love investing or I love finance

that no I do now yeah no no I was going

to say that really bleeds through a lot

of your videos that actually you are

very interested in the research side of

Finance that's how I found your videos

is I was looking for somebody who talked

about not just like their opinion about

stocks but what the research actually

said and you'll often cite you know

journals and articles in your videos

which I really appreciate but it's

interesting so the counterintuitive

thing that I want to get at in this

video why I'm calling it investing for

idiots be besides the Prov of title is

that I think it is interesting and

deeply counterintuitive that in most

Industries expertise is how you get the

superior advantage in the field so if

you would want you know something done

right you hire an expert to do it for

you that is the intuition that is at the

heart of almost everything we do in the

world and there's like a saying you get

what you pay for right um there's a

reverse saying in Finance now which is

popularized by I think Jack Bogle which

the the founder of Vanguard where he

says in finance you get what you don't

pay for meaning that it's the reverse

and that often times hiring the best

wealth manag manager in the world will

lead to worse outcomes than doing the

very at this point now simple and dumb

thing and the idio like it almost feels

too dumb which is hold a very Broad

Diversified Index Fund not choose stocks

not choose timing not choose any of the

things that you would think you would

have to do if you want to achieve a kind

of

a above average is a bit misleading

because actually you're getting the

average but the getting the average is

in finance weirdly above average can you

break down why this is the case that

that that is deeply

counterintuitive so I think the average

return piece there that you just

mentioned is actually really important

that with with index funds I've heard

people say like well why would just

settle for the average return why

wouldn't I try and do better by by

picking stocks or timing the market but

I think if you look at what are average

returns like what are what are the

average returns of investors or what are

the average returns of actively managed

mutual funds they're way below index

fund returns so I think what you said is

not incorrect that you're getting

relative to other investors you're

getting above ad average returns using

index funds you're getting the market

return which is the average but if you

compare yourselves to yourself to other

investors uh or or other types of funds

I think you're getting an above average

return with index funds why is that the

case expertise is weird in financial

markets I think it's because financial

markets are competitive they're a

competition now if you have one skilled

person and nobody else is doing anything

to price stocks St stocks are priced

based on trading so if I think a stock

is worth more and you think it's worth

uh and you think it's worth less we

might have a transaction and and every

time that that happens it puts

information into stock prices now

everybody wants to make a profit if

there's one person pricing assets and

nobody else is there they they could

make a lot of money because there'd be a

bunch of mispriced assets and they could

go decide what to pay for them and and

they' they'd be become very wealthy very

quickly but that's obviously not the

reality there's a bunch of people

competing to be the one putting their

information into the price to try and

make a profit and that competition is

what sets stock prices but it also

results in a situation where you've got

if you've got two extremely skilled

traders to and like you know we talk

about active manager underperformance

and I think a lot of the times it almost

becomes pejorative where active managers

are dumb and I don't think that's the

case I think they're some of the

smartest people in the world like

finances become this brain drain for all

the other smart Fields so it's really

smart people and but they're competing

with each other to be the ones to to

make a profit and when you get that you

you get this thing called the Paradox of

skill where when the the players playing

against each other in a game are

increasingly skilled the outcome is

increasingly determined by luck rather

than skill take like NBA games for

example uh you take two NBA players that

are equally skilled and make them play

oneon-one against each other and they

play 100 games like the winners is going

to be determined by luck assuming

they're equally matched right uh yeah so

I think that's it there's there's a

paradox of skill and it creates a

situation where being skilled does not

lead to better outcomes and then for

investors the the you get what you don't

pay for comment is because for the

service of hiring someone to try and do

that for you you're going to pay a high

fee you're also going to have high

transaction costs because every time

they trade a there's a cost implicit or

explicit or or usually both and so net

of fees and costs trying to beat the

market on average is going to be a

losing game so you got those two pieces

one the outcomes are determined by luck

because all the players are so highly

skilled and two you're paying a cost to

participate in that game to try and beat

the market and so net of costs on

average you're going to lose it's a it's

a losing

game when you say it it it sounds simple

but it it is uh hard to get your head

around and I have you know I have a

bunch of uh you know family members for

example who will tell me like yeah I've

got this active manager he's charging me

you know sort of 1% and uh and I want to

like I want to shake them I want to just

tell them like this is gonna be horrible

for you but they just always tell me

like no no no this guy's a smart guy

he's a smart you know he's a smart guy

and

um and I've I've said something in the

past and and my wife has told me like

hey you got to stop this you got to stop

it's not you're not you don't need to

evangelize about this because for some

people they need this get they wouldn't

save the money if not for the fact that

somebody's holding on like if they if

they were in charge of these decisions

they wouldn't act as rationally as you

think they would act which is they would

just put it in you know an index fund

and just hold it can you there also is

this piece which I think is hard to expl

understand and wrap your head around

when you think about it in terms of like

textbook Math versus there's a

behavioral side of this too um how do

you think about Behavior behaviors as

they impact returns and how

do people work against themselves so to

speak I think there's like a saying like

we've met the enemy and the enemy is us

um that I think is true of most people

who are

investing yeah for sure I mean you look

at the data on how do investors perform

relative to the assets that they invest

in so you can look at that for indexes

you can look at for mutual funds

investors pretty much always

underperform so you take the a stock

index fund for example or a stock index

and and the index returns whatever 8% a

year or something like that investors

typically would earn uh less 7% or 6% or

something like that depending on what

asset class we're talking about explain

by

what that's the the difference what's

the explanation for the behavior no no

what what is causing that

underperformance are they just trading

it because they trade at the bottom and

they buy at the top it's it's bad

timeing decisions yeah so that's it's

it's really comparing money weighted and

time weighted returns I mean Finance

terms I guess but there's this Gap if uh

if people are investing at the top and

selling uh at the bottom there's going

to be a difference between the money

weighted and the time waited return the

mechanics that don't really matter but

that's why we see those those gaps it's

poor poor timing decisions and that's

really it's it's really everywhere and

it's been around for a long time but I I

think your your comment about the person

needing handholding is important because

there's a separation between

the investment strategy and the fact

that somebody may need investment advice

I'm I'm biased here because I'm the

chief investment officer of a wealth

management firm we use lowcost funds to

build portfolios like we believe all the

stuff that I'm saying on the investment

management side but I still do think

that there's room for handholding as you

called it but also other things like

Financial Planning and tax advice that

people need so I don't think those two

things have to be combined someone who's

giving Financial advice doesn't have to

be selling you crappy High fee

investment funds unfortunately that has

been the synonym for a while where

Financial advice has become synonymous

with like this self-dealing that is

happening where they're selling often

tools that they are getting kickbacks

from selling um so that is just an

unfortunate like you know I think

well-deserved reputation of the

financial it is well deserved yeah I

industry industry but um you touched on

something thing which I think is worth

talking about which is uh market

efficiency where you said you know as

the players get better then the outcome

is increasingly determined by luck which

brings me to a question which H are

markets getting more efficient as

information gets faster and the players

become more

sophisticated market efficiency is a

really really hard question to answer uh

whenever I ask academics about this on

my podcast they kind of laugh and like

how how are you defining market

efficiency how do you want me toine

market to Define market efficiency

market efficiency is is technically is

kind of the plain English definition it

means that prices reflect all available

information stock prices reflect all

available information now how do you

actually test for that to check like our

Market's getting more efficient there

are a lot of different ways none of them

are completely conclusive uh but if you

look at something like information

production so is is there is information

about individual stocks

uh being produced at at a higher rate or

or a lower rate than than the past uh I

think from measures like that markets

are at least as efficient as they've

been in the past possibly getting more

efficient but that's not the only thing

that that uh that matters like another

big one is active manager performance so

we talked about can active managers beat

the market and that's been pretty stable

for a very long time very few active

managers are able to beat the market if

markets were getting less efficient we

might see we might expect to see that

reverse the other thing so yes

information is more available yes

technolog is getting better the other

thing that we're seeing though as a big

trend is that a lot of people are moving

to index funds which means there are

fewer dollars invested with active

managers and the way that prices got

right in the first place is because the

active managers were trading on

information trying to make a profit so

this is a thing called the Grossman

stiglets Paradox it's basically the

Paradox is basically that markets can

never be perfectly efficient because if

they were there would be no more

information production it's kind of like

an equilibrium though in reality where

if if the pendulum ever swings too far

toward passive there will be

opportunities for active managers then

at least in theory they'll come back

make a profit for a bit and then markets

will be efficient again yeah because

fundamentally Index Fund investors are

sort of getting a free lunch of the work

of pass of active managers to determine

the price of stock the fair price of

stocks uh talk to me about about

diversification and what a type of risk

is that you can diversify away and

things that you can't diversify away

because I I think this is also something

that's counterintuitive where you go why

would I buy a basket of stocks when that

basket of stocks is for sure going to

have a bunch of losers like stocks that

are going to be terrible why would I not

just pick the stocks that I know are

going to be good you know I know hey I

believe in Tesla right I believe paler

Alex C whatever his name is uh that that

guy you know he's got he's got Big Ideas

Ben why don't I just invest in that

instead of your dumb idea where I you

know invest in these losers what is what

is the answer to that

yeah it's really easy to identify past

winners like we can say hey that guy's

really smart or hey this company's doing

really really well that's reflected in

the price and so I think that's a bit of

a trap that people get can get caught in

where people can end up paying a really

high price to invest in an objectively

good company but because you paid a high

price for it your investment returns are

going to suck we've seen that happen uh

throughout the course of financial

Market history again and again like it's

it's a again back to investor Behavior

it's something that people kind of love

to do they love to overpay

for exciting companies more generally

though the problem is most stocks

perform poorly they perform poorly

relative to treasury bills they perform

poorly relative to the market a few

stocks perform really really well so I

mean to your question can we identify

those winners ahead of time that's

really really hard to do and because

most stocks perform poorly you're much

more likely to pick losers than to pick

uh winners so if you look at people

building concentrated portfolios there's

a study that looks at this if you build

concentrated portfolios of stocks you're

much more likely to underperform the

market than to uh to outperform it so

that that's concentration uh the risks

that you can diversify away are company

specific risks or industry specific

risks so that's like take two companies

that are otherwise identical they're

exposed to the same uh the same big

picture risks but one Company CEO starts

doing some crazy stuff that the market

really doesn't like that company is

going to do relatively poorly its

returns are going to be relatively poor

compared to the other company uh because

of what the COO is doing not because of

anything that's going on in the overall

market so that that's company specific

risk that can be Diversified Away by

owning all of the companies in that

industry or or uh or sector okay right

and then when you diversify all the

risks away like company specific risk

you've got industry risk which you can

diversify Away by investing in other

Industries you've got country specific

risk which to an extent you can

diversify a way by investing in other

countries and then you roll all that up

you're left with what's called Market

risk the reason this matters is that

market risk is priced that means you

expect compensation for taking on Market

risk you do not expect compensation for

taking on individual company risk or

industry

risk is this that is this why they say

like diversification is the free lunch

in finance or like there there's some

saying about that because you're

actually getting above average or you're

getting extra expected return for not

having uh for not taking on more risk

where most of the time taking on getting

more return means taking on more risk

yeah yeah so if if you diversify with a

bunch of risky assets those stocks are

risky if you have a whole bunch of them

you're reducing your risk without

decreasing your expected return whereas

typically in finance if you want to take

less risk you have to expect lower

returns so why do all these people pick

stocks I think it's exciting I think

people think they're smart I think

there's a lot of overom confidence in

investing uh whenever I make a video

smart I I'm no that's why this video is

investing for that that is like the

whole premise is that kind of the most

genius thing to do as an investor is to

know what you don't know and sort of and

kind of take the counterintuitive

position of

of realizing that average returns are

really easy to get and above average

return slightly above average returns

are incredibly hard to get and almost no

one gets them that is like the very odd

thing at play here yeah and you're

introducing a whole bunch of risk that

you're going to get below average

returns by trying to get above average

returns and you're much more likely to

get below average

returns I think it's the overconfidence

uh people want to believe that that

there's a smart person out there or that

they're the smart person that can give

them a out performance but yeah it's uh

not not very well

supported okay so I got another another

question for you which is I hear about

AI Hot Topic robots Hot Topic I want to

screw you know Screw the total market

index I want to put my money in the uh

roll the dice in the AI funds in the you

know whatever uh why is that a bad idea

or a good idea is it a good idea so I

got a lot of questions about this when

Arc Kathy Woods fund or funds were doing

really really well like there were a

couple years or a few years where they

were just crazy rocket ships crushing

and so I started getting questions like

why would we invest because her

narrative was the index has all these

old boring companies that really suck

and they're not Innovative and we're

going to pick the Innovative ones they

going to do really well so I started

getting questions from clients like why

why wouldn't we why would we want to

invest in these old companies why

wouldn't we want to invest in the new

economy so I did a lot of work digging

into that I made a couple videos on it

on investing in technological

revolutions I did one on uh Superstar

fund managers or something like that too

uh which those two things of go hand

inand so what tends to happen why is

investing in Revolutionary Technologies

or or or new economy stocks historically

a losing a losing game it comes back to

asset pricing so when something's really

exciting so AI for example I think

crypto went through this too marijuana

stocks went through it too electric

vehicles I mean it's just recent history

but this is a this is something that

happens throughout history Railway

stocks went through this too so what

happens is people people realize this

thing is exciting they realize it's

going to be impactful and ass prices

start to reflect that and so the asset

prices shoot up and what happens when

asset prices shoot up more people hear

about this thing oh AI it's going to be

really big and the stock prices just

went up a bunch so more people invest in

it and the price keeps going up and that

cycle carries on for a while and you see

asset prices go up up up investors tend

to buy after they've gone up and then

they tend to come back down because

nothing nothing tends to be as as

revolutionary as quickly as I think

people expect

and you have a dilutive

factor don't you like the companies also

are issuing a bunch of new shares

they're also you're not capturing the

full um profits of that sector that you

think you are yeah that's one of my

favorite pieces of this whole thing so

you get high asset prices and one of the

reasons that they're high I've heard

someone called this the big Market

delusion which is basically that every

stock is priced as if they're going to

capture all of the market share of that

new industry but that's never what

happened so even if there is a massive

amount of new earnings that are going to

be available for an industry to capture

when it's a new exciting industry like

you said a lot of companies are going to

issue new stock a lot of new companies

are going to be created and so there's

this huge earnings pie but it's not one

company capturing it and the more

companies that go after that huge

earnings pie the lower the earnings per

share which is what matters to investors

which is what matters for stock prices

is going to be and so you can end up

with massive earnings growth for a new

industry and really bad earnings per

share growth for all the companies that

are issuing stock to try and try and

capture that that new opportunity and so

investors end up just kind of getting

getting hosed and this is like you go

back through history this happens again

and again and again High stock prices

exciting technology investors buy at the

peak and they get

smoked this this is what is so

interesting to me

about um finances there are all

these traps for otherwise smart people

to make catastrophic mistakes with their

finances because of things that seem

intuitive until you like know a bit more

of the picture like um you're not I have

a guy I won't say his name but a very

you know popular Finance guy on YouTube

and he was he's telling me behind the

scenes oh you got to invest you know

this smart you know industry and da d d

d da and he was making the case so

strongly to me that I was like what is

the like research on emerging market

like like some of these like really you

know interesting Industries and that's

when I found your video on I was like oh

this is not the easy buy that I thought

it was where it's like yeah just buy a

few of these you know hot AI stocks or

hot robot look it's going to be the

future it's not as simple as I

identified as if not as if everyone

can't see that Ai and robots are going

to be an important part of the the

future anyway to say nothing of that um

I want to touch on an interesting piece

which is that even though we all know

past performance is no indicator of

future you know results we all kind of

behave a little bit differently than

that everyone sort of behaves as if the

opposite is true and I want to talk

about us versus International right this

is a big

conversation um where the US has sort of

especially in the past decade or so has

sort of crushed um and so there is a

narrative that crops up every time

something like this happens which is

well I just want to abandon this loser

which is everybody else but the US US

number one we're the Kings sorry Canada

you guys are you know you guys

are sorry I'm just it's you're not

performing I'm dumping the loser for my

portfolio in theory intuitively like if

you just didn't know anything else it

kind of there's some tendenc to believe

that idea can you explain why this might

be a problem and explain the trend of us

assets that have become higher priced PE

wise relative to other International

assets AKA is investing in international

stocks a dumb

idea yeah so the the US market has been

wild for for the last 15 years it's been

just I mean incredible insane like

anyone that was not investing in the US

over that period like you you you you

missed out on a lot of returns and you

don't get those back like that's it uh

which which is one of the reasons that

you know even though we're about to talk

about us expected returns maybe being a

little lower than the past I don't think

that means anybody should get out of the

US market because I could have sent I

could have said the same thing five

years ago and here we are the US market

has been

incredible uh so what has happened over

the last 15 years but really over the

last 30 or so years years is that us

stock prices have gotten higher relative

to their

fundamentals and that the fundamentals

have been they' been good um like

there's no question there the US market

is objectively strong economically uh

but but the other thing that's happened

is the valuations of US Stocks have

gotten Higher and Higher and Higher and

right now if you look at the the the

Schiller price earnings ratio which is

one way to measure stock market

valuations it's you know it's not as

high as it was in the year 2000 but it's

really high Ben it's really high it's

about as close as it's been since since

then since the 20 year 2000 and you know

it's not conclusive by any means but

typically when stock prices are high

expected future returns are low and

realized future returns are are low like

if you go and sort historical US market

returns by their starting Cape they're

starting cyclically adjusted price

earnings ratio higher starting capes are

ass explain what you just said what's a

what's a cape I'm sorry sorry sorry

cyclically adjusted price earnings ratio

so it's a way of measuring stock market

valuations it's the 10year smoothed real

earnings of companies yeah so you're

measuring the prices relative to that

smooth earnings figure and that just

helps to balance out big changes in

earnings from year to year and so that

that measures really high right now

meaning meaning buying a dollar of

earnings of us company earnings is

really expensive right now compared to

history and historically that has led

had been associated with lower future

returns now what does this mean for for

does international investing make sense

if you look back to 1980 or so up until

now a huge portion us has completely

obliterated International stocks over

that period and a huge portion of that

difference has come from rising

valuations and so if we think about is

the same thing going to happen for the

next 20 years for the next 30 years it's

it's really hard to say that valuations

us valuations are going to keep going up

the way that they have over the last 15

or so years to deliver the type of

returns that people might expect when

they say oh I'm only going to invest in

US Stocks so I think that's a little bit

of a trap uh currently expected returns

are low uh they're low partially because

past returns have been high which has

led to increasing valuations and so

people see the past returns and they

project that into the future but in

reality they should probably probably if

anything be expecting the opposite lower

returns now if we look at uh US versus

International stocks throughout history

I looked at this a while ago I looked at

10year rolling periods from I think 1900

to 2023 or something like that and it

was about 60% of the time that us beat

International which is like it it won

most of the time but it wasn't all the

time by any means it wasn't what you'd

expect if you were only alive from 2010

or something that's right that's right

so yeah like I I I think International

divers diversification makes sense I

made a video on it I I diversify

internationally the US is only one part

of the world it currently makes makes up

about 65% of the global stock market

which is a lot uh it's increased each

year partially because valuations have

been going up and up uh but there's a

huge portion of the global stock market

that is not the US and the US I don't

think will perform the way it has in

recent history forever and historically

when the US has faltered when it's had

lower returns International returns have

been better relatively speaking and

that's diversification it's like basic

this is another way to diversify it's

just interesting because people who talk

about diversification especially in the

US are usually talking about us Equity

diversification they're not actually

they don't want to diversify to the rest

of the world they're like they actually

want to bet on their country there's a

bit of a country preference of you know

and and and we have uh historical

returns we look back and we go see look

we proved it we're we're the best we

want to but it is interesting like the

same I I I find this because I follow

some of these um there's this community

called the bogleheads have you heard of

these guys oh I've heard of them yep

these bogleheads uh they're they're like

people who kind more or less subscribe

to the the theories of Jack Bogle the

Vanguard kind of father of uh index

investing they and to some I don't want

to treat them all as a monolith but some

of them have issues with this idea of

international like most of them are like

look even people who in theory

completely subscribe to the idea of

diversification sort of half subscribed

to it cuz they go look I don't want to

really hold that much you know I back

tested this and I'm a little smart I

backed and I found out that you know

International is not worth holding so

I'm fully us and then Jack Bogle even

himself is like I don't hold any

International I I hold like and Max 20%

something like that

so

do if we are looking at this from what I

wanted to give my audience is no advice

just a theoretic

understanding a framework for how to

think about this in my mind this is an

irrational side of both Jack bogle's

philosophy and in the philosophy of a

lot of people who even subscribe to

diversification if you really subscribe

to it you kind of have to subscribe full

send unless you're making arguments

about like tax efficiency of

international like I guess I guess but

uh what what is your thought about that

do you think that the the most sound

theoretical framework is just buy

everything

and if that's true do you buy more than

just equities do you buy every like

Commodities you buy oil yeah yeah yeah

what what is your answer yeah so I I

think on the international

diversification piece if someone wanted

to be only us

Equity it's it's probably not the end of

the world I don't think it's a good

decision but there are worse countries

to invest 100% of your wealth in like

the US is 6 it's 65% of the global

market and it it it has companies that

do have exposure to markets all around

the world right it's not it's not quite

globally Diversified because us

companies that sell overseas are going

to perform differently than companies

overseas so it's not perfect but again

if if you wanted to invest in one

country the US is probably the way the

way to do it I do also think for us

investors like you mentioned tax there's

also currency issues costs there are

reasons to have Home Country bias if

you're in the US or elsewhere like in

Canada many people have a home country

bias and I think to an extent that can

make sense

just because of of the frictions of

owning foreign stocks there's other

weird stuff too that you can start

thinking about like the risk of

expropriation by Foreign governments in

times of conflict like those are real

things that are worth considering and

thinking about

diversification uh so I you know I don't

think it's the end of the world if a

us-based investor said I'm going to

invest everything in US Stocks I'm not

recommending that or suggesting it and

I've argued against that including with

the bogleheads community many times

every time I make a video on

International diversification they lose

their

minds

yeah by the way I like this guy I like

that I'm not I'm not hating I I I think

uh they're one of the more sound you

know um Financial groups out there

actually but and and they have you know

interesting discussions but it is

something that's cropped up that I think

is interesting because I'm like wow this

uh knowing the theoretical underpinnings

and actually believing in it when you

have all this data that that kind of

pushes you towards well the US seems so

good um is is hard

to it's kind of hard to argue against

the past performance of a guy who's like

I invested in the US in the last 40

years and I you know everyone who

invested in Fe you know International is

an idiot compared to me and like the

yeah you know in theory no yeah not not

in theory but I guess in practice he's

right in those 40 years he was right you

know correct just like if you invested

in Nvidia for the last 10 years and I'm

going to come to you and say hey you

shouldn't have shouldn't have done that

and they would say well in theory you're

right in practice you know you're wrong

yeah I think be there there's a little

bit of rear viw mirror bi bias because

the US market has done so well on recent

history but you go back like from 2000

to 2010 US Stocks returned

zero for 10 years it's like those those

those periods happen and over that

period uh other other St elsewhere did

did better I mean even in the US I don't

know if we're going to talk about this

but even in the US the US market which

is what everybody sees the past

performance of right now was flat us

small cap value stocks over that 20120

period did incredibly well that's not

quite diversification that's not like an

appropriate term for it um but investing

in something other than the US market

capitalization weighted index can make a

lot of sense in some cases the theory

piece of that is is pretty simple if

markets are efficient uh the global

portfolio of assets is the theoretically

optimal portfolio and that like that's

the it's pretty simple that's the basic

argument for why you should be globally

Diversified okay question on top of that

because you say that Ben you say that

but you don't do that you don't do that

in your own life you do a little thing

called the slice and the factor tilt

yeah what are the uh you know see I've

done my research I've done my homework

what are the

factors uh in the F French model what is

the F let's back up what's who's

fam and does he know French and what are

these things I think we have to back up

even further actually I think we have to

go back one step further to this is for

idiots B yeah we're going for going for

idiots yeah I'm G to I'm going to do my

best here so we talked about Market risk

earlier you can diversify everything

away uh and you end up with Market risk

and that's the one priced risk that's

the risk you expect compensation for for

taking okay uh that's you get that by

owning a an index fund a total market

index fund so that idea really comes

from a 1964 paper in the Journal of

Finance by a guy named Bill Sharp who he

won the Nobel Memorial prize in economic

Sciences for this this work he came up

with this thing called the capital asset

pricing model the capm and this model

basically predicts I hope this is not

too nerdy but it basically predict

predicts that uh expected returns are

explained by exposure to Market risk so

you you take on Market risk you get you

get an expected return if you take on

more Market Risk by taking by owning

stocks that have a higher Market beta

that's pretty Nery what talk but riskier

stocks should have higher expected

returns in his in his model uh but it's

a single Factor model meaning Market

risk is the only risk that explains

expected returns so that's 1964

from then until the '90s there were a

whole bunch of things that were

violating that that model so there were

a whole bunch of types of stocks where

if you looked at their capm if if you

analyze them through the lens of the

capm it looked like they had higher

returns that were too high for the

amount of Market risk that they were

exposed to so that could mean two things

it could mean markets are inefficient

and that there are all these profit

opportunities these risk-free profit

opportunities for people to take or it

could mean that the capital asset

pricing model was not the best model to

to to explain how assets are priced to

explain what risks are incorporated into

stock prices so this is where F and

French f is the guy who came up with the

idea of market efficiency in the 1960s

and 70s and his co-author Ken French uh

they came up with the idea that maybe

there are more than the one market risk

maybe there's more than one risk that

investors care about when they price

assets because the the capam was

empirically wrong meaning you could find

lots of way lots of places where it was

not not working yeah so they they came

up with this uh a three Factor model

where they said it looks like investors

probably care about Market risk but also

the specific risk of small stocks and

the specific risk of of value stocks and

those were two of those empirical

irregularities is this dumb enough I

don't know like we be no yeah this is

fine no you want to explain value versus

growth real quick yeah yeah okay so

value the way that F and French measure

it they they measure price relative to

book value so the book value is like the

just the value of a company's assets and

then its price is the value of its

assets plus the discounted value of

future cash flows so basically if if

people think a company's going to do

really badly in the future it might

trade at its Book value like this

company's going to generate no profits

it really sucks right if a company's

going to do really well it's going to

have a really high price relative to its

Book value so a growth stock would be a

high price relative to book value stock

a value stock is a cheap stock it's got

a low price relative to its Book value

so they had observed that value stocks

tended to beat grow stocks

over time likewise they'd observed that

small companies measured by their market

capitalization had tended to outperform

big companies so they added these two

independent factors to the asset pricing

model and all of a sudden a lot of those

empirical irregularities that the capm

was failing to explain they kind of went

away so from that paper this whole field

of of financial economics was born

called uh multiactor asset pricing which

is really the study of like how are

assets priced like what what information

goes into the price of a stock what do

investors car about uh so they had that

three Factor model and they later in

2015 came out with a five Factor model

let's not talk about the five let's just

let's just do let's stick with the okay

for now for now yeah that's that the

three Factor model is really the it

explains the the the capm explained like

two-thirds of the differences in returns

between Diversified portfolios the three

Factor model brought that up to about

90% that means like if you take two

actively managed portfolios for example

and ask why are their returns different

the capm is going to explain about 2/3

of it the the three Factor model is

going to explain about 90% of it the

five Factor model explains about 95% so

there's definitely some diminishing

returns that is to

say their returns are explainable as a

function of the amount of risk they're

taking on that is fundamentally their

the whole idea is exactly that yeah

so because this is something that was

con that was confusing me when I first

learned about this is I was like oh are

the factors like another way like

diversification to get sort of this uh

free lunch like I just buy more small

cap index funds and I buy more value

stocks and I just get better returns as

opposed to people who buy the whole

market index is that what you're

saying well theoretically there are

independent risks that a lot of

investors probably should not be taking

and that is why they're compensated so

the market portfolio in theory the the

market capitalization weighted like you

go and buy the market index fund that's

the optimal portfolio for the average

investor now if you're not the average

investor if you're in a position to take

more risk than than the average investor

and take more risks that show up at

really bad times than the average

investor like risks that will show up at

the same time that you might lose your

job somebody who has a job that's

exposed to those types of risks they

maybe shouldn't be investing in value

stocks someone who's retired for example

and doesn't depend on their income at

all Maybe they can take a little bit

more Risk by tilting toward toward value

stocks but they're they're not for

everybody and they are risk at least in

in the F French thinking they're risk

premiums which means like no it's not a

free lunch it's an additional risk that

you're taking and doing it can suck like

if you were investing in value or small

cap value stocks over this recent period

where the US Market's been going nuts it

hurt like I I have a value tilt in my

portfolio and it sucks yeah because

growth actually has been value doesn't

always beat growth and growth has been

killing yeah um so anyway I wanted to

kind of uh bring that up because it's an

interesting you know um Deep dive on the

specifics of you know diversification

people talk about these Factor tilts

they're not talking about the same thing

as diversification where you get sort of

an increase in expect expected returns

for no additional risk you are getting

an increase in expected returns for

taking more risk just like if you were

to have you know 100% equities versus

having 80 20 bonds or something like

that you would get an expect more return

but you're taking on more total risk um

I think probably we should touch on

bonds a little bit everyone kind of is

bored to death by bonds but for the

first time ever they've become a little

bit interesting well at least the first

time in sort of my investing lifetime um

where they're actually paying something

how do you think about Bonds in

somebody's portfolio so far we've just

been talking about equities but that is

not sort of the uh the commonly

understood way to invest because if you

want to diversify you should also be

thinking about diversifying away from

just pure Market risk as well depending

on how much risk you want to take what

is the kind of theory behind why someone

should consider Bonds in their portfolio

what are they maybe just jump into that

sure so stocks pieces of equity

ownership in a company you're

participating in in the expected future

earnings of a business and because of

that earnings are they can fluctuate a

lot businesses can have bad times and so

stock investors are exposed to a lot of

risk so that's investing in a company's

stock there are also these things called

bonds which is another way for companies

to raise Capital if they don't want to

issue stock they can issue bonds and

that's they're effectively borrowing

money so if you buy a bond you're kind

of lending money to a company or to a

government or whatever and they're going

to pay you interest they're called

coupon payments and then at the end of

the when it when it matures they're

going to give you your principle back

the the other interesting thing is that

if a company goes bust stockholders

usually get zero but Bond holders often

have some claim on assets so there's a

couple different reasons there like

you've got guaranteed payments you've

got principal at maturity and you've got

potential claim on assets in a worst

case scenario so all of that together

suggests that bonds are a little bit

safer than stocks which you know it's

more complicated than that but that's

kind of step one they're a little bit

safer yeah want to talk about what is

risk later if you have if you have time

I I don't want to take too much of your

time but

um okay the point is a little bit lower

downside in the in theory bonds have a

lower uh downside risk of losing money

especially when you talk about what a

lot of people are thinking of when they

think of bonds at least for their

Investment Portfolio is some type of

government bonds or highgrade bonds um

for a while the us especially has been

in an odd position I don't know the

interest rate situation around the world

but the US was in the interesting

position of paying very little for bonds

so there was you know the what's

sometimes known as like the risk-free

rate for the least risky thing we can

think of is like sort of what the

government going bust um so the closest

thing to risk-free as you can get was

basically nil I mean nearly nil um so

how should people think of bonds and and

there's long-term bonds there's

short-term bonds there's medium-term

bonds I

ironically these are have different

types of risk because when I first

understood bonds I was like oh well the

longterm seem the safest get a 30-year

Bond you're guaranteed to have that

payment for like what's the risk can you

explain the different types of risk of

short medium long-term bonds yeah really

question no it's it's a great it's great

question it's it's not an investing for

uh idiots question but but I love it but

I love the

question okay so shorter maturity bonds

are going to be really low in volatility

so volatility is like the price can

change if you buy a a short or treasury

bill for example like it's basically

like cash like you're going to earn some

interest it's not going to move around

the price is not going to move around as

you go longer out in maturity the price

is going to move around more and more uh

day-to-day based on changes and things

like interest rates break that down

because if I buy a 30-year Bond today at

5% just so everyone's

clear I will if I wait the full 30 years

the price doesn't fluctuate and the

interest rates don't fluctuate so why

are you saying that the price

fluctuates it if all of a sudden

tomorrow so you've got a bond that's

paying you 5% if all of a sudden

tomorrow I can go and get a bond for 6%

your bond is going to be worth

relatively Less in the in the market so

it'll be repriced based on what the new

what the new rates are and if you went

to sell it you're not going to get your

principal back so and because because

assets are priced daily you're going to

see a price fluctuation the longer you

go out and maturity the more extreme

those price fluctuations are going to be

so at like the 30-year Mark you they can

be extremely volatile but now back to

your question what is risk so for short

maturity bonds uh you're not going to

have any volatility which is one way to

think about risk you're also going to

have a relatively low interest rate uh

and if you look in the in the data

around the world for how to bills like

short very short-term government debt

obligations how do they perform they're

there's a pretty good chance you're

going to lose money in real terms

holding very short-term debt so they're

not

volatile but there's a good chance they

won't keep up with inflation so you're

not taking on volatility risk but you're

taking on the risk of losing your

purchasing power if we go to the other

end of the spectrum uh it's nominal

bonds what we're talking about so bonds

that don't adjust for inflation there

are also real bonds or tips in the in

the states that do adjust for inflation

it's this is an idiot's class it's hard

it's hard to ignore them so I I'll talk

though about long long-term bonds like

you mentioned earlier if you if you have

a a nominal liability and that's

important it's frustratingly complicated

but it's important if you have a nominal

so it's $100,000 but it's a $100,000

nominal so it's not going to change in

in real terms like there's no inflation

on this liability that you have right

and you buy a bond for that you're going

to get your interest over time and

you're going to get your principal back

at maturity and even the price

fluctuations in the inter term are not

going to matter to you because you have

this 30-year liability that you need to

fund and you don't care about the end

term so it's not it's going to be

volatile uh but it's going to hedge your

future

liability the problem is most

liabilities are not nominal like I don't

think an individual house like you or I

do not have nominal liabilities I don't

think in in any anything like there's no

nothing that I'm going to want to buy in

the future that's not exposed to

inflation insurance companies have

nominal liabilities because someone buys

a million dollar insurance policy it's

going to be a million dollar insurance

policy in 30 years or whatever uh but we

we households people want to buy stuff

food whatever those are real liabilities

so a nominal Bond even if it perfectly

Hedges a nominal liability can be

extremely risky in real terms and so

this gets to the the really interest

interesting thing about now you can buy

you can buy an inflation protected bond

to hedge that real liability um but

bonds more generally nominal bonds how

do they fit into portfolios they reduce

your volatility for sure bonds to your

stocks reduces your

volatility but they probably decrease

your ability to maintain purchasing

power in the long

run and so we should yeah we yeah we

should

first we need to we need to probably

Define what volatility is even though

we've been talking about it for a while

because most of us myself included we I

usually think of risk in just in terms

of volatility like you know the the risk

that price will go up or down and the

the size of those swings um but that is

not all that risk is risk is actually

very hard to Define anyway go ahead

what's

volatility uh it's the price how much

the magnitude of price changes I guess

is one way to think about it so a stock

is going to be volatile it's going to be

worth you know $10 today but it might be

worth $15 tomorrow or $5 Bitcoin is

volatile you know Bitcoin one day it's

worth you 10,000 one day it's worth

100,000

um and then as compared to that we talk

about bonds as being less risky what do

we mean by that we mean they are going

to be subject to lower price

fluctuations but that as you say is not

the only risk a huge risk that we you

know all are concerned with is okay

in 30 50 80 years when you know when I

need to fund some retirement do I have

enough money at relative to uh my

standard of living and infl the

inflation that has happened during that

period of time that is a huge risk that

and there is an argument maybe you could

give it that equities having equities as

part of your portfolio actually Dr risks

that yeah so equities are very risky in

the sense that they're volatile and they

do have an uncertain long-term outcome

like there there's no sane world where I

would say that investing in stocks is

going to give you a guaranteed

inflation adjusted return the long

there's still a chance you lose money

but relative to nominal

bonds uh Bond stocks have historically

been much safer there's a paper on this

that's not published yet it's going

through like the conference uh cycle and

stuff and it's it's getting interesting

comments I've been talking to the author

about it the whole time but it's uh the

paper's called challenging the status

quo it's basically saying that the

status quo is that people think they

should start out investing in stocks

when they younger and then add bonds as

they get older because bonds are safer

and that's like you know Common Sense

textbook and so their paper basically

shows if you go and look at the they use

global data going back to 1870 and they

did something called bootstrap

simulations basically they they created

a whole bunch of hypothetical scenarios

using actual historical data but it gave

them way more potential hypothetical

scenarios based on historical data than

we actually have historical data right

and what they found in those simulations

is that the optimal portfolio for the

whole life cycle is 100% stocks now this

is like it's pretty controversial

because while their data show that like

a lot of people get really upset that

anybody would possibly say that but it's

at very at the very least it's a very

interesting finding and it's driven by

the fact that stocks are still very

risky and they emphasize this in the

paper stocks are still super risky at

long Horizons but bonds nominal bonds

are a lot riskier you're much more

likely to lose money in bonds and so

adding them to your portfolio crazy

right adding them to your portfolio

makes it riskier it makes it less

volatile which is great if you're really

worried about volatility but it makes it

riskier from the perspect perspective of

funding your future

consumption okay that that being said

one thing that always freaks me out

about things like that and maybe this is

the you know

the slightly risk averse volatility wise

guy in me which is that every Financial

investor can read all the theory till

they're kind of blew in the face but

they only get one shot at the financial

markets and they can't predict

beforehand what their ride is going to

be so they have they have all this

history but they're guaranteed a

different ride than the historically was

the case so saying historically we had

all this you know evidence that you know

stocks or whatever um stocks don't

always beat bonds now they beat bonds

over if you take a long enough time

frame you could say that they you know

they they beat them over you know this

many if you take this many years but we

also don't know that that's even a

guarantee that that will continue to be

the case so what always you know freaks

me out about that is like you have to

plan for what historically didn't happen

to happen and that is like to me the

basis of a lot of a sound framework for

investing is you have

to build a portfolio

where yes you want us stocks to rip a

100 like for the rest of time but you

have to plan for the event that doesn't

happen because you only have one shot at

the your investing time period does that

make sense it does it does make sense

and I mean there there are different

ways that people have tried to express

that I've seen some pretty crazy

portfolios that take what you're saying

to the extreme where it's like we're

going to have 10% gold 10% stocks 10%

Bitcoin like every possible thing that's

going to perform potentially differently

from the other stuff so I I don't

disagree with you and bonds are a pretty

tame example of of diversification

obviously and I I'm not advocating for

100% stock portfolios we have not very

many clients that are firmed that are

actually invested that way I I think

it's an interesting idea um yeah I mean

there there are limits to that thinking

I I we don't know the distribution of

all future asset returns and because of

that we don't know which assets are

going to be good diversifiers I think

looking at historical data is one

interesting lens but I agree with you

like if you look at just the theory and

forget about that empirical paper yeah

of course bonds makes sense but then you

look at the empirical paper and it's

like well yeah okay this gets me to

actually where I want to um where I want

to sort of try to start wrapping things

up which is

through listening to the boggles to the

Ben Felix's of the world to all you

smart guys who are reading all these

papers

I've sort of come to an

interesting

um place

where the fundamentals are sort of

Undisputed in a lot of these circles

where it's like okay passive investing

you get what you don't pay for most

active investors will lose so the

average makes sense and then it's almost

like when you get into like the basics

of fitness and then you get into

advanced Fitness where there's all the

these new papers that come out and

people excitedly rush into these like

new theories about like how to optimize

the you know the little tidbits of this

or that but they are sort of

making tiny little I would say like a

like uh you know

theoretical I don't know bets is the

right word I guess in finance it's a

little bit more of bets uh because you

don't know the outcome But

ultimately when you do think about

people who are not plugged in

what do you think about this is I guess

where we're going to end where we

started which is what should most

investors okay that they're not reading

journals they don't want to pay

attention to any of this stuff they

don't want to be worried about um you

know sort of what the latest paper says

about allocation what are their what is

like the basics and then we can't tell

them what portfolio to build because

obviously they need to make their own

decision based on that but let's get

back to ignoring like the daily trends

of or I get it's not I know it's not

daily but like the year-to-year decade

to deade trends of you know we think

this is interesting this is you know a

slightly better way to do it what is the

ad not advice but framework for most

people to think about investing going

back to for idiots so let me give you an

interesting example we talked about

factors we talked about the F French

three Factor model we didn't get to the

five Factor model and that's okay but

there's a there's this term that's

that's uh been created in acad Finance

called the factor zoo and that term was

created because there were so many

documented factors there were so many

they're called pricing anomal anomalies

like so many observations that this type

of stock or that type of stock did

better than other models would predict

and for the exact reason that you're

saying that is that is a problem for

someone who's trying to optimize down to

the most recent paper so I I I don't

think that anybody should be doing that

the problem that creates for people who

want to pursue Factor investing is that

there's always competing models so the F

and F and French have a model but

there's a ton of other models out there

and a lot of people say now that while

the F French model is no longer relevant

because of this this and this so if

you're a f French value investor it's

really hard to stick with your value

portfolio when it's underperforming and

people are saying well no F and French

are wrong now because of this this and

this you should be using this Factor

model so for most people who don't want

to get into the details of why they

think F and French are still right uh

they should probably not that type of

investing now some some people can do it

like I have we have an online community

for our podcast called the rational

reminder Community named after our

podcast and there's a bunch of people in

there that like it it blows my mind

honestly I I love that community and I

interact in there often but there are

people in there that literally nerd out

all day spend hours in there talking

about you know value should be defined

this way no it should be this way or

like momentum is a good Factor no it's

not uh so some people love that and I

mean I think that those people probably

treat it like a hobby that is not most

people the rational minor Community is

not most people so I think for someone

who's listening for the uh Investing For

idiotes listener the intended consumer

of this podcast they should probably be

using lowcost index funds that just

track the market now whether that's us

or globally Diversified I don't know man

like there there's funds like VT that's

a that's not a recommendation but that's

an all stock Global portfolio that's a

that's a pretty nice security as a

starting point at least on the equity

side of a portfolio one thing you don't

have to think about it you have to worry

about it in Canada we have similar

products called asset allocation ETFs

they're not quite like V VT because

they're not they give an overweight to

Canadian stocks they're not market cap

weight but same same idea one thing and

you buy that and that's your portfolio I

think that level of Simplicity like we

talked about investor Behavior earlier

too uh when you look at the data on that

funds that are self-contained that

rebalance themselves they tend to have

much lower Behavior gaps investors tend

to behave much better in those products

so for for the typical person that's

listening to this podcast that's like

trying to learn about investing and they

want to just make good decisions uh

total market index funds market

capitalization weights are a great

starting point and the more simple you

can make it the better you're going to

be in the long

run and if I could humbly add one tiny

thing to your great wrapup there low

fees we didn't really Touch Too Much on

like because ETFs and and mutual funds

have their own set of fees involved you

need to pay attention of that and keep

it as low as low as possible um Ben

Felix you have been a uh fascinating

character for me to to learn from and I

really appreciate you coming on the show

where can people find you obviously you

have the rational reminder podcast and

you have the YouTube channel is that

your main two outlets where people can

discover your work yeah those are I

release videos every two weeks on my

YouTube channel and then I just search

Ben Felix I guess on YouTube and you'll

you'll find my channel and then rational

reminder we post an episode every week

those are like they're pretty nerdy I

mean if people want to be like really

get into the weeds I guess that they can

listen but I mean yeah investing for

idiots is not is not rational reminders

intended

audience yeah that's not a bad that's

that's fine these are our meme coin

investors our our our Wall Street bets

guys uh okay thank you for watching

we'll see you next time