How to Bake a Cake: An Asset Allocation Mashup | Rick Ferri & Paul Merriman | 134 - Catching Up to FI

Episode Transcript
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(00:01):
for every 10% that you put intobonds, you are going to reduce your
return by about a half a percentper year for whatever period of
time you're sitting on those bonds.
And so I really discourage.
Young people from having any bondsin their portfolio and to hope that

(00:22):
the market goes down for the first 10years of their investing experience,
but of course, Rick is right and thewhole industry is really concerned
about people having the ability.
This is what John Bogle said,the ability to stay the course.
He felt that was the number onething you needed to be able to

(00:43):
do to be a long-term success.
You look around your office and Ican guarantee you 80% of the stuff
that we're sitting on and lookingat wasn't made in the United States.
It was made by companies outside the us.
So why are we not investingin those companies?
I think what's going on hereis a lot of recency bias.

(01:04):
Oh, US stocks outperform.
So let's go back and come up withall the reasons why they outperform
and extrapolate that into the future.
Well, that's wrong.
You don't wanna do that.
You wanna say, look, these areviable companies overseas in Europe,
in the far East, in Australia.
Let's go ahead and takea bite of that apple too.
if you go down this path of puttingsmall cap value in your portfolio,

(01:27):
you have to, number one, understand itthoroughly what you're getting into.
Number two, know that you'regoing to be paying more money.
The cost of these funds is higherthan just buying a S&P500 fund
or a total stock market fund.
It costs 0.03% to buy atotal stock market fund.
It might cost 0.3% to buy a small valueindex funds, but it is 10 times higher.

(01:53):
So the cost will always be higher.
And the last thing is it may not work.
You may not get a premium.
Nobody's guaranteeing a premium.

(02:32):
Hello and welcome backto Catching Up to FI.
I'm Bill Yount one of your co-host,and I'm with my beautiful esteemed
co-host, Jackie Cummings Koski.
We are honored today to have two titansof the financial literacy movement, and
we'll introduce them in a second, butwe wanna talk about first the charities

(02:52):
that they both have picked to support.
And maybe we'll let them also tell usa little bit about them in a minute.
But Jackie, where are those?
Here we got, Paul wants to support theMerriman Financial Education Foundation
at Western Washington University, andyou can find that at wwwpaulmerriman.com.
And Jackie or Paul first tell usa little bit about that because

(03:15):
it's unique and we want this tobe a model for other universities.
Well, what's exciting about thisprogram my wife and I started 10
years ago, we're more supportinga class on personal investing for
non-finance majors at Western.
But it was obvious that therewere a whole bunch of young people

(03:38):
who were not getting the message.
And so we have worked with them for yearsto create a program that every student
coming through Western, about 15,000of them will be required to take about
30 to 40 hours of financial literacy.
And I think it will be trulylife-changing for these young people.

(04:01):
Oh, that's awesome.
And then, that should be a model forall universities, quite honestly, and I
hope you market that across the nationbecause I wish I went to that university.
I, maybe I'll encourage, my grandchildrento go to Western Washington University.
Should I ever have any of those?
And then Rick Ferry is also with ustoday, and he is a Bogle Head through and

(04:22):
through, and he wants to support the Johnc Bogle Center for Financial Literacy.
Rick, can you tell us alittle bit about that?
Well, as you know, John Bogle was thegrandfather of the first Index Mutual
fund and the founder of the Vanguard Groupwhich is a mutual benefit company for the

(04:43):
lack of a better way of describing it,where it's a nonprofit investment firm.
Anyway over the years Jack Bogle hadbeen instrumental in helping people
manage their own portfolios increasingthe number of index funds that are
available to people through Vanguardand has really changed the whole.
Investment landscape for all of us andsaved all of us as a group, billions

(05:05):
upon billions of dollars in fees thatare normally charged by Wall Street and
actively managed funds and so forth.
So the Bogle Heads was created startingin the late 1990s to help people who
wanna become do-it-yourself, investors.
And in 2012, a group of us createdthe John c Bogle Center for

(05:26):
Financial Literacy under Jack's.
Oversight to fund this nonprofitorganization to create the content
the conferences podcasts on onlinewebsite, bogleheads.org and everything
to help people be able to managethem their own money and to go

(05:49):
forward make a better world forpeople , and save them a lot of money.
So that's at the bogle center.net isthe website for the Bogle Center, and
every year we put out a conference,and this year we're putting it on
in San Antonio, Texas, in October.
So hopefully we'll see everyone there.
I
can't be there this year, but Jackieis speaking at it and we've been to

(06:09):
the last two and we wholeheartedlyrecommend this conference.
It's actually migratingtowards a younger crowd.
There's not so many peoplewith white hair there anymore.
There's the fire community and youngerfolks, and they're embracing that.
So we encourage our audience to joinyou there and help grow the conference.
Yeah.
And Rick mentioned that he is inTexas and this is a great thing

(06:33):
to see on YouTube, but you'vegot this cool artwork behind you.
It's an actual pair of boots.
So I'm like, gee, you must be from Texas.
You're like, yeah.
my
wife is from Texas.
There's a saying if your wife is fromTexas, eventually you'll be from Texas.
That's right.
Tell us, tell us aboutthat artwork behind you.
It's just so cool
looking.

(06:53):
Yeah.
They're pair of boots,
but they're on the wall.
Yeah, when we were in Fredericksburgwhich is a German community where
Nimitz was born, actually, they a prettyfamous German community here in Texas.
Beautiful area, great widened region,by the way, if you like, wines.
But we were walking through an artshop and they had a boots like this.
Local artists had painted them and theiractual boots, so their cowboy boots
that they get from the rodeos, from thecowboys who sort of discard their boots.

(07:17):
This artist picks up theseboots and she paints them.
And this particular pair of boots belongedto a bull rider , he was thrown off
the bull and he messed up , the heelof the boot and just discarded them.
And she asked if shecould have those boots.
And she then painted a picture of theboots and we bought the picture from her.
So it's, they're prettyinteresting piece of artwork.
Texas art, if you will.
Well, we encourage everybodyto go to the YouTube on this

(07:38):
one because both Paul and Rick.
Out haircuts and put on makeup for this.
So they're looking
not put out any makeup.
Maybe Paul did.
I did not.
He's joking about the makeup,but they do look great.
I have
to say.
They're looking pretty good.
Alright.
They don't need an introduction,but we better do one anyway.
For our listeners that the fewlisteners in the world that haven't

(08:00):
heard about Rick Ferry and PaulMerriman, Jackie, would you please
do me the honor of introducing Paul.
Yeah, this is Paul's secondappearance on catching up to FI.
Go back to episode eight and nine andyou can hear us talk about his book.
We're Talking Millions.
Actually, that's when Beckywas co-hosting the show.
So you'll get to hear her on there.
But definitely worth going back to.
He is a nationally recognizedand award-winning authority on

(08:23):
mutual funds index investing.
Asset allocation among hismany professional lives.
He has been a stock broker on Wall Streetand a wealth manager at Merriman Wealth
Management, which was founded in 1983.
I don't even know if I was in high school.
I didn't even think
you were born back
I.
oh, see, there's a guy thatknows how to give a compliment.

(08:50):
He's, you can see Yeah.
If you wanna see me blush, if you wannasee a black girl turn red, then watch.
But Jackie retired at49, so you figure it out.
I'm not yet retired, but one ofour guests is in his eighties
and he is as vital as ever.
You can't tell the differencebetween Rick Ferry and Paul Merriman.
They're both timeless.

(09:11):
But Paul Merriman travels the world.
He is so active and involved inthis financial literacy movement.
I hope I'm as vital ashe is when I'm his age.
The difference is I will need a napafter this this get together will not.
Well, the funny thing is, is youallegedly retired in 2012, but it

(09:33):
seems like you are busier than ever.
So just to finish up a little bit moreabout Paul he created the Merriman
Financial Education Foundation that isdedicated to providing investors of all
ages with free information and toolsto make informed decisions in their own
best interest and successfully implementtheir own retirement savings program.

(09:56):
You know, I love that.
I'm a huge financial literacy buff.
He's the author of eight books, acolumnist for MarketWatch and produces the
podcast sound investing at his website.
Paul merriman.com.
He provides an abundance ofevidence-based free books and resources.
So make sure you check that out andI will drop that in the show notes.

(10:20):
He also is a tables guy, andif you want tables upon tables.
Upon tables.
You go to his website and hehas evidence for everything.
And we're gonna talk about small capvalues today because if Bill Bangin
is known as Mr 4% Paul Merriman shouldbe known as Mr. Small Cap Value.
that's true.
introduce Rick before we diveinto our topics today.

(10:43):
You know, Rick Ferry this ishis first time on the show.
He is a CFA chartered financialanalyst and prominent figure in
the world of personal finance.
He is a former military pilot,so thank you for your service.
Accomplished author, financial advisor,and speaker known for his expertise in low
cost investing strategies and index funds.
Rick is recognized for a straightforwardapproach to investing, advocating

(11:05):
for simplicity, diversification,and long-term thinking.
I mean, he has a new endeavor,which we should ask him to talk
about too in just a minute.
Through his books, articles, andspeaking engagements, he has helped
countless individuals understand andimplement sound investing principles.
There it is, sound investing againto achieve their financial goals.
Ferri's Insights are highly regardedwith his investment community, making

(11:28):
him a trusted source for wisdomfor both Novice, that's maybe our
audience and seasoned investors alike.
He is the host of the popular podcast,Bogleheads on investing and author
of the popular book all about assetallocation, one of his many books.
But what he wants us to know is that heis an accomplished pickleball player.
He lives in an over 55 communityand you know they must have

(11:50):
pickleball out the wazoo.
These two guys have differentphilosophies, but there is one
important area they agree on, andthat is deep passion for financial
literacy and investor education.
Paul, welcome to have youback here and Rick, welcome to
the show for the first time.
Thank you.
Great to be here.
All right, Jackie, we wanna start,this is all about asset allocation

(12:14):
factor investing and sort of alittle bit of a how to, but also
looking at the breadth of choicesin simple, less complex portfolios.
So we've talked with Bill Bengenabout the 4% rule now, soon to be
the 4.7% rule when his new bookcomes out with his new research.
So he's gonna have to change hislicense plate from mr 4% to MR 4.7%.

(12:38):
There are rules of thumb butare there Goldilocks portfolios
allocations for asset allocation inearly, mid, and late accumulation.
Then are there, good asset allocationsfor early and late Decumulation.
The phases of life, theseasons of investing.
I'm kind of interested in peopletalk about, find something, stick

(13:00):
with it for life, but it would seemto me that there's glide paths of
sticking with it for life that occur.
So what do you recommendfor early asset accumulate.
So the question we're talking abouthere is asset allocation, which would
be how you allocate your money betweena cash component for your emergency

(13:22):
fund, or some people call it a reserve,how much you should put in fixed
income for stability and how much youshould put into equity for growth.
So that's really the question we'reasking and the, what you're asking is
for a younger person or somebody who isjust getting started with accumulating

(13:44):
for retirement, how would you allocate?
And the first off, I want to talkabout asset allocation in general,
where whatever you decide, whateveryou choose to use, it has to be within
your ability to handle that risk.
So if you decide to be very aggressive andhave mostly stock, you have to be able to

(14:07):
stay the course through the entire periodin which you're holding a lot of stock.
So if you decide you're going to bein equity for 20 years, you have to
hold that equity for 20 years becauseif you jump horses or change horses
in midstream because the market wentdown, then you probably had the wrong
allocation in equity to begin with.

(14:27):
You had too much risk.
So whatever it is that you choosegrowth, where you're going to have
more volatility there, more riskon a a year over year basis, you
need to be able to stay the course.
Now, with that being said, in general,since you do have more time when
you're young, you should probablyhave, if you can handle the risk.
More equity in yourportfolio than fixed income.

(14:51):
You're going to have a cash component,which is on the side for your emergency
needs and liquidity and things thatare coming up in the next few years.
But after that, you'rereally looking long term.
So you wanna get the long termgrowth of equity over fixed income.
And what is that?
Well, the experts are telling us that inthe very long term, you should get about
a 4% equity risk premium over bonds.

(15:15):
So if bonds are yielding 4%, youshould be looking to get a long-term
return of about 8% on your equity,but it's much more volatile ride.
So now the question is, first,how much equity can you handle?
And then when you're young, you shouldprobably go to the top of that level if
you, and make sure that you stick with it.

(15:36):
So that's my answer, bill.
Okay, Paul, what do you think aboutsort of early and we'll move to
sort of mid and late accumulation.
Well, for the early, I think the importantthing to understand I mean Rick is right.
We all need to identify our risk limitsand make sure we stay within them.
But it's important for a young first timeinvestor to realize that for every 10%

(16:03):
that you put into bonds, you are goingto reduce your return by about a half
a percent per year for whatever periodof time you're sitting on those bonds.
And so I really discourage.
Young people from having any bondsin their portfolio and to hope that
the market goes down for the first 10years of their investing experience,

(16:28):
but of course, Rick is right and thewhole industry is really concerned
about people having the ability.
This is what John Bogle said,the ability to stay the course.
He felt that was the number onething you needed to be able to
do to be a long-term success.
So I'm, for as much equity as you canpossibly stand when you are young,

(16:52):
and and of course we have to thenask what that equity looks like.
And Rick and I might have somedifferences of opinion, but I do think
it's probably some combination of, tokeep it very simple, some combination
of an S&P500, maybe total marketfund and a small cap value fund.

(17:14):
It could be very little small cap value.
It could be half small cap value.
Again, depending upon how muchyou understand the reason to
do that and the risk that isinherent in making that decision.
I.
So, Paul, I have a, question foryou talking about, simplicity and
trying to make this look simple.

(17:35):
So obviously the work that youdo with your foundation and that
you want to try to help everyoneunderstand regardless of their age.
What things do you do tohelp people understand what
sometimes can be kind of complex?
When you talk about small cap value andthings like that, how do you approach your
students to make trying to construct aportfolio like this a little more simple.

(17:59):
Well remember that the goal is tohelp the do it yourself investor,
and I believe if you're going to bea successful do-it-yourself investor,
you actually need to have a lot of theknowledge that a good investment advisor.
Would have, because in essence, youare the investment advisor for the

(18:21):
most important investor in the world.
And so I really encourage people to beable to dig beyond the most simple level.
I believe that we should understand,and we have tons of tables to help
you understand what is the risk thatyou take if you have a portfolio that

(18:43):
is half inequities or 70% inequitiesor all inequities, and not only what
is the real risk that you're likely.
To be exposed to, but what isthat premium that you're likely
to receive over the long term?
Because we are really trying tohelp y young people to start with

(19:07):
learn how to build a business.
I think the investments that these youngpeople make should not be viewed as some
sort of a passive thing that's going on.
No, they are investing inbusinesses that they own.
Part of that the people who are in thosebusinesses that they still have a job
are going to work and working hard andhelping you build your financial future.

(19:32):
You are a business owner.
When you have a portfolio and wewant people to understand that, which
then, gets you into diversification.
You wanna own one business ordo you wanna own a thousand?
Well, Rick and I wouldboth, I think, agree.
We want to own manybusinesses in our business.

(19:55):
So, Rick, what do you think?
Try trying to simplify some ofthis for the average person.
Well, we, I think we're gonnaget into how Paul and I differ in
how we would do the investments.
So let's say that you're a younginvestor and you decide to be a hundred

(20:15):
percent of your in long-term capital,long-term investment portfolio in equity.
What should you do?
Well, it's, you have to decide whetheror not you think you're smart enough.
To beat the stock market or not, or youthink you're smart enough to pick people

(20:38):
who can beat the stock market or not.
That's the first thing you have to decide.
Or you say, look, the return ofthe stock market is just fine.
It's been doing fine for well overa hundred years, and I'm just going
to accept the return of the stockmarket and I'm gonna try to do it
with the least amount of fees andthe least amount of taxes because

(20:58):
fees and taxes are corrosive when itcomes to getting a return from stock.
And if you're okay with getting the returnof the stock market, which is better
than 95% of what people get, who tryto beat the market over the long term.
I mean, there's a few whooutperform, but you can't tell
whether they're lucky or skillful.
Everybody points to Warren Buffet, butwhen I ask them, do you own Berkshire

(21:21):
Hathaway in your portfolio, the 95% of thepeople who say Warren Buffet is a, good
investor and has outperformed the market.
And I asked them, do you ownBerkshire Hathaway in your portfolio?
Almost all of them say no.
Well, why not?
You just told me thathe's a great investor.
Right.
It really gets to be very weird whenyou start asking people who think they
can outperform the market, why theythink they can outperform the market.

(21:44):
They don't have any moreinformation than anybody else.
It's really a fallacy that's perpetratedby the media and by Wall Street,
because that's how they make money.
They make money through trading.
So me, a long, long time ago, 25years ago, if not more than that
now, almost 20, almost 30 years ago,I, I started following Jack Bogle.
He said, you're notgonna be able to do this.

(22:04):
You're not gonna be ableto outperform the market.
So just be the market.
Become the market.
Buy an index fund that tracksthe whole market and you'll
outperform almost everybody else.
And you know what?
It's absolutely right.
That's true.
Not only for the US market, but forthe international market as well.
So really the question onhow to set up your portfolio.

(22:25):
On the equity for equities is howmuch should you have in the US stock
market, and how much should you havein the international stock market?
And a lot of the work that I've doneshows that it's about two thirds of your
money should be in a US stock market indexfund that tracks the US stock market,
the total stock market, all 3,700 stocks.

(22:47):
And then you should have maybe theother third, the other one third
in an international portfolio thattracks the international stock market,
which would include emerging markets.
And that is all you need.
You don't need anythingelse, you just need that.
And anything else after that is justspeculating on something and you don't
need to speculate, let the markets justdo what they're going to do and you're

(23:08):
gonna outperform almost everybody else.
Interestingly, people say that you don'tneed international equities and we need
to get into international a little bit.
And I find it interesting that youwould put in a third I think the
market is about currently 65% US and35% international, if I'm not correct.

(23:28):
And that is increased recently.
So you recommend sort of buying theworld market is kind of what you're
saying, but international equities havenot performed for like 15 years and have
provided a big drag on the portfolio.
And you know, there's a way totilt too, as American investors.

(23:49):
People say if I invest in all US,I've got international exposure
because of the company's revenues.
But you don't recommend that.
Right?
And, but Paul, take that first.
all.
Well according to what I learnedfrom Dimensional Funds in 1994,
when I went through their trainingwhat I was taught by those folks

(24:10):
and it's an, an organization thattheir work is, is academically based.
I was told that when you addinternationals that you are not expecting
to increase the return of your portfolio.
What you are doing is you are diversifyingwhich, whether it's because of currency

(24:32):
differences or just different economicscenarios, you're diversifying amongst
more large cap blend companies.
I believe, and I learned thisfrom the people at DFA as well.
I believe that if I'm going to addsomething, I want to add something.

(24:52):
That has a history, one ofactually being different and
more than just a diversifier,but that will add the potential.
To get a better rate of return.
And so I would prefer if I had ayoung investor with me that I would
rather have them put they might put amajor part, they might put 90% in the

(25:18):
S&P500, but the studies show if youput 10% in small cap value, you have
the potential of an extra 4 tenthsof 1% a year return looking backwards.
Now, if you put 20% in, you get a littlemore, but that I, if I'm gonna diversify

(25:39):
or recommend young people diversify,I want them to diversify in a way they
get additional equity asset classes fordiversification, but also equity asset
classes that are built to make more.
And so.
While it may soundcomplex, it isn't complex.

(26:01):
It means you have two funds toput in your equity portion of
your portfolio instead of one.
Big Earn is not a fan of internationalstocks and nor is Frank Vasquez.
Two of our friends, Frank Vasquez saysthat, you know, he can take a look
at currency trends and tell you theperformance of international stocks.

(26:25):
So he feels that, currencies dictatethat performance and we won't see
better performance of the internationalsuntil the value of the dollar drops,
which it has not Historically.
Do you think currency is adiversification or a speculation?
And do you agree with Frank's tenants?
Well, I'm not familiar with what hisopinion is about international stocks.

(26:49):
If you look at say the Vanguard worldEquity Fund, which covers the entire
world, you have about 3,500 stocks thatare US and 6,500 that are international.
So we're talking about a lot ofcompanies here from around the world
and a lot of different currencies.
And it's true that if the dollar isstrong, that the US stock market has

(27:14):
a higher probability of outperformingjust because of the exchange rate.
And that has been the case for thelast 15 years since the financial
crisis, not the case this year.
It's not the case in 2025.
And we begin to see international stocks.
Outperformed by a coupleof percent right now.
We don't know if that's gonna continue ornot, but I don't want to take that risk of

(27:35):
trying to guess which way currencies aregonna go, or guess whether the US stock
market is gonna continue to outperformthe international market, which by
the way, the international stocks havenot been bad over that 15 year period.
What's, what has happened is theUS stock market has been so good.
So you've got this overshadowing, okay.
I mean, if you just invested ininternational stocks, you didn't do

(27:57):
that badly over the last 15 years, youdid almost about what you would expect
to get an equity risk premium sayof, of three or 4% over fixed income.
That's what the international market did.
That's normal.
That's what you would'veexpected 15 years ago.
But it's the US market that didso well because of large tech.
Now what goes around comes around theexpected return going forward from today.

(28:19):
For US stocks and internationalstocks, it's the same.
It's about 4% over a 10 yeartreasury, call it 8% expected return.
That has never changed.
I mean, there's no reason whyinternational stocks would underperform
us stocks . There are equities.
You look around your office and Ican guarantee you 80% of the stuff
that we're sitting on and lookingat wasn't made in the United States.

(28:41):
It was made by companies outside the us.
So why are we not investingin those companies?
I think what's going on hereis a lot of recency bias.
Oh, US stocks outperform.
So let's go back and come up withall the reasons why they outperform
and extrapolate that into the future.
Well, that's wrong.
You don't wanna do that.
You wanna say, look, these areviable companies overseas in Europe,

(29:02):
in the far East, in Australia.
Let's go ahead and takea bite of that apple too.
I'm not saying you putall your money there.
But you know, two thirds in us, likeyou say, 65% a market weight in us
and then a, a market weight of 35%in international certainly makes a
lot of sense from diversifying stocksbecause you get now three times the
number of stocks in your portfolio.

(29:22):
It certainly does diversify yourindustry groups because you're not
getting this magnificent seven techstocks that you're getting here
in the us you're getting a lot ofindustrials and materials and financials
and it's not a lot of high tech.
It's more likely what the sand p looked like 50 years ago
with chemicals and so forth.
That's what you're getting when youinvest international and you're getting

(29:42):
currency diversification against theUS dollar, which yes, in the last few
years it's been very good for 15 years,but it's not always going to be good.
So all it is is diversification.
That's all.
It's, I wanna diversify that riskyportion of my portfolio as best I can
and having one third international in twothirds US does it over the very long term.

(30:03):
Now granted.
There's periods of time when us doeswell and there's periods of time where
international do well, but we tendto have a recency bias just focusing
on what just did well in the past,extrapolating it into the future.
And that's where we come up with alot of people who now say, 'cause they
have to say things in the media, oh,we should just have us portfolio or,
and, and forget about international.

(30:24):
So I'm not for that.
Now, do you want me to getinto the small value thing or
do you want me to stop there?
Let's hold off on the smallvalue for just a little bit
I want to hear Paul's take.
I think I'm aware that he has 50%US growth and 50% international,
so he tilts probably a littlemore towards international.
And why do you do that, Paul?

(30:45):
Well, again, what I learned from DFAback in 1994 was they made the case
for 10 different equity asset classes.
And so what I have in myportfolio in the equity portion.
Is 10% each in those 10equity asset classes.

(31:08):
And I have an expectation that atsome point they will all perform well.
At least that is the beliefof the academic community.
And having said that I think the olderI get, the better I feel about having
a massive amount of diversification.
But the reality is, and this was a turningpoint in our educational work, was when

(31:34):
we were able to go from a 10 fund strategyand 10 equity asset classes down to two or
three or four, and perform with the samelong-term, approximately the same return.
So we've been working to make it simple.
For me, I love it being a spreadamongst all of those, I don't even

(32:00):
know what return I got last year.
It doesn't matter whatreturn I got last year.
We take out 5% of our investmentsthe first of each year.
That's what we have to spend.
And we believe with all of those differentequity asset classes, about half of our
portfolio, that we'll be treated fairlyover a long period of time, regardless

(32:24):
of whether it's US or international.
And we've gotta be careful about lookingbackwards always, whether it's about
small cap or international, and saying,here's how it's done over the long term.
What a lot of people fail to realizeis the great performance back in
the seventies of the internationalmarket was because of Japan.

(32:50):
Japan's prices went through the roof.
I mean, I, I think at the, at the peak,their PE ratio was about twice that,
of what the peak was of the boom, thetechnology boom back in the late nineties.
And what are the likelihood, what is thelikelihood of that happening again in
the Japanese market or some other market?

(33:12):
I don't know.
I'll be there when it happens aslong as I'm alive, but I can't
know, but I'm okay with not knowing.
and, And that's what, where Rickand I totally agree, I think broad
diversification really takes theresponsibility of trying to be on
top of things and do the right thing.

(33:33):
Now it takes that whole considerationout of your life as a, either
do it yourself, investor or,hiring others to do it for you.
I.
Yeah, like sticking with your plan, soPaul, a few times you mentioned DFA.
Can you tell us what DFA is?
Are they just, are theyanother fund company?
They are a fund company and theybuild index like portfolios.

(34:00):
At, at the point that I was introducedto DFA, they were the only one like this.
Today we have Avantis, whichis a similarly run organization
because the people at adv, VTIcame from DFA and, and so DF.
Believed.
And, and a lot of the work was from Dr.

(34:20):
Fama and Dr. French, that there arethese factors which is what Rich Rick
and I talked about before, the factorinvesting, the big, the small, the
value, the growth, the US International,all of these of these different things
that impact the value of our portfolio.
And they have a history.

(34:41):
As a matter of fact, they havea small cap value portfolio
that's been managed since 1993.
That's a long time to havea small cap value portfolio.
And it has way outproducedthe S&P500 since 1993.
So they are believers in this factorinvesting process and their expertise

(35:04):
has been on how to build the portfolioto capture those factor premiums.
Gotcha.
Gotcha.
So we will get into the small cap value,but I'm so curious, you guys this is
debated a lot amongst other people amongstour community, but target date retirement
funds, is that enough because they'retempting to put together these portfolios.

(35:28):
Right.
And normally if you're working for ana company or an organization, if they.
Default you into a fund is likely tobe one of these target date funds.
So Rick, I'm gonna start with you.
What do you think abouttarget date retirement funds?
well, as you say, the concept isit's already a balanced portfolio,
so it already has US stocks, it hasinternational stocks, it has a bond

(35:51):
component to it, and it's done for you.
It's managed by the, mutual fund companyfor you, you don't have to do anything.
So you get instant diversification.
All you have to do is pick the date or theyear that you technically, but the word
is, well, if you're gonna retire in 40years or 30 years, you should pick a 2000
and 55 fund because that's 30 years out.

(36:13):
Okay.
Or you could do it another way.
You could look under the hoodand you could say, well, what's
the asset allocation of thefund between stocks and bonds?
And, you know, what assetallocation do I want?
And then you pick a fund basedon that rather than the year.
Okay.
Now there's two typesof target date funds.
There are actively managed funds andthere are target date index funds.
And the actively managed funds,they're moving things around

(36:34):
trying to outperform the markets.
As I said before, activemanagement, they're charging up.
A fee of maybe a half a percent,maybe 0.6% versus the index.
The target date index funds, which arejust a composite of various index funds,
a US stock index fund, internationalindex fund, a bond fund, extremely

(36:54):
low cost fee, maybe 0.1 or less 0.08%.
A few companies have these, A lot of401k funds have these I really like
target date index funds for peoplewho are putting money away in a
retirement account, like a 401k, 4 0 3B, or SEP IRA, I think they're great.

(37:18):
You just have to decide whatasset allocation you want.
Find the fund that has that allocation.
Put your money there and leave it alone.
There you go.
So Paul, you are a bit of a fan ofthis too, but there are some downsides
to target date funds and maybe youcould talk to what are the downsides?
I think you have about 10 of them.

(37:38):
Well, well, I mean, target date fundshave got to be built for the average
investor, and, and that's a big dealbecause they are trying to figure out
how do we manage these portfolios sothat we keep all of our investors onboard
staying the course for the long term.

(38:01):
And so what you're going to find isthey're generally very conservative,
as a matter of fact, in the Vanguard,and I think they have great target
date funds, but in the VanguardFund, they have 10% in fixed income.
Which means that in their twenties andtheir thirties, they are going to be

(38:22):
making a half a percent more than likely,and we can't know, but at least the
probabilities are, they'll make a halfa percent less per year for 20 years.
And when I met with John Bogleback in 2017, this was one of
the things I wanted to understandwhy they had that 10% in bonds.

(38:46):
And what he said is, is that theinvestors, because they're trying to
keep it real simple, the investorsneed to understand we are going to,
over time, going to build a portfoliothat's gonna have stocks and bonds.
In the beginning, you're goingto be almost all in stocks,
but the bonds are there and wewill know when to change that.

(39:10):
Now does he understand that it costs.
A half a percent a year.
Yes, he does.
But they believe that keeping itsimple and showing people how it works
and then they get to be part of theprogram and they are going to be more
or less like the market, even thoughthey've got 10% in fixed income, that
is part of the stay the course goalthat he's, they're trying to build.

(39:36):
I say, why not educatepeople to understand that?
Any bonds in that portfolio,it, it's not gonna protect
you from a, a, a bear market.
You are not gonna be able to braghow well you did in a bad bear
market because you had 10% in bonds.
This doesn't work that way.
It's still gonna be awful.

(39:58):
And so my goal is for young people, I wantall the money going into that thing that's
down and dirty during a bear market.
'cause those things as a group are gonnacome back, at least they have in the past.
And we wanna maximize the opportunitythrough the dollar cost averaging.
The other major thing is it's allbasically large cap blend equity.

(40:23):
So we have a free book,two Funds for life.
One fund is the target date fund.
The other fund is strangely enough, smallcap value and you build the portfolio
with the target date fund along with somelittle amount or maybe a larger amount

(40:44):
of another different equity asset class.
Well, you actually have withthe two funds for life, a glide
path and a formula for this.
Can you tell us about that?
Well, there are several waysthat, that it can be done.
The book explains both.
The most aggressive one is that you wouldbasically take your, years to retirement.

(41:09):
In other words, you, when you havemany years to retirement, you want to
increase your exposure to small cap.
And as you get closer andcloser to retirement, you get
less and less in small cap.
In fact, the portfolio by thetime you get to retirement,
is out of small cap in total.

(41:29):
Now that's one way it could be done.
The other way it can be done is justsimply to put 20% in small cap value
forever along with the target date fund.
I mean, you can go both ways.
And Chris Peterson, the author anengineer and, I think a great
teacher who works with our foundation,wrote the book and it takes people

(41:52):
through the process step by step.
And it is, again, it's free.
Well, one way you can actually, you know,maintain some risk in the target date
fund is to pick a date that's further outfrom your retirement date, right Rick?
That's correct.
Again, that's getting underneaththe hood and saying, okay, what,
forgetting about the date, whatdo I want as an asset allocation?

(42:16):
And Paul is right, I mean, let's say withVanguard target date funds, the index
funds, you can only go out to 90% equity.
And so they start, 90% equity, I believe,starts at the 2045 fund, and it's the
exact same asset allocation for the20 50, 20 55, 20 60, 20 65, 20 70.

(42:39):
It's the same allocation.
So if you wanna maintain 90%equity in your target date fund,
you could buy the 2070 fund.
And you're pretty much guaranteedto be 90% equity in that fund
for, for the whole entire timethat you're gonna be working without
having to make a change later on.
Because if you don't change.
If, if you buy a, a 2045 fund ora 2040 fund every year, you get

(43:03):
less and less and less in equity.
It takes money out of equity and putsmore and more in bonds, which maybe
isn't what you would want to do.
So yes, you could look underthe hood, go further out if you
wanna maintain that 90% equity.
And why does it have 10%?
A lot of investing ispsychological, right?
I mean, if you have a hundredpercent equity, it's really hard
to be a hundred percent equitya hundred percent of the time.

(43:26):
And just that little bit 10% in bonds,even though it may not do anything
to the portfolio as Paul said, oreven if it may reduce the return in
the long term, which I'm questioningwhether it's a half a percent.
'cause after all, if the stock marketgoes down, you're gonna be selling
bonds in that fund and buying stock.
So there is an asset allocationor a reallocation component where
you actually pick up more returnbecause of this rebalancing between

(43:48):
stock and bond within even 90 10.
So let's call it point.
Two, five instead of 0.5.
The fact that you have bonds in theportfolio, to some people that's important
because it helps them stay the course.
So again, a lot of investing is first andforemost, you have to stay the course.
Whatever strategy you come upwith, you have to stay the course.
If you don't stay the course,it's not gonna work if you're

(44:09):
gonna get out at the wrong time.
So that little 10% inbonds may help you do that.
If it does, then it was, was worthgiving up that quarter of a percent.
Yeah.
And one of the things that if I justmay in insert this, whether it's
a quarter of a percent or a half apercent, what we teach, in fact, I've
got a senior's graduating class I'llbe speaking with in May, and one of the

(44:35):
points I'll make to them is for everyextra half a percent you make on your
investments over a lifetime, you are morethan likely adding one to $2 million.
More to spend and more to leave.
So even if it's only a quarter of1%, and so instead of a million

(44:55):
to two, it's a half to one.
I mean, whatever it is, it'sreal money and the cost.
Or the reward comes with theeducation as far as I'm concerned.
And the more they understand this process,I, I think the better they're going to do.
And so I under, I think Rick is right,it's an emotional thing, but I think

(45:20):
the whole idea is to figure out how dowe teach people to do the right thing
from the day they start investing.
And Rick and I would agree, we wantno load funds, never buy a load fund.
Call me if you're about to buy a loadfund and tell me which one you're about
to buy, I'd be happy to help, help yousort through the funds and find a no

(45:41):
load fund that does the same thing.
There are a bunch of things that weboth agree a hundred percent on and
it's all about the probabilities of agreater success if you do those things.
Yeah, so why don't we, because I, Iloved both of you guys' perspective

(46:02):
and that's why we really wanted to haveyou guys on together, but small cap.
So Bill, you ready to get intothe small cap a little bit?
'cause that's really the meat of whatwe wanted to chat about with these guys.
What's interesting is whenI started and woke up.
I think I found Paul Merriman first, andI, I read a book of his and I started
out in the 10 Funds for Life domain.

(46:23):
And I forward rebalanced into theright, into the down equity classes.
'cause I was a physician and Iliked complexity and I thought,
just like you say, you're gonnaget those half of extra percents.
But as I went forward I was like,you know, I don't wanna manage this
this way and my wife is not gonnabe able to manage this this way.
So I started getting simpler andthen I probably oversimplified a

(46:49):
little bit and I was sort of, youknow, VT and treasuries and chill.
That was kind of where I ended up.
And then I started diversifying a littlemore because, the rebalancing was within
vt, which is a total world fund, whichmay be Rick, you would agree with that?
I don't know.
Well, in a, Roth account or aretirement account, VT works well.

(47:12):
It's just simply the World Equity Fund.
Now, why wouldn't it workin a taxable account?
It has to do with taxes.
If you invest in a, a mutual fundthan invest in international stock you
have to have 50% or more of the fundhas to be in international stock for
you to get the foreign tax credit.
And with vt. It's only35% in foreign stock.

(47:33):
So you lose the foreign stacktax credit if you have that
fund in a taxable account.
So in a taxable account, you would have65% in VTI, which is the US Total Stock
Market Fund, and 35% in VX us, which isthe Vanguard Total International Fund.
Therefore, on that VXUS, youwould get the foreign tax credit.

(47:55):
So that's a little nuance there,but it just has to do with taxes.
But in general, you, you are correct.
All right, Paul.
Small cap value.
And let's dive deeper intothis because of your tables.
And we talked a little bit aboutthe target date, two funds for life.
One of our listeners and friendsadvocates of 50 50 in the growth phase

(48:17):
between, large cap and small cap value.
But for me, small cap valuehas a long market cycle.
I mean, it's, you know, a 30, 40 year tome, if I'm, I mean you correct me if I'm
wrong, market cycle, especially lately.
And to do this just like you do withyour two funds for life, it's really
better to start when you're younger.

(48:39):
And what would a late starter do?
Well it, first of all, can wejust talk about this performance
problem with small cap value?
People need to understand there'ssmall cap value and then there's
small cap value, and then there's.

(48:59):
Small cap value.
And then there's small cap value andthere are more of those small cap
values because there are at leastsix major ways they slice and dice
and they call 'em small cap value.
And then people come out with funds thatdon't even fit any of those six small cap

(49:20):
value designations in terms of an index.
And yet they manage them in a way thatis considered by the US government,
actually a non-traditional index fund.
They still consider it an index likefund, but it's called non-traditional.
And what do we knowabout these index funds?

(49:43):
The difference in returnover time is huge.
If you looked at the 15 year returndifference between the top and the
bottom of those six major smallcap value indexes, it's a 3% a year
difference from the top to the bottom.
Well, 3% a year is a big deal.

(50:05):
If you compared six differentS&P500 funds, probably the only
difference you would see would bemanagement fee that would dictate
whatever that difference might be.
So when we talk about small capvalue, we really need to understand
what way are we looking or countingon the manager to manage the money.

(50:27):
Now, what I do know.
'cause people are saying smallcap values just hasn't done well.
Well I can tell you over thelast five years, I just pulled
the numbers up this morning.
Small cap value at Avantis and DFA, thatthey are providers of small cap value.
They both have done better thanthe total market index and the

(50:50):
S&P500 over the last five years.
Okay.
That's number one.
If I go back to 2000, and one of thema DFA fund started in February, 2000.
I know that the return overthe last 25 years is about

(51:11):
twice that of the S&P500 twice.
Now there were periods, like you say,there are periods where the small
cap value came down and touched.
Basically the S&P500 andthen it took off again.
Yes, there are long periods ofunderperformance, let's call it,

(51:31):
and some great periods, shorterperiods of outperformance.
But the bottom line is there is noevidence that small cap value has failed.
Because what has failed are smallcap value indexes that are not
built to take advantage of all thepremiums that are possible within

(51:53):
the small cap value universe.
So I think the performance is stillthere and yes, there are historically
15 to 20 year periods, about four ofthem, where you got the same return
at the end of the 15 to 20 years insmall cap value versus the S&P500.

(52:17):
Now that, by the way.
Is not exactly true for somebody who'sbuilding a portfolio because for every
dollar that went into the small cap valueindex over the last 90 plus years, dollar
cost averaging every year into it, youended up with about $24 in small cap

(52:37):
value to every one that you ended up with.
In the S&P500.
If you looked on a lump sumbasis, it's about 12 to one.
So you are absolutely rightfor the young investor.
Whoa, what an opportunity fromeverything we know about the past.
So in my case, at 81, I've only got about25% of my equities in a small cap value,

(53:05):
and that's as much exposure as I want.
But I do have it not because ofme, because I. My wife and I have
enough money to live on in the fixedincome portion of our portfolio.
The equity portion is for WesternWashington University, our children and
those other people that we're working toleave money to, and we think we should

(53:29):
take more risk for them than we do withour own money that we're living on.
Important because that's generationalwealth and that's one of the things
that Rick is gonna be working on.
But I'm really curious, Rick, do youhave small cap value in your portfolio?
I have had small cap value for

(53:50):
almost well over 20 years.
I used to be an advisor and, I went tothe same DFA conference that he went to,
and I, I studied this and I'd like tosay that what Paul said is right about
value is in the eyes of the beholder.
So, at different times, differentvalue factors do better than others.

(54:13):
You might say, well, we're gonna usePE ratio as our value factor, and
we're going to buy low PE ratio stocks.
Okay?
There are periods of time wherethat is the best performing
value factor out there.
Then there's, I wannause return on equity.
Another value factor, enterprisevalue, another value factor price

(54:33):
to book another value factor.
So there are many, many differentways of measuring value, value is
in the eyes of the beholder, okay?
And so all the different fundcompanies do it all differently.
All the different indexproviders do it all differently.
So Paul is right.
Some of them have done better thanothers and you can go back and look.

(54:56):
And over the last five years I justlooked at the way Advantis did.
It did slightly tiny outperform the marketover the last five year period of time.
Now, the value funds didn't, notto say Advantis is gonna be the
one that's gonna outperform overthe next five years, we don't know.
But unlike small cap, where you've gots and P, you've got crisp, you've got

(55:16):
MSCI where they say, this is large cap,this is mid cap, this is small cap.
If you look at the performance of allof the large cap funds and the, they're
going to be highly, highly correlated.
They might be off by 0.1%.
Just like Paul said, all the S&P500 fundsare all the same except for the fee.
If you look at the mid capindices, it's all the same thing.
We're just talking.
The mid cap stocks andsmall cap the same way.

(55:38):
It's all very highlycorrelated because the cuts.
Are fairly close amongst s andp, who is an index provider and
CRISP and MFCI and fse, whoeveryou're using as an index provider.
But when you get to valuenow, it's all over the map.
Everybody has their ownversion of what value is.

(55:58):
And Jim O'Shaughnessy wrote a book calledWhat Works on Wall Street, and he went
back decade after decade after decade.
And he said, what worked?
What outperformed?
And a lot of these things were brokendown between different deciles of factors.
Like, oh, it's, you know, high dividendyield outperformed this time, which
can be considered the value factor.
And then price to book outperformedthis decade and then low price
to book outperform that decade.

(56:19):
So the problem with small capvalue is which value do you pick?
We don't know.
I mean, you know, it's,it's an active strategy.
You don't know which one isgonna outperform in the future.
Now you could say,well, we'll go with DFA.
Well, they use price to book.
Actually, it's the inverse ofthis called Book to Market.
Okay?
That's what they use.
Avanti uses a combinationof various things.

(56:41):
S and p uses something else.
And you could do these backward lookingstudies and you could say, well, which
one outperformed over the last five years?
And say, well, the way that Advantisor DFA did it price to book or book to
market, that actually outperformed bya little bit over the last five years.
That's great, but is that gonnaoutperform over the next five years?
I don't know.
Who knows whether it will or not?

(57:04):
So when you're looking at your valuestock and your way of doing value,
you really have to really dig intoit and look under the hood and
say, well, how do they do value?
And how does this other one do value?
And how do they do value?
And what do I think value is?
It's really not easy to come up withwhat the best way of doing value

(57:26):
is because of all these differentways rotate around as far as you
know, which one is outperforming theother one at any particular time.
And so you gotta kind of pickone and you have to stay with
it for the rest of your life.
This is not a trade.
It's not a trade.
This is a philosophy of how you'regoing to invest your equity money.

(57:47):
If you decide to take 20% of yourequity money and put it into a small
cap value fund like Avantis or DFA ormany of the other ones that are out
there, there's research affiliates,fundamental indexing strategy, whatever
it is, however you're gonna do it.
It has to be a lifelong investmentstrategy that you are gonna stick

(58:07):
with because if you bail on this,you're gonna bail at the wrong time.
And now you have locked in, you have sunkcost and you've just locked them in, and
now you're gonna underperform, guaranteed.
So if you go down this path of puttingsmall cap value in your portfolio,
you have to, number one, understand itthoroughly what you're getting into.

(58:29):
Number two, know that you'regoing to be paying more money.
The cost of these funds is higherthan just buying a S&P500 fund
or a total stock market fund.
It costs 0.03% to buy atotal stock market fund.
It might cost 0.3% to buy a small valueindex funds, but it is 10 times higher.

(58:50):
So the cost will always be higher.
And the last thing is it may not work.
You may not get a premium.
Nobody's guaranteeing a premium.
I mean, gene Pharma just recentlycame out in an interview and said,
look, when small cap value becamepopular because of my research and Ken
French research on small cap value.

(59:10):
When we came out with that, peoplestarted piling into small cap value,
particularly because of dfas success.
As Paul said in the, in the 1990s,people started piling into small
cap value because of excess return.
Oh, we're gonna make more money beingin small cap value, so let's buy it.
And people piled in and all of thesefund companies came out with small

(59:30):
cap value indices and small cap valuefunds and fundamental indexing, and,
and now there's ETFs and, and there'sall this small cap value out there.
Even df, even Vanguard has three differentsmall cap value funds that you can buy.
People buy it not because.
You get a higher returnfor taking higher risk.
They bought it becauseyou get a higher return.

(59:53):
You get a higher return.
That's what the data says.
Well, guess what?
Because of that, and this is Gene Pharmatalking, not me, because everybody buying
it or bought it, because you get a higherreturn now, it's not working anymore.
It distorted the market.
Just like in physics, if you observesomething, it changes the observation.

(01:00:13):
It's really weird.
You know, quantum physics is that way.
It's really strange.
You can't observe something and expect itto actually happen that way in the future.
Once you observe it and you write aboutit and all these fun companies pile
on with all their products and theysell the outperformance of it, it's
no longer gonna be that way anymore.
It changes the market.

(01:00:34):
This is what happened to me.
I've been investing in smallcap value for a long time.
I understand why I am not outperforming.
It's because everybody else.
Knows.
And when you say something,there's a saying on Wall Street.
Once everybody knows something,it's not worth knowing anymore.
And unfortunately, this is what'shappened to small cap value.
I don't know if it's gonna changeor not, but I'm kind of stuck in it.
I've underperformed and Iknow I gotta stick it out.

(01:00:57):
I'm 67, I gotta stick it out for, andthat was 20, 25 years, however long I
lived to, maybe, maybe it'll outperform,but I know I'm gonna pay fees and I know
I'm not gonna track the US stock market.
You really need to understandwhat you're doing here.
If you deviate from the total marketapproach, you really need to, because if

(01:01:20):
you don't, you're not gonna stick with it.
You're gonna bail at the wrong timeand, and you're gonna hurt yourself.
So is it not also true that the S&P500from 1975 to 1999 compounded at 17.2%?

(01:01:41):
The s and p 500.
Did it I'm
fine,
yeah, that's what it was.
And so people they found the magic.
They knew what to do with their money.
So money goes in.
I remember being at some conference thata money conference of some sort and people
saying, why should we do anything butjust put it in the S&P500 and since 2000.

(01:02:03):
The compound rate of return has been 7%.
Of the S&P500, I'm notsure about that, but I, I
could run and
And so
what
does that mean?
Does that say that we can'tcount on the S&P500 making 10%?
Yes.
That does mean that we don't know.
small cap value is such a tiny, tiny,tiny, tiny portion of the US stock market.

(01:02:26):
it's a small microcosm of the US stockmarket, and you're piling an awful
lot of money into this small, tinymicrocosm saying this small, tiny
microcosm outperforms by 4% per year.
No, The data says that in the past,because of illiquidity, because of high
trading costs, because nobody even knewthis existed, it actually did in the

(01:02:51):
past, based on farmer French research,outperform by a, by a significant amount.
It hasn't done it since because peoplefound out trading costs shrunk liquidity.
All of a sudden now there's a lotof liquidity because all these
funds out there, so the premiumgoes away or at least You have
this thing called factor decay.
More people do it the less it works.

(01:03:11):
Okay?
I'm not saying you don't do it all I'msaying to people, and I've been saying
this all along, if you decide to go downthe road of doing small cap value in your
portfolio, you better know what you'redoing because odds are you're gonna bail
on it, and you're gonna bail on it atthe wrong time, and your performance is
gonna be less than just buying the market.
That's all I'm saying.
And the other side ofthat coin is the trap.

(01:03:34):
And this is true of the market in general.
It's true of technology stocks as well.
The trap is people are actuallymore likely to buy when they're up.
So after small cap valueis at a five or 10.
Year run.
There was a 10 year period, I thinkit was maybe it was 2000 to 2009.

(01:03:56):
That small cap value outperformedlarge cap blend in all but one year,
all but one year.
And so, people then say, whoa,that's a good place to put money.
So
if all we do is jump in at peaks, Idon't care whether it's technology
or the S&P500 or small cap value,we are not likely to do well.

(01:04:19):
And the question is,will there be a premium?
The average 40 year return on smallcap value going back to 1928 is 16%
plus a year looking backwards at theindexes that Fama and French created.
That's the good news.
What we talk about is the possibility ofgetting a 12% return, that in relationship

(01:04:45):
to the 10 that people are likely toget historically from the S&P500.
That might be a pipe dream as well.
So it's, it's a 2% risk premium insmall cap value over the market.
Which by the way, I mean the equity riskpremium today going forward is about 8%.
Obvious, excuse me, is 4% over treasury.

(01:05:05):
So you're talking about like an8% expected return from equity.
So you're talking about a 10%expected return from small cap value.
And I don't know if that's true or not.
I, I mean, I, again, I, I don't know.
I mean, nobody knows whether thesmall microcosm of the market is gonna
outperform the rest of the market,but theoretically it should because

(01:05:25):
there's theoretically more risk there.
Those companies are not.
You know, if you looked at 'em and say,Ooh, why would I ever buy this company?
I mean, look, they've got a lot of debt.
It looks like it's gonnago bankrupt next week.
I mean, why would I wanna buy it?
And you probably wouldn't go outand buy one company, if you bought a
thousand of these companies that alllook the same way, or 700 or 800 of

(01:05:46):
these companies, now you've mitigatedaway any of the individual risk of each
one of these companies going under.
'cause you're owning this big portfolioof these companies and then you have
to look at that portfolio and say,okay, well what is the risk of this it?
But it is still higherrisk than the market.
It is no different than saying,I'm gonna buy a junk bond fund.
Versus buying an investment gradecorporate bond fund, which have all

(01:06:10):
the, the best companies in it, allthat are double A rated, single A
rated investment grade, corporate highquality corporate versus junk bonds.
You buy junk bonds, you're expectedto make a higher rate of return
because they're junk bonds,they're really junky companies.
It's really the same waywith small cap value.
You're buying reallyjunky small cap stocks.
You're just packaging them togetherin a portfolio that the idea is, well,

(01:06:34):
I'm gonna buy a whole bunch of thesejunky stocks and therefore the expected
return on the junky stocks is gonnabe higher than the rest of the market.
Same thing with small cap withhigh yield bonds, junk bonds
versus investment grade bonds.
I mean, that's the theorybehind what you're saying, Paul.
So the other part of this, whichwe haven't talked about is yes.
You might get a higher returnfor small cap value, but there

(01:06:57):
is definitely more risk there.
You're taking more risk to do it
about that?
more fees.
we talk about
that?
Well,
sure.
I don't know how you can saythere's not more risk, but go ahead.
Of course we could
This is,
this is great.
This is what we wanted is thebattle of small cap value.
This is the Paul versus Rick thing.
Now, Paul, you need your turn.

(01:07:18):
Well, I've, I've got a table that wehave tracked the return one year at a
time of the S&P500, as well as smallcap value and the portfolios that we
recommend people could put together.
What we know looking over the periodsince 2000, is that the small cap

(01:07:40):
value, if you accumulate the lossesof all the years, they lost money.
And you did the samething with the S&P500.
The losses were actually higher.
On the S&P500, then the accumulatedlosses on the small cap value.

(01:08:00):
now, that's not as long aperiod as we would like.
If we take it back to 1928, it's not thatpretty because you have this horrible
thing that happened in the thirties.
But if we look since 1970 where morepeople know about small cap value
and know about the S&P500, there isnot that advantage in terms of risk.

(01:08:23):
And remember that the higher standarddeviation, which isn't all that
much higher with small cap value,that standard deviation is measuring
upside volatility just like it'smeasuring downside volatility.
And most of that extra volatility iscoming from the upside, not the downside.

(01:08:44):
I just did this.
This morning, looking back to2000, we always argue is five
years enough, 10 years enoughis 50 years enough information.
I do know this, that at the end of 1999,the hot stock was Qualcomm up over 2500%.

(01:09:07):
The second was Verisignup over 1100% during 1999.
So I, I could have taken all of the hotperformers in 1990 and of course it was
a technology boom that was going on.
So we understand why thesepeople were where they were.
If you put money into Microsoft, youwould have, oh, and by the way, Qualcomm

(01:09:31):
has grown to be worth about 284%.
Verisign is up since 2007 0.3%.
Not compounded, 7.3 up, 7.3 period.
Microsoft is up almost1400% since that date.

(01:09:55):
In 2000 dimensional small cap value fundis up 1288% during that period of time.
From my view, when I look at wherepeople have taken a lot of risk to
get a higher return, by the way,for what it's worth, VOO for that

(01:10:16):
same period of time is up 600%.
So the small cap value doubledthe return from 2000 through 2024.
Or right now in 25, all I'm saying isthere's evidence that it can perform.
And the reason I gravitate and werecommend the DFA small cap value fund or

(01:10:41):
ETF, the avantis ETF, because there arepeople that are all dedicated to looking
at this in an automated academic way.
And so I feel like when my now twoplus year old granddaughter was
born, we put half of her 401k money.

(01:11:01):
This is money for later whenshe's older in small cap value
avantis and half in a total marketavantis fund for large cap blend.
And when she's 18 and she findsout about this, what I'm hoping is
she will see years that small capvalue did better, years that large

(01:11:22):
cap blend did better and that shewon't touch it, that she will just.
Converted into her, ira, her Rothira, or her Roth 401k and let it go.
But I do believe that if we put it all insmall cap value, she'd see periods that
were terrible and would want to quit.

(01:11:43):
But by diversifying between S&P500kind of and small cap value, I think
she's gonna learn the right lesson.
But you're right.
You gotta have the abilityto stay the course.
And I probably made a mistake.
I don't know if you were ever insmall cap value, Jackie, but I was
in it, in the 10 funds for life.
And I probably suffered from recency biasand I, as a late starter, got out of it.

(01:12:08):
I just didn't see the benefit for mebecause I wasn't willing to stay the
course into my eighties and nineties.
I needed a little more returnand I was like, well, this isn't
working for me and wanna retire.
Jackie, what do you thinkabout small cap value?
Well, I think, well, I reallylove Paul, but, but I think

(01:12:30):
I'm more on the Rick side.
And, and, and kind of like
sorry, Paul.
I, I think if you sent in some more,tables, maybe we might, resolve this.
to both of, to both of you guys' point.
Stay the course is probablymy biggest takeaway.
I remember, and I think a lot of latestarters might feel this way, bill
would get this question every day inthe Facebook group where they're like,

(01:12:52):
okay, I'm ready to start investing.
What do I do?
And they, a lot of times they wantto say, let me listen to this person.
Let me listen to that person.
Let me add this.
They wanna start with the complex andthey're likely not to stick with it
because they're just figuring this out.
Right.
And I know when I was a bit younger andI was trying to figure out what to do
with my 401k and, and I was just startingto teach financial literacy, Paul.

(01:13:15):
So my, my heart was in the right place.
So I came up with the silly acronymto try to teach people that this
is to help you stay diversifiedor to help you be diversified.
The acronym was smile.
It obviously didn't take off, but itwas small cap, mid cap, international
large cap and emerging markets.
And that was my way of tryingto remember to spread it out.

(01:13:38):
Now, I didn't stick with that.
Way.
Way too complicated.
Hey, that's
my point.
That is my point.
Now, it took me a few years to realizethat it was way too complicated.
Right.
And I definitely wouldn'thave stuck with it.
So I have since changed it and it's alot more like you, Rick, and bill always

(01:14:00):
outs me, but my go-to fund is a oh gosh,I don't know how you guys are gonna
respond, but it's a large cap growth.
And then I have a little bit offixed income, typically not bonds.
But anyway, that's what I stick with.
That's what I feel comfortable with.
But I was trying to over complicateit and it was fun for me.
I did enjoy putting togethermy own portfolio, so it

(01:14:22):
wasn't a waste of time for me.
There was a learning experience inthere, but that was just my sort of
journey from, okay, how do I not makethis so com Yeah, that was my journey.
And there was a lot of lessons in there.
So
what do you
tell your daughter?
I'm gonna tell my kids,one fun a hundred percent.
For 10 years maybe.
And then you know, you can look atsomething else and if you get to a

(01:14:43):
hundred thousand dollars, you can startdiversifying like one of my friends.
I disagree with that.
I really do.
I believe that we should teach youngpeople to invest like multi-millionaires
immediately right out of the gateso that they do the right thing.
Indexing low fees, low taxes, or no taxes.

(01:15:07):
All those things shouldbe part of what they do.
And to the extent thatwe keep it very simple.
That's, I don't have anything wrong.
I'm not arguing about simple.
We have 44,000 people approximatelywho subscribe free to our newsletter.
Most of them are engineers.
Does that come as a.
Right.

(01:15:29):
No, not at all.
who love the evidence.
They are people who understand longterm, they are understand how to
design a plane, and they try to takeevery ounce they can off the plane.
So it minimizes the cost of fuel.
All these things that'spart of their life.
Most people are not going to like the workthat we do if they don't like the idea of

(01:15:55):
what I would consider meaningful evidence.
We can never know the future, but we
can
on.
the past and learn from it.
Alright.
Alright.
Right.
I, we gotta stop with this evidence thing.
This is not science.
This is not physics.
Okay?
This is, the markets are not that way.
So this whole idea thatthis is evidence-based

(01:16:17):
investing with the marketing.
Idea of, gee, if people think it'sscience, then they're gonna invest with
us and they're gonna put money with usand we're gonna make fees off that money.
I mean, that's where thewhole term evidence came from.
Evidence-based investing came from a,a marketing person that used to work
at Buckingham Asset Management and theysaid, let's call it evidence-based.

(01:16:38):
'cause it sounds so scientificand people want absolute answers.
And so let's start calling it that.
It's not evidence.
Sure.
You can look backwards and say, well,there's evidence that small cap value
outperformed because here's the data.
It means nothing about going forward.
This is not science, it's not physics,not mathematics is a probability.

(01:17:01):
And how big is the probability that smallcap value will outperform going forward
just because it outperformed in the past?
I don't know.
Neither does Gene pharma.
He doesn't know either.
Gene Pharma says you're not gonnaknow whether small cap value
outperformed or not over yourlifetime until your life is over.
And then you're gonna know.
But until that time, you're never gonnaknow because there's no evidence that

(01:17:23):
it's going to actually happen that way.
So the evidence thing,evidence-based investing is a
marketing pitch, is what it is.
It's not reality whenit comes to investing.
It's not science.
This is not science.
Person
I would never do that, Paul.
A.

(01:17:43):
to be fair when we allof us make a decision.
About almost anything in life.
We use less than scientificpoints of information.
What we do have, and Ithink it's meaningful to me.
I believe that the future willlook like the past as opposed to

(01:18:05):
most people say you can't depend onthe future looking like the past.
No, I think it will look justlike the past with one exception.
Last year the market was up 25.
Year before that, it was up about 25.
You can go back and look at lots of years.
The market was up 25, in fact, over 30.
In fact, I'm losing 10 or more.

(01:18:27):
You can look at all of thesereturns and I have no idea what
went on during each of those years.
Going back to 1928, all I know issomething was going on that got
investors to push small cap up and andlarge cap down or the other way around.
We have quilt charts that I hope youwill share with people, bill and Jackie,

(01:18:48):
because they can't let you go back to 1928and look at each year and see how these
different asset classes performed and whatis the most meaningful thing is they're
it's a random event kind of a thing.
They're all over the place, but thereare some important lessons that tell
us which ones should be the mostproductive, least based on the past.

(01:19:12):
You may not call that evidence.
Now, by the way, the one thing Idon't have, I don't have anything to
say about the sequence of returns.
We can never know the sequence of returns.
The fact that the marketwill be up 10% or 15%.
That's an easy thing to say.
But how they come in, in how thesequence is through the rest of my life.

(01:19:34):
If I've got 10 years,I'm gonna feel great.
And they got seven stents in me rightnow, and they got me on a heart monitor
trying to figure out what are they gonnado next to keep me alive for 10 years.
Well, I'm, gonna make it 'cause I want tobe here to debate you in 10 years, Rick.
Okay.
I hope so, Paul.
But the fact.
Maybe you'll win one of those before.

(01:19:56):
Before then.
evidence we can make of it what wewish, but our whole life is based
on decisions are based on evidence.
The evidence that most people had, andBill, you said it, you got out because
it wasn't doing what you wanted for it.
So you took a piece of relativelyshort period of time and said, this

(01:20:20):
is not right For me, that is thetypical kind of evidence people use.
We're trying to look at decadesand decades of evidence in the
hopes that people will make agood decision and stay the course.
I think Rick's, I mean, bothof you have great points.

(01:20:40):
And Paul, what I've learned today isthat there are different flavors of
small cap value, and Rick talks aboutthe cake and the icing on the cake.
And small cap value is theicing or sprinkles on the cake.
And I.
The color, the color the colorof the sprinkles on the cake.
It doesn't matter whetheryou have small cap.
Know it doesn't matter.
What matters is have a globalequity portfolio stay the course.

(01:21:04):
That's what matters.
this peripheral stuff, you know, whetheryou should have small cap value or whether
you should have this little thing in yourportfolio, that little thing, or 2% in
Bitcoin or whatever it, it is di minimus.
It doesn't matter.
What matters is focus on the cake.
Focus on the cake.
The cake is your allocation betweenglobal equity, fixed income, and your cash

(01:21:28):
component that you need for, your livingexpenses and anything that might pop up.
That is the cake.
That's what people should focus on.
These conversations that are out therein the noise and the media is not about
the cake, it's about the icing, it'sabout the sprinkles, and it's really
about the candles and the bright candlesthat are flashing like this, that get
blown out at the party and it's over.

(01:21:51):
Right.
focus
that's, so great.
we're trying to do.
Yeah.
Yeah.
Now we know that Rickhas gotta get outta here.
But Rick, that is a greatway to sort of end the show.
And we just love you guys becauseyou have such deep knowledge.

(01:22:12):
You're so smart, and it's just greatto kind of have these conversations
and to show that you don't haveto agree on everything, especially
when it comes to something as bigas investing in your portfolio.
So we see how people can actuallypeacefully have a conversation where
they don't agree a hundred percent.
So for our audience, you know, ourchallenge to you is, which do you prefer?

(01:22:35):
You know, think about your own situation.
Think about the mistakes.
Bill and I mentioned, think aboutthese two gentlemen and the masterful
philosophies.
Well, I mean, and it turnedinto a bit of a SmackDown here.

(01:22:57):
I mean, it was emotional.
I, I love it.
Because a healthy debateis what this is about.
And we may have gotten in the weedsfor our audience a little bit, but we
wanna encourage you to look at this,educate yourself if it's right for you.
My opinion is it's starting at 50.
And wanting to retire at 63 or 65,it probably wasn't right for me.

(01:23:19):
And it may not be right for late starters,you know, I think it probably might
be right for the 25, 30, 35-year-oldthat's willing to stay at the course.
And that's the lesson for me.
What I've also learned is whengrowth fails that's when your
recovery asset classes bloom.
That's when international blooms,that's when small cap blooms.

(01:23:41):
And, and that's the seesaw, theteeter-totter of you know, the, the
quilts that you're talking about.
So, I mean, this has beenreally beneficial for me.
I love the debate.
I love the knowledge you'vebrought to our audience and I hope
that this encourages people to.
Investigate their ownpersonal philosophy and needs.

(01:24:04):
You need to use something likeportfolio visualizer or portfolio charts
to, you know, test your portfolio.
Are you meeting your ability to takerisk and your need to take risk?
Right?
Well, and if I may recommendsomething that we do to try to
help we're all free all the time.

(01:24:25):
So we have a thing called boot camp.
And if you go through bootcamp, youwill be taken to 10 forks in the road
that every investor's going to make.
And we do a podcast, we do avideo, and we do an article
about each of these subjects.
And our hope is it will givepeople the education that they

(01:24:48):
need to make that decision.
Stocks versus bonds, to make thedecision what funds, equity funds
to be in, to make the decision.
How much in bonds, how much instocks to make the decision where
you take mother money out on avariable basis or a fixed basis.
Each one of these is dedicated to helpingyou as a do-it-yourselfer, at least

(01:25:13):
understand how we feel about the past.
Because that's what it is.
It's all about the past.
We have nothing elseto to hang our hat on.
We have a shout out to the bogleheadsconference here because they have a
Bogleheads 1 0 1 or Financial Education1 0 1 series where for maybe our late
starter audience, that would be anexcellent way to get your feet wet

(01:25:38):
and, and learn the basics of investing.
Right Rick?
Yeah, it's on the website@boglecenter.net.
We have all the videos.
They're all there for free.
You could go back and you couldreview, bogle Head, university 1
0 1, and then there's the AdvancedBogle Head University 5 0 1.
In fact, not last year, but theyear before, Paul and I were both
on stage debating the same thing,and I I put up some pretty funny

(01:25:58):
slides and I think I won that debatetoo, if I'm not mistaken, right?
Paul,
there you go.
You know, there are no winnersand losers there, there are just
differences of opinion, right?
And we take these, and I love the sortof the opposite ends of the opinion

(01:26:19):
because somewhere the, the answeris always somewhere in the middle.
To me it's the hybrid solution, you know,
not being orthodox about it, right?
it's what's right for you.
I mean, if it works for you, fine.
As long as you gotta stay the course.
If this is what you wish to do, fine,just understand why you're doing it,
implement it, maintain it for therest of your life and you'll be fine.

(01:26:41):
If you don't understandit, then don't do it.
Yeah, I mean, the cake analogy is agreat way to end this thing because we
all gotta take a slice of Rick's cakeand we all may want some sprinkles
and candles on it, or we just want youknow, a plain cake, a pumpkin bread
or something else that doesn't, thatdoesn't have all the accoutrements.

(01:27:02):
So guys jp we wanna, we wanna thankour guests for what I, per what I
think was a very healthy debate.
And I think there was a, a 50 50 growthfund and small cap value outcome.
Oh, I don't agree with you, but
the 50 50 outcome, okay,

(01:27:23):
we don't know what it is.
We don't know what the, what the50 50 outcome is, but we know it's
always a 50 50 outcome.
as.
Stay the course.
We agree with
Yeah, just thank you so you guys so muchfor joining us today and being open to
share what you really think and not reallycare so much about the other, because
our audience

(01:27:43):
I'm shocked.
How could you say thatI lost care about Paul?
Of course I do.
all, all care about him,but you guys are passionate.
Yeah, so it was just so good to be ableto hear your different perspectives.
Nobody's wrong or right.
And you are so on it with lookat your own individual situation.
Stay the course.
If you took away nothing else fromthis conversation, stay the course I.

(01:28:05):
All guys, thank you very
much.
Thank you.

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