JL Collins: How to Beat Wall Street with a Boring Portfolio [GREATEST HITS WEEK]

0:00Welcome. Next week, we're airing episode 500. In honor of that, this week, we're airing a special five-day series in which we look back on the earliest days of the Affordering podcast. In case you missed it, we air five of our greatest hits from those early days. So five episodes, five days in honor of episode 500. Today is day two of five. We are replaying our interview originally recorded in 2016 with a name that's going to be very familiar to many of the people in the financial independence community, J.L. Collins. J.L. Collins has been financially independent since 1989. And he achieved this in the simplest way possible.

0:44He saved half of his income and he invested it in index funds. Now you might be thinking, whoa, whoa, that doesn't sound simple. There's a distinction between easy and simple. Saving half of your money is not easy, but it is simple, meaning there is no particular complexity to it. It's difficult, but it is not complex. JL Collins in this interview joins us to talk about the great irony of investing, which is the fact that the simpler of an approach you use, the more powerful results you are likely to obtain. He talks about this as the simple path to wealth, and he shares universal classic principles which are as true today as they were back then.

1:26If you want to learn a time-honored, time-tested approach to smart, simple investing, then enjoy this upcoming episode. I'm excited to be talking to you because you have a very famous stock series on your blog. Can you tell the listeners, what does the stock series cover broadly? What does it talk about? Well, basically, it's how to invest to ultimately achieve financial independence. And it's written for people who really aren't interested in this whole investing thing. basically it's written for my daughter i think knowing how to manage your money and invest it is an incredibly powerful tool to navigating this modern world of ours and to ultimately having the maximum freedom that we can have in in this modern world and so from when she was very little i i've tried to to show my my daughter some of these principles and lessons but it's just not something that she's interested in.

2:29And at one point she was home from college and I started one of my many lectures and she stopped me and she said, you know, dad, I know this is important. I get that, but I just don't want to have to think about it all the time. And that was an epiphany for me because I suddenly sat back and realized that I'm the odd one out. You and I, Paul, are the odd ones out. You know, most people don't want to think about this stuff all the time. Most people want to get on with curing diseases and building bridges and writing peace treaties and much more interesting things. But the smart ones know they have to have some kind of handle on their money.

3:07So the objective of my blog and my stock series and now the book is to give people the tools they need with as little time commitment from them as possible. And the good news is the great irony of investing is the simpler approach you use, the more powerful results you get. So here's a way to think about it. Imagine that you and I are sitting down at this huge banquet table. Okay. And on this table, this table is absolutely laden with every delicacy of food and drink from around the world you could possibly imagine. And incredibly complex in their preparation and flavors. and what have you. And now think of that in terms of that banquet table, those foods instead of food and drink, all of the different things you could be investing your money in, all the different investment products.

4:03And they are almost endless and almost endlessly complex because that's how Wall Street makes their money, is selling complex investments to whoever. I'm going to sit down at that table. I'm going to put my arm on it, and I am going to sweep all of that onto the floor. because we don't need it. And left, when I'm done, on one tiny little corner will be the only investments that we really need. Let's go into this stock series. Let's dive in. And I noticed that it begins with a post that's called, The Market is Crashing. I'm assuming that's because one of the most common objections you hear is, what if I put all my money in the market and it crashes?

4:45One of the principles that you need to understand if you're going to invest in stocks is that it is a long-term gain. And the stock market fluctuates. The stock market is volatile. If you look at a chart of the stock market's long-term performance, if you look at it over 100 years, you're going to notice two very important things. One is that it always goes up. It is higher today than it was 10 years ago, 20 years ago, 50 years ago. So the market has an upward bias, and there are some key reasons why this is true that we can talk about. But the other thing you notice is that it is not a smooth ride.

5:30It's an incredibly volatile ride. And most people aren't prepared for that volatility. And what exacerbates that problem is that when the market drops, the news media goes into an absolute frenzy. Right. Right. There was, I think, last fall or maybe the fall before, sometimes I forget, a 10 % correction in the market. 10 % is perfectly common, even healthy for the stock market to periodically drop 100%. Well, one of the great headlines, and I wrote a post about this, was bloodbath on Wall Street. And I'm like, bloodbath, I mean, this is a perfectly normal thing. I tell my daughter, who is in her early 20s and is hopefully going to be investing for the next 80 years, she can expect market corrections, which are defined as about a 10 % drop, routinely.

6:25These are routine things. She can expect bear markets, which is defined as about a 20 % drop, on a regular basis. She can expect in the course of her nice long lifetime, two, maybe three market crashes like we had in 2008, 2009. The important thing is this is a normal part of the process. This is how markets behave as they relentlessly over time march upward. So the question then becomes, well, what do you do about it? And the thing that you do about it is nothing. But nobody can predict when these things are going to happen, even though the media is filled with people predicting exactly that.

7:09The truth is nobody successfully, reliably can predict when this is going to happen. So you need to accept that it's a natural part of the process. You need to invest for the long term and not panic when everybody else panics. And how long is long term? Six months? Six years? So that's a great question. And it's a little bit of a moving target. Six months, I think we can categorically say is short term. Right. 20 years, we can categorically say is long term. Where the question comes in and most practically is, I'll get questions in the blog where people will say, you know, I want to buy a house in the next five years and I'm saving my down payment and I want to invest in the stock market and make these great returns you're talking about.

8:00Well, the answer is that if you're going to be using your money in the next five years or less, the stock market is not where you want to be. Right. I don't know where the market's going to be tomorrow. I don't even know what it's doing today. I don't know what it's going to do next week, next month. I don't know what it's going to do the rest of this year or next year. Five years out, there's a pretty good chance it's going to be higher than it is today, but not entirely. You go out 10 years, it's a very rare 10-year period where the market's not higher than it was 10 years earlier. You go out 20 years, I think there's one time in history, history being the last 120 years or so.

8:40I think there's one time on the hills of the Great Depression where it wasn't higher after 20 years. So the further you go out, the more reliably I could say the stock market will make you wealthy. The shorter your time horizon, the more aware of the volatility you need to be. Right. Now, how does that work practically? Well, if you're young and you are working and you're investing, as you should be, and hopefully a significant amount of your income, because it's not how much you make, it's how much you keep that counts. Now you're looking, as my daughter is, as an example, you're looking at decades, which is the way to think about stocks.

9:22So absolutely, that's long-term. And I say to her, you should be investing in the Total Stock Market Index Fund and put as much money as you can in it. You shouldn't care even a little bit what the market's doing today or tomorrow. In fact, if anything, because you're adding money to it, you should be hoping it goes down. Anybody, any young person in our listening audience who is beginning to invest or is even 10, 20 years into it and has 40, 60 years to go should be hoping it crashes. So they're buying stuff on sale. Now, there's not a hard finish line either. I'm in my 60s. I'm now drawing down on my portfolio, but I'm not selling it all at once.

10:09So I am still having a long-term horizon. I still want the long-term growth that the market can give me. Let's talk numbers. What reasonable returns can the average person expect if they stick with index funds and hold for the long term? I'd say, you know, if you go in at about 7-8 % over time, understanding that it's going to be much higher some years, much lower than other years, that's probably a reasonable number to use. My actual guess would be you will be pleasantly surprised at the end of 40 years. You certainly would have been if you'd done that in the mid-70s and came today. Okay. Well, so given that 8 % seems to be a reasonable return over a long-term period of time, does it make sense for people who carry debts with less than an 8 % interest rate, such as a mortgage or a car loan, does it make sense for them to pay those debts off early or to invest in the market?

11:08Well, I actually, that's a question that I get on a fairly regular basis on the blog. And I actually have come up with sort of a little bit of a hierarchy and I wouldn't go all the way up to 8 % on your debts. But basically what I say is if you've got, if you, and by the way, I would not go out and borrow money to do this, right? So I would not go out and borrow money with the objective of turning around and investing in the market. But if you're carrying debt, whether it's a mortgage or student loan or whatever, and your interest rate is 3 % or less, I would hang on to that debt because rather than paying it off quickly, if you invested that in the market, again, understanding that it's going to be a wild ball of a ride over time.

11:55Inflation over time is 3%. Right. You will probably outperform that 3%. If your interest rate is between 3 % and 5%, I would say it's kind of a personal preference. If you're really anxious to be debt-free, and that speaks to my own personal psychology, then there's nothing wrong with paying off your debt. And there's a lot right with it. And, of course, that increases your cash flow going forward. On the other hand, if you are a little more aggressive, you might say, you know, I've got this debt at 4.5%, and boy, looking at these historic averages, I will probably do better. Then that's a possibility.

12:43I think once your debt starts getting over 5%, 5.5%, 6%, I think at that point, I'd pay it off because a guaranteed 6 % return is no small thing in this day and age. And it's guaranteed and there's no volatility. Yeah. Yeah. Can you explain that a little more? I mean, because if the historic evidence is so overwhelmingly positive about market returns, why? And if 8 % is kind of a conservative long term projection of future returns, why would you pay off 5 % or 6 % interest rate debt? Well, because you get that 5 % or 6%. So when you pay off debt, it's essentially whatever your interest rate is, is in essence, in a sense, a return on your investment, right?

13:35So if you have debt at 6 % and you pay it off early, that's the equivalent of getting a 6 % return on your money. Right. Now, the advantage of that is there's no volatility to that 6%. So one of the reasons that stocks provide the handsome returns that they provide, you have to accept the idea that if you invest today, tomorrow might be a repeat of 2008. And you're going to have to suffer through that and hold on and keep investing to get the payoff a decade later. And that's risk. So you get paid for taking that risk. You get paid for being willing to accept that volatility. Right. So it's looking at returns in context of risk.

14:27In context of volatility. Right. So there's and this is an interesting thing, too. So I cringe a little bit when I hear people say that stocks are risky. I think the better way to lay, and that's the most common way to refer to them. I think the better terminology is stocks are more volatile than alternatives. So let me give you an example of what I mean. Okay. Let's say you have$100 ,000 and you put that$100 ,000 in an FDI insured savings account at your local bank, and you'll get about 1 % interest in this day and age, something around those lines. Most people in the financial world would say you have made a safe investment.

15:12But now what if I said to you, you know, let's look out 20 years. And in 20 years, I can guarantee you, guarantee you that your$100 ,000 in the savings account will buy a fraction of what$100 ,000 today will buy. The spending, the power of that$100 ,000 will be vastly diminished. And that loss is guaranteed. Now, which one's risky? You know, when I was a kid, I remember on Christmas morning, I got lots of toys, lots of books, lots of clothes, gifts. The books were always my favorite. I'd spend all of Christmas day just reading and reading and reading. But you know, none of those are things that I have anymore.

15:56They were wonderful in the moment. But decades later, I have no idea where any of those things went. But by contrast, when you give a gift that brings somebody financial security, that's something that lasts a lifetime. Now, when it comes to financial security, nearly half of American adults say that if they lost their primary income earner, they would suffer financial hardship within six months. And so if you want to secure your future before the new year begins, lock in your life insurance today because that's something that you don't buy for yourself. You buy it for your loved ones. You buy it so that in the event that the worst were to happen, your loved ones would have some financial security.

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17:52Background for the listeners. Every index fund advocate I've ever encountered recommends diversifying. Every time you read or listen to somebody who talks about index fund investing, that's what you always hear. But Jim, you say put it all in the U.S. broad market. Why? Doesn't that make me refreshing? It makes you intriguing. And you don't even recommend bonds. Why? I recommend bonds at a certain stage in your life. And your question covers a lot of ground. So in my world and in my stock series, if people read it, they will hear me talk about sort of two stages of your life. And these are not necessarily related to your age.

18:36These are related more to your cash flow from your labor. So if you have a salary or a business or what have you. Trading time for money. Right. Trading time for money. So there is a wealth accumulation stage and there is a wealth preservation stage. So there is a time when you are building your wealth and there is a time when your wealth is supporting you. Right. So when your wealth is supporting you, and that might just be that you're taking a sabbatical in the middle of your career. When your wealth is supporting you, you're going to want to have some bonds to smooth the ride. And that's the function that bonds have.

19:16When you're working and building your wealth, your income, part of which, if you're smart, you're diverting into your investments, that new money going into your investments plays that role of smoothing the ride. That's why I said earlier, if you're young and you're building your wealth, you want the market to crash. You want to be able to buy shares at lower prices. So I do occasionally recommend bonds. I own bonds right now because that's the stage of life I'm in. But for people who are building their wealth, you're right. My recommendation is 100 % stocks. And specifically, if it's available and sometimes in your 401k, it's not.

19:59but in a perfect world. Specifically, I like Vanguard and I like VTSAX, which is Vanguard's total stock market index fund. Right. So why? Why not international fund exposure or small cap exposure? Well, let me address both of those things, but let's first understand what we own when we own VTSAX. Okay. People say, well, gee, Jim, you're not diversified. I say, au contraire, when I owned VTSAX, I owned a piece of every publicly traded company, virtually every publicly traded company in the biggest economy in the world, the United States of America. That's about, last time I checked, 3 ,600 companies.

20:413 ,600 companies across all kinds of industries filled with people striving to compete in an unforgiving world where only the best survive. Those that fail will fall off the index. And those companies that fail, right? The companies that fail will fall off the index and be replaced by new blood. The companies and the most you could possibly lose with a company that fails and usually it falls off the index before long before this, it would be 100 % of your money. But the companies that succeed can grow by 100%, 200%, 2000%. I mean, there's no limit to the upside. This is a process in looking at the total stock market index fund that I call self-cleansing.

21:27So those that fail drift away and those are replaced by new blood and that continually, those companies continually strive and grow. And that's why the stock market relentlessly marches upwards over time and will continue to do so as long as we have a viable economy. Right. So, yeah. So, certainly a total market index fund provides diversification, but it is tilted towards large caps as a share. Right. So, let's look at the two things, the two why nots that you asked me. So, why not international? Why not small cap? Well, first of all, I don't have any great idea. If somebody came to me and said, you know, Jim, I really want international and I really want small cap, I don't have any great objection as long as you understand what you're really getting.

22:22So let's look at small cap first. Small caps typically over time outperform large cap stocks, but they do so with even greater volatility. And we already talked about earlier that one of the challenges to being a successful investor in the stock market is being able to stomach the volatility. If you're good with that, then if you want small cap, go in with your eyes open and over 20 years, you will probably outperform a little bit. Now, international, or before I go to international, do you have any questions on, does that make sense or any? It does make sense. So it sounds like it's a behavioral, it's a behavioral recommendation rather than a mathematical one.

23:04Well, and to a certain extent, investing does become behavioral. So I can sit here and say mathematically, investing in stocks is the most powerful thing you can do with your money, short of adding sweat equity into it with real estate, investing and flipping houses or something. But as a pure investing in stocks is the most powerful asset that we have. But you do have to adjust your psychology to the fact that it is a wild, volatile ride. And if you can't do that, if you are going to panic and flee the exits when it drops, and I guarantee you it will drop on occasions and sometimes significantly, if you're not sure you can stomach that, if you're going to panic and flee when it happens, then you will hurt yourself.

23:51That's why part three in my stock series is most people lose money in the market. This is why. So when the market took its big crash back in 08, 09, people were saying, well, you look at Warren Buffett and Warren Buffett didn't lose money in the great stock market crash. Well, that's not entirely true. The value of Warren Buffett's holdings in the stock market dropped just as dramatically as everybody else's did. I think at one point I looked at it and he was down$33 billion. And I was irritating my friends by walking around saying, gee, I wish I could be down$33 billion. Because, of course, he was still worth about$25 or$30 billion at that point.

24:38The thing that Warren Buffett did that investors who actually lost money didn't do is he didn't sell. He didn't panic. In fact, he doubled up and invested more. So that's the key thing. That's the psychological part. The math is sort of easy, but the volatility is a lot tougher to deal with than people think until they actually go through it. Well, then tell me about international stocks. Would you, for the listeners who are wondering, if they should put a slice of their portfolio into Europe or into emerging nations? What are your thoughts there? Well, you're right. My thinking on this runs counter to the vast majority of people who talk about this stuff, and I don't know, maybe even everybody.

25:25I think there are very few people who, like I do, say you don't really need international. As I said, in terms of small cap, if somebody came to me and said, you know, I really want international, I wouldn't fight them a lot. But here's why I don't think you need it, and here's why I don't hold it. basically i don't feel the need for international for three reasons there's added risk with them there's added expense and we've already got international covered okay so let's walk through those those three together so what do i mean when i say that we have added risks well when you invest internationally you take on currency risk because international companies trade in the currency of their home country, and currencies fluctuate against one another.

26:14So the U.S. dollar might rise or fall in relation to the currency of whatever international investment that you're making. So there's an added dimension of currency risk. There's also an added dimension of accounting risks. So we have certainly in our country had companies like Enron blow up through bad accounting procedures and not being transparent enough. But as we sit here today, for all of its shortcomings, the U.S. market is the most transparent in the world, which means that when you look at the numbers of the companies report in the U.S., they are the most transparent and the most reliable of any place in the world.

27:00The second thing is you have added expense. When you go to international funds, even Vanguard international funds, you're going to pay a much higher expense ratio. So those are the risks. But here's the really important thing to me is we've already got international covered. What do I mean by that? Well, as we already talked about, when you go into VTSAX, which is the total stock market index, it is weighted towards the largest companies in the country, in the U.S. So the top 500 companies are about 80%, if I remember, of that index. Those companies are almost all international businesses. Many of the largest generate 50 % or more of their sales or profits overseas.

27:51So we're talking about companies like Google, Facebook, Nike, Coca-Cola, Procter & Gamble, companies that do a lot of overseas business. General Motors, Caterpillar, ExxonMobil. I'm not sure if ExxonMobil is a U.S. company. So you're right. I mean, most every large U.S. company is by definition an international business. So I could go and invest in the local cola company in Africa, for instance, and I would take on those added accounting risks, the added currency risks, the added expenses of buying an African fund that would invest in such a thing or the transaction costs of doing it. Or I can invest in Coca-Cola, which is going to be in that market.

28:36And I can let Coca-Cola worry about the accounting risk. And I can let Coca-Cola worry about the currency risk. And they are better prepared than individual investors or even mutual funds to deal with those risks. So we're going to wrap up. Jim, is there anything that you'd like to impart the listeners with, any key lessons regarding either investing or creating financial independence? Well, in terms of creating financial independence, there's really three elements. And that is spend less than you earn, invest the surplus, and avoid debt. And if you do just those three things, you'll wind up rich.

29:17And you'll wind up rich not just in money. And if financial independence is your goal, the greater a percentage of your income you save and a greater percentage of your income that you invest, the faster you'll get there. Some people see this as deprivation. I suggest that instead of deprivation, when you're saving and investing money, you think of it as just a different way to spend. But instead of spending it on a new car or a fancier house or a new wardrobe, you're choosing to spend it on your freedom.

29:53I hope you enjoyed episode number two out of five in this special five-part series in which we are sharing some of our favorite episodes that originally aired during the earliest days of the Afford Anything podcast back in 2016 or 2017. Back then, we had a much smaller audience, so you may not have heard these episodes when they aired. and so I want to make sure that you get a chance to hear them now and that's why we're running the special five-part series in celebration of our upcoming episode 500. Thank you for tuning in. My name is Paula Pant. This is the Afford Anything podcast and I will see you tomorrow for the third installment of this special five-part series.