Peter Lazaroff on The Perfect Portfolio

0:00Jon Luskin, your host here for the 98th Bogleheads on Investing podcast. We're going to try something new for this episode and jump right into the interview. Stick around to the end for important announcements and my final thoughts. Peter Lazaroff, chief investment officer over at an investment shop that oversees billions in assets. Why write a book about the perfect portfolio?

0:21Peter Lazaroff:Well, Jon, you know, it's one thing to manage, I guess, over$10 billion for clients at this point across the country. it's another when you're trying to educate the masses. I host a podcast called The Long-Term Investor. You can go to thelongterminvestor.com to learn more about that. But one of the things I've learned over the years is that there is so much information that if you need a resource to try to have, like, instill all of the best advice from the investing classics and incorporate stuff like behavioral finance, incorporate things that didn't exist when investment classics were written, it's hard to just give somebody one book.

1:01Peter Lazaroff:I feel like all the time people are like, Peter, what is a book I should read that would get me a little more educated, better understand your philosophy? And I feel like I have to give them six or seven different books. Here, I could try to do something that's approachable, that uses more modern examples, and is not 400 pages long and just kind of hits those high points and maybe makes you think about things differently or learn something new, even if you've been a student of the market for a long time. Well, speaking of favorite books, I'm biased. Jack Bogle's Little Book of Common Sense Investing is one of my favorites that I recommend to a lot of folks who are first starting to learn about investing.

1:39I'll link to that in the show notes for folks to check out. Let's jump to an audience question. This one is from Xanath from Bogle Ads Reddit. They ask, what's the goal of the perfect portfolio? Is it the highest expected return? Or is it something that you feel confident that you can stick with for the long term?

1:59Peter Lazaroff:Wow, that is actually an incredible question. For me, the perfect portfolio, first of all, there's not like a one size fits all universally perfect portfolio. I make it very clear right out the gate that I think that there is a perfect portfolio for all of you out there. You just have to find it and understand some things, some basic foundational ideas in order to find that portfolio. And to me, it's not necessarily about return maximization and is certainly more on the spectrum of what is the portfolio and strategy I can stick with for decades on end. Because most of investment success is about minimizing mistakes and just making sure you don't interrupt compound interest in an unnecessary fashion.

2:42Peter Lazaroff:So for me, it's definitely that what can you stick with for multiple decades? In the book, you have a great little analogy about cereal. Tell us about that and how it relates to investing. Well, sort of, you know, I just mentioned how the perfect portfolio is more about the one you can stick with for multiple decades. But that doesn't mean you can't make changes. Like, it has to be a little bit adaptable. And in the opening chapter, I talk a strangely large amount about food. But I note how for much of my life, I would eat, I mean, four, maybe five bowls of sugary cereal right before bed, whether it's Froot Loops, Cinnamon Toast Crunch, Corn Pops, like whatever.

3:26Peter Lazaroff:I'm all in on it. And as I've aged, so I turned 42 this year, I can't really do that anymore. And I mean, I still love cereal, but that's not good for my body. And certainly that much of it right before bed. that's not a thing that is necessary and or good for me. Whereas, you know, in my teenage years, in my 20s, actually, I had a hard time gaining weight. And so anything I could consume that I enjoyed eating, I should eat. You know, things change over time. So with your portfolio, what you need in your 20s or your 50s or your 70s is obviously going to change. So the perfect portfolio is not just a static portfolio.

4:02Peter Lazaroff:If anything, it's this philosophy and strategy and process for making decisions so that you can adapt as life changes with you. So I think one of the biggest things that is different in people's lives, like we could try to corner certain decades of life, but I don't know how you feel about this, John, but to me, the playbook is if there's this official playbook. Maybe we could write a book called the playbook to accumulation is largely agreed upon. It's, hey, max out your tax deferred accounts, keep your investment costs low, like save, you know, spend less than you earn, save money effectively.

4:35Peter Lazaroff:It's all pretty basic. It's not that complicated. De-accumulation, on the other hand, I don't feel like there is a one size fits all because everybody's objectives are so different. And that's the thing with investing. I think a lot of investing, both the classics and the current books, address investing for the accumulator. Whereas I think holistically, one, the accumulators are all going to have different goals, like whether you are a few years away from retirement or having just entered retirement or just getting started in your career, you're going to have different goals and objectives. And so I think, you know, the cereal thing is a good example of, hey, the way that I eat has changed.

5:16Peter Lazaroff:Now, I used to, you know, everybody who's listening to this podcast has had to deal with the terrible effects of aging and how you have to eat less and less and less over the years. But it's not just quantity, it's types of foods, you know, it's the types of things that maybe will make your stomach upset that didn't used to. I think you could make an easy, almost cliche analogy to investing of the things that make your stomach upset as you get older versus when you're younger as an investor. So to me, I think it kind of this perfect portfolio, especially with the food stuff, for whatever reason as I was writing, maybe I was just hungry the whole time, but it just occurred to me that like, everybody's perfect meal is different.

5:52Peter Lazaroff:And John, if you and I go to the restaurant or any restaurant, not the restaurant, but we could order any number of things. The likelihood of us ordering the exact same thing is pretty low. And even if we do, we might like modify the side or like have it cooked a little differently. But even if somehow we have truly the exact same order, you and I are gonna have physiologically different responses to that order. We're going to react to it. We're gonna enjoy different amounts. And so, look, I think I really just wanted to talk about cereal in my book. I've written about it in more casual blog posts before.

6:25Peter Lazaroff:I'm a huge serial aficionado, but hopefully it does tie nicely to the adaptability and changes that we go throughout life in. Yeah, I thought it was a pretty neat analogy, how it just spoke to the fact that what you could do when you're young, you can no longer necessarily do when you're at more advanced stages. And the same applies to your portfolio. The portfolio that got you to retirement isn't necessarily the same portfolio that will get you through retirement. So let's talk a little bit more about some of those changes that you may be making to your portfolio over time. This is actually a question we got from the BullGlads community for our last interview, for our last guest.

7:02Didn't have time to get to it, but it's a really interesting topic. And you touch on it in the book. You have a pending inheritance. How should one invest in light of that?

7:13Peter Lazaroff:Such a good question. And there's going to be always this caveat that it depends on your situation. However, here's what I will tell you is when we're working with clients at PlanCorp, at least, if someone thinks they're having an inheritance and we are building a financial plan, we don't account for it. And I believe in that approach. I don't think you should really count on an inheritance until it's like an irrevocable trust and it is yours because a lot can change. Let's say mom and dad have told you that you're going to inherit money, but either mom or dad passes away. and then the other one remarries.

7:50Peter Lazaroff:And then a totally different set of circumstances comes in. Or maybe there's a lot of health complications at the end of life. There basically are always health complications at the end of life. And so I think when you're investing, I don't think investing as if you're getting an inheritance to sort of bail you out is the right approach. Maybe if your investment plan and overall financial plan is in really solid shape and you decide that you want to take a bigger vacation or maybe you don't travel as much with your spouse and your children or whomever as much as you'd like. And you've done a really good job and you can like, maybe you can't take your inheritance to the bank, but you can count on something being there.

8:29Peter Lazaroff:Well, maybe we should live a little this year. And so I think it doesn't have to be a permanent lifestyle choice, but I don't think you have to fully ignore it. I just, I always feel really uncomfortable baking it into a financial plan. Now, one last thing that I would consider is, and this is where the caveat depends on how old you are. So if you're in your 20s or 30s, I think you need to invest as if it doesn't exist. If you're in your 50s or 60s, what you have saved for retirement, most of the compounding is gonna happen based on what you've already saved. And so maybe the calculus and the psychology around it changes a little where you get more flexible, not just in how much you save year to year, but in what your asset allocation would be.

9:10Peter Lazaroff:I think the older you get personally, you start to realize like some of this money isn't really for me. It's for my heirs. And so how am I going to align my asset allocation with the risk tolerances and the time horizon of those who are actually going to spend it? And so like if the inheritance would equal, would double the size of your net worth, that's going to be a lot different than if the inheritance represents 5 % to 10 % of your net worth. Also, is the inheritance in an inherited IRA where you're going to take taxes? Or is it going to be in a taxable account? Or, you know, there's just so many caveats.

9:44Peter Lazaroff:And I realize I started the answer that way. But I think, you know, as a framework, the later you are in life and the more established your financial plan is, I think the more flexibility you can use, less so in how you invest and more so in how you're living your life year to year. Yeah, I certainly want to echo your point about not counting on inheritance planning in the absence of it. All right, let's talk about risk tolerance. You have a great line in the book, past behavior tells you more than risk questionnaires. Tell us as investors, how should we be assessing our risk tolerance? Boy, I love this question.

10:23Peter Lazaroff:So I think of it in two categories. There's ability, to me at least, there's ability and willingness. And ability is very objective and you can calculate it. And you typically, like once you have a financial plan, you've arrived at it. And so ability has things like time horizon, human capital, flexibility of goals, you know, because with ability, basically like imagine you're young and you have a long future of earnings ahead. Well, your time horizon is long and you can keep saving if the market turns down on you. Whereas if you're a year away from retirement and, you know, a bear market kind of introduces that sequence of return risk, like your ability goes down, The flexibility of goals like your retirement date or how much you want to spend, those can really impact your ability as well.

11:11Peter Lazaroff:So that's like very something that you can calculate effectively. Willingness, however, is very subjective. And I would argue that people are not the best interpreters of their own willingness to take risks. And, you know, the thing about risk tolerance questionnaires is that typically people's responses change based on what's going on in the market. And there's pretty decent studies like documenting this happening. The other thing with like risk tolerance questionnaires is they really have to be worded very well in order to make sure that they're measuring what is actually trying to be measured.

11:48Peter Lazaroff:Most risk tolerance questionnaires that I see, I'm like, that has nothing to do with how somebody is going to behave. And so to me, I think if you look at what you did during the great financial crisis, if you look at what you did during COVID or during 2022, those behaviors are going to signal a lot better to me what your willingness to tolerate risk is. So were you buying more stocks as they were falling? Or were you selling and going to cash? Were you making moves? Or did you stick to your plan? Like, even if you weren't buying stocks, like with new money, were you like rebalancing? Were you staying the course with plan?

12:23Peter Lazaroff:Were you watching the financial media? Were you just freaking out? Or were you like, oh, yeah, I kind of remember that. Like, I'm glad that like that's over now. Those are very different experiences. One thing that I've noticed, though, when we talk about market losses, so like. just throwing some generalities out there. Like the market falls 10 % on average about every 12 months. It falls 20 % on average every three and a half years or so. And then it falls 30 % or more about once a decade. And these are S &P 500 statistics. I think you can get people comfortable with that and they can even live through some of them.

13:00Peter Lazaroff:But what I've gained a greater appreciation over the past two decades working with people is that it's not necessarily the percentage decline or even the dollar value loss, it's the narrative tied to it. You could have ice water running through your veins through all these other drops, but whatever makes this drop feel different, you know, the terrible words this time is different. We know that you're never supposed to say that, but the media makes it feel that way. And so like for the financial crisis, which I referenced, well, that narrative was the whole system is coming down. That's what, That was the narrative.

13:35Peter Lazaroff:In COVID, it was, we are all going to die. You know, these are scary things where those might trigger you. In 2022, it was interest rates are rising. That doesn't seem as scary. But look, that was a much more orderly decline. I've just come to appreciate that the narrative is sort of what scares people. And the S &P 500, that's just a representation of large U.S. stocks. It's a common benchmark for the stock market. I want to talk more about ability and willingness. Now, we work with different client demographics. I work with do-it-yourselfers. You work with delegators. And one thing that I see a lot with do-it-yourselfers is that they're singly focused on their willingness to take risk, but oftentimes ignoring both their ability and their need.

14:22I'll be working with folks and they have likely more money than they can spend. Their retirement is fully funded, and then they just still want to invest aggressively. I'm curious, what do you see in the delegators that you work with? Is there a disconnect between their ability and their willingness and the need to take risk?

14:39Peter Lazaroff:Well, I think one thing that the people I work with and you work with, John, that they share in common is that they're good savers and, you know, they have built substantial wealth, whether they're delegating or do it themselves or like kind of sitting somewhere between the two on the spectrum of that. And when you have been such a good saver, what I actually tend to see most is that you don't want to spend, like all the things that made you a great saver and investor, make you a terrible spender, make it really hard to enjoy life. And there is a couple like schools of thought, like when you have much more wealth than you could possibly need, on one hand, your ability is super high, you could go 100 % stocks, really have nothing to try to offset the volatility.

15:20Peter Lazaroff:Because in reality, even if the market were to fall 60%, you'd be fine, you can live the life that you want to live. There's another like school of thought where it's like, well, hey, you have everything you need. Why don't we sort of lock this in and be more conservative? I think I was hearing you say this being true of yourself as well, but correct me if I'm wrong, but like I see people resist doing that because they're like, well, look, no, investing in stocks for the long run is the smarter choice. Like over a 20 or 30 year period, you're almost knowingly locking in a lower return by owning bonds.

15:51Peter Lazaroff:I'm actually working on a podcast episode right now that's just asking the question like, are bonds really less risky than stocks? And I think it's all about your definition of risk. Like day-to-day, bonds are less volatile than stocks. So if volatility is your measure of risk, then yeah, like day-to-day volatility. But if I were to look at 30-year real returns, or actually, so there's some data in the book that comes from Jeremy Siegel and Jeremy Schwartz. It was in stocks for the long run in 2022. They were so kind to update the data for me through 2025, but it goes back to 1800. And you look at like the real return on stocks.

16:27Peter Lazaroff:So the return after inflation, and it's about 7%. And they also look at it through different economic regimes, because I kind of referenced this earlier, I always hear like this time is different in the world is changing. But in reality, the world has always been changing. And then you compare that to bonds. And depending on like what the duration of the bonds you're looking at are. Maybe the real returns are anywhere from like one to three percent. Let's be friendly and call it three percent. So you're like knowingly accepting four percentage points less of long term growth when you allocate to bonds.

17:01Peter Lazaroff:And what that does over the long term is it is it riskier towards like meeting whatever goals you have for you and your heirs? I don't know. I'm still kind of like workshopping it. You touched on the issue of bonds being riskier than stocks. This is actually something we discussed with Ben Felix in a previous podcast episode. I'll link to that in the show notes for folks to check out. All right, let's jump to a question from the community, again from Bogled's Reddit, who did the best job submitting questions for this episode. This one is from username Lynette, and they ask about designing the perfect portfolio.

17:33Do you lean towards something like a Bogled's three fund model or something else?

17:38Peter Lazaroff:Well, there is a whole chapter in the book explaining on how I have my portfolio set up, and I do discuss it actually within the context of my balance sheet. I have a hard time thinking about the portfolio and the choices I've made with mine and explaining them to others without them understanding what else is going on in my balance sheet. One of the approaches though, like the three fund portfolio, let's just get out in front of this. I don't really have any issue with that. I think an index portfolio versus like a factor portfolio is something I explore and I don't point to one being better than the other.

18:11Peter Lazaroff:I do think, though, that it is important to understand what an index portfolio is. And so the book is sorted into three sections. It's like some foundational theory. It goes through history. It goes through behavioral finance. It goes through actual asset pricing portfolio management theory. And the second section is kind of evaluating these different strategies on the stock side, on the bond side. Do alternatives make sense? And then the third section is all about implementation. And the reason I mention all that is when I talk about indexing, it's a rules-based system. I am a huge fan of rules-based systems, something that doesn't try to predict the future, something that can keep costs low.

18:54Peter Lazaroff:Indexing was the original like investable form of that. And the analogy I use is like, think about John, like fastballs and velocity. Like when we think about, ask people like, what makes a great fastball? they're going to say velocity they're going to say speed but before the radar gun nobody actually knew how hard anybody was throwing like the scouts would kind of like sit behind the batter's cage and squint and like if the glove popped loud or if the batter swung really hard and like missed a lot effort like but the pitchers just buzz and balls by like oh yeah that guy's throwing fast but then we introduced the radar gun and suddenly we knew whether people were throwing 89 or 94 or 100 And so like all of baseball reorganized itself around this one number, like velocity.

19:43Peter Lazaroff:And if you were a pitcher and you had it, you were a prospect. And if you did not have velocity, you were not. Now, today, you fast forward today, there's actually like newer systems. And it's stuff like it's called like pitch FX and stat cast. And they're looking at vertical access, spin rate, movement, wrist angle, grip, all these like little nuances that actually explain more about what makes a fastball effective than just velocity. Now, what does this have to do with investing? Indexing is the radar gun and velocity of rules-based investing. You know, market beta is sort of like the original thing of what explains stock performance and indexing gives you exposure to that.

20:25Peter Lazaroff:Factor investing, what it does is it just takes more things that explain return and uses rules to adjust market cap accordingly. Now, does that make it better? No, it does not. Factor investing explains market returns more, but it comes with more risk. And so there's like no guarantee that any one strategy is going to work. But I am very clear, like the listeners like, well, how does like how does he design it? When I think about stock strategies, I don't like traditional active management in the stock arena. Like I think the evidence is overwhelming that stock picking or trying to time the market is not an effective strategy.

21:03Peter Lazaroff:The evidence is also overwhelming that high costs are typically going to lead to bad performance. Now, it's really like, I mean, I think the nuance of the data is it's like, hey, the 10 % most expensive funds underperform the 10 % cheapest funds. I was going to try to avoid using the word decile, but like, basically, like being cheaper doesn't mean you're better. But at the extremes, like the evidence is very, very strong. Sometimes you pay more for something like a factor fund and it can add value. And I'm just going to say this as an example, but I don't want my compliance getting upset with me, but you can like look out at an index fund like VTI and another ETF from dimensional DFUS, which is like a broad market fund, but it is not an index fund.

21:48Peter Lazaroff:It's just using more of these factors that explain return. You know, most people think of DFA and dimensional as like a value shop and a size shop and that sort of thing. DFUS is a broad market fund. It's not intended to be like severe overweights towards any of these factors. It's just saying, hey, like if we're going to build the broad market using rules that explain the overall market, this is what would happen. The thing about indexing that I do like is that once you do anything other than indexing, you're introducing uncertainty, you're introducing cost, you're introducing complexity, and not everybody should be doing those things.

22:27Peter Lazaroff:The average, like we all know, and Bogle did a great job of doing this is saying like, hey, the average market participant owns the market. And so he or she who owns it cheapest will have the most return at the end of the day. Could not agree more. However, that's the average market participant. So if you're watching and listening to us, ask yourself, well, how am I than average? Do I have more wealth or income than the average American? And I'm just going to sit with Americans because we're talking about American markets, but you could think globally, although it's going to really skew the data, but like, am I healthier?

23:03Peter Lazaroff:Do I have more money? Do I have different goals? And so like, how am I different than average? So the index question can be the right answer for most people, but that's what the perfect portfolio is all about. It doesn't necessarily mean it's the right answer for everybody. All right, you mentioned some tickers, so I'll just throw out there. Non-investment advice, speak with your financial professional before making any decisions. And then we talk more about factor investing on two previous Bulkleds on investing podcast episodes we did recently. Ben Carlson and Ben Felix, I'll link to those in the show notes for folks to check out who want to learn more about that subject.