Your Biggest Investment Risk is Not the Stock Market

21:53Mo Milevsky:I also think that that then means you're not wasting time on trivial decisions. You're spending all this mental energy trying to figure out whether or not you should buy a little bit more Bitcoin at these reduced prices or whether you should get out of the stock market now until geopolitical risks calm down. That's a trivial sum of money you're looking at. Focus on what you're studying, what skills you're acquiring, how you're going to deal with the AI challenge, what jobs are immune or partially immune to what's happening in that space. Focus more of your energy on your biggest investment, you.

22:27Mo Milevsky:Don't waste time on the tiny little investments that are irrelevant and expenditures as well. Yeah, massive. If I can improve my lifetime earnings by 10%, that's going to be more of an impact than any investment decision I ever make. Thank you. I feel like my net worth has just increased. I'm not too worried about my assets Now I've got millions. You're going to buy another change. Yeah, I'm going to buy some more jewelry and some more Bitcoin. This idea of human capital, how you mentioned like DB pensions and DC pensions have changed. What other aspects of human capital have changed over time?

23:01Mo Milevsky:Yeah, I think that because of the fact that our jobs have become insecure, that is obviously one of the changes in human capital. I think we're much more financially aware of the, you know, the value of things than we were in the past. I think that changes human capital. I think that in some sense it's not just the job aspect of human capital. We're starting to rethink why am I investing time studying something that may not provide a yield down the line. And there's a rethinking about what the purpose of education is. You know, it may be it's more consumption than it is investment, which is just fancy economic terms for I'm having fun studying this versus I'm studying something that's going to generate more income because of my ability to get a better job.

23:51Mo Milevsky:So I think that's one aspect of it. I think we're starting to think about insurance very differently, protecting, you know, home insurance, car insurance, life insurance, health insurance. Even in an environment where you do have state coverage of health insurance, life insurance is still a concern, property insurance is still a concern. So what is the proper amount of insurance to have and what are the deductibles that we should have is another aspect of human capital I think that's changed over time. You should tailor your insurance policies to your true risks, considering human capital, as opposed to, you know, using the same rules of thumb we did in the past.

24:31Mo Milevsky:And I can give some examples, but certainly insurance is an important one. Yeah, I think I didn't have insurance for a long time. And then kind of when I started to understand this point around human capital and the idea of if you had 10 million pounds in the bank, say, or 5 million, pick your number, do you want to insure it for 20 pound a month? It's that, isn't it? The biggest risk that could happen to me is I lose my ability to work in my 30s or 20s. So insurance actually starts to look quite sensible for protecting your biggest asset. For human capital, for human capital. Not the trivial, not the extended warranty.

25:06Mo Milevsky:You know, you buy a new laptop or a phone and they're pitching a 10 pound a month fee. That's ridiculous. You're insuring something that's trivial relative to the big things. Take that and insure the important things. So redirecting your insurance premiums is another aspect of human capital thinking. Once you look at a balance sheet as well, and you see the phone's worth a thousand pounds potentially, but your life's worth three million, you go, well, I should be insuring the three million quid, not the phone. Even work insurance. I'm the only breadwinner in my house. I was ill a few weeks ago, and I was like, if I can't work, who's going to bring in the money in my household?

25:39So work insurance is something I never thought about in my life until recently.

25:43Mo Milevsky:So yeah, these are important topics. Yeah. And you know, these aren't commodities. I know we all encourage people to read the fine print, but to make sure that the risks that are pertinent to you are the ones that are covered in that work insurance. It's not a commodity where everybody gets treated the same way. You have to think about, well, what are your specific risks and is that going to be covered? It breaks my heart every time I see stories of people that thought that they were insured, but then when it came down to it, oh, that particular risk. No, travel insurance didn't cover it or this insurance.

26:13Mo Milevsky:to spend more time on looking at that than on your portfolio and on your investments. To me, that's an important takeaway. Yeah. So I want to just quickly finish on the human capital bits by looking at the changes again from 2008. Do you think human capital is now worth less than it was? Has that been reduced? And do you look at other jobs now differently? For example, what about the self-employed, say? What about, I think in the book, you give examples of, say like, you know, professional athlete is like a stock or something. Have you changed your view on job roles? I haven't changed my view.

26:48Mo Milevsky:I would say I've refined it. I think if I can use a corporate finance term, you know, MBA style, risk adjusted returns. When we look at returns, we want to know it's risk adjusted returns. You know, that has gone up 11 % a year, but on a risk adjusted basis, it's only three because it's volatile. I think that human capital's risk adjusted value has gone down, even though interest rates themselves since 2008 have gone down. And as we all know, when interest rates go down, the present value of everything goes up. So, you know, we should all be worth more because interest rates have gone down. But the risk adjusted returns and specifically the risk adjusted value of human capital has gone down.

27:30Mo Milevsky:Our jobs are a lot riskier than they were 10 or 15 years ago. We study something. We think that it's going to produce a high return. Everybody was told, go and study computer programming. That's the future. Now with Vibe coding, it's unclear whether anybody will have to learn a computer programming language. Chad GPT does it better than many experts that have been doing this for years. So the risk-adjusted value of that programmer's human capital has plummeted because of the fact that, wait a minute, I invested all this energy and time and tuition into this, but on a present value basis, I'm not going to reap the same rewards.

28:06Mo Milevsky:So I think the stability of human capital is deteriorated and it's become a lot more industry specific. What industry are you in? You have that risk characteristic. I think that's the first statement that I would make. The values of our human capital have declined. OK, thank you. I want to bring this into practically now how you would apply it to personal finances. We're not going to give advice, say, but let's say you had an example of someone who's a 35 year old earning 40K, investing for 30 years. Would you say then that they should be quite heavily into equities, ceteris paribus? Yeah, I know.

28:44Mo Milevsky:In fact, this reminds me very much of sitting with the students because after 20 minutes of me lecturing about theory of human capital, they also want to know, give me something practical. Here's a practical example. My barber, I go every few months to get a haircut. And he immigrated from Italy 30 years ago. He's been cutting hair. He recently was asking me about the stock market. Should he be investing in the stock market? He wants to diversify. He wants to build a portfolio. What's the right investment for him? Normally, someone that has very little financial literacy, who hasn't had formal education about investments in portfolio theory, you would say, oh, you want to stay away from that because you don't understand it.

29:27Mo Milevsky:But to be honest, my barber's human capital is zero beta. People will need haircuts whether we're in a bull market or bear market. If the economy is doing well or they're not doing well, you can't have Chad GPT cut your hair. You can't ship your hair to India to have someone cut it there. It is uncorrelated with the economy. And I asked him, you know, have you seen a reduction in the number of people coming in because we're in an unemployment desire? He said, well, actually, more people come in, they have more time. So that individual is a great example of someone that should be going all in in a diversified equity portfolio, indexed Morgan Stanley Capital International, MSCI World Index, because of the fact that his human capital is completely uncorrelated with equity markets.

30:17Mo Milevsky:That would be one extreme example. At the other extreme are MBA students that wanna become investment bankers. Their dream is to go work for Goldman Sachs or JP Morgan or Barclays, and they just can't wait to get recruited so that they can stay up till three in the morning running simulations on spreadsheets. That's their dream. That's what they wanna do. They think they're gonna become wealthy. That's great. Their human capital is very stock-like, very financial stock-like, very financial industry specific. I plead with them. Your human capital is very, very risky. Your financial capital, put it in the safest things that you can.

30:56Mo Milevsky:Buy a barber shop. Like just do something completely different. But that is not the way people are thinking. People tend to focus on things they do. We have a big oil industry here in Canada. People who live in Alberta and Calgary and Edmonton, they work in the oil industry. They're engineers. They're petroleum engineers. They're working for people to work in the oil industry. And then you look at their financial portfolio. It tends to be invested in oil company stocks because they live there. They know. They understand. Airline pilots, famous academic study. What's their portfolio concentrated in?

31:30Mo Milevsky:Airlines because they know airlines. And the list goes on and on and on. People are investing in what they think they know. It should be the exact opposite. invest in things you know nothing about because you don't work there so you obviously know nothing about it that's where i would say the practical lesson is well i know nothing about anything mate so i'll be i'll be investing there you go what about how you go what about home bias then because um you know i think there's been a lot of chat about home bias and how actually it can be good beyond the status quo is it the paper um that argues sort of up to a 33 home bias but you would I guess would say you should not be investing in your domestic market.

32:09Mo Milevsky:You know, again, it's the doctor with the knee. I mean, let's take a look at what they do for a living. Are you really home biased if you work for an international company? Are you home biased if you're in an industry that's deriving most of its revenue from international sources? Or are you, you know, delivering pizza, in which case you're very localized? I think one of the key messages that I'm trying to impart here is personal finance can't be summarized in sound bites that investments can. When you talk about investments, it's very easy to say, yeah, oil now going through the roof. You might want to take some profits.

32:44Mo Milevsky:That's it. We're done. Take some profits. Oil is going up. When it comes to personal financial planning, you really have to dig a lot deeper and you have to start with the personal balance sheet. So home bias, is it good or is it bad? Well, let's take a look at what you do for a living and what the risk factors are on your personal balance sheet. Okay. Have you got a job that's in the middle of the spectrum that might help people think, you know, someone that's on 50-50? Yeah. Independent contractors, people that have control of their time. I think that's a great example of someone that's in the middle.

33:17Mo Milevsky:So if you, there are many jobs out there that no matter how much overtime you put in, you're not going to get paid more. Your boss is very clear. There is no overtime. Get out of here. It's 4 p.m. in the afternoon. There are other independent contractors that can put on more time, side gigs they can put in there. So they now have another lever. It's not just about are you a stock or a bond? It's also about do they have the flexibility to generate more human capital if they need to? Yeah, they don't, if they don't have to, they won't. But are they able to do that? Can they put in extra hours and get paid more?

33:50Mo Milevsky:That's a lever that can be used to diversify extra risk in your portfolio. I used to think that way myself. I had a lot of risk in my equity portfolio because I felt my career was relatively safe, but I knew in the back of my mind, if that portfolio tanks and we go into a 20-year bear market, Japan style, well, I can always teach a little bit more in the summertime. There's always a need to teach over the weekends. I'm a teacher. They're always asking for someone. So I can put in that extra time. That's a buffer that I can add to my human capital. So I would say people with job flexibility, not when they work, but to work more.

34:27Mo Milevsky:That enables them to invest more aggressively. So on this podcast, we talk a lot about global index. It's nice and simple, just invest regularly. But with your philosophy, I guess, it seems a bit more complicated. You have to think about your kids, your parents, all the aspects of your human capital. Could this lead to people making mistakes in their investing? Look, to the first point about it being complicated, you know, life is complicated. And if what we want is soundbites, just invest in the global index, and then, you know, go back to playing video games, that's not going to give people financial security.

35:06Mo Milevsky:I think on a first, you know, this is about lessons. What is the first lesson you teach someone who is completely ignorant of financial markets and finance and personal finance. The first statement you teach them is, hey, global markets tend to outperform individual sectors, diversification, don't try to outguess the market. Lesson number one. Once they've absorbed lesson number one and they're ready for lesson number two, you can't just throw this all at them at the same time. What I'm saying is, is that if you work in the biotech sector, you work in biotech and your spouse works in financial services, so you have biotech exposure by virtue of your job and your spouse or your partner has financial services exposure, you should not be owning the global index because the global index contains about 30 % financial services and about 20 % bio.

36:01Mo Milevsky:You already have exposure to that by virtue of your job. Scale down a little bit of that, not entirely. Don't have a global portfolio. carve out the pieces of the global portfolio that you already have. I'm advocating for less duplication in investments. You own that already. Why are you buying it again? I don't think that's a complicated statement. I'm buying the global index. No, you own pieces of that already by virtue of your job. Take it out. Don't buy two things. You already have one. So we have to simplify it up to a point. But after a while, you have to understand life is complicated and we, you know, we have to work our way around this complexity.

36:39Mo Milevsky:But one pushback is, you know, I own a piece of Goldman Sachs, but if JP Morgan does well, that's, I don't have exposure to that. So like, you can't say that financial market, like one company is representative of the whole financial market. Yeah. I agree with you. You certainly want to hold Goldman if you're working for JP Morgan, but you do know the correlations in the financial sector are much higher than correlations with oil and gas or biotech or any other industry. There are natural correlations there. I can tell you if Goldman Sachs is down 30%, there's a very good chance JP Morgan's fallen that day as well.

37:14Mo Milevsky:There has been some shock to the financial sector. They're not uncorrelated. Whereas if oil and gas prices decline or oil goes up, I don't really know how it's going to impact Barclays today. There is some natural correlation there. We want to strip that out. Part of this is to be provocative and to get people to think. When it comes down to it, would I tell them to completely eliminate all financial services in the index? No, obviously not. The point you just made is very good. You have to provoke people. You have to get people to think. You have to get people to absorb it, to push back. And then you say, okay, but would you agree that since you work there, you shouldn't own Amazon?

37:51Mo Milevsky:You work at Amazon? Or since you work at NVIDIA, you shouldn't own NVIDIA in your index fund? You already have 2%. It's a process, not a sudden binary, do this, do that. Do you think then risk appetite is a silly question? Like your, you know, how much risk do you feel comfortable with would be the wrong type of frame? And it's more this, this is how people should look at risk. Yeah, I'm very uncomfortable with the idea of a risk appetite or risk tolerance. And it's not just me. I mean, I'm leaning on giants here. Daniel Kahneman, great psychologist, passed away a year or two ago, behavioral finance, behavioral economics.

38:32Mo Milevsky:He, in a number of places, wrote and said very clearly that he doesn't believe that risk tolerance or risk appetite can be measured in any accurate way. You wake up in the morning, you haven't had your tea or your coffee yet, you're edgy, you're foggy, you're very risk averse. You know, you don't want to deal with that. And then at the end of the day, you're cocky, you're arrogant, you're happy, you had a beer, you're with your mates. Sure, let's take on some risk. You have the crowd that's backing you up. So what is your true risk tolerance if it changes so much during the course of the day? I think that that is not what we should be gearing asset allocation to, you know, this thing that's so difficult to measure, questionnaires that are unreliable.

39:14Mo Milevsky:I would much prefer to start off looking at what a person does for a living, what their balance sheet looks like, than to ask them these abstract questions. If you had a choice between this and that, and this went up 12%, and this, especially with the weakness in financial literacy. So my short answer to your question is, no, I'm not a big fan of risk appetite. What if their portfolio drops 20 % and they sell because they weren't prepared for that volatility? Does that risk appetite not become very real in that moment? I think it's risk education. I think what we really have to do is explain to them eventualities, scenarios.

39:50Mo Milevsky:Look, if you do this, there is a chance that that goes down. Are you going to continue to hold on? Are you capable of holding on? Are you going to be placing your future at risk? I think it's about literacy. It's about education. It's about dialogue with risk as opposed to giving people a number. Oh, your coefficient of relative risk aversion is a seven. so you definitely want to have treasury bills. Oh, you're a three. Okay. You can afford some stock. I don't think it's this, you know, we've yet to discover the gene, you know, there we go. We found the gene for risk aversion. You, you don't have risk aversion.

40:26Mo Milevsky:You lack that gene. I don't know. I'm skeptical. I mean, I definitely understand where you're coming from, but for example, people that want to get into crypto or Bitcoin, I, because I worked in the industry, I tell them like, this is not get rich quick overnight. You will be stressed at some point. You might get gray hairs. You might feel sick when you see like a downturn. So you have to be mentally prepared, but I get what you're saying. It's better to kind of give them the education about risk than say, where are you on the scale? Yeah, there's no like, it's not a flavor profile, though, is it?

40:56So I'm not like Nando's. And like you say, people - How spicy do you like it? You ask a beginner how much risk do you want to take? They're always going to say, well, I don't want any of that. Like, I just want, you know, do you want max risk or no risk? you know, I'll take no. And then people educate themselves and they always tend to go, oh, I probably need more equity exposure than I've got at the minute. When people start investing and thinking about getting started, is asset allocation the wrong place to start then?

41:22Mo Milevsky:Well, it depends what they mean by asset allocation. I mean, if it's a mixture of stock and bonds, it's a good beginning point. I think that there's a paradox at the heart of this. If we tell everyone to index, right? If we show them conclusive research that's very difficult to outperform the indices, risk-adjusted performance tends to be negative, fees eat up your returns, just go buy the index. Just keep it boring, my friend. Just go buy the index. If we tell them to do that, they'll never become financially educated because you've just told them something that'll take them five minutes to do.

41:55Mo Milevsky:They buy a fund or an ETF that's indexed and they don't have to pay attention ever again. The key is not just to get them to diversify and have a broad asset allocation, but to learn about this and to have skin in the game and to watch this and care about it in a way that teaches you something. And the only way to do that is active management. So it's this paradox where a large fraction of your portfolio should be diversified indexed globally, but there should be enough there where you're taking action so that you continue to learn about financial markets. Otherwise, you'll continue to be ignorant.

42:30Mo Milevsky:And that's not good either, even if you're diversified. So the short answer to asset allocation is important, but don't stop there. I encourage people go out and try to beat the market. Yeah, you go out and do it. And I know, and the research says they're never going to be able to beat it. But boy, do they learn from this and they lose and they understand how painful it can be. And they go in and they try to understand the financial statements of a company. And they say, I think this company is an undervalued asset, so I'm going to go invest in it. It's a great exercise. You'll learn from it. But will you make money above what you would have from the index?

43:04Mo Milevsky:I don't think so. I'm not sure I've answered your question. Very well. You've given us a good question. Don't you think that people, I know a lot of people, when I started like this, when you start investing, you pick randoms. Oh, I know Amazon, I'll buy Amazon stock. And then you don't realize that's high risk. But at the same time, we have our nest pensions, and they put people 50 % in equities, 50 % in bonds so that you don't lose much money in the first few years. You don't get scared. So both ways have their flaws. If you pick random stocks, you're probably not going to beat the market. You'll probably lose some money.

43:33Then you might say, oh, this isn't for me. I've lost money investing. I'd rather just keep it in the bank, keep it under my mattress. But if they put you 50 % equities, 50 % bonds, you might not see the most growth, but you'll understand it a bit, but you'll not really be like performing as well as you could be. And you've wasted those first three to five years being in bonds when you could be 100 % equity, so you're missing out on returns. So it's kind of like, what's the perfect way to go?

43:58Mo Milevsky:Yeah, so you're getting into another area that I think is extremely important, and that is what should the default be in these funds that are just putting people in and hoping that they forget about it for the next 30 years? Is 50 % bonds too much bonds for this individual early in their life? And depending on what you do for a living, there it is again, I think it might be unnecessarily conservative. You know, certainly if you've got some measure of job security, I don't understand why bonds that barely beat inflation are such a big component of those funds. I would have more equity. Now, I would also have equity that is uncorrelated with what this person does, what industry they're in.

44:41Mo Milevsky:You can't just put everybody into equity and say, you know, we're putting youngsters into equity because they have time. Well, some youngsters are working in the banking industry. Some are working in mining. Some are working in petroleum. Some are working in high tech where we really don't know what their human capital is going to be like. So I think that just these one size fit all is not the way to go. And we have to make it a little bit more specific, tailored, personalized medicine, personalized investment allocation. Yeah, the allocations of the default funds here in the UK baffle me because they will sit there and say 90 % of people don't log on.

45:20So it could be in anything. It could be in, you know, Mars bars and people wouldn't even know. But then they'll say, oh, we de-risked them in their earlier careers because we're worried that if it drops, they'll leave. But they're not even logging on. So it's like a paradox of sorts or whatever. But yeah, we spoke to the head of Nest Invest, which is the largest default pension system here. I don't know if you've heard of them. They're pretty big. And they have that attitude of, in the first few years, we de-risk people, which just seems wild to me, considering what you're saying.

45:53Mo Milevsky:Yeah, I think we have to make it more interesting. The reason they're not logging on is it's just not interesting to them. So how do we make it more engaging? How do we make personal finance more interesting? How do we not bore them? They would log on if we made it more interesting. Maybe we have to gamify it somehow. now. There's something fundamental about financial education that just turns people off. And if we did it in a way that was more engaging, maybe we'd have a much higher percentage of people logging on and saying, hey, what am I invested in? What does this mean? I actually think it's ridiculous to even use the word retirement when you're talking to a 20 or a 30 year old.

46:30Mo Milevsky:I mean, that is a meaningless concept. Like that's grandfather, grandmother. We have to talk about smoothing your lifestyle. Over the course of your life, this will help you smooth your lifestyle. That's what this account is for. Smoothing consumption over the course of your life. Never use the R word. Never ever use retirement. Maybe when you're in your 50s. We're putting this money there so that if there's a disruption to your standard of living, you can tap into it to fix the disruption. That may occur in 30 years, 50 years, or tomorrow. How do we allocate the money in that account to stop the disruptions.

47:05Mo Milevsky:That's it. It's not about retirement. Would you give access to those funds then beyond just retirement as in 57 plus or whatever the age is? Would you say that there is flexibility there? I would say if there's a disruption to your life or your lifestyle, that's what you tap into that for. Enough of this boxing. That is only for a house and that is only for retirement. That complexifies the whole system. And there are many players that benefit from that complexity. They're selling services based on that complexity. This is a bucket. That bucket is taxed in this particular way. And it's going to help you smooth consumption over the course of your life.

47:44Mo Milevsky:I mean, we saw that during the pandemic where a lot of people were given access to their accounts because they're in financial distress. I think this idea of taking specific goals and attaching boxes to them makes it complicated. And that's why people get turned off. Retirement, the whole concept. I mean, I don't want to retire. I like what I do. I like what I'm doing. If I'm dragged out on my last day of teaching to go to the cemetery to bury myself, I'll be happy because I like what I'm doing. The idea that you physically pick a date and time and say, it's 62. I'm going to stop. Some jobs you have no choice.

48:20Mo Milevsky:Other jobs you can continue. We really have to retire the word retirement in all literature. Yeah, I think financial independence is a bit maybe sexier. The fire movement there, just take the start of it. I think that's what made me switch onto this, as in more flexibility over my time and choice, right? But I do worry about accessing pension funds for life events because life has a way of eventing on a regular basis. And it's like, how do you justify that? There's an inertia point around retirement savings that means the fact that you can't touch the money is a really powerful mechanism to get people to save long term.

49:01And if they could come every time they have something bad go on in their lives and go, I'm just going to tap that pot, would there be anything left by the time they got there?

49:08Mo Milevsky:Well, so you're questioning, you know, whether people are going to be rational enough and whether we have to be paternalistic and tell them how to manage their... I mean, that's a political question, you know, way above my pay grade. Are people capable of making their own financial decisions or do we have to make it for them? Because if they do it themselves, they're going to do it wrong. I think that people get into financial distress and it's unfair and it'll ultimately be harmful if we tell them, no, that pot of money you can't touch for 10 years. But they need it now. They have a crisis now.

49:36Mo Milevsky:And if we define crisis properly, we should enable them to tap into it and tap into it without tax penalties and tap into it without a lot of paperwork and hassle. Otherwise, other people will look at this and say, no, I'm not saving in that because if I have an emergency, I can't tap into it. It's a tough question. I agree with you. It brings up issues that are beyond just asset allocation. Yeah, I think you've hit on a point there as well. And if someone slips into financial hardship because they can't access the funds, it limits their ability to save into that pot anyway. I wonder how many people opt out of their pension because they're in debt, for example, and they never get back into the scheme or they're missing out on the employer match because they've got pressing credit card debt.

50:15If you just let them get the money to clear the debt, they would stay in the scheme and benefit long term. them. Yeah.

50:20Mo Milevsky:Or at least borrow against it at a reasonable rate, not at some atrocious high rate. Those would be some of them. Look, you know, there's a whole bunch of policy issues that come into this. Well, is the tax system too complicated? And is that what's impeding people from logging onto their account and finding out what the account is going to be worth? Is that part of what's driving it? But I think that this idea that we're all saving towards an event 30 years in the future and that's all that matters is not the way to smooth our standard of living over the course of our lives. We need something to be able to tap into.

50:55Mo Milevsky:If something goes wrong, that's how we smooth things as opposed to, oh no, no, no, that's for the crisis in 30 years, not for the crisis today. Yeah, I do think it would improve engagement. I think you're right. So the crisis in 30 years, let's talk about that a little bit. We have a lot of people on that say that they expect returns to be lower going forwards than they have been, especially inflation-adjusted returns. Let's say if they're 3 % to 4%, what does that do to the retirement outlook for people in, say, mine and Tomein's cohort? Yeah, so... Sorry, I used the word retirement and you just told us to retire it.

51:30So, yeah,

51:32Mo Milevsky:old habits die hard. At some point, the language forces us to dialogue in a certain way. That's the way it's looked. Look, people have been concerned about risk-adjusted returns and the long-term return on equity for decades. I mean, when I was in graduate school in the 1990s, there were people warning that risk-adjusted returns aren't going to be as high, and they actually ended up being higher than even some of the most pessimistic forecasts. But if we really are in a new era, you know, to use a term, this time it's different, if really we are, then it's not just about saving more. It's not just about, you know, exiting the workforce later.

52:07Mo Milevsky:It's also about making sure that those dollars or pounds that we put in work harder for us, paying less fees, making sure that the charges on these accounts aren't high. I think finding careers and professions and jobs that will enable us to ease out of the labor force slowly over time as opposed to all at once. To be able to continue doing things that generate create labor income until very, very advanced ages in our life. I think that's going to be part of it as well. So it's not just what do you do for money or for income or for wages? What do you do that you can continue doing into your 70s and 80s?

52:45Mo Milevsky:That's how we have to think in this environment, if indeed returns are going to be lower. But we don't know until we get there in a way. You know, we kind of got to, you deal with it at the time. Yeah, not only do we not know until we get there. You know, sometimes after the fact, we don't know what our risk adjusted return was. I mean, you know, you ask people that are at the cusp of their 60s and 70s, you know, what was your adjusted return? They don't know. They see a pot of money. They see half a million pounds. They think they're doing well. No, your risk adjusted return was actually worse than had you done something else.

53:18Mo Milevsky:So it's not just ex, you know, ex ante. It's ex post also. It's not just before. It's I don't know. What was the risk adjusted return? I do think we have to spend a lot more time on financial literacy issues to make people aware of some of these risks because of all of these changes in the environment compared to 30, 40 years ago. I think one that you do really well on this is the story, the Stephanie and Brett story, if you remember it. So it's Stephanie Swipp and Brett Bucket. It's the two people, same returns, completely different outcomes. I think this is a real risk that people need to understand about how you can be on the same timeline as someone in a pretty similar place and end up in completely different places.

53:57Can you just summarize the story for me if you can.

53:59Mo Milevsky:Yeah, that's known as the sequence of return effect. That speaks to a slightly higher age group. This is people that are withdrawing money from their portfolios already. They're decumulating. And the key message there is that the order in which the returns are being earned is going to have a much bigger impact on how long the money lasts compared to what the actual rate of return was. So, you know, I earn 9 % on my portfolio. You're earning 7%. So I'm 9, you're 7, my money should last longer. I'm earning 9, you're only earning 7. But in fact, your money might last longer because of the order in which returns come.

54:37Mo Milevsky:If my returns are more volatile and I have negative returns early on, they might not last as long. So the message in that particular chapter was to pay a lot more attention to the order in which returns are coming as opposed to what the compound growth rate was. Stop focusing on, I earn 9, they earn seven, so nine is better. No, nine may not be better than seven if you earned it in the wrong order. I think that's kind of the key message. How do you protect against that risk as you approach? I'm a very big believer, and this gets into retirement planning, even though I hate that word, this gets into decumulation planning, which is a word that I prefer a lot better.

55:14Mo Milevsky:Not being greedy when you reach your 50s and 60s. And I think that that's something that's very important. You're building a portfolio to say to yourself, you know, if you earn more than 10 or 15%, you really got very lucky. Do you really need anything above the 10 %? And of course, everybody wants the most they can get. But my pitch is, if I have a pitch, don't be greedy. Give up anything above 10%. Enter into an agreement where if my portfolio earns more than 10 % in a year. I don't want it. Give it to someone else. Now, of course, that sounds ridiculous. Who's going to get it? Well, instead, protect me that if my portfolio goes down by more than 5%, I want to be protected.

56:02Mo Milevsky:I want a put option, to use a fancy term. So let's collar our returns as we move through the life cycle. Don't give me those very, very high returns, which I never really was expecting anyway. My expected return was much lower. Give it to someone else, but in exchange, give me insurance, give me protection, give me puts on the downside. The outcome for retirees will be much better if they enter those sorts of arrangements versus kind of an all or nothing. Yeah, I'm going to, if the market goes up, I get the whole return. If the market goes down, I'll lose as well. To start, another term is to collar your portfolios.

56:40Mo Milevsky:And there are products, at least on this side of the Atlantic, that are now being sold to current 50, 60, 70-year-olds that are becoming very popular because of that trade-off. They're saying, look, if the market declines, you won't suffer those horrendous losses. But if the markets go up, you have to give up above a certain amount. It may be explained to them differently, but the key idea there is don't be greedy, call her the portfolio. That's fascinating. So you limit the spread of outcomes within this tighter range so that you're not going to be the person that gets a minus 20 odd or 30 percent in a crisis yeah what do you do about what's the withdrawal rate looking like through that period are you taking just like a yeah so you obviously have to be realistic on what you're withdrawing i mean if you're pulling out very high amounts no collar will save you but if you limit your withdrawals to reasonable percentages then you should be able to weather the storms with that sort of protection strategy.

57:39Mo Milevsky:I would never pitch that to a 25-year-old. When I was 25, there's no way I'd sign up for that. I want the entire upside. And they would say, but what if the market goes down? I don't care. I'm not selling. I'm holding it on for 30 years. I don't care what happens between now and 30 years from now. But as a 55-year-old, that really appeals to me. I don't know. I think valuations are very high. I think PE ratios are at a historical high, especially if you use Shiller metrics, CAPE ratios. I'm very worried. We could see a decline of 20 or 30 % in the value of the market, and this will affect my ability to accumulate.

58:15Mo Milevsky:I'm willing to enter into an agreement. I'll give away the upside, maybe even greater than 8 % returns, protect me on the downside. It really appeals to me at my stage of the life cycle. And more and more financial services firms are packaging these things, or advisors as using puts and calls to do it to appeal to folks that say, hey, I'm not interested anymore in this very widespread of outcomes. Tighten the range. What are some of these products called? I don't know if we I don't think we have these over here, but we sounds great. I love some of that. I mean, the closest I think we've got to that is like an annuity.

58:51But yeah, what are some of these products called over there?

58:54Mo Milevsky:Every jurisdiction has its own names, but I am absolutely certain that targeted outcome funds, protected ETFs, buy-right strategies, they have a million names. In the U.S., they're called variable annuities. Why in the world are they called variable annuities? What does annuity have to do with what I've just described? It's a legal term. But every jurisdiction nearly around the world now has these instruments. Some are marketed and popularized. Some are niche. But I think that as we see a generation of people go through the torment of volatile markets, reach advanced stages in life and say, hey, you know what?

59:32Mo Milevsky:It's time to stop chancing. In the olden days, the only choice was moving into bonds. In the olden days, oh, you're worried about the spread of outcomes, just put it in cash. We don't have to satisfy ourselves with that binary strategy anymore. Oh, just move it to cash. We don't have to do that anymore. We can literally tighten the range of outcomes and continue to be invested. And that might be like a fund, like you say, it could just, it could still be 100 % equity fund. It's just got a cat. It's got the collar on the top and the bottom, right? So you only ever see it at max 10 minus five. Yeah.

1:00:04Mo Milevsky:And that brings up the question of what does asset allocation mean? I mean, am I 100 % equity? Yeah, I'm 100 % equity. I'm all in the S &P or I'm all in the FTSE index. Well, but if the market goes down, I'm capped. So am I really 100 %? So I think part of it is the terminology we're using to describe it prohibits us from being able to put that in our vocabulary. It's like, no, I'm 100%. You are 100 % equity today. Tomorrow, you might be 100 % cash if the market's gone down and you've exercised that put option. But it enables you to continue to be invested without worrying about the spread. I think those are going to become very popular for a given generation, not the 23-year-old I'm teaching in business school.

1:00:48Mo Milevsky:They have no interest in this and they really shouldn't. Their parents and their grandparents, this is going to sell. Yeah, yeah. In 50 years, I might be interested in it or 40 years, you know, because then I'm, it's, you know, it's hard for people to accept that they might miss out. But if you've got enough and you just don't want to have to worry, this is so valuable at that point, right? You just want to play your golf or go on your holidays. And, you know, as long as I get within this spread of outcomes, I am fine. Do that all day. could I give you um how I was going to approach the sequencing risk you can rip it apart and tell me if it's a terrible idea so just just say like a three years worth of cash equivalent that I can live off in terms of a downturn so I'd live off year one I have year two and year three and they just kind of sequence down or like a waterfall any time in good years I replenish year three by selling down with variable withdrawal and if the markets go bad I just live off those three years and hope that I can see out the three-year period.

1:01:46Would that work in theory, or do you see holes in that?

1:01:51Mo Milevsky:Look, it's a placebo, to use a medical term, but if it makes you feel better, by all means, take it every morning. Reddited. Yeah, go on. Yeah, it doesn't work. Yeah, it doesn't. It makes you feel better. Go on. Why do you think that doesn't work? So let me explain to you. I think it's a bit of sleigh of hand. You know, it's the person with three cups and they have a ball and eventually the ball disappears and you thought it was under that cup. What you're doing is you're swapping out stability of cash flows, which is what you're generating, for variability of asset allocation. Your asset allocation is going to be unbelievably volatile in that because you're looking at your cash that you set aside and you're saying, I'm not thinking about that.

1:02:32Mo Milevsky:That's not part of my investments. My investments are here. But you have to look at it in totality, total balance sheet. and on a total balance sheet basis, you've traded stability of cash flows for huge variability of asset allocation. And you might wanna do that. That's the placebo element. You just want stability of cash flows. But it doesn't change the fact that if you incur a very bad sequence of returns early on when you're withdrawing, the money's not gonna last as long. So if I can get even more technical, run a computer simulation. This is called a Monte Carlo simulation of your strategy.

1:03:06Mo Milevsky:run a Monte Carlo simulation where you've collared things or a Monte Carlo simulation where you just keep the asset allocation static and count how long did your money last in your strategy and how long did the money last under my strategy. Inevitably, there will be some scenarios in which you win. There will be some. You can cherry pick them and you're going to say, Mo, you see, on that path, my money lasted longer. But when you look at the totality of the paths, all the different things that can happen, most of the time, the money will last longer under my simulation. So I don't know if I've convinced you.

1:03:40I'm not going to argue with you, Mo. I'm not going to argue with you. I bet you've done the simulations. I would be building up the buffer prior to retirement. So I wouldn't be, and then I guess my argument would have been that a three-year sequence of bad returns is quite, quite long historically. Hopefully I would be okay through that period. And there's normally a mean reversion, right? So the returns normally come good again at some point, which maybe your Monte Carlo simulations didn't factor in.

1:04:10Mo Milevsky:They would assume, do they? No, we, look, I know we're getting very technical now, but you can put in serial correlations in these Monte Carlos. You can bootstrap historical serial correlations. The short answer is if we would sit down in front of a simulation or a spreadsheet and run it, I am absolutely certain that in 5 % of the scenarios, you would win. You would point to 5 % of the scenarios and say, see, it was better. It was better. It was better. But 95 % of the other ones, it won't. And I think ultimately I look at it and I say, look, the odds are 95 over five. And even if it was 10 % of the scenarios, you win.

1:04:44Mo Milevsky:90 to 10, I still take the ones with the higher probabilities. You're killing me here, Mo. No, no. 10%. You're 5 to 10%. Yeah. I'm smiling. I'm smiling for one reason. Your question that you just posed is precisely the final exam question I give everybody in my retirement income models course. I say, the people in the street think this will work. What do you think? It's a placebo running up that hill. Your knee still hurts. Yeah. Well, I mean, like I said, I'm not going to argue. That's why I wanted to ask you because this is, I mean, we've had financial advisors talk about this strategy. They call it like a waterfall strategy or things like this.

1:05:23I think it's quite a common one. And I wanted to put it to the test because I knew you were the man to do that and I will change how I talk about that

1:05:30Mo Milevsky:going forward. Look, I'll also say this. There's no way I can convince you verbally. This is not the rhetoric that one uses to convince people. You have to sit down, write down the maths, write down the equations, and you show people this is just, it doesn't work. That's why it sounds great. It's one of those things that just sounds wonderful, but when you actually sit down and model it. It's just not, it's not working. Yeah. I mean, I completely understand them. And what you're saying is clean and people think I remain 10 control of my money and it all makes sense, which is why I liked it versus what you're saying of giving up the, giving away the upside.

1:06:06And there tends to be more upside because markets tend to go up more than they go down. And people are not going to like that in the same way that whenever we talk about annuities, people hate the conversation of annuities because they're giving up the pot. Do you know what I mean? Like, So it's unfortunate that the thing that works is the thing that kind of takes away a bit of the control or a bit of the upside as such. But yeah, I'm not going to argue with you.

1:06:27Mo Milevsky:No, it also brings up another issue that's related, which is how many decisions and actions will you have to take with your strategy versus how many decisions and actions will I have to take? Remember who we're talking to now, 50, 60, 70 year olds, every single financial decision and action that they have to take is costly from a cognitive point of view. It creates risks. Are you able to make those decisions in the same way when you're 70 and 80? One of the things we want to do is to automate our asset allocation investments withdrawal strategy so that we don't have to make those decisions. And that's something that's very difficult for youngsters to understand.

1:07:04Mo Milevsky:When you're 30 or 40, you love making these decisions. I still enjoy them. I open up my spreadsheet at the end of the month and I say, look at that, European stocks, they've gone up more than American stocks. Maybe it's time to take some profits. What's the PE ratio in Asia? Maybe it's time to go Japanese. I love doing that at 50. At 60? At 70? At 80? At 95? At 95, will I be opening up my Excel spreadsheet to see PE ratio? 95? I mean, I'll be happy at 95 with a, I don't know, a decent bowel movement. 95? Right? Now, just think about it. So, I want to automate it. I want it to be on autopilot. I don't want to make these decisions.

1:07:42Mo Milevsky:Oh, markets are down. Let's take money from the cash, cascade. Nor do I want to pay a financial advisor for it at that phase. Why should I be paying 2%, 1 % of my assets? I want it to be automated. I'm a do-it-yourself investor. I think that's also something that when I write a book when I'm 30 versus when I write a book when I'm 50, this ability to make decisions over time is something that deteriorates. So it's like a cognitive risk. What are other risks of people? What do you think the biggest risk is that people don't think about? Yeah, I think that cognitive decline is something that's just beyond comprehension for people, unless they're exposed to it at home.

1:08:17Mo Milevsky:I think the cost of longevity is another very important one, the cost of health care and longevity, which is very context and country specific. If you're in the U.S., health care costs are a huge part of what you worry about in that phase of life. In Canada or in the U.K., we have socialized medicines a little bit less than that. the cost of longevity, not so much how long I'm going to live, what that's going to cost, and the impossibility of predicting expenses towards the end of that lifespan. It is very, very difficult to budget once you get to those stages. You can figure out how much you'll spend on coffee, what you're going to do over the weekend, what you'll spend on clothing.

1:08:56Mo Milevsky:Very easy to do that when you're 30s. Once you get to 70 and 80, the cost of some of these health expenditures and having health care people to help you through your health care expenditures will depend very much on family. Do you have family that can help you or do you have to pay for it yourself? You have kids that live around you that can assist you in that phase of life, or are you going to have to hire people to do it? That is not necessarily a risk, but that is an unpredictable expenditure that people have to get a grasp on as they age.

1:09:30go on entraman what did you think this time mate i thought mo was great he's got good energy i wish he was one of my teachers great teacher all his students are pretty lucky and also it gives you like this whole human capital idea like i said it makes me feel a lot wealthier after this interview like my net worth is higher looking at all my future potentially earned income and then he brought me back down to talk about my liabilities but yeah it's really really different way to think about it yeah i also think saying to someone you know it's a placebo but if it were if you think it works that's okay for you it's like one of the coldest takedowns ever it was like the polite shattering takedown yeah yeah yeah but delivered from him i was fine with it facts yeah we'll see you next time peace normally this is where we'd say this isn't financial advice and it really isn't but if you want to speak to a good financial advisor then we might be able to help We've partnered with a few advisors to offer a range of services from one-off flat fee guidance to ongoing advice.

1:10:28I'm actually using the guidance service to sort out my finances. If you'd like to understand your options, there's a link in the description where you can answer a few questions and then book a free call with my colleague Will so you can figure out what might be right for you. This episode was produced by Ruth Edwards and it was filmed and edited by Ben and Jack at Flowspire. See you next week.