TDI Podcast: The Perfect Portfolio (#960)

29:32The big, like Salesforce. So you have all these companies out there that were the disruptors, that were, I don't know, we'll call it, I want to call it first-level tech efficiency

29:48and productivity beneficiaries. Now, all of a sudden, things are a problem, right? We see industry after industry all of a sudden freaking out and flinching with AI. In fact, just earlier last week, there was a discussion from altruist.ai, which where you could upload your tax forms and a few other forms and all that. And voila, they do all this work for you. And some of the guys, like I was talking about this at the beginning of the show, Schwab, Morgan Stanley, a few others got just beat to crap in a day. is ai generally speaking um from our portfolios what how should we be looking at this gosh i mean this is one of those things that it's very it's very very hard to decipher what is going on because the and this is part of the problem with the the world today is that things are changing faster than they've ever changed.

30:50And, you know, I was reading this piece. There's a great piece by Matt Schumer called something big is happening. Uh, people should Google it and read or read it. It's on Schumer's website. Schumer is a, he's involved in the, the kind of on the ground and the whole AI ecosystem. And he talks about how there is this seismic shift that's going on that really has not even started to impact things. He basically was saying that, like, you know, in short, the AI is starting to rewrite the code for the AI. And so he's a developer involved in writing AI where all of a sudden the people developing the software that is transforming everything are no longer, they're basically irrelevant inside of developing the software itself.

31:34And so you can start to see this world where when people who are that involved in actually developing the software become irrelevant, well, what does it mean for the rest of us? where this software eventually just starts doing all of the other things around the world. And I don't know. I mean, I think that there are pockets that are going to be disrupted and probably eliminated. And that's the scary thing from an employment perspective is that this isn't like, you know, the innovation of like the car is something that a lot of people would look at and say like, oh, well, this is going to, it's going to ruin all of the mail delivery services.

32:10and the Wells Fargo delivery service from horse and carriage is gonna go away. And that's a really interesting way to look at all of this because the adoption of the car was different than today because it took, God, it took really like 50 years for cars to get really widely adopted. It wasn't until really like people came back from World War II and even like Vietnam and then really started to, the average American and then really owned a car in a widespread manner. This is happening much faster. So this is different in that sense. I don't think I buy into quite the narrative that this is gonna like destroy the employment market.

32:53And because there's kind of a catch 22 in there where the paradox in all of this is that if the AI start really destroying a lot of jobs, well, the demand for AI then goes down because people won't be able to afford to buy all these crazy subscriptions to, you know, all these different services. And so there's kind of a paradox in there where the, you know, unless you have somebody else coming in and fill the spending void, you know, if you get enough employment, well, we reach a point where people aren't even buying this technology in the first place. So, and the other thing is like, this is still very, I think, sort of niche in terms of its impact and the way it's going to materialize out over different sectors, because until this becomes something that is like for me, the moment where this becomes really scary is when, when I wake up one morning and I see robots walking across a construction site, that is the scary moment where you kind of know that it's going to happen.

33:50I have no doubt. I think it's going to happen in our lifetimes, but you know, I, that's really scary because at that moment, those robots are doing even the most manual of labor. That's the one thing. That's the last thing. This whole thing, Colin, is I call this, I've been calling this for years. When we saw some of the productivity and efficiency come out, consumption cannibalism. Whereas you have a robot or you have a, let's talk about a robot in an Amazon warehouse, right? They don't need to take breaks. They don't need to have a vacation. They don't whine to HR, right? Nobody's harassing them.

34:28Nobody, they don't need to ask for a raise. They don't need to take a lunch break. They don't need a smoke break. You know, this is where all of a sudden this happens and we see all these potential things. Now, what happened was productivity got better. More people made more money. There was more consumption. I get it. But this is kind of like that. I see this as a little bit of the tweaking of the potential for that consumption cannibalism where all of a sudden people may be out of work in certain areas or not necessarily. Look at, for example, graphic artists. I mean, man, you can go to Grok and ask just a very simple thing.

35:04It'll do a whole image for you. That's beautiful. Beautiful. You used to have to send that out. You wait to the guy, tweak it up. You send it to Upwork, which, by the way, stock was down, I don't know, 25 % this week on just piss poor earnings. You could do something like, how about this? I look at your book. I read. I'm like, hey, Chapter 12, the counter-cyclical rebalancing portfolio. Chapter 13, the Bernstein no-brainer portfolio. Hey, I have an idea. I'm going to feed that into AI and say, do me a favor, analyze this, take your time. And I want you to spit out what is the most appropriate for this.

35:35And I want you to help me work the rebalance on this on a regular basis quarterly. Yeah. You know, I'm just saying just something like that. You know, you wrote it, my friend, you gave it to us. You're, you're thinking about this. I think the exact right way where you're taking a creative approach to utilizing AI that I think these are the, those are the use cases that where people are going to actually add a lot of value utilizing this software. And, you know, it's the, it's, it's hard. It's impossible to predict where all this is going. I think that, I think if I was a, if I'm a creative entrepreneur utilizing this software, the boy, the world is your oyster.

36:19I mean, I think that the upside is limitless for those types of people who can really creatively use things like this. If you work at like a big clunky fortune 500 company, you know, punching tickets, you know, that those jobs, those companies actually weirdly, I think are much, much more at risk than like, cause that's the, that's the thing. I think AI is the ultimate disaggregator. It is the ultimate decentralizer because it, it gives people who want to operate from a fully autonomous and sort of decentralized position a huge incredible value add potential so whereas this is much more disruptive for big big firms that are doing things that are very repeatable processes that these large language models are just really really good at doing and we're not even talking about eliminating those those jobs we're not even talking about uh inference or or no one near agentics yet right we're yeah we're getting there but can you imagine where where you deploy that.

37:17That's what people are freaking out about. Let me talk about the book. The book is called Your Perfect Portfolio. By the way, I don't know who picked out the particular texture for this cover, but it's very soothing. You got to get this book, and seriously people, get the book and just to feel the cover, if nothing else. But you got to do that. That's what the book is for. I call it good sleeping material. I made it very comfortable in case it puts you to sleep. So you can just fall asleep right on top of I could have this instead of a fidget spinner. I'll just kick the book. No, no. Great, great stuff.

37:51The book is called Your Perfect Portfolio, The Ultimate Guide to Using the World's Most Powerful Investment Strategies. We got some good commentary from Morgan Housel, which, by the way, are you good friends with Morgan? Because I want to get him my show. He was on years ago. I haven't been able to. Somehow we're not connecting. I'll ping him. Yeah, Morgan's an old buddy of mine. God, we were both lame bloggers back 20 years ago before anybody knew who either of us was. Morgan is just astronomically more famous than I am. He sold 10 million copies of Psychology of Money. Unbelievable, right? Unbelievable.

38:31But yeah, if you could do that for me. So let's talk about this. First of all, I'm going to ask you straight up. What did you learn from writing this book? Boy, I learned a lot about all of these different strategies. You know, the most, I think, educational piece for me was actually studying the history of all of the different strategies. Because it's funny when you talk about, so people kind of know, the book is sort of an overview of mainly 20 famous strategies. From either Warren Buffett strategy to like the Boglehead three fund strategy to factor investing to the all weather portfolio. All these different styles and strategies.

39:12And I kind of go through and I tear them all apart and I kind of try to objectively analyze them. But I also like rip through the history of all these. And so it was it was really cool, like looking back and really studying the history of what where did these strategies come from and why are they a thing and why do they work the way they do? And so like for me, I loved like going through the history of like the 60-40 strategy was really interesting. So that's 60 percent stocks and 40 percent bonds. and it was really interesting to kind of study the history of that one because it doesn't have an origin story kind of like a lot of the other strategies.

39:47Yeah, that's a good point. I was thinking about that just as you said it like because all these other ones have like a bit of an origin story who's famous for it. They have an origin story or a founder, some famous person who is attached to the strategy and the 60-40 doesn't and that one's interesting because 60-40 is arguably like the most famous and widely used strategy of all of the strategies. I'm taking credit. I'm taking credit. I invented 6040 and prove me otherwise, by the way. But yeah, it's weird because it didn't seem to have this origin story. And so I kind of, I don't know if I exactly got the history right, but I kind of traced it back to the Great Depression and, you know, the old Wellington fund that was created back then.

40:25And so it was, it was interesting because the origin story there, it actually like runs through, you know, not only the Wellington fund, but then, you know, John Bogle ends up running the Wellington fund at some point in his career through the 60s and 70s. And this materializes into Vanguard, which obviously everybody knows of Vanguard now. But the story there is basically that the fund itself was created right before the Great Depression. And the founder of it had been, or the manager had been burned in the past. And he created a more balanced type of portfolio, hoping that, hey, if I load this thing up with a big slug of bonds, if the stock market were to go down a lot, I wouldn't get as harmed as, say, an all-equity portfolio.

41:14And it's funny because the portfolio is built basically or implemented right before the Great Depression. It falls 40%, which is pretty catastrophic by most measures, but it did way, way better than 100 % stock portfolio, which fell 80 % plus during that period. And so it becomes kind of widely adopted because it creates this more balanced type of return. And it stood the test of time through World War II and the inflation of the 1970s. And then obviously in the last 40 years, the 60-40 has kind of become the gold standard in asset allocation to a large degree because it's just so diverse and so balanced.

41:51And so, but it was cool to kind of trace that back to the Wellington Fund and this more balanced type of asset allocation that now has become very, very popular, but wasn't really so popular throughout all of history. You know, it's interesting. You talk about, early in the book, you talk about, and I think you argue quite well that there's no universally accepted optimal portfolio. Even though the book is called Your Perfect Portfolio, right? There's no perfect portfolio per se. It's just out there on the shelf. I remember post the 60-40, And as we got into the Harry Markowitz, William Sharp, Brinson B.

42:29Bauer and Hood and, you know, pick your poison of who else, you know, DFA funds, all that stuff. I was like so engrossed with getting one more percent in the commodities. I think that will be perfect. You know, the efficient frontier and all that. And then one day I'm like, what am I doing? Like, seriously, it was like a year into this. I'm like, hold on a second. This is silly. One percent, even if I'm wrong, doesn't mean anything. That was the whole point. by the way, of these studies, right, of the major pieces, the white papers that were put out about all this. And I got kind of soaked up in this.

43:05But how did you kind of distinguish between a portfolio that's kind of uncomfortable versus one that's genuinely misaligned with who the people are that are investing in it? Yeah. Yeah. Well, I mean, that's the main message of the book is that there there really isn't a an overarching perfect portfolio. There's only a portfolio that's perfect for you. And so the you know, part of the one of the analogies I used in the book was to dieting and that there you know, there's all these interesting dieting studies. And one of them found that basically the there they studied all these different sort of fad diets.

43:46And what they found was that they all worked, but they only worked for people who stuck with them. And so, you know, that's one of the messages of the book is that, hey, here are a whole bunch of really good strategies. These will probably all work fairly well if you stick with them, but you've got to find the one that's right for you. And that's kind of the main message of the book is that we're all different. We're all unique. We all have different financial goals and needs, and you've got to find a portfolio that you can ultimately stay loyal to and stick with. And if you do, that portfolio will probably serve you pretty well, but you've got to find the one that's right for you.

44:22Because if you're incompatible with it, you know, it's kind of like finding a spouse in a lot of ways. That's the other metaphor I use in the book a lot is the, you know, finding a good portfolio is like finding a spouse and someone you can stay loyal to. And someone that, you know, you don't want to do, like, I spent a lot of my 20s having, you know, not real one night stands, but portfolio one night stands where I was constantly flipping and kind of tweaking and changing things, trying to optimize everything to, to make it better and better. And I finally realized like, Hey, actually I need to just find something that is good enough for me because perfect really is the enemy of the good in this process.

44:59And you have to find something that is just, it's good enough for you that is going to solve your financial goals, hopefully, and you stay loyal to it. And you got to make changes of course, on the fringes over time, cause your life is going to change and the portfolio needs to be rebalanced and, you know, reallocated to be consistent with the underlying strategy and you're changing goals across time. But you have to find a process, especially that is something you can really stick with and stay loyal to. And that that'll be your perfect portfolio in the long run. I have this envision of you in your 20s with like a dating app for portfolio swiping left and right.

45:36Exactly. That's that's pretty much who I was. And then and you know, the other thing is, I want to also put this analogy metaphor, depending on how you want to look at this. I don't remember which is which. You know, when you have people in the kitchen, there's some people that like to cook freestyle and there's some people that like to bake. Some people like to be like, I need a quarter cup of teaspoon, you know, 42 milligrams of whatever it is, right? And some people are like, hey, throw the garlic in the pan, throw the wine in the pan, you know, get it around, mix it up, throw some salt, get on the plate.

46:06So there's, but that person can't be the baker and the baker can't be that person. And if you ever try to do so, So you're probably going to be miserable. And then you're not going to want to do it. And that's exactly what you're saying with this. So let's talk about – you talk a lot about behavioral discipline, investor psychology. And I think if I – I guess when I kind of wrote this down because I was taking notes, I was reading, you often emphasize that behavioral risk is often more damaging than market risk, which is kind of an adjunct of what we're talking about here, right? So which portfolio structures do you look at as maybe doing the best job of protecting an investor from themselves, right?

46:54Not just from volatility. Because that's what you're talking about, but I want to expand on that. Well, that's the hardest part about all this, I think, is that people are constantly chasing performance and looking at where the grass is greener. And those shifts oftentimes occur at the worst possible times. And so one of the things I emphasize in the book is that don't, don't spend so much time chasing to where the grass is greener, because oftentimes you, when you, you know, you, you go to where the grass is greener and you're buying, you know, a lawn that is actually on the verge of dying. And then you have to, you know, you're going to realize that lawn is dying.

47:30You're going to look across the yard and you're going to see, you know, grass growing where you just were, and you're going to flip back to that one. And you want to avoid that process because it, it just results in suboptimal returns because you're constantly chasing to where the returns are actually the worst and the risks are the highest. And so, you know, for me, it really does depend. I mean, the portfolios that are more diversified that do sort of a more of a sort of, I guess, an all weather style of investing strategy where you sort of you have to acknowledge that the grass in some part of your portfolio is always going to be brown.

48:04And that's actually not necessarily a bad thing. I think a lot of people look at their portfolio and they sometimes think, well, gosh, you know, the the foreign equities in my portfolio really just they've done so dreadfully compared to the U.S. equities. I'm just going to I'm going to ditch them completely. And then you get, you know, years like the last couple of years and the the international piece blows the pants off of the the domestic piece. And you realize, ah, I should have just, you know, I should have watered my own lawn. I shouldn't have just been jumping around. And so I think that's sort of all weather style strategy where you're very broadly diversified.

48:37And that, you know, for some people that might just be stocks and bonds across very, you know, structurally different time horizons. It may be something more like, you know, the permanent portfolio where you're buying something very intentionally to own things like gold or commodities. And you're hedging against very specific regime structures where you've got kind of this all weather portfolio that you've got to get into something like that, knowing that in the long run, in totality, it'll serve you very well. but there's going to be times where pockets of that portfolio do really poorly. And that's one of the, it's one of the big lessons from diversification is that, you know, one of the quotes I love from Brian Portnoy is that good diversification is learning to hate some of your portfolio all the time.

49:21And that's really true. It's that you're, you're never going to find a portfolio where the whole thing is performing really, really well all the time. And, and that's perfectly fine. And so again, kind of going back to that perfect is the enemy of the good is that you don't necessarily want your whole portfolio to be perfect all the time, because it probably means your portfolio actually isn't that diversified. Cause that's one of the things you have to acknowledge is that when the stock market gets really hairy and starts going down, you need, if you, if you're going to remain comfortable inside of that thing, you need other hedges and those other hedges are, they're not going to perform as well.

49:58When the stock market is rip roaring and doing really well, those hedges are not going to be doing well. And that's just the tradeoff that you have to accept in part of this process. So I'm going to give you something for your next book, something that I wrote about in my first book, which is the flower garden. So I've been talking about this for, I don't know, 15 years. And that when we build a portfolio, you want to look at it as a flower garden, similar to your brass. But in that flower garden, if you have things that only pop up once a year and you fill your whole garden with that, they look beautiful for a month or two.

50:27But then you just got this arid, dirt-ridden patch of dry that goes into mud. And it looks horrible. But then it pops back up. That's great. Whereas if you had roses, heliconias, and impatience that come up, and you have annuals, and you have semi-annuals, and you have evergreens, by the way, which are like your money markets, right? Never changing color. Something is going to hopefully pop at any given time. Now, unless we have a hurricane that comes or a tornado that rips through everything, like tornado 2022, you know, that's going to be the kind of thing, and we want to call it old weather, but I call it my flower garden, that we can kind of visualize something in bloom at any given time of the year.

51:10Yeah. Well, hey, that's why I need inside plants. Exactly. That's why I need fake plants. I like that. The flower garden strategy. Yeah, that's what we do. All right. I need to add a chapter. You want to write it for me? Yeah, I've written it right. I I can give it to you. We can just bolt it on the back. So again, in this book, which by the way, you can go over to thedisciplinedinvestor.com for show notes, episode number 960. And the link right to Amazon will be right there. So you can grab the book. I encourage you to do so. And also, by the way, tells you more about Cullen and founder of the Disciplined Funds, which is missing a D clearly for the Disciplined Investor, but there is no relationship with us.

51:52But he also does a grouping of ETFs called the Discipline Funds. But I want to ask you about that. So one of the things you talk about, and then I think it reflects also in your actual real life investment strategy, is the idea of defined duration, right? Could you explain exactly what that is? yeah so really i'm sort of extending the idea of bond duration to other instruments specifically mainly the stock market i think the stock market is very hard for people to remain disciplined with in large part because people don't understand the time horizon over which they should judge the stock market and so what i basically have done with this methodology i've created a way of actually trying to assign a time horizon to the stock market so to to use kind of a simple example, if you were really trying to quantify like what a financial planner would call the sequence of returns risk inside of this instrument.

52:52And that's the risk that if you were to buy a 100 % allocation in the stock market today, and let's say it fell 50 % tomorrow, what is your temporal risk in that instrument? And so if you were to apply something like a CAPE ratio and assume the, let's just assume the future expected returns of the U.S. stock market are 5 % in real terms. Um, well in that scenario, if the stock market were to fall 50 % and generate a 5 % annualized return in real terms from there, it would take about 14.2 years for you to break even. And that's your point of indifference. Basically that's the time horizon over which that instrument has no sequence risk for you anymore.

53:32And so when you embed this into a broader sort of like bond duration methodology, you You can start to assign very specific time horizons to the instruments where we can look at something like the stock market and say, well, in today's environment, 14 years for a retiree who's very sensitive about the way they're going to generate their returns, 14 years is the time horizon over which they need to think about that instrument. And so I utilize a very sort of structured asset liability matching process inside of my planning processes where like I'm going in and for somebody I work with, I'm quantifying the expenses they have and the liabilities they have.

54:10And then we're matching instruments to give them actually a time horizon over which they know they have principal certainty of that instrument. And so for me, the stock market is this very sort of long-term instrument where if you're thinking of it inside of like your retirement plan, you've got to think of it as a decade plus long instrument because that's functionally what its sequence risk is potentially across different time horizons. Whereas something like a money market fund or a T-bill, something like that, you can match that thing to, you know, your emergency fund, your annual expenses, something like a five-year bond.

54:47You can match that to, you know, if you, if you're planning to buy a house and at some point in the next five years, you don't really know when you could reasonably go out and buy a five-year bond. And, you know, if that thing's got a duration of about five, you kind of know what your sequence risk is inside of that instrument. And so for me, good financial planning is all about really understanding time horizons and the way we're going to apply certain assets to match certain goals. And so I created this methodology that I call defined duration to try to help people kind of implement more of like an asset liability matching process where they can go in, understand their liabilities and expenses over time horizons, and then build a really diversified portfolio that isn't just diversified across asset classes so much, but is very strategically matched to very specific time horizons so that the investor can look at the portfolio and say, ah, well, I own$100 ,000 of T-bills because I needed$100 ,000 for a home down payment in the next year.

55:46And I know that's not gonna beat the stock market, but it's serving a very specific temporal goal inside of my portfolio. Right, it's also not gonna make them buy a$65 ,000 house in a year. Right, yeah. So you can match these things very quantifiably though, where the whole portfolio is basically serving a really a financial planning-based set of goals rather than the, you know, sometimes we put together sort of cookie cutter portfolios, like a 60-40 where, you know, your 60-40 is great. It's diversified. But what is the underlying goal of the instruments in there? It's not always necessarily very clear.

56:22Yeah, I hear you. Cullen Roche, your perfect portfolio. Get it wherever you get things. It's going to be available. I'm sure it all fine bookstores that are remaining out there that are actually standing up or right on Amazon. You can go there or go to thedisciplinedinvestor.com. Amazon, Harriman House. All those places. It's great. Thanks for coming on. We'll have you on again soon. Great book. Appreciate you coming on and imparting all this great knowledge as well. Awesome, Andrew. Thanks for having me. All right. Thanks. That was really interesting. The book is great. He is a really interesting fellow, and I appreciate him coming on.

56:59We'll definitely have him on again more than five years from now. I'll tell you right now, we'll definitely do that. Thanks for joining me this week and every week. We're working our way into the middle part, the heart of February, a short month for markets, oftentimes a little bit of a squirrely month for markets. But here we are. Thanks for joining me. Make sure to go over to thedisciplinedinvestor.com. See what's available there, the various strategies that we manage for clients just like you, whether it's our specialty of dollar-cost averaging through opportunistic and time-based DCA, dollar-cost averaging, or whether it's our lobster trap mentality.

57:36or even investing like the flower garden. All this is available to you. Make sure to go over there if you want some really clean advice. Yes, we manage IRAs. We manage non-IRAs and trusts and we do estate planning. We have wealth management. All that is available to you. So go on over to Disciplined Investor. Just reach out. That's all you have to do. And we'll make sure to get back to you and figure out how you can be best situated and into the hands of your future financial security. Thanks for joining me this week and every week. I'll see you again real soon. This podcast is intended for informational purposes only and does not constitute personalized investment advice.

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