How to Get 9% Returns with Half the Market Volatility

0:00Have you ever tried to make a good portfolio and just have struggled with exactly how to compose it? We're going to teach you today how to make a conservative portfolio, a good portfolio, a portfolio that earns returns, and might even be an awesome portfolio. Stay tuned. See you on the other side. Evening. Buyers remorse. Buy a new car? I'll be moving in. Let's get started. Sorry, I think there's been a mistake. I bought it from Carvana. You what? Yeah, great price. I even have seven days to love it or return it. So there's no... No, no buyer's remorse. More like buyer's rejoice. I guess I'll let myself out.

0:39Congratulations. I mean it. Buyer's rejoice. Buy your car today on Carvana. Limitations and exclusions may apply. See our seven-day return policy at Carvana.com. This episode is brought to you by Accenture. When your advertising operations fall out of sync, everything else follows. Spotify and Accenture are working together. to reinvent the rhythm of ad sales, using automation, analytics, and smarter workflows to simplify campaign delivery and access better data across the business. The result? Less time spent on operations, more time connecting brands with the moments and fandoms that matter most.

1:13Learn more at Accenture.com slash Spotify. You're tuned in to the Investing for Beginners podcast. Investing for Beginners podcast. The show for the long-term investor. We cut through the noise to focus on what works. Compounding, discipline, and the conviction to buy wonderful businesses and stick with them. Your path to financial freedom. Start now. Welcome to the Investing for Beginners podcast. Have another fun show for us today and have a guest. We have Jared Dillian joining us. He's one of the industry's most original entertaining contrarian voices. also a master of market psychology and been called the doctor house of trading.

1:58So thank you for joining us today, Jared. Thank you. Thank you very much. So contrarian thinker, you've been doing a daily newsletter since 2008, I believe. Yeah. What do today's investors misunderstand about past markets? well you know the funny thing about the markets is i mean i've been in the business for uh gosh 28 years long time uh and i've seen a lot of different stuff in the whole microstructure of the market has changed drastically over time like i'm actually old enough that when i first started uh in trading stocks were in fractions this is before decimalization I was actually trading like 16th and 8th and quarters and stuff like that.

2:54Like, you know, decimalization happened in 2002. So I was trading stocks in fractions. Also, I was on an open outcry trading floor filling out paper tickets. None of it was computerized. Bid offer spreads were wide. um you know now like the really liquid stocks like apple are typically a penny wide bid offer spreads but you know you you would have bid offer spreads of a quarter you know 25 cents or more um in options they would be more than that they would be like three quarters for an at-the-money option um but having said all that even though and also you know as you know we now we have uh algorithmic trading and high frequency trading and everything is computerized And I think all the changes to the market have been good, but I think the one constant over time is human behavior, right?

3:53And it's funny because I got the book right here, and I was looking through it before I came on the podcast. And there's all kinds of historical data going all the way back to the Great Depression and before that. And you look at charts of the Dow from the 20s and the 30s and the 40s and the 50s, and the structure of the market was very different. But really, like I said, human behavior is constant over time. You have booms, you have busts, you have crashes, you have manias. It really just repeats itself over and over and over again, and it just takes a slightly different form. So, you know, right now we're in probably a bubble, I guess, with the AI stuff.

4:43I lived through a tech bubble 25 years ago. I kind of know what it looks like. This bubble is very different. There's a lot of earnings. Like the companies are actually profitable. In fact, insanely profitable. And also, instead of 2000 individual dot com stocks, now we're talking about just a handful of mag seven stocks and IPOs and stuff like that. So it's different, but it's ultimately the same. How is it the same?

5:20Well, you know, I guess I see the same stuff over and over again. So right now, interest rates are high, you know, relatively speaking. Over the last 40 years, they're about average, but relative to the last 10 years, they're high. So 30-year bonds are at 5.3%. 10s are about 4.7%. Fed funds is 3.75%. Interest rates are high. And I've been telling people, guys, now is actually a really good time to invest in bonds. right? You're getting 5 % approximately. It's risk-free. The duration of a 30-year bond is about 15. So if rates go from 5 % to 3%, you're going to have a 30 % capital gain. And even if rates go up, you're getting the coupon.

6:18So you're not getting hurt that bad. Like the math around bonds really makes a lot of sense here and nobody wants to do it. people are so negative on bonds. We're talking about deficits that are getting bigger and bigger. They're talking about inflation that gets worse and worse. And no matter how many times you do the math for people, they just refuse to do it. And markets are always the same. People don't want to buy things when they're cheap. If something is cheap, it means that there's something wrong with it, right? They don't want to buy it. They want to buy it once inexpensive. Like in 2019, during the big bond bubble, when interest rates were going negative around the world, like that's when people want bonds.

7:06They wanted negative interest rates. They don't want 5 % interest rates. They want negative interest rates. So it's just the same over and over again. People don't want to buy things when they're cheap because they assume that there's something wrong with it. You know, if you have a chart of a stock that goes from 80 bucks to 20 bucks, and you say, now is a good time to buy the stock. They're like, well, I don't want to buy the stock. It's on the lows. Like there's something wrong with it. It's bad. You know, but if the chart goes up to a hundred bucks and they're like, oh, that's a great chart.

7:36I want to buy the stock. And financial assets are unique in that they're kind of like Giffen goods. Like people like them more when they're expensive, right? So if you go to the store and buy eggs and eggs are 50 cents a dozen, you're going to buy like 10 dozen eggs. If they're$10 a dozen, you'll buy no eggs. But like I said, like if a stock, if it's, if it's a hundred bucks, you'll buy it. But if it's at 10 bucks, you won't, right? It's, it's completely backwards. So, you know, the point I was trying to make about bonds is that, you know, on a historical basis, they're actually pretty cheap. The yields are good.

8:19And everybody's worried about deficits and inflation. And they come up with all kinds of reasons to buy bonds. If you remember, in the late 70s, when yields were 14%, nobody wanted them. They called them certificates of confiscation. Right. And that was the time to buy bonds so what whether you think obviously it's gotten cheap it's been sold off a bunch um do you think like greed plays a part in that too of the upside being capped um i don't necessarily think so um i don't think it's necessarily a function of greed um it's really just human beings are hardwired to be bad investors right like um actually there's uh i after after the awesome portfolio i was uh i just finished another book that's going to come out next year and uh in the book i talk about um there was actually a study done in finland which tried to establish some relationship between IQ and investing returns.

9:36So the Finnish government had IQ data on all these men because they were military conscripts. They had mandatory military service. And then they looked at their brokerage accounts and their performance over time. And they actually found that smarter people outperformed dumber people. And it was by quite a bit. It was by about 5 % a year. And it was actually because of market timing, right? Like smarter people have the ability to time the market, which is really interesting because if you read any of the literature about efficient markets hypothesis or anything like that, they tell you not to time the market and just be in the market, be in index funds, let it compound over time.

10:24You know, some people actually can time the market, but they tell you that you can't. That's a super interesting, if you don't mind sending me that link, or I can look it up after listening. That sounds really interesting. Yeah. So you were also in, you worked at Lehman for a little while. I was wondering what was that like and did that shape the way you think about investing maybe from a portfolio perspective at all? Yeah, absolutely. I worked at Lehman from 2001 to 2008. I traded index arbitrage for three years and then I was the head of ETF trading for four years.

11:11and 80 % of USDA chicken inspectors no longer eat chicken. Okay. So the point of that is having worked in the stock market for nine years, I don't really like stocks, right? Like, you know, after seeing how the sausage is made and how risky the market is, I really don't like investing in stocks. You know, I do it at a minimum, uh, you know, I do at the, in the 20 % in the awesome portfolio. Um, but I just, I really have an aversion to stocks after, you know, spending my time on wall street. So, so are you, uh, when, when you meant you mentioned bonds and people don't take advantage of that. And then obviously, if you're not doing individual stocks, you're doing ETFs.

12:07Do you have favorite type of ETFs? And how do you do bond ETFs as well? Or what's your thinking around that? Well, the awesome portfolio is stocks, bonds, gold, cash, and real estate. So you can set this up 20 % each. You can have five ETFs. For stocks, you would use VTI, which is the Vanguard Total Market Index. For bonds, you would use BND, which is the Vanguard Total Bond Market Index. For gold, you would use IAU, which is the BlackRock Gold Trust. For cash, you would use T-BIL, T-B-I-L, which is just T-BILs for cash. And real estate, you would use VNQ, which is the Vanguard REETF. So with five low cost ETFs, by the way, the expense ratio on this portfolio of ETFs is 11.8 basis points.

13:06So for every 10 ,000 you invest, you're paying$11.80 in fees. It's incredibly cheap. And these are the five ETFs that you would hold forever and just rebalance it once a year. And that's the awesome portfolio. So the rebalancing part kind of goes to what you're saying about the market timing.

13:31Well, you would rebalance it once a year. It doesn't have to be on December 31st. It could be on some arbitrary date. But the point is, is that let's say gold goes up a lot and stocks go down a lot. At the end of the year, you're going to have 30 % gold and 10 % stocks. So at the end of the year, you want to get it back in line so everything's 20%. I'm not going to lie. Running a small business has been stressful lately. Swamped in paperwork, different state agencies, and got all these expenses to track and everything. And it's hard to have visibility on these things. But I've stumbled on a better solution, kind of like a one-stop shop for my bookkeeping, my expenses, my P &L, my banking, my contractor payments.

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17:03Learn more at Accenture.com slash Spotify. So is this something for people who are like brand new in their journey, like middle wealth accumulating or wealth harvesting? Like, where do you kind of see this fit in? You know, the great thing about it is it's actually for everybody. So in the past, we used to say that your allocation to bonds should be equal to your age. So if you were 70 years old, you should have 70 percent in bonds. And if you were 20, you should be 20 percent in bonds. So what you have to do over the course of your life is gradually rotate out of stocks and into bonds. So you have to do this asset allocation thing throughout your lifetime.

17:46The cool thing about the awesome portfolio is you never have to think about that. It's a one-size-fits-all portfolio. And the attraction of it is that it returns. It has historically returned about 9 % a year, which is just about 1 % or 2 % less than the stock market, except you get half the volatility. And the drawdowns are minimal. So the worst year ever for the awesome portfolio is down 12%. The second worst year was down 9%. And that was during the financial crisis. So you have this portfolio that has half the volatility, very small drawdowns, and gives you 1 % or 2 % less than the S &P 500.

18:25It's really perfect. So does Bitcoin or cryptocurrencies fit in there or why did you exclude them? So I talk about that in the book. I mean, theoretically, you could take one or two percent of your gold allocation and put it in Bitcoin. But the whole purpose of the awesome portfolio is to completely eliminate your stress and get you to the point that you never look at your portfolio. Right. You just never look at it. You just work at your job, take care of the kids, go out for pizza, carry on with your life. You never have to worry about your portfolio. And as soon as you put Bitcoin in it, what are you going to do?

19:10You're going to be looking at Bitcoin all the time, right? Because it's volatile. Now, somebody pointed out to me, because I've been talking about the awesome portfolio for seven years. So this was like four or five years ago. Somebody said, well, if you add Bitcoin to the portfolio, it actually increases the sharp ratio. Well, that was true back then. but Bitcoin's in a bear market now. And it actually, now it actually hurts your Sharpe ratio. So you're just really getting a lot of risk for nothing in return. So was there something in particular that inspired you to take a no stress perspective to investing?

19:50Well, you know, like a lot of people, I've had not financial troubles, that's not the word, but during the financial crisis, I got hurt pretty bad. And part of that was because I had a lot of Lehman stock, which went to zero. And the rest of my portfolio also got hurt. So, you know, from 2007 to 2009, my net worth got cut in half. And that was stressful. That was very, very stressful. It's not like I was ever in danger of ending up at a food bank or anything like that. But if you lose half your money, it's stressful. Right. So it was at that point that I resolved never to be in that position again.

20:36So back in 2010, 11, 12, 13, I was building these portfolios, kind of a Rube Goldberg contraption of all this different stuff that grew at about the same rate as the stock market, but had less volatility, significantly less. and then in 2019 i was talking to one of my newsletter subscribers he's a financial advisor and we were trading date we were backtesting different portfolios and i basically you know it was just tinkering and purely by accident i put together the awesome portfolio i had this incredible sharp ratio and i said this is the answer you know so that's really the genesis of it that's cool um the t-bills thing i haven't heard that much um is that strictly because sometimes everything crashes and so you need something to kind of hold its value um not necessarily you you you want to have cash really for two reasons uh one it smooths out the volatility of everything else.

21:43So that's number one, actually three reasons. The second reason is at this point in time, you actually get some yield, like it pays interest, right? That wasn't true seven years ago, but it's true now. And the third reason is you want to have cash because it's infinitely liquid and it's an option to buy something cheaper in the future, right? So So if you don't have a lot of cash laying around, then you can't take advantage of opportunities. Let's say somebody comes up to you with this can't-miss investment proposition to invest in a private company and a friends and family around, and you know it's going to be a home run, and you can't scratch together$100 ,000 to invest.

22:32So you need to have cash for situations like that. Or you're taking a vacation in Fort Lauderdale and you're like, oh, let's look at some condos. And you see the perfect condo, right? But, and you want to put in a bid right now, but you don't have$200 ,000 for a down payment. So now you're selling stocks, you're selling your assets, you're incurring a tax liability because you weren't liquid. You didn't have the cash to take advantage of the opportunity. So that's why you keep cash around. for you um with your portfolio do you kind of spread it between retirement accounts is like how do retirement accounts play a role here well it's good to have it in a retirement account because when you're rebalancing it there's going to be some tax consequences right and not to say that you can't have it in a non-retirement account you're just going to be paying a little bit of taxes here and there, right?

23:30Which is, you know, I don't, I'm not a tax expert. I don't optimize for tax. You know, there's a lot of discussion these days about, you know, these hedge funds that, you know, give you all this tax protection. I don't really understand that. But yes, like this is ideally should be in an IRA or 401k or something like them okay yeah it makes sense is there a way it doesn't sound like uh very hard to implement is there a way to screw this up that i'm not thinking of the only way this gets screwed up is if interest rates go up a lot um which happened in 2022 so that is the one vulnerability of the awesome portfolio.

24:16So in 2022, stocks went down about 20%, bonds went down about 20%, and gold went down, right? So real estate was kind of flattish to up and cash did what cash always does. So that actually was, I mentioned that the awesome portfolio had a 12 % drawdown. That was the 12 % drawdown. It was 2022. And there's really, there's no way around that. You know, if interest rates go up, there's really no place to hide except for commodities. And sometimes that doesn't even work. So can we talk about the real estate part for a bit? So I'm not familiar with like real estate ETFs. What how are those structure?

25:05What are they investing in? So it's all REITs, right? So the thing about REITs is a REIT is really a tax structure. It's not an asset class. And there's all different kinds of REITs. So REITs stand for Real Estate Investment Trusts. And you can have office REITs and apartment REITs and mall REITs. There's all different kinds of REITs. There's also some stuff that's not really real estate related. There are cell phone tower REITs and data center REITs. So that's really not what you would traditionally think of as real estate. but by and large, if you buy a REIT ETF that has a bunch of REITs in it, it's going to be 90 % real estate.

25:54Is it track like commercial real estate, residential, or kind of just does the whole basket? Does the whole basket, yeah. Okay. All right. Have you gotten a lot of criticism? What's been the biggest criticism of this idea? Well, the criticism is there's look, I anticipate the reviews for this book are going to be bad.

26:20I think I think I think I'm going to I'm probably going to I would say low four stars on this book on Amazon because people are just so jammed up in the conventional wisdom, which is basically all stocks all the time. You know, in the last 18 years, stocks have done really well. And the assumption is they'll do well forever for the next 18 years. And when I show people this portfolio that has 20 % stocks in it, they're like, that is insanity. You only have 20 % stocks in the portfolio. And I'm like, yes, stocks are risky, as you will find out one day. And then we get to the gold part and they're like 20 % gold.

27:01That's way too much. I can see like 5%, but like gold is risky. Like why would you have 20 % gold? Actually, gold is about the same volatility as stocks. It's not any more volatile. There's this perception that it has a lot more risk. It really doesn't. And the cool thing about gold is it has a correlation of zero to stocks. It's not correlated at all. And then we get to the cash part and people are like 20 % cash. That's a madness. Like I want to be fully invested. If you're not fully invested, then you're missing out on returns. And at which point, you know, then you get into the whole, I just gave you the whole rationale for having cash.

27:43You know, it's an option to buy something cheaper in the future. It's liquid, et cetera, smooths out the volatility. But like, like I said, people are just so jammed up in, you know, what they've been told about, you know, Bogle and indexing and all this stuff for the last 25 years. And it's hard to get through. What are your thoughts on indexing passive investing? Like it has gotten so, um, so many more people do it every single year. Um, I was just actually reading something, I think this morning just and there was a chart showing like active managers versus passive and just the amount of funds all the funds are leaving active management going to these passive indexes like you've kind of seen that play out in real time would have been your thoughts around that trend um so i was one of the early adopters of indexing so in 1997 i was 23 years old and i was just scratching some money together to invest.

28:46And the first thing I put it in was a Vanguard, like a Vanguard index fund. And that worked for me until about 2012, at which point I pulled all my money out of Vanguard and started doing it myself. But in 1997, indexing was 2 % of assets under management. Now it's 56%. 56 % of assets under management is indexing. And not to say that all indexing is bad, but what people don't understand is if you invest in an index, you get the returns of the index, which are good, but you also get the volatility of the index, which is bad, right? So the S &P 500 has about a 16 vol, which means that it moves around about 1 % a day on average.

29:41I don't really want my life savings in something that moves around 1 % a day. Or, you know, even last year during the tariff tantrum was moving around 9 % a day. I don't want my whole life savings to be in something that moves around 9 % a day. I just don't, right? Right. So people don't know how to mitigate risk. They just look at the returns and they say, look, this returns 11, 10, 11 percent a year. And if I dollar cost average and hold this for 40 years, I'm going to have 10 million dollars at the end. But the thing is, is that the road is bumpy and you have big drawdowns and you sometimes liquidate at the worst possible time.

30:28And that's the purpose of the awesome portfolio is to, it's the awesome portfolio returns less. There is no doubt about it. It absolutely returns less. But in the end, people do better because of that behavioral coaching that the awesome portfolio does. It's much less volatile. You don't have the drawdowns. So you're never tempted to do anything stupid. This episode is brought to you by Accenture. When your advertising operations fall out of sync, everything else follows. Spotify and Accenture are working together to reinvent the rhythm of ad sales, using automation, analytics, and smarter workflows to simplify campaign delivery and access better data across the business.