Investing at All-Time Highs and Preparing For the Next Market Crash (EP.148)

0:28We all need to make smart decisions with our money. on the Best Interest podcast to talk about investing at all-time highs and preparing for the next market crash. I got a lot of feedback from you that you like when I replay some of the guest interviews I'm doing on other podcasts. So that's what we're going to do here today. So as you listen to the conversation, you'll hear us unpack the historical performance of stocks following new all-time highs, the inevitability of market volatility, and the fundamental connection between corporate earnings and stock prices. As always, you can go to the longterminvestor.com for show notes and resources mentioned throughout the conversation.

1:09And with that, here is my interview on the Best Interest Podcast.

1:17All right, Peter, here we find ourselves early March 2024. While stocks happen to be down today, it's about 2 p.m. Eastern here as we're recording. The market, whether it's the S &P, the NASDAQ, the Dow, is nevertheless, we are at all time highs right now. So let's talk a little bit about investing at all time highs. What is the logical or rational way to approach this question, Peter? Should we be investing at all time highs? It's interesting. When you look at the data, we're actually at an all time high more often than we're in a bear market. And when you think about the fact that on average in any given year, like 75 % of years, the market is up.

1:58And so if we were gambling people, and maybe we are making a bet on capitalism when we invest in stocks and such, but truly, if you had to guess, the probabilities would suggest the market's going to be higher. And if it's going to be higher, well, then that means that we're going to be hitting new all-time highs. But I do understand the feeling investors have when you're at an all-time high. Because on one hand, it means things are going well. It's a testament to growth and resilience of the market. But then they also have this little sense of, hey, does this mean we're on the brink of a downturn?

2:33Because whatever goes up must come down. It's sort of the narrative we tell ourselves in our head. But really, even as I look at some of the closing data, just looking at monthly data going back to 1926, following an all-time high, the average annual return on the S &P 500 is 13.7 % one year later. And we averaged 10.6 % per year over the subsequent three years and 10.2 % over the five years following a new all-time high. And that really isn't that different from just any sort of historical annualized return. So on one hand, it's great. On the other hand, like many things, and investing, the best action is often inaction.

3:18Yeah, I like that. That's the John Bogle quote, don't do something, just stand there. Just inaction. Well, it sounds like part of that data series then is just the idea that all time highs happen all the time. And that's part of your argument right there is that I think whether it's us as individuals, or maybe we're kind of pushed by the financial media into thinking like, whoa, here's this crazy thing that's going on. we're at an all-time high. Well, it's not that crazy because it's happening all the time. But you did hit on a couple things there, which is, well, what about what goes up must come down?

3:52That's a very human thought. Or what about this investing axiom we've all heard before, buy low, sell high? Well, if we're at an all-time high, shouldn't I be selling right now? Yeah, it's a really good point. The first one, like what goes up must come down. Yes, that did come out of my mouth, in part because it's what a lot of people think of. And just because the market making all-time high isn't necessarily a distinct risk worth making a change to your portfolio, I still acknowledge that markets are cyclical. Nothing goes up forever. And one of the things as an investor that you absolutely must do in order to earn a reasonable return is assume some degree of risk and uncertainty.

4:39So, I mean, if it's just the cost of higher expected returns in stocks than what you would earn in cash and bonds, yes, if the stock market goes straight up, it will pull back. It will go down at some point. On average, just using the S &P 500, because it's well known and people talk about it a lot, it's not necessarily the whole market, but great proxy. The S &P 500 averages a 10 % loss about every 12 months. So any pullback should be expected. I mean, it's laughably normal. And then you see historically that 20 % drops happen about every three and a half years, and then 30 % or greater drops happen about once a decade.

5:20So for me, seeing a great rally from October 2023 to the present, March 2024. If we just keep going up and up and up, then yeah, I think there is some sort of pullback. But Jesse, you and I, we are long-term investors. We are not concerned about missing the 10 % pullback. Yes, it would be profitable if we could foresee it and time it and get out of stocks and somehow not pay taxes and then get back into stocks at the exact right time. That would all be wonderful. I'm not saying that would be a bad thing. That would be wonderful. I would love to do that. That would be buying high and selling low.

6:01But in reality, we can't really know when those downturns are going to occur. And if we have a financial plan that takes into account volatility, like I discussed, downturns like I just discussed with a similar magnitude and frequency as we've experienced in the past, well, then we don't really have to worry about whether this all-time high is just the latest mile marker, like latest milestone on the continued trend up and to the right, or if we're at a peak and it doesn't get any better than this and we go into a bear market, which on average takes about two years to decline and then come back to the previous peak.

6:42We never really know. But I do think you try your best to remember why you're investing in stocks, which in my mind, you invest to grow your wealth at a rate greater than inflation without taking undue risk. Undue risk. And so, yes, sitting in the stock market at an all-time high is not an undue risk. Trying to avoid a downturn introduces a lot of unforced error, a lot of undue risk. And even as the market is going up, if you are a diversified investor across stocks and bonds, you can actually buy low and sell high via rebalancing. So look, it's a catchy headline. It's hopefully a headline that we see a lot.

7:25I love seeing that it's all time highs. It means I, as an investor have made money. It means that the economy is doing well and that companies are doing well and that chances are because over the long term, stock prices tend to follow company earnings pretty closely. It means that earnings are looking pretty good. I'm glad you touched on many of those topics there, Peter. I want to come back to rebalancing. I want to come back to earnings at some point because those are important topics that fit into this conversation of investing at all-time highs. But specifically, I want to respond to the idea of the frequency of different drops that you have, different percentage drops that you have.

8:00So I'm talking to the 33-year-olds out there. I'm 33 right now. So talking to the 33-year-olds listening to the Best Interest Podcast, you might own a large percentage of stocks, say, till you're 53. And then you'll start to eventually start shifting maybe more into bonds by the time you're 63. But even as you retire, and now you're 73 and 83, you still might have a portion of stocks in your portfolio. So you might have 50 years in the future of having stocks in your investment portfolio. And based on some of the 20 % and 30 % decline data that you gave us, we're setting ourselves up for what?

8:35Sounds like 15 instances of 20 % drops before we dropped dead at 83 and five or six instances of a 30 % drop. Like this is expected. We know this stuff is going to happen. And something that I like to do with myself and with my clients and with my listeners and readers is prepare them for that fact. Like, get ready, get your arm around right now because it's going to happen. Well, and even NASA, who sends astronauts to space, does what they call exposure therapy. and they go over everything that could possibly go wrong so that in the moment they can remain calm. Because once your brain, I mean, there's real strong science about this, that the moment that there is fear and anxiety inside the brain, then you don't make logical, rational choices.

9:24There's some podcasts about NASA training. They go through some of the things that they talk about and they can't predict every single thing that might go wrong. but it's all about the practice of slowing everything down. And I think that can be applied to markets where I kind of put out the same information that you just said, where if you're sitting down and we're talking to the 33 year olds in the house that, hey, you're going to have like a dozen of these in your lifetime. Every single client I get in front of, I say, hey, in our lifetime working together, we're going to go through multiple 30 plus percent drops.

10:00And I can't tell you why they're going to happen, but they're going to be scary. And each one is going to feel different and feel like that history doesn't matter. And look, there are some things that are different, but that doesn't mean that what you're doing when you're investing, which is providing capital to companies who are trying to earn more profit, that will still be true. Now, if you as an investor, for some reason, are providing capital to companies who don't like profit, then yeah, that is different and concerning. That is where financial theory doesn't exist anymore. It all falls apart.

10:35It exists. It's just all wrong at that point. Right, right. Yeah, Peter, it's funny. It's almost similar to the idea of timing the market. Of course, none of us want to be investing in unprofitable companies that are just siphoning money into the nether void. But sometimes we own those like index fund investors. It's so funny. I was just talking to someone the other day about how when they own a portfolio of say 50 individual names, 50 individual stocks, there's something in the human brain that looks at that and says, okay, well, these 30 are doing well, but why the hell do we own Disney? Like what's up with that?

11:07I want to sell that. It's BS, get it out of here. What's the point of owning it still? Well, if you would have owned S &P 500 index fund, you would still own Disney. Actually, I don't know for sure if Disney's in the S &P. I think it is, but something about the wrapper of the index fund, you know, the index fund is up 14 % year to date or whatever it is. And people just ignore the fact that 60 % of those companies in the index fund might have lost money or might be down on the year. And it just kind of gets wiped away. But just an interesting little aside there. One thing that you did say that I thought was very, very interesting is this idea of you can never really time the market.

11:43Of course, we would love it if you could, we would love it if you knew exactly when to sell and exactly when to buy back in, and you could avoid any sort of tension and anxiety that comes with investing at all-time highs. You mentioned before, you brought up the market's performance since late October, early November of 2023. And I just think it's so interesting that you could have sat there, anyone listening could have sat here in mid-October of 2023 and put together an extremely rational argument for why the market was gonna continue into this uncomfortable slide downward. just as it did through August, September, and most of October last year.

12:23And I would have sat there and said, yeah, all those points totally make sense. And then Jay Powell comes out at the end of October, says a couple things about interest rates, and the market rips 8 % in one week and 19 % before the end of the year. So that rational argument that you would have made in the middle of October completely got imploded by what actually happened. And it just, again, it just proves that point of it's really hard to get the timing of this right. And it's probably not worth trying in the first place. You know what I love about your Fed example is even the Fed doesn't know what they're going to do with interest rates.

12:58So if we go back to 2022, worst bond market on record, full stop. And at the beginning of the year, so the Federal Reserve, the Federal Open Market Committee, the group within the Federal Reserve that's setting interest rate policy, after each of their meetings, they publish what is called the dot plot. They basically put dots where they think that they will be setting interest rates themselves six months from now, 12 months from now, two years from now, etc. And none of them at the beginning of 2022 thought that they'd be raising interest rates from zero to 5%. None of them. None of them had really anything going on.

13:36And like you said, in October, Jerome Powell comes out and says, hey, actually, we may not be cutting interest rates, even though their dot plot said that they might. They're just humans, too. They don't know what's going to happen. And I think that's what's really challenging for investors of all types and even for financial advisors. I think advisors sometimes suffer from this more than in clients is that you hear someone make this extraordinarily intelligent case full of facts, objectively factual case for bad things to happen. And it sounds smart. And then you hear guys like us saying, well, you know, just stay the course, everything's going to be fine.

14:16Staying the course doesn't mean putting your head in the sand and saying there's nothing bad going on. However, it is hard to digest whether you're an investor professionally or you have an advisor or you're doing it yourself to see these really intelligent cases and be like, no, that just doesn't make sense. Yes, everything they're saying is true. But you know what? Millions of market participants are out there, have that information also, and they are pricing in the probability that that person's thesis will lead to impending doom. The other thing is like, people predict doom because they know it's what gets them airtime.

14:51And I think knowing what people's motivations are, are really important. I feel like if you put up a bearish bet, like on CNBC, you should also be required to disclose what is in your portfolio. Like you ask those guys, well, what's in your 401k? Well, it's a bunch of index funds. I would never change those. Yeah. Like maybe in their taxable account, they have some trades on, but for the most part, I think the Fed themselves, the people setting interest rates, what in hindsight, we could call the perfect catalyst for this run-up. They didn't know they were going to do it. And anyone who to your point was making the perfect bear case, they were wrong.

15:25And even if they were right, and there was a decline, who's to say that the reason that the theoretical decline happened even aligned with what they were saying in the first place. It's just such a tough thing to do. And I think sometimes it's easy for advisors like us to be on a bit of a soapbox and say, like, it's so silly to listen to this. But everybody involved is humans and humans love stories. And look, a doom story is just more interesting. It's why the media sells it. So if you're listening to us, this is a biased statement, but at least you found some people who are preaching. Here's what you know when you're listening to the two of us is that we're not concerned about what's happening next week, next month, even next year.

16:07We're in it for the long game. And when you catch a soundbite of somebody, it is extraordinarily rare, unless their name's Warren Buffett, that they're in it for the long game. And they have an agenda and it's different than yours. You have multiple decades to write out what these downturns that we've talked about a few times that we know are going to occur. Just tune it all out. Now, if you want to do it like a hobby, like I do fantasy baseball, or you know, like I watch professional sports, that's totally different. And I actually don't mind it when people carve out a small portion of their portfolio, and they time the market, and they buy individual stocks, and they make all sorts of bets and like, that's great.

16:49That's fine. But 90 to 95 % of your wealth should just be staying the course in a long-term strategic asset allocation. It has been shown time and time again, financial theory and long-term investing are effectively undefeated. And it's just hard to recognize because the long-term is an eternity to live through in the moment. Right. And it's so human to think, so wait a second, like Peter was just telling me, and Jesse apparently supports Peter, in that the boring thing is the right thing. You're saying it's not the flashy thing? You're saying it's not the Wall Street secrets? I mean, Robert Kiyosaki, he wrote Rich Dad, Poor Dad.

17:28It's like the best-selling book in the personal finance space ever. And he's got a headline every single day calling for doom and gloom in some way. You're telling me he's wrong? But to me, Robert Kiyosaki is the poster child of what you were saying, Peter, of what are the incentives? And Robert Kiyosaki, it stinks because I've actually had readers and listeners, they've heard me rail against Kiyosaki before. And a few have reached out to me and been like, Jesse, I don't get it. Like I just read Rich Dad, Poor Dad, and I kind of liked it. Like it clicked with me and I understood it. And now here you are saying these bad things about him.

18:02A quick detail about that is, I think the book actually espouses some reasonable thoughts about owning income-producing assets. and then he leveraged his fame into being a snake oil salesman for the past 25 years. I mean, both of those things can be true. That's right. I agree with that take, by the way, for whatever it's worth. Thank you. Yeah. And like, it's okay to say that both are true. It's a reasonable book and he's now shilling. I don't even know if he believes his own statements. I think he doesn't. That's my take. I don't think he believes what he says, but he knows that it attracts eyeballs.

18:32And what's the one thing, basically, if you can instill fear in someone, you can probably then sell to them. And that's what he does. So no respect there from me. Yeah, I'm with you. We're on the same team there. And he's probably the worst of them, or at least the worst of them that get a lot of airtime. Well, Dave Ramsey isn't necessarily harmful, but he's stubborn to the point. He actually reminds me of Eugene Fama, who's unwilling to acknowledge behavioral finance. I once asked Eugene Fama, Nobel laureate, efficient market hypothesis guy for all those listening. I once asked him, hey, is there anything that you know to be true without data?

19:10And I was hoping he'd say, yeah, like humans are fearful and greedy or like, so he's like, there's nothing you can know without data. I was like, okay, well, thanks, buddy. Just sticking to his guns, talking to his book. Dave Ramsey has a brand and it's anti-debt, even if that is not the optimal choice financially, which by the way, the optimal financial choice is not always the right choice for every human, but he's willing to steer people that direction, even when it's not the right choice for them, the human. And Dave Ramsey does so many good things. Again, like you said, both can be true. We don't live in a black and white world, just like in the market.

19:47We're at an all time high and a lot of things can be bad. Both can be true. So many shades of gray. And I think their incentives are just so important when you think about who is giving financial advice. Now, Jesse, you and I, I would bet that our biggest incentive is that we would love listeners to become clients of our firms. Okay. Yeah. That's an incentive. That doesn't seem as harmful as I want you to follow me. I want you to buy my stuff. Like you need me. A lot of what we do, if someone has all the time in the world and can be completely objective all the time, maybe they don't need advisor.

20:22I mean, I have a personal trainer. I have someone who cleans my house. I have someone who cuts my lawn. I have an executive coach, you know, the coach, the trainer that probably falls more into the bucket of what we do where you get regular feedback. It's better. But look, when I have a health issue, I still go to a doctor. I do WebMD the heck out of it. And that's not good. It's not healthy. I shouldn't do that. Every time I get sick, my wife's like, don't Google anything. Do not open Google. I think that people can fall into the same trap with investing where there's so much information out there.

20:53But unlike medical information that is, I'm going to say pure science, at least it should be pure science. There's so much bad stuff in the finance world that is not science. And what's really confusing about the science of investing is that the evidence typically cuts both ways. And so the example I'll give to a lot of people is if you're trying to choose whether to include or exclude something from your portfolio or make some sort of change to your investments, if you take an approach like the FDA does where they're seeking to approve a drug and they want to approve something that's net beneficial to society but minimizes bad side effects, you're going to fail to approve some drugs if you're worried about the side effects.

21:40Now, we could have the FDA that just approves everything that has a slightly good test, even if they're bad side effects. And that'd be a problem too. What I'm talking about is actually, I mean, you're an engineer, Jesse, you like type one and type two error. We could talk statistics, but I don't know if the listeners will revolt, but I'm talking about type one and type two error. And in general, my feeling is that I am more concerned about implementing a bad idea than missing out on a good one. And I think when you look at the investment world, the evidence-based peer-reviewed investment world, like a doctor, like you're practicing medicine with that lens of recognizing that the vast majority of success comes from a couple really big decisions and then just minimizing mistakes after that.

22:23I think it does start to simplify stuff. Now here, we've been talking for, I don't know, I haven't been keeping track, let's say 20, 30 minutes. We don't always get that long to get people's attention. That's why the soundbite people win because they have soundbites that are catchy and actionable. And like you said, steer some fear, a little bit of a tangent, but interesting nonetheless. I really liked it. You reminded me of one of my favorite Buffett quotes is he tells this little story. It's not very quotable because it's almost a little too long, but essentially that investing is a no called strike game.

22:55Baseball is a called strike game where you can have the bat on your shoulder in baseball. If the pitcher throws three strikes, well, then you're out. So you're kind of incentivized to swing in baseball. Well, there's no called strikes in investing. And you can sit there with your bat on your shoulder. And if you don't like the opportunities that are presented to you, you don't have to swing at them. And you can wait for the perfect pitches. You can take your swings at those. Hopefully most of them are successful. And all the ones that you didn't swing at, you're not any worse off for having not swung.

23:24But I think a lot of people don't realize that fact, feel some sort of obligation to swing, some obligation to act on whatever news or opportunity they're presented with. And you simply don't have to. Well, if we transport ourself a hundred thousand years back into the jungle and Jesse, you and me are standing there and we hear rustling in the bushes and you take off running because you assume it's a lion. And then I sit there calculating the probability of it being a lion versus the wind. I get eaten. So, you know, like you survived because that instinct to act when there's a little bit of a threat.

23:58It happens with our money. It happens with every sort of decision we make. Well, since I've already mentioned our primary bias as advisors is that that's one of the things advisors do for you. They just take the emotion out of it. Even me, I sort of treat my money, I have it all invested in a single globally diversified mutual fund in parts that I don't ever have to think about trading or rebalancing or asset allocation, because I'm overseeing a lot of assets and I can approach those with like a robotic discipline. But my own money, you know, from my first, let's call it decade of being a professional, I don't know that I was robotic and systematic.

24:39In fact, I know I made mistakes. And so it's sort of finding a way to take it out of your hands and getting a couple really good decisions in place and then just staying out of the way, making sure you don't make mistakes. The only mistake I can make with money that's designed for 30 or 40 years from now, even 20 years from now, but probably more likely 30 or 40, just don't touch it. Like I did all the research. I did all the homework. I got it what it needs to be in. It might do poorly for the next 10 years, but it's very rare over 20 or 30 years that if I go back to that very simple first principle level investing purpose is to grow my wealth at a rate greater than inflation.