The 3 Components of Successful Investing with Rick Ferri (EP.96)

0:28We all need to make smart decisions with our money. cost ETFs, who has published seven books on the topic over the course of his career. Today, he offers hourly financial advice and hosts the Bogleheads on Investing podcast, which is part of the John C. Bogle Center for Financial Literacy. In our conversation, Rick and I discuss the tenets of simple investing, including the three components of successful investing. I think you're really going to enjoy our own experiences that we share throughout the conversation. And as always, you can can find links to everything mentioned in the show notes at thelongterminvestor.com.

1:04And while you're there, be sure to sign up for my newsletter, which comes out every other Wednesday morning with links to my latest work, as well as resources from around the internet that will help you make smart decisions with your money. And with that, here is my conversation with Rick Ferry. Welcome to the Long Term Investor. Rick Ferry is joining me today. Rick, how are you doing? I'm doing wonderful. Thank you, Peter, for inviting me. Well, I'm really excited to have you on the show. You're somebody I've followed throughout my career because you were really one of the first champions of ETF investing, of what I think you refer to as simple investing, and in really being one of the faces that champions the message that you could argue started with Jack Bogle.

1:54There's obviously a lot of academics, Charlie Ellis, Burton Malkiel, who championed these ideas that I think you and I agree upon. And you've been such the face of it that you were even the president of the Jack Bogle Center for Financial Literacy for quite some time. You host the Bogle Heads on Investing podcast, which is supported by that institution. I was just hoping we could start there, talk a little bit about what that is, the Jack Bogle Center for Financial Literacy. Well, thank you for asking. The John C. Bogle Center for Financial Literacy, his friends refer to him as Jack, so he liked to be called Jack, but the official title is the John C.

2:33Bogle Center. It was created about 11 years ago with Jack's backing to have a place where all of the teachings about low-fee passive investing, we have about 10 principles of simple investing. And we were gathering a lot of information on the Bogleheads forum. And we were doing podcasts and we were doing an annual conference and we were gathering all of this content and we had really no place to house it and it should have been a nonprofit. So back in 2012, we created the John C. Bogle Center for Financial Literacy, a 501c3 nonprofit, created the website bogelcenter.net. And now this is where all of that content is housed, including all of the videos that Jack ever did, all of his writings that he ever did, all of the content from podcasts, from discussions, from, I mean, everything that you could ever wish for is there in some way.

3:38There's also links to the bogelheads.org chat or online forum. There's the Reddit forum. There's the Facebook forum and a place where everything is housed. And we try to keep it categorized so you can find what you need very easily. And every year we put on a conference. And last year, our conference was in Chicago in October. And this year, it's going to be in Washington, DC, also in October. So once a year, we put on a conference. And it's non-commercial. This is a nonprofit organization. So we don't have companies coming in and pitching products or we don't have booths where companies are pitching anything.

4:15It's really just educational, 100%. That's really great. And for anybody watching or listening, you can go to bogelcenter.net to find all this information. And I'm going to have lots of links and resources at the show notes at the longterminvestor.com. And with Rick here today, we're going to talk a little bit about the three parts required to be a successful investor. Rick, I had the pleasure of seeing a talk you did recently, and you kind of highlighted three areas, the intersection of philosophy, strategy, and discipline. And the thing that really strikes me as interesting with philosophy, and we're going to maybe riff off this a little bit, is that everyone does have a unique journey and they reach the light, so to speak, in different stages.

5:01So I was hoping that you could use some of the framework within how you think about this. And we can talk a little bit about both our personal experiences and what we see others go through at these different stages. So the idea of having an investment philosophy before you even try to construct a portfolio strategy makes a lot of sense. Because if you don't have a philosophy of how to approach the markets, then it's really difficult to put together a plan. It's like saying, I'm going to go to college, but I don't know what I'm going to study. You might graduate, but in what field? It's a little bit better if you have an idea of what it is you want to do and what you're trying to do with your life.

5:44And the same thing with investing. So philosophy is, this is what I believe and this is the approach I'm going to take. And so now strategy, which is the second portion of that is, how am I going to do that? How am I going to put together an asset allocation? which funds am I going to use? What's my taxes? And then the last thing is the discipline, the third part of it, which is sticking to the plan. Now, the plan might be changed a little bit as you go along in life. There might be amendments to the plan or so forth, but generally, you're sticking with the philosophy, you're sticking with the strategy, and this is what's going to make you a successful investor in the long term.

6:18Too many people don't have the philosophy to begin with. They don't have a philosophy, and this is where we begin the journey, so to speak. Well, someone like you or myself, I think if forced to summarize a philosophy in one sentence, or if you told us to do it in three sentences or in a certain number of words, you and I could do that because we have been through the different stages that so many people go through. And the first one that you identify is darkness, which I really love because we obviously are a blank slate and we pick up little bits of information. And so much of how we view the world outside of investing doesn't really apply to how the world should be viewed from an investment perspective.

7:01People try to pick stocks. They try to time the right moment to get into the market. They listen to people who they view as experts and somehow think that even though we know definitively through all sorts of great research that predicting the future isn't possible, that people somehow think that it is possible when it comes to their money. I'm kind of curious, and I'll share my own, but maybe you can start with your own investment journey, where you started and how you began to see the light and come out of the darkness stage. Well, all of us are bombarded with 99.9 % of the investment information we hear about, either on the internet, on television, through the media, through our financial advisors, if you want to call them that, brokers, is all marketing.

7:50I mean, they're trying to make money off of you as an investor. That's not investment advice. It's advice to bring money to them, bring commissions or revenue or fees or something to them. And this is 99.9 % of everything you hear out there. So that's all you know. That's all that I knew. When I first started investing when I was in the military back in the early 1980s. I had a broker that was relative, and I didn't know any better. I just called him on the phone and say, hey, I've got a couple of thousand dollars. What am I supposed to do? And whatever the flavor of the month was, that's what he sold me.

8:33I didn't know any better than that. I thought, hey, he worked for this big firm and they have all kinds of information and this is going to be good. But it wasn't. I mean, it was just okay. When it went down, the market went down, that went down more. It was difficult. This guy kept switching investments. Oh, no, this isn't working. Let's try something else. And let's go over here. Give me another idea. So we would pitch whatever the flavor of the month was then. And I'd buy it. And finally, it occurred to me that this wasn't getting anywhere. and I ended up moving my money to Vanguard, but not to buy index funds at the time.

9:14I just thought that, well, low fees do make a lot of sense. So, I mean, I'm paying too much money. I don't want to pay commissions anymore. So I did move there, but I still didn't have the philosophy of indexing in mind per se. That didn't actually happen for me, even though I was at Vanguard until I got out of the military eight years later, and I went into the brokerage industry, and I went to work for the very company that this person who I was using initially was working for. I went to their broker boot camp, is what they called it. I mean, you've seen the TV movies, how to train brokers to get on the phone and make a thousand calls a day and pitch the stock of the day and all that.

9:57I mean, I went through all of that. I was under the impression that there was knowledge here, that I was actually pitching investments that were going to do well for my clients, that were going to do well for the firm, were going to do well for me. I mean, that's what I thought I was doing. I thought that's what the business was all about. But then when I was in the business for a few years, I went and I achieved my charter financial analyst charter, CFA charter, and I got a master's of science in finance. So I started educating myself. And by the way, this was not, it was not endorsed by the brokerage industry at the time that brokers go out and get an education.

10:36That was not cool, so to speak, because they really didn't want you to know what was going on. And so, you know, I went out and got it and I'm trying all these things and nothing seems to be working. And then one time, one day I went to a CFA conference in Atlanta. It was the national conference in 1996, I believe it was. And Jack Bogle was a speaker. Now, Jack Bogle is the founder of Vanguard. And he created at Vanguard the first index fund. So he gets up there and he starts talking to all these analysts who are not index oriented. I mean, their job is to do the opposite. So it was ironic that he was speaking at this conference to begin with.

11:21But he was getting to be well known at the time and he was speaking. So I'm listening to him. And he starts talking about the exact same stuff that I was seeing every day. I said, there's something more to this. I mean, he's right. And I bought his book, Bogelon Mutual Funds, which was the first book he wrote. And I read it a little later in 1996. And I had my aha moment. Oh, I get it. It was like a chemical reaction. It's almost like my DNA changed at that point. I said, I understand now what is going on. I see it. I get it. I see it in my own clients' accounts. This makes complete sense. And from then on, I mean, I was a low-cost, simple low-cost index fund investor, which did not fit well with the brokerage industry.

12:07And I ended up having to leave a couple of years later. And I think so much of your story of finding a path towards low cost, passive investments really mimics mine. And you're right. Everything that you hear in the newspaper, on TV, even academic research, white papers, it's all research. White papers, they're just really, I think white papers are just a fancy term for long form marketing and academic research. I'm not criticizing those who do it, but there's a lot of incentives. And people don't always think about the incentives of academic research, of white papers, or the quote unquote experts that you hear again in public speaking, on TV and whatnot.

12:50And when you talk about your initial experience with a broker and how there would be different changes, I always find that when I'm working with a manager that's using active strategies or trying to time when to get in and out of something. There's always this reason that something didn't work and a solution, which is what we're going to then buy. And I think, again, it gives this sense that there is something to know. As you point out, I also thought that the business was all about knowledge too. Education helped me refine and realize that I knew very little. And I suddenly realized just because I read the Wall Street Journal and the New York Times in the Financial Times every day and had a Bloomberg terminal didn't mean I was special because that information is available to everybody.

13:39It's also a little bit tainted. I mean, their advertisers are those active managers and those brokerage firms and those hedge funds and so forth that are trying to get business. So they advertise in those publications and they have to be very careful about not upsetting the Apple card. so they can mention things like index funds and so forth and they can write stories about it. Right now, it's much easier to do that because the word is out there, if you will. But back in the 90s, it wasn't. So they had to be very careful about what they wrote about. They had to give the other side of the story as well.

14:16So even if they were believers and they had the epiphany and they saw the light, they still couldn't really write about it like they wanted to. Well, and I think that for me, it wasn't until I found, I can't remember which was first, if it was Burton Malkiel's A Random Walk Down Wall Street or Charlie Ellis's Winning the Losers game. But it was one of those two. And I know I read them in succession and shortly thereafter read a book by Jack Bogle. And honestly, Ricky, I remember reading all about asset allocation from you. At this point, you had established the importance of asset allocation, something that academia had established decades ago, but yet wasn't being taken seriously by those in the financial advice profession, that it's not so much about the investments itself.

15:06It's about the mix of investments. And it's about keeping costs low, things that you can control. And so a lot of people, by the time they find me, and I'm sure by the time they come to you, Rick, chances are they have gotten out of the darkness. They've gotten to this place that you define as enlightenment where you realize, Hey, there's something wrong here. Is there anything that you see in those who've come to you? They've just gotten out of the darkness that seems to be pretty common amongst those who are speaking with you. Sure. So, I mean, I just do an hourly model, so I don't manage money anymore.

15:41I used to, I had a company and I managed money for many, many, many years, but now I just do an hourly to help people who are self-managing their portfolios, the people who I work with. So there's actually two types of people who contact me. There are those that you described who just had the enlightenment and realized, oh, I've been doing this all wrong. I need to change. And how do I do that? How do I get from where I am to where I need to be? I need some help with this. And they've decided they're going to self-manage their portfolio. and they maybe have read the Bogle has and so, but they need some help getting from where they are to where they want to be.

16:18So that's one group of people. And the other group of people are already there. They're already where they want to be. They're just looking for validation, confirmation, looking for maybe some holes that they may have missed that I can help them with. So those are generally the two types of people that I work with. But the people who are newly enlightened, they're upset. I mean, I have to say they're feeling pretty stupid. And I tell them, look, don't worry about it. I mean, everybody's going through it. It's water under the bridge. Time to move forward from here. You still have a lot of time.

16:51Let's just move on. But they are feeling pretty dumb to have been taken to the cleaners, if you will, by whoever their advisor was. I mean, you see some pretty ugly stuff. And sometimes they're very reputable firms. And I'm not going to mention any, but very reputable firms who you would think wouldn't do this. I look at portfolios of 50, 60, 70 mutual funds constantly being traded. And you wonder, I mean, how do they get away with this? They're supposed to be fiduciaries, but they're not. They're not acting like fiduciaries. They're trying to just generate a fee for themselves. So, I mean, they are upset, but we move on from that and we say, okay, now we're just going to work on getting you from where you are to where you need to be.

17:37And it could take a little bit of time, especially with there's a taxable account and there's a lot of embedded capital gains. I mean, it's sometimes difficult. It's easy with retirement accounts because you can change it all around in one day, but taxable accounts are where the pain point is really is. Yeah. And I do think that there are some innovations in the space that might make that easier for investors going forward, but you're right. A lot of people assume that their advisor has their best interest and the advisor might even say that and actually believe it themselves. That's actually, I think one of the challenging things is advisors who actually think that what they're doing isn't harmful.

18:16I'm the general. I got a story about that. No, no, hold on. No, hold on. I have a story about that. Okay. So I was at a conference, an ETF conference. This is way back in the early 2000s. I mean, this is like one of the first ETF conferences. I'll even tell you where it was. It was down in Miami, Florida. So we weren't that many people in the room because ETFs were not a big thing like they are now where you get thousands of people showing up. But back then, 20 years ago, I'm sitting on a panel next to probably one of the most famous financial planner advisors in the country. I mean, famous. And I'm giving my pitch for why you should have just a simple portfolio of low cost index funds.

18:54And he gives a pitch on how he can pick funds that are going to outperform the market. And I'm looking at him saying, just thinking to myself, there's no way you can do this. I know you're telling everyone you can, but there's just no way you can't. Anyway, at the end of it, here's the thing. At the end of it, he turns to me and he says, if I was going to do this all over again, I'd do it the way you're doing it. And he left. Okay. Why did you just tell these people? Because that's what he does. I mean, that's how he made his name. And so you can't just change. It's hard to change your business model.

19:27Some do, some have. And this particular fellow actually did over time change, but not 100%. They went to a core and explore, a core and satellite. Where are you? The core funds should be index funds. But you know, these are these other things out there that like emerging markets, a small cap, where there's still inefficiencies. That's a bunch of nonsense. But I mean, that's what they went to in order to justify the fee. And it will be interesting to see 20 years from now, how much of that still exists. Because I too am convinced that there are some people who are just too deep. They're in too deep in their careers.

19:58They've been telling their clients for decades that they can add value through superior investment information and access, when in fact, the data is overwhelmingly showing the opposite. And when clients come to us at PlanCorp with these taxable accounts and you can't get out of them, it is complicated to find a way to right the ship, so to speak. And there are more and more really unique personalized solutions to doing that. But that introduces the next step in this evolution of a philosophy, which is complexity. Correct. And I think that a lot of people, particularly people in a seat similar as mine, their chief investment officer, their director of investment research, and their job is just to look at research all day long.

20:43And you find things in white papers, again, academic research, which I just called fancy marketing. And that's probably a little bit overboard, but you suddenly start to look for things beyond what's most simple. And Rick, I am the type of person where I'm more concerned about implementing a bad idea than missing out on a good one. But when you are an individual and you see all these strategies and they are being promoted by such smart people with such strong narratives and even very strong data, it can start to look like you need complexity to make it work. I feel like private assets, alternative assets is the poster child, at least in my world, where people hear that their friends have some sort of investment and it sounds cool and they think, well, gosh, I have money.

21:36Why aren't I doing that? Why doesn't my advisor do that or I need an advisor just so I can do that, which is also false. Just kind of curious what your experience in that stage where people see the light, but then they suddenly get in their own way with the complexity side of it. Great. So we're still talking philosophy here. There was still on that. And we've come out of darkness now. We've had an aha moment where, hey, you know what? Indexing makes sense. I believe in it. I'm there. I'm not going back. But you begin to hear, well, what about factor investing? Those are indexes, kind of. And what about alternative investments?

22:12I mean, those are indexes over there, kind of. And you start looking at the data, like you said, the white papers or things online. And you say, well, you know, if I had a little of this and a little of that and a little of this and a little of that, I'd be on the efficient frontier. I'd have an optimal portfolio. and all of these very academic words that you hear out there if you start getting into the weeds of this. And so you're adding a little bit of the factor funds, the value funds, the momentum funds, the small cap funds. You're adding some of the alternative investments. You're adding this, you're adding all of a sudden your simple portfolio, the simple concept, the enlightenment gets very cloudy and very opaque and your portfolio starts taking on a lot of funds and you wanted to go from a bunch of funds to a few funds and all of a sudden you find yourself adding another five funds, six funds, seven, eight, nine, 10, 11, 12.

23:12All of a sudden you're becoming complex. You're taking the aha moment and you think you're doing the right thing because you are going down the path of indexing in a way. A lot of these things are called indexes, although I call them spindexes, special purpose indexes, as opposed to market-based indexes. Anything can be an index these days. I mean, people who tie their shoe with the left bow over the right bow index, or people who tie their shoe with the right bow over the left bow index, you know, whatever. Anything can be an index, and then you can turn it into an index fund. So the SEC has allowed this to happen.

23:49And so you get to be very confusing and very muddy. And so as people add these things to their portfolio, they're sort of going back the other way. They're doing it in a different mindset because they're trying to use index products, but just going back the other way and they're making their portfolio more expensive, more complex, less tax efficient, and it's called complexity. So it's the third stage of what I call the education of an index investor. And so how does somebody get to your fourth stage, which is that simplicity that you and I desire? Well, they come to a realization. Again, And it's another aha moment, if you will.

24:23It's another enlightenment. What am I doing? This is not getting me anywhere. I mean, I just lost track of what I'm supposed to be doing. I mean, the efficient frontier isn't working. The optimization isn't working. I have to do a Monte Carlo simulation model every 15 minutes based on what I add to my portfolio. It was so much simpler when I had that aha moment. I think that I'm just going to dump all of this other stuff and just go back to something simple. I mean, certainly as people get older, what I see, okay, I'm 65. So as people get older and a lot of the clients I work, I work with clients anywhere from their 20s all the way to their 80s.

25:01But what I can see is as people get older, they want more simplicity, not only in life, but they want more simplicity in their portfolio. So at some point, the people who are doing a more complex portfolio, even though they've had enlightenment, want to go back the other way towards simplicity. And that's the ultimate. But that's the nirvana, if you will, of this simple investment philosophy. Keep it simple, but not only just for yourself. If you're married, it could be for your spouse. I mean, there's usually an interested spouse and then a disinterested spouse. And again, I work with a lot of individual investors who are self-managing.

25:38So the interested spouse wants to get the portfolio as simple as they can so the disinterested spouse can at least understand it and hopefully keep that some way. And so this move back towards simplicity and stay there. That's it. Done. I mean, this is the nirvana, if you will, of the simple investment philosophy. Well, Rick, I think we aren't doing people a favor if we don't point out that cognitive decline later in life is a real thing. And if you are self-directing your own investments, you have to keep things simple. Otherwise, you're just setting yourself up for a problem. And there was actually somebody who had mentioned meeting with you who sent me an article.

26:22He's a listener of the show and of the email. And he said, you know, I met with Rick Ferry a few years ago and he had all great things to say to you. And he had sent me this research paper on cognitive decline. And ultimately, I think that to me, yes, it's the backup for the spouse. It's the backup for yourself. And if you do not use an advisor regularly, you have to make sure that it's something that you can maintain through all stages of life and make those choices now while you're sound of mind and can understand what those implications would be. Because if you wait to enlist help when it's too late, you're more at risk of getting taken advantage, I would think.

26:56And so I take a little tangent there. We've talked a lot about philosophy. I'm going to make some broad statements here, but I think Rick, you and I both, if we look at our investment philosophy, we both believe in low cost. We both believe that you can't predict the future. We both believe in less is more. We both believe in owning the whole market. But the thing is that applying that philosophy and practice is going to differ from investor to investor. People have different types of accounts, different sizes of accounts. And the best strategy for you might be different than for me. Absolutely.

27:31We both have the same philosophy, but I can guarantee you our portfolios are different. What I own, you might own a few of those funds, but you may not. Everyone's different. So you have different job, you have different income, you have different tax bracket, you have different tolerance to handle risk. There are so many differences between us, different family, different goals. Your 401k has different investment options probably than my 401k. So we're getting into the second part of this, which is strategy. So even though you and I have the same philosophy, we are not going to have the same portfolio.