Episode 299: The Most Important Lessons in Investing

23:43This one is crazy though, because I remember learning how this actually affects people way back, I don't know, probably about 10 years ago, I was giving a talk to a group of employees at a company and I was talking about all this stuff, about how active funds tend to underperform and why index investing makes sense. And the person's like, well, I just sat down with a financial advisor at one of the big banks and they showed me this whole menu of funds and all of them had beaten in the market. It's like, that's where survivorship matters. Okay. That's exactly your question mark. They should have asked the bank financial advisor to show them all of the funds that have closed down over the last 10 years.

24:18But of course, nobody has that. It's not in any of the sales material. It's not in any of the easy to access databases. Closed funds just kind of disappear. Makes it very hard for people to make good decisions. I think the reality is for many advisors, their entire value proposition is picking winning investments. And so the idea that they can just buy an index fund portfolio completely removes what they believe to be their value proposition. And especially if you've been in the industry for a long, long time, that's what you've always done. It's really not easy to just switch over to index funds, especially if you've convinced your clients for years that you have an ability that they can't go and do themselves or that nobody else could do for you.

24:53And so if they do that, what's left to be paid for if they haven't been providing other benefits and financial planning services and behavioral management and that type of thing, then they will basically talk themselves out of a job if they switch to a low cost index fund portfolio. I think you're dead right. Yeah, definitely. All right. Number eight, expected economic growth and stock returns are not related. This one also messes people up. It kind of comes back to the narratives thing too, I think. But it's got to be one of the most persistent misconceptions among investors, particularly among inexperienced investors, is my observation.

25:26The idea is that if you invest in the highest growth company or sector or country or whatever, your investments are going to outperform. But I think the reality is a lot more nuanced than that. Expected economic growth is incorporated into asset prices, markets forward-looking, all that stuff we talked about earlier. If high expected economic growth materializes as expected, investment returns will not be spectacular. They'll be in line with the risk of the investment. If economic growth is much better than expected, an unexpectedly good economic outcome for that thing, for whatever it is, then returns can have a positive surprise.

26:01And if it's worse than expected, then it can have a negative surprise. You get worse than the expected return. The relationship between expectations and actual economic outcomes is what's going to drive investment returns, not the economic outcome itself. I think that's really important. The result is a pretty random relationship between realized economic growth and stock returns. In a lot of cases, it's even a negative relationship. It's not a super statistically strong negative relationship, at least at the country level, but there is an economically negative relationship because things that people expect to do well often have what you could argue are overly optimistic expectations.

26:43I think an interesting recent one, I saw a chart on Twitter, I don't know when that was, a couple of months ago, just on the stock returns in China relative to GDP growth over, I don't know, 10 or 15 years. And their economic progress has been incredible. Stock returns, terrible. And that's a conversation I've definitely had within the last 10 years of people wanting to invest in China because it's such a high growth economy. But those things are less connected than I think people realize. Totally. And it's so counterintuitive, but people really do have to have an open mind and follow the evidence on this one.

27:21and it's something you've done lots of work on this over the 299 episodes. All right, number nine, good portfolio management does not make up for bad financial planning. I think it's another really important one. Investing is a means to meet long-term financial goals. That makes understanding yourself an important first step in deciding how to invest. Taking lots of risk in hopes of earning high investment returns is not going to lead to living a good life, even if the risk pays off, and it probably won't, but even if it does. Trying to solve the perfect investment portfolio without knowing what it's supposed to accomplish doesn't really make sense.

28:00People tend to fixate on their investments and they tend to chase past returns like we talked about earlier. They try to pick winners. They try to do all this lottery-like stuff when they should be focusing on how much they need to save, minimizing fees and taxes, getting the right insurance in place, planning for their retirement, planning for their a state to pass efficiently and to the right people. I think financial planning mistakes, a lot of the stuff that I just mentioned, can't be resolved by getting great investment returns. Again, to reiterate, you're probably not going to get the great returns that you think you will.

28:33I think a lot of people think about how great their financial future would be if they just won this lottery effectively, if they just picked the right stock or got in on canopy growth at the right time back when that was a thing before it blew up. and got out at the right time too yeah that's right yeah i see this stuff all the time with clients and somebody dm'd me on twitter like just last week and said hey my accountant wants me to put all of my investments into canadian dividend stocks for the tax benefits and this is so common right like people focus so much on one area like say lowering tax that they completely ignore the potential impacts of that decision right like imagine missing the returns of the u.s stock market over the past decade, all because of a tax decision.

29:15Like, look, if you want to pay less tax, just go make less money. Like, take all your money and stick it under your mattress, you'll generate zero income, you'll pay less tax. What you should be concerned about is the after tax outcome of all of this, right? And if you can put together a better portfolio, that might pay a little bit more tax, but that gives you a better after tax outcome. That's obviously better than just being tunnel vision laser focused on paying the least amount of tax possible. Yeah, and this has been a pet peeve of mine for a long time. People who haven't have the good financial habits through their earning years, look at the portfolio to do the heavy lifting.

29:47And it's like, if you just had the right habits at the right time, you wouldn't have to be in that position. Oh, and usually over a short timeframe too, right? Like they'll come at 57, 58 years old and be like, okay, now I'm ready to start thinking about retirement, but we needed to get you 20 years to go on the right path because now the required return on your portfolio to meet the goals you've set for yourself is just totally unrealistic. And Mark, show me how you've beaten in the market over the past five years is often the point of decision, right? Yep. A hundred percent. Yeah. It's a good way to think about it.

30:16People are hoping that they can undo bad past decisions by hitting it out of the park, but that gets increasingly difficult. The longer people are not following the right habits because of compounding. If you can get a 6 % return for 35 years, that's great. But if you miss the first 25, you need a really high return in those last five years to get anywhere close to where you should be. Yeah. It's like they say, you can't outrun a bad diet. Yeah. And I don't think you can out invest bad behavior or bad savings habits, right? Yeah. Okay. Number 10. Number 10. Risk and expected returns are positively related.

30:55I think risk is required if you want to earn positive expected returns in financial markets. The most obvious example is contrasting stocks, which have higher expected returns with short-term government bills, which have lower expected returns. You know exactly what your short-term bills are going to be worth tomorrow, at least in nominal terms, but your stock portfolio's value is going to change from day to day. It's a requirement to endure the uncertain and volatile nature of stocks in order to participate in their higher expected returns. I think this is important for two reasons. If you want to earn higher expected returns, you need to be willing to take on more risk or at least more volatility.

31:32Measuring risk is a big mess. You got to be able to take on more volatility if you want higher expected returns. And the other piece, the reason this is important is that if someone tells you that you can earn high returns with no or low risk, I think this kind of relates to what we were just talking about. You've got to be extremely skeptical. Yeah. Yeah. I think one thing that investors often misunderstand is that higher risk doesn't mean higher returns. It means the possibility of higher returns, right? You've talked a lot about compensated risk versus uncompensated risk in previous episodes, but like I can go and buy a zero day expiry call option contract on GameStop tomorrow.

32:10Like the highest risk thing that you could buy, it's either zero or it's going to make me a millionaire. But just by taking higher risk, I shouldn't expect a better outcome, but it gives you the opportunity to get a better outcome, but it's not perfectly correlated where I can just crank up the risk in my portfolio and expect a better outcome. So how you put those risks together in a portfolio is really important. Yep. Number 11, I have nothing to add. Okay. Number 11, the risk expected return trade-off has a term structure. Might be the most jargony item in the list, but I do think it's really important.

32:41That's why I kept it in there. I read that like three times and I was like, okay, then I'll explain it because I don't understand it. Okay. So I said measuring risk is really messy. An important follow-on lesson from the previous one is that the risk return relationship, the risk expected return relationship changes with time horizon. For a short-term investor, volatility in asset prices is a pretty good way to measure risk. You care about how much your bank account is worth from day to day. But long-term investors may not be as concerned with short-term volatility. Due to the nature of stock returns, which tend to be somewhat mean reverting, stocks are a little bit less risky at long horizons than we would expect if returns were completely random.

33:23and due to the nature of inflation, which tends to be persistent over time, assets typically considered safe at short horizons can actually be extremely risky at long horizons, like short-term government bills. You know how much they can buy at the grocery store tomorrow, but over 30-year periods, they're more likely to lose purchasing power than stocks. Yeah. I've said this before, but if you think investing is risky, wait till you hear about inflation. It's exactly that. Over long periods of time, inflation is potentially the biggest risk. In the short term, it's market volatility, maybe. And that's mostly because of how you might behave in the face of volatility.

33:59But over long periods of time, it's the decrease in the purchasing power of your money that if you're not keeping up with it, you're gonna have a bad time. Absolutely. Yep. Mark, you had a question there. I think it's worth answering. Yeah. So you said inflation is persistent. And I wanted to know if what you meant by that was that you should always expect some level of inflation, like it's persistent through time, or do you mean the rate of inflation over long periods of time is relatively stable? And I guess it depends what country or market you're talking about, but I'm curious how you explain that.

34:26Inflation is both of the things that you said, but what I'm talking about there is how high inflation tends to be followed by more high inflation. Whereas stock returns, low stock returns are a little bit more likely to be followed by high stock returns. So you get a little bit of mean reversion in stocks, which is protective. Whereas the big risk in bonds is inflation and inflation tends to be a little bit more persistent. So you get mean aversion, I guess, in periods of high inflation. Interesting. So it can snowball, basically. Pretty much. All right, number 12, fees and taxes matter. We've touched on this as we've gone through the previous ones, but one of the reasons that actively managed funds underperform the market is their fees.

35:09Everybody knows that. But the thing is investment products that aim to beat the market, they'll also tend to be less tax efficient. They've got higher fees for sure, but they also tend to be less tax efficient. We know Morningstar has done a couple of studies on costs. Lower fees are one of the best predictors of future fund performance. That just is a fact. If you stratify funds by their fee level, higher fee funds will tend to have worse performance on average than lower fee funds, which shouldn't be particularly surprising, but that is what it is. Fees are only one piece. Active strategies are going to tend to have more trading in the fund, which results in additional costs, trading costs inside the fund, but also for taxable investors' taxes.

35:52There's an older paper and an update, more recent paper that looks at the after-tax performance of actively managed funds. Basically, it's even worse than the pre-tax performance that we know about. If you compare active funds to index funds, pre-tax, active funds will tend to underperform. Post-tax, it's even worse because active funds tend to be less tax efficient than index funds. ETFs have changed that a little bit in the US because of the way that they're taxed. In Canada, we don't have the same advantages, but anyway, fees and taxes, they matter a lot. So this is the pitch for the permanent insurance industry, which is, I saw something on LinkedIn the other day and it's like, wouldn't you love a supersized TFSA?

36:31And it's a pitch for whole life. And I think people are so sensitive to tax and the idea of something being tax-free and we're fairly heavily taxed, I think, in Canada. So the idea of being able to have your cake and eat it too is very compelling for people. But as we talked about earlier, it's the after-tax outcome. After fees, after costs, after-tax outcome that you need to compare when you're looking at alternatives. So the idea that something is tax-free, like I said, I mean, if you stick your money under your mattress, that's tax-free because you'll never earn anything on it. So you need to be aware of the after-tax costs.

37:00And with respect to the taxation or the after-tax performance of funds, doesn't Morningstar have some way of kind of measuring this for certain funds? Like it's another ratio that they put, I don't know if the public has access to it, but I've seen it in Morningstar where there's kind of an estimated tax cost to the fund as well that they provide. Yep. Yeah, they do have that. You can run after tax returns based on their calculation, which is based on US taxes. So it doesn't work perfectly for Canada. And they also have, I think it's called the tax cost ratio, which basically calculates like a expense ratio equivalent based on the tax drag from the fund.

37:33Yeah, that's what I was thinking of. One of the things that jumped out, I know we're going to talk about that CBC cover story. But the lack of awareness on management fees, I think must be really low. The awareness is really low. The lack is high. The awareness level is really low. Because some of the answers that were given by several examples of bank employees was clearly wrong, like not even close, right? Only charge on the growth. So I'm guessing the public must be incredibly, many people in the public must have incredibly low knowledge of these management expense ratios, which I think Canada is well known to have pretty high MERs.

38:10You got me thinking, I got to find it now. The OSC did a study in 2022, and it was a financial literacy survey basically. They asked questions on a whole bunch of topic areas though, not just like the big five. They went much deeper than that. And one of the questions was on investment costs. So there were six financial literacy questions on the survey focused on investing costs. They related to the link between fees and returns, MER impact, index funds, no load mutual funds, products with MERs and advisor costs. And on average respondents answered 36%, two out of six of the investment costs questions.

38:49Correct. Right. Wow. Well, you've probably heard from people who, when you ask them, what are you paying your advisor? And they say nothing. Okay. You think it's free just because you don't see it, right? And they're paying the MER inside the fund. And usually these are those commission-based funds where there's a trailer fee paid, but you don't see, it's not very transparent. So they think they're not paying it. I've seen that. I've also seen functionally the opposite where people know what they're paying their advisor because it's a fee-based advisor, but they don't realize that they're paying another 1 % or more MER for an F-class mutual fund.

39:19I talked to somebody online a few weeks ago where they were asking about PWL's fees and they were kind of like, well, I only pay my advisor 1%. percent. I was like, well, what are you invested in? They gave me the name of a fund and I looked it up and the fund had, I don't know, it was around a 1 % MER. So their total fee was more than 2 % in that case. Yeah. Big lack of awareness on fees. And I would guess even less so on taxes, on the tax efficiency of whatever investment. For sure. And I mean, a lot of people are invested in RSPs and TFSAs where this is less important. Like there's some nuance with foreign withholding taxes and stuff, but for the most part.

39:56So when we're talking about taxes here, they were thinking non-registered accounts. So if you filled up your RSP and your TFSA, you've got investments in a taxable account. You need to be aware of how your portfolio is being taxed based on the types of assets you're invested in, the turnover and everything you just discussed. Yep. To your point on permanent insurance, number 13 on our list here is complexity and costs are positively related. Permanent insurance contracts tend to be pretty complex and the payoffs tend to be pretty complex. And there are meaningful fees buried inside and taxes, which that's a whole other interesting topic.

40:33People think permanent insurance is tax-free. It's not. There are layers of tax that you just don't see as explicitly. But anyway, that's a topic for another day. Complexity and costs are positively related. So I think a lot of investors are attracted to complex investment products. Their market is having special features like high income yields, downside protection, leverage, maybe access to private assets, maybe tax efficiency in the case of permanent insurance. Typically though, complex products are going to have higher fees and costs to the end investor. And most evidence does suggest that complexity generally makes investors worse off.

41:06All else equal, a more complex product will tend to be worse for the end investor. But due to the complexity, it's not always easy to see the added fees and costs. So I would say as a rule of thumb in investing, simple low cost solutions are going to tend to dominate more complex ones. Yeah. And the complex ones always come with great narratives, great stories. And so people buy into these narratives. I call it manufactured complexity, right? Like where you intentionally obfuscate stuff and make stuff complicated to make people feel that they couldn't go and do this on their own or to make it look like you're doing more work than justifying the cost that you're paying.

41:40So the advisors I found, obviously, when I say advisors, I'm never talking about everybody. I'm just calling out certain bad actors, but people will intentionally create complexity to confuse clients and to justify the work that they're doing. Simple is beautiful. Totally. All right. Number 14, there is no single optimal investment strategy. I think it's common and I see this all the time in the rational reminder community for people to agonize over the contents of the perfect portfolio or to argue with other people on the internet about why their portfolio is superior or their investment strategy is superior.

42:15I've never done that. Just to be clear, I've never argued on the internet with people about portfolios. You're talking about other people. I agree. Other people, not you. I've done it too. I do enjoy taking shots at dividend investors, although I've softened on that a bit. I think that there are some actually pretty good behavioral arguments for people to invest with a dividend focus. If it makes them behave better, then whatever. But it is fun to see the reaction of dividend investors because you know what? I'm going to stop there. We'll just carry on. But the reality is, and to the point that I just made about behavior and dividend investing, everyone's got different objectives.

42:50They've got different constraints. They've got different beliefs. They've got different preferences. And I think it's perfectly normal for two people to have different portfolios while both being optimal for their respective situations. It doesn't mean that all investment strategies are good. I'm not saying that I'm a dividend investor now. And I also think that a lot of people make big mistakes with their investments and a lot of people still own actively managed funds and so on and so forth. But I think the main point is that perpetual tinkering of portfolios to try and find the perfect thing or comparing your portfolio to somebody else's and being like, oh, maybe I should be doing that.

43:24I think that's probably an error. I think two people can have materially different portfolios while both of those portfolios being perfectly fine for their specific situations. I agree. I remember being at a presentation a long time ago and it's either Gene Fahm or Ken French has said the perfect portfolio is only known in hindsight. Yep, 100%. And if you could see it with foresight, then we'd all own it. And if everybody owned the same portfolio, there'd be nobody on the other side to trade with, right? Wait a sec. Does that mean that the market portfolio is the perfect portfolio and everyone should just index?

43:58Holy smokes, Mark. You just solved investing. Crazy. You're welcome, Ben. That's actually point number 20, but we're not going to get ahead of ourselves. You're stealing his thunder. But on that point, though, just quickly, if you look at a lot of the content that's on the internet, or even just a lot of amateur investors, I think they have trouble understanding the point that you just described. I'm not calling anybody out in particular, but oftentimes, one individual's answer will be VGRO and chill. There's a subreddit on Reddit called VGRO and chill. And the idea behind this is that nobody ever needs to own anything except for Vanguard's, whatever it is, the Balance Growth Fund, VGRO.

44:32and to your point for some people that's absolutely the perfect portfolio it's not for me and it's not for a lot of people and it's not for some of my clients it's a great portfolio like it's a good starting point perhaps but the idea that there's one strategy that is just applicable to everyone regardless of risk tolerance and risk profile stage of life goals everything else is just silly and back to the dividend behavior point number 15 on this list is the best investment strategy for you is the one that you can stick with there is no objectively optimal investment strategy like like you were just saying, Mark, but the best strategy for each individual investor is the one that they're actually going to stick with.

45:07I think sticking with an investment strategy through bad times, it is a requirement of capturing its benefits. We talked earlier about time in the market versus timing the market, but we also know empirically that it's one of the hardest things for investors to do. I think a big part of sticking with a strategy is separating your decision to invest in the strategy from the outcome that you get, especially in the short term. But I also think dividends are such an obvious example where even if it's objectively suboptimal on all other measures, tax inefficient, it's poorly diversified, blah, blah, blah, we can go on.

45:44Even if we agreed that that's true, if dividend investing lets someone stick with their portfolio and motivates them, I've heard that from dividend investors many times that it motivates them to save and invest. That's great. Why would I say that that's not a good idea? So I think that's important. Yeah, I think to be clear, it has to be a reasonable, rational strategy. The diet that I can stick with is just eating chocolate donuts all day. I could do that, but it's not good for me. And likewise, I can pick a really bad investment strategy that I can stick with and not expect a good outcome. So I think when you're making this point, you're talking about reasonable portfolios, like a diversified dividend portfolio versus the market portfolio versus a factor-based portfolio or something like that.

46:29There are reasonable strategies. And if you can pick one over the other and stick with that one better, then that makes sense. Yeah. The best investment strategy for you is the bracket reasonable one that you can stick with. Yes. Owning Tesla is not a reasonable investment strategy. Here we go. Here we go. Number 16, there's no such thing as a passive investment. There's a spectrum of how passive or active any investment strategy is, but nothing is truly passive. People often refer to the S &P 500 as the passive benchmark, but even that's full of active decisions in the way that constituents are chosen.

47:06And then in addition to that, choosing to invest in the S &P 500 rather than the MSCI all country world index is itself another active decision. I think the positive attributes associated with what is often referred to as passive investing are low costs, low turnover, tax efficiency, broad diversification. But there are lots of funds that meet none of those criteria, lots of index funds that meet none of those criteria, and lots of active funds that meet all of them or most of them. And so because every investment is active on some level, I think it's important for people to understand which active decisions they're making and why.

47:44And passive is such a loaded word as is active, right? I mean, one definition of active investing that I like is anytime you make a decision to not simply invest in something that's total market, it's an active decision. So to your point, the S &P 500, even to go only into that is an active decision, you can argue, let alone what S &P does in terms of the constituent selection, the reconstitution, everything else that goes along with that. So I agree with you. I try not to even use the word anymore I've tried to replace it with indexing when I'm talking about that topic is passive to your point it's such a loaded word it's confusing now to people I think the media has talked about things like mutual funds versus ETFs and active versus passive and they've a lot of the nuance behind that discussion has been lost so I try to specifically say like global market cap weighted indexing even though it's a mouthful to me it's a much more accurate depiction of what you're trying to capture which is broad diversification low turnover, low fees, everything else That sounds so lazy.

48:43Who wants to be lazy? Yeah, you don't want to be average, Cameron, right? Who wants to be average? Even if average beats 90 % of professionals, but that's another discussion. And even calling an investment strategy indexing, that can also be problematic because you look at funds from dimensional, for example, which are explicitly active, like they're not index funds. They don't track a third-party index. They're different than the total market. They're different than the total market, but they meet all of those criteria that I just listed. They've got low cost, low turnover, tax efficiency, broad diversification, but they're not index funds.

49:16Yep. There's so much nuance in that. And often people don't have the drive or desire ability to understand and pick up on this nuance. So it's a complicated world, even though the solutions can be so simple. And especially if you're trying to talk to somebody about like how markets work and why something like index investing or factor investing makes sense, like you got to walk before you can run. And so trying to explain to somebody, like all the things we've been talking about stock picking and everything else trying to take them in one brief conversation all the way to factor investing or even market cap weight and indexing it becomes very easy to just explain something as say passive like i think it's reasonable to call it indexing or passive as a tool for educating people on how things work but at some point you've got to get deeper into the subject to make sure that you understand to your point ben that everything is active to some degree yeah i've also seen people who are like yeah i'm an index investor see the portfolio and it's like S &P 500 and I don't know, like a mining index or something.

50:14Yep. I have a client like that. And that's how we started talking. We started talking on Twitter and he said, no, I'm an index investor. And I was like, oh, cool. Like let's see your portfolio. And it was industrials and REITs, just those two sectors, but they were index ETFs. And so he considered himself an index investor. And once we had the conversation about what the spirit of indexing really means, like a global market cap way to portfolio, it was kind of an aha moment for him. And we've been working together for over a year now. Great client. But yeah, I think you're absolutely right. Owning index funds doesn't make you an indexer.

50:43Yeah. It's a tough one. Because people hear the media or whatever, or us just now talking about, yeah, index funds are good. Like, great. I'll buy this. Like you said, I'll buy a technology ETF or something. Yeah. Well, it's an index fund. I'm doing the right thing. Anyway, number 17, wealth does not give you access to market beating investments. Let that sink in. Warren Buffett's talked a lot about this in a couple of his annual letters, but a lot of the benefits of investments or supposed benefits of investments like private equity, real estate, direct real estate, hedge funds, permanent life insurance, like you brought up earlier, Mark, they're probably more fairytale than reality, at least on average.

51:25They typically have super high costs. They're often sold on an era of exclusivity, but they're economic benefits to most investors. And I say most because there are some weird characteristics, like there's major skewness in venture capital fund returns. If you can get the best funds, they tend to be persistently good. Most people can't, including the ultra wealthy. But anyway, on average, the economic benefits of these more exotic investments are not well supported. somebody called them access funds a while back like on twitter and i just think that's just such a perfect way to describe it right and as you guys know i work with a lot of physicians and i think many of them do very well and become wealthy and there's a sort of peer comparison at some point that happens not just amongst physicians but amongst a lot of people and as you get wealthier and wealthier you want exclusive access to things that other people don't have because you feel you deserve it because you're special it doesn't mean they're like you said market beating investments but they feel special.

52:23And as we talked about earlier, you can craft a very good narrative around these things. And so it's very easy to sell stories. It's a lot harder to sell being boring and sitting in your seat and just keeping costs low. It's a lot easier to talk about the newest sexiest asset class that exists and why everybody, you know, pension style investment management is my new favorite. Every firm in the country is talking about pension style investing. Your goals and how a pension manages their money are two totally different things, but pensions have alternative asset classes like real estate and infrastructure and that kind of stuff.

52:53And so this has become a new marketing engine in our industry is selling the idea of pension style investing. And that sounds great, but it doesn't necessarily mean you're going to get better returns or lower risk or anything like that. And don't forget these stories help people tell their story. If you're able to get into something and have great returns from something that's a little more exotic, a little more private, it helps tell your own narrative. We're all here trying to tell our own story in life. I think that's a big part of it too. That's a good point. All right. Number 18, diversification is the only free lunch in investing.

53:26It's been called the only free lunch in investing because it offers this rare opportunity to reduce risk measured by return variance without reducing expected return. It's magical. Usually as we talked about earlier, you have to take more risk to get higher expected returns, but this is a case where that relationship does not exactly hold up. At the extreme, buying a single stock exposes you to a little bit of market risk, which has a positive expected return and a lot of company-specific risk. Like I made the joke about owning Tesla not being a good strategy earlier. Company-specific risk does not have a positive expected return.

54:01Now, the exact number of stocks needed to call it a diversified portfolio is kind of hard to pin down. But in general, more diversification is going to be better than less. There are some cases where you might want to have a more concentrated portfolio to get exposure to some specific thing, like a small cap value fund, for example, that's a little bit more concentrated, but it's targeting very specific stocks with higher expected returns. And a small cap fund is still going to have whatever, hundreds of stocks in it. And then the other thing is that other than just reducing return variance, diversification also helps reduce the impact of skewness in individual stock returns on portfolio outcomes.

54:37Some stocks do really, really well. Most stocks don't do so well. So you're much more likely to miss out on winners by having a concentrated portfolio. And that skewness is probably another reason that most actively managed funds underperform. They tend to be a lot less diversified than an index fund. That probably contributes to their difficulties in beating the market. Tell me if I'm wrong here, but if you look at something like the S &P 500, the returns of the S &P 500, is it not true that most of those returns are driven by a very small subset of the constituents? Yes. For sure, the wealth creation, which is distinct from returns, is driven by a single digit percent.

55:16But the actual returns would be probably more of the constituents, a little bit more. But most stocks in the market have underperformed. A lot of stocks have negative absolute returns. Yeah. So the reason I ask is because you often hear, there's been studies that show that the diversification benefits after owning, there's different studies, but 30 to 50 stocks is commonly quoted as, you know, after 50 stocks, the diminishing benefits of diversification start to fall off so quickly that you don't need more than 50 stocks. And I think if I've understood correctly, that argument completely ignores the fact that most stocks underperform.

55:53So yes, you might get the risk diversification benefits by owning only 50 stocks, but the probability of you underperforming significantly by missing the stocks that are going to drive the performance of the market in the future is huge. Yep. I think that's correct. I think those charts used to be called diversification. I don't think there's a line I said more in this business than diversification is your buddy. Perhaps markets work, but markets work and diversification is your buddy. Yep. There's nuance here too. If you're concentrating a portfolio in stocks exposed to specific factors, then a concentrated rebalanced portfolio is maybe less likely to underperform the market, but it's going to be a much bumpier ride than a more diversified portfolio exposed to the same factors.

56:39Can I just buy a high conviction funds, Ben? Well, you can. I love high conviction funds because the implication is that their other funds are low conviction funds. Like what are your other funds doing? These are the funds we really believe in our stock picks and these ones, but these ones, yeah, whatever, right? That is pretty funny. High conviction probably just means more concentrated though, right? I think it often does. Yeah. It's taking their best ideas and yeah, and overexposing them. It is funny though. I remember a fund back in the day and someone can help me remember the name, but they had the highest conviction managers pick their highest conviction stocks.

57:14I think it was five managers and might've been five or 10 stocks each. This is going back a long time. Total train wreck. Anyways, great story. Yep. It's all marketing. Good marketing. It's great marketing. You get double conviction. I think diversification is super important. I'm not saying that it's not, but I think about the Alpha Architect products, which are relatively concentrated for a very specific intentional reason. Still, I think they have 50 stocks. I haven't looked at them in a while. Concentrated compared to a total market index fund, but set up in a way that you could argue has a positive expected outcome over the market with the way that they've done the weighting and the rebalancing and the general design.

57:59But anyway. As Wes said, that's pretty risky stuff, right? Like he calls it compound your face off. And I think even those guys, and with apologies to the Alpha Architect team, I don't know that they would even recommend for like the majority of people that they go a hundred percent into these strategies. I know portfolio managers in Canada that use Alpha Architect and they use it as sort of a sleeve, right? I mean, they take the market and then they use that as their factor exposure by taking 10 % of the portfolio and going into one of their value funds, for example. Yeah. They call it capital efficiency.

58:31Instead of having a factor fund that has a relatively high fee on the whole fund, you have a very, very cheap beta fund and you can combine it with a concentrated factor fund. Anyway, so there's some nuance on the diversification stuff. We did an episode years ago now on concentration versus leverage as different means to get higher expected returns. That's the topic that's been discussed in, I don't know, thousands of posts in the Rash Reminder community. Anyway, number 19, investments should be evaluated on process, not outcome. I think people can get lucky or unlucky with an investment after they've made the decision to make the investment, but outcomes are so noisy in investing that it's really hard to say over, I mean, any period of time.

59:19I don't know. Any period of time that would be relevant to most investors, it's really hard to look back and say based on the outcome, whether it was a good or bad decision. But you can look back on the process that you used to make the decision and the information that you had as inputs. That's really important. But it's so easy to make that decision based on the outcome. And we can pay homage to Danny Kahneman, who we learned passed away today. You can use system one thinking, which would be to look at the outcome and say, oh, great outcome, great performance, I'm in. System two thing is a little more difficult to understand the nuance.

59:52What is the process? Wasn't there a paper that suggested that it takes something like 68 years to prove skill in stock picking? Have you guys heard of this paper? I don't know if it was a paper. I think it was just a very simple statistical demonstration. Maybe that's what it was. Most of the stuff that I get, Ben, I get it from Twitter, so I don't know how well thought out some of this stuff is. And I'm not going to actually go and read 100 pages of academic papers. That's what I got you for, man. I'm not going to go and read it. I'm going to ask for your opinion on it. I don't know if it's true or not.

1:00:23And we see this with the messers all the time. Even when I'm talking to people, they'll say, oh, well, I've crushed the market. It's easy to beat the market. What's your time horizon? Well, over the past 18 months, I've dominated the stock market. It's like, okay, well, you picked nine stocks and got lucky, right? As we went back to earlier, if your time horizon is 60 years, the probability of you continuously outperforming or outperforming enough in one period such that your probable underperformance in another period is overcome by those good periods. Like that's, and some people will, some people will do it.

1:00:53Absolutely. But it's just a game that most people shouldn't play and evaluate your performance over a reasonable timeframe as well as the process. Yep. All right. Last one, number 20, which I alluded to earlier, investing has been solved. No one's going to fail to meet their financial goals because they didn't have, I don't know, tail risk insurance or structured products in their portfolio. I think for most people, investing in a broadly diversified portfolio of low cost, total market index funds is good enough, even if it's not perfect. Even if it has some warts. I'm actually going to work on a video and we'll do it on a podcast episode too about the problems or the downsides of the growth of indexing.

1:01:30I think there are some interesting arguments on that. But anyway, even if it's not perfect, it's pretty good. There are enormous incentives for people to tell you that you should be doing otherwise, even if they're right, even if there are ways to potentially optimize a portfolio, low cost index funds are, I think, good enough as the approximate solution to investing for most people. Especially these days, it's so cheap, right? You can own the global stock market for a couple beeps, like start there. If you need to deviate for some other reason, like we talked about with factors or something like that should be the core of the portfolio, you know, adjusting for risk tolerance and that, but start with the market.

1:02:06Improve your habits, plan better, improve your behavior. Once you've got all that checked off and figured out, then maybe look for something, maybe, but skeptical. Great list. Those are the 20 most important lessons that I could think of. And if people listening want to chime in with their ideas for additions to the list, then maybe we can read them out in a future episode. So you can leave them as a, I don't know, a comment on YouTube or post it to the Roush Reminder community, send it to us on Twitter, but we'll read out the good ones that we get. Okay. That was awesome. All right, guys, you want to go to the after show?

1:02:38Sure. Yep.

1:02:44Let's kick it off with a discussion around that CBC story that was, I think it was a repeat of something they first did back in 2018. And Ben, you got some notes down here. Why don't you kick us off? I mean, this is just such an incredible story. Sorry to interrupt, but But you just watch and you're paying for these people. The examples they show in the episode, you're just paying for these people getting this kind of advice. And we know firsthand from people we know that it really is a sales culture in many of these environments. So with that, Ben, take it away. Well, before the CBC article came out, somebody had posted on Reddit.

1:03:21They later deleted their post, but I had taken a screenshot of it because I thought it was worth sharing. They posted about their experience working at one of the big banks. And they talked about how the sales culture was super aggressive and that it completely disregards what's best for the customer. They're solely focused on selling products, even if it's detrimental to the customer. So I posted that screenshot on Twitter with a comment, always remember that banks sell financial products, not financial advice. And then along with that, I posted findings for 2018 paper that looks at data from a large Swiss retail bank to analyze how banks and their financial advisors generate profits from customers.

1:04:01But they basically showed that the bank's own mutual funds and structure products are most profitable for the bank, which is not surprising. And the bank advisors tend to recommend them, which is also not surprising. And they did this interesting experiment where they looked at advised trades, so trades placed by bank customers that were on the advice of an advisor, and then also trades independently placed by clients into financial products. And the advised trades that came through the financial advisors were associated with higher profits for the bank and the performance was worse. So that paper suggests that bank financial advisors put their employers' interests ahead of their customers.

1:04:43I don't know if you guys want to say more about the CBC article that came out. I think it's important to also understand the tiers and this sort of hierarchy of service that the banks offer to you, right? Like I've got friends that work for the brokerage divisions of some of these banks and I consider them to be great advisors, great planners. They're everything we talked about on today's episode, for example, right? And so they're fee-based planners like we are here at PWO Capital. And so I think it's important to understand that when somebody walks into the bank branch to deposit a check or pay a bill, they're not gonna just automatically get access to some of these really good advisors that work through the brokerage divisions of the banks, but they are going to get ushered into an office with somebody potentially called a financial advisor or some other title.

1:05:25And it's often those types, or at least in this article, that's the level of service or advice that the investigators in the article were dealing with. So I just don't want to be overly critical on the entire institution because I do know there's great people there. Most people are never going to get to the level of wealth that you would need to be able to work with one of those great advisors. So the average person walking into the branch is likely going to be subjected to exactly the type of tactics that were exploited in the article. And that's a tough environment because so many different service requests are coming at you.

1:05:57So I'm sympathetic to that. Like I have great people that help me in my bank, love them. They're fantastic. So I think you raised a good point. But Canada's got this very bizarre level of affection for their banks. And as I often say, it's come down to colors in Canada. Like if I say green, you know which bank it is. If I say blue, you know which bank it is. If I say burgundy, you know which one it is. Like I find it kind of weird how it's come down to six colors and the ability for the banks to extract. And another thing I've heard people say, the ability to extract high expense ratios from people, from Canadians is truly astonishing in many cases without getting the level of service that would be warranted by paying such a fee.

1:06:37Have either of you guys worked at a bank in your career? Can't really know. I haven't worked at a bank, I worked at a credit union and it wasn't nearly as bad there as what was described in the article. But I do want to point out that the individuals who were, the term guilty seems a bit too loaded, but the individuals who were maybe responsible for some of the advice that came out of the article, you got to start somewhere. And a lot of these people probably think they are doing the right thing. So some of the people they interviewed, it was very clear that they had the moral compass and at least the understanding that what they were doing was wrong.

1:07:08But I don't think that's always the case. I think some of these people are trained, and I talked about this on the Canadian Investor Podcast with Simon Belanger a couple weeks back, you're often trained in some kind of corporate environment. And if that's the only access to information that you have, and you're not curious enough to seek out other information, you likely think the thing that you are doing is the right way to do it for not only the institution, but also for the customers. So in a way, I can sympathize to a degree with some of these people, because I did work in, again, not as harsh of an environment.

1:07:38And again, you do have to start somewhere. So they often have little training, little education in the things that they're selling. And I think to a degree, we should give some of them the benefit of the doubt. But at the end of the day, the outcome to the customer is what matters. And I think the institutions have a responsibility to take this one on the chin and do something about it. Yep. Yeah. I never worked in a bank, but I worked in a pure commission mutual fund dealer, which was like the sales pressure doesn't get higher than that because you have to sell to eat. Cameron, you've lived that too.

1:08:06And I totally agree, Mark, that in that environment, there were a lot of people who, some combination of thought they're doing the right thing and needed to put food on the table and didn't think that they were doing anything bad. They just knew they needed to sell this stuff, which they may have thought was good, but they're highly motivated because they needed income. And then there's also that paper on the misguided beliefs of financial advisors that looks at, it was actually Canadian data and they basically find that financial advisors are doing all of the same mistakes that they're doing for their clients.

1:08:37So they're not just selling these high fee active funds to their clients because they're malicious. They're doing it because they think it's the right thing to do. And one of the things that I remember from that paper is that the advisors continue doing the same stuff in their own portfolios after they had retired, because it's trying to test for like, are they just doing this stuff while they're working to convince their clients to buy the same stuff? But no, they kept doing the same stuff after they retire. So it suggests that it's misguided beliefs as opposed to conflicts of interest. But I do want to read a couple of quotes from this article on the conflicts because these are pretty overt in this case.

1:09:09One TD employee says she's usually not acting in the best interest of her clients. She's trying to sell them products that will help her meet her sales targets and keep her from being fired. Another one says, I had to mislead customers into getting products they didn't need to reach my sales target. Another one says, it's not a customer service environment. we're there to sell and make money for the bank. Now, also keep in mind incentives matter on both sides. The media wants a sensational story. So they would have picked excerpts that are sensational, but I think it's worth Canadians being aware and keeping in mind that there's also that academic paper from 2018 that found similar stuff and the other TD anecdote that came out before the CBC article.

1:09:50So like, it's a, it's a thing. It's a thing people should be aware of. Yeah, I will say this type of behavior is, I'm playing devil's advocate here, if you guys can't tell. And the reason is, I can see the reaction of some people going, oh, yeah, look at these guys, independent advisors, how easy is it to just slam the banks and looks like you're talking your book and all that. I think everything that we've talked about and how the banks have perpetrated some of this stuff is absolutely correct. I will say it's not just the banks, to your point, incentives drives outcomes, and you have to be very aware of those incentives.

1:10:20it's probably not the time to talk about it now maybe we'll talk about it next episode but on the back of that cbc piece i came up with kind of just off the top of my head five questions that you should ask an advisor before you engage with them or at least five questions that you must have the answers to to determine whether or not you're dealing with somebody who you can trust is giving you advice that's in your best interest and i don't have the questions up in front of me i did post it on twitter as a kind of short article if somebody wants to go look it up maybe we can talk about it in another episode, but I think educating the public on how to defend against this type of behavior is important too.

1:10:54So up next here, one of you guys has a note about sleep restriction. Yeah. So I, I've always struggled with sleep always. And I discovered this thing. It's very evidence-based as well research. It's a form of cognitive behavioral therapy called sleep restriction. It sounds terrifying because it is. So you basically, and this is a gross oversimplification. I followed this whole specific program where you calibrate your sleep beforehand or whatever. But what sleep restriction is, is you basically go to bed late, later than normal for a period of time. So in this case, in the program you're doing for a week.

1:11:30So I normally go to bed at like 10 and this thing wanted me to go to bed at, I think, 1130. And you have to wake up at your target time, which for me is 630. So I went to bed at 1130 every night for a week. Woke up at 6.30. Felt awful. You slept solid straight through? Not so much at first, but as you get increasingly tired, what happens is it compresses your sleep window. So you're getting fewer hours of sleep and it forces your body to reset your, I guess, circadian rhythm and your sleep cycle. So you end up sleeping through the shortened sleep window with better quality sleep. And then once you've done that, then you extend the sleep window at the back end by going to bed a little bit earlier.

1:12:15So I've come out the other side of that now. And my sleep is like dramatically improved. Huh? Do you get woken up in the night by your kids, Ben? Or is this just something you've struggled with for like before having kids? Like you wake up frequently. I'm curious, what's the problem with your sleep that you were trying to solve? And is it, there is sort of like any exogenous forces, like young children crawling into your bed? I used to struggle falling asleep when I was younger. And now, more recently, I have not so much trouble staying asleep. It's not like I'm waking up in the middle of the night and can't fall back asleep, but I would wake up way too early and not feel well rested.

1:12:51But so far, this sleep restriction thing seems to be helping. I'm a week into extending my sleep window again. So I'm sleeping better, feeling pretty good. Good for you. It's all my kids though. The way that our living arrangement is set up, my kids don't bother me. I'll say that. I sleep fine. You have to give me some tips. All four of us sleep in a bed most nights. It's not sustainable. Yeah, that is not sustainable. No. Virtual reality exercise. What is that? Oh man. So I used to do this and I got back into it the other night. I can barely raise my arms today because they're so sore. So you guys are familiar with virtual reality headsets like the MetaQuest and obviously Apple just released their flagship version.

1:13:32I got the MetaQuest 2 when it first came out, which is a few years ago now, maybe three years ago. And it's a standalone headset, right? So the battery's inside, the computer's inside, you got your controllers. And like, I've dreamed about this stuff since I was a kid. And I had the, what was it, VR Boy? And it was like this big, nasty red headset. And it was nothing like what we've got now with the technology and virtual reality. And you step into this thing, it feels like you've been transported to another world. And it's incredible. And what I realized after playing some games there is that some of these games are very active games, like you're flailing your arms around and stuff.

1:14:03And there's a lot of games that are built specifically as exercise tools right so just trying to exercise more and i do some stuff here and there but i remember that i used to really enjoy some of these games and some of them really get the heart going so a couple nights ago i fired it up for the first time in like a year and there's a boxing game called thrill of the fight and i've never been so gassed in my head like i'm 40 years old i used to play hockey like baseball like you know i have never been so tired in my entire life as i was playing this game and it's a boxing game and so you've got an opponent and you're in a ring and you've got the headset on you've got your controllers basically the bell goes and you fight but because it's gamified the incentive to just keep going even when you're so tired like if i'm riding on a bike or something i'll just stop when i'm tired but because i've got an opponent coming at me i'm throwing haymakers and like like overhand rights and just doing everything i can to and i can barely breathe i'm so tired and then the bell goes and you just kind of rest for a minute.

1:15:00You're like, oh, that's it. I can't do another round of this. And then the bell goes and you're like, I didn't hear no bell. Like here he comes and let's do it again. And after 10 or 15 minutes of this, like I had to lay down because I was so tired and I can barely move my arms, but it was so much fun. And there's like dancing games and all sorts of other games that are really, really active. So if anybody's having trouble finding the motivation to exercise virtual reality headset, they're pretty cost effective. Like the meta ones, at least the games are really, really cheap. It's a ton of fun.

1:15:27You don't need a huge space and I just love it. So I'm going to get back into doing it every night after the kids go to bed. So maybe Ben, you should do some VR boxing to go with your sleep restriction. I'll stick to my real life basketball. I do like the idea. It's fun. Maybe we can do it like play online against each other. We can box each other or something. I thought that probably would be a lot of fun. I'd have to punch up, but I'll figure it Yeah. So my item is a few weeks ago, I was on with Giorgio on Mr. RIP, Retirement in Progress. So that's the Twitch that you were on a year ago, Ben, and Giorgio was on with us back on episode 257.

1:16:04So I went on a show live, I guess, two or three weeks ago now, and it was super fun, two hours. Have to hand it to him. He's like a one-man show doing this, especially in English. He's alone and the questions are coming. He's got his own questions. so it's quite something to watch and maneuver that. So we'll put a link to that show in the show notes. It's now up on YouTube along with yours is up there as well. But we talked about the history of the company, my background, a little bit about the banking situation in Canada that we talked about, ETFs. That was a fun, really fun conversation. Lots of questions came in, which is cool.

1:16:37One of you guys want to read this review we've got here from Bulgaria? Mark, you want to read your first review? Oh, bigger responsibility here, yeah. Thank you. Let's see. Recent reviews. Juco, I'm probably mispronouncing that, J-I-W-K-O from Bulgaria. Interesting, educating, level-headed. The only podcast I regularly tune into. Ben and Cameron are the best. Thank you for your service. And Mark. You have to get your name in there. It'll come in time. I had a couple of people reach out on LinkedIn, said, hope you're doing good. You mentioned the latest episode of RR that you didn't receive any feedback the preceding week.

1:17:13I've been thinking about sending one for some time. So now I thought I'd take this opportunity to chime in. RR was what convinced me to do my master's in finance. And as been mentioned before by others, the interview style is commendable, asking well-researched, open-ended questions, and then letting the guests do the majority of the talking. A lot of reporters can learn a thing or two from you both love the podcast. That's from Kishit Deej, pardon my pronunciation. and then Brian reached out saying he loves the podcast. Just want to let you know I love listening to Rational Minder each week. The interviews are always interesting.

1:17:47Guests in some of the papers I end up discussing with my workers in the research department. As someone who has family on both sides of the border, I've used your podcast to help family understand some of the things I do at work. Keep up the great work. If you are ever in the D.C. or Baltimore area, let me know. If you're free to meet up and looking to buy my vest for work and Carhartt often does branded gear. And Ben, I think you had a suggestion from someone about doing Cotopaxi vest, which I think could be a cool idea. Yep, could be. Look into it. People were sad that the Patagonian ones didn't work out.

1:18:25Yeah, it didn't go well. Any scoop on the money scope or in the community? Money scope, you know, I realized that I haven't been mentioning money scope on Roush Reminder, which I had intended to do. I guess I just forgot. but we had an episode and a case last couple of weeks on taxable investing. So good. So good. So clear. Coming up this week, we have an episode on investing in a Canadian corporation, which is I think one of the episodes that people were really excited about. And that's really the topic that motivated us to do another podcast to talk about really niche stuff like that. So the next few episodes are investing in a corporation.

1:19:05And then we've got some, I think there's two on that. And then there's cases. And then there's corporate compensation planning. How should you pay yourself from your corporation? And that one gets pretty serious. I think there's a lot of new ground that we've uncovered in that episode. Mark and I digging into the stuff together, working on modeling different things. But then the other thing we did is once we had assembled our base notes, we brought in two CPAs and two financial planning experts that I know when I just said, Hey guys, we wrote this thing. I think it's pretty interesting. Can you look at it?

1:19:39And so the amount of brain power that went into that thing is just like, I don't know if anything like that's been done before. So anyway, there's going to be a really interesting run of episodes. Interesting to people who have corporations or work with clients who have corporations. I show it to a lot of my clients and physicians that I know it's not just for physicians, but obviously being with Mark Soth from the Looney Doctor, a lot of them are familiar with his work and those who have listened so far to the money scope absolutely love it and not just the really detailed nerdy kind of tax and financial planning stuff but some of the stuff you guys talk about in terms of goal setting and finding and funding a good life and all that so the feedback that i've heard from professionals that have listened to it has been really really great same here so next week guys is our 300th episode and we have a great guest an expert in decision making.

1:20:30So we're welcoming Abby Sussman from Chicago Booth. Great episode. And in two weeks, we're joined by our friend and past guest from episode 258, Mayor Statman. He has a new book coming out called A Wealth of Wellbeing. So he will join us in that episode. Then in three weeks, Scott Galloway, yes, Prof G will be here. He has a book that's coming out. And in four weeks, our good friend Dan Solon will be here. have we mentioned what you're doing with Dan Solon yet Mark can we say it I don't know can we I think we can sure go ahead he's a good friend I'm sure he'll be happy with the plug sure no sounds good so I followed Dan Solon for a number of years on various social media and he's a well published and more respected author from the US and I know PWL and obviously you personally Cameron have a long-standing relationship and friendship with Dan so he's written a number of books, but he's written a new one.

1:21:24And it's geared towards a millennial audience, specifically in the US right now. And a lot of what this book is about is teaching them how to do things themselves when it comes to financial planning and personal finance and investing. And I think part of the motivation for this is that from his discussions or interactions with those folks, they will likely at some point maybe benefit from having a great advisor or maybe not, but to get there because great advisors often have really high minimums or are only taking select types of clients, millennials, even if they want to work with a great advisor down the road to get there, they're going to have to figure out how to do it themselves in the beginning and how to develop good behaviors and understand a lot about certain financial planning and personal finance topics.

1:22:05So he sent me an advanced copy. I read it a couple of weeks ago. Great book, really simple to the point, has just a ton of different things that people need to think about. So it's not just on investing, for example, it talks about insurance and crypto and all sorts of stuff. Anyways, he would like to Canadianize this book. And so he reached out to you two, to Ben and Cameron, to see if there was any interest in doing that. And I was fortunate enough to be able to take on that project. So I will be writing with Dan's already done the work, but I'm going to take the segments or the chapters that are specifically geared towards an American audience and rewrite them for a Canadian audience and release it here in Canada.

1:22:46And the book is called Wealthier, correct? Wealthier. That's right. Awesome. So Dan's on to talk about the launch of that book, which should be super fun. So we'll all be on that episode. As usual, all of us are on LinkedIn and Twitter. We all have Caldi links in our Twitter bio as well, which I know is actively used. Love hearing from people. Reach out anytime. You guys have any final thoughts this week? I'm good. Good. All right. Great episode. Thanks for listening, everybody.