Afford Anything - 10 Rules for Building a Portfolio That Actually Works for Your Life, with Cullen Roche

Episode Date: January 31, 2026

#685: You're not an investor. You're a saver. That's the first of 10 principles Cullen Roche shares in this conversation about building what he calls "the perfect portfolio." Roche, the founder and chief investment officer of Discipline Funds, argues that when you buy stocks on the secondary market, you're not actually funding companies or making investments in the traditional economic sense. You're just swapping your cash for someone else's stock position – reallocating your savings. This reframe matters because it changes your entire approach. Instead of trying to beat the market, you focus on the boring, prudent work of allocating your savings across different time horizons. We walk through all ten of Roche's principles. He explains why you are your portfolio's worst enemy – not just because fear makes you panic-sell during crashes, but because FOMO during bull markets leads you to chase performance at exactly the wrong time. He breaks down why diversification is the only free lunch in investing, why costs matter more than you think, and why real returns are the only ones that count after you strip out inflation, taxes, and fees. Roche introduces some concrete strategies most people have never heard of. The 351 exchange lets you swap concentrated stock positions into diversified ETFs without triggering immediate capital gains taxes. The "defined duration" approach matches specific pools of money to specific future expenses—like pairing a six-month treasury bill with next year's bathroom remodel. He also tackles the hardest allocation question: what to do with money earmarked for three to ten years from now. That awkward middle timeframe sits between "keep it in cash" and "put it in stocks," and Roche explains why traditional approaches like sixty-forty portfolios don't always work. The conversation covers everything from why long-term bonds make terrible matches for long-term goals to why thinking in time horizons beats thinking in investment styles. Timestamps: Note: Timestamps will vary on individual listening devices based on dynamic advertising run times. The provided timestamps are approximate and may be several minutes off due to changing ad lengths.

(00:00) Principle 1: you're a saver, not an investor (04:48) Real wealth comes from direct business ownership (06:43) Principle 2: you are your portfolio's worst enemy (09:58) FOMO during bull markets vs fear during crashes (12:43) Principle 3: beating the market is hard (15:18) The 5 percent "fun money" allocation debate (16:18) What to do when your position explodes (17:18) The 351 exchange tax strategy explained (20:28) Should you rebalance concentrated stock positions (22:18) Principle 4: diversification is the only free lunch (31:03) Gold and stock market both high simultaneously (35:43) When diversification becomes diworsification (40:03) Principle 5: the cost matters hypothesis (44:23) HSAs, 401ks and unavoidable fee structures (47:03) Why ETFs beat mutual funds on taxes (51:03) Principle 6: real, real returns matter most (1:00:58) Principle 7: risk is uncertainty of lifetime consumption (1:06:18) Longevity risk and unpredictable healthcare costs (1:13:03) Principle 8: asset allocation as temporal conundrum (1:24:43) The 3-10 year allocation problem explained (1:28:03) Principle 9: past performance doesn't predict future (1:31:18) Principle 10: set realistic expectations, stay the course Resources: Cullin's website and newsletter: https://disciplinefunds.com Grab the FREE handbook: https://affordanything.com/financialgoals Learn more about your ad choices. Visit podcastchoices.com/adchoices

Today's conversation is going to challenge everything you think you know about investing. Welcome to part two of our interview with Cullen Roche. In today's episode, Cullen Roche breaks down the 10 principles that will help you become your portfolio's best friend rather than its worst enemy because most people are their own portfolio's worst enemy. You'll learn about why people's biggest investing mistakes isn't about picking the wrong stocks, it's about picking the wrong relationship with your money. You'll hear about why people put too much emphasis on investment styles like growth versus value or large cap versus small cap.

People put too much emphasis on that and not enough emphasis on time horizons. You'll learn about the 351 exchange strategy. This is a new thing that formed in the last 18 months. You'll learn about the take half off the table rule. You'll hear about the defined derives. You'll hear about the defined duration strategy, which helps you match pools of money to specific future expenses. You'll learn about price compression risk. So what happens when gold returns 60% in a year? Well, you've pulled forward years of future returns, and that sets you up for potential sequence risk down the road. We're going to talk about that. We're going to talk about why long-term bonds are terrible for long-term expenses. We talk about the problem with asset allocation for the three to 10-year

time frame. We cover a lot of ground today. Welcome to the Afford Anything podcast. the show that knows you can afford anything, not everything. This show covers five pillars, financial psychology, increasing your income, investing, real estate and entrepreneurship. It's double-eye fire. And today's episode is about that second letter I, investing. Cullen Roche, our guest, is the founder and chief investment officer of discipline funds, which is a low-fee advisory firm.

This is part two of our interview with him, part one, aired earlier this week. Enjoy. Thank you for joining us for part two. Welcome back. Hey, Paula. Great to be back. I want to talk to you about your 10 principles. Most of this conversation has been tactical and sort of embedded within how to choose. You've touched on some principles, but I want to make those principles more salient. Let's actually talk through the 10 principles that you have outlined. Starting with principle number one, which is that you're a saver, not an investor.

Yeah, so this is something that I kind of battled with. I wrote a different book called Pragmatic Capitalism 10 years ago. And that book was a finance book and an economics book. I talk a lot about the principles of economics in that book. And something that I struggled with in that book is that the word investing has totally different meanings in the field of finance and in the field of economics. And in the field of economics, it means to spend for future production. And that's done by firms. Firms or individuals. when you're building your human capital, your skill set, you might spend money to go to school. You're making an investment in your future production. And firms do this. We describe investment in economics as spending for future production. And that might be something like building a factory or something. And the firm is actually allocating capital into something that is going to generate a return on investment in the future.

And the weird thing about what we do in finance is that, you know, I talk about how you're allocating your savings. When you actually go out and you buy stocks and bonds on, you know, the stock exchange or whatever, you're not actually spending for future production. You're not even financing the firm's ability to do that necessarily. You're literally just buying someone else's savings. You're buying a stock. The person selling the stock is buying your cash. And the firm actually isn't even involved in any of this. They don't care what's going on with your secondary market purchases because you're literally just reallocating your savings. And so the reason I like this concept is because from an application perspective, the idea of investing,

I think sometimes is it's sort of viewed as something sexy or like a get rich quick kind of endeavor, whereas allocating your savings is fundamentally boring. It's a prudent process. It's a long-term process. And so I try to communicate that concept of people, not to be a dork about the jargon in the industry, but because from a very sort of fundamental perspective, you are reallocating your savings and you should go into the process of building a portfolio with that sort of mentality that, hey, this is a process that, sure, I could make a lot of money doing this, but it should be a long-term, thoughtful process that is much more akin to reallocating your savings than sort of a get-rich, quick investing endeavor that a lot of

people might think of it as. Right. Would it also be accurate to say that, I mean, if a person really wanted to get wealthy, you would need direct involvement in a business that you yourself own and operate. Yeah, that's true investment. If you really, but again, running a business is really risky. The vast majority of businesses over a 10 or 20 year period are going to fail. And so investment, actually spending for future production at like a firm level, it can be really risky. But it's a fundamentally like very different thing than just reallocating savings into a diversified index fund or something. It's also a highly specialized in a different way of allocating cash. capital because typically when people are starting a company or something like that or investing in

their own human capital, they have a specialty in that. You're a great communicator. So you're very good at allocating capital into your business because you're such a great communicator. And that's a skill set that you've developed over a long time and you have a unique ability to take advantage of that that, you know, a lot of people probably don't. In a way, you're taking a high risk, but you're taking a very specialized sort of risk in something that you have a unique skill set in. And so running a business is typically something that is an allocation of capital that's, although it's risky, it is built on your skill set and your specialized human capital that you're then trying to leverage into something greater or more valuable in the long run.

But it also is, as you mentioned, it's the primary way that people get rich, whether it's just becoming a lawyer or a doctor or being an entrepreneur who runs their own business. I mean, typically the doctors will get rich also, but they may not get as rich as the business owners of the world because maybe they're just not taking quite as much risk. They're still taking risk, but they're maybe not taking as much risk as the entrepreneur. So it's a very fundamentally different thing. All right. Let's talk about principle number two. You are your portfolio's worst enemy.

Yeah, and this kind of goes into the behavioral component of all of this, that you're the person who is constantly going to second guess the way you've allocated your savings, and you're going to be the person who, when you go through the big bear markets and the big bull markets, you're going to constantly question, you know, what am I doing here? I see the grass seems greener on the other side of the street, and, you know, should I be more invested in it? AI. And, you know, it's hard because, like, we talk a lot about fear in bare markets, but the, the FOMO, the fear of missing out, is equally as potentially disastrous for a lot of investors

because it's the thing that leads to performance chasing. And when you look at things like the huge outperformance of the U.S. market or the huge outperformance of AI, you might look at that and you feel this FOMO where you say, God, I maybe don't own enough of this high return yielding stuff that maybe now I should chase it. And oftentimes people chase performance and that ends up being one of the worst things people can do because oftentimes you're just, you're chasing risk. You're not actually chasing return. And, you know, so it's, it's hard because you are going to consistently be your own worst enemy in this whole process. And I think you have to, you have to go into it knowing yourself and knowing the behavioral biases that are going to inevitably arise over the course

of your investing lifetime because you're going to constantly expose yourself to the risk that you intervene and you become your portfolio's own worst enemy. Could you also have the opposite risk where you become negligent and, I mean, fail to rebalance, fail to do anything that isn't automated? Yeah, I mean, it's the reason why, you know, I think a lot of people like to offload portfolio management to financial advisors is because they feel like, oh, if I've got a second set of eyes on this, you know, I mean, people are busy. If you've got a full-time job and whatnot, you're focused full-time on something else, you know, it's really easy to let a portfolio

get disorganized. Like, I woke up one day, and this is crazy for a financial advisor, but I woke up one day, you know, about 10 years ago, and I looked at all my different accounts, and I had, you know, 401ks and IRAs at different custodians. And I looked at it and I said, this is crazy. Across me and my wife's accounts, we've got like eight different custodians in eight different accounts and you know we sat down one night and we were like we've got to collapse all this down into like a more manageable just simplified custodial process where we're looking at like one or two custodians maybe and you're not having to log into like treasury direct and fidelity and your 401k account and your swab account and your bank account it it can all get super complex super fast especially as

you get older and life gets more complex so you can you really easily become negligent of it because it just, it can so easily become disorganized. And simplifying things and organizing things to make the management of it really simple is super important. And I'm actually, for a financial advisor, I'm actually a huge advocate of being a DIY investor. Like, one of the best things that happens over the course of working with a client is when they come to me and they say, you know what, I really like you, Cullen, but I'm going to DIY this. And I'll oftentimes say to them, like, that's, that's awesome. That means that, like, you're not incurring the fees that I charge. And if you're super comfortable and you know that this is something that you can DIY, that's amazing.

But at the same time, I understand the psychosis behind people who hire financial advisors because they look at people like us and they say, you know what? I need someone to help me navigate all of this because I just, I'm overwhelmed by my everyday life. And I can't feel like I have this burden of like a second job managing my money and understanding all the crazy stuff that's going on. on in the economy and the financial markets all the time. Let's talk about principle number three. Beating the market is hard. Yeah.

The reason why I don't talk about stock picking a lot is because I try to emphasize the data that, I mean, over the course of a 20-year period, more than 95% of all active managers will underperform an index fund, which is a crazy, crazy stat. I mean, these are the smartest people in what? Wall Street and they're going to inevitably in the long run, they're going to underperform a simple index fund. I think you've got to go into this whole thing when you start to build your perfect portfolio, you've got to understand that, okay, if I'm trying to beat the market, if I'm trying to do something really sexy and, you know, higher risk than the market or whatever it might be,

you've got to go in knowing that this is a really hard game. This is why people like John Bogle were such big advocate, why Warren Buffett is such a big advocate of index funds is because he knows the math behind all of this. I try to emphasize that you know, you want to keep things simple and you don't want to be, you don't want to be two hands on with stocks because, again, you might end up being your own worst enemy by trying to be so involved and trying to play this game where you're trying to beat the market where you actually end up doing a lot of counterproductive things. Is it reasonable to have a small, let's say, 5% or less of your portfolio or maybe 10% or less of your portfolio, small allocation towards the individual stock picking,

like people refer to it as fun money? Yeah, totally. You know, I describe it as like scratching that itch. I don't think there's anything wrong. In fact, I mean, with stock picking, you know, the sort of like academic work behind it is basically that once you own more than 25 stocks, you're probably diversified enough in the stock market that you've sort of, you have an eliminated single entity risk, but you're diversified enough that you probably own something that will look relatively close to like a diversified

S&P 500 fund or something like that, especially if you've done it sort of methodically across different sectors and different styles. But yeah, I'm not like militantly against stock picking. I do like to emphasize that the psychology of all this is so important that if if that 5% piece is keeping you interested and it's keeping you kind of, you know, it's scratching that itch that's making the 95% piece sort of viable, then yeah, you know, scratch that itch and have the 5% piece because if that's the thing that's making the 95% viable in the long run, then that 5% component is actually maybe the most important piece of the whole puzzle. What would you do then?

Let's say that you've got that 5% piece and something wildly takes off. And so what started on a cost basis point of view, what started as 5% has now grown to 20%. Do you let it ride because you're playing with house money? Or are you factoring that to a new? Yeah, it's hard. It depends. You know, if it's in a taxable account, you kind of feel handcuffed.

You know, you've got these golden handcuffs on where you've got a, you know, a huge taxable event. The good financial advisor would say, well, you've got to rebalance, you know, reduce the single entity risk. You know, now you've got to, you know, rebalance that component back down to roughly where you wanted it to be roughly where the 5% piece is. But there's also a really cool solution these days with 351 exchanges and not to get like too wonky about this. But what a 351 exchange basically does is it allows an investor that's got an outsized allocation and say like a single stock. Like let's

say like I see it a lot these days with like Google or Nvidia or, you know, a lot of the Mag 7 where someone's got this huge taxable event inside of a component like that. And what a 351 exchange does is it allows you to take that single stock and actually allocate it to a new ETF issuance. These funds have become really popular in the last, really the last year. Alpha Architect issues a few. They're doing three or four this year, I think. And then Meb Faber's Cambria Investments also does some. I think they partner with Alpha Architect on those products.

But basically what this is is it's a new ETF issue. And it allows an investor to actually allocate their high basis individual stocks to the new issuance ETF. And what the investor gets is you will actually get the ETF itself. And what you're basically doing is you're not necessarily eliminating the taxable event, but you're swapping out a single stock with the diversified equity fund. And so that's a really kind of cool and innovative way, a new way to basically reduce some of that single entity risk where you're not eliminating a taxable event, but you're you're eliminating the single entity risk that you had in, say, invidia or Google. And you're you're then getting,

a diversified equity fund that looks basically like your 95% component, but you're not incurring the taxable event. So you're eliminating the single entity risk, not eliminating the taxable event necessarily, but you're rebalancing your portfolio without having to incur the taxable event that you would if you were to sell the Nvidia and rebalance it. Wow. I've never heard of a 351. Is this a new thing? Yeah, they're pretty new. They've become really popular, really only in the last year. And so it's kind of cool. I mean, I partner with Alpha Architect on different products at times. And so I'm super familiar with the way that they work and stuff. And these are things that they really only became ETFs. And I think the first issue was probably like 18 months

ago. So they're really new. Wow. But really cool, really innovative sort of methodology to get get out of this really concentrated stock exposure into a more diversified sort of ETF without having to go through that taxable event. Right. If we take one step back and we go to the question, should you get out of that single stock exposure, there are a few different philosophies around it, right? So there's, I'm thinking of my portfolio based on current valuations and based on current valuations, I've got way too much in that single stock exposure.

there's the philosophy of, hey, that 5% that I set aside, that was, I'm framing that from cost basis and then let it, if it goes wild, let it go wild. I've also heard the idea of every bucket of money has a goal. And this five, this wild money or the fund money, that's not tied to any particular goal. So there's no goal or timeline associated with it. And therefore, if it gets crazy, let it get crazy because this is not a, a goal-oriented bucket of money. Yeah.

Yeah, you're playing with house money kind of is the, that mentality. My wife has a great approach on this sort of stuff that when you, when you have a position that just makes a crazy return, you know, maybe you don't have to choose to go all in or all out of it. Maybe you, like, she's a big advocate that just take half of it off, you know, let the rest of it ride. And that way, you kind of split the difference. And you're kind of, it's regret minimization, basically, is what it is.

that way, if the stock continues to go up a lot, you're still riding the gains, and you can look at it and say, you know, I'm a genius. I didn't sell all of this. And if it goes down a lot, you also can look at it and you can say, I sold half of that. I'm a genius. That sort of an approach is something that I really like because it kind of splits the difference. And it's one thing that I think a lot of people kind of, it helps mitigate that sort of gambling mentality of being, having to make an all in or all out decision about something that is a really different. decision. Does the answer change if what we're talking about is not a single stock, but rather crypto? I don't think so. I mean, it's, you know, crypto is hard because it's so fundamentally different than the stock market. Like, it's very easy to look at Nvidia, for instance, today, and say, well, I can see a world where invidia is five times larger in 20 years today, Whereas the drivers of crypto are so oftentimes, they're not fundamentally cash flow driven. A lot of them are more narrative driven or something like Bitcoin. It operates more like fiat currency insurance, basically, that especially if you live in like a third world country, it almost seems negligent not to own Bitcoin.

If you live in a, you know, a Nigeria or, you know, a Somalia. and these are countries that have long histories of, you know, their governments or experts at destroying their currencies, basically. So not having exposure to sort of like this unique, universal foreign currency like Bitcoin, it does seem negligent. And so the argument there, though, again, is it's not as fundamentally driven as something like Nvidia, which makes it a very different type of alternative asset, which makes the decision process around all of that really hard. But, you know, again, I think you can apply that same sort of. a principal where, you know, I've had some friends who made insane amounts of money in Bitcoin in the last 10 years. And they roughly did something close to what my wife would advocate,

where they took half of the money off the table and they reallocated it into, you know, either a T-Bill and Chill portfolio or a diversified stock portfolio or something like that. But they still got skin in the game there where, you know, they're still riding Bitcoin through the future. But they've also captured some of the realized gains and reallocated in to something that is a little more fundamentally driven. Yeah, I have a friend who made, he bought Bitcoin very, very early in the game and made a lot of money in it and did sort of a modified version of that where he took out a portion so that he could buy a home in cash.

It was a way of realizing or locking in a little bit of that gain, but for a very discreet, you know, big ticket, discreet purchase. Yeah. And your house is such a unique. investment. And it's a, you know, what is a house? A house is basically just a big block of commodities that they're going to deteriorate through the course of time. So there's huge costs with investing in a house. And it's the funny thing about when people talk about how much money they make in their, you know, their real estate investments or whatever, people typically, they remember

the purchase number and they remember the sales number. And they forget that over the course of time, throughout owning this instrument, that you replaced 10 walls or five doors. and you pulled a million weeds, and there were all these costs of maintaining the commodities there that actually in the long run, they reduced your real, real return in a huge, huge way. Homes are really expensive assets. It's a weird thing from a purchase perspective

because your house is one of the most personal assets you're ever going to own, maybe the most personalized asset you're ever going to own because it's the place where you're probably going to raise kids and you're going to eat most of your meals and all the sort of small comforts of life are going to be experienced in the house. It's one of the things that I think, not to get into like an economic tangent,

but I think it's one of the things that people are really frustrated about in today's economy is that the fact that housing is so unaffordable is really frustrating because housing is so important to people. And I think when, especially when people are renting or whatnot, they maybe feel like, oh, like this isn't mine. And the unaffordability issue is really frustrating

and leading to things like the low consumer sentiment, surveys because it stinks to not be able to even have the optionality to be able to afford a home because it's such a personalized asset. Right. Right around New Year's, I watched the master class that was taught by Chris Voss on negotiation. Chris Voss is a former FBI negotiator and in his class, he talks about tactical empathy, how to connect with people, how to mirror them, how to make them feel heard, even as you're trying to gently persuade them.

So it was an incredible class, not just on negotiation, but on developing a facet of emotional intelligence. With Masterclass, you can learn from the best to become your best. Plans start at $10 a month, build annually, and you get unlimited access to over 200 classes taught by the world's best business leaders, writers, chefs, and more. With Masterclass, you get thousands of bite-sized lessons across 13 categories. So you can learn how to design your dream home on a budget with Joanna Gaines, or learn about habits from the author of Atomic Habits, James Clear, feel better with courses on gut health, brain health, skin health.

And 83% of surveyed members have applied something they've learned from Masterclass to their lives. Right now, our listeners get an additional 15% off any annual membership at Masterclass.com slash afford. That's 15% off at Masterclass.com slash afford. Masterclass.com slash afford a F-F-F-O-R-D. I was guilty of multiple skin care crimes. Two counts of sleeping and makeup,

one count of using disposable wipes. I knew my routine had to change. So I switched to Garnier-Misler water. It gently cleanses, perfectly removes makeup, and provides 24-hour hydration. Clear away the evidence with the number one Missler Water worldwide by Garnier. The secret to Charlotte-Call-R-Rour,

Day's captivating eyes? Panorama mascara by L'Oreal Paris. The multi-level bristle brush catches every lash from inner to outer corner. For panoramic volume with lashes that are so fanned out, eyes appear 1.4 times bigger. See life in panorama because

you're worth it. Shop L'Oreal Paris Panorama Mascara on Amazon now. Principle number 4. Diversification is the only free lunch. This is the basic principle that if you own just NVIDIA, you know, you're not diversified, but if you buy something like, let's say, like a consumer discretionary stock,

like Procter & Gamble, it's a totally different type of business. They're diversified in very different ways. And the interesting thing about owning these two instruments together is that they're going to generate very different types of returns over the long term. And so the simple example is where the two instruments actually generate the same return over a certain time horizon, but they do it in the exact opposite way. So one goes up a lot. One goes up a lot. One goes down a lot, and then they both end up roughly at the same point. And what happens over the course of time there is that that portfolio actually looks like kind of just a straight line. If you had an equal weight allocation in the two of those, your portfolio on a risk-adjusted basis,

it did way better on a risk-adjusted basis because you created a much more predictable and stable return stream by just owning this other instrument. The basic principle of diversification is that it's a free lunch in the sense that you're mitigating some of the volatility. inside of the portfolio by eliminating that behavioral risk that you've got when that asset goes down, the other one, you might be tempted to sell there when it's going down. But in the long run, the fact that you own the other one, it offset that to a large degree. Brian Portnoy likes to say that diversification is learning to hate some part of your portfolio all the time. Weirdly, that asset going down could be a really good thing in the intermediate term because

it's potentially offsetting some of the performance that might happen later on in life where, you know, when that other asset that went up a lot, when it goes down, maybe the other one's going up a lot. And so it's the other basic principle behind owning something like bonds in a portfolio that are owning T-bills in a portfolio that typically when the stock market gets really scary, the T-bills will keep you calm. And they're, even though they're lagging, you know, 95% of the time over which the stock market is performing, that 5% that's really scary, that 5% of the time when the stock market

goes through a bare market, it's going to frighten the hell out of you. But that that T-bill component will keep you comfortable. And the fact that it's lagging most of the time is actually a good thing in the long run because it's creating diversification that over the 100% course of the return stream, it'll keep your entire portfolio kind of more viable. I think one thing that often throws a lot of people for a loop is that they think that they're diversified, but the reality of finding assets that either are low correlation or inverse correlation is more challenging than it appears in this increasingly interconnected economic environment. And that becomes really cute too.

I mean, anybody who invested in 2008 knows that there was nowhere to hide in the stock market. Right. Utility stocks were down 65%. So the things that people think of as like even the safest components of the stock market, they can get really, really scary when things get really, really bad. And COVID was kind of like this too, where a lot of asset values just all went down at the same time. That's the thing that makes a strategy like risk parity potentially more interesting or one of the strategies I talked about that we didn't mention yet was trend following, which is the strategy that the trend following traders, what they're basically doing is they're buying commodities.

or true alternatives, and they're just riding trends. And the interesting thing about that is that those sorts of strategies, they oftentimes work best when everything else is terrible. And so typically inside of like stock market, it crashes and things like that. The trend followers are, they're short the market because what trend followers are trying to do is they're trying to capture what looks like a small trend with the hope that it eventually becomes a really big trend. And that's kind of like the best trend followers are really good at capturing those types of

events and they're not biased against being long or short. So a lot of the times they're buying weird instruments or they're they're shorting weird instruments and they're getting exposures that are truly totally uncorrelated. And that's one of the things that, you know, you're getting into markets there where you're finding versions of greater diversification in a strategy like that that aren't necessarily going to be viable inside of like a 6040 or just segmenting yourself to stocks and bonds. We're at the beginning of 2026. The stock market is high, but gold is also high.

You know, you typically don't see those two high at the same time together. We're seeing things now that we don't normally see. How do you make sense of that? Yeah. It's a really weird time to be an investor because the arguments and benefit of diversification are stronger than they've ever been because the, The disparity across so many different asset classes is just wider than it's ever been. And, you know, this is most apparent with the U.S. versus foreign cap ratios.

If you look at like the, this is the cyclically adjusted PE ratios, the United States is at 40, which is basically equivalent to like what it was during the NASDAQ bubble. Foreign stocks are at like 22 or something. And, you know, the weird thing going back to the NASDAQ bubble was that these two components, they tracked each other almost perfectly through the NASDAQ bubble. but today they've like gone in completely different directions. It's a very, very different environment, but you also see it in the disparity in like, you know, commodities last year.

Right. Silver was up 150% or something. Yeah. I think gold was up 70s or 60 or 70% whereas the average commodity was only up like 16%. So you had this huge disparity in the commodity market. You know, I'm not typically like a huge advocate of buying commodities in general, but I would say that in this sort of an environment where you've got these huge disparities in returns, diversification, again, makes a huge amount of sense.

We're going on and buying, if you want to own commodities, I think it makes a lot more sense these days to own a diversified commodity basket versus owning something individually like, you know, the Harry Brown permanent portfolio talks about how gold is the only component that they own there as like the inflation hedge, which is potentially like much higher. these days because the way that the way I like to think about really high return markets is that when you generate 60% inside of a single year, you create what I call a price compression where if gold on average, let's say it generates 8% per year, when you take 60%, what you've done is you've basically taken 8% and you've compressed all these long term returns way down

into the short term. And what does that do? It creates potential for sequence risk again, where let's say you average 8% over the course of the next 50 years, but if that includes 60% in year one, well, that means that along the way, you're going to get a lot of negative volatility along the way. So I think, again, going into this sort of an environment, you have to look at something like Golden say, my potential for sequence risk is through the roof right now. And that may not necessarily be a bad thing in the very long run, but it might expose you to a huge amount of behavioral risk in the short term. People often say that behavioral risk can be offset by having a very clear investment thesis. Does that actually work, though?

Does having a very, very clear investor policy statement help you hold on to it when things did not go the way that you expected? Yeah, I mean, I think you should understand what you're doing and having a process and going back to the Warren Buffett methodology. I think one of his superpowers is that Buffett built this really brilliant process through which he does it. everything. And he he stays steadfastly disciplined to that process. And so not only does he have this incredible understanding of the things that he's buying and holding in the long term, but he has this process that he understands so well that, you know, I do think that if you don't understand the things that you're buying, you will second guess them at times. And it's, it's an interesting one for me from like a behavioral perspective, because I've seen this front and center in my own

business where sometimes I understand something really well, but if the people I work with don't understand it almost equally well, they'll come to me at times and they'll say, hey, this thing isn't performing well. I don't understand it. I'm now second guessing you. That creates behavioral risk where people then look at something. When you get involved in something that maybe you didn't fully understand, you then look at it and you start to question it. And that creates the risk that, especially when things are, you know, no bueno, that creates the risk that then you're going to sell into the downturn, which is like the worst possible thing you can typically be doing. And so you got to go into this whole process, I think, with a really solid understanding of what is the process, what are

the things I'm owning? And do I feel fully comfortable with my understanding of all of it, knowing that weird things are going to happen and I'm going to expose myself to environments where I might second guess this, but, you know, I understand this stuff well. enough to know that, hey, yeah, it feels risky in the short term, but I know in the long run the probability of the outcomes to stay comfortable with it. At what point does diversification become diversification, and how does that happen? How does it typically happen? It usually happens with a bad financial advisor in my experience. You wouldn't believe the number of portfolios I've seen where somebody will come to me with

50 different holdings, and they probably look roughly like the S&P 500. and I run the math on it and I'm like, oh my God, like you could have owned one index fund and this would have looked exactly the same. But the financial services industry has mastered the art of making things look very, very complex to, I think, make it look like, oh, my God, this is so difficult to do that you have to pay somebody 1% a year or else you'll never be able to figure it out yourself. All the big brokerage firms, I always laugh at looking at their like financial statements because you get like a monthly statement and, you know, the thing is like 15 pages and half of it is

illegible or written in language that, you know, nobody can decipher. And it's all part of the confusing nature of finance and the way the industry has kind of been constructed. But it's important to look at a portfolio and understand what you've constructed to know that, hey, did I do something that made all this overly complex in a way that relative to something really simple, like an S&P 500 index fund, you know, would have been way lower cost and just way, way easier to manage. And so it's one of the dangers with stock picking that you can very quickly get into a portfolio where you, if you have 25 or 30 stocks, you probably own something that looks a lot like, whether it's the Dow or the S&P 500, it probably looks a lot or has a very high correlation to the S&P 500. And so

So you can very quickly get into an element there where you have to question, you know, hey, was there a simpler way to do this? And I think the biggest danger of diversification is when people start trying to make things overly elaborate, where they're building a portfolio that kind of going back to that risk parity portfolio where finding 15 uncorrelated return streams is really, really difficult in a fast track to diversification because before you know it, you've got 15 different really opaque sort of unusual components in a portfolio where maybe this thing is really no better than like a 60-40 portfolio.

The other thing about financial services is it's an industry that is made up of very, very brilliant people, but also people that love to overthink things and build things that are overly complex and oftentimes with the intent just to sell the product to somebody. And so it's very easy to build in layers and layers of added complexity that, you know, know, maybe they're not that beneficial compared to something like, you know, a 6040 portfolio or understanding, like, it's one of the reasons why I'm such a big advocate of understanding the global financial asset portfolio because look at that portfolio and then you can benchmark everything to that and you can say, okay, I've got five different mutual funds and 10 different

ETFs and then I own 25 individual stocks and looking at that and comparing it to something like the global financial asset portfolio, is it really any better? And, you know, the GFAP, as I call it, the global financial asset portfolio, it can be owned with as simple as like four ETFs. And so you've got to benchmark things correctly and understanding from a correct starting point, you know, so that you're not just building in layers and layers of complexity, you know, not too dissimilar to the way that like we were talking about different accounts earlier where you can get all these different accounts in different places over time.

And before you know it, you've diversified everything because you've just made everything unnecessarily complex. Keeping things simple, it just will make everything much more manageable in the long run. But it's a balancing act, too. You can, you don't want things to be too simple to the point where it's counterproductive, but you want to find that right level where you're also not just making so much complexity in the portfolio that it becomes impossible to manage or the different elements are just so costly that they start actually being counterproductive relative to your returns. So unnecessary complexity is essentially the factor that makes it worse. And that same unnecessary complexity can also, especially if you're not working with a financial advisor, can make you freeze because you get frozen by indecision. Yeah. I mean, and I think that's part of the complexity aspect that is so, it's so important to be really well organized with all of this and make it, you know, you want it to be complex enough, but not so complex.

that it becomes counterproductive. I try to distill all of this down as simple as it should be, but it's, again, it's subjective. So you've got to do what's right for you. And that's such a personalized and subjective sort of thing. But it's something that is a balancing act because there's a fine line between building something that is way too complex and then building something that is way too simple to a point where, you know, like I'm a little bit critical of the three fund portfolio because you can argue that the three fund actually requires more funds. Maybe it requires a cash fund or, you know, you could

argue maybe it's not aggressive enough, you know, like the three fund portfolio isn't appropriate for Paula, but it might be more appropriate for like a retiree or something. It's a balancing act and it's personalized. Right. And if it's something like a three fund portfolio, you don't really have much opportunity to practice asset location. Yeah. And that gets into, to, you know, real financial planning and the aspects of all of this where, especially the older you get and the closer you get to retirement, I mean, when you have kids and things like that, life gets really complex. I think this is something that a lot of people struggle with as they get older is that your life gets really complex as you get older. And it gets more unpredictable also

as you get older. Being young and having a decent job and having a lot of time, it's like the easiest time to be an investor. And I think it's one of the reasons why a lot of young investors take a lot of risks is because they kind of know they have the flexibility to be able to do that. But when you get older and life gets more complex, it actually becomes even more important to simplify your portfolio because everything else in your life is so complex that you don't want to deal with a lot of excessive complexity in managing your finances. Distilling that down into like a really simple portfolio, it can be accretive to the rest of your life in really beneficial ways because you're offsetting some of the complexity that you've got

in the rest of your life that's inevitable. Right. Let's talk about the fifth principle. The cost matters hypothesis. Yeah, so this is probably John Bogle's most famous conclusion. And we talked earlier about the 6040 portfolio and the origin story of it. And one of the most interesting components of the 6040 portfolio was that Walter Morgan eventually hires John Bogle to run the Wellington Fund. It's kind of the thing that made the Wellington Fund most famous and ultimately led to like Vanguard and and Bogle's fame. The most famous thing that Bogle was an advocate for and the reason why Walter Morgan hired him was because he wrote, Bogle wrote a really critical thesis paper at Princeton about how important costs are and how changing the

cost structure of the industry could be really beneficial in the long run. This kind of became Vogel's most important contribution to the whole industry was that he became the advocate of the low-cost index fund. He talked a lot about how these seemingly small numbers add up to humongous numbers in the long run and how that one percent figure, it doesn't seem very big when you just think about it. You're like, oh, one percent doesn't seem like a lot. But when you think of one percent as being 1% of that real, real return in the long run, let's say it's 5%. Well, wait a minute. Now all of a sudden, 1% of 5% is actually 20%.

And all of a sudden, 20% actually is a lot. And when you add in the fact that this is a compounding return over the course of the long run, that fee can add up to for a lot of people, it'll be hundreds of thousands of dollars. And so the old book was called Where Are the Customers Yachts? and the reality is the customer's yachts are sitting in the harbor, you know, across the street here because they're owned by the financial advisor who was charging 1% a year. Right. And sometimes, you know, like, for example, inside of an HSA, there are such limited choices

and there's a necessary fee that you have to pay. And there are probably a bunch of people who are listening who are saying, I have an HSA or an employer-sponsored 401K or maybe a 529 plan where there are just these fees inside it that I can't escape. Yeah. And you feel trapped. The traditional financial services industry, it moves at the speed of molasses in a lot of ways, where, you know, these, especially these old legacy structures like 401Ks, they still have not

fully evolved. And it's one of the crummy things about the industry is that we haven't updated these things fully to reflect even like, you know, like I'm a huge advocate of owning ETFs over mutual funds for the basic fact that a mutual fund is just, it's a far world. product wrapper from a tax efficiency perspective, that the beauty of the ETF wrapper is that ETFs are able to basically reallocate and diversify their assets inside of themselves in a way that doesn't necessarily spit off capital gains distributions. At the end of every year, we see these capital gains distributions reports from mutual funds. And I mean, you could buy a

mutual fund in July and have a zero gain in it by the end of the year. And you could still get a tax bill from that fund at the end of the year because they distribute some of the shareholder capital gains distributions in it. Whereas ETFs are much more easily able to eliminate or mitigate that risk because of the way that they fundamentally operate, the way that the, you know, not to get too deep in the weeds about like the structure of the product itself, but ETFs do what are called in-kind redemptions. Rather than cash redemptions like the way mutual funds operate, ETFs operate in a fundamentally different tax structure basically. You know, it was actually one of the weird things with the cost matters hypothesis that Bogle didn't love

ETFs. And I never, it's one of the few things that I think Bogle got wrong in his career was that he was really critical of ETFs because he thought that they necessarily induced like more of a trading mentality because they trade on the exchange all day. Whereas a mutual fund, it basically, you know, it doesn't necessarily trade on an exchange. It settles every day at the end of the day. And you can only buy and sell it basically once a day. So there's not this like gambling mentality and Bogle was very specifically critical of the gambling mentality, but he also was just critical of ETFs in general because I think he thought they induced to that need, which I don't know, I think that can be mitigated just with good disciplined behavior. But it was an interesting

thing to think about in the scope of like the cost matters hypothesis because ETFs are from a total return perspective, they can be far, far lower cost than mutual funds and other types of of instruments. They're hugely beneficial. And the industry just, you know, even to this day, the amount of assets in mutual funds is still enormous relative to ETFs. It's a slow moving change, but we're moving in the right direction. Right. First, just to clarify for the audience, when you say mutual funds, you're including index funds in that, index mutual funds. Yeah. I think, um, colloquially, people often distinguish actively managed mutual funds versus index funds. but when you say mutual funds, you're also referring to index funds.

In the defense of some mutual funds, like the Vanguard mutual funds, for instance, they were able to eliminate this capital gains distribution event because of the way that they had a patent actually on the ability to use their ETFs the same way they basically use all their mutual funds. Vanguard's kind of a unique beast in that sense, but yeah, I mean, indexed mutual funds and I'm generally being probably more critical of like the assets. actively manage mutual funds that are doing things like, you know, maybe they're buying or implementing like a risk parity strategy inside of the mutual fund wrapper. And when those funds are rebalancing

and being active in the underlying, they're incurring capital gains potentially that they have to by law distribute to their shareholders. For a person who's holding these assets in tax advantaged accounts, does this matter inside of a tax advantaged account? Or is this something that you should really only be concerned about inside of your taxable brokerage? Yeah, no, it's not as big of a deal. I mean, I generally, I don't know, just from a practitioner's perspective, I always default to ETFs. I mean, like one of my favorite stories is when I was a young analyst at Merrill Lynch,

beginning my career, I remember like looking at the I shares ETFs had sort of just come out at that point. And they were basically brand spanking new. But I was looking at these and studying them. And I'm thinking, we own all of these actively managed mutual funds for our clients. and I go to my boss one day and I was like, you know, hey, there's these ETFs. And they seem to do the exact same thing that the mutual funds do. They generate roughly the same returns.

But the fees are like a fraction of what the mutual funds are. Like, what are we doing here? Like, why are we buying the mutual funds? And my boss basically said he was like, well, you get paid to sell this one and you don't get paid to sell this one. So you can sell this one if you want, but you're just not going to make any money working at this firm. And I was like, okay.

And I up and left. like six months later. I'm just a huge advocate of ETFs because I just think that the ability to buy and sell the liquidity, the innovation in a lot of the different ETFs, like we're talking about the 351 exchanges. This is still a component of the market that is, I think, relatively young compared to mutual funds. And I just, the wrapper itself, I just think is superior in numerous different ways. As long as you can, you know, restrain yourself from that temptation to kind of buy into the gambler's mentality and to, to, to, to, to, Vogel's credit, he weirdly has been right in some ways and that there are a lot of really crazy

ETFs coming on the market all the time now. Like, you know, I see these things like the super triple leveraged ETFs or whatever they might be. Like these things are, these are instruments that, especially on an aftertax basis, they are just crazy, crazy expensive. And they're feeding into that like gambler's mentality of like, oh, you're only getting one X the S&P 500 return. Well, wouldn't you be better off with 3x? And it's like, well, no, in a lot of ways, you'll actually be way worse off because of the excess volatility,

the excess fees, and all these other things that they kind of feed on that gambler's mentality. But when it comes to just plain vanilla sort of indexing style ETFs, they're really, really hard to beat. Did you know that Staples Professional can tailor a custom program to make running your business easy?

With a Staples professional account, you get one vendor, one delivery, and one invoice for all your must-haves. From tech to cleaning supplies and dedicated support from Staples experts who guide you on everything, from product selection and ordering to payment. Join today at staplesprofessional.ca and get expert solutions tailored to your business. That was easy. Outside of fees, where or how else should individual investors be appropriately tuned into costs?

And where I'm going with that is financial advisors in general. There are a lot of people who say, well, the voices on the internet, the keyboard warriors on the internet will say, like, you don't need a financial advisor. You can figure all of this out on your own. Or you don't need to pay for coaching or training or classes. You know, you can get any answer that you want through Google or now prompts. But I would argue, or I think some would argue, that people will shortchange themselves by not getting education or not. not hiring advisors, you know, not building out that team, that structure, that support. So to what extent is it appropriate to be tuned into costs?

And to what extent do you actually harm yourself by being too concerned about the pennies? Yeah. It's hard. I mean, one thing I see a lot working with individuals is that you don't know what you don't know. So if a financial advisor has some sort of unique understanding about something that you just don't know about, then what's the benefit of having worked with that person relative to the alternative? So it's a super personalized thing. And I think it's one thing that's really important, actually,

when picking a financial advisor, or considering whether to work with one in the first place, is that what are you really paying for? Are you paying for a 60-40 portfolio that this person is going to basically tell you, you know, during the course of a bare market to, hey, you know, stay the course? Like, is that what you're paying for? because I would argue for the vast majority of people, that is not worth paying for a financial advisor for. Whereas, you know, if you're paying a financial advisor to do detailed financial planning

and structuring a portfolio in a way where, you know, it's based on a financial plan and you're getting the benefit of like help with Roth conversions and doing things like required minimum distributions and things that are a little more difficult for your average investor to handle on a, you know, a daily or monthly basis, that's a totally different structure. And, you know, it's also important, I think, to understand the different types of fee structures where, like, I'm generally a big advocate of a flat fee financial advisors where you're paying someone a flat fee more akin to like the way you might pay your doctor or your, you know, your accountant rather than like that compounding effect of paying an AUM fee and assets under management percentage

fee where that number can add up to a lot of money really fast. The funny story that I steal from Mep Faber is the story that he tells about when if you have a million bucks and you pay one percent fees a year, think of this as you go to your financial advisor once a year. And before you go into that meeting, you take a briefcase to the bank and you take out $10,000 and you walk into the meeting and you walk out without the briefcase. That's how big of a fee that is. So on an AUM basis, and again, this is a compounding fee. It's something to be really mindful of not just the amount of fees you're paying, but the type of fee you're paying. But then there's also other fees. You know, the biggest fee, arguably, is the inflationary fee that we all pay every year along the way. And so you have to

build in an inflation hedging component to the portfolio where if you're in a T-Bill and Chill portfolio, you're not really getting much of an inflation hedge. Maybe you're not getting an inflation hedge at all. You know, 10 years ago, you weren't getting an inflation hedge there at all in that portfolio. You have to layer in things that will compound in a way where you're offsetting that cost. And then, you know, there's the other big fee, which is taxes. Taxes are ultimately one of the biggest fees, maybe the biggest fee you're ever going to pay in the long run. And so you have to do things, you know, you mentioned tax location earlier, that you have to structure a portfolio in a really thoughtful way where you're optimizing for taxes. But

again, this is something that is, it's a balancing act because taxes are something that I think people can start to over-optimized for. Like, I to some degree have gotten a way from owning like municipal bonds for people because behaviorally I think they they confuse a lot of my clients but also you can start getting into structures where you start using certain instruments in different accounts where maybe they're not the most beneficial like a lot of people will actually argue from a tax location perspective that like you should put your bonds in your retirement accounts because bonds are typically pretty tax and efficient instruments and and I would look at something like that and say, well, wait a minute, I think that's actually completely wrong because if this

investor is, say, 30 years old and they've got a 40-year time horizon here, you know, they might not be required to start withdrawing from that IRA till they're like 75. In which case, you know, this person has a 45-year time horizon. There's an argument there that bonds are a completely inappropriate allocation because based on the time horizon, you're subjecting yourself to inevitable low returns in that allocation. It's a super personalized thing, but you have to be conscientious of all of these different types of fees that you're going to be paying, whether it's the actual fees in the funds and the cost of management or if it's inflation or if it's taxes. Let's talk about principle number six. Real, real returns are all that matter. Yeah. So one of the

the things that I really emphasized was that when I portrayed all the data, I did it on an inflation-adjusted basis because the main reason that I did this was because we sometimes hear the gross figures in the financial media. And you hear things like, oh, the U.S. stock market does 10 to 12 percent per year. And kind of going back to the emphasis on all of the fees we pay along the way. You know, inflation is a biggie. Taxes are a biggie. And then the, you know, the actual fees in the underlying are really important. And so when I talk about real, real returns, I'm trying to back out all of these other costs. And I think that's the right way, because this is ultimately, this is the return that you actually eat. This is the return that you can actually

go out and spend because, you know, once you liquidate something, you'll have to pay to offset inflation for whatever the goods and services you're buying are. But you're you're also paying the taxes ultimately from having distributed that, you know, or liquidating the instrument. And so this is the actual money that matters. It's the money in your pocket. And so that 10 to 12 percent figure is exaggerated because it's, it's unrealistic. It's not the actual money that you're going to end up with at the end of the day.

I portrayed everything on this real return basis to try to emphasize that, hey, especially with the stock market, the stock market actually doesn't do, it's not going to generate as much a return as you really think it will, because when you liquidate the stock holdings and actually go out and pay for things, the actual dollars in your pocket are going to be far lower than the gross figure that we talk about in the financial media sometimes. Right. There's taxes. There's the distinction between nominal dollars and inflation-adjusted dollars.

There's all of these forces that eat away at those returns. There are those who say that a big purpose behind investing is simply trying to beat inflation, that if you can beat inflation plus have some additional margin of a few percentage points on top of that, that that's really the game that we're playing here. Would you agree with that? Yeah, to a big degree it is. But it's a balancing act because it's, you're trying to do two things with a savings portfolio. You're trying to build a certain amount of principle that is predictable.

You know, you want to have predictable pools of money at certain points in your life, you know, especially working from like a financial planning basis. Like I like to emphasize the strategy that I call defined duration, which is it's basically like an asset liability matching strategy where you're actually trying to construct expenses in the future. And you're creating like a almost like a bucketing strategy where you're creating pools of money that are funding very specific needs into the future. Using like a really simple example,

let's say you just want like two years worth of emergency funds. And then you've got a house down payment that you're, you know, maybe looking at for at some point in the next two years, and then you've got maybe a kid going to college in 10 years. You can, from a planning perspective, you can actually quantify what these numbers are going to be, and then you can match them to very specific instruments that are going to be matched to specific time horizons to fund that need. And you know then, from a planning basis, you kind of know, like, okay, I've got, you know, going back to Bill Bernstein's tips ladder, like if you build a 10-year tips ladder, you can go out all the way to your kids' college

needs and you can build this tips ladder in a way where you know from an inflation-adjusted basis, I'm going to have exactly this amount of dollars to fund this need over a certain time horizon. And so in the long run, inflation is in a lot of ways the whole ballgame because you need to adjust for inflation to be able to consume the future goods and services that are going to be inflation-adjusted. And you've got to build a portfolio, though, that also has the nominal principle stability to be able to predictably consume. And especially if you're drawing down a portfolio, this becomes even more important where you need pools of sort of short term money.

The great thing about the T Bill and Chill component is that you're generating a real return. You're getting actual inflation protection inside of that instrument. But you've also got to build in the fact that the stock market is typically the best inflation protector because of, in the long run, what do corporations do? Corporations, they buy things at cost and they try to sell them at a markup, basically. And the return that stocks generate is a function of that markup, basically, the profits that they distribute in the long run. But again, that's a, you know, what I call the next principles is the temporal conundrum idea that the allocation of savings is a temporal conundrum that you're trying to consume in the short term, but you're allocating assets

that are on average in the long term. This, creates temporal confusion for everybody because you don't know how much money you're going to need in the future, but you want to allocate its assets that are going to grow enough that you know you can fund your needs in the future. Let's talk about that. You want to be able to fund your needs in the future, but you don't know what those needs will be and you don't know how long that future will be. So with retirement planning, in particular, let's even just take the quote unquote standard age of 65, you still don't know if you're going to live to be 75, 85, 95, 105, right? You've no idea what you're, and I think it's hilarious that it's called quote

unquote longevity risk because only in financial planning is living a long and healthy life considered a risk. But there's the risk that we might have a long life. So we don't know how much time we're planning for. And the great unknown is, are we going to need assistance with activities of daily living? Are we going to get to a point where we are no longer able to cook our own meals and button our own shirts? And we're going to need to hire help for that. The standard thing that people say when they're young, which is I'll just adjust my lifestyle, might not be an option in old age because there's that necessity of spending. So how do we deal with that? Yeah. You know, it's interesting to talk about

asset management in the concept of allocating or savings, but what people probably don't talk about enough is liability management. One of the things that Bogle like to talk about is, you know, how you should control what you can control, like fees or something that you can very acutely control in your portfolio. You can very acutely control the way you're diversified. But the other thing that people can control, especially when they're younger, is their liabilities. And this kind of gets into the conversation of like needs versus wants. I think one of the great superpowers of investing and having a good financial plan in the long run is understanding your needs versus wants. And Bogle actually wrote a whole book called Enough and understanding, you know, what is enough for

you. And, you know, do you need to constantly be chasing where the grass is greener and finding that point in life where you just feel like you have enough will, you know, in a lot of ways it'll enhance your overall financial plan because you get to a point in life where, you know, if you discover what is enough for you, you be able to control your liabilities in a very controlled manner where you say, you know, oh, I don't need, I don't need a Ferrari. I could afford a Ferrari, but I just, you know, I'm totally happy with a Honda Accord. It may not be as flashier, you know, as fast getting me from point A to B, but it's still going to get me from point A to B in a really reliable way. So that liability management is really important in the context of all of this,

because in a lot of ways, it's maybe more important than the asset management part of the whole equation. But again, it gets really hard, especially when you get older, because the liabilities become fixed to inflation, and they're fixed to the worst components of inflation. Like, the real risk of longevity risk is health care cost, basically. And health care is something that is probably only going to get more and more expensive as we all get older, especially as the demographics of the current economy continue to deteriorate where everyone's living longer and people are seemingly less healthy. And so the health care inflations are going to be probably one of the biggest risks going forward. I make a ton of bad leg day jokes in the book.

And part of the thinking, yeah, I keep reminding people, don't skip leg day. And it's a corollary to all of this in large part because maintaining a healthy lifestyle is probably the best liability management that any of us can do. You know, not that I'm like a fitness guru or fitness expert by any means, but it is from a financial planning perspective, like one of the things that's probably the most important element of managing your longevity risk and your liability management in the long run because it's one of the best ways to mitigate your health care risks in the long run. Right. Well, and to the extent that fitness can facilitate that, that's great. But, you know,

the challenge in financial planning is that I have no idea if I might suffer dementia. Yeah. And if I do, that presents me with a major expense. There's all of the expense associated with knowing that I will need to pay for whatever care is required at a time in my life when I am increasingly incapable of being able to pay my bills. Yeah. It's especially hard with, like I do a lot of what I call asset liability matching with people I work with. And it's one thing that's really hard with especially older people because you're trying

to build certainty into the portfolio in a way where you're trying to match assets very specifically. And like Bill Bernstein is a big advocate of long duration tips ladders. And the reason he likes that is because. he says that you can match the long duration assets to long duration expenses. I'm a little bit critical of that idea because of what you're saying that those long duration expenses are totally unpredictable. And I actually think that long duration bonds, long term bonds, I think they're actually really terrible matching assets for long term expenses because those long term expenses

are so unpredictable that you probably, you're almost, I would argue, certainly better off if you've got a 20-year time horizon, you probably can and should take stock market risk with that component of your portfolio. Because, you know, it's not a 100% guarantee like the, you know, that's the beauty of the 20-year tips instrument is that that thing has 100% certainty of having the amount of money, basically, that you quantify out. But the problem is, is that the opportunity cost of not having owned the stock market that whole time is probably gigantic. And even though it's not a hundred percent guarantee, you know, over rolling 20-year-old. periods, the stock market will outperform things like tips 99% of the time in historical terms.

You know, it's not a guarantee, but it is a super high probability outcome. But it's one of those things that from a planning perspective, it's really hard because you're, you're necessarily trying to make these predictions about things. And it's one of the reasons why it's so beneficial to take diversified stock market risk over the long term, knowing that it's a long term instrument because the probability of that thing funding those unpredictable needs is much higher than trying to pay it to something like a 10-year treasury note yielding 3.5% or something like that, where you're locking in a low real return that probably is not going to come close to paying for things like health care costs in the long run.

Right, right, exactly. And you have, as you alluded to earlier, a lot of the expenses that we pay, particularly as in older age, rise at a rate that exceeds inflation. You know, healthcare being one of them, I think car insurance recently has all insurance. Right. Yeah, exactly. Property taxes often exceed insurance. It's one of the screwy things with inflation, because inflation is a hyper-personalized thing. You know, we talk about things like the consumer price index and the government issues these like nationalized levels, but your personal inflation rate is probably completely different. than what the CPI is.

And, you know, living in New York or, you know, I live in San Diego, like the inflation rates in places like that are wildly different than they are in places like Idaho or, you know, other parts of the country. It's a super personalized thing. And you've got to actually understand it and quantify it at a personal level. Right. Local news is in decline across Canada. And this is bad news for all of us.

With less local news, noise, rumors, and misinformation fill the void. and it gets harder to separate truth from fiction. That's why CBC News is putting more journalists in more places across Canada, reporting on the ground from where you live, telling the stories that matter to all of us, because local news is big news. Choose news, not noise. CBC News.

We have already talked about principle number seven, which is that risk is uncertainty of lifetime consumption. Is there anything else that you want to add? This is a famous Ken French quote. The reason I like it is because it's kind of all-encompassing. And in sort of academic terms, like we define risk as basically standard deviation or volatility. It's kind of a neat little academic function because it's quantifiable. But for your average person, volatility isn't necessarily a risk.

In fact, volatility could be like we were talking about with the stock market risk. In the long run, stock market volatility is a really good thing because it's the thing that correlates to higher returns in the long run. You've got a lot of different definitions of risk, and the reason I like the Ken French quote is because when you think about your ability to consume in the future, it involves things like inflation risks and fee risks and volatility. And when you think about your ability to consume out over different time horizons,

you can then start to think about risk in a little bit of a different nature where you're customizing it more to a financial plan. and the actual risks that are exposed inside your financial plan, rather than the sort of like jargony academic concepts like volatility or standard deviation. I think where a lot of people that I talk to where they feel frustration is the challenge in modeling that out, people often, especially if you're in your 30s or 40s, you kind of have to use these extremely heuristics and shortcuts and rules of thumb because what else can you do that there's no.

way that you can in any way accurately predict your needs or costs in your 80s or 90s, 50 years into the future. I try to think about this stuff in very specific time horizons where, like you said, I mean, 10, 20, 30 years out, I mean, who even knows what the world's going to look like then? I mean, I've got a four and a five-year-old daughter and I have no idea, like, are they just going to be sitting around the house all day, like being served by robots all the time, like when they're 50 years old. Like, I have no idea. The world's going to change so much between now and when they're 50 years old that it's, it's like crazy and unpredictable to think about all this stuff. You do have to just sort of block that out in a way where you sort of say,

like, I don't know what that's going to do. You can also, like, create a lot more predictability across different time horizons. I try to emphasize with people, especially like the people I work with, that the most important time horizon is the zero to five year time horizon because the zero to five your time horizon is the one where you can't actually, to some like sort of rigorous way, actually quantify all the needs out over the course of five years. You can inflation adjust an emergency bucket or, you know, expenses out over five years. And you can kind of know, okay, inflation is unlikely to deviate too much from, you know, my estimate over this time horizon. You've even bed like a three to four percent inflation adjustment or something like that.

But you can also predict things like, hey, I've got a 15-year-old car, and I know this thing's going to kick it in the next five years. So I've got to block out, you know, 50 grand to go buy a new car. I don't know when in the next five years, but at some point in the next five years or, you know, my kids are going to college in 10 years. Like there are certain things that are somewhat predictable. But I do think in the, especially that zero to five-year time horizon, that's the one that is the most predictable. And it's where good financial planning can really function well because, you know, you know, you can then start to build out these, you know, whether it's bond ladders or, you know, like I like to talk about it in terms of like asset laddering in the defined duration chapter

where you're building a financial plan and then you're matching assets very quantitatively to the zero to five year buckets in very structured ways where you kind of know, like, you know, I've got X number of dollars to cover, you know, Y expenses over these time horizons. and the biggest benefit actually of having seen this implementation in real life is clients actually will see the front-loaded certainty of the expectation or the liabilities being structured in this sort of a methodology. And it frees up a ton of behavioral bandwidth where before when I would do risk profiling, like the traditional sort of financial planning way to do all this is to say like, okay,

like you get scared when the stock market goes down a lot or you're 60 years old, so maybe we need 40% in bonds or something like that and, you know, using these sort of heuristics. And then you run a Monte Carlo simulation through your software and it says, okay, well, based on your 6040 allocation, we know that your financial plan with your starting balance, it has a 99% success rate. But you're not giving anybody like the understanding of, am I going to have money at certain times in life to pay for certain things that I need to?

And by blocking these things out in more of a time segmented fashion, you're then matching very specifically to the most predictable time horizons. And when you block out that zero to five year time horizon, it's interesting, I notice with a lot of people that I work with that they actually end up being able to take a lot more risk. You might not have 6040. You might end up actually being like 70, 30, where the investor, taking more risk because they've quantitatively taken that 30% component and they've blocked it out over, say, zero to five years or zero to 10 years or something like that in a rigorous way where

that person knows, well, I've got 30% of my assets here and I'm covering five to 10 years of all of my expenses and my car purchase and, you know, my house down payment or something like that. And that frees up the 70% for me to take risk with, to take long-term risk. For me, We, you know, kids did this weird thing to me where they forced me to think across different time horizons very specifically because before I had kids, it was basically just me and my wife's money and I was kind of like, you know, I was 100% stocks and I was just like, oh, this is all long term money. We both have good high paying jobs and we don't need this cash or this allocation so we

can be super high risk with it. Whereas once you have kids, all that goes out the door because then you have to start thinking about like, oh, I need to pay for diapers and I need to pay for daycare and I need to pay for school down the line and I need to pay for college tuition potentially in 20 years. And then I want to like also think in multi-generational needs where it's like I want to leave my kids some money. You know, like I like the, I am a big fan of the die with zero component, but I also like Warren Buffett's quote about giving your kids enough to do something but not enough to do nothing. And I think that's a great way to think about multi-generational inheritance.

needs and whatnot because you want to give your kids some, you know, certainty in the future, especially because I don't know what the world's going to look like. Like, what if inflation is crazy high? And my kids are, you know, unable to get jobs because the robots are doing all the work in the future. And it's to my benefit to work hard now and try to provide a little bit for them down the line knowing that I can give them something. But also, that's a super long time horizon.

So it adds in that layer of multibreesome. temporal thinking that is required in good financial planning. And that actually ties perfectly with your next principle, principle number eight, which is that asset allocation is also a temporal conundrum. Yeah. I mean, this is the thing that is the most important thing for all of us is time. You know, it's the most valuable thing that any of us have. And it's the thing that makes portfolio construction really difficult is navigating all of those

different time horizons. And so when I say it's a temporal conundrum, I say that. it's unpredictable. It's navigating future consumption across all these different time horizons. So time is the thing that it's like the one thing we all understand universally. It's interesting from like a portfolio construction process too because the industry has specialized jargon around like factor investing and style investing and, you know, mid cap and small cap and large cap and growth and value and to your average person, they're like, I don't know what any of these things are. Like, I personally, like, I couldn't even define exactly what a midcap is.

Like, I don't, off the top of my head, I don't know what is the actual market capitalization of what comprises the midcap definition right now. Your average person definitely has no idea of what these things probably even are. Like, they have some vague concept of it. Like, you know, what is a value stock? Well, I assume it's a stock that's selling it a good value. And it's like, well, duh, but, you know, even the pros can't actually identify what that thing is. If everybody knew what the best value stocks were, you know, everybody would generate the best returns.

You know, we talk in the industry in these very sort of like alternative languages sometimes that your average person just doesn't understand or doesn't even care about, frankly. They want to know, can I pay for the vacation that I'm taking next summer? Can I pay to send my kids to Harvard? Can I pay for a new car next year? People think in time horizons, and they don't think in factors and styles, and yet the whole industry and the asset management business is structured around style investing, basically. And when you try to communicate that inside of a financial plan, I think people just, they have a vague understanding of it, but they don't really understand it.

When you can talk to people about things in terms of time horizons, it's really valuable because people get it. Like you wouldn't believe I was working with somebody. They had an incredibly complex financial plan and all the wife cared about was the ability to remodel the bathroom next year. It was the only thing she cared about. She desperately wanted this new bathroom. When I modeled out the financial plan and I showed her that, hey, we've got a six-month treasury bill that is perfectly matched to your bathroom remodel next year. It was like the only thing she cared about. And she was like the biggest smile you've ever seen anyone have was her ability to understand that,

hey, I've got an asset that is specifically matched to my ability to remodel the bathroom that I want. That's how people think. People think in time horizons. And so I think the ability to think about these things in time horizons and resolving this temporal conundrum, as I call it, is hugely valuable. And the answer might be treasury bills, but I should ask, one of the big challenges that I hear from a lot of the people who are in this audience is what to do with money that's earmarked at like a three-year time horizon, right?

Because it's three, it's that awkward length of time where if it's six months or a year, you'd probably just keep it in a savings account. If it's five to ten years, you'd have some equity or bond exposure if it's three years. Yeah, it's really hard. It's not just the three-year time horizon, but also like the 10-year time horizon. To me, that whole like sort of intermediate space, it's a really hard one to navigate because it's not, you know, like if you've got a 20-year time horizon, you know, you come to me, I say, put it in stocks. You got 50 years, maybe you put it all in tech, you know, maybe you're just crazy aggressive with that stuff. That's easy. That's like the no-brainer

to me. The other one that's a no-brainer is the emergency fund. bucket. The zero to two-year time horizon, to me, it's kind of like, oh, you're just buying, you actually shouldn't take any risk with that. You, you buy necessity probably need treasury bills or at most like, you know, Vanguard short-term bond fund or something like that. Those intermediate ones are tricky. It's that allocation, that intermediate time horizon is the one that roughly corresponds to like the global financial asset portfolio. And it's the, or something like 6040, because it's a blended time horizon. You've taken all of the, instruments and you've diversified the allocation in such a way that, you know, and what I would call

my defined duration methodology, it creates a blended time horizon where it's not long duration like the stock market, but it's also not super short like a T bill is. And it makes it really hard, actually, because that's sort of like three to 10 year time horizon, not only is it hard to predict from a, you know, a liability and expense perspective, but it's hard to build a portfolio that actually aligns with that where you're not taking so little risk that you're going to not beat inflation, but you're also hopefully taking enough risk that you're generating an inflation adjusted return, but one that isn't also whipsawing you in the intermediate term where you're trying to, you know, if you're matching it to like a house down payment, it's sort of a, you know,

like, well, gosh, maybe 6040 isn't right. What if 6040 exposes me to the risk of, of like a 2008 where it falls 30%. And all of a sudden, when 2008 comes around and house prices are down 10%, and I want to buy the house, my asset allocation is also down 30%. And here I am, like, double whammy, you know, feeling like I made a huge mistake. It's a hard one. It requires a little more finesse probably in like the way you're constructing the asset allocation.

And I'm kind of a fan of building like multi-asset types of instruments where you're getting maybe a little bit of stock market exposure. of something like that, but you're still building something that's really safe. But it's hard. It's the hardest time horizon, I think, to navigate. Yeah. Principle number nine. Past performance is not indicative of future returns.

Yeah. We hear that all the time. This is in basically every investment document in human existence now. Part of the things that we need to go into all of this understanding is that the future is not going to look like the past. And it could look very, very different, you know, like we've gotten used to. to the United States doing incredibly well relative to foreign stocks. Who knows if that's going to, it's one of the reasons why I'm a big advocate of global

diversification because I think that the world of the future is just going to look so different. And I don't know if, you know, it's interesting, like, from a historical perspective, to think about, like, an investor in the year 1700 who was looking at, like, something like what I would say the global financial asset portfolio is, you're like, what were they investing in? They didn't even, the United States wasn't even a thing. back then. And so it's weird to think about this through a historical lens because that investor is probably

somebody who, let's say they were living in the UK. They're a British investor who probably owns almost exclusively British companies. And two, 300 years later, you know, what are all the best performing instruments? They're all just totally different. And so the world is going to look very, very different in, you know, even 10 years, 50. I think the world is changing faster than it ever has. has, and especially with AI and the robotics and the shifting technological landscape of everything, I think it's useful to go into all this with real expectations that the future is going to look really different. And I don't know what inflation is going to be.

I don't know what the U.S. stock market is going to do relative to emerging markets. Or, you know, it was actually one of the one of my favorite portfolios that we didn't talk about was the forward cap portfolio, which is a portfolio that I actually try to extrapolate a lot of the big macroeconomic trends out into the future to sort of skate to where the puck is going. So like the thinking is like, well, if technology is 35% of the S&P 500 today, well, what is the forward capitalization of the technology sector going to be in, say, 50 years? And if it's, if I think it's going to be 50%, well, shouldn't I own 50% in my allocation today, kind of skating to where the puck is, knowing that I'll generate higher returns along the way by kind of skating

to where the puck is rather than what a, you know, a market cap-weighted index fund basically does is it, it skates with the puck. So it's constantly, you know, which is very effective, obviously, but it's not skating to where the puck potentially is going. I tried to extrapolate some of this out, but also with the full admission that, like I, and I emphasize this a lot in that portfolio, that this thing is high risk. And I'm making a ton of guesses. I'm making a ton of really active guesses about what the forward portfolio was going to look like. Going into this with realistic expectations, I think, is useful because it adds to the benefit of why you're diversifying your portfolio in the first place. You diversify in large part because we don't know what the future

is going to look like. Right. And the risk of that guesswork is the risk that you're wrong. Yeah. And the risk of missing the thing that takes off. And accepting the inevitability that you're going to be wrong about certain things at certain times, you know, like you're going to allocate money to cash or bonds potentially that looks really stupid in years like 2022. And that's just part of how all of this works is that it's never going to be perfect. There is no perfect portfolio. All right. Let's talk about the 10th and final principle, which is to set realistic expectations and stay the course. Yeah. So this is again kind of tying into number nine that go into this with realistic expectations where you're not deluding yourself into thinking that the stock market

is where you're going to become like fantastically wealthy. It's not going to necessarily be the driver of how you get rich. And, you know, I think you have to go into this understanding the way that certain instruments generate certain returns and build in realistic expectations by understanding things like the real, real returns and adjusting for all of these things where you can go in and you can say, okay, well, I could realistically generate four or five percent in aggregate. And over the course of the long run, this will generate, you know, X outcome. And that'll serve me fine. You know, that'll meet my financial needs and I'll be able to retire and, you know,

pay for all of the things that I wanted to consume along the way and whatnot. But you got to go into that with really realistic expectations. Because if you go in with like, I think these sort of like expectations that you're going to generate 10% per year, that you're going to. like be the next Warren Buffett. Like I was convinced when I was 20 years old that I was going to be the next Warren Buffett. And unfortunately, I invested into the teeth of the NASDAQ bubble implosion for my first, you know, four years of investing there. So I got, I got kicked in the, in the, you know what, right off the bat and then got kicked again just a few years later.

2008, yeah. But, you know, so I had a kind of a hard introduction to portfolio management right off the bat. But I had these diluted expectations also where I went into all of this thinking that I was going to generate 20% per year for the rest of my life because I was convinced that I'm a smart guy who I have a finance background and I'm going to beat the market and have these incredible returns. And then you actually start paying the bills by realizing the returns and you realize, you know, oh, crap, inflation was higher than I expected and the tax bill was higher than I expected. The fees I paid, the other, you know, sort of intangible costs were higher than I expected. So you've got to go into all this with really realistic expectations. And I think those realistic expectations make your

portfolio much more viable in the long run because you won't, you won't get derailed when things go haywire and you get frustrated or you get disappointed at times and because you didn't meet those like sort of unrealistically lofty expectations that you had going into it all. How do you know if your expectations are too wild? That's a great question. I would say, you know, just go into it with a realistic set of assumptions that, you know, you're embedding into the planning process where, you know, if you're assuming that inflation is going to be 1%, you're probably going to be wrong.

If you think you're going to do 10% net returns on average throughout your portfolio, you're probably going to be wrong. And so you can set these sort of like probabilistic outcomes based on the assumptions you're embedding. And that's the other hard thing about investing is that we're all necessarily making, you know, forecasts about the future in sort of explicit or implicit ways. And it requires us to sort of project all of this out in some way. But you want to approach all of that in just a, I think a super realistic way where you're,

You're using past data to understand the future, but also being realistic about what are the likely outcomes in the future so that you're not tripping yourself up before you even take off. Thank you for spending this time with us. Where can people find you if they would like to learn more? My affirm is discipline funds. Our website's discipline funds.com. And I write kind of a bloggy commentary there called Discipline Alerts that people can subscribe to if they want to listen to me ramble on more. Thank you, Cullen. What are three key takeaways that we got from this conversation? Key takeaway number one, you are your portfolio's worst enemy because the biggest threat to your investment returns isn't a recession or a crash.

The biggest threat is you. Behavioral risk cuts both ways. There's a risk, of course, that during a downturn, you might get scared and sell. And people don't think that they're going to do that in advance, but then the downturn comes and you're like, oh, but this time, it's different. And there's always a reason why. 2008, the Great Recession, we had never experienced anything like that before in our lifetimes. So this time it's different. March of 2020, the pandemic, we had never experienced anything like that before. This time it's different. So yes, there's the risk that you might sell during a downturn. But there's also the risk that cuts the other way, the risk of FOMO during bull markets. And that's just as dangerous because if you see AI stocks going to the moon, you're tempted to chase performance, but usually you're chasing risk rather than chasing

returns. You think you're chasing returns, but you're actually chasing risk. We talk a lot about fear in bare markets, but the FOMO, the fear of missing out is equally as potentially disastrous for a lot of investors because it's the thing that leads to performance chasing. And when you look at things like the huge outperformance of the U.S. market or the huge outperformance of AI, you might look at that and you feel this phomo where you say, God, I maybe don't own enough of this high return yielding stuff that maybe now I should chase it. That is the first key takeaway. Key takeaway number two, the 351 exchange. This is new. I learned about this during the interview with Colin Roche. So if you have a stock position that has absolutely

exploded in value, just gone bonkers, bananas. Often, you have this golden handcuffs scenario, right? If you sell, you pay really big taxes on all of the capital gains, but if you hold, then you have a risk concentration. In the last 18 months, there is a new solution that has emerged. So this is brand new. It's called the 351 exchange, and it lets you swap a concentrated single stock into a diversified ETF at the fund's launch. What a 351 exchange basically does is it allows an investor

that's got an outsized allocation in say like a single stock. Like let's say like I see it a lot these days with like Google or Nvidia or you know a lot of the Mag 7 where someone's got this huge taxable event inside of a component like that. And what a 351 exchange does

is it allows you to take that single stock and actually allocate it to a new ETF issuance. these funds have become really popular in the last, really the last year. That is the second key takeaway. Finally, key takeaway number three, think in terms of time horizons rather than investment styles. Many investors like to talk about small cap versus large cap or growth versus value. What the average human thinks about, what the average individual investor thinks about is your life.

And as a subset of that year, time. So you think about paying for next summer's vacation. You think about sending your kid to college in 10 years. You think about your retirement at the age of 55 or 60 or 65. So you build your portfolio around these time horizons. And if you do so, you can actually take on more risk overall because you have certainty around your near-term expenses. People think in time horizons.

I was working with somebody. They had an incredibly complex financial plan, and all the wife cared about was the ability to remodel the bathroom next year. It was the only thing she cared about. She desperately wanted this new bathroom. When I modeled out the financial plan, and I showed her that, hey, we've got a six-month treasury bill that is perfectly matched to your bathroom remodel next year.

It was like the only thing she cared about it. That's how people think. Those are three key takeaways from this interview with Colin Roche. This was part two. If you did not catch part one, please check out part one, which aired the previous episode, and I hope you enjoyed part two. Thank you so much for being part of the Afford Anything community. If you enjoyed today's episode, please do three things.

First, download our free 52-week guide to hitting your financial goals, and you can download this. You'll never guess the URL. That's right. It's afford anything.com slash financial goals. It's completely free and worth every penny. No, it's great. Somebody actually messaged me the other day and said that they used it last year.

You know, and it's one thing that you can do every single week throughout the year. This person messaged me and said that they used it last year and made these really small tweaks. Each one individually, it seems like nothing, but then added up over the span of a year. it turned into a lot. So download that. It's a great way to spend the next year making these small tweaks in your financial life that each one in isolation seems like nothing but then together the effect compounds. Affordainthing.com slash financial goals. That's the first thing that you can do. The second thing that you can do is please share this with your friends. Friends, family, neighbors, colleagues, coworkers, share it with your loved ones, share it with your liked ones, share it with your

tolerated ones. Share it with all the people in your life and the people who are not in your life. I don't know how you'll do that, but you'll find a way because that is the most important way that you can spread the message of F-I-I-R-E. Finally, open your favorite podcast playing app and leave us up to and including a five-star review. Thank you so much for tuning in. I'm Paula Pan. This is the Afford Anything podcast, and I'll meet you in the next episode.