Afford Anything - Money for the Rest of Us, with JD Stein

Episode Date: September 18, 2017

#95: J. David Stein used to manage billions of dollars. He retired at age 46. Now that he's retired, he faces a different challenge: How should he invest his own money? What investing philosophy should he follow in his own life? And what can we learn from that? Stein, who now hosts a podcast called Money for the Rest of Us, joins me on today's show to talk about his big-picture investing ideas. For a list of my takeaways, go to http://affordanything.com/episode95 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else. And that's true, not just of your money, but also your time, energy, focus, attention, anything in your life that's a scarce or limited resource. So what's most important to you? And how do you align your day-to-day decisions around what is most important to you? Answering those two questions is a lifetime practice, and that is what this show is here to explore. My name's Paula Pant. This is the Afford Anything podcast.

and I want to tell you a story about a man named David Stein. David used to manage billions of dollars. As the chief investment strategist at the Fund Evaluation Group, which was a $33 billion investment advisory firm, his job was to develop the group's investment philosophy and process. He guided investments for major universities and big nonprofits, including the Texas A&M system and the Sierra Club. He was wildly successful at his work,

and he retired at the age of 46. Now that he's retired, he faces an entirely different dilemma. How should he invest his own money, his own personal individual money? What investing philosophy should he follow in his own life? And what can we learn from that? David, who also now hosts a popular podcast called Money for the Rest of Us, is joining me on today's show to talk about his big picture investing ideas. Let's hear from him right now. Hey there. Hi. Thank you for joining us on today's show.

Oh, it's great to be here. Thanks for having me. I invited you on because your podcast and what you write about and your YouTube channel, which I binge watched this morning, is very heavily based around investing. So let's just jump right in. Can you, in a nutshell, describe your investing philosophy? Sure. It is asset focus. So it's focused on asset allocation, primarily buy and hold. So using mostly ETFs and index funds, but willing to make change. My fundamental view is most passive investors are in fact active. And I would say most are active in the sense that they're very much overweight the U.S. market versus the global market.

Whereas the global market's 50% U.S. stocks, many investors are 80% U.S. stocks. or 90 within their equity allocation. So I'm willing to be active in the sense of adjusting the portfolio based on, you know, objectively looking at market conditions. So what are valuations? What is the economy doing? And what is the level of fear and greed out there? And we'll make allocation decisions based on that.

Not trying to time the market two to three times a month or we're really talking about over a period of years. So when I used to be an institutional money manager and develop this philosophy there, there we would make two to three changes per year. For personal investors, you don't even have to make that many. Because many of those changes were because when your money manager, your clients expect you to, one, to predict the future and two, to make changes. And so I would be managing money in our consultant team. You could tell when clients are getting restless. Well, you haven't done anything in six months.

Well, there isn't really anything to do because conditions are the same. So oftentimes we would have to tweak around the edges just so we can make a change and write about it and write about markets. But generally speaking, in fact, I was just talking to a member of my website just foreground this call. And we were talking about when you look over the last two decades, there really have only been in terms of major changes in terms of where it would make sense to pull back. risk significantly. It was the internet bubble and it was 2008, 2009. So I believe primarily passive makes sense. There are areas, and we can talk about it where maybe active makes more sense. And occasionally, looking for regime change, it was something major has shift and be willing to change your portfolio to reduce risk or to increase risk when it makes sense.

Okay. There are a few questions that this opens up. But what I'd like to start with is how do you know, because in hindsight the Great Recession were times when a person might have wanted to shift their portfolio, but that's with the clarity of hindsight. How do you know in advance of that that you are at a time in which you should make some changes? And we'll use right now as an example. As of the time of this recording, the Dow just topped 22,000. A lot of people are afraid that we're at the height of a bar. a nine-year bull run, how do you decide if this is actually the time to make a move versus a normal, cyplical time?

There's some criteria you can look at. First is valuations. And so I just go back to the Internet bubble. It was clear when you saw the P.E.s of growth stocks or the stock market in general, but particularly the Internet stocks, when everyone had their favorite Internet stock, that something was amazing. miss here. You couldn't time it exactly, but certainly going into 99, late 99, 2000, it just made sense to not be investing that heavily. And I was just talking to somebody recently. The broker, he lost 80% in the internet bust because that's the type of stocks that the brokerage community was often recommending. And so you can look at valuations, but you can't look at

in isolation because you point out, well, valuations were pricey two years ago. So what you also need to look at is what the economy is doing because, you know, valuations get impacted by earnings. And we've been in a period where earnings have been rebounding. And so even though the market, you know, we've hit all times highs, the actual valuation of stocks haven't gone up so much this year because earnings have rebounded. So you have to look at drivers of the economy. And one of my favorite measures that I look at is something called purchasing manager indices. And these are business surveys done all around the world where surveyors ask business, and how's business doing?

What are your hiring plans? What's your inventory like? What about new orders? And they have been very, very good advance indicators of recessions. And typically they're done. So they scale it. So it goes from zero to 100. So when it's 50 or higher,

usually it signals the economy is expanding people, and things are going well. When it's generally sort of 48 or below, that has been indicative of a recession. How is this number calculated? It's based on all the surveys they do, and I just sort of, it's kind of a numerical way to where, you know, at the end of the day, if the number, like right now, the global, because it's done around the world. So J.P. Morgan puts together a global indicator. So the global PMI for manufacturing, I think, came in. around 53, which is indicative of the fact that the economies around the world are, they're in expansion mode, as opposed to contraction mode. And these surveys often will show up before, and you could see it in 2008.

So in 2008, January 2008, you saw the U.S. manufacturing PMI was down to 46. And then you saw it globally. So by the spring of 2008, most countries around the world had PMI's below 50. which was a pretty good sign that a global recession was imminent. And in fact, it already started in the U.S. But the markets didn't completely collapse until later that fall. So there are some indicators, but you can never get the timing exactly right, but that's not what we're trying to do.

We're not trying to be expert market timers. We're trying to be risk managers. And when valuations are high or when the economy appears to be slowing, we want to reduce risk, not get completely in cash, but maybe take some profits. And you can do the reverse. When everybody's fearful, but the economy by some of these indicators are starting to improve and valuations are cheap, such as they were by spring of 2009, then that's a time to take more risk.

But if you recall back in spring 2009, people were still absolutely terrified. And some investors, it took them three years before they went back into stocks. And what were the PMI indicators like in the spring of 2009? They were about 50 by then. They were starting to show improvement. The primary indicator that you look at? That's a primary one. I mean, I try to, I look at a number of them, but that's one that's helpful because it's

global. It's been around a long time, and people can somewhat understand. I also look at their other leading economic indicators, the conference board, does one that's been very effective for the U.S., where you just, they basically have all these different components that are indicating what the economy is doing. And if that rate of change compared to six months ago is negative, like as contracted by more than three to four percent, that's typically been, and the subcomponents are also contracting, that's also been indicative of recessions. And they've just been very, very good indicators to least manage risk to some

extent. Are there any particular P.E.s that you use as sort of hard cutoffs, like an S&P 500? Not an absolute. What I'll do is I'll look at it relative to how many, and this is a statistical term, standard deviations is it away from the average? So you have the average PE for the past 20 to 50 years. What standard deviation measures is the range of returns of the observations. So generally, if something is greater than one standard deviation than from the average, then it's an outlier. So that starts to cause some concern. When you see what happened in the Internet bubble, I mean, it was sort of two to three standard deviations outside of the norm. And where are we now?

Right now, if you look at the global market, it's about 0.6 standard deviations. So it's not that, for example. So I use what's called the earnings yield. So it's the inverse of the price to earnings ratio. So the earnings is the numerator. The price is the denominator. And so right now, that's about 4.8% for the MSCI All-Ccountry World Index. The 20-year average is 5.4.

So a 5 would be like equivalent to P of 20. So it's about 0.6%. So it's above average. Now, when you look at the U.S., U.S. is, you know, close to one standard aviation right now. in terms of the earnings yield. So it's overvalued, but not obscenely. So like you saw in 2000, 2001, which is why the markets continue to go up because when we look at what the economy has done, it's growing.

It continues to be an expansion mode. And those are sort of two things you can look at. Now, the other thing I also look at is I look at the level of fear and greed. And there's surveys that do this. Like, are most investors bullish? Or are they still fear? Are they still holding back? And, you know, we're not in a period.

It's not anything like the housing bubble where it was palpable. People were just climbing over each other to buy a house, right? Or they had three houses. And you could tell, I mean, I could tell as early as, you know, anecdotally in 2004 that something's just not right here. Back 2003, I remember somebody moved to our town in Idaho from Kentucky and who was going to college. He had made money going to college because he heard that land prices were going up in Florida. He drove down to Florida and he bought some building lots, site unseen, and then flipped them. And then he took the money and went to college to went back to school.

And so, I mean, there's, you can sort of see. I mean, there's official surveys, but you can see when investors are, if everybody, every taxi driver has their favorite internet stock. Something's wrong. And there was. There was something fundamental wrong in 2000, but everybody thought it was a new era. One of the things that happened, I mean, I don't want to go too far down the topic of how real estate got wonky, pre-great recession. But one of the justifications that I heard many people use at that time was that people were afraid that they would be priced out of the housing market. And I'm starting to hear the same thing now.

I just talked to somebody yesterday. She lives in Sydney, Australia, and she's afraid of getting priced out. She says everything there is above a million. Prices just keep going up and up and up. I'm afraid that if I don't buy something now, I'm never going to be able to. How do you distinguish between greed versus... Well, you can look at... In fact, I did an episode on Australia Housing because I had members sort of same thing.

And it's this fear of missing out. There's a couple of things you have to look at, though, is because housing, as you know, as a real estate investor, is very specific to the locale. And so it very much depends on inventory and how landlocked it is. Seattle, for example, right? There's only so many places you can build in Seattle, and there's some zoning restrictions. And so there, there is the potential of missing out. But what you can always do is look at, well, what are houses priced relative to rents?

And when you looked at 2005, 2006, housing compared to average rent and compared to median income was completely out of line. It was unsustainable because people need money to pay rent and to buy their houses. And so unless there is people coming in somehow or there's some outside source of income, And Australia sort of does have that because you have a lot of money coming in from China, potentially buying up some of those premier properties. But fear of missing out is a primary driver of markets. And that's where people get, they get overly zealous or they get fearful that they might miss out. And that can put valuations out of bounds. But you have to be patient.

At the end of the day, I mean, sometimes you just have to say, all right, I might miss this one. And I'm willing to ride it out and not expose my capital and I'll rent or, you know, in the case of housing, I'm going to buy the cheapest house in an up-becoming neighborhood. There's ways you can get around it. But it's a tough thing. I personally, like, we build a house. Like, I knew there was a housing bubble. And I was managing money institutionally. And I got a lot of insight from real estate, institution of real estate manager.

Yeah, we wanted a house. So we built a house. I thought, all right, $100 a square foot is what we built that house for. Oh, that's very cheap, yes. It was just cheap, right? It was a beautiful house, but the houses went down even in Idaho. So my houses depreciate just like cars. They get old.

And so we kept that house eight years and we sold it for $80 a square foot. And we lost 20% because that's what houses often do. Unless you're in an area where for whatever reason, you're near a beach or something is keeping the inventory down and they appreciate. But when most people see appreciation in houses, what they're really seeing is the impact of having leverage. So a house might go up by inflation. But because they only have 20% equity, it looks like they're doing very, very well.

Right. Well, and the underlying land could appreciate the structure itself appreciates. Or the land. And if the land's appreciating, usually it's because there's a limited supply of it, because they're not either from a zoning reason or there's something geographical, they're not continuing to subdivide land and turn agricultural into new housing lots. What should a person do when they're in a FOMO market? If you don't want to invest in stocks or in any asset class because you're worried,

because you don't think that FOMO was an adequate justification for exposing your capital, where do you put that capital instead? Well, you can leave it in cash. It's okay to hold cash. The most successful money manager I know is a man named Seth Clarman. He runs a hedge fund called the Bell Post Group. And I used to have a private foundation client that had half their money with this manager. And I would go meet with them once a year.

And at his core, he was an asset allocator. He had a very diversified portfolio. But he was willing to hold 40% cash. if there was nothing cheap that didn't mean his criteria. And in the institutional world, holding cash is just, or even individuals, is somehow bad because you're losing compared to inflation. But if that's really just dry powder that you're waiting for opportunity, then it's okay to hold cash and just wait.

There's nothing wrong with that because eventually there'll be an opportunity. Because if everything's overvalued, and there was, when the housing bus occurred, There was plenty of opportunity. Or in 2009, even with the bond market, non-investment-grade bonds, you could make equity like returns because they were yielding 20%. So it pays to wait when there is clearly a bubble. Now, we're not in a situation right now where we're clearly in a huge bubble. The economy is doing fine.

Valuations are a little above average. and it would probably be good if most investors didn't have all of it in U.S. stocks. Non-U.S. stocks are cheaper. And until the economy rolls over, we're not in a situation. It's not anything like it was in 2001 in terms of stock market valuations right now. How do you distinguish between holding cash when assets are overvalued versus simply just having your asset allocation out of whack? let's say you've got Jack and Jill, right, or you've got person A and person B. And let's assume that both of them have 40% of their portfolios and cash.

But one person has that level of cash because they believe that they are rightly or wrongly, they believe that all available investments are overvalued and that they should wait. the other person, even though the numbers look the same, just does not adequately have a well-balanced portfolio. Well, I think, one, when someone decides to hold a lot of cash, I mean, you can't invest based on a feeling. You have to have objective criteria. And it also depends on having realistic expectations of the future.

So I mentioned earlier that the stock market is. overvalued, but not extremely overvalued. But what that means is with 2% dividend yields and above average valuation, expectations for U.S. stocks over the next decades, about 5%. And so you have to sort of make these allocation decisions based on what the expected return is. And so if somebody's going to be that much in cash, you need to be cognizant of why and what are valuations, what's the future expect to return and why am I holding cash? If it's because I, for example, I got emails after this recent presidential election from people that were fearful before the election and a different set were fearful after the election

and deciding whether to not invest in stocks because of election is not a good thing. You have to look at more objective criteria. What were valuations? And you also have to base it on regret because we can't necessarily predict exactly especially the next six months, what's going to happen? And particularly after a presidential election, there was no way to predict what our president would do in the first six months. That would potentially would impact the stock market.

And so this person that asked a question, I actually answered it on my show, you have to look at how do you decide? Well, if I take my money out of the stock market, how will I feel if the market goes up 30%? versus if I keep it in and the market falls 30%. Because then it becomes, and that's hard to do. I mean, it really is hard to do.

But that's one way to look at it. If you're not going to look at objective criteria, then decide from a regret standpoint, how am I going to feel if this happens? Because the market, in fact, did very, very well, and many people did pull their money out out of fear. Hey, hey, we'll be back to the show in a second, but first I want to give a shout out to Fresh Books.

They have signed on as one of our main sponsors in 2017. and they have an awesome product. It's meant for freelancers, solopreneurs, small business owners. If you have a side hustle or if you're self-employed and you need to send out invoices to your clients, yeah, it's necessary.

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It automatically sends follow-ups to invoices that haven't gotten paid. It lets you know whether or not your client has even opened your invoice or not. Basically, they take the suckiness out of invoicing. Give them a try for free for 30 days at freshbooks.com slash Paula. That's freshbooks.com slash p-a-u-l-a. I want to give a shout out to Bluehost. If you're interested in starting your own blog, check out Bluehost. They're a company that offers hosting, which is basically the term for the space on the internet where your blog lives.

Absolutely fantastic if you are getting started as a blogger and you need hosting and a domain name. You can learn how to set up a blue host account in five minutes or less by visiting afford anything.com slash start a blog, where I've got a full set of detailed instructions, step-by-step guide, including screenshots of every step along the way, plus a YouTube video. that out, afford anything.com slash start a blog. With all of this, everything that we've discussed so far, a lot of this involves using judgment, looking at information and then using judgment to interpret that information. How and why is this, do you believe that this is advantageous over a purely passive approach? Well, it depends on your stage in life. Somebody that's in their 20s that has 50 years until they retire or more.

Now, a purely passive approach might be very, very appropriate because they can ride the market down like a roller coaster and back up because most of the return is going to be driven by how much they're putting in. But for somebody that is approaching retirement or has a seven-figure type portfolio, I believe, because I've done it and I've seen others do it, you can make more money adjusting your portfolio based on risk because all we're really doing is saying, here's the expectation for stocks or for bonds or other asset classes and we're making allocations based on those future expectations. That's what really buy and hold passive investing should be.

It shouldn't be just, I'm going to buy the Vanguard U.S. Stock Fund. I'm going to buy the Vanguard bond fund and ignore it. because the Vanguard bond fund has about a 2% yield, and it has a very high sensitivity to rising interest rates, because its duration is so high, which is a measure of interest rate sensitivity. There are other ways you can invest in bonds that isn't as risky that is purely passive just by the standard Vanguard funds suggest. So one thing that you said within that answer is you said that you talked about asset allocation. and risk management through the lens of looking at what may happen in the future. But, well, one thing that you said in one of your YouTube videos, and I'm going to paraphrase it, because I actually wrote it down because I thought it was fairly insightful, you mentioned

the range of potential outcomes, and then there is the individual's capacity to deal with said outcome. So something is more risky if there's a wide range of potential outcomes and the harm to the individual caused by that is great. And conversely, something is less risky if there's a narrow range of potential outcomes and the harm caused to the individual is small. And in the world of investing, the potential outcomes are universal. They apply to everybody who has the same investments invested in. Everybody who holds the same investments faces the same potential outcomes, but the harm is individualized. So would it not make more sense that a person's risk management be focused on the harm that they as individuals would endure rather than predictions

about the future? Well, it should be both. And when I say prediction, well, let me ask, you're correct. So again, somebody that is younger in their 20s, the potential harm from a 40% decline in the global stock market, which is the average decline during a global recession, historically, it's small because their balance is small and they have a much longer time horizon compared to somebody that's close to retirement, that that 40% decline, if they have too much in stocks, could set back their retirement five years or more. And so that's an important component. But when I talk about predicting the future, because I believe the world is unpredictable, I do think there are clues that we can set realistic expectations. So when we're talking about

allocations, we need to have, I remember I had an exterminator come to my house once, and he wanted to know, how much could you earn in stocks? Before I could even answer, he says, I think it's 80% a year. Because he had bought two stocks that went up that much. And that's what his anchor was. We have to anchor to something realistic. And bonds are very easy to, and some other income strategies, it's easier to predict what the returns are going to be. Bonds are based on math, generally speaking, especially investment-grade bonds. So, I mean, you can have really good predictions of the bond market over the next 10 years. Ten years from now, the U.S. bond market will have returned, as we measure it by the Bloomberg-Barkley's aggregate,

will have returned about 2.5% annualized. Interest rates might go up. The bonds would go down, but then you're reinvesting at a higher interest rate. And so your total annualized return is going to be pretty close to what the current yield to maturity is. That's just how bonds work. Stocks, I use a building blocks approach. The primary driver stocks is their income stream, so their dividend yield. And we can come up with an estimate for earnings growth, which is tied to some extent to the growth of the economy.

that's the primary driver of stocks. The wild card is what are people willing to pay for those earnings? And that's why the range of potential outcome for stocks is so much wider. It's not that the world's so much unpredictable. What's unpredictable is human emotion. Ten years from now,

are they going to be willing to pay 30 times for earnings because we're in a bubble or are they going to be very, very concerned to be paying 10? That does impact the return. But I believe it's better to least anchor to someone something objective that we can look at in terms of dividends, income, and look at the,

come up with some estimate of earnings growth. Because as a real estate investor, that's what you do. You're looking at the cash flow. You can look at, here's my income stream that I'm going to get on this property and come up with a realistic expectation. What you don't know is what will investors be willing to pay for that income stream 10 years from now. But most of the return is going to be the income stream unless you sell it. And that does impact it. But there's even there, there's a range, right? You're probably not going to see cap rates of two. And you'll probably

never see cap rates of 12. It's going to be whatever, probably four to eight somewhere. Yeah. But I mean, to that analogy, that's why I always tell people, you know, purchase real estate based on that income stream and not based on anticipation of capital gains. Well, right, right. But people, even in the real estate, we talk about potential bubbles, private real estate is very, very pricey when you look at the income streams that people are willing to pay here locally. So we have a friend that's a builder and he built a student apartment complex in a college town nearest. people are so afraid of the stock market that they're willing to take all their individual retirement account and buy a building through their IRA and there's only a few banks that

will lend to buy buildings and through IRAs because they can't get a personal guarantee. So the lending rates are about six and a half percent. And we decided we didn't want to do. We bought real estate in the past, private real estate. We just didn't like the headache of managing it. But here is an opportunity. Well, we'll land. So we did the lending on it.

it. And our yield on our, we got a six and a half percent yield on the note that's secured by the building. He put up 50 percent equity. It's higher than the cap rate that he paid for the building. So his yield was 5 percent. Now it's before the debt, like after the debt, he'll be fine because he levered it up. But if he paid 100 percent equity, the amount that he paid for that building was a 5 percent yield. Well, you know, it doesn't make any sense to pay a 6 and a half percent interest rate on a five cap. I mean, that's just basic math. It doesn't.

But he's coming from the perspective of I'm terrified of the stock market. All right, I'm just going to buy this building. Then I don't have to worry about investing. My loan will be paid off in 15 years and I can live off the rents. And so even then, I mean, I suppose with the leverage, he'll come out okay. It's a strategy. I wouldn't do it. I wouldn't do it.

I don't know. Right. I mean, a deal has to make sense outside of financing. Which, again, gets to the point of when we talk about active asset allocation, look at what the potential return is based on the current conditions and be willing to adjust your allocation and go where there's opportunities. And if there isn't any opportunity, then hold cash. And by opportunity, that's often outside of the public securities market. Perhaps it's owning a piece of land or a building. Perhaps it's owning some gold.

Perhaps it's investing in your education or something, but just have as many return drivers as possible in your investing. Don't just depend on stocks and bonds. There's plenty of other asset classes. Learn about them. That's where I talk about my investment approach. It's asset class focused. I'd rather spend time learning about new asset classes and coming up with expectations as opposed to researching individual stocks or options or something like that. because I think asset classes, it's easier to do and you're less likely to get burned.

Right. Exactly. And that, what you just said relates to something that you talk about often, which is referred, which you refer to as pockets of independence. Right. And that's what those are. Those are things outside of traditional financial markets. For example, we own gold coins.

I'm not a gold bug. But I reckon, and I have no. And gold, the other thing to look at with investing is, What's an investment versus what's gambling versus what's speculating. Investment is something where there's generally an income stream or there's some objective way to value it, either historical evaluation or something like that. So stocks, bonds, real estate, those are investments. Speculations is where there isn't really a way to value it objectively. And there's some disagreement of whether the return is going to be positive or negative.

Most investments, if you buy them right, the expectation is for positive return. Gold is speculation. There is no way to know what the true value of gold is, but it has been a hedge. People have valued it as something they want to own for millennia. And there's a limited supply of gold. And so I'm comfortable owning gold coins because if, for whatever reason, we have another financial crisis or something horrific happens, which I'm not predicting. I don't expect, but here I have a pocket of independent. I have some gold coins.

I have some Bitcoin because that's just separate. We have food saved up just in case. Some people own ammunition. I don't. I don't have any guns. But these are things, and it kind of gets a bad rap, but these are just pockets away from the financial system. So you're not completely tied to these digits that make up our economy. And how do you determine what percentage of your portfolio goes to,

each of these pockets of independence? There isn't really a way because you don't have, I mean, theoretically, traditionally you would do an asset allocation and say, all right, here's what I expect to return, but we don't. So, for example, I have about 5% in gold and Bitcoin, right? Enough to whatever use over a period of years is something bad happened. But there's no right answer. You don't, with anything, you don't want to be extreme.

And that's where people get into trouble. primarily your investment should be things that generate income. You can have 5 to 10% in speculations or hedges, and that seems appropriate. Once you get above that, that seems extreme to me. But there isn't a right answer. It depends on the individual person, but you don't want your retirement to be dependent on speculations, which is why you want to invest, and that typically involves traditional asset classes, both public and private.

All right, switching gears a little bit. Let's talk about retirement. First, let's define retirement as the point at which you've collected sufficient assets that you're able to stop working for money, such that any future work is optional or unnecessary. By that definition, you retired at 48. Can you tell us that story? Yeah. Well, I was actually 46. Oh, and I had been in, thanks. I had been an investment manager. So I, I, I'd been a professional advisor for about 12 years. We had bought back our company from our parent and it'd done well. So we took out a bunch of leverage. I got lucky. So we took out leverage and it worked out. All my partners were the same age.

And I just, I was sort of in my mid-40s. And I felt like really, I'd peaked in the sense that I just sort of, I remember speaking at our annual conference because I was our firm's chief investment strategist. and I was on the stage, 500 people in the room, and I'm giving my speech. But in the back of my head, you have this dialogue that often happens when you're speaking in public. I'm thinking, like, this is it at this particular place. Why would I continue to work here? And it sort of bugged me because I was already – had been living in Idaho.

I didn't have a boss, so I'm a partner. But there was just this sense that there was something else, that I could have more freedom, this idea that I have to be connected to at least my cell phone because a client might call. And I just felt like it was time that I was no longer growing as much as I could otherwise. And I'm conservative. And I'd hit my number in the sense that I knew what the valuation. I knew what my 401K was worth. I knew what my IRA was worth.

And I had this big nut in terms of the valuation of this private firm. And I knew if I walked away how much my partners would pay me. And I decided I didn't want, what if somebody came along and sued us or something else happened? So part of it was the desire for more freedom. Part of it was realizing that I could leave and not never work the rest of my life. Well, I could. All right. If I had cut back and lived much more frugally, Mr. Money Mustache like, well, more better than that.

But I could be fine. But what I found as a 46-year-old retiree, one, you can't, it's hard to even think about being retired for 30 to 40 or 50 years. It's just, it's unfathable. And it's stressful to not have any type of income stream other than your portfolio, which is why for most retirees, I think it's helpful. If you're still in your 60s, find a way to generate some income outside of your investments. Usually, people do it naturally, but why not figure out? A lifestyle business, something that you do, that you feel rewarded in, that you enjoy doing, but that still generates a little bit of income.

Because when you're retired and not doing anything, you literally do stagnate. And it can affect your health. So having something, that type of routine, I think, is very very important. That's what I found even as 46. And so I eventually worked in. It took me a while. It took me a while to figure out what I wanted to do when I was, quote, unquote, retired. And I used to tell people I retired.

And then the people kept thinking, oh, I didn't have anything to do so they would come up with projects for me. So I stopped using their work we're retired. But it takes a while to figure it out. Leaving a job or career is really, it's like getting a divorce is what a friend told me. And I found that's exactly the way it was. It's emotional. It's draining. And it just takes time to figure out who am I outside of this career or this profession or this company that I've been with in my case for 12 years.

And it took me a while to figure that out. But eventually you realized, and then this becomes the normal, right? Your normal is not working for anyone, working for yourself. It took me a while to get there. But now that feels normal, but it takes time for people to get used to that. And that's kind of what retirement is. So last question before you wrap up, for the people who are wondering what actionable steps should they take next, particularly in the current environment, where, as we've talked about, probably not overvalued,

but probably not in a bubble. What should the average listener do? The most important thing is to figure out where your portfolio is. In other words, what is your asset allocation in terms of how much do you have in stocks versus bonds? So people have their 401k and they might have money outside of the 401k and they might have their IRA and they have this whole jumble. And in many regards, they have no idea what is the overall allocation. So they should get a spreadsheet and just see what it is. And I think that's an important first step.

I had a gentleman tell me the other day. It took me a year and a half to do that. And I finally realized, because he explained it to me, because he was a psychologist, it was not that it was hard mechanically to do. It was it was terrifying because he had to face his future that in his case, he was in his 60s and he faced the fact that, you know, do I have enough? And I might die in whatever in the next decade or two. And that was hard for him to sort of pull those numbers together.

But I think that's a realistic first step. Figure out what your allocation is on a spreadsheet. And then I think another reasonable step is to sort of anchor. What are you expecting to return in your portfolio? And I think if those approaching retirement, I think it's helpful to use different retirement calculators to figure out, do you have enough? Am I saving enough?

Because most people don't even do that. And would you, go ahead. Oh, I was going now. Would you say that there is general benchmark for a good model allocation for the average person based on their age or their timeline to retirement? Yes. And no, because there's so many other variables. For example, somebody that has a pension plan, defined benefit plan, they can afford to take more risk in their 401k versus somebody that doesn't or the situation of their spouse or how much savings. I already have, so it's hard to do.

I show some model portfolios on my site, so my most aggressive portfolio ends up being about 60 to 70% stocks, and the more conservative is 30% stocks. But it depends, again, on our definition of risk, is what would happen if you're in more aggressive in terms of the outcome. How could that, will that change your lifestyle if the market fell 40%. So I don't think there's a hard fast rules other than generally younger people. that have smaller portfolios can take way more risk than people that are older that are closer to retirement and have bigger portfolios because, in their case, that a big market sell-off

could have a more detrimental impact. Thank you so much. Well, great. I appreciate all the opportunity. Thank you so much, David, for joining us on today's show. What are some of the key takeaways? One of the things that I wanted to cover, and I don't want this to be too real estate-focused, but there is something that I wanted to touch on.

Many people have many different ideas around rental property investing. And one of the ideas that's out there is this notion that even if a particular property does not give you a good income stream, some people believe that that's okay as long as you're not putting too much cash into the deal. And so the equation is something that's known as the cash on cash return. And this equation, the way that it's constructed, it rewards people for putting the least amount of cash into the deal as possible. So if you put zero of your own money down, then your cash on cash return is infinity. You know, if you put $1 of your own money down, your cash on cash return is high. If you put $100 down payment, meaning that you purchase the house in cash, your cash and cash return is going to be low and so on and so forth.

So anyway, there are a lot of real estate investors who make their decisions based largely on the cash on cash return formula. And their position is that even if they're not making a good income stream, even if their cap rate is low, as long as they're not putting too much of their own cash into the deal, as long as they're leveraging into it, they're essentially getting something for nothing and eventually the house will be paid off after 15 to 30 years. And so that's what he and I were talking about. That was when I said, well, that is a way of doing it. That is a approach that exists. But it's certainly not one that I would do. A deal needs to make sense in cash in order to go into it. In other words, never rely on financing to make a bad deal good.

In other words, never say, hey, if I paid cash for this thing, this would be a terrible deal. But as long as I take out a loan for it, then it's better. I mean, like, think about that logically. In what kind of a world, is that a good financial decision? I'm ours, apparently. I guess that's the world we're living in now where we have to rely on leverage in order to make bad decisions have the veneer of good.

But I see that as BS accounting. TLDR, if you would not buy an investment in cash, do not justify buying that investment by taking out a loan. The best financing in the world is not going to turn a bad deal into a cash. to a good one. So that's one of the points that came up during this conversation that I wanted to emphasize during these closing takeaways. Now, switching gears, the second point that I want to make when reflecting on our conversation is that personally, I'm still not convinced, I'm personally still not convinced that there is a strong enough reason to deviate from a

purely passive approach. And so as those of you who are longtime listeners to this podcast know, my approach to market investing has always been stick with passively managed index funds, don't try to time the market, decide on a simple, broad-based allocation. So, for example, you might choose one total U.S. stock market index, one total international index, and maybe one bond index, a very, very simple, very broad allocation. And then just stick with that and rebalance annually or periodically, because by virtue of rebalancing, you are necessarily selling off some of the winners and buying more of some of the losers. Rebalancing is inherently a contrarian activity. And so my approach has always been that as long as you stick with

passively managed broad-based index funds in major asset classes and you decide on an asset allocation that is in line with your age and your timeline to retirement and you rebalance periodically. As long as you do that, you'll be set. and there is no reason to make it any more complicated than it needs to be. The more complexity that you add into a system, the more you introduce the potential for that system to fall apart or break down. So a system should be as simple as possible unless there is sufficient evidence to warrant or justify the addition of complexity. So that's my approach. And David's a similar, really. I mean, you know, he also believes in broad-based asset class-focused investing.

He doesn't trade individual stocks. He's not a day trader or a high-frequency trader. So, yeah, we have some small differences. He believes in a little bit of market timing. But our investing philosophies are more similar than they are different. We are analogous to like one person is a complete vegetarian and the other one is a pescatarian type of a thing, you know, in terms of we're more similar than we are different. By the way, on a related note, so twice a year, I calculate my net worth, typically once in the winter and once in the summer.

And so I just recalculated my net worth a couple of weeks ago. And when I do so, there are a lot of programs that will automatically do it for you. You can link your accounts to various pieces of software, like personal capital, and they'll track your net worth for free. But if you sign up for multiple different programs, you'll always get a slightly different. different number I've noticed. And beyond that, and perhaps more importantly, there is something to be said for the benefit of manually going through every account and transcribing each number onto a spreadsheet. And the reason for this is simple. When we are handed information that we don't have to work for, when that information is automated, we are subject to what is known as information

blindness. And this prevents us from being able to turn data into true knowledge and then that knowledge into action. But when data is slightly more difficult to acquire and slightly more difficult to process, the human mind tends to internalize it better. This concept is known as cognitive disfluency. And it was written about in a book by Charles Duhigg called Smarter, Faster, better. This is where I first learned about it. In this book, Dohigg tells the story of South Avondale Elementary School, which was one of the, in 2007, was ranked as one of the worst schools in Cincinnati, Ohio, which, by the way, is my hometown. So, thanks to major corporate benefactors like Procter and Gamble, the school had a decent amount of money. In fact, it had almost three times more money than

affluent schools in nearby areas. And so the administration used this money to invest in software that tracked all of this data, student attendance, homework, test scores, participation. They had incredible amounts of data and very cutting edge data visualization dashboards. This software would track the progress of every student. It would graph this information on weekly and monthly bases, and it gave all of this data to the teachers. And yet after six years of having all of this data available, schools such as South Carolina, Avondale were no better in terms of academic improvement. And 90% of the teachers admitted that they didn't really even look at the dashboards very often. So in 2008, South Avondale Elementary School implemented a new program in which they mandated that the teachers transcribe that data by hand onto index cards and draw graphs of that data by hand onto butcher paper. As you can imagine, the program was not very

popular with teachers, but it worked. It caused a massive turnaround in student performance, and a large part of that was attributed to the fact that as the teachers were transcribing that data by hand, they had time to truly process the information, to internalize it and think about it. It was, in essence, almost a meditative activity. What I am describing is cognitive disfluency, meaning that if something is disfluent, if it is not easy, if it's not fluent, we may be able to process this information a little bit better. And so anyway, cycling back to what I was saying earlier, twice a year I calculate my net worth. And rather than using automated software in order to do this, I manually log into every account, look up my balances, and transcribe it onto a cell within a spreadsheet. And as far as my home values go, I manually go to a variety of different websites, including

Zillow, Realtor.com, homesnap.com. I used to go to homefax.com, but they haven't really been giving much information lately. But I will go to all of those websites, look up the address of every single house, throw away any extreme outliers, and then manually calculate the average of the non-outlier numbers. And that's how I estimate. the current market value of each property. So calculating my net worth takes like half a day, which is why I only do this twice a year. But it gives me time to process the information, to deeply, deeply process it. It creates that cognitive disfluency. So all of this, this is a very long tangent, but all of this is to say that I tabulated those numbers and I realized

that I only keep 1% of my portfolio in individual stocks. One percent. And that's not even 1% of my total net worth, it's 1% of my invested portfolio. The other 99% is all in index funds. Wow, that was an incredibly long tangent to get to that point. But I hope it was educational and entertaining. That was why I could see myself veering, but I ran with it. So back to the original point, look for the common threads. And I think, you know, when you hear these interviews with people like David Stein, Andrew Hallam, J.L. Collins, people who've been on the show who've done very, very well in the investing world, as well as people who I would love to get on the show, but who haven't been on, such as John Bogle, Charles Schwab, Ken Fisher, heck, Warren Buffett, you know,

the very successful investors of our day, if you look for some of the common threads that while their investing philosophies may diverge, if you look for some of the common threads that they all share, And a shoeing of individual stock trading and high frequency or day trading is the common thread. As both Philip Fisher and Warren Buffett have said, our favorite holding period is forever. So I will leave you with those takeaways. Thank you so much for tuning in. My name is Paula Pan. I'm the host of the Afford Anything podcast.

Please share this podcast with a friend if you enjoyed it. And also head to your favorite podcast player, whether that's iTunes, Stitcher, overcast, however it is that you listen to us, and please hit subscribe and leave a review. These reviews are incredibly helpful when it comes to helping us book awesome guests onto this show. Man, I would love to get John Bogle on the show. He's the inventor of index funds and the founder of Vanguard. Man, that would be crazy. Okay, my name is Paula Pant.

This is the Afford Anything podcast. I'll catch you next week.