Afford Anything - What We Learned in 2022

Episode Date: December 29, 2022

#420: Harvard professor Arthur Brooks described two types of intelligence – and explained, in scientific terms, the wisdom that comes with age. Dr. Ellen Vora, M.D., shared insight into the roots of procrastination, offering evidence-based tips for how to overcome our own inner demons of anxiety, fear and laziness. Psychology professor Bill von Hippel described why too much happiness is just as detrimental to our long-term health and wellbeing as too little happiness. Wall St. Journal columnist Spencer Jakab observed the perfect storm of conditions that gave rise to meme stonks and other oddities of our era. Former financial planner Joe Saul-Sehy argued for “strategic under-diversification” and explained the Sharpe Ratio. Data scientist Nick Maggiulli explains the save-invest continuum. And financial planner Bill Bengen, the creator of the 4 percent retirement withdrawal rule, talks about what most people misunderstand about the safe withdrawal rate. These are just some of the highlights from the Afford Anything podcast in this 2022 year-in-review episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode420 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to any limited resource you need to manage, like your time, your effort, your attention, your energy. Saying yes to anything comes with trade-offs. And that opens up two questions. First, what matters most to you?

And second, how do you align your decision-making accordingly? answering those two questions is a lifetime practice, and that's what this podcast is here to explore and facilitate. My name is Paula Pant. I'm the host of the Afford Anything podcast. Merry Christmas. Happy holidays. Happy New Year's. It is the week in between Christmas and New Year's.

And this seems like a perfect time to do a wrap up of what we learned on this podcast in 2022. This is not a comprehensive list, of course, but it's a sampling of some of our favorite lessons. Let's dive right in. we kicked off the year with the guy who you hear on every other episode, former financial planner Joe Saul C-high. Normally he joins me to answer your questions, but we actually kicked off 2022 with an hour-long interview in which he discussed the topic that's been on everybody's mind all year,

how to beat inflation. If we're looking at long-term investments, the key thing if we're looking long-term, which is 10 years or more, we want to make sure that we are kicking inflation's butt. That is our number one goal because if we don't keep up with inflation, we're going to have to save dollar for dollar what we intend to spend. It'll look like we have a lot more money, but everything is going to cost a lot more than it costs today.

So we need to get started on that growing season as fast as we can and give our things time to double. And those two asset classes that have done this very, very well over time are stocks and real estate. And when you compare the REIT index, a REIT is a real estate investment trust, a North American real estate investment trust index against the SMP 500,

over long periods of time, Paula, those have come out nearly even. How they get there is much different, but if you've got a long period of time, those are two great asset classes. And so people ask us all the time, like which one should I use? And my answer today here is,

lead with the one you're more comfortable with, but I wouldn't let the other one go. Because, and we'll talk about modern portfolio theory later, if they're both going to get you there, but there's the chance that you might need some money early on, if we do both instead of either or, and we need to harvest early some of our money, there's a better chance that some of it's going to be ready for us ahead of time. What he's talking about here is making investing decisions based on your withdrawal strategy, which is basically a fancy way of saying start with the end in mind. You may have two asset classes like stocks and housing that over the long term produce similar returns, but the way in which those returns are generated differ.

And what that means, especially for those of you who are new, any asset creates returns in two forms. One is capital appreciation, meaning the value goes up over time. And the other is the dividend or the income stream that it pays out. those are the two ways in which an asset generates returns. And so the total return is a combination of the two. It's a combination of the value going up plus the money that it kicks off, the income that you make from it. Now, in a perfect world, you keep reinvesting both.

In a perfect world, you let your winners ride, let what's growing keep growing, and also you reinvest the income. But at a certain point, you'll need or want to start harvesting those gains. might be when you retire, it might be when you send your kids to college, or when you send yourself to college. Whatever the reason, when it comes time for you to start tapping into that money, the bucket that you tap is going to be based on different characteristics. And so that's why you want to do two things. One is you want a mix of investments that produce returns

in different ways. You want some investments that bias towards dividends or an income stream, such as rental properties. You want other investments that bias towards. You want other investments that bias towards capital appreciation, stocks do a great job of that. You also want investments that represent a balance of the tax triangle, some of which are in tax exempt accounts, some of which are in tax deferred accounts, and some of which are in taxable accounts. That way, you have maximum flexibility when it comes time to tap your gains. Now, all of that said, there is also an argument for intentionally under-diversifying your portfolio. When poker players play, they're thinking about percentages.

When a great restaurant, restaurants are so, so ugly, and it's such an easy place to lose money that I remember a great interview I heard with Nick Kekonis, who's one of the owners of one of my favorite restaurants, a place called a Linney in Chicago. I've never been there. I want to go there. I don't know that I'm up for an $800 dinner,

but if I was going to have an $800 dinner, it would be with Nick Kekonis. But Nick said this same thing very well, Paula. He said that you need to understand odds. So you need to understand what are the risks that I'm taking and how do I make sure that I have at least considered all of the risks that this investment might have? And let's walk through that for a second because I think this is really important whenever you invest, whether you're trying to under diversify to buy things that are. going to make you wealthy, or you're trying to just appropriately diversify to get to your goals. I had this client that was an engineer building highways back when I was a planner, and she told me that before they did any highway project, they would walk through everything that could go wrong,

and they would work to eliminate all of those possibilities. And only once they eliminated those possibilities, all those things, would they then begin to build? And yet we see people often say, well, I've heard that you buy what you know. My buddy knows this. So I'm going to buy what my buddy bought. That is not an investment strategy. And that's not strategic under diversification, probably. But that's not strategic under diversification.

So we talk about strategic. We talk about this isn't an all or nothing game. You don't need to take all of your portfolio and under diversify it. You could have most of your portfolio diversified appropriately. And then if you want your investments to shoot, the moon to do better, you cut out asset classes that work against you. He gives the example of cutting out bonds. So some people, if they are more than 10 years away from withdrawal, will have an

all equities portfolio, all equities of the heavy cash allocation. It's called a barbell portfolio. He also gives the example of maybe trimming back on some large cap or large company index funds in favor of small and midcap. He also gives the example of going all in on a side hustle or a business that you. you're starting. That's also a type of investment. At the end of the day, the key to strategic under diversification, which is another way of saying the key to putting more chips on the table when you really believe in the bet, the key to doing that well is, number one, protect your downside, figure out

what's the worst case scenario and don't ever risk that. Build your safety net. Protect yourself against what poker players refer to as the risk of ruin. You don't want to be so wiped out by a bad bet that you're no longer in the game, right? So figure out what you have to do in order to, at a minimum, stay in the game. Then you pick that portion of your portfolio, pick the amount that you're prepared to go big on, know what that number is, know what the limits to that number is ahead of time. And that's where you strategically under-diversify. Strategically under-diversifying to have one company could be insanity. But there are things you did and that I did in creating our companies that I know because we've had long chats about

these to increase the odds that we would succeed. I think the more seriously you take how risky it is, it shouldn't be a deterrent as much as something that really helps you, really helps you be real about what type of a commitment it is going to be and how much courage you're going to have to have and how much patience you're going to have. And when Malcolm Gladwell talks about 10,000 hours and some people talk about a minimum of five years in an industry just to really get your footing. I think there's so many lessons there. And the main reason I see that most people don't succeed in strategic under diversification is they don't give themselves enough time to swim the moat. And there's a big moat when it comes to under diversifying. You have to, and by

Mo, if I'm talking about investments and under diversifying your investments, you have to get used to the fact that your investments now in a daily basis are going to swing more than they used to. If you're a small business owner, you're going to have to get used to those same swings but in a small business. You're going to make the wrong moves. You're going to have to evaluate those moves more often. You're going to have to consistently, and I talk about this a lot, not just when we answer listener questions, but we detail it in the book. Work on your investment policy statement. don't just make a move once, ask yourself, how do I make sure that the next time these conditions arrive again that my machine works better and I don't step in it? And if you're consistently

working on your machine instead of this point in time, you're much more likely to be successful. All right. So moving on to 2022 year in review, we then talked to Andrew Hallam. Andrew was a school teacher trying to remember if he taught middle school or high school. It was one of the two. Andrew's a school teacher who became a millionaire by his early 40s. And he did it the old-fashioned way, living frugally and dumping all of his extra money into index funds. He has joined us on this show many times. I've known Andrew for a decade. But most recently, in January of this year, he came back on the show in one of our most popular episodes of this year to talk about the four quadrants of a successful and happy life.

and those four quadrants, spoiler alert, are money, relationships, health, and purpose. Andrew says that life runs smoothly when all four of these elements work together in tandem, like the wheels on a car. You know, when you're looking at these studies, and one in particular published in the Journal of Epidemiology and Community Health,

suggesting that even retiring like one year before a traditional retirement age can end up increasing a person's level of mortality, regardless of what their initial health was at previous. So I know Harvard Health did an interesting study that was really similar as well. And I think that it's something that we should really be focused on as young retirees too. But again, it's a natural thing for us to do. Like when we're striving for FI, we're the sorts of people generally who are goal-oriented anyway.

So even though many of us will set these goals to retire early, once we've achieved it, we don't typically end up stopping. And you've probably read and interviewed different people who have done it and they've stopped for a while thinking that playing golf every single day and going to the beach is going to be like the cat's asses they're going to absolutely love it. But eventually what ends up happening is these people. And I think because we're wired to be productive end up doing things. And I think that's the healthy thing that we need to keep in mind when we're striving for FI. Because if we don't, you know, we're not going to feel like good, productive adults.

And our moods are, they hugely affect our immune systems in terms of how we think and feel both about ourselves and about the world in general. It affects us on a cellular level. We need that sense of purpose. Now, with regard to the money element of money relationships health purpose, the four quadrants, the good news is this is the one arena in which laziness pays and doing less is more? When it comes to managing money, I've always felt that the less you do in terms of spending time thinking about it, the better. So if it's an actual investment platform, the less you're doing the better. And a lot of people think that they have to actually follow their investments and they have to track the economy and they have to purchase the

latest, greatest ETF or the latest greatest stock. But I'm a little little. I'm a little bit of bit in the camp of Kathleen Vos when she looked at how much we actually think about money with respect to how that affects us on a social level. And so Kathleen Vos's research is fascinating in this capacity because she shows the more we think about money, the less helpful we are to our fellow human beings typically. And I'm not going to say that everybody who thinks a lot about money isn't going to be helpful to other people or as social as they could be. But on an aggregate, that's the research that she's found. And she ended up looking at dozens of different studies whereby that premise was replicated.

And that's what I think is so interesting. So now back to your investments. The idea that, okay, one, if we think less about it, I'd like to think of your investment portfolio as like a bar of soap in the shower, like the more you get it, the smaller it gets. And Morningstar's research on multi-asset class investment funds is, fascinating. Somebody might say to me, okay, well, Andrew, you know, you're talking about just feeling good. No, I want to make lots of money, so I want to think about this.

I want to actually follow my investments. I want to track how the market's doing. But if you look at Morningstar's research, one of the cool things Morningstar has been doing for years is it has been looking at cash flow analyses of different funds. So what's going into them, what's going out of them? I'll give you an example of the ARC funds, for example. She absolutely ripped it up in 2020. and so many people ended up looking at Kathy Woods funds, June, July, August of 2020, getting really excited because it had this great track record, right?

And especially in 2020. And what it ended up happening is most of the money that went into those funds, went into Kathy Woods' Arc ETFs, went in late. So now you get 2021, where despite the fact that the stock market's up about 28% for the year, Kathy Woods' Arc funds are down. So she's lost to the index. The tragedy is in people who are watching things rise that jump onto rising bandwagons end up buying high after it's really, really popular. And it's a human nature sort of thing to do, like trying to follow whatever's hot is a really bad strategy. So there was an interesting study that was published, and I think Bespoke did the study,

where they looked at the average investors' return based on cash loan into Cathay Arc's funds since their inception. And so since their inception, especially because of the last few years, they've just had this incredibly profitable, like 30% per year, 35% per year run since their inception of these funds, which is unbelievable. However, the average investor in those same funds only averaged at the time. And this study was done to February 2021, earned a return of 5% percent. per year. So what we would get now is if we were to look at a cash flow assessment of that,

we would find that most of the people that invested in Kathy Wood's funds, because they've dropped quite a bit since February, would actually not have beaten inflation. So the idea that we chase rising asset classes and are always looking for the thing that's hot eventually usually comes down to bite us in the butt. So now back to the asset allocation funds, the really simple ones like Vanguard's target retirement funds or Vanguard's life strategy funds. So a Vanguard Life Strategy Index fund, for example, maintains a consistent allocation as a component of U.S. stock market index, international developed market index, emerging market index, and a bond market index. And Vanguard essentially just rebalances that allocation to maintain it. And they do it

with monies that are coming in and out. So they're not always like selling things. to rebalance more money when money comes in they just push that money in manner such that that fund typically then maintains that allocation but this is a really hands-off approach and so many investors will say like you know what that's just that's just way too simple i want more control and i'm going to be able to do better on my own often doing research but the irony is that when Morningstar does its cash flow analysis, they find that investors in these all-in-one funds more or less set it and forget-it products. Because they don't end up chasing the market, they end up paying or speculating or not knowing when they should rebalance. They end up

earning on aggregate higher investment return than the funds themselves. At least the study was done over the last 15 years. Well, that was prescient. The interview that we did with Andrew aired in January of 2022. In it, he's describing the performance of Kathy Woods funds as of February of 2021. And everything that he says, only amplified over the span of this past year. Andrew makes the point that paying excessive attention often leads to chasing trends. And trend chasing, jumping on what's hot, is a losing strategy.

The more often you look at your portfolio, the more likely you are to transact, but touching your portfolio too often can make it diminish. If you want to hear that full interview, and again, it was one of our most popular from this past year, go to afford anything.com slash episode 359. That's 359. After we chatted with Andrew,

our next interview was with Wall Street Journal reporter Spencer Jacob, who chronicled the behind-the-scenes. drama, intrigue, and flawed thinking that led to the infamous GameStop AMC Theater's meme stonks revolution. You know, it's fascinating because a lot of things had to happen all at once, technologically and socially and financially to create the conditions for this to happen. And I mean, just to recap quickly for anybody who might not remember, might not have been following, although it was a crossover story. It wasn't just a financial story, of course, was that. a band of millions, but really the core group was hundreds of thousands of young traders who organized themselves on Wall Street Betts, which is a subreddit on Reddit, decided to target hedge funds that were short, some dowdy stocks that had not seen their heyday for 10, 20 years in some cases. The biggest one was GameStop, but it wasn't the only one. And they sort of used its shares and options and its shares as a weapon.

to hurt Wall Street to blow hedge funds. And they did hurt a handful of people on Wall Street. They basically, you know, there were some sophisticated people on the board who said, you know what, the short interest in these stocks is so high that if we all get together and buy the stock and buy options, certain types of options in the stock, then they'll be forced into huge losses, possibly losing all of their money. And this will be a way to stick it to the man and we're going to make money. That is sort of what happened.

There was one hedge fund in particular that lost about $6 billion in a few days, one of the most successful hedge funds on Wall Street, several others who lost a lot of money. So how did it happen? So a lot of things had to occur. One is that trading had to be cheap, or not just cheap, but it had to be specifically, it had to be free. These days, when you go to any retail broker in the U.S. and in other countries, sometimes, too, they'll say no commissions. You pay no commission when you trade. It's free to trade. It's not really free to trade. They call it free to trade because there is a cost. Everything has a cost. Just like when you're on Facebook, is it free? I mean, it's so you can send, you know, look at the photos of all your kids' friends and everyone's wedding photos. It's not free because you're sort of paying the dues and all the information you share. And trading isn't free either. I go into the ways later into the ways that it really isn't. But you have to think that it's free, which means that you can trade many, many times. not really worry about kind of chewing up the value of your account. And that's something that was

pioneered by a company called Robin Hood. They weren't the first to do it, but they're the first to make it really popular. They introduced it some years ago. That was their thing, free trading for the masses. And they attracted lots of young people with not very much money and not much of sophistication either. And they have a beautiful app that's won an award. The first year came out in 2015. It's frictionless. It's intuitive. It's perfect for a generation that grew up with smartphones. And in late 2019, because Robin Hood, by that point, was getting about one out of every two brokerage accounts opened in the U.S., everybody else threw in the towel.

Schwab and Fidelity and Ameritrade, eBay, all these much bigger firms just said, well, okay, we're going to stop charging commissions too. And it's going to cost us a lot of money, but we have to do it to compete. What happened was that there was an explosion in trading in retail interest. So the opposite happened from what they expected because they, of course, they still do make money when you trade in other ways. And they wound up making a lot more money. This was leading into 2020. Well, you all remember what happened in 2020, which was that the COVID-19 pandemic began.

Now, the COVID-19 pandemic began. You know, millions of young people around the U.S. were sent home or went home to mom and dad or were sitting at home not going to work. All of a sudden, a lot of money that they were spending. going out with their friends, going out for beers and whatever they weren't spending. They got stimulus checks. A lot of them got unemployment checks as well. They had money and nothing to spend it on, and they were bored. Another thing that it happened was that sports betting had taken off like a rocket since 2018.

Sports betting is legal now, I believe, in 46 states, and you can do through a smartphone. Daily Fantasy Sports is legal pretty much in every state that had been for a number of years. And especially the young men, men between the ages of 18 and 35, who really drove this phenomenon, this GameStop mania, also happened to the, if you draw a Venn diagram, they overlapped with young men who were into sports betting, who suddenly had no sports to bet on. You might remember March, April 2020, there were no sports. The only sports you could get on ESPN were like bowling, Korean baseball, you know, and just reruns of old events. like sports cease to be a thing. And as a matter of fact, the real boom in trading kind of got another leg up when March Madness was canceled, the men's NCAA basketball tournament, which is the most gambled

upon event each year in the U.S. That led to an explosion in speculative trading and, of course, the stock market plunged. And volatility is very exciting. If you're new to the stock market and you don't care, you know, you don't own a lot of stocks already, that you're not saying, oh, man, my 401K is. getting creamed. You're just seeing this thing moving up and down a couple of percent a day. There are some stocks that are moving up 10 percent or more a day, and especially exchange-traded notes that have a lot of leverage in them, and trading in those took off like a rocket.

I mean, there was one that was a bet on volatility futures that had just a massive, massive surge in trading. And people made, if they bought at a certain time and sold at a certain time, about 30 times their money in that note. That was one of the more popular things that people traded. They traded things that owned airline stocks. You know, airlines were going to have the verge of bankruptcy and then they got bailed out. So it was like a great game. It was more exciting than sports betting or a casino and more profitable too. And so that laid the stage for tens of millions of new, inexperienced people to come into the market who were then looking for the sort of the next rush and we're learning what to do by going on social media,

TikTok, YouTube, and as specifically affects this story, Reddit, Wall Street Betts, which was a very sort of, you know, wild, uproarious, meme-filled place to find trading advice. So that's a primer on the initial conditions, the environmental conditions that were set in place for such a weird thing, the quote-unquote Reddit takeover of Wall Street to happen. Many people at the time blamed social media, but it was notable that people have been discussing investing online for as long as the internet has existed. Back in the 1990s, people talked about investing on Yahoo chat forums. But the other conditions that he described, the proliferation of commission-free trading, the sudden halt of all sports betting, the excess liquidity in the hands of average investors, all of those conditions together.

created the perfect storm. But what did it accomplish? Did it actually harm Wall Street? Let's hear what Spencer Jacobs has to say. Let's say there's like a religious movement, Paula, and like, you know, and people had been in the movement for a while and they get a new recruit. I don't know. Have you noticed that, I don't know if you know anyone who sort of suddenly become religious or kind of adhered to some group or denomination, they're the most enthusiastic ones, right? Yeah, exactly. And that's what happened here is that the people who were late, the people who are getting in in January 2021, and there were millions of them. All they saw was, let's do this, let's blow these guys up.

A lot of the people, and I speak with the founder of Wall Street Bats, Jamie Rogazinsky, a really interesting, bright guy who founded this bulletin board. And he's like, no, that's not what Wall Street Bats is about. Wall Street Bets is about hacking the system and making money. The thing is like, yeah, that's what the original Wall Street Bats was about. And that's what the, you know, that's what it was about once upon a time. But that's not what it became about for a short while. And so you've had a lot of people who basically were all about blowing up hedge funds.

That was their, that was what they wanted to accomplish. But at the same time, you had people who were just, you know, they were like, yeah, you know what? I just made a lot of money. I just made, I just made like enough to buy a house, enough to buy a car. I'm selling. And they did sell. So once the smoke cleared and you looked at the figures, they sold. Like lots of people who got in early.

sold and made money. They did not stick around. They did not have diamond hands. They did not take one for the movement. And I feel really sorry for the people who kind of have stayed in there and absorbed losses who bought at, you know, $400, $450, $480 and higher and are sitting on losses that are meaningful to them because they wanted to be part of the movement. And some of them would say, I don't care. I don't care that I lost money. Well, okay, fine. But some of them do care. And there are support groups for people who lost money on these meme stocks. And it's kind of sad.

And I hope that those people go out or parents those people or branches of those people read my book because there really is a way to stick it to the man, I think, on Wall Street. If you really resent Wall Street, which makes a ton of money and you don't like the way that they do business and you don't like their ethos, yeah, there's a way to stick it to Wall Street, which is don't pay them money. They did the opposite. They paid them a lot of money. Do the opposite.

Don't pay them a lot of money. You can own stocks and own mutual funds and things like that for very, very little money. And you can slowly get rich. And Wall Street provides all the tools. And you can be like an unprofitable customer for Wall Street. You know, you could open up a Robin Hood account, buy a bunch of stocks and not check it for five years. You know, buy some conservative stocks, I hope. But like, you know, and just not just not check it.

And, you know, they're not going to be making any money off of you. They have to pay all the overhead of running your account. They can't call you up and say, sorry, you're not crazy and you're not trading all the time. You can't keep your account. They have to keep your account open. And your account is kind of going to be subsidized by all the people who are very active. So there's a way to stick it to the man. I mean, that's kind of the opposite of what they did.

But that's a good way to do it. So low fee passive buy and hold investing is the actual movement. Jack Bogle, who was the one who found the true movement? Yes. Yeah, I think so. Yeah, that's the movement. You don't like Wall Street making a crazy amount of money off of you. You don't like Wall Street's ethos for whatever reason.

I don't hate Wall Street or love Wall Street. It is what it is, you know, but if you have a chip on your shoulder and you want to stick it to Wall Street and you and millions of other young people do that, Wall Street is going to hate you. That is Wall Street's worst nightmare, is you reaping the benefits without paying them crazy fees. Now, I realize that this is textbook confirmation bias and that when all you have is a hammer, everything looks like a nail. But I do have to say, I love that the ultimate takeaway from the GameStop Revolution is that the way to quote unquote stick it to Wall Street is through passive investing, passive index fund investing. To reduce transactions, to do what Andrew Hallam talked about, don't touch your account that often. the hands-off approach is not only better for you, but it's the approach that keeps the most amount of money in your pocket and not in the hands of the hedge funds. So if that's something

that matters to you, cool. There's another reason to do it. And if that's not something that matters to you, that's fine too. Either way, passive investing, no matter what lens you look at it through consistently comes out as the most optimal approach. No matter how often people want to make arguments to support active trading, day trading, time and time again over the long term, whatever your reason is, the passive approach continues to win the day. So those are some of the takeaways that came from the earliest interviews that we did at the start of 2022. We're going to take a quick break for a word from our sponsors, and when we come back, we'll recap two types of intelligence with Harvard Professor Arthur Brooks,

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Sale ends December 7th. This Giving Tuesday, Cam H is counting on your support. Together, we can forge a better path for mental health by creating a future where Canadians can get the help they need, when they need it, no matter who or where they are. From November 25th to December 2nd, your donation will be doubled. That means every dollar. goes twice as far to help build a future where no one's seeking help is left behind. Donate today at camh.ca.ca.cgivings Tuesday. Welcome back. Earlier this year, we talked to Harvard professor Arthur

Brooks, who described an unusual phenomenon in the middle of our careers, even in knowledge-based industries, our jobs, including tasks that we've done for a decade plus, weirdly start. to feel a little harder. I've been teaching and studying the human performance and human happiness for a really long time. And I started to see this really weird pattern. My data, which is the people between about the ages of 35 and 50 in knowledge industries, most people listening to us, people who work in the realm of ideas, whether lawyers or

doctors or data scientists or anything, really, where you're sitting at a desk and doing things, they kind of go into a crisis and their profession. It's like, I don't want to do this anymore. And a big part of it is because their jobs stop getting easier and start getting weirdly harder. You know, as I see this with lawyers, especially all the time, it's like, I used to be able to cruise through these cases. Now it's kind of drudgery and the young people seem to be doing it a little bit faster than me. And so I started doing a little bit of research. And it turns out that this is really common.

This is a very common phenomenon that the structure of the brain is such that that idea jobs, you know, the innovation and speed and, and the ability to solve problems, it tends to get a little bit worse and then get a lot worse. And what I was seeing was not aberrant. It was not unusual. It was the norm. Professor Brooks explains that this is because there are two types of intelligence. In our 20s and 30s, we have high levels of fluid intelligence or raw intellectual horsepower. We can ace tests, impress people with our memory and recall, analyze full. facts, documents, data. But in our 40s and 50s,

we have higher levels of crystallized intelligence, which allows us to draw together novel insights from across domains. In other words, fluid intelligence allows us to analyze or break apart, whereas crystallized intelligence allows us to synthesize or put together, which means that there is, academically speaking, evidence for the notion that wisdom accompanies age. However, he says, those who are reluctant to admit that some of that raw intellectual horsepower of their 20s may not be there, at least not in the way that it was,

those are the people who block themselves off from the opportunity to use their crystallized intelligence. And he gives a case study of the career of Charles Darwin versus the career of Johann Sebastian Bach. Charles Darwin, he enjoyed early, unbelievable worldly success. He came back from his voyage on the Beagle, which is a five-year around the world trek on a boat to pick up samples of botanical samples

and zoological samples. And when he came back, he dropped this bomb, ideological bomb or intellectual bomb, on science, which was the theory of evolution. 27 years old. 27, you know, it's like, oh, man, that is so far in the rearview mirror for me. Then he spent the next 30 years elaborating this, getting more and more and more famous on this one big idea,

making it better and better. And then he hit a wall where he couldn't go any further because he couldn't understand the math that he would need to get to the next great big breakthrough. It actually came from a monk, a Czech monk by the name of Gregor Mendel. It's a pretty famous guy, but not as famous. as Darwin, who invented genetics. But genetics required a lot of math that Darwin,

Darwin had been a very lazy student, by the way. He actually didn't study his math or his stats. And so when he hit the wall intellectually at 50-something, he was unable to break through. And his research stopped completely creativity. He wrote like 11 more books, but they're all kind of derivative. And he died a sad man feeling like a failure.

He was buried in Westminster Abbey because he's such a hero, but it was for his past accomplishments. And he was just straw. Everything was just boring and he felt bad about himself because he wasn't, he was a complete success addict hit after hit after hit after hit and it stopped. And the one thing you don't want to do is basically go to a cigarette smoker, you know, for that matter, an alcoholic and say, I'm just going to take away the subject of your addiction. Just going to take it away.

You'll be fine. No, no. You're not going to be fine. You're going to be really, really unhappy. And if you don't actually come to terms of the fact that your life would be better without it, If you actually think that you're better off as a smoker than not, then you're going to spend a long time maybe years regretting that. Johann Sebastian Bach is another model.

Bach, maybe the greatest composer of serious concert music who ever lived, he hit his wall at age 50 as well, where he was the greatest innovator of the high Baroque, which is this, you know, everybody loves Baroque music practically, and everybody loves Johann Sebastian Bach for that matter. He's the maybe the most famous composer ever lived, lived from 16, 85, and 1750. And Bach hit the wall because he was unable to go with new trends in concert music.

It was his son, Carl Philip Emanuel Bach, that invented a new style of music that completely overtook his father. So he was the most famous composer in Europe and suddenly became obscure because he couldn't stay. He's like writing disco effectively. And his son was all the rage. And his son, even for years and years later, was the most famous of the box. So Mozart said, you know, Wolfgang Amadeus, Mozart said,

Bach is the father. We are the children. And he was talking about Carl Philip Emmanuel Bach, the son, not the one that we still remember today. Okay. So the father, what did he do at 50? He couldn't, he could have turned into Darwin, really bummed out and bitter and feeling like a failure.

Uh-uh. He said, I'm going to do what I'm really still good at. And he became the master teacher. He took the job as the canter in the Tomas Kirchen, Leipzig, which is this big famous Lutheran church in Leipzig. And he would write these cantalifference. for every Sunday in the church liturgical calendar. This kind of fell off his pen.

Now that the greatest music ever written, but it was written in the high baroque. So it was an ancient style. He taught the choir. He taught the organ. And he became this beloved teacher to his kids. And he had 20 kids. He had tons of grandchildren.

He had thousands of students. And when he died at age 65, he was surrounded by his children and grandchildren and his students. And he died a beloved happy man. who was truly, truly successful, not famous anymore, but successful in what really mattered, which was in building up other people using his crystallized intelligence. Now, later, 100 years after he died, another composer by the name of Felix Mendelssohn, it just found his stuff, the father's stuff, and said, yeah, you guys are all listening to this Bach,

this C-P-E Bach, but his dad's stuff is even better, and he made him into this rock star that he still is today. historical anecdotes about Darwin and Bach might be entertaining, but they're not really relevant to our lives. How do we apply this information? Arthur Brooks used his own life as a case study, describing how he transitioned from being a professional French horn player who performed at Carnegie Hall to becoming an academic, getting a PhD, then transitioning again in his early 40s to becoming a CEO of a think tank based in D.C. and then re-transitioning back into academia as a Harvard professor, except a different type of professor. Now he does less original research and more metasynthesis pieces of other people's research. One of the great things about the modern economy is that most of our true skills are fungible, even between really, really different professions. So when I went from being a French horn player to becoming an academic, I was a really, really good lecturer. And the reason is because I'd been thousands and thousands of hours on stage.

And you see what my point, right? And then at the same time I was becoming an academic, I was learning the research process. I was learning how to instantiate real creativity in the context of the frontiers of scientific knowledge. And that helped me a lot when I became a CEO, which was my next career. which I did when I was in my early 40s. I became a CEO of a think tank in Washington, D.C., of an economic and policy analysis think tank where I had all these PhDs working for me. And so I knew the difference between the good research and the creative research and the not so good research.

And that was a highly fungible skill. And on top of that, I was giving 175 speeches a year, you know, promoting policy and talking. And I was really, really super good at it. And so the things that I needed to learn new skills, but I was able to to funge the old skills that really mattered into the new. new line of work that was getting progressively more and more crystallized. See what I'm saying here, right? So when I was a, you know, the French horn player, I don't know how much of that was crystallized versus fluid intelligence.

But by the time I was an academic, it was using fluid intelligence, just like crazy and, you know, doing this research, et cetera. Then I became a CEO where I was using fluid and more and more crystallized intelligence. And now I'm back in academia and I'm teaching, I'm writing, but I don't write academic journal articles. I read a column for the Atlantic where I synthesize everybody else's cutting edge knowledge. I talk about how people can use it in their lives. Those are the two types of intelligence that we learned about earlier this year during our interview with Professor Arthur Brooks.

Next, we spoke with Dr. Ellen Vora. She spoke to us about anxiety and the roots of procrastination, particularly as it applies to work. Our relationship to motivation and attention is its own false and true split. And sometimes we're struggling with attention because we're, we are in a state of chronic sleep deprivation, which can be because of our habits and our lifestyle. Maybe we're doom scrolling or on TikTok until 1 a.m. Or maybe we have a kind of subclinical sleep apnea or for some reason, you know, maybe we're mouth breathers and we're just not properly oxygenating our brains overnight. And then it's very hard to be fully rested and rejuvenated

the next day. A lot of inattention and hyperactivity I see relates to the quality of sleep. And a lot of times low quality sleep has to do with low quality breathing. And so then that hyperactivity the next day is really just a tired brain attempting to keep itself awake. And it's really hard to have good attention when we're sleep deprived because that is like the highest level order human capacity. It's this part of our brain that's so ornery and fragile. And when it doesn't have everything going right, good sleep, good nutrition, steady supply of blood sugar, it kind of goes on strike. And so these are some of the false ADHDs and things like that that I see. But I think that there's this other very true inattention that's occurring where sometimes we are living in a mismatch with our work,

whether we're out of alignment with the values of the work that we're doing, or we might be perfectly aligned with the values, but it's inhumane working conditions in some way, in the ways that our time is valued or in the autonomy that we're given, or all the ways that sort of corporate America is not necessarily conducive to human beings getting their needs fully met. And so I think sometimes procrastination and inattention is the way I call it. Here's my most clinical definition is like the soul rebelling against inhumane working conditions or feeling out of alignment with our work. And so I see a lot of my patients that that's how it's showing up, is that they're like,

I wish I was more motivated. I wish I could focus. Why am I always procrastinating? But if we really look underneath the hood, they hate their job. She went on to describe how she herself sometimes rebels against the upcoming work week. She has throughout her life consistently been a high performer. She did her undergrad at Yale. She received a medical degree from Columbia.

She's published books. She started her own practice. And yet there is a part of her, she says, that is afflicted by the Sunday Scaries. part of it is physiological. Part of it is self-talk. There is something unique about Sunday night where there's a confluence of different false anxieties coming together. Many of us exist with a kind of social jet lag over the weekend.

Maybe we're going to sleep at 10.30 or 11 on weeknights and maybe it's more like midnight 1 or 2 a.m. on weekends. So Sunday night we're trying to almost like change time zones back to get enough sleep before the alarm goes off Monday morning. And then we have different habits on the week. weekends. Maybe we ate at a restaurant or ordered takeout. Maybe we ate foods that we might not ordinarily indulge in in the more routine ways that we eat during the weekdays. And then there's sometimes more alcohol. There's sometimes free refills of coffee at brunch. There's sometimes all

these different things that are going to contribute to a physiologic state of imbalance on Sunday night. And that's not helping us. But then I think there is also a true anxiety component to Sunday Scaries where it dawns on us that we are heading into a week of work. And if we are out of alignment with our work, if there are inhumane working conditions, if anything's not quite right there, if we're not sufficiently rested, then our soul rebels once again.

And it says like, hey, we're heading into something that does not feel good. And I think anybody who, like, take for me, for example, I've been in jobs where my soul really rebelled against it, where I didn't feel treated well or I didn't feel valued. And I was having some serious Sunday scurries. I'm at a phase in my career now where I love what I do.

And I'm passionate about it. I have some autonomy and locus of control. So there's a lot about it that's not, my soul doesn't rebel against my job at all. But Sunday night, there's still that feeling, of course, of like, oh boy, here we go. And I think in many ways it's a habit at this point, that I have to retalk, I have to talk to and reframe Sunday night

and be like, no, I'm just going to get into the rhythm. It's going to feel good this week. It's going to be engaging and I'm going to make a meaningful impact. And I have to remind myself that here's what I love about what I do. And so if our procrastination, our sense of dread about work, come not from genuine problems, but rather from habitual, almost reflexive thought patterns, then building a habit of healthier, more gratitude-based self-talk could help us improve our relationship with work

and, by extension, reduce our procrastination, our sense of low-level dread, all the things that plague us that also, to a certain extent, can end up becoming enshrined as habit. Those were some of the lessons from our interview with Dr. Ellen Vora. Next, we turned to a question that a lot of people have asked this year, why does the stock market crash? To answer that, we turned to Brian Ferraldi,

the author of a book that describes the opposite phenomenon. His book title is, Why Does the Stock Market Go Up? Very glass half full. Here's what he had to say. Now, to understand why the stock market crashes, you really have to understand what stock prices really represent at any given time. Whenever you see a stock price, this could be, an individual company or the markets in general. What that's reflecting in a minute-by-minute basis

is two things. One is the earnings power, the profits of the underlying businesses that represent either that individual stock or the stock market as a whole. And two, how investors feel about the future of that company or company's profits. That's what prices represent. Now, if you break those two down, the current earnings are a very, very small part of the current price of a stock, and the expectation or how investors feel about the prices of those stocks are a large component of the price at any given time. So when stock prices are changing rapidly, typically falling or crashing, what that represents is a broad-based feeling that the profits or the way that investors are valuing those profits of those companies takes a sudden and dramatic turn for the worse.

And that leads to fear, and that fear causes investors to fear that prices are going to fall. Investors get into the market and sell their stock. That causes other investors to become fearful, that prices are going to fall. That causes even more selling pressure. And what happens is the stock market crashes. And again, if you look back at history, stock market crashes have happened several times in my lifetime. I mean, there was the COVID crash of February 2020. There was the great recession of 2008. There was the dot-com crash of 2002. And there was even Black Monday, which is when

the market indices fell essentially 30% over the matter of a month in 1987. So, stocks crash because people are afraid, which is why the contrarian move is sometimes described as being greedy when others are fearful and fearful when others are greedy. But what causes that collective fear? It doesn't come from nowhere. There needs to be some type of assessment of the future in which enough people have reason to be afraid. We take our cues from each other. The best quote I've ever heard on what happens to stock prices in the short and long term comes from Benjamin Graham, who is one of Warren Buffett's mentors. He says in the short term, the market is a voting machine. But in the long term, the market is a weighing machine.

What that means is that in the short term, stock prices move up and down based on the emotions of market participants, broadly speaking. However, over a long period of time, what moves stock prices is the underlying economic earnings power of the companies that are in that index, i.e., how profitable are those companies and what direction do those companies profits head in? So if it seems as though the profitability of a company may go down, for example, in an economic environment in which capital is harder to obtain and so businesses make fewer investments, or in an environment in which consumers are spending less, or in a shrinking industry, or for any number of factors, if it seems as though companies may be less profitable, then of course the amount that you're willing to pay for a share of that. company, which means the amount that you're willing to pay for a claim over its future earnings

will drop. But also, when that happens, it can then create a self-reinforcing cycle in which other people see that drop, become afraid, react based on that fear, and then the whole down cycle shifts out of proportion. And then the same thing happens in reverse. Both bubbles and crashes, start with a rational assessment, a future profitability, and then get blown out of proportion through collective emotion. But ultimately, in the long term, the U.S. stock market as a whole over the long term has always gone up. That's a fact that's easy to forget when we've come out of an 11-year bull run, when we've seen nothing but gains from 2009. until pretty much this year with the minor blip in 2020,

we've gotten used to seeing the market so consistently perform well in such an artificially low interest rate environment that everybody sort of got used to the party. And to a certain extent, people started to view the market once again as a high-yield savings account. The duration of this beat-up stock market in 2022 and the fact that 2023, at least as far as we can tell, looks like it might also suck. This presents a situation that to many investors, particularly younger investors, feels new.

But let's not forget the year 2000 through the year 2002. The dot-com bubble, that was steep, it was painful, and it lasted for a long time, it lasted years. Dot-com bubble bursts, then 9-11, the market was in the tank for a while. Is that the expression in the tank, had tanked, tanking, tank? You know what I mean. Don't worry if everything got beat up in 2022, if your portfolio is not nearly as pretty as it was a year ago at this time, because you're in it for the long haul. And in the long term, historically, in the U.S., stocks have always gone up. That's what we covered with Brian Feroldi.

That was a Stocks Explainer episode to recap the start of the year. And next, we spoke with psychology professor Bill Von Hippel. He is a graduate of Yale and the University of Michigan. He is now a psychology professor at the University of Queensland in Australia. And he joined us to discuss the history and science of happiness. Evolution gave us happiness because it wanted to motivate us to do what's in our genes' best interest. And so those ancestors who got happy by doing things that were unhealthy or by going off alone and never talking to any other human, well, they didn't become our ancestors because they didn't get

into the mating game or they killed themselves off before they could do a good chance in raising their kids. But those ancestors who got happy by doing things that were in their genes best interest, by doing healthy things, and then by meeting and mating, where they're the ones who ended up in that we reflect their genes. And so what happiness does is it gets you to do things that, over time, it's been winnowed down by evolution, it gets you to do things that are in your species' best interest. So if you and I were dung beetles, we would be very happy if we could roll a really big ball of poo because that's what it takes to be a success as a dung beetle. As human beings, however, what makes us happy are the things that are going to make us attractive to other members of our group, that are

going to make other members of our group want to keep us around, and that are going to make us individually success so that if we could rise and stay this a little bit compared to other members of our group, maybe we'll be picked to be somebody's mate. But we're wired for survival and reproduction, not happiness in an evolutionary sense. That's right. But happiness is a tool that gets you there. So just imagine two ancestors. One of them really loves the taste of feces.

The other one really loves the taste of fat, sugar, and salt. Well, the one who loves the taste of feces is going to kill himself before he gets very far. The one who loves fat, sugar, and salt, which are very rare in our ancestral environment, is going to be seeking out healthy sources of food. And so one of them will be fit and strong and will be an attractive partner at other people, and one won't be. And so happiness, just like everything else, evolution is no advanced plan. People who have the right motives who work in ways that serve their genes, then they're going to have more children.

And the proclivities that made them happy are going to make their children happy to. And these things will spread throughout the gene pool. And so in today's world, it's super duper rare to find somebody who gets happy by doing, you know, things like eating feces. Although it happens, of course, there's always randomness. but it's super duper common to find people who get happy by being with close others, by being with their friends, by having really good food, by doing the kinds of things that we tend to think about every day is what makes us happy. There's a negative consequence of this, though, and that is that evolution also doesn't want to lose its best tool. If it can motivate you by making you

happy when you do X, let's say you achieve something that causes you to raise in status, maybe for our ancestors, that was a successful hunt. For you and me, it might be. be picking the right stock or going out to a great dinner or meeting a new friend or something like that. The problem is that evolution can't give you permanent happiness because then it would lose one of its best tools. And so evolution gives you a little bit of happiness and the bigger your achievement, the bigger your rise in happiness. But then it's super important that you drop back to baseline because if you were permanently happy, then you're unmotivated to do anything ever again and the world's going to leave you behind. So complacency then becomes a detriment. Exactly.

And so to that end, is contentment a detriment? I mean, I think a lot of us are striving for contentment, but is that to our disadvantage? Well, contentment's not a detriment. Contentment's a great thing, in fact. And part of the reason for that is that we can see happiness in others. And so if I run into you on the street and we're meeting for the first time and you seem happy, I'll say, well, Paula, obviously, has lots of good things going on in her life. She's happy.

She would be a good person for me to get to know, be part of my coalition, whatever. because all signs are indicating that you're a success. If you're really down and upset, but then I think, maybe things aren't going so well for Paula. I've got enough trouble in my life. I'm not sure that I want to form a friendship with her. And so it's very visible to others,

and it's important. The problem is you don't want to be a 10. If you're a 10 out of 10 scale, well, then you're not motivated to do anything. What you really want to be is a 6, because a 6 has lots of room to go up, but it's on the positive side of the scale. And so a bit of contentment,

a bit of baseline happiness is a really good thing. and most people show that. But too much happiness is just as detrimental for your future success as too little happiness. This was personally one of my favorite interviews from this year. Professor von Hipple describes how we are wired to feel surges of happiness that fade so that we are intrinsically motivated to keep repeating behaviors that lead to additional surges of happiness.

And this goes hand in hand with all the research that shows that when people achieve some type of a milestone, for example, lottery winners, those lottery winners have a spike in happiness that later drops back down to baseline. There is, I should put an asterisk here, there is actually some competing research around that. There is other research that shows that they form a new higher baseline, but that's a different topic for a different episode. The point is, dopamine spikes are temporary for a very good reason. And by, understanding this, we can apply this knowledge to making better decisions for our work, our money, and our lives. It's important to become financially successful in order to gain financial freedom.

But at the same time, work is, for almost every human, work is a large part of their life. And so if you're lucky, it may only be a few hours a day. If you're less lucky, it may be many hours a day. But in either case, most of us are forced to work at least some of the time. Now, if that's the case, and if you don't enjoy your work, well, that's a real problem. Now, sometimes people are lucky and they love their jobs, and so they just want to get to it every day. I happen to love being a professor, and so I enjoy teaching my class, I enjoy doing research, and that gives me purpose and meaning. But if I had been less lucky, imagine that I have a job that I don't particularly enjoy,

it doesn't mean I can't still get purpose and meaning out of it. And the key to achieve that is to find ways to be a helpful, useful, cog in the machine to be a cooperator who makes the world a better place. And so if my job is working at a petrol station, well, if I can help people out when they come to my petrol station, they can't find the right motor oil, or they don't know which of these sodas is the tastiest, if I can be engaged in people's lives and I can be a cooperator and I can be helpful, I'm going to go home from work with a sense of satisfaction. And it's even better if I happen to work in a team and whatever it is that my team is doing if I can make my team more successful.

If I can bring ideas to the table that benefit them, if I can help execute the goals that we've all agreed on. And so by all means, when I work hard and gain financial freedom, that can give me happiness. But I can also gain happiness, even in drudgery, if I do that drudgery in a way that met the ancestral goals that we have, of cooperating and elevating all of us. Greater engagement with work and particularly greater engagement

with the people around us, our colleagues, our teams, our team, our customers or students, the interactions that we have with others, that is foundational to our happiness at work. And that is a main lesson that came from our hour with psychology professor Bill Von Hipple. We are going to take one more break for a word from our sponsors. And when we come back, we will continue to recap some of the lessons that we learned from the interviews that you heard here on the Afford Anything podcast in 2022. Black Friday is here at IKEA, and the clock is ticking on savings you won't want to miss. Join IKEA family for free today and unlock deals on everything from holiday must-haves to cozy at-home essentials,

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the PC Holiday Insiders Report. Please feast responsibly. Continuing our recap of interviews from 2022, we spoke with data scientist Nick Majuli. He is the chief operating officer at Ritzholt Wealth Management. He holds an economics degree from Stanford. And he joined us to discuss, among other things, the save-invest continuum, which is a framework for deciding where to focus your time and attention. Should it be on your investments or should it be on your earning potential? Everyone's on this continuum. And it's a question of like, you know where you are kind of based on two numbers, right?

And they're all relative to your life. So the first number is like how much could you save in the next year like reasonably? So let's say you can save 500 bucks a month. You do that for 12 months. That's $6,000. So that's number one, six grand, right? That's how much you could save? And then how much can your money earn you in the next year?

So let's say you have $20,000 invested. You're going to get, let's say, a 5% return. You're expected 5% return like in an average year. okay, so that's $1,000. So that's your second number. Your expected investment return is $1,000. So now compare those to, which one's bigger? The $6,000 expected savings or the $1,000 expected investment return.

And in this case, because the $6,000 is bigger, you need to spend more time focusing on how you get and how you can raise your savings and then put that into investment so you get your investment income up over time. You know, when I was starting this whole thing, like, you know, in my early 20s, my expected investment income was, as I said, like $100 or something, maybe $500, whatever. It was small, right? And a given year, it was very, very small. And that's with a 10% return. So I was actually pretty liberal with the return. But my expected savings was much higher. I could probably save a couple thousand dollars in a year, right?

So a couple thousand versus a hundred. It's not even close. I should have been focusing much more on what I was doing, how I was raising my income to save more money. And that's what you need to do. Because over time, you're going to see this flip, right? There's like the same invest continuum. There's also a phrase I use to kind of represent this.

And I say savings for the poor, investing is for the rich. Now, when I say poor, I don't mean that in absolute terms. I always mean this in relative terms. And I mean this relative to yourself. Like, if you do this properly, if you're in your early 20s, you start saving money, investing, your wealth starts to grow, you will be relatively richer in your future than you were when you started. It doesn't mean you're going to be in the 1% or you're a billion. It doesn't mean any of that.

It doesn't mean you're an abject poverty if you're living in San Francisco as a 22-year-old college grad. Like, no, that's not what I'm getting at. It's about the relative difference. And so when I say that is like, you're going to see over time in future years, if you do this right, like when you're older, you can lose more money in a year from your investment returns than you could ever expect to save. Like if there's a bad year in the market, like, there's nothing you could do to like make up for that. Like let's say you have a $10 million investment portfolio hypothetically is a really extreme case, right? A 10% drop is a million

dollars. Like how are you going to save a million dollars after tax in a year? It's not possible for most people unless you have a very, very high paying job. For most people, let's say you could, even if you could save $100,000, which is a lot of money, that's still 10x more. You know, taking a 10% drop, that's not that outrageous. Like, those things happen pretty often. I think when you think of it that way, you start to realize, like, oh, my gosh, no wonder. Like, your investments don't really matter as much when you have very little invested. But as you kind of have a lot more invested, that's all that matters because it can have a bigger impact on your wealth than anything you do personally.

Nick's core message here is that up to a certain point, your contributions are the single biggest determinant of your portfolio performance. Which is just a fancy way of saying, unless you have a real. really, really big portfolio, you should be focused more on shoveling money into it than you should be about tweaking around the margins trying to eke out an extra couple percent as a return. Mathematically, let's say you have a $250,000 portfolio. With an 8% return, that's a return of $20,000 per year. With a 10% return, that's a return of $25,000 per year. So the difference, that 2% difference represents $5,000. Now, if you can start a side hustle as a freelancer or a contractor,

or if you can take on even one weekend per month of decently compensated part-time work, or if you can learn a new skill that allows you to get a better paying job, or if you can learn to negotiate, or all of the above, that can lead to much more than $5,000 per year. Now, if you're fortunate, you may get to the point where your portfolio is so large that managing it is itself the equivalent of a pretty lucrative side hustle. And when that becomes the case, when you've moved further along that save invest continuum, that's when you know that it's time to switch your focus and start paying more attention to your investments. And by the way, investments don't simply have to mean an index fund portfolio. Your investments could also include a portfolio of rental properties.

Or maybe you're a silent investor in a chain of privately held businesses like laundromats or vending machines. We're using the term investment broadly here to refer to the management of any asset. And as Nick points out, the amount of time that you allocate to managing your assets versus the amount of time you allocate to essentially raising capital, which is what you're doing with your job and with your side hustles, that split can be informed by where you are on the save invest continuum. Nick also describes the 2X rule as a guideline when thinking about how we spend. I think there's a lot of stuff in the personal finance space where a lot of people are guilty into, you know, you have to, oh, you don't buy your coffee, you're peeing away a million

dollars you've heard i mean you've heard a lot of these things you know you should reuse your dental floss or make your own laundry so and i've heard it all i'm like is this the new thing that they're pushing right and so i know i've read your work paul i know you're against a lot of this guilt stuff you can't afford this you can't afford that i understand you're you're all against that stuff as well and so for me i think i am trying to come up with different ways that people different tricks people can use to kind of get them out of that guilt there's this spending guilt that's out there and so one of the tricks i use if i'm ever splorging it's not for something like when i go to buy eggs or something i don't care about that, right? But like, if I'm splurging, like, if I want to take myself out, go out for a nice dinner,

buy myself a nice pair of shoes or something, right? Whatever it is, if I ever spend a large amount of money, let's say I'm going to spend $300, $400, 400 bucks, whatever it is, I make sure to take the same amount of money and I either invest it, right? So let's say, so if I'm going to buy a $300 pair of shoes, like a nice pair of dress shoes, I will take another $300. So 2x my original purchase price and I will invest it in something or I can donate it. There's different ways you can do this to kind of get rid of the guilt. So you don't feel guilty about it. buying the shoes because you're like also investing for your future or you're also helping a good cause or something like that. So I think this rule is really effective not only from like an

affordability perspective because if you can save two X for it, then you can obviously afford the first X, so to speak. Right. But also it really eliminates spending guilt in a lot of ways. And I think that a lot of the personal finance issues out there are, you know, issues that are in people's heads and they get, oh, should I not spend this? And they're very frugal and there's nothing wrong with being frugal. But there are times on, hey, you want to support it on yourself a little it's okay, and this is a way to kind of allow yourself to do that. That tip to alleviate some of the guilt associated with spending, as well as just to have a reality check on, hey, am I spending too much?

That tip called the 2X rule comes from Nick Majuli. Next, we spoke with, and this was just total nerd fun, Bill Bangan, who is, can we get a drum roll here actually? Bill Bangan is of all of our guests. He's the one who deserves the drum roll. Bill Bengen is the guy who invented the 4% withdrawal rule. And if you are a retirement planning nerd, if you wake up every morning being like, ah, sunrise, time to plan retirement. If that's how you think, then Bill Bengen is a legend. So for those of you who have a life and are wondering what we're talking about let's climb in our time machines and return to 1994. Saved by the Bell was on TV,

Ace of Base and Boys to Men were playing on the radio, and financial advisors were telling their clients that they could safely withdraw 7% of their retirement portfolio each year. At the time, they were using the simplistic logic that thought, hey, the stock market has historically yielded between 7 to 9% returns, so a 7% drawdown rate probably shouldn't dwindle the principle, right? Along came Bill Bagan. He was an MIT graduate and former rocket scientist who decided to model different retirement withdrawal strategies, and so he looked at the performance of investment portfolios across 30-year time horizons, beginning in 1926, using the assumption that the portfolio was invested 50% in an S&P 500 index.

fund and 50% in intermediate term bonds, and that all of this is held in a tax deferred account. Under that set of assumptions, and by the way, if everything that I just said sounds like Charlie Brown, want, want, want, what I've essentially just said is that under the assumption that your retirement portfolio is in some type of official retirement account, meaning it's an account that gives you some sort of a tax benefit, and under the assumption that half your portfolio is in stocks and half is in bonds, so it's a well-balanced, portfolio for your age at the time in which you retire. Under that set of assumptions, he found that in the worst case scenario, a person could withdraw 4.2% of their portfolio in the

first year of retirement, and then that same amount adjusted for inflation every subsequent year, and that that would give people a reasonable chance of not outliving their money based on historic performance. He published those results in the Journal of Financial Planning. It caused a massive stir in the field. It upended all of the assumptions that dominated the field at the time. It remains a cornerstone of retirement planning to this day. And Bill Benkin joined us to talk about what people get right about it, what people get wrong about it, and what else people should be focusing on. I was frustrated for many years because people are focusing on the safe withdrawal rate, which is actually based on the worst case that investors, retirees had to face in their late 60s.

It's where you got that four and a half or 4.7% of rule from. But I knew that historically, some retirees have been able to withdraw much higher rates up to 13%. And I could never determine a rational method by which one could determine what are the right set of circumstances under which you can take higher than that safe withdrawal rate. because they clearly have existed in the past. And then about a year and a half ago, I made a discovery. I realized that it was important not only to focus on, you know, returns early retirement, but inflation. And if you look at market valuation at the time of retirement, stock market,

and couple that with the inflation regime you're in, those two factors together allow you to very reliably pick a redraw rate from history that should work over, you know, your 30-year period. It could well be much higher than the 4.7. For example, you remember the terrific bear market we had in 2008 to 2009, when the market dropped almost 60%. I determined that the retiree, who retired at the end of March in 2009, really near the market bottom, could safely take out 6.5%.

Instead of the 4.7, now, that's a big difference. That's like 30% more spending for a whole lifetime. So the person who had blindly followed a 4.7% or 4.5% rule would have short of themselves. By now they would have had so much in their bank account, they're saying, oh, my goodness, why didn't I spend this to have more fun the last 15 years? So when I was finally able to determine that, that kind of like completed my research in terms of providing a complete, systematic approach to managing and defining withdrawals. And it was very gratifying.

after all those years to finally come up with because it was purely by amount of chance. I was just playing around with things. And I had this aha moment. And I drew another chart. I said, oh, my goodness, this is it. And once again, I sat there for an hour and a half and looked at this chart I created and said, yeah, this really works. So that's the way discoveries are. Remember that the safe withdrawal rate is not the optimal one.

The optimal withdrawal rate is based on market. valuations and inflation, the safe withdrawal rate by contrast is meant to represent the historic worst case scenario. Going back to a concept that we talked about earlier in today's episode, it's meant to protect you from the risk of ruin. It's a defensive strategy. It's not meant to be optimal. It's meant to be defensive. And so one of the points that Bill Bangan emphasized in our interview was that that is one of the big misconceptions of the 4% withdrawal rate. and one of the ways in which broad public perception gets it wrong or misapplies it. Another idea that he talked about is that even though the research was done with the assumption that retirement would last for approximately 30 years,

for example, you retire at age 65 and you plan to live until age 95, the mathematical modeling still shows that for a much longer retirement, 40, 50, 60 years of retirement, the optimal safe withdrawal rate is fairly close to what it would be for a 30-year retirement. You would want to be a little bit more conservative, maybe roughly half a percentage point more conservative, according to Bill Bagan. If you're going to use 4.7% as the new finding, then I would say probably 4.2% would be the, let's say the what I call a Methuselah client, somebody who lives essentially forever, would be somewhere in that range, low fours.

One thing that he emphasizes at multiple points during our interview is that the pernicious effect of inflation is something that we as investors need to be extremely cautious about. Nothing kills wealth faster than inflation, particularly the wealth that is held by retirees who are necessarily tilted towards more conservative investment. investments and a higher cash allocation. I had only looked at tax deferred accounts in my initial research. So since that time, I've looked at taxable accounts. I've looked at time horizons, much different than 30 years. I've looked, you know, from 10 years and on practically to infinity, and turns out, as you take longer and longer during time, if you get 60, 70, 80, 90 years, your withdrawal rate

reaches kind of like what's called an asymptote mathematically where it just kind of flattens out. and you get to a certain level where no matter how long you live, this will be a safe withdrawal rate. It's a bit lower. It's about half percent lower than what's called a safe withdrawal rate. But let's say, you know, you want to use four and a half percent for the historical safe withdrawal rate for a 30-year person. If someone to live 100 years, it would be about 4 percent, which is pretty much what the fire people are using, which, you know, to me makes a lot of sense. So you think it's appropriate for somebody who is an aspiring early retiree, someone who might want to retire at the age of, say, 35 and live ideally to 100?

You think a 4% withdrawal rate would be reasonable for that person? Yeah, once again, another variable is whether it's a taxable or tax deferred account. That would apply to a tax deferred account. Taxable accounts probably about 10% less than that. So that's another thing you have to look into. We're talking what's happened historically. I don't predict the future. I basically report what's happened in the past.

It's really important to understand that. Because the environment we're in today has components which have never occurred historically. This combination of very high stock market valuations, very high bond market valuations, and high inflation has never existed. So I can't really say with absolute assurance that 4%, 4.5%, whatever rule you want to use, is going to hold up in these circumstances. And unfortunately, we won't know for a long time. So I would urge people to be a little cautious and conservative, you know, in their selection

of withdrawal rates right now. What do you mean by a little cautious and conservative? Do you think something around 3.5% would be reasonable? I think that's too draconian. I think 4% from a tax deferred account would take into a lot of terrible things into account. I mean, that would be worse than the 1970s, which was pretty terrible for investors. But you never know.

You never know what's going to happen in the markets and with inflation. Those are some of the highlights that came from our interview with Bill Bankin, one of the most memorable interviews that I've ever done with someone who has absolutely revolutionized the field of retirement planning. All right, let's do one last recap from this year. This is a review of the first five months. These are episodes that we ran from January through. May. So we will do a part two of this episode where we review some of the interviews that we've done from June through December. But to close out today's episode, let's close with a quote

from the same voice that opened the episode. Former financial planner Joe Saw See High describes the sharp ratio. I'm highlighting this because I believe, to the best of my recollection, this is the only time on the podcast that we have ever talked about the sharp ratio. And the big picture idea to keep in mind as you hear Joe describe it is that the purpose of this ratio is to compare potential returns of an investment with the risk of an investment. And that notion comparing return to risk is at the heart of every investment choice that we make. To calculate the sharp ratio, we need to know what standard deviation is. And to keep it really, really simple, I know it's more mathematical than this, but in a normal market, when you look at the number that's the standard deviation, that is on most days, you will find that your position will move, whatever that percentage is, up or down from what you're expected return is. as an example, if we have an investment that we expect to do 8% and the standard deviation is 14,

that means it is perfectly normal for that investment to be at negative 6 sometimes because it's 8 minus 14. And it's also perfectly normal for that to be at plus 22. So standard deviation shows us what pros call the wiggle. Nobody calls it the wiggle. Joe calls it the wiggle. But it is the wiggle. It shows you what type of roller coaster you're going to be on. And when I was a planner, I like looking at that to tell people, there's going to be times when this is down 6%.

And you know what? That is normal. That's what this normally does. And so that is one standard deviation is that number. Now, there's people yelling at their device that it's more mathematical than that. It certainly is, but I think we're trying to keep this on a beginner level in a normal market if you look at it that way. Another one that I like, and you can look at this if you have mutual funds, is something called beta. And the beta of a mutual fund is how much it's going to vary against the index

it's being compared to. So as an example, if the beta, the index it's compared to is a one, they call, they use the number one to represent that index. So if the index is the S&P 500, and we have a fund that is a mix of the S&P 500 and something else, and it is a beta of 1.1, that is roughly 10% more risk you're taking than the S&P 500. So if it beats the S&P 500, that helps you ask yourself, well, is it beaten the S&P 500 because the market's up? Because if this fund takes 10% more risk, in an up market, it should do better. And also, by the way, if the market's down and it's getting cream versus the S&P 500 and the beta's 1.1, well, I would expect it to get cream more than the S&P 500 because it takes more risk.

What Sharp does is tries to put all of this together. So the goal of Sharp is to compare two investments specifically to see if we add something to our portfolio, does it really help with a risk-adjusted return? The equation that we're working is you take the return you think you're going to get and you minus out the what's called the risk-free return. And the risk-free return would be, what would I get if I were in cash? And some people might even use a treasury in a normal market as that. So if I think that I'm going to get eight and a treasury is paying three, my risk-adjusted return is five.

So it's going to be the five minus three. And we take that number and we divide it by the standard deviation number that I just said. And essentially what we're coming up with the number that once again is really around one. a lot of the time it's going to be around one. So if I have a portfolio and it's large company stocks, let's say largely, and my sharp ratio is one, and I add a fund to it, and the new fund makes the sharp ratio 0.9, that's a lower sharp ratio. If something has a lower sharp ratio, that means I probably shouldn't add that fund

because I'm not getting more risk-adjusted return, I'm getting less. Right. So if the second number, once you've added something to portfolio, it gives you a smaller number with the sharp ratio. It means you're not adding any real value. If it makes it 1.1, now we're adding some value when it comes to other returns. Now, you have to be careful. There's a few things here.

Number one is the sharp ratio compares volatility to risk. As you and I know, Paula, there are some investments out there that have other risks outside of just volatility. Right. Exactly. And that's a good distinction to make because a lot of times people use the terms volatility and risk interchangeably when in fact they are separate concepts. Yeah. So if as an example, oil, we're seeing that right now, right? Oil is subject to other risks on top of it. So even if it makes your sharp ratio look prettier, adding oil is going to add some different risks than just adding S&P 500 fund would. Right. Exactly. And to clarify that, so volatility is the wiggle, as you described earlier. Volatility is standard deviation, whereas risk

encapsulates all of the different things that could go wrong. So with oil, for example, oil is subject to not just volatility, but also political risk, as well as many other additional risks. Yes, specific risk, right, that you're investing in one commodity. There's specific risk there as well, among others. Yeah. So you need to use the sharp ratio, realizing that there is no measure that you're going to use that's infallible. Just know what the Achilles heel is of the measure before you use it. So that's the sharp ratio. It's really neat. I loved using the sharp ratio when I was when a client and I, when I was a financial planner and we would discuss adding something to a portfolio, we would use the sharp ratio to,

to give us a mathematical number to show us if it really is additive. Those are some highlights of what we learned at the beginning of 2022 here on the Afford Anything podcast. Thank you so much for tuning in. My name is Paula Pant. If you enjoyed today's episode, please share it with a friend, family member, neighbor, colleague, sibling. Share it with somebody in your life.

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