Evidence-Based Investing with Larry Swedroe – Podcast #181 | White Coat Investor


Podcast #181 Show Notes: Evidence-Based Investing with Larry Swedroe

Practicing evidence-based medicine is important to physicians, looking at data and changing our practice according to it.  Due to this, you will really appreciate our guest in this episode, Larry Swedroe, who has been a proponent of evidence-based investing for a long time.  His teachings have affected me over the years and certainly affected my portfolio construction.  He was among the first authors to publish a book that explained the science of investing in layman’s terms and he has since authored 17 more books.  He writes for dozens of peer-reviewed financial journals as well as appearing on national television shows sharing his knowledge.  In this interview we talk about the limited data set in finance in comparison to other, more scientific fields and how much we can rely on that retrospective data going forward.  We discuss portfolio construction, alternative asset classes, recommended strategies for spending down assets in retirement, and investment mistakes smart investors make.  Are you a smart investor?  Find out in today’s episode.

This podcast is sponsored by Bob Bhayani at drdisabilityquotes.com.  He is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor.  He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies.  If you need to review your disability insurance coverage to make sure it meets your needs or if you just haven’t gotten around to getting this critical insurance in place, contact Bob at drdisabilityquotes.com today by email [email protected] or by calling (973) 771-9100.

Quote of the Day

Our quote of the day today comes from Charlie Ellis, who said,

Investing in stocks helps keep us young.

Obviously, stocks have a long-term return that you need to be around for the long-term to collect.  So, in that way, investing in stocks makes you try to stay alive longer, a little bit like buying an annuity.

The Best Financial Books for Doctors

In this episode we talk a lot about good financial books.  You can find my list of the best financial books for doctors here.

I think reading books is one of the best ways to learn about investing.  Not only do you avoid the short-term information you see on CNBC and in the newspaper and on the radio, but when you write a book, you write differently than you do for the internet.  Your arguments are more coherent, the books are better proof-read, designed, and edited.  It is a great way to get a foundation of financial literacy under you.  On that recommended list are all kinds of books: doctor-specific books, books on personal finance, investing, advanced investing, behavioral investing, mortgages, real estate investing, taxes, contracts, estate planning, and asset protection.  All the subjects I think you need to know about.  If you are looking for good book recommendations, start there.

Larry is a prolific writer and has turned out a lot of great books.  Several are on my recommendation list.  Here are the ones we discuss in this episode:

Wise Investing Made Simple

The Only Guide to a Winning Investment Strategy You’ll Ever Need

The Incredible Shrinking Alpha

Your Complete Guide to Factor Based Investing

Your Complete Guide to a Successful & Secure Retirement

Investment Mistakes Even Smart Investors Make and How to Avoid Them

Rational Investing in Irrational Times

 

Evidence-Based Investing with Larry Swedroe

Larry serves as a Chief Research Officer for his firm and a member of the firm’s investment policy committee.  He has been published in a number of journals and been on NBC, CNBC, CNN, Bloomberg, and writes regularly at Advisor Perspectives, Evidence-Based Investor, Seeking Alpha, and The Geeks, in addition to the 18 books he has published.

His personal favorite of the books he wrote is Wise Investing Made Simple, which was a collection of 27 tales.  He called it “To Enrich Your Future”, but they’re using stories related to cooking, gardening, movies, and sports history that make these sometimes difficult concepts in finance easy for people to understand.  It didn’t sell all that well, but he got great feedback from people.  They used it a lot in his company to help teach and train clients to be good investors.

The book that sold the best was the first book, The Only Guide to a Winning Investment Strategy You’ll Ever Need.

His newest book out is the second edition of The Incredible Shrinking Alpha.  One of the big themes that you hear from the active industry is, as more and more people move to passive investing, it will become easier for active managers to outperform because there’s less price discovery going on.  His colleague, Andy Birkin, and he believe that story is exactly backward.  They present the logic and the evidence showing that as the trend of passive investing increases, the percentage of active managers generating statistically significant alpha has collapsed.

When I wrote my first book, about 20% of active managers were generating statistically significant alpha. That was in 1998. Now that number is about 2%. And of course, that’s before taxes because taxes have the largest expense, typically, for a taxable investor in a mutual fund – higher than the expense ratios, even than the typical high expense active fund. That number is probably more like 1%. So, all of the things you hear about passive investing making it easier for active managers, and they continue to repeat that story, is just a big lie, like much of what you hear from Wall Street.

The one critique about that book was about translating that great information into what to do about building a portfolio.  So with the new edition, he added chapters on portfolio construction, recommended funds and a couple of appendices on key issues that investors make mistakes on.

Portfolio Construction

What are the most important principles when it comes to portfolio construction?

  1. Confusing strategy with outcome.  A strategy in a world where no one has a clear crystal ball should only be judged based on the quality of the process you went through in making your decision, never on the outcome, or you’ll make mistake after mistake after mistake by confusing luck with skill.
  2. Markets are highly, but not perfectly efficient.  That means that the market’s price may not be the right price.  We don’t know that, we don’t have perfect foresight, but it’s the best estimate of the right price.  The evidence is overwhelming that we see passive or systematic or indexing strategies generally significantly outperform.  And therefore, you should be a systematic indexed type of investor because of that.
  3. If you believe that markets are efficient, even if they’re not perfectly so, then the only logical thing you can conclude is that all risk assets must have very similar risk-adjusted returns.  If you believe in those two principles, markets are efficient, all risk assets have similar risk-adjusted returns, and the only logical thing you can conclude is you should diversify your portfolio across as many unique sources of risk that you can identify, that meet whatever your criteria is.

One of his teachings that affected me and certainly affected my portfolio was to take your risk on the equity side, advocating for very high quality, short to intermediate duration, fixed income.  Why does he advocate for that?  Does that advice change with interest rates at their current historical lows?

The answer to the second question is no, the advice doesn’t change. Those rates can go lower, number one, and the risk can still show up. But the answer to your first question is the reason we recommend that is because correlations are time varying, and investors, many of them, fail to understand that. So, they look at, for example, something like a high yield bond fund, and they say it might have a correlation, maybe 0.4-0.5, something like that, with equities. And they say, “Okay, that’s a low enough correlation, that’s a good thing”. The problem is when the risk of equities shows up, and they get hit, you want the other portion of your portfolio doing well. Now the reason is twofold. One, that means that your entire portfolio is collapsing at the same time. So, you’re trying to figure out what’s the maximum loss you could take. You have to account for the riskiness of all the assets. Number two is you want to be able to rebalance. And if stocks are down, you want to be buying it with something that’s gone up. So, you’re selling that hot, right? You’re not selling that also at distress price.

Recommended Reading from the Blog:

Portfolio Construction Case Studies

Investing Goals: Designing Your Portfolio

Relying on Retrospective Data

Our data set is pretty limited in comparison to physics or other, more scientific fields.  How can you tell how much you can rely on this retrospective data going forward?  Larry said investing was pretty simple back in the late 60s and 70s.  We had what was called a one-factor model, the capital asset pricing model or CAPM.  All you had to know was what was the market beta of your portfolio.  Market beta is a measure of the risk of your individual stock, a mutual fund, or your portfolio relative to the risk of the market.  So, if you have a beta of more than one, you have more risk and a higher expected return.  It doesn’t mean better.  But higher risk, higher expected return.  And if you own stocks like supermarkets and drug store chains, utilities, they have low betas.  They have less risk in the market.

Then Fama and French came along, and we added the size and value factor and then momentum and then some others.  Today, in the literature, it can be confusing, with over 400 factors.  How do you know this isn’t the result of data mining?  Larry said we want to see evidence of this premium and it has to be over long periods of time through economic cycles.

So, in the U.S. we now have good data of 90 plus years. So that’s pretty good for this stuff. But we also want to make sure that it wasn’t just a lucky outcome. What if you lived in Germany or Japan, did you get the same outcome? That’s an out of sample test. So, we look all around the globe to see if the factor meets that criteria. We also look at does it work in every sector or industry or the vast majority of them. Each time you add one of these tests that are out of sample, you’re dramatically reducing the risk of a data mining outcome. Because you’re doing more tests that are unrelated to each other.

And then we said, what about asset classes. Well, if it works across, as I said, value buying what’s cheap and selling what’s expensive, does it only work in stocks? Well, it works in bonds and commodities and currencies. So now the odds, if it works in every one of them and in almost every country in the world, and it works on various definitions, your odds of it being a data mining outcome are close to zero. They are never zero, but you’re putting the odds greatly in your favor.

And then we added those other two. It has to be implementable. So, it has to survive your transactions plus. And we want to make sure there is a reason you should believe it should persist. So, we prefer a risk space explanation. We all believe emerging market stocks are riskier than developed market stocks for a whole bunch of reasons. So that’s a reason that should be an emerging market. Dozens of papers are providing sound economic, intuitive reasons why value stocks should have higher expected returns.

Tactical Asset Allocation

A lot of investors and even a lot of advisors engage in a process they like to call tactical asset allocation.  Rather than keeping their percentages of each asset class fixed, they change them in reaction to valuations, market events, or political events.  What does Larry think of this practice?  He said the evidence shows from tactical asset allocation funds that try to do this they have abysmal track records.  That is the best evidence that you can have.

So, the evidence is overwhelming that you should not try it. And simply engaging in rebalancing forces you to do what every investor dreams of, which is to buy low, relatively, and sell high. That’s the dream. That’s the hard part because it’s easy to buy when things are going up, it feels good and it looks safe. It’s much harder to buy when the only light at the end of the tunnel looks like a truck coming. What I advise people is, do not engage in tactical asset allocation as a good general rule. And if you’re going to sin by trying to time the market, because of valuations, sin only a little. So, maybe you move an allocation by 5%.

Recommended Reading from the Blog:

Tactical Asset Allocation Pro/Con Series

Alternative Asset Classes

Larry has been a fan of alternative asset classes in the past so I asked him if there are any alternative asset classes he saw as viable in the past that he no longer recommends?  In his book, The Only Guide to Alternative Investments You’ll Ever Need he listed 20 of them but thinks only five or so are good ones.  He originally had 3-4% of his portfolio in alternative asset classes.

But like any good investment, they can become bad based on valuations. And this is what gets tricky for individuals. And so, it’s a problem if you’re going to not be able to stay the course or you’re unwilling to consider valuations. And for many people, this is a difficult thing.

For example, the NASDAQ was trading at a PE ratio of over 100 in March of 2000. There was no way those stocks would ever provide a good return, and prices would have to eventually collapse, which they did. Even the large cap growth stocks in general got hammered, and we have the largest value premium ever.

We talk specifically about commodities.  They are not there for high returns, but he did recommend a fund they thought would provide about a 1% premium over the risk-free rate.

And that was related to the fact that it invested in TIPS, which were then yielding much higher than the T-bill rate. And that would provide the real expected return. The reason you wanted to invest in it is it provided, combined with the TIPS, inflation hedge on one side. So, from inflation spike, because of rising commodities, stocks and bonds both tend to do poorly, and this would do well. It would also provide a supply shock if you had, like, an oil embargo or a war or hurricanes or earthquakes that blew up. Like the Japanese earthquake, that almost created a serious problem when the nuclear plant was hit by that. So, you would expect it to do well in those periods.

Now we also knew it would not do well if you had a demand shock. Meaning like a Covid crisis, economic collapse. So, stocks would go down and your commodities would go down. You had to recognize that risk. If you’re going to own commodities, you should extend the duration of your bond portfolio at the same time, because that mixes well. You’re now going to pick up a term premium between short- and longer-term bonds. And if inflation picks up, then your commodities are hedging your bond position, as well as maybe hedging stocks. And if inflation is no worse than expected, you got the bond term premium. You’ve got it anyway. So, it gave you a good hedge.

That’s one of the mistakes a lot of people make when they criticize performance of commodities. They never looked at the two pieces together. And despite the poor performance of commodities in and of itself, which is much worse than expected, if you did both things, commodities had virtually no impact on your portfolio for any reasonable level 3%-5%.

But he has since sold out after holding that position for 4-5 years.

The assumption was, and this is always an assumption, that over the long-term the futures prices relative to the spot would average about zero. So, there will be no backwardation or contango. So, spot oil today was trading at $40, next month would be also $40. In the real world that goes up and down. It could be in contango and it’s trading at $41, or it could be in backwardation at 39. The historical evidence showed that it wanted on average, it was about zero or slightly backwardation. When it’s in backwardation, the evidence showed you how to tell when, because at the spot, say is $40, and you’re buying the future of $39 while you’re making that $1, you make it every month. So even if prices go down, but not as much as the backwardation, you’re ahead. And the other end, if you pay $41, even if it goes up to $41, you make nothing. It has to go up more than that and it can go down.

The literature is filled with strategies that show that when you buy stuff that’s cheap in backwardation and sell what’s expensive in contango, you come out ahead. And there have been funds that trade that in commodities. They go long in commodities in backwardation, short them in contango and have no net position. It’s also called the carry type of trade. It works the same way.

But commodities became highly popular because of the publication of the research and lots of institutions became investors and drove the futures prices into what looked to be a permanent contango.  Larry said he assumed it couldn’t persist because people would see losses and money would flow out.  But that didn’t happen.  And for him it is too big of a risk.  He said he has learned from that that, for people who can’t change and don’t watch, you probably don’t belong in an asset where that can happen.

I asked if he had to pick one or two alternative asset classes these days, which ones would he pick?  He said re-insurance and middle-market lending.

Recommended Strategy for Spending in Retirement

What would be his recommended strategy for spending down assets for someone retiring with 25 or 30 times their annual spending?

He doesn’t think the 4% rule of 25 times your money works anymore, due to stock valuations being much higher than their historical average and the bond portion of your portfolio is going to be lower.  And the third problem is you’re now living quite a bit longer than the people who were retiring 30 years ago.  Your money has to last longer, and you are getting lower expected returns from your investments.  Planning for those things as well as the risk of needing expensive long-term care, he thinks a new safe withdrawal rule should be 3%.

In terms of withdrawals, one thing that is really important is any plan should be a living document and be adapted to the circumstances at the time. And if any of your assumptions change, then you need to change your plan. For example, if you’re still working and planning retirement, but you get laid off and you can’t go back to work, you no longer have as much ability to take risks. Your labor capital is gone. You need to lower your equity allocation all else equal. You get an inheritance. Now you have less need to take risks. You may want to lower your equity allocation or your allocation to risky assets.

As far as withdrawing money, he said the one general rule is take money out of your taxable assets first, out of your IRA and 401(k) second, and your Roth last.  You want to use up the lowest tax brackets always.  So, if you can withdraw money, but don’t need it, but if you’re doing it at the lowest brackets, do that.

He believes tax rates will be much higher in the future and encourages Roth conversions now when your tax rates may be lower.

Recommended Reading from the Blog:

The Most Important Factor in Retirement Withdrawal Plan

Investment Mistakes Smart Investors Make

Larry talks about 77 mistakes in his book but made mention of 2 common ones in the podcast.  One is this idea of recency.  His advice,

What I’ve learned is that when it comes to judging the performance of a strategy asset class mutual fund, most individual investors and even institutions think that 3 years is a long time, 5 years is very long and 10 years is an eternity. Any good financial economists will tell you when it comes to judging the performance of a risk asset, 10 years is noise and should be completely ignored. When it comes to the performance of, say, value or re-insurance or anything else, real estate, they think three years is a disaster. It’s noise. It has to be ignored and that’s what differentiates Warren Buffet from the average investor. He understands this and he runs the poor performance.

The other one is this. Investors, almost all of them that I meet, make the mistake of confusing what I call information with value relevant information. Information is what you hear like from Jim Cramer on TV. Here’s 12 reasons to bias stocks. Well, you and I could agree those all make sense. And I tell people it’s irrelevant. “What do you mean it’s irrelevant? There’s 12 good reasons”. I asked him, “Are you the only one who knows this? – You just heard it on national television.” Whenever you think you have value relevant information, you should ask this question – “Am I the only one that knows it?” The obvious answer will be no. Which means the only way you can profit from it is if you can interpret it better than the Warren Buffett, the Goldman Sachs, the Renaissance Technologies of the world. And the odds of you doing that persistently, in my opinion, are close to zero.

 

Ending

I hope you enjoyed that interview with Larry Swedroe. If you want to hear more from him follow him on twitter, @larryswedroe.  But especially follow his advice to have a well thought out plan, diversify globally across many sources of risk, stay the course, rebalance and tax manage.  You do those things and you will be just fine.

 

Full Transcription

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.
Dr. Jim Dahle:
This is White Coat Investor podcast number 181 – Evidence-based investing with Larry Swedroe.
Dr. Jim Dahle:

This podcast is sponsored by Bob Bhayani at drdisabilityquotes.com. He is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor.
Dr. Jim Dahle:
He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. If you need to review your disability insurance coverage to make sure it meets your needs or if you just haven’t gotten around to getting this critical insurance in place, contact Bob at drdisabilityquotes.com today by email at [email protected] or by calling (973) 771-9100.
Dr. Jim Dahle:
Welcome back to the podcast. Thanks for what you do. I hope you’re having a great October. I know I am. I had a wonderful time on the Middle Fork of the Salmon, wonderful time kayaking down there. Beautiful terrain, got to see eagles and sheep and deer and elk. And even some river otters. It was a wonderful trip. Then got to spend some time with friends at Lake Powell, having some adventures. Great times down there, both, doing some Jerry-Rig parasailing, as well as some canyoneering and the usual surfing and wakeboarding and skiing and that sort of stuff.
Dr. Jim Dahle:
So back at work now, let’s record some podcasts, I guess. Meanwhile, thanks for what you’ve been doing out there. It’s not easy work to be a doc. It’s not easy work to be an attorney or a pharmacist or whatever you might do. And I want to say thank you if nobody else has told you thanks today.

Dr. Jim Dahle:
Our quote of the day today comes from Charlie Ellis, who said, “Investing in stocks helps keep us young. Obviously, stocks have a long-term return that you need to be around for the long-term to collect”. So, in that way, investing in stocks makes you try to stay alive longer a little bit like buying an annuity that way that.
Dr. Jim Dahle:
Today we have something special. We’re going to get into an interview here in just a minute. But before we get there, I want to make sure you are aware of a resource we have on the White Coat Investor site. If you go there and you go to the tab called “The Books” and go down to the bottom link there, called “Great books by others”, it will take you to a page that I have titled “The Best Financial Books for Doctors”.
Dr. Jim Dahle:
Reading books, I think is one of the best ways to learn about investing. Not only do you avoid the short-term information you see on CNBC and in the paper and on the radio, but when you write a book, you write differently than you do for the internet. Your arguments are more coherent, the books are better proof-read and better designed and better edited. And I think it’s a great way to get a foundation of financial literacy under you.
Dr. Jim Dahle:
On that list I have put together all kinds of books. Well, doctor specific books, books on personal finance, investing, advanced investing, behavioral investing, mortgages, and real estate investing, taxes, contracts, estate planning, and asset protection. All these subjects that I think you need to know about.
Dr. Jim Dahle:
And so, if you’re looking for good book recommendations, I would start there. That can be found at whitecoatinvestor.com/best-financial-books-for-doctors. And you can get that under the tabs there on the recommended place on the site there.
Dr. Jim Dahle:
All right, let’s get into an interview. We have a special guest today – Larry Swedroe. Let’s roll it.
Dr. Jim Dahle:
Okay. Today on the podcast, we have a very special guest. Somebody I’ve been looking forward to getting on here for a long, long time. Larry Swedroe, who is a definite expert when it comes to investing. Am I pronouncing that name right? Is Swedroe or Swedroe?

Larry Swedroe:
Swedroe. You got it right.

Dr. Jim Dahle:
Swedroe. Absolutely. He has a long list of accomplishments with regards to investing in his life. Not the least of which is having a significant impact on the way I invest after reading his books. He’s actually the author of eight books, right? And a coauthor of eight more is that right?
Larry Swedroe:
It’s a total of 18 and I’m currently working on three more.
Dr. Jim Dahle:
Wow, no wonder I can’t keep up. Very prolific there. You serve as a Chief Research Officer for your firm and a member of the firm’s investment policy committee. You’ve been published in a number of journals. Journal of accountancy, journal of investing, personal financial planning monthly, the journal of indexing. You’ve been on NBC, CNBC, CNN, Bloomberg and you write a regular blog on etf.com as I recall.
Larry Swedroe:
Well, one, I’m really proud I just coauthored a paper for The Journal of Portfolio Management. So that’s kind of moving up a notch.
Dr. Jim Dahle:
Alright.
Larry Swedroe:
Like a doctor getting published in the New England journal of medicine. And I used to write for etf.com, but my writing is way beyond the ETF. So, I now write for four different sites. I write for Advisor Perspectives, which is kind of an advisor’s industries publication, directed more at them, but their blogs articles are available I believe to everybody.
Larry Swedroe:
I write for Evidence-Based Investor, which is basically your everyday investor. I think that the typical person following you, Jim. And the Bogleheads, that of our group. I write also for Seeking Alpha, which I’m kind of the antichrist maybe for that one, because I’m all about not seeking alpha, but seeking different forms of beta, which we can talk about. And I write for The Geeks. The engineers and the mathematicians are really interested in the deep science, the math of investing. I write for a site called Alpha Architect.
Larry Swedroe:
So, it just depends upon the article and what it’s looking at, where I post there. For those of you who are interested in following, the easiest way to do it is follow me on Twitter. Whenever article appears, I post there.

Dr. Jim Dahle:
And that’s @larryswedroe on Twitter.

Larry Swedroe:
@larryswedroe. That’s right.
Dr. Jim Dahle:
You have a bachelor’s degree in finance and MBA in finance and investment, but I want to go further back. I want you to tell us a little bit about your upbringing and how it shaped your views on money.
Larry Swedroe:
Yeah, well, I grew up, I didn’t know we were poor. I grew up, I would say lower middle class in the Bronx. Grew up first few years of my life, sleeping in the kitchen. Eventually shared a bedroom with my brother and sister in a one-bathroom apartment. We didn’t have a car, but we had a great life. And I can’t think of a better childhood growing up. Great public-school education in those days. New York City public school system was fabulous. At least in the area where I live.
Larry Swedroe:
I had a great public-school education. Basically, free college. I paid about $50 a semester. The books were more expensive than the tuition because I had a limited region scholarship. And then I went to NYU for my master’s.
Larry Swedroe:
And interesting enough, I wanted to be a security analyst and portfolio manager. That’s what my training was for. And I mentioned, I’m sort of the antichrist for that group today. Just coincidence. One of those things, like there was a movie, I think it’s called “Sliding Doors”. You miss a train and you don’t get on it, just missing it. Or if you did make it, what happens in your life?
Larry Swedroe:
But I got out of school and despite graduating at the top of my class from one of the better MBA programs in the country, it was at the wrong time because it was right in the middle of the big recession caused by the oil embargo. There were lots of firms on Wall Street going bankrupt because of the ending of the fixed commission era at the same time.
Larry Swedroe:
Wall Street firms were able to hire people with 10-20 years’ experience for almost the same price I would get an MBA right out of school. So, I was finding it difficult to get a job. I decided to go try and interview with wherever I could. I was getting married, needed a job.
Larry Swedroe:
I ended up going for an interview with CBS only because they owned the Yankees and I was a diehard Yankee fan. And I thought, I don’t care. I’ll drive a bus, but nothing else. I had no interest in the news or anything else about CBS.
Larry Swedroe:
As I get on the subway, I pick up the headline and the New York Times that morning, and it said, CBS sells the Yankees famously to George Steinbrenner, but I figured I’m all dressed in my suit. I might as well go anyway. Ended up working for them. But CBS having known the Yankees if it had been that sale a little bit early, I probably would have gone and who knows where I would have been. Strange how things happen in life.
Larry Swedroe:
And I certainly didn’t end up seeing myself writing books because when I went for my PhD, I was going for a PhD but one of the reasons I chose NYU is they had an MBA program that didn’t require you to write a thesis. You could participate in a game program. It was the first of its time running a company on a computer. So, I thought, that’s great. I don’t want to write a thesis. I did choose NYU partly for that reason. And here I’m now written 18 books.
Larry Swedroe:
The world is a funny place. Strange things, little coincidences, sliding doors, whatever. And for the last 25 years have been, I was at Buckingham, but our quick recap of the career as you asked. So first two years at CBS helping them manage international financial risks, exchange rates, interest rates.
Larry Swedroe:
Then I went to Citicorp to help other companies, because this was a new era of floating exchange rates. Brent woods had broken up recently dealing with all those risk issues. And that was all of two years’ experience, but in a land of the blind, the one-eyed man is King. So, they hired me to help other companies. I did that for two years.

Larry Swedroe:
And then Citicorp sent me out to San Francisco to help start a West coast investment bank for the treasury part of the bank. And I had to run a foreign exchange trading room. I had a funding off shore bank, never ran a trading room before, as well as sell our international financial services. Act as an economist, if you will and forecasts and stuff.
Larry Swedroe:
I did that for 10 years and then joined Prudential Home Mortgage, which eventually became the largest mortgage company in the country. So, I was now involved with managing credit risk and interest rate risk for the largest mortgage company. And then I joined Buckingham to help individual investors. I joined up with a group of people who were financial planners and I brought the investment and risk management skills.

Dr. Jim Dahle:
Awesome. So, 18 books. Which one is your favorite and which one sells the best?
Larry Swedroe:
My personal favorite is “Wise Investing Made Simple”, which was a collection of 27 tales. I called it “To Enrich Your Future”, but they’re using stories related to cooking and gardening and movies and sports history that make these sometimes difficult concepts in finance, easy for people to understand. And I believe I was the first person to ever write a book like that.
Larry Swedroe:
It didn’t sell all that well, but I got great feedback from people. We used it a lot in our company to help teach and train clients to be good investors. I’m actually working on, putting that book back together again. I’ve really gotten the rights to publish it myself and I’m updating the stories. And it’s one of the projects I’m working on.
Larry Swedroe:
The one that sold the best was the first book, which I did a second edition of seven or eight years later – “The Only Guide You’ll ever Need to a Winning Investment Strategy”. And that book sold in its two versions about, I think, 75,000 copies.
Dr. Jim Dahle:
Awesome. Well, congratulations on that success. That’s great.
Larry Swedroe:
Yeah. There’s an interesting story for your listeners, Jim. You’ll like this a little. So, the first book that was not my title. I thought a clever title of “What Wall Street Doesn’t Want You to Know”. The publisher loved the book, but said he didn’t like the title at all. So, he asked me to go create another title. I went to the… there were bookstores in those days. And so, I visited Barnes & Noble and several of the other bookstores. And I came up with a list of like 15 titles and combinations and they created this super long title, which wasn’t my choice – “The Only Guide You’ll Ever Need to a Winning Investment Strategy.”
Dr. Jim Dahle:
A little bit of a play of Tobias’s book.
Larry Swedroe:
Yeah, well, a little bit of play on that. Yeah. And two years later I wrote a second book. So, I liked the first title – “What Wall Street Doesn’t Want You to Know” so I kept that title. The same publisher, I send it to him, he said, “I love this title. It’s fantastic”. And that became the title of the second book. It shows you how strange the world is.
Dr. Jim Dahle:
Yeah, that is interesting. So, tell us about your newest one out.
Larry Swedroe:
The newest one out is the second edition of “The Incredible Shrinking Alpha”. One of the big themes that you hear from the active industry is, as more and more people move to passive investing and you yourself have helped fuel that trend, it will become easier for active managers to outperform because there’s less price discovery going on.
Larry Swedroe:
My colleague and I, Andy Birkin believed that story is exactly backwards. And we present the logic and the evidence showing that as the trend, the passive investing has increased, the percentage of active managers generating statistically significant alpha has collapsed.
Larry Swedroe:
When I wrote my first book, about 20% of active managers were generating statistically significant alpha. That was a 1998. Now that number is about 2%. And of course, that’s before taxes because taxes have the largest expense typically for a taxable investor in a mutual fund higher than the expense ratios, even then the typical high expense active fund. That number is probably more like 1%.
Larry Swedroe:
So, all of the things you hear about passive investing, making it easier for active managers, and they continue to repeat that story is just a big lie. Like much of what you hear from Wall Street.

Larry Swedroe:
We wrote a second edition to update the data. It’s was five years. But also, the one critique about that book, the first version was “Larry, this is great information, but what do we do with it in terms of building portfolios?”
Larry Swedroe:
So, we added a whole bunch of chapters on portfolio construction, recommended funds and a couple of appendices or several on key issues that we think are important that investors make mistakes on like focusing on dividends when not only you should think dividends are irrelevant, but if you’re a taxable investor, you should try to avoid them where possible all else equal because they’re a tax inefficient way to receive returns. And so many investors get that wrong.
Dr. Jim Dahle:
That’s a good segue into my next question. Let’s talk about what you think are the most important principles when it comes to portfolio construction.
Larry Swedroe:
Yeah, that’s a really good one. I do a presentation now and have been doing it for the last year, what do you do when a strategy performs poorly? There is a big mistake that people make as they make the mistake, I call confusing strategy without outcome.
Larry Swedroe:
So, what I mean by that is Jim, you take your IRA account and you buy a lottery ticket and you win the lottery. That doesn’t mean the strategy was good. You can have a bad strategy and the good outcome. Conversely, you can have a good strategy and a bad outcome because risk showed up. Or I’ll use an extreme example. Are you married, Jim?
Dr. Jim Dahle:
I am.
Larry Swedroe:
Children?
Dr. Jim Dahle:
Yes, four children.
Larry Swedroe:
Four children. Do you have life insurance?

Dr. Jim Dahle:
I do.
Larry Swedroe:
You do. At your age and as a doctor, I assume you know the odds of you dying say in the next 10 years are about 1%, right? Maybe 2%.
Dr. Jim Dahle:
Maybe a little higher given my habits, but I agree, it’s very low.
Larry Swedroe:
Very low. And yet with 98% or 95% certainty at an extreme, you’re willing to transfer profits to insurance companies. And 10 years from now, today, you haven’t died. You don’t look back and say, “Boy, that was a dumb strategy”.
Larry Swedroe:
But if you diversify and thus keeping it simple and on international investments and they happen to do poorly for a decade, investors make the mistake of confusing a good strategy of diversification with a bad outcome.
Larry Swedroe:
A strategy in a world where no one has clear crystal ball should only be judged based on the quality of the process you went through in making your decision, never on the outcome or you’ll make mistake after mistake after mistake by confusing luck with skill.
Larry Swedroe:
So, that’s an important message of that talk. In that talk, I open it with here are the three core principles, all investments strategies my view should be based on. And this is at Buckingham, we live by these principles.
Larry Swedroe:
The first is we believe the markets are highly, but not perfectly efficient. That means that the market’s price may not be the right price. We don’t know that, we don’t have perfect foresight, but it’s the best estimate of the right price. And the evidence is overwhelming that we see passive or systematic or indexing strategies generally significantly outperformed. And therefore, you should be a systematic indexed type of investor because of that.
Larry Swedroe:
If you believe that markets are efficient, even if they’re not perfectly so, there are some anomalies in the literature. But you should act as if they’re pretty much efficient. If you believe that Jim, then the only logical thing you can conclude is that all risk assets must have very similar risk adjusted returns. That doesn’t mean similar returns. I mean, similar risk adjusted returns.
Larry Swedroe:
So, we know, for example that say small value stocks are much riskier than the large growth stocks and the S&P. It doesn’t take a genius to know that. You can go online, check their historical standard deviation and you’ll see it’s about twice that of the large cap growth stocks. They’re great companies of the world.
Larry Swedroe:
So clearly, they are riskier. So, they should have higher expected returns. You cannot believe if you think markets are efficient, that small value stocks don’t have higher expected returns. It doesn’t make any sense.
Larry Swedroe:
But it also doesn’t make sense to believe they have higher risk adjusted returns because if they did, then money would flow out of the large growth stocks, lowering their prices. You don’t change their earnings. And lower valuations mean higher returns for the same earnings. And you would be driving up the prices of small value stocks until they had higher valuations and lower expected returns until we got this equilibrium.
Larry Swedroe:
So, when people ask me is small value a better investment? No, one has more risk and a higher expected return. And today emerging markets and developed markets outside the U.S. have much lower valuations. Therefore, they have much higher expected returns than the U.S. That doesn’t make them better investments. The perception is U.S. stocks are safer and therefore they have higher valuations, which means they must have lower expected returns.
Larry Swedroe:
So, if you believe markets are efficient, you have to believe that all risky assets have very similar risk adjusted returns. Once you account for all risks, including not just volatility, but what’s called the second and third movements here beyond volatility. So, things like skewness, and kurtosis, how big the tails are, the bigger the potential losses. So, you have fat tails that makes something more risky because people are on average risk averse. So, they hate that. They’re going to require a higher expected return for an asset that has a bigger fat left tail. So that’s a risk.
Larry Swedroe:
Liquidity is a risk if you need it. So, if you have the new liquid asset, you should have a much higher expected return. You might use a rule of thumb, a 2% plus, but at the same assets, that’s in a public security. Most people don’t know, for example, if you pool a group of say high quality credit cards, you may have a yield as a security argument sake of 8%. If you own that same thing in a public security, not in a private security, instead of 8%, the yield might be 6%, exactly the same risks. So, for somebody who needs liquidity, they’re willing to give up the extra 2% because they might need it.
Larry Swedroe:
For someone who doesn’t need it, and almost all of your listeners probably have some portion of their portfolio that they could give up liquidity. They don’t need it. Most of our clients, for example, don’t take more than their RMD, which even at age 75 might only be 5% or 6%. So, if you don’t need more than that, then you can obviously put some of your assets, but not all in less liquid assets.
Larry Swedroe:
If you believe in those two principles, markets are efficient, all risk assets have similar risk adjusted returns. And the only logical thing you can conclude is you should diversify your portfolio across as many unique sources of risks that you can identify that meet whatever your criteria is.
Larry Swedroe:
Andrew Birkin and I in our book, “Your Complete Guide to Factor‑Based Investing”, we established five criteria beyond having a risk premium. It’s got to have that, or you wouldn’t take risk.
Larry Swedroe:
Number two, it has to have evidence that premium is persistent over very long periods of time. It’s pervasive all around the globe, of course, industries and sectors. It’s robust, the various definition. So, value works whether you look at price to earnings cashflow, price to sales, dividends, it doesn’t matter. It works. It works in every asset class you look.
Larry Swedroe:
Momentum works, whatever the holding period and formation period. These are metrics or characteristics you want. Persistence, pervasive, robustness, as well as implement the ability. So, you don’t want to have a 4% premium that costs you 6% to trade and you want to have a logical reason why you think it’ll persist. You want those things to make sure that the outcome you found of a premium isn’t a result of a data mining exercise, where a correlation doesn’t mean causation.
Larry Swedroe:
A famous exercise in this field was an economist took the UN economic metric database, and found the best predictor of the S&P 500 was butter production in Bangladesh. Now you and I would not put our money on the S&P going up or down based on that.
Larry Swedroe:
So, you have these criteria. And yet we see so many investors make the mistake of home country bias, putting all our assets in the U.S. ignoring these principles. They have all of their assets or many of them in only market beta and ignore other sources of risk. And we think it’s more prudent to diversify across these sources of risk. And then that creates its own risk of what we call tracking variance regret, which nobody should care about, but people do.

Dr. Jim Dahle:
One of your kind of teachings that you’ve had over the years that affected me and certainly affected my portfolio was to take your risk on the equity side, advocating for very high quality, short duration, fixed income.
Larry Swedroe:
Well, let’s say short to intermediate.
Dr. Jim Dahle:
Short to intermediate. Why have you advocated for that, number one? And number two, does that advice change with interest rates at their current historical lows?
Larry Swedroe:
The answer to the second question is no, the advice doesn’t change. Those rates can go lower, number one, and the risk can still show up. But the answer to your first question is the reason we recommend that is because correlations are time varying and investors, many of them, fail to understand that.
Larry Swedroe:
So, they look at, for example, something like a high yield bond fund, and they say it might have a correlation, maybe 0.4-0.5, something like that with equities. And they say, “Okay, that’s a low enough correlation, that’s a good thing”.
Larry Swedroe:
The problem is when the risk of equities shows up and they get hit, you want the other portion of your portfolio doing well. Now the reason is twofold. One, that means that your entire portfolio is collapsing at the same time. So, you’re trying to figure out what’s the maximum loss you could take. You have to account for the riskiness of all the assets.
Larry Swedroe:
Number two is you want to be able to rebalance. And if stocks are down, you want to be buying it with something that’s gone up. So, you’re selling that hot, right? You’re not selling that also at distress price.
Larry Swedroe:
Well, the correlation of things like junk bonds and MLPs and preferred stocks, things that lots of advisors recommend because of the high yield, you get in a 08 and while an intermediate bond fund treasury only, which is what we tend to buy. They went up double digits. And that hold the left tail of your portfolio way in, because instead of going down, the market went down to call it, let’s round it at 40%. At the bottom was probably 50 or 60, but it was down for the year, 37 on a calendar basis. But your five-year treasury portfolio was probably up 10.
Larry Swedroe:
But if you want junk bonds, even say Vanguards fund high yield, which isn’t junk, I think it was down about 25% high yield. High yield was down like 50 emerging market bonds, or maybe down 60 or 70. Preferred stocks got slaughtered, REITs got slaughtered. All these, what are on average, low correlation got slaughtered. You want to own something that will tend to do well so it dampens the risk of your overall portfolio to acceptable level.
Larry Swedroe:
Another reason why we want to own it is we have found that the evidence shows very clearly that credit risk has generally not been rewarded well. It will shock your listeners, but the full premium between long-term treasuries and long-term corporates has been about 20 basis points. That is before the expenses of your funder trading costs. And you can easily format by buying CDs with yield more than treasuries. So why would you want to own that when there’s no evidence of a long-term premium?
Larry Swedroe:
And what you really own is what people don’t understand is when they own say a high yield bond, they really own a combination of equities and treasuries. That’s really what you’re owning. And the correlations there shift at the wrong time. So, when the market’s going up, let’s just say on average, it’s 50/50 just to pick a simple number. When the market is going up, it looks more like equities. But when is collapsing, it also looks more like equity.
Larry Swedroe:
And so, you might calculate that I’m willing to take a 30% loss on my portfolio. That’s the most as I would panic and sell beyond that. And if you own 60% stocks and 40% five-year treasuries, you’re probably okay with that. But if you own 40% high yield bonds and preferred stocks and MLPs, now your risk could easily be for a much bigger loss than 30%.

Larry Swedroe:
So, we believe the right strategy, if you’re going to take risks, take it where it’s been rewarded well in things like illiquidity. And if you don’t need liquidity, for you it’s at least a free lunch or close to it.

Dr. Jim Dahle:
Now in medicine, we have evidence-based medicine. It’s really important to us to look at the data and change our practice according to it. You’ve been a fan for a long-time of evidence-based investing, which doctors can relate to well. But our data set is pretty limited in comparison to physics or other more scientific fields. How can you tell how much you can rely on this retrospective data going forward?
Larry Swedroe:
It’s a really important, great question. That’s why Andy Birkin and I wrote that book – “Your Complete Guide to Factor Based Investing”. Investing was pretty simple back in the late 60s, 70s. We had what was called a one factor model, the capital asset pricing model or CAPM.
Larry Swedroe:
All you had to know was what was the market beta of your portfolio. Market beta is a measure of the risk of your individual stock, a mutual fund, or your portfolio relative to the risk of the market.
Larry Swedroe:
So, if you have a beta of more than one, you have more risk and a higher expected return. It doesn’t mean better, right? But higher risk, higher expected return. And if you own stocks like supermarkets and drug store chains, utilities, they have low betas. They have less risk in the market.
Larry Swedroe:
So, they may have a beta of say, 0.8. If the market goes up 10% you should only expect to go up 8%. It doesn’t mean you underperform. You got rewarded for the risk. If you own a bunch of high-flying tech stocks with a beta of 1.2. you should be up 12%. And if you didn’t get 12, you got 11 in some active fund one, your alpha was negative. You actually underperform.
Larry Swedroe:
Then Fama and French came along and we added the size and value factor and then momentum and then some others. Today in the literature, it can be confusing and John Cochran, in my opinion, our best financial economists. I’d recommend everyone to follow his blog, which I read daily. He called this a zoo of factors. We have over 400. In the literature I’ve read one estimate as high as 600.
Larry Swedroe:
So, Andy and I try to figure out how do you navigate your way around the zoo? And to answer your question, how do you know this isn’t the result of data mining? So, we said, we want to see evidence of this premium and it has to be over long periods of time through economic cycles.
Larry Swedroe:
So, in the U.S. we now have good data of 90 plus years. So that’s pretty good for this stuff. But we also want to make sure that it wasn’t just a lucky outcome. What if you lived in Germany or Japan, did you get the same outcome? That’s an out of sample test. So, we look all around the globe to see if the factor meets that criteria.
Larry Swedroe:
We also look does it work in every sector or industry or the vast majority of that. Each time you add one of these tests that are out of sample, you’re dramatically reducing the risk of a data mining outcome. Because you’re doing more tests that are unrelated to each other.
Larry Swedroe:
And then we said, what about asset classes. Well, if it works across, as I said, value buying what’s cheap and selling what’s expensive, does it only work in stocks? Well, it works in bonds and commodities and currencies. So now the odds, if it works in every one of them and in almost every country in the world, and it works on various definitions, your odds of it being a data mining outcome are close to zero. They are never zero, but you’re putting the odds greatly in your favor.
Larry Swedroe:
And then we added those other two. It has to be implementable. So, it has to survive your transactions plus. And we want to make sure there is a reason you should believe it should persist. So, we prefer a risk space explanation. We all believe emerging market stocks are riskier than develop market stocks for a whole bunch of reasons. So that’s a reason that should be an emerging market. Dozens of papers are providing sound economic, intuitive reasons why value stocks should have higher expected returns.
Larry Swedroe:
But there are also some behavioral explanations. We know that dumb, naive retail money overpays for stocks that have distributions of outcome that looked like lottery tickets. The vast majority of them have got awful returns. And a few of them go on to be Microsoft. Well, people like that bet. They buy lottery tickets. And the problem is the costs and the risks of shorting, make it very difficult for professional investors to correct those mis-pricings, especially when these very small stocks are thinly traded. So, those mis-pricings can persist.
Larry Swedroe:
Now I’ve written about that you should just avoid buying those stocks. That’ll improve your returns to some degree. But those behavioral reasons continue to persist because even after we know about these anomalies, these limits to arbitrage as a fault, prevent sophisticated investors from completely correct them as pricing.
Larry Swedroe:
So, if you can identify a behavioral anomaly, you have to be able to show why it will persist. It’s unlikely to persist in large caps because they are much easier to short and plenty of securities around to borrow and you can generally borrow them very cheap. But there’s still a big risk of unlimited losses on those stocks. And a lot of people are even prohibited from their charters to go short. But in small stocks, these tiny micro caps, sometimes you can’t even find stock to borrow or the cost of shorting is so high that these anomalies can persist.
Larry Swedroe:
So, we wrote in our book, we found five factors for stocks and two for bonds. And once you have those seven, you get to know the other 500 or whatever there are because they don’t meet all of these criteria. And you may find that you believe more in one than the other.
Larry Swedroe:
For example, I have less faith in momentum because it’s purely behavioral. So, I will overweight value and size and I’ll have less in momentum but I won’t ignore it because the evidence is overwhelming that over the long-term, it has benefited portfolio.
Larry Swedroe:
So, the key here, it’s not black or white, but it should I think be putting your weight of your assets, where you have the most confidence and what the data supports.

Dr. Jim Dahle:
Now, a lot of investors and even a lot of advisors engage in a process they like to call tactical asset allocation. Rather than keeping their percentages of each asset class fixed, they change them in reaction to valuations or market events or political events. What do you think of that practice?
Larry Swedroe:
Well, let me say it this way. The evidence shows from tactical asset allocation funds that try to do this they’re abysmal track records. That’s the best evidence that you can have. And we see that in looking at the records of active managers in general, if they could shift asset classes between value and growth and shift countries and stuff, it would show up in their persistence.
Larry Swedroe:
So, the evidence is overwhelming that you should not try it. And simply engaging in rebalancing forces you to do what every investor dreams of, which is to buy low relatively and sell high. That’s the dream. That’s the hard part because it’s easy to buy when things are going up, it feels good and it looks safe. It’s much harder to buy when the only light at the end of the tunnel looks like a truck coming the other way as it did in March of 2009 or in March of 2003, or whenever, I think 2002, at the end of that year, we started that recovery there.
Larry Swedroe:
What I advise people is, do not engage in tactical asset allocation as a good general rule. And if you’re going to sin by trying to time the market, because of valuations, sin only a little. So, maybe you move an allocation by 5%. I wouldn’t do it. I’ve only done it in my career basically once, one major move, which occurred in the late 90s.
Larry Swedroe:
I believed that growth stocks were in a huge bubble. Based on valuations they were on stretched levels. This was in 1998. I of course was wrong for about two years, which was difficult or would have been for a lot of people. But I believe that markets are rational in the long-term. And the next eight years from 2000 to 2007, were the largest value premium in history.
Larry Swedroe:
I believe we are setting up likely for that exact same event now because valuations today are as bad or worse for growth stocks as they were then relative to values stocks all around the world.
Larry Swedroe:
So, I made one big change. I decided I would get out of growth stocks altogether. In 1998, I moved everything to value. And eventually over time, as I was able to absorb tax impact, I moved to small value and develop a portfolio that was much more of what’s called the risk parity portfolio. One where it has low allocation to beta, market beta, at a high allocation to the size and value premiums and other premiums.
Larry Swedroe:
So, I was creating this portfolio that was built on this principle, not having all my assets only in market beta. And that’s one thing investors don’t know. If you own a total market fund, you have exposure to one factor. So even though 20% of your portfolio is of value and about 10% is small stocks, you have no exposure to these factors. You need to tilt your portfolio more than the market is so you would need to be more than 20% value and more than 10% small to have exposure to these factors.
Larry Swedroe:
So, that was the only trade I made really. I’ve made one other minor as the U.S. valuations have gone up. And now where the U.S. is 50% of the market, I’ve moved the other way a little bit. I used to be 50% U.S. but valuations have gotten so stretched relatively speaking that I’m sinning a little and I may be adding a little bit more at my emerging markets and international in the last few months. Just a little bit. I can’t resist a little bit, but I would tell the average investor, don’t do that. Just stick with your plan. But if you’re going to sin, sin a little bit.

Dr. Jim Dahle:
Now you’ve been a fan of alternative asset classes in the past. You wrote an entire book on the subject. Are there any alternative asset classes you saw as viable in the past that you no longer recommend? Such as commodities, peer to peer loans, et cetera.
Larry Swedroe:
Yeah. Well, let’s begin. I’m a fan of some alternatives. In fact, most of them, I’m not a fan of. The book that was called, “The Only Guide to Alternative Investments You’ll Ever Need” had a list of 20 of them. I think there were five or so good ones, a couple of good, bad, flawed, and ugly. There were a few flawed, like preferred stocks and most of them were in the bad and the ugly category. So, there were a few they would have to pass all of these tests.
Larry Swedroe:
And one comment here before I’ll go into and I’ll touch on commodities, which is the one that I have not… I originally had significant investments, like 3% or 4% of my portfolio, which is typical for me. I’ll divide my alternatives, of course, a series of them.
Larry Swedroe:
But any good investment can become bad based on valuations. And this is what gets tricky for individuals. And so, it’s a problem if you’re going to not be able to stay the course or you’re unwilling to consider valuations. And for many people, this is a difficult thing.
Larry Swedroe:
So, for example, the NASDAQ was trading at a PE ratio of over 100 in March of 2000. There was no way those stocks would ever provide a good return and prices have to eventually collapse, which they did. Even the large cap growth stocks in general got hammered, and we have the largest value premium ever. I, as I told you that out of a bit too early, but suddenly it proves to be the right strategy in the long-term.
Larry Swedroe:
So, what happened is with commodities, there’s a very good logical argument because while they are not there for high return, I believe that the fund I recommended, we thought would provide about a 1% premium over the risk-free rate. And that was related to the fact that it invested in TIPS, which were then yielding much higher than the T-bill rate. And that would provide the real expected return.
Larry Swedroe:
The reason you wanted to invest in it is it provided combined with the TIPS, inflation hedge on one side. So, from inflation spike, because of rising commodities, stocks and bonds both tend to do poorly, and this would do well. I would also provide a supply shock if you had like an oil embargo or a war or hurricanes or earthquakes that blew up. Like the Japanese earthquake, that almost created a serious problem when the nuclear plant was hit by that. So, you see the fun you would expect it to do well in those periods.
Larry Swedroe:
Now we also knew it would not do well if you had a demand shock. Meaning like a Covid crisis, the man collapses, economies collapse. So, stocks would go down and your commodities would go down. You had to recognize that risk.
Larry Swedroe:
So, we told people, if you’re going to own commodities, you should extend the duration of your bond portfolio at the same time, because that mixes well. You’re now going to pick up a term premium between short- and longer-term bonds. And if inflation picks up, then your commodities are hedging your bond position, as well as maybe hedging stocks. And if inflation is no worse than expected, you got the bond term premium. You’ve got it anyway. So, it gave you a good hedge.
Larry Swedroe:
That’s one of the mistakes a lot of people make when they criticize performance of commodities. They never looked at the two pieces together. And despite the poor performance of commodities in and of itself, which is much worse than as expected as I’ll get into the moment. If you did both things, commodities had virtually no impact on your portfolio for any reasonable level 3%-5%. And I wrote about that and show that several times.
Larry Swedroe:
But here was the problem with commodities and why I sold out after having a position for, I think, it was maybe four or five years. The assumption was, and this is always an assumption, that over the long-term the futures prices relative to the spot would average about zero. So, there will be no backwardation or contango. So, spot oil today was trading at $40, next month would be also $40. In the real world that goes up and down. It could be in contango and it’s trading at $41, or it could be in backwardation at 39.
Larry Swedroe:
The historical evidence showed that it wanted on average, it was about zero or slightly backwardation. When it’s in backwardation, the evidence showed you how to tell when, because at the spot, say is $40, and you’re buying the future of $39 while you’re making that $1, you make it every month. So even if prices go down, but not as much as the backwardation you’re ahead. And the other end, if you pay $41, even if it goes up to $41, you make nothing. It has to go up more than that and it can go down.
Larry Swedroe:
The literature is filled with strategies that show that when you buy stuff that’s cheap in backwardation and sell what’s expensive in contango, you come out ahead. And there have been funds that trade that in commodities. They go long commodities in backwardation, short them in contango and have no net position. It’s also called the carry type of trade. It works the same way.
Larry Swedroe:
So, what happened was commodities became highly popular because of the publication of the research and lots of institutions became investors and money float in. And that drove the futures prices into what looked to me to be a permanent contango, or it could be for a long time.
Larry Swedroe:
My assumption going in which turned out to be wrong is that couldn’t persist because if it did, people would see losses and money would flow out, right? And their contango would disappear. Just like big backwardation over time would disappear because everyone would jump in to buy this great investment.
Larry Swedroe:
Well, it didn’t happen. And I said, all right, we’re seeing this persistent contango. I think there are now better alternatives as well. It gives you diversification, inflation, hedges, et cetera.
Larry Swedroe:
When I saw the persistent contango, that’s when I decided to sell out of that position because it was a big headwind and I would wait until that went away. And it never really has gone away. It disappeared for a month or two, here or there over the last few years. But right now, for example, we’re trading at an annualized one-month premium for oil at 9%.

Larry Swedroe:
So, if you have a fun cause for argument’s sake of even 50 basis points and you’re paying 9% premium, the price has to go up more than 9.5% for you to break even. You’re getting even any trading costs inside the fund.
Larry Swedroe:
To me, that’s too big of a risk. The payback could go up more than that, of course, but I think there are better alternatives. So that’s why, what I learned from that is, some people who can’t change and don’t watch, you probably don’t belong in an asset where that can happen.
Larry Swedroe:
But that’s true actually of every single asset. Look at the lodge growth stocks and their valuations today. They’re trading at nifty 50 levels and tech stocks. I wouldn’t own them at all today. But I would recommend investors, don’t put in money into something they can stay with for the very long time.
Dr. Jim Dahle:
Now, if you had to pick one or two alternative asset classes these days, which ones would you pick?
Larry Swedroe:
Well, the most logical one to me with our question is re-insurance. Everyone can understand that. There are a couple of funds out there. Stoneridge runs one, SRRIX. And also, another fund family. Unfortunately, the name has escaped me, but it’s XILSX is the fund. They’re both available.
Larry Swedroe:
Warren Buffet owns one of the largest reinsurance companies in the world. People don’t write re-insurance without expectation of premiums. And if you have losses which happen. If there were no losses, guess what? The premiums would collapse. There has to be risk. 2005, 2004, we had big losses in re-insurance. And that’s 11 years where we had almost no losses, massive profits. We’ve now had three years in a row of losses.
Larry Swedroe:
So, people think this is a bad investment. That’s as logical as thinking the S&P is bad because we had three years of losses from 2000 to 2002. Or forget the 13 years from 2000 to 2012, when the S&P underperformed totally riskless treasuries by 40%, but people don’t give up on that idea. But if they have re-insurance losses for three years, I don’t know, maybe 25% now, that’s a disaster, this is bad. It’s really hard to find a dumber argument then that.

Larry Swedroe:
Warren buffet and reinsurers are increasing their exposure because they know the premiums have jumped. In fact, the no loss of return to Stoneridge’s fund. Three years ago, was about 15%, say 8%, expected average losses 7, T-bills were about 2. Nice expected risk premium 5. About the same as you would expect from equities. And totally uncorrelated, right?
Larry Swedroe:
The losses in one don’t cause losses in the oven. So, that’s exactly what you want. It’s completely illogical. You know when you’re buying insurance, you’re likely transferring a risk premium to the insurance company.
Larry Swedroe:
Now that no loss return is 22% and going up, which means if you have average historical losses of 8, you’re going to get low double-digit returns. Now some people think it’s higher losses, maybe climate change. So, 50% increase from 8 to 12, you would still get close to a double-digit return in the fund. So, to me, this is the most logical.
Larry Swedroe:
The other ones I really like are a middle-market lending. It’s done conservatively. Cliffwater runs a fund called CCLFX. Next is the middle size high-quality companies who aren’t big enough to issue their own public debt. So, you’re getting a big illiquidity premium which basically covers the costs of the fund. I think that’s about 7.5% to 8% right now. That’s 8%, 7.5% to 8% premium higher than expected return to U.S. stocks, I think by a good margin. And much less risk, the volatility of that fund, I think there’s about five or less, historical defaults over 20 years, about 1%.
Larry Swedroe:
Now you would expect in 2008, that fund might lose 8% or 10%, but that’s a lot better than the minus 16 that the S&P had at the bottom. Now on the other end, you can’t get 20% or 30% on the upside, right? Because the best you can do is get the yield, which is about say 10% or 11%.
Larry Swedroe:
And the other is a fund run by Stoneridge called Len Dex, consumer and small business now dumped in FinTech companies. That expect their return now is about 7%. So big risk premium. That fund has done exceptionally well, had a higher sharp ratio than even we thought years ago and despite the Covid crisis. But in it 08 again, we might expect that to lose 8% or so, but that’s a lot better than the down 60 stocks had. And yet the volatility of this bond is starkly. We think about five. It’s been much lower than that since inception.
Larry Swedroe:
So those would be the three funds I’d recommend people look at or look for others similar to those. They are simple, not complex, easy to understand, very intuitive. But you have to understand that these are not mutual funds. In the sense that they are not going out and buying public securities, which could be done cheaply like an index fund. They’re actually running a business if you will. So, Len Dex is like running a bank. You can’t run a bank for 10 or 20 or 30 basis points. It’s built into the expense, but I’m giving you the net expected returns there.
Larry Swedroe:
And re-insurance. Stoneridge is literally running a reinsurance company for you. So, you’re going to see higher expenses than you would more similar to what a reinsurance company does.
Larry Swedroe:
So, the mistake people make is they say, “Oh, this is a high expense fund”. No, it’s not when you understand their expenses into an income statement and look at it as if you’re running a business and am I getting a good expected return from that business?
Dr. Jim Dahle:
We are running a little bit short on time, but I wanted to talk just a little bit about retirees. What would be your recommended strategy for spending down assets for someone retiring with 25 or 30 or 33 times their annual spending? What would the strategy be?
Larry Swedroe:
Yeah. So, the first thing in my book, “Your Complete Guide to a Successful & Secure Retirement”, we talked this 4% rule of 25 times your money is what you should have. That rule we think doesn’t work. It doesn’t make sense anymore for a bunch of reasons.
Larry Swedroe:
One is stock valuations are much higher than their historical average. We got 10% returns to stocks. Those PE ratios average about 16. Today PE ratios are much higher so you have to expect lower future returns.
Larry Swedroe:
Second, bond yields average about 5. They are now 1. So, your bond portion of your portfolio is going to be lower. And the third problem is you’re now living quite a bit longer than the people who were retiring 30 years ago. It’s about I think seven years longer now than it was then.

Larry Swedroe:
So, your money has to last longer and you’re getting lower expected returns from your investments. That’s a problem. And as you age and we’re living longer, the risk of needing long-term care, which is very expensive, also increases. So those are the four horsemen of we call that the retirement apocalypse, which you need to plan for. We think the new safe withdrawal rules should be 3%. And even that’s not a hundred percent, nothing is, but it should be good enough for most people.
Larry Swedroe:
In terms of withdrawals, one thing is really important is any plan should be a living document and be adopted to the circumstances at the time. And if any of your assumptions change, then you need to change your plan.
Larry Swedroe:
For example, if you’re still working and planning retirement, you get laid off and you can’t go back to work, you no longer have as much ability to take risks. Your labor capital is gone. You need to lower your equity allocation all else equal. You get an inheritance. Now you have less need to take risks. You may want to lower your equity allocation or your allocation to risky assets.
Larry Swedroe:
In my book, “Your Complete Guide to a Successful & Secure Retirement”, we have a chapter on withdrawal strategies, which specifically gives case studies to help people figure out how to withdraw.
Larry Swedroe:
The one general rule I’ll mention is that you want to generally take money out of your taxable assets first, out of your IRA second, and your Roth last. You want to use up the lowest tax brackets always. So, if you can withdraw money, but don’t need it, but if you’re doing it at the lowest brackets do that, I fully believe regardless of who is president or controlling Congress, over the next few decades, tax rates are going to have to go much higher because of the budget deficits we’ve accumulated and obligations, social security and Medicare.
Larry Swedroe:
So, Roth conversions now when your tax rates may be lower, especially in a year like this, maybe people have losses and have low incomes. You should be using Roth strategies as well.
Larry Swedroe:
And now you may have for the wealthy people listening, I would argue especially as it looks like a democratic victory in the presidency and likely maybe even the Senate now. Anyone who has assets of any real significant size should be getting with their estate planning attorney and moving assets into irrevocable trust before the end of the year. Because once the new year turns, even if they don’t act immediately, they can make it retroactive.
Larry Swedroe:
Today you have almost $23 million you can get excluded from an estate as a couple, and I’m urging everybody to get those if you have assets of more than say a million each, so I’ll say $2 million. I doubt it would go that low. Why take that risk? For a few hundred bucks or a few thousand, get an estate plan and you could save millions in taxes if you’re a high net worth individual. So, those are a few key points I would make.
Dr. Jim Dahle:
Well, we better wrap this up. But this podcast will be listened to somewhere between 30,000 and 40,000 high-income earners, mostly doctors. What else have we not covered you think they ought to know?
Larry Swedroe:
Well, I wrote a book called “Investment Mistakes Even Smart Investors Make and How to Avoid Them”. It actually covers 77 mistakes. It was a sequel to my book, “Rational Investing in Irrational Times”, which only covered 52. Over the next five years I learned that there were 25 more. If I have to do it today, I could probably come up with another 10.
Larry Swedroe:
I recommend people read that book so they can see themselves and the mistakes. I’ll mention two of them that I think are the most common made. One is this idea of recency. So, here’s my advice. What I’ve learned is that when it comes to judging the performance of a strategy asset class mutual fund, most individual investors and even institutions think that 3 years is a long time, 5 years is very long and 10 years is an eternity.
Larry Swedroe:
Any good financial economists will tell you when it comes to judging the performance of a risk asset, 10 years is noise and should be completely ignored. And if anyone doubts that, here’s a statistic that would shock most people. The S&P 500 has endorsed three periods of at least 13 years where it underperformed totally riskless treasury bills. That’s 1929 through 1943, 15 years. 17 years from 1966 to 1982. And the 13 years from 2000 to 2012. That’s 45 of the last 91 years.
Larry Swedroe:
Now, of course the other 46 years, you had massive premiums. Almost 20% maybe, right? But the only way you got that is if you had the discipline to wait out those very long periods. But when it comes to the performance of say value or re-insurance or anything else, real estate, they think three years is a disaster. It’s noise. It has to be ignored and that’s what differentiates Warren Buffet from the average investor. He understands this and he runs the poor performance.
Larry Swedroe:
I think if you ask your listeners, what’s the single equity that they would avoid around the world, now would be Japanese stocks. No return for 30 years. Warren Buffett just loaded it up on Japanese stocks. Biggest investment he’s made in years. Because their valuation are dirt-cheap and he understands buying cheap is likely, but not certain. They give you better returns. So, have a plan, stay the course of no other noise, rebalance.
Larry Swedroe:
The other one is this. Investors almost all of them that I meet make the mistake of confusing what I call information with value relevant information. Information is what you hear like from Jim Cramer on TV. Here’s 12 reasons to bias stocks.
Larry Swedroe:
Well, you and I could agree those all make sense. And I tell people it’s irrelevant. “What do you mean it’s irrelevant? There’s 12 good reason”. I asked him, “Are you the only one who knows this?” – “You just heard it on national television”. – “You think Goldman Sachs and Morgan Stanley and Renaissance Technology and all these big hedge funds and pension plans are unaware of that?”
Larry Swedroe:
If they thought the stock price should be higher because of that, it would already be higher. They wouldn’t be sitting on their hands, watching a stock trade of $40 that they think is worth $60. They would be buying it until it got to $60.
Larry Swedroe:
Whenever you think you have value relevant information, you should ask this question – “Am I the only one that knows it?” The obviously answer will be no. Which means the only way you can profit from it is if you can interpret it better than the Warren Buffett, the Goldman Sachs, the Renaissance Technologies of the world. And the odds of you’re doing that persistently in my opinion are close to zero.
Larry Swedroe:
So, have a well thought out plan, diversify globally across many sources of risk. Stay the course, rebalance and tax manage.
Dr. Jim Dahle:
Thank you, Larry. I appreciate you coming on the podcast.
Larry Swedroe:
My pleasure. Good to be with you, Jim. Happy to come back anytime.
Dr. Jim Dahle:
All right. I hope you enjoyed that interview. Larry makes for a great guest. He’s obviously got a big interest in investing and evidence-based investing. I’ve known him for a long time online. It’s the first time we’ve actually chatted. I guess it’s Zoom, but face-to-face in that respect. First time I’ve ever heard his voice. And so, I enjoyed that and I hope you did too.
Dr. Jim Dahle:
The podcast has been sponsored by Bob Bhayani at drdisabilityquotes.com. He is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor.
Dr. Jim Dahle:
He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. If you need to review your disability insurance coverage to make sure it meets your needs or if you just haven’t gotten around to getting this critical insurance in place, contact Bob today at [email protected] or by simply calling (973) 771-9100.
Dr. Jim Dahle:
Be sure to check out our recommended books as I mentioned at the top of the show. A lot of Larry Swedroe books are also excellent books to broaden your financial literacy.
Dr. Jim Dahle:
Thanks to those of you who’ve left us a five-star review and told your friends about the podcast. Our most recent review comes in from ER – DR who said, “Great show. Listen to Jim. This guy will help add a couple of commas to your net worth. One tip, listen on 1.5 speed as he talks a little slow (this will make him sound normal and his guests sound slightly manic)”.
Dr. Jim Dahle:
Man, I’ve never been accused of talking slow before. It’s kind of a funny review, but I appreciate the five-star review nonetheless.
Dr. Jim Dahle:
Keep your head up, your shoulders back. You’ve got this and we can help. We’ll see you next time on the White Coat Investor podcast.

Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.





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