Andrew Stotz 00:02

Andrew, fellow risk takers, this is your worst podcast host, Andrew Stotz from a Stotz Academy, continuing my discussion with Larry swedroe, who for three decades was the head of Research at Buckingham wealth partners. You can learn more about his story in episode 645, Larry's unique because he understands the academic research world as well as the practical world of investing, today we're going to discuss a chapter from his recent book, enrich your future the keys to successful investing, and that chapter is number 14, stocks are risky no matter how long the horizon. Larry take it away.

Larry Swedroe 00:35

Yeah, thanks for having me back again. I think this is one of the really most important chapters of the book has maybe the most important lesson for investors. And I like to begin this section by talking about a book that a lot of investors know about. Jeremy Siegel, a Wharton professor, wrote a book, stocks for the long run. He said, As long as your horizon is long, just own stocks. And he based that on the evidence that over the last now 100 years in the US of data, we have stocks returned basically 10% a year, 3% inflation, 7% risk premium. What could go wrong? Right? You got to love stocks. Unfortunately, that's a really bad way of thinking about things. Because, for example, let's say Siegel was born in Japan in 1900 or so, and now it's 1945 and you're wiped out. You have nothing, or Germany, you have nothing. Stocks are risky, no matter how long the horizon is, and we have to be very careful. There's an old expression that you can't judge a strategy solely by the outcome, but you have to consider what other alternative universes might have shown up. So I began the chapter of the book with the story retold about the 13 days in October, which is the story of the Cuban Missile Crisis. And in his book, Noah Chomsky, a professor at MIT, related this story, so I'll just read.

Andrew Stotz 02:23

And before you do for those people that don't know what the Cuban Missile Crisis was, it was a confrontation, a showdown between us and what was called Soviet Union at the time. And there's some great, great books that I've read where they have the conversations of the US generals with President Kennedy and their argument is, you know, a general, his argument is always to fight, you know, it's like you got a hammer every problem's a nail. And it was interesting to see the way Kennedy tried to think about it. And basically try to understand that the US and Soviet Russia was, you know, Soviet Union was at each other's, you know, throats in Germany. And what he was concerned about is not so much about Cuba, but what are we going to set off, you know, if we mess this up? So anyways, that's a little backdrop. You may have more to add on that,

Larry Swedroe 03:20

and there was a time of Mutually Assured Destruction right both sides had enough nuclear weapons to destroy the whole world. So Chomsky writes, we learned eventually that the world was saved from nuclear devastation by a Russian submarine captain named Arkhipov who blocked an order to fire the missiles when the Russian submarines were attacked by us destroyers, because Kennedy had set up a quarantine line, had a kapov, of course, followed orders the nuclear launch would almost certainly have set off an interchange that would have changed history, and maybe we wouldn't have the same returns to US stocks there. But I also provide in the chapter a few other examples, in case you think that stocks are great for the long term. In the 1880s there were two countries that were vying to get capital from all of Europe, which was where all the wealth of the world was to exploit the natural riches of those countries. And the leading country that was getting the most capital was not the US, it was Argentina. And if you've been an investor in Argentine stocks for the last 100 years, you really haven't done very well. So that's one example in 1900 the fifth largest stock market in the world, and. I was in Cairo, investors have never earned anything on Egyptian stocks. And of course, in the night early 1900s the Russian Stock Exchange was one of the largest in the world. And here's a couple other examples that make the point the Japanese were dominating the world in the 70s and 80s in terms of valuations. And in fact, the Nikkei index was constituted 60% of the global market capitalization, if my memory serves. And in 1990 at the start of the period the Nikkei was about 39,000 it's not there yet again today, and that is 34 years later, with no return except the dividends. In fact, it's a negative return for the dividends, and probably a negative return after inflation and to a few other quick examples, we have three periods of at least 13 years with the S and P underperformed T bills 1929 to 43 that's 15 years from 1966 to 82 that's 17 years. That's a life horizon for a lot of investors, and then, more recently, from 2000 to 12. So you have 45 of the last 92 years or so. That's almost half the time there was no return securities. And my final example for those who believe that US large growth stocks are the place to be in 1969 if you invested in either us large growth stocks or US Small growth stocks, you would have underperformed 20 year treasuries, which is the riskless events for pension plans with nominal obligations. That's 40 years, right? It shows you that stocks are risky no matter the horizon, which means one thing, that you should diversify your portfolio against those big left tail risks that can show up and not have all of your assets in any one country, any one asset class, because any one of them can go for very long periods of poor performance. Having long periods of poor performance is not a reason to avoid an asset class. It's a reason why we should diversify.

Andrew Stotz 07:46

Yeah, and for those people that want to learn about Russia and how you could lose all your money, there my guest on episode 783 was a guy named Bill Browder who basically wrote the book, read notice and he lost, you know, he went to Russia in 1986 and the title of that episode is, don't go to Russia.

Larry Swedroe 08:08

That's, by the way, one of my favorite. What a fabulous book that is. Everyone needs to read that book. Yeah,

Andrew Stotz 08:16

and it's crazy. It's got 4.7 rating on Amazon and 46,000 reviews. Incredible. So, yeah, that was an interesting one. Um, one of the things that I wrote about in my book How to start building your wealth investing in the stock market is I was saying, you know, own stocks for the long term, but be lucky. And and I said, and I should

Larry Swedroe 08:40

hope your long term is the right long term, right? So

Andrew Stotz 08:43

I just all I did in that case is, I said, Imagine that you were born in 1900 and you had a 30 year investment horizon. Let's say you really started investing when you were 30, and you retired when you were 60. What would have been the return if you were born in, you know, 1900 What about 1910 What about 1920 and then I showed that the returns can vary quite substantially. And so then the question becomes, okay, what if you are born in a time where, let's say the PE multiple is very high, stocks have done really well. Companies have done really well. And you know, part of what I try to show too. I mean, obviously you've got diversification, but there's times that you just have to admit that I have to put more money towards my investment, because I may not be in a period. I may not be the lucky one that was born in a period. You know, that was always going up. In fact, I think about my mother, Larry. She came to Thailand eight years ago, and her portfolio has done amazingly well. You know, like she I was like, you retired. You came to the end of your life at the perfect time when she's really drawing down that portfolio. Yeah,

Larry Swedroe 09:50

that example I gave you of the three periods where S, P underperformed, T, bills, if you happen to retire, you. Just then you get what's called the sequence risk, and your portfolio blows up. You might end up eating cat food because you're withdrawing from the portfolio early. And then when the market eventually recovers, you can't recover because you've drawn down the portfolio and you run out of money. What

Andrew Stotz 10:21

risk Did you call that?

Larry Swedroe 10:22

It's called sequence risk. So for example, in one of my books, I gave this example. So it's 1966 and now it's say 2024 stocks have probably returned something like 10% with 3% inflation. So you could think, knowing with certainty this happened, you could safely withdraw 7% a year, in real terms every year, and you'll have still the same amount of money you started with, and live nicely for that period. The fact of the matter is, if you did that, you were bankrupt in nine years, because the first few years the market crashed, and you draw down on that portfolio.

Andrew Stotz 11:15

So what? What do you do when right? What do you do when you are born at the wrong time, and you start investing, let's say, in your 30s, you start to have, you know, a sizable amount of money that you start to invest, and you make a prediction that I'm not going to get the same level of return as you know, my dad did or my mom did. What do you do in that case? Well, I

Larry Swedroe 11:38

wrote a book called your complete guide to a successful and secure retirement. Specifically addressing that in the opening of the book, I called it the four horsemen of the retirement apocalypse. And actually I then added a fifth for Americans. And the problem, or the four horsemen, was this, if you were looking back, as we said, stocks got 7% real returns. Bonds gave you a nice, real return as well. Stocks got roughly 10, let's say bonds got roughly five. So a 6040, portfolio may have gotten you 8% and you're thinking, Man, that's great. The problem is in 2020, when I wrote the book, PE ratios were in the 30s. Let's say so instead of a 7% real return, which is what you would expect if PES were 16, remember, we're going to invert the PE to get an earnings yield. So 16 PE, which was about the historical PE, we get a 7% real return. No coincidence, but when the PE is 30, like it is today, for large growth stocks, you should expect a 3% real return. If you then think inflation is going to be 2% the Fed's target, let's just use that so you're gonna get 5% on that 60% and bonds were yielding zero or one, all right, so there's no way you're gonna get 8% maybe you're gonna get three and a half or four, right? And now, how long can your portfolio last if you're withdrawing, say, 4% a year. Well, it will depend a lot on the sequence of returns. If they're good early and the portfolio is growing, then you could withstand withdrawals later. They start off. Let's use an example. It's 1973 and we'll just roughly play it. Let's say you had a million dollars. I think the market dropped like 25% in 73 so now you've got 750,000 and you said I could withdraw 7% and inflation was high, then I don't know what it was. Let's say it was six. So now you're going to take out 13% of the 750,000 that's 80 or 90 grand or so. Now you're down to 660,000 and the next year, the market's down another 20% so now you're down to 520 and now, yeah, and inflation was hiding, and you can see what's so even the next year, you're down to 400,000 and you're trying to withdraw that same 7% real you started with, even if the mark goes up 15% it only goes up to 460 but you're withdrawing 90 or 100 because there's been more, and you can very quickly See what happens. That's what's called sequence risk. So that was one problem there bonds and stock returns expected were much lower. Today, we're a little bit better because bond yields are better more near their stock but stock fees are still relatively high in the you. 22 range or so. So that would mean about a four and a half percent or so expected real return to stocks. Call it six and a half for your nominal maybe you get four. No, it's not even four anymore. 10 year bonds of three, eight. So you figure out if you get, you know, call it seven, and even four. A 6040, portfolio is going to get you about 6% you know. And after inflation, it's only four, right? So the other two problems everyone is facing this around the world, we're living longer, so your pie has to last longer at a time when expected returns are lower. And the fourth problem is, as we age, once you get above 70, the risk of dementia, Alzheimer, all those kinds of problems, increases, which means the need for long term care increases dramatically. I mean, it grows very rapid, like exponentially, each year. And then for US citizens, we have the Fifth Horseman, which is in now only eight or nine years, Social Security will only be able to pay out about 77% so you shouldn't count on getting your full benefits. So that's the problem. So you have to then say, I either need to plan on working longer if you're able, and we don't know always that that will be the case, you can lower your goals. You can save more. Or you could say, well, I'm going to move to, let's say, hope Arkansas and I can sell my million dollar Connecticut home and buy a nice $150,000 home and use those resources, right?

Andrew Stotz 16:58

Bangkok, Thailand, yeah,

Larry Swedroe 17:00

who moved to Thailand? There you go. I know a lot of Americans actually now go to Guadalajara or Costa Rica or Panama for that very reason. Yeah, they sacrifice other benefits to try to live a little bit better lifestyle.

Andrew Stotz 17:17

It brings you to an inevitable conclusion, and that is, if you are conservative in your assumptions about future returns, then you're going to have to con you know, the best option is to contribute more at a young age, because you sacrifice at a young age that money can compound. The last thing you want to do is contribute more when you're 55 because

Larry Swedroe 17:43

better than contributing less, but you lose all the benefits of compound.

Andrew Stotz 17:50

The other thing that's interesting is having some business revenue stream, or cash flow stream that some people like. For instance, I have my valuation master class boot camp, which I can run from my home, and it am I fully employed with that? No, but you know, it is something that I can generate a cash flow. And you could argue that, you know, maybe you're, you're working longer, you know, than my dad, who retired at 60. But when I look at my dad now, I'm just amazed, 22 years of retirement after working as a, basically as a technical salesman for DuPont all of his life, never having huge years or anything like that, not like big financial gains, but he managed to have a 22 year retirement that was comfortable. And when my mom came to sign them and my father passed away eight years ago, she still has enough money to survive comfortably. I'm just like, you can't

Larry Swedroe 18:45

live below his means, so then he can enjoy life later. And he didn't spend keep up with the Joneses and those things, and didn't buy, you know, today, $500 pair of Michael Jordan sneakers. You bought PF flyers for 10 bucks, right? Yeah,

Andrew Stotz 19:03

I had, you know, hand me downs and, you know, all of that stuff. So, yep. Well, Larry, I want to thank you again for another great discussion about creating, growing and protecting wealth, and I'm looking forward to the next chapter where, and by the way, this chapter reminded me of when I arrived in Japan in 1989 for my first trip outside of the US. And it was so expensive because that was the peak, as you mentioned in this chapter, but chapter 15 is individual stocks are riskier than investors believe. For listeners out there who want to keep up with all that Larry is doing, find him on Twitter at Larry swedro, and also on LinkedIn, this is your worst podcast host, Andrew Stotz saying, I'll see you on the upside now.