At the Money: The Right And Wrong Way to Invest

Investing can be complicated. But what if there was a simple solution? On this episode of 'At the Money,' Barry Ritholtz talks to Dave Nadig about one simple approach to the matter. Nadig is the Financial Futurist for ETF Trends and ETF Database. He has been involved in researching, reporting and analyzing the investment management industry for more than 20 years.

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Episode Transcript

Speaker 1 (00:11):
Investing is a complicated problem. What if I told you
a beautiful solution has been found? Investing is not easy.
How do you pick the correct asset class? Which sectors
do you buy? How do you know which are the
right stocks or bonds to own? Do you use leverage?
Do you hedge? Do you time? What about private equity,
hedge funds, venture capital? It's really complicated, or is it?

(00:35):
I'm Barry Redults and on today's edition of At the Money,
we're going to discuss investing as a problem that's been solved.
To help us unpack all of this and what it
means for your portfolio, Let's bring in Dave Kndig. He
is financial futurist at VETIFI and a well known ETF
industry pioneer. So I love this quote of yours investing

(00:59):
is a problem that's been solved.

Speaker 2 (01:01):
Explain well, what I mean by that quote, Barry, is
that I think a lot of people spend a lot
of time and energy and frankly emotion caught up in
the idea that they have to figure out investing. Right.
They have ten thousand dollars, they have one hundred thousand dollars.
They want to grow that for some purpose five ten
hundred years out, whatever it is, and they feel like

(01:22):
their job is to solve this puzzle and get all
those pieces just right, and if they get it right,
they win, and if they get it wrong, they're destitute.
And I think that's the wrong approach. The core of
investing is in fact, a solve problem mathematically. If you've
got a set of assets you can invest in. For
almost sixty eighty years, we've understood the fund fundamental math

(01:44):
of how you put that portfolio together to get a
certain pattern of returns for a certain level of risk.
There's nothing really all that interesting or complicated about that.
You can do all the math on your phone. There's
one hundred different apps you could download that will make
a model portfolio for you. That's not the part people
should be focusing on. I contrast that to advice. The

(02:05):
knowing what to do, when to do it, how to
do it. That's the really hard problem. That's where people
should be putting their energy.

Speaker 1 (02:12):
So let's break this up into a couple of different pieces.
If I say to the average lay person, investing is
a problem that's been solved, they're going to say, great,
what's the solution.

Speaker 2 (02:23):
Well, the problem with your question is that an advisor
then would turn around and say, great, how much money
do you have to invest? When do you need it back?
What's your tolerance for risk? There's another fifty questions you
have to ask before you get to the investment part.
Once you've gotten to the end of that chain of questions,
you know, oh, this, I have one hundred thousand dollars,
I need this in fifteen years because that's when my

(02:46):
kids are going to go to college. I understand my
tax situation, and oh I can put some of that
in a five twenty nine or I can't. Once you've
answer all of those questions, then constructing that portfolio, what
do I own to get a pattern of returns deliver
me the maximum chance of being able to put my
kids through college in fifteen years. Honestly, you can do
that in a target date fund, and that's most of

(03:07):
the math baked in for you. Anything you do other
than that is trying to get a different pattern of
returns that is inherently going to have more risk associated
so with.

Speaker 1 (03:16):
Target date fund For listeners who may not be familiar
with this, these typically are the default settings for a
one k's. They're managed by big fund managers, Fidelity, Vanguard, etc.
And they start out with a certain percentage of equities
and a certain percentage of bonds depending on how far

(03:36):
out eighty twenty, seventy thirty, whatever, And as time goes by,
they gradually lower the risk by raising the percentage of
bonds and lowering the percentage of equity.

Speaker 2 (03:46):
Fair enough to statement, absolutely, and it's very easy to
criticize those things. They're very naive, right, I buy a
twenty thirty fund, Okay, Well, how much is precisely in cash?
How much is precisely in international equities. There is a
decent amount of variation in between the Vanguard and black Rock,
and everybody's got a version of these things, So there
are differences between them. But the point is they're all

(04:07):
trying to do the same thing, and they're all basing
it on the same fundamental understanding of how asset classes
interact with each other. So that part of the problem
is not actually the difficult one. Making the decision to
do that and then sticking with it is the difficult part.

Speaker 1 (04:23):
Let's stick with the portfolio part, because when I hear
you say investing is a problem that's solved and knowing
your background working in the ETF industry and what you've
done for so many decades. I think of a low cost,
diversified portfolio of ETFs consisting of broad indices, rebalance once

(04:45):
a year. You're done. Am I making it to simple?

Speaker 2 (04:48):
I think it's actually that simple. I think that the
value of going further than that is fine tuning it
to your individual needs. Is rebalancing that once a year.
The best answer is rebound it once a quarter of
the right answer, there's a different answer for different people.
Is the honest answer there. But the math about how
you do it very straightforward. For most people, as you said,

(05:10):
a diversified portfolio of low cost indexed ETFs is going
to get you ninety percent of the way there. That
last ten percent, you know, do you get an active
manager to run to your bond fund. Do you put
a little bit of money in commodities or crypto or
real estate or something that's a little spicy. Those things
are really all about getting that last ten percent, those

(05:31):
last three miles of the marathon and having some energy there.
That's what that's all about. But the base of it
that the eighty ninety percent of your returns is just
about getting your money in the market and not making
any dumb mistakes. Big low cost ETFs are really good
at keeping you from making dumb mistakes.

Speaker 1 (05:47):
So I'm glad you brought it up that way because
Charlie Ellis wrote a wonderful book years ago, Winning the
Losers Game, where he makes the analogy to tennis. And
when you look at professional tennis players, they win by
scoring points. Sounds obvious, right now. You compare the professionals

(06:08):
to the amateurs, and they don't win by scoring points.
They lose by all these unforced errors. And what you're
describing is don't worry about the points, just avoid the
big mistakes. You're ahead of.

Speaker 2 (06:23):
Most people, absolutely, and it has nothing to do with
how smart you are. I think this is the other
thing people sometimes get upset about is when you say
something like this, they're like, well, but I'm smarter than that.
I can figure out something better than just buying a
target date fund. It has nothing to do with being smart.
It has to do with whether or not you're actually
going to be doing this every single day. So it's

(06:43):
those unforced errors. It's the panicking because the market went down,
so you sell out of everything, it's the thinking the
markets are a little bit too pricey, so you stay
out for six months and you miss a rally. Those
unforced errors really suck most of the returns out of
individual investor portfolios. And even at the institutional level, even
the folks that get paid to play the game, their

(07:05):
hit rates on these things are like measured in the
fifty one to forty nine percent rate. Nobody hits home
runs over and over again. Really good institutional active managers
hit singles more reliably than they should, and that's considered magic.
So the idea that an individual investor is going to
somehow do better than that is ridiculous.

Speaker 1 (07:24):
And I'm always fascinated by the concept of intelligence because
my experience almost thirty years in the markets, intelligence is
table stakes. Just to sit down at the table. Hey,
everybody doing this is really smart, and some people are
really really smart. But if it was just intellectual horsepower
that mattered and nothing else did well, then long term

(07:47):
capital management wouldn't have blown up as spectacularly as it did,
nor any of the past dozen funds that blew up.
These are filled with MIT and Harvard whiz kids who
are brilliant, right, But it's not just about intelligence.

Speaker 2 (08:00):
Well, it's not, because there's so much luck involved, right,
And I think people in the business are very reluctant
to point out how uncertain finance is. I'm not saying
that it's luck. Whether Tesla stock goes up or down.
There's always a reason, right, And gosh, the financial media
is really good at telling you the reason whatever happened
in the market happened. They'll tell you why, even if
they're just making it up.

Speaker 1 (08:21):
Well, that's the narrative fallacy large right, Hey here, let
me explain to you what just happens that I was
unable to warn you about an advance because I had
no idea.

Speaker 2 (08:29):
Right, So something as simple as market timing, like, oh gosh,
the market seems expensive, maybe I should take them off
the table. A very common sort of retail investor reaction
to seeing a lot of headlines. Whether you get that right,
and the math proves this over and over again, is
blind luck whether or not you actually time the market
correctly as a coin flip, and generally you're going to
get it wrong because you're going to be on the

(08:50):
wrong side of sentiment. So that uncertainty is the reason
why intelligence only gets you so far, because the way
you mitigate uncertainty is not by being smarter, it's by
being unemotional and managing risk really well. And for most investors,
the way you do that is you give the money
to a giant index fund and don't think about it
for as long as you can.

Speaker 1 (09:10):
That's really fascinating, you know, when you speak to certain
people like Annie Duke, who wrote the book Thinking and Bets,
one of the things that poker players where there's an
unbelievable amount of luck involved. One o the thing that
Annie Duke talks about all the time is avoiding resulting,
meaning looking at the outcome, looking at the results and

(09:33):
try and extrapolate backwards. What you need to do is
focus on the process. And sometimes a really good hitter
is going to strike out, and sometimes wood gets hit
on the ball and you get a double triple home run.
But a good swing with a well thought out strategy
at the plate doesn't guarantee anything, and people seem to

(09:55):
lose track of that.

Speaker 2 (09:56):
Yeah, and one of my favorite books, I think she
has a whole thing in there about learning to deal
with bad beats? Right, how do you deal emotionally with
you know, again and again doing the right thing, having
the right hand, and somebody who's just an idiot just
hits it out of the park and you lose, and
then you lose again. And that is a very common
story in investing. And I think that people, particularly folks
who who think about investing, who are attracted to individual investing,

(10:20):
they think about stocks and performance and fundamentals. I think
those types of folks are the ones that are most
in danger of making bad mistakes because you can be
wrong on fundamentals for a very long time. Even if
you were right on the underlying truth right, the market
cannot reward you for a very long time. Your brilliant
stock can go from a PE of twenty to a

(10:41):
pe of eight for reasons you don't understand right.

Speaker 1 (10:45):
There's an old expression, never confuse a bullmarket with brains.
The flip side of that is a rampaging bull market
covers up a lot of errors. I love the way
the book thinking in bet starts. I don't remember which
team it was and whether it was a Super Bowl
or I think it was a conference game where the
coach goes on goes for it on fourth and one

(11:07):
stopped at the goal line. The other team gets the
ball and scores, and the coaches excortiated, why don't you
go for a field goal? But she defends that decision
as statistically speaking, this is your best outcome. Hey, you're
down by seven. If you're not going to get the
ball in now, what makes you think you get a
field goal and then march all the way down the

(11:29):
field and score again. It was the right process, and
unfortunately it's not guaranteed. You had a bad outcome. You
have to work past that and stick with the good process.

Speaker 2 (11:39):
And you have no alternative as an investor, right, I mean,
the insurance industry would try to sell you a lot
of products that guarantee you things, but there aren't no
free lunches, and you certainly cannot guarantee market returns. If
you're going to be an investor and you're going to
do something other than just clip coupon's on your thirty
year treasuries for the rest of your life, you have
to be willing to accept some level of uncertainty.

Speaker 1 (12:00):
And that's just the way it is. And investing is
a probabilistic exercise, using imperfect information to make decisions about
an unknowable future. That sounds to me like the definition
of uncertainty exactly.

Speaker 2 (12:14):
And when I say it's a solve problem, I mean
the overlaps with quantum physics are endless. Right, we are
working living in a probabilistic world. Investors have to get
comfortable with that. That's why it's a solved problem. We
understand the parameters, we understand how historically things have reacted
alongside of each other, but that doesn't mean that's how
they're going to react tomorrow.

Speaker 1 (12:34):
So let's sum this up. Investing is complicated, especially if
we make it complicated. But if we want to take
a simple solution, it's not that difficult. Own a globally
diversified set of low cost index ETFs, rebalance those ETFs
once a year, have a good night. That's all that's necessary. Sure,

(12:58):
we can make it more complicated, we can think about
lots of other aspects to this, but that solution will
work for the vast majority of investors. And as Dave suggested,
that solution isn't even the most important aspect of your investing.
It's why are you investing? What are your goals, what
are your risk talentses? And how does this portfolio fit

(13:21):
into what you hope to accomplish. That's the variables that
are complicated, but investing itself, it's a problem that's been solved.
You can listen to At the Money every week, finding
in our Masters and Business feed at Apple podcasts. Each

(13:42):
week we'll be here to discuss the issues that matter
most to you as an investor. I'm Barry Ritolts. You've
been listening to At the Money on Bloomberg Radio.