Crunching the Numbers: The Science of Investing, With Researcher and Author Larry Swedroe

Episode: 187
Guest: Larry Swedroe

Originally Aired: February 8, 2017

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:

  1. Introduction of Larry Swedroe
  2. Investment Lessons from 2016
  3. Active Money Management Is a Loser’s Game
  4. Passively Managed Funds Outperform Index Funds
  5. Better Value Justifies Higher Operational Costs
  6. Best Returns Occur When the Unexpected Happens
  7. Resist the Urge to Panic and Sell
  8. Good and Bad Sides of Donald Trump Will Disrupt Markets
  9. Emerging Markets Attractive to Investors Who Can Handle Volatility
  10. Investors Would Be Smart to Ignore All Market Forecasts
  11. Keep Your Political Views Out of Investment Decisions
  12. Trump’s Opposition to Free Trade Is Dead Wrong

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction of Larry Swedroe

Dan Weinberg: And welcome to the Lange Money Hour. I’m Dan Weinberg along with Jim Lange, and our guest this week is Larry Swedroe, a noted researcher and nationally recognized investment expert. Larry is director of research for Buckingham Strategic Wealth. He has authored 15 books, including his latest, Your Complete Guide to Factor-Based Investing, as well as Think, Act & Invest Like Warren Buffett, among many others. Larry has made numerous appearances on TV, sharing his ideas with viewers of NBC, CNBC, CNN and Bloomberg Personal Finance. As a researcher, Larry has earned a reputation for evidence-based investing and exposing misinformation coming out in the mainstream financial media. Over the next hour, you’re going to learn what alpha is, why most investors don’t take Warren Buffett’s advice, why active money management is a loser’s game, and we’re going to spend a significant amount of time on Larry’s list of some of the lessons we learned from the market in 2016. With that, let’s say hello to Jim Lange and Larry Swedroe.

Jim Lange: Welcome Larry. It’s always a pleasure to have you on the show.

Larry Swedroe: Thanks for having me back. Great to be with you.


2. Investment Lessons from 2016

Jim Lange: Well, I’ll tell you, you know, you sent me a whole bunch of things that we could talk about, and, of course, your book, Factor-Based Investing, which is your most recent, is excellent. But I thought for our listeners, the intelligence report that you put out, called “Lessons From 2016,” was spectacular, and it also happens to be consistent with what you have been advocating, what, for 15, 20 years? So I thought if we could go through some of those lessons, that our readers and listeners would get a lot of information from the program. So would that be OK if we went through some of those valuable lessons?

Larry Swedroe: Yeah, sure, that’d be great. Just for your listeners’ benefit, if they’re interested, my blog, which is on www.etf.com, and I’ve been writing for several years there, a couple of weeks ago, they posted this series and you can find it under my name there, and your readers can follow it there, but they should also know that I’ve been writing this lessons-learned piece now for, I think, something like 10 years because every year, the markets do provide us with lessons on the prudent investment strategy, and, many times, the markets provide us with, what I call, remedial courses, meaning they cover lessons that it provided in previous years. So most of the lessons, or, at least, many of the ones that the market taught in 2016, you would’ve found in my lessons learned in 2015 and ’14 and ’13. Unfortunately, many investors keep doing what Einstein said is the definition of insanity and repeating the same mistakes over and over again.

Jim Lange: Could you repeat the resource that our listeners could go to if they wanted to read both that blog as well as many of your other helpful blogs?

Larry Swedroe: Yeah, sure. The website is www.etf.com, and that’s the general section, so you could do a search under my name, but they also have a section called “ETF News and Strategy.” If you highlight that, a dialog box opens up and there’s a section called “Index Investor Corner,” and then you’ll get a list of every blog I’ve written for as far back as you’re willing to go.


3. Active Money Management Is a Loser’s Game

Jim Lange: OK, great, but the simple thing is to go to www.etf.com, type in Swedroe, and there it is.

So why don’t we get into the meat of the program, and let’s talk about lesson Number 1: active money management is a loser’s game, and by the way, that’s a similar phrase that Charles Ellis wrote a book called The Loser’s Game. So why don’t you tell us what the loser’s game is, and then maybe tell us why?

Larry Swedroe: Yeah, so, Charles Ellis, his first book came out literally at the same time my first book came out, and I think every one of your listeners who hasn’t read it, his book is certainly a classic, and Ellis called active management a loser’s game, and you can define a loser’s game as one that, while it’s possible to win, the odds of doing so are so poor you shouldn’t try. So you obviously can get rich buying lottery tickets, but you wouldn’t take your retirement account to the lottery-ticket office, you wouldn’t take it to the racetrack if you’re intelligent, either, and Ellis would say perhaps you shouldn’t take it to the Merrill Lynch or Goldman Sachs or TD Ameritrade or whatever office because, while it’s possible to outperform the market, picking stocks and trying to time it, the odds of doing so are so poor, and yet, year after year, the vast majority of investors pour the vast majority of their money into active funds, not index funds. And every year, Jim, active managers come up with excuses about why they failed, but then try to tell you why this year will be different. So what I presented here was a perfect example of why all of the nonsense that active managers use as excuses for their failure is simply nonsense. So last year was a very typical year in the sense that we had a very wide dispersion of returns. The S&P return, 12 percent. Twenty-five stocks returned almost four times that, at least. So 25 stocks returned at least 46 percent, and 25 stocks lost at least 23 percent, so underperforming the S&P by at least 35 percent.

Now, obviously, this should have been very simple to outperform the market, right? All you had to do was overweight the top 25 performers and underweight, or totally avoid, the bottom 25 and you would’ve blown away the market, and yet, the vast majority of active managers failed to outperform. And what I show here in 2016, which was a pretty typical year, Vanguard’s index funds had an average ranking of 37, which means they outperformed 63 percent of all of the active managers, and even better, the fund families that I use mostly in our firm, the funds of Dimensional Fund Advisors, which I think of them as more sophisticated versions of index funds, had a ranking of 18, so they out performed 82 percent, and even better, Jim, when we look at 15 years and we adjust for survivorship bias, the Morningstar data, which anyone can find, unfortunately excludes funds that are disappeared and, of course, the ones that are disappeared are done poorly. But I added those funds back in, got a hold of the data and made the adjustments. To do that over the last 15 years, Vanguard’s index funds have outperformed 79 percent of active managers, and the DFA funds have outperformed 90 percent. I don’t like those odds working against me. Clearly, the vast majority of investors would have been better off simply using index funds or the passive funds of Dimensional Fund Advisors.

Jim Lange: All right, as you probably know, Dimensional Fund Advisors are the set of index funds that our firm recommends to clients and that we work with.

Larry Swedroe: Shows you what a smart man you are, Jim!

Jim Lange: Thank you, but frankly, the real beneficiaries are my clients.

Larry Swedroe: Right.

Jim Lange: Why would one set of index funds, and I know that DFA is a little bit of a hybrid; it isn’t exactly a pure index fund, but it’s still ultimately not active money. It’s passively managed. Why would one passively managed set of funds outperform, let’s say, the Vanguard S&P 500, which is what most people think of as the benchmark to beat, and you’re saying four out of five companies fail to beat it and actually underperform it.


4. Passively Managed Funds Outperform Index Funds

Larry Swedroe: Right, well, they didn’t underperform necessarily the S&P. For 80 percent on average underperform if they were in that, call it, asset class of large-cap blend stocks, and so, for example, over the last 15 years, with the survivorship bias and the data, Vanguard’s 500 fund outperformed 74 percent of all of the active funds. But you have to compare things on a apples-to-apples basis. So, for example, the DFA small value fund should be compared to, say, an active manager who invests in small-value stocks, not an S&P 500 because they have very different risk and return profiles. The DFA small-value fund outperformed 98 percent even before survivorship bias. So we want to make sure we’re comparing apples to apples here.

Second thing, to answer your question, is this: People can debate whether something is active or passive. There’s a lot of what I call semantical arguments here. So you could even argue while most people would say an S&P 500 index fund is passive, it really isn’t if you want to take an extreme point of view because if it was purely passive, it would own the top 500 stocks, but the S&P isn’t run that way. There is a committee that chooses 500 stocks that they think fairly represent all of the major industries, but they think they’ve chosen somewhat stronger companies, whatever. So it is a committee that is actually choosing it. So if you want to make the case, I wouldn’t argue it’s active, where if you bought the top 500 stocks, that would be passive.

Now, second point I want to make is DFA, while you and I would agree they’re passive because they do no individual stock picking and no market timing, they are in index funds because they don’t try to replicate any individual indexes, and, in my mind, any index fund except a total market fund is really a dumb index, and really, in general, investors can find better alternatives. So there are just some pure negatives of indexing. One is simply that, for example, if a small stock leaves its index, it immediately must be sold by an index fund at the same time every other index fund is selling it, and that creates very large transactions cost, and active managers can actually gain the system, knowing they’re going to trade sell ahead of it and exploit that. There are some negatives of indexing that are like that. The DFA funds avoid all of those negatives, or minimize them through their structure, and that allows them to outperform. So, for example, in the last 15 years, the Vanguard small-value fund has underperformed the DFA small-value fund by something, if my memory serves, like 1.1 percent a year, and I can explain to people why that is pretty simply. So here’s a way to think about it. Small stocks outperform large stocks, right Jim? Because markets perceive them as riskier. It doesn’t happen every year, but that’s what you should expect in the long term, correct?

Jim Lange: That’s right.

Larry Swedroe: All right, so most people think of two small-value funds, especially if they’re passive, should be similar, but because of the index Vanguard chooses to replicate, the average stock in that index — and by the way, you can look up this data on www.morningstar.com — has a market capitalization of about $3 billion. Now that doesn’t sound actually all that small to me, but, at any rate, that’s the figure. If you look at the DFA fund in that same category, it has an average market capitalization of less than a billion-and-a-half. So it means it’s much smaller, and therefore has a higher expected return. Now, if you look at the value portion of those same two funds, the Vanguard fund has a higher P/E ratio, for example, than the DFA funds, something maybe like 18½ versus 17½. So the higher price-to-earnings you have, the lower expected returns are. So DFA’s fund is smaller and more valued because it chooses to define stocks that it will buy its universe in a different way that gives it deeper exposure to these factors, and, in the long term, that should result in higher returns. So structure matters in how funds trade. One last thing is a good example: Vanguard’s index fund will sell the stock as soon as it leaves an index. DFA’s fund will stop buying it, but it may not sell it right away. It will put it in a hold category for a while and eventually sell it off slowly over time rather than trying to sell it immediately and maybe have large trading costs. So there’s a couple of examples.

Jim Lange: OK, so the trading cost has won, but I think the thing that people can understand, and frankly, I think accounts for probably the lion’s share of the difference, just on the issue, for discussion’s sake, of size and price/earnings ratio, that the smaller companies, very small, like 1.5 billion, historically have done better than companies that are, say, twice that big at 3 billion, and one of the reasons why the DFA small would outperform Vanguard small was because the DFA’s are actually much smaller.


5. Better Value Justifies Higher Operational Costs

Larry Swedroe: That’s exactly right. The Vanguard fund, over the last 15 years, has returned 9.67 percent. The DFA fund — I’m actually just pulling it up, so to make sure your listeners have the latest information, it’ll take me one more second — has returned 10.84 percent. Now most people would think, “Why shouldn’t I buy the Vanguard fund? It’s a hell of a lot cheaper. Its expense ratio is only eight basis points. DFA’s fund costs 52.” But it’s that higher exposure to the size and value factors, as well as more patient trading and some other things it actually does that are based upon academic research. So DFA funds, for example, even if it’s in that size bracket, if that security has large investments and low profitability, it won’t buy it at all. It screens it out because the academic research says that those types of stocks have very poor returns. So it’s not in their eligible universe even though it might be in an index. They won’t buy IPOs. They won’t buy stocks trading under $2 because they, historically, have poorer returns as well. So they don’t decide “I’ll buy this IPO but not that one,” they just screen out all these stocks with these negative characteristics, and so the DFA fund is outperformed by quite a bit, even though it costs 44 more basis points a year to run. So it’s the value that matters. The value added is higher than the extra expense.

 

Jim Lange: All right, well, I think that that is helpful. So why don’t we go on to the second lesson? So the second lesson that you write about is that returns come in very short and unpredictable … and I think that short is maybe relatively understandable, but maybe if you could answer that question: Why do returns come in short, but more importantly, unpredictable bursts?


6. Best Returns Occur When the Unexpected Happens

Larry Swedroe: Well, if they were predictable, they wouldn’t happen in short bursts. Everyone would know when they’re coming, and it would happen immediately on Day One as soon as information became available. The problem is, most returns occur because something unexpected happens, and a great example is last year. If it’s unexpected, by definition, it can’t be predicted. So the DFA small-value fund — I use that example — had a great year. It was up 28.3 percent. But through October, it had a pretty average year. It was up about 8 percent, certainly not a bad year, but it was up 8 percent. In other words, November and December were up, those two months, 18.8 percent. Now, that all happened basically after Trump’s victory, which, I think, almost everybody would say was not a predictable event, and, in fact, most people were betting that if Trump got elected, the markets would crash, but that didn’t happen. So there’s a great example of what we mean by that one case. I go on to point out some great examples from history I dug up. Looking at the academic research, there was a study called “Black Swans and Market Timing,” meaning how not to generate alpha. It looked at 107 years of data, ending in 2006. There were over 29,000 trading days. If you took out the best 100 of those days, you lost 99.7 percent of the returns. 99.7 percent. So 100 days out of 29,000, that tells you it clearly must be unpredictable. Nobody could identify ahead of time the best 100 days. Now, I will tell you, the same thing is true of the worst 100 days. If somehow you could’ve avoided those, you probably would’ve avoided almost all the losses. But nobody can tell you, out of 107 years, which’ll be the worst 107 days.

Jim Lange: I’m finding this very interesting. I don’t know if we’re going to get to all our lessons, and I would love to continue with lesson three, which is events occur that no one predicted, and I will also mention that Larry is a prolific author, has written, I think, 15 books, the most recent being Factor-Based Investing, which, I think, is a wonderful book. My favorite is Think, Act & Invest Like Warren Buffett, and the other resource is if you go to www.etf.com, and, in the search bar, type in “Swedroe.” You will find a wealth of information from a very bright guy who has nothing but the consumer’s best interests at heart.

Larry Swedroe: Well, thanks very much, Jim. I appreciate that.

Jim Lange: Well, I mean that sincerely. I think you’ve played that role probably your whole career, but certainly since I’ve known you and known of you.

So the third lesson is, events occur that no one predicted. So why don’t we talk about some of the big events that did occur that no one predicted and what the lesson is regarding events occurring that no one predicted?


7. Resist the Urge to Panic and Sell

Larry Swedroe: Well, I think the two I chose to highlight here were two events that shocked all of the pollsters, the experts. One was Brexit, that no one thought would happen, or certainly very few, and on top of that, they thought if it did happen, it would be a disaster for the market, and when it did happen, the immediate reaction was, of course, highly negative, but, of course, markets then immediately turned around, and if you panicked and sold, you really suffered. And the second, of course, was Donald Trump’s election, which almost nobody predicted, and the immediate reaction was exactly what people thought might happen, which was the market dropped 800 points, and, of course, we now know that the market went on a nice rally right after that, and again, if you had sold at the bottom with the first wave of panic selling, now you’re stuck and you don’t know what to do because you still got Donald as president, but the market’s higher. How do you get back in? That’s one of my warnings to people: you should never panic and sell. By the way, Warren Buffett never panics and sells, and he’s actually bought one of his largest investment commitments in a long time since Trump was elected. So I think you might ask yourself, if you’re tempted to panic, ask if Warren Buffett’s panicking. The answer’s generally going to be no, and then ask yourself “What do I know that Buffett doesn’t know, and maybe I ought to do what he does and emulate him, and not give in to my emotions.” So that’s a good lesson for people right there.

Jim Lange: Can we talk about Donald Trump for a minute?

Larry Swedroe: Sure.

Jim Lange: And I don’t mean to get political, but I will be honest with you. I was very surprised that the markets did so strongly, and, particularly, as you pointed out earlier, the small companies did extraordinarily well in November and December following his election. Why do you think that is? Maybe, in a way, what you’re going to say is, it doesn’t matter. Why doesn’t it matter?


8. Good and Bad Sides of Donald Trump Will Disrupt Markets

Larry Swedroe: No, I think it does matter, Jim, and first, I’ll tell you I voted for Charles Krauthammer. That was my write-in vote for president. So, you know, I’m certainly not pro-Donald Trump. But with that said, actually, I think, here’s my advice for people: so, one, I think, even those who are not for Trump, you need to recognize that there’s actually two Donald Trumps here. Think of him as the Good Donald and the Bad Donald. The Good Donald, which is the one that dominated the markets early, is anti-business regulation, free the animal spirits of capitalism up and you’ll get much better growth. A lot of business regulation strangles businesses. It’s really unnecessary. For example, in my view, Dodd-Frank was one of the single worst bills ever written, and no bill written that has 2,000 pages could possibly be good, but what most people don’t know is that since Dodd-Frank, 25 percent of all the small banks in the U.S. have disappeared. The small banks make virtually all the loans in the United States to small businesses. Small businesses create, on average, more than 100 percent of the new jobs in the country. So if you don’t have small banks to lend to small businesses, that’s one of the good explanations for why this economy has been the weakest recovery in post-war history. That’s just one example. So the hope is if regulations could be peeled back — it doesn’t mean you have no regulations, but you don’t have regulations that strangle businesses — we could get a lot more growth. That’s part one. Part two of the Good Donald is cutting back corporate income tax. Now, every single economist you talk to will tell you the corporate tax rate should be zero. There’s virtually no debate on it because corporations don’t pay taxes. The buyers of products pay the tax, and the only intelligent way to tax that is through a VAT, or a consumptions tax. That would be far more intelligent. So cutting a bad tax rate, where we’re disadvantaging U.S. corporations and putting them at a huge disadvantage, will certainly be helpful. It could lead to a lot of capital coming back to this country and stimulate growth. That’s what the market looked at initially. Now we’ve had more volatility, and some days, some not such good action, because the Bad Donald is showing up. Anti-immigration, which is a strong force for growth in the U.S., and this whole nationalist attitude, not good. We could see trade wars as a result, and the other problem with our president is the uncertainty, because nobody knows what will come out of his mouth the next minute, and markets hate uncertainty. So what I think is what you’re likely to get over the next four years is a lot of volatility as markets move between the Good and the Bad Donald, and which is dominating at any one point in time, and if you can’t stand volatility, then you probably should be de-risking your portfolio.

So let me get to some real quick advice there. So de-risking means removing some equity risk from the portfolio, and here’s some suggestions that you can take without lowering the expected return of the portfolio. Suggestion one is lower your equity allocation but raise your allocation, the remaining portion, to international and emerging markets. The U.S. currently has much higher valuations, which means much lower expected returns. U.S. expected returns, most economists think about 6 percent, developed markets more like 8 percent or 8½ percent, and emerging markets more like 10½ percent or so. So if you own higher expected returning assets, you can own less of them to get the same expected return. So that’s one thing investors could do, and I urge people to move towards, if not have 50 percent U.S. and 50 percent international, because that’s the way the markets are allocated.

Jim Lange: By the way, Burton Malkiel was on the show and he said something very similar. He talked about the price-earnings ratios of the emerging markets being very favorable.

Larry Swedroe: They’re about 12 developed, about 15, and the U.S. about 28. That’s the CAPE 10 numbers.


9. Emerging Markets Attractive to Investors Who Can Handle Volatility

Jim Lange: And he made the case that most investors, and particularly for long-term investors who could handle a little bit of volatility, should be involved in these markets, at least to some extent.

Larry Swedroe: I think you should have 50 percent U.S., three-eighths developed, one-eighth emerging, and that’s because that’s how the markets allocate capital, and I’m not smarter than the markets. Now, if you’re willing to take more risk to shoot for a higher return, you could do more than that, but I wouldn’t stray far from there. Most U.S. investors have very low international allocation, an average of about 10 percent. I think that’s a very bad error. Just too much concentration of risk. Second thing you could do, Jim, is the equities you hold, let’s say, in the U.S., instead of owning, say, an S&P 500 fund, own a small-value fund. Small-value stocks have gotten about, at least if you’re buying the kind DFA buys, 13½ percent versus the S&P 10 historically. So if you own higher expected returns, you can own less of the equities and then own more, say, bonds, which will protect you if markets actually crash. Now, I wrote a book called Reducing the Risk of Black Swans. For investors who are interested in that strategy, you will find that, historically, that has been a far superior strategy over the long term than investing only in a total market or an S&P 500 fund, a far superior strategy of owning less equity, but the equities you own having really be in the riskier portion of the market.

Jim Lange: Well, I think that that’s terrific, but before we go on to the next lesson, I wanted to throw in one other potential explanation of why the small companies did so well. So a lot of the corporations obviously have top tax attorneys who finagle around so that not that many of the big companies are actually paying the top income-tax rate.

Larry Swedroe: No, the average is 25 percent, not 38 percent, or 35 percent, I think, is the corporate rate. But the average is about 25 percent.

Jim Lange: Right, but if we’re going to take your words to heart and that the smaller companies are the ones that are more profitable, and many of the smaller companies are Subchapter S or LLCs that are taxed at the individual rates, even a small company like my own, if Donald Trump is successful in lowering the taxes, then that will not just help the big corporations, but that will help the, let’s call it, small-business owner …

Larry Swedroe: Oh, absolutely. I would completely agree.

Jim Lange: … and that might be one of the reasons.

Larry Swedroe: Yeah, absolutely. I don’t think there’s just one issue. I think I gave you the two biggest ones, but you’re absolutely right. I think that certainly played into it.


10. Investors Would Be Smart to Ignore All Market Forecasts

Jim Lange: OK, so let’s now talk about something that’s a little bit controversial, which is ignoring all forecasts. All crystal balls are cloudy. So it’s really interesting. You see all these talking heads on TV, and they’re talking about either a particular stock or even a particular year or particular segment, but ultimately, they are forecasting, or you get a guy like Jim Cramer who is talking about different trends and different things that could happen. And by the way, I shouldn’t say anything bad about Jim Cramer because if you actually invested in everything that Jim Cramer recommended when he recommended it, you would have $1 million today … if you started with 2 million.

Larry Swedroe: Right!

Jim Lange: But why should investors ignore all these talking heads and all these articles that are predicting what might happen?

Larry Swedroe: Yeah, well, for those of your listeners who are interested, there’s actually good scientific evidence. There’s a wonderful book called Expert Political Judgement that did a study of the science of forecasting, not just in economist and stock-market forecasters, but medicine, science, et cetera, and they found, basically, that there are no good forecasters in any field, period. They basically don’t exist. But the evidence is overwhelming that that is true in the stock market, but if you don’t like my advice, again, I would suggest if you ask people who was the greatest investor of all time, at least of our generation, the vast majority would say Warren Buffett. Warren Buffett has told investors that you should never pay attention to any forecasters because a forecast tells you nothing about where the market’s going, but it tells you a lot about the person, and I recently heard him say he hadn’t read or listened to a market or economic forecast in 25 years. So again, you might ask yourself before you’re going to follow some forecaster’s advice, are you smarter than Warren Buffett? So my advice is don’t, and I’ve listed here, I think, six or seven forecasts by well-known people, chief economists for major banks, who warn, one after another, of disastrous forecasts. For example, Charles Robinson, a chief economist, he predicted that, in July, stocks would crash 56 percent within the next 12 months. Well, he’s still got a little bit of time to be right, but, in the meantime, the market has done quite well, and Carl Icahn, one of the great investors of all time, right? A big name. He said, in May of 2016, that the market was in for a day of reckoning, and I’m putting my money where my mouth is. I have a net-short position of almost 150 percent. So there’s a whole list of these there, your readers can read them, and every one of them turned out to be wrong. Now I will admit, I was cherry-picking. You probably could’ve found some forecasters who got it right. The problem is, how would you have known which ones to listen to and which ones to avoid? The evidence says there are no good stock pickers.

Jim Lange: And before we get to the next lesson, I’d actually like to skip to lesson six.

Larry Swedroe: Sure.

Jim Lange: I want to give our listeners two resources: one is your blog, which can be found at www.etf.com, and then, in the search bar, type in “Swedroe,” and I think I botched the name of your Warren Buffett book.

Larry Swedroe: It’s Think, Act & Invest Like Warren Buffett.

Jim Lange: OK. I know that you’ve written 15 books, and I’ve read a number of them. That one is my favorite. Think, Act & Invest Like Warren Buffett.


11. Keep Your Political Views Out of Investment Decisions

Larry, what I’d like to do is go out of order in case we get cut off near the end, because I actually think your lesson number nine, don’t let your political views influence your investment decisions. And I think that that is a really important lesson. I believe that the majority of the listeners of this show are probably a little bit right-leaning and tend to be Republican. On the other hand, I work with a lot of college professors, and they are probably very left-of-center, and most of the left-of-center people that I know are in total misery, and not just, let’s say, civil rights and international, et cetera, et cetera, but they are also anticipating doom and gloom for the economy, where some of our friends on the right are, perhaps, overly optimistic, thinking that Trump is going to be the answer to all their problems, and it looks like your lesson number nine might be that they’re both wrong. Could you give us your views on why you shouldn’t let your political views influence your investment decisions?

Larry Swedroe: Yeah, the reason is, we’re all subject to something called confirmation bias, and so if you’re … a Democrat now, and then you read something that’s going to tell you that Donald Trump is a disaster for an economy, his anti-trade policies are really bad, he’s going to stoke inflation and budget deficits or whatever they’re saying that’s negative, it will confirm your biases, and then you will tend to want to panic and sell and stray from your well-thought out plan. On the other hand, if you’re a Republican who has heard that, you will develop cognitive dissonance. You’ll say, “Oh, that can’t be right. This person doesn’t know what he’s talking about. He’s just biased.” And you’ll ignore it, and you’ll actually be a better investor for that. And the reason is the following: There’s actually academic research, specifically a paper called Political Climate Optimism and Investment Decisions, that found the following: that, as individuals, we become optimistic and perceive the markets to be less risky and more undervalued when the party we favor is in power. This leads them, generally, to take on more risk, overweight riskier stocks. They also tend to trade less, and that’s a good thing because we know, the evidence is very clear, the more people trade, the worse they tend to do. So if you’re just going to stick with your plan, take risk, you’re, in the long-term, likely to do better. The opposite is true. When the opposite party is in power, you become more concerned about uncertainty, you exhibit even stronger behavioral biases, leading to poor investment decisions. And here’s a perfect example of that, Jim. I just recently read, there’s a newsletter I get called The Spectrum Affluent Investor & Millionaire. They publish confidence surveys, and they found this very interesting thing: Prior to the election, if you were identified as a Democrat, you had much higher confidence than those who were Republicans or independents. This completely flipped after the elections, where Democrats registered a confidence reading of -10, Republicans a +9 and independents +15. So here’s the problem and what I can tell you. From 2000 to ’08, my experience was Republicans were much better investors. They tended to stay the course, didn’t panic and sell after 9/11. If anything, they rebalanced and stayed the course because they were more optimistic that the administration would solve the problem and get it right. All the calls that I was getting during those eight years were virtually all from Democrats, liberals. In the next eight years, the exact opposite was true. The Democrats became much better investors. They tended to stay the course, rebalance, et cetera. It was the Republicans who were convinced that Obama would destroy the economy, et cetera, and they ended up much worse investors. Either they panicked and sold or, at least in rebalances, they should’ve, and now it’s flipping again. The key thing is have a well-thought out plan. Stick to it. This country has survived 250 years. We survived George Bush, who, I think was one of the worst presidents we’ve ever had, and I tend to vote conservative. We survived Obama, who, I think was one of the worst presidents we’ve ever had, and I think we will survive Donald Trump, who may turn out to be as bad or worse than either one of them. I’m confident in our democracy and our economic system.

Jim Lange: I’m sorry, everybody here at the station is cracking up! It’s good that you don’t like anybody.

Larry Swedroe: There are plenty of people that I would’ve liked. As I said, I voted for Charles Krauthammer.

Jim Lange: Well, interestingly enough, we actually have a guest on, and I mainly have him on because he provides such great information regarding Social Security, a guy named Larry Kotlikoff, who, I think, is a brilliant economist.

Larry Swedroe: A very smart guy.

Jim Lange: And he ran for president, and his premise was that none of these guys know anything about the economy, and that the amount of debt that this country has is significantly understated, and only an economist really understands it and that’s why he wanted to run.

Larry Swedroe: Well, so here’s why, while I would not have voted for Trump, I remain optimistic because I’m hoping that Paul Ryan will actually be setting the economic agenda, and Ryan would agree completely with Kotlikoff and is trying to attack the problems of the budget deficit, the entitlement programs that need to be fixed, and why I thought Bush was an awful president because he blew up the budget deficits and did not do anything about them. Obama made it worse and did nothing to correct the problems. Ryan is the only person in Congress virtually standing up and saying “We must fix these problems.” So I’m hoping. I’d much rather be an optimist than a pessimist. It’s much more fun going through life that way. So I’m hoping Ryan is the one who’s controlling things. So I have the exact same plan I had eight years ago and 17 years ago and I stuck with it through Bush and through Obama and I’m sticking with it through Trump. Again, I’m an optimist that our democracy and our capitalist system will get it right in the end.

Jim Lange: And finally, I don’t think we have a lot of time left, but one of the things I found very interesting, of course, there’s massive protests against Donald Trump and his immigration policy, but one of the very interesting protestors who are trying to organize Republican senators to rally around his cause is not people on the left, but actually the Koch brothers, who are objecting to limiting trade, and they are free traders. I happen to be a free trader.

Larry Swedroe: Same here.

Jim Lange: Can you comment? And, perhaps, it might be the last thing that we have time for. Can you comment on Donald Trump’s position on free trade, and whether that can help or hurt?


12. Trump’s Opposition to Free Trade Is Dead Wrong

Larry Swedroe: He’s really wrong on this. He’s got it dead wrong. Now, he may have it right that we have been taken advantage of and gotten some deals poorly. Tax structure can solve some of it, so whether you use a border tax or cut our corporate income tax and substitute it with other types of taxes, but you do not want to start trade wars. The worst thing we could do is start slapping tariffs on. Then what happens is you get countries retaliating. That’s exactly what fueled the Great Depression, the Smoot-Hawley Tariff, which was designed to protect American businesses. Worse is that it can lead to wars. If you want to make sure the world is safe, trade with people and help them make their country safer. If you can help the Mexican economy, fewer people will leave Mexico to come to the U.S. They’ll buy more of our goods, and we all win. The worst thing Donald Trump, his worst position, is on trade. There, he is a complete disaster, in my opinion.

Jim Lange: Do you think that his view will win, or do you think that the more traditional Republican free traders will ultimately win that battle?

Larry Swedroe: I don’t have a clear crystal ball. Certainly, I’m not a political forecaster, but if I had to guess, or, what I’m hoping is, I think you’ll end up with some kind of compromise that pulls him in an intelligent direction. A lot of it could have been bombast to win the election, appealing to these nativist instincts, because most people don’t understand how important free trade is, and once you get through that and he listens to people who make the arguments, then maybe he can pull people like Ryan, and others can pull him back towards a more intelligent position and solve some of the trade-issue problems through the tax structure.

Jim Lange: All right. Well, we have about two minutes left, and one of the things I sometimes like to do when I have such a knowledgeable and valuable speaker is, do you have anything that I haven’t asked that you think would be good for our listeners to know in the final two minutes?

Larry Swedroe: Yeah, the one thing I could suggest is there’s been a lot of talk in the industry about the term “smart beta.” I personally hate that term. It led me to write a book called Your Complete Guide to Factor-Based Investing, which really gets at this issue of investing in factors in what is called smart beta. So for those of your listeners who are interested in learning about factor-based investing, I’ve written really, I think, the first book. As is typical with my books, it’s filled with the academic research. We cite 106 studies providing you with the evidence so you can draw your own conclusions rather than relying on my conclusions and those of my co-author. So I’ll recommend to readers who are interested in the science, pick up a copy of Your Complete Guide to Factor-Based Investing, and I’ll close by saying readers of my books, I’m always happy to answer questions. Just e-mail me, and I return every e-mail I get.

Jim Lange: All right. Larry, this has been a very informative show, and listeners, I really highly recommend that you take advantage of two of the resources that Larry has mentioned. Your Complete Guide to Factor-Based Investing is a little bit more intense, but for people who are looking for something a little bit simpler, www.etf.com, and, in the search bar, type in “Swedroe,” and the book, Think, Act & Invest Like Warren Buffett, by Larry Swedroe. Thanks again, Larry.

Larry Swedroe: Take care. My pleasure.

Dan Weinberg: All right, and listeners, if you’d like to meet with Jim Lange in person, give the Lange Financial Group a call at (412) 521-2732 to see if you qualify for a free initial consultation, or you can connect with Jim’s office through his website at www.paytaxeslater.com. While you’re there, you can also get a free digital copy of Jim’s latest book, The Ultimate Retirement & Estate Plan for Your Million-Dollar IRA. You can also listen to some of our previous radio shows. You can hear more than 150 hours of very valuable shows featuring some of the top national names in investing and retirement planning. The best part is it’s all free to you. I’m Dan Weinberg. For Jim Lange, thanks so much for listening. We’ll see you next time for another edition of the Lange Money Hour, Where Smart Money Talks.

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