Think, Act and Invest Like Warren Buffett, with Larry Swedroe

Episode: 174
Originally Aired: July 27, 2016
Topic: Think, Act, & Invest Like Warren Buffett with Larry Swedroe

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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  1. Guest Introduction: Larry Swedroe, Author and Wealth Manager
  2. Most Investors Do the Opposite of What Warren Buffett Advises
  3. Warren Buffett’s Advice:  If You’re Not Me, Invest in Passive Index Funds
  4. It’s Possible, but Very Few Win the Loser’s Game of Active Management
  5. With the Right Value Stocks, You Can Outperform Warren Buffett
  6. ‘Gross Profitability’ and ‘Equality Factor’ are Different from Earnings
  7. The Importance of the ‘Profitability Factor’ in Index Funds
  8. Small-Value Funds from the Bottom Third Capture More Premium
  9. Beyond the Investments, You Need the Discipline to Withstand Bear Markets
  10. Why the New Rules on Fiduciary Responsibility are Critical
  11. Whoever Wins the White House in November Will Have an Effect on Investors

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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 Now get ready to talk smart money.

1. Guest Introduction: Larry Swedroe, Author and Wealth Manager

Dan Weinberg:  And welcome to The Lange Money Hour.  I’m Dan Weinberg along with CPA and attorney Jim Lange.  Who wouldn’t want to invest like Warren Buffett?  He’s one of the most successful investors in the world, and yet, most people don’t follow his recommendations about where they should be putting their money.  Our guest tonight, nationally recognized investment expert Larry Swedroe, is the author of the book Think, Act and Invest Like Warren Buffett: The Winning Strategy to Help You Achieve Your Financial and Life Goals.  Like Warren Buffett, Larry believes that passive investing through index funds is the best path to prosperity, and he’s done the research to back it up.  Larry is director of research for Buckingham Asset Management.  Including the Warren Buffett book we’ll be talking about tonight, he’s authored fourteen others, including his latest, The Incredible Shrinking Alpha, and he’s working on book number 15 as well, called Your Complete Guide to Factor-based Investing.  Over the next hour, you’ll learn a great deal about passive and active investing and how to get into that Warren Buffett mind-set.  So, let’s get started by saying good evening to Jim Lange and Larry Swedroe.

Jim Lange:  Welcome, Larry!

Larry Swedroe:  Hey, Jim, how you doing?

Jim Lange:  Good!  It’s always a pleasure to have you on because not only do you have a great, let’s say, deal of wisdom, but it’s in so many areas, you know, like Dan mentioned, the author of 14 books.  We’re probably going to concentrate a little bit on Think, Act and Invest Like Warren Buffett, but your book on alpha and your book on mistakes are also wonderful books, and if people are interested in your books, I would probably just go to Amazon.  We’re probably going to be spending the most time on Think, Act and Invest Like Warren Buffett of the 14 books, and I know you’re working on another one, although I guess that’s a constant state.  My favorites are the Warren Buffett, the mistake book, and the alpha book.

But anyway, Warren Buffett is probably one of the most successful active investors of our time, very durable.  People who bought in, if you will, 20, 30, 40 years ago are doing very, very well today.  So, a lot of people are interested in investing more like Warren Buffett.  On the other hand, Warren Buffett is an active manager, and you usually recommend passive investment strategies.  What could somebody who is, let’s say, trying to be like Warren Buffett, but they are also buying into the passive investments, what should they be thinking about as they’re developing their portfolio?

2. Most Investors Do the Opposite of What Warren Buffett Advises

Larry Swedroe:  Well, I think, Jim, a good place to start that discussion is to note what I’ve found to be probably the biggest anomaly in all of finance, which is if you ask people who they think the greatest investor of all time is, I think you and I could agree that probably 98 percent of them would say Warren Buffett.  Maybe a sprinkling might throw in Peter Lynch and maybe somebody else, and yet despite that fact, the vast majority of people not only ignore Warren Buffett’s advice, which he hands out liberally on national television and in his annual letters to the Berkshire Hathaway shareholders, but they tend to do exactly the opposite of what he recommends, and in my book, I touch on three key areas that investors, if they just followed those three, would be served so much better and end up with much better results.

Jim Lange:  Well, maybe that’s because people are listening to (Jim) Cramer on TV?

Larry Swedroe:  They certainly tend to listen to Cramer probably more than Warren Buffett.  Unfortunately, that’s true.

Jim Lange:  Well, to be fair, if you listen to Cramer and you follow all of his advice, today, you would have one million dollars … if you started with two million.  By the way, that’s a joke, before I get sued!

Larry Swedroe:  Yeah.  There’s actually a website that has tracked Cramer’s recommendations, and there are several academic papers actually that have also done so, and they found that basically, there is zero alpha, even before expenses, in his recommendations, and the only alpha that tends to occur is to the institutional investors, and here’s what happens.  Cramer comes out with a recommendation, say, to buy a stock.  The next morning, the stock jumps up because ? I’ll use the phrase ? dumb retail money thinks Cramer knows something.  The institutions sit on the sideline and wait, then they come in and short the stocks, driving the price back down, and it ends up right back where it started.  So, the institutions make money and the individuals lose.

Jim Lange:  Well, that almost sounds like a conspiracy, if you will.  I hope Cramer isn’t benefitting from that information.  I’m hoping that he is, even if he’s wrong, that he, like you, is a fiduciary adviser that has nothing but the best interests of his audience in mind.

Larry Swedroe:  I think he certainly does.  Although I don’t know him personally, I think he’s a very smart guy, but he’s become an entertainer rather than an adviser.

Jim Lange:  All right, well, let’s get back to what you had said earlier about Warren Buffett.  So first, we know that Warren Buffett gives his advice freely.  Very frankly, the letters to the shareholders that he writes in the annual reports for Berkshire Hathaway are almost considered like a great financial resource in and of themselves, both for their content and their excellent prose.  So, as you said, he isn’t shy about giving people advice.  What advice does he give that most people do the opposite?

3. Warren Buffett’s Advice: If You’re Not Me, Invest in Passive Index Funds

Larry Swedroe:  Right, so I broke this down in my book into three big issues that I thought would help people, and the first one is: Should you use active or passive funds?  Now, we know that while there’s a trend towards more passive investing, with the key leader in that effort of course being John Bogle, I hope I’ve done my part to contribute, but the fact is, even today, probably 80 percent or more of individuals have their money invested in actively managed funds.  Now, that’s way down from the 99 percent of twenty years ago.  So, there is a trend there.  So, Buffett, specifically on this issue, here’s what he has said: ‘By periodically investing in an index fund, the know-nothing investor can actually outperform most investment professionals.’  And then, he added: ‘Most investors, both institutional and individual, will find that the best way to own common stocks is through an index find that charges minimal fees, and those following this path are sure to beat the net results, after fees and expenses, delivered by the vast majority of professionals.’  So, his advice is very clear there: Do not use active funds.

Jim Lange:  So, basically, he’s saying ‘Do as I say, not as I do?’  Because, of course, he’s running … I don’t know if it’s the biggest, but it’s certainly one of the huge actively managed companies in the world.

Larry Swedroe:  Well, I would say it this way: Buffett might be saying this: ‘If you look in the mirror and you see Warren Buffett, you can go ahead and try to pick stocks and beat the market.  But I’m the only one who does that.  Maybe me and Charlie Munger.’  So, unless you think you’ve got the skill set and access to information that Buffett has, as well as his discipline, you are far more likely to produce better results by just building broadly diversified portfolios using index funds, and then staying the course, and very importantly, avoiding panic selling.

Jim Lange:  And I think, isn’t that one of the main focuses of a different book?  And I don’t like to plug more than one book because then people might buy none, but to me, the most fun and, let’s say, the most readable of your books is Think, Act and Invest Like Warren Buffett, by Larry Swedroe, and that, and maybe about 10 others, or 13 others, are available on Amazon.  But what you’re describing there sounds like another one of your books, which is The Incredible Shrinking Alpha, and I think there, that book and Warren Buffett are saying the same thing, which is it’s just too difficult, particularly after fees and expenses, for an active money manager to beat the index.

4. It’s Possible, but Very Few Win the Loser’s Game of Active Management

Larry Swedroe:  Yeah, it’s not that it’s impossible, and, of course, that slim odds of outperforming provide that hope, but here’s the important message in my book, The Incredible Shrinking Alpha.  Twenty years ago, a fellow named Charles Ellis, one of the most respected men in our industry, he wrote a book called Winning the Loser’s Game.  Now, a loser’s game is one where it’s possible to win, but the odds of doing so are so poor that the prudent thing is not to try at all and just don’t play.  So, I’m sure we can all think of loser’s games like roulette, or buying lottery tickets, or any game at the Las Vegas casinos where they have the odds.  Sure, you can win.  It’s possible, and you might even be willing to lose some as an entertainment account, but you wouldn’t take your retirement account there.  And when Ellis wrote his book almost 20 years ago, he noted that about 20 percent of actively managed funds were generating statistically significant alpha.  So, you could say it wasn’t luck.  That still meant that 80 percent were failing, and that’s even before the impact of taxes that individuals had to pay.  That number would rise to about 90 percent on an after-tax basis.  Today, that 80 percent failure rate is now up to 98 percent before taxes.  So, only about 2 percent of actively managed funds are generating statistically significant alpha even if you’re investing in your IRA, and maybe 1 percent if it’s in a taxable account.  Now, I don’t know about you, Jim, but I don’t like playing a game where I have a 1 in roughly 50 chance of winning pre-tax and 1 in 100 winning after tax.

Jim Lange:  So, we had some Missouri-type people show me.  Can you give me a source for that statistic?  Because there’s going to be a lot of active money managers who are going to want to argue with that, and I want to arm our listeners with that information and where they could find that.

5. With the Right Value Stocks, You Can Outperform Warren Buffett

Larry Swedroe:  Well, the best place is go pick up a copy of my book, which cites the academic research, and one of the papers was written by a Nobel Prize winner, Gene Fama, and his colleague Ken French, called “Luck Versus Skill in Mutual Fund Performance,” and that paper is several years old, and a more recent paper also came to the same conclusion.  But I can add this: This may surprise most of your listeners.  Now, we all know that Warren Buffett has had a tremendous track record, but what most people don’t know is that almost all of his success occurred prior to the last 15 years, when the markets have gotten ? call it ? smarter, as the academic research has uncovered, the type of stocks that Warren Buffett bought and have now built mutual funds that gain exposure to them.  So, I know you and I both use funds of Dimensional Fund Advisors to gain access to the type of value stocks that Warren Buffett bought.  So, if we look at Berkshire Hathaway’s returns, and I wrote this up recently, for the 15-year period ending March 2016, Berkshire returned 8.2 percent.  Now, the DFA runs two domestic value funds.  One of them is large value.  It returned 7.4 (percent).  The other is small value which returned 10.1.  The average of those two is 8.8, and Berkshire returned 8.2.  So, it’s hard to argue even now that Berkshire is able to outperform similarly risky investments.  That’s a pretty good example of the point we made that if you look back 30, 40 years ago, Buffett was swamping comparable funds, and today, for the last 15  years, he’s had a very difficult time generating outperformance on a risk-adjusted basis.

Jim Lange:  All right, so is it fair to say that you’re saying that for the last 15 years, one major source of his outperformance, if you’re even going to call it that, would actually be an asset-allocation issue, which he was just much smarter than, say, a typical mutual fund or even a standard recommendation by Vanguard that would not have as high an exposure to small value or large value?

Larry Swedroe:  Yeah.  So, let me say it this way: We now know today the secret sauce that Buffett used.  This is, I think, a good way for investors to think about it.

Jim Lange:  We all want to know the secret sauce.  So everybody’s perking up now: “Oh boy!  Secret sauce!”  All right, Larry, tell us the secret sauce.

6. ‘Gross Profitability’ and ‘Equality Factor’ are Different from Earnings

Larry Swedroe:  Right, and he got that secret sauce from his mentors, David Dodd and Benjamin Graham, who authored the book Security Analysis. And Buffett, this wasn’t so secret, he would tell people for decades, ‘Here are the types of stocks I buy.’  And the first thing that the academics uncovered, by the way, and often, academics uncover these sources of excess returns by studying the performance of great investors, people who had high returns to figure out if their secret sauce could be replicated, meaning was there a common characteristic in a stock that anyone could identify and just buy all the stocks with that characteristic, or was their secret sauce not replicable?  It was a skill set that they have.  So, there would be no common trait that would be replicable.  So, in the 1980s, academic research began to be published that showed that value stocks, stocks that had low prices relative to earnings or book value or cash flow, outperformed the market by roughly 5 percent a year, and eventually, then mutual funds, like Vanguard, would create a value index fund, DFA  ? the fund family we use ? mostly created more sophisticated versions, and that captured much of Buffett’s alpha, because they would just buy all of the stocks; but still, Buffett outperformed those value funds.  There was another missing ingredient that the academics hadn’t uncovered, and then in 2006, Ken French and Gene Fama, who I had mentioned earlier, wrote a paper that showed more profitable firms were generating higher returns even though you paid a higher price for them.  So, they had higher price/earnings ratios, but that still did not prevent them from providing higher returns, and over time, more research came out on that.  In 2012, a fellow named Robert Novy-Marx wrote a paper showing that if you focus on what he called ‘gross profitability,’ not earnings, but the revenue minus cost of goods sold, you actually generated about a 3½ percent a year premium, and it enhanced the value of value strategy.  So, in other words, if you bought value stocks, stocks with low prices to earnings, but also then bought companies that were higher return on equity, higher gross profitability, you would do better, and the academics expanded on that and funds like DFA began to incorporate it, and today, that research has been further expanded to include what’s called ‘equality factor.’  So, not only was Buffett buying stocks at a higher return on equity, for example, or higher earnings, but he tended to buy higher-quality companies.  Many of your listeners may know, Buffett has often talked about companies that have moats around them, so that gives them some protection.  These companies tend to have more stable earnings, they tend to have higher margins, and they tend to use less leverage, and now we know there was a paper called Buffett’s Alpha that identified these common characteristics, and now we know that if you simply bought all of the types of stocks that Buffett bought, not just the ones he bought, but all of the stocks that had these common characteristics, you would have had basically the same return as Buffett if you also had his famous discipline.  Now, very importantly, Jim, I don’t want your listeners to get the wrong message.  This takes nothing away from Buffett’s accomplishments.  He figured this stuff out 50 years before the academics.  But today, you don’t need to be Warren Buffett to buy the same types of stocks.  There are mutual funds like those of DFA, the fund family we use, AQR, another fund family we use, Bridgeway and others are incorporating these factors.  We now know that it’s important to buy the type of stocks, not which ones, and that’s what’s showing up.  Berkshire has not outperformed, as I mentioned, a combination of a DFA large and small value in the last 15 years.

Jim Lange:  Larry is the author of Think, Act and   Invest Like Warren Buffett, by Larry Swedroe, available on Amazon.  I am a big fan of Larry’s books.  I like that one.  I like his The Incredible Shrinking Alpha, and I like his book of Investment Mistakes Even Smart Investors Make (and How to Avoid Them).

So Larry, you had mentioned French and Fama several times as authors of an important study, and they are, let’s say, the founding members and are still very, very involved with the group of index funds that we are advocates of, that is both your firm and ours, which is called Dimensional Fund Advisors.  And you talked about an additional premium.  I think a lot of people know about the equity premium, meaning if you are willing to buy companies instead of lending money to companies, that you can, over a longer period of time, expect a higher return.  And we have spent the first portion talking about some of the advantages of a value and a small value premium, meaning that if you invest in smaller companies, and if you invest in value, that is companies that have a lower price/earnings ratio, that over a longer period of time, you can expect a higher return, and that is a premium.  And I think that a lot of people know about that, but French and Fama actually identified another premium that you call profitability.  Can you tell our listeners about the profitability premium and what the impact of that is on investors and DFA, and how that might compare to, let’s say, an excellent set of index funds that doesn’t use that?  Perhaps like Vanguard?

7. The Importance of the ‘Profitability Factor’ in Index Funds

Larry Swedroe:  Well, Professors Fama and French are best known for creating what was called the ‘three factor model.’  It added on to our understanding of how markets work.  Prior to their paper, which was published in 1993, the only premium that investors tended to focus on ? because it was the only one that was documented in the literature ? was this equity-risk premium, which has been about 8 percent a year.  Fama and French summarized prior research which showed that small companies tended to outperform large companies by about 3 percent a year, and value companies tended to outperform growth companies by about 5 percent a year, and that led to the development of index funds, like Vanguard’s, to capture these premiums as indexes were created by companies such as Standard & Poor’s and Morgan Stanley’s Country Indices and the Russell Indices.  They all published these smaller-cap indices and value indices, and then Vanguard created mutual funds to replicate them.  DFA operates a little differently.  They don’t actually create index funds, which just purely replicates some popular index, but they instead use academic definitions of these factors, as they’re called, which can be somewhat different from index funds, and we believe that they deliver superior results, and that’s why we use them.  It was, as we discussed earlier, in 2006, Fama and French, in their research, uncovered this other newer factor on profitability and found that companies that have higher return on equity, higher cash flows and higher gross profitability saw higher sales minus their gross cost of the sales, so that profit margin actually tend to look like growth stocks.  They’re growing faster, but they still outperform.  So, they started to screen for this profitability factor in their funds and added that to their construction model.  So, they would buy value stocks but then add exposure to these companies and focus on ones that had greater profitability.  The index funds that Vanguard had, for example, at least currently, don’t do that.  So, that’s one of the benefits because these retail indices don’t add that profitability factor in.

Jim Lange:  Okay.  So, let’s take a look at that.  So, let’s say, for example, that French and Fama said, ‘Hey, there’s this profitability premium that we have identified.  We’re not going to use a traditional definition of an index, but we’re going to have whether you call it an enhanced index,’ or, you used the term ‘academic version of an index, and we’re going to include a profitability portion, or waiting, to the equities or the stocks that we pick.’  And then, if they are right, then theoretically, and let’s forget about expenses for the moment, if they are right, they should theoretically, either looking back or what they actually did, outperform a straight index fund that doesn’t have a profitability premium built in.  Is that correct?

Larry Swedroe:  That’s correct, because the profitable stocks, if you look at them in isolation and don’t look at their other factors, have outperformed the low-profitability stocks by about 3½ percent a year.  But the value premium captures some of that.  If you add in profitability, you probably can pick up somewhere in the area of about 50 basis points a year.  So, that’s what DFA thinks that they will add over the long-term if over just a pure value fund.  That’s one of the ways that they can differentiate is by screening for this profitability factor and more heavily weighting the stocks in their fund that are more profitable and providing that benefit.  One other thing, Jim, is this: Vanguard uses popular indices, and I’m just going to use a simple example for your audience.  So, let’s say there’s an index that splits stocks between the top half of stocks if you rank by price-to-earnings ratios.  So, the ones that have the highest PEs are called growth, and the bottom half of stocks are value, and Vanguard’s value fund buys those bottom 50 percent.  DFA, using an academic definition, the way academics tend to split things up, is they would take the bottom 30 percent of stocks in that index when you rank them.  So, if you buy the stocks that have the bottom 30 percent as ranked by price-to-earnings ratio, you’ll end up with stocks that have, on average, a lower PE ratio than if you buy the bottom half.  That’s simple math, right?  So, if you look at DFA’s value funds and compare them to Vanguard’s value funds, you will note that they tend to have lower price/earnings ratios, lower price-to-book ratios, and lower price for cash-flow ratios, which means, based on the evidence, that you also have higher returns in the past and should expect them as well in the future.  So, that’s some of the differences.

Jim Lange:  Okay, and then there’s also another filter of profitability.

Larry Swedroe:  Right.

8. Small-Value Funds from the Bottom Third Capture More Premium

Jim Lange:  All right.  So now, I’m going to walk without a net for a moment.  Okay, so we have some of these theoretical differences, and I guess that we could expand that theoretical difference to not only the value, that is not just picking the lower half, but picking the lower third.  They might do the same thing with size.  So, they’re not necessarily picking the lower half that go into their small indexes, but maybe the lower third.

Larry Swedroe:  That’s exactly right, and if you look at, for example, Vanguard’s small-value fund, it has an average market capitalization, the last time I looked, at about $2.8 billion.  DFA’s fund had an average market capitalization of about half of that.  So, the evidence shows that the smaller the company, the higher the historical return.  So, it doesn’t mean Vanguard’s fund is bad.  It does exactly what it’s supposed to and does it at very low cost.  It just doesn’t give you as much exposure to that size factor, or the value factor, so you capture less of the premium than the DFA funds do.

Jim Lange:  All right, so let me see if I am correctly paraphrasing you, that DFA has … their value funds actually have a lower price/earnings ratio than, say, the equivalent value fund in Vanguard, for example, and their small companies are actually smaller.  That is, they have a lower total capitalization than the small in, say, Vanguard, and, at least historically, the smaller ones, that is, the, let’s call it, very small or micro, have outperformed small, and the very low price/earnings ratio have still outperformed what might traditionally be called value, but value with a higher price/earnings ratio.  And if you combine those two, you can expect better performance.  Is that a fair characterization?

Larry Swedroe:  Yeah, and the logic is simple as well, with the research of these companies are riskier, and therefore, investors require a larger premium to invest in, and that means they will only buy them if their prices are lower.  So, here’s a good example for your audience I’m just pulling up while we’re chatting.  The DFA small-value fund currently has an average market capitalization of $1.4 billion, and the Vanguard fund has an average market capitalization of $2.9 billion.  The DFA fund has a weighted average price/earnings ratio of $15.6 billion.  The Vanguard fund has a P/E ratio of much closer to $17 billion.  So, the higher the price you pay, the lower the expected returns.  That’s a very good example, and here’s another one.  DFA looks at price-to-book ratio, so the lower the price of the book, the higher the expected return.  DFA’s fund has a price-to-book ratio of $1.1 billion.  Vanguard’s fund is $1.6 billion.  So, almost 50 percent more expensive relative to book value.  Of course, Buffett likes to buy stocks that trade at low prices, and DFA funds look more like the kind of company that Warren Buffett buys.  So, that’s the difference.  Both funds do exactly what they’re supposed to do at relatively low cost, but DFA funds give you more exposure to these factors, and as we mentioned, DFA is now adding a screen for profitability as well, and as one example, that should show up in lower prices to cash flow.  DFA’s fund is $4.7 billion, and Vanguard’s fund is higher at over $6 billion.

9. Beyond the Investments, You Need the Discipline to Withstand Bear Markets

Jim Lange:  One of the things that Warren Buffett talks about, and I think is an important point, is that it’s not just about the investments.  So, you know, the early part of the show, we were talking about index funds and some of the advantages of value and small value and some of the differences, say, for example, between Dimensional Fund Advisors and Vanguard, but I think Warren Buffett’s point is hey, it’s not just about that.  It’s about other areas.  So, Larry, if you could tell us what you think Warren Buffett means by that, and where do you get that type of advice?  Whether you can read that, or whether that is an advice that an adviser would give, but could you tell us a little bit about the idea that it’s not just about investments?

Larry Swedroe:  Well, I think the first thing is that I always tell people you should never work with an investment adviser, which may sound strange, but you should only work with someone who is a true wealth adviser  looking out for your entire financial picture.  But before we delve into that portion of it, what Buffett is talking about, I believe, is here, you could have a great investment plan in terms of your asset allocation, and if there is even such a thing as a perfect asset allocation.  It does you no good unless you have the stomach-acid ability to deal with bear markets, which we know occur with great regularity.  In fact, Jim, when the 2008 crisis hit, I did a little research and went back 40 years and found that we had had a major crisis, maybe not quite as big as that one, but a major crisis about once every 2½ years.  So, if you’ve got, even at 65, you’ve probably got a 30-year horizon you got to plan for, you should be planning to have to deal with 14 or so crises, and boy, you’d better have the discipline, and that’s really what separates Warren Buffett, I think, from other investors, not just that he had identified these stock characteristics to buy, but he never in his career engaged in a panic selling, and that’s a big problem.  So, the job of a good adviser is not only to make sure you have the right strategy, and you haven’t taken too much risk because if you do, you will panic and sell, but to enforce the discipline, not only to buy when panics happen and markets crash, not because you’re predicting anything, but you’re simply rebalancing the portfolio to its target, but also tax managing the portfolio, harvesting losses in taxable accounts.  For example, in 2008, we had many clients who owned small businesses and operated at a loss, and we were engaged in lots of Roth conversions because they could convert from a traditional IRA to a Roth and not have to pay any taxes because their business provided the losses to shield the income that year, and then all future withdrawals would be tax-free.  So, you want somebody who is looking at all of those issues and providing the discipline.  Returning to this issue about why you want to work with a true wealth manager, someone like yourself, you could have that perfect investment plan, but as a great example, that plan can fail for reasons that have nothing to do with investing.  Great example: I worked with a young adviser about 20 years ago and helped him review his plan, a pretty good one.  I made some minor suggestions, but after that, we did a needs analysis.  He was a young guy, married with a couple of kids, and he didn’t have enough insurance.  We recommended he buy a couple-million-dollar declining-term policy, because that would be the cheapest to cover the need, and as he lived and worked, he would save and invest, and that would grow, and each year that passed by, there’d be one less year to support.  The good news was he took our advice, bought that policy; the bad news, unfortunately, was he was dead a year later of cancer.  So you could’ve had that perfect investment plan, but if somebody wasn’t looking out for situations that had nothing to do with that, whether it was the loss of a life, having liability insurance, making sure you have an umbrella policy, having disability policy, many of our people now looking at needs for long-term health care, and integrating the estate planning.  Things like when do you take Social Security, which I recommend your book to all of your listeners.  It’s an important part of the story here.  And making sure your estate plan, your will, having durable powers of attorney for health and medical care, these are all extremely important issues and they change over time as life events occur.

Jim Lange:  Well, you did happen to mention the two areas that we love to, and we call it running the numbers.  So, what you did in 2008 just makes all the sense in the world.  That is, I always tell people, let’s say, we typically work more with IRA and retirement-plan owners and business owners, but I always tell people that usually the best years to make a Roth IRA conversion, and typically, you want to do it at the lowest tax rates like you did in the year 2008, for your business owners, are the years that they do not have wages, so they’re retired.  On the other hand, they are less that 70, so they don’t have their minimum-required distributions from their IRA, and we actually run mathematical models and determine literally the ideal both year and amount to convert, and then we integrate that strategy with Social Security and come up with, ‘Well, this is what we think that you should do for Social Security.  This is what we think your spouse should do for Social Security.  This is what we think you should do for Roth IRA conversions.’  And then we show the, let’s say, the differences between what we might come up with, which might be a combination of holding off on Social Security in a series of Roth conversions versus, say, taking it at 62 and not making Roth conversions, and the difference over time can literally be hundreds of thousands of dollars.  So, I think your point that it’s not just about investments is very important, and then you had mentioned estate planning and insurance and disability and all these factors that probably should be taken into consideration.

Larry Swedroe:  And Jim, one quick thing I want to make clear:  There’s no robo adviser that will be looking out for all of these issues for you.

10. Why the New Rules on Fiduciary Responsibility are Critical

Jim Lange:  All right, good.  I like a little slam on the robo advisers.  But the other thing that is, let’s say perhaps one difference between a wealth adviser  and a financial adviser, or even a stockbroker, and now, we have some new legislation on it, is the relatively new requirement that if you are going to invest somebody’s rollover 401(k) plan, that that must be invested with a fiduciary standard.  I was wondering if you could tell our audience what that means and what the implications of that are, and how that actually might affect their choice of who they work with.

Larry Swedroe:  This is really unfortunately one of the great tragedies in our country that the politicians have been overrun, if you will, by the lobbyists.  Imagine if you went to a doctor, and the doctor was not required to give advice that was in your best interest, or an attorney, whatever.  They all have fiduciary responsibilities.  A fiduciary, under the law, is required to give advice that only considers the client’s or the patient’s position.  So you can’t recommend anything because you or your firm will benefit from it.  Unfortunately, stockbrokers, insurance agents, almost all of them and many other advisers, anyone who’s on commissions, for example, operates under a much weaker standard called the suitability standard, and the simple example I like to provide is this: Let’s say we decide to recommend somebody put money in an S&P 500 index fund because that’s appropriate.  You and I would have to recommend the lowest-cost vehicle because that’s in their interest because all S&P 500 index funds are identical, except for expenses.  So, you might recommend a Vanguard fund or an ETF, whichever is more appropriate for the situation.  Both are going to be exceptionally low cost.  On the other hand, if you’re an insurance salesman, you got a 401(k) plan and your funds are in there, they might recommend that you buy XYZ insurance company’s S&P 500 fund, which might have an expense ratio of 50 or 75 basis points instead of Vanguard’s maybe seven, and you and I legally couldn’t do it, but they can.  So, the simple question I would ask your listeners to consider: Why would you ever ? I can’t think of a single reason why ? choose to work with somebody who is not required under the law to give you advice that’s solely in your interest?  I think the answer is obviously there are no reasons, and the only reason people choose to do so is because they’re unaware of the difference.

Jim Lange:  I would agree with that.  But I noticed, in your answer, you took a little shot at Washington and saying that you can’t understand why Washington doesn’t make that a strict rule.

Larry Swedroe:  I understand why.  It’s the lobbyists who put pressure on these people, and every one of them who voted against the Obama program requiring fiduciary responsibilities, in my opinion, should be tarred and feathered and run out of town with no holds barred!

Jim Lange:  Well, it sounds like you don’t have a very strong opinion about this, so …

Larry Swedroe:  It’s a disgrace; actually, that anyone should be allowed to offer advice that isn’t in their client’s interest.  I’m sure none of your listeners can come up with a single reason why they would ever choose to work with somebody who isn’t giving them advice that’s solely in their interest.

Jim Lange:  Well, is it fair to say that you also don’t have any strong feelings about the election, and I’m not going to even ask you about support, but maybe what listeners should be thinking about as the election nears?  And by the way, you have about two minutes.

11. Whoever Wins the White House in November Will Have an Effect on Investors

Larry Swedroe:  All right.  So, all of the advice I give, like you do, Jim, is based upon academic research, not our opinions.  So, here’s what I can tell people.  We know the research shows the following: when Democratic voters are faced with a Democratic president in office, they are much better investors than Republican voters, and the reverse is true.  So, when Republican voters have a Republican president in office, they become much better investors than their Democratic counterparts, and the reason is simple: When the party you favor is in power, you tend to be more confident that problems will be resolved in a favorable way, so you tend to do nothing.  Maybe, at most, rebalance your portfolio, but you don’t engage in panic selling.  So, in 2000 through 2002, after the 9/11 events and the markets crashed, I know Republican investors were much better.  They were much more likely to stay the course than Democrats.  When 2008-2009, that financial crisis hit, the reverse was true.  All the calls I was getting about worries about the next Great Depression came from Republicans, and Democrats tended to be more willing to stay the course.  So, the advice that I have for your listeners is to be like Warren Buffett and not look at your political views, and don’t let them bias your investment decisions in any way.  You’re likely to make a mistake if you do.

Jim Lange:  Well, thank you so much.  Again, we are here with Larry Swedroe, author of Think, Act and Invest Like Warren Buffett.  Thank you so much, Larry.

Larry Swedroe:  My pleasure.  Happy to come back any time, Jim.