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- [00:01]
A
What's up everybody? My name is Demetri Kofinas and you're listening to Hidden Forces, a podcast that inspires investors, entrepreneurs, and everyday citizens that challenge consensus narratives and learn how to think critically about the systems of power shaping our world. My guest in this episode of Hidden Forces is Cullen Roesch, the founder and CIO of Disciplined Funds and author of the new book you, Perfect Portfolio, a groundbreaking approach to portfolio management. Cullen is also the founder of Pragmatic Capitalism, an educational platform where he has written extensively about monetary mechanics, portfolio construction, and financial planning for nearly two decades. Cullen and I spend the first hour of this conversation discussing his philosophy on portfolio construction, what goes into constructing the perfect portfolio, and how variables like one's time horizon, financial circumstances, and behavioral biases are arguably the most important determinants of financial returns and therefore must be actively taken into account when structuring your portfolio. We explore the fundamental distinction between saving and investing, the hidden costs that erode portfolio performance, and why managing the liability side of your balance sheet is arguably more important than any other decision you can make when it comes to portfolio construction. The second hour is a deep dive into specific portfolio strategies, including the Permanent portfolio, the Endowment portfolio, the Buffett portfolio, dividend investing, countercyclical rebalancing, and Cullen's favorite, the Defined Duration portfolio. We discuss how to think about asset allocation across different time horizons, the role of gold and other insurance like assets in one's portfolio, the importance of cost control in financial life, and practical frameworks for managing behavioral responses to market volatility. If you want access to all of this conversation, go to HiddenForces IO, subscribe and join our Premium fee, which you can listen to on your mobile device using your favorite podcast app just like you're listening to this episode right now. If you want to join in on the conversation and become a member of the Hidden Forces Genius community, which includes Q and A calls with guests, discounted access to third party research and analysis, and in person events like our intimate dinners and weekend retreats. You can also do that on our subscriber page and if you still have questions, feel free to send an email to infoiddenforces IO and I or someone from our team team will get right back to you. Lastly, because this conversation deals with investing, nothing we say on this podcast can or should be viewed as financial advice. All opinions expressed by me and my guests are solely our own opinions and should not be relied upon as the basis for financial decisions. And with that, please enjoy this incredibly rich, useful and practically valuable conversation with My friend, Cullen Roesch. Cullen Roche. Welcome to Hidden Forces.
- [03:09]
B
Demetri, how are you? It's great to be here.
- [03:11]
A
It's great to have you on Cullen. We've known each other for. We were just reflecting on how long it's been since we were last in physical contact.
- [03:21]
B
Neither of us can remember. That's how long it's been, I think.
- [03:25]
A
Yeah, well, we remember, but the discrepancy is between just a few months, but it was essentially about 13 years ago. And before that, you were a guest on Capital Account, which was my old TV program. And that was back when you were blogging at Pragmatic Capitalist and you were one of those folks who, I mean, we're not going to get into. I actually don't want to spend too much time on this because I think the background is less important than your book. But essentially, you were writing about sectoral balances and modern monetary theory and all this stuff back when very few people knew about it. You were able to benefit from those frameworks when it came to thinking about the way that monetary policy worked, how money worked in the modern economy, when people like me with our rudimentary Austrian monetary frameworks were stuck in the mud post 2008, despite the fact that those frameworks work very well for predicting the crisis. So we might have a chance to talk about monetary theory, economic theory, in the course of this conversation. But what you're here to talk about is your new book, which I should congratulate you on. It's titled you, Perfect Portfolio, and it's essentially, I think, a really awesome book. I finished reading it this weekend and I found it helpful. I'm by no means financially sophisticated, but I'm not a total moron in terms of, like, not knowing anything. And I certainly found it valuable. But I think it can appeal to a wide range of people. So maybe we should start with that. What is the book about and what is the perfect portfolio?
- [04:50]
B
Yeah, well, gosh, it's interesting that you mentioned, you know, that period because that time period was really when I was actually. That was when I was writing my first book was that 2013, 2014 period. So it's been. It took me 12 years to write a second book, which, you know, I don't know what that says about me, but it was interesting, like, getting to know you, because I was going through a period there where I think I was trying to. I mean, everybody was trying to digest what the hell just happened with the financial crisis and all the huge Fed policies that were implemented that were all Seemingly new and, you know, kind of like they were super confusing. I think everyone was trying to figure out, like, what is all this stuff going to actually cause in the future? Is it going to cause hyperinflation? You know, is it going to cause interest rates to skyrocket? Is the stock market going to boom or is the stock market going to bust? And you know, I was going through my own process of really trying to navigate and understand the world for what it is. And I think that first book was really sort of fun to write because it was, I mean, it was wonky and much more, much more theoretical because it was so macroeconom based. This one is very, very different. This one is sort of, I would say more of like a microcosm of that exploration where. Well, the. My first book was very, very top down, very macro oriented. This one's a little more micro in the sense that I get into every single portfolio and strategy style. And this is an extension also of like the same sort of, I think, learning process where over the course of the last 15, 20 years, as I've been managing money, I've gone on my own sort of exploration of trying to find a perfect portfolio. And I think a lot of us go through this mentality where we're in search of something perfect. And what we really should be looking for is something that is just a good fit for us, something that's perfect for us. And that's the main ethos of the book is that, you know, I titled it your perfect portfolio very intentionally because the goal of this is to help people understand portfolio construction and understand lots of different styles and strategies with the goal of finding a portfolio that works specifically for you so that you can customize something and tailor it to your life rather than, you know, the whole industry is kind of built around selling strategies to people. And there's usually like an origin story to strategies or some, you know, person, godlike figure behind a strategy that you just buy into because, you know, you looked at the backtests and the history of it and you, you think the person who came up with it is a genius or whatever. And what I found more often than not in my career is that you can't just buy something that somebody else is selling and think that it's gonna work for you because it may conflict with certain aspects of your personal life, your financial life and your behavioral needs. And so you've gotta find something that works for you. And this book is really designed to help people expedite that process.
- [07:45]
A
You know, I love This. I actually haven't had a chance to talk to my wife about this book, but she works in coaching, and I know this applies absolutely in the coaching world where so many influencers and people that essentially build large audiences, sell themselves and maybe have had some success in the entrepreneurial space, sell themselves or sell their program as the thing that you need to do to scale your business. And in fact, that's not the way it works. You know, each individual business is. And each individual is unique. And so you have to. You have to be able to work on a sort of customizable basis. And of course, that doesn't scale as well. So there's a whole sort of, I suppose, a divergence of incentives between what's best for the entrepreneur, in this case, the investor and the money and the advisor or the coach.
- [08:31]
B
One of my favorite analogies in the book was this dieting study where there were all these diet studies that came out five, six years ago, and they studied all sorts of different fad diets. And I'm sure you've heard of them, you know, keto diet or whatever it.
- [08:44]
A
Might be, south beach diet.
- [08:46]
B
Yeah, there's a million of them out there now. And it was really funny because what the data ended up concluding based on this study was that they all worked, but it only worked for people who it works for. So you've got to find the diet that you can stick with. And that was the kicker, was that these are all fairly good methodologies for losing weight. But you. If you can't stick with it in the long run, it won't work for you. And so it was interesting that it almost didn't matter which diet people used, as long as people stuck with a specific diet, it ended up working for them. And I think portfolio construction is very much the same thing where once you find a group of fairly good strategies, if you find one that you can really stick with and stay loyal to, it's going to serve you fairly well in the long run. And it'll be better than an alternative where you're constantly, you know, flipping from the keto diet to the south beach diet and trying all sorts of different things and basically failing at each one along the way.
- [09:46]
A
All right, so he's established there's no perfect portfolio in the aggregate, but there is a perfect portfolio for you as an individual. And the book explores a number of different types of portfolios which we're going to get into. And I'm very excited to do that. I imagine that you have had more conversations with people about their portfolios over the years than you could probably remember. Are there some typical ways that people are predisposed to thinking about money that they have invested? In other words, is there a certain way that people typically present when they come to you?
- [10:19]
B
Yeah, well, I think the vast majority of people who come to me, they typically are. They're realizing that their process has been inefficient for some reason and they're typically encountering some sort of event. I mean, so I'm. I don't know, I'm a little bit unusual, I guess maybe in that I'm. I'm a little bit on the younger side. For a financial advisor, a lot of my business is built around succession planning and sort of these big events. It's typically retirement and a succession event. Unfortunately, a lot of people reach out to me because they know that a succession event is coming. So it might be an older man who, he has terminal cancer and he comes to me because he wants me to operate as basically a succession planner between him and his wife and the rest of his family. And, and so that's typically the, the thing. There's usually some jarring event. More often than not, it's retirement rather than succession planning. But retirement's really difficult for people to navigate because they're starting to grapple with this idea that they're going to lose their income basically. And I think that for somebody, especially somebody who is wealthy, who has accumulated a decent amount of financial assets, when you transition to the perspective that you're going to potentially start drawing on your portfolio rather than just growing it, you know, up to retirement, the goal is really simple. It's basically just grow your portfolio as much as you can. And then when you start to transition into retirement, everything changes. You lose your income and you start living off of your portfolio and you go through this sort of, you know, this mind trip where you have to start realizing that, hey, my portfolio might start going down or my goal no longer is to just grow the portfolio. And that's, it's just really psychologically difficult for people to wrap their heads around that. And so you have enough stuff going on. Typically with retirement, outside of the financial side, that makes things difficult. So the, I think the financial thing is something that a lot of people like to offload for a financial advisor or somebody with, you know, who can help on a third party basis just because it's stressful. And I think that getting a little bit of guidance especially I find in the early and sort of middle retirement years, but that's the kicker. Usually is that it's usually an event that people wake up to and they realize, hey, I'm not doing this maybe as well as I could be.
- [12:39]
A
So that's really interesting. I mean, I think part of it certainly is that there's something around self actualization and growing your net worth and having that goal, that losing that can be jarring or can be unsettling to an individual who has spent his life or her life defining themselves in this way or defining part of their success this way. But I think another big part of it, and I'm curious what you think of this, is that planning for retirement, where you say this is all I need, is acknowledging tacitly that you're gonna die. Because you're saying this is all I need because I don't need to worry that I'm gonna run out of it. Cause I'm gonna run out of life if I do this right. I'm gonna run out of life before I run out of money. And I just think a lot of people aren't prepared to confront their mortality. And when they enter that late stage, 60s or 70s, whatever it is, it's the first time that they're really being honest with themselves about that. Does that resonate with you?
- [13:32]
B
Oh, 100%. I mean, and I think that, you know, a common theme throughout the book is time. I talk about time really repeatedly throughout the book because I'm, I talk about how like going back to the original conversation about pragmatic capitalism and that whole, you know, the time horizon of working, especially for me, I worked with a lot of banks and, and a lot of bank traders basically coming out of the financial crisis where I was really helping them try to understand how things like quantitative easing were going to impact the bank balance sheet. And it was really interesting. I had never worked with a bank on eye to eye level before and when you start to see how they manage their assets, you start to understand that banks are very, very time sensitive. Because banks are, they're fairly simple institutions in the sense that they have short term liabilities that are constantly going out. Their deposit outflows are hyper volatile on a daily basis because they got people moving around a lot of money and then their assets are most long term instruments. And so banks have this inherent asset liability mismatch where they have to be very, very careful about the discrepancy, the mismatch in their assets and liabilities because if they're not careful about it, they end up like Silicon Valley bank, basically. Silicon Valley Bank's story was very simple in the sense that they basically had way too many long duration assets. And when they got a lot of short duration liability outflows, they couldn't actually liquidate or manage the portfolio in a way where they could actually meet the liquidity needs of the portfolio. And so, but it was interesting coming out of the financial crisis and then you know, kind of extrapolating this to not only my own life, but my clients lives in the sense that, I mean, for instance, when I had children before children, my time horizon is very, very simple. It's me and my wife. And I'm just thinking long term life is really simple when you don't have kids because you can just, especially when you're working. If you're young and working especially, you just think in one time horizon you can be aggressive. You know, you don't have to worry about owning any sort of hedges for the most part. And you just sort of like this money's going away for, you know, the next 30 years and I don't care what it does in the next 30 minutes. And when you have kids, you wake up one day and all of a sudden, you know, your whole life gets thrown upside down and you're like, you know, I, when I had my first daughter, it was right in the middle of COVID right the beginning of COVID And so the world was kind of a, you know, a mess to begin with. But then I'm going through the mind trip of having had my first daughter and I'm, all of a sudden I'm waking up and I'm realizing like, wait a minute, I need to buy term life insurance and I need to start thinking about multi generational needs. I need to start thinking about can I afford daycare? And I have to start thinking about five to nine plans for college and things like this. And all these things that they're weird because they happen over very, very different time horizons with children. And so, you know, a child's life, you see, is really like this big sequence of events where you have to plan everything out very strategically to some sense and your financial plan needs to meet that. And so I talk a lot about time in the book because time is the thing that we're all grappling with ultimately. And it's the thing that makes investing really hard. Especially with instruments that are what I call inherently long duration instruments. Things like the stock market is something that I would call a very long duration instrument. Or there are things like God, things like gold or Bitcoin are even more confusing because I'd Argue they're even longer duration instruments like you could argue they're in some ways they're the longest duration types of instruments that exist. And so, but people don't understand what is a proper time horizon for these instruments. And so when you allocate them into your portfolio, it's very psychologically difficult because I think especially with things like the stock market, people look at this and they see a hyper volatile instrument that you don't have any certainty over what is the time horizon over which this instrument is going to do something. So it's very different than something like say a one year T bill, where I can look at a one year T bill. And I know mathematically, I know almost all the things I need to know about what that instrument is going to do. I know exactly what its credit risk is, I know what its return is going to be, and I know exactly what its time horizon is. So the clarity around an instrument like that is almost perfect. Whereas something like the stock market, what is the stock market? Is it a 15 year instrument? Is it a 15 month instrument? Is it a perpetual instrument? And we don't really know. And so it's very hard to assign time horizons. And so dealing with that inside of your financial plan is very difficult because people realize, whether explicitly or implicitly, they know they have a finite amount of time here and they've got a plan around that finite amount of time by allocating to assets intelligently. But a lot of this includes this. I talk about what I call a temporal conundrum in the book a lot where the temporal conundrum is this confusion over how do you relay the time horizon of your portfolio to the time horizon of your life? And it's really hard to do. And it's got to be personalized.
- [18:35]
A
So is it possible for someone who's in their 20s or very early 30s to know what the perfect portfolio is for them? Or do you have to f around and go through the process yourself of making mistakes as an investor to figure that out?
- [18:51]
B
I think it's good to f around a little bit. You know, I, I make bad jokes about the analogy to, you know, a relationship. And when you're in your, when you're in your 20s and you have a lot of time, and more importantly you don't have a lot of money to lose, you have the ability to, you know what the bad analogy I use is one night stands. You have the ability to go through that process where you're having one night stands with different portfolios and you're testing Things, you're trying things. You know, maybe you, maybe you try something ultra, ultra aggressive, maybe you try something that is a little more balanced and you've got to find what works for you. And that's ultimately, there's no better way of doing that than ultimately doing. I mean, I'm a huge, huge advocate of learning by doing. And I think the best way to learn things is to experience them. And so I think again, you can't just read a book like this and put it down and conclude this is the one for me. You know, this is the portfolio I'm going to implement and this is what I'm going to implement for the rest of my life. Because you might realize after six or 12 months that, you know, hey, I really don't like a certain aspect of this, or this makes me way too scared, it's way too volatile. And so maybe you need to try something else. And you know, I do think ultimately, especially as you get older and wealthier, I think you ultimately do need to find a set of processes that work for you and be loyal to them and you know, at the same time understanding, hey, life is going to change and life is going to evolve and I've got to evolve with it. But at the same time, you do need to ultimately settle down and find something, a set of processes that work for you really well so that you can stay loyal and not constantly be flipping things around and having portfolio one night stands that are counterproductive.
- [20:38]
A
That's an interesting way of putting it. Portfolio one night stands. So what's the first question that you start with when you're working with a client who comes to you and is looking for the perfect portfolio for them? How do you determine that?
- [20:50]
B
Well, I mean, I work on a planning basis, so everything for me is about the underlying financial plan. I mean, that's, you know, one of the reasons I like focusing on time horizons is because you have to get really personal with somebody. When you talk about time horizon. You have to have those uncomfortable conversations about, hey, you know, John, you're going to die one day. And we need to confront that head on. And this is good financial planning, that we need to talk about the finite nature of your portfolio, your life and everything that's going on in your personal life and your, your financial life that interplays with all of this across different time horizons. And so for me personally, like, I get deep into a very personal conversation about what does somebody's personal life look like and their financial life look like relative to all the different time Horizons that they're going to experience over the next, you know, year, five years, 20, 30, 40 years, whatever it might be. And that's a very fundamentally income statement and balance sheet based conversation because you're talking very specifically about what do you have now and what are you earning now and what are you spending money on now. And how does this all relate together in the long run, in the short run and the intermediate run to serve certain financial goals? Because that's ultimately the, you know, the, it's funny to me, working in the industry and thinking about all the strategies that are very popular, because the strategies that are popular are typically built around styles, things like large cap growth or, you know, small cap value or whatever it might be. We talk about these strategies and styles and normal people just, they don't care about that stuff. They probably don't even know what the growth factor is versus the value factor in the first place. I bet you most financial professionals don't even actually know what the values of the size of market caps are for large cap versus mid cap. I mean, because they're constantly changing. So we talk about these sort of vague concepts. These are the most popular styles and strategies in the, in the financial services industry. And your average person just doesn't care about that stuff. They want to know, you know, hey, can I afford to send my kid to college in 10 years? Can I afford to remodel a bathroom next year? Can I afford to retire in 15 years? And so all of this, to me it has to be a time based conversation because that's the thing that matters. And it's the thing most importantly that people actually understand. People understand, hey, I need to do X, y, Z in 12 months, tell me I'm going to have a guaranteed 100 grand to achieve that goal or something. And so for me, time is the essential element in all of this.
- [23:39]
A
How much do you feel that normal people, your average person underappreciates the scope of risk that they are taking or could potentially be taking in their portfolio when they think that they're not doing anything particularly risky.
- [23:53]
B
Yeah. God, that's a great question. I mean, just because the concept of risk is so vague in the financial industry. I mean, vague is lots of different things. Like it's weird to think about it in the sort of academic sense because risk is basically just volatility. But then you can get into like this wonky academic debate about, well, okay, but positive volatility is a good thing actually. Like when a price goes up a lot and it's, you know, standard deviation is high in a positive way. Well, that's a good thing. Nobody dislikes when the price goes up a whole lot. Whereas negative volatility obviously is the thing that everyone's really worried about. You're worried about your prices going down. But so you can get into these very wonky debates. I mean, Morgan Housel defines risk as what we don't know. That risk is just these things, they're anomalies, events that come out of nowhere and you know, things like Covid nobody, you know how many people thought that a global pandemic was going to hit and that we were going to shut down everything in, you know, for two years and you know, implement all sorts of crazy policies and all that. It's, you know, so in that sense, risk is what you don't know. But then you can get in debates about like, well, risk might be that you're not taking enough risk. It could be that you're being overly conservative with a portfolio. And so. But at the same time, risk could also be that you take too much risk. So, you know, I really like in the book, I talk about a Ken French quote where he says that risk is uncertainty of future consumption. And I think that's the thing that I like about that quote is that it's sort of all encompassing. That risk is really the inability to predict how much money you're going to have across future time horizons to be able to do the things you want to do, whether that's a, a vacation next summer or paying for a new car in two years, or paying for kids college in 10 years, or having the ability to retire. Risk is not having money when you need it. And so when you create a lot of uncertainty in your financial life because you don't have an ability to understand how much you're going to be able to consume in the future. It exposes a lot of risk. And that is sort of all encompassing because it includes things that are unknowns. It includes things that are, you know, might be the more academic nature of the idea of standard deviation and whatnot. So to me, risk is when you have a financial plan where you don't understand exactly what you're doing and how it interplays with your future financial goals.
- [26:19]
A
How important is having realistic expectations? And do you find that people have a difficult time with that?
- [26:26]
B
Oh my God, yeah. I mean, because I think a lot of us do a disservice, especially in the financial media of communicating this to people because I think that the expectations a lot of the times are on they're unrealistic in the way they're presented. And so one of the things I did in the book that's kind of unusual for a, a finance book is I presented everything in, in an after inflation based return. And so I tried to focus on real returns in the book because the numbers are literally inflated across the board with your gross returns. We often hear that like the, the stock market does 10% per year and well, that's probably true. Maybe the reality is that the amount of money you're actually going to get into your pocket after you pay for taxes, fees and inflation, it's probably closer.
- [27:14]
A
To like 3 or 4%, depending on your time horizon. You don't know what those taxes are going to be.
- [27:18]
B
Yo. Yeah. And so there's a huge amount of uncertainty inside of all of that. And so. But it's crazy, you know, when you think about setting realistic expectations that, you know, if you start getting into the stock market world and you start running the math and you start thinking, you know, like, this is my mentality when I'm 20 years old and I get out of college and I'm reading about, you know, Warren Buffett's incredible returns and I start saying to myself, well, the stock market does baseline 10% per year. Well, if I could do, you know, say 12 or 13 or 15% per year, you know, and I'm investing X number of dollars. Well, you start running the math on that, you know, you can start getting pretty unrealistic expectations about what you're going to do. And you know, this becomes especially true after you start realizing that, holy cow, inflation is a real thing and the tax man is actually the biggest fee you're going to pay in all of this, probably. And those numbers are, they're gigantic. They're a huge, huge piece of your net return. And so you have to back all that stuff out. So I was very intentional in the way I presented the data because I wanted to present the data in such a way where people would look at it and say, hey, I can make a lot of money in the stock market and I absolutely should be allocating my assets to different sets of financial assets and building a smart portfolio. But at the same time, I shouldn't have unrealistic expectations about how fantastically rich the stock market is going to make me in the long run.
- [28:41]
A
So you have 10 principles that you lay out early in the book, and we covered some of them indirectly, like time horizon and defining risk and realistic expectations. One of them, the very first one, is that you are a saver, not an investor. What does that mean? Because so many people think of their investments as their savings today.
- [29:02]
B
Yeah, so this is something that I actually grappled with when I was writing my first book. Because it's really strange, actually, that the, the fields of economics and finance, they don't define the word investment the same way, because in the field of economics, investment means to spend for future production. That's basically what firms do when firms spend. They, for instance, if they're building a factory, let's say when a firm spends money on the factory, they're spending for future production. They are making. They are investment spending. And this is very different than consumption because consumption is basically a sunk cost in the future. You, you consume a candy bar. But if a firm builds a factory, well, that actually contributes to future income, or at least it should if it's done well. And what's interesting about buying things like stocks and bonds is that when you're buying stocks and bonds, you're not literally investing. You're not spending for future production in any meaning, any meaningful sense. The same way that firm is when they're spending for future production. You're buying actually an instrument whose value is going to be reflected by the way that the firm spends for investment. So buying the analogy, the. To understand this is to think of, and not even.
- [30:14]
A
Right. Because what you're really doing is you're buying an instrument tied to what other people's future expectations are about what that instrument is worth and your ability to sell it.
- [30:21]
B
Exactly. So this whole other behavioral element around what the valuation of this thing is going to be. And so. But it's analogous to buying a ticket at a horse race versus being the trainer of the horse. The trainer of the horse spends for investment. They actually can get in there. They can determine who the jockey is, how well that horse is trained, what kind of drugs it's taking, or whatever the diet is for the animal. And so they actually have a very direct influence on the way that that outcome is going to result. Whereas the people who are just going to a horse race and buying the gambling tickets, markets, you know, they, they have zero influence on the actual outcomes. They can try to guess and predict. But buying stocks and bonds is not really that different in that sense. It's very different from gambling in the sense that the, the stock market is typically a positive sum game, whereas, you know, buying a horse ticket at a race is a negative sum game actually for everybody involved. But the analogy holds true in the sense that what you're doing when you're allocating your savings is very, very different than what the actual firm is doing when they spend for investment. And I try to emphasize this because the. To me, the process of allocating your savings is very different than the process of doing something that is analogous to investing. Because I think investing is oftentimes portrayed as this sexy sort of get rich quick endeavor. And when you think of it as you're literally allocating a piece of your savings, I mean, you're literally taking some of your income, you're saving some of it, and then you're allocating that savings to stocks and bonds. That process to me is totally different. It involves planning and methodology and a sequence of processes and discipline over specific time horizons that you need to adhere to. And to me, having that right mentality, that right set of expectations is really important because again, it'll avoid a lot of the traps of having unrealistic expectations where you go into this thinking that this is some sort of get rich quick scheme or, you know, something analogous to betting on horse races, specifically where you're going to make a lot of money really quickly. And that's not the way it works.
- [32:20]
A
It's also true that the way that people view their investment portfolios today is very different from how they viewed them in, say, the 1950s, when of course, fewer people owned stocks to begin with, in part because the memory of the Great Depression, of The Crash of 1929 was still vividly in people's minds. But over the years, it seems that people's relationships to the stock market has also changed in line with changes to the social contract that began to emerge in the late 19th and early 20th centuries between the workers and the owners, between labor and capital. And that contract was negotiated on the factory floor. And it led to things like pension systems, predictable wage increases and work hours mediated by labor unions, employer sponsored health care, et cetera. And. And as the coordination costs of doing business outside of large corporate structures have dropped in the last few decades and accelerated really since COVID what we have seen is a disintermediation of the cost savings and productivity gains that normally would have come within the firm structure. As the economy has become increasingly decentralized and people have come to depend on the stock market in place of corporate pension systems in a sort of parasitic way that allows them to benefit from aggregate economic growth. And because of how many Americans that have their life savings tied to equity performance, the government has itself become the primary investor and insurer in the stability of the stock market, which has gone from Being a marketplace for allocating capital to a political utility.
- [33:57]
B
Yeah, I mean, gosh, that's a whole big can of worms that it's almost like the, you know, is there, there's like a fundamental disconnect between the way we view what the stock market should be and the value of the stock market should be versus the, the way that the stock market is actually contributing in an underlying way to the well being of all of our lives. And I think that, you know, in a lot of ways public policy has, has definitely created this. I think a bad incentive structure where we're increasingly incentivized to just make number go up and number go up doesn't mean that necessarily living standards are increasing. And so I think there's a, there's a really messy interplay in all of this with the, the debates that are going on in a lot of social circles where like you look at things like consumer sentiment. I think consumer sentiment is low these days because in part because the policy has been so driven around number go up where as long as the stock market is doing well and we protect housing prices and things like that, and as long as the numbers stay up, I think a lot of politicians think that that means that that reflects a good situation. And I think a lot of consumer sentiment right now is exactly the opposite. That people are actually frustrated by the way that the numbers have gone up and they haven't necessarily participated. And a lot of public policy has been built around that. Whether it's God, I mean things like the whole Covid experience or a lot of people will argue that policies like quantitative easing are purely driven around things like asset price inflation and things like that. And so I think there's a lot of truth to that. In a way, we've put the cart before the horse in the sense that we're not incentivizing long term investment. The kind of getting away from what I was talking about earlier. We're not incentivizing long term investment the right way. And instead we are in a lot of ways sort of incentivizing more of a, a gambling mentality now. I think it's part of what especially young people feel like they almost need to be doing these days, that they almost feel like they need to be gambling on the stock market or crypto or whatever it might be because they feel like it might be their only way out. That they don't see a long run path to achieving wealth and financial independence through just a prudent long term savings set of goals.
- [36:23]
A
Man, so much to Talk about there. I'm just trying to think about how much of this do we want to broach now or wait for the second hour? Let's just dig into that really quick with one more question. What is your view of that mentality and that perspective? Do you think it's empirically based or do you think it's a subjective feeling generated by a consensus view obtained from social media and living in a digital world where you're seeing other people that seem to be doing better than you, but they all represent some small, tippy, tippy, top of the pyramid?
- [36:52]
B
It's hard. I mean, I think there's definitely a lot of truth to it. I mean, I think that, I mean, look at the real estate market, for instance. I think that anyone who didn't buy before COVID I think they're super frustrated.
- [37:03]
A
I heard you locked it in at two and a half, so.
- [37:05]
B
Yeah, I can't remember. I think mine was 265 or something like that. But yeah, I mean, it's crazy because I think that if you were, especially if you were someone who was saving, who was being really prudent, you know, in the years running up to 2020 and then Covid happens, real estate prices jump 50%. And then all of a sudden the worst thing that happens is interest rates go up and mortgage rates go up from, you know, 2, 3% to 6, 7%, 8%. It's a double whammy. Everything feels unaffordable. And if you didn't buy before 2020, I think you almost feel like you're permanently locked out. You know, so there's a lot of credence to that view that someone who's looking at that situation is now, they feel like they're on the outside looking in and they, they feel like maybe their only way to be able to get in is to take sort of extreme risks and try to accelerate things that make up for the acceleration that happened during COVID And again, so much of that was public policy driven. Like, I think that the, the real estate market is especially interesting in the context of COVID because so many people came out of COVID and said, ah, the inflation is transitory and the, you know, we know that there were these huge supply shocks in certain components. And real estate's really interesting because real estate kind of debunks a lot of that, that there was no shock, there was no supply shock in housing because there was already a supply shock in housing well before COVID ever happened. And so the impact of inventory on prices was relatively Minimal during COVID Mainly because we know that what drove housing prices then was we kept interest rates too low for too long. And we blasted. We flooded the economy with trillions of dollars of fiscal spending. And so we know very acutely that in the real estate market, that 50% jump in housing was largely due to the way that public policy impacted things, and it influenced and incentivized people to do certain things. And so, you know, I do think that there a lot of the sentiment around this is totally rational, you know, and it'. It's really hard to sit down and look at a young person in the eyes and say, hey, you know, just do what I did and build a company and work really hard and be patient and just keep, you know, trudging along every single day for the next 20, 30 years and, you know, be disciplined about it. Because they look at the last five years especially, and they're like, dude, you blasted $5 trillion into the economy. You made prices go up 50%. And how do I know you're not going to do that again? I feel like I've got to, like, do something to accelerate my financial life and get ahead. So I totally get it. I, at the same time, I probably still would sit down with most young people and say, you know, put your head down. Be patient, keep working hard. You know, you can't control what public policy is going to do, so don't gamble your life savings away and potentially put yourself in a worse position than you otherwise would be. So it's hard. I totally sympathize with, with young people who feel like they're on the outside looking in and actually feel like kind of crummy sitting here and saying to someone who's in that situation, like, hey, you got to just put your head down and grind. Because that's kind of a crappy answer for them.
- [40:13]
A
Yeah, no, I'm with you. I think I totally agree. I mean, it's something I've explored on the show for years. In fact, to tie this into the observation earlier about the social contract that has led to your average American viewing the stock market as their primary savings vehicle and therefore a political utility of the government, which basically has to do something if it drops by a certain amount. It's actually interesting because if you ask the average person, I bet they would look at you like you had 50 heads if you said to them, there's a government put on the price of gold. But if you ask them, do you think the government will let the stock market fall below X a larger percentage of those people will tell you, no, they won't, because there's an embedded expectation on the part of the public that the government is there to save the financial system and with it, the value of their portfolios. And where did they get that idea, I wonder? They got it from the last 20 years of financial policy. And this new social contract that we're talking about here overwhelmingly favors not just the owners of capital, but who happened to be the owners of capital, older people. So there's also a generational gap between policies that serve older demographics versus younger people. And I want to reference a conversation I had with Nicolas Cola recently, who made this brilliant observation on the podcast, that the new social contract, the one that will emerge from this crucible, will be negotiated within the construct of housing. Because the cost of owning a home has become so expensive that people can't afford to live where the jobs are. And while the economy has become more decentralized, as we've discussed, and more people are working from home, that cost is still a giant drag on people's standard of living. And the same is true for the cost of education, the costs associated with healthcare, which are also multifaceted. And there are so many things that we could be doing better as a society to incentivize the emergence of a healthier food system and healthier lifestyles for people who have become themselves a burden to the healthcare system. That is totally broken. But anyway, that opens us up to an entirely different conversation. I have one more question for you, Colin, before we get to the second hour. And that has to do with where one's primary income stream fits in this discussion in terms of being able to generate a predictable cash flow that can be used to make investments in the stock market or anywhere else beyond just what is needed for basic consumption.
- [42:39]
B
Yeah. So one thing I write about, a common theme across the book, is that your income is really. It's a function. It's the value of your human capital, basically. So the skills that like going back to the conversation about savings versus investment, I would emphasize that the actual investment spending that most of us make is in ourselves. It's in the way that we develop skills and knowledge over time that we then utilize to leverage into generating an income. And so you generate skills. And whether that is, you know, paying for school or actually paying to learn how to do certain things, whatever that investment spending at your personal level might be, you're doing this in a very intentional way where you're trying to make yourself more valuable to other people. And that allows you to Earn, hopefully, a higher income over time where as you become more valuable to other people, they, you know, they compensate you for that value. And then you're able to more predictably save some of that income and allocate it into things that are going to protect your human capital in the long run from things like inflation and taxes and whatnot. And so. So the analogy that I use is that your income is a lot like a bond allocation in your overall total portfolio, that the income you're earning is actually very similar to having this bond allocation, that you may not properly have a bond allocation in your portfolio, but functionally speaking, it is something that if you make, for instance, say, $100,000 a year, you have something that's very similar to, say, a $2 million bond that is roughly earning about 5% per year. And so you have this implicit bond allocation, and this is really valuable to you because it gives you a lot of certainty of future consumption, first of all. So going back to the Ken French quote, it gives you a lot of certainty of future consumption, but it also fuels your ability to save. And so, and then you can take that savings and reallocate it into other instruments that hopefully will compound your, you know, your balance sheet in the long run. And so, so again, this is an income statement versus balance sheet relationship. And that's a conversation that I talk about that's really important because especially when you're young and you have this fixed income, this implicit fixed income allocation in your portfolio that totally transforms the way the rest of your portfolio might have to look. And it's part of why, when you're young and you've got a really long time horizon, this implicit fixed income allocation, it allows you to be really aggressive because if you've got a $2 million bond, implicitly that's earning, you know, 5% per year, well, that means that maybe the way you're actually allocating your savings should be all equities. Maybe it should be in aggressive instruments, whether that is, you know, crypto or gold or, you know, an all stock portfolio. You have this capability to be really aggressive because you've got this implicit, really safe fixed income allocation that it frees up a lot of behavioral bandwidth and a lot of balance sheet bandwidth to take risk with.
- [45:40]
A
So one more question, or maybe a couple more questions in the gig economy. So we talked about how the economy itself is transforming. People used to have steady jobs. They worked at one corporation. They worked there for 20, 30 years, they got a pension, they retired, et cetera. Today, people are much More on their own, they're untethered, they don't have the same type of safety net. And also they're entrepreneurs. More and more people are entrepreneurs, whether it's their primary business or side businesses. And so investing in yourself takes on a much more literal significance for a broader swath of the population today, it would seem to me, and I'm curious, in your conversations with younger people that come to you, does this show up, in other words, this trade off between putting my money in the market versus investing in myself or building up this business, this side hustle that I'm working on? Is that trade off more acute in your experience?
- [46:30]
B
It is. You know, I think it's a lot more important these days because I think that the ability to create your own brand and create your own value that isn't so dependent on a corporation is a lot easier these days. And so I do think that, you know, like you touched on this, that decentralization is a theme that I think is going to get. Get far more exacerbated as the next 10, 20, 30 years play out. And that's in large part a function of technology. The way that, you know, everything that's going on these days, it gives us the capability to do things that you see this especially with things like AI where, I mean, God, I spent half of last year just, you know, writing software. What people are. I guess, you know, I was doing what people now call vibe coding. But I spent like, I mean, almost five nights a week, I was up till 2, 3am Just building tools and software components for my own business that, I mean, God, even just two years ago doing something like that, it would have taken a team of software engineers in here doing things with me, and I'm. I would have had to relay things, I mean, even, God, even a couple years ago doing really simple things. Like when I would outsource, like, you know, logo design, I would go to, you know, TaskRabbit or something. And you outsource something like that and you send it to some guy in India and he sends back a fancy design 18 hours later. And, you know, it's this very clunky process 18 months ago, whereas today you can do this in literally 18 seconds. And so it's a totally different environment. The ability to, I think, build brand, just personal brand value and build something that is creative and differentiated. You have the tools at your fingertips now to be able to do these sorts of things. And I think that's going to become just, you know, vastly more important. This ability to navigate the changing technological landscape in a very creative and personalized way weirdly becomes a lot more valuable than say, being able to get a job at Microsoft or Nvidia and a lot of these big firms where, you know, the old school way, the old traditional way of work, the way we thought of it as being, you know, just another employee at a big firm, is very, very different. And so, you know, I don't know if it's necessarily easier. You know, there's a lot of logic in still doing the traditional thing where you, you say you go to school and you get a law degree and you get a very safe high income earning job that is probably going to, you know, pay you very well for a very long time. There's still a lot of logic in doing that. So I don't think it's, you know, there isn't a one size fits all answer. But I do think that people, especially people who are creative, outside the box thinkers who have the ability to build and invest in themselves, the tools are, they're more valuable, more accessible than they've ever been now.
- [49:23]
A
Absolutely. I mean, it's both exciting and scary. I can see how as an entrepreneur, first of all, I'm not constituted as an individual to be an employee within a large corporation. That felt like death for me when I had tried that. But putting that aside, I would actually be very uncomfortable in such a situation because I'm so specialized in my vocation and I'm also very vulnerable to industry wide layoffs. And then what happens if I lose those skills? The economy moves at a much faster rate. So having an entrepreneurial mindset and having an entrepreneurial skill set and toolbox is invaluable regardless of what your official training is in or how smart you are. You can put that to use in any context. But I also think that even as an entrepreneur, the landscape is so different today than it was five years ago. And I'm not just saying technologically though certainly it is the technology that I think is the primary driver of this, which is that I don't feel safe anymore in the way that I do business. I recognize that I need to be on top of these changes because I already see that if I implement large language models for the post production of the show that I can dramatically reduce my costs today. I've already seen it, actually. There's so much more that we can do and we're trying to do it. And that means that other people are losing money and other people are losing jobs. When I'm cutting my costs, which means that I need to be prepared for that to happen to me. And so what are the things that I can do to push back against that and offer more value? And it's interesting in the content business, Cullen and I don't know how much you're in this business anymore because I don't know how much you blog anymore at Pragmatic Capitalist. But what's essentially happened is large language models don't just allow the Internet and bots and all this stuff out there to inshitify the Internet to create more and more garbage. They also allow really smart people to create more and more interesting stuff that no one reads because no one has time to read the additional content you've created because they didn't even have time to listen to the two hour episode that you were on last week. And so I think there's something really interesting going on here, Cullen, in terms of how we navigate this deluge of information and arrive at a new sort of plane, a new equilibrium where people can actually make sense of the world and not just feel overwhelmed by not knowing what to focus on and what not to focus on. So I just think for me it's a really exciting time, but it's a nerve wracking time. So the book, as I said it was split. I mean most of the book is actually going through these portfolios. That's what I'd like to spend the second hour talking about as well as larger macroeconomic theory. And I'd love to go back and forth with you a bit on that and some of those big topics. And there are so many of portfolios that you have highlighted in the book. Like you've got the Buffett portfolio, the 100% stock portfolio, the T bill and chill, the 6040 factor investing, forward capitalization. There are a few that I found especially interesting like the permanent portfolio or countercyclical rebalancing and, and dividend investing as you know, or defined duration, which is your favorite portfolio and I think has so many elements that are sort of consistent with my own objectives. Even the endowment portfolio is something that I found like, okay, I feel like a lot of what I do actually looks and feels like an endowment and so I'd love to explore those things as well as, as I said, a larger conversation about macro in the second hour with you, Cullen. For anyone new to the program, Hidden Forces is listener supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want access the second hour of today's conversation with Cullen, head over to HiddenForces IO subscribe and sign up to one of our three content tiers. All subscribers gain access to our Premium Feed, which you can use to listen to the rest of today's conversation on your mobile device using your favorite podcast app. Just like you're listening to this episode right now. Cullen, stick around. We're going to move the second hour of our conversation onto the Premium Feed. If you want to listen in on the rest of today's conversation, head over to HiddenForces IO subscribe and join our Premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces IO, you can follow me on Twitter cofinas, and you can email me at infoiddenforcesio. As always, thanks for listening. We'll see you next time.