Rethinking Investing with Greenwich Associates' Charles Ellis

Summary

Masters in Business: Rethinking Investing with Greenwich Associates' Charles Ellis

Episode Overview

In the February 21, 2025 episode of Masters in Business hosted by Bloomberg's Barry Ritholtz, listeners are treated to an insightful conversation with the esteemed investor and author, Charles Ellis. The discussion delves into Ellis's extensive experience in the investment world, his new book Rethinking Investing, and his perspectives on modern investment strategies, particularly the efficacy of passive indexing versus active management.

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Introduction to Charles Ellis

Barry Ritholtz begins by introducing Charles Ellis, highlighting his illustrious career trajectory—from his early days at the Rockefeller family office to founding Greenwich Associates. Ellis has authored 21 books and has held significant positions, including serving on Vanguard's Board of Directors and chairing Yale's Endowment Investment Committee. Ritholtz remarks:

“He's published 21 books... his new book Rethinking Investing is just a delightful snack. It's only 100 pages and it distills 60 years of investing wisdom into a very, very short read.”
[02:51]

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Evolution of Investing: From Rockefeller to Greenwich Associates

Ellis recounts his early career experiences, emphasizing the transformation of the investment landscape from the 1960s to the present day. He reflects on his time at the Rockefeller family office, noting:

“Trading volume was 3 million shares on the New York Stock Exchange... Now it's 6, 7, 8 billion.”
[06:05]

This exponential growth in trading volume underscores the shift towards institutional investing and the advent of modern portfolio theories that were once considered mere academic curiosities.

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The Paradox of Skill and Active Investing Challenges

A significant portion of the discussion centers on the diminishing returns of active investing amidst heightened competition and information accessibility. Ellis introduces the concept of the "paradox of skill," where increased skill among investors leads outcomes to be more influenced by luck. He cites:

“When everybody knows exactly what you know, then they've got computing power so they can do all kinds of analytics. It's really hard to see how you're going to be able to beat them by much, if anything.”
[11:16]

Ellis further explains how active managers often underperform due to high fees and the inability to consistently outperform well-informed, technologically equipped competitors.

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Embracing Passive Indexing: A Superior Strategy

Ellis advocates for passive indexing as a means to mitigate the inherent risks and costs associated with active management. He references studies by Morningstar and Dalbar, which illustrate that actively managed funds frequently underperform their benchmarks. Highlighting the efficiency of index funds, he states:

“Over the 20 years ending in mid-2023, investing in a broad-based US total market equity fund produced net returns better than more than 90% of professionally managed stock funds that promised to beat the market.”
[37:14]

Ellis emphasizes that passive indexing not only reduces costs but also leverages the power of compounding over long-term investment horizons.

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Behavioral Economics and Investor Behavior

A pivotal theme in Ellis's discussion is the role of behavioral economics in investment decisions. He points out that human biases often lead investors to make suboptimal choices, resulting in underperformance relative to market indices. Ellis remarks:

“The average investor in an average year loses 2 full percent by making mistakes with the best of intentions.”
[30:57]

He underscores the importance of recognizing and curbing these behavioral biases by adopting disciplined investment strategies like indexing.

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The Power of Time and Compounding

Ellis and Ritholtz explore the profound impact of time and compounding on investment growth. Ellis illustrates this with the example of missing the top-performing days in the market:

“If you miss only the 10 best days out of 10,000 trading days, the return drops from 11.2% to 9.2% annually.”
[43:26]

This demonstrates how consistent, long-term investment strategies can harness the exponential growth potential of compounding, far outweighing the tactics of short-term active management.

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Total Financial Portfolio Perspective

Introducing the concept of a "total financial portfolio," Ellis advises investors to consider not just their investment holdings but also the present value of future Social Security benefits and the equity value of their homes. This holistic view can lead to a more balanced and equity-leaning securities portfolio. He explains:

“Include the present value of your future Social Security payments and the equity value of your home as sort of bond-like. And that should help you shift your allocation a little away from bonds, a little more into equities.”
[50:12]

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Advice for Aspiring Investors

Towards the end of the episode, Ellis offers guidance for recent graduates aspiring to enter the investment field. He stresses the importance of intrinsic motivation over financial incentives:

“If it's your desire to lead your life making money or doing something that you would say was at the end of your life, I'm so proud to have what I did...”
[53:25]

Ellis encourages budding investors to focus on helping others achieve their financial goals, suggesting that genuine passion leads to greater professional fulfillment and success.

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Key Takeaways from Rethinking Investing

1. Shift to Passive Indexing: Active management is increasingly untenable in a world of information abundance and high competition. Passive indexing offers a cost-effective, reliable alternative for long-term growth.

2. Mitigate Behavioral Biases: Recognizing and addressing inherent human biases can prevent costly investment mistakes.

3. Leverage Compounding: Time is a critical ally in investment growth. Early and sustained investment harnesses the full power of compounding.

4. Adopt a Holistic Portfolio View: Incorporating non-traditional assets like future Social Security benefits and home equity can optimize investment allocations.

5. Passion Over Profit: A career in investing should be driven by the desire to assist others rather than merely financial gains.

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Conclusion

The episode concludes with a reaffirmation of the merits of passive investing and a nod to Ellis's impactful contributions to the field. Ritholtz encourages listeners to explore Ellis's Rethinking Investing for a concise yet profound exploration of sustainable investment strategies in the modern era.

“If you invest for 20 plus years, passive indexing... ends up in the top decile.”
[37:56]

Ellis’s insights serve as a compelling argument for re-evaluating traditional investment approaches and embracing strategies that align with the evolving financial landscape.

---

Notable Quotes

• Charles Ellis:
  “Active investing is an exciting idea... but the circumstances now are so different that it doesn't work beautifully. It works negatively.”
  [49:44]

• Charles Ellis:
  “If you have the time, the impact of compounding really is terrific.”
  [47:34]

• Charles Ellis:
  “Don't do it [applying outdated investment lessons].”
  [55:59]

---

Final Thoughts

This episode of Masters in Business offers a wealth of knowledge for both seasoned investors and newcomers. Charles Ellis's perspectives challenge conventional wisdom and advocate for evidence-based, disciplined investment practices that stand the test of time.

Transcript

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[Bloomberg Radio Host]

Bloomberg Audio Studios Podcasts Radio News this is Masters in Business with Barry Ritholtz on Bloomberg Radio.

[Charlie Ellis]

This week on the podcast I have an extra extra special guest. Charlie Ellis is just a legend in the world of investing. He started for the Rockefeller family office before going to DLJ and eventually ended up launching Greenwich Associates. He's published 21 books. He's won every award you can win in the world of finance. He was a member of Vanguard's Board of Director. He was chairman of the Yale's Endowment Investment Committee and his not only did he write 21 books, but his new book Rethinking Investing is just a delightful snack. It's only 100 pages and it distills 60 years of investing women wisdom into a very, very short read. I found the book excellent and Charlie as delightful as always. I really enjoyed our conversation and I think you will also, with no further ado, my discussion with Charlie Ellis.

[Barry Ritholtz]

Thank you Barry.

[Charlie Ellis]

Well, thank you for being here. First of all, we're going to talk a lot about the book in a bit, which I really just devoured over a cup of tea. It was that short and very delightful. But before we do that, I want people to fully understand what a fascinating background you've had and how really interesting your career is, where you began and where you ended up. You get a master's in business from Harvard business school, a PhD from New York University, and then you sort of happen onto Rockefeller Foundation. How did you get that first job? How did you discover your calling?

[Barry Ritholtz]

Friend of mine at business school said, have you got a job yet? I said, no, not yet. Got a couple of things that I'm working towards. He said, well, I've got a friend. And I thought he meant the Rockefeller Foundation. Actually he meant the Rockefeller family in their investment office. And very, very bright guy came up from New York to Cambridge, Massachusetts, climbed to the third floor of my apartment building and we did an interview in what I would have to describe as shabby graduate student facility. And at the end of half an hour, I realized it isn't the foundation that he's talking about, he's talking about something else. And I got to figure out what that is. At the end of the second half an hour, I knew he was talking about investing where there were no courses at that time, at the Harvard Business School on investment management.

[Charlie Ellis]

And he's really describing the Rockefeller family office. Yes, not necessarily the foundation. So what were they doing at that time? What were their investments like?

[Barry Ritholtz]

Well, they invested the family's fortune at that time relative to other family fortunes. It was the large major, so on and so on. They were also, because they'd been generous philanthropically for years, managing several charitable organizations, endowments. So the combination made us a consequential investment client for Wall street, as Wall street was just coming into doing serious research on individual companies and industries. So it was takeoff time for what became institutional investing.

[Charlie Ellis]

So give us some context as to that era. This is the 1970s and 80s essentially went.

[Barry Ritholtz]

That was the 1960s, so late 60s.

[Charlie Ellis]

Not a lot of data available on a regular basis. And modern portfolio theory was kind of just coming around.

[Barry Ritholtz]

Oh, it was just an academic curiosity. Nobody in his right mind thought it had a chance of being proven. But you know, if you go back to those days, if we came back to it, we would all of us agree with the people who said, no, it's not going to happen. The transformation of the whole investment management world. Information availability legislation, who's participating, what's the trading volume. What kind of information is available? How fast can you get it? Wow. Every one of those dimensions has changed and changed and changed. The world is completely different today.

[Charlie Ellis]

You detail that in the book. We'll talk about that in a little bit. That if you just go back 50 years, completely different world. As you mentioned, the volume, but who the players are, how technology allows us to do things that we couldn't do before and that we've also learned a lot since then.

[Barry Ritholtz]

We sure have. It's hard to remember, but I do because I was new and fresh. And so it made an impression. Trading volume was 3 million shares in New York Stock Exchange listed. Now it's 6, 7, 8 billion.

[Charlie Ellis]

That's a huge change order of magnitude.

[Barry Ritholtz]

The amount of research that was available was virtually zero.

[Charlie Ellis]

That's amazing. Now I recall the CCH binders used to get updates on a regular basis, the clearinghouse binders. And then it was essentially Zach's and a whole bunch of different companies. But that's really late 80s, right? Like when did the research explosion really happen?

[Barry Ritholtz]

Research explosion happened in the 70s and then into the 80s. But the documents that you were looking at or thinking about were all looking backwards, right?

[Charlie Ellis]

That's right.

[Barry Ritholtz]

Give you the plain vanilla facts of what's happened in the last five years in a standardized format with no analytical or insight available. Now, everything about research is the future and it's full of factual information and careful interpretation. It's really different.

[Charlie Ellis]

That's really interesting. So how long were you at Rockefeller before you launched Greenwich Associates in 1972?

[Barry Ritholtz]

Well, I was there for two and a half years. Then I went to Wall street with Donaldson, Lufkin and Jen Rhett for six. And then I started Greenwich Associates.

[Charlie Ellis]

So what led you after less than a decade to say, I'm going to hang my own shingle? It seems kind of bold at that point. You're barely 30 years old.

[Barry Ritholtz]

It was a little nervy. I have to graduate. There are a couple of different parts. One is that I knew from my own personal experience I had no ability to get my clients to tell me what I was doing right or wrong. They'd always say, oh, you're doing fine. Just keep it up, you're doing fine. I no idea what my competition was doing. You know, if we could give factual information on exactly how well each firm is doing and how every one of their competitors are doing, we could interpret that in ways that clients would find really useful. And then we could advise them on specific recommendations based on the facts. Really Undeniable facts based on 300, 500, 600 interviews with people who made the decisions. And it worked.

[Charlie Ellis]

Well, I can't imagine they're happy with the outcome, because what you eventually end up learning is that a lot of people who charge high fees for supposedly expert stock picking, expert market timing, expert allocation, they're not doing so well. And it turns out, at least on the academic side, it appears that the overall market is. Is beating them.

[Barry Ritholtz]

I wouldn't quite say it that way. I wouldn't deny what you're saying, but I would say it differently. The purpose of any market, a grocery store, drugstore, filling station, the purpose of any market is really to find what's the right price that people will buy and trade at. And the secureds industry is a very strong illustration of that. Lots of buyers, lots of sellers. What do they think is the right price to do a transaction? And they put real money behind it. So that purpose of a market gets better and better and better when the participants are more skillful, when the participants have more information, when the information is really accessible. And that's what's happened to the securities markets. The ability to get information from a Bloomberg Terminal, if you don't mind using Mike's name. But seriously, Bloomberg Terminal will spew out so much in the way of factual information. And there are hundreds of thousands of these terminals all over the world. So everybody in his right mind has them and uses them. Everybody in his right mind has computing power that would knock the socks off. Anybody who came from 1970 got dropped into the current period. They would just be amazed at the computing power. And they don't use slide rules anymore. You know, back in the early 70s, everybody used a slide rule. Wow. And we were proud of them and we were pretty skilled at it. But it's nothing like having computing power behind you. In those days, there were very few in the way of federal regulations. Now it's against the law for a company to have a private luncheon with someone who is in the investment world.

[Charlie Ellis]

Right. Reg FD said it has to be disclosed to everybody at once. So it is just whisper it to.

[Barry Ritholtz]

And everybody gets the same information at the same time. So basically, what you've got is everybody in the game is competing with everybody, knowing everything that everybody else knows at exactly the same time. And you can be terribly creative and wonderfully bright and very original. But if everybody knows exactly what you know, then they've got computing power so they can do all kinds of analytics. Then they've got Bloomberg terminals so they can do any backgrounding that they want to find. It's really hard to see how you're going to be able to beat them by much, if anything. And the truth is that people who are actively investing are usually making. They don't mean to, but they are making mistakes. And those mistakes put them a little bit behind, a little bit behind, a little bit behind the market. And then of course, they charge fees that are high enough, so trying to recover those fees while trading. And you can only trade successfully by beating the other guy when he's just as good as you are, he's got just as big a computer as you have, he's got just the same factual information you have, then all those other different dimensions, there's no way that you could think, oh yeah, this is a good opportunity to do well. That's why people increasingly, in my view, sensibly turn to index funds to cut down on the cost.

[Charlie Ellis]

So it's interesting how well you express that because Sometime in the 1970s, you start writing your thoughts down and publishing them. Not long after, in 1977, you win a Graham and Dodd award. Tell us what you were writing about back in the 1970s, and what were you using for a data series when there really wasn't a lot of data?

[Barry Ritholtz]

Well, the data did come, but it came later. And fortunately it proved out to be very strong confirmation for what I'd been thinking. But I was in institutional sales and I would go around from one investor to another to another to another to another. And I knew pretty quickly they're all really bright guys, they're all very competitive, they're all very well informed. They're all very serious students trying to get better and better and better. Their job is to beat the other guys, but the other guys are getting better and better and better all the time, striving to be best informed. They get up early, they study on through the night, they take work home on weekends. Competition, competition, competition, competition. How are you going to do better than those other guys when there's so much in the way of raw input is the same? And the answer is no, you can't.

[Charlie Ellis]

Michael Mauboussin calls that the paradox of skill. As all the players in a specific area get more and more skillful, outcomes tend to be determined more by random luck because everybody playing is so good at the game.

[Barry Ritholtz]

Absolutely true.

[Charlie Ellis]

So I'm fascinated by this quote, we've been talking about errors and making mistakes. One of the things from your book that really resonated is quote, we are surrounded by temptations to be wrong in both investing and in life. Explain.

[Barry Ritholtz]

Well, we all know about life. They were tempted by beautiful men, beautiful women were tempted by whiskey, gin, other drinks, where some of us get tempted by drugs and other things like that. So there are lots of temptations out and around. You think about all of us in the investment world are striving to be rational, which is a terribly difficult thing to do. Warren Buffett is rational and is brilliantly rational. He also does an enormous amount of homework. He also has terrific ability to remember things that he studied, and he spends most of his time reading, studying, memorizing and reusing. Very few people have that kind of ability, natural ability that he has. But most of us now have equipment that'll damn near do the same thing. And you could call up things from historical record anytime you want to. It puts everybody in a position of being able to compete more and more skillfully all the time. And therefore, candidly, I think the fees are a big problem. And then the second problem is, yes, we've got opportunities to be more and more skillful and more and more effective. But actually, what we also have, which really drives anybody who's serious about examining the data, drives them nuts. And anybody who is an investor wants to deny it. And that is that we make mistakes. We get scared by the market after it's gone down, we get excited about the market positively after it's gone up, and we interpret and make mistakes in our judgment. Now, there's a wonderful section in this little bitty book that I've just finished. Wonderful section on behavioral economics. Terrific book by Daniel Kahneman. Thinking fast, thinking slow. That's several hundred pages. And. And anybody in the investment world ought to read it because it tells you all about what we need to know about ourselves. And I've got one chapter that just ticks off a whole bunch of things like 80% of people think they're above average dancers. 80% of people think they're above average drivers. If you ask men a question on are you really above average at various kinds of skills? They get up to pretty 90%, 95% saying that they're very, very, very good. Now, if you look at any college group, are you going to have happier life than your classmates? Yes, by far. Are you going to get divorced as much as your classmates? Oh, no, that won't happen to me. And all kinds of other things that anybody looking at it objectively would say, you know, Barry, that just isn't the way it's going to happen. These guys aren't that much better drivers than the normal crowd. In fact, they are part of the normal crowd.

[Charlie Ellis]

You know, we all imagine that we're separate from the crowd. I love the expression I'm stuck in traffic, when the reality is if you're near a major urban center during rush hour on a workday, you're not stuck in traffic, you are traffic. And we all tend to think of ourselves as separate. Really, really fascinating stuff.

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[Charlie Ellis]

I'm fascinated by the evolution of your investing philosophy. You start with Rockefeller family office. I assume back in the 1960s, that was a fairly active form of investing. Tell us a little bit about how you began, what sort of strategies you were using, and then how you evolved.

[Barry Ritholtz]

Oh boy, that's a complicated question. First of all, in the early 60s when I was working for the Rockefeller family, that was the old world. All kinds of changes have taken place since then and virtually turned every single dimension of what was the right description of the investment world into a very different, opposite version. And it changed like that makes it almost a waste of time to talk about what was it like. But just for instance, I did some analysis of a company called dupont, which was one of the blue chip blue chips of all time. And I had also been studying IBM, which was a wonderful company. And I realized, you know, IBM has got an ability to generate its own growth because it is creating one after another advancement in computing power. And they've got a terrific organization behind it, and they are able to create their own growth. IBM is a true growth company. Dupont needs to invent something that other people will really want, and it has to be something that's really new. And then they get patent protection for a certain period of time, and then they lose the patent protection because it's completed. They've got a different situation. Both companies were selling at 30, 32 times earnings. One company I thought was sure to continue growing, and the other I wasn't so sure. So I got permission to go down to Wilmington, Delaware, and for three days I had nothing but one interview after another after another after another with a senior executive of the DuPont organization. And they were very candid. And they told me about their problems. They told me about their opportunities. They told me about their financial policies. Their first level financial policies were that they would always pay out half their earnings in dividends long established. And that was the way they did things. The second thing is they had a major commitment to Nylon, but nylon was no longer patent protected. And so the profit margins of nylon were going to come down for sure and come down rather rapidly because competition was building up pretty quickly. They hoped to build one terrific business in a leather substitute called Core Fam. But as I talked to the executives, they kept talking to me about, we're having difficulty getting people to use Core Fam. We're getting people who make shoes to think about using Core Fam. We can't get sales outside the United States to really get going, and we're having a difficult time getting sales inside the United States. And candidly, it doesn't look like this is going to turn out to be the bonanza we had all thought it was going to be just a year or so ago. Well, it doesn't take a genius and it doesn't take a very experienced person. And I was not a genius and I was not an experienced person, but I could see the handwriting. Wait a minute. If you only reinvest half your earnings each year and your major business is going to be more and more commoditized and your major new business is not taking off you got a real problem here and you're going to have a tough time keeping up the kind of growth that would justify selling for 30 plus times earnings. Whereas IBM was guaranteed to be virtually guaranteed to be able to do that because they didn't have very much the way of competition and they really knew what they were doing and they kept cranking it up. So what do you do? I came back and said, I know that the family, the Rockefeller family has many friends in the DuPont organization, but they also have many friends in the Watson family of IBM. I think it would be a great thing if we would sell off the holdings in DuPont and use the money to buy into IBM, go out of one family friends into another family friends, they would all understand it. And that was what was done. And of course, it involved a substantial amount of ownership being shifted. And I've always thought to myself, wow, in that one specific recommendation, I earned my keep for several years.

[Charlie Ellis]

Really interesting. And it's fascinating because that's what was being done in every institutional investor and every endowment. People were making active choices, but they.

[Barry Ritholtz]

Also were making lots of mistakes.

[Charlie Ellis]

Right.

[Barry Ritholtz]

If you looked at what happened in the two years after my recommendation, IBM doubled and dupont almost got cut in half.

[Charlie Ellis]

Wow. So that worked out really well. So it's kind of fascinating that you've evolved into really thinking about indexing, because when you were chairman of the Yale Endowment Investment Committee, David Swensen was famously the creator of the Yale model. And he had a lot of focus on private investment, on alternatives, on venture capital, hedge funds, as well as commodities. What made that era so different, where those investments were so attractive then and apparently less attractive to you today?

[Barry Ritholtz]

First, you have to understand that David Swensen was a remarkably talented guy. He was the best PhD student Jim Tobin, Nobel Prize winner ever had. He was the first person to do an interest rate swap, which is the first derivative transaction that took place in this country between IBM and the World bank, which just to show you, everybody had told him, you'll never be able to do that, David. So we're talking about a very unusual guy. And he was creative and disciplined in a remarkable combination. And he was the first person of size to get involved in a series of different types of investing. And then he very carefully chose the very best people in each of those different types. One day I was thinking, you know, he's really done some very creative work. I wonder what's his average length of relationship? Because the average length of relationship with most institutions was somewhere between two and a half and three and a half years high turnover of managers. The calculation, it was 14 years on average, and they were still running. So it'd probably be something like 20 years of typical relationship duration. Many of these managers, when they were just getting started. So it's the most dicey period in any investment organization. Very, very unusual. And creative guy said to me after he'd been doing this for quite a long time, you know, the nature of creativity payoff is getting less and less and less because of everybody else's doing what I've been doing, it's not as rewarding as it used to be. And because I've been choosing managers and other people are trying to get into those same managers, they're not as differentiated as they used to be. The rate of return magnitude that I've been able to accomplish 10 years ago, 15 years ago, I'm not gonna be able to do in 10 or 15 years into the future. And I think he was right. Huh.

[Charlie Ellis]

Really, really interesting. So how do you end up from going from the Yale Endowment to the Vanguard board of directors? Tell us where that relationship came.

[Barry Ritholtz]

Completely different. Each one was doing what they were capable of doing really well. And Vanguard was focused on minimizing cost. And they really systematic at it. Different orientation. The orientation of the Yale Endowment was to find managers and investment opportunities that were so different that you might get a higher rate of return. So attacking to reaching for higher and higher rate of return, Vanguard was reaching for lower and lower cost of executing a plain vanilla proposition. Index funds. Keynes once had somebody say, you seem to have changed your mind. He said, yes, when the facts change, I do change my judgment. What do you do when the facts change? And the reality is we've been looking at a market that has changed and changed and changed and changed. And the right way to deal with that market has therefore changed and changed and changed and changed. Then what you could have done in the early 1960s you can't do today. And what you should have done in the early 60s was go find an active manager who could knock the socks off at the competition. But it just the competition is so damn good today that there isn't a manager that can knock the socks off.

[Charlie Ellis]

And a quote from your book is the grim reality is clear. Active investing is not able to keep up with, let alone outperform, the market index. That's the biggest change of the past 50 years is that it's become pretty obvious that the deck is used to be in favor of active managers. Now it seems to be very much.

[Barry Ritholtz]

Stacked against them because they're so very good. It's ironic. Ironic. Ironic.

[Charlie Ellis]

The paradox of skill.

[Barry Ritholtz]

Yep.

[Charlie Ellis]

Huh. Really, really fascinating.

[Barry Ritholtz]

You.

[Charlie Ellis]

You referenced some really interesting research in the book. One of the things I find fascinating is that research from Morningstar and Dalbar show that not only do investors tend to underperform the market, they underperform their own investments. Tell us about that.

[Barry Ritholtz]

Because we're human beings, as any behavioral economist would point out to you, we have certain beliefs, and those beliefs tend to be very, very optimistic about our skills, and we think we can help ourselves get better results or at least to minimize the negative experiences. And the reality is that over time just doesn't work out to be true. The average investor in an Average year loses 2 full percent by making mistakes with the best of intentions, trying to do something really good for themselves. They make mistakes that are costly and that cost. Think about it. If you think the market's going to return something like 6 or 7%, you lose 2%, maybe two and a half, maybe three for inflation. Call it two and a half. Whoop. That's something down. Then you've got fees and costs. Gee, was you. Add on to that. If you did, add on another 2% that you've made mistakes. You're talking about a major transformation to the negative of what could have been your rate of return.

[Charlie Ellis]

Let's put some. Some numbers, some meat on that bone. You cite a UC Davis study that looked at 66,000 investor accounts from 1991 to 1996. Over that period, the market gained just under 18% a year, 17.9% a year. Investors had underperformed by 6.5% a year. They gave up a third of gains through mistakes, taxes and costs. And then Dalbard does the same thing. That's where the 2 to 3% in a low return environment is. So how should investors think about this tendency to do worse than what the market does?

[Barry Ritholtz]

Well, in my view, and it's part of the rethinking investing concept in the book, is if you find a problem that's a repetitive problem, and this sure is, attack the problem and try to reduce it. So what could you do to reduce the cost of behavioral economics? And the answer is index or etf. And the reason why index or ETF would help is because it's boring. If you own an index fund, you don't get excited about what happened in the market as anything. Like you would get excited about if you had just had five stocks or if you had two or three mutual funds and you were tracking those mutual funds. Because they change more. The market as a whole kind of goes along in its own lumbering way. A slow, wide river of flow over time. And yeah, there's nothing to get excited about. So you leave it alone. You leave it alone and you leave it alone. And it's a little bit like when your mother said, don't pick at that scab. Let it heal by itself. Well, but mom, it itches. Yeah, just be a little bit tolerant and don't itch it or don't scratch it and it'll heal faster. And sure enough, mother was right. In the same way, if you index, you won't be excited by the same things that other people get excited by. And you just sort of steadily flow through and have all the good results come your way. That's it, huh?

[Charlie Ellis]

Really, really interesting.

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[Charlie Ellis]

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[Charlie Ellis]

So, first of all, I have to tell you I Love this book. It's totally digestible. It's barely 100 pages. I literally read it over a cup of tea. And you've published 20 books before this. What? First of all, what led to this very short format? Why? Why go so brief? I'm curious, Barry.

[Barry Ritholtz]

It's really an interesting experience for me. I love helping people with investing and I keep trying to think of how can I be helpful and what are the lessons that my children, grandchildren ought to learn, what are the lessons that my favorite institutions ought to learn, my local church, whatever it is, what could I offer that would be helpful? And I thought to myself, you know, the world has changed a lot and some rethinking of what's the right way to invest might turn out to be a good idea. I should try penciling that out. And the more I tried to scratch it out for the church investment committee, I realized this is something that could easily be used by virtually everybody else. There are some major changes that have taken place and the world of investing is very different than it used to be. And the right way to deal with the world is really different than it used to be. And I owe it to other people because I've been blessed with this wonderful privilege of being able to learn from all kinds of people what's going on in the investment world and how to deal with it and add it all together. I should put this together in a one last short book. And my wife laughed and said, you never get this down to only 100 pages. I think that's all it takes.

[Charlie Ellis]

Yeah, pretty close. I think it's like 100 and something. 102, 104.

[Barry Ritholtz]

One of those pages is blank and then there's several pages that are half blank.

[Charlie Ellis]

So it's barely 100 pages. So I love this quote from the book. Over the 20 years ending in mid 2023, investing in a broad based US total market equity fund produced net returns better than more than 90% of professionally managed stock funds that promised to beat the market. Really, that's the heart of the book, is that if you invest for 20 plus years, passive indexing, and we'll talk about passive the phrase in a minute. But basic indexing ends up in the top decile.

[Barry Ritholtz]

Yeah. And you're talking about 20 years. And many people say, oh, gee, that's a long time. Wait a minute, wait a minute, wait a minute. You start investing in your 20s, you'll still be investing in your 80s. That's a 60 year horizon. And if you're lucky enough to do well enough you might leave some to your children and grandchildren. So it might not be 60 years, it might be 80, 100, 120 years. Try to think about that long term because that is a marvelous privilege to have that long a time to be able to be an investor.

[Charlie Ellis]

And you cite the S and p Research Group, Spiva. The average annual return of broad indexes was 1.8 percentage points better than the average actively managed funds. That's nearly 2% compounding over time. That really adds up, doesn't it?

[Barry Ritholtz]

It sure does. And compounding is really important for all of us to recognize. Some people call it snowball, and I think that's perfectly fine because as you roll a snowball, every time you roll it over, it gets much thicker. Not just a little bit, much thicker. And you do compounding. 1, 2, 4, 8, 16, 32, 64, 128. Those last rounds of compounding are really important. So for goodness sake, think about how can you get there so you'll have those compoundings work for you.

[Charlie Ellis]

So we mentioned the phrase passive, which has come.

[Barry Ritholtz]

Oh, please don't do that.

[Charlie Ellis]

Which comes with some baggage. But you describe what a historical anomaly the phrase passive is. It really. Why don't I let you explain? It really just comes from an odd legal usage. Tell us a little bit about where the word passive came to be when it came to indexing.

[Barry Ritholtz]

Glad to. Indexing is, to me, the right word to use. Passive has such a negative connotation. I don't know about you, Barry, but I wouldn't want anybody to describe me as passive. I'm going to vote for so and so as President of the United States. It's not going to be because he's passive. Passive is a negative term. However, if you're an electrical engineer, it's not a pejorative. There's two parts, two prongs or three prongs on the end of a wire. And there's a wall socket that's got either two holes or three holes, depending on which electric system you have. The one that has the prongs is called the active part. The one that has the holes is called the passive part. And because indexing was created by a group of electrical engineers and mechanical engineers, they just used what they thought was the sensible terminology. And then other people who had not realized where it came from saw it as being a negative. I don't want to be passive. I want to have an active manager who go out there and really do something for me. That is a complete misunderstanding and it really did terrible harm for indexing investing to be called passive.

[Charlie Ellis]

Let's talk about some of the other things that index investing has been called. And I put together a short list because there's been so much pushback to indexing. It's been called Marxist, communist, socialist. It's devouring capitalism. It's a mania. It's creating frightening risk for markets. It's lobotomized investing, a danger to the economy, a systemic risk, a bubble waiting to burst. It's terrible for our economy. Why so much hate for indexing?

[Barry Ritholtz]

Well, if you were an active manager and you were life threatened by something that was a better product at a lower cost, you might have some negative commentary too.

[Charlie Ellis]

It's just as simple as their livelihood is dependent on flows into active. And that's where all the animists are.

[Barry Ritholtz]

And it's partly livelihood, it's partly religious faith, it's partly partly cultural conviction, it's partly what I've done for most of these people would say I've been doing it for 25 years and I want to keep doing it for 25 years. Oh, by the way, I get paid really well to do it and I like that job to continue.

[Charlie Ellis]

Sure. You mentioned we talked earlier about the temptation that we're surrounded by temptations to be wrong. I wanna talk about some data in the book about what happens if you're wrong and out of the market during some of the best days. And the data point you use was 10,000 trading days over 26 years. On average, that's about 11.2% returns. So if you have money in broad market indices over 26 years, 10,000 trading sections, you're averaging 11.2% annually. If you miss only the 10 best days, not a year, but over those 10,000 trading days, that 11.2% drops to 9.2% 20 days down 7 point to 7.7% a year. And if you miss the 30 best days out of 10,000, the return goes from 11.2 to 6.4, almost a 500 basis point drop. That's amazing. Tell us about that.

[Barry Ritholtz]

Well, first of all, you have to recognize when you select out the most extreme days, it does have a really big impact. Second thing is, when do those days come? And the best days usually come shortly after the worst days. The bounce, the hey, wait a minute. This market is not as bad as everybody's saying. It really does have terrific opportunity. And that's when the best days typically come. So the time that we all get frightened and all of us get unnerved is the wrong the most wrong time to be taking action.

[Charlie Ellis]

And the statistical basis is those 10 days are only 0.1% of total training sessions. But you're giving up one fifth of the gains. That's an amazing asymmetry and it's a.

[Barry Ritholtz]

Hell of a great lesson to learn. Hang in there. Steady YETI does pay off.

[Charlie Ellis]

Another quote from the book. Why should investors care about the day to day or even month to month fluctuations in prices if they have no plans to sell anytime soon? That sounds so perfectly obvious when you hear it. Why are people so drawn into the noise?

[Barry Ritholtz]

Well, when I advise people on investing, I always start with what do you most want to accomplish? And then the second question is, when do you plan to sell your securities? And most people say, well, what do you mean when do I plan to sell? Well, when are you most likely to say, I need money out of my securities investment for life spending, probably in retirement. Oh yeah, and then they'll give you a date. And then you say, and how far out into the future is that? And then really want to be difficult for somebody. Okay, that's 43 years out into the future. Let's go back 43 years. Tell me what you think was happening 43 years ago, today's date. 43 years ago. I have no idea. Why do you ask? Well, I'm asking because you have no idea and you have no idea. 43 years out into the future. And the reason for that is because you don't care. It's the long term trend that you care about and you care greatly about that, but you don't care about the day to day to day fluctuations.

[Charlie Ellis]

So you sum up the book by pointing out every investor today has three great gifts, time, compounding and ETF and indexing.

[Barry Ritholtz]

Discuss time to be able to have the experience of compounding where you each compounding round you double what you had. Boy, does it really pay off to be in it for the long term and have saved early enough so that you compound a larger amount. But that leap from 1 to 2, it's not very exciting. 2 to 4 is not much. 4 to 8 is not really all that much. 8 to 16 starts to attract your attention. 16 to 32, that's really something. 32 to 64 and to 128. Holy smokes. I want that last doubling. That's really a payoff. Only way you get there is start early and stay on course, compounding away as best you can.

[Charlie Ellis]

You know, people have pointed out, and I think you reference this in the book, that as successful as Warren Buffett has been over his whole career because of the doubling. It depends on the rule of 72, but let's say every seven or eight years, half of your gains have come in the most recent seven and a half, eight year era. And Warren's now in his 90s and the vast majority of his wealth have only happened in the past 10, 15 years. It's kind of fascinating.

[Barry Ritholtz]

Well, he's a brilliant and wonderful human being and all of us can learn great lessons from paying attention to what Warren says or has said in his annual meetings are a treasure chest of opportunities to learn. But he did start as a teenager, not in his mid-20s, but in his early teens. And then he is not stopping at 65, he's roaring right past that. And when you bolt on those extra years, it gives him a much larger playing field in which to double and double and redouble and redouble. And all of us ought to pay attention to that. One most powerful lesson. If you've got the time, the impact of compounding really is terrific. And the only way you get to be have the time is to do it yourself. Save enough early enough and stay with it long enough to let the compounding take place. But it's inevitable power of compounding is just wonderful to have on your side.

[Charlie Ellis]

So three of the things I want to talk about from the book. First, as alpha became harder and harder to achieve, as it became more difficult to beat very good competition, the aspect of reducing costs, reducing fees, reducing taxes, became another way of generating better returns. Tell us a little bit about what led you to that conclusion and what firms like BlackRock and Vanguard have done to further that belief system.

[Barry Ritholtz]

Perhaps really candidly just been pay attention to what the numbers say and pay attention to the data. And the data is so powerfully, consistently strong that active investing is an exciting idea. And in the right time and circumstance, the 1960s, it worked beautifully, but the circumstances now are so different that it doesn't work beautifully. It works candidly negatively.

[Charlie Ellis]

Two other things I want to go over. One is the concept of total financial portfolio, meaning when you're looking at your allocation, you should include the present value of your future Social Security payments and the equity value of your home as sort of bond like. And that should help you shift your allocation a little away from bonds, a little more into equities. Tell us about that.

[Barry Ritholtz]

Well, I think it's one of those ideas that once it pops into your mind, you'll never walk away from it. Most of us have no idea what the total value of our future stream of payouts from Social Security are, but you can do the calculation fairly simply. Most of us would be really impressed if we realized how much is the real value of that future stream of payments that are coming from the best credit in the world, federal government, and it's inflation protected. So it's even better than most people would imagine. That's the single most valuable asset for most people. The second most valuable asset for most people is the value of their home. And I know people would say their first reactions, but I'm not going to sell my home. I'm going to continue to live there. Fine, true. But someday either your children or your grandchildren will say, we don't really want to live in that same house, so we're going to sell it. So it does have an economic value and it will be realized at some point down the line. Take those two and put them side by side with your securities. And most people would say, my God, I've got more in the way of fixed income and fixed in bond equivalents than I had ever imagined. I think I ought to be careful in my securities part of the portfolio to rethink things and probably be substantially more committed to equities in my securities portfolio because I've got these other things that I was never counting on before, but now that I've been told about it, I really want to include that as my understanding to the total picture.

[Charlie Ellis]

And I like the concept of outside the market decisions versus inside the market decisions. Explain the difference between the two.

[Barry Ritholtz]

Well, outside market decisions have to do with what's changed in your life, most obvious being when you retire. But sometimes it's when you get a better job, higher pay, or even you get a significant bonus because of the wonderful achievement that you'd had during the particular year. When your circumstances get changed, getting married is another real change. When the circumstances change, you really ought to rethink your investment program just to be sure that it's really right for.

[Charlie Ellis]

Your present total picture Makes a lot of sense. I know I only have you for a few more minutes. Let me jump to three of my favorite questions that I ask all my guests, starting with what are some of your favorite books? What are you reading right now?

[Barry Ritholtz]

My favorite books tend to be history, and the one that I've most recently read is a wonderful biography of Jack Kennedy as President and the things that he did that made America the most popular country in the world.

[Charlie Ellis]

And our last two questions, what advice would you give to a recent college grad interested in a career in investing.

[Barry Ritholtz]

Think about what really motivates you to be interested in investing. If it's because it's a high income field, that's okay. But candidly it's not an inspiration. And you only have one life to lead. Is it your desire to lead your life making money or doing something that you would say was at the end of your life? I'm so proud to have what I did or I'm so glad I did what I did. If you're thinking about investing because it's a profession where you help people be more successful in achieving their objectives, then candidly you could have a fabulous time. It won't come because you beat the market. But that's not the problem for most people. For most people, beating the market is very clearly secondary to what's their real need, which is to think through what are their objectives, what are their financial resources and how can they put those together into the best for them investment program. And the same thing is true for every college, every hospital, every church, every organization that has an endowment needs to think carefully about what is the real purpose of the money and how can we do the best for our long term success by the structure of the portfolio that we have.

[Charlie Ellis]

And our final question. What do you know about the world of investing today that would have been really useful back in the 1960s when you were working for the Rockefellers?

[Barry Ritholtz]

Oh boy. First, that the whole world is going to be changing. So don't stay with what you think is really great about the early 1960s because all of that is going to be upended. And all the lessons that you would think were just great about how to do things in the early 1960s will work against you. Then by the time you get to this time of the year, you will be making mistakes one after another after another after another by doing things that are just completely out of date. And the world of investing will change more than most fields will change. Computer technology will change more. Airplane travel will change more. But candidly, investing is going to change so much that if you take the lessons that you're learning for how to do it in the 60s and try to transport those into the 2000 and 20s, you're going to pay a terrible price. Don't do it. Don't do it.

[Charlie Ellis]

Thank you Charlie for sharing all of your wisdom and insights. I really greatly appreciate it. We have been speaking with Charlie Ellis, talking about his new book, Rethinking Investing, A Very Short Guide to Very Long Term Investing. If you enjoyed this conversation, check out any of the 500 or so we've done over the past 10 years. You can find those at Bloomberg, iTunes, Spotify, YouTube, wherever you find your favorite podcast. And be sure and check out my new book, how not to Invest the Bad Ideas, Numbers and Behavior that Destroys Wealth. I would be remiss if I did not thank the crack team that helps put these conversations together each week. Andrew Davin is my audio engineer. Anna Luke is my producer. Sean Russo is my researcher. Sage Bauman is the head of Podcasts at Bloomberg. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio.

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