Joe Weisenthal (2:45)

Thing. It always felt to me like a study in behavioral science almost, because I think everyone always says, you know, just invest in an index fund or maybe 60 40. Although as we saw in 2022, that has its own problems and we can talk about that. But I think this is like the one area in people's lives where they actually crave complexity. Right. Like it doesn't sound right to be like, just put your money in an index fund and forget about.

Tracy Alloway (3:11)

It. I know, it's like the simple. It's like the simplest investing strategy is the.

Cullen Roche (3:15)

Hardest.

Tracy Alloway (3:16)

Yeah. For people. It's really hard though, like when you see were making life changing amount of money because like, oh, I was in, you know, SanDisk. Right. And suddenly everyone wants memory because of AI and they're up 500% and you're like, damn, you know, like I'm really happy with my 12% a year that I've been making, but I really, it's really.

Joe Weisenthal (3:36)

Hard. I was 100% invested in a leveraged Doge.

Tracy Alloway (3:39)

ETF. Right. Yeah. Right. Like if you did that and then you retired the next day, I'd be like really annoyed. I'd be like really upset. But it is a fun puzzle. You mentioned 2022 and we saw what we've seen really since COVID What we've really seen since the worst inflation in 40 years is that some of these portfolio constructions that worked very well for a very long time, particularly anything that sort of resembles that 6040 thing, which just worked so beautifully in the 2010s, but even before it hasn't worked as well. Don't. I think you're still doing fairly well. But yeah. So it gets you. The question is like, well, I remember we asked Bill Gross why even own bonds at a.

Joe Weisenthal (4:19)

Time. He was like, well.

Tracy Alloway (4:20)

Don'T. Yeah, he don't. He's like, I'm in. I'm in pipelines. That's where. That's where I'm getting my. Or I'm in whatever ML, MLPs or whatever. That's where I'm getting my yield. But yeah, I think there's some real question about like why own Treasuries, why own whatever.

Joe Weisenthal (4:35)

Etc. Well, the other thing is timing. Like this is the thing that everyone has to consider, right? So in 2022, if you were about to take out a big chunk of your portfolio to buy a house, or if you were a retiree and you needed to make some chunky payment, you were really, really unlucky in 2022, if you were, if you had taken everyone's advice and invested in a 60:40 portfolio. So this is the other thing. Like you can try to smooth out returns, but your own spending is going to go up and down quite a.

Tracy Alloway (5:05)

Bit. There's one other issue that I think a lot about with the very standard, and it sort of relates exactly to this with the sort of standard advice. So in theory, it's like we're not supposed to time the market, Buy the highs, you buy the lows, et cetera. 2020 was a great time to buy. March 2020 would have been a fantastic time to buy. The problem is layoff surged and there's this sort of phenomenon where often the best times to invest in the market are when you don't have a.

Joe Weisenthal (5:33)

Job and you don't have money and you really need.

Tracy Alloway (5:34)

Money. And actually, yeah, they always say don't sell, don't panic, sell at the bottom. There's a good chance that's when you might need to sell. That's maybe when you lose your job or something. The ability to sort of mechanically actually follow the rules, setting aside behavioral stuff, just the ability to like, have the income or have the ability to like, hold through drawdowns, buy the dips, et cetera, may not even be.

Joe Weisenthal (5:56)

Possible.

Tracy Alloway (5:57)

Absolutely. Well, anyway, I'm excited to say we really do have the perfect guest. Someone we've had on the podcast before, also someone we've just known for a very long time. One of the most interesting thinkers in the realms of investing and portfolio managing and so forth. A voice of sanity, I would say, which is very rare these days. We're going to be speaking with Cullen Roche. She is the founder of Discipline Funds and he is the author of a brand new book called you'd perfect Portfolio about exactly this topic. Cullen, thank you so much for coming back on the podcast. It's nice to see.

Cullen Roche (6:28)

You. So nice to be.

Tracy Alloway (6:29)

Here. Why did you write this.

Cullen Roche (6:31)

Book? Well, this is a problem that I've always run into throughout running my business is that I think as the portfolio manager and financial advisor, I've run into this issue where I'm trying to construct a model portfolio that is ideal for my business so that I can easily implement something and then kind of just plug and play it in the client portfolios. And what I've realized over the course of managing money for, you know, however long it's been now multiple decades, is that everyone's different and everyone needs their own level of customization. And so it's very hard to just take a model portfolio and then plug and play. And the, you know, the kind of funny thing with the financial services industry is it's largely built around These ideas that you take a product and then you sell it to the client. And oftentimes what I find is that when you're trying to sell the product to the client, it just doesn't mesh with their needs. And so everyone needs to find their own perfect portfolio. So the book is entitled the Perfect Portfolio. And the purpose of the book really is to. What I do is I go through a number of sort of famous portfolios and some of them are very boring and some of them are more sophisticated. But the overarching ethos of the book is that you have to understand all these different approaches and then you can plug and play the way that you want to build your own perfect portfolio so that it works for.

Joe Weisenthal (7:50)

You. One thing I'm curious about, because I've never had a professional financial advisor or anything, but how do you actually evaluate your clients needs? Like, what do those questions look like? I imagine, you know, there probably a lot of finances involved, but are there questions like, how do you feel about losing 40% of your portfolio in a single.

Cullen Roche (8:11)

Year? That's actually, that's my, my very favorite question. The question I hate the most because for, I don't know, 20 years, I used to print out these phony risk profile questionnaires and I would send them to people and one of the questions is always, you know, how do you respond to a market that falls 30 or 40%? And literally 98% of people will answer that question the exact same way because they know the right answer. They'll say, oh, I stay the course, I, I will buy the dip or whatever. And then Covid happens and 50% of my clients are calling me like, this has never happened before. What the hell do we do now? This is terrifying. We need to sell everything, right? And I'm there, even I'm looking at that and I'm kind of like, you know, because in the throes of, yeah, that's the hard part about investing into a bear market, especially when it's actually going on. It all feels rational, is justified. Totally. And you're looking at it. One of my favorite charts in the book is a chart of the Great Depression downturn. And it shows this like horrific 80% downturn where the market just went down like every month for basically three or four years and it goes down a full 80%. And when you're in the throes of that sort of 30 or 40% downturn that we saw say during the GFC or during COVID you're thinking to yourself, well, wait a minute, I know that the market has gone down 60, 70, 80% in the past. So if we're at 40, that means we probably have another, you know, 40% haircut or coming down the line. And so that's the psychology of it, when people are actually in the middle of it. And I remember it vividly during COVID because even people like Buffett and Bill Gates, like some of the most practical thinkers in the world, they're sitting around, they're saying, this has never happened before. We've never seen this. No one living has seen what is going on right now. And so it all feels rational. And then, you know, so from a risk profiling perspective, it's really difficult because that sort of subjective nature of it all is really sort of irrelevant because when you're actually in it, it all will feel totally.

Tracy Alloway (10:13)

Rational. Now I remember thinking that even like obviously April of last year, during the brief but very sharp sell off after Liberation Day, and it's like, well, Trump just changed the rules of capitalism. This is going to be different. This is really different. Or going back to Covid, like we all say we're going to just hold through the downturn, but in that moment we're like, oh no, this isn't really. This is, this is not like the other seller. This is different. This is not like dot com, where there was just an overvaluation. This is not like 1991 when we had a Fed engineered recession. This is something different. The old rules about buying and holding must not.

Joe Weisenthal (10:50)

Apply.

Cullen Roche (10:51)

This. Yeah, it's funny, you know, I see a lot of people get mocked. A lot of the analysts back then were, you know, they were changing their estimates and they kind of, you know, after the tariffs more or less got scrapped, they then, you know, up their estimates for the year end targets. And in retrospect, that looks kind of stupid, but in the throes of it, if you remember like they were saying they were going to replace the income tax and like I'm writing, you know, they're doing the math on that and I'm like, wait a minute, that's a $2.5 trillion corporate income tax increase. Like, that's a gigantic number of incredibly frightening number if it's true. And then, you know, of course the CEOs of Home Depot and Target and all them walk into the White House and are like, do not do this. And so they're still doing the tariffs and they're still impactful and there's still a corporate tax and whatnot, but they're not nearly the size that you know, they were going to be, you know, they were claiming to be. And so that frightening moment where, you know, they announced that, you know, got quickly scrapped when they kind of reversed course on.

Joe Weisenthal (11:49)

It. I feel like we should note here that we're recording on January 8th, and we are expecting the Supreme Court to make a decision on the tariff. So the entire game could change.

Tracy Alloway (11:59)

Again. Change again?

Joe Weisenthal (12:00)

Yeah. You mentioned the Great Depression, and one thing I thought was really interesting in the book is you talk about how no one really quite knows the origins of the 6040 portfolio, even though it's become fairly standard in finance, but you trace it back to the Great Depression. So tell us how you did.

Cullen Roche (12:16)

That. Yeah, well, I don't know if I did do it correctly, but it was kind of a guess. But I found that so fascinating that 6040 is arguably the most famous portfolio of all the portfolios. And we all probably own something that kind of looks like 6040 at some point in our lives. And it was actually Corey Hofstein, who manages the return stacking ETFs, that he asked on Twitter one day, where did this thing come from? And there were hundreds of responses, and none of them seemed right. And so I just had so happened to be writing the book at this time. I'm writing the chapter on 60 40, and I started digging into it, and I found the story about this guy named Walter Morgan who's running a fund called the Wellington Fund. And Wellington Fund, obviously, you know, famous because it turns into a Vanguard fund later, is run by John Bogle, who some people may have heard of. And he's doing this, though, in a very unusual way, back in the Depression, where during the Depression, equity investing was kind of the dominant way to actually allocate assets. And Morgan had been burned before that. So he goes into the Great Depression. He launches the Wellington Fund right before the Depression. But he does something really unusual. He adds a huge chunk of bonds to the portfolio, and the thing gets crushed in the Depression, but it gets crushed way less than everything else got crushed. And so then all of these research analysts are starting to look at kind of picking through the dust of the Great Depression and the returns there, and they're noticing that, hey, this fund did really well in a relative sense. So Morgan's fund kind of takes off because of this, because the relative performance was so good. And then the story is interesting because then Walter Morgan hires John Bogle. Bogle runs the Wellington Fund through the fund, goes through the World War II and the boom of the 1960s, and then the scary inflation of the 1970s, Bogle actually does something really weird. He turns the fund closer into like an 8020 fund, kind of chasing performance and which was sort of like antithetical to everything that Bogle ultimately is kind of known for. And then we all know the story from there. The 6040 from 1980 to, you know, present day has been, you know, kind of like one of the best performing portfolios ever. So it's, you know, through all of these trials and tribulations though, this portfolio has done incredibly well. And I traced its origin mostly back to the Great Depression in the way that Wellington Fund was sort of built as the first real balanced index.

Joe Weisenthal (14:41)

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Tracy Alloway (17:04)

Done, zoom out or back up a little bit and talk theory. Because you said that many of us or most of us will have some portfolio that is 6040 ish, but then there's going to be various modifications and people are going to want to slug of real estate or commodities, whatever. But what are you talking about? Maybe from the academic perspective, like what is the 6040 portfolio really is? And like what is it theoretically achieved that has given it this sort of it's lindy this sort of enduring effect that it accomplishes Goal. Talk to us about like why from the perspective of a planner, maybe it's not perfect for everyone, but it has certain qualities. This is a good.

Cullen Roche (17:46)

Portfolio. To me, the 6040 is like the good enough.

Tracy Alloway (17:49)

Portfolio. So just to be. Just to define it. So a 6040 portfolio means basically 60% equities and 40%.

Cullen Roche (17:56)

Treasuries.

Tracy Alloway (17:57)

Exactly. Okay, but talk about why it's good enough. What is it, what other.

Cullen Roche (18:00)

Properties. I mean, so it's the portfolio that by owning 60% stocks, you will, you'll do well enough, you'll capture enough of an equity market bull market. And also conversely, during a bear market, because of the 40% bond slice, you typically will buffer the equity volatility in the portfolio just enough that you won't capture all of the downside. And so it's, it is balanced in this way that it doesn't capture all of the upside or all of the downside and kind of can help you stay the course. I talked specifically in one chapter about something called the global financial asset portfolio. And I really like understanding this portfolio, especially from like a theoretical perspective because the most interesting thing about it actually is that nobody owns this portfolio because it's mostly uninvestable or you can't fully invest it. And it's actually, you know, I talked to a lot of famous researchers about this topic when I was researching the book and they all kind of concluded that the screwiest part about actually quantifying that portfolio is that it's actually really controversial how to quantify it because all of the assets in that portfolio are not investable. So for instance, like China A shares are not necessarily investable for foreign investors. And there's lots of assets that are held by the Swiss national bank owns a lot of assets that make the assets then uninvestable. And so the Fed has been buying a lot of treasury bonds. So technically you could say, you know, what happens to the market cap of outstanding bonds when the Fed is the owner of a lot of these bonds. And you can start getting into these sort of very academic theoretical debates about, well, what is the market portfolio and what's actually investable versus uninvestable. And it's especially interesting from like a.

Tracy Alloway (19:40)

Theoretical. And in theory, that portfolio includes like gas stations in Burma.

Cullen Roche (19:45)

Right? Yeah, if you, well, God, if you go into all of the assets, you know, I did financial assets only, so I kind of excluded all the non financial assets. So things. Because then then the whole portfolio kind of turns into a real estate portfolio. Basically everybody's house is everything that we own. But from a financial asset perspective, it was really interesting because especially when you look at things like the full cap versus the free float, which is basically the actual assets you can invest in versus the portfolio that is actually the issuance of outstanding financial assets. These portfolios are really different. And like for instance, in today's environment, the outstanding market cap of stocks versus bonds is roughly 65, 35. And when you look at the, sorry, the equity market, when you look at the US versus foreign, it's 65 versus 35. But when you look at the actual issuance, the full cap, it's almost the opposite. And so the US is way smaller from a full issuance perspective. But from an actual investable perspective, the US is, you know, what we call like this extraordinary market, this unusual huge part of the full market cap. And which is weird to think of because when Vanguard and some of these big index funds create these products, they have to issue what is investable. They can't just say theoretically, like I sometimes will tell my clients, well, hey, if you want to actually own the true market cap portfolio or the market issuance portfolio, you should actually be closer to like 40% US. You should be underweight. The US market versus foreign in this environment, because that actually is representative of the full issuance. Whereas if you're Vanguard and you're running this index and you have to buy what has actually been issued, it's almost the exact opposite. And you're way overweight us. So you get into these interesting sort of like theoretical debates about how to even do this in the first.

Joe Weisenthal (21:31)

Place. I want to talk more about illiquid assets like real estate, because for most people, this is their biggest investment, right? Their actual house. But before I do, you just reminded me gold. So in the book, you talk about gold as like one of the true uncorrelated assets. But of course, over the course of last year, it's. It looks like a momentum stock. Right. How are you judging gold at this moment in.

Cullen Roche (21:54)

Time? You know, gold and commodities are really hard to compartmentalize in the portfolio construction process because I typically think of commodities in general as they're just, they roughly track inflation because they are just cost inputs in, you know, corporate, you know, costs. And so they should roughly reflect something close historically to the rate of inflation, which is pretty close to what the data shows. Gold is a really screwy one because gold has this whole other element to it where there is huge swaths of the population that view gold as money. Even though, you know, in a modern monetary system you could argue that gold is actually a pretty terrible form of money just because it's impractical to use for the most part. It's got this store of value in this sort of. I refer to it as a faith put inside of it where its price almost gets like a premium because it's not just an input in, you know, cost inputs. It is something that people believe in, that people hold and people have demand for because it's got this other strange use. And so it's weird in the context of today's environment. Another concept I talk about is I talk a lot about time and the book about how important it is to think about portfolios and asset performance across time horizons. And you know, I do a lot of asset liability matching and that basically entails working with somebody where I'm quantifying liabilities and expenses over time horizons and I'm matching assets in not dissimilar way to like maybe a big pension fund would or banks might operate. And that's all about understanding time and an asset liability mismatch. And if you get that wrong, you end up like Silicon Valley bank.

Joe Weisenthal (23:31)

And which you talk about in the.

Cullen Roche (23:33)

Book. Yeah, and the interesting thing about even like a retail investor, you know, and it took me for, you know, two decades working in the business to realize this, that the better way to go through a risk profiling process is not to ask people phony questions about this subjective nature of how they feel in a bear market or something like that. It's figuring out, it's solving that asset liability mismatch. Because what happens to an investor when they go through a bear market is they're realizing that they own too much of. I refer to equities as long duration instruments. Corporations are very long term entities by design, by function. And when someone owns 100% stock portfolio and they go through a Big bear market. What happens to them is they get scared. They're realizing I don't have enough safe assets to make me feel comfortable with this. So if they own the 40% slice, like the 60 40, maybe they feel more comfortable. Or if they own, you know, there's a whole chapter on what I call the T Bill and Chill portfolio, which is like the liquid reserve.

Tracy Alloway (24:27)

Portfolio. You know, I heard a story, I don't know if it's true. Speaking of T Bill and Chill, though, I don't know if it's true because I heard the second hand. Someone was telling me there was like some famous, like very, very successful trader like Goldman Sachs was like trading commodities, pulling down millions and millions of dollars each year. And he just like had all his money in T Bill. He said, look, look, I make a ton of money. I just like basically want to save it. I don't know if that's even true, but I do wonder. So when we're talking about alternate ways of assessing risk profile, do you think about like, try to get a sense of the client's income volatility. So like maybe someone who, you know, a federal judge who is going to have a job for life, etc. And a guaranteed pension, maybe they don't make a ton of money, but you are very confident that you could predict their income for the next 50 years, maybe. Whereas someone who makes a lot of money, but they're like a real estate developer in Miami and the odds of those guys going broke every 10 years is pretty high, etc. Talk to us about like sort of that role of calculating expected.

Cullen Roche (25:31)

Income. It's arguably, I would say, the most important part of the whole equation because one of the things I talk about in the book is I frame your human capital and your income as a literal fixed income allocation. So I almost like to think of your income and your job as like a bond allocation. And so in the context of like, you know, someone like you're talking about, or let's use an even simpler example of someone who's, you know, 25 and they make a decent amount of money, that person not only has a really long time horizon, but if they've got a really stable job, they've got this embedded fixed income allocation that maybe they don't actually quantify it like that on a, you know, portfolio statement, but.

Tracy Alloway (26:09)

That has a net present value you.

Cullen Roche (26:11)

That.

Tracy Alloway (26:11)

Exactly.

Cullen Roche (26:11)

Yeah. You know, so if the really simple example is if you make 100 grand a year in, you know, you could almost think of that as I've got a million dollar bond that earns 10% a year. And what that does, especially if it's a very stable fixed income, it frees up a huge amount of behavioral bandwidth for you to take other risks. And that's one of the arguments why if you're 25 and you've got, you know, 40 years to retirement or whatever, and you've got a stable, you know, solid income, well, you can think of your income versus your balance sheet as being super stable, which allows you to take a lot of risk with your balance sheet that you might not otherwise have. And that's another thing. I talk a lot about retirement planning in the book because the thing that I've seen very front and center is that when people get close to 65, that income issue becomes hugely important because people start to realize that, oh crap, that fixed income allocation that I've had all these years, it's about to just disappear overnight or it's about to shrink down to whatever your Social Security income is or whatever. And so people go through this sort of psychological mind trip where when they near retirement and then enter retirement, they struggle with that, you know, adapting to this big, big change in their income because they're realizing that, hey, I don't have this fixed income that I could fall back on for the last 40.

Joe Weisenthal (27:33)

Years. Is investing time horizon more important than macro? Because in the book you do talk about the importance of macro. But on the other hand, if people are reacting to a changing economy all the time, then that looks a lot like what you're not supposed to do.

Cullen Roche (27:49)

Right? Yeah, I mean, gosh, I generally, in my practice, I am constantly trying to downplay macro, econ and geopolitics and things like that. I mean, and it's funny, the reason that I probably even know you guys is because I've written so much about macro econ and I'm not an economist. But people, I think, sometimes think of me as a macro thinker in large part because I've spent so much of my career fielding bad questions about, hey, is the US Government going bankrupt or what is going on with China? And I'm trying to sort of write about this stuff not because it's important in the context of portfolio construction, but because it's more so about understanding how these things operate at more of a sort of a first principles level where you can look at a bond allocation if you own a huge slug of, you know, U.S. treasury bonds, for instance, or T bills, you know, you can look at these things when you understand them more mechanically you can look at these things and say, okay, well, the odds of the US government actually going bankrupt are extraordinarily low because I understand how these things function. I understand that the US government is not going to run out of money. I understand that, you know, maybe Bond vigilantes aren't quite as powerful as we've all been told. And you can understand these things in the context of owning something so that you're more comfortable with what you're doing. And that's actually the hardest part about all of this, is that it's all very complex and it's all very emotional. And if you don't understand what you own, then you won't be comfortable with it and you won't stick with.

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Tracy Alloway (30:47)

Estate. I bought a House in 2016. I think it's done all right. But then sometimes I'm like, man, I really wish I just put that all into QQQ or something like that. And then the other thing with houses that I think is interesting, which is like you could look at maybe I'd say you own a house outright and it's like, oh, it's worth a million dollars or something like that. You can't really sell it because then you have to buy a house. And so it's like, I'm not even sure, like I got to live somewhere and so I don't. You can't monetize that to the same degree. You could you know, sell your stock and buy stuff. But talk to us about how one should think. Let's start this. How one should think about the role of their home in their overall.

Cullen Roche (31:25)

Portfolio. It's the hardest asset to buy, I think, because it is. It's an instrument that you want to generate a return on. So you want to do, like, some financial analysis on it and, you know, try to. Nobody wants to buy a house in, you know, 2007 or something and then see it go down 30%. But also, your house is where you live. It's where you're going to raise your kids and you're going to eat most of your meals and where you're going to do all the little boring things in life that are actually really important to you. And so there's this really personal part of it that it makes the. To some degree, it throws all the financial math out the window. But from a basic, you know, first of all, going back to your 2016 purchase, I would say, you know, that was unbelievable timing.

Tracy Alloway (32:10)

Because. Oh, thank.

Cullen Roche (32:11)

You.

Tracy Alloway (32:12)

The. Thank.

Cullen Roche (32:14)

You. You could argue that going through Covid. I mean, any house that was leveraged, did you have a mortgage? Yeah, yeah. So any house that was leveraged was the best inflation.

Tracy Alloway (32:23)

Hedge. Right? Right.

Cullen Roche (32:24)

Maybe. Maybe the best inflation hedge trade of the last 50 years. You could argue just in terms of just providing this stable level of certainty. You know, the low mortgage is an inflation hedge. The you got 50% price appreciation or probably something like that. So that's interesting, too, to think about that when you're kind of going back to the question on gold that I didn't fully answer. What happens when an asset goes up so much in the short term? The way I like to think of it, at least, is that let's say that housing typically generates a low real return, or, you know, even historically, it hasn't generated a real return. The way that I like to think about things like that are environments where you get these, what I call a price compression. You get a huge boom in an asset class. And it's almost easier to think of this in, like, a fixed income market where, like, when the bond market goes down a lot, interest rates go up. The math completely changes on all that. So a lot of people these days are saying, like, bonds are dead. And I would say, like, no, bonds are actually probably more attractive because mathematically, from a yield perspective, relative to the falling price decline, the future returns are much more stable now, much more probable. And so what happens in an environment where you get a 50% increase in real Estate or a, you know, what was gold up last year? 65%. You know, let's say that. Let's just be generous and say gold is going to continue to do 8% per year for the next, you know, however many years. When you get 65% of that return all crunched down into one year, I think what happens is you create a higher probability of what a financial advisor would call sequence of returns risk, which means that the probability that the future returns are going to be much more volatile becomes much higher. And so that's one thing with real estate is that, like, I'm not super optimistic about future real estate prices for now because we went through this big boom. It creates this price compression, and you get lots of returns into one year all crammed up. And that means that the likelihood of either sideways or, you know, not great returns is. Is pretty probable. So, you know, going forward, you know, I think that it's good to think of your house as basically a. It's a block of commodities on an appreciating piece of land. And, you know, the thing that's important with real estate is I talk about this a lot in the book, that you have to think of everything in terms of real, real returns. And that means you have to back out inflation and you have to back out all the other costs. And that's the thing that, you know, I have probably the worst housing story in the world because in 2017, I bought a house in California that had a small waterway on it. And without knowing that, which I should have probably known in the state of California, anything with water on it in the state of California is basically the biggest permitting nightmare that you could possibly imagine. It gets the EPA involved, it gets the Coastal Commission involved, it gets the State Department official wildlife involved. And all of a sudden you get an introspective look at, you know, how all these government agencies work.

Joe Weisenthal (35:16)

Together. And now I'm really curious, what were you trying to.

Cullen Roche (35:18)

Do? We were literally just trying to remodel the house. Yeah. So we bought this old.

Joe Weisenthal (35:22)

House. You weren't touching the water at.

Cullen Roche (35:23)

All? No, we weren't touching the water at. And in fact, the water is not even. I mean, San Diego gets 10 inches of rain a year. So, you know, that's very, very little rain. And so this waterway, we call it is really. It only has water in it. I mean, 10 days a year or something. It's crazy. It's dry. It's not like it's a lagoon or.

Tracy Alloway (35:44)

Something. This is how you're a libertarian.

Cullen Roche (35:46)

Arc yeah, well, it's really funny because my wife is very, very liberal and we were going through the permitting process and she was like, these people are trying to turn me into a.

Tracy Alloway (35:55)

Libertarian. I get.

Joe Weisenthal (35:57)

It. Oh, actually, since you brought up your wife, I got to ask. There's a bit in the book where you talk about marrying a portfolio and then you have a tiny footnote that says, apologies to my wife. And then it says, I'm just testing if my wife actually reads this. Did she read.

Cullen Roche (36:11)

It? She caught it. She actually was the first editor of the book. So she. And she did go through it and she caught it. She didn't just jam it all through GPT, which she kept trying to convince me to do. But no, it's funny. There's another footnote about my mother in law in there that she has not caught.

Joe Weisenthal (36:27)

Yet. Oh, what's that one? I didn't see that.

Cullen Roche (36:30)

One. So she got trapped with us during COVID and I make the joke that I had just had my first daughter right after Covid and you know, the shutdown happens, the international travel shutdown happens. She lives in France, so she was just happened to be visiting us for the baby's arrival and she gets trapped with us for six months. And I make this joke about how I was crying in the shower.

Joe Weisenthal (36:49)

Every morning, not because of the baby screaming into a sock. I think he said, just going back to bonds for a second. It is true that, you know, you see investors behave in exactly the opposite way that they should be behaving when it comes to bonds. If you like bonds at a 2% yield, you should love them at like a 7% yield. Talk a little bit more about, you know, what you're talking about just now with gold and real estate is a momentum factor, right? And momentum seems to have done very, very well over the past few years. I mean, this is why we say flows before pros, right? Can we just follow what everyone else is doing? That seems to be the way.

Cullen Roche (37:30)

Now. Yeah. Gosh. I mean, there's momentum, there's the momentum factor and the momentum factor. And this is the more academic version of portfolio construction where in the Factor Investing chapter I talk very specifically about, you know, it's called cross sectional momentum, basically. And this is basically picking the stocks that have performed well in the past with the expectation that they continue to perform well in the future. And they weirdly, the data actually shows that that is a thing. And so it frustrates people like Gene Fama of the efficient market hypothesis. But it's interesting because in the context of today's world, that momentum factor is basically just everything tech, everything that's performed the best. And so you're. Which has, you know, weirdly continued to work and work and work throughout the.

Joe Weisenthal (38:18)

Years. And so you get this like self reinforcing cycle.

Cullen Roche (38:21)

Right? Yeah. And there's also, you know, the one chapter that I actually thought was almost even more interesting than the momentum one is one that's related, which is called the trend following chapter. And that is very different in the sense that these guys, these traders are, they're not necessarily just looking at the past and trying to, you know, they're not picking stocks necessarily and then extrapolating it into the future. These guys are just trying to find trends and they're looking, maybe they're looking at, you know, chart data or whatever, but. And they're. It's a go anywhere strategy. So one of the most interesting things about this strategy is that it is one of the truly fully uncorrelated strategies to everything else. And it's had this sort of big resurgence in the last. It became very popular after the GFC because it. Oh yeah, it beat the pants off of everything and was uncorrelated, had these huge asymmetric returns and then went through this period of like a 10 year lag. And it had kind of like what I was referring to earlier where you had this like you had that price compression, the trend following things all went up. All these CTA funds go up, you know, 50, 100% and then they all lag for. And they lagged for a long time. And that's the thing about finding uncorrelated assets, that sometimes these uncorrelated instruments, they're not like cash flow generating instruments like stocks and bonds necessarily. So the trend followers though, they go through this 10 year period of lagging which exposes people to all these behavioral.

Joe Weisenthal (39:46)

Biases. I remember CTAs also became a really convenient scapegoat for any. Oh yeah, that was happening in the market. They were like the multi strat. Yeah.

Tracy Alloway (39:56)

Right. I forgot how much we used to talk about CTAs in the early 2000s as an important driver. Actually, can we talk a little bit about tech stocks for a second? Because this strikes me as very important and I think about this all the time. You know, you see these surveys that bank of America does of fund managers, like what's the most crowded trade in the world? Tech. They've been saying that since like 2013, you know, and it still just performs and all these other there are all kinds of other knock on things. You know, it's like people talk about us versus international exposure, but at the end of the day, this is just a bet on tech when we're talking about the US and the other thing I think about tech a lot is that setting aside sort of theories of portfolio construction, these companies make gobs of money and they make more and more and more and more each year. We recently did an episode and Ben Snyder, the top equity strategist of Goldman was on. He's like, well, the big tech companies, it's like 33% of S&P 500.

Cullen Roche (40:50)

Earnings.

Tracy Alloway (40:50)

Earnings. And I listen to that. It's like, well, that's another 67% of total earnings for them to gobble up. But it strikes me that can you just talk. It must drive portfolio managers crazy that there is this one sector and this is a novelty because these are big companies that are growing faster than almost anyone else, which is not the case in many environments. When we associate big companies with maturity and slow growth, there is this thing going on for years and years and years that just feels to bust every other strategy. And if you're not overweight tech, you're probably.

Cullen Roche (41:23)

Underperforming. Yeah. And it's really frustrated the hell out of people, especially the factor investors who haven't been in the momentum trade, who have been more value oriented or you know, the people who know that small has outperformed large in the long run. Like it's all been flipped on its head. And so I again, going back to the time horizon thing, the way that at least I try to think about this is tech and growth is really interesting in the current environment because. And going back to the NASDAQ bubble, you can actually, you know, a lot of people make that corollary. And the interesting thing about the NASDAQ bubble is that if you bought the very tippy top of the NASDAQ bubble and held on to today, you've made like 8% per.

Tracy Alloway (42:01)

Year. It was.

Cullen Roche (42:01)

Great. You've done really, really well, which is crazy. But you had this crazy sequence of returns risk because especially in real terms, you went through this traumatic like 15 year downturn over that period. So the interesting thing, you know, compared to then is that like you said, these entities are completely different. Like everybody was expecting the Internet to be a big thing and it was. And everybody expects AI to be a big thing. And I think it will be. But the interesting difference between that environment and this environment is that these companies are, they make more money than any entities have ever in human existence. So this is completely different than.

Tracy Alloway (42:36)

The. And every year they beat analyst.

Cullen Roche (42:37)

Expert. It's crazy. And they're growing crazy, crazy fast. So it's almost unbelievable. But the, the thing is kind of going back to that whole idea of like price compression and thinking about time horizons. The way I think about it is that, and I write about this specifically in probably my favorite chapter to write in this book was an original strategy that I call the forward cap portfolio. And what I did was I took five huge macroeconomic trends and I distilled them all down and I tried to extrapolate data out into the future. And one of the big ones is tech, where I look at something like E commerce retail sales and I say, you know, this is currently, whatever it is, 25% of all E commerce retail sales as a percentage of total retail sales is 25%. And that number, you know, is probably going to go to 50 or 60 or 70% at some point in the future. All retail sales will just turn into E commerce sales at some point, like you said. Like, you know, this is. There's 75% more for E commerce to gobble.

Tracy Alloway (43:35)

Up. I believe.

Cullen Roche (43:35)

That. And so if you believe that and you want to buy technology, well, what should you own? Should you own the market cap weighting of 35% like it is now in the S&P 500, or should you go to like 50 or 60%? And the way I kind of frame it in the book is it's skating to where the puck maybe is going. Rather than when you buy a market cap weighted index fund, what you're doing is you're basically skating with the puck, which is, it's a good strategy, it works really well. But you're not necessarily trying to skate to where the puck is going. And so I'm doing a lot of guesswork. It's obviously very active. And you know, there's a lot of, there's a lot of estimates that are involved in all of this. But if you think forward, like I don't think it's unreasonable to say that in 40 or 50 years the market cap of technology in the s and P500 might be 50, 60, 70%, who knows? Like, everything's probably turning into a. But the tricky part about that is that when, especially when valuations are really high, I talk about how valuations are the equivalent of high expectations. And when expectations are really high, it doesn't take much to disappoint. So your margin for error when expectations are really high is just really Low. So what that does is it causes this potential where you have higher sequence of returns risk in the short term. Where, you know, I would say if I'm talking to, you know, a 20 year old who's coming out of college, he just got a great job on Wall street or something, I might tell him, well, hey, your time horizon is so long and you could be so aggressive, you should maybe just go buy a growth fund and just, you know, lose the password to your brokerage account for like 40.

Tracy Alloway (45:11)

Years.

Cullen Roche (45:11)

Yeah. And open it up and you'll probably have done really well. But if you look at that thing in five years, it might be down 50%, you don't know. And so that's the way I kind of frame it. And so if you're, if you're very time sensitive, I would say, you know, the retiree who is retiring next year and they're loaded to the gills with Nvidia and Google and Microsoft, that person has a totally different risk exposure than that 20 year old.

Joe Weisenthal (45:34)

Does. How do you think about the index providers in this equation? Because, you know, there's this perception, you put your money in an index fund, it's a passive investment, but actually it's kind of active because the index provider is making decisions about what to do. And I know the index providers always say they're just holding up a mirror to the market, but you know, some of that seems very subjective to me, like whether or not you're going to add Chinese bonds into a debt index and things like that. Are we just outsourcing our investment decisions to the.

Cullen Roche (46:07)

Indexes? To a large degree, yeah. I mean, I, I talk about how there is no such thing as passive investing a lot more than I should because it annoys a lot of people. But there's a lot of people who demonize passive investing, I think for kind of phony reasons. And a big part of that is this fact that, you know, the reason I talk about and try to quantify the global financial asset portfolio is because I was trying to create a benchmark for if we were going to define something as passive as, you know, truly passive to me is you're buying the full market portfolio. You're not deviating at all, you're not making any active decisions at all. And so when you quantify the gfap, you can actually create a benchmark there where you understand, okay, well, this is the only. If you were truly fully 100% passive, this is the only thing you would own. And the funny thing is nobody can buy this thing and Nobody does buy this thing because even at a stock bond weighting, the stock versus bond weighting right now is something like 4555. So you're, you're inherently underweight stock. So it's not even that close to even like the 6040 portfolio. And so everybody deviates from this. And I write about how that's totally fine. There's nothing wrong with deviating. There's nothing wrong with being a little bit active. And so even from the indexing perspective though, like I laugh at like the, you know, the way the s and P500 is constructed. It's a committee of people that are constantly picking and choosing which firms to introduce. And it's very methodical, it's, you know, very data dependent. So it's a very systematic sort of process. But at the end of the day, they're choosing the 500 companies that go into that index in the first place. And so, you know, in the context of the global equity market, it's even more interesting because they're excluding thousands of other entities just, you know, by their own volition. So everyone's active. And you know, there's very smart ways to be active and there's very stupid ways to be active. And I would say that, you know, a lot of the things, the most sort of disconcerting thing that I see going on these days is that I see the issuance of a lot of strategies. And especially with the rise of crypto, there's a lot of things going on that I would describe as stupid active, where people are more having like a gambling mentality approaching all of this than anything.

Tracy Alloway (48:12)

Else. If we had like another hour, actually, I would love to just pick your brain about the investment advisory business, like less the portfolio construction per se and just how this world works because I have so many questions about that. But I've won. And you know, we've seen you, we run into you every once in a while down at the Future Proof conference and Southern California, you know, or there's a lot of advisors and then there's a lot of vendors and they're selling various products. And one of the hot things that we know that they're trying to get people excited about owning private assets or so various alternatives, et cetera, non vanilla things in your perspective for most clients that you see do, is there like a compelling reason for some of these novel products or for some of to include like yeah, private credit, private assets, private whatever it is, do these solve problems for the portfolio manager or for the investment advisor that the existing publicly liquid assets don't.

Cullen Roche (49:13)

Provide. Yeah, 2022 messed a lot of people up, because when stocks and bonds become highly correlated and you own that 6040 portfolio that, you know, the bonds go down 15% or whatever and the stocks also go down 25%, well, then you look at your portfolio at the end of the year and you say, I don't. I'm not actually diversified. If you were that retiree that you mentioned, Tracy, that is retiring that year, you feel like you made a bad decision. Even though the 60:40 portfolio, for the most part is a pretty good portfolio, there is an increasingly compelling argument in that context for things like alternatives. I. Me personally, I tend to just default towards simple is better, because I think that this whole process can get so complex so quickly that the little things you can do to create organization and structure, to simplify it as best as possible, is going to result in a better process, a better outcome in the long run. So, you know, little things like, I mean, God, I woke up 10 years ago and I looked at me and my wife's financial accounts and I was like, oh, my God, we've got. I've got a mer. An old Merrill Lynch 401k, and I've got. You've got old Fidelity 401ks, and you've got, you know, a bank account over there. I have a bank account over here. We've got three brokerage accounts at Charles Schwab and, you know, different custodians, TD Ameritrade or whatever it might be. And I was like, this is. I can't manage all this. I've actually forgotten the password to some of these accounts or something. And so collapsing all this down and consolidating it and simplifying it and trying to own, you know, something that is very, very simple. I. One of the portfolios I talk about is the Boglehead 3 Fund portfolio in the book. And I think one of the reasons that so many people love that and those. The followers of that portfolio are they're very. Almost militant about it. And I think in part because it is so simple that it is. It's just beautifully elegant in its simplicity. But then you could get into debates about, is it too.

Tracy Alloway (51:10)

Simple? What is it? The Bogohead.

Cullen Roche (51:11)

3? It's basically the bond aggregate. And then. And you can mix this up, you know, in different slices based on your risk profile. But it's three funds. It's a domestic equity fund, a foreign equity fund, and a bond aggregate. And these investors will buy this and they'll buy it for, you know, costs like three basis points or something in.

Tracy Alloway (51:27)

Total.

Cullen Roche (51:27)

Yeah. And so it follows like all the sort of like, Taylor Larimore was the founder of it. And Taylor was, he's someone I interviewed in the book. And he's not. He wasn't really in the financial advisory business, but he became great friends with Bogle over the years because he was just emailing with him. He had a. Actually a funny backstory where he comes back from World War II and he fought in the battle of the Bulge and jumped out of airplanes and had all these cool stories about it. He comes back and I guess he married like the hottest woman in Miami or something, and she was a model and she's making crazy, crazy amounts of money modeling. And so he comes into all this money and he doesn't know what to do with it, and he hires a financial advisor who hoses him. And he starts emailing John Bogle. And Bogle then starts telling him, like, nah, you should be doing this, this and this. They become great, great friends. Bogle ultimately crowns him the king of the Bogleheads later in life. And so he's kind of like the most famous of all the Bogleheads now. And. But he distilled all of Bogle's thought processes down into like the simplest of all possible portfolios, which is this famous three fund portfolio. But it's arguably, I am minorly critical of it because I would say that to some degree there is such a thing as too simple also, where, for instance, like if you own the three fund portfolio in 2022, you probably wish you owned some of the T Bill and Chill portfolio, or maybe you wish you owned, you know, something completely uncorrelated, like the trend following portfolio or something, you know, that added a little bit of diversification that kept you, you know, helped you stay the course, as Bogle would.

Joe Weisenthal (53:00)

Say. I really enjoyed the Warren Buffett portfolio chapter in part because it demonstrates how people get decision paralysis around all of this. So even if you're trying to replicate Warren Buffett's investment style, you come up with three different ways to do it, Right? So it just seems like an infinite way to invest. But the thing I want to ask you is you also say that you wrote to Warren Buffett and you actually got a response. What did he say? This was like before you wrote the book, early in.

Cullen Roche (53:29)

Your. Oh, this is in my early 20s when I was too poor to own a share of Berkeley. So in order to go to the shareholder meeting, you had to be a shareholder And I was too poor to own a share of Berkshire back then, so I. I wrote him a letter and I said, hey, could I come to the conference? Even though I'm this poor schmuck who can't even afford to buy your shares. And I get a typewritten letter on it, comes in like a, you know, probably a five by six little piece of paper and it's typewritten and it was from his assistant on behalf of him, but he wrote and invited me and.

Tracy Alloway (54:06)

I. That's really.

Cullen Roche (54:07)

Cool. It was awesome. I. I had a family event. I ended up not going, which.

Tracy Alloway (54:11)

Was. Have you ever.

Cullen Roche (54:12)

Been. I've never been.

Tracy Alloway (54:13)

So. Terrible decision, but I went once and it's a. It was a fantastic experience. It was extremely.

Joe Weisenthal (54:20)

Cool. Yeah, we should do an. All thoughts.

Tracy Alloway (54:22)

From. Well, he's done here. We're done. Oh yeah, there's not going to be. I mean, yeah, I guess there'll probably still be one, but it's not gonna be the.

Cullen Roche (54:27)

Same. Yeah, you guys should definitely do an odd lots with me. That would be.

Joe Weisenthal (54:30)

Great. Can you introduce us since your.

Cullen Roche (54:33)

Corresponding. Do you have a.

Joe Weisenthal (54:35)

Typewriter? Yeah, no, but I can find.

Tracy Alloway (54:37)

One. Cullen Roche. Really fun. Thanks for coming in studio. Congrats on the new book. Let's stay in touch and really enjoy.

Cullen Roche (54:45)

Chatting. Thanks for.

Tracy Alloway (54:45)

Talking. Absolutely. That was a lot of fun. Tracy, have you ever. Have you heard of the fintech startup Acorn? Is that.

Joe Weisenthal (55:05)

Really. Yeah, that's the one where you like invest tiny bits of like loose change.

Tracy Alloway (55:10)

Basically. Yeah. So years ago, like, I think actually probably about 10 years ago or nine years ago or something like that. I read about it. I was like. I was like, curious how it worked. So I like signed up for an account and it takes this like, small amount and also the app, at least I'm not trying to slag them. It doesn't work very well. My password is always getting resigned, but every like year and a half I remember that exists that has outperformed every other investment because it's like the one thing that I've like lost my password to and I can't access.

Joe Weisenthal (55:41)

It. Oh.

Tracy Alloway (55:41)

Seriously? Yeah, it's done.

Joe Weisenthal (55:42)

Great. What did you actually invest.

Tracy Alloway (55:43)

In? Like. Yeah, it's like their growth. Whatever their growth fund is, it's not very much, but. God, like, like that one thing where it's just like the one I think about and look at absolutely the least. Because I could never open the app and every once in a while I go through the effort to reset the password. It's done very.

Joe Weisenthal (55:59)

Well. But this Is like, this is the entire irony, right? We talk about how there's no such thing as passive investing, but actually if you just forget the password to your account and never look at it.

Tracy Alloway (56:08)

You tend to outproof you come.

Joe Weisenthal (56:09)

Close.

Tracy Alloway (56:10)

Yeah. I really. I just find this to be such a fascinating topic. It does feel like, again, it feels a little unsexy because people are so interested in the incredible amounts of money that people have made in crypto and AI, etc. But, like, the puzzle of, like, putting it all together and how you find assets that make money across cycles but are sufficiently uncorrelated, et cetera. It's like an interesting intellectual.

Joe Weisenthal (56:33)

Exercise. Right. And you also have this entire industry that's built on the promise of outperformance, mostly. And it feels really difficult to resist, I guess, the mostly masculine urge to.

Tracy Alloway (56:45)

Outperform. I liked your question in the beginning because it's something I've always thought of about actually assessing risk profile, because, as Cullen put it, everyone knows the right answer. Oh, I'd buy and hold. But I've always been skeptical that anyone is a good judge of their own risk profile. So to hear him talk about, no, let's not talk about it like that. Let's math it out. Let's talk about asset liabilities. Let's talk about the predictability of your income stream. How that is a de facto fixed income asset strikes me as a much more sort of sound way to think about it than just sort of try to imagine how you're going to behave the next time a.

Joe Weisenthal (57:22)

Pandemic. Well, it also gets back to what we were talking about in the intro, right? Which is you can say, I'm going to buy the dip if there's a 40% drawdown. But chances are a 40% drawdown is happening in a very bad economy where you might lose your job and not have that much to actually buy stuff.

Tracy Alloway (57:37)

With. No. Like, March 2020, it felt like the world was ending. Who wants to buy? Like, Cohen used the word rational, which is, I think, exactly right. Like, it feels rational all the time. Everyone should be selling it this time. It's very hard, very hard to actually adhere to, like, simple.

Joe Weisenthal (57:54)

Rules. Yeah. Shall we leave it.

Tracy Alloway (57:55)

There? Let's leave it.

Cullen Roche (57:56)

There. All.

Joe Weisenthal (57:56)

Right. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me, Tracy.

Tracy Alloway (58:02)

Alloway. And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our guest, Cullen Roesch. He's cullenroesch. And of course, check out his new book, your Perfect Portfolio. Follow our producers Kerman Rodriguez at Kerman Erman, Dashiell Bennett at dashbot, and Kale Brooks at Kel Brooks. For more Odd Lots content, go to bloomberg.com oddlots or the daily newsletter and all of our episodes and you can chat about all of these topics 24. 7 in our Discord, Discord, GG.

Joe Weisenthal (58:29)

Oddlauds and if you enjoyed this conversation, if you like it when we talk about building your your Perfect portfolio, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg Channel on Apple Podcast and follow the instructions there. Thanks for.

Cullen Roche (58:51)

Listening.