Rethinking Investing with Greenwich Associates' Charles Ellis

Barry speaks with Charles Ellis, author and Founder of Greenwich Associates. Prior to founding Greenwich Associates in 1972, Charles worked with the Rockefeller family investments office and Donaldson, Lufkin, and Jenrette. Charles was appointed to the faculty of the Yale School of Management and twice to the Harvard Business School. He also served as a trustee at Yale from 1997 to 2008. After stepping down as Managing Partner at Greenwich, Charles served on the Vanguard Group Board of Directors, was a trustee of the Robert Wood Johnson Foundation, and an advisor to the GIC of Singapore. He currently serves as chair of the Board of Directors at the Whitehead Institute for Biomedical Research. On this episode, Barry and Charles discuss his path through finance, the evolution of his investing philosophy, and his new book Rethinking Investing. See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  At KKR, we've spent 50 years understanding what matters to our clients and companies. From pioneering private equity to investing across credit, real assets, insurance and sports, KKR has built the experience to navigate complexity, the judgment to recognize opportunity, and the conviction to create lasting value. Because when people and institutions are counting on us, understanding what matters isn't just important, it's everything. KKR, understanding what matters. Visit kkr.com/whatmatters.

• 0:31Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs, and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 1:13Speaker 01

  and hiring practices, but according to recruiters, advisors and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at ChatGPT.com.

• 1:56Speaker 02

  Bloomberg Audio Studios, podcasts, radio, news.

• 2:04Speaker 02

  This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

• 2:10Barry Ritholtz?

  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, his new book, Rethinking Investing, is just a delightful snack.

• 2:51Barry Ritholtz?

  It's only 100 pages and it distills 60 years of investing 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.

• 3:15Speaker 04

  Thank you, Barry.

• 3:16Barry Ritholtz?

  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 Masters 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?

• 3:53Speaker 04

  A friend of mine at business school said, "Have you got a job yet?" And 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 and their investment office.

• 4:10Speaker 04

  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 gotta 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.

• 4:45Barry Ritholtz?

  And he's really describing the Rockefeller family office?

• 4:49Speaker 04

  Family office, yes.

• 4:49Barry Ritholtz?

  Not necessarily the foundation. So what were they doing at that time? What were their investments like?

• 4:56Speaker 04

  Well, they invested the family's fortune. And 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.

• 5:31Barry Ritholtz?

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

• 5:37Speaker 04

  No, it was the 1960s.

• 5:38Barry Ritholtz?

  So late 60s, not a lot of data available on a regular basis, and modern portfolio theory was kinda just coming around?

• 5:47Speaker 04

  Oh, it was just an academic curiosity. Nobody's 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 nothing, it's not gonna happen. The transformation of the whole investment management world.

• 6:12Speaker 04

  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.

• 6:29Barry Ritholtz?

  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 then we've also learned a lot since then.

• 6:45Speaker 04

  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. That's a huge change.

• 7:03Barry Ritholtz?

  Order of magnitude.

• 7:04Speaker 04

  The amount of research that was available was virtually zero.

• 7:08Barry Ritholtz?

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

• 7:28Speaker 04

  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.

• 7:40Barry Ritholtz?

  Right, that's right.

• 7:41Speaker 04

  Giving 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.

• 8:02Barry Ritholtz?

  Mm-hmm. Huh, that's really interesting. So, how long were you at Rockefeller before you launched Greenwich Associates in 1972?

• 8:10Speaker 04

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

• 8:19Barry Ritholtz?

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

• 8:29Speaker 04

  It was a little nervy, I have to grant you. 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." And then, I had 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

• 9:07Speaker 04

  on the facts, really undeniable facts, based on 300, 500, 600 interviews with people who made the decisions. And it worked.

• 9:19Barry Ritholtz?

  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 stockpicking, 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 beating them.

• 9:44Speaker 04

  I wouldn't quite say it that way. I wouldn't deny what you're saying, but I would say it differently. When, 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 securities 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

• 10:24Speaker 04

  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's right mind has computing power that would knock the socks off anybody who came from 1970, got dropped into the current

• 11:05Speaker 04

  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. And we were proud of them. And we're 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's in the investment world.

• 11:33Barry Ritholtz?

  Right. Reg FD said it has to be disclosed to everybody at once.

• 11:38Speaker 04

  So it is.

• 11:39Barry Ritholtz?

  You can't just whisper it to your favorite.

• 11:40Speaker 04

  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 terminal so they can do any background 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

• 12:24Speaker 04

  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 excellent 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 and in my view sensibly turned index funds to cut down on the cost.

• 13:01Barry Ritholtz?

  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?

• 13:24Speaker 04

  Well, the data did come, but it came later. 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.

• 14:09Speaker 04

  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.

• 14:21Barry Ritholtz?

  Michael Mobison 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.

• 14:35Speaker 04

  Absolutely true.

• 14:37Barry Ritholtz?

  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.

• 14:55Speaker 04

  Well, we all know about life. We're tempted by beautiful men, beautiful women. We're tempted by whiskey, gin, other drinks. Some of us get tempted by drugs and other things like that. 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's studied.

• 15:36Speaker 04

  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 the 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

• 16:21Speaker 04

  who's serious about examining the data, drives them nuts, than 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. 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. There's several hundred pages, 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

• 17:06Speaker 04

  think they're above-average dancers, 80% of people think they're above-average drivers. If you ask men a question of, "Are you..." Really above average at various kinds of skills. They get up to pretty 90%, 95% saying they're very, very, very good. Now, if you look at a 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. Then 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.

• 17:49Speaker 04

  In fact, they are part of the normal crowd.

• 17:52Barry Ritholtz?

  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.

• 18:13Speaker 00

  At KKR, we've spent 50 years understanding what matters to our clients and companies. From pioneering private equity to investing across credit, real assets, insurance, and sports, KKR has built the experience to navigate complexity, the judgment to recognize opportunity, and the conviction to create lasting value. Because when people and institutions are counting on us, understanding what matters isn't just important, it's everything. KKR, understanding what matters. Visit kkr.com/whatmatters.

• 18:43Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk, and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs, and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 19:27Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.

• 20:08Barry Ritholtz?

  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.

• 20:28Speaker 04

  Whoa, 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 a change 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 trip, blue trips of all time. And I had also been studying IBM, which was a wonderful company.

• 21:14Speaker 04

  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 would 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.

• 21:59Speaker 04

  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. They're 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.

• 22:41Speaker 04

  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 Corfam. But as I talked to the executives, they kept talking to me about, "We're having difficulty getting people to use Corfam. Now, we're getting people who make shoes to think about using Corfam. 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."

• 23:24Speaker 04

  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 of a way of competition, and they really knew what they were doing, and they kept cranking it out. So...

• 24:08Speaker 04

  What do you do? I came back and said, I know that the family, 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.

• 24:51Barry Ritholtz?

  Huh, 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.

• 25:03Speaker 04

  But they also were making lots of mistakes.

• 25:06Barry Ritholtz?

  Right.

• 25:07Speaker 04

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

• 25:15Barry Ritholtz?

  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?

• 25:51Speaker 04

  First, you have to understand that David Swensen was a remarkably talented guy. He was the best PhD student that 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 show you, everybody had told him, you'll never be able to do that, David. So we're talking about a very unusual guy.

• 26:20Barry Ritholtz?

  Uh huh.

• 26:21Speaker 04

  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.

• 27:06Speaker 04

  So it'd probably be something like 20 years of typical relationship duration. Many of these managers, when they were just getting started. So that's the most dicey period in any investment organization. A 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 is 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.

• 27:48Speaker 04

  The rate of return magnitude that I've been able to accomplish 10 years ago, 15 years ago, I'm not going to be able to do in 10 or 15 years into the future. And I think he was right.

• 27:59Barry Ritholtz?

  Huh, 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.

• 28:08Speaker 04

  Completely different. Each one was doing what they were capable of doing really well. Vanguard was focused on minimizing cost and they're really systematic at it. Different orientation. The orientation of the Yale Endowment was to find

• 28:28Speaker 04

  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 saying, you've, you seem to have changed your mind. He said, yes, I, 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

• 29:12Speaker 04

  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 the competition. But it just, the competition is so damn good today that there isn't a manager that can knock the socks off.

• 29:30Barry Ritholtz?

  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 stacked against them.

• 29:55Speaker 04

  Because they're so very good. It's ironic, ironic, ironic.

• 29:59Barry Ritholtz?

  The paradox of skill.

• 30:00Speaker 04

  Yep.

• 30:01Barry Ritholtz?

  Really, really fascinating. You, you reference 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.

• 30:25Speaker 04

  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

• 30:40Speaker 04

  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 2.5%, maybe 3% for inflation. Call it 2.5%. Whoop, that's something down.

• 31:25Speaker 04

  Then you've got fees and costs. Gee whiz, 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.

• 31:43Barry Ritholtz?

  Let's put 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 Dalbar 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?

• 32:26Speaker 04

  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 you would index or ETF would help is because it's boring. You know, if you own an index fund, you don't get excited about what happened in the market.

• 33:06Speaker 04

  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, it kind of goes along in its own lumbering way, a slow, wide river of flow over time, and 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. You just be a little bit tolerant and don't itch it, or don't scratch it, and it'll heal faster.

• 33:48Speaker 04

  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'll just sort of steadily flow through and have all the good results come your way. That's it.

• 34:03Barry Ritholtz?

  Huh, really, really interesting.

• 34:07Speaker 01

  This is the Bloomberg Tech Minute, brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk, and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs, and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 34:48Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company. And Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.

• 35:30Barry Ritholtz?

  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.

• 35:52Speaker 04

  Very, 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,

• 36:34Speaker 04

  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 have put this together in this 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.

• 37:17Barry Ritholtz?

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

• 37:22Speaker 04

  Yeah, and one of those pages is blank and then there are several pages that are half blanks.

• 37:27Barry Ritholtz?

  Well, 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.

• 38:05Speaker 04

  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.

• 38:40Barry Ritholtz?

  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?

• 38:57Speaker 04

  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 at 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.

• 39:33Barry Ritholtz?

  So, we mentioned the phrase passive, which has come-

• 39:37Speaker 04

  Oh, please don't do that.

• 39:38Barry Ritholtz?

  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.

• 39:57Speaker 04

  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. There's 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.

• 40:41Speaker 04

  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'll 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.

• 41:14Barry Ritholtz?

  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?

• 41:48Speaker 04

  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.

• 41:57Barry Ritholtz?

  It's just as simple as their livelihood is dependent on flows into active and that's where all the animus comes from.

• 42:04Speaker 04

  It's partly livelihood, it's partly religious faith, it's 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.

• 42:21Barry Ritholtz?

  To continue, sure. You mentioned, we talked earlier about the temptation, that we're surrounded by temptations to be wrong. I want to 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

• 43:01Barry Ritholtz?

  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 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.

• 43:35Speaker 04

  Well, first of all, you have to recognize when you select out the most extreme days, it does have a really big impact. The second thing is, when do those days come? And the best days usually come shortly after the worst days.

• 43:53Barry Ritholtz?

  Right.

• 43:53Speaker 04

  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.

• 44:06Speaker 04

  The time that we all get frightened and all of us get unnerved is the wrong, the most wrong time to be taking action.

• 44:16Barry Ritholtz?

  And, and the statistical basis is those 10 days are only 0.1% of total trading sessions, but you're giving up one-fifth of the gains. That, that's an amazing asymmetry.

• 44:31Speaker 04

  And it's a hell of a great lesson to learn. Hang in there. Steady at e does pay off.

• 44:38Barry Ritholtz?

  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?

• 44:55Speaker 04

  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 to say, "Okay, that's 43 years out into the future. Let's go back 43 years. Tell me what

• 45:40Speaker 04

  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.

• 46:06Barry Ritholtz?

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

• 46:20Speaker 04

  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 one to two is not very exciting. Two to four is not much. Four to eight is not really all that much. Eight 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.

• 47:03Speaker 04

  Only way you get there, you start early and stay on course, compounding away as best you can.

• 47:10Barry Ritholtz?

  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.

• 47:42Speaker 04

  Well, he's a brilliant and wonderful human being. All of us can learn great lessons from paying attention to what Warren says or has said. And his annual meetings are a treasure chest of opportunities to learn. 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.

• 48:28Speaker 04

  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 its inevitable power of compounding is just wonderful to have on your side.

• 48:47Barry Ritholtz?

  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.

• 49:23Speaker 04

  Parents 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.

• 49:53Barry Ritholtz?

  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.

• 50:21Speaker 04

  No, 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. So, and that'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.

• 51:06Speaker 04

  And I know people would say their first reaction, 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

• 51:50Speaker 04

  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.

• 52:03Barry Ritholtz?

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

• 52:13Speaker 04

  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, a 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, oh, and 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 your present total picture.

• 52:51Barry Ritholtz?

  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?

• 53:07Speaker 04

  My favorite books tend to be history.

• 53:09Barry Ritholtz?

  Uh huh.

• 53:10Speaker 04

  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.

• 53:26Barry Ritholtz?

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

• 53:35Speaker 04

  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 of what I did, or I'm so glad I did what I did?

• 54:05Speaker 04

  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

• 54:49Speaker 04

  and how can we do the best for our long-term success by the structure of the portfolio that we have.

• 54:57Barry Ritholtz?

  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?

• 55:08Speaker 04

  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. And 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.

• 55:47Speaker 04

  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 2020s, you're going to pay a terrible price. Don't do it. Don't do it.

• 56:08Barry Ritholtz?

  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 podcasts. 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.

• 56:53Barry Ritholtz?

  Andrew Davin is my audio engineer. Anna Luke is my producer. Sean Russo is my researcher. Sage Baumann is the head of podcasts at Bloomberg. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio.

• 57:37Speaker 05

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• 58:13Speaker 06

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