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The Delusions of Crowds with Bill Bernstein – Podcast #207

Podcast #207 Show Notes – The Delusions of Crowds with Bill Bernstein

Bill Bernstein is one of the smartest people we know in the investing world. Listen to this interview with Dr. Bernstein about his new book, The Delusions of Crowds and you will see why. The book is about religion and finance and is Bill’s attempt to explain to a secular audience the current polarization of American politics and culture. We really like his focus on financial history. It is important to understand what has happened in the past and to carry those lessons into your current investing. We discuss past manias, mass delusions, and bubbles while comparing them to today’s world. Bill emphasized that we need to treat investing as a serious subject with fundamental textbooks and peer-reviewed literature.

After our discussion on the delusions of crowds, we discuss new financial developments such as cryptocurrencies, tech growth stocks, bonds, ARK funds, SPACs, non-fungible tokens, and how to tell if you can be a successful do it yourself investor.

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Quote of the Day

We decided to use a quote of the day from William Bernstein in today’s podcast. He said,

“Most brokers service customers the same way in which Bonnie and Clyde serviced banks.”

Unfortunately, there is a lot of truth to that.

Financial Educator Award

This award is for doctors and other high-income earners, but not financial professionals or bloggers, who are helping their trainees and peers to become financially literate. This is usually out of the goodness of their hearts, giving lectures, developing curriculum, talking to people on the side during their shifts.

If there is someone you would like to nominate for the White Coat Investor Financial Educator Award, please send an email, a paragraph is plenty, to [email protected] and we will highlight their efforts, and one nominee will receive a certificate and cash award. The deadline to nominate is April 30th.

Milestones to Millionaire

Episode #10: Millionaire 5 years Post Residency


Sponsored by 37th Parallel

Jacque reached a net worth of a million dollars five years out of training. She practices outpatient internal medicine and is a military doctor with the National Guard. How did she become a millionaire so quickly? She prepared a plan for her finances while she was in medical school. 

 

The Delusions of Crowds with Bill Bernstein

Dr. William J. Bernstein is a trained neurologist, co-founder of Efficient Frontier Advisors, an investment management firm, and has written a number of titles on finance and economic history.

He has been praised by Money in an article titled “The Man Who Knows Too Much”. His books include the three we call the comprehensive investing books: The Intelligent Asset Allocator, Four Pillars of Investing, and The Investor’s Manifesto; the investing books for adults: The Ages of the Investors, Skating Where the Puck Was, Deep Risk, and Rational Expectations; plus the wonderful PDF that he has provided for free, If You Can.

He has written four history books now: A Splendid Exchange, The Birth of Plenty, Masters of the Word and the newest one, The Delusions of Crowds, which we are talking about today. This is an extensively researched volume, clearly inspired by Charles Mackay’s Extraordinary Popular Delusions and The Madness of Crowds published in 1841.

It is pretty clear from the epilogue in the book that he views The Delusions of Crowds as the sequel that Mackay would have written if he had lived longer. Why did Bill find Mackay’s book fascinating enough to write a sequel for it?

“Well, that question has a two-part answer. The first part is that I read Mackay’s book almost 30 years ago, back in the early 90s. I thought it was interesting. His description of financial mania just really got my attention, but I didn’t think it was terribly relevant to the well-behaved capital markets of the time.

And then, several short years later, the wild descriptions of Mackay’s financial markets going bonkers came alive before my very eyes, and it saved my bacon, and I’m not alone in that. This book has been saving people’s bacon for the past hundred years.

The second part of the answer is, like a lot of people, I was just astonished by the ability of the Islamic State several years ago to attract recruits from around the world to fight and die in one of the worst places on the Earth. The way they were able to do it was by deploying a narrative, an end times narrative, that was very compelling. And it’s very similar, in fact, to the Christian and Jewish end times narratives, which is no surprise. All three Abrahamic religions have pretty much the same cultural roots.

So, I realized at that point that I had to rewrite Mackay’s book, because Mackay not only spent a lot of his book on financial manias, but he also spent a lot of his book on religious manias, as well.”

Bill’s book is probably more about religion than finance. Bill said he chose to write so much about religion because we’ve become a much more polarized society in the United States over the past couple of decades, and he wanted to flesh that out for readers who might be somewhat mystified as to why that’s occurred.

“You cannot understand the current polarization of American politics and our cultural polarization without understanding something called pre-millennial dispensationalism, which is a theological term for the end times belief system. But it’s behind most of Protestant evangelicals, and it’s an end times narrative. When you recount that narrative for secular Americans, their jaws drop to the floor. They can’t believe it. On the other hand, to an evangelical Christian, that’s just like the Godfather or Gone with the Wind; it’s a very familiar narrative.

So, the major goal when I wrote the book was to explain that narrative to secular Americans like myself. That was the first reason why I did it. Now the other reason is, I think that this narrative has some very real risks to it. Several times over the past couple of decades, we’ve nearly incinerated the planet by accident with nuclear weapons. So, obviously it may not be a good idea to have someone who believes in a narrative that has the world undergoing an inevitable tribulation in not-too-distant future, but they’re going to be raptured up to heaven before all the bad stuff goes down, anywhere near a nuclear weapon or making nuclear weapons policy, for that matter.

The second reason why I wanted to write about dispensationalism and explain it to a secular audience is that you don’t understand U.S. involvement in the Middle East without understanding a phenomenon called Christian Zionism, which is the end times narrative as deployed in the Middle East.

And then, finally, I wanted to write about it because there’s this fascinating convergence of all three end times narratives, the Christian one, the Jewish one and the Islamic one, on the Temple Mount. At least a couple of times during the past several decades, especially since the 1967 conquest of Jerusalem by the Israelis, that has almost led to a regional war. So, I wanted to deploy this narrative and explain it to a secular audience so they’d have a better understanding of it.”

The first few subjects touched on are Christian sects, small and large, who basically predicted a specific date for Christ’s second coming and then were repeatedly disappointed when it did not occur. Why do so many of them overlook a rather prominent scripture from the book of Matthew that says, presumably in the words of Christ himself as pinned by Matthew, “But of that day and hour knoweth no man, no, not the angels of heaven, but my Father only”? How did so many of those sects overlook this direction that you can’t divine from the Bible or anywhere else when that second coming is supposed to come?

“Trying to calculate the end times is an irresistible thing to do. And the reason is, it’s a basic psychological drive we have, which is called by neuropsychologists, ‘Bad is stronger than good’. We are very attracted to bad news, and we are also attracted to compelling narratives. What more compelling narrative than the story of how the world ends and trying to divine from that narrative when exactly that is going to occur? It’s simply an irresistible subject for many Christian dispensationalists that can’t be ignored.”

The Ape That Imitates

Bill writes that it is hard to avoid the dark conclusion that, had enough of our peers deemed genocide desirable, many, if not most of us, are capable of it. Why are we as humans such herd animals? Why does it matter to us so much what other people around us think of us? Why do we want to be like other people so much?

“If there’s one message in the book, it is, first and foremost, we are the ape that imitates. So, the question is, why do we imitate? And the best way to understand that is to think about the migration of human beings across the Bering Strait, about 10,000 or 15,000 years ago. And within the space of 3,000 to 5,000 years, human beings settled everything, almost all of the land between the High Arctic Wastes down through the Great Plains and Central America and into the Andes and down to Tierra del Fuego. And along the way, they had to adapt to many different environments. They had to learn how to hunt seals and whales and build kayaks in the High Arctic. They had to learn how to hunt bison on the Great Plains. They had to make poison blowguns while they were in the Amazon.

And if you’ve never seen one of those things done before, it’s almost impossible. You’re never going to figure it out by yourself unless you’re extremely lucky. So, the most evolutionarily adaptive behavior we have is our ability to watch other people and to imitate. And that works very well in a stone age environment.

Unfortunately, in a modern post-industrial environment, it can be very, very dysfunctional. It can lead to mania. We are effectively living with stone age minds in a space age world. And that’s our problem.”

Mass Delusions

Most religious people view people of other religions as being deluded in at least some of their beliefs. If those other religions have many members, they could rightly be described as mass delusions. In Bill’s mind, what’s the difference between a mass delusion and a shared faith, if any?

“Oh, there’s no difference at all. We are all functioning under the service of mass delusions, every single one of us. Fortunately, most of those mass delusions are beneficial. For example, we believe that little green pieces of paper are money. And that’s a con game that works only so long as the rest of us believe that it’s money, that everybody else believes that it’s money. If people stop believing in it, it stops working. It is the so-called Tinkerbell principle.

The same thing is true in the belief of rule of law, which can be terribly fragile when people stop believing it, as we saw on January 6th. Most religions are mass delusions that functioned as sort of a very useful social function, keeping people together, helping them support one another, giving meaning to their life.

So, what I wanted to write about in the book was not really about how helpful or beneficial mass delusion is, but I wanted to write about the ones that went bad, which is what the book is really about.”

Perhaps the religious and financial lessons in the book are more related than might appear at first glance. The religious and financial events appear to represent different phenomenon, but they are powered by the same social and psychological mechanisms.

  1. The irresistible power of narratives.
  2. The human proclivity to imagine patterns where there are none.
  3. The hubris and overconfidence of their leaders and followers.
  4. The human proclivity to imitate the behavior of those around us.

Why does the combination of those four mechanisms cause mass delusions, both religious and financial?

“The most important one is the last one you mentioned—our proclivity to imitate. And, of course, it’s also about the power of narratives. The analogy that I like to use is the analogy between mass delusions and pandemics. This audience is going to be very familiar with the fact that a pandemic has two basic pieces. One is the causative agent, the active agent, the pathogen, and then the other is the vector. So for example, with the current pandemic, it’s a little RNA virus and the vectors are people’s respiratory droplets, coughing on each other.

For mass delusions, whether they are financial or religious, the agent is the narrative, the narrative is the pathogen. And then the vector is the medium through which it spreads.

So, for example, the primary medium for both the mass delusion of election fraud or for some of the financial shenanigans we’re seeing lately is social media.”

FOMO

Bill used a quote from Charles Kindleberger. He said, “There’s nothing so disturbing to one’s well-being and judgment as to see a friend get rich”. Why does FOMO—‘Fear of Missing Out’—affect us so much as humans?

“We’ve already talked about the two basic parts of human nature, which is we are the ape that imitates and the ape that tells stories like narratives. But there’s a third part of it, which is we are the ape that seeks status.

And so, when we see someone getting rich, that lowers our relative status, and that we find very, very disturbing. So, we want to be rich like them, and regain our relative status. It’s pretty much that simple. And it’s the same thing with religious manias. There is nothing that gives someone status so much as believing that they’re saved and everybody else isn’t.”

Bubbles

Bill listed four Ps required for a financial bubble:

  • Promoters
  • The Public
  • Politicians
  • The Press

It was particularly interesting, in the British railway bubbles, that the companies actually produced their own newspapers. Does he see any parallels in today’s diffused media environment with blogs, podcasts, and social media to that railway bubble era?

“Well, if you look at the history of bubbles, and of religious manias, as well, you see that they spread through the leading-edge media of the time. So, you can go all the way back to the first financial bubbles or the religious manias of the medieval period, and you see it. They follow hard on the heels of Gutenberg’s invention of the printing press. Without the printing press, there wouldn’t have been the first bubbles or probably there wouldn’t have been the religious manias. There certainly wouldn’t have been the Religious Wars. And there probably wouldn’t even have been reformation, without Gutenberg’s press.

And you see the same thing happening with each successive bubble. It spreads through the vector, which is the leading edge media of the time. And of course, the leading electronic media of our time is social media.”

You can create quite an echo chamber, and Facebook, as a company, helps you to create it around you.

“If I had to describe our current political crisis and what drives our political polarization, to compact it down, it would be, we have a social algorithm-driven epistemic crisis. People don’t know what the truth is because their attention is being driven by Facebook’s algorithm that drives them only to things that appeal to their confirmation bias.”

One of my favorite news sites is a site called allsides.com. They put up right-wing news and left-wing news and what they see as middle news and identify them and let you read the same story from two different perspectives. It is really pretty enlightening if people have never actually done that before. The good news is, when they do studies of how polarized we are, we’re not nearly as polarized as we think we are, but certainly we are far more polarized than we used to be.

We discussed some of the experts during these bubbles. He wrote that he doesn’t know if Charles Mackay lost money in the railway mania, but he didn’t comment on it as you would expect having lived through it. Sir Isaac Newton, who we all think of as this physicist, he actually served as the master of the mint for decades, but he lost money in the South Seas bubble. If these financial masters can’t recognize a bubble that they’re living through, what hope do the rest of us have?

“Not much. If the likes of Charles Mackay and Isaac Newton got swept along by a bubble, it’s going to be very hard for the individual to do it. The only way, the only defense you have, is to read history. I like to say that the only black swans are the history that you haven’t read.”

There is a lot of truth to that. Certainly, that has been helpful to us, to know a little bit about financial history while looking at today’s events. Bill listed four characteristics of bubbles in the past:

  • Financial speculation becomes a primary topic of everyday conversation.
  • Competent and sane people abandoned secure, well-paying professions for full-time speculation.
  • Hatred and vitriol become directed at skeptics.
  • You start seeing extreme predictions.

We have certainly experienced our share of vitriol from people who don’t share our opinion of whole life insurance, dividend investing, Bitcoin, or individual stock picking. But one of the more interesting things we have noticed over the years is that people tell us if we would just learn a little bit more about IT, whatever IT might be, we would be a super fan of it just like them. Is this simply people responding to the cognitive dissonance that occurs when someone they previously respected does not share their opinion on a particular topic?

“Yeah, you’re referring to a doctrine, called ‘Doctrine of the Balanced State’, which is something that was described by a psychologist by the name of Fritz Heider about 80 years ago. And here’s what the balanced state means. Let’s take a nice topic that has some emotional balance.

So, say it’s whether you’re an Android or an iPhone enthusiast. And let’s say that your very best friend loves iPhones and so do you. Well, you’re in a balanced state because it’s a modestly important subject. You like iPhones, you like your friend, you’re in a balanced state.

Now, if you have somebody who thinks that Android phones are much, much better than iPhones and you think that that person is a moron for other reasons, you’re in a balanced state, too, because it allows you to dismiss his opinion.

Where you get into trouble is where you’re in an unbalanced state. It’s when your best friend thinks that you’re dead wrong about loving iPhones and he thinks that Androids are better, and you have to resolve that. And most people have no trouble resolving that. Where we get into trouble is where the issue contains much more emotional balance, say, for example, Donald Trump. And we’re seeing all over the country people who are basically disowning their friends and family because of political differences.”

That balance theory does explain a lot of it. It’s psychologically uncomfortable and you have to resolve that by either deciding that you agree with their opinion on whatever the subject is or deciding that they’re just an idiot and not the fine person that you thought they were beforehand.

It has been interesting to look back historically at these bubbles and see that these promoters of bubbles were frequently venerated until they weren’t. Then they became victims. Will future generations look at Elon Musk and Cathie Wood and the infamous Satoshi Nakamoto differently than society looks at them today? Will we look at them, like we consider Andrew Carnegie a great philanthropist, or more like George Hudson from the book, or perhaps some sort of combination such as John Law of the Mississippi bubble fame?

“Yeah. Or Samuel Insull, who wound up disgraced for reasons of fraud, but basically built a lot of the nation’s electrical power infrastructure. I don’t know about Musk. I think that it’s very likely he’ll be treated as a hero by future generations, but a lot of his behavior is very disturbing. It is the kind of behavior you do see in people who are the recipients of a lot of adulation and particularly even a lot of these industrial heroes. So, I don’t know which side he’s going to come down on.”

Bill felt like Cathie Wood fits in a different category, a rather well-defined, small pigeonhole, which is the superstar active mutual fund manager.

“Their trajectory almost uniformly winds up being unhappy. They tend to flame out very rapidly, because they wind up attracting a lot of uninformed investors who overload them with funds that basically crash in a bubble sort of explosion.”

Bubbles are not all bad. They often leave society with tangible benefits, essentially funded by the early investors who graciously donated to the public good. In the book, Bill called them “capitalism’s unwitting philanthropists”. This was the case with the railroad bubbles in England, in particular, which left thousands of miles of track. And the internet and telecom bubbles, which laid the foundation for the internet we’re using right now. Will that also be the role of current cryptocurrency investors, that they are funding the development of useful blockchain technology and a useful cryptocurrency?

“I think so. I think that a lot of people who are investing in cryptocurrencies are going to be very sorry they did, but the blockchain technology itself is a revolutionary technology. Now, the question is who’s going to take it over if it comes into wide use? And I’m pretty sure the answer is not going to be private companies. If a major part of our financial system works through it, the government is going to have to very heavily regulate it, if not take it over. So, you’re certainly not going to get rich investing in it.”

A Successful DIY Investor

Bill writes that few individuals possess the quantitative skills, historic knowledge, and emotional discipline required to be a successful 401(k) investor. How can investors know whether they have the skills, knowledge, and discipline to do this? And what can they do to acquire them? And should they even try?

“My own belief is that our current retirement system, which places the entire onus and all of the risks on the retiree, is dysfunctional. When your child develops double vision and becomes toxic, you don’t walk into the ER and get handed a tuning fork and reflex hammer and told to figure it out itself. When you get onto an airplane to go to Chicago and you enter the cabin, someone doesn’t tap you on the shoulder and make you turn left to go into the cockpit and fly it.

The best advice that I could give any physician or any professional listening to this podcast is to treat finance the way you would any other serious discipline. Don’t read the Wall Street Journal, don’t read popular finance magazines. Go and look at the basic texts of finance. The books by Bogle and Mackay and people like that. Try and read the peer reviewed finance literature, because otherwise it’s like trying to practice medicine by reading Psychology Today. It’s just not going to work.”

How about the emotional discipline, in particular? How do we develop that ability to not follow the herd in order to be successful managing our own investments? Bill had two answers to these questions.

What was your behavior like in past financial crises? Did you log into your investing accounts every 5 minutes or were you not fazed, sleeping like a baby. You have to recognize which of those people you start out being. Are you the kind of person who doesn’t really pay that much attention to finance and who basically slept through all the market crashes in the last couple of decades? If you’re that kind of person then great, you’re in good shape. If you’re the kind of person who was logging into your account every five minutes, you have a big problem and need to fix it.

To fix it you need to decrease the amount of risky assets in your portfolio.

“Very slowly over the decades you acclimate yourself to what it takes to invest in risky assets, to be buying when everybody else is selling, to, as Warren Buffet famously said “Be greedy when others are fearful”. That is a skill you have to acquire. And if you can’t acquire it, then you’ve got to figure out a way of distancing yourself from your investing.”

Distancing yourself can be done by hiring a financial advisor or investing in a single vehicle that does it all for you with a very low-risk level, like a target date retirement fund.

New Financial Developments

While we have “The Man Who Knows Too Much” as a guest on the show we wanted to discuss some of the new financial developments.

Crypto Currency

What are his thoughts on Bitcoin, on incorporating Bitcoin into a portfolio? How should we view the various cryptocurrencies and what should we think about them?

“Well, an investment operation by definition is one that capitalizes a stream of income. And so, you might invest in a stock that is a growth company that doesn’t have a dividend yet, but you expect that company to have a dividend because, at the end of the day, that’s all you’re going to be left with in those cases. Most companies after a century or a century and a half go bankrupt, and all you’re left with is the reinvested dividends.

Well, I’m not aware of any cryptocurrencies that produce a dividend. Basically, you are relying on someone else taking it off your hands at a higher price. And that is not an investment operation. That’s a speculation operation. So, you should stay away from it. I can’t tell you with absolute certainty it’s going to be, that Bitcoins and cryptocurrencies are going to wind up as a terrible investment. But I can tell you that the history of financial innovation is in general not a happy one.”

Initially when it came out, people talked about it being a useful currency at some point down the line. Here we are at 12 years after the invention, and it’s still not a useful currency; you can’t go anywhere and buy anything with it. It’s far too volatile and apparently energy consuming to use as a currency. Is there a time in the future when the volatility of cryptocurrencies will be low enough that people can actually use it as a useful currency?

“If you have a state cryptocurrency, one that uses the block chain technology, sure. But it’s going to have to have a stable value. There are several characteristics of money. And I put that in air quotes for the people listening to the podcast. But the most fundamental one is it has to have a stable value. No one wants money whose value bounces up and down by factors of 5 or 10 in the space of 12 months.”

That volatility also affects its role as a store of value. A lot of people talk about it being digital gold. And gold is a pretty volatile asset class, but it has nothing on cryptocurrency. The volatility of cryptocurrency is a factor of 10. It’s an order of magnitude more than the volatility you see with precious metals.

How do you convince people not to invest in it when they see it going up by a thousand percent a year? Bill said you don’t argue with people about cryptocurrency for the same reason that you don’t argue with people about religion.

Tech Growth Stocks

Tech growth stocks like Tesla, which wasn’t even in the S&P 500 a few months ago, is now one of its largest companies. How should we be thinking about these large growth stocks, these shiny, well-known growth stock companies that we all use, that have just done spectacularly the last few years? What should investors think about that? Is it time to tilt the portfolio toward tech stocks? Or what should we be doing with regards to that outperformance?

“Well, the default stock investment for anybody is the total market, because, by definition, that’s what everybody in the aggregate owns. And so, that’s where you should start. Now, I happen to believe that value stocks have higher returns than the market within growth stocks over the very, very long-term. And the problem is I’ve been wrong for the past 10 or 15 years.

Now, there are reasons why I continue to believe that I’m still right, but those are probabilistic beliefs that I could easily in the long run be wrong about. But if you look at the very long sweep history of investing, fashionable growth stocks tend to have lower returns than the overall market, or than the  cheap value stocks, stocks that no one likes. And the reason is very simple, as people overestimate the growth prospects of growth stocks.”

He points out that people are valuing Tesla like it is going to be the only company that’s going to make electric cars. They will not be, 20 years from now, the only people who are manufacturing the world’s stock of electrical cars. They will get competition. That competition will drive down prices and will hurt their profits. People still may be paying too much for it. But if you don’t want to take that risk, just own the market on the total stock market.

People are talking about investing a slice of their portfolio in technology companies. Whether it was 5% or 10%. Back in the 90s people were recommending 5% in tech and 5% in telecom. Is there a role for a sector tilt like that in the portfolio? Bill said only to the extent that it doesn’t correlate with the rest of your portfolio and, unfortunately, tech stocks correlate very highly with the rest of the portfolio.

Bonds

A lot of people are wondering now with bond yields being near historic lows, should they drop bonds? Is it even worth investing in bonds? What are his recommendations to people who have held bonds in their portfolio for the last 10-20 years? Should they make a change now just because interest rates are low?

“By far, the biggest diversifying asset in your portfolio is going to be the bonds that you hold, the cash and the bonds that you hold; they will be what enable you to sleep at night. People will look at bonds and cash right now and say, “they’ve got a near zero yield”, which is true, but I would come back and I would observe with only a slight amount of sarcasm that they may turn out to be the highest yielding asset in your portfolio, because they will be what enables you to sleep and to hold on to the rest of your portfolio when things really go south.”

So, no, Bill wouldn’t make any change. For these reasons:

“The big reason is that if you make an intelligent guess or a rational guess about the expected returns of stocks and bonds, you look at the returns of bonds. They are going to be transported in their maturity and credit rating is about 1%, but your expected return on your stocks, probably, at these levels of valuation, is going to be about 4% or 5%. So, you’ve got an equity risk premium of 3% or 4%. In other words, you get 3% or 4% extra.

Now the world we were in 20 years ago was, you had an expected bond return of 4%, because that was the yield, but you had an expected stock return of 8%. Same equity risk premium. You were getting 4%. It’s the same thing. You were getting 4% more. So, that tells you that your mix of stocks and bonds shouldn’t be that much different.

Now, the second thing I tell people to help them get their arms around this is to consider the counterfactual. Imagine what the world would look like if treasury bills were yielding 4% and short treasuries, or very high quality short corporates, were yielding 5%, or say 6%. What do you think would happen to the price of your stocks and the value of your overall portfolio? What you would have is a portfolio with a much higher yield than it has today, much, much higher yield, but it would be a much, much smaller portfolio.

So, you should be philosophical and say, ‘Yeah, I’ve got a portfolio that has an absolutely crappy yield, and my bonds have absolutely crappy yields, but I’ve got far more assets than I deserve to have because of low interest rates’. So, you’ve got a big portfolio. In other words, you have a choice between a big portfolio and a crappy yield or a small portfolio with a good yield.”

Excellent perspective.

ARK Funds

We mentioned Cathie Wood earlier. ARK funds are the hot funds right now. Lots of investors, including physician investors, are looking at those and looking at the spectacular returns and wanting to add them to their portfolios. You look at what is inside the portfolios, and a large chunk of most of those funds is actually in Tesla. What does Bill think about ARK funds in general? Like all of us, Bill doesn’t have a working crystal ball. But he can tell us what has happened to funds that looked like ARK funds, namely tech funds that were run by hot, very popular fund managers in the past. They lost 95% of their value.

SPACs

Special Purpose Acquisition Companies, SPACs have recently had some pretty outstanding returns. What does he think about investors buying SPACs?

“Well, one of the parlor games that economic financial historians like to play is supposedly there was a bubble company back in 1720 called the company for the undertaking of a great advantage, but no one knows what it is. And financial historians have argued about whether that company actually did or did not exist. Most people believe that it was just a figment. It was an apocryphal story. And that’s what SPACs remind me of. Give us this great big pool of money, we’re not going to tell you how we’re going to invest it yet, but don’t worry, it’s a great advantage, but we can’t tell you what it is just yet.

I’m sure some of them are going to do well. There are some lottery tickets that are going to do very well, too, but they’re not a good investment strategy overall.”

SPACs are being endorsed by athletes and entertainers. That is generally not a good investment company to be in.

Non-Fungible Tokens

What are Bill’s thoughts on Non-Fungible Tokens as an investment?

“So, I think it’s a very interesting and perhaps very beneficial technological innovation, but it’s probably going to be quicksand for the people who invest in the actual products, just like cryptocurrencies.”

 

Ending

Bill emphasized that we need to treat investing as a serious subject with fundamental textbooks and with peer-reviewed literature. He is one of the smartest people on investing out there. What we really like about him, though, is his focus on financial history. It is really important to understand what has happened in the past and to carry those lessons into your current investing. It helps you to have a long-term perspective.

Really, when you’re investing, it’s all about the long-term. Investing is a single-player game. It’s not you against the market. It’s not you against your colleagues. It’s not you against the crowd. It’s you against your goals. When you’re looking at your goals, most of your goals are long-term. So, you need a long-term perspective to reach those.

 

Full Transcription

Intro:
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011. Here’s your host, Dr. Jim Dahle.
Dr. Jim Dahle:
This is White Coat Investor podcast number 207 -The delusions of crowds with Bill Bernstein.
Dr. Jim Dahle:

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Dr. Jim Dahle:
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Dr. Jim Dahle:
We decided to use a quote of the day from William Bernstein in today’s podcast. He said, “Most brokers service customers, the same way in which Bonnie and Clyde serviced banks”. And unfortunately, there’s a lot of truth to that.
Dr. Jim Dahle:
Thanks for what you do out there. I know a lot of you on your way into work, on your way home from work, maybe working out, trying to keep your sanity, whatever you’re doing as you listen to this podcast, thanks for what you do. I hope I’m not the first person to thank you for your difficult job. That’s one problem with high-income professionals, right? The reason you have that high income is because you have a hard job.

Dr. Jim Dahle:
If you haven’t heard yet, we have a new service available – Advice for Student Loans. If you’re not sure what to do with your student loans, and just want to sit down with somebody for an hour and talk about your situation to make sure you’re managing them right, we have a service for that. It’s called studentloanadvice.com.
Dr. Jim Dahle:
Check it out today. For just a few hundred dollars, you can make sure you’re not throwing away tens of thousands or even hundreds of thousands of dollars by managing your huge student loans wrong.
Dr. Jim Dahle:
We also have a financial educator award we’re giving away. This is not for finance bloggers. This is not for YouTubers. This is not for those selling online courses and that sort of stuff, it’s not for financial advisors. It’s for docs who are helping their trainees, especially and their peers to become financially literate. Usually out of the goodness of their hearts. Maybe they’re giving lectures. Maybe they’re developing a curriculum. Maybe they’re talking to people on the side during their shifts.
Dr. Jim Dahle:
But if there’s somebody you would like to nominate for the White Coat Investor financial educator award, please do so. You can send an email, a paragraph is plenty, [email protected] and we will at least highlight their efforts if not give them a certificate and a cash award, a thousand dollars cash award if they are selected as this year’s winner.
Dr. Jim Dahle:
Past year winners have been some pretty awesome people doing some pretty awesome stuff, and we expect a similar winner this year, but get those in by April 30th.
Dr. Jim Dahle:
All right, we have a special guest today. We are really excited to have Bill Bernstein back on the podcast. Let’s get them on the phone.
Dr. Jim Dahle:
Dr. William J. Bernstein is a trained neurologist. The co-founder of Efficient Frontier Advisors, an investment management firm, and has written a number of titles on finance and economic history. He’s contributed to the peer reviewed finance literature and has written for several national publications, including Money Magazine and The Wall Street Journal.

Dr. Jim Dahle:
He has been praised by Money in an article titled “The Man Who Knows Too Much”. I count 12 books that he’s written. Hopefully that’s still accurate. The three that I call the comprehensive investing books, The Intelligent Asset Allocator, my introduction to his writing, Four Pillars of Investing and The Investor’s Manifesto. The investing books for adults, The Ages of The Investors, Skating Where the Puck Was, Deep Risk, Rational Expectations, the wonderful PDF that he has essentially provided free to all millennials, if you can.
Dr. Jim Dahle:
And four history books now. A Splendid Exchange, The Birth of Plenty, Masters of The Word and the newest one, The Delusions of Crowds, that we’ll be talking about today. This is an extensively researched volume, clearly inspired by Charles Mackay’s Extraordinary Popular Delusions, and The Madness of Crowds published in 1841.
Dr. Jim Dahle:
But the bibliography and notes section, this book runs 70 pages of small type. I read every word of the text, maybe not all of the notes. And I actually found myself up late several times reading the book. Bill, welcome to the podcast.
Dr. William Bernstein:
I’m glad to be here.
Dr. Jim Dahle:
All right. It’s pretty clear from your epilogue in the book that you view The Delusions of Crowds is the sequel that Mackay would have written if he had lived another couple of hundred years. Examples from this book have inspired parts of many of your other books as well. Why did you find Mackay’s book fascinated enough to write a sequel for it?
Dr. William Bernstein:
Well, that question has a two-part answer. The first part is that I read Mackay’s book almost 30 years ago, back in the early 90s. And I thought it was interesting. His description of financial mania has just really got my attention, but I didn’t think it was terribly relevant to the well-behaved capital markets of the time.
Dr. William Bernstein:
And then several short years later, the wild descriptions of Mackay’s financial markets going bonkers came alive before my very eyes and it saved my bacon and I’m not alone in that. This book has been saving people’s bacon for about the past hundred years, most famously Bernard Baruch’s, who was so impressed with it to be wrote the forward to 1931 edition of the book. So that’s the first part of the answer.

Dr. William Bernstein:
The second part of the answer is like a lot of people I was just astonished by the ability of the Islamic state several years ago to attract recruits from around the world to fight and die in one of the worst places on the Earth. And the way they were able to do it was by deploying a narrative, an end times narrative that was very compelling. And it’s very similar in fact, to the Christian and Jewish end times narratives, which is no surprise. It’s all three Abrahamic religions have pretty much the same cultural roots.
Dr. William Bernstein:
So, I realized at that point that I had to rewrite Mackay’s book because Mackay not only spent a lot of his book on financial manias, but he also spent a lot of his book on religious manias as well. And I realized that writing a sequel to Mackay’s book was a good conceit for a book proposal.
Dr. Jim Dahle:
Now, a lot of readers might be surprised and it appears reading the reviews on Amazon that at least a few of them were surprised that the book is probably more about religion than it is about finance. But that’s not different from Mackay’s book, the off cited first three chapters in that book were about financial bubbles, but the rest of that book wasn’t. It covered all kinds of topics. The crusades, witches, haunted houses, alchemy, and magnetizes as cures of disease. What point were you making by using so many religious examples in your book?

Dr. William Bernstein:
I wrote so much about religion because we’ve become a much more polarized society in the United States over the past couple of decades. And I wanted to flesh that out for readers who might be somewhat mystified as to why that’s occurred.
Dr. William Bernstein:
You cannot understand the current polarization of American politics and our cultural polarization without understanding something called pre-millennial dispensationalism, which is a forbidden theological term for the end times belief system. But it’s behind most of Protestant evangelicals, and it’s an end times narrative. And when you say that narrative or count that narrative for secular Americans, their jaws dropped to the floor, they can’t believe it. On the other hand, to an evangelical Christian, that’s just like the godfather or gone with the wind, it’s a very familiar narrative.
Dr. William Bernstein:
So, the major goal when I wrote the book was to explain that narrative to secular Americans like myself. That was the first reason why I did it. Now the other reason is I think that this narrative has some very real risks to it. Several times over the past a couple of decades, we’ve nearly incinerated the planet by accident with nuclear weapons. So, obviously it may not be a good idea to have someone who believes in a narrative that has the world undergoing an inevitable tribulation in not-too-distant future, but they’re going to be raptured up to heaven, before all the bad stuff goes down.
Dr. William Bernstein:
So, it might not be a person like that anywhere near a nuclear weapon or making nuclear weapons policy for that matter. I’m not alone in worrying about this. A lot of prominent theologians have raised the issue. And also, the issue has been raised by Daniel Ellsberg, who as many may know, really got his start in national security as a nuclear theorist.
Dr. William Bernstein:
He was actually much more worried about this than he was in his involvement in Vietnam. And he went and released the Pentagon papers because he lost all of his documentation concerning the nuclear problem.
Dr. William Bernstein:
The second reason why I wanted to write about dispensationalism and explain it to a secular audience is that you don’t understand U.S. involvement in the middle East, without understanding a phenomenon called Christian Zionism, which is the end times narrative as deployed in the middle East.
Dr. William Bernstein:
And then finally, I wanted to write about it because there’s this fascinating convergence of all three end times narratives, the Christian one, the Jewish one and the Islamic one on the Temple Mount. And at least a couple of times during the past several decades, especially since the 1967 conquest of Jerusalem by the Israelis. That has almost led to a regional war. And in one or two occasions could have spiraled into a global war. So, I wanted to deploy this narrative and explain it to a secular audience so they’d have a better understanding of it.

Dr. Jim Dahle:
Now, the first couple of chapters, first few subjects touched on it are Christian sect, small and large, who basically predicted a specific date for Christ’s second coming and then were repeatedly disappointed when it did not occur.
Dr. Jim Dahle:
Why do you think so many of them overlooked what I see as a rather prominent scripture from the book of Matthew that says, presumably in the words of Christ himself as pinned by Matthew, “But of that day and hour knoweth no man, no, not the angels of heaven, but my Father only”? How did so many of those sects overlook this direction that you can’t divine from the Bible or anywhere else when that second coming is supposed to come?

Dr. William Bernstein:
Well, in the first place, most Christian sects, mainstream Protestant sects, certainly, Catholicism as well as the Eastern sects of Christianity do recognize that passage very well from Matthew. Starting with St. Augustine of Hippo, who more than a millennium and a half ago, very prominently gave the injunction to not try to calculate the end times, but it’s an irresistible thing to do.
Dr. William Bernstein:
And the reason is, it’s a basic psychological drive we have, which is called by neuropsychologists, “Bad is stronger than good”. We are very attracted to bad news, and we are also attracted to compelling narratives. What more compelling narrative than the story of how the world ends and trying to divine from that narrative, when that exactly is going to occur. It’s simply an irresistible subject for many Christian dispensationalists that can’t be ignored.

Dr. Jim Dahle:
Now, the book’s not particularly complimentary toward Seventh Day Adventists, Southern Baptist and other evangelicals, devout Muslims, and Orthodox Jews. What message do you hope people of those religious persuasions get from the book?
Dr. William Bernstein:
I don’t expect to change the minds of a single one of them. They’re not my audience. I very much doubt that even one of them is going to write me an email thanking me for removing the scales from, in front of their eyes.
Dr. William Bernstein:
Well, the real reason why I wrote the book was simply to give everybody else and understanding of their worldview.

Dr. Jim Dahle:
All right, at times in the book, and you mentioned this earlier, you appear, as I read between the lines, you appear pretty alarmed at the prospect of an end times a believer of any of several religious beliefs, starting a nuclear apocalypse, believing that it must occur. What would you guess is the probability of that occurring at some point in the next hundred years and what can be done to lower that risk?

Dr. William Bernstein:
Well, let’s start with the probability of accidental nuclear war. Like almost everybody else in the world, I’m concerned about global warming and climate change. But if I had the opportunity to remove, to take off the table, either that, or the prospect of an accidental nuclear war for my grandchildren, I would have no doubt about which one of them I would pick. Because several times in the past 50 years, we’ve very nearly incinerated the planet. It came within literally seconds of doing it.
Dr. William Bernstein:
And so, the prospect of an accidental nuclear war sometime in the next couple of decades or fifty or hundred years is high. It’s certainly much greater than a few percent, and it may be as high as 30% or 40%. So, I’m very concerned about that risk. And I think that if you look at that, let’s call it a 25% risk. I think that a fair chunk of it, maybe 5% or 10% of that would come from a psychotic commander who in the throes of a schizophrenia psychosis has a religious hallucination that makes him or her deploy a nuclear weapon.

Dr. William Bernstein:
I might add that Daniel Ellsberg wrote a very well-regarded book called The Doomsday Machine. And in that book, he describes seeing Dr. Strange Love, which is about just that scenario. And he and his boss, the man by the name of Harry Rowan, went out, blinking into the fun light after coming out of the theater. And they both realized what they’d seen was not entertainment. It was a documentary.
Dr. Jim Dahle:
And you write in the epilogue that it’s hard to avoid the dark conclusion that have enough of our peers deemed genocide desirable. And this is after discussing some of what went on in Nazi death camps, et cetera. Many, if not most of us are capable of it. Why are we as humans such herd animals? Why does it matter to us so much what other people around us think of us? Why do we want to be like other people so much?
Dr. William Bernstein:
If there’s one message in the book, it is first and foremost, we are the ape that imitates. So, the question is, why do we imitate? And the best way to understand that is to think about the migration of human beings across the Bering Strait, about 10,000 or 15,000 years ago. And within the space of 3,000 to 5,000 years, human beings settled, everything, almost all of the land between the High Arctic Wastes down through the Great Plains and Central America and into the Andes and down to Tiara, Gulf Waco.
Dr. William Bernstein:
And along the way, they had to adapt to many different environments. They had to learn how to hunt seals and whales and build kayaks in the High Arctic. They had to learn how to hunt bison. On the Great Plains they had to make poison blowguns while they were in the Amazon.
Dr. William Bernstein:
And if you’ve never seen one of those things done before, it’s almost impossible. You’re never going to figure it out by yourself unless you’re extremely lucky. So, the most evolutionarily adaptive behavior we have is our ability to watch other people and to imitate. And that works very well in a stone age environment.
Dr. William Bernstein:
Unfortunately, in a modern post-industrial environment, it can be very, very dysfunctional. It can lead to mania. We are effectively living with stone age minds in a space age world. And that’s our problem.

Dr. Jim Dahle:
I wanted to make sure we discussed some religious topics here while we’re doing this because a good chunk of the book does talk about religion. But I just want to talk about one more question for you about religion before we turn to the financial lessons of the book, since this is a financial podcast. But I don’t want anybody picking up the book thinking that it’s a pure finance book and being surprised that there’s a heavy amount of religion in it.
Dr. Jim Dahle:
But most religious people view people of other religions as being diluted in at least some of their beliefs. If those other religions have many members, they could rightly be described as mass delusions. In your mind, what’s the difference between a mass delusion and a shared faith, if any?
Dr. William Bernstein:
Oh, there’s no difference at all. We are all functioning under the service of mass delusions, every single one of us. And fortunately, most of those mass delusions are beneficial. So, for example, we believe that little green pieces of paper are money. And that’s a con game that works only so long as the rest of us believe that it’s money, that everybody else believes that its money. If people stop believing in it, it stops working. The so-called Tinkerbell principle.
Dr. William Bernstein:
The same thing is true in the belief of rule of law, which can be terribly fragile when people stop believing it, as we saw on January 6th. Most religions are mass delusions that functioned at sort of a very useful, social, function, keeping people together, helping them support one another, giving meaning to their life.

Dr. William Bernstein:
So, what I wanted to write about in the book was not really about how helpful or beneficial mass delusion is, but I wanted to write about the ones that went bad, which is what the book is really about.
Dr. William Bernstein:
By the way, let me thank you for warning readers, warning your podcast listeners about the book, because I have gotten a lot of pushback by people who are familiar with my work and expected something that was going to be about economics and finance and were a little disappointed. Only about a little more than a third of the book is actually about finance.

Dr. Jim Dahle:
Well, let’s turn to some of those financial lessons, although perhaps the religious and financial lessons in the book are more related than might appear at first glance. I think you wrote in the book on their surfaces, the religious and financial events appear to represent different phenomenon, but they are powered by the same social and psychological mechanisms.
Dr. Jim Dahle:
One, the irresistible power of narratives. Two, the human proclivity to imagine patterns where there are none. Three, the hubris and overconfidence of their leaders and followers. And four, the human proclivity to imitate the behavior of those around us, as you explained so well earlier.
Dr. Jim Dahle:
Briefly, and I know the long answer is “Go read the book”, why does the combination of those four mechanisms cause mass delusions, both religious and financial?
Dr. William Bernstein:
The most important one is the last one you mentioned – Our proclivity to imitate. And of course, it’s also about the power of narratives. The analogy that I like to use is the analogy between mass delusions and pandemics. This audience is going to be very familiar with the fact that a pandemic has two basic pieces. One is the causative agent, the active agent, the pathogen, and then the other is the vector. So for example with the current pandemic, it’s a little RNA virus and the vector are, people’s respiratory droplets, coughing on each other.
Dr. William Bernstein:
With the black death, it was your yersinia pestis and rats and fleas for the vectors. And for mass delusions, whether they’re financial or religious, the agent is the narrative, the narrative is the pathogen. And then the vector is the medium through which it spreads.
Dr. William Bernstein:
So, for example, the primary medium for both the mass delusion of election fraud or for some of the financial shenanigans we’re seeing lately is social media. And the analogy I would use for both of those, for both the political and the financial mania that we’re seeing, there was social media spread as we’ve moved from a large ballroom where people are widely separated into a Volkswagen where people are coughing on each other. That’s what social media has become. And that’s what it’s done to the medium which the pathogen spreads.
Dr. Jim Dahle:
Now, early in the book, you used a quote from Charles Kindleberger. He said, “There’s nothing so disturbing to one’s well being and judgment as to see a friend get rich”. Why does FOMO – ‘Fear Of Missing Out’ affect us so much as humans?

Dr. William Bernstein:
We’ve already talked about the two basic parts of human nature, which is where the ape that imitates and the ape that tells stories like narratives. But there’s a third part of it, which is we are the ape that seeks status. And that has mainly to do with sexual selection. And I’m not going to bore the audience with going about how our desire for status goes through the mechanism of sexual selection, but we seek status.
Dr. William Bernstein:
And so, when we see someone getting rich that lowers our relative status, in that, we find very, very disturbing. So, we want to be rich like them, and regain our relative status. It’s pretty much that simple. And it’s the same thing with religious manias. There is nothing that gives someone status, so much as believing that they’re saved and everybody else isn’t.

Dr. Jim Dahle:
All right. So, let’s talk about bubbles for a minute. You listed four Ps required for a financial bubble – Promoters, the Public, Politicians and the Press, interestingly enough. And I found it particularly interesting in your account of the British railway bubbles, that the companies actually produce their own newspapers. Do you see any parallels in today’s diffused media environment with blogs, podcasts, and social media to that railway bubble era?

Dr. William Bernstein:
Well, if you look at the history of bubbles, and of religious manias as well, you see that they spread through the leading-edge media of the time. So, you can go all the way back to the first financial bubbles or the religious manias of the medieval period, and you see it, they follow hard on the heels of Gutenberg’s invention of the printing press. Without the printing press, there wouldn’t have been the first bubbles or probably there wouldn’t have been the religious manias. There certainly wouldn’t have been the Religious Wars. And there probably wouldn’t even have been reformation, without Gutenberg’s press.
Dr. William Bernstein:
And you see the same thing happening with each successive bubble. It spreads through the vector, which is the leading edge social media of the time. And of course, the leading electronic media of our time is social media. Something like 70% of Americans get their news from Facebook, if you can imagine such a thing. I mean, why any rational human being would get U.S. news from Facebook is beyond me, but that’s how it’s happening these days.
Dr. Jim Dahle:
Yeah, it’s pretty amazing actually. And you can create quite an echo chamber and Facebook as a company helps you to create it around you. It’s amazing to read and I think there was a recent film out that explained exactly how they do that, but it’s pretty amazing.

Dr. William Bernstein:
Yeah. If I had to describe our current political crisis and know what drives our political polarization, I would say just to use a lot of words, but to compact it down, it would be, we have a social algorithm driven epistemic crisis. People don’t know what the truth is because their attention is being driven by Facebook’s algorithm that drives them only to things that appeal to their confirmation bias.

Dr. Jim Dahle:
One of my favorite news sites is a site called allsides.com. And what they do is they put right-wing news and left-wing news and what they see as middle news and identify them and let you read the same story from two different perspectives. And it’s really pretty enlightening if people have never actually done that before. The good news is when they do studies of how polarized we are, we’re not nearly as polarized as we think we are. And that’s reassuring to me in some ways, but certainly, we are far more polarized than we used to be.

Dr. William Bernstein:
Yeah. And there is also some very good data that shows that when you do expose people who are hard to one side or another of a political view, and you just very casually present a contrary opinion to them, it does move the needle. And really, somehow or other, we have to figure out a way of getting Facebook and the other social media companies away from maximizing their income, which unfortunately leads to this algorithm driven polarization. Somehow, they have to get off that jag and it’s going to be hard to do because it goes straight to their bottom line.

Dr. Jim Dahle:
Yeah, for sure. But most of us have at least one friend or family member that we can see quite clearly in that echo chamber, whether it’s on the left or on the right. And it’s definitely a big concern.
Dr. Jim Dahle:
I want to talk about some of the experts during some of these bubbles. You wrote that you don’t know if Charles Mackay lost money in the railway mania, but he didn’t comment on it as you would expect having lived through it. And sir Isaac Newton, who we all think of as this physicist, he was not just a high browed scientist. He actually served as the master of the mint for decades, but he lost money in the South Seas bubble. If these financial masters can’t recognize a bubble that they’re living through, what hope do the rest of us have?
Dr. William Bernstein:
Not much. If the likes of Charles Mackay and Isaac Newton got swept along by a bubble, it’s going to be very hard for the individual to do it. The only way, the only defense you have is to read history. I like to say that the only black swans are the history that you haven’t read.

Dr. Jim Dahle:
I think there’s a lot of truth to that. Certainly, that has been helpful to me to know a little bit about financial history while looking at even today’s events. You’ve listed four characteristics of bubbles in the past. Financial speculation becomes a primary topic of everyday conversation. Competent and sane people abandoned secure well-paying professions for full-time speculation. Hatred and vitriol become directed at skeptics. And you start seeing extreme predictions.
Dr. Jim Dahle:
Now I’ve certainly experienced my share of vitriol from people who don’t share my opinion of whole life insurance, dividend investing, Bitcoin, or individual stock picking. But one of the more interesting things I’ve noticed over the years is that people tell me if you would just learn a little bit more about it, whatever it might be, you would be a super fan of it just like me. You just don’t understand it.
Dr. Jim Dahle:
So, from the book, basically in your words, that I’m a dimbulb and I just don’t get it. Is this simply people responding to the cognitive dissonance that occurs when someone they previously respected does not share their opinion on a particular topic?

Dr. William Bernstein:
Yeah, you’re referring to a doctrine, called “Doctrine of the Balanced State”, which is something that was invented or described by a psychologist by the name of Fritz Heider about 80 years ago, 75 or 80 years ago. And here’s what the balanced state means. Let’s take a nice topic that has some emotional balance, but not balanced, but not a little bit.
Dr. William Bernstein:
So, say it’s whether you’re an Android or an iPhone enthusiast. And let’s say that your very best friend loves iPhones and so do you. Well, you’re in a balanced state because it’s a modestly important subject. You like iPhones, you like your friend, you’re in a balanced state.
Dr. William Bernstein:
Now, if you have somebody who thinks that Android phones are much, much better than iPhones and you think that that person is a moron for other reasons, you’re in a balanced state too, because it allows you to dismiss his opinion.
Dr. William Bernstein:
Where you get into trouble is where you’re in an unbalanced state. It’s when your best friend thinks that you’re dead wrong about loving iPhones and he thinks that Androids are better and you have to resolve that. And most people have no trouble resolving that. Where we get into trouble is where the issue contains much more emotional valence, say, for example, Donald Trump. And we’re seeing all over the country people who are basically disowning their friends and family, because of political differences. I might add its liberals that are much more prone to doing this than conservatives.

Dr. Jim Dahle:
Yeah. It’s been an interesting phenomenon to watch for sure. And I think that balance theory does explain a lot of it. It’s psychologically uncomfortable and you have to resolve that by either deciding that you agree with their opinion on whatever the subject is or deciding that they’re just an idiot and not the fine person that you thought they were beforehand.

Dr. William Bernstein:
Yeah. And in fact, what you can demonstrate with FMRI is that I think it’s the amygdala, amygdala lights up with everything bad, but I think the amygdala does light up when you’re in an unbalanced state. And then when you resolve, that unbalanced state, there are some prefrontal areas that light up.

Dr. Jim Dahle:
Now, it’s been interesting to look back historically at these bubbles and see that these promoters of bubbles were frequently venerated until they weren’t. And then they became victims. Will future generations look at Elon Musk and Cathy Wood and the infamous Satoshi Nakamoto differently than society looks at them today? When we look at them, like we consider Andrew Carnegie a great philanthropist, or more like George Hudson from the book, or perhaps some sort of combinations such as John Law of the Mississippi bubble fame.
Dr. William Bernstein:
Yeah. Or Samuel Insull who wound up disgraced for reasons of fraud, but basically built a lot of the nation’s electrical power infrastructure. I don’t know about Musk. I think that it’s very likely he’ll be treated as a hero by future generations, but a lot of his behavior is very disturbing. Smoking a doobie on national TV, making homophobic remarks about one of the Thai cave rescuers, the Game Stonk post, whatever that meant.
Dr. William Bernstein:
And it’s the kind of behavior you do see in people who are the recipients of a lot of adulation and particularly even a lot of these industrial heroes. So, I don’t know which side he’s going to come down on.
Dr. William Bernstein:
Now, Cathy Wood fits in a different category. She fits in a rather well-defined small pigeonhole, which is the superstar active mutual fund manager. And their trajectory almost uniformly winds up being unhappy. They tend to flame out very rapidly, because they wind up attracting a lot of uninformed investors who overload them with funds that, basically crash in a bubble sort of explosion.
Dr. William Bernstein:
But when you look at Cathy Wood, she fits into a category of people that’s a very long list starting with people like Bill Miller Bar-B-Q, who’s Legg Mason Value Trust beat the S&P 500 for 15 years straight every single year. And then he lost it all in the three years following that as more and more people invested with them. And so, the trajectory of superstar fund managers is not a happy one in general.

Dr. Jim Dahle:
Bubbles are not all bad. They often leave society with tangible benefits, essentially funded by the early investors who graciously donated to the public good. In the book you called them capitalism’s unwitting philanthropists. This was the case with the railroad bubbles in England, in particular, which left thousands of miles of track. And the internet and telecom bubbles, which laid the foundation for the internet we’re using right now. Do you think that’s also the role of current cryptocurrency investors that they are funding the development of useful blockchain technology and a useful cryptocurrency?

Dr. William Bernstein:
I think so. I think that a lot of people who are investing in crypto currencies are going to be very sorry they did, but the blockchain technology itself is a revolutionary technology. Now, the question is who’s going to take it over if it comes into wide use. And I’m pretty sure the answer is not going to be private companies. If a major part of our financial system works through it, the government is going to have to very heavily regulate it, if not take it over. So, you’re certainly not going to get rich investing in it.

Dr. Jim Dahle:
We’ll talk a little bit more about that toward the end of the podcast. After a bubble burst, investors go looking for someone to blame. As Fred Schwed said, “The burnt customer certainly prefers to believe that he’s been robbed, rather than admit he has been a fool on the advice of fools”. Why is this so painful for us to admit that we were driven by fear or greed in our financial decisions?

Dr. William Bernstein:
Well, because we’re human beings. We like to think well of ourselves. One of our basic drives is the drive for self-affirmation. We all believe that we’re good moral people. One book that I recommend to everyone is Lawrence Rees’s history of Auschwitz. The title is “Auschwitz: A New History”. At least that’s what the American edition of it is, is titled.
Dr. William Bernstein:
And it’s simply the story of the camp personnel at Auschwitz and to a man and a woman, they believe that they were good people doing moral work, which was ridding the world of vermin, namely Jews. And Almost none of them believed that they were doing anything wrong. And that was because everybody else around them told them that they were doing good work. And as I’ve said, many times in this podcast already, we are the ape that imitates. We take our cues from the people around us.

Dr. Jim Dahle:
Now, you also wrote that few individuals possess the quantitative skills, historic knowledge and emotional discipline required to be a successful 401(k) investor. How can investors know whether they have the skills, knowledge, and discipline to do this? And what can they do to acquire them and should they even try?

Dr. William Bernstein:
That’s a difficult question to answer. My own belief is that our current retirement system, which places the entire onus and all of the risks on the retiree is dysfunctional. When your child develops double vision and becomes toxic, you don’t walk into the ER and get handed a tuning fork and reflux hammer and told to figure it out itself. When you get onto an airplane to go to Chicago and you enter the cabin, someone doesn’t tap you on the shoulder and makes you turn left to go into the cockpit and fly it. I’ve known my share of physicians and so do you, airline pilots who don’t do very well with investing, it’s not an easy subject.
Dr. William Bernstein:
And the best advice that I could give any physician listening to, or any healthcare professional listening to this podcast is to treat finance the way you would any other serious discipline. Don’t read the Wall Street Journal, don’t read popular finance magazines. Go and look at the basic texts of finance. The books by Bogle and Mackay and people like that. And try and read the peer reviewed finance literature, because otherwise it’s like trying to practice medicine by reading psychology today. It’s just not going to work.
Dr. Jim Dahle:
How about the emotional discipline in particular? How do we develop that ability to not follow the herd in order to be successful managing our own investments?

Dr. William Bernstein:
Well, there’s two answers to that. First of all, I’ve found that there is an enormous range of behaviors. I’ve known people who the crashes of 1999 to 2002 or the global financial crisis of 2007 to 2009, or for example, what just happened last March, didn’t faze them in the least. They didn’t log onto their investment accounts. They slept like babies, and I think that’s dispositional. And then there are other people who are up checking their portfolios every five minutes, which is very bad psychology.
Dr. William Bernstein:
So, you have to recognize which of those people you start out being. Are you the kind of person who doesn’t really pay that much attention to finance and who basically slept through all the market crashes in the last couple of decades? If you’re that kind of person then great, you’re in good shape. If you’re the kind of person who when the excrement hits the ventilating system, you’re logging on through your account every five minutes, you’ve got a big problem. You’ve got to learn how to fix it.
Dr. William Bernstein:
And the way that you learn how to fix it is you lower your risk level. You decrease your amount of risky assets in your portfolio. And you very slowly over the decades you acclimate yourself to what it takes to invest in risky assets to be buying when everybody else is selling, to be as Warren Buffet famously said “To be greedy when others are fearful”. If you can learn how to do that, then that’s a skill you have to acquire. And if you can’t acquire it, then you’ve got to figure out a way of distancing yourself from your investing.
Dr. William Bernstein:
So, you can do that by hiring an advisor, which has its own risks, because a lot of advisors really don’t know what they’re doing either, if not most of them. Or investing in a single vehicle that does it all for you with a very low risk level. For example, picking a relatively conservative fund, inside your 401(k), a target date retirement fund.
If you’ve got access to a good cheap one, like one from Fidelity or Schwab, or especially Vanguard, if you can do that, that’s another way of distancing yourself. So, it’s a problem. I think the real problem is not teaching people to invest. I think it’s the system that we’ve got of defined contribution investing, which as far as I’m concerned, makes no sense at all.
Dr. Jim Dahle:
I wanted to ask your thoughts for the remainder of the podcast on some of the new-fangled financial developments we’ve seen in the last few years. Let’s start with cryptocurrency. There’s lots of discussion about cryptocurrency out there, especially with the price of Bitcoin going up a thousand percent in 2020. What are your thoughts on Bitcoin, on incorporating Bitcoin into a portfolio? How we should view the various cryptocurrencies and what we ought to think about them?
Dr. William Bernstein:
Well, an investment operation by definition is one that capitalizes a stream of income. And so, you might invest in a stock that is a growth company that doesn’t have a dividend yet, but you expect that company to have a dividend because at the end of the day, that’s all you’re going to be left with in those cases. Most companies after a century or a century and a half go bankrupt, and all you’re left with is the reinvested dividends.
Dr. William Bernstein:
Well, I’m not aware of any cryptocurrencies that produce a dividend. Basically, you are relying on someone else taking it off your hands at a higher price. And that is not an investment operation. That’s a speculation operation. So, you should stay away from it. I can’t tell you what the absolute certainty it’s going to be. Bitcoins and cryptocurrencies are going to wind up as a terrible investment. But I can tell you that the history of financial innovation is in general not a happy one.

Dr. Jim Dahle:
Initially when it came out, people talked about being a useful currency at some point down the line. And here we are at 12 years or something after the invention, it’s still not a useful currency, you can’t go anywhere and buy anything with it. It’s far too volatile and apparently energy consuming to use as a currency. Do you see a time in the future when the volatility of cryptocurrencies will be low enough that people can actually use it as a useful currency?

Dr. William Bernstein:
Well, yes. I mean, if you have a state cryptocurrency and one that’s followed that uses the blockchain technology, sure. But it’s going to have to have a stable value. There’s several characteristics of money. And I put that in air quotes for the people listening to the podcast. But the most fundamental one is it has to have a stable value. No one wants money whose value bounces up and down by factors of 5 or 10 in the space of 12 months.
Dr. Jim Dahle:
Yeah, for sure. And that volatility also affects its role as a store of value. A lot of people talk about it being digital gold. And gold is a pretty volatile asset class, but it has nothing on cryptocurrency. The volatility of cryptocurrency is a factor of 10. It’s an order of magnitude more than the volatility you see with precious metals. Do you see any role there as a store of value?

Dr. William Bernstein:
No, no, no, not at all. And again, that gets back to its volatility. Owning gold is a walk in the park compared to cryptocurrency.

Dr. Jim Dahle:
Now, how do you convince people not to invest in it when they see it going up by a thousand percent a year?

Dr. William Bernstein:
Cryptocurrency, for that matter Tesla, one is the currency, the other is the car, their religions. You talk to Tesla owners about their car and this glean comes into their eye and they talk about how it’s going to change the continuum of time and space. And it’s the same thing with cryptocurrency. You don’t argue with people about cryptocurrency for the same reason that you don’t argue with people about religion.

Dr. Jim Dahle:
All right. So that’s a great segue into my next topic, which is techie growth stocks like Tesla. It wasn’t even in the S&P 500 a few months ago, now it’s one of its largest companies. How should we be thinking about these large growth stocks, these Amazons and Googles and Facebooks and Tesla and Netflix and these shiny companies, these shiny well-known growth stock companies that we all use, that have just done spectacularly the last few years? What should investors think about that? Is it time to tilt the portfolio toward tech stocks? Or what should we be doing with regards to that outperformance?

Dr. William Bernstein:
Well, the default stock investment for anybody is the total market, because by definition, that’s what everybody in the aggregate owns. And so, that’s where you should start. Now, I happen to believe that value stocks have higher returns than the market within growth stocks over the very, very long-term. And the problem is I’ve been wrong for the past 10 or 15 years.
Dr. William Bernstein:
Now, there are reasons why I continue to believe that I’m still right, but those are probabilistic beliefs that I could easily in the long run be wrong. But if you look at the very long sweep history of investing, fashionable growth stocks tend to have lower returns than the overall market, or and then over cheap value stocks, stocks that no one likes. And the reason is very simple as people overestimate the growth prospects of growth stocks.
Dr. William Bernstein:
So, people are valuing Tesla, for example, as if it’s going to be the only company that’s going to make electric cars. I assure you they will not be 20 years from now the only people who are manufacturing the world’s stock of electrical cars. They will get competition. That competition will drive down prices and will hurt their profits. And I think that the valuations that people are paying for Tesla, which may or may not be a great company, it’s turning out to look better than it did a couple of years ago, that’s for sure. But they still may be paying too much for it. So that’s my belief. But if you don’t want to take that risk, just own the market on the total stock market. And then by definition, you will own all of the Tesla’s and Apple’s of the future.

Dr. Jim Dahle:
Now I saw something recently that I hadn’t seen for over 20 years, which is people talking about a slice of their portfolio invested in technology companies. Whether it was 5% or 10%. And it reminded me of a book I read back in the 90s where people were recommending 5% in tech and 5% in telecom. Do you see any role for a sector tilt like that in the portfolio?

Dr. William Bernstein:
Only to the extent that it doesn’t correlate with the rest of your portfolio. And unfortunately, tech stocks, biotech stocks, telco stocks correlate very highly with the rest of the portfolio.
Dr. William Bernstein:
What doesn’t correlate with the rest of the portfolio? Well, foreign stocks over the very long-term don’t. Over the short term, day-to-day they certainly do. But you can have long periods of time when foreign stocks do better than U.S. stocks and vice versa.

Dr. William Bernstein:
Real estate investment trusts tend to have a somewhat lower correlation than other asset classes. The same with gold stocks. Now the trouble with gold stocks is they have a very low return, but they have a near zero return with the rest of the portfolio and with other stocks.
Dr. William Bernstein:
But by far, the biggest ballast, the biggest diversifying asset in your portfolio is going to be the bonds that you hold, the cash and the bonds that you hold, they will be what enable you to sleep at night. And people will look at bonds and cash right now and say, “they’ve got a near zero yield”, which is true, but I would come back and I would observe with only a slight amount of sarcasm that they may turn out to be the highest yielding asset in your portfolio, because they will be what enables you to sleep when things really go south and hold on to the rest of your portfolio.
Dr. William Bernstein:
If a hundred percent of your portfolio was in stocks and they lose 60% or 70% or 80% of their value, which could easily happen over a short period of time, you’re not going to sleep well and you’re very likely going to bail. But if only half of your money is in stocks you can take comfort from the half of your portfolio that hasn’t been cratered and stay the course.

Dr. Jim Dahle:
Now, that’s a good segue into bonds. A lot of people are wondering now with bond yields being near historic lows, should they drop bonds? Is it even worth investing in bonds? I don’t recall who it was, but there was a famous fund manager who recently said it was basically stupid to be investing in bonds right now. What are your recommendations to people who have held bonds in their portfolio for the last 10 or 15 or 20 years? Should they make it change now just because interest rates are low?

Dr. William Bernstein:
Well, I would be philosophical. No, I wouldn’t make any change. There are two or three reasons for that. The big reason is that if you make an intelligent guess or a rational guess about the expected returns of stocks and bonds, you look in the returns of bonds, they are going to be transported in your maturity and credit rating is about 1%, but your expected return on your stocks, probably at these levels of valuation is going to be about 4% or 5%. So, you’ve got an equity risk premium of 3% or 4%. In other words, you get 3% or 4% extra.
Dr. William Bernstein:
Now the world we were in 20 years ago was, you had an expected bond return of 4%, because that was the yield, but you had an expected a stock return of 8%. Same equity risk premium. You were getting 4%. It’s the same thing. You were getting 4% more. So, that tells you that your mix of stocks and bonds shouldn’t be that much different.
Dr. William Bernstein:
Now, the second thing I tell people to help them get their arms around this is to consider the counterfactual. Imagine what the world would look like if treasury bills were yielding 4% and short treasuries, or very high quality short corporates, rebuilding 5%, or say 6%. What do you think would happen to the price of your stocks and the value of your overall portfolio? What you would have is a portfolio with a much higher yield than it has today, much, much higher yield, but it would be a much, much smaller portfolio.
Dr. William Bernstein:
So, you should be philosophical and say, “Yeah, I’ve got a portfolio that has an absolutely crappy yield, and my bonds have absolutely crappy yields, but I’ve got far more assets than I deserve to have because of low interest rates”. So, you’ve got a big portfolio. In other words, you have a choice between a big portfolio and a crappy yield or a small portfolio with a good yield.

Dr. Jim Dahle:
Excellent perspective. All right, we mentioned Cathy Wood earlier. ARK funds are the hot funds right now. And lots of investors, including physician investors, are looking at those and looking at the spectacular returns and wanting to add them to their portfolios. You look what’s inside the portfolios and a large chunk of most of those funds is actually in Tesla. What do you think about ARK funds in general?

Dr. William Bernstein:
First of all, like anything else in the world, I can’t predict what’s going to happen to them, but I can tell you what has happened to funds that looked like ARK funds, namely tech funds that were run by hot, very popular fund managers in the past has been and it has been a very sorry story.
Dr. William Bernstein:
All you have to do is pick up an old newspaper from the year 2000 and look at who the hot fund managers were then. They were people like Ryan Jacob and Garrett Van Wagoner. I think from the top to bottom, the Jacob internet fund lost 95% of its value. Garrett Van Wagoner’s fund did almost the same thing. But in their day, they were heroes. They were icons. And I don’t see that Cathy Wood doesn’t look any different to me than Garrett Van Wagoner and Ryan Jacob look back 20 years ago.

Dr. Jim Dahle:
So maybe ARK funds are the Janus of our generation. Huh?

Dr. William Bernstein:
Janus would be a generous comparison. The Janus’s funds were much more conservative than the Van Wagoner and Jacob funds.

Dr. Jim Dahle:
Speaking of something that’s maybe back from the late 1990s, let’s talk about Special Purpose Acquisition Companies. SPACs have recently had some pretty outstanding returns. What do you think about investors buying SPACs?

Dr. William Bernstein:
Well, one of the parlor games that economic financial historians like to play is supposedly there was a bubble company back in 1720 called the company for the undertaking of a great advantage, but no one’s know what it is. And financial historians have argued about whether that company actually did or did not exist. Most people believe that it was just a figment. It was an apocryphal story. And that’s what SPACs remind me of. Give us this great big pool of money, we’re not going to tell you how we’re going to invest it yet, but don’t worry, it’s a great advantage, but we can’t tell you what it is just yet.
Dr. William Bernstein:
I’m sure some of them are going to do well, but there are some lottery tickets that are going to do very well too, that they’re not a good investment strategy overall.

Dr. William Bernstein:
The thing that really gets my attention about SPACs are the people who are, I wouldn’t say sponsoring them, but who are endorsing them, who tend to be athletes and entertainers and particularly rap musicians. That’s not a good investment company to be in.

Dr. Jim Dahle:
Yeah. So, it’s March 24th as we record this. And I read an article this morning that Donald Trump is starting a SPAC, that Alex Rodriguez is starting a SPAC, that Shaquille O’Neal is starting a SPAC. Although Shaquille O’Neal’s actually has not a bad investment record, he actually did a good job diversifying the income he got out of the NBA. I’m not sure I’d take him as a fund manager, but compared to most athletes, he did pretty well. And these are the celebrities you’re talking about promoting these, and maybe these promoters are one of the four Ps from a bubble.

Dr. William Bernstein:
Yeah. I didn’t pick up the news this morning. I wasn’t aware of the story about Donald Trump thinking that he was going to set up a SPAC, but boy, that can’t be anything but solid gold given his investment track record, right?

Dr. Jim Dahle:
Yeah, yeah, exactly. How many bankruptcies are we talking about here? All right. So, the latest thing that I’m seeing out there are NFTs – Non Fungible Tokens as an investment. What are your thoughts on those?

Dr. William Bernstein:
Well, that’s another fascinating investment technology story, very similar to cryptocurrency. It turns out that NFTs solve an age-old problem in the ARK market, which is that of provenance. And once you’ve got a blockchain, a piece of ARK, you would know exactly what its provenance is now. The problem is of course, is that they can be manufactured at will and that doesn’t generally do good things for evaluations.
Dr. William Bernstein:
So, I think it’s a very interesting and perhaps very beneficial technological innovation, but it’s probably going to be quicksand for the people who invested in the actual products, just like cryptocurrencies.

Dr. Jim Dahle:
We better wrap up here soon. But we had to do our White Coat Investor conference this year virtually. We’re planning to do it next year, live in person in Phoenix. What would it take to get you to Phoenix for the next one?

Dr. William Bernstein:
A corn dog and a plane ticket maybe.

Dr. Jim Dahle:
I think we can handle that. All right. Well, as we wrap up, you have the ear of probably 40,000 high-income professionals, mostly doctors that’ll listen to this podcast by the time all is set and done. What else should they know that we haven’t talked about today?

Dr. William Bernstein:
Well, it’s just to reinforce what I said, I don’t know about 15 minutes ago, treat investing as a serious subject with fundamental textbooks and with peer reviewed literature. You should no sooner invest your money based on what you read in the Wall Street Journal or Kiplinger or Money Magazine then you should practice medicine from what you learn in psychology today.
Dr. William Bernstein:
Treat this as a serious subject, and invest the time to treat it as a serious subject. Stop whatever you’re doing, don’t invest another penny based on whatever methodology we’re using for. Take a year off from investing and learn the fundamentals. And that’s why give away If You Can, because If You Can, the pamphlet that I give away and all you have to do is Google it with my last name. We’ll get you started on the academic roadmap learning about finance as an academic venture.

Dr. Jim Dahle:
Awesome. Well, this has been an interview with Dr. Bill Bernstein. His new book, “The Delusions of Crowds: Why People Go Mad in Groups” is available anywhere you buy books, Amazon, Barnes & Noble, et cetera. I encourage you to check it out if you’ve been interested at all in the subjects we’ve discussed today. And Bill, thank you so much for being on the podcast again.

Dr. William Bernstein:
It was my pleasure.
Dr. Jim Dahle:
I hope you enjoy that interview. I always have a lot of fun talking to Bill. I think he is one of the smartest people on investing out there. What I really like about him though, is his focus on financial history. And I think it really is important to understand what’s happened in the past and to carry those lessons into your current investing. It helps you to have a long-term perspective.
Dr. Jim Dahle:
And really when you’re investing, it’s all about the long-term. Investing is a single player game. It’s not you against the market. It’s not you against your colleagues. It’s not you against the crowd. It’s you against your goals. And when you’re looking at your goals, most of your goals are long-term. So, you need a long-term perspective to reach those.
Dr. Jim Dahle:
Also, I’m glad he’s willing to come to WCI con. For those who aren’t aware, that’s going to be February 9th through 12th in Phoenix, Northeast Phoenix, we got a sweet resort there. It’s going to be a really great conference, if you haven’t heard about that.
Dr. Jim Dahle:
You won’t be able to sign up until this fall. Make sure you’re getting the newsletter. Obviously, we’re going to announce it on the podcast and those sorts of things. So, watch for that.
Dr. Jim Dahle:
This episode is brought to you by the Laurel Road student loan cash back credit card. Laurel Road is committed to serving the financial needs of doctors. You take care of us, it’s time someone took care of you.

Dr. Jim Dahle:
With the new Laurel Road student loan cash back credit card, you can earn 2.0% in cash back rewards towards eligible student loans for each $1 spent on eligible purchases or 1.0% in cash back rewards as a statement credit.
Dr. Jim Dahle:
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Dr. Jim Dahle:
Okay. Just a reminder, if you want to nominate somebody for the financial educator award, you need to send that in by April 30th, that’s [email protected] We appreciate you doing that. Obviously, as you are hearing this, I’m in the Grand Canyon rafting, so I’m having a great time. But there are staff here that are going to be taking care of those and compiling those so that we can select a winner. And we’ll announce that about a month after that.

Dr. Jim Dahle:
Thanks for those of you who’ve been leaving us a five-star review and telling your friends about the podcast. Our most recent one, comes in titled “First-year medical student loves WCI”. I am currently a first-year medical student, and I cannot thank WCI enough for the financial education. I have learned so much in the podcast and forums. I find medical schools doesn’t prioritize financial literacy and that’s one of the main things that’s causing burnout in physicians. I appreciate the new books you provided us, I can’t wait to receive it and start reading it. Thank you so much for all your help Jim. WCI deserves more 5 stars!”
Dr. Jim Dahle:
All right, head up, shoulders back. You’ve got this and we can help. We’ll see you next time on the White Coat Investor podcast.

Disclaimer:
My dad, your host, Dr. Dahle, is a practicing emergency physician, blogger, author, and podcaster. He’s not a licensed accountant, attorney or financial advisor. So, this podcast is for your entertainment and information only and should not be considered official personalized financial advice.

The post The Delusions of Crowds with Bill Bernstein – Podcast #207 appeared first on The White Coat Investor – Investing & Personal Finance for Doctors.

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