WCI #207: The Delusions of Crowds with Bill Bernstein

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 is your host, Dr. Jim Dali. This is White Coat Investor Podcast 207 the delusions of Crowds with Bill Bernstein. This episode is brought to you by the Laurel Rhodes 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. 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 subject to credit approval. For terms and conditions, please visit www.l LaurelRoad.com WCI that's www.l LaurelRoad.com wci LaurelRoad is brand of KeyBank NA member, FDIC and equal housing lender NMLS number 399797. 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. 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. 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 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.

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All right. 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. Podcasters. It's not for financial advisors. It's. 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. 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. Awardsitecoatinvestor.com and we will at least highlight their efforts if you. If not, give them a certificate and a cash award, $1,000 cash award if they are selected as this year's winner. 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. All right, we have a special guest today. We're really excited to have Bill Bernstein back on the podcast. Let's get him on the phone. All right. 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 financ in 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. He's 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 Investor, Skating where the Puck Was, Deep Risk, Rational Expectations, the wonderful PDF that he has essentially provided free to all millennials if you can, and four history books now. Splendid 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. But the bibliography and notes section in this book runs 70 pages of small type. I read every word of the text, maybe not all of the notes, and actually found myself up late several times reading the book. Bill, welcome to the podcast.

Glad to be here.

All right, it's pretty clear from your epilogue in the book that you view the Delusions of Crowds as the sequel that McKay would have written if he had lived another couple hundred years. Examples from this book have inspired parts of many of your other books as well. Why did you find McKay's book fascinating enough to write a sequel for it.

Well, that's a two part. 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 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, you know, several short years later, the wild descriptions of Mackay's financial markets going bonkers came alive before my very eyes. And it, it saved my bacon. And I'm not alone in that. It's been this book has been saving people's bacon for about the past hundred years. Most famously Bernard Baruchs, who was so impressed with it that he wrote the Forward to the 1931 edition of the book. So that's the first part of the answer. 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 is very similar in fact to the Christian and Jewish end times narratives, which is no surprise since 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. And I realized that writing a sequel to MacKay's book was a good conceit for a book proposal.

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. I don't know whether it's McKay or MacKay's book. The oft 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 magnetizers as cures of disease. What point were you making by using so many religious examples in your book?

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. You cannot understand the current polarization of American politics and our cultural polarization without understanding something called premillennial dispensationalism, which is a forbidden theological term for the end times belief system that is behind most of Protestant evangelicism. It's an end times narrative. And when you tell that narrative, 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, you know, 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 the not too distant future. But they're going to be raptured up to heaven before all the bad stuff goes down. 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 it's been raised. The issue has been raised by Daniel Ellsberg, who, as many may know, really got his start in national security as a nuclear theorist. He was actually much more worried about this than he was in our involvement in Vietnam. And he went and released the Pentagon Papers because he lost all of his documentation concerning the nuclear problem. The second reason why I wanted to write about dispensationalism and explain it to a secular audience is that you don't understand US 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. 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 may have 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.

Now, the first Couple of chapters. First, few subjects touched on it 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 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 penned by Matthew, but if that day and hour knoweth no man, no, not the angels of heaven and 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?

Well, in the first place? Most Christian sects, mainstream Protestant sects, certainly Catholicism, as well as the Eastern sect 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. 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, 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, you know, divine from that narrative when that exactly is going to occur? It's simply an irresistible subject for that many Christian dispensationalists can't ignore.

Now, the book's not particularly complimentary toward Seventh Day Adventists, Southern Baptists and other evangelicals, devout Muslims and Orthodox Jews. What message do you hope people of those religious persuasions get from the book?

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. The real reason why I wrote the book was simply to give everybody else an understanding of their worldview.

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 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?

Well, let's start with the probability of accidental nuclear war. You know, I'm like everybody else in the world, I'm concerned about global or 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 very nearly incinerated the planet. I mean, came within literally seconds of doing it. And so the prospect of an accidental nuclear war sometime in the next couple of decades or 50 or 100 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 schizophrenic psychosis, has a religious hallucination that makes him or her deploy a nuclear weapon. I might add that Daniel Ellsberg wrote a very well regarded book called the doomsday machine. And in that book, he describes seeing Dr. Strangelove, which is about just that scenario. And he and his boss, a man by the name of Harry Rowan, went out blind, blinking into the sunlight after coming out of the theater. And they both realized what they had seen was not entertainment, it was a documentary.

And you write in the epilogue that it's hard to avoid the dark conclusion that if 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?

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 or 15,000 years ago. And within the space of about 3 to 5,000 years, human beings settled everything, you know, 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 during, you know, while they were living in the, while they were in the Amazon. And if you've never seen one of those things done before, it's almost impossible. You're not, 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 manias. We are effectively living with Stone Age minds in a space age world. That's our problem.

I wanted to make sure we discuss 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. But 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 your mind, what's the difference between a mass delusion and a shared faith? If any?

There's no difference at all. We are all functioning under the in 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. All right? 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. 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, you know, on January 6th, most religions are mass delusions that function. It's sort of a very useful social function, keeping people together, helping them support one another, giving them meaning to their life. So what I wanted to write about in the book was not really about helpful or beneficial master leaving illusions, but I wanted to write about the ones that went bad, which is what the book is really about. And by the way, let me thank you for 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.

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 phenomena, but they are powered by the same social and psychological mechanisms. 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 fourth, the human proclivity to imitate the behavior of those around us. As you explained so well earlier, 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?

Well, 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. So, you know, this audience is going to be very familiar with the fact that a pandemic has two basic pieces. One is the, is the causative agent, the active agent, the pathogen, and then the other is the vector. So, for example, you know, with the current pandemic, it's a little RNA virus and the vector are, you know, people's respiratory droplets and coughing on each other. You know, with the Black Death, it was Yersinia pestis and rats and female fleas. For the vectors and for mass delusions, whether they're financial or religious, the agent is the narrative. The narrative is the pathogen. 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 financial, Some of the financial shenanigans we're seeing lately is social media. Okay? And the analogy I would use for both of those, for both the political and the financial mania that we're seeing, there's social media spread is 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 through which the pathogen spreads.

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.

Well, 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, that likes narratives. But there's a third part of it which is we are the ape that seeks status, all right? 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. 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 then and regain our relative status. It's pretty much that simple. And it's the same thing with religious manias. There's nothing it gives that will give someone status so much as believing that they're saved and everybody else isn't.

All right, so let's talk about bubbles for a minute. You list 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 confused media environment with blogs, podcasts and social media to that railway bubble era?

Well, if you look at the history of bubbles, you see that the and of religious manias as well, you see that they spread through the leading edge media of the time. So, you know, you can go all the way back to the first financial bubbles or the religious manias of medieval period, and you see that they follow hard on the heels of Gutenberg, Gutenberg's invention of the printing press. Without the printing press, there wouldn't have been the first bubbles or there probably wouldn't have been the religious manias. There certainly wouldn't have been the religious wars, and there probably wouldn't even have been in a reformation without Gutenberg's press. And you see the same thing happening with each successive bubble. It spreads through the vector, which is the social media of leading edge social media of the time. And of course, the leading edge, the leading media, 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 as news from Facebook is beyond me. But that's how it's happening these days.

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. And you know, 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.

Yeah. I mean, you know, if I had to describe our current political crisis and, you know, what drives our political polarization, I would say that it's just to use, you know, a lot of four but words. But to compact it down, it would be, we have a social. An 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.

Yeah. 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.

Yeah. And people. And there's 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, I think 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 or other they have to be gotten off that jag and it's going to be hard to do because it goes straight to their bottom line.

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. All right, 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 highbrowed 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?

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

Yeah, 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, you know, even today's events. You've listed four characteristics of bubbles in the past. Financial speculation becomes a primary topic of everyday conversation. Competent, insane people abandon secure, well paying professions for full time speculation. Hatred and vitriol becomes directed at skeptics and you start seeing extreme predictions. 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. So from the book, basically in your words that I'm a dim bulb 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?

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. Here's what the balance state means. Let's take a nice topic that has some emotional balance, but not balance, but not a little bit. So say it's whether you're an Android or an iPhone enthusiast. 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 that you know 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. You have to resolve that. Okay. 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. Okay. And we're seeing all over the country people who are basically disowning their friends and family because of political differences. I might add, it's liberals that are much more prone to doing this than conservatives.

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.

Yeah. And in fact, what you can demonstrate with FMRI is that I think it's the amygdala. The 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 hydarian unbalanced state, that there are some prefrontal areas that light up.

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 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. You know, smoking a doobie on national tv, calling one of the Thai cave, making a homophobic remark about one of the Thai cave rescuers, you know, the Gamestonk post, whatever that meant. And it's the kind of behavior you do see in people who are the recipients of a lot of adulation and particularly a lot of these industrial heroes. So I don't know which side he's going to come down on. Now, Cathie 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. But when you look at Cathie Wood, she fits into a category of people that's a very long list. Starting with people like Bill Miller, whose 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 invest, invested with them. And so the trajectory of superstar fund managers is not a happy one in general.

Well, 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 were using right now. Do you think that's also the role of current cryptocurrency investors? That they're funding the development of useful blockchain technology in a useful cryptocurrency?

I think so. I think that a lot of the 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 regulated if not take it over. So you're certainly not going to get rich investing in it.

We'll talk a little bit more about that toward the end of the podcast. After a bubble bursts, 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 that he has been a fool on the advice of fools. Why is it so painful for us to admit that we are driven by fear or greed in our financial decisions?

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 Auschwitz. The title is A New History. At least that's what the American edition of it is titled. And it's simply the story of the camp personnel at Auschwitz and to a man and a woman. They believed that they were good people doing moral work which was ridding the world of vermin, namely Jews. None of them believed that they were doing anything. 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.

Now, you also wrote that few individuals possess the quantitative skills, historic knowledge and emotional discipline required to be a successful 401 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?

That's a difficult question to answer. My own belief is that our current retirement system, which places all the onus and all of the risk on the retiree, is dysfunctional. When your child develops double vision and becomes ataxic, you don't walk into the ER and get handed a tuning fork and a reflex hammer and told to figure it out itself. When you get onto an airplane to go to Chicago and you enter the cabin, you know they don't. Someone doesn't tap you on the shoulder and makes you turn left to go into the cockpit to fly it. And you know, I mean, I've known my share of physicians and so have you, and airline pilots who don't do very well with investing. It's not an easy subject. And the best advice that I could give any physician listening to, or any healthcare professional listening to this podcast is to, for God's sakes, treat finance the way you would any other serious discipline. Don't read the Wall Street Journal, don't read Kiplinger's, don't read popular finance magazines. Go and look at the basic texts of finance, the books by Bogle and Malkiel 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.

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?

Well, there's two answers to that. First of all, I found that there is an enormous range of behaviors. I've known people who the crashes of 1999-2002 or the global financial crisis of 07 to 09, or for example, what just happened last March didn't phase 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 a very bad psychology. 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 or. And who basically slept through all the market crashes of the last couple 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 onto your account every five minutes, you've got a big problem. You've got to learn how to fix it. 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, acclimatize yourself to what it takes to investing in risky assets. To be buying when everybody else is selling. To be, as Warren Buffett 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. If you can't acquire it, then you've got to figure out a way of distancing yourself from your investing. 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, 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.

I wanted to ask your thoughts for the remainder of the podcast on some of the newfangled 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 1000% 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.

Well, an investment operation is one that by definition, is one that capitalizes a stream of income. Okay. 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 most 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. So basically, you are relying on someone else taking it off your hands at a higher rate 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 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.

Now, 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?

Well, yes. I mean, if you have a state Eurocurrency, if you have a state cryptocurrency, and one that is, one that's followed uses the blockchain technology. Sure. But it's going to have to have 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.

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's a pretty volatile asset class, but it has nothing on cryptocurrency. I mean, 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?

No, no, none at all. Again, that gets back to its volatility. Yeah, I mean, owning gold is, is a walk in the park compared to cryptocurrency.

Now how do you convince people not to invest in it when they see it going up by 1000% a year?

Well, it's almost a religious cryptocurrency. Or for that matter, Tesla. One isn't a currency, the other isn't a car. They're religions. You talk to Tesla owners about their car and this, this gleam 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.

All right, so that's a great segue into my next topic, which is techie growth stocks like Tesla wasn't even in the s and P500 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 investor 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 investment stock investment for anybody is the total market. Because by definition that's what everybody in the aggregate owns. That's where you should start. Now I happen to believe that value stocks have higher returns than the market or than 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 and I could easily in the long run be wrong. But if you look at the very long sweep of history of investing, history of investing, fashionable growth stocks tend to have lower returns than the overall market and then over cheap value stocks, stocks that no one likes. And the reason is very simple, is people overestimate the growth prospects of growth stocks. 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. 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 years ago, that's for sure. But they still may be paying too much for it, that's my belief. But if you don't want to take that risk, just own the market, own the total stock market and then by definition you will own all of the Teslas and apples of the future.

Now, I saw something recently that I hadn't seen for over 20 years, which is people talking about a slice of their pockets 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?

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. 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 US stocks and vice versa. 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. 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, God, 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 are going to turn 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. If 100% of your portfolio is 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 going to get, 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.

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's 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 a change now just because interest rates are low?

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 are going to be depends on what your maturity and credit rating is, about 1%. But your expected return on your stocks, probably at these levels of valuation, is only going to be about 4 or 5%. So you've got an equity risk premium of 3% or 4%. In other words, you get an extra 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% in short treasuries or short corporates, very high quality short corporates 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. All right, let's talk. We mentioned Cathie Wood earlier. ARK funds are the hot funds right now and lots of investors, including physician investors are, 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?

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 look like ARK Fund, namely tech funds that were run by hotel at very popular fund managers in the past has been, and it has been a very sorry story. All you have to do is pick up a newspaper, 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 Wagener. I think the top to bottom, the Jacob Internet fund lost 95% of its value. Garrett Van Wagener's fund, the Van Wagener Fund, did almost the same thing. But in their day they were heroes, they were icons. And I don't see that Cathie Wood doesn't look any different to me than Garrett Van Wagoner and Ryan Jacob looked back 20 years ago.

So maybe ARK funds are the Janus of our generation, huh?

Janus would be a generous comparison. The Janus funds were much more conservative than the Van Wagener and Jacob funds.

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?

Well, one of the parlor games that economic financial historians like to play is supposedly there was a company, a bubble company back in 1720 called the Company for the undertaking of a venture, but no one to know of. Great advantage, but no one to know what it is. All right. 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 reminds me me of. Give us this pool of 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 to great advantage. But we can't tell you what it is just yet. 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. They're not a good investment strategy overall. The other thing, the thing that really gets my attention about SPACs are the people who are, I wouldn't say sponsoring them, but who are investing, endorsing them, who tend to be athletes and entertainers and particularly rap musicians. That's not good investment company to be in.

Yeah. So it's March 24th as we record this and I read an article this morning that Donald Trump is starting to spac, that Alex Rodriguez is starting to spac, that Shaquille o' Neal is starting to spac. Although Shaquille o' Neal 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. These are the celebrities you're talking about promoting these. And maybe these promoters are one of the four P's from a bubble.

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, you know, solid gold given his investment track record.

Right, 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?

Well, that's another fascinating investment technology story, very similar to cryptocurrency. It turns out that NFT solve an age old problem in the art market which is that of provenance. And once you've got a blockchain piece of art, you would know exactly what its provenance is. Now the problem of course, is that they can be manufactured at will and that doesn't generally do good things for valuations. 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 the actual products, just like cryptocurrencies.

All right, well, 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?

A corn dog and a plane ticket maybe? Maybe.

I think we can handle that.

Yeah.

All right, well, as we wrap up, you have the ear of probably 40,000 high income professionals, mostly doctors, that will listen to this podcast by the time all is said and done. What else should they know that we haven't talked about today?

Well, it's just to reinforce what I said, I don't know, about 15 minutes ago, which is for God's sakes, treat investing as a serious subject with fundamental textbooks and with a peer reviewed literature, you should no sooner invest your money based on what you read in the Wall Street Journal or Kiplinger's or Money Magazine than you should practice medicine from what you learn in Psychology Today or Kiplingers or the Wall Street Journal. I mean, treat it as a, for God's sakes, treat it as a serious subject and invest the time to treat 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 fundamental text. And that's why I 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 will get you started on the academic roadmap to learning about finance as an academic venture.

Awesome. Well, this has been an interview with Dr. Bill Bernstein. His new book, the Delusions of why People Go Mad in Groups is available anywhere you buy books, Amazon, Barnes and 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.

It was my pleasure.

I hope you enjoyed 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. 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. Also glad he's willing to come to WCICON. For those who aren't aware, that's going to be February 9th through 12th in Phoenix, Northeast Phoenix. We've got a sweet resort there. It's going to be a really great conference. If you haven't heard about that, 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 that this episode is brought to you by the Laurel Rhodes 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. 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 subject to credit approval. For terms and conditions, please visit www.l LaurelRoad.com WCI that's www.l LaurelRoad.com wci LaurelRoad is brand of KeyBank, NA member, FDIC and equal housing lender NMLS number 399797. 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 awardsitecoatinvestor.com 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. 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'm currently a first year medical student. I cannot thank WCI enough for the financial education. I've learned so much in the podcast and forums. I find medical students schools don't prioritize financial literacy. 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. Five stars. All right, keep your head up, shoulders back. You've got this and we can help. We'll see you next time on the White Coat Investor Podcast. My dad, your host, Dr. Dahl, is a practicing emergency physician, blogger, author and podcaster. He is 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.