In this special Investing 101 episode, the Rational Reminder hosts—Ben Felix, Dan Bortolotti, and Ben Wilson—team up to revisit the fundamental concepts that every investor should understand before diving deep into portfolio construction or market theory. Drawing from Ben’s original “Investing 101” presentation and years of client experience, the trio lay out why investing matters, how inflation shapes your future, what stocks and bonds really represent, and why a disciplined, evidence-based approach beats prediction and luck every time. They unpack core ideas like financial independence, risk versus volatility, global diversification, and market efficiency, then connect them to practical tools like ETFs and Vanguard’s asset allocation funds.
Key Points From This Episode:
(0:00:24) Why this episode revisits “Investing 101”—inspired by a listener still unsure how to begin.
(0:05:03) Why investing matters: inflation erodes purchasing power, investing fights back.
(0:06:33) The math of compounding: how a 7% return versus 2% changes your retirement entirely.
(0:10:57) Saving early and often: habit formation beats late-life catch-up.
(0:11:53) The trade-off between saving more and taking more investment risk.
(0:14:04) Utility theory and the psychology of saving when young.
(0:16:39) Marginal utility: when more money no longer adds happiness or purpose.
(0:20:47) Stocks and bonds explained: ownership versus lending and the role of each.
(0:23:11) The Japan story: a cautionary tale about chasing past winners.
(0:26:49) Narrative investing: why investors love stories and get burned by them.
(0:30:19) Market capitalization weighting—how global prices tell you what to own.
(0:33:42) The stock market is not the economy: why news headlines mislead investors.
(0:37:14) The power of diversification: why most individual stocks fail—and a few drive all returns.
(0:41:56) Bonds, volatility, and inflation risk—why “safe” assets aren’t risk-free.
(0:44:41) Building your mix: matching volatility tolerance with long-term goals.
(0:45:10) The behavioral challenge: risk is only useful if you can stay invested.
(0:48:08) Active management as gambling: adding unrewarded noise to your portfolio.
(0:51:43) The paradox of skill: why markets punish even brilliant active managers.
(0:55:51) Efficient markets and Eugene Fama: the evidence that prices already reflect all information.
(1:00:20) How small fees compound into big losses over decades.
(1:03:07) The behavioral hurdle of indexing: trusting a system with “no one at the wheel.”
(1:04:54) The real value of financial advice: behavior, discipline, and holistic planning.
(1:07:24) Implementing the plan: how asset allocation ETFs simplify everything.
(1:11:41) Rebalancing and emotion: why automation protects investors from themselves.
(1:14:24) Paying a bit more for simplicity: why 0.10% in fees can be worth it.
Read The Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from three Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer, Dan Bortolotti, Portfolio Manager, and Ben Wilson, Head of M&A and Portfolio Manager at PWL Capital.
Dan Bortolotti: All right, good to do another episode with all three of us.
Ben Wilson: Looking forward to it.
Ben Felix: Yeah, it's fun bringing on different PWL folks to episodes. It's always a different dynamic.
It's kind of neat. I had an interaction with someone recently who was all excited to come up and tell me that they've been listening to this podcast and that that's encouraged them to move away from their bank's high-fee mutual funds and start investing in ETFs. I'm listening to them like, oh, that's great.
That's great. As we continued talking, I realized that there were still a lot of blanks that needed to be filled in, which makes sense. If you listen to 20 Rational Reminder podcast episodes, you might not actually come away equipped to implement the general ideas that we talk about on the podcast.
You'll get all these bits and pieces and you might get sort of very, very broad strokes, but that interaction kind of got me thinking back to when I first started working at PWL with Cameron almost 12 years ago now. One of my first big take the training wheels off assignments after I'd been working with Cameron for a bit was giving this 45 minute investing 101 talk to employees at a local tech company, which is like, I was super nervous, whatever. I did a bunch of preparation, spent the whole weekend recording myself and testing out the presentation to try and make it good.
It's probably still terrible. I did get good feedback. It was good enough that I got invited to come back every month and it became a thing.
Be this kind of packed boardroom once a month of people who were all excited to learn how to invest. People would hear about how good the talk was and so everyone would be all excited. It was cool.
In a lot of ways, those talks were sort of a precursor to this podcast and to my YouTube channel. I thought it would be useful to do an episode that covers that basic investing 101 information. Now, that talk did cover other stuff too.
It covered Canadian account types and when to use each type of account and that kind of stuff, but this we'll just focus on the investing aspect here. The intention is for this to be like a jumping off point for someone like the person that I spoke with recently who's new to investing and learning about this stuff so they can listen to this and really have a good foundation. Then also, I think it's hopefully useful as a reaffirmation of important principles for even seasoned investors.
We will cover why investing matters, what stocks and bonds are, what a sensible approach to investing looks like and what tools you should consider using to implement these ideas.
Ben Wilson: I think this is a very worthwhile topic. I've had many clients that I've talked to say like, oh, your podcast is great. There's lots of good info, but 90% of it goes over my head.
This would be a very good episode for the average Canadian out there that doesn't care to nerd out on some of the topics like we do and a lot of people in the community do.
Dan Bortolotti: I think it's important too. A lot of the deep dives that we've been doing on the podcast are all really important after you've mastered the basics. Sometimes if you try to run before you learn how to walk, you get distracted from what's really important and you forget about some of the basic principles.
As you said, some people, this will be all brand new to them. Other people will have heard it before, but you can always use a refresher. I find even with clients from time to time, we have to have these conversations.
Let's remember why we're doing this in the first place. Everything leads off from there. Always good to have that refresher.
Ben Felix: I would be remiss, Dan, to not give a shout out to your book, which we talked about back in episode 308 when you were on as a guest before you were a host. Your book, Reboot Your Portfolio, Nine Steps to Successful Investing with ETFs is really a deeper dive than we're going to do in this episode, but a similarly great starting point of basic information for someone who's just starting out.
Dan Bortolotti: The first few chapters of the book are pretty much what we're going to cover here. Just the basic principles of investing. We don't dive into how to construct a portfolio or which specific accounts to use.
Just the general stuff that we all need to master before we move on to those advanced topics. It's pitched at a Canadian audience, but again, before we get into the real specifics in the book and in the podcast, these principles apply everywhere, not just in Canada.
Ben Wilson: Absolutely. Very important topic and worth going over the basics, I think. It's a good refresher for anybody that's listening.
Ben Felix: All right. We're ready to jump into it?
Ben Wilson: Yep.
Dan Bortolotti: Let's do it.
Ben Felix: Why do we invest? At the most basic level, investing is important because inflation is a real thing at a baseline level.
Inflation, of course, means that stuff gets more expensive, measured in dollars over time. Central banks and countries like Canada and the United States target low but stable inflation for reasons that go beyond the scope of this video. Even before central banks were targeting inflation, inflation was there.
It was probably higher historically than it was post-inflation targeting. It's a real persistent phenomenon that anyone living in this modern society that we have constructed and this modern economic system that we've constructed, it's something that we have to contend with, whether we like it or not. The important thing here is to understand that inflation should be expected, meaning that dollars held under your mattress should be expected to lose purchasing power over time.
That just means the same number of dollars will buy less stuff in the future than they buy today. It's also worth mentioning that it's not like a grand conspiracy. I think the solution is actually pretty simple.
Ben Wilson: Reminds me of the presentation that you're talking about. I think one of the slides you had was a liter of milk or a gallon of milk was worth X dollars in 1920. Now, for the same amount, you can get six teaspoons of milk or something like that.
It just visualizes you get less for the same amount of money or your dollar buys less than it will today in the future.
Ben Felix: The important thing there is that if you leave dollars sitting under your mattress, I think that's one of the funny things. There are a lot of conspiracy theories about inflation and a lot of charts out there showing how much a dollar has depreciated over time and as if it's this horrible thing. There are things that you can invest in that are pretty safe and straightforward that would have kept pace with inflation historically.
The idea that the purchasing power of a dollar has decreased, that is true, but combating that inflation at a baseline has not actually been very hard to do. It's pretty straightforward rather than putting dollars under your mattress, which of course, nobody would actually do, but even sitting in a bank account, not earning any interest, that's the general idea. Rather than doing that, investing your dollars into assets with positive expected returns, which we'll talk more about what that means in a minute, can at minimum offset the effects of inflation and then some, which we'll talk more about in a minute.
Low risk investments, risk is a funny term. We'll talk more about that as we go here, but stable investments like GICs, Guaranteed Investment Certificates in Canada, certificates of deposit in the US and treasury bills and high interest savings accounts would be another one. Those are generally sufficient to keep pace with inflation.
You're going to earn an interest rate on those investments. When inflation is higher, those interest rates tend to be higher such that if you left your dollars in those things, you would roughly keep pace with inflation over time. That's like bare minimum.
We don't want to have our dollars in nothing. They should be in something that is going to keep pace with inflation. Now, where it gets interesting is that beyond just keeping pace with inflation, investing in riskier assets with higher expected returns can help you on your way to becoming financially independent.
Financial independence means that it's this concept that over your working life as you're earning income, you save a portion of your earnings, of your employment income. By doing that, you're converting what's called your human capital, your ability to earn income by working into financial capital, which is the ownership of financial assets that can eventually replace your need to earn income by working. Eventually, you get to a place where your human capital is no longer worth as much because you've decided not to work anymore, but you have this pool of financial assets that you can use to fund your lifestyle.
I did do a couple of examples that were kind of fun to play with the numbers actually. Imagine a 30-year-old today saving 10% of their income and they expect to earn a 7% rate on their investments. In that case, with these simple numbers, you could retire at 65 and replace about 60% of your pre-tax income from your savings until age 95.
You're 30, save 10% of your income, earn a 7% return, retire at 65, you can replace 60% of your income until age 95. Now, that is not including pension benefits, government pension benefits. Like in Canada, we have Canada pension plan and old age security.
In the US, they have social security. Those numbers that I just said were not including those government pension benefits. If instead of earning 7% in the example, you earned 2%, which I didn't mention is the rate of inflation in this simple model.
Your salary is going up with inflation and then your expenses are also going up with inflation at that 2% rate. If you only earned inflation on your investments, instead of 10% of your income, you would need to save 50% of your income to get the same ultimate outcome, to be able to retire at age 65 with 60% of your income until age 95. Now, if you imagine your life today, the difference between saving 10% of your income and 50% of your income obviously has huge implications for your lifestyle.
I think one way to think about this is that by taking on some risk to earn higher expected returns with your investments, you are letting the financial markets do a huge amount of the heavy lifting toward funding your eventual retirement.
Dan Bortolotti: Pretty remarkable illustration, isn't it?
Ben Felix: It is.
Dan Bortolotti: The difference between investing and just treading water is you would have to quintuple your savings in order to do the lifting of a 5% additional rate of return.
Ben Wilson: It's crazy. I think another parallel example, the return obviously lifts, but also if you start saving earlier, that makes a huge difference. My dad was a financial advisor and growing up, he always, when I was a kid, said, you've got to save 50% of everything you get.
And I obviously still don't do that today, but it built this habit that I am a regular saver. And because I've built that habit to save regularly over time, it's put me in a pretty position to where I am today. And I've kept that habit to keep a regular savings throughout each year of my career.
And that's going to put me in a much better position in the future and result in me having to save less for the same retirement goals. Whereas if I had waited until 30, 40, or later to start more aggressively saving, I'd have to save a lot more to get the same goal.
Dan Bortolotti: Or you'd have to invest more aggressively, which is the other part of this formula too. I've definitely spoken to people who are really aggressive savers. They save significantly more than 10% of your income.
And if you are able and willing to do that, then you can probably afford to take less risk in your portfolio. If taking additional risk is stressful for you, that's a perfectly reasonable trade-off to me. Earning a 7% return obviously means it's a fairly aggressive portfolio.
If you think you're going to fall somewhere in between the 2% and 7% in your model, then you end up going 40, 50% stocks instead of 100%. You probably need to save more. Well, you certainly need to save more, but you might be willing to do that or you might just naturally do that depending on your temperament.
It's an interesting trade-off, I think, save more versus invest more aggressively.
Ben Felix: Totally. It's all connected. We see this come out when we're onboarding clients or talking with clients about asset allocation.
We always frame it in the context of the overall financial plan. It's hard to think about risks. We say, okay, stocks are risky.
What does that actually mean? They're more volatile. They go up and down a lot.
They're theoretically riskier because if a company goes bust, you're taking the full brunt of that, whereas with a bond, you're not. We'll talk more about what I just said there in a minute. When you frame that in the context of this is how much more or less you would have to save by making this asset allocation decision, I think it makes it a lot more tangible for people to think about that concept of risk and what it means to their long term expected outcome.
Ben Wilson: Yeah, exactly. Risk is a very loaded term I find. I've even seen that in client meetings where someone that is less involved in decisions or isn't aware of all the financial terms.
If you use the word risk out of context in a client meeting, that can mean a lot of things. It could be scary. Risk doesn't necessarily mean it's scary.
I think we're going to get into what risk can mean and the different aspects of risk that you need to consider as an investor.
Ben Felix: That was a great point to bring up, Ben, that saving is really a necessary precondition for investing. If someone is listening to this, investing 101 episode, wanting to learn about investing, it presupposes that they have money to invest because otherwise they would be listening to an episode about how to pay off debt most efficiently, which is another really interesting topic, but not what we're talking about today. Yeah, that saving habit is really important.
I think the amount to save and when to start saving is a really interesting discussion because to your point, Ben, starting earlier is good because it results in compounding over time, which means you need to save less over your lifetime. There's this really interesting concept in economics called utility. It's basically like spending earlier on in your life when you have less money may be much more valuable to you than the benefits you'd get from saving over the long term.
If you're having to make material sacrifices to save when you're younger because your income is much lower, even if that would make you better off in the long run, the trade-off might not make sense, at least in an economic model. I think the challenge with that thinking though is that if we go and tell someone that you don't need to save when you're young because you're going to maximize your utility, they might not build that habit that you talked about, Ben, and they might end up being terrible savers. I think there's a whole habit formation angle to it too that's interesting.
Ben Wilson: I think on the other end of utility, we often talk a lot about marginal utility with clients that have come into a situation of fortunate wealth that are still working and have the ability to earn more income, but they've already reached a point in their life of pretty significant financial independence. We often compare, yeah, you could hold on to your individual stock and you've seen growth over the years. What happens if it doubles or triples in value or what if you keep working at this high salary for years to come?
Yes, you'll have more financial assets, but what is the marginal utility of that? What I mean is if you can spend $20,000 a month now and you're doing everything that you could ever dream of, does it matter that you could spend $10,000 a month or more above what you're currently spending or are there other goals that you might want to achieve if you reach that? That's kind of a question it's psychologically hard to wrestle with because as humans, we have drive to do better and it becomes what is the purpose of your doing this?
If it's just for money, that shouldn't be your main driver, but if there's other reasons to do that, then it's worth thinking about, but it brings into question, what is the marginal utility of your future growth if you've reached a certain point in your life where you don't need it?
Ben Felix: Totally. The working example there, that is interesting. I think the risk you mentioned like an individual stock, that's from a marginal utility perspective, super interesting for the purposes of this discussion where if someone's done really well in an individual stock or picking individual stocks for a period of time and they've ended up with enough wealth to fund the lifestyle that they've always dreamed of, like you mentioned Ben, in many cases, they'll still be hesitant to sell because they want to double it again or they want to whatever, continue to take that risk, but yeah, thinking about that from the perspective of marginal utility, how much happier would you be if you continue taking that extreme risk and it pays off versus how much sadder would you be if it doesn't pay off or if you lose a lot of what you gained? That's an important idea.
Okay. The basic premise of investing, at a minimum, you need to keep pace with inflation. If you're strategic about taking the right kinds of risk at the right time in your investing lifetime, you can use financial markets as quite a powerful tool on the path to financial independence.
The next important concept is understanding what we're actually talking about when we say things like taking risk and investing in higher expected return assets because that might have sounded jargony to someone not familiar with this information. That's where we'll go next. Two of the largest and most practically relevant asset classes or types of assets for long-term investors are stocks and bonds.
These are both financial assets. A financial asset is not a physical asset like a house or like a piece of gold or silver or something like that. It is a contractual claim on future cash flows.
Financial asset, contractual claim on future cash flows. A stock is a piece of ownership of a company. When you invest in a stock, you're buying an asset, a financial asset whose value today is based on the expected future profits of that business.
As a shareholder, as an equity shareholder, you own a piece of equity in the company. You participate in the ups and downs of the company's successes and failures. If a company that you own stock in does well, you can earn high returns.
If it does poorly, you can lose money on your investment or you can even lose your entire investment. In extreme cases, which is actually not an uncommon outcome for individual stocks. Stocks in aggregate have performed quite well historically.
Global stocks have returned a little more than 8% before inflation or a little more than 5% after inflation for the last 125 years, which remember earlier we used a 7% return with a 2% inflation rate in that simple model illustration earlier. That's about what stocks have actually returned historically, which isn't necessarily what you should expect them to return in the future. That's a whole other interesting topic is what return should we expect going forward from stocks.
We're not going to talk about that today, but we have definitely done episodes on that. The stock market of some individual countries have performed much better than the global average. That's the 8% before inflation historically.
Some markets within the global average have performed much better than that and some others have performed much worse. But I think it's really important not to read too much into that when deciding where to invest. The most prominent example right now or relevant example right now is the U.S. stock market, which has delivered exceptionally high returns in both recent and distant history, but that's not necessarily always going to be the case. The Japanese stock market is really the big cautionary tale, not just because of the numbers that we're about to talk about, but because the Japanese stock market was massive. There was a period of time where it was the largest stock market in the world. It was and is a massive economy, so it's not like some little unknown market that just happened to do well over a period of time.
It was and is a huge market. These numbers are crazy. From 1970 through January of 1990, so we've got more than 20 years here, Japanese stocks more than doubled the annualized return of world excluding Japan stocks.
Doubled the annualized return, so that means the compound growth rate was twice as high.
Ben Wilson: These numbers are wild.
Ben Felix: They're wild.
Dan Bortolotti: Over 20 years. We're going to see in a minute how much that compounds.
Ben Felix: Correct. I don't even have notes on compounding for this episode, but compounding is a phenomenon in investing that results in exponential growth over time. So over such a long period of time with double the annualized return, $1 invested in Japanese stocks grew to $53.56. This is crazy. Well, an investment in rest of the world stocks, so Japan, you invest $1, you get $53.56. Rest of the world excluding Japan, you get $6.72 over the same investment horizon. Crazy. Now Japan had become over this time a dominant stock market.
I was not alive then, but it likely seemed crazy to not be investing in Japan. There were narratives that I have read about, about Japanese innovation and efficiency making Japan this just terrifyingly unstoppable powerhouse economy, which is being reflected in their stock prices. The cautionary tale here is that if you had invested $1 in Japanese stocks in January 1990, you would have $1.90 in August 2025. The cost of goods over that period, using US CPI to measure the cost of goods, had increased to $2.54. So you lost purchasing power. You lost money after inflation if you invested in Japanese stocks at the peak in January 1990. Over the same period, an investment in rest of the world, world excluding Japan stocks, would be worth $22.94, far greater than inflation. That's an extreme outcome, but I think given the challenges in selecting which country will perform well in the future, or which one to avoid, which one will perform really poorly, holding a globally diversified portfolio of stocks, covering a cross section of the world stock markets is generally wise. It's really important not to get hung up on recent past performance. A lot of the times I'll talk to people who, like the story I told at the beginning of this episode, people who have discovered the idea of index investing, they get, okay, actively managed funds don't perform well.
I'm going to use ETFs. I want low cost, and so on and so forth. Then they just buy an S&P 500 index fund.
Dan Bortolotti: One country?
Ben Felix: Correct. S&P 500 is a 500 leading US companies.
Ben Wilson: It's important to not get hung up on past performance, as you said, but it's a lot easier to say that and to actually do that in reality. It's very common for clients to come forward and say, where should we be investing? Which countries, which industries should we be focusing on?
It honestly doesn't always matter if they're a new investor or someone that's been doing it for so long. There's so much in the news headlines that people are questioning their beliefs and where they should invest. Well, this country or this industry is doing great.
Everybody wants to invest in AI right now. Everybody's invested and made lots of money on US equity for the past decade. If you were all in on US equity, from the start of the year to now, you're actually falling way behind the rest of the world.
Canadian and international stock returns have been much higher than the US this year. Another random example, but this happens all the time throughout history and every year going forward. There's always so much randomness that you can't account for and can't accurately predict consistently over time.
Ben Felix: People want patterns. They want simplicity and they want patterns. Then they end up being overconfident when they think they found one.
The US market outperforming is a good one where there are a lot of people you could talk to today that believe that should be true and will be true forever, which was likely the same kind of feelings that people had around the Japanese market in the 1970s and 80s.
Dan Bortolotti: I think a lot of investors will remember we had a situation like this in Canada as well, between about 2000-2010. Canadian stocks dramatically outperformed US stocks, at least as many Canadian dollars for us, for Canadian investors. As you alluded to in the Japanese example, there's always a narrative.
It was while the US has had its best days and Canada is the country to invest in in the future. We had people saying like, why would I ever buy US stocks? I'm just going to buy Canadian equities.
Then you know what's going to happen. As soon as that reaches a fever pitch, the worm turns and the opposite ends up being true. It's interesting to go back.
We had Japan or let's call it international stocks because the Japanese market was the biggest of non-North American markets in the 80s. The 90s belonged to the US. The first decade of the 2000s belonged to Canada.
Now it's back to the US. You mentioned a minute ago that international stocks have started to outperform. Now, who knows where that will go?
You've got to look back more than five or 10 years if you want to try to make decisions about diversification. The lesson of history has to be hold everything all the time in rebalance as necessary rather than trying to pick the next decades of performance.
Ben Wilson: I made a LinkedIn post over a year ago that getting a good outcome from a stock pick is one of the worst things that can happen to you because it results in overconfidence. Yes, you might get a quick win, but over time, if you think, oh, I can do this, chances are you're not going to be able to do it consistently over time. You're probably just going to end up with worse outcome until you decide to take a more diversified rational approach to investing.
Ben Felix: I did pull the numbers up there, Dan. From March 2000 to December 2010, I don't even know if this is the most extreme time period. That's just what I picked here.
The S&P TSX composite index returned an annualized 5.93% in Canadian dollars. The S&P 500 index in Canadian dollars returned negative 2.35%. Yeah.
That's a tough one. You can see how people form these stories in their head about why what we're seeing now is the way things are always going to be. Historically, that's just not how it has been.
I think those narratives form very easily. Right now, the US is dominant because of it's got all the AI companies maybe is one of the narratives. Although, as you said, Ben, this year it hasn't actually outperformed.
We tell these stories. This is super common though. Investors want to invest in the stuff that has recently performed well or avoid investing in the stuff that has recently performed poorly, but that performance chasing behavior is likely to do more harm than good.
Then there's another interesting question, figuring out how much to put into each country. We've got all of these countries around the world. We've got all these index funds, all these indexes.
How do you actually figure out how much to put in each place? I think the really interesting thing here and the useful mental model to have is that the market has answered that question for us. The market is shorthand for the huge amounts of buying and selling of stocks that occurs around the world every day.
Huge and huge amounts of trading. Every transaction is a self-interested party, often a highly informed one who is buying or selling based on the information that they have. Each one of those transactions is contributing a little bit of information to the price of a stock or of a bond.
All that buying and selling that happens throughout the day ultimately determines the value of the companies traded on the stock market. That pricing machine assigns values to companies based on things like their expected future profits, their riskiness as assessed by market participants, how the company behaves relative to other stocks in the market. We've got all these hyper-competitive, well-informed parties.
Could be institutions, it could be individual investors, it could be hedge funds. They're all competing to take the information that they have and trade on it in a way that hopefully lets them profit. The act of them doing that makes stock prices pretty good reflections of their actual value.
All that trading is what results in the company's price. If you think about the mechanics of how that works, larger and less risky companies, less risky as assessed by the market are going to earn a larger weight in the market, all else equal. Then the other thing that we can understand from that is that the collection of companies in each country are going to determine that country's weight in the global market.
Those are called market capitalization weights. Those are a very good starting point for any portfolio. You need a very good reason to be different from market capitalization weights.
In super simple terms, this means that you can look at the relative size of each company in a market or of each country relative to other countries around the world and you can allocate your portfolio accordingly. Market prices, market weights give you a very, very good starting point for portfolio construction.
Dan Bortolotti: It's probably worth taking a second to take note of what those market caps are on a country by country basis because they're not incremental. I'm just going by memory here, but the US now is over 60% of the global market. If you were just doing a market cap weighted portfolio across all countries, your equity allocation would be in the range of 60% or so.
Then the next biggest country after that is still Japan, which is about 8%, something like that. The gap between the US and the second biggest country is enormous. The US market is bigger than all other countries combined.
If you're a US investor and you put 100% of your equity allocation into the US, that's home bias, but it's not wildly home biased in many ways because international diversification is probably going to have less of an effect on you than it might an investor in a different country. In Canada, we're still around 3% or so. Most Canadians will not put only 3% of their equity allocation in Canada.
There are some good reasons for overweighting your home country, but it is worth having a look, call up total global stock market by country market cap and have a look at it when you're putting your portfolio together. You might be surprised at just how uneven those divisions are.
Ben Felix: I've got it here. I pulled it up as you were talking there, Dan. These are world equity market capitalizations in Canadian dollars, which is important.
This is as of December 2024. A little bit out of date, but directionally still very relevant. At that time, the US market was 65% of the global market.
Again, measured in Canadian dollars. Apple as a company, one company, is 4% of the global market by market capitalization. That's remarkable.
It's crazy. Canada, like you said, Dan, 3%. The next biggest market after the US, it looks like it still was in December 2024. Japan at 5%. The UK, 3%. China, 3%.
Then there are a bunch of countries at 2%. Taiwan, Switzerland, France, Germany. Then it drops off after that to 1% and below.
Dan Bortolotti: Nobody is more than five other than the US, which is 65. I think it's important to remember too, just for what it's worth. That's the measure of the global stock market, which is publicly traded companies.
It's not measured of the economy. The Chinese economy is not 3% of the global economy, even if it's only 3% of the global market cap. It's just a matter of most Chinese companies are not publicly traded and open to investment to the rest of the world.
It can be a bit skewed. The publicly traded stock market does not equal the global economy, but it's the best proxy we can use as individual investors. Unless you want to go out and buy private equity all around the world, the best we can do is stick to publicly traded companies.
Ben Wilson: Dan, you touched on the stock market not being the economy. I think that's an important point because people often interchange those two terms and those are two vastly different topics. They often view the current economic state as how the market is going to be impacted, especially in a time like now where there's political controversy with Trump leading the US and the tariffs and everything that's going on and the war in Israel and Gaza.
There's always people thinking all these terrible things are going on in the world. The market's going to go into a recession because economy is taking a hit. That doesn't necessarily mean it's true and that's been covered on previous episodes.
That's not the focus of today, but it's just important that stock market does not equal economy at a very basic level.
Ben Felix: Definitely. Just for context to bring it back to the Japan example, I believe I would need to find a source for precisely the number, but in December 1989, so right before things turned around, I believe Japan was about 50% of the global stock market by market capitalization. The US is obviously above that now.
I think when I started working in this industry, the US was about 50% of the global market. It's risen above that because it has performed better than the rest of the countries or most other countries around the world over that period. Still, interesting that directionally, the market capitalizations were not terribly dissimilar.
Japan was around 50 at its peak. Not drawing the comparison, not predicting that the US market is going to crash, but it is just interesting to look at how similar those two numbers are.
Global stocks, we mentioned the number was about 8% annualized before inflation. They've done quite well in aggregate, in total. Individual stocks have been very risky.
Many of them perform poorly, often going to zero, as I mentioned earlier, and a relative few stocks perform exceptionally well. That's called a skewed distribution of returns for anyone that's interested in a very nerdy word. The problem is people might hear that and say, well, great, I'll pick the relative few that perform extremely well, but picking those winners ahead of time is really, really hard to do.
I would say in general, similar to not trying to pick countries that are going to win, it generally makes sense to hold a diversified portfolio of many stocks. Again, similar to market capitalization weights for countries, we can also look at market capitalization weights for individual stocks. Now that might sound daunting.
You have to go find out what the market cap weight of every stock is and build a portfolio on that basis. That's not what I'm saying. There are low cost investment products that make it super easy to build a globally diversified market capitalization weighted portfolio of stocks.
We'll talk more about what those products look like a little bit later. One thing that is important to mention though is that even a properly diversified portfolio of stocks can have quite violent ups and downs. You should be prepared for a 50% drop in the value of an all stock portfolio.
That doesn't happen super often, but it has happened historically enough for that to be within the realm of expectation for a portfolio of 100% stocks.
Ben Wilson: The big difference there is that with an individual stock, there's not necessarily a positive expected return, whereas with a diversified set of stocks, there is. It's like, yes, you might get that 50% drop, but you're almost guaranteed to see recovery over time. Whereas with an individual stock, there's a lot more concentration risk.
You could experience total loss or never recover from that loss if you're all concentrated in a single stock or a group of individual stocks.
Ben Felix: An individual stock still has a positive expected return, but that expected return is like the discount rate applied to the expected future cash flows of the business. You're still going to have that with an individual stock typically, but there's a much higher probability that you'd get a bad outcome, including a zero. You lose all of your investment.
To your point, Ben, when you're properly diversified, when you own a broad cross section of all stocks, like through a total market index fund, which we'll talk more about in a minute, I don't know if I'd go as far as almost guaranteed. That makes me nervous to say.
Ben Wilson: Well, not guaranteed, but if you believe in capitalism, the market should go up over time. That's what I meant, not that returns are guaranteed. Compliance won't be happy with that one.
Ben Felix: Yeah, no, that's a compliance red flag there. Definitely not guaranteed. There's a lot of risk, a wide range of potential future outcomes.
I think the point that you're making is that with an individual stock, it's likely to lose on the investment, to underperform the market for sure, and to lose your whole investment is not terribly uncommon. Whereas with a diversified portfolio of stocks, that really bad outcome of total loss is less likely. If you believe in capitalism, we would expect stocks to go up over time in the future as they have done in the past, even if there's still risk associated with getting that outcome.
That's the objective risk of stocks. They can be volatile, they can go up and down, even if you are diversified. I think where this gets challenging is that when your stock portfolio represents your financial future, we talked earlier about this is your financial independence, this is transitioning your human capital into financial capital so that you don't have to work forever.
When your stock portfolio represents that, it represents your hopes and your dreams and your future, it can be very hard to watch its value swing wildly, as can happen, as we just talked about, which makes stocks really hard for a lot of people to invest in. Dan, this is something you and I have talked a bunch about in past episodes. Paradoxically, and I don't know if that's the right word to use, that difficulty, the riskiness, the volatility, the scariness of investing in stocks is exactly what makes them good long-term investments if you can hold them because they have high expected returns because they're scary to hold.
Not everybody is willing or able to hold them. Now, because not everyone can hold a portfolio of 100% stocks, for the purposes of our investing 101 discussion, this is where bonds come in. Bonds are loans made to companies or governments.
Instead of buying a piece of ownership in a business with bonds, you're effectively making a loan to a business or a government. Unlike a stock, if a company performs much better than expected, its bonds probably won't change in value much. If it does worse than expected, its bonds probably won't change in value much.
Even if a company goes bust, you can still lose your money in bonds. Even if a company goes bust, it's still possible to recoup some value as a bondholder. It doesn't mean you are guaranteed to recoup all of your money, but it's possible for bondholders to recoup some value in a corporate bankruptcy, whereas stock holders would not recoup anything.
That's corporate bonds. Government bonds tend to be even more stable. Bonds are still not guaranteed investments and they do come with their own unique risks, but they don't tend to change in value from day to day as much as stocks do, typically.
In finance speak, they're less volatile investments. Now, I think an important point here and we talked earlier, Ben, you mentioned the difficulty of talking about risk. Bonds are less volatile than stocks.
They move up and down in value day to day, typically less than stocks, but they also have lower expected returns and are more sensitive to inflation. Periods of high inflation can quickly reduce the purchasing power of money invested in bonds, which makes them risky in their own way. I think from the perspective of volatility of emotional riskiness and a value moving up and down from day to day, bonds are safer than stocks.
From the perspective of maintaining or growing your purchasing power over long periods of time, I think it could be argued that bonds are riskier than stocks.
Dan Bortolotti: It's a good point. You guys mentioned earlier about the word risk means different things. I remember having a wise client say to me one time when we were talking about risk tolerance and she said, I have a high tolerance for volatility risk.
I have a low tolerance for the risk of not meeting my financial goals. I thought, that's a really wise thing to say because you can sit in a portfolio of overwhelmingly bonds and GICs and say that it's no risk, T-bills are quote-unquote risk-free. You put that in a retirement portfolio for 40 years, that's a pretty good risk you're not going to have enough money to retire on.
It's really important. I think volatility is only the most immediate type of risk. It's the one that keeps us awake at night in the short and medium term.
The nature of stocks is that additional risk you take means higher expected returns, which means less risk of falling short of your financial goals.
Ben Wilson: Yeah, exactly.
Ben Felix: We have these two tools. As we just talked about, they have these different competing trade-offs where in one case you can reduce volatility, but you might increase the risk of future consumption. The other case is the opposite where with stocks, you have a higher expected return.
You may be on expectation to have a better chance at meeting your long-term goals, but you're going to take on a lot more volatility. These two broad asset classes, they're opposites of each other. They offset each other in different ways.
But because we have two of them, because we have these two asset classes, you can build an investment portfolio that matches your specific desired level of expected return and volatility. That's kind of a cool thing. A stock heavy portfolio should be expected to be more volatile and have higher expected returns, while a bond heavy portfolio will be expected to be less volatile and have lower expected returns.
I know we just talked about this. I think it's important to be intentional. I have been trying to be very intentional about referring to stocks as more volatile rather than more risky because risk is ambiguous.
Again, I know we just talked about this, but I think it's a really important point to drive home. Volatility is a way to think about risk. The risk of not being able to meet your long-term financial goals, as your client so eloquently put it, Dan, is another way, another really important way to think about risk.
Some research has – recent research that we've talked about quite a bit throughout this podcast, including with the co-author of the research, has suggested that from the perspective of meeting your long-term goals, stocks may actually be safer than bonds despite their higher volatility as long as you can handle the ups and downs, which is a really big as long as because not everybody can.
Ben Wilson: The key point here is you need to accept the level of risk that you can maintain. You need a portfolio that you can keep a disciplined plan. Whatever that looks like for you that helps you to achieve your goals, but also stay in your seat in those volatile times, that's the sweet spot that you're looking for.
If you have something too risky and you freak out and make a bad decision, that could make you worse off than just staying in your seat with a lower exposure to stocks.
Ben Felix: Totally. Jordan Tarasoff is one of our portfolio managers. He said that he thinks that one of our most important functions as advisors to people is to get them to invest in stocks and maintain exposure to stocks.
When you model it out, when you look at how important is exposure to stocks, to meeting your long-term goals, it's super, super important. That trade-off is huge, but it's not always easy psychologically. These broad asset classes, there are other asset classes, but for the purpose of investing 101, this is plenty.
These two broad asset classes, stocks and bonds, they exist. Their expected returns are really useful tools to plan for the future. The expected returns of stocks and bonds are useful tools to plan for the future.
We access those expected returns, ideally with a diversified portfolio, which as long as you can stick with psychologically, is a really useful tool to help you in achieving your long-term goals. What I just said is not terribly complicated. Stocks and bonds exist.
They have expected returns. We can use those expected returns to plan for and meet our long-term goals. Great.
The problem is, many people have been taught, many, many people. I still talk to people every day. We just got an email from someone recently who still holds these beliefs, but is slowly changing their mind listening to this podcast, which is interesting.
A lot of people have been taught that investing requires or means or involves guessing and predicting, predicting which stocks or markets are going to do well, predicting when to get out of the market or out of a stock before it declines, before the market crashes. This general idea of following the market super closely, subscribing to newsletters, and I don't know what else people do to try and get daily market information, but trying to find an edge, doing all this stuff, staying really in the loop, trying to find an edge by guessing and predicting, that's typically referred to as active management. At the most basic level, active management is the idea that you can use your knowledge and your information to out-guess the market, resulting in improved performance.
The problem with this idea is that as we talked about earlier, the market's main function is aggregating all available information, including expectations about the future, into the prices of stocks and bonds. I think the idea, and I'm not the only person that thinks this, as we'll talk about in a minute, the idea that any one person or even a team of people can consistently out-guess the combined information production of all market participants, it's really far-fetched. The idea that you can sit down at your computer and subscribe to an information service and figure out what trades that you're going to make in a way that's going to outperform all of the other people that are trying to do the same thing, all the other people and institutions, professionals, algorithms, and so on and so forth, who are trying to do the same thing, it's frankly just a little bit ridiculous.
Ben Wilson: Closer to gambling than it is to anything else. Almost like active investing could be referred to as gambling, but with a PowerPoint deck. You're doing some analysis and trying to figure out what's going to work well, but at the end of the day, you're rolling the dice and hoping that you're right based on your educated analysis.
Ben Felix: When you invest in an active strategy, there are two types of risk. You're still taking on market risk because active funds still invest in the market. Market risk has a positive expected return.
You're also taking on active risk, which is the risk that you're going to do better or worse than the market through your active decisions. I would argue that active risk does not have a positive expected return and I would therefore gladly call it a gamble. You still have positive expected return from investing in the market, but you're adding on this random noisy risk without a positive expected return by nature of trying to beat the market.
Dan Bortolotti: That randomness and that noise that you mentioned is a huge part of why intuitively active management still has so much appeal because there will be times when smart people make calls with good outcomes and they will take credit for those. It will be easy to say, well obviously so-and-so knows what he's talking about because their fund outperformed dramatically. I don't just mean over six months.
I mean it could be over 10 years, but in aggregate over time as we all know, it's very unlikely for those types of decisions to add value over your investment lifetime. The outcomes take so long to unfold that most of us will be swayed by the noise and the randomness at some point and it just has a very intuitive appeal. Smart people will do better in the market than people who don't do their research or don't know what they're talking about.
The problem with that logic is that yes, you might be a better trader than me, but you're not trading against me. You're trading against the entire aggregate knowledge of the market and all of those together are smarter than everybody. As we know, it's something we tend to take for granted, but we certainly see when having conversations with prospects or new clients, it's still a learning process and it takes a while to have that sink in and have you really internalize those beliefs.
Ben Felix: That's such an important point. I would even say, Dan, that it's not even necessarily smart people that end up having good outcomes, just people. They don't have to be smart.
Dan Bortolotti: Smart and dumb people both can have good outcomes in the short term, it's true.
Ben Felix: I think active managers are generally very smart and educated and successful financially and otherwise. I don't want to try and discredit people who engage in active management. They are probably very, very smart, but I don't think that is what predicts whether or not they're going to be successful active managers, which is kind of the crazy part.
There's this idea called the paradox of skill, where as active managers become increasingly skilled, increasingly educated, knowledgeable, well-resourced, the outcomes of them trading against each other is increasingly determined by luck. That's an interesting thing in financial markets, where the more skilled and intelligent and well-resourced active managers are, the more likely the outcome of them competing against each other is going to be determined by luck. We get back to this position of, were they lucky or were they skilled?
It's really, really hard to disentangle those things in financial markets.
Dan Bortolotti: You see a similar sort of thing in baseball. This has been written about too, this idea that as hitters and as pitchers have become better over time, you don't see the vast differences in batting average that you used to. There was a time where if you were the batting champion, you hit 395 and the average hitter hit 220.
You don't see that anymore. There's much more narrow dispersion of averages because everybody is so much better and there are no more outliers. And then a lot of times things like batting average are determined by luck.
Balls that drop in when they shouldn't have and that will vary a lot over the course of the season. There's a similar thing happening with active management as you say. There's unlikely to be another Warren Buffett.
Someone who is so much better than his peers that he stood head and shoulders above him, that is almost impossible to happen in the market today. When we see big variance in active managers from year to year, maybe they made a great call but a lot of it has to be put down to luck at this point.
Ben Felix: It hasn't happened. Even with Buffett, early on when he was head and shoulders above everybody else, he did outperform dramatically in more recent history. I'd have to look at the data.
We did an episode on this, I think earlier this year though and Buffett has not beaten the market for a very long time now.
Dan Bortolotti: Those opportunities don't exist like they did in the 50s and the 60s when the market was less efficient.
Ben Felix: He would agree. He said exactly that.
Ben Wilson: Oh, for sure. Statistically, there's always going to be winners that guess right and it's a question of luck or skill. Do you want to try to find the winner, the advisor that's going to pick the winner in that year?
There's so many investors out there that are shooting for top quartile returns but in doing that, they're risking that they get bottom quartile returns. Why not try to go for average or slightly above average by taking what we know is to be an effective long-term strategy which is a diversified index portfolio?
Ben Felix: Just the idea that from a planning perspective, we talked about how the expected returns from stocks and bonds are useful tools for planning your future and funding your financial goals. When you add on that active risk, there's this whole chunk of uncertainty about, hey, maybe you find a good active manager and you dramatically outperform or maybe you find that you are able to actively manage your portfolio in a way that you can outperform, but maybe you're not. Statistically, you're probably not.
Either way, that's noise that's really hard to plan for when we're trying to think about what are your goals? What should your asset allocation be? How much do you need to save?
It's just a whole lot of noise that we're adding with active management. Anyway, this has become a bit of a digression about active management. We're actually going to go a little bit deeper on that in a second.
I did want to mention, because I just remembered from that talk that I used to do, people love this data point, so I pulled it up. If you look at the equation to calculate the T statistic, to determine statistical significance, an active manager's alpha, that's their excess risk adjusted performance. That's what you're hoping to get from an active manager if you choose to engage in active management.
To conclude that their alpha is statistically different from zero at the 95% confidence interval, which requires a T statistic of two, we must have an alpha of 2%, assuming a 6% standard deviation of alpha for 36 years. Before we can say that the alpha is statistically significant, we need to have 36 years of data, assuming a 2% alpha and a 6% standard deviation of alpha, which is pretty crazy.
Dan Bortolotti: Which is like saying, if you start investing when you start your career, then by the time you're retired, you will know whether you should have invested in a certain active manager. Too late.
Ben Felix: The active manager's retired. Yeah, that's right. If you're the active manager, by the time you've determined your ability to do it, you're out of time.
Ben Wilson: Exactly. Or your career didn't even last that long and you don't even have statistical significance to measure.
Ben Felix: Yeah. Okay. Tying all this together, an economist named Eugene Fama, who has been a guest on this podcast, I think in episode 200, he shared the 2013 Nobel Memorial Prize in Economic Sciences for his work on this idea of efficient markets, the efficient market hypothesis, EMH.
This is really the economic work that formalizes the idea that prices are pretty good representations of all available information about stocks and bonds. Kind of what we've just been talking about. From the perspective of investors, so there's an idea of efficient markets.
Okay. Prices reflect all available information. How do we actually test that?
One of the things that Fama said when he was on this podcast is that one of the best tests from the perspective of investors is whether professional active managers can consistently beat the market. The idea here is that if prices do not reflect all available information, if markets are not efficient, a savvy active manager should be able to learn things about a stock or about a market that are not currently reflected in the price and then profit by trading on that information. Profit consistently.
If that were the case, if that's what we were seeing, there'd be a pretty good argument that markets are not efficient. What we see in practice is that only a small, very small percentage of professional active managers are able to outperform the market. Even the ones that do outperform the market over one period, even a long period, like say a 10-year period, they are rarely going to go on to continue outperforming in the future.
We talked about the 2% alpha thing too. That makes picking winning managers before the fact really hard. Now the alternative to active management, which we haven't actually talked about yet, even though we've talked about the concepts, is typically referred to as index investing.
An index is a representation of a stock market. In Canada, we have the S&P TSX composite index. The US market has a whole bunch of indexes tracking it, but the most popular common one that people are probably familiar with is the S&P 500 index.
Those two indexes are groupings of stocks that have been put together by a research firm, in this case S&P or S&P and the TSX together. They've been put together to be a representation of a country stock market. These are market capitalization weighted indexes, as we talked about earlier, meaning that larger companies get a larger weight in the index than smaller companies.
Now since the indexes hold the stocks or represent the stocks as they exist in the market, they're also often used as the benchmark for active managers. The stocks exist like this. Let's look at how they perform.
If you can do better than that as an active manager, that's great. An index itself importantly is an investment. It's just a concept, I guess, a representation.
There are funds that rather than trying to beat the market like an actively managed fund would, they simply invest in the stocks in the index in an effort to capture the market's returns. Index funds were first created in the 1970s based on the observation back then that active managers were not delivering index beating returns. The other important issue that we've not talked about yet for active management is that to do all of the analysis, all of the stuff, all of the effort trying to beat the market, they have to charge higher fees because they have higher costs.
Even small fees and investing matter a lot due to compounding over long periods of time. We think back to the earlier example of saving 10% of your income for retirement and earning a 7% expected return on your investment. We are saving 10% of your income that was retiring at 65, 60% of your retirement income being replaced until age 95.
If you were paying an extra 0.64% in fees, and that number is the average fee difference between fee-based active funds, so there's no commission built into that number, and index funds in Canada, and you don't earn higher returns in exchange for the higher fees you're paying for active management, which is what you should expect as we've been talking about, you would need to save 25% more, 12.5% of your income to have a similar long-term outcome.
Dan Bortolotti: Just 64 basis points, that's pretty dramatic because a lot of people pay more than 64 basis points in excess of an index fund portfolio. Some people are paying double that and all of a sudden now you're 10% of your income, it's probably going to be closer to 20.
Ben Felix: Yeah, exactly. Those little points of a percent or percentages matter a ton over such long periods of time. Then if the active fund that you choose underperforms by more than its fees, which is often the case because it's so hard to pick the winning stocks before the fact, the numbers are going to look worse still.
There is academic research showing that even before fees, the median actively managed fund underperforms. I mentioned the word skewness earlier because a huge portion of the market's returns come from a relatively small number of stocks. Actively managed funds are more likely to miss those winning stocks while index funds are always going to own them.
That skewness results in underperformance even before fees are accounted for. One of the things that's challenging, I think in Canada in particular, because of the dominance of our banks is that when you sit down with a financial advisor, they can probably show you a list of actively managed funds that haven't performed. You'll listen to this podcast episode, you'll go into the bank and you'll say, I want index funds.
They'll say, well, why? Look at all of our funds, they've outperformed. It makes active management seem really compelling.
The problem is that over any 10-year period, and I say that just because that's what we have good data for, roughly less than half of funds survive. Call it half of funds closed down over a 10-year period. That's usually because they performed poorly, didn't attract investor assets and were no longer profitable to run, so the fund company closed them down.
Half of funds. It's pretty crazy. The ones that survive tend to be the ones that performed well and attracted assets.
That creates this problem called survivorship bias. The sample of actively managed funds that exist at any point in time are really not a good representation of the performance of actively managed funds in general once you account for survivorship bias. I mentioned earlier, one of the other issues is that funds that both perform well and survive in one period are no more likely to continue outperforming in future periods.
You can't just say, well, I'm going to pick the past winners. They're probably not going to be the future winners. Index funds, I think they take the guesswork out of investing.
They make investing accessible to anyone. You don't need to know how to analyze companies, predict the economy or whatever. I think people get intimidated by that kind of stuff.
You just need some baseline knowledge about index funds, about the stuff that we've been talking about, and enough conviction in your chosen strategy. If that's index funds, for example, you have to have enough conviction that that is the right thing to do and will be the right thing to do to allow you to stay disciplined through inevitable difficult market conditions. That needs a lot of emphasis.
There's a famous quote from David Booth, who's the founder of the large fund company. He says, the most important thing about an investment philosophy is that you have one that you can stick with. I think that is really, really important.
Dan Bortolotti: It's worth mentioning here too, that I think intuitively, index investing is more difficult, behaviorally, I think, just because most people, I think, can confidently say something like, well, I trust the person making my investment decisions, in this case, an active fund manager. They obviously have access to all this great research. They have all of this experience.
They know what they're doing. I don't know what I'm doing. I'm happy to delegate that to a professional.
Whereas with index investing, sometimes people will say, nobody's holding the wheel. The index fund just does whatever the market does. If it's going to be in freefall, then your fund's going to be in freefall too.
That is actually true. But it's difficult to get your head around this idea that even though that's true, over the long run, you're probably still better off because your overconfident active manager might very well be lucky, or it might very well be correct. When the market starts to go down and they lower their exposure to stocks, they protect you from some losses in the short term.
But then once the recovery starts, almost inevitably, most active managers miss it, and they end up buying back in at higher than they sold, and that undermines long-term returns. Until you see that in action, the narrative told by active managers sounds much more appealing than the narrative told by those who advocate index investing. That's a big leap you need to make as a beginning investor, is to internalize that idea.
It's not that intuitive, but less is more when it comes to trying to manage a portfolio in many ways.
Ben Wilson: To that point, index investing is often referred to as boring. It's intentionally boring. If you're taking the active approach, it may feel more exciting because it's more similar to gambling as we've talked about.
But then active investors or active managers may take that and spin it and say, well, if your advisors only investing in index funds, then what are you paying them for? You can go buy that yourself. We talked about how fees are important.
I think it's important to highlight that fees for investments are not the only reason you'd pay fees. Even though fees can impact your long-term return and your long-term goals, there are many other factors that can impact it. Having an advisor to help you stay in your seat, which is probably one of the more high-value items that advisor provides to clients, is providing that behavioral coaching through some of the volatile times, keeping clients in their seats.
I can't count how many times I've had those types of conversations where X is happening in the world, should we be doing something different and talking through how you think about these types of decisions. Then there's things like tax and financial planning and different strategies that can add value over and above your investing. Be aware of fees, but not so much that it could actually negatively impact your plan if you don't actually know and fully understand what to do to implement a successful financial plan on your own.
Ben Felix: That's not to say everyone needs an advisor. Some people can be successful DIY investors. Probably not as many as think that they can be successful DIY investors, but a lot of people can be successful.
It does take a certain amount of conviction and commitment. Community probably helps too, like having other people that are interested in those ideas to talk about, to ask questions like what you just said, Ben. You see it on Reddit all the time, same thing where when markets are crashing, people are going on the internet and asking, was everything going to be okay?
Should I get out of the market? The advice is mixed, but usually it's pretty good where people are saying, no, stick to your plan, whatever.
Ben Wilson: Yeah. You and I had a client years ago, Ben, that came to us after making a poor market timing decision as a DIY investor. They were doing good on their own until they weren't.
They saw a recession coming, they guessed wrong and it cost them six figures. They said, I'm my own worst enemy. I need an advisor to coach me through some of these tough decisions.
Ben Felix: That self-awareness is definitely good, but also rare. Putting all of this into practice, other than finding an advisor that does this stuff, which for the record, PWL does do that, but putting this into practice, not with an advisor, which is what I'm going to talk about here. We need to talk about investment products.
We talked about a lot of concepts. We talked about inflation, expected returns, stocks and bonds, asset allocation, how you mix stocks and bonds together. At the end of the day, the rubber hits the road with investment products.
In 2018, Vanguard launched the first asset allocation ETFs in Canada. An ETF is an exchange traded fund, which is a fund that you purchase on a stock exchange like a stock, but it gives you exposure to a diversified portfolio of assets. Everybody used to invest in mutual funds, which is the same thing.
You buy a unit of a mutual fund that gives you exposure to a diversified portfolio of assets, but in that case, you're buying units of the fund from the fund company. In the case of an ETF, you trade them on the stock market like a stock. You're transacting with other people or with something called an authorized participant.
It's a different mechanism for buying a diversified portfolio of assets. Asset allocation ETFs are available now through a ton of different financial companies in Canada. We'll talk a little bit about Vanguard's asset allocation ETFs to see what I'm talking about.
VGRO, VGRO, is the Vanguard growth ETF portfolio. If you look at the holdings of the ETF, it holds a US market index ETF, a Canadian total market index ETF, a developed markets excluding North America index ETF, which covers countries like Japan, the UK, France, Germany, Switzerland, Australia, and a bunch of others. It holds an emerging markets index ETF, which covers China, Taiwan, India, and a bunch of others.
It holds three bond ETFs, which cover Canadian, US, and global bonds. You buy this one ETF, this one ticker, VGRO, and it's giving you exposure to all of those different underlying ETFs covering the global stock and bond markets. This one, VGRO, overall consists of 80% stocks and 20% bonds.
We talked about market capitalization weights earlier. Dan, I think you mentioned home country bias as a concept. In this ETF, Canada does receive a much higher weight in the fund than its market capitalization weight.
That was a deliberate decision by Vanguard, which reflects that concept of home country bias, which may be appropriate for Canadians. At PWL, we do also typically apply a similar level of home country bias. We agree that it makes sense for various reasons.
We did a whole episode on that a while ago. Now, Vanguard and these other financial companies have created asset allocation portfolios for more conservative, so higher allocation to bonds, and also more aggressive asset allocations that allows investors to choose a product that makes sense for their expected return and volatility needs. BMO, RBC, iShares, TD, McKinsey, and probably others have similar asset allocation products.
Again, these are ETFs, you just buy one thing and it gives you exposure to a diversified portfolio with the appropriate asset allocation for you. You have to pick the appropriate asset allocation for yourself, but the tools are there. Another important point is that these asset allocation ETFs are rebalanced for you.
What does that mean? Rebalancing is the action of keeping your portfolio's asset allocation targets in check as markets change over time. If you were to build your own ETF portfolio today with the same underlying ETFs and the same weights as VGRO, you would need to keep an eye on the weights of each fund.
If the US market goes on to do particularly well over some period relative to everything else, all of a sudden it would make up a larger portion of your portfolio than maybe you had initially intended it to. To resolve that, you would need to buy more of the other ETFs or sell some of the US equity ETFs. That's not insurmountable, but rebalancing is real work that needs to be done.
Dan, I remember in the earlier days of your blog, you would write a lot about rebalancing because it was this thing that was super relevant to people before the asset allocation ETFs existed.
Dan Bortolotti: Yeah, it's just so much easier now than it was in the past. I do think though, it's really worth stressing here, rebalancing is not just work that needs to be done on a spreadsheet. It's really hard to do behaviorally because when you think about what rebalancing is, it is almost always selling what has recently done well and putting the proceeds in what has recently done poorly, which is the exact opposite of what your lizard brain is telling you to do every day.
It's really common for people just to not rebalance their portfolio because they want to let it ride. As they say, let the winners keep winning. Over time, it is something that is really about risk management more than it is about enhancing returns.
Just having the fund manager in these asset allocation ETFs do that for you is an enormous benefit. It's more than just time saving. It's probably going to save you from making a lot of behavioral mistakes over time.
Ben Felix: That's a great point.
Ben Wilson: And you just don't have to think about it. Set it and forget it. If you're rebalancing, you have to look every month or every couple months to see if there's been any drift away from your target mix and it just takes that thinking away from it completely.
The other behavioral piece that you didn't touch on, Dan, is those funds that have done well, if it happens to have done well in a taxable account, you're now forcing yourself to realize capital gains if you're rebalancing back to a target allocation. On the flip side, you can use some losses to offset gains but realizing gains is a lot harder for people that have those component portfolios when they realize this is going to result in me giving the government more money sooner than I plan to.
Dan Bortolotti: An asset allocation ETF will do that at the fund level and if you hold the asset allocation ETF in a taxable account, chances are that over time it will distribute some capital gains and you will have to pay taxes but likely at a lower level than if you're doing that in your individual account. And that's simply because as new money comes into the ETF from new investors, the fund manager is routinely buying whatever is underweight. So they're probably selling a lot less than you are and they're buying more and that allows the fund to kind of rebalance itself with new cash flows rather than doing a lot of selling.
So there's some tax efficiency there as well. If you're just saving in a TFSA, an RSP or some other tax sheltered account, it doesn't matter but it's still beneficial for all of these other reasons that we've talked about.
Ben Felix: One other point actually that this came up in the conversation that I had that spurred this episode is that you will pay a little bit more in fees for these asset allocation ETFs. The Vanguard ones are at 0.24%. The iShares ones might be at 0.2% whereas you could build a portfolio of the underlying for probably 0.1 or 0.2%. So call it at 0.1%, a 10 basis point difference in fees. For someone who's just heard us hammer on the importance of fees for all this time, they might see that 10 basis points and think, well, no, I don't want to pay the extra fees.
I think when we're down to the 10 basis point level, it's at a point where the trade-off, unless your portfolio is very, very large, which would also make managing it more involved, but unless your portfolio is very, very large, the trade-off of paying an extra 10 basis points to have all of that work taken off of your plate, there's a good chance that it's going to be worth it. You mentioned this earlier too, Ben, just with the idea of paying for advice. As much as fees are important, as much as people need to be aware of fees, it's also very important to be aware of trade-offs.
I think in this case, where we're talking about 10 basis points to automate a lot of the hard stuff for a lot of people, it's going to be worthwhile.
Dan Bortolotti: Yeah. I think just saving yourself having to go in and make those transactions. The other thing is, let's agree too that if you were to hold for the Vanguard equity ETFs, as an example, the asset allocation ETFs hold four different underlying equity funds.
If you were to hold those four funds individually, yes, it would be nine or 10 basis points cheaper, but you are not going to have the same performance as you would if you had held the asset allocation ETF, because those funds are going to move at different rates over the course of a year or two, and no one will be rebalancing as they are at the asset allocation ETF level. That might work against you, or it might work in your favor, but over time, it's not likely to move the needle very much at all. As we said, the behavioral benefits of wrapping up all of those funds into a single asset allocation ETF really outweigh any small additional cost.
Ben Felix: I think that's very true. It was important to talk about these. Again, this is one of the things with the conversation that I had that made me want to do this episode. The person that I was speaking with was not aware that these products existed.
They had gotten to the point of index funds exist, great. They were using a couple of individual index funds to build a portfolio that had weights that were quite a bit different from market cap weights. I was like, man, just knowing that these products exist and why they make sense is a huge financial leg up.
It takes so much of the thinking out of doing really solid investing practices. A quick recap here. Investing is important because at a minimum, it combats the erosion of purchasing power over time.
Then when you add on some risk being taken, with of course risk being difficult to define as we talked about, investing also offers the expectation of growing your wealth for the future. The two main asset classes to think about at least at the 101 level are stocks and bonds, both of which are financial assets. Stocks are more volatile and have higher expected returns while bonds are less volatile and have lower expected returns.
Depending on your goals and your ability to withstand the volatility of your investments from day to day, you can arrive at some mix of stocks and bonds that make sense for you. People tend to believe that successful investing requires understanding the stock market, the economy and individual companies in order to guess and predict what to invest in and when to get in and out of those things. Decades of research suggests that these are fool's errands.
Successful investing simply requires capturing the returns of financial markets that financial markets have to offer, which can be accomplished using globally diversified low cost index funds and this is achievable in Canada today with the many asset allocation ETFs that are available to us.
Ben Wilson: One more point to reiterate there is that fees are important to be aware of, but also keep in mind the trade-offs that come with those fees.
Dan Bortolotti: Sounds so simple, doesn't it?
Ben Wilson: Yes.
Ben Felix: It does sound simple.
Dan Bortolotti: It's simple in theory, but very difficult to implement over time. Simple, but not easy.
Ben Felix: Quick review here. I'll do the disclaimer. Ben, you want to read the review?
You've never read a review before. Sure. Let me read the disclaimer and then you can read it.
We have a review from Apple Podcast Read. Under SEC regulations, we are required to disclose whether a review, which may be interpreted as a testimonial, was left by a client, whether any direct or indirect compensation was paid for the review, or whether there were any conflicts of interest related to the review. As reviews are generally anonymous, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest.
This one is somewhat anonymous because they did leave a first name, but I don't know who they are.
Ben Wilson: Don't recognize the name either. The subject or the title of the review is the Best Finance Podcast. The Rational Reminder Podcast is the only finance podcast that I feel comfortable recommending to friends and colleagues.
The latest episode with Mark Higgins was great. I'm fascinated by the intersection between history and finance. I just finished reading his book, Investing in U.S. Financial History. I would encourage anyone with similar interests to give it a go. To Ben and team, have you considered doing an episode on the differences between money market funds, short-term treasury ETFs, high-yield savings accounts, and other cash equivalents, along with any of their potentially underappreciated risks? If this is something that has already been discussed, could you point us to the episode?
Best wishes from a fellow Northeastern alum, Jacob E.
Ben Felix: Cool. We have not done an episode on that. Could be interesting though.
I did get one other, I can't remember where this came from, an email or a LinkedIn message, but I posted it into this episode for future reference. Someone said, I'm sending this at an odd hour now that my newborn has gone to sleep. I began my financial services career in 2015, acquired the CFP designation in 2018 and have listened to your podcast since 2019.
I first found your content daunting because I was trained to sell proprietary variable annuities and insurance by my original broker dealer and the academic research you covered hurt my head to process. I listened to your new shows each week, driving to work and a far better advisor and investor for consuming your show for years on end. Your hard work has unknowingly improved my career and helped several hundred households in the Rochester market. Very nice.
Ben Wilson: Seeing comments like this are always encouraging and it's pretty common. We've seen lots of advisors that are benefited from the content and in turn has benefited many Canadians and investors around the world, which is great and part of the mission that we're trying to achieve as a company together.
Dan Bortolotti: Whenever we connect with an individual listener, it's always great because you feel like, okay, maybe we might've even changed somebody's life, but if you connect successfully with an advisor, you just compound that because that person can then bring what they've learned to all of their clients. It's nice to be able to appeal to the professionals as well as the retail investor at that level.
Ben Felix: Totally. I think we've seen this, Ben, with your role in our entrance into the M&A market here in Canada. We've been talking to a lot more advisors and I think the frequency with which the podcast comes up as one of the reasons that someone is interested in talking to us is pretty crazy.
It's definitely something that has impacted a lot of advisors in Canada and now that we're on this path of hoping to attract more advisors, it's put us in a pretty unique position.
Ben Wilson: It's always fun to have those conversations regardless of what the outcome is. I'm looking forward to having many of those conversations this week at the DFA Advanced Conference in Santa Monica. Ben and I are going down tomorrow, so it should be fun.
Ben Felix: Should be fun. I do want to say real quick that in the Rational Reminder community, there's been a bunch of discussion about the disclaimer that plays at the end of this podcast. You guys listen to the podcast, I think sometimes.
I don't listen to it usually because I record it. I've never heard the disclaimer, but apparently it's quite long. Someone said though that if they had more context for who was reading it, it might make it better to listen to.
I'm going to say now that the disclaimer is read by Matt Gambino, who's our producer, who is on the recording with us now, so that's his voice. Actually, Ross, who wrote the disclaimer, he's one digital compliance. He's also here.
Hey, Ross. There you go. There's some context for the disclaimer.
Hopefully, nobody suffers too much. It's actually pretty funny hearing that there's a few people in the Rational Reminder community who are super vocal about how much they dislike the disclaimer. There are a lot of people who are like, dude, you can just skip it. What's wrong with you?
Ben Wilson: Yeah, exactly.
Dan Bortolotti: You're not compelled to listen to the end.
Ben Felix: I think they say that they'll be listening to the podcast as they're falling asleep and then the disclaimer comes on at the end. It's like, oh, it wakes them up. Anyway, let's go to the disclaimer. Thanks for listening.
Disclosure:
Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, Inc. (“PWL Capital”) which is regulated by the Canadian Investment Regulatory Organization (CIRO) and is a member of the Canadian Investor Protection Fund (CIPF). Investment advisory services in the United States of America are offered exclusively by OneDigital Investment Advisors LLC (“OneDigital”). OneDigital and PWL Capital are affiliated entities, however, each company has financial responsibility for only its own products and services.
Nothing herein constitutes an offer or solicitation to buy or sell any security. This communication is distributed for informational purposes only; the information contained herein has been derived from sources believed to be accurate, but no guarantee as to its accuracy or completeness can be made. Furthermore, nothing herein should be construed as investment, tax or legal advice and/or used to make any investment decisions. Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional adviser to see how the information contained herein may apply to your individual circumstances. All market indices discussed are unmanaged, do not incur management fees, and cannot be invested in directly. All investing involves risk of loss and nothing herein should be construed as a guarantee of any specific outcome or profit. Past performance is not indicative of or a guarantee of future results. All statements and opinions presented herein are those of the individual hosts and/or guests, are current only as of this communication’s original publication date and are subject to change without notice. Neither OneDigital nor PWL Capital has any obligation to provide revised statements and/or opinions in the event of changed circumstances.
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Links From Today’s Episode:
Stay Safe From Scams - https://pwlcapital.com/stay-safe-online/
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/
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Benjamin Felix — https://pwlcapital.com/our-team/
Benjamin on X — https://x.com/benjaminwfelix
Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/
Dan Bortolotti — https://pwlcapital.com/our-team/
Dan Bortolotti on LinkedIn — https://ca.linkedin.com/in/dan-bortolotti-8a482310