Most investors are scared of the same thing. What if I invest and then the market crashes tomorrow? I mean, just imagine for a second investing moments before the dot-com crash, or at the peak of the Japanese bubble, or how about just before the Great Depression. Ben Carlson is the author of popular investing blog Wealth of Common Sense and director of institutional asset management at Ritholtz Wealth Management. In his new book, Risk and Reward, he looks at the history of the biggest market crashes and what they can teach us about investing when the future feels uncertain. As you've probably noticed, I injured myself recently, which meant that I couldn't travel down to London to make a recent recording batch for the podcast. So, we reached out to Toby Newbould last minute and asked him could he do us a favor and step in for me. And he kindly agreed to be the co-host for four episodes. So, for the next four episodes, I won't be in them. I'm going to leave you in the very capable hands of Toby and Tain, and I'll just pass over to them now.
Welcome to Making Money podcast. Ben Carlson, author of the famous blog Wealth of Common Sense and also his new book, which is directly behind him. There's actually two copies in this room already. One I'm looking at and one's already in my bag. Um, that was a great book. By the way, I wanted to start kicking off right at the hot topic of the moment, which is pretty much that stock markets have been close to all-time highs or hitting new all-time highs very often. Lots of investors here, certainly in my channel in the comment section, are all very, very nervous. Um, if someone's coming to you right now, whether they're clients or other people, talking about markets at all-time highs, what would your response be to them?
Generally, it's understandable that people are nervous because it's like one of those all-time highs is going to be the one, right, before there's a crash or something bad that's going to happen. And I think that's what makes people nervous. The crazy thing is, if you look at the data, investing at all-time highs is actually better than investing on any other days. So, like the average returns from investing at just all-time highs is actually slightly higher going out one, three, and five years than just pick any other random day outside of all-time highs. Um, now the thing is the stock market has been booming of late though, so it's understandable that people are nervous like what comes next. So, I guess what I would tell them is now is a great time to try to reassess your risk profile, right? Am I taking too much risk? Am I nervous? Like am I okay holding the amount of stocks that I hold right now? Would I be okay holding them in a bear market too?
And I think that's what, you know, you don't want to reassess once stocks have already gone down. Then it's too late. So now I think you go, okay, is my allocation of stocks too high? Do I need to pull it back a little bit? I think that's the conversation people need to have these days.
Yeah. And do you think that's the same sort of question? So we get a lot of new investors. So maybe touch on this a bit later, but in the UK there's a lot less direct investment in the stock market. Most people have got a pension but very few, a lot less people are involved in the stock market. If someone asked you again, is this a good time to start investing? Would your answer be a similar thing as well?
I think my answer would be a lot of it depends on your time horizon and if you're a new investor and you're a younger investor and you have many, many years and decades ahead of you, then yeah, I think it's a great time to invest because you have time behind you, you know, it's the wind at your sail. Right. You have a lot of time ahead of you. If you need to spend the money in the next couple years, maybe the stock market is not the right place for you. So, I do think that risk means different things to different people at different points of their life. Like, if you're going to be putting money in out of every paycheck, you know, you get paid every two weeks and you're going to put a little bit of that in the stock market, then you shouldn't be that nervous about down markets. It should be welcomed in some ways because you're going to be buying at lower prices. I think that's the kind of mindset versus someone who's a retiree who has no income coming in and they're just relying on the stock market or their investments to fund their portfolio. Then they have to be a little more nervous about those bear markets.
How unusual are all-time highs or usual?
All right, so I looked at this in the US going back to 1950 and it's something like 7% of all trading days hit an all-time high. So that might seem high to some people, low to others. So, I guess the thing is if you flip that and say, well, 93% of the time we're not at all-time highs, right? Um, most of the time you're in some sort of state of drawdown. Even right now, the US stock market is like 2% from all-time highs, right? It's fallen a little bit. So, it's not like it happens every single day during a bull market. Um, and I guess the point is over your investing life cycle, your horizon, if you're invested for many, many years, all-time highs are a perfectly normal part of investing. It is just like, oh man, one of them is going to be like the peak, right, before the 2008 crash or before the dot-com burst. Like one of them is going to be like, and that's what makes people nervous. And I think a lot of people have this mentality that when I put money in, I'm going to jinx it and the stock market is going to fall. Right? Everyone has that in the back of their head going, 'Oh my gosh.' So, I mean, you do have to have a plan for it. You can't just hope that the market keeps going up all the time. I think the point is you have to have a plan for investing when the market goes down too and how to deal with it because volatility is like the price of admission in the stock market. You can't get rid of it.
It's interesting. Um, obviously in the book you talk a lot about market timing and timing the market. It's a phrase we all say, like I've said on my channel numerous times, but I still get people commenting things like I'm just going to hold cash on the sidelines until we get a dip. Oh, it's all-time highs or we're close to all-time highs, therefore I'm not going to invest. What would you say to those people who are just convinced that they can time the market?
It's really seductive and it really seems like why shouldn't I be able to do this? I'll just take my money out. I'll sit in the safety of cash and then when the dust settles after the stock market falls then I'll put it back in. It sounds so easy and the problem is that you have to be right twice. You have to not only get out, like getting out is easy. So there's this old like Roman army thing that says that action removes fear, right? So if you're scared of the stock market right now, doing something removes that fear, like I'm just going to hit the sell button and then I'll figure the rest out later. And the problem is that's the easy part. The first part is always the easiest, the hitting the sell button. The hard part is when do you get back in? And you could say, well, I'm going to get back in when the stock market falls 20%. And that sounds great, but what happens if in the meantime the stock market rises 50% from there? Do you go, 'Oh, shoot. Am I going to wait till it gets all the way back to this point and then invest or am I going to like chase stocks higher?' And that's where the psychology of it gets, it can really play head games with you. And the other part is, let's say you time it perfectly and the stock market does fall like 10% immediately. You sold, the stock market falls 10%. Oh my gosh, I'm a king, right? I showed the market gods.
Then you probably go to yourself, wait a minute, but what if the market falls even further? And then it becomes like cash becomes this addiction and you're like you can't force yourself to put it back in. So that's the hard part is the psychology behind it, that it's always something where the market can play games with you and it's just really difficult to do. And even if you do get it right once, I sold and then I put my money back in and it worked out. Uh, I've never met anyone who can do that consistently. So you do it right, you do it once and it's almost the worst thing that could happen to you because then you think I can do it again and it's really, really hard to do. It's basically impossible.
To illustrate that point, you told a story about a colleague who did time the market right but actually ended up worse off afterwards. Uh, can you explain to us what happened?
Yeah, I had someone who in 2008 got out in like September, right? And just before all the Lehman Brothers stuff happened and AIG and all these banks around the world are failing and the stock market fell a further 40% or something, and she felt like a genius. She was walking around the office with like her chest puffed out like, look at me, you know, like I did it. And then she slowly but surely got back into the market and then a couple years later there was all this stuff with the Greek debt crisis, right? And European debt crisis and people are really worried about that. Remember people were concerned the European Union is going to break up and like the euro is going under, all this stuff. So she does it again and we had a little bit of a pullback but then the market kept going higher and kept going higher and she got left behind. And then at that point she's kind of thinking, 'Oh my gosh, what did I do? I don't know what to do anymore.' And we had this with a ton of clients in the early 2010s where like 2015 people would come to us and say, I've been sitting in cash since 2008 and I'm terrified. I don't know what to do. I'm just, I'm paralyzed. Help me and put this money to work because I can't force myself because I missed out on this huge snapback bull market rally and I've just been waiting for another crash and waiting and waiting and it hasn't come. And that's the hard part about market timing.
Just on a side note, do you think that, I guess one thing firstly, do you think we're always going to keep doing this as humans? And secondly, I guess do you have clients that call you up with that same sentiment that maybe have got a lot of their portfolio in cash or something or they've again paralyzed themselves?
I do think it is just human nature in a lot of ways. I think people can get better at this. I don't think, I think there is something to it where some people just have to, like there's this idea that you should stand on the shoulders of giants and learn from the mistakes of those who came before you, right? Some people have the ability to do that. Other people have to touch the hot stove first, right? They have to do it themselves. I have a financial advisor friend who says he'll have people come to him and say, um, I want to be a client of yours. Here's, you know, what I do. Here's how I do it. And he'll say, you're not ready for me yet. Go back and make some more mistakes. Come back to me in three or four years when I think you're ready. So, I think some people just have to go through this themselves. They have to like pay their tuition to the market gods and test it out for themselves to see because it's funny, a lot of people understand like there is no like really holy grail, like there's no perfect way to invest, but everyone has that little voice in the back of their head that kind of goes, yeah, but what if there is for me? Like what if I find that secret key to the secret door or whatever it is? And so I think some people just need to figure it out. But yeah, you're right, the human nature element is the, that's the one constant across every market environment, every person, and that piece of it is never going away.
Um, I know you probably touched on this briefly earlier, but um, you did write a blog post about what if you only invested at market peaks. I believe it's like one of your most popular ones and you had this character Bob. Do you want to just go through that briefly for everyone? Um, and explain what you were trying to explore in that post.
Yeah, it's funny. I wrote that over a decade ago. And the reason I wrote it is because of your initial question about all-time highs. It was we had the market peak in 2007 before the great financial crisis and we had this huge 2008 financial crisis and then it took until 2013 for new all-time highs again. So this is a really long time between all-time highs and we hit all-time highs again and everyone said, oh my gosh, I remember what happened last time. Is it going to happen again? Are we going to run off the cliff Wile E. Coyote style and just fall? And so I said, okay, let's play, you know, let's put up a scenario here where what if you did just have the worst luck in the world and all you did was invest at all-time highs. You saved money in your bank account and you hoarded cash and hoarded cash and you put your money in right before an all-time high and then you had a huge crash. So I looked at, you know, this guy invested over 40 years. He invested before four or five of the biggest crashes in that time, right? He lost 50% of his money in the 70s and he had the 1987 crash and the dot-com bubble and the 2008 crash, all these times. But his one saving grace was that he just, once he put it in, he kept his money in, right? And when I ran the numbers, I didn't know what it was going to look like. I was just curious. And the numbers, I'm like, 'Wow, these are way better than I thought they would be.' And so I sent them off to one of my colleagues, Nick Maggiulli. He writes at Dollars and Data, and he says, 'No, these are right. You did it correctly and it's better than you think.' And we both kind of went, 'Huh, interesting.' And the reason that it worked is because he had a long time horizon with the money that he kept in the market, right? He made terrible timing decisions on his purchases, but he kept the money compounding in the market. He didn't interrupt it, and that was his saving grace.
And I think the numbers, he still got like 8% returns per year and ended up a millionaire or something. Uh, and yeah, that story really resonated. It was actually kind of the inspiration for the book. Yeah, because I also had a lot of people saying, 'Okay, that's fine. Bob did this in the United States, but what if he did it in another country that didn't fare so well?' So, I had a lot of pushback. And I said, 'All right, fine. I'm going to write a book that's going to kind of go through all the exceptions and pushback to the long-term trends that I espouse.'
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Yeah, it was interesting as you mentioned Nick. He also wrote a really interesting blog post. I've covered it twice in my videos, but it was exactly, it's 'Even God Can't Beat DCA'. He did a similar setup basically saying this person hoards cash, only invests in market bottoms, and basically he doesn't even come, it's not a huge difference, but the DCA person basically beats him just ignoring all the market noise with no perfect timing and even the perfect timer doesn't really come out that much better anyway.
Which it's so weird, isn't it? You wouldn't expect that at all but it's weird how markets work. No. And I looked at this soon and I said, see, sorry, we just got to clarify for our audience what DCA is. Dollar cost averaging. Sorry. Dollar cost averaging. Yeah. That's basically putting money in regularly. Yeah. So if we get too jargony, we always use this button because we like to try and keep a very broad audience. So if I use jargon, hit the button for me too. Um, I actually looked at this thing and I said, well, what if Bob would have bought at the bottom of the bear markets instead of the tops? And then I compared that to the dollar cost averaging, right? And actually the dollar cost averaging beat if he would have just hoarded all his money and put it at the bottom.
So the point is most regular people put their money in on a periodic basis because that's when they get paid. So it's not like you're trying to time the market or something. You know, some people sure have a lump sum because of an inheritance or a bonus or something, but most people, the majority of people get paid, they take money out of that paycheck, they put it into their retirement plan or their brokerage account, and they invest it every week or two weeks or month. Right. And the great thing about that is that you're diversifying your entry points into the market, right? Sometimes, sure, you're going to buy when stocks are overvalued or stocks are too high. Other times, you're going to buy when stocks are too low. Most of the time, you're buying when it's sort of in some middle phase where it's not too high, it's not too low. And I think that's the beauty of dollar cost averaging, that it takes away a lot of the guessing game of, oh geez, should I put it in here or should I not? And that's why I think most people are better off just having these things happen automatically and not thinking about them.
I think a lot of people like to point to Japan as proof that like a downturn can last for decades. What do you think most people take from the Japan example and what should they take and how should they look at it?
So this was the biggest pushback for me on the Bob story is everyone kept saying, okay fine, that was the US, now show Japan. Look what happened in Japan. Japan topped in 1990. They didn't hit new all-time highs again until 2024, I think. Right. You not only had a lost decade, you had like a lost three decades if you put money in at the top there. Um, and what I wanted to show in the book is that the long term, the really long term in Japan, it actually has been okay. If you look at the last 50 years in Japan, the returns are like 9% per year. It's just that they had such a huge asset bubble in the 1980s when everyone thought Japan was going to take over the world, right? Japan's going to be the biggest economy. At one point the Japanese stock market was the largest one in the world. Like the US is that now, but Japan in 1989 had the biggest share of global stock market. They were 45%. They went all the way from 45% of the global stock market down to 5%. And the point is that they compressed their returns in such a short period of time. In the 1970s and 1980s, the Japanese stock market was up more than 20% per year. And so to get kind of the long-term average of 9%, the returns had to be bad going thereafter. And I personally think, and I kind of make the case in the book, that Japan is the biggest asset bubble in history. It was, and it wasn't just the stock market, it was the real estate market and people kind of lost their heads there. It's kind of funny they haven't really had any bubbles like that since, anything even approaching that. And the point was just that there's mean reversion. So if you have really above average returns for an extended period of time, you have to have below average returns following that to sort of even it out. And that's what happened in Japan.
It was great because obviously you dedicate a chapter in the book to this and I remember you saying one of the stats that was really interesting. Was it the grounds of the Imperial Palace, they valued it basically the same as the entire Canadian real estate market or something like that, or stock market?
Tokyo, Tokyo, the real estate of Tokyo was worth more, just the city was worth more than the entire real estate market in the United States. And so it was just bonkers. That's the thing. It was crazy.
And that I think just shows about trying to time bubbles and things when you're in it. I guess so many people would have jumped through and done so many mental gymnastics to say, 'Oh, this is perfectly normal. This is just going to keep going and keep going.' Um, on that note, actually our next question just talks generally about the US. Now the US has been an exceptional stock market, you know, for a very, very long time and I guess the question would be do you think that exceptionalism can continue and what should people be thinking about because like we touched on at the beginning, it's almost like you keep seeing something doing so well that your brain just says, well, it has to stop doing so well soon, it has to crash soon. What are your thoughts around that?
Yeah, so the US coming out of the great financial crisis was 45% of the global stock market, today it's like 65%. So you're right, it's been by far the best performing country really since the 2008 financial crisis, but over the past, you know, 10 or 15 years especially. Uh, it's interesting to note that yeah, over the last two to three years, a lot of the foreign markets have started coming back in a big way and you're seeing things spread out. I think the way that I look at it is that technology, especially in like a world of AI, I think really flattens the world. And I think if people assume that all of the good ideas and all the good innovations and all the motivation to improve yourself and have the corporations increase profits and ingenuity and these things that only come from the US, I think that's really shortsighted. Uh, there's the phrase that winners write the history books, right? Of course, the US has been by far the best performing stock market, and we have some of the biggest and best companies, but I think you're already starting to see it that, you know, with places like Taiwan and South Korea coming up in recent years where like they're being beneficiaries of the AI trade, and this thing has really gone more global, I think, than anyone. So I am a big proponent of international diversification because the people who worry about a Japan-like situation, if you have all your money in the US, I'm not saying we could see another Japan because things would have to get really crazy to get to that point. Um, but, you know, you can still have extremes where, you know, one country does really poor and other countries do well. That happened and it wasn't that long ago here.
Yeah, it's a really interesting one because on my own channel I talk about, I think UK investors and international investors especially will look at, they tackle a big question. Should I just invest in the S&P 500 or should I invest in a global index fund? Now my personal preference has always been to global. I think going along the lines of what you've said, as the world gets more globalized and it's almost irrelevant where a company is based. Would you kind of agree with that to a certain extent? You know, like you mentioned, you can have a South Korean or Taiwanese chip manufacturer be listed in the Taiwan stock exchange, but ultimately it can sell all around the world. What would be kind of your thoughts on that prospect for investors?
Yeah, I think if you invested your money for the long term in just the S&P 500, you would probably be fine. I think you would probably end up okay. It's the biggest, best companies in the world. Um, but you know, it wasn't that long ago that in the decade of the 2000s, the first decade of this century, the S&P 500 went nowhere for a whole decade and I think it essentially lost money over 11 or 12 years, right? Nowhere, lost decade, but a bunch of other asset classes did just fine. If you invested in small or mid-cap US companies, you did much better. If you invested internationally in foreign markets or emerging markets, you did a lot better. And so I think that's the point of diversification. It's not like any days or weeks or months, it's like these really long cycles that you could have these big bouts of underperformance. I think that's where diversification really shines. And I don't know how the future's going to play out. And I think that's one of the, you know, Peter Bernstein, I'm paraphrasing here, said something about how diversification is like admitting your own ignorance about the future. And I don't know if the US is going to continue its dominance like it has. Um, it could just be a way more mature market and there's other markets that are coming up that could sort of, you know, take some of the share. So I think that's the thing, is like as a risk management strategy, it not only helps manage risk against those bad times, but I think it casts a wide enough net so you can potentially find the winners where they often come from places that are unexpected and you don't know ahead of time.
Yeah, absolutely. Absolutely. Hit me with some of your least favorite life admin tasks. I don't do much admin, but the one thing I hate doing, which I have to do regularly, almost every day, is take out the bins because I walk down and I'm obviously tall and I somehow manage to bang it on my leg and then it either explodes or has a hole in it and leaks bin juice all the way down my stairs or it's just like, I just hate taking out bins. What about you?
You need some better quality bin bags. And I don't know what being tall has to do with it hitting your legs. A short person's going to get clapped by the bag just as much.
I think it bounces obviously because I'm tall.
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So in the book you look at the Great Depression. Um, do you think that could happen again?
I don't, um, just because I think the financial markets are so much more important than they were in the past and I think policymakers have kind of learned. It's interesting. If the Great Depression never happened, um, a lot of the things that we take for granted today wouldn't be involved, right? A lot of financial regulation came out of the Great Depression. Like the SEC and financial regulators, um, in the US, we didn't have any backstop for people. There was no social security. There was no unemployment insurance. It was kind of like if you got ruined by a financial crisis, you were just ruined. There was no backstop at all. And the Great Depression kind of helped that. And then a crisis like the 2008 financial crisis where it seemed like the financial system could have really gone under, policymakers looked at the mistakes that they made back then and they said, 'We're not going to make those again because we like, they really did let the economy just, you know, barrel off a cliff.' And so I think we've learned and you saw how quickly policymakers responded in 2020, right, during COVID around the world. Trillions of dollars were pumped into the economies, people were handed out checks. Uh, so I think we've kind of cut that outlier event off. Now the question would be like what other risks are we creating by doing so, but I think that, you know, I talked about in the book how I think 1 to 2% of households invested in the stock market back then because most people didn't have enough disposable income to invest. And so the stock market wasn't nearly as important. If the stock market fell 80% today, uh, there might be rioting in the streets or something. It's just so much more important to everyone's bottom line that I don't think policymakers would allow it to happen. Uh, so maybe I'm wrong, but that's kind of the way that I view it.
Yeah. Yeah. Go on. So I was just going to say, do you think...
Because there's so many more people in the market now, if there is a crash, it's easier to rebound because there's more people saying, 'Oh, it's a discount, I can buy in.' Do you think it's a bit more robust now with more people in?
I think that could be the case, where yeah, there's more households who are tied to it, and people have also studied market history. You see this, you've seen it a lot. I mean, people have been pounded on the head for years and years now of, 'Hey, you don't run out of the store when things go on sale,' right, when stocks fall. Obviously, people are still going to panic and there's going to be forced sellers. If you took too much leverage and you're going to be a forced seller because you get a margin call, then there's nothing you can do about that. But I do think people have kind of learned their lesson, and we've seen it this decade alone. Anytime stocks have fallen hard, money has rushed in. It hasn't rushed out the door.
And so I do think that there is something to this fact that yeah, there's just, and especially there's more retirement. You know, people in the US used to rely more on pensions, and now it's these automatic retirement savings vehicles, and the fact that people are putting that money in on a regular basis again without thinking about it. I do think that's had a really big impact on how the stock market functions that wasn't like that in the past.
Which then kind of leads me on to another, I guess the question after that is almost like if we do have some crashes in the future, I know it's almost impossible to predict, but do we think that they're ever going to be as bad as what they were before? I mean, it's difficult, isn't it? Like the global financial crisis, is that not really going to happen again? It's quite an outlier. Like you said, the Great Depression was a serious outlier. Are we now going to enter the era of super quick dips, you know, super quick market crashes which very quickly correct, and like you said, policymakers instantly rush to correct things and print money and put rates to zero? What does it mean for the future?
I don't think that we've like totally rooted out financial crisis situations. Like there still could be, you know, banking crises or something, you know. Um, if you think about AI, how tied into the economy it is, like I think a huge slowdown in AI spending could actually lead to a minor recession. I think that's, you know, that wouldn't be like a financial crisis-like situation unless things got really bad, I guess.
But I think there's also this idea of like the wealth effect, where people are more comfortable spending money because their stock portfolio has gone up so much and their house is worth way more. So they kind of go, 'I don't really need to save as much because I made a bunch of money in the stock market, so I'm just going to keep spending it.' So I do think there could be a reverse of that, where if we have a more prolonged downturn and people start losing jobs, I think that's the thing we haven't seen this decade really, and you've seen the reason people have been comfortable rushing back into the stock market is because they still have a job.
Right. So the unemployment rate in the US has been below 5% really since the pandemic, that period ended. And so I think if people started losing their jobs and we had a real, you know, economic slowdown, I think that's when people might get a little nervous and say, 'All right, I can't afford to put more money in the stock market.'
And only certain people could. And I think that's when it, and I don't know what the reaction function to that will be because we haven't really had it in a long time. We haven't really had, I make this point a lot, we haven't had a real recession in the US since 2008. Like the one in COVID was a month or two long, but it wasn't a real economic cycle. It was, you know, we turned the economies off for a couple months and turned it back on. And so I don't know how people will react because it's been so long.
You said during the briefing call that people see history often as like a checklist, and right now we're in the AI bubble, which looks similar to the dot-com bubble. What do you think the difference is between the AI bubble and the dot-com bubble?
I think there are a lot of similarities, right? Of course. Like anytime a new technological innovation comes along, people get super excited and extrapolate out the future, right? And money pours in and you're getting all of that stuff. It's kind of like if it looks like a duck and smells like a duck, quacks like a duck.
But I think the biggest difference now is just that these are the biggest, best companies in the world that are doing this, right? And it doesn't mean that they can't make mistakes and they can't go overboard. But in the dot-com bubble, a lot of these companies not only had no profits, they had no revenues. So the fact is that these companies are so, you know, we're talking about these multi-trillion-dollar companies now, right? Nvidia and Microsoft, and they sure can make a misstep. I think that's the thing that is different, is just that the quality of the companies that are leading the charge are much higher, and these companies are so huge that I think it does kind of make a difference, and there's probably a bigger margin of safety than there was back then.
