Wall Street Pro Reveals Why He Ditched Trading for Index Funds
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What if one of Wall Street's most legendary risk takers told you that slow and steady actually wins the race? Victor Higani, once at the center of a high stakes hedge fund, now champions low cost, long term index fund investing. In this episode, we unpack how he got there and how his hard earned lessons could protect your fire portfolio from burning out.

Hello, hello, hello, and welcome to the BiggerPocketsMoney podcast. My name is Mindy Jensen, and with me as always is my slow and steady co-host, Scott Trench. Thanks, Mindy. Always great to see the expanding portfolio of introductions that you bring to every podcast. Today, we're talking to Victor Hagan, two-time TED Talk presenter who got his start at Salomon Brothers and founder of Elm Wealth, a low-cost ETF management company. Welcome to BiggerPocketsMoney, Victor. Great to be on. Before we get started, I want to thank you for joining us.

we get started talking about index fund investing and long-term diversified portfolios, I would love to hear just a little bit about your background. What has your investment journey and your experience with investing been like? So I'm 63 years old, and I started working in Wall Street in 1984 after studying finance. And I started off working in the fixed income area and research

And then I moved out onto the trading floor and was doing bond trading for my Wall Street career that went through Salomon Brothers and then into the hedge fund LTCM. So from 1984 until about 1999, I was a bond person. You know, amazingly, I came to Wall Street and I just didn't.

wasn't told anything about personal investing. I wasn't taught anything about personal investing. And I didn't know anything about personal investing, and I didn't pay any attention to it. So here I was, you know, like, I don't know, like kind of at the forefront of financial innovation, working with Nobel laureates and finance and lots of other smart people,

But I just didn't have a clue about personal investing and why. Well, I was really busy. I was learning a lot about finance, but not personal finance, about personal investing.

And I just didn't really do any investing. There were also compliance constraints around working at a bank in terms of what you could do. So basically, you know, I was just making money, you know, more or less not really investing it. And then when I worked for the hedge fund, LTCM, you know, then the natural thing to do was to take a lot of my savings, too much of my savings and put it into the hedge fund, which was a lesson learned.

an expensive lesson in diversification and overconfidence. So I really made it through almost 20 years of working in Wall Street without thinking about how to invest. So when I came out like 1999, 25 years ago,

I was like, OK, I've got to focus now on investing for my family. I was taking a long sabbatical. You know, I was coming out of the industry. And so I looked around and I started down a path of like following what I thought were really smart things, like what David Swenson was doing at the Yale Endowment. And I don't know, I just thought that it made sense for me to be an investor in private equity and venture capital and hedge funds and all this.

And it took me about six years till I woke up from that wrong fork that I think I took and decided to go back to basics, to go back to what I had been taught at university and to become an index investor. And so I really kind of went through these different phases. And so since about 2006, I have tried only to invest in index funds. You know, whenever I see, you know, a single stock recommendation or a private investment, I've mostly passed and turned them all down and just...

kept on moving my family's savings more and more into index funds. Another thing that I think will be really interesting in my journey for your listeners is that once I decided to invest in index funds and to become primarily or solely an index fund investor for my family,

I realized that there were still these questions, not terribly difficult questions, but still questions I needed to answer. How much U.S. equities did I want? How much non-U.S. equities did I want? How much did I want factor exposures and smart beta? Did I want to change my asset allocation over time? Was I going to solely be basing my asset allocation on market cap weights?

within the global equity market. The more I thought about all that, the more I realized that while stock investing could make sense as a passive market cap weighted investment approach where it's like, okay, I want to invest in VTI and own all of the US stocks.

weighted by their market caps. And I think that makes a lot of sense that you can't do that with asset allocation. So I think that asset allocation always has to be an active thought through deliberate decision, because you can't just say, I'm going to use market cap weights to decide how much to have in stocks versus bonds. If you do that, you would wind up with like 15% in stocks and the rest in bonds and fixed income because bonds and fixed income are like six times bigger than

than the market for global public market equities. And so when you get to the point of the asset allocation, you have to then think about the expected return of equities relative to safer assets, their risk,

And, you know, your personal risk aversion. So once I decided to be an index investor, the last piece where I decided I needed to be like a an eyes open dynamic index investor was the last piece of my journey. And I've been sticking to that ever since, you know, around 2007 or eight. And then I started Elm Wealth.

to offer this to other people as an investment approach at the end of 2011. I don't know if that qualifies as brief. Well, no, but it's very interesting. And now I have a thousand more questions to ask you. First of all, I want to go back to where you said, I made it through 20 years working for Wall Street without really investing personally, for lack of recall exactly what you said. Is this

common among Wall Street workers? Because I'm a real estate agent and there's so many real estate agents who are like, oh, real estate investing is really, really powerful and I don't invest in real estate. So I'm wondering if this is something that happens on Wall Street, too. I think it happens a lot. First of all, you come to Wall Street and nobody talks to you about personal investing. You're working in investment banking. You know, you're doing, you know, corporate finance. You're working on a bond trading desk. You're a salesperson, whatever it is.

Basically, as far as I know, from early 1980s until now, you come to Wall Street and they will train you in everything that you need to know to make money for your bank. But they're not going to train you in what is the most sensible way to take your money.

earnings that you're making by working there and invest them sensibly and wisely. I think that to whatever extent, like if you go to Wall Street and you work in private banking, what you're going to learn is how to make the most money from your clients while keeping them relatively happy.

So you're still even if you're in the area that you would think is the best place to learn about personal investing. I think that the conflicts of interest are going to teach you stuff that isn't really that good for you as an individual investor. So I think it's really common. You know, there are all of these compliance constraints that stop you from doing active investing if you're working for a bank.

And then also historically, I left this part out. But when I worked at Salomon Brothers, they took half my money and put it into Salomon stock. So all of a sudden I had a lot of risk anyway. You know, like half of my money was in Salomon stock. And then the other half of the money I would get. And then I had to pay tax on that. So I wound up and then I had to spend it on rent and living and all that. So over time, I just had more and more Salomon stock.

and less and less money at the bank or in treasury bills or money market funds. So I think it is really, really quite typical. Although over time, I think with the availability and cost of index funds going down, the availability going up, the knowledge about index funds going up,

I think more and more young people come to Wall Street and they realize, I'm going to put my money into index funds. And then also, don't forget that the whole 401k IRA thing was really just getting started when I started on Wall Street in the early 80s. You know, now people going there, they'll get their 401k plan. They know that they should put a lot into it because it's pre-tax. And then they'll have these good options in general in their 401ks that are nudging them into a better direction future.

for their investing. So I think things are a little bit better, but in general, yeah, I think it's really typical. You said in 2006, that's when you made the jump to index funds. What was your net worth before 2006? And where was it allocated? Was it still all in Solomon stock or did you sell that when you left? Well, I left Solomon in 1993 when I got married.

And I joined, I was a co-founder of a hedge fund, LTCM, which spectacularly blew up in 1998. So I had a lot of our savings in LTCM, came out of LTCM. Luckily, I didn't have all of our savings in LTCM. From 1999 on, you know, I was really focused on just trying to grow our wealth in a sensible way. You know, I guess in 2006, you know, my family's savings was probably

a quarter of what it is today or something like that, or a third of what it is today. In 1999, I had lost a lot of money, but I was a fire. I was financially independent and I had retired early. And from like 2000 or 2001 until 2011, I was an at-home dad. I was with my young kids and I devoted that period to being retired. And then I started back up working gently in 2011. Mm-hmm.

you know, the way you're presenting it, it makes it appear as if you just made so much money on Wall Street that it overcame the lack of investing and so much money managing the hedge fund that even when it blew up, you still had enough assets to be financially independent, retired early in 1999. Is that the right impression that I'm picking up from the story? I mean, it also, you know, that my family's spending needs

you know, were not off the charts. But yes, I mean, you know, that Wall Street was incredibly generous and kind. I was very, very lucky. I couldn't have done worse with my investing. You know, yet, you know, I made so much money on Wall Street that after all of that disastrous personal investing, you know, there was still enough for my family, you know, to retire. I mean, not to retire with yachts and private jets, really comfortable and being able to send our kids to university, however much it cost and all this stuff. We could have a comfortable life

life if I didn't ever work again from where we were in 2001 or so, I would say. All right. We've got to take a quick ad break, but while we're away, head on over to YouTube and subscribe to our channel. That's youtube.com slash at BiggerPocketsMoney. And if you want some diversification, you can go to Instagram and follow us there as well at BiggerPocketsMoney.

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Whether you're new to investing or looking to diversify your portfolio, BAM Capital offers the tools and expertise you need to reach your financial goals. So take the first step towards savvier investing today. Visit biggerpockets.com slash BAM to learn more and get started. That's biggerpockets.com slash B-A-M.

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Welcome back to the show. What was the catalyst or what was the core philosophical reasoning that drove you away from private equity and hedge fund investing to index funds? You know, it might be a little bit surprising for some. It was I sat down with my accountant, like I was looking at our tax return from like 2005 or something. I was like, David, why am I paying so much in taxes? I haven't made that much money in 2005 on our investments. This

This seems like such a high tax rate. What's going on? And he took me through the tax return and I realized...

how incredibly tax inefficient my different investments were. So I had all these investments, like say in private equity, where I was paying a management fee. There were other expenses that were flowing through. And those expenses and management fee, I couldn't offset them against my income. They were after-tax fees, for instance. Then there were all these different investments I had that were generating short-term gains. Sometimes I had some investments that were generating gains laterally.

that were bigger than the economic gains because they had some accelerated taxes. And so I just was like, wow, you know, if I were invested in index funds, you know, I'd be paying tax at a low rate on my dividends and I'd be paying capital gains tax at the long term rate when I eventually realize the gains. Like I wouldn't be paying even every year. So I'd effectively have a much lower tax rate in index funds.

than I would in all this crazy, frenetic, active investing I was doing. So that was like the catalyst where, wait a second, this, you know, like that got me thinking that I was going down the wrong path. Then I thought about it more and I was like, well, wait a second. So now let me get this right. If I'm invested, say in some hedge fund as a private investor, private US taxable investor with a decent amount of income, like this hedge fund has to make

a 15% return on its capital before fees and before taxes so that I wind up in the same place as some index fund on owning stocks earning 6%. That's right. I mean, it's incredible. 15% the hedge fund needs to make

to get to the same place that I would be with an index fund making like 6% or so. And that's because first of all, the hedge fund has got two and 20 fees, right? And then the hedge fund is tax inefficient for me. And you put those together. It's like, wait, I mean, it doesn't even have to be 15%. Call it 13% versus 6%, right? It's like, this doesn't make sense. Remember, I was a hedge fund guy, you know, too, you know, but as I thought about it as a private investor, etc, I just didn't think that

could possibly make sense. So I really started to think about the fees, what it was doing, the diversification. I wanted so much diversification. Any investor, the only two ways you can beat the market are concentration. You have to be less diversified than the market. You have to make bets that are concentrated and or the use of leverage. Those are the only two ways. There's no other way to beat the market other than to be concentrated in your positioning and

and or using leverage or both, you know, use doing both. And, you know, I just wanted diversification, I didn't want leverage, I wanted to reduce tail risk as much as I could. And so the catalyst was taxes. And then, you know, as I thought it through, I was like, I'm a private investor, I value my time.

This is crazy. I've got to just simplify and just get back to basics and invest in index funds. So I was looking up, I was trying to find some sort of statistic to actively managed funds outperform the market in general. It says before costs and fees, active managers on average beat their benchmarks by five basis points.

After costs and fees, they underperform the benchmarks by about five basis points. So it doesn't really make sense to go with those actively managed funds because it doesn't matter about before costs and fees. That's not what I'm paying. I'm paying after costs and fees. So they're underperforming. Why would I continue to invest in an underperformance? I mean, yeah, every once in a while, there's one. Please don't email me and tell me about this one.

One time your fund outperformed by like 30%. Great. I'm so happy you had that success. But also, that's not the norm over time. Yeah, absolutely. And that's only half the story. Because the other half of it is that these funds are taking more risk. Because remember what I said, the only way you can beat the market is to take more risk, either through leverage or concentration. So...

All active funds on average have to be taking more risk than the market portfolio. So not only should you expect a lower return after fees from actively managed funds, but

But on a risk adjusted basis, it's even worse. So that was the decision I had to make when I kind of glossed over that. But when I decided to invest in index funds, I decided I wanted to invest in broad market market cap weighted index funds. I didn't want to get into, you know, value stocks or growth stocks or quality stocks or whatever. You know, I really wanted to have

a broad market representation of my stock investing, be it in the U.S. or ex-U.S. But I kind of skipped over that because I went from being in the most concentrated risky things, these hedge funds and private equity and so on, right to index funds. And I skipped over the actively managed funds. Like once I decided I wanted to be in funds and low cost funds,

I skipped over like actively managed stock picking funds of all flavors, whether they be smart beta or star investors or whatever. You know, I just wanted to go right to market cap weighted index funds for the reasons you said and also this risk reason. I would just love to react to what you've said here about the advantages of index fund investing or low cost index fund investing specifically versus actively managed funds. And I'll frame it this way.

One, if you want to get an outsized excellent return, you must do something contrarian, something that everyone else is not doing by definition, and you must typically concentrate those investments. So a private equity firm that invests in 10 businesses, for example, in a niche industry could outperform the market.

That's why they're going to get the 2 and 20 fee structure. That can fool you, however, because that outperformance can happen for 1, 3, 5, 7 years in that particular sector, and it could be totally different in the next 7 years. So it's really hard to pick those winners. And the other trap that you can find with actively managed mutual funds is that they're really not that different from an index fund investment. They really have a large number of holdings in a widely diversified basket of

of investments and if they are doing that the returns are going to be very close to the index fund before fees and after fees they're gonna underperform and so the index fund is just the better answer for the vast majority of people who are not going to attempt to

try to outperform the market and if you're going to output try to outperform the market i feel like you got to make a concentrated set of bets in some of these and you got to be ready to hold on for the ride because you're going to get a different type of return if you go with something that is truly uncorrelated or truly has a chance to outperform over time

How am I doing? Do you agree with that, Victor? I agree with all of that. I would put a little bit of icing onto that cake that you baked and say that if you do decide to try to beat the market by doing something different than the market, right, you have to do something different than the market. You also have to realize that there's somebody else who's doing the opposite of what you're doing. And who is that person that's doing the opposite, right? There has to be somebody that if you're going to underweight some stocks and overweight other stocks,

somebody else out there has to be overweight and underweight. They have to be on the other side. And who is that? You know, is it somebody that's smarter than you, better equipped than you or not? Who do you think it is? And I would say that in general, you know, if I were trying to do that, I would definitely feel like the minnow with the sharks, the sharks being on the other side. So in some ways, contrarian doesn't

mean anything in the sense that if you're a contrarian, there's somebody else that's contrarian because they're also being different than the market portfolio of stocks. Contrarian might not be quite the right word. You're just taking some bets and somebody else is taking the opposite bets. And which one of you is going to win those bets knowing who's out there

whether it's the Citadels of the world or whoever, knowing who's out there, I would be afraid to do that because I know that in general, the other side of my trades is probably going to be somebody much better equipped to beat the market than I am. And they need me. Where is Citadel and Jane Street and these guys making their money from? They're making their money from all these people that are trying to beat the market but are not well-equipped. The only place where I attempt to beat the market in terms of better risk-adjusted returns is

is with rental real estate properties in Denver, Colorado of the type that I've been buying for the last 10 years, right? And there's no fees associated with that. - Right, it's a business. It's not investing in the stock market, yeah. - You mentioned another really important point here around asset allocation should always be a thoughtful decision. I know that the vast majority of people who listen to BiggerPocketsMoney

are essentially 100% in index funds. When what they mean by that is 100% in stock market, broad-based market cap weighted index funds, even if that would take them a second to articulate that. Like they're in VOO, VTSAX, the Vanguard, old school, low cost index funds here. These people are primarily in stocks. They have almost no bond exposure.

And the majority of our listeners would not change their allocation to be more heavily weighted towards bonds under really any circumstance. There's no price to earnings ratio that would be too high for the stock market.

And there's no interest rate that would be high enough to change their bond allocation. As you can tell, I disagree with the majority of our listeners on this. And I'm trying to change that framework and say there's got to be a decision here, some kind of active management, some price at which you would sell stocks and reallocate to bonds or some ratio of earnings to interest yields, for example.

I don't know what that is. I'm going to explore that for the rest of my life and try to figure that out and put those rules in place. I don't know if anyone has the answer. What's your answer to that? Or how would you approach answering that question? I love how you laid it out and said it. You know, it seems suboptimal.

To choose a very charged word, suboptimal to say there's, you know, there's no circumstance under which, you know, I would go into fixed income. The way I think about it, and I think a lot of people feel this way, is that our best estimate of the long term real return of the stock market is zero.

the earnings yield of the stock market today. You know, how we come up with that earnings yield, we could use last year's earnings. We could use an estimate of next year's earnings. We could use the last 10 years of earnings and use inflation to bring them to today and average them together. You know, somehow it's like you're buying a rental property and

your buildings are more or less full and they're rented at the market level of rent, like that's a really useful predictor of the long-term real return you're going to get. Because if you can raise your rents in line with inflation held for a very long time, your return on holding those rental properties is going to be the rental yield at the beginning after inflation. Well, there's another thing for the rental properties, but if you buy properties at a 7% rental yield,

But you got a couple percent of expenses. So it's really a 5% net rental yield. And you think that the rents on your properties today are more or less the market rents. And your market of Denver is like more or less an okay place. And the 2% that you're taking out of the 7% is going to also be part of that, keeping those properties in nice working condition. Then your long-term expected return after...

inflation would be 5% if you can raise your rents with inflation. With the stock market, it's the same thing. If we look at the earnings yield today,

That's a good predictor of the long-term real return of the stock market. That makes logical sense. The basic idea there would be to say that if companies were paying out all of their earnings as dividends or stock buybacks, that their earnings per share would stay constant after inflation, which I think makes sense, is a reasonable thing. It's also borne out by the history such as it is. Over the last 125 years, we can look at what earnings have done. We can look at returns.

And we find that the earnings yield is a decent long-term predictor of the return of the stock market after inflation. Once we have that in hand, now we can compare that to the long-term real return of safe assets. Well, where can we find that number? Well, the long-term after inflation return offered by safe assets, the best place is to look at long-term yields

on U.S. government Treasury inflation-protected securities tips. So we can just read that off the screen right out of the newspaper. Right now, long-term tips are yielding about 2.7%.

Right now, the earnings yield on the U.S. equity market is around 3.5%, 4%, call it, whatever, something in that zone. So if you own U.S. equities right now, you're expecting to make only 1% to 1.5% more than what you would get

from owning tips with much less risk. First of all, I would say that under those circumstances, I don't want to have 100% in equities. Now, if I'm a young person and my financial capital is really small compared to my human capital, sure, maybe I'm like, whatever, you know, I'm always going to be at 100% in equities until my financial capital gets to be big relative to my human capital. But

that 1.5% is just so measly. It's just not a great compensation for the risk of holding equities. The real question is, what if through some combination of the yield of tips, let's say tips go to 3.5% and the stock market stays where it is. Well, now you're getting zero

extra long-term return relative to TIPS. And I would say, don't own any US equities at all at that point. Or what if TIPS yields go back to 4%? Or what if the US equity market rallies another 30%? Or whatever it is, I think that you could imagine a case where the long-term return on equities is the same or lower than what you could get on TIPS. And in those circumstances, you don't want to own 100% in equities.

So that's how I would answer it. And has that ever happened? Yes, it has. It happened in the year 2000, 1999 and 2000. Long term tips were offering a 4% return and the earnings yield on U.S. and non-U.S. equities was less than 4%. And it made a lot of sense to get out of equities and to be more in fixed income instead.

And that righted itself and got back to a much more normal level three or four years down the road. And you would have been a much happier investor by taking chips off the table in 2000 and getting more into fixed income. Let's look it up right now. What's the tips yield right now? Do you know? I think long-term tips are 265 right now. Okay. And what's the price to earnings ratio that you prefer for U.S. stocks?

Professor Bob Schiller from Yale produces an online spreadsheet that's available where you can get those numbers. And his number is like low threes. I would use this. We produce our own number at Elm Wealth, and our number is more like three and a half percent because we're a little bit more optimistic on the way we do the calculation. So I take three and a half percent. So you're getting the spread between the stock market and tips right now. That's positive. It is still positive, but it's awfully small.

All right, this is our final ad break and we'll be back with more portfolio theory after this. Are you looking to level up your investing game? BAM Capital can be a game changer for investors seeking reliable returns. With a proven track record of success, they've distributed over $215 million to date

thanks to their hands-on management approach and deep market expertise. BAM Capital specializes in carefully managing your investments, ensuring they are handled with precision and care to maximize growth potential and mitigate risk. Whether you're new to investing or looking to diversify your portfolio, BAM Capital offers the tools and expertise you need to reach your financial goals. So take the first step towards savvier investing today. Visit biggerpockets.com slash BAM to learn more and get started. That's biggerpockets.com slash B-A-M.

All right, we're back. Thanks for sticking with us. How do I take this conversation about tips and all this jargon, Shiller price earnings ratio or CAPE, whatever you prefer there, tips and these spreads? How do I translate that to how I ought to be thinking about this if I'm approaching, you know, maybe I'm three or four years away from early retirement and listening to this podcast in terms of my asset allocation?

First of all, you want to have a framework that you're going to use, you know, that's going to take you through different environments. You don't want to do it on the fly or by the seat of the pants. And, you know, I think a reasonable approach to take is to let that earnings yield spread relative to tips drive some of your asset allocation. Now, I'm not saying you should have no equities because of that, but you should have less equities than you would have

You should say, if that spread were 4%, if I were expecting to get 4% more on my equities than tips, how much equities do I want to have then? Maybe I want to have 80% or 100% in equities. Well, if it's much lower, I should want to have less. And you should think about

how you want that rule to work for you in the future. Like you might say at 4% extra return from equities, I want to have 80% in stocks. And then you might say, well, if the earnings yield is 2%, I want to have 50% in stocks, you know, and you could just be like proportional in that manner. But I think when you get to this point of the earnings yield and real interest rates are right on top of each other,

You should think to yourself, how much do I want to have in stocks then? And it might not be zero. You know, you might say, you know, even though my metric for the excess return is such and such as zero, you know what, I still want to have 25% in equities because I just don't want to put that much faith in this metric, you know. So you might, but anyway, you have a rule and you're like, okay, and if the earnings yield is above 4%, I'm going to be 100% in stocks.

And I think that's how you want to come into the whole thing. That's what we do at Elm Wealth in managing our client portfolios. We set this whole thing up for them and then we implement and execute on it. We're doing that automatically for clients and trying to do it tax efficiently. With the FIRE movement,

The FIRE movement is tricky because you're really talking about retiring, you know, maybe in your 30s or your 40s, you know, and boy, everything is more consequential because you're looking to hopefully be able to sustain a nice standard of living for 60 years or more.

And although, of course, you know, you always have the flexibility to go back and get back into the workforce and earn more money. But, you know, I think that thinking things through is more consequential for the fire people than it is for more normal people retiring at 65 to 70. You know, if you're retiring 65 to 70, you've got also some other options to help you. You know, you've got Social Security there.

You've also got the possibility of buying some deferred annuities that could help. The case is that your spending and your investing have to be policies that are consistent with each other. You can't invest in equities and then have a spending policy of spending some fixed amount for the rest of your life while you're invested in equities.

If you're going to be invested in equities, then you also have to move your spending up and down as the equity market is going up and down. You know, you can't run a fixed spending policy off of a – and when I say fixed, you know, it could be inflation-adjusted. But you can't run a fixed spending policy off of a risky portfolio. So are we talking about this for an on-the-path-to-fi portfolio or an after-fi?

wealth maintenance portfolio? Both. Asset allocation is always an active thought through decision based on expected returns and risk.

And that holds for before and after retirement. You know, there's a lot of debate around should portfolios change at retirement? I'm more on the side that portfolios shouldn't change that much as you age. You know, that what's right earlier on and later on are kind of similar. I think the biggest way in which things change is when you're really young. And again, your human capital is really big and your financial capital is puny.

then, sure, you want to own more equities and it doesn't really matter so much what you're doing anyway because your financial assets are small. But once your financial assets are kind of big and your human capital has gone down relative to that, then I think your asset allocation needn't change all that much as you go through the last 40, 50 years of your life. And you still need to take account of social security and things like that. I mean, there's still things to take account of.

But I don't think that this gradual move towards fixed income makes a lot of sense to me. And, you know, there's a lot of academic research that says, you know, there's a lot of circumstances under which your portfolio stays relatively constant once it's pretty big. You know, like, again, not when you're in your 20s or 30s, but once you've done a good amount of savings, you don't really need to be changing your portfolio all that much as you age. Victor, walk me through why changing my allocation is

even according to a set of pre-written rules, based on the difference in price-to-earnings ratios, whichever I prefer for the stock market, and risk-free returns.

is different than market timing. You know, market timing, if we ask Chad GPT or Perplexity or Claude, what's market timing? You know, basically what you get is, and this is exactly how people think about market timing, that market timing is making dramatic shifts to your asset allocation based on relatively short-term signals, you know, based on news and a general reading of the macroeconomic environment. When people say market timing, that's really what they mean. It's like,

You know, I was reading the paper. I've been listening to all these podcasts. And man, it's bad up ahead. I'm going to reduce my equities by 70%. Just doing that, you know, week to week, month to month, whatever. Like that is...

what is meant by market timing, I think what we think of it as. And also, you know, I think that's kind of, you know, it's interesting that the LLMs, you know, give us that description of market timing. That to me is very different than asset allocation driven by expected return and risk. Those are really different, to me, really different things. There's no reading of the tea leaves. You know, you're not trying to capture short-term market moves.

You're just thinking about what's the long-term expected return of my portfolio or of my equity holdings relative to safe assets? How risky is the market right now? I want to calibrate for that. And what's my personal degree of risk aversion that kind of sets the baseline in a way? Now, if we define market timing as anybody that changes their asset allocation, well, of course, then both of those things that I've described are market timing. But that's not really, I think, what people mean

when they're thinking of market timing. And market timing, as we're describing it here, has a terrible track record. It's unbelievable. I'm going to come to something I really want to talk about in a second about market timing. Market timing has a terrible empirical record. Whereas empirically, not only logically does what we're talking about with earnings yield and risk and risk aversion make sense,

from a logical point of view, but empirically it's worked really well. Now, I'm not saying that you should do it because empirically or historically it's worked well, but at least, you know, you shouldn't like, if somebody says to you, market timing is a really sensible thing to do, and then you look historically and see that everybody's lost money doing it, that might change your mind. And, you know, I think the same thing with,

If you say, oh, it really makes logical sense to run things off of expected return and risk. And then we go historically and see, oh, my God, you would have lost a ton of money doing that. That's, you know, you would probably say, OK, it sounded good, but I don't think I'll do it. But empirically, it's been good. And so I think that just it doesn't tell you you should do it. It just tells you that you shouldn't not do it.

Let me ask a more practical question here. I'm listening to this podcast and I'm 100% in stocks and I've been 100% in stocks for 15 years. It's just not my policy. I just throw it in the index fund and forget about it. Now I'm waking up. I'm like, oh, that's not really the optimal portfolio that anybody prescribes in the space. Not JL Collins with Simple Path to Wealth, not Victor here. There's always some, once your capital grows to some level, a recommendation of diversification to fixed income investments.

to some degree. How do I jive that reallocation event from what has historically been a 100% index fund portfolio to a new set of rules with the concept of market timing? Because that catalyst is gonna come from a fear perspective, a fear, you know, I've been greedy for 15 years, I've been rewarded for it. How do I mentally make that shift

for the first time in creating those rules to a more balanced portfolio, for example, that I can follow from this point on. Yeah, I think it takes some introspection and realizing that, you know, for whatever reason, things turned out great and you should really congratulate yourself and be happy and then step back and say, okay, I don't have any positions at all.

I'm coming at this fresh. I need to have a tabula rasa. I just need to have a blank slate and decide how I want to invest going forward and then think that through. And the fact that it worked out great is just not consequential from a statistical point of view. Like 15 years of something working doesn't mean that you found something that's going to work well forever. And so I think you just have to be willing to step back

and look at everything fresh and as a student with curiosity, you know, to think about it. Now, at any point in time, it can make sense for people to have 100% in equities. You don't always need to have in fixed income. Again, depending on the expected return of equities, depending on your baseline,

your human capital versus financial capital, it can make sense to be 100% in equities. But as you said earlier so beautifully, it cannot make sense to always be 100% in equities, no matter what the market is telling us. And if you were an investor in Japan in the late 80s,

when the P.E. of Japanese stocks was at 100 and Japanese investors were like all into Japanese stocks and real estate and everything, you know, that's a really incredible lesson to see that. Yeah, I mean, you could really, you know, stock markets can get to levels where they just are not offering any risk premium relative to safe assets. And when that happens,

you have got to pare back, you know, otherwise, you know, it depends on your path. Now, if you did all your savings, and you've done really well through that, well, you're going to lose all of you know, that's your wealth at that time. And no matter when you got into it, and you know, maybe you made a lot of money in the run up. But you know, just losing the money is always the same. It just always is terrible. And it always is suboptimal to stick with something when,

The expected returns are telling you it makes no sense to be taking this risk. The only catalyst is to like step back and think about a blank slate. How would I do things if I were starting today, you know, irrespective of how I got here with this great fortune? Fantastic. Well, Victor, where can people find out more about you?

We have two websites. We have elmwealth.com. That's where clients come that want us to do separately managed accounts for them. And also where we put our research and you can learn more about a book that we wrote and stuff like that. And then we also have elmfunds.com, which is the website for our ETF that's out there, trades on the New York Stock Exchange. And we keep all of the ETF information on the elmfunds.com website. I'm also on LinkedIn and

but not on X or Insta or those things. But you can also find lots of our research on SSRN.com, but all of our research is on our website. And, you know, I would also recommend taking a look at our book. It's called The Missing Billionaires, A Guide to Better Financial Decisions. It was the best book chosen by The Economist when it came out at the end of 2023. And that has like all of our thinking about risk and return and sensible long-term investing and spending policies. So,

So, yeah, probably that's more than anybody wants to consume of our thinking. Awesome. Well, go check it out. You've been a wealth of knowledge here, Victor. Thank you so much for sharing your experience and philosophy on this particularly important point, right? Index fund investing does not mean just being 100% exposed to stocks. There is a philosophy and an active component to it, hopefully governed by a set of rules that

around your asset allocation approach, even if you are a passive index fund investor. Victor, thank you so much for your time today. And that wraps up this episode of the BiggerPocketsMoney podcast. Our guest is Victor Hagani from Elm Wealth. My co-host is Scott Trench, and I am Minnie Jensen saying off we go, leopard gecko.