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The Good News About High Valuations; the Problem With Glide Paths

In this podcast, Motley Fool host Ricky Mulvey and Jules van Binsbergen, a finance professor at the University of Pennsylvania’s Wharton School, discuss:

  • Market sentiment.
  • Savings goals.
  • How to prepare for periods with lower rates of return.
  • Disconnects between the real economy and financial markets.
  • Whether the U.S. stock market is merely a “lucky survivor.”
  • The dangers of institutional thinking.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on January 14, 2024.

Jules van Binsbergen: It’s certainly true that stock markets have been supported in their returns by these secularly declining interest rates, because lower interest rate implies higher valuations. But the question is, for how long can you keep that up? If when you’re gradually slowing down in our economic growth, and is it possible that we can have these very high stock returns from here on forward because the level of stock returns is in equilibrium, tied to the growth rate of the economy.

Mary Long: I’m Mary Long, and that’s Jules van Binsbergen, a professor at Wharton, who studies asset pricing and the history of markets. Ricky Mulvey caught up with van Binsbergen to talk about the good news about high valuations, the problem with glide paths, and why the world needs more Galileos. Before we get to that conversation, a quick note that we’re off tomorrow for the holiday to make it up to you. Today’s show runs a little bit longer than usual. We hope you enjoy the conversation and the long weekend.

Ricky Mulvey: Joining us now is Jules van Binsbergen. He’s the co host of the All Else Equal Podcast 1 that I particularly enjoy. I find myself engaging with it, learning from it, disagreeing with it sometimes, he’s also the Nippon Life Professor in Finance at the Wharton School at the University of Pennsylvania. Jules, welcome to Motley Fool money.

Jules van Binsbergen: It’s great to be on the show. Thank you so much for having me.

Ricky Mulvey: Let’s start. We’re going to tackle some big questions about how much you should save, how risky your savings should be? But first, I want to touch on some research that you’ve done. Because I think it’s especially pertinent right now, where we see a lot of investment firms, investment banks starting the year with these large scale market forecasts and they turn out to be very wrong, spectacularly the majority of the time. You’ve done research on basically, measuring economic sentiment throughout centuries, and how that can actually act is a predictive measure. For folks who are less familiar with the research, how powerful is economic sentiment is a predictive measure for the labor market and business cycles.

Jules van Binsbergen: Indeed, what we did in a recent paper, which is called Almost 200 Years of Economic Sentiment, what we looked at was about 13,000 local newspapers. We just tried to find out from the tone that was used in those newspapers what the level of economic sentiment also across regions in the United States look like and you can then aggregate that to get a national level of economic sentiment. One of the things that we found particularly interesting was that, that economic sentiment did seem to have predictive power for GDP growth, something like the business cycle indeed. We also found that of the components of GDP that add value, say, for capital versus labor, it was mainly operating through the labor channel and not so much through the capital channel. That was, to some extent, surprising to us. It wasn’t the result that we necessarily expected. It also implied that, we didn’t find that much predictive power of this level of economic sentiment. This measure of economic sentiment for say, stock returns or something like that, it seemed to really have predictive power for business cycles in the labor market, even over and above and that was somewhat interesting what forecasters, professional forecasters were saying. We could beat professional forecasters. Our economic sentiment measure is a leading indicator of the GDP forecasts that these professional forecasters produce.

Ricky Mulvey: I know you looked over decades and even over a century, but I think that played a lot into what happened last year. Many people, so many professional economic forecasters started the year, oh, we’re going to have higher interest rates. The market has done really well. Everybody should bank on 100% chance of a recession. Things will cool off, and then where do we end the year? Which is that the labor market still looks all right. It’s cooled down in a recent report, but the Nasdaq and text stocks are up 50% which I don’t think any of the forecasters, the experts would have expected based on the sentiment at the time.

Jules van Binsbergen: No, that is so true. Although I think that particularly since COVID we are in a particularly complicated environment, where there are a whole bunch of different things that are interacting with each other. We’re all trying to find out which one of these factors is going to dominate. Certainly, we just came out of COVID where we had an unprecedented level of support and economic support, where people build up lots of savings. Those savings had been building down and people were wondering whether the level of spending could be kept up yes or no. The Fed started raising interest rates and interest rates, higher interest rates generally means lower valuations also to fight inflation. Then at the same time, we have this long term growth driver, that is artificial intelligence that is starting to sneak in and starting to actually provide quite some good news. Then the question was, well, which of all of these competing forces was going to win out in terms of how optimistic people would be going forward in terms of the stock market? As you said, the investors came together, they traded, and they came up with this increased valuations, which I think for long term growth might be somewhat good news. To tell you the truth, that was news that at least for me was long overdue. I was really hoping that we would get some revival and long term growth expectations because they’d been pretty poor recently.

Ricky Mulvey: There’s definitely a swing to pessimism. I think one overall takeaway from your research on that though is that for a long term investor, for the average investor, it ultimately does not matter how they, their family, even the masses care about the economy in a particular moment to make a guess about what the stock market will do. One level deeper. Why do you think that is? Why is there that disconnect where sentiment shows us what the real economy will do, but not necessarily the financial markets?

Jules van Binsbergen: Well, you’re presenting it a little bit as the glass half full. You can also half empty, but you can also present it as the glass half full. Which is that the forecasting power that our sentiment measure has for growth is already incorporated in stock valuations. If it’s already in the price, then that means that it won’t have any more predictive power for returns going forward. That is the glass half full interpretation of our results. That if investors are properly taking into account the effect of sentiment also on GDP growth and labor markets going forward, then the lack of predictive power for the stock market would be a result of it. The lack of predictive power for the stock market is not a bad thing in that sense, it’s a good thing. It means that information is already in prices. Does that make sense?

Ricky Mulvey: Well, I agree, and I also do think it’s a good thing because it says that the crowd can be wrong. If they feel bad that might not necessarily. It’s an argument against trading in and out of investing.

Jules van Binsbergen: Yes. Although the question now is what do you define as the crowd? What we are measuring in our paper, which I think is very important and it’s also important to make this distinction is really the tone of newspapers and 13,000 of them meaning that the way that the news and economic news is reported and that varies over time. There’s another crowd, which is the crowd that collectively sets prices in the stock market. Those two crowds don’t necessarily have to be the same thing. To give you another, which I thought was one of the most surprising findings in the paper was that the overall tone of news reporting since the 1970s has essentially been on a downward trend for 50, 60 years it’s been really bad. The question is, why is reporting becoming increasingly more negative and what does that say about our news reporting? We also found that, that negative news reporting was not so much related to economic news per se. It was, if we just did the analysis on all newspaper articles, including the ones that didn’t cover economic news, we just saw the downward trend of negative reporting across the board. It didn’t matter what the topic was across all topics across the entire body, we saw that there was this downward trend and it was also not even that related to any particular state. It was just that across all states in the United States we just to see this long downward decline in the optimism that people have in their news reporting. Which I thought was interesting because I think a lot of our mood and a lot of the way we interpret the news might be driven by the way it’s reported. If there’s this downward trend in it, because people want to know sell newspapers by reporting negative news, it may be something that we should be wary of.

Ricky Mulvey: Or get attention and negative bias and reporting will get more attention.

Jules van Binsbergen: For sure.

Ricky Mulvey: The way many people plan for retirement in the United States is through a 4019(k) and the primary investment vehicle that people use in a 4019(k) is a target date fund. It’s because it’s a default option in many cases. You have with the target date funds, which are a way of you pick a date of retirement, you have risky savings at the beginning, and then slowly it becomes less risky as more bonds enter the portfolio. Seems to work for a lot of people, but what is your issue with target date funds?

Jules van Binsbergen: Well, I wouldn’t say that I necessarily have a big issue with it, I just do think it’s important that we also discuss the potential downsides of it and what it implies. Let’s start with the first one, which is, there’s a glide path or a so called glide path that these funds have. The glide path implies that early in your age you’re young you put a lot of your money in stocks and then gradually as you get older, that stock allocation is slowly built down and the bond allocation is going to be increased. Of course, and I’ve done a lot of work on that too, you need to be careful what exact bonds you’re going to put in your portfolio, because long duration bonds are actually very risky too. Your duration match bonds may actually be riskier than equity, but that’s an entirely different story. What is more important is the question, where does this glide path come from? Who’s computed it? How do we know that it’s optimal? One thing that we did for one of the pension advisory committees at the University of Pennsylvania was to simply ask from all the providers that offer these glide paths to just put in one graph what all the glide paths look like. What you’ll see is that across the different target date funds that are being offered by different providers, there is quite some variation in what that glide path looks like, even though it’s the same retirement year, the 2045 one or the 2051 and so forth. If you just put all of them next to each other for all the different dates that people can retire on, you look at what the glide path looks like across providers, it’s no consensus. So who’s right? What is the right glide path that you’re supposed to use? Many people, particularly to their default option, pick one, and so you’re just essentially being defaulted in one of these glide paths.

There’s even some academic research that are used at the glide paths, the downward sloping glide paths make no sense to begin with. They should never have been downward sloping to begin with and early academic research under restrictive assumptions, came to the conclusion that they should look the way they look. Not even just the level but the shape, but even that shape is under debate. So is it more an historical accident that we all ended up with all these target date funds, with all of these different life paths, or is there something good about it in the sense that despite all of its shortcomings, we’re still fine and it’s better that people go for these target date funds compared to, say, the alternative that they have. I certainly think that for certain investors that might be true. It is true that there is a group of people that on their own, wouldn’t diversify very well, they would put all of their retirement savings into one company, sometimes even the company that they work for. For example, think about Nokia. If you work for Nokia and you put all your retirement savings into Nokia’s stock, because you couldn’t imagine a world without Nokia and suddenly Nokia essentially doesn’t exist anymore. At least it’s market value took such big hits that you lost and your job and your retirement savings in one shot. There is a group of investors for which I think putting them in these target date funds might be better. But not all people are the same. So when we talk about these glide paths, it’s not just that different providers have different glide paths that they offer, but different individuals, depending on how risk averse they are, should have a different profile of how they should invest their money over their life cycle. To just force people into one of these options and say, this is it, because this is your default option and whether you like it or not, and it happens to be this provider versus another provider, this is the path that you’re stuck with, also has downsides and so we face a trade off here. There is certainly a mistake that we make by offering that glide path to that person. The counterfactual could be worse or could be better depends on the individual.

Ricky Mulvey: There’s also a case. Usually it’s not just a target date fund or put a bunch of your savings in the company’s stock for retirement. Often you’re given a menu of options in terms of what funds, how much risk you should take, and the benefit of a target date fund and I’m saying this more as a devil’s advocate, is that, maybe most investors aren’t going to make the best decision for themselves. Maybe they would go a little bit less risky than they should be, or they’re not going to pick the most optimal funds with the lowest fees when they’re presented a menu of options.

Jules van Binsbergen: Yes, that’s true. I largely agree with that statement, though, target date funds aren’t quite the cheapest because the fact glide path is implemented does imply higher fees and if you would do that yourself, you could already save some money. That is a counter argument to that one. I do agree with you that certain people might not know very well what is the optimal investment for themselves and to tell you the truth, that was always one of the more, to use an old fashioned word, paternalistic arguments for defined benefit plans. Which was, let’s manage the pension for these people because they don’t know how to do it themselves. Which of course means that there’s a lot of responsibility with that and I do think that that responsibility needs to not be taken lightly. It’s a very big responsibility because you then better do a better job for those people than they otherwise would have, otherwise your existence as a fund cannot be justified.

Ricky Mulvey: This is where I would go in with my actual planning and I’m happy to have a Wharton professor break it down. I think that the vast majority. I’m in my late ’20s, and if I had a target date fund, then some of that money would be in bonds. In my personal savings, I do have a little bit of bond funds primarily because for me it’s a defensive investment with higher interest rates right now. But putting that aside, I don’t think for most retirement savings, and we’ve said this at the Motley Fool, the money that you need in 3-5 years, a lot of that money should be in riskier investments, or perceived riskier investments in the stock market itself. With a glide path, the problem is that you’re slowly introducing more bonds into one’s retirement when in reality, and this is the shape that you mentioned before, maybe all of that money should be in equities, except the money you need in 3-5 years, perhaps to buy a house or for an emergency fund. Then as you get to retirement, that becomes more in cash out of the stock market as you need to prepare for living expenses in the event that the stock market has a 2008 style crash, your first year of retirement, and you need that money for your life.

Jules van Binsbergen: Well, so yes, that’s fine that you make that argument. I just want to make you aware of the implicit assumption that you made when you made that argument.

Ricky Mulvey: That’s why I’m making it to you.

Jules van Binsbergen: I love it. Which is that you are relying a lot on what’s called intertemporal diversification. Which means that if you can stay in it long enough, it’ll all work out. That’s what you’re assuming about the stock market. Maybe one interesting paper for you to think about is a paper that I wrote with a colleague of mine at the Wharton School, Jessica Walter, and one of her PhD students, Sophia Wah. Where we asked the question, well, is the US Stock Market really a lucky survivor or is the equity risk premium or this extra return that you get for investing in stocks, is that truly a higher expected return that people also thought they would get? The reason why I’m saying that is there are many stock markets that once started and no longer exist. That means that you put your money in that stock market and there is no point where you can say, as long as I stay in it long enough, it’ll all work out. Those stock markets ended. Whether it was due to communist regimes or whether it’s due to other political tensions that happened around the world and so there is a little bit of what we call a survivorship bias in the stock markets that we’re observing today. The reason why we’re all talking about the US stock market is because the US has been such an unbelievably lucky and successful economy in the world. Right now we need to figure out, is that skill or is that luck that the US ended up where it ended up. Obviously there have been many moments in history where it was quite iffy, things could have gone differently, particularly risky situations between the USSR and the US and other global crises could have ended up differently. They didn’t. I’m fine with you saying if I can wait, I have some intertemporal diversification, so I’m happy to stay in it and I’m staying in it for the long run. Stocks for the long run is a perfectly fine argument, but don’t assume that everything will work out in any case. There’s still risk there that I would like you to think about.

Ricky Mulvey: I think that’s completely fair and one of the stocks for the long run arguments of Schwartz and Siegel is that one should have more investments in international equities. That might be similar to the case you’re making right now.

Jules van Binsbergen: The international diversification, yeah, which is also important.

Ricky Mulvey: Going to the part about how much to save then. You’ve said that on your show a good savings target for 20-30% of your income for a general savings target. I’ve heard the 20% rule, I haven’t heard that move up to 30% and that seems for most people, that’s going to be a huge percent of their income. For how much to save, why is that a good goal to aim for?

Jules van Binsbergen: No, let’s first start with what we do on the podcast is we first say that 10 is probably too low, then we move to a benchmark of 20, and then we discuss circumstances under which it might even be justified to do 30. But I do think that if people would be willing to even go to 20, I think that would already be much better. I think that the most important thing to think about is we are in a lower rate of return environment today than we were before, and I think it’s hard to argue against that. We saw long term interest rates come up a little bit for a bit, and then over the last couple of months, they’re again all the way back down to around four, maybe even just under 4%. That is a pretty low rate of return in nominal terms for bond investments because it means that the real rate of return in the long run that you can make after inflation is subtracted is just maybe 2% or so. The idea that if you just put away 10% of your money, you then invested and risky, which means that you’re not even sure that you’re going to reach the target that you want, but at least on average you think you can reach it and then you can just put it away in a stock market of 11, 12% per year and everything will work out. That’s a bit of a risky proposition to go for. The math doesn’t quite add up, and so it may be better to increase that savings rate.

Then depending on how risky your investments you want to make, and you may want to go for a higher savings percentage. Now that’s said, there’s another argument that I want to add to this, which I think is important, which is the following. If everybody would decide to start saving more. That might actually depress in equilibrium the long-term rate of return even further. So, maybe and that comes back to our first option value of retirement argument. Maybe one thing to start thinking about is, hey, maybe that 65 number was picked because it was the life expectancy at the time and maybe I should think about ways in which I can just work longer in something that is not so terrible for me to do. I would actually say, but that’s my personal bias, perhaps, that for many Americans, they’re actually quite disappointed after they retire. I mean, work has huge benefits too. It provides social structure, it provides social contexts and so I think that giving up a job has other costs as well and so obviously, the savings percentage that you need, you can make that lower by simply deciding to work longer and retire when you’re 70 or 75. So the savings rate is definitely higher than 10% given the rate of return environment that we’re facing now and so I think people should just decide what their retirement problem looks like. But one thing that I think they should be careful of is that there are still financial advisors that are working with realized average past returns in their financial planning going forward. They will still use, they will say things like, I’ve met with them and they made these arguments to me. They said things like the stock market has returned 12% in the past. So I see no reason why it wouldn’t keep doing that going forward and I think that’s tricky.

Ricky Mulvey: But when you’re talking about the plan of putting, assuming a historical return, and we’ve seen that with markets where there very rarely do you get what is it, a series of years where it’s 11% return for the S&P 500. But do you have enough of a statistically significant sample size to use that and then project 20-30 years down the road, what’s the issue with that?

Jules van Binsbergen: The issue with that is what I would call something that’s called secular trends. Which is this idea that, and I think a lot of people are not quite so aware of this. Let me give you a simple example. We have economic growth data from something that’s called the Madison database, going back to 1,300. Now we can debate a very long time about what the quality of that data is and whether we should trust it and how it is exactly measured and all of that and I’m perfectly open to all of that criticism. But one thing that database at least says or shows is that between 1300 and 1800 we had a 500-year spell of essentially no economic growth and then something magical happened, which was the Enlightenment, the Industrial Revolution and then we had 170 years of quite impressive and population growth and economic growth. Then in the ’70s, very gradually, both of those started to slow down what a lot of people call secular stagnation.

So it’s certainly true that stock markets have been supported in their returns by the secularly declining interest rates because lower interest rate implies higher valuations. But the question is, for how long can you keep that up? So if we are gradually slowing down in our economic growth, is it possible that we can have these very high stock returns from here on forward? Because the level of stock returns is in equilibrium tied to the growth rate of the economy. So this is the reason why I was so happy with that. At least now with AI, we are starting to see the first signs of positive economic growth news. So still way too early to see what the long-term consequences of this are going to be, but I hope that long-term growth rates will start to come back up again a little bit. Because in developed countries we have long-term growth expectations of maybe one, if we’re at the high end, 2% or something. Those are not very high economic growth rates and so with low growth rates, it’s tough to support high returns going forward. So low growth rates, low interest rates, low stock returns, that is that low return environment that I think we should at least plan for for that scenario. So that we’re not surprised if that is what occurs in the long term.

Ricky Mulvey: Which I guess one of the arguments for that would be the declining population growth in a lot of developed countries.

Jules van Binsbergen: Yes. So, for example, I think if you look at Japan. Japan peaked its population in 2010 according to the United Nations. They will have roughly half the population left by 2,100. That country will have been cut in half. I think that Europe, in the current forecasts, will lose over 100 million people. China is going to lose multiple hundreds of million people between now and 2,100. Also because of the one-child policy. I think that the main continent in the world that’s still growing fast is Africa. So Africa is currently, I believe, at 1.5 billion and will grow to something like four, if I remember correctly. So that country is very fast growing in its population. The rest of the world is already declining or will still soon start declining.

Ricky Mulvey: So on that happy note, what’s the average investor to do? I have mostly stocks in my 4019(k) in my personal savings account. Should I be looking for those emerging markets? India would be an emerging market, which is difficult for the average investor to go toward, but the BRICS countries, there’s also the option of real estate investment trust. So maybe I’m not just relying on the stock market. I can include real estate in them and look, would you suggest looking for those alternatives outside of the stock market?

Jules van Binsbergen: Yeah, just definitely I would look internationally and also at alternatives outside of the stock market and I do think that many people have. I think that you see a very large interest of pension plans of institutional investors and others that are all trying to diversify across different investment opportunities. One of the reasons I think of the rise of private equity is also related to this. I think people are evaluating all the possible asset classes that they can find in trying to find where the growth opportunities are, and I think that search is in itself a good thing. It may be possible that for certain asset classes, just completes this can lead to certain bubble-type behavior. Where people get so overly excited about a particular new financial innovation that they bid up the price of certain things to very high levels. But I do think that this overall search for innovation and growth across sectors and across the world I think is a good thing.

Ricky Mulvey: Yeah, I do worry about private equity, which you mentioned I think and you’ve expressed these reservations on your show. That’s something that grew quite a bit with a low-interest rate environment because you have companies that are taking on a lot of OPM, taking a lot of other people’s money, investing in smaller firms, loading them up with debt, and then not in every case, but in a lot of cases they’re looking for, let’s say, 3-7 year turnaround to, if not sell, put the company in a position to sell. The question now becomes a lot of investors are looking for interest rate cuts. Let’s set that aside and assume you have somewhat higher interest rates for longer, the debt becomes more expensive and maybe the assets, the businesses that they’ve purchased, may need to be repriced. Maybe they go down in value and then what happens?

Jules van Binsbergen: Now, so and I think in the episode that we have on the podcast with Eric Zinterhofer, we had to talk about this indeed and that is one of the upsides I think of stock market traded firms is that you can view the stock market as this constant barometer that is constantly measuring any updates to valuation, anything that happens to the firm, anything that happens to interest rate, anything that happens to marketwide conditions and there’s this constant consensus mechanism, doesn’t mean that that consensus mechanism is always perfect. But it does seem that I think having that consensus mechanism and being able to add that to your information set is better than not having that and so once we rely on particular parties valuing a private equity company, and doing that very infrequently, inevitably implies that even though, say, public valuations for certain things already go down, that means that you won’t see that in the private equity sphere necessarily. Now, as you said, it is true that growth firms have recovered quite a bit this year and so we’ll see what that implies for private equity companies because I do think that a lot of these private equity investments share a lot of features with these long duration growth type investments and so it may be possible that in the end by just waiting it out and they won’t have to market down as much. But I do think that that’s a bit tricky because in this particular case, they locked out and therefore much of that reevaluation did not necessarily have to happen or not as much.

Generally, I think it’s important that prices will reflect what current valuations actually look like and so in that sense, let’s wait and see, let’s see what markets will do in the coming year, and let’s see what the private equity companies indeed are going to do when these valuations do come due. Now, one particular tricky issue there is the following. When we think about risk and when we think about putting things in our portfolio, we care a lot about the diversification properties that these investments have and diversification, how we measure it is how the valuation changes correlate with each other. So if I don’t observe those valuation changes because people are not doing the evaluation, you can make it look like it’s a fantastic diversifier even though, in fact, it isn’t actually such a great diversifier that investment relative to the other investments that you hold. It’s just that you make it not observable that you don’t observe the co-movement and that you therefore think it’s a great diversifier. So that’s another tricky thing. That is very hard to determine for private equity how much diversification does it truly provide compared to comparable publicly traded companies that you may already have in your portfolio.

Ricky Mulvey: I also worry with private equity, and this is somewhat biased, is you’re going to start seeing a longer time where a lot of these smaller firms have been under private equity ownership, sometimes multiple private equity ownerships where they’ve been designed to go through these five-year cycles and ultimately that can do a lot of damage. Where you have these firms that might not be able to grow like they should because they’re constantly put through this lowering costs, upping margins squeeze, and how many times can you make that turn work before the whole thing doesn’t work?

Jules van Binsbergen: I understand what you’re saying, and I’m sympathetic to that argument. Let me just for the sake of it, give you the other side of the argument which is this. This is also more generally an important argument to think about, valuations in public markets. If we believe that investors understand that stock investments are long duration, long term investments will by definition be long term view type valuations. If you ask managers to focus on maximizing the stock price, that is not something short term. That is actually something long term because the value at which you can sell something to somebody else if that other person also thinks about the long term, then they will understand that you doing short term things that hurt the value of the company, they will pay you less for that company if you want to sell it to them. The only way in which you can say, oh, certain investors are just short term maximizing earnings, or manipulating them is just so that they can sell it to somebody else at a higher price. You need in that argument, the assumption that the person you’re selling it to is not particularly bright and doesn’t understand that you’ve been doing that. Right now there may be arguments and reasons for why sometimes you might believe this. But I also want to point out that, particularly in public markets, the level of competition that we’re seeing there between qualified people, the number of professional investors in US markets that are currently trading against each other is off the charts.

Whereas in the post war period, still a very large percentage of stocks was held by individual households. At this point, the vast majority of corporate equities is held by institutional investors and those pretty much are all professionals in the investment field. The person you’re selling it to would then have to be fooled, even though they’re just as much a professional as you are. The same thing then let’s translate that to private equity. If the purpose is that you sell it to somebody else, the private equity, or you do an IPO, if that’s the exit strategy that you have in mind for your private equity investment, you will still have to convince the person who buys it from you that it has long term value. If you’ve been churning it too much through these cycles that you’re talking about, and therefore you’ve been hurting the value of the company then the only way in which you could sell it at a high price is again, if the person that you sell it to has misunderstood how it all works and that you can fool them. I’m always a bit wary of strategies that rely on fooling other professional investors. It may sometimes work, I’m not saying it doesn’t, but it’s at least something to think about.

Ricky Mulvey: No, and I think to your point of more professional investors being in the market, I think that’s why I know we disagree on individuals owning stocks and the benefit of that. But it is important if you’re going to go that route and own individual stocks to keep a much longer time horizon than many of the professional players who have access to access to data and knowing who you may be trading against.

Jules van Binsbergen: Yes, no. Knowing who’s on the other side I think is important. There’s no question about that. Tell me a little bit about this. I actually I have two questions for you if I may ask them to you. Before we go there, there’s one very important question that I have for you and which all the guests may have asked. I absolutely love the name of the podcast and I want to know from you how you came up with it, and then I’ll tell you why I think it’s so important that you pick this name and what value this name has.

Ricky Mulvey: Motley Fool Money?

Jules van Binsbergen: Yes. Well, the Motley Fool. Why did you take the Motley Fool reference?

Ricky Mulvey: It goes back to the idea that the fools are able to tell you the truth that many others cannot. In a court gesture, the fool is often the one who speaks truth to power and you can often do that with a little bit of humor.

Jules van Binsbergen: I love that. The reason why I’m asking you this is that I think particularly in the current environment and also in the current environment at universities, the idea that there are people that can just speak the truth without having to worry about getting their heads chopped off has never been more valuable than it is today. I think that’s just wonderful.

Ricky Mulvey: I also don’t want to make the assumption for someone listening to the first time. I did not make the name The Motley Fool. I was hired a few years ago that was named by our co founders, Tom Gardner, David Gardner, Erik Rydholm, they are the founders who are genius enough to come up with that. I work on the talkie part. But no, I think it is important. One of the benefits I had working here is one, I’ll give you an example. Bitcoin was hotly debated more so a couple of years ago than it was now. None of the people who work here were told to have a certain opinion like this is the message you need to send about Bitcoin. I think you have to have that in any university and also any type of investment firm. Otherwise you’re going to fall into institutional thinking that’s going to go a bad way very quickly. I think that I’ve heard some of the ways that institutional firms make investing decisions. I think what ends up happening is someone pitching an investment is not necessarily trying to pitch the best investment, they’re trying to pitch something that will please their boss. In doing so, it becomes much more difficult for an institutional firm to beat the market then I would say than an average person who has a level of interest and wants to put some time in to learning about investing.

Jules van Binsbergen: Now I think and what you’re bringing up there is absolutely key. I mean, even when we think about truth finding and finding out what’s really going on, the incentive structure that is in place matters a lot. If you incentivize people to say certain things and not others, you will get the answer that you incentivize them for, regardless of whether that’s the truth or not. I think that is important in the investment world. It’s also incredibly important in the academic world today. I mean, we need to incentivize people to be the Galileis of the world so that they can say exactly what is the least preferred thing to be heard at that moment in time. If it is the innovation that we need to hear about, no matter how unpleasant, it’s the way that we move forward. I think for investment decisions, it’s absolutely key to have a culture within the investment firm that you work for that people feel that the investment choices that are made are poorly motivated and not very properly thought through. Do you have a culture inside that allows people that disagree to just speak up and say, I think these investments make no sense and here’s why?

Ricky Mulvey: I think one of the benefits I would say of individual investing off that point is you can disagree with something and there is a market value result of whether or not you are correct, while one may not beat the market in the long term, that’s a difficult proposition. I’m hopeful that I can do it over a 30 year period. I don’t know. I think that investing forces someone to confront their biases in a way that’s especially important right now.

Jules van Binsbergen: Yes, agreed.

Ricky Mulvey: Where you can fall into whether it’s a problem in academia, as you mentioned. It’s a problem on the Internet where you can fall into circles of people who think just like you really easily. The longer you spend there, the more comfortable you get. But it’s ultimately a bad outcome for you and the people around you.

Jules van Binsbergen: Because actually finding like minded people like yourself has never been easier as it is today. As it turns out, people have a huge preference for hanging out with the people that say exactly the same thing as themselves even though growing as a human being implies that you should constantly be confronted with people that think exactly the opposite to what you’re thinking. The second question, you said that we disagreed on individual stock investing. Tell me tell me where you think we disagree I’m curious.

Ricky Mulvey: Basically it’s a bad idea for people to invest in individual stocks. They should diversify as much as possible by only owning something like exchange-traded funds, or spread out investments like that.

Jules van Binsbergen: What are your thoughts on this?

Ricky Mulvey: I think it’s not just a series of coin flips that people can identify great businesses and by holding them for extraordinarily long periods of time, thinking about time durations that professional investors don’t have the luxury of participating in, they can ultimately find an edge with patients, a little bit of research, and hopefully finding biases where the market may be pricing things.

Jules van Binsbergen: Although that, I don’t think we disagree at all. I think our point generally, also in our papers with Jonathan Burke, is you can only make money if you have a competitive advantage. You can make extra rents if you have a competitive advantage. That competitive advantage can exist out of many different things. One of them is the information, although a little bit of research is going to be tough. I think the way you mentioned it because I think that if your competitors do a lot of research, you may still be behind on the ball. But what you’re essentially saying is that if institutional investors don’t have the competitive advantage of being able to be long term, and you can be long term and that’s your competitive advantage and that allows you to outperform, that is certainly a hypothesis worth exploring. I think I still want to see some more evidence for that hypothesis that that’s true. I mean, there are institutional investors that potentially also are long term investors because they’re not as one year constrained as say mutual fund managers or others are in their compensation structure. But it’s still possible that there are people that have a competitive advantages there.

Ricky Mulvey: I know we’re low on time. I want to thank you for joining me on Motley Fool Money. I really enjoyed the conversation. Thank you. I love having a little bit of polite disagreement on the show.

Jules van Binsbergen: Me too.

Ricky Mulvey: That’s where we learn and that’s where we grow.

Mary Long: As always, people in the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Mary Long. Thanks for listening. We’ll be back on Tuesday. See you then.

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