JOSH: Hello and welcome to Clearer Thinking with Spencer Greenberg, the podcast about ideas that matter. I'm Josh Castle, the producer of the podcast, and I'm so glad you've joined us today. In this episode, Spencer speaks with Jim O'Shaughnessy about common mistakes in investing, conceptions of growth versus value, and integrating intelligent factors in investment strategies.

SPENCER: Jim, welcome.

JIM: Thanks so much for having me on.

SPENCER: Now, you've been investing for a very long time and very successfully. What do you see as one of the biggest mistakes people make when they're trying to invest their own portfolios?

JIM: Wow, I used to say quite a bit that the four horsemen of the investment apocalypse are fear, greed, hope, and ignorance, and that only ignorance was not an emotion. I think that those three — fear, greed, and hope — are things that investors trying to select securities on their own fall prey to with a great amount of consistency. So I think maybe what many more casual investors get wrong is that it's probably going to do them a great deal of good to develop a process. It can be a checklist, it can be a variety of things, but most importantly, it should be something that feels right to them. I used to believe very much that this is the best way to do it. Then I came into contact with thousands and thousands of different investors, and what I realized very quickly was it's got to resonate with you as the investor. So I ended up being a pure quant, where it was all process. I did that to kind of suppress those fear, greed, and hope in myself because I recognized I'm running human OS just like everyone else. I'm not exempt from those things happening to me, but for somebody else, it might be a niche that they are really great at, or it could be a style of company or investing that they have a particular affinity for. The bottom line, basically, if you're asking me for advice on that, is to find something that works really, really well for you, Spencer, and then just use it consistently.

SPENCER: A situation that many of our listeners are in is that they have some savings. Maybe they built up some from their income over time, and it's just kind of sitting around in a bank account. Do you think that someone in that situation, where their main job is, let's say, being a software engineer or something like that, should actually be buying individual stocks, or should they be putting that in index funds? What kind of advice would you give them if they have, let's say, $10,000 or $40,000 that they know they're not going to need for a long time?

JIM: Yeah, the advice you gave — for somebody who doesn't have a passion for investing and doesn't love going down all of the complexities of individual securities — is something I highly recommend.

SPENCER: I think most people know that you're supposed to buy when everyone is fearful and that you're supposed to sell when everyone is greedy. But of course, the problem is that you're part of everyone. If everyone else is afraid, you're probably afraid too. And if everyone else is feeling greedy, you're probably feeling greedy too. How do you think about overcoming those basic emotions that cause us to make bad investment decisions?

JIM: Again, back to the process. If you can turn, even if your own style is highly idiosyncratic, let's stick with the people who are just putting it into a broad ETF at the lowest cost. And it comes time to make your quarterly contribution, and you go to make it, and you see that since you made the last one, you've actually lost money because the market's down 20%. Your normal impulse would be to immediately look at the news, and what you're going to see in the news is a bunch of, if you're a TV person, you're going to see a bunch of talking heads screaming about how this is the big one. This is the time that the market's going to go down worse than it did during the Great Crash of 1929. Why? Because fear sells. And you need to remind yourself that these guys and women who are screaming these warnings at you are doing it for a reason. They've got something to sell you. And conversely, if everything is going great, and you look and you're like, "Wow, I'm up 15% since the last time I made a contribution." Same deal. Go online, go watch TV. You're going to hear a lot of cases about why this is the best market in the history of all markets, etc. None of that is true, and so the way I overcame it was to literally have a process automating buying and selling of securities, a process that had been tested over long periods of time that had an error factor, like everything is going to have an error factor, but to just do it consistently. Woody Allen joked that 80% of success is just showing up. Same is true in the market. I even put it higher; 90% of success is just consistently making investments in a timely fashion in a broad-based ETF. Again, now you're doing better suddenly than 90%. But yeah, emotions are difficult. The great John Templeton, who was a fantastic investor, once told the story of how he would often put in buy orders for stocks that he liked way below the price at which that stock was trading at the time. And people would say, "Well, why would you do that? Why wouldn't you just buy it when it hit that price?" And he goes, and I'm paraphrasing here, "Because I would be so scared that I wouldn't have the ability to pull the trigger and actually enter that buy order at that low price because I would think that it was going to zero." So if one of the greatest investors of all time had to do a process by putting those orders in ahead of time to avoid his own emotions, that's your competition. To think that you're going to have better emotional control than Sir John Templeton is probably a bridge too far. So understand you are, in many cases, when your emotions are heightened, you are your own worst enemy, and you just gotta figure out, okay, let's take a 35-year-old software engineer. You're not going to need that money for a minimum of another 30 years, and just look at long-term returns to the marketplace. The crash of '87 looks like a blip. You can barely see it on there, but that was something I lived through as a young 27-year-old investor. And let me tell you, people were absolutely terrified, and it kept people out of the market. Some people for a decade in which stock prices did remarkably well.

SPENCER: I think a lot of people, not only do they struggle to continue investing at the market lows, but they actually attempt to pull their money out. And I know people who've done that, where the market collapses, and at first they're like, "Okay, I can deal with this. I can deal with this." But at some point they've lost so much money that they start fearing, well, if it goes down another 20%, it can affect my lifestyle. And then, they pull out at the very bottom of the market.

JIM: Yeah. That is the truest thing about investing. If we're sticking with index funds and ETFs, the single point of failure for that investor is doing what you just said: letting a short-term market movement control your much longer-term investment goal. It's interesting to me because many people understand it intellectually, but when the actual thing happens, emotions are in real time, and they are really hard to overcome. What we get is — sorry for the technical term, but it really describes it perfectly — hyperbolic discounting. What that means simply is, rather than thinking about his real time horizon, which is, if he wants to retire at 65 in 30 years, he collapses his time horizon to this week or today. He or she doesn't realize they're doing that, but it leads to completely different situations. If you collapse your timeline to the week, then, "Yeah, I've lost half of my net worth. How will I ever recover from this?" The way you recover from that is to remind yourself that, "No, you haven't. The only way that you are actually losing that money is by selling and locking the loss in." These are part of our base code as human beings. Evolution made us acutely aware of dangers. Fear alerts us to potential danger, and so you're fighting millennia of conditioning by evolution. If you think that you can gut it out, I return yet again to process: if you could do it so that it was fully on automatic. In other words, you just put X percent of your paycheck into that particular index or a group of index funds automatically, no matter what's happening in the market. Now we're up to, you're probably 30 years from now going to have done better than more than 90% of investors just using that simple technique.

SPENCER: I think what a lot of people imagine is that the market goes down a whole bunch. They pull their money out, and they're going to wait until it continues to go down, and then they'll put their money back in. But the reality is, predicting the large market movements is one of the hardest things in the world. Furthermore, how do you know when to put your money back in? Let's say you pull it out and then the market goes up 10%. Do you put it in now? If it goes up another 20% before you put it in, you're putting yourself in this impossible position of trying to guess when it's time to put it back in.

JIM: Well, people like guarantees. I'm going to guarantee your listeners something. If you behave like that, I pretty much guarantee you're going to do poorly. By the way, this is all of us. For everyone listening, it's not just you, it's me too. It's Spencer, it's any human being because our base code is highly similar. As much as we like to yell and shout at each other about our differences, we share vastly more in common with one another than we have differences. This key in market investing is universal, and it is across the board. It doesn't matter how smart you are, how diligent you are, any of those things. When fear strikes, it is almost impossible to override using conscious will, and we also suffer under the delusion that we will know when the right time to get back into the market is. No, you will not. I don't. Most people don't. If it is overwhelmingly positive about your own view about, "Okay, now is the time again." You're probably wrong. I only wrote pieces about either being in the market or not in the market. Over my 30-year career, I wrote maybe three, and they were all data-driven. In other words, it wasn't my opinion, it was what the data was telling me. I wrote a piece in March of 2009 during the end of the great financial crisis, saying it was a generational buying opportunity. What was interesting, I heard crickets, Spencer, just crickets. If I didn't hear just crickets or no comment, I had a bunch of comments from people telling me what an idiot, fool, loser I was for advocating people put money into the market at that point in time because clearly I didn't understand that markets were going to zero. It sounds silly now, but that's another thing that is helpful. However long your investment career has been, think of a time when you did that. Think of a time when you got so freaked out by the market that you sold out, then you failed to get back in. Or conversely, think of a time when markets were on fire and you just poured money into them because, "Hey, I can't lose." Then you did lose, and you didn't make all of that money. Do you still feel about it the same way now that you did then? My guess is no because it's been drained of all its emotions. The last premier of the USSR, the old Soviet Union, basically said a really interesting thing, "During the full-blooded right now, we are guided by things that are immediately apparent to us." When you have the time and luxury that time affords, let's call it six weeks later, six months later, basically drained of all those emotions, you see it so much more clearly. You could play that game with your own past. Think of the last time that you really blew it, and my guess is you're going to see, "Wow, it was just totally emotions. They were 100% of the reason why I did what I did. I can see that so clearly now. Why couldn't I see it then?" Because you were blinded by your emotions, and we're all the same in that regard too. Keeping a journal on your investment decisions can also be helpful because it can remind you of what it felt like to feel that fear. If you're diligent and record, if markets are down 20% and you're terrified to let that allocation go into your ETF, reading about the last time you felt that way and then playing it forward in time, you see that in most cases, things ended up doing fine. If you're in America, the US stock market, since its founding in the late 1700s under the Buttonwood tree, has never seen a 20-year negative rate of return. Those are amazing odds. Whenever I say that, people say, "But what about Japan? What about Russia?" Okay, so Japan hit a super bubble, and it took a long time to unwind that. The Japanese market does not have the depth of liquidity, the number of companies trading on it that the US market does, so it's going to offer up different lessons. Nevertheless, if you're a Japanese investor, you should want to know about those lessons. As far as Russia, what they're usually talking about is the Russian stock market prior to the revolution when the Communists took over. If one of your worries is that we're going to have a violent revolution in America and that a communist authority is going to take hold here, I think the odds of that happening are so low that you don't need to discount too much for that. That's the reason that happened there. I'm not saying that lots of bad things can happen here, but if you want to put the base rates on your side, America has gone through some very trying periods, from civil wars to huge depressions to lots of divisiveness, and we've come out on the other end of it usually better for it. The awareness factor is what you really want to focus on.

SPENCER: Some economists argue that people have a lot of bias towards investing in their own country, and that this is irrational, that in fact, you should be buying ETFs that try to track the entire world's economy, the entire world stock market, not your own country. How do you feel about that?

JIM: So I think that they're in general correct. I think that the country bias is especially dangerous unless you live in the United States. The reason I say that is, if you look at the composition of world market GDP or market capitalization, you're going to see that the US market is vastly bigger than other markets outside the US. We have individual companies that have a larger market cap than entire other country indexes. That is a very important caveat, if you're not domiciled in the United States. As far as the United States goes, you could probably end up doing much better over time by buying a World Index that's ranked by market cap. In other words, you're going to get 65% US stocks anyway, and then the exposure to other markets has times where those foreign markets do significantly better than the US. Now we haven't had that happen in a long, long time and again, back to hyperbolic discounting. People are like, "Yeah, foreign markets, they haven't done anything. They've done much worse than the US, etc., and I'm just going to stay with the US." If you're in the US, that's fine, because you're going to get a lot of coverage. If you're not, then you want to be really careful about over-allocating to your domestic market. The idea that we can't know the future seems like a hard pill to swallow for a lot of people, but we can't know the future, and so generally, I find that a fun metric to look at is to kind of look at what percentage of investment advisors are recommending a global portfolio versus just being fine with domestic equities. When that number of advisors recommending a global portfolio declines to single digits, generally speaking, the next five years, those foreign markets do really, really well, but that's timing the market. That's just an observation. I would not base my actual investment decisions on it, but yeah, I think the cheapest global equity ETF, all other things being equal in terms of where you live, etc., is probably the best diversified bet that you can make for your long-term savings, notwithstanding the fact that regulation and certain policies in other countries have become increasingly hostile to say startups and the types of companies that now are the behemoths of our indexes here in the US. A cheap cap-weighted global equity exposure ETF is kind of a one-stop shop, and then you can move on to focusing on the things that really animate you or that you really love.

SPENCER: Sometimes, when people advocate investing in the US, it's kind of deemed American exceptionalism in a negative way or backward-looking. Sure, the US did fantastically if you look backwards. But of course, it doesn't mean it's going to do exceptionally well in the future. Do you think that there are good reasons to bet on the US in particular in the next 10 to 20 years? I'm also curious if there are other countries that you think you'd bet on if you had to make a long-term investment in their stock markets for the next 20 years.

JIM: I would never short the United States of America. It's not just because of our historical ability to generate so many incredible companies that dominate their space globally. Things like having a constitution are incredibly important because the rule of law is also an incredibly important thing, as are all of the things enumerated in our Bill of Rights, free speech. If you pay any attention to social media at all, you'll see that other countries, like the UK, Australia, and New Zealand, where you would never believe that they would do anything to interfere with their citizens' right to free speech. Well, they have, and in the UK, right now, people are being sent to jail for Facebook posts, and the only reason that that isn't happening in the United States is because of our Bill of Rights and because of our separation of powers. We do have some unique characteristics that lead to better optimized outcomes than if we did not have them. I think there are a couple of countries right now that are very interesting, just from a demographic and quantitative way. The first one I would mention is India. India has one of the best profiles demographically on age. They have lots of young people, and young people tend to be the ones that embrace new ideas, start new companies, etc., and they're also highly educated. The caveat there is that India, unfortunately, still suffers from a fairly high degree of corruption, which leads to what's called a low-trust social network, and they also have an abundance of bureaucracy. If they could move towards less bureaucracy and clean up the whole corruption system, that is a country that could compete amazingly well with all of the other countries in terms of the economic engine that is possible within India. I think that's pretty amazing. As a second country, I would call it a continent, and that would be Africa. Africa is a challenge for lots of reasons, but they too have an incredible demographic profile, a very young population, but they're not as far along as, say, India is on the educational side, etc. We have been working with some early-stage investors who are on the ground in India, and they're telling us it's really, really changing quite rapidly. You can get ETFs or mutual funds that are specific to these regions. If you said, "Jim, just give one piece of advice." I'm still going to make your investment in that all-world ETF with the lowest cost to you. The minute you start saying, "Maybe I should also do India, maybe I should also do Africa." Well, they'll be included in that world index. Just make sure that it also has an allocation to emerging countries.

SPENCER: Are there any standout countries in Africa you'd point to, like Nigeria, for example, or other countries?

JIM: Since we invest across all the countries there. I'd rather not single one out for praise. I think the entire continent is really interesting. I would advise listeners, if they're interested, to look across pan Africa, and you'll see lots of very innovative things going on and lots of green shoots from all the various countries, some obviously better than others, but you'll be able to see that when you look into it.

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SPENCER: If you look in economics papers, but also if you look at websites that help you allocate your investments, you'll find a lot of them will recommend a mix of stocks and bonds. Do you think that someone with $10,000 of savings or $40,000 of savings should be thinking about a mix of stocks and bonds, or do you think they should just be investing in stocks?

JIM: That's the perennial question. It's been the question ever since I started my career. The old rule of thumb was take 100 minus your age, and that's your allocation to stocks versus bonds. So if you're 20 years old, you would have 80% of your money in stocks and 20% in bonds. I think that hasn't really worked out. Another popular one has been the 60/40 allocation, where you reallocate money every year. If bonds have done really well, you take some money off the table there and put it over to stocks. Conversely, if stocks have done very well, you take some money and put it in bonds. For a young person, I would much rather be an owner than a loaner. Bonds are essentially a loan to the company, the country, the municipality, etc., and all you're going to get is your interest and your principal back. That's what it means to be a loaner, whereas if you're an owner, you're going to get a lot more and you're going to participate in that company's compounding success. Bonds are also, unless you're intentionally only looking at inflation-protected treasuries, which they call TIPS, treasury bonds that are pegged to inflation, so they pay you an after-inflation rate of return on your investment. Bonds and fixed income are very sensitive to inflation. Just to give you an example: if you looked at an investment in a proxy for the S&P 500 and a proxy for U.S. T-bills, which are considered the least risky investment that you can make, and you started with $1 in 1927, I think is where we have the data, the dollar invested in the stock market, as typified by the S&P or its proxy, is now several hundred dollars. The dollar invested in treasuries is worth just a little over $2 after inflation. Let's make that clear. The dollar invested in treasuries is worth just a little over $2. So sometimes the thing that appears to be the least risky in the short term actually ends up being the most risky in the long term, and vice versa. I have found that to be quite true for stock and bond markets. Now you can't give blanket advice here because somebody who's 70 or 80 years old probably should own a lot more fixed income because they can't stand and weather the variability that they might have to go through with stocks. You could say, if we're going to talk about economists, Keynes always said, "In the long run, we're all dead." So if somebody is 70 or 80 years old, then, yeah, of course they should have more bonds. But for a younger investor, be an owner. You're going to compound at a much greater rate of return than if you are really risk-averse and just hiding out in bonds. It does not work well over long periods of time.

SPENCER: For an individual who has some savings, do you think there's any justification for them investing in long-term bonds, or do you think they should mainly invest in short-term bonds, let's say a year or shorter, with the idea being that if they're investing in long-term bonds, they put themselves at a lot of risk of interest rates changing?

JIM: So there has been one perfect long-term bond trade, and it happened back in the early 1980s in America. We had runaway inflation, and we had a Fed chairman, Paul Volcker, who decided this was going to end. He pushed Treasury rates up into the double digits. Anyone who had the good fortune of locking in a 30-year Treasury at an interest rate of 14% was very, very happy 30 years later. But the challenge is, we don't see conditions like that right now. We don't see a Fed chairman who has that kind of dedication to getting rid of inflation. So the longer term would be something I would avoid. There are funds, ETFs even, that they can buy where they follow what they call a laddered approach. They own one-year maturity, three-year maturity, five-year, etc., and then they keep replacing the one that matures in the ladder. That is going to give you some protection to the variability of interest rates, especially on the shorter end, but also some of the benefits of having the higher interest rate of the longer end. So that's where I would point people who are thinking about investing in longer-term bonds.

SPENCER: When I think about how the stock market operates, my mental model is that there are sort of two forces happening simultaneously. One is the value force, where if a company performs really well, gets lots of customers, has a profitable business and a moat that they can protect, they'll tend to perform well in the long term. At the same time, there's a separate force, which is what you might call hype, which is what's cool, what's popular, what do people want to invest in right now, what's the next big thing? Sometimes that will drive returns for a while, where, in the internet bubble in the late 1990s, all kinds of internet stocks, pets.com, whatever, got driven really far up and sometimes for years before collapsing. I'm curious, how does that mental model map onto yours? Would you look at it differently, or do you think I'm on point there?

JIM: So back to Keynes. He had a great saying, which is, "Markets can remain irrational longer than you can remain solvent." There's a lot of truth in that. In my own investing, I tend to be very aggressive, so I overweight more growth-style investing. Ours were unique in that — well, not unique — but ours were also strategies where we had a value carburetor lurking somewhere in the selection criteria, so that we got really fun and interesting growth companies, but not ones that were priced to perfection. Again, that kind of question is more suited to somebody who's going to be actively interested in style investing, value and growth being the two most popular. If they were songs, value investing's title would probably be something along the lines of, been down so damn long that it looks like up to me, and growth investing would be the future so bright I gotta wear shades. Both have their times in the sun. A portfolio balanced to how well you deal with risk and uncertainty that has allocations to both growth and value makes a lot of sense. But again, we're negating our original advice, aren't we? Unless you have fallen in love with trying to figure markets out, or you enjoy it, the easiest thing for you to do is just buy that world ETF that's ranked by market cap. Growth and value are always a horse race. Now, growth has dominated for so long that many people say, "Oh, well, value is just never going to work again." I find that to be short-sighted because ultimately, value will out. If you just look at it in your own life. I used to give the example: let's say you want to run a food truck in Manhattan, and you find somebody who's selling their food truck, and they happen to be making food that you enjoy. Everything looks great until they say, "Yeah, it's going to cost you ten million." And you're looking at their profit and loss statement. You see that they only make a hundred thousand dollars a year. You're going to say, "You're crazy. I would never be able to make good on that ten million investment." But when we make it a stock that's traded on an exchange, then the story becomes so compelling. My point is simple: ultimately, if you can reliably buy $1 for 65 cents, you're going to ultimately do that. Because it's just such a wonderful arbitrage opportunity, and that's kind of what value does. Now, as I said, it's been way out of style for a long time. That doesn't mean that math has changed, and ultimately, it generally comes at a time when no one expects it. You're going to get a bunch of people saying, "You know what, I really like that idea over there, that I can buy that dollar for 65 cents." And then you'll get a flip in which style is doing better. They very rarely make an announcement or tweet about it. It happens gradually and slowly, and oftentimes you don't even notice until, say, value has outperformed growth by some significant amount, or vice versa, growth has outperformed value by some significant amount. I just think all of these questions orient people towards believing that they are going to be able to uniquely time when value is going to be in favor or when growth is going to be in favor and when not. All of our track records, with the exception of a few, are very poor in that regard.

SPENCER: Do you think it's worth distinguishing between growth and what you might call hype, where you have companies that are growing really fast and nobody really knows how big it's going to get, and it could be a very compelling investment, because as long as the exponential growth keeps up for a while, it'll be worth a huge amount, versus there are things that are essentially like the tulip bulb bubble in Holland in the 1600s, where a tulip bulb used to be the price of someone's house, because tulip bulbs were considered this incredible investment, and it kind of became circular. Some aspects of the market seem to be much more about just what's in fashion and not about creating fundamental value, whether it's value in terms of value investing or value in terms of long-term growth potential.

JIM: Yeah. We've had, they used to call them glamour stocks in the 1960s and basically insert hype stocks. Look, that's part of the entire market's ecosystem. There's always going to be somebody who's going to be a grifter or who's going to try to con you into believing something, and so you definitely want to pay very close attention to ridiculous forecasts and prophecies of what a particular company might be able to achieve in the future. Forecasts are almost always wrong, and the way you want to believe that is just read old ones, find somebody who's highly thought of or well-known, and then go back and find what they were forecasting five years ago and have a good laugh. The fact is, again, we're back to the temporal nature of markets. In real time, somebody can be incredibly persuasive, and it involves our emotions, because it's real time. It makes us feel like we're going to miss out on this and all that. These are all psychological traits and acts that people who are trying to promote a stock whose intrinsic properties might not be all that great are going to use. So get used to reading old forecasts, and it will hopefully cure you of believing any forecast that you read, right now. I think clearly there are companies where the vast majority of analysts get it wrong. I don't know too many analysts who were making forecasts for Nvidia, for example, five or ten years ago that were even close to what Nvidia has achieved. The challenge is you can't know that ahead of time. We have this wicked thing called hindsight bias, which makes us all believe that it would have been obvious for us at the time, and we could have easily seen that. The answer is no, we could not have, and looking at things retrospectively, of course, they're obvious because they've already happened. A good way to cure yourself of this is to read all of these research reports, read all of these prognostications and forecasts, but read them from five years ago.

SPENCER: I heard about this psychology professor who was very frustrated because whenever he would present his results, people would feel like the result was obvious. So he switched up his method in his presentations, where he would present the study and ask people in the audience to predict what he found, and have them raise their hands, and then he would show the result, and suddenly it would be way more surprising, because if you present the result first, people would immediately rationalize why it was obvious that that was going to happen.

JIM: Yeah, that's clever. You could do things like that with yourself too. The more you do that, the more you inoculate yourself against that very compelling emotional component that is almost always only present in real time, because that's the way emotions work.

SPENCER: One of the famous theories in economics about the stock market are that there are different factors associated with higher returns, such as small companies performing better, or that companies with low price-earnings ratios perform better, so-called simple value stocks. Or maybe that stocks that pay dividends perform differently. What do you think of those theories? Do you think they hold any weight? Did they hold weight in the past? Do they still hold weight today?

JIM: Given the fact that I wrote a bestselling book on that very subject, called What Works on Wall Street, I believe factors can be incredibly predictive. If you have a large data set and the ability to test each factor, both individually and in combination with other factors, it emerges that there are factors that end up doing vastly better than other factors. It's also fairly intuitive; if I'm asking you to pay $100 for every dollar of sales on one company, and I'm asking you to pay 50 cents for every dollar of sales on another, math usually wins out. Now, will it win out in that particular security? Not always, but that group of securities with those characteristics tends to do very, very well in certain factors and poorly in others. So I think, like everything, it doesn't work 100% of the time. That's why, in the book, we always look at all rolling five, seven, and ten-year periods to see how often it underperforms, how often it outperforms, etc., by what amount. You can kind of prepare yourself for what's normal with that type of factor combination. I think that factor investing is still my preferred way. It's the way I invest my own money for public markets, and I think we've seen them continue to work through many different types of market cycles. Two examples: we have a strategy at my old firm, O'Shaughnessy Asset Management, that buys market-leading companies that have high shareholder yield. Shareholder yield is dividend yield, which is a cash dividend that they pay, plus any buyback activity that the company engages in. But it isn't just those two factors; we have a lot of quality factors in there too. We make judgments quantitatively about whether this is a significant buyback or not, etc. Those factors work quite well for large-cap value style investing for many years. Conversely, we have a micro-cap strategy where I have a lot of my own money because I like risk that is super high variance. In other words, the market could be up 12% and you could be down 20%, and conversely, you could be up 25% while the market's flat. The micro-cap strategy is pure factor, and it works super well down there because very few analysts cover micro-cap style stocks. Again, they're just not big enough for the analyst community to allocate any time to them. So, yeah, I think there's nothing that's happened recently in investing that would make me say, " Yeah no factors had their day and they're not going to work anymore." They're going to continue to work because there's a reason why they call economics the dismal science. Trees do not grow to the sky, nor do all of those fantastic things that get people really excited continue indefinitely, and factors are a great way to help guide you, as well as give you the historical picture of what those types of stocks did over time.

SPENCER: So do you believe that smaller companies actually perform better on average if you're just going to buy them indiscriminately?

JIM: Indiscriminately, no. On micro-cap, for example, that would be the worst thing you could do. Micro-cap stocks, typically, the index itself is not a great investment vehicle because the majority of micro-cap stocks are micro-caps for a reason. That's where factors really get the ability to amplify your results when you run micro-caps through factors based on things like financial strength, the health of the balance sheet, and all of those types of things. What happens is that out of the 3,000 micro-caps you're looking at, a handful emerge like diamonds in the rough from the overall universe, which actually is quite dodgy.

SPENCER: So it sounds like what you're saying is that the classic factors found in economics, like size, smaller companies perform better, are not sufficiently nuanced. It's not just that, on average, smaller companies perform better, but you have to overlay extra filters on top of that. Otherwise, it doesn't actually work.

JIM: Specifically, for micro-caps and small caps, we found that investment in smaller stocks broadly outperformed larger stocks, but with a significantly higher degree of risk, if you're measuring risk as the standard deviation of return. The portfolio has so much more variability in small stocks. Do they do better than large stocks over long periods of time? Yes, but not by the types of margins that many had hoped for and anticipated when making an investment just based on size. But again, let me stress, micro caps are a really separate category. These are the tiniest of tiny stocks that are publicly traded. The performance in micro cap land is very, very different than, say, a small cap index like the Russell 2000.

SPENCER: If you analyze this from the point of view of the efficient market hypothesis, which says that all the information is already priced into a stock's price, the argument would say the only way you can outperform with a simple factor is by taking on more risk. The reason small cap companies might perform better is because they're riskier, and so you can compensate more on average, but you're also taking on more risk. Do you buy that when it comes to small companies performing better, or do you think that's sort of missing the mark?

JIM: Well, the efficient market theory has been disproven by reams of empirical data. That does not mean that markets are not efficient in the sense that they do manage to price in a good deal of readily available information on securities in general, which is one of the reasons why index funds work so well, for example. The empirical data on factors by decile compared to broad market indexes is closing in on a hundred years of data now. We are finding that certain types of factors end up performing significantly better than other types of factors. I think the efficient market theory is in need of an update. If you're interested in that kind of stuff, I would read a book by Mandelbrot called The Misbehavior of Markets for a single chapter alone in which he dismantles efficient market theory, essentially using just observable data. He's a good writer, too.

SPENCER: What are some of the other robust factors that are not proprietary that you can talk about? So you've got the size factor, but what other ones do you think really work?

JIM: A combination of value factors. One of our principal findings was that it's probably a mistake to use just a single factor for anything. So we created a series of composites for value, for growth, for momentum, and those work significantly better, because individual factors come in and out of style, just like everything else. And so we found that, say on the value side, it made much more sense to not only look at price-to-earnings ratios or price-to-sales ratios, but to look at varying ratios that take the balance sheet into account. You can find all of the data at my old firm, which has a great deal of research material, and that's at www.osam.com. I'm no longer affiliated with O'Shaughnessy Asset Management as Franklin Templeton bought it at the end of 2022, but they're still using exactly the same strategies. Hopefully, the research team has improved them. My guess is they have, but you can see all of the data there in terms of which factors work quite well and which ones have a lower batting average or base rate. One combination factor that I like a lot is one I dubbed kind of cheap stocks on the mend. So in other words, stocks that score very well on the value composite, so they're definitely not overpriced. But then you marry that to a momentum price momentum index composite factor, and essentially what you're doing is you're buying stocks that are cheap in terms of the various factors, but the momentum has shifted for them, and investors are buying them up. That's a great combination of factors in terms of total performance for the portfolio over time, but I would again, really depend on the risk profile and disposition of the investor. If somebody is a very, very risk-averse person, they're probably not going to get much of a benefit from trying to use a price momentum factor, because variability makes it kind of a wild ride. I would point them more toward the composited value factors.

SPENCER: When you're talking about price momentum, are you basically talking about companies that have had large percentage price increases recently?

JIM: Yes, I am.

SPENCER: One thing I'm curious about why you published your results about what factors work. Wouldn't that undermine your own investing?

JIM: Not at all. There are two kinds of anomalies. One group are mathematical anomalies that, if you do publish them, they disappear because other people take advantage of the same anomaly, which arbitrages it away. All of the various factors are basically much more behaviorally motivated. I cannot tell you the number of people who would get in touch with me saying, "I can't believe you published this book. I have been doing incredibly well using factor (fill in the blank, depending on which one they were using)." Then the same people, one quarter after that, factor underperformed significantly. I heard, "How could you publish this? This is misleading." And where are we back to? We're back to emotional responses. The factors in what works essentially are kind of evergreen in that they are highly contingent on the human beings that are using those factors. One of the most common traits that we saw was that people's time horizons are just misallocated. You get even institutional investors who say that their time horizon is nearly infinite. Why do they still want quarterly reports from you? The idea is we say all of these things, but they aren't the way we really are. The way we really are is highly emotional, and as long as something is working, we think it's the greatest thing in the world. The minute it stops working, if only for a quarter — God, don't even talk about three years — they immediately lose interest in it. It's sort of a good metaphor for life. You know podcasting. You probably know this, Spencer, as a podcaster. If you publish more than 20 podcasts, you're in the top — I don't know what percent — but it's like the top 5% of anyone who ever tried to do a podcast. People give up on things way too quickly, and it just seems like it's part and parcel of our operating system in that the minute a defeat comes, people throw in the towel. I saw that happen with factors as published in what works time and time again. It's not a question of intelligence; super bright people down to just regular, average folks all behave the same way in terms of reaction to a factor when their actual money is in it, and whether they think of you as a genius or an idiot is correlated directly to the short-term performance of that factor group.

SPENCER: What do you think the right time frame is to evaluate an investment or an investor?

JIM: Well, people aren't going to like my answer because it requires a lot more patience and time. I think three-year evaluations are the most misleading. In fact, there was a study that looked at institutions that fired a manager based on underperformance for three years, and then when they went in and looked at the data, they found that the vast majority of managers they hired to replace them had had an unusually good three-year performance period. Then they extended that out to the next three years, and you can see this one coming a mile away. The manager they fired did better than the manager they hired. Reversion to the mean is quite a real thing in style and stock market performance. I think the longer horizon you can give, the better the accuracy of whether you've determined somebody is a good investor or not. Again, a lot of this is incidental advice to somebody who's going to actually take the advice we gave at the top of our discussion and just buy an index, because that all kind of comes out in the wash in the index. Because indexes are comprised of both value and growth, and skill is not a big part of the index. But if you're looking at a portfolio or an investor and you're interested in placing money with that individual, the longer term the track record you have access to, the better.

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SPENCER: I remember a while back, I was reading about the best mutual fund of the decade that had performed the best relative to the market. It was really fascinating because although it performed incredibly well, if you put a dollar in right at the beginning of the decade and just let it ride, the average return of investors was actually terrible in that same mutual fund. It's because it would go up a lot for a couple of years, then people threw money into it, then it went down a bit. People pulled their money out, then it went up again. They threw money in. It zigzagged. Every time it did well, people added more money. They never did badly; they pulled their money out. So a dollar riding the whole time did amazingly well, and yet the average dollar in it did terribly because of investor behavior.

JIM: That's such a great example of the reality of why we fail as investors. We let our emotions drive us out when things are underperforming, and we let our emotions throw money into something because it's doing so well. The fund you're referring to is a perfect example of that, and this is true across all funds. I'm fascinated by these analyses because they're universally true; it doesn't matter which mutual fund you're looking at. I used to joke that market timing doesn't work with one exception, and that is if you do the opposite of what the majority of investors are doing at any given time, you're probably going to get your timing much better than you would under any other kind of timing situation. The problem with timing is that, let's take something as simple as a 200-day moving average. As you might be able to guess, being an inveterate researcher, we researched virtually every market timing tool we could find, and one of the simplest ones is you buy an index or a stock when it's above its 200-day moving average, and you sell it when it's below it. Over long periods of time, it works very well and does add value. The challenge is it also has a lot of false positives. People say, "Well, I could deal with that." The answer is probably you can. Because if, let's say, you do all your research, you did it all yourself, and you see that using a 200-day moving average with this particular index is really a great way to avoid the downturns in the market, etc. Then you decide, "I'm going to do this," and you start, and right out of the gate, you get three false positives. It tells you to buy. You buy. It tells you to sell, and you're selling below where you bought at. You're getting pretty upset with this. It tells you to buy again, and that one's wrong too. In the scheme of things, those three things will do more to tell you, "Wow, this used to work, but it certainly doesn't work anymore." If you simply waited for another 10 signals, you would have gotten out of that big market crash, or you would have gotten in at the right time again. Tying all of this back to the way we actually do things and the way we actually let emotions determine our actions has a far greater impact than whether you know so much about stocks that you have a PhD in quantitative stock theory from the University of Chicago.

SPENCER: This is a bit of a side point, but it's something I've wondered about, which is, suppose you have a deep conviction that something is in a market bubble. You think something's way overvalued. How do you actually profit off of that? I've had this happen to me where, for example, there was a period when SPACs were in this giant boom, and there were all these really, really trash companies doing SPACs. And I was like, "I know this is a market bubble. I know this is crazy." But the problem is, what do you actually do? You could short it, you could short the bubble, but then the bubble could go up 10x before it collapses, and then you've absolutely obliterated yourself. Or you could buy options into the bubble. But then the problem with those is you have to time it properly. The fundamental thing is that a bubble could continue going up for years and completely kill your investment. So I'm curious, if you were absolutely convinced something's a bubble, how do you actually make that trade and make money off of that?

JIM: So the easiest way to do that, so you don't have to face those limitations that you just outlined, is to simply avoid investing in that sector. That becomes its own kind of quasi-timing tool, and it doesn't cost you anything. If SPACs, special purpose acquisition vehicles, is what SPAC is short for, they were all the rage, and you're right. A lot of awful SPACs were floated on the market. If your position was, "This is a bubble, this thing's gonna blow up, no doubt about it," but you're worried about your timing element, either in shorting it too soon and not being able to withstand all the margin calls as it continues to increase in bubble size, or you don't really know how to time an options purchase because you lack certainty as to when the bubble is going to go away, just avoid the sector. Then you avoid getting whipsawed. Because if you're like everyone else, and let's say you invest early during that bubble phase, and the evidence you have in the short term just continues to confirm, "Boy, this is great. This is the best thing in the world." It gets very difficult for you to exit when things are about to pop. Avoid the sector is probably the advice that I would give for the safest, lowest-risk way to either get decimated or get sucked into a bubble in a particular sector in the economy.

SPENCER: I know an investor who correctly predicted that the internet bubble was happening and shorted the market, but he was a little early. So he was totally right, but it was incredibly painful to watch it continue going up and up and up and losing more and more. And then, that's gonna make you sweat a lot. It may make the whole thing not worth it, even if you're approved, right in the end.

JIM: No question about it. I wrote a piece in April of 1999 called the Internet Contrarian, in which I stated that 85% of the stocks in the dot-com sector were going to get carried out feet first. In other words, they were going to go bankrupt, and the other 15% were probably going to go down 90% or more in value. We acted on these convictions in sort of the summer of '99, but we abandoned it, because we were wrong, and we were getting absolutely hammered on the upside. The reason we abandoned it was that it wasn't our line of business. Shorting stocks was not something that my company did, and I did it more as a personal experiment than anything else, but it's also kind of the ideal illustration of what we've been talking about for the last hour and a half. I got the thesis right. I was right. The Internet did blow up. I was just too early. I started shorting them too early. I was getting absolutely hammered by the stocks that I was shorting, going up and up, getting margin calls, doing all of that. So I'm just like, "Well, this is taking my attention from my actual business, which is long stock investing." That's why we closed it down. And I just had continued it through 2000, that portfolio of stocks that we were shorting would have had the equivalent of a gain of 108% in 2000, but we didn't continue because of that short-term pain. It wasn't our main business line. It's very, very tricky to try to get that stuff right. I would increase my service area of luck. If I was out there listening to this, I would just say, "Yeah, I think I'm just going to pay attention to the advice he gave at the top of the podcast, which is dollar-cost average into an index fund with the lowest fees."

SPENCER: I think one of the themes of this conversation has been that if anything you're doing involves timing, you should be rethinking it. Unless you're literally a world-class expert in timing that exact thing, you probably can't time it. So you better do something that doesn't require getting in and out at the right time.

JIM: Totally.

SPENCER: Before we wrap up, I just wanted to hear a little bit about what you're focused on now. As I understand it, you have a sort of new venture that has all these different sub-projects: Infinite Ventures, Infinite Films, Infinite Media, and your fellowship program. Do you want to just tell us a little bit about that?

JIM: Sure. So after I sold O'Shaughnessy Asset Management to Franklin Templeton, I thought, "What fascinates me and where do I see an opportunity with a great arbitrage opportunity?" I've always loved books, movies, and media of all kinds. Books happen to have a huge arbitrage opportunity in that most of the existing big publishers are using best practices from 1924, not from 2024, and there are a ton of innovations that can be made in the publishing industry. Our company is called Infinite Books, and it can enhance not only the tools that the publisher gives to the author, which is paramount, but also do so at considerably lower cost, and therefore be able to share more of the revenue with the author. Everything that O'Shaughnessy Ventures is focusing on happens to be a love of mine in an industry where we think there's a great deal of arbitrage opportunity by moving to different ways of doing things. The same is true in the media and in film. You do not need the millions of dollars you used to need to have successful media properties or successful film properties. That's why I picked the particular industry that I picked. As far as the fellowships go, I think we are living in maybe one of the most exciting times in history, in that the amount of innovations, things like AI, and the ability to gain insights from the manipulation of massive data sets, not only with AI but with a variety of other tools. One of the things I really wanted to point out was, in the past, a genius could be born, live, and die without even the genius themselves knowing that they're a genius. We were bound heavily by geography, kinship, familial circumstances, etc. There was no way for me sitting in Greenwich, Connecticut, or in Manhattan, down in Union Square, to read about the incredible person in Zambia who has great ideas on how to better serve people with healthcare needs or mobility needs. Now I can do that, and I think it's incumbent upon me to do it. So what the fellowships do is give grants. For $100,000 over a year; a grant is $10,000, so different project sizes, but to highlight people with great ideas and innovative solutions to age-old problems, then amplify them to the world. We've been delighted with the results, and it's only in its second year. It begins its third year next month, but I think this is a great way to highlight the fact that there are so many smart people in the world today working on solutions that are going to make society better, make a variety of things better. What better way to remind everyone of these people than to fund them and show, show, don't tell? Don't say, "Oh, you know, so and so is doing great work over here." Fund them and then show their progress. Show where they succeeded, show where they failed, too, so that that information can be shared more broadly with other groups of innovators present. The new firm is really fun. The only real challenge is I have to change kind of mental models so often throughout the day. I can start the day getting a pitch from an author for a fiction book, then switch over to reviewing the technical specifications of what a fellow is trying to achieve, and then hearing a pitch from a documentarian about this great documentary he wants us to fund and make. Having to change mental models is a small price to pay for being exposed to so many incredibly cool things, opportunities, and people.

SPENCER: If a listener is hearing this and they're thinking, "Oh, hey, maybe I should apply," who are you looking for? Who are the right kind of people to apply for your ventures?

JIM: We are looking for innovators, creators, and kind of off-the-wall thinkers. It doesn't matter how old you are, what color you are, what sex you are, or what your preferences are in terms of who you want to love. All that we care about is your idea. If it's a great idea and we can help you bring it to fruition, you should apply. By the way, when I say creatives, financial people are creative too. They're just creative in a very different way. People who start companies are very creative, and then clearly the more normal association we have with creatives are artists or writers. We have a very broad definition of what we view as creative. This year's fellowship includes a woman who is building an at-home bio-device that allows you to get consistent readings on your skin cells or your poop cells or whatever. She's got a PhD in Biology and is doing that kind of work, but we also have one where he lost his fingers due to cancer, and he couldn't find an adequately useful prosthetic hand, so he built one, and he's in the process of standardizing it to allow people to build their own hand to their own specifications. Then we've got a songwriter in India who we gave a grant to last year. He used that money to record a song called Chore, which had 2.2 billion downloads last year. He's got a fellowship this year, and he's working on other songs. We really run the gamut from creative scientists to creative singers and songwriters to artists of all scopes and entrepreneurs. If you've got what you think is a great idea, definitely go to www.osv.llc, and you'll find the fellowship application at that website.

SPENCER: Great. We'll also put in the show notes. Jim, thank you so much for coming on.

JIM: My pleasure, Spencer. Thank you so much for having me, and best of luck to you and your listeners with all of your long-term investments. Try to remember, don't think short term.

[outro]

JOSH: A listener shared the following belief with us, and I want to get your reaction to it. Their belief is: "International travel is way overrated. People always talk about how it broadens your mind, but I don't buy it. If you really care about broadening your mind, you can do so more cheaply by consuming foreign news or media or getting a pen pal. But people don't do that because the real reason they like to travel is that it's a sign of status or cosmopolitanism, and they like the food and photo ops."

SPENCER: It's interesting. Certainly for some people, travel is a status symbol. We can't rule that out. On the other hand, I think there are actually a lot of reasons people really enjoy traveling. First of all, I think that people get a lot of pleasure from the novelty of being in a new place where everything is new. It's almost like being a child; you go into a new place and you're constantly noticing things that you would never normally notice in your typical environment. It kind of imbues everything with a certain magic, like, "Oh, look at the doorknobs and how they're different from ours," and "Oh, wow, look at the snacks in their 7-Eleven; it's so different from our 7-Eleven," and so on. I think that is actually kind of a wondrous feeling that a lot of people get a big kick out of. Additionally, being exposed to other cultures can really have benefits for people. It's easy to think that your world is the whole world and that everyone is kind of similar to you, but then if you go and see people doing things wildly differently, it can shake up your worldview a bit and say, "Hey, you know what? Maybe people are really much more different than I realized, and I have a kind of provincial perspective." I think it can be broadening in that way. Yes, you can learn about other perspectives in other ways. You can read books about other cultures or read news from other cultures, and so on. But there is a sort of experiential learning where you're actually interacting with other cultures that is different from those things. Not to say that those aren't beneficial too; they could be, but it's just a different way of broadening your experience that is quite different from merely reading about something.