Bill Bernstein: We're Starting to See all of the Signs of a Bubble

Our guest this week is noted author and advisor, William Bernstein. Bill’s background and entree to finance is unique--a neurologist by training, Bill taught himself the principles of investing and asset allocation, eventually parlaying that knowledge into a successful financial advisory practice and a series of influential, critically acclaimed books such as The Intelligent Asset Allocator, The Four Pillars of Investing, If You Can: How Millennials Can Get Rich Slowly, and his latest, The Delusions of Crowds.

Background

Bio

Books

“Bernstein: ‘I Don’t Think the System Needs Nudges. I Think the System Needs Dynamite,’”The Long View Podcast, May 7, 2019.

Current Market Environment

The Wisdom of Crowds, by James Surowiecki

“A Stock Market Bubble Is Forming,” by John Rekanthaler, Morningstar.com, Oct. 20, 2020.

“From 1720 to Tesla, FOMO Never Sleeps,” by Jason Zweig, wsj.com, July 17, 2020.

“The 4 Pillars of Investing,” by Larissa Fernand, Morningstar.com, June 19, 2020.

“4 Ways Today’s Stock Market Resembles That of the Late 1990s,” by John Rekenthaler, Morningstar.com, March 4, 2021.

Inflation, Bonds, and Other Asset Classes

“The Case for Minimizing Risk in Your Bond Holdings,” by William Bernstein, wsj.com, Oct. 18, 2015.

Inflation, Deflation, Confiscation & Devastation--The Four Horsemen of Risk,” by Wade Pfau, forbes.com, March 4, 2020.

“What if Inflation Isn’t Dead?” by John Rekenthaler, Morningstar.com, Aug. 11, 2020.

Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment by David F. Swensen.

“Fran Kinniry: Applying the Vanguard Approach to Private Equity,” The Long View Podcast, April 1, 2020.

“What Are SPACs and Should I Care?” by David Sekera, Morningstar.com, March 2, 2021.

Retirement

“How to Think About Risk in Retirement,” by William Bernstein, wsj.com, Nov. 30, 2014.

“Retirement Planning When You Have Enough,” by Christine Benz, Morningstar.com, Sept. 11, 2020.

"Of Viruses, Distressed Sales, and Stocks' 'Rightful Owners,' " by Bill Bernstein, efficient frontier.com, 2020.

ETFs

“No Room on the ARK?” by Ben Johnson and Bobby Blue, Morningstar.com, March 3, 2021.

“Digging Into ARK Innovation’s Portfolio,” by Amy Arnott, Morningstar.com, Feb. 18, 2021.

“Gerard O’Reilly: Control for the Unexpected, Focus on the Expected,” The Long View Podcast, Jan. 26, 2021.

Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance for Morningstar.

Jeff Ptak: And I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Benz: This is the 100th episode of The Long View. And we're grateful for our longtime listeners, as well as those of you who are newer to the podcast. We appreciate that you've subscribed to and rated The Long View and shared feedback and guest ideas directly with us, too. We've also been lucky to have so many great guests on the podcast so far and we've lined up many more for the weeks ahead.

For the 100th episode, we wanted to go back to the person who was our first guest for the podcast, William Bernstein. Bill is a neurologist turned investment advisor. He is also the author of several books, including The Intelligent Asset Allocator, The Four Pillars of Investing, If You Can: How Millennials Can Get Rich Slowly, and his latest, The Delusions of Crowds.

Bill, welcome to The Long View.

William Bernstein: Glad to be here.

Benz: We're glad to have you here. You're a physician. So, before we get into the investment portion of the discussion, we'd like to touch on the pandemic. What have been the most surprising aspects of it from your vantage point?

Bernstein: Tragically, how poorly it was handled. And I was rather surprised with how poorly it was handled, because the WHO, and the world in general and the nations that were involved, did a marvelous job with the SARS epidemic of the mid-aughts. They did everything right. They restricted travel early on; they did contract tracing; they did quarantine; they made people wear masks. And mistakes were made, but it didn't become a global pandemic. And so, now, we've got an infection with a very similar virus, and you would have thought the world would have responded in the same way. But pretty much everything that could go wrong, did go wrong.

So, the Chinese hid the danger early on. They actually started putting people in jail who were whistleblowers. They weren't allowing people from our CDC into the country. Initially, they weren't forthcoming. The WHO and our CDC gave poor advice about wearing masks. They should have known that it's a SARS virus and it transmits respiratorily, and they didn't jump on that right away. And then, finally, our country just responded very poorly. It did not help that we had a president who basically made fun of people who wore masks, told people that it was nothing to worry about. It was going to go away like a miracle. And there was no national-level response to the pandemic. There was no national public health response. And so, pretty much everything that could go wrong did go wrong.

And when you look around the world at the countries who did well--your Taiwans and your Thailands and your Vietnams, and eventually, China--they were countries that did have experience with SARS. And so, they'd seen the movie before. And they knew exactly how to respond, whereas we didn't have that experience. So, we didn't respond well at all.

Ptak: Have we turned a corner?

Bernstein: I think so. You look at infection rates, they're dropping dramatically. You look at death rates, they're dropping not quite as quickly, but that's because death lags infections. And then, finally, I think we're starting to at least approach--at least we're more than halfway toward herd immunity. The infection rate of documented infections in the population is now about 10% of the population--9% or 10%, which tells you that probably there's at least double that amount that's been asymptomatically infected. So, that gets you to something like 30%. And then, 15% of people have had at least one shot. That gets you to roughly 45%. So, I think we're going to probably be there, and I think we're going to do well, but at the cost of more than half a million fatalities.

Benz: Let's switch over to discuss investing, starting with the current market environment. You just published a book on popular delusions. Does that describe this market in your opinion? Are we in a bubble?

Bernstein: Well, a year ago, I would have answered that in the negative. I just didn't see any of the usual diagnostic signs that one sees during a bubble, which is people thinking that they're going to be coming effortlessly rich, which they chatter about endlessly whenever you go to a party or you meet people casually on a social basis. We weren't seeing people quitting their jobs to day trade. You weren't getting a lot of anger or pushback when you express skepticism, and you weren't seeing extreme predictions. But we're starting to see all of those things now. And particularly, with Robinhood and GameStop and the other short squeezes that are going on, there's now a significant population of relatively young people who really believe that this is the path to effortless wealth, and they've already made it to easy street, and they're quite excited about it. And I have to admit that I missed this for a while because I don't hang around a lot with too many 30- to 40-year-old people aside from my kids who are too smart to get involved in this sort of thing.

Ptak: You cite James Surowiecki's book, The Wisdom of Crowds, in your just-published book, and it lists three requirements for effective crowd wisdom. First is independent individual analysis. The second is diversity of individual experience and expertise. And third is an effective way for individuals to aggregate their opinions. So, what do you see when you apply those requirements to three stories that have captured headlines in recent months? I think you've referenced at least a few of them. One is GameStop, second is Tesla, and the third one being Bitcoin.

Bernstein: Well, you've got the third of those criteria, but you certainly don't have the first two. The Surowiecki book is a fabulous book. And I recommend it to just about everybody I meet. And the only quibble I have with it is it's mistitled. He is really not describing a crowd. When I think of the crowd, I think of going to a stadium and seeing people doing the wave or screaming all at once. What Surowiecki is describing is the opposite of the crowd, which is just what you described, which is well-informed observers who are making independent judgments. And that's hardly what's happening on the various Reddit forums and people who are using Robinhood--they all are basically going back, bouncing off each other in an echo chamber. And that's the opposite of Surowiecki described.

Benz: In the book, you also cite research that's found we tend to prefer situations where there's a large potential payoff, even if the odds argue against taking that bet. It seems like we've seen this lottery ticket phenomenon in stark relief during the pandemic, with people wagering what little they have on long shots. Do you think the rise of free trading and also easy-to-obtain margin has worsened this tendency?

Bernstein: Without a doubt, and I would put "free trading" in quotes, if anything, but free. Citadel Securities and Wolverine and, of course, Robinhood itself are skimming these people off the top with remarkable effectiveness.

Ptak: Let's shift and talk about the recent market events a little bit more specifically. The recent market volatility has been attributed by some to rising bond yields. But do you think overvaluation has been the biggest driver?

Bernstein: I don't see increasing volatility. If you look at VIX, or if you look at just the 30-day rolling standard deviation of daily returns, you're seeing value standard deviations in the 20% to 30% range, which is a little high, but Lord knows, that's nothing out of the ordinary during the Great Depression. And, of course, during the financial crisis, we saw values approaching triple digits. So, this is not at all unusual. In fact worse volatility than we're seeing now back at the end of 2018 and at several points before that, as well.

Benz: Are there any pockets of value left in the market, especially given that we've had a rally in value stocks recently?

Bernstein: Well, first of all, we've seen a rally in value stocks. But relative valuation gap between value and growth is still at historically low levels. It was at absolutely historical levels at the third quarter of the year, and we're starting to climb out of that hole, but we've got a long way to go till we get to anything that looks like historically reasonable ratios. So, I think value is still relatively undervalued. And I think everyone who looks at this agrees that emerging markets are also very reasonably valued as well. Developed international markets less so and, of course, the U.S. market in general is significantly overvalued.

Ptak: Since we're talking value, I wondered if you could update us on your views on the relationship between inflation and value stocks. I think this is a topic that we touched upon the first time we had you on the podcast. We've seen value stocks rally. We haven't necessarily seen inflation spike up. And so, has that changed your views at all? Or do you still think that's a relationship that investors should keep an eye on?

Bernstein: Well, it's a combination both of inflation as well as just absolute interest rates. If you see absolute interest rates rise, that devalues earnings that are far off in the distance, which is what growth stocks are providing. And then, we haven't seen any inflation yet, but inflation also works in value stocks' favor, because value stocks tend to be overly indebted and if inflation melts away the real value of those obligations and that goes right to their bottom line. So, typically, during periods of high inflation, value stocks outperform.

Benz: How big a risk is inflation in your opinion?

Bernstein: At the present time, not much. But when you take a step back and you look at financial history from 50,000 feet, inflation is the biggest risk. There are very few nations that have escaped hyperinflation. We verged on it after World War II, as well as in the late 1970s and early 1980s. So, that's a risk you always have to keep in mind. And you don't need to have a PhD in macroeconomics to realize that if the economy bounces back as people start traveling and going to restaurants and going to movies that we could see inflation heat up as well. When people ask me do I worry about the macroeconomic effects of the pandemic, I tell them that not to worry about the pandemic; you should worry about the recovery from the pandemic.

Ptak: And so, if they are worried about that, and they wanted to build some protection into the portfolio, let's say, to hedge against inflation risk, how would you advise they go about that? I mean, TIPS are an obvious option. Are there other things that they should be mindful of?

Bernstein: Well, there are very few things that can actually protect greatly against inflation in the short term. The very best thing in terms of fixed income is, of course, T-bills, since you can roll those over very quickly with high frequency and there's no duration risk there. In the very long term, stocks are certainly a good hedge against inflation, because they are a claim on real assets. And if you really want to tilt to an anti-inflationary stock portfolio, you should go heavily into commodities stocks or commodities-producing companies. And I don't think there's anything wrong with doing that.

The one thing that is definitely not a hedge against inflation is gold. Because when you look around the world and you look at how gold has done in various countries during periods of inflation, it doesn't do well. In fact, gold does very well in periods of deflation, because deflation is associated with financial crises and banking crises. And so, when people stop trusting money, they stop trusting gold. But inflation generally doesn't do good things for the real value of gold. It happened to have done that to the U.S. in the late 1970s. But almost everywhere else in the world, if you look, it doesn't really work.

Benz: I wanted to pick up on the assertion that people would look for inflation protection through commodity-producing equities as opposed to other strategies for obtaining commodities exposure. Can you talk about that, about a commodity equity strategy versus commodity futures?

Bernstein: Commodities futures strategy is not an asset class. It's a compensation scheme. And it really doesn't work, because when everybody in the world is trying to do that, or when large numbers of people are trying to hedge against inflation with a futures strategy, you wind up driving futures prices, which gets you into contango, which is not a dance they do in Buenos Aires; it's something that works to the detriment of people who are long financial futures, who are long commodity futures.

Ptak: It seems like that's an example where investors love something that could, in theory, have portfolio utility, love it to death, just the sheer popularity of the strategy. It ruins any sort of portfolio benefits or diversification benefits that it would confer. When you look across the investing landscapes, do you think that there are other things that we have relied on to this point as diversifiers or portfolio bulwarks that perhaps would be at risk of the same? That they simply wouldn't be as diversifying in the future as they've been in the past because there's too many people doing it?

Bernstein: Yeah, the moment that a particular strategy becomes useful as a "diversifier," it becomes a risky asset that correlates with everything else. And so, it loses its diversification value. My favorite way of explaining this is to talk about David Swensen's famous book Pioneering Portfolio Management. And what people didn't understand when they read that book, which is a magnificent book, is that the keyword in the title wasn't “portfolio management,” it was “pioneering.” You want to be the first person to the banquet table and get the prime ribs and the lobster. And by the time everybody else knows about the strategy, you're getting the tuna noodle casserole. That's all that's left. And that's what's happened to the traditional alternative asset classes, venture capital, private real estate, hedge funds, commodities futures. That table has been picked over and overvalued and you are last in line when you're investing in those things.

Benz: Well, speaking of investments that might confer some diversification, fixed-income, high-quality government bonds have long been the ballasts that investors rely on for their equity exposure. With yields as low as they are today, do you think bonds are going to be good diversifiers going forward, given those ultralow yields, the fact that investors have less of a cushion?

Bernstein: You invest in fixed income not for the return on your capital, but the return of your capital. If you have a Treasury bill that yields close to zero, in the long term, it still may be the highest-yielding asset, the highest-returning asset in your portfolio, because it is the asset that allows you to sleep at night and stay the course. And that's the real purpose. You're not looking for yield; you're looking for safety. And that's what those things provide. Fairly frequently in a Berkshire Hathaway annual report you'll read Charlie and Warren discoursing about all the bad things about Treasury bills, about all the disadvantage they have, not the least of which lately is they're near zero yield. And then, the final sentence in that paragraph usually is something like, “Nonetheless, Berkshire will continue to invest the large bulk of its liquid reserves in Treasury bills.”

Ptak: We're jumping around a bit, but I did want to ask you about another potential diversifier, though perhaps it's lost some of its potency as the diversifiers become more correlated with U.S. stocks, and that's foreign stocks. One assertion we keep hearing is that foreign stocks are cheap versus the U.S. and that investors who haven't rebalanced for a while should revisit their geographic exposures. I think we heard you reference emerging markets earlier as maybe an attractive area. But are you in the camp where you feel that foreign stocks boast more inviting valuations than U.S. stocks and, therefore, people should be looking to allocate maybe a little bit more there than they have in the past?

Bernstein: Yeah, I think that's right, strictly on a valuation criteria. When people say that foreign stocks have lost their diversification benefit, they are correct if they're talking about month-to-month or day-to-day returns. I mean, let's face it, on a day when the U.S. market is going to be down 3%, foreign stocks will be down a large amount, too. So, on a day-to-day basis, it doesn't help you at all or on a month-to-month basis. But if you look at longer-term returns, there is real value. And the exercise I recommend that anybody do if they have access to the database is to take the period between, say, the beginning of 1999 and the end of 2008, which is the 10-year period that had contained within it two horrible bear markets and then look at the returns of U.S. stocks, large-cap U.S. stocks, which did horribly during that period, and look at the returns of foreign stocks, which at least gave you a positive real return. And you'll realize that the diversification value there wasn't something you saw on a day-to-day basis. It was something you saw on a decade-by-decade basis.

Benz: In their recent capital markets forecast several investment firms noted that they had higher return expectations for private equity than for public markets. Is that justified in your opinion?

Bernstein: No. Most of the studies I've seen on private equity suggest that their returns are a little higher than for public equity, but they come at considerably higher risk and less liquidity. And that's a game that I think some people can do well, but it's just not available to retail investors. If you're David Swensen, you can find the very best managers. If your broker at a large full-service bank, is not going to be able to find those managers for you. She will tell you that she can do it, but she really can't.

Ptak: What do you think of Vanguard entering that space?

Bernstein: I'm not happy with it. I wish they hadn’t done it.

Ptak: Maybe a quick follow-up from me, since we're talking privates--SPACs, what do you make of them? There's been a boom in SPACs in recent months. You referred derisively to certain types of investments as compensation schemes. Would you say the same thing with SPACs?

Bernstein: Yeah, I think so. And you're starting to see people enter into the SPAC space, who already have very severe disciplinary problems in other areas. I'm not going to name names, but I think we all know who we're talking about here. And that's always a bad sign.

Benz: You've suggested for retirement planning that people should hold 25 times their residual living expenses, meaning after Social Security and pension income in safe assets. Do you still believe that given how low yields are today?

Bernstein: Yeah, I still believe that. Twenty-five years is, it's an ideal. And when I say that to a young person, the response I'm most likely to get is, “OK, boomer.” But if you can do it, or if you can't get 25, at least try to get 10 or 15 or 20. The next question you're going to ask me at some point down the line is, “How do you mitigate sequence return risk?” And that's how you do it. You do it by having a large amount of cash that you can spend down when the markets do poorly.

Ptak: You said that single premium immediate annuities can make sense for some retirees. Do very low yields embellish the attractiveness of such products, or do they diminish it?

Bernstein: I think they diminish it a little bit. But the real thing that you're doing when you buy a SPIA, a single premium immediate annuity, is you're getting the mortality credit. You're basically monetizing your mortality, or more accurately the mortality of your peers. And that doesn't go away. So, yeah, they're a little less attractive. But whenever I talk about annuities, I always have to add the caveat that don't even think about an annuity until you’ve figured out how to defer Social Security until 70. Because that is the best annuity in effect that money can buy. Nothing that you can get from a commercial insurance company will ever come close to that.

Benz: One thing that we've been discussing a lot internally at Morningstar in the wake of the Robinhood phenomenon, is the best way for investors to get started in investing and to learn about investing. So, I guess the question I'd like to hear your take on, is some experimentation in individual stocks OK, in that new investors can learn these painful lessons before they have a lot of money at risk? Or is individual stock investing always a bad idea for people just starting out?

Bernstein: Well, the very best way to learn about the dangers of individual stock investing is to familiarize yourself with the basics of finance and the empirical literature on finance. But if you can't do that, then, sure, what you have to do is put 5% or 10% of your money into individual stocks. And make sure you rigorously calculate your return, your annualized return, and then ask yourself, “Could I have done better just by buying a total stock market index fund?” And pray that you don't get really lucky, because if you get really lucky, you may convince yourself that you're the next Warren Buffett, and then you'll have your head handed to you when you're dealing with much larger amounts later on.

Ptak: We've talked about it earlier in the conversation, but we have seen a lot of newer investors getting into the market over the past year or so. What do you think is motivating them? Does it come down to just boredom and we hate to say it, despair, or do you think that there are other factors in play?

Bernstein: Well, there are three narratives surrounding Robinhood, which is sort of the petri dish for this. One is that these young people really think that they're going to get effortlessly rich by flipping stocks. And, of course, that's because they're woefully uninformed. The second possibility is that they're just bored. I don't know how important that is. There may be an element of that, and I don't know how to disentangle it. And then, finally, there's the social justice aspect of it, which is really uninformed. Because they may have stuck it to one relatively small hedge fund, Melvin Capital, but there are much bigger fish out there and sharks out there that are eating their lunch that they don't even know about.

Benz: We've had some great discussions on the podcast about financial education. And Bill, this is a topic that you and I have discussed separately as well, specifically, what works and what doesn't. Do you have any thoughts on that for people who want to try to improve investor outcomes? And there are a lot of well-meaning people who are trying to enact change in that area. Where should they focus their energies?

Bernstein: They should focus their energies on accessible sources of good finance. So, the classic book I recommend to everybody is one of two books by Jack Bogle, either, Common Sense Investing, or The Little Book of Common Sense Investing. And almost anything by people like Larry Swedroe or Rick Ferri is a good place to start as well. Unfortunately, when you go to the bookstore, or you go to Amazon and you see what are the top-selling books, you're going to find things that are much less nutritious than that. And that's the problem, is you have to know where to look and most people don't.

Ptak: But knowing that there's going to be a certain cohort of investors that aren't willing or able to do that kind of sort of self-enrichment, I guess, do you think that frictions in a way can play a valuable role? We've seen trading costs fall away. And I suppose that's an example of a friction that might have kept investors from hurting themselves? And so, do you think that the elimination of things like trading commissions, it actually could end up working to investors’ great detriment, especially those that maybe haven't taken the time to read some of the texts that you mentioned?

Bernstein: I couldn't agree with you more. I don't have anything to add to that. The worst thing you can do to an uninformed investor--him or her—give the tools to trade freely. What we've done with frictionless trading is we've given chainsaws to toddlers.

Benz: Earlier on when we were discussing the whole bubble phenomenon, you referenced the entry of a star manager or star funds as being a characteristic of the bubble. So, I wanted to talk about the ETF, ARK Innovation, which has grabbed headlines and investor dollars over the past year. It's recently hit a rough patch of performance. What's your take on that fund?

Bernstein: Ah, here's where the parlor game comes in. And then I'll get to it when we're done with the parlor game, which is there's three of us here, and I'm going to start off with what puts me at a disadvantage, by naming a historical star manager, who was an absolute superstar who then planted their face, and then you each have to go and name your own. The last person standing is the one who wins. So, I'm going to start with the easiest one, which is Bill Miller of Legg Mason Value Trust--readers who aren't familiar with him--know beat the S&P 500 not just over 15 years, but for 15 straight years, every single year. And people thought that he was the financial fountain of youth. And then, he lost it all within the next three years after that. That's my entrant.

So, Jeff, you go next. Who's your favorite one?

Ptak: I would probably go with Garrett Van Wagoner. He was another example of a can't miss growth and tech-investing superstar. And it was sort of a similar rags-to-riches-to-rags story, at least if you were to follow the arc of that his fund's performance, they soared and then they came down to earth and at the worst time for investors who had flocked to them. So, he'd probably be my choice. Christine, what do you think?

Benz: Yeah, I was the Janus analyst back in the late 1990s. And so, I have a number of fund managers to choose from in this realm. One who comes to mind though was the manager of Janus Mercury Fund, which was one of their hot funds. Warren Lammert was his name. And like many Janus managers, he had very concentrated positions in all the top stocks of that era, and notably face-planted--in your term, Bill--performance was terrible, and investors left in droves. And when we looked at the dollar-weighted returns for many of the Janus funds, most investors really undermined their own performance by purchasing the funds and selling the funds at really inopportune times.

Bernstein: Well, since we're still in the Janus, there's another Janus manager who you will know and that's Helen Young Hayes who ran Janus Overseas. And exactly the same thing--she was on the front page of Money magazine. And if you would go to a conference in the late ‘90s, and you would talk about the efficient market hypothesis, someone would always stand up and say, “Well, what about Helen Young Hayes?” So, Jeff, you're next.

Ptak: Oh, my goodness, I think we could probably go on for hours. I can think of the fellow who ran Jacob Internet—the Firsthand Technology manager--I think Firsthand Technology is actually still going if I'm not mistaken. But those are examples of funds that a similar sort of story where they were phenomenons in their day, which was back during the tech and Internet craze, and had it come up in some sorts after the bubble burst there. So, those would be a couple of others for me.

Bernstein: Well, I'm going to stop the game here. Because I think the audience would probably get bored. But if we wanted to, we could probably go on for another 10 minutes. And I would press my advantage, because I'm older than you guys and I can name names that some of you guys may not even remember from the ‘60s and ‘70s. And the point is, is there's a much quicker question to ask, one that has a much faster answer, which is, who was the star manager 15 years ago, a superstar manager who is still a superstar manager? And the answer is…

Benz: Well, Will Danoff at Fidelity Contrafund I think has delivered.

Bernstein: Yeah, I think so. And I think that you mentioned Ryan Jacob, he's interesting. He's absolutely fascinating, because actually, if you look at him over the past 23 years, he beat the S&P 500 by about 3%. If you start at the end of 1998 or so, he beat the S&P 500 by about 11% to 8%. But the way he did it was by losing 95% of his money from 2000 to 2002, and then making it all back in two spurts. And I'm reasonably sure there are no sentient beings in this quadrant of the galaxy who have invested with them throughout that entire period of time. So, the answer is, it's a very short list. And so, the next question is, what do I think of Cathie Woods? And I think she is the next Garrett Van Wagoner or Robert Sanborn, or Helen Young Hayes or Lammert or Ken Heebner or Bill Miller--there are lots of these names, and they all plane out.

Ptak: What's your take on active ETFs generally? One of the things that is clearly different even if there are some similarities that you've noted between the situation we're seeing at ARK and maybe what's come before. Active ETFs, ETFs can't be closed. So, do you think that that's a fatal flaw for active ETFs?

Bernstein: I think it's a theoretical problem. But the real problem with active ETFs is that they are active. There's nothing magic about getting an ETF. It's just a different wrapper. Instead of wrapping the fish that spoiling in a pink wrapper, you're wrapping it in a blue wrapper. One is an open-end fund and the other is an ETF, and I don't think it really matters what you wrap the bad fish in.

Benz: What's your take on DFA's entrance into the ETF space? Are their new ETFs a worthy alternative to Vanguard's in some cases?

Bernstein: I don't really think so. The reason to go with DFA, if you're going to go with DFA, is to get their very highly tilted products. That's what they do that is absolutely unique is products that are very heavily tilted toward small and value. And the ones that they are offering as ETFs basically their core funds, which are not all that tilted. And if you really want tilt, probably the best way to do it is to put most of your money into a nearly zero-cost total market fund and then buy a tilted fund on top of that and there are other people who offer tilted funds besides DFA, particularly Invesco. But if you've got a financial advisor who has access to those funds, then that is a way to do it. But I don't see them offering their highly tilted products as ETFs.

Ptak: You're part of the Bogleheads community and you're on the board of The John C. Bogle Center for Financial Literacy. But are there areas where you go outside of Vanguard because you're seeking exposure to an area that Vanguard's lineup doesn't provide exposure to?

Bernstein: I just basically described that, which is, I do use DFA when I want highly tilted products. And when I want the total market products, I go with Vanguard, because they're the least expensive. Vanguard, of course, is not the only player in that game now. Schwab and Fidelity offer very low-cost index mutual funds as well. And there's some ETFs, total market ETFs, that are also just as inexpensive, a couple of basis points here and there.

Benz: You've said that you used to think that individual investors could create and manage their own investment plans, but you've come to believe that most people need an advisor or some kind of outside help. What prompted your change of mind on that?

Bernstein: Oh, life--just seeing what people did, even the ones who were well-informed. You need a very specific combination of skill sets to be able to invest well. You just don't need to know about the basics of finance and the theoretical finance and financial history, so you can stay the course through the bad times. You also need a certain amount of emotional discipline. And when I think of the people that I know, the people who do the best are the ones who basically are able to sleep through bear markets and don't even notice them. They don't look at their brokerage statements; they just keep their money in a low-cost fund and they do fine. Very few people are able to do that. And this is a terribly paternalistic thing to say, but I don't think that the average person has any business managing their own retirement portfolio. They have about as much business doing that as they do stepping into an airliner and flying the plane to Chicago. It's a difficult thing. You have to learn how to do it. You have to have the emotional discipline to do it. And I think that our entire retirement system needs to be revamped around that reality. The answer is certainly not better financial advisors and having professionals do it, because that doesn't work so well, either.

Ptak: What about a target-date fund for somebody that's in a retirement plan? Do you think that that can be an effective substitute for getting advice from another party?

Bernstein: Absolutely. The way to do it if you're a typical employee who isn't that interested in investing, and isn't overconfident, which is really an important characteristic to have, is to just put the money into a good low-cost target-date fund every single month, and don't ever look at your brokerage statements. Don't ever look at your plan statements. And by the time you've done that for 20 or 30 years, you're probably going to have a decent retirement. But very few people are able to do that.

Benz: We've been seeing kind of a contrarian trend in fund flows with assets going to bond and international funds and away from U.S. stocks, which, of course, have performed really well. What's behind that in your opinion?

Bernstein: That's interesting. It's the first time I've heard you say that. And I think that's a good thing. If people are moving away from U.S. stocks and into bonds, they're de-risking their portfolios, which is not necessarily a bad thing to do with valuations the way they are. And if they're moving into international stocks, then they're also moving into an asset class that may have higher expected returns. So, this may be one case where the crowd really is wise.

Ptak: For our last question, returning to the book, you make some interesting observations about imitation and how important that skill has been to our ability to adapt to our environment. As you point out, imitation makes credulousness valuable as it's key to interacting with others and learning, but in investing credulousness can be dangerous. Given that, how would you advise someone to ward against the danger of being swept up in a mania or popular delusion? What should they ask themselves or do to prevent that?

Bernstein: I would ask them how empathetic they are. When they see someone around them happy, do they get happy? When they see someone around who is very sad, do they get sad along with them? And if you answer those two questions yes, then you really have to be on your guard, because that tells you that you're the kind of person who is going to feed off other people's investing emotions, which is death in investing. Now, it makes you a good human being. Empathetic people tend to be really good people, but they also tend to be not such good investors. And if you're the kind of person who is not so empathetic, that doesn't feed off other people's emotions, that probably doesn't make you a good human being, but it may make you a good investor and you should use that to your advantage.

My favorite part of The Big Short, both the movie and the book, is that the people who made the money during the crisis were all people who had very low empathy quotients. And the funniest part of the book was reading the excuses that these people's wives made for them about their bad behavior. And I think that's a lesson. You have to ask yourself, how empathetic a person you are. And if you really are an empathetic person, you have to really be on your guard.

Benz: Well, Bill, as always, this has been great food for thought. We so appreciate you taking time out of your schedule to talk with us today.

Bernstein: My pleasure.

Ptak: Thanks again so much.

Bernstein: You guys take it easy and let's do it again sometime, OK?

Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)