Ben Carlson: The Numbers That Break Your Brain About Long Term Investing | #637

Ben Carlson, author of 'Risk and Reward: How to Handle Market Volatility and Build Long-Term Wealth,' explores the fundamental principles of successful long-term investing through historical analysis and behavioral economics. The conversation centers on several core themes: First, there is no secret to investing—no strategy works all the time, and if one did, everyone would use it until it stopped working. Carlson illustrates this by analyzing allocation strategies where the dispersion between best and worst performers averages 20 percentage points annually, despite all being theoretically sound approaches. He presents the concept of 'Bob,' a hypothetical worst market timer who only invested at all-time highs during major crashes (1973-74, 1987, dot-com, 2008) yet still achieved roughly 8% annual returns by holding long-term, demonstrating that time horizon matters more than entry timing. The discussion explores how even perfect foresight—picking the correct asset between stocks and bonds every year—only yields 20% annually, yet somehow people find ways to lose money anyway, highlighting the behavioral challenge of investing. Carlson emphasizes that asset class volatility compresses dramatically over longer holding periods. While stocks are four times as volatile as bonds over one-year periods, they converge to similar volatility at 10-year rolling returns and become even less volatile over 30 years. This challenges the conventional narrative about stock market risk. The conversation extensively examines historical bear markets and their lessons. The 1970s stagflation is presented as the only decade in 100 years where stocks, bonds, and cash all underperformed inflation, with average inflation exceeding 8% and peaking above double digits. Housing was the only major asset class that beat inflation during this period. Japan's bubble of 1989, where the CAPE ratio reached 100 (versus 45 for the dot-com bubble), serves as the extreme example—Japan went from 15% of world market cap in 1979 to 45% by 1989, then back down to 5%, yet investors who maintained global diversification through this entire period still achieved roughly 8% annual returns. Carlson argues this demonstrates not to base investment strategy on outlier events. The discussion addresses the psychology of investing across different life stages. Young investors should view bear markets as buying opportunities since they have decades to recover. Middle-aged investors face a unique challenge—having significant assets but still potentially 30+ years of earning years ahead. Retirees face sequence-of-returns risk where bear markets sting more in dollar terms. Carlson shares a story of a colleague in his 50s who wanted to move his 401k to stable value funds in 2008 due to financial system collapse fears, contrasting this with his own 20-something perspective of continuing to buy at depressed prices. The concept of 'winning over time doesn't mean winning all the time' emerges as central—a top-quartile fund over 10 years is only in the top quartile 53% of the time on rolling five-year bases, meaning even excellent long-term performers underperform frequently in shorter periods. Rules-based investing is positioned as a solution to emotional decision-making. Carlson notes that nine times out of ten, following predetermined rules produces better outcomes than gut instinct in the moment, even when the emotional reaction suggests the rule-based decision feels wrong. He explicitly avoids discretionary products due to their complexity and the track record of even brilliant managers failing to maintain discipline when strategies underperform. The discussion covers why sentiment indicators may be broken in the current environment due to social media, COVID's impact on psychology, and changing demographics of market participants. Current sentiment is at historic lows despite record stock prices and no recession, suggesting traditional sentiment-based indicators may have lost predictive power. Carlson advocates for defining what you won't invest in rather than what you will, drawing a parallel to Jack White's creative constraints in The White Stripes' album production. He avoids leveraged products and maintains rules about what his portfolio won't include, believing constraints drive better decision-making than unlimited optionality. The role of annuities and forced spending mechanisms is discussed positively, noting that people with large portfolios often struggle to spend down principal despite saving their entire lives, and that annuities psychologically function better as 'income' even though they're technically returning one's own capital. Rules-based structures that force behavior change prove more effective than willpower alone. The AI and tech bubble discussion reveals Carlson's attempt to remain agnostic rather than dogmatic. While AI checks all the boxes of previous bubbles (concentrated market leadership, CapEx binge, technological innovation), he resists being in either the 'definitely a bubble' or 'definitely transformative' camp, noting that Templeton said 'this time is different' is dangerous but true 20% of the time. Anthropic's explosive revenue growth gives some credence to the transformative narrative, but execution risk remains enormous. Finally, Carlson discusses his new Porterhouse Strategy—a momentum-based, concentrated SMA created with Canvas Direct Indexing that uses Josh Brown's CNBC stock screens combined with intelligent rules to avoid frequent buy-sell-rebuy cycles, offering clients a more aggressive option within a diversified overall portfolio.