May Day (EP.08)

Episode Summary

Executive Summary: The episode examines how low expected returns could strain pensions and investors, argues that historical returns overstated what most investors actually earned because costs were far higher, and discusses Bitcoin as a fledgling mania driven by concentrated ownership and small-dollar speculation. It also highlights behavioral investing data, especially women’s more disciplined habits, and closes with broader reflections on market crowd psychology and leadership.

Main Topics: Pension underfunding and unrealistic return assumptions (Priority: 5/5): The hosts discuss Jack Bogle’s warning that pensions may face weak bond and stock returns over the next decade, making it hard for public pensions to meet their assumed 8% targets without taking more risk or forcing tax increases and benefit cuts. Private equity and venture capital as pension Hail Marys (Priority: 5/5): They argue that underfunded pensions are increasing allocations to alternative assets in hopes of boosting returns, but the math suggests those allocations are unlikely to reliably close the funding gap. Gross versus net returns in historical market data (Priority: 4/5): The conversation explains that long-run market returns look better on paper than they did for actual investors because trading commissions, bid-ask spreads, and mutual fund loads used to be much higher. Bitcoin as an early-stage mania (Priority: 5/5): They discuss Bitcoin’s rapid rise, concentrated ownership, retail FOMO, and the likelihood that many participants are only risking small amounts, making the bubble dynamic unusual but still potentially unstable. Behavioral investing and the wisdom of the crowd (Priority: 4/5): Using Michael Mauboussin and the Asch experiment, they explore how herd behavior and social conformity make markets inefficient in the short run and hard to exploit. Women as better behaved investors (Priority: 4/5): Betterment data is used to support the claim that women trade less, log in less often, and make fewer extreme allocation changes, which likely improves investment outcomes. Index proliferation and active decisions inside passive investing (Priority: 3/5): They note that index construction itself involves active judgment, and the growth in indexes is not necessarily a problem even if there are now more indexes than stocks.

Key Arguments: Public pensions are structurally underfunded and cannot realistically assume 8% returns if stocks and bonds deliver only modest gains. Pensions are taking more risk through private equity and venture capital because lowering return assumptions would force governments to contribute more money now. The historical 9% to 10% equity return narrative is overstated for actual investors because transaction costs and mutual fund loads were much higher in earlier decades. Modern low-cost index access means investors today may keep more of the gross return than past investors ever could. Bitcoin’s apparent decentralization is misleading because ownership is concentrated among a small number of holders. Many Bitcoin buyers are participating with small stakes, so a crash may not trigger immediate mass capitulation, though the market remains vulnerable. Crowd psychology and conformity help explain why bubbles persist and why contrarian investing is difficult. Women tend to exhibit better investing behavior because they trade less frequently and avoid extreme allocation swings. Index design is an active process, so the rise in indices does not necessarily contradict passive investing principles.

Data Points: Pension funded status: 40% to 60% - Average funded status cited for the 50 state pension plans. Estimated pension underfunding: $3 trillion to $5 trillion - Approximate underfunding depending on discount rates and interest assumptions. Long-term real equity return estimate: 5% - WisdomTree/Jeremy Siegel view of long-term after-inflation stock returns. Implied nominal return estimate: 7% - 5% real return plus 2% inflation. Historic U.S. stock market return: 9% to 10% - Commonly cited long-run gross return figure discussed as hard for investors to actually capture. Historical bid-ask spread/trading cost: A couple percent per trade - Earlier stock trading costs due to large spreads and illiquidity. Mutual fund load: 10% to 12% - Load fees in the 1950s and 1960s mentioned as common historical costs. Dow portfolio trading cost in 1988: 1% of portfolio - Charles Schwab commission schedule example for a $300,000 equal-weight Dow portfolio. Commission rate reform: 1975 (May Day) - Year fixed-rate commissions were abolished in the U.S. 60/40 portfolio historical return: 10.7% annually - Average return since 1976 using the Barclays Aggregate Bond Index inception. 2020s year-to-date 60/40 return mentioned: almost 14% - The portfolio’s strong performance during the year discussed in the episode. Assumed bond return in scenario: 2.5% annually - Used to show how high stock returns would need to be to preserve a 10.7% 60/40 average. Required stock return to hit 10.7% 60/40: over 16% annually - Illustrates how unrealistic maintaining historic blended returns may be. Bitcoin ownership concentration: Top 1,000 owners hold 40% - Bloomberg data cited to show concentration in Bitcoin holdings. Bitcoin ownership concentration: Top 100 owners hold 17% - Used to argue that price is influenced heavily by a small set of holders. Coinbase customer behavior: Only 3% buy $20,000 worth of Bitcoin - NYT data suggesting most retail participation is in small amounts. Betterment women’s trading frequency: 20% less frequently - Female customers changed allocations less often than male customers. Betterment women’s monitoring frequency: 45% less frequently - Female customers checked accounts less often than male customers. Extreme allocation changes by men: Nearly 6x more likely - Male customers were much more likely to swing from 100% stocks to 100% bonds or vice versa. Average logins per week: Men: 5; Women: 2 - Betterment account-login behavior data.

Pivotal Quotes: "The very factor that causes market inefficiency, correlated beliefs, makes exploiting that inefficiency difficult." — Michael Mauboussin (quoted by hosts): Used to explain why crowd-driven market mispricings can persist and be hard to arbitrage. "When nearly everyone adopts a point of view, whether it's bullish or bearish, the psychological pull to conform is powerful." — Michael Mauboussin (quoted by hosts): Referenced in the discussion of Bitcoin mania and herd behavior. "My favorite takeaway in this was from Michael Santoli at CNBC. He tweeted this a while ago and he said, 'Worrying that there are more indexes in stocks is a bit like worrying that there are more books than words.'" — Ben Carlson: Comment on the growth of indexes and whether that trend is inherently problematic.

Implications: Listeners should expect lower future returns, diversify thoughtfully, and focus on minimizing costs and behavior mistakes. Pensions may face slow-moving but serious pressure, while speculative assets like Bitcoin may keep rising or crashing in a way shaped by crowd psychology and concentrated ownership.