Meb Faber: 'To Be a Good Investor, You Have to Be a Good Loser'

Episode Summary

Executive Summary: Meb Faber discusses his investment philosophy, emphasizing valuation and trend following. He argues that U.S. stocks are overvalued (CAPE ratio at 39) and warns of low future returns, advocating for global diversification and value tilts. He also highlights the benefits of trend following to avoid major drawdowns, the importance of low fees and taxes, and the potential of private startup investing via QSBS tax exemptions. The conversation covers behavioral biases, the flaws of market-cap weighting, and the need for a written investment plan.

Main Topics: Valuation and Market Cap Weighting (Priority: 5/5): Meb critiques market-cap weighting for overexposing investors to bubbles, citing the U.S. CAPE ratio at 39 (second highest ever). He advocates for value tilts and global diversification, noting that foreign markets are cheaper. Trend Following vs. Buy and Hold (Priority: 5/5): Meb explains trend following as a strategy to avoid large drawdowns, using metrics like the 200-day moving average. He combines it with buy-and-hold in a 'Trinity portfolio' for diversification. Behavioral Biases and Investor Psychology (Priority: 4/5): Meb discusses common biases like overconfidence and loss aversion, emphasizing the difficulty of sitting through 50% drawdowns. He stresses the importance of a written plan and being a 'good loser.' Fees, Taxes, and Structure (Priority: 4/5): Meb argues that fees and taxes are more critical than asset allocation. He notes that average mutual fund fees can render the best strategy mediocre, and highlights the tax advantages of ETFs and QSBS for startups. Private Investing and Startups (Priority: 3/5): Meb discusses his angel investing in over 250 startups, leveraging QSBS tax exemptions. He views illiquidity as a benefit, allowing long-term compounding without the temptation to trade. Global Diversification and Home Country Bias (Priority: 3/5): Meb criticizes U.S. investors' home country bias (80% in U.S. stocks) and recommends half U.S., half foreign allocation. He notes that 75% of top-performing stocks are outside the U.S.

Key Arguments: Market-cap weighting is a momentum strategy that overweights bubbles; value tilts and global diversification improve returns. Trend following helps avoid catastrophic losses (e.g., 50%+ drawdowns) and reduces volatility, though it can suffer from whipsaws. Fees and taxes are the primary determinants of long-term returns; asset allocation matters less when costs are high. U.S. stocks are overvalued (CAPE 39) and likely to deliver low single-digit returns over the next decade, while foreign markets are cheaper. Private startup investing via QSBS offers tax-free gains up to $10 million, and illiquidity can be an advantage for long-term compounding. Investors should have a written plan and be open-minded to structural changes (e.g., buybacks replacing dividends).

Data Points: U.S. CAPE Ratio: 39 - Second highest ever, indicating overvaluation. Historical Average CAPE: 17 - Long-term average for stock markets. U.S. Dividend Yield: 1.3% - Near all-time lows, contributing to low expected returns. Expected U.S. Stock Returns (next decade): 0-2% - Based on Bogle's formula with valuation compression. Foreign Developed Market CAPE: 22 - More reasonable than U.S. Emerging Market CAPE: 15 - Cheaper than developed markets. Percentage of Top Stocks Outside U.S.: 75% - Any given year, most top performers are non-U.S. U.S. Investor Home Country Bias: 80% - U.S. investors allocate 80% to U.S. stocks. ETF Fee Advantage vs. Mutual Funds: 70 basis points - Lower fees for ETFs. ETF Tax Advantage vs. Mutual Funds: 70 basis points - Structural tax benefit. QSBS Tax-Free Gain Limit: $10 million or 10x investment - Whichever is greater, tax-free after 5 years. Number of Startups Meb Invested In: 250+ - Since 2014.

Pivotal Quotes: "The conflict of interest in the industry is not active versus passive, it's high cost versus low cost." — Meb Faber (quoting John Bogle): Discussing the evolution of index funds and the importance of fees. "All that changed was people's opinion of the place." — Meb Faber (quoting Kurt Vonnegut's Galapagos): Explaining how sentiment drives market crashes and recoveries. "You need to be a good loser because the average market over time, there's only two states: you can be in an all-time high or you can be in a drawdown." — Meb Faber: Emphasizing the psychological challenge of investing and the need to accept losses.

Implications: Investors should reassess their portfolios: reduce home country bias, consider value tilts and trend following, prioritize low fees and tax efficiency, and explore private startup investing for long-term tax-free gains. A written plan and behavioral discipline are crucial for navigating volatile markets.