The Long View

Cullen Roche: Macro Is About Understanding the World for What It Is

Episode Summary

The popular blogger and financial advisor discusses the macro outlook, the link between portfolio construction and investor behavior, his new ETF, and more.

Episode Notes

Our guest today is Cullen Roche. Cullen is the founder and chief investment officer of the Discipline Funds. In addition, Cullen heads up Orcam Group, a registered investment advisory firm he established in 2012. Cullen also authors the popular blog "Pragmatic Capitalism," where he writes about a range of macroeconomic and investing topics. He is active on social media, including Twitter, where you can find him at @cullenroche. Cullen started his career as an advisor at Merrill Lynch and did a stint at an event-driven hedge fund before starting his RIA firm. He received his bachelor's degree in finance from Georgetown University's McDonough School of Business..



Pragmatic Capitalism Blog

Pragmatic Capitalism: What Every Investor Needs to Know About Money and Finance, by Cullen Roche

Macroeconomics and Financial Planning/Advice

Three Things I Think I Think—Macro Thoughts,” by Cullen Roche,, Aug. 3, 2021.

The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness, by Morgan Housel

The Most Important Investment Factor—Behavior,” by Cullen Roche,, April 6, 2018.

What Is the Value of Financial Advice?” by Cullen Roche,, Sept. 18, 2019.

Understanding Quantitative Easing,” by Cullen Roche,, Feb. 10, 2014.

2 Reasons the Surging Deficit Worries Me,” by Cullen Roche,, Sept. 26, 2018.

Economic Cycle and Fiscal Picture


Three Things I Think I Think: Cycles, Hunting Biden and Life,” by Cullen Roche,, Oct. 15, 2020.

Three Things I Think I Think: Housing Bubble 2.0, Passive Investing and Hyperinflation,” by Cullen Roche,, April 8, 2021.

Should House Prices Be in the CPI?” by Cullen Roche,, Aug. 24, 2021.

Understanding Government Liabilities,” by Cullen Roche,, March 28, 2021.

Inflation and Interest Rates

Let’s Talk About Inflation,” by Cullen Roche,, May 12, 2021.

Is Hyperinflation Coming?” by Cullen Roche,, Oct. 25, 2021.

Three Things I Think I Think—Myths That Never Die,” by Cullen Roche,, Oct. 5, 2021.

Government Bond Markets Aren’t ‘Free’ Markets,” by Cullen Roche,, Oct. 8, 2020.

What if It’s all Going to Zero?” by Cullen Roche,, Nov. 9, 2021.

Why Stocks and Bonds Are the Core of any Portfolio,” by Cullen Roche,, March 16, 2021.

Discipline Fund ETF

Introducing the Discipline Fund ETF,” by Cullen Roche,, Sept. 21, 2021.

John Bogle: How to Create Perfect Asset Allocation,” video interview,, June 24, 2018.

Discipline Fund ETF Overview

Wesley Gray

What Is Discipline-Based Investing?” by Cullen Roche,, Jan. 1, 2019.

Target-Date Funds

The Zoom Climb Glide Path & Why the Age in Bonds Rule Is Wrong,” by Cullen Roche,, Sept. 30, 2021.

The Portfolio Size Effect and Using a Bond Tent to Navigate the Retirement Danger Zone,” by Michael Kitces,, Oct. 5, 2016.

Three Things I Think I Think—Dangerous & Terrible Stuff,” by Cullen Roche,, Sept. 29, 2021.

Episode Transcription

Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance and retirement planning for Morningstar.

Ptak: Our guest today is Cullen Roche. Cullen is the founder and chief investment officer of the Discipline Funds. In addition, Cullen heads up Orcam Group, a registered investment advisory firm he established in 2012. Cullen also authors the popular blog "Pragmatic Capitalism," where he writes about a range of macroeconomic and investing topics. He is active on social media, including Twitter, where you can find him at @cullenroche. Cullen started his career as an advisor at Merrill Lynch and did a stint at an event-driven hedge fund before starting his RIA firm. He received his bachelor's degree in finance from Georgetown University's McDonough School of Business.

Cullen, welcome to The Long View.

Cullen Roche: Hi, guys. Thanks for having me.

Ptak: Oh, it's our pleasure. Thanks so much for joining us. I wanted to start with a little bit of background. Some of our listeners are familiar with you, but others might not be. So, let's start off with a quick thumbnail. What do you do day to day? And how did you find your way to where you are today?

Roche: Well, first of all, I was telling Christine before we jumped on, this is maybe my favorite podcast. It's all signal, no noise. So, you guys do a great job. So, I'm really grateful to be here. My story… How much time do you have? I was born on June 30th, 1980, in Georgetown University Hospital. I weighed seven pounds, eight ounces. Nobody wants to hear about that.

Ptak: Maybe the relevant, tracing the arc of your career, what's brought you to where you are today?

Roche: It's actually interesting--thinking about how I've sort of come full circle. I started at Merrill Lynch in the early 2000s. And it's funny to think back on my career because I was in the era where ETFs were just becoming a thing really. And I remember studying a lot of the early iShares and SPDR funds, and I was enamored with them, really obsessed with these new products that had come out. And it was funny, because this was back in the era where we were still really stockbrokers for all practical purposes. We were still selling research and stocks and bonds to clients, charging commissions, very, very high fees, by any measure.

And I remember, I had this vivid memory of approaching some of the other advisors in my office, asking them about these low-fee ETFs. And I said, “Why do we sell these high-fee mutual funds and closed-end funds and stocks and bonds to people when we could be offering them these things that seem to provide all of the same performance but have much, much lower fees?” And the answer from everybody was, “Well, we make money on the high-fee stuff; we don't make money on the low-fee stuff.” And I remember having this very, sort of, dirty feeling almost in those moments where I felt like--I didn't feel like, I knew--I wasn't doing what was in the best interest of my clients. And so, it was funny. I left Merrill probably 18 months after having this realization and naively started my own business and started doing the same thing, essentially but with a much lower fee structure. And that's essentially what I've been doing ever since now. And it's interesting coming full circle, because I just launched a low-fee global allocation ETF that is called the Discipline Fund, and now my firm is Discipline Funds. And so, I've come full circle where this world that I felt sort of dirty in and not like a full, true fiduciary, I feel like I've developed something that is at least more so in line with all of that.

Benz: You write a lot about macroeconomic issues. So, where do you think macro belongs, or perhaps more importantly, doesn't belong in the financial advice and planning process?

Roche: So, to me, so much of this is about behavior. I think a lot of people study macro, and they think they're going to become the next George Soros or Ray Dalio, and they're going to use these ideas and beat the market and have some sort of high-fee type of hedge fund-type of allocation where they're able to generate tons of alpha and that sort of narrative. Whereas I take it from the opposite view that to me, macro is really about understanding the world for what it is so that as we navigate it, and we encounter all of the behavioral difficulties that are inevitable across the investing environments that we're trying to navigate, that we behave better, in essence, because we feel more comfortable because we understand a lot of these big-picture things that a lot of which are just incredibly, incredibly confusing.

Ptak: You mentioned the behavioral aspects. One of the things I think that occurs to Christine and I, with the benefit of hindsight, is that people do tend to dwell on macro issues at what 2020 hindsight proved to be the wrong times. Based on your experience, managing your practice and working with clients, do you agree and what are the proactive steps that you take to try to counteract some of that so that they're focused on coming up with good plans with you and sticking to those?

Roche: And so much of it is education-based. To me, it's not so much about understanding the world so that we can take advantage of these things in an alpha-generating way where we're trying to be able to time the market or things like that. Really, so much of this is about being able to understand the world for what it is so that we don't behave badly. And I think that one of the problems, especially in the Internet age is that, to me, I think a lot of the financial media has an inherent conflict of interest where they are promoting views and narratives that are inherently short term. And a lot of that is emotion based. A lot of it is hysteria that is based on either trying to drive eyeballs, or in a lot of cases, it's based on just bunk, a lot of misunderstandings about things and the causality of them and the potential outcomes. And so, to me, so much of macro is just about understanding the stuff for what it is so that as we try to navigate the day-to-day trials and tribulations of the financial markets, that we're not tripped up and prone to all of these behavioral biases that can result in really catastrophic mistakes for people at times.

Benz: Do you think people have a greater propensity to fight the last war when it comes to macro issues compared with other types of issues that have a bearing on their financial success?

Roche: One-hundred percent. Morgan Housel's book Psychology of Money had a great take on all this, where people tend to focus on the environment that they're born into, that's the environment that shapes them, and it shapes their psychology of how they end up navigating the next 10, 20, 30 years of their financial life. And so, somebody who was born in, say, the Great Depression has a very different financial perspective than somebody that was born in the last 10 years, for instance. I definitely think that the tendency to sort of dwell on the big catastrophic mistakes of the recent past will shape people. One of the things that's nice about macro is that if you study the history of macro and the markets in general, you can develop a greater understanding of the likelihood that unusual things happen. And even though you've been born into a certain environment, the likelihood that the future is going to be completely different is extremely high, on average.

Benz: So, where do you think investors right now are fighting the last war? What things are looming large in their psyche that were things that happened in the past and may not carry forward?

Roche: We tend to see a lot of the same narratives in the financial markets. In today's environment, for instance, the last war that I feel like I'm fighting endlessly is narratives about things like quantitative easing and is the U.S. government bankrupt. And to me, these are narratives that tend to have maybe a shred of truth but are based on huge complex issues that I think people tend to overrate. And so, those are two of the big ones that I’m consistently running into and writing about in a mindlessly repetitive way trying to just add some clarity to the way these things actually work.

Benz: We're coming off a decade where markets have shaken off a lot of macro concerns and powered higher. Do you think that that is cyclical, and macro will matter again in time, or is it more structural?

Roche: It's interesting. The macroeconomy is usually very, very boring, on average. I think Jason Zweig loves to talk about this on Twitter about how if you wrote a really honest newsletter for finance, you would say something to the extent of, “Some stocks went up, some went down, not much happened, it was pretty boring, on average.” And that is literally probably 98% of all the macroeconomics that goes on across time. And so, it's weird thinking about the way that people think about macro, because macro tends to matter much more inside of these very acute periods where typically you have a shock to the economy, and you have an event like the financial crisis, or say, like the pandemic--at least the negative extent to which they impacted the economy was very surprising and very rapid, very unpredictable. And so, macro always matters. I would say that it matters much more in certain environments than it does in other because, in my view, the potential for behavioral biases become so much more exacerbated inside of specific shocking events than most of the time when things are just very boring.

Ptak: We haven't had a prolonged recession in the U.S. since the global financial crisis. That's a long time between recessions. So, do you think we're due for one? And is the timing and cause predictable in your view?

Roche: No, I don't think anyone can predict when these big traumatic shocks are going to happen to the economy. And to me, you don't need to be able to either. Obviously, it would be great if you had some sort of crystal ball that could predict when these big seismic shifts would happen. But to me, again, it's nice to look at the world less like it's cyclical and more like it is this boring sort of trend. And what a recession really is, and tends to be is the economy, is just chugging along, and for whatever reason, a pandemic, or some sort of exogenous shock to the economy, things get shifted or shocked into a different environment. And these shocks can come out of anywhere, and they're very unpredictable. And I think that it's one of the reasons why I think building behaviorally robust portfolios is so important, because we don't know what the future entails. And you want to approach all of this with the idea of, yeah, we're planning, hoping for the best, but you prepare for the worst with your portfolio as well. Because you never know. I always tell people the likelihood of going through a Japanese-style stagnant environment or even a Great Depressionary-type of environment is probably extraordinarily low. But I wouldn't want to put together a portfolio that didn't, at least to some degree, prepare me for that. And so, to me, that's what a lot of this is more about. It's not about necessarily being able to predict the next recession or trying to time the market so much about this but building something on average that is robust so that, really, you don't need to be able to predict these sorts of things, because you're always prepared for them regardless of that.

Benz: How is the consumer doing now compared to, say, just before the pandemic and also relative to where things stood coming out of the global financial crisis?

Roche: I think a lot of people feel kind of frustrated by the last few years. Obviously, it's been really tough for obvious reasons with COVID and everything. From a balance sheet perspective, the consumer is in phenomenal condition. Household net worth is higher than it's ever been, debt ratios are super low. A lot of these metrics are better than they've ever been. But I think people feel like we're in this environment where we are not that dissimilar from 2019, but everything is more expensive. Depending on what you've been trying to purchase--if you're, for instance, a first-time homebuyer in this environment, I think you feel a lot worse than you did in 2019, a lot more frustrated. So, it's a really strange environment. In a lot of ways things are better than they've ever been. And I think people feel maybe not worse than ever, certainly, but not like the gains have been broadly distributed in the way that the data would make a lot of people think.

Ptak: And you mentioned one of those dimensions, which is housing. I did want to ask you about that. The housing market has been on fire by a number of measures. Do you see overheating in residential real estate as a risk to economic expansion?

Roche: The housing market is so interesting in the United States. There's been a lot of research on this that, in a lot of ways, the U.S. economy is just the housing market, you could say that so goes the housing market, so goes the economy. And this is one of the reasons why the financial crisis was so damaging was because having this asset class that was so broadly impactful across so many facets of the different economic sectors, when it declined in value the way it did, it was a huge, huge deal. And so, again, I don't do a lot of trying to predict short-term things. I actually think of housing as a very long-term asset class. And I generally tell people, if you're thinking of buying a home, you should think of it almost like it's a 10- or 20-year bond, and you better plan on holding that thing to maturity. So, if you're speculating on this thing, and you're planning on flipping it or something in the next few years, you're speculating, you're doing guesswork on what the future asset price is going to be, rather than taking a more measured and evidence-based view of what the future returns are likely to look like.

And so, housing is strange in the current environment, and to some degree worrisome, because we've had this huge boom that is in a lot of ways reminiscent of the financial crisis boom. You don't have the same degree of speculation from people whose balance sheets were poor. So, again, in a lot of ways, the balance sheets are better than they've ever been. So, the quality of borrowers, for instance, purchasing homes these days is very, very high. So, you probably don't have the same level of risk that you do in the period like the 2005-06 era. But it's worrisome to think of what the potential ramifications of, say, a five, 10, or a 1990, early 1990-style housing recession would look like. Because it's hard to imagine that that wouldn't cause a meaningful negative impact on the U.S. economy if you had some giveback from what we've had in the last few years.

Benz: You've talked about why it's a mistake to liken the U.S. government's balance sheet to a household's, which is something that deficit hawks tend to do. Can you explain why you think that's not a valid comparison to make?

Roche: Finance is filled with fallacies of composition, people taking their personal experiences and then extrapolating them out to either everyone else or big sectors. And the government is just a huge sector. When you actually look at the government, the entire U.S. government is comprised of thousands of different entities, millions of employees and all the state and local governments. This is a huge, huge sector inside of our economy. And the problem with thinking about the government like a household is that, well, think about the household sector, in the aggregate, think of all of our household assets and liabilities in the aggregate--do we pay those assets and liabilities back over time? No. In fact, in the long run, the Cullen sector relies on the Christine sector to be expanding over time. If I'm paying down my debts, the likelihood is that the aggregate economy needs somebody else to be expanding their balance sheet.

So, in the long run, what you tend to see is assets and liabilities expand over time, and hopefully, we're producing the real goods and services that where you end up with some net worth, you end up with real stuff, you end up with the physical real stuff that we all want, that makes everything valuable in the long run. But the kicker is that at a broad, aggregate sectoral level, none of the sectors pay back their debts in the long run. And, in fact, we should expect them to expand. Now, the government obviously is a much trickier one, because the right size of the government is a pretty hot topic of debate all the time. And I don't know what the right size of the government is, but it's not surprising that over time, the aggregate government balance sheet and their assets and liabilities would expand across time, simply because in the long run, the economy gets a lot more complex, the rules need to be changed and updated over time, you have entities that need to be created at times to provide the regulations, the court systems and the things that keep a lot of things functioning somewhat well. And so, I don't know what the right size of the government balance sheet is. But in the long run, we actually probably shouldn't expect the government's balance sheet to get paid down like an individual's might, because in the long run at the aggregate, sectoral level, by definition it will expand as the economy expands, in all likelihood.

Ptak: I wanted to jump to another hot topic, which is inflation, and also, we'll talk a bit about interest rates. And after a long dormant period, I suppose you would say, we've seen inflation really pick up recently. I think it's hotly debated. But in your opinion, what caused that pickup? And do you think it will stick?

Roche: COVID was a really strange event in the way that it constrained supply chains in a very specific manner. You had the government shutdowns, a lot of which resulted in, for instance, a lot of the things that are made in China and Vietnam and Malaysia and places like this in and around the world where these factories were literally shut down. So, people weren't making things. But at the same time, the governments around the world, and especially the U.S. government, we were spending an incredible amount of money, we were running huge deficits, $7 trillion over the course of the last two years. And so, you have this perfect recipe for inflation to pick up because you had at a very basic macroeconomic level, you had rising demand because you had more money being pumped into the system, and you had lower supply because you had all these supply shocks. It's really multifaceted. It's a very, very complex situation. A lot of people like to blame either the government or just the supply side issues and kind of break it down as like this binary issue when it's really multifaceted. It's very complex.

Will it stick? I don't know. I wish I knew the answer. Looking forward, I think that a lot of people have predicted sustained, very high inflation. Jack Dorsey was on Twitter a couple months ago saying that hyperinflation was coming, and he got like a million likes on that tweet, which is crazy. I think that sort of thinking is wrong. I tend to think that the economy is very different than it was in, say, the 1970s or any real high inflationary environment. That's mainly because of big secular headwinds, things like demographic trends, and globalization and technology. These are all huge macro deflationary long-run trends, which is why I think we've seen a lot of the low inflation and low interest rate trends of the last 30 years because these big macro trends are, these are huge dynamics at work that you need enormous government responses to offset these big macro headwinds.

And so, outside of that, if I were to pick what would cause very high sustained inflation, it would be, if we were running $3 trillion deficits every single year for the next 20 years, well, maybe that would cause inflation, but you're actually going to see a lot of this reverse in the next couple of years. So, you're going to see a big fiscal giveback, for instance, in 2022. And so, it's not safe to say that this is going to be transitory in the way that the Fed was kind of talking about it all being transitory. But I think it's safe to say that the people who think that a hyperinflation is coming or that a very high inflation is coming, I think, are not fully understanding both the secular headwinds and the short-term dynamics that caused the high inflation of the last couple of years, which are likely to start reversing to some degree--in large part because the government is going to rein in spending to a large degree in the next couple of years.

Benz: The bond market seems pretty sanguine about inflation. It continues to price in very low inflation expectations. Are bond investors too complacent in your opinion?

Roche: I think the bond market largely takes their cues from the Fed. And so, the way I like to talk about the way that interest rates basically work is that I think of interest rates as being similar to someone walking a dog. The Fed is the person holding the leash, and they let the long end, the long end being the dog, the dog is able to wander from side to side, but it's still in some control of the Fed to some degree. But if you think of the leash back to the handle, the Fed has an exact amount of control over where that handle is at any given time. And so, they control that. And by extension, they have a huge impact on the long end of the curve, because they indirectly control the long end through the leash. And so, I think that what the bond market is essentially saying is that the bond market is essentially saying that the Fed believes that they have tight control of inflation in the short end, and that the long-run expectations are likely to look more like the pre-COVID trends than this new regime where we're going to see a very high inflation. So, I think it can seem irrational that interest rates are low, and inflation is high for now. But in the long run, I wouldn't be shocked to see that inflation ends up moderating some, and the bond market ends up looking pretty smart in the long run.

Ptak: What approach do you take when it comes to setting an inflation expectation for clients you work with, for instance, a retiree who is trying to plan how much they can spend over the rest of their life, and to what extent do you think it's important to personalize that inflation expectation that you said based on their consumption basket, so to speak?

Roche: It's a great question. It's a really difficult one from a financial-planning perspective to answer, because everyone's inflation is different to some degree. And it brings in a necessary element of forecasting and trying to predict the future that is very tricky for everybody, because nobody really knows. I always tell people I have no idea what really causes inflation. We have all these very basic models for what causes inflation: more money chases the same amount of goods or something like that. But inflation is very, very complex, very, very difficult to predict. And from a planning perspective, we meet generally, I take an extrapolated expectations perspective, meaning that you can look at historical rates of inflation and extrapolate that into the future to some degree. But I also think that it's not irrational to take that approach of hoping for the best but planning for the worst. It makes logical sense to have inflation hedges in your financial life so that you do have protection from, say, a 1970-style environment if it were to actually occur.

Obviously, all of this is very customized and personalized. For instance, if somebody owns a home, I would argue that that is, in general, a very good inflation hedge in the long run. So, someone who owns a home versus someone who rents, they have a very different potential asset allocation going forward because they have different inflation hedges built into their portfolios there, because one person has real assets and the other one really doesn't. This is all very personalized. But in general, taking that approach of hoping for the best but planning for the worst, I think, is a sensible approach within the realm of using a historical average.

Benz: What kind of returns do you expect from the stock and bond market over the next decade? And how did you arrive at that?

Roche: A lot of guessing. No. The bond market is actually at least somewhat easy to predict. You can look at the current interest rates, current yields on like an aggregate bond fund, and you can forecast that out pretty reasonably over the course of the next five, six years. The bond market on average is like a six-year average instrument if you took all the bonds in the U.S. market. And so, it's not super hard to predict what the bond market is going to do. The stock market is where a wrench gets thrown into everything, because the stock market has all these variables that impact the values that aren't really based on anything all that fundamental to some degree. And so, for instance, multiples. Multiples can change over time, just because people's access to the stock market changes over time or because the relative importance of the stock market changes, interest rates change. And so, you have all these things that all these variables that can cause stock market returns to change over time that are extremely unpredictable. On average, I like to think of the stock market like it's a 30-year high yield, high-quality bond. And if the stock market were to pay out, if they were to distribute all of their profits every year, all the entities in the U.S. stock market, for instance, that thing would yield pretty safely something like 5% to 7% per year. It doesn't do that on average every year, obviously, or consistently every year. But on average, over a 30-year period, if you applied a 30-year duration using that sort of thinking, you could expect to earn something like 5% to 7% per year.

So, that's sort of the foundation that I start from. I think it's safe to say in an environment like this, where typically, at a minimum, when multiples are this high, when things like P/E ratios are as high as they are today, by many metrics at all-time highs or very high in a historical sense, the stock market has tended to generate lower future returns. I don't know. People have been saying that for a long time. I've been thinking like that for a long time. So, I don't know if that is necessarily the right methodology to take. But I would say that one thing that is consistent is that when multiples are this high, the stock market tends to be more volatile. So, for whatever reason, you tend to be having more of these shocks that occur across the stock market. And even though you could look at, for instance, like the last five years and the stock market returns have been phenomenal. But there were some pretty harrowing moments across that period. I have clients--a lot of people have come to me, because they got out of the market in March of 2020. That was such a frightening environment that even though the stock market has done very well, behaviorally, you could argue that the high multiples create what is a very challenging environment, because there's the potential for this more volatile type of return. So, yeah, you're getting these higher returns from higher multiples, but you're also getting a higher level of risk, which makes it behaviorally more difficult to navigate.

Ptak: That's a good segue to another question that I had, which is, your expectation for bonds. I think you laid out your thinking clearly, essentially at what the yield to maturity across a range of different tenors of bonds is, and that will give you an idea of what maybe the next seven to 10 years is going to look like. That's not a very palatable return to earn. But I think I've read pieces where you said that's not a reason for people to ditch their fixed income. Maybe you can explain your reasoning there. Why should they hang on to fixed income when it's expected to return so poorly?

Roche: So, to me, I think that the bond market is essentially a principal hedge in a portfolio. It's something that is cash-like to some degree, but over specific periods of time, will pay out returns that are mathematically superior to cash. And so, it provides the same sort of principal protection in a portfolio that cash would, but it gives you a little bit of extra return across specific periods of time if you have the patience and the proper time horizon over which to wait for the bond market to actually pay out its income. And so, to me, I think a lot of people tend to think of the bond market as being an inflation hedge or trying to use it as an inflation hedge. And I think that can get you into trouble. I actually tell people, I think you should expect to lose money in real terms in the bond market. But the bond market isn't there to provide you with a real return.

You have other assets in your portfolio that will provide you with a real return. The stock market tends to be a very good inflation hedge. Your home tends to be a very good inflation hedge. And so, there's other ways to get inflation hedging. But you have to blend that, in my view, with principal hedges, in essence. And so, because these other instruments, because they earn this higher return that will better protect from inflation, they also expose you to higher potential downside. And so, the bond market is really a behavioral hedge there. A bear market in the bond market is a totally different animal than a stock market bear market.

I think that people need to put these things in the proper buckets, depending on their personal situation, so that they have the right types of stability in their portfolio so that their portfolio is behaviorally robust so that they can navigate different environments where, yeah, the bond market is going to be pretty boring over the next 10 to 20 years, but the stock market has the potential to be extraordinarily frightening at times over that 10 to 20 year period. And it's interesting to look at a period like the 1940s to the 1980s, because interest rates rose pretty much the whole time from about 2% to 14%. So, if you think that we're in the 1940 period right now, and you're worried about rising interest rates, well, it's interesting to look back at a balanced portfolio of 50% stocks and 50% bonds compared to a 100% stock portfolio, because the 50-50 stock-bond portfolio, it generated a lower return, but the bond piece actually generated 3% per year in nominal terms using a constant 10-year Treasury bond portfolio, and more importantly, it reduced the standard deviation of the portfolio by 50%. And so, for somebody who was potentially exposed to a lot of behavioral biases over this period, the 50-50 portfolio, yeah, it generated a lower return, but it generated a much more stable return despite the fact that the bond market generated pretty poor risk-adjusted returns, especially compared to the bond market that people have become used to over the last 40 years from the 1980 to 2020 period where risk-adjusted returns in the bond market were crazy high. And so, even using this period of rising rates, bonds still did what they should do, which is, they provided some insulation from stock volatility, which that to me is what diversification of the bond market provides an investor with.

Benz: What's your take on the torrent of money that's going into private equity and credit? It seems like there's a theoretical case to be made for it. But it also seems like some of it is performance-chasing behavior mixed with people fleeing bonds when perhaps they shouldn't. What's your take?

Roche: I think that's right. A lot of these markets have become democratized to some degree. They're much more open to people. And so, it's not surprising that these markets, at least to some degree, have earned higher returns because to a large degree, they've been inaccessible to a lot of people. And so, now, you're seeing more money flow into these markets, the valuations are going up, and it's becoming harder to find the higher returns in those sorts of markets. And a lot of that is it's easier now to access your venture capital and private equity and private REITs and things like that in large part because the Internet has made all of this stuff so much more democratized. So, it's sort of the same effect that's going on in the stock market to some degree where the stock market has become a lot more democratized over the course of the last 30 years, really. There's been just a torrent of never-ending money flooding into the public equity market simply because it's easier to access.

Ptak: I think it's probably fair to say, and correct me if I'm wrong, but you don't think the market is especially target-rich right now, just given that valuations are elevated, and yields are paltry by a lot of measures. And I think you already alluded to the fact that we can probably expect more volatility going forward. But it doesn't seem like you're very fond of cash. In fact, I think I saw a piece from you recently where it looked like that was at the lowest point in your pecking order of different potential investment opportunities. But wouldn't it make sense now to keep some powder dry? How come you don't like cash?

Roche: It could. Because I approach so much of this from a behavioral perspective, I've become a big advocate of bucketing methodologies over time, and bucketing things specifically in a very behaviorally consistent manner. So, I like an asset-liability matching perspective when it comes to financial planning and building portfolios, meaning that, basically, I like to take a portfolio and apply specific time horizons to certain components, and apply that in a way so that people are really behaviorally robust across that specific bucket in a certain asset class.

So, for instance, somebody who has a million dollars who is planning to put $200,000 down on a home in the next five years. Well, that person has a need for a specific type of liquidity bucket where cash could be totally fine for that. They don't really know the period--in which it was five years, they're going to want to put the down payment down on the home, they need the optionality to be able to access funds and know that they have a certain amount of principal for that down payment at a specific unknowable time.

Using this sort of bucketing approach, it’s a way to build a very behaviorally robust asset allocation because you can take things and put them into specific time horizon buckets where cash could be totally fine for somebody. I actually, personally, I hold a lot of cash because I sleep better with it. So, I tend to build portfolios for myself that are actually relatively conservative based on my age and things like traditional asset-allocation modeling that a lot of people would look at and say, “He should be holding a lot more aggressive assets.” But for me, personally, I like holding a lot of cash because it just makes me comfortable.

So, everyone is different. In general, looking at this from a real return perspective, going forward, cash looks especially bad right now, just because inflation has bumped up. And going forward, if you have the time horizon to take more risk, you should be stretching yourself out a little bit more, because you should be trying to maximize your real return to some degree the best you can. But it's tricky within the constraints of behavioral biases and short-term needs and things like that. There's potentially nothing irrational about holding cash, especially if you're someone who likes the optionality of being able to have a little bit of dry powder to wait for who knows an environment where you think you might be more behaviorally comfortable getting more fully invested. That makes a lot of sense to me.

Benz: We want to switch over to talk about your new fund, the Discipline Fund ETF. Can you talk about its makeup and what you sought to achieve in launching it?

Roche: I've always been a big advocate of a sort of Boglehead style--very simple, low fee, very diversified portfolios. For instance, most of my portfolios that I run over the course of my last 15 years or so have been very simple--typically five or six fund-type of portfolios that are sort of bucketed in the way that I was describing before. But the problem that I would consistently run into with people was, one, bad behavior, and two, tax inefficiency of rebalancing a multi-fund portfolio. I've known Wes Gray for a long time. We partnered with Wes--it's been 18 months now. And Wes helps people build ETFs. And so, I went to Wes and told him about this idea. And the beauty of the ETF approach is that we built what is essentially a global fund of funds.

We're taking a whole bunch of essentially Vanguard and SPDR and iShares ETFs, super-low fee, super-diverse funds, and we put them all into one fund. I typically build portfolios that are basically always 40-60 or 60-40-type portfolios. And what I started thinking over time was, I love a 40-60 and I love a 60-40. But what if I could behaviorally rebalance these portfolios in a way so that I was better protecting people at times, let's say, for instance, right now, where valuations are very high, where the potential for behavioral mistakes is potentially high. What if we could be the 40-60 now? With the potential to rebalance systematically, in the future, let's say, when the equity market declines in value and things potentially become more attractive, could we rebalance into the 60-40? And could we do it in a tax-efficient manner where you don't have the friction that would be problematic from running a multi-fund portfolio. And that's the beauty of the fund that we built is that it's a fund of funds that is able because of the structure of the single ETF, it's able to rebalance inside of the fund without capital gains distributions where we can be a little bit more dynamic, trying to better insulate people from behavioral mistakes without sacrificing the tax inefficiency of, say, having a big stock allocation right now where if you want to rebalance it, you could rebalance it back to your original weighting. If 60-40 has grown into 70-30 now, you can rebalance that if you have, say, a traditional three-fund Boglehead-style portfolio. The problem is, you incur capital gains when you rebalance that in a taxable account. And so, you run into this problem where you want to maintain a consistent risk profile. But the problem is, you end up paying capital gains inside of a more aggressive satellite position inside of your portfolio, where it ends up being very tax-inefficient across time. And so, this fund because it's a fund to funds, it solves that problem and applies a more what I believe for a lot of people is a more behaviorally robust asset allocation where you're not just simplifying things, and also maintaining a low-fee diversified approach but maintaining something that hopefully will keep people more comfortable across time.

Ptak: I wanted to ask you, if Vanguard were to go out--and just using Vanguard as an example, they are a low-cost provider--if they were to go out and create an ETF version of one of their popular balanced or target-date funds, how have you thought about the edge that you would have in the Discipline Fund ETF? Is it in the way it rebalances some of the leeway that you have there?

Roche: So, it's interesting. We thought about just approaching Vanguard, or actually, weirdly, I did actually go to--I'll leave them unnamed--a large fund provider, and we pitched an idea of doing a fund of funds basically just using the tax efficiency concept of it. This was several, several years ago, probably five years ago. They have since started a fund like that. But it's basically it's a static allocation fund, and doing something that is like a 60-40, where they're doing a fund to funds.

And the problem with a fund like that--or you could say, the potential problem with a fund like that--is that you're using a core position there, where typically you need other buckets. Most people need a liquidity bucket, maybe you want a more aggressive bucket--if you're using a traditional core and satellite approach, and you're using a liquidity bucket, and then a more aggressive bucket or other buckets to be able to take advantage of tax-loss harvesting, things like that, or whatever it might be, you still have this problem where the satellites grow out of balance with the core, because the core is fixed. And what our fund does, which is really unique, is that it inverts the core and the satellite.

So, what I mean by that is that the Discipline Fund, typically, let's say that its benchmark is about a 50-50 stock-bond allocation. If the stock market were to go through a big boom, and you had, say, a three fund: a liquid bucket, an aggressive bucket, and a core bucket. What will happen in your traditional core and satellite approach is that your aggressive bucket will grow a lot. And you'll have to rebalance that; you'll still have to incur capital gains. Because your core piece, even though it's a fund of funds that's tax-efficient, it's a static allocation. So, in aggregate, your total allocation has become unbalanced because of the aggressive satellite. The Discipline Fund inverts that so that what happens is that as your more aggressive component expands, the Discipline Fund is internally rebalancing against the trend occurring inside of the aggressive satellite. And so, not only is it keeping your risk profile more consistent across time, but because it's rebalancing in this sort of countercyclical way, it's reducing the need to rebalance the aggressive piece, which means it's reducing the need to pay capital gains across time. So, it's essentially because of its countercyclical rebalancing component, it's providing you with this ability to essentially be more tax-efficient, while maintaining your risk profile in a multi-bucket-type of portfolio.

Benz: You've defended target-date funds in the past, but it sounds like you have some misgivings about how they work for people who are navigating their retirement years. Can you walk us through that?

Roche: I love target-date funds. If I were to describe my entire methodology, I would describe it as a discipline-based investing approach. I would describe target-date funds as a very discipline-based investing style, because typically they create something similar to the asset-liability matching methodology I was talking about before, where people are given a very specific time horizon where they know--and this is why 401(k) investing works so well too--because people are given a specific time horizon. They know, OK, I shouldn't touch this money until the year 2045 when I retire, and they're given this goal and this exact end date where they know, OK, this is the point where I can start to tap into this. And that reduces the potential for a lot of the behavioral biases and the tinkering that will result in poor performance in the long run for a lot of people just because they're trying to do more than they should be with a portfolio. And so, it instills a very discipline-based approach.

I think the one criticism that I would have of target-date funds, and this is probably more just being a function of someone who overthinks everything and is probably too involved in our industry because we spend a lot of time debating things that nobody else really cares about and probably in the long run are not that important. But for target-date funds, they apply a generalized--most of them apply this at least--a general age in bonds rule where I think you can get into situations where that rule is probably overly general. I would argue, for instance, that bonds are essentially a form of term insurance in portfolios. I think most people actually probably shouldn't even own bonds, but there's a period in most people's lives, typically the age of 55 to 75 where you will transition into retirement and you're going to go through this really psychologically difficult transition in your career and your income-generating period of your life where it will hyper-expose you to behavioral biases, making this transition. Bonds can be very useful in that sort of a period as really a hedge, an emotional hedge because they will reduce the likelihood of instability in the portfolio.

Michael Kitces calls it a bond tent. I like to call it a zoom glide approach, because it's for somebody who is basically under the age of 55, you can zoom into a huge bond position around this period preparing for retirement, and then you can take a glide path approach, shaving down the bond portfolio as things become more certain over time, because in a weird sort of morbid sense, things become more uncertain as you reach your age of death. And I don't want to give people the impression that I don't like target-date funds. I don't want to sound overly critical, because in general, I love anything that applies a very robust behavioral edge for people, which target-date funds do; I think it’s a fantastic way to allocate assets. So, 60-40 funds in general, very broad diversified funds that are low fee and apply all of the sort of evidence-based understandings that we're all aware of. Yeah, you can tinker with all this stuff and get brain damage trying to overthink it all. But it has to be customized at the same time though. So, for specific people, a target-date fund might be inappropriate, whereas in a more general sense, they're fantastic.

Ptak: In closing, on a personal note, you have two young children. How has parenthood changed your personal and professional perspective? Do you look at the world in ways maybe you didn't before you had kids? And does that manifest itself in how you think and the kind of advice you give clients?

Roche: I remember how great it was to sleep. But it's funny, having kids you become a lot less selfish when you have to think about the future of all the other people in your world and your time horizon changes completely. In a weird way, I've become hypersensitive not just to my financial health but to my literal health, because I now worry about my kids not having a dad at some point in their future. It's made me much more aware of, I think, being more thoughtful about the way that my own actions will end up in the long run impacting other people because it's much more magnified now that the things that I do that could potentially harm me in a weird way could, in a long run, have a huge catastrophic impact on my children. And so, it's made me probably even more boring than I already am in a lot of ways so that I'm more financially prudent, more financially thoughtful, and hopefully, a little bit better.

Ptak: Well, this conversation has been anything but boring, Cullen. It's been a real treat to have you on The Long View. Thanks for sharing your time and insight with us and our listeners. We really enjoyed chatting. Thanks again.

Roche: Thank you so much for having me. Happy New Year, everybody.

Benz: Happy New Year. Thank you so much.

Ptak: Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

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Benz: And @Christine_Benz.

Ptak: 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 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.)