CONSUELO MACK: But in this day and age, with stock pay­outs low, and div­i­dend yields low, do they mat­ter as much, and will they mat­ter as much in the future?

PETER BERNSTEIN: Yes. I think they mat­ter, first, because it is cash in your pocket. And at a time when, who knows what earn­ings are, there’s been so much hanky panky all the way. Now they’re going to start expens­ing options, so that it gets a lit­tle more com­pli­cated. This, at least, you know what it is. And you can make more of a judg­ment about a stock, the growth rate div­i­dends. But div­i­dends at this point, I think, have two pos­i­tive fea­tures that deserve atten­tion. One is the tax rate is the same as on cap­i­tal gains, 15%. Not a big num­ber. I mean it’s 85% is yours.

CONSUELO MACK: Right.

PETER BERNSTEIN: And the other is that because the pay­outs are so low, and because of the tax thing and so forth now, there is pres­sure for com­pa­nies to increase their pay­outs. I think div­i­dends are going to increase faster than earn­ings. So if you’re in some­thing where you think the earn­ings growth is there, and the div­i­dends, that it is impor­tant. It is an impor­tant con­sid­er­a­tion. Even Microsoft is pay­ing a dividend.

CONSUELO MACK: Yes, they are. They paid a big one as a mat­ter of fact. Let me ask you about that point. Because a lot of ana­lysts, or strate­gists that one talks to, will tell you that the com­pa­nies that keep earn­ings, and don’t pay them out in div­i­dends, you know, they can grow faster, and you know, they’ll give you bet­ter growth over the long term. You have found through your research absolutely the opposite.

PETER BERNSTEIN: That’s cor­rect. That the lower the pay­out, and the big­ger the rein­vest­ment, the lower the future earn­ings growth. There’s noth­ing like hav­ing man­age­ment a lit­tle starved for money. Because then they will only choose the best invest­ments. Best things to do, if they’ve got lots of it. If they’re plow­ing back most of their earn­ings, oh, boy, that’s like, in a … I for­got the metaphor. But they can just pick any­thing. So they will be mak­ing less than opti­mal invest­ments, because they have so much money. That’s how it works. Man­age­ments like to have money. They like to be expan­sive. They like to add the power. And there’s more dis­ci­pline when there isn’t as much. This is a lot about the whole buy­out busi­ness of the 1980s was about– cor­po­ra­tions accu­mu­lat­ing too much cash, and not using it prop­erly. The com­pa­nies that have to go into debt in order to expand will be much more care­ful about what they do. Much more selec­tive in what they invest in. That’s very important.

CONSUELO MACK: A cou­ple of more ques­tions. You wrote a book about the his­tory of risk. What you know, when you and I have talked, you were actu­ally, it strikes me that you’re an optimist.

PETER BERNSTEIN: Yeah, I really…

CONSUELO MACK: And why, given the risks that all of us toss and turn about every night, why are you essen­tially an optimist?

PETER BERNSTEIN: I’m an opti­mist about the U.S. But I’m an opti­mist because prob­lems do get solved. Maybe not one day you wake up, and every­thing is back in order. But it takes an awful lot to crush a sys­tem as vital, in many ways as flex­i­ble, as the U.S. econ­omy. We went through, in 2000, when the bub­ble burst. I mean the bot­tom really dropped out of NASDAQ, and a big drop in the U.S. mar­ket, too. And word about bank­rupt­cies, and peo­ple were say­ing that the deriv­a­tives were going to pull the whole… noth­ing bad hap­pened, really. I mean, Enron, all of the scan­dals, those com­pa­nies dis­ap­peared. We kept right on going. Now this Revco, an enor­mous, really ter­ri­ble fail­ure, though it’s a rip­ple. So there’s a lot of resilience. There’s a lot of youth in this coun­try; a lot of new peo­ple com­ing in, who want to be part of it. Sure I’m an optimist.

CONSUELO MACK: So, one last ques­tion. And what is the … for indi­vid­ual investors, for suc­cess­ful, long term invest­ing, what should our phi­los­o­phy be? I mean what should our mantra be? What should our approach be, to really take advan­tage of the vital­ity that you see in the cap­i­tal markets?

PETER BERNSTEIN: Well, the vital­ity, I mean vital­ity you get in the equity mar­kets.  I mean there’s no ques­tion about it. You must be there. All the scare sto­ries about what might hap­pen and so forth, you should still have some money in the equity mar­kets. This is essen­tial. As I say, I think big things out­side the U.S. also. I am– since I don’t like stock pick­ing, and I’m not very good at it– a big believer in funds, rather than in try­ing to do it your­self. And although– this occurred to me the other day– the mutual fund indus­try has been crit­i­cized, because their returns aren’t good enough, and so on. How much worse, the peo­ple who were in mutual funds, may be dis­ap­pointed with what hap­pened. But if they’d man­aged that money them­selves, I know they would have done worse. So this may not be divine and per­fect. But it’s bet­ter than doing it your­self. It’s worth the cost.

CONSUELO MACK: Peter Bern­stein, thank you so much for your time and your just, bril­liance. Thanks for shar­ing it with us.

PETER BERNSTEIN: Thank you.

CONSUELO MACK: Our sec­ond wise man of Wall Street is Charles Ellis. Charley is the founder and for­mer man­ag­ing part­ner of the inter­na­tional con­sult­ing firm, Green­wich Asso­ciates, from which he advised the world’s lead­ing finan­cial firms on strat­egy for decades. He’s found time to author 15 books, includ­ing Win­ning the Loser’s Game, Fifth Edi­tion: Time­less Strate­gies for Suc­cess­ful Invest­ing. And he’s also taught at Har­vard and Yale’s busi­ness schools. He has chaired Yale’s invest­ment com­mit­tee, which over­sees one of the best per­form­ing endow­ments of all time. I talked to Charley about why he thinks Wall Street is a loser’s game for most individuals.

CHARLES ELLIS: Active invest­ing is the Loser’s Game, and the rea­son I call it Loser’s Game is the out­come is deter­mined not by the win­ner but by the loser. And I like to use the anal­ogy of ten­nis. The way some peo­ple play ten­nis. The win­ners with 120-mile-an-hour serves and bril­liant shots at net and ter­rific place­ment, they win points. Game I play, we lose points. And who will come out ahead is deter­mined by the per­son who loses the most points makes the other per­son the win­ner. And if you’re in a Loser’s Game, it’s impor­tant to know the right ways to play that game.

Give you another illus­tra­tion. Teenage dri­ving is a Loser’s Game. The kids all think if they’re really good with their steer­ing, if they really take off when the light changes, if they’re clever about find­ing ways to bob and weave in and around traf­fic, that’s great. But as the father of a teenage dri­ver, or the mother of a teenage dri­ver, what do you really care about? Only one thing. No seri­ous acci­dents. No seri­ous acci­dents, your kid is a great dri­ver. And if it’s my kid that’s dri­ving your daugh­ter, and my kid has no acci­dents, you’re very glad to have your daugh­ter in my car. Same thing with invest­ing. Active invest­ing is, the out­come is dri­ven by the behav­ior of the per­son that winds up, while they’re try­ing to get it right, try­ing to win, try­ing to get ahead, they wind up doing them­selves more harm than good, and the net result is they lose rel­a­tive to the market.

CONSUELO MACK: Why is that? What is it that indi­vid­ual investors do in try­ing to man­age their port­fo­lios that puts them in the Loser’s cat­e­gory? And you know, who are the win­ners, num­ber one? And define what you mean by win­ning in the market.

CHARLES ELLIS: Well, to me, win­ning in the mar­ket is truly get­ting the results you really, really want, that are right for you over the long, long, long term. And I think of invest­ing much more like mar­riages and most peo­ple who are active investors are doing more dat­ing. And I have noth­ing against dat­ing. But great rela­tion­ships will be devel­oped only by hav­ing a mar­i­tal com­mit­ment and work­ing together to have some­thing of real impor­tance take place. And I think anybody’s been mar­ried under­stands. This is a real dif­fer­ence, and none of us who are mar­ried want to go back to dat­ing. Same way of invest­ing. If you will think care­fully about what are your real, long-term objec­tives and find a way to artic­u­late those objec­tives, you can then find invest­ments that match with what you’re try­ing to accom­plish. And you’ll be rel­a­tively happy all the time and over the long term you’ll be very happy.

CONSUELO MACK: So, when I think about objec­tives, you’re talk­ing about more than just, “I want to make money in the mar­ket.” You’re talk­ing about really estab­lish­ing an invest­ment phi­los­o­phy and dis­ci­pline is key and then going out and seek­ing out the invest­ments that will ful­fill those goals.

CHARLES ELLIS: True.

CONSUELO MACK: Is that right?

CHARLES ELLIS: Yes. Most of us, most of us, our first objec­tive is to not lose.

CONSUELO MACK: Actually…

CHARLES ELLIS: What Mark Twain used to call return of the money and then return on the money is the sec­ondary thing.

CONSUELO MACK: So, that should be our first objec­tive, is not to lose, as opposed to win?

CHARLES ELLIS: Yes.

CONSUELO MACK: Which is the way most peo­ple go about it. All right.

CHARLES ELLIS: Because we’re human beings, we do a whole bunch of stuff that there’s now in the field of eco­nom­ics being described as behav­ioral eco­nom­ics, we do crazy things that are not in our best inter­ests. But that’s who we are. So might as well accept that that’s who we are and find a way to live with who we are. Those of us who get ner­vous when prices are com­ing down ought to study. You know, when prices are com­ing down, they’re less costly. You can buy more value for less money. This is actu­ally, although you’re uncom­fort­able, it’s good news, and those of us who get excited about, “Look, my stock is going up, it’s really going up.” Well, yes, that’s right. But, Char­lie, in the long run, if it’s gone way up, what’s the des­tiny? The des­tiny is, it’s going to come back to its aver­age, long-term value to price rela­tion­ship. It prob­a­bly will come down. So it’s not nec­es­sar­ily good news for you that the stock has gone way up in price if you’re a long-term investor, and I’m only inter­ested in being a long-term investor.

CONSUELO MACK: So, for long-term investors, you are a big pro­po­nent of index funds ver­sus actively man­aged funds.

CHARLES ELLIS: I am.

CONSUELO MACK: Why? Why index funds; why not just go with the market?

CHARLES ELLIS: The data shows over and over and over again that most all active man­aged funds under­per­form the index, a sen­si­ble index. Now, if you’re a small-cap value man­ager, active, the right index to com­pare against is a small-cap value index. Not high-growth, high-priced index. You have to choose your index. But if you choose the right and fair index, 75 to 80% of the active man­agers over every ten year period under­per­form, plus– and this is worth keep­ing in mind– you have higher taxes because the turnover is pretty rapid, and so, you’re get­ting short-term taxes as well as more fre­quent long-term taxes. Index funds don’t do much. So they don’t have much taxes, and the com­bi­na­tion of low fees, low taxes, and low errors, index funds keep com­ing up with a bet­ter result.

CONSUELO MACK: There are tons of index funds being cre­ated as we speak. The exchange-traded funds, which are index funds that trade like stocks, you know, I feel like there’s one being cre­ated every day prac­ti­cally. How do you pick the best index fund, num­ber one, and what kind of diver­si­fi­ca­tion should you have in your index fund port­fo­lio? Again, think­ing as a long-term investor?

CHARLES ELLIS: Well, you’re ask­ing sev­eral dif­fer­ent ques­tions at the same time. So, I’ll try to–

CONSUELO MACK: Yes. I am. Sorry.

CHARLES ELLIS: –pick it up. Now, first thing in index funds, you want to be with a highly-reputable index fund man­ager who has spe­cial­ized in this field, has become pro­fi­cient at it, because if you’re really good at doing index fund man­age­ment in your trad­ing activ­i­ties, you’ll be a lit­tle bit less costly than any­body else. Secondly…

CONSUELO MACK: So, names– Van­guard, for instance.

CHARLES ELLIS: Van­guard, with whom I’m asso­ci­ated because I’m a direc­tor. I became a direc­tor because I so admire the work that they do. It’s not the other way around. But they do a great job. Sec­ond would be that the fees are low. It’s really upset­ting to me, again, I’m back to Van­guard, they’ve got a low-fee strat­egy towards life, and their con­cept of value-delivered ser­vice to investors. Low fee of ten basis points. You get to some index funds .Exactly same index fund. Now, ten basis point but 100 basis points. And you’ll never get that money back. And you’re not get­ting any­thing for it. You’re just pay­ing up for nothing.

CONSUELO MACK: So, don’t pay them basi­cally and those costs can really add up over time?

CHARLES ELLIS: Over the long, long period, they do add up.

CONSUELO MACK: So, sec­ond part of that ques­tion: Asset allo­ca­tion. Very impor­tant, right, for long-term invest­ment results?

CHARLES ELLIS: Yes. If you think about your chil­dren or grand­chil­dren or the peo­ple that you love and care about the most, and you said, “Okay, I could give them the abil­ity to pick stocks really well or I could give them the abil­ity to pick man­agers really well, or I could give them the abil­ity to know which kinds of stocks to be invest­ing in or whether to go inter­na­tional or go emerg­ing mar­kets or go large cap or go small cap, or I could help them get the asset mix right.” So, okay, those are five dif­fer­ent deci­sions. I could get only one of them. They’re going to get, like, the oth­ers will get aver­age expe­ri­ence. Which one would you choose? Absolutely– asset mix. If you get the asset mix right, you’d have to make a major mis­take to get any­thing neg­a­tive to get a bad result in the whole. Get the asset mix right, most every­thing else can take care of itself. Get the asset mix wrong. You don’t have a chance.

CONSUELO MACK: How do you get the asset mix right?

CHARLES ELLIS First, under­stand who you are and under­stand what the money’s pur­pose is in your life. If you’re a very wealthy per­son, you’re prob­a­bly invest­ing for phil­an­thropic insti­tu­tions that you’re going to give money to or your grand­chil­dren and their chil­dren and their children’s chil­dren. Think about it that way, you’ll prob­a­bly be entirely involved in equity invest­ing. If, on the other hand, you have a mod­est amount of sav­ings– maybe it’s in your 401k plan, maybe it’s in your own invest­ment account– and it’s prob­a­bly enough to make it through your life with finan­cial secu­rity, then you should be more pro­tec­tive. If, as a human being, you just do like sta­bil­ity, you don’t like the ups and downs of the mar­ket, accept who you are and behave accordingly.

CONSUELO MACK: Final ques­tion. Actively man­aged funds, which, you know, many investors fol­low slav­ishly. How do you han­dle the actively man­aged funds? Do you invest in them at all? Under what cir­cum­stances? What per­cent­age of your port­fo­lio should you put with an active port­fo­lio manager?

CHARLES ELLIS: The last ques­tion about what per­cent­age. That’s a mat­ter of per­sonal judg­ment. The fun­da­men­tal propo­si­tion that I would put to you is if you’re going to choose an active man­ager, choose some­one that you’ll stay with for at least 20 years. If you’re going to stay with a man­ager for 20 years, you’re not going to choose because of their recent per­for­mance, you won’t choose because of the stocks they own now.  Those will all be replaced. You won’t choose because of the indi­vid­ual fund man­ager. He or she will be replaced. You will choose char­ac­ter or cul­ture or the value set of the orga­ni­za­tion. And as you know, and just slip in, I think there’s one such orga­ni­za­tion. They man­age the Amer­i­can Funds. It’s called the Cap­i­tal Group Com­pa­nies. And I wrote a book about it because I wanted to under­stand: why were they so able over every long time period to out­per­form and com­pete so suc­cess­fully? And I believe they under­stand how to man­age pro­fes­sion­als in such an effec­tive way that they will achieve very sub­stan­tial results. So, if you wanted to tease me a lit­tle bit, my wife owns the Amer­i­can Funds. And I own the Van­guard Index Funds. And we get along fine.

CONSUELO MACK: And the rea­son the Amer­i­can Funds– and Cap­i­tal is the name of the book– that they do man­age so suc­cess­fully, why is it?  What is it about them that’s enabled them for 75 years to do so well?

CHARLES ELLIS They start with a very strong con­vic­tion. Their pur­pose, and they recruit for it, and they train for it, and they believe it in deeply; they drink the Kool-Aid, as they say. Their pur­pose is to serve the indi­vid­ual investor– full stop. It is not to make money for the peo­ple who are work­ing there, to make money for the own­ers. That is not their objec­tive. Their objec­tive is to serve the investor, and, as a result, they do some very inter­est­ing things. For an exam­ple, when money mar­ket funds first came out, they would not intro­duce one. Why not? Because they were afraid that money mar­ket funds came out in the early mid ‘70s, and that was the worst time to move out of stocks and into cash. And they didn’t want to make it easy for peo­ple to make that mis­take. So, they wouldn’t offer them. Then, as a result, their investors stayed more in equi­ties and get the ride in the best bull mar­ket the world has ever seen.

CONSUELO MACK: Charles Ellis, it is a treat and an honor to have you here. Thank you so much.

CHARLES ELLIS Thanks.

CONSUELO MACK: At the con­clu­sion of every Wealth­Track, we try to leave you with one sug­ges­tion to help you build and pro­tect your wealth over the long term. This week’s Action Point is: put the power of div­i­dends to work in your port­fo­lio. Over the last eight decades, div­i­dends have accounted for more than 40% of the total return of the stock mar­ket. How do you invest in div­i­dend pay­ing stocks? Obvi­ously you can buy com­pa­nies that have a his­tory of pay­ing and increas­ing div­i­dends year after year. Stan­dard & Poor’s pub­lishes a list of what they call their Div­i­dend Aris­to­crats– stocks with a 25-year his­tory of increas­ing div­i­dends. If you pre­fer mutual funds, you can buy an equity income fund or an ETF, such as the Morn­ingstar rec­om­mended Van­guard Div­i­dend Appre­ci­a­tion ETF– the sym­bol is VIG. The key to get­ting max­i­mum returns from any of these invest­ments is by rein­vest­ing the div­i­dends, thereby unleash­ing the power of com­pound­ing over time.

That con­cludes this edi­tion of Wealth­Track. Next week, we’ll be dis­cussing how to max­i­mize your ben­e­fits from social secu­rity with retire­ment income guru, Mary Beth Franklin. It turns out that tim­ing is every­thing. Thanks for watch­ing and make the week ahead a prof­itable and a pro­duc­tive one.