Well, we forced a mic on you this time and we know you're going to be doing some geo arbitrage soon. So hopefully we found one small enough that you'll be willing to put it in the bag and carry it along with your very limited personal belongings on this trip.

I think you just should send me a new one each time. That'll be our frugal fail of the

week. Hey, but we're happy to do so too. For part three and four, that's a small price to pay.

So today what we'd like to start with is, and if I were going to tie this to one of the articles that you did, this would be part four of the stock series, the big ugly event, deflation, and also a bit on inflation. But to put this in context, as we're having this conversation, it's 2017 and there are a lot of people that feel that maybe the market is headed for a downturn. Now it doesn't matter whether or not that actually happens. We're not professional prognosticators. If you want that you can look on TV and get 50 people with 75 opinions. That's fine. We'll leave that alone. But let's say that we're looking backwards and this ends up being 1929. What happened during the Great Depression? And in the FIE community with the information that we have access to, how do we approach a situation like that?

Well, the lead up to the Great Depression, the crash of 1929 was of course the roaring twenties and it was a very robust time. There had actually been, as I recall, and I'm not a historian on this, so.

Nor did you experience it personally. Nor did I experience

it personally. I just missed it. But there had been, as I recall, a crash around 1920, something like that. And of course, the country had just come off of World War I at that point. And then you hit what we're all familiar with, the Roaring Twenties. And those were boom times for a lot of reasons. And in good times, people get exuberant. And sometimes they push the envelope a little bit too far. And towards the end of the 20s, the stock market started to have a very nice rise during this period. And I think that's what and greed are what drive the market, right? And people got greedy. And at the time, it was very easy to buy stocks on margin. It is still fairly easy to buy stocks on margin, which in buying stocks on margin simply means that you are borrowing money from your stockbroker to buy stocks. And the power of that, like in in any leverage, like the leverage when you borrow money to buy a house, is that if it goes up, you make more money. So let's take the house example just real quickly because that's what everybody is familiar with. And say you're going to a house for $100,000, Jonathan, and I'm gonna buy a very similar house for $100,000. Maybe the two houses are next to each other. And you buy your house for all cash. You plunk down the $100,000 and you just buy that house for cash. I go out and I get a mortgage for 90% of it, so I just put down $10,000. That's leverage. That's the same thing as buying stocks on margin. Now let's suppose that a year from now, we've bought well in the right neighborhood, and a year later, our houses have both gone up 10%. Well, you have made $10,000, which is 10% of the $100,000 you put in the game. I have made the same $10,000, but because I use leverage, I only have $10,000 in the game, so my gain is a hundred percent. So I have magnified using leverage my gain on the same price increase we both enjoyed. That's great. And that's one of the reasons, by the way, that people are so enamored of houses is because leverage magnifies the gains when they go up. That's also the thing that made it so terribly ugly when housing prices crashed in 2008. That's the problem because leverage is a double-edged sword. It cuts both ways. So let's take that same scenario. You buy your house for $100,000. I buy my house for $100,000, you put cash, I put down just 10,000, 10%, and a year later, it's gone down 10%. Well, you have taken a 10% loss on your $100,000, you got $90,000 left. I've been wiped out. I've taken a 100% loss. So now let's go to the stock market and back to the 1920s, people are buying stocks on margin and they're bidding up the price of those stocks to irrational levels because everybody is making money hand over fist because when you buy on margin, that puts more and more money into the game and it extends things more and more and has always happens. Eventually the music stops and everybody's scrambling for a chair. And when the music stops and the market starts dropping, if you are not buying on margin, just like with your house, the most you can lose is 100% if it goes completely to zero, which the market's never done. But if you've margined yourself by say 50%, which is common on one stock margins, if the market drops 50%, which of course it did not just in the Great Depression, but just a decade ago in 2007, 2008, you are wiped out. And if your broker is calling you for margin calls, which means that the stock is going down and they want to make sure it doesn't go down so far that they're holding the bag for what you owe, you are forced to sell. And that creates an even greater selling pressure on the market than the natural ebb and flow would ordinarily have. And so when you have a lot of margin built into the market and the market starts to drop and markets are very volatile, they're always going up and down. So there's always times they're going to drop. If you add margin into that, suddenly that drop gets accelerated and it gets faster and faster and deeper and deeper. And in 1929, you had the stock market crash.

And I want to pause on that for a second because it's that margin call that makes the comparison so much more dangerous for doing this with stocks as opposed to getting a mortgage on your home. Because you don't see that many people worried about using leverage to purchase their primary residence. The fundamental difference there is that if your house does go down in value 40%, the mortgage company is not coming to you and asking you to cough up the balance as long as you can afford to make the payments. That's the difference. And I guess if you were to go back to 2008, the problem was because of the massive scale and the horrific lending practices, they were not ensuring that the people that were getting these homes could make the payments and ultimately, you know, not to go down that rabbit hole, but that's why the whole system crashed in 2008. So

Jim, in this article, part four of the stock series, you have four lessons here. And the first one, which we've talked about is never buy stocks on margin. The second, if you don't mind me reading, I love the writing here. If a time comes when you're reading and hearing about people routinely making fortunes in an aggressively rising market using margin, something very, very bad is around the corner. And you say, Joseph Kennedy has said to have known it was time to exit the market in early 1929 when he started getting stock tips from shoeshine boys, and I just love that.

Yeah, that's, as far as I know, is a true story. And

I want you to comment on lesson four, but let me just quickly read lesson three. If you see lesson number two forming, it is a good time to take your chips off the table, which is very tough to do when everybody is making, quote unquote, easy money. And lesson four, once the crash comes, it is too late.

Well, let first comment on lessons two and three, because they are kind of linked together. I am somewhat famous for saying that the market is volatile and we can't predict when it's going to plunge. And therefore, we ignore the volatility we're buying for the long term. And if anything, we make the volatility work in our favor when either we are building our wealth and adding money to the market weekly or monthly or as our earned income comes in and we're saving a portion of that and we're adding it in. So when the market dips we get to buy at those lower prices and that smooths the ride or once we're living on our portfolio bonds play that role and we adjust the allocation, which takes advantage of those market dips. So in lesson two and lesson three, though, you hear me saying something that begins to sound a lot like market timing, which I mostly preach against. So those two are things that are really out on the far edges of the market when things really get out of whack is the only time that I would say begin to take your chips off the table. And of course, whenever you have a long bull run like we have now, people start to get antsy and say, now the time to take the chips off is now the time. And those times are very, very rare and probably unpredictable. And then lesson four is that once the crash comes, then it's too late. So typically investor behavior is the market goes up for a number of years and it begins to feel normal and the money feels easy and they start investing and then all of a sudden it crashes or maybe it doesn't even crash. Maybe it has a correction, which is a 10% decline or a bear market, which is a 20% decline. Crashes are like 30 plus percent. And then people get all nervous and after the decline they sell. Well, that's the classic closing the barn door after the horses have run away.

That is the most painful thing. And I think when it comes back to it for our community is latching onto this idea of the beer and the foam. And especially when we're following your, your general advice and we're following the more or less the advice of the fight community and we're latching onto index funds. We own a very small piece of the United States economy. And what you're asking yourself is, do I think that at some point in the five or 10 year future or whatever it may be, it's going to come back. And if you sell at the bottom because you say, I don't want to lose any more, you're contributing to a fire sale that you can never recover from. And I think having the confidence and just stepping it away and saying, what does this volatility represent? What does this crash represent? Is there a actual change or do I still own at the end of the day, a piece of the US economy? You've got to be able to make peace with that in your mind and then hopefully make a decision based on that.

I think I agree, Jonathan. I think you're absolutely right because the fundamental investing choice you're making, first of all, we should say that there are index funds these days. There's a huge range of index funds and there are index funds for very small sectors of the market and that's not what we're talking about. We're talking about broad-based index funds. Index funds attract the S&P 500 or my personal preference that track the entire stock market, a total stock market index fund like VTS AX. So if you buy something like VTS AX, total stock market index fund, or even an S&P 500 fund, you are basically betting on the economy of the United States. And to do that, you have to believe that the United States is going to, for the foreseeable future, remain a dynamic, successful economy. It's always going to be volatile. It's the nature of economies. But unless you believe that the United States in a permanent long-term decline, or it's about to collapse as an economy, you know, I'm famous for a post in this series where I say the market always goes up. Well, as long as the US economy is remaining strong and robust overall that has a future, that will always be true. If the United States goes into a tailspin that's non-recoverable, then eventually that, and someday it will, by the way. I mean, nothing lasts forever. Then obviously the VTS AX and the US stock market by extension won't be going up at that point. But I don't see that happening in the near future. I think the United States is good for at least another hundred years a dynamic, volatile economy. It's not going to be the same as the last hundred years. It's not going to be the same as it was today. But I don't think we're going away anytime soon. And if you believe that, then the way I recommend you invest makes sense. If you don't believe that, not everybody does. If you believe the U.S. is on the verge of collapse, then obviously you don't want to be investing in the stock market of the US. Just like if you believed in any country, if you thought it was on the verge of collapse, you wouldn't be investing in its stock market.

I think that definitely simplifies it from all the other variables that maybe you have to look at if you're an active investor. It simplifies it down into a much more easy to comprehend, almost binary choice, which then will allow you to dictate the decisions you make. So I get that. That makes sense to me. I think it would be interesting just for the sake of conversation to dial it back and talk just for a second about that person to be that investor in 1929.

That's a great question. So let's start out by saying that there's no way around it. The stock market crash in 1929 and the ensuing great depression was, as I say at the title of that post, a big ugly event. I mean, there's just no way around that. Stocks went down from their peak to their bottom, something on the order of 90%. So, if you had a million dollars in the stock market in 1929, before the crash, by the time it hit its bottom, assuming that you didn't sell, you'd be a hundred thousand dollars. So there's no question that's ugly. And it did eventually recover, but you know, it took a fair amount of time to recover. With that in mind, it pays to step back and say, well, okay, are there any mitigating factors? Well, if you'd stayed the course, you would have eventually recovered. That's number one. It would have taken a while. If you had been one of the 75% who kept their jobs, so the unemployment rate during the Great Depression reached 25%, the implication of that, of course, is as bad as that is, 75% of the people were still working. If you were one of the fortunate 75% and the odds, of course, were in your favor, and you kept investing in that stock market, if you kept the faith, you would have been buying stocks at extremely advantageous prices.

So I guess the takeaway point there is may the odds forever be in your favor. It's almost like a tagline for a movie. I wish I... Yeah.

The point is I've said that if you were a young investor, the very, just starting out or just even a few years in, the very best thing that could happen to you is a stock market crash, assuming that it doesn't scare you away, and assuming that you keep working and you keep investing because you are buying stocks at lower prices. You're buying them on sale at bargain rates. So anybody who's listening to this who's young and just starting, you should be rooting for the market to take a plunge. I get on the blog periodically, I get a lot of comments from investors of all stages, but I have a fair number of young beginning investors and a typical comment that concerns them is they'll say, I've put together $10,000 or $20,000 and you know, it's sitting in my bank account. I want to put it in the market, but I'm just afraid. I'm just afraid that if I put it in the market today, that it's going to drop dramatically tomorrow and I'll lose my money. And that's an understandable fear. But if you take the longer horizon and you're working towards financial independence, that $10,000 or $20,000 is not a lot of money. You're going to look back on it in a couple of decades and it's going to be pocket changed to you. So as hard as it is to believe, if you put that $10,000, which probably took a lot of blood, sweat and tears for you to pull together, you put it in the market and tomorrow the market chooses to plunge 50% and you get cut in half, celebrate because you are going to continue to invest in the market and you're going to be buying at better and better prices. So in a sense, that's why volatility doesn't concern me. As long as you don't panic and sell, it's going to recover. If you're continuing to put money in, it's going to work to your advantage. If you are at the stage of your life where you no longer are earning money and so you don't have cash flow to continue investing, at that point, if you're following my advice, you diversified into bonds. And so when the market plunges, you will be selling some of your bonds to buy those stocks at that lower price. And by the same corollary, when the market recovers and goes up, you'll be selling some of that to go back into bonds to maintain whatever asset allocation you have chosen. Does that make some sense?

Yeah. So my big takeaways are the psychology of it, which is don't get freaked out. Even if you do see your money and your hypothetical go from 10k down to all the way down to 5,000 and really the bedrock foundational principle of the FII community is live below your means, right and have a savings rate. Hopefully, it's 30, 50, 70 percent, something like that. And you are continually pumping money into your stock investments and to your point you're buying it at a huge discount. So that's why you're saying you should celebrate if that happens to you, if that timing is exactly right. Now, obviously in a perfect world, this person isn't losing the $5,000, but you're saying that's completely immaterial over the long run and you're then getting to buy at discount prices potentially for a year. You

know, Brad, you're absolutely right. You hit the nail on the head. In fact I might even go so far as to say let's suppose I had a magic wand and I could make things work and somebody in their 20s comes to me and I want them to be as successful as possible and they have $10,000 and they put the $10,000 in the market. I'm gonna use my magic wand and immediately have it go down 90%, go down to $1,000. Just because the power of that savings rate that you talked about and the new money coming in will so vastly eclipse the $9,000 they lost, they will be better off by taking that hit early. That's why I can't emphasize enough that unless you think the United States of America is swirling down the drain, I can't emphasize enough how important it is not only to stay the course and not panic and sell, but to take advantage of the drops and keep adding money as you go along. And by the same token, you don't want to stop adding money when the market goes up because the market can go up for long periods of time to heights that at the beginning you wouldn't have thought were possible and you don't want to lose that. Just keep putting the money in, keep putting it in. And truly, I tell my daughter, don't pay any attention to it. The ideal thing is put money in, the savings rate is key, put as much money in as you can, whenever you can, and otherwise ignore it. Jack Bogle says something similar and he said, he says, you know, and then in a few decades, when you decide to finally look at your statement, he said, don't even look at your statements for decades. And then in a couple of three decades, when you finally decide to look at your, at your statement, see where you are, make sure you have a cardiologist next to you because you're going to have a heart attack. And how well you've done. And

the reflexive thing that I want to point out here is that nobody in this room wants a recession to happen. That there's a lot of pain and heartache that comes when the market crashes and that's recognized. But when you're talking about your mental game, when you're talking about how in the FII community, how to handle that and how to handle the own personal fear that you have about whether or not you should put money in and what to do if it crashes, for you to recognize that if it does crash, if the market does go down, there is a play for you there. And by being empowered with this information, you will financially benefit from this in a very big way that that's going to be big for you. So if you're armed with information, you are going to do very well.

Well, I would also say, Jonathan, that whether we want a recession or we don't want a recession, whether we want a market crash or don't want a market crash, Mr. Market doesn't care even one little tiny wit. The market is in the economy are going to do what markets and economies do regardless of what we want. So that's part of adjusting the psychology. That's part of in one of my earlier posts in the stock series where I say toughen up cupcake because you can't, recessions are never going to go away. We're always going to have recessions, whether we like them or we don't like them. It just doesn't matter. They're a fact of economic life in our economic system. The market is always going to be volatile. It's always going to have bull runs like we're having at the moment and it's always going to have bear markets like we will at some point. I have no idea when. Let me say I'm not predicting a bear market tomorrow or the next week or but it could happen and I will say absolutely that we will see bear markets again. But yeah, the markets don't care what we want or what we don't want and so we have to toughen up and just accept that this is the way it is. Once you understand that's the way it is, then you can begin to think about, okay, how do I deal with this reality? How do I deal with it when it goes up? And how do I deal with it when it goes down?

I'm adopting that tagline, toughen up buttercup. That's definitely a tagline. Cupcake, toughen up cupcake. You

can change it to buttercup if you want. My blog, it's toughen up cupcake.

Perfect. You know, you made this great on the article and you said, none of this is to say that big ugly events are not very scary and destructive things, but they are rare. And in the context of our overriding approach, spend less than you earn, invest the surplus and avoid debt. They are survivable. That ties in so perfectly with what I would say is the overall theme of your article series. And it's that simple is good. Simple is easier and simple is more profitable.

And it's more powerful, absolutely. And it does tie in with that theme. And it's not to say that we will never see another Great Depression again. We have seen stock market crashes. I mean, we just, I imagine most of the people listening to this lived through the crash in 07, 09. I mean, that was the second ugliest in our country's history. So it's not like these things are never going to happen again, but they are exceedingly rare events. There was a book, I forget the author's name, but the guy who wrote the book about black swans. Oh,

Nicholas Taleb.

Taleb. Yeah. So, he wrote this book, The Black Swan, which is a great book. I highly recommend it. And just real quickly, a black swan is a very rare, but very traumatic event that happens. And it could be in the economy like big depression, the great, the crash of 29. It can be war. It can be any of number of different kinds of traumatic, earth-shaking things. But by definition, it's important to remember that they are very rare. So if we look at it in terms of the stock market and the economy, black swans like the Great Depression, the crash of 29, even the one in 08, 09 are very rare events. And so as an investor, you have to ask yourself, okay, I know black swans exist. I know they can happen. What should I do about that? And the problem is that if you fall prey to fear of a potential black swan and you start adjusting your investment strategies, expecting one or against the time it might come, you are going to leave a lot of money on the table because they are so rare. Most often, they don't happen. So let me illustrate this. Let's suppose that the three of us are sitting around in 1975. And I picked 1975 because in my book, I talk about the stock market period from 1975 to 2015, which is when I was finishing the manuscript and writing this, and that's a nice 40-year period. I chose 1975 because that happens to be the year I personally began investing. It happens to be the year that Jack Bogle created the first index fund and it happens to be a nice four decade chunk of time. So let's suppose that the three of us and maybe our audience were all sitting around having a cup of coffee and it's 1975 and I say, guys, I got some news.