What's the key to achieving financial freedom? And what's the real risk investors face?
In this podcast, Motley Fool analyst Buck Hartzell and contributor Rich Lumelleau talk with financial theorist and neurologist Bill Bernstein, the author of numerous books, including The Four Pillars of Investing.
The conversation covers a variety of investing topics, including:
- Advice for new investors.
- Misconceptions about risk.
- Mindset and volatility.
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A full transcript is below.
This podcast was recorded on August 03, 2025.
Bill Bernstein: We're human beings who evolved over millions of years of biological history. The way that we react to risk or the risk that we respond to is immediate risk. It's seeing the yellow and the black flash of light in your peripheral vision or hearing the hiss of a snake or the roar of a lion, and you respond just like that. That's the way most people perceive risk in financial markets. It's the day that the market calls falls three or 4% or when there's very bad economic news. That's not risk. That's volatility. What real risk is is living under a bridge or eating cat food when you're old.
Mac Greer: That was Bill Bernstein, a financial theorist, neurologist, and author of numerous books, including the Four Pillars of Investing, the Intelligent asset allocator, and the Birth of Plenty. I'm Motley Fool producer Mac Greer. Now, Motley Fool contributor Rich Lumelleau and Motley Fool analyst Buck Hartzell recently caught up with Bernstein and talked risk reward, and financial freedom.
Buck Hartzell: Rich and I both have young adults. People that are either getting ready to graduate or graduating college and got their first job. I just had 10 of those people over at our house this weekend. One of the questions that we got asked during that conversation as we sat down is, how much do we need to save? In order to be prepared and reach one day, financial freedom. I don't like the word retirement because I think freedom is something different. You can do what you love. You don't need to retire and people aren't meant to sit around and watch TV on their couch and stuff. How much is a reasonable amount do you think that they need to save in order to reach their goals, Bill?
Bill Bernstein: Well, I've in recent years, I've changed my mind about this. I used to think that 15% was enough, which is the figure you'll see in that particular book. 15% is adequate if you have a relatively low income because what will happen when you retire is you will get a very nice replacement ratio out of your Social Security. The person who has below average income or average income is going to get probably in the realm of about 50%-60% replacement from social security. But if you're an upper and for that person, 15% is adequate. But if you're an upper income person, then Social Security may only replace 30 or 35% of your income or even less if you've got a very high income. That person should be saving at least 20% of their income.
Rich Lumelleau: Bill, you've written that investing is simple but not easy. What do you think makes it so hard for most people to follow sound investing principles?
Bill Bernstein: Well, there's a very precise analogy for that, which is losing weight. Losing weight is simple. Exercise more, eat less. It is not easy. It is also simple to say, I'm going to invest 15 or 20% of my salary every month into the financial markets. It's an easy thing to say that. But when the world looks like it's crashing down around you and maybe you're losing your job, it's not such an easy thing to do. The other analogy I like to use is, if you've ever had any flight training, it's flying in a simulator, preparing for an emergency or a crash landing in a simulator is easy. It's very non stressful. I've done it. But doing it in the real world, unfortunately, I never had to do it, I imagine it's a good deal more stressful, and the financial markets are the same way. It's one thing to have a plan in a spreadsheet or in a beautiful mathematical model. It's another thing to actually execute it in real time.
Rich Lumelleau: I guess a follow up to that is, are there misconceptions about risk that you see from your work and your writings that persist among both amateur and professional investors?
Bill Bernstein: We're human beings who evolved over millions of years of biological history. The way that we react to risk or the risk that we respond to is immediate risk. It's seeing the yellow and the black flash of light in your peripheral vision or hearing the hiss of a snake or the roar of a lion, and you respond just like that. That way most people perceive risk in financial markets. It's the day that the markets falls three or 4% or when there's very bad economic news. That's not risk. That's volatility. What real risk is is living under a bridge or eating cat food when you're old. Those are two entirely different risk. Unfortunately, people pay much more attention to the first risk, the immediate risk, what I call shallow risk than they should pay to deep risk, which is the second risk, long term risk.
Rich Lumelleau: Is there a way for investors to cultivate the discipline to do nothing during periods of market volatility. You mentioned those three and 4% down days. Obviously, three months ago, we had a 20% correction. Obviously, you were rewarded if you just stuck. Is there a way to cultivate that discipline?
Bill Bernstein: Well, like everything else in life, there's theory, and there's practice. The theory is to look at financial history and understand that once every three or four years, the markets fall by 20%, and once every 10 or 20 years, they fall by 50%. It's to have that knowledge in your knowledge, bank, so it's to know that theory, but the theory isn't enough. The practice part of it is to actually live through it yourself and see how you respond. People respond in different ways. There are people who are utterly impervious to falling markets and will happily, invest even in the worst of markets. They find it very easy to do. I find those people are very rare. I'm not one of them myself. There are other people who when the markets do poorly and the world looks like it's going to end, they panic. I've known people I've known men who risked their lives in combat and seem to execute that very well. But on the other hand, when their portfolio fell by five or 10%, they threw up. It's very odd.
Buck Hartzell: Yeah, it's funny even business owners people that run their own business and they've been through swings and upturns and downturns and COVID and all this stuff, and they can handle that fine. But then when they see their stocks go down 5 or 10% it's something that blows their mind a little bit. I'm like, Some of these people are friends. I'm like, you've run your business through all downturns and things that happen. Why does it bother you? I think it's 'cause they feel like they're in control of their business, and they're calling the shots where the movements and these stocks. I tell them, Just don't watch. This is long term investing. If the up and down bothers you, don't look at it. Go play golf. You like that.
Bill Bernstein: As I already mentioned, I like to think about things evolutionarily, and I like to think in terms of analogies as well. The analogy, I think it's appropriate here is the skunk. The skunk evolved over tens of millions of years to have a given reaction to a large predator that threatened it, which is to turn 180 degrees, lift its tail, and spray. That's very effective. But it's not effective in an environment where your major predator is a hunk of steel weighing two tons moving 60 miles an hour. That's not the appropriate response. That analogy to finance is precise.
Buck Hartzell: Now, I want to go toward a little bit diversification because four pillars was a great book that you wrote and shared a lot of great lessons for people. But one of the comments in there was, when things look the brightest, returns are typically the lowest. When things look the darkest, returns are the highest. I have a question for you today. We sit here July 22nd, 2025. Where do you think we are on the brightest to darkest continuum as far as investors today?
Bill Bernstein: A lot of clouds in the sky that I can see. People are talking about tariffs and a debt spiral and the unsustainability of the treasury market. But that's not the way people are behaving. People are behaving like everything's fine. That's a really important concept because in the financial markets, you are paid to bear risk and uncertainty. The worst things look, the lower prices have to fall in order to attract people back into the market with higher expected returns. The best fishing is done in the most troubled waters, and the time to be wary is when things look the brightest. Warren Buffett, very famously said to be greedy when others are fearful and fearful when others are greedy. People look pretty greedy to me right now.
Buck Hartzell: Yeah, the risk trade seems to be back on right now. With most people. I'd say, also, stocks are relatively expensive. It leads me into another question, and this goes to diversification. A recent Wall Street Journal article posted that over the last decade, small CAP stocks have returned about 6.6%. That trailed large CAP stocks that returned over 13%. They trailed by about 7.3% per year. That's the widest gap that we've seen going back the whole way to 1935, as they were mentioned. That includes dividends. I just wonder, from an allocation standpoint today, where are you on small caps versus large caps? Can you just give us? Do you adjust your allocation based on how well that particular class has done or not done well the last 5 or 10 years?
Bill Bernstein: Well, my emotional, excuse me, my discipline, my intellectual discipline tells me I shouldn't do that at all. But I have to admit that my emotionality, when I see something like that tells me, yes, I should act on it. Whatever my given allocation was to small cap stocks, say, five years ago, maybe it's a little higher now. Just for that exact reason. The financial markets do have a tendency to mean revert, which is what that article by Jason Zweig talked about. Mean reversion is a relatively weak phenomenon. It's at best a 55, 45 bet. But if you bake enough 55, 45 bets over the course of your lifetime, you're going to win some, you're going to lose some, but on average, you'll come out ahead. I think that's a bet that's worth making, but don't be surprised if it doesn't work this time.
Buck Hartzell: Intellectually, you say, I stick to my guns. I've had my allocation. But also, you say, I might tilt a little bit more in that direction, given that reasoned data. Can you give for people that are listening at home, so they have an idea? What are your rough allocations, would you say in a simple form to large CAP versus small cap and say international and maybe bonds in there?
Bill Bernstein: Well, I think the typical investor is well advised to hold the market, the total stock market. If they want to tilt toward small cap stocks, they can do it with a small portion of that allocation, say, a quarter or at most a third of it. Understand that there are going to be long periods of time, like the last 20 years when you're sorry you did that. You have to be extremely patient.
Rich Lumelleau: How does geopolitical risk, and I'm going to throw tariffs into that just because it's basically we're dealing with every country in the world. How does geopolitical risk influence your long term investment strategy?
Bill Bernstein: I like to channel Ken Fisher, bless his soul, who observed that he pays close attention to the headlines because he knows that if something is above the fold, that is, it's the top of the headlines, it's an archaic term, I guess, showing my age. If something is above the fold, then it's already been impounded in the prices so he knows he can ignore it. Those are the things that fit into that category, geopolitical risk, what's the feds doing? Everybody knows about that stuff. It's impounded in the prices. That's not a new observation. I think it was almost over 100 years ago that Bernard Baruch said it's something that everyone knows isn't worth knowing.
Buck Hartzell: If it's in the paper, it's in the price is usually what I tell people.
Bill Bernstein: Exactly. That's a great way to put it.
Buck Hartzell: We tend to be bottoms up here at the fool. We get a lot of questions, particularly around the tariff noise. We can point to them and tell them, Hey, in 2016, there was a similar conversation that was going on. Here's what happened then. Most of those international stocks traded down pretty significantly once the presidential election happened in 2016, and then the year afterwards, international stocks took off, I think China was the best performing up probably over 50% in 2016 during President Trump's first year in office. We can tell them the data, but it's hard because people focus on what's in the newspaper, and I'm like, if you can just keep your goalpost focus on how the business is doing in the company and pick good businesses, you're probably better off because the noise is immense that is out there.
Bill Bernstein: If there's one data I tend to pay attention to, I do it as a negative indicator, which is you'll often hear people say, Country X Y or Z, has a great economy. It's going to take off buy its stocks. It turns out that there's an inverse correlation there. There are a lot of different reasons for that. But the poster child for that phenomenon is China. Over the past 30 years, economic growth in China has been through the roof, almost 10% real over the past 30 years every single year. Yet, over the past 30 years, Chinese stocks have been money losers. They've had terrible returns. For, again, many different reasons. That's one argument that I tend to pay attention to because it's so specious, but it usually works out the opposite direction.
Buck Hartzell: I remember when the bricks were all a big thing, and that was Brazil, Russia, India, China, and they were the emerging growth stories. Well I think over longer periods of time, those emerging market stocks tend to perform less than a developed world because like I said, everybody runs toward the growth, and then the multiples get bit up. But we even had some members that posted some ETFs because they wanted exposure to the growing middle class of China, which is a smart thing. They had huge growing middle class. But if you looked at some of the ETFs that were available for investors, most of those were investing in government run entities in China. They were state owned enterprises like banks and manufacturing and stuff like that. They were getting very little exposure to the rise of the Chinese consumer. I said, You got to be careful sometime when you just look at some of these ETFs that think they're meeting your needs. You got to understand what's in them, as well.
Bill Bernstein: There's a more general principle, epistemological principle here, which is that narratives and stories are very misleading. We're human beings. We tell each other stories. That's how we communicate. That's a really lousy way to invest. If you're buying a story, you're very liable to have your head handed to you. What you should be looking at is the data. What's the data? It's the valuation. What earnings yield are you getting? What dividend yield are you getting? That's what you should be paying attention to.
Buck Hartzell: You've talked a lot about behavioral finance and psychological tendencies. I think investors that are trained in those tend to do better, and they protect themselves from making a lot of mistakes. I want to spend a little bit of time on that. I grew up. We had one investor in my household, and that was my mother, and she was probably the best investor I've ever known because she's had the ability to buy good companies and hold them for six decades. Those are companies like Apple and Microsoft and things like that. At the end of her life, your portfolio reflected the fact that she held onto her winners. I want to just ask you a little bit about people that are just beginning. I've worked a lot with our interns this summer, as well as many summers before. I've seen a difference between men and women investors. Like I said, I grew up lifelong relationship and investing with my mother. She was very patient with her stocks. Men that I know tend not to be. They tend to want to buy and sell and trade a little bit more. I just want to know, like for people that are beginning investing, I'm talking about people that are pretty humble here and they're scared to lose money on their first investment. They're scared to take that first leap, and I tell them, if you're great, you're going to be wrong 40% of the time. Don't sweat it. It's fine. What do you tell those people that are a little scared to get started because they're going to buy that first investment, whether it's a stock or Eta and afraid it's going to go down?
Bill Bernstein: Before I answer that question, the first thing you talked about the gender difference is quite salient. Testosterone does wonderful things for muscle mass and reflex time. It does not do good things for judgment. Women tend to be better investors than men are. Now, as far as what you do with your first investment, you have to find out what person you are. I tell people who are starting out to invest relatively conservatively, so that when they hit their first bear market, they find out what their actual risk tolerance is. The first investment that a person makes, generally tell them start with a 50, 50 portfolio, and when the market goes down 50%, which is liable to happen at some point in your first 10 or 15 years of investing, then you're going to find out who you are. If you bought more or you held on, fine. You know what to do. You're either going to keep that allocation or you're going to up your equity allocation. But if it ruins your life, maybe you should be 30, 70 for the rest of your life because that may be sub optimal, but a sub optimal allocation that you can execute is better than an optimal one, a stock heavy one that you can execute.
Mac Greer: That was Bill Bernstein. His books include the Four Pillars of Investing. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against. Don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For the Motley Fool Money team, I'm Mac Greer. Thanks for listening, and we will see you tomorrow.
