Bringing you our top podcast episodes of 2023

LIZ ANN SONDERS: I'm Liz Ann Sonders.

KATHY JONES: And I'm Kathy Jones.

LIZ ANN SONDERS: And this is On Investing, an original podcast from Charles Schwab. Each week, we're going to bring you our analysis of what's happening in the markets and how it might affect your investments.

On this week's episode, we are going to answer some of the most frequent questions we get from investors. Kathy, you and I often always constantly speak at events where there are question-and-answer sessions, and it seems like a lot of the same questions come up time after time.

KATHY: That's true. And some of those questions are ones we get every single year, and some of them are unique to this point in time, since this is really kind of an unusual economic cycle. And I think most people who are asking these questions really are concerned about what's going on in the economy and how that can impact their investment plans.

LIZ ANN: Absolutely, and there are a lot of important questions out there that everybody wants answers to. And we also see them pretty much every single day in the comments and replies on our social media posts. But before we get into a list of some of these recent, let's call them hot topic questions, let's talk a little bit about how we spent the last week.

KATHY: So last week, Liz Ann, we were at IMPACT, the big conference that Schwab holds for advisors. This time it was in Philadelphia. A lot of great sessions there and a lot of great questions. So I'm sorry you missed quite a bit of it.

LIZ ANN: Well, I was, as you know, Kathy, I was actually in Philadelphia. I had gone down the day before IMPACT started for one of the advisors on Schwab's platform that always attends IMPACT. Interestingly, he runs a firm that was founded 60 years ago by his grandfather when we never even heard of the initials RIA or investment advisors. I guess it would have been termed some sort of mutual fund shop at the time, but his grandson took it over. So we had the 60th-anniversary celebration. I was not feeling well at all that day, but I had tested for COVID before going to the event, obviously, and I was negative. But then the next day, the day IMPACT started later in the day, I tested positive and was highly symptomatic.

So I spent IMPACT in a Philadelphia hotel room, but I was also very fortunate to have our colleague on my team, Kevin Gordon, who was attending IMPACT, and with very short notice, got up on stage, as you know, Kathy, for a couple of sessions and did just an absolutely extraordinary job. So I was very grateful for his involvement, his attendance there, and his poise and knowledge that he brought in my stead, but it's one of my favorite events. And I really miss seeing all of you in person. And hopefully that's a one-and-done in terms of missing IMPACT after 22 years of attending every one.

KATHY: Well, I will say a lot of people missed you. Kevin, you're right, Kevin did a fantastic job. Really impressive. But everyone was walking around going, "Where's Liz Ann? Where's Liz Ann? What happened to Liz Ann?" So you were missed. And then when I didn't want to say anything because I wanted you to reveal the information, not me, I just said you weren't feeling well, and they all wished you that you would get better quickly. So glad to have you up and about.

LIZ ANN: Yeah, thank you. I feel I'm pretty close to back to normal. So thank you.

KATHY: Yeah, I will say though, I'm sorry you missed it, because it's just some great conversations, great questions. Certainly on the fixed income side, a lot of concern, interest, questions. So, my session, I do an education session, was packed with people and a lot of great engagement. So obviously, people are … advisors are really asking a lot of questions right now about this environment and what they should do.

LIZ ANN: And I think that's one of the best things about some of these larger-forum conferences, particularly IMPACT, is not just what we impart when we're up on stage or the question-and-answer sessions that are a formal part of the events that we participate in, but those  in the conference center, just informal chats and conversations, I think those are often incredibly illuminating in terms of what's really on the mind of investors and in particular the advisors on our platform that advise so many individual investors.

KATHY: OK, so here are some of the most frequently asked questions we're hearing right now.

SPEAKER 3: What do you see the Federal Reserve doing over the next year?

KATHY: We think there's a very good probability the Fed is done raising interest rates in this cycle. And we can't rule out one more rate hike, but we kind of doubt it. Inflation is coming down. The core PCE, this is the benchmark measure that the Fed uses for inflation when they give their estimates, and it's down to 3.7% on a year-over-year basis. And it'll likely come in even lower by the end of the year.

The Fed was aiming for 3.7 at the end of this year. So we're there now. If it comes in a little bit lower, that would indicate they don't really have to do a lot more to achieve their inflation target on a timely basis. But there's also, keep in mind, the Fed is doing quantitative tightening. That is, they're allowing their balance sheet to decline by allowing bonds to mature and not replacing them. And that's a form of tightening. So just because they're not hiking rates doesn't mean they're not still tightening policy.

And then many other goals are being achieved. Bank lending standards are tightening. That means it's harder to get a loan, whether you're a business or an individual trying to buy a car or a house. And that's kind of the point of tighter monetary policy, making it harder to borrow. That slows the economy down. And we are seeing slower growth in some segments of the economy, especially manufacturing. Wage growth is slowing down. That's part of the goal of the Fed is to have wage growth closer to something in the 3 percent area than 4 percent plus, where we are, but it's well down from where it was and heading lower. And then regional surveys that the Fed uses when they survey the businesses in their district and individuals. They're showing a lot more concern now about slowing growth than about inflation. And this is a big shift over the last couple of months. I think that another motivation for the Fed to stop raising rates is they don't really want to trigger a problem in the financial system. There are some fragilities with smaller banks, exposure, that have exposure to commercial real estate, and really no reason to put more stress on the financing system in the country.

Another reason is growth in the rest of the world is slowing. Europe is really edging toward recession. China's growth rate has been disappointing. Further tightening by the Fed would just push up the dollar, which in and of itself could make it hard on countries that borrow in U.S. dollars, especially emerging-market countries. So just standing still with rates where they are for a while should achieve the Fed's goals, and I think that that's a motivation for them to just sort of stick with this "higher for longer" policy until they start to see inflation really get closer to that 2% target.

LIZ ANN: Hey, Kathy, can I jump in with a follow-on question that I often get when we're talking about the Fed in pause mode and what are the implications for the stock market associated with a Fed that has stopped raising interest rates? And what sort of drives me crazy is how many times I either see reference to or comments around, well, the typical action by the stock market or the average path the stock market takes once the Fed puts in its final hike. And I always think, boy, it brings up that old adage of "Analysis of an average can lead to average analysis." And you have to add to it the fact that we don't have a huge sample size of Fed rate-hiking cycles. There's only 14 of them, going back to the combination of the history of the S&P and the history of the Federal Reserve being in existence as we know it now, and that's 14 prior to the current one. And yes, you can look at averages. The average performance six months after the final rate hike is slightly down, like literally negative 0.4%. It jumps into mild positive territory 12 months later, 1.8%, but that does not suggest that you typically don't see much performance at all in the market because six months later of those 14 prior instances, the range is from as negative as minus 18% for the S&P—that was when the Fed stopped hiking in 1974—but you also have an experience of a 20% gain six months after the final hike. That was in 1989. If you go 12 months later, the range is even more dramatic. So again, the average 1.8, but the range goes from negative 29%, that was 1929 associated with the crash in that year, to up 32% in 1995. And there's also a huge span in terms of the number of days between the Fed's final rate hike and the subsequent first cut, going from as little as 59 days, again, back in 1929, because that was the crash of '29 era. But when the Fed stopped hiking in 1981, it was 874 days later that they made their initial cut in the next cycle. So again, beware of the words "typical" or "average" when it comes to data like this. And it also reinforces that there are lots of other things that impact what the market is going to do aside from just the Fed ending a hiking cycle.

KATHY: Yeah, and I would add, Liz Ann, it's a similar story with longer-term bonds. So we look at 10-year Treasury yields, and we look at how they performed going into the last rate hike and coming out of the last rate hike. And typically, what you see, and I say typically, in the last five or six cycles, long-term yields have peaked before the Fed makes their last rate hike and then come down over the next six to 12 months.

This time around, for the first time in modern history, going back to the '60s, if the last rate hike was the peak, we've seen 10-year yields actually go up after that. Very unusual cycle that we're in. And that goes to the point of you can't just look at the past to try to figure out what's going to happen in the future.

SPEAKER 4: Is a recession coming or not? And if it is, what should I do?

LIZ ANN: Well, I'll take that one to start. If I wanted to be a little bit snarky, but honest, yes, a recession is always coming, because that's how cycles end. The timing, of course, changes. I think this cycle has been particularly unique. We even spent some time on the pilot episode of this talking about the unique aspect to this cycle and all the cross currents that have come at investors and consumers making it a bit more difficult to figure out where we sit in the cycle.

And a lot of it has to do with the nature of the pandemic and how strength and weakness has sort of rolled through different segments of the economy at different times, which is why we've been using the term "rolling recession" to describe the backdrop where earlier at the very early stages of the pandemic when we were still in lockdown mode and all the stimulus kicked in, the surge that that caused in the economy was very much concentrated in the goods and goods-related side of the economy, like housing, housing-related, manufacturing, a lot of consumer-oriented goods that were beneficiaries of the lockdown phase and services were getting hammered at that time because we simply had no access to it.

But fast-forward to the more recent period of time, we've had what they often call the revenge-spending on services. Services is a larger employer in the United States. That's helped keep the labor market afloat. But we had actual hard landings, or recessions, if you want to use that term, for many of those segments that had the early burst when the stimulus had kicked in. So housing, housing-related, manufacturing, a lot of consumer-oriented goods, went into recession-type declines. You just had the offsetting strength on the services side. Now the hope, and I think still best-case scenario, absent an official NBER declared recession—they're the official arbiters—the best case scenario to me is less a traditional soft landing, because we've had hard landings in some of those aforementioned areas, but a continued roll through where if and when you start to see some weakness in services, and there's a few minor cracks that you could point to, but nothing significant, that you have that coming weakness, if it is coming, offset by either stability or improvement in areas that have already gone through their hard landings. Unfortunately, there was hope earlier for housing to represent one of those improving areas, but that was a fairly short-lived lift that we got, and now most of the data has rolled over again. And then as recently as this week, we got an update to ISM manufacturing, which is a key way to look at the health of the manufacturing industry, and that moved back down.

There was also, I think, some short-lived hope that maybe manufacturing was finding its legs. So I still think, more likely than not, a recession will be declared. What's important for investors is, number one, the stock market is a leading indicator. Inherently the data being used to judge recessions and when they start are, at best, coincident indicators if not lagging indicators. So the one piece of advice we often give investors, particularly if a question is phrased something like, "Why wouldn't I just stay out of the market until I know there's a recession and it's already over?" But the lags associated with not just the declaration that, OK, it's a recession, but the backdating nature of the start point. So NBER, what they do, their Business Cycle Dating Committee, is when they conclusively say, "OK, it's a recession," simultaneous with that announcement, they date the start, and they do that by month, not by day. And the average lag is seven months. Interestingly, at the back end of recessions, when you ultimately get the NBER coming out and saying, "OK, recession ended," the average lag in terms of where they date the end is 15 months. So keep that in mind. If you're waiting for the all-clear sign by the official arbiters of recessions that it's over, boy, you've probably missed a heck of a lot of movement in the market and in many cases, upside movement because the market is anticipatory in nature. And even during recessions tends to be really good at sniffing out the inflection point to a pickup in growth from inside a recession. So you certainly don't want to make all-or-nothing decisions based on the official timing of recessions. That is a pretty late part of the process.

KATHY: So, Liz Ann, I pick up on your comments about how, you know, every cycle is different. I often, having been an English literature major, think of recessions in terms of the famous opening lines to Anna Karenina, where it's "Happy families are all alike, but every unhappy family is unhappy in its own way." And I think of recessions as unhappy time periods, right, and each is different. So the economy normally grows. Its normal path is for expansion. When we hit a recession and it's not growing, it's because something really unhappy is going on, right? And each time it's a little bit different, has different causes, different outcomes. But for a bond investor, it's a little bit more straightforward, I think. Typically, what you see in a recession, even before it's declared, is a slowdown in growth. There's evidence of that, and that brings inflation down, and that's good for bonds. But it's good for high-quality bonds, not the riskier parts of the bond market. So, if you're concerned about a recession or you think a recession is on the horizon soon, it would behoove you probably to have some high-quality fixed income, meaning Treasuries, other investment-grade bonds like investment-grade municipal bonds or corporate bonds or some other government-backed securities. And maybe move out a little bit longer term because typically they respond the best to falling inflation and slowing growth and the likelihood of Fed rate cuts.

SPEAKER 5: What would cause the Federal Reserve to actually start cutting rates?

KATHY: Well, I think that's pretty straightforward. So, you know, A, if we saw signs that the economy is actually tipping into recession or really slowing down significantly, I think the Fed is really focused on the labor market. So, if the unemployment rate starts to really rise quickly, that could be a reason for them to shift to easing. I mean, they have a dual mandate of keeping inflation low and stable and of trying to keep employment at full employment.

So that trade-off, they've been focused only on inflation, but if that trade-off switches and we're seeing high unemployment, the Fed would probably start to cut rates. The other major reason would be stress in the financial system. You know, if there were some significant threat to financial stability, which could be rising defaults among large companies, a problem in commercial real estate that's threatening the banks, something that could threaten the financial system, then that's the kind of the thing that the Fed would react to by cutting rates.

SPEAKER 6: Your tactical guidance is often around factors and sectors, but why don't you talk about specific growth and value categories of stocks? How come you don't talk about growth versus value?

LIZ ANN: Well, interestingly, we do, we just get at it a little bit more indirectly, but for some really important reasons. I think there's a lot of simplicity around the discussion that often happens about growth versus value. I think growth and value can be seen in three different ways. The way I generally think about it is around the actual characteristics of growth and value, which goes to the whole discussion of factors.

But then I think that there's also preconceived notions around what are growth stocks and what are value stocks. Examples would be, I think most people would say, technology stocks are growth stocks and utility stocks are value stocks. And then, particularly important this year, is the fact that there are growth and value defined indexes. I call them capital G and V, in contrast to the lowercase g and v, growth and value, meaning the characteristics of growth and value. And the reason why I mentioned specifically this year is there are two index providers that create and maintain some of the most popular growth and value indexes, and it's S&P and Russell. In S&P's case, they have four indexes, two growth, two value. They don't do it by capitalization size. They do it sort of by purity. So S&P has an S&P Pure Growth, an S&P regular Growth, or just S&P Growth, S&P Pure Value, S&P Value.

And if you are a stock that lives in S&P Pure Growth, you don't also live in one of the value indexes. Whereas if you're in the regular growth index, you can also be in the regular value index because there's plenty of stocks that have characteristics of both. Russell has their four-index breakdown based on capitalization. So they've got Russell 1000 Growth, Russell 2000 Growth—that's large-cap growth, small-cap growth—and the same on the value side. Now the reason why this year is particularly important is the different rebalancing timings. Every year, both index providers rebalance those growth and value indexes so that it reflects the actual characteristics. And S&P does their rebalancing in December every year, Russell not until the end of June.

Why is this important? Well, on December 18th of 2022, the day before S&P did its rebalancing, their Pure Growth index had all eight of the mega-cap eight. Those are the largest eight stocks in the market. And technology, as a sector representing some of them, was 37% of that Pure Growth index. On December 19th, the day of the rebalancing, only one of those mega-cap eight was still in the Pure Growth index. The other seven stocks moved to a combination of regular Growth and regular Value S&P indexes. And as a result, the technology weighting within Pure Growth went from 37% to 13%. Even today, the spread is dramatic. And I'll get to that in a second.

So you might wonder, OK, well, if tech was no longer the largest weight, what became the largest weight? Guess what it was—energy. Because at the time S&P did its rebalancing, that's where the growth characteristics were most pronounced. That was where the strongest earnings growth was in the period that they were analyzing. So energy became the number-one weighted sector. Healthcare was actually number two, and tech was number three.

Fast-forward to the end of June when Russell did their rebalancing. You had seen deterioration in the earnings profile for energy, and technology stayed as a very hefty weight in their growth indexes, both large and to a lesser degree small. But as I mentioned, the differential this year has been unbelievably stark. You've got the Russell 1000 Growth index with 43% technology right now, this is as of the end of October, and only 14% technology in S&P Pure Growth. So many people look at those indexes and think, oh, they probably generally look the same. They're … S&P by its nature is large cap, so large-cap growth, large-cap growth, they look the same. Well, 43% tech versus 14. Russell 1000 Growth has 1% energy. The S&P Pure Growth has 29% energy. As a result of that, year-to-date through the end of October, Russell 1000 Growth is up more than 22%. The S&P Pure Growth index is down 3.5%.

So the real moral of that part of the story is, you better understand what you're buying. And where we get at growth and value is when we talk about factors. There are going to be times where the factors we are emphasizing right now, high-interest coverage. That has more of a sort of a value bias in terms of a characteristic. There are going to be times where we emphasize, like now, profitability and positive earnings revisions. That's more of a growth factor. So we just get at it a little bit different a way. We come at it from the perspective of characteristics. The last thing I'll say is it's not all that hard to categorize stocks into growth indexes.

It's based on their earnings growth. But what's interesting is if you don't meet the parameters, you're automatically put in the value basket. But it doesn't necessarily mean that those are actually value stocks. At a particular point in, I don't remember exactly when, in 2022, the utility sector had a sector P/E ratio that was higher than the S&P to a degree never before seen.

So that's really expensive stocks. Now utilities live in the value indexes, but there was an example of … they didn't really offer a lot of value. They just happened to be housed there because they're not growth stocks.

SPEAKER 7: If the yield curve is inverted, why should someone consider buying intermediate or long-term bonds?

KATHY: Well, yeah, this is a question we get a lot because, you know, intuitively, well, if short-term rates are higher than intermediate or long-term rates, then why should I buy anything beyond short-term, right? So currently, and what I mean by short-term and long-term is usually up to about, you know, two years is very short-term. As you move out to five-year maturities, five to seven years, five to 10 years, you get into intermediate, and long-term is beyond 10 years in maturity. So just to define those ranges. So first reason you might consider it is these are good yields. I mean, we haven't seen yields in this vicinity for about 15 years. 

It's especially true for people in retirement or going into retirement who are looking to build in that income component. And you're getting that in high-quality bonds, whether it's in Treasuries, roughly 5%-ish or so. You go into investment-grade corporate bonds, close to 6% and above. And municipal bonds on an after-tax basis is also very attractive. So we want to take the opportunity, I think, for many investors, to lock in some of these yields for the future.

The second is there's reinvestment risk. If you stay in cash or very short-term maturities, and rates do start to fall, you're going to be rolling over those maturities into lower rates. So, with the Fed tightening, it's likely that interest rates will fall in the future. Timing the market is really hard to do. I know there's a temptation to wait until you believe rates have peaked and then start to invest. But just like the stock market, it's really hard to time the market. The market tends to try to discount the future. So you're implicitly, if you're sitting very short-term right now, you're implicitly saying you can time the market. I think the third reason and the last reason I'll cite is just the risk-reward from here is much better now that yields are higher if you move out into intermediate-term or long-term bonds. So if you're worried about prices moving down as yields move up, note that it takes a lot more of an increase in interest rates to reduce your total return when you're getting a coupon of 5% than when coupons were 1% or lower. In other words, total return you get from a bond is the income stream plus or minus the price change. Well, right now, what you're getting is a lot more in the way of the income stream. That typically is the biggest component of your total return. And with that income stream being higher than it has been for the last decade or so, the chances of actually having a negative return are much lower. So it's skewed to the upside. That's not to say to run out and buy all 30-year bonds, but we do think having some bonds with maturities in that five- to 10-year area can make a lot of sense for investors.

SPEAKER 8: What are your latest thoughts on the economic implications of high government debt?

LIZ ANN: Yeah, so in general, we've written and spoken about this a lot over the years. If you take a really long-term look, and not just United States-specific, but much of the developed world, a high-and-rising burden of debt tends to correspond with lower economic growth rates, and the various components tend to move along with that. Now there are exceptions there, but that's one longer-term implication. More specific to what we're dealing with here, of course, is that we now have a debt burden just at the federal government level of about $33 trillion. There's more than 100% of U.S. GDP, and no sense that that's going to start falling because of higher deficits. And now with interest rates having done what they've done, both on the short end courtesy of the Fed and then more recently what's happened in the longer-term Treasury yield area, the cost of servicing that debt has gone up quite significantly. Now, we have lots of experiences over the years and decades and centuries with debt crises that have erupted, certainly recently in 2008 with the mortgage bust, and we've had crises on the consumer side of things, on the commercial side of things, on the corporate side of things.

But here is a situation where more acutely we're dealing with excess borrowing that has been undertaken by the actual U.S. government. And it's hard to judge, is there some sort of tipping point? We can look back in history, and when the interest burden and the cost of servicing debt has jumped to about 14% of tax revenues. That historically has been a point where some combination of the conversation being more frequent and the groans louder, versions of austerity kicking in, constituents caring more about it and maybe at least attempting to demand answers from politicians.

So we may be at one of those critical points because we did just hit that 14% level. So I do think it's going to be a larger part of the conversation. And then finally, the other issue of course, is that when you have high deficits and a high rise in burden of debt, you've got the necessity of the Treasury issuing more debt. And why it's particularly important to think about that now is, because we have a Federal Reserve that's gone from being in quantitative-easing mode and being a huge, the number one buyer of Treasuries, while they were doing quantitative easing, and they were a price-insensitive buyer.

But now that they are doing quantitative tightening, they are shrinking the balance sheet in terms of Treasuries to the tune of $60 billion a month. So we have lost that powerful, price-insensitive buyer in the name of the Fed.

SPEAKER 9: There is a lot of concern that increasing deficits means the Treasury will have to issue a lot more bonds. Who's going to buy all those bonds?

KATHY: Well, as Liz Ann mentioned, the increasing size of the Treasury auctions has really captured a lot of attention recently because of the rising deficit. But there are buyers. So we haven't had any failed auctions. We haven't had any auctions where the Treasury put some bonds out there, and nobody showed up. So it's more a question of at what yield will the market clear the debt.

And so, as Liz Ann mentioned, with the Fed stepping back from its bond-buying program under quantitative easing, that gap has to be filled, the amount that the Fed was buying. We haven't had a significant problem attracting buyers, though. Despite some of the headline reports to the contrary, foreign buying has been pretty steady. So foreign holdings for reserve purposes or for other purposes has pretty much run at a steady level.

But the real shift that we're seeing is in households. So household, individual investors, mutual funds, because individual investors often buy Treasuries through mutual funds, they have stepped in to fill the gap. And that signals to me, at least for the time being, that yields in the 5% region for Treasuries are high enough to attract individuals and mutual funds. So, you know, evidence suggests that we're finding buyers. There always will be some buyer. It's a question about what yield. Right now, it looks like 5%-ish is a pretty good yield for filling that gap.

LIZ ANN: So now let's focus on where things seem to be headed for next week. Kathy, what's on your radar for the coming week?

KATHY: Well, usually we get a little bit of a break from the big numbers in the second week of the month. So I'm looking forward to actually having less news. But we will likely get a stream of people from the Fed speaking now that the meeting is over and the quiet period has ended. So that's going to be interesting. It's where they reiterate the message that they're trying to send. And then in addition, I think, Liz Ann, retail sales, usually important. And this time around, because consumer spending has been pretty healthy, that's probably going to be something that affects the market.

And so that's where we are this Friday. What about you, Liz Ann? This has been a big week for economic news. What are you going to be watching for next week?

LIZ ANN: Well, obviously, many of the same things you are, Kathy. In addition, some of the data coming out is around consumer credit. I think these days, that's important to get a broader sense of the health of the consumer. I think mortgage applications are coming out. Obviously, that is a gauge of the impact of higher yields on the housing market. We've got wholesale sales and inventories, and that's typically a component that's part of the calculus of the NBER in recessions. I think increasingly weekly unemployment claims are important for obvious reasons, but they're a leading labor-market indicator. And then we get the University of Michigan data, which includes consumer sentiment, it includes inflation expectations. So that typically has a lot of nuggets in it. And then we'll also get the monthly budget statement, which I think many times no one pays much attention to that, but probably a report that maybe is going to garner a bit more attention than it has in the past.

So that's what the two of us are going to be looking out for next week.

So as always, thanks for listening, and be sure to follow us for free in your favorite podcast app. And if you've enjoyed this episode, tell a friend about the show. And if you want to keep up with the charts and data that we post in real time, the best way to do that is follow us both on Twitter (X) or LinkedIn. And for me, my handle is @LizAnnSonders. There's no E at the end of Ann, and Sonders is S-O-N-D-E-R-S both on Twitter and LinkedIn, and in case of Twitter or X make sure you're following the real me because I've had a rash of imposters recently.

KATHY: And I'm Kathy Jones—that's @KathyJones on X, Kathy with a K, and also on LinkedIn. On next week's show, we'll be joined by Mike Townsend, host of Schwab's WashingtonWise podcast.

MIKE TOWNSEND: Hi, I'm Mike Townsend, Schwab's managing director of legislative and regulatory affairs and host of the WashingtonWise podcast. Next week I'll be joining Kathy and Liz Ann to discuss what's going on in Washington. We'll talk about the likelihood of a government shutdown, what's happening with the House of Representatives, and much more.

In the meantime, you can listen to the latest episodes of WashingtonWise at Schwab.com/WashingtonWise or wherever you get your podcasts.

KATHY: For important disclosures, see the show notes or visit Schwab.com/OnInvesting, where you can also find the transcript.

Peter Bergen: It was in the middle of the night in a mud hut in Afghanistan, which was then controlled by the Taliban. It was March of '97, so it was cold.

Katy Milkman: This is Peter.

Peter Bergen: I'm Peter Bergen.

Katy Milkman: Peter is an author and journalist, best known as a national security analyst on CNN. In March of 1997, Peter sat down for an interview with a man who would forever alter the course of American history.

Peter Bergen: He appeared out of the darkness and sat down and did the interview and basically declared war on the United States.

Katy Milkman: Peter had his suspicions that Osama bin Laden had planned the 1993 bombing of the World Trade Center in New York. By September 11th of 2001, bin Laden's involvement was no longer in question.

Speaker 3: Oh, my God. Another plane has just hit another building.

Speaker 4: You are looking at live pictures of what appears to be an attack on the Pentagon.

Speaker 5: Osama bin Laden, according to this newspaper editor, warned three weeks ago that he would attack American interests and …

Speaker 6: All the indicators do seem to point to Osama bin Laden being responsible for this attack.

George W. Bush: Osama bin Laden and other terrorists are still in hiding. Our message to them is clear, no matter how long it takes, America will find you, and we will bring you to justice.

Katy Milkman: After 9/11, a date that now haunts every American, bin Laden became the most wanted man in the world, and for good reason. But he proved incredibly elusive. The full force of U.S. military and intelligence was deployed in the hunt for this terrorist leader, and he was tracked to the mountain caves of Tora Bora in Afghanistan, but somehow he managed to escape; and then the trail went cold.

In this episode, we'll share the story of an incredibly difficult prediction made during the hunt for bin Laden and some key lessons from behavioral science about forecasting that you can apply to your own decisions.

I'm Dr. Katy Milkman, and this is Choiceology, an original podcast from Charles Schwab. It's a show about the psychology and economics behind our decisions. We bring you true stories of high-stakes decisions, and then we examine how these stories connect to the latest research in behavioral science. We do it all to help you make better judgements and avoid costly mistakes.

Peter Bergen: The CIA was a lead on finding bin Laden. They realized by 2005 there was no single person who was going to lead them to bin Laden who was in American detention or in detention of a foreign country. They got a lot of false leads—bin Laden is in Rio de Janeiro or bin Laden is here—and all of these were nonsense as it turns out, but all of them had to be chased down.

Katy Milkman: After four years of searching, the top U.S. intelligence agency was no closer to apprehending the mastermind behind the September 11th attacks than when they'd started. The CIA would have to change its approach.

Peter Bergen: They realized they're not going to find bin Laden directly. They're going to have to find him with a bank shot, to use a pool term.

Katy Milkman: That bank shot was to focus on the courier network that relayed messages to and from bin Laden.

Peter Bergen: The intelligence world is dealing with imperfect information, fragmentary information, you're trying to put things together.

Katy Milkman: One fragment of information led to an Al-Qaeda operative who had recently rejoined the network as a driver in the Pakistani city of Peshawar. Intelligence agents picked up that he was driving a white Jeep.

Peter Bergen: They followed the Jeep to the city of Abbottabad, which is a very sleepy city in Pakistan, and he drives into a compound with one large house, one small house, and set on about an acre of property. That compound was surrounded by 20-foot walls, and the inhabitants are burning trash. There're not connected to the internet. They don't have a phone system. Kind of a strange thing for somebody that clearly has some money.

At that point, the people who are looking for bin Laden brief the director of the CIA, which is Leon Panetta.

Leon Panetta: I'm Leon Panetta, former director of the CIA. I had established a task force at the CIA to basically focus on whatever evidence might tell us where bin Laden was located.

Katy Milkman: The evidence that bin Laden might be in Abbottabad was thin. But there were several clues that something was quite suspicious about this particular compound.

Leon Panetta: We identified a family that was living on the third floor that never came out, always stayed within the compound. And we soon found out that in order to make a phone call, the couriers would go 90 miles away from this compound. So they were exercising very high security. So that's what gave us the best evidence that perhaps bin Laden might be located there.

Katy Milkman: Director Panetta briefed the president on this lead in August of 2010.

Leon Panetta: When I reported what we had found to the president, he said obviously what we needed to do was to conduct surveillance on the compound to try to determine if bin Laden was actually there.

Katy Milkman: But surveillance was difficult for a number of reasons, including the high walls around the compound. The only views they had were from satellites, and those images were largely inconclusive. But there was one tantalizing piece of visual evidence.

Leon Panetta: There was one moment when we were able to see somebody who was a little older come out into the yard of that compound and walk in circles. This happened usually each day, would come out, walk in circles, and go back into the compound like a prisoner in a prison yard.

Peter Bergen: The pacer would pace around this garden, but he was wearing a cowboy hat and he was pacing underneath trellises. There was no overhead imagery that showed that this was bin Laden.

Leon Panetta: So at that point I said to the CIA team, "That could be bin Laden. Can you get me a telescope or get me a camera or something close to see if we could get a facial ID on that individual?"

And they said it was very difficult to do because of the walls on all sides. I remember saying at the time, "I've seen movies where the CIA could do this," and we laughed about that. But we were still unable to really get a facial ID.

Peter Bergen: At one point, Leon Panetta said, "Well, let's measure his shadow since we know he's six foot four." And the analyst from the National Geospatial Agency came back and said, "Well, he's between five foot four and six foot eight." Well, it's not a particularly useful piece of information.

Katy Milkman: So there was no photo confirming their suspicions, and there were plausible alternative explanations for the behavior of the people in the compound.

Peter Bergen: This was a drug trafficker. This was somebody in Al Qaeda who had retired. This was somebody who just wanted to keep a low profile, so there were other explanations. Nobody could say for sure that he was there. It was an entirely circumstantial case.

Katy Milkman: Despite the lack of concrete evidence of bin Laden's location, the compound in Pakistan was the best lead they had. By this point, it had been nearly 10 years since 9/11. The pressure was on to take action. But the CIA was still chastened by intelligence failures in Iraq.

Peter Bergen: The CIA had taken a huge hit off the weapons of mass destruction fiasco in Iraq, which was built on a circumstantial case that Saddam had weapons of mass destruction. Well, turned out to be 100% wrong.

Katy Milkman: Intelligence and military leaders faced a high-stakes decision in the face of inconclusive evidence.

Peter Bergen: At a certain point, there's no more information to provide. It becomes a political question about what to do with the information. There was, first of all, elaborate discussions of what was the evidence of if bin Laden was there.

Leon Panetta: At one point I asked the key people at the CIA to come to my office, and I had my chief of staff there as well as my deputy, and I just basically asked all of them, "What do you think? You know what the evidence is. You know what we've been looking at. What is your best advice here as to whether or not we should conduct a mission?"

Peter Bergen: But then it became more of a, "Well, OK. We don't know if he's there, but we should maybe have a plan to do something about it," and there were a bunch of ideas on the table.

Leon Panetta: I called Admiral Bill McRaven, who was head of special forces. By that time we had done a model of the compound, showed him that model. I asked him to come up with several options. He did.

Peter Bergen: B-52 bombing raid, launch an experimental drone, gather more intelligence, do a joint operation with the Pakistanis.

Katy Milkman: All of these proposals were fraught. Bombs might cause collateral damage and destroy evidence of success. The experimental drone had never been used in this type of operation and might fail. A joint operation with Pakistan might risk tipping off the target.

Peter Bergen: A bunch of things that could go wrong, there could be dangers if SEALs did a ground operation. People could be killed, captured. Bin Laden might not be there. We'd completely blow up our relations with the Pakistanis.

Katy Milkman: The discussion was becoming one around whether or not to proceed at all. The decision hinged on everyone's level of confidence that bin Laden was actually at the compound.

Leon Panetta: Interestingly enough, it varied. Some thought 60% that we should go ahead. Some were below 50%, thought it was too risky of an operation. And there were a couple people who felt very strongly that bin Laden was there. I remember one analyst saying, "I think it's 90% that bin Laden is there."

So it varied a great deal, but they all gave their opinions. And based on their input, I ultimately had to make up my own mind as to whether or not I would recommend to the president whether we should proceed with the mission.

Katy Milkman: In addition to considering the varied opinions, there was also a concerted effort to interrogate important intelligence to rule out alternative explanations.

Leon Panetta: We did some red team stuff where we looked at other possibilities.

Peter Bergen: After the Iraqi weapons of mass destruction fiasco that the CIA was deeply involved in, in 2003, they set up these red teams to kick the tires of any circumstantial case or any big kind of intelligence question. They would always red team it and say, "What are the alternative explanations for the same set of facts that we have?" so that we're not just all drinking our own bath water and all agreeing that we're right.

Katy Milkman: With potential alternative explanations explored and the limited evidence thoroughly analyzed, it came time to make a decision.

Leon Panetta: Ultimately, it came down to a meeting of the National Security Council to determine whether or not we would go ahead with that operation.

Peter Bergen: The last meeting was on April 28th, 2011.

Leon Panetta: A number of key people at the National Security Council meeting, the vice president, secretary of state, secretary of defense, head of the CIA, director of national intelligence, chairman of the Joint Chiefs of Staff, and a number of others.

Peter Bergen: These meetings were conducted in a very high level of secrecy. It's a big, relatively big corporate-style conference room. There are clocks on the walls. So Kabul, Afghanistan; Baghdad, Iraq; Washington D.C.

Leon Panetta: And the president went around the room.

Katy Milkman: Like the CIA analysts, members of the National Security Council had very different levels of confidence around what should be done.

Leon Panetta: The vice president thought we needed to gather more intelligence and thought we needed to have a little more time to be able to verify if it was bin Laden. The secretary of state recommended that we should go. Bob Gates, who was secretary of defense, was concerned, and there were others that had just shared the same concern. They thought back to when the helicopters went down during the Carter administration going after people who'd been locked up from the embassy there.

Jimmy Carter: Late yesterday, I canceled a carefully planned operation. Equipment failure in the rescue helicopters made it necessary to end the mission. Two of our American aircraft collided on the ground.

Katy Milkman: Operation Eagle Claw was a failed attempt to rescue 52 people held captive at the U.S. Embassy in Tehran on April 24th, 1980. Eight U.S. servicemen were killed. A helicopter and a transport aircraft were destroyed. It was the type of scenario that the National Security Council desperately wanted to avoid. Despite that history, the president was increasingly leaning towards a ground operation.

Peter Bergen: There's some important reasons for that. One, you could prove to yourself that you had actually captured or killed bin Laden. If you do … drop a big bomb, you can't. If you do the drone strike, you can't. Two, you might gather a lot of intelligence from the site.

Leon Panetta: The chairman of the Joint Chiefs, the director of national intelligence, myself, obviously all recommended that the president proceed with the mission. The national security advisor made the same recommendation.

Peter Bergen: President Obama went around the table, he listened, he just wanted to hear what everybody had to say. It wasn't a vote. He was asking for advice.

Leon Panetta: I said, "Mr. President, when I was in Congress and I faced a tough decision, I would pretend that I was talking to an average citizen in my district and saying if you knew what I knew, what would you do?" And I said, "If I told the average citizen in my district that we had the best evidence on the location of bin Laden since Tora Bora, I think that citizen would say we have to go. And that's what I'm recommending to you."

So in the end, to the president's credit, he let everybody say their piece, and then, as always, it comes down to the decision by the president. The president took it all in and spent that evening thinking what his decision would be.

Peter Bergen: President Obama went to his private office in his residence at the White House and sat up pretty late and thought about the victims of 9/11. Thought about what the United States knew about this situation. He came down the following morning at 8:30 a.m., met with his national security team.

Leon Panetta: I got a call from the national security advisor, who told me that the president had decided to go with the mission. It was a gutsy decision, because there's no question it was risky, and there was no question that we did not have 100% confirmation that bin Laden was there.

If something happened, if the helicopters went down, if bin Laden was not there, we would have to accept responsibility, and there would be repercussions as a result of that.

Katy Milkman: A decision was made. A team of Navy SEALs, SEAL Team Six, would fly by Black Hawk helicopter, under cover of darkness, about 120 miles into Pakistan from Afghanistan to raid the compound in Abbottabad.

Leon Panetta: The directions I gave to Bill McRaven, I said, "I want you to go in, get bin Laden, and get out of there. And if you go in and you can't find bin Laden, get out." That was the direction.

So a lot of risks, a lot of risks. But at the same time, probably the most important covert mission we had ever undertaken.

I went to Mass on Sunday morning and prayed a lot. When I got to CIA headquarters, and we were running the operation out of the CIA, I really felt pretty confident that we were doing the right thing.

Katy Milkman: On May 2nd of 2011, SEAL Team Six took off from their base in Afghanistan at approximately 10:30 p.m. local time. Operation Neptune Spear had begun.

Leon Panetta: When you're going through the operation, and when we were following the SEALs into Pakistan, you're very consumed by the moment and wanting to make sure that the mission is going right.

But I have to tell you, when one of the helicopters got above the compound, because it was hot that day, the air came up and stalled the engine, and the warrant officer who was in charge of that helicopter had to settle it down with a tail up on one wall. And it's one of those moments where your stomach is in your mouth because you know some of the worst concerns about what could happen.

And I remember asking Bill McRaven, "What's going on?" I think I said, "What the hell's going on?" And he didn't miss a beat. He said, "Helicopter's down, but everybody's OK. They're going to continue with the mission. They're going to breach through the walls, and they're going to continue to go after bin Laden." And I remember saying to him, "God bless you. Let's do it." And he did. Again, another very important decision that had to be made in order to complete the mission.

We heard gunfire, which meant that they incurred some resistance. They then turned to go into the compound itself and go after bin Laden. And it was about 20 minutes of silence, the longest 20 minutes of my life, where you really didn't know what was happening.

And it was at the end of that 20 minutes that Bill McRaven came back on and said, "I think we have Geronimo," which was the code word for finding bin Laden. And it was at that moment where all of us in headquarters embraced one another knowing that all of the information, all of the intelligence, all of the work on the mission had proven right.

The trip back was another hour and a half, but they finally, finally landed, and that was the moment when we really were relieved that the mission had been successful.

Barrack Obama: Tonight, I can report to the American people and to the world that the United States has conducted an operation that killed Osama bin Laden, the leader of Al-Qaeda, and a terrorist who's responsible for the murder of thousands of innocent men, women, and children.

Leon Panetta: And it was a real source of pride that we had accomplished something special and that the world was safer as a result of what we had done. I also thought about the victims of 9/11, those who had died and their families, and thought we were finally delivering justice to those families who lost loved ones.

I often say that leadership requires that you have to take risks. If leaders were always facing decisions that were 100%, it would be an easy job. But there are many decisions that involve questions as to whether it's the right or the wrong step. And you've got to decide whether you think there's enough evidence to justify that kind of operation and weigh the risks that are involved. That's why we elect presidents, is to ultimately make that kind of decision. And the president, to his credit, not only made a gutsy decision, he made the right decision.

Katy Milkman: Leon Panetta is the former director of the CIA. He has also been the secretary of defense, the chief of staff to the president, and a member of Congress. More recently, he's the author of Worthy Fights: A Memoir of Leadership in War and Peace.

Peter Bergen is a journalist and producer who is CNN's national security analyst. He's the author of several books, including Manhunt: The Ten-Year Search for Bin Laden From 9/11 to Abbottabad. His most recent book is called The Rise and Fall of Osama bin Laden. You can find links in the show notes and at schwab.com/podcast.

We all grapple with a degree of uncertainty when we make predictions, like how long it will take to complete a project, or what will happen with the stock market this year, or what will the weather be like on Thursday?

In the case of intelligence analyst predictions about whether or not bin Laden was present at the compound in Pakistan, you could argue that they just got lucky, and it's very easy to see how the raid could have turned out quite differently. But the officials involved in the decision to proceed employed a number of strategies and techniques that improved their chances of success.

They worked in groups comprised of highly experienced, enormously qualified analysts. They used red teaming, essentially playing devil's advocate, to interrogate ideas and find errors in their thinking. Conflicting opinions were encouraged and considered. And the range of probabilities from different intelligence analysts were articulated and combined, increasing the likelihood of an accurate prediction.

My next guest has done incredibly important research in the field of forecasting, and she co-designed an elaborate multi-year study involving tournaments where participants were randomly assigned to face different forecasting conditions and then have their forecasting abilities put to the test.

The study was done to determine what conditions lead to the best forecasts. Barbara Mellers is my colleague at the University of Pennsylvania, and she is the I. George Heyman University Professor of both marketing at the Wharton School and of psychology at the School of Arts and Sciences.

Hi, Barb. Thank you so much for taking the time to talk to me today.

Barbara Mellers: Hi, Katie. It's great to be here.

Katy Milkman: I am really excited to get into some of your research on psychological strategies for becoming a better forecaster. And I wanted to start by asking you to define a few strategies that your work has proven can add huge value before talking about the research where you tested the impact of each of these techniques. So first, could I ask you to talk about probability training? What is that exactly?

Barbara Mellers: Probability training. We created an interactive module for people that lasted about 45 minutes, and it essentially gave them a lot of tips. We didn't teach them much in the way of mathematics, but we told them about how to look for professional forecasts on the internet, if they find multiple forecasts, average them. There are a handful of cognitive biases that are important when it comes to forecasting, and those include overconfidence and base rate neglect and probably the confirmation bias.

Katy Milkman: We've done previous shows about two of those topics.

Barbara Mellers: OK. All right.

Katy Milkman: Some of our listeners will be familiar with them.

Barbara Mellers: Great. Forecasters who were assigned to the condition with probability training had to do that training module prior to making any forecasts.

Katy Milkman: OK. So could you also tell us a bit about teaming? What does that look like?

Barbara Mellers: Teaming was an intervention in which we placed people together in virtual teams that consisted of, say, 15 people or fewer. And they worked together on a website, but they weren't in the same room.

Katy Milkman: Great. And then what is tracking, and what does it mean in the context of trying to achieve great forecasting results?

Barbara Mellers: Well, tracking is well known in the educational context where we talk about putting kids with similar abilities in the same classrooms. And that's all good if the kids have high abilities; it's controversial when they don't.

We decided to put forecasters together, those who had the top 2% in terms of forecasting accuracy. We placed them into teams of 10 or 15 people and allowed them to work together because we had already learned that teaming works. Tracking means being elitist about who works together and allowing a very enriched environment for those who do extremely well.

Katy Milkman: That's really interesting. OK. Thank you for defining those different techniques, and I would love it if you could talk a bit now about your research evaluating the effects of these different techniques on people's forecasting ability. Could you describe how you put together this really incredible tournament and how you assessed the benefits of probability training, teaming, and tracking?

Barbara Mellers: We were one of five research groups that were funded by IARPA, which is the Intelligence Advanced Research Projects Activity, sort of the little sister to DARPA, the research funding area. And we had a variety of people who worked with us, computer scientists, economists, political scientists, psychologists, and you name it, statisticians. And when we read the literature about how to improve human forecasting, we had no idea what the best method would be.

So our group decided to run experiments, which is the thing we do that comes naturally. And we recruited a lot of people and then randomly assigned them to conditions in which they either got a training module on probabilistic reasoning or did not get one. And we did that with teaming as well. We had people who worked independently, we had people who worked in groups, and then eventually after the first year of the tournament, we decided to take this elitist approach and put the best forecasters together, and that was not randomly assigned. We took the top 2% from each of our conditions and put them together in teams and allowed them to work with each other.

Katy Milkman: Could you talk a little bit about what the forecasting activities were that you had people doing over this sort of two-year experiment?

Barbara Mellers: Actually, it was four years. This paper just talks about the first two years. So we replicated things four times, believe it or not. Some of the questions—I was just looking back at them—one of them was about whether Berlusconi would be elected by a particular date. Would he be the leader of Italy? Would Putin be elected in Russia in 2012? Believe it or not, there was actually uncertainty about that at the time among a number of people. Would there be an international incident in the South China Sea?

Katy Milkman: There were basically all …

Barbara Mellers: Geopolitical.

Katy Milkman: Geopolitical events, and were people doing this weekly or monthly, and were they doing dozens or hundreds of forecasts?

Barbara Mellers: Well, each year there were roughly 100 plus questions that we launched, and we launched a few of them each week. They were questions of interest to the intelligence community, economic questions, "What will the price of Brent crude be?" "Will a particular UN decision go through?"

So they were all over the map, and we gave people feedback after each question was resolved. People jumped on the website, made forecasts about as many questions as they wanted to throughout the course of nine months. And these nine-month tournaments occurred during four years, so we could fine tune what we'd learned the previous year and test it further and build on it and so forth.

Katy Milkman: I love this experiment and I really appreciate you describing it. It's so creative and important. I would love it if you could talk a little bit about the key things that you found worked and why you think they added so much value to forecasting quality.

Barbara Mellers: It is effective to give people simple training modules that don't require too much in the way of mathematical knowledge or statistical knowledge. They benefit from tips. It's also useful in this kind of situation to allow people to work in teams where they can share knowledge, point each other to different articles, motivate each other when someone's not talking, and correct each other's errors. And that was more beneficial than working alone.

Now, the rationale for working alone is statistical. You can obtain independent forecasts and average them, and then the idea is that the errors will average out and you'll get a better estimate of the true score or the best forecast. And allowing people to talk and work together proved to be far more beneficial than allowing them to have independent errors.

Katy Milkman: It's really interesting, and it does contradict a lot of things we thought we knew about the importance of independent evaluation, and of course you have to worry about things like groupthink, people becoming echo chambers …

Barbara Mellers: Herding.

Katy Milkman: Yeah.

Barbara Mellers: Yes, social loafing.

Katy Milkman: But it's really interesting that here you find this benefit from teaming that's so clear. And what about tracking?

Barbara Mellers: Tracking was, most surprisingly, it was the best intervention by far. It was sort of like putting forecasters on steroids. Once they worked together, they were really interested in helping each other and providing articles and knowledge and tracking down esoteric kinds of information on the internet. And then they debated. And we monitored what … their interactions, and they were much more likely to ask each other questions than regular teams. They were much more likely to answer questions that people had asked, and they were much more likely to express gratitude for the interaction and sharing and saying thank you and so forth.

So they actually became really good friends, and there are actually, believe it or not, 10 years later, there are still groups of superforecasters getting together each month to talk about political affairs and so forth in San Francisco and New York and Washington D.C., in Los Angeles and so forth.

Katy Milkman: That is so interesting. And so the teaming intervention is great, but when you team up these top performers, that's when absolutely incredible things started to happen.

Barbara Mellers: Yeah, right.

Katy Milkman: How do you apply what you've learned about superforecasting in your life?

Barbara Mellers: Ah, yes. I am very aware of how poorly I make forecasts. I am bad when it comes to planning. How much time will something take? Planning fallacy, of course. I am bad at predicting how much I'm going to like a movie or a book or whatever, and I have learned to change my mind. I've learned to say, have a three-episode rule for a TV series. Look at it three times and then reject it.

I think just very simple lessons have pervaded my life about the importance of base rates and taking the outside view and not being overwhelmed with all of the details of, say, the Ukrainian war or Chinese interventions in Taiwan or whatever it is.

Katy Milkman: Are there important mistakes that you think people ever make when they're trying to apply the key findings from your research to make better forecasts in their own lives or in their organizations? What do people get wrong?

Barbara Mellers: Well, I think that there's two things that people don't do that they should be doing much more often than what occurs. And one is to actually make forecasts. We don't really put ourselves out on the line and make a numerical prediction very often. We say, "Oh, it's likely, or it's unlikely," and that vague verbiage lets us get out of lots of tricky situations that may not end the way we want them to.

Second, we need to keep records so that we can start to learn how good we are at forecasting, and where we're bad, where we could learn something, where we're pretty solid.

Katy Milkman: If you could leave our listeners with a key suggestion about what they might want to do differently in their own lives, especially now that they know about your findings on probability training and teaming and tracking, what suggestion would you offer them?

Barbara Mellers: I'd say the best way to become a better forecaster is to practice, and there's no better way to do that than to write down forecasts. But force yourself to predictions of events that are resolvable, that you don't need a lawyer to determine what happened. And then start seeing where your skills are, where you might need help.

In businesses there's a company spun out from this particular intelligence forecasting tournament. It's called Good Judgment Inc., and it does consulting and helps financial institutions with forecasts and so forth. So there are places that help people become better forecasters as well. But just testing yourself, making forecasts, keeping track, getting records, and seeing how well you do.

Katy Milkman: So you can learn from the good and the bad.

Barbara Mellers: And the ugly. Yes. Right.

Katy Milkman: Yes. Barb, thank you so much for taking the time to do this. I really appreciate it, and I learned so much.

Barbara Mellers: Thank you, Katy. It was fun.

Katy Milkman: Barbara Mellers is the I. George Heyman University Professor at the University of Pennsylvania, where I also work. Barb is jointly appointed as a professor of marketing at the Wharton School and as a professor of psychology at the School of Arts and Sciences. You can find links to her research on forecasting in the show notes and at schwab.com/podcast.

Forecasting is an unusual activity because the uncertainty inherent in it means that even the world's best forecasters are often wrong. Barb's work with her partner and Penn faculty colleague Phil Tetlock has revolutionized our understanding of what it takes to generate what they call superforecasters.

Simple probability training can add tremendous value. A key ingredient in that training is to encourage people to look at relevant reference points when making estimates, like looking at the price of other houses that have recently sold in your neighborhood if you're forecasting the sale price of your own home.

Another key ingredient is to teach people to first search for and then average independent forecasts made by others. Like, the price estimates offered by several different Realtors who have all expressed an interest in listing your house. These are simple steps we can all take to make better forecasts.

When you're forecasting how long it will take to refinish your basement, your forecast shouldn't be made in a vacuum. First, collect relevant data points. How long did it take other people to do similar projects? Maybe your project is quite unique, but those reference points will still be useful. You can collect multiple independent forecasts from people with decent knowledge of the building business too and average them together.

Do you need to do this kind of research to make every forecast in your life, like whether it will rain tomorrow or what TV show you'll like most in the year ahead? That probably wouldn't be a great use of time, but for big decisions, it's a great idea.

You might also pick up a copy of Superforecasting: The Art and Science of Prediction, a terrific book on this topic that was co-authored by Barb's partner and collaborator Phil Tetlock and the journalist Dan Gardner.

You've been listening to Choiceology, an original podcast from Charles Schwab. If you've enjoyed the show, we'd be really grateful if you'd leave us a review on Apple Podcasts, a rating on Spotify, or feedback wherever you listen.

You can also follow us for free in your favorite podcasting app. And if you want more of the kinds of insights we bring you on Choiceology about how to improve your decisions, you can order my book, How to Change, or sign up for my monthly newsletter, Milkman Delivers, at katymilkman.com/newsletter.

That's it for this season, but we'll have new episodes for you in late summer. In the meantime, check out the growing catalog of Choiceology episodes in our archive, or follow some of Schwab's other great podcasts, including Financial Decoder and WashingtonWise. I'm Dr. Katy Milkman. Talk to you soon.

Speaker 12: For important disclosures, see the show notes, or visit schwab.com/podcast.

BOB DILAURA: And that phone call—it still rings in my mind, and I'm still chilled when I think about it. It literally changed our lives from that moment forward.

MARK RIEPE: Meet Bob.

BOB: This is Bob Dilaura. I'm in Castle Rock, Colorado.

MARK: Bob is a Chartered Special Needs Consultant, and he works with us here at Schwab—and he's had an interesting life. In this episode, we'll hear Bob's story and some key lessons about planning for the worst that you can apply to your own life.

I'm Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.

And today's episode touches on the deepest emotions.

Bob grew up in Michigan.

BOB: I was born and raised in Detroit, literally born and raised. And my first job, even right out of high school, was working in the factory at Ford Motor Company, and my dad thought I was a big success in life.

I was working on the assembly line at Ford Motor Company, and the guy working across from me said, "Hey, isn't this great?" And I said, "Hey, how long have you worked here?" He said, "30 years." I said, "And what did you do here?" And he said, "I worked here for 30 years on the assembly line in the same job for 30 years," and my brain kind of exploded, and I said, "This cannot be what life is all about."

MARK: Bob left the factory life behind and got a science degree from Michigan State University.

BOB: I worked for years there in Michigan, and then eventually moving down to Texas. I was actually a polymer chemist, and that's where I started to cut my teeth and working, working, working after I graduated from college, which I thought was great. Now I'm all set in life. And then I realized there was still more stuff to do in life.

So I ended up, when I was living in Texas outside of Dallas, I went to the University of Dallas and got a master's degree in international business.

MARK: Bob's wife was from Colorado, so they ended up moving there and starting a family.

BOB: Our kids were growing until you know—we were getting them through school—until the graduation day of kindergarten for our youngest, who was around six years old at that time, when we got the phone call.

So our son's graduation from kindergarten, and it's the frantic phone call. "Oh my gosh. Oh my gosh. Something happened. Oh my gosh." And it was that our son was involved in an accident where he had a head injury.

MARK: This was the day that would change Bob's family forever. He and his wife needed to rapidly try to make sense of what had happened and what the future might hold. This is complicated at the best of times, but Bob was also in the midst of finishing a doctorate in artificial intelligence.

BOB: And so while our son had this accident, went into the hospital, I was literally finishing my dissertation in his hospital room as he was getting taken care of.

Some people describe, you know, when you face this kind of shock of a disability from an accident because, you know, disabilities can come from a lot of different directions. In this case, it's almost that reaction of disbelief, and you can say, "This isn't possible. This can't be happening." I remember saying that.

MARK: But of course, it was happening. Bob and his wife spent two months living in the hospital while their son was unconscious and slowly recovering.

BOB: And I remember one night in the hospital talking with my wife and just saying, "You know, look, this is, this is, I can't imagine what, what has just happened to us. But you know, either you let something like this just crush you or it's a gut check," and that was the conversation we had one night, about a month in, and I said, "Somehow, I don't know how, but we're going to hold this in a positive light. I'm not going to hold this experience negatively. Somehow we'll figure out how to take care of our son and take care of our own lives."

MARK: To make matters worse, this was at the height of the dot-com bubble bursting. Bob lost his technology job and his shot at a lucrative IPO. So he was also looking around for a new career.

BOB: I ended up, because I was a process engineer in my earlier years, helping companies to make improvements. After living in the hospital for two months with our son, I started to notice the doctors, the nurses, the labs, they didn't work very efficiently together, and so I started to make recommendations to them.

MARK: The recommendations weren't exactly well-received at first, but he persisted.

Even at one point, my wife was just rolling her eyes. I made a flow chart of how things were working every day for us and how it was very inefficient.

And literally it ended up, when we left, we had met enough doctors and nurses and hospital staff, they ended up—knowing I was unemployed—they offered me a job. And that was a career change.

They brought me on board to help them improve their technology processes for clinical research at Children's Hospital of Denver. I became the head of technology in pediatric clinical research. Go figure out how can that possibly happen.

MARK: Bob ended up working as a very senior technology leader for hospitals across the United States before he shifted to a role in financial services. And today we're going to be speaking with him in depth about what happens if your family is affected by a disability, and what are some of the financial options that can help.

So this episode isn't about an emotional bias per se, but rather a look at some of the financial protections you should be putting in place now for yourself or if you are taking care of someone with a disability.

This could be a child, partner, sibling, parent, grandchild, friend—or it could be you. In fact, people with disabilities aren't as rare as you might think. According to the Annual Report on People with Disabilities in America for 2023, an estimated 13.5% of the population have disabilities.

And this experience in life can be overwhelming. The powerful emotional toll is obvious, but an event like this opens up a door to all kinds of specialized financial tools, which can be helpful if you know they exist and how to use them.

In addition, the financial costs are complex and highly variable. Minimum estimates put the cost to raise a disabled child to age 17 at $233,000. However, the National Autism Organization puts that estimate at closer to between $1.4 and $2.4 million over a lifetime, either out-of-pocket or through various insurance and federal/state programs.

Not surprisingly, the more severe the disability, the higher the cost. The National Disability Institute estimates it takes 28% more income to obtain the same standard of living as a household with no disability. This works out to be, on average, an additional $17,690 per year.

The good news is that Bob Dilaura is here to help make sense of all this.

Bob is a senior financial planner at Schwab and is a Chartered Special Needs Consultant from the American College of Financial Services. It's the only credential designed to prepare financial advisors to help people with special needs. So when you are looking for a planner to help you with a disabled family member, this designation ensures your advisor understands what you are facing and knows how to help.

Bob is also an Accredited Estate Planner® and a Certified Trust and Fiduciary Advisor, disciplines closely related to financial planning for special needs.

Bob Dilaura, thanks for being here today.

BOB: Hey, Mark, thanks. Good to be here.

MARK: Bob, we just heard great, great story of how you got here and your son Jason and his situation. How's he doing today?

BOB: Yeah, thanks for asking. He is a huge success story. If you met him on the street, you wouldn't see any visible disability. And yet he is disabled, and we deal with it every day. But he's become aware of his own life situation. And he's on top of it. But he is just a stellar kid. People love him where he works. And we're always just smiling because he's a real success.

MARK: Bob, obviously this would be a very emotional situation for a lot of people. So how do you approach that? Just the emotional weight when you're first sitting down with a client, I mean, you know, we both know—financial planning, wealth management—it requires a certain level of trust in the person we work with. How do you build that trust? Are people reluctant to disclose the situation that they're facing when they're first sitting down with you?

BOB: Yeah, great question. For people with special needs—maybe it's individuals who are disabled or their parents—we have to first get our heads around that term "disability," which can be a label. There can be some discrimination that is associated with that, even some emotional reaction from people that research has shown. There can be some shame or embarrassment or even depression when a disability exists in a family, for family members, even siblings, not just the disabled person. A disability is a specific term that's written into regulations and laws. It's a medical determination. I don't like to wake up early in the morning. That doesn't mean I'm disabled. But for some people, it's subtleties that may get tested and defined as a medical determination. That is protected health information. And people have a right to privacy and confidentiality and to not share that. And for people not to know it, and that's OK. That's legally protected. So sometimes it's difficult to know.

And I wouldn't normally ask that question, except here's this little story for you. I was working with a client, and we were on a video conference and building her financial plan. And all of a sudden, in the background, I noticed a teenager waving his arms that ran across about 10 feet from left to right. And I stopped and wondered, "OK. What just happened?" And about 10 minutes later, zoom. Another young man running across the screen behind her, 10 feet, waving his arms. I finally stopped and said, "Um, is everything OK? I mean, what's going on there?" She said, "Oh, that's just my son," and didn't blink, and we kept going. Now, that was a clue to me that I picked up on, and I started to tell her about my son and his disability and how he lives with us and the way we process this environment in our home. And she said, and we talked for about five minutes, a very personal conversation about our lives and our kids, and it was a very strong connection. Her son was disabled. This was a particular disability, and that's just the way he acted. She had accommodated that, and that was the normal for her. So sometimes we find it out indirectly like that. It's sometimes rare for a client to disclose that up front.

MARK: Bob, disabilities as you were just describing with that story as well as your own son's situation, these disabilities come in various forms. Some are visible. Some are not visible. Paint a picture for us of the landscape, if you will, and the wide variety of situations that are out there.

BOB: Sure. First of all, I would like to say that there are different words or terms that are used, and this is a bit of a controversy. It's great social media grist in this space. The word disability or sometimes it's referred to as special needs or someone who is incapacitated or a handicap or an impairment. So it can be debated, and I'll try to be consistent with using the word disability, and sometimes we try to keep the person first. It's an individual who may have a disability. So just using that as the framework for our language.

There's generally four groups of disabilities. The first is, as you mentioned, Mark, physical disability. This might be if someone has muscular dystrophy, multiple sclerosis, CP, things like that where you can see it.

But the other ones are tougher to even know. If you were talking with my son right next to us, you really wouldn't know he was disabled. This could be sometimes things that we refer to as IDD, or intellectual and developmental disabilities. These can be things like autism, learning disabilities, dyslexia, dyspraxia—these are all kinds of different medical terms—but you can't see it. And unless they exhibit some kind of behavior, you'd never know that they just may not process information the way you do. They may not be able to speak based on what's in their head the way that we do. That would be the second category.

Third is behavioral disorders. Again, this is the brain usually exhibiting the way people say or outbursts that they make. This could be sometimes OCD or ADHD, which some people have heard and often medications are treatments there.

And the last is sensory impairments. Which may be related to vision or hearing, all the way from limitations to full-on blindness or someone who's deaf. And so that's kind of the fourth category.

I would like to add one last thing. This has been evolving over decades from like the 1970s to the 1990s. And it's now falling under an umbrella, which was the acronym is IDEA, the Individuals with Disabilities Education Act, IDEA. This says that particularly in that time in life for a disabled person, when they're going through school, this is a critical time period, and now there are legal services and benefits that are available while people are in school through usually graduation of high school. The IDEA says there's 14 categories, and you have to be in one of them with a medical diagnosis for the school to open the doors to all types of free and appropriate public education.

MARK: Bob, given the 14 categories and the four types that you laid out, I'm guessing that there's a spectrum of, I don't know, let's call it severity, where some people are able to live very long, successful lives. Other people, they require a lot more help. As you were talking about also, people's willingness to … kind of disclose their situation. What's been your experience there?

BOB: Um, yeah, I would say generally people are a little sensitive about this. Um, but there are some very public figures that have shared this information, and it resonates with people to know that disabilities aren't necessarily something that's unusual. It's actually fairly prevalent. Uh, if I could, let me just kind of review quickly some well-known names of people with disabilities that people may not be aware of because it may not be something you could see or you would ever know.

The first one I like to refer to is Harry Potter, exactly. So this is Daniel Radcliffe. He disclosed, after his tremendous success in that whole series, that he has what's known as dyspraxia. So it's a challenge in moving and how he communicates with others. Daryl Hannah is autistic, so she's on the spectrum, with a level of difficulty that she's learned to manage, and then she's gone forward and had a tremendous career. Will Smith, ADHD, has been one of those disabilities that he has publicly disclosed.

And then, Mark, maybe here's a pop quiz for you or for our listeners. What does Tom Cruise, Cher, and Charles Schwab all have in common?

MARK: I think I know the answer to that one. I'm going with dyslexia.

BOB: They have all a learning disability referred to as dyslexia. So it's a challenge in the way that people process information and language in particular, including writing or reading. And so as you notice, again, lots of people can have this, and it doesn't mean that they can't be very successful in life. I sometimes say, "Disability does not equal incompetence." It doesn't mean that somebody can't be very successful in life and be able to do all kinds of things.

Let me mention one last thing. This is kind of interesting. This has been very topical. A couple weeks ago, literally from this time we're recording, there was a movie that was released by Apple TV regarding Michael J. Fox from all the Back to the Future movies, a tremendous acting career. This movie is called Still. He in his 20s discovered from the twitching of his pinky that he had something going on, and he disclosed—after decades of figuring out how to deal with it—he has Parkinson's disease. The fact that he disclosed that and how he dealt with it and still went on to be tremendously successful bringing awareness and literally raising billions of dollars for Parkinson's research, that's a movie well worth watching. So it doesn't mean, again, a disability is something that's bad. It's just something that people have to make adjustments for. They can still be very successful.

MARK: We're going to get into the kind of the financial aspects of this in a second, but before we do that, one more question, Bob. Is there a resource, a starting point, 800 number, website where people who are just coming really at the beginning of this journey that they're coming to grips with that they can go to to get a kind of a broader picture of everything that's involved with this?

BOB: Well, you wish. Whenever a disability is diagnosed, detected, or happens in an unsuspecting way, you are thrust into very deep water very fast. So parents have to learn how to process tons of information while providing care for the disabled person and still trying to work and not take off too much time for all the treatment and to earn a living all at the same time. So there's no one source that you can call. If anything, there's what I like to refer to as TMI. There's too much information. If you did an internet search, there are so many websites, organization, benefit programs, books, and research, you will get buried beyond the medical challenges you face. So it's really too much.

So here's what I would suggest. Think of a wheel. The parent has to be the hub of a wheel that must connect well and communicate and work with a whole series of people in your care team or your network. So this could be the doctors and nurses, therapists and social workers, government, program personnel you have to work with, attorneys or tax specialists or financial planners. All of these are essential. And yet there's what I call a care team paradox. If I were to ask my neurologist about our son, and if I were to ask him, "Hey, doc, what's the best government eligibility program? What has the easiest eligibility requirements? Is it SSI or SSDI?" He'd look at me like, "I don't have a clue. I don't even know who you should call." So even though each of them are experts and I need all of them, they don't all work seamlessly together. So I have to have those connections, pull them all together so that our particular needs are being met and somehow coordinate all of that together.

MARK: So let's maybe narrow the scope here a little bit. For someone who might be caring for a disabled family member, maybe a newly family member who's just kind of discovered a disability, where should they start in terms of the financial aspects of this? How should they reach out to an advisor or a planner? Maybe they already have one, but now because of the situation, they've got bigger concerns than just, you know, retirement planning or college planning. How do you get started on that?

BOB: Yeah, so first I would say there is a path, there is a river that kind of flows where your lives financially unfold and things happen and finances are a piece of people's lives. But when an individual with a disability comes into that setting, it has to somehow run in parallel. And I would say there's general phases that are involved there, some of which I've talked about. You've got to discover as early as possible—what is the disability? Try to get treatment for that, right? So you just have to accommodate that. And in some cases, that involves money, right? There are insurance questions that have to do with that, or some things that are not covered by insurance. So that first phase has to get done.

The educational setting would be the second. You have to get kids through learning as much as they're able to learn as well as they can. Again, this may require some time, may require some costs. Things we did with our son was additional technology. Maybe we could help him learn at home. Maybe there's stuff he does over the summer, all of which ties to—there is an expense for these things. So that has to be part of what we're doing.

The third phase of these five that I would say has to do with a work environment for the disabled individual, once they get past school. Now you've got a transition to make. What does that look like? Are they able to work? Are they able to be hired or interviewed? Whole separate program to be done on that. But they are able to do whatever, and sometimes it evolves for them to be able to do better and better at earning something, which may not be about the income. But it's about their interaction with a work environment and with others.

Fourth of those five areas would be regarding living. Maybe, and in many cases, clients I work with, the individual who's disabled is living at home with mom and dad. And that's fine. That's very common. But eventually, maybe there's a question of independence, and maybe they don't want to be living at home anymore for various reasons, right? This can be a love-hate relationship. So you have to figure that out. What's work going to look like, and are they able to earn income or get enough government benefits to be able to afford to move out?

And the last would be what does life look like after mom and dad also are not able to take good care of themselves or pass away? And that is a real challenging area to talk about. Let me add a quick story here. I was talking with a client. We were building a financial plan. She had specific questions about long-term care. And so I was talking to her and we were going over how's long-term care work and the costs and what's she going do with her home. And as we were talking, I noticed in our systems that there was a gentleman with the same last name who had the same address living at home. Now this lady was getting to be a bit elderly, and so as I asked about that, and she goes, "Oh that's not my husband. That's my son."

Now this is where sometimes Social Security refers to as an adult child. It's not just kids who have disabilities and special needs. We often talk about that, but they eventually grow up, and they get out of school. And they often are living at home for decades. It doesn't mean that they aren't going to live a long life. Well, she was facing the challenge of, "How do I transition out of my home into long-term care, including possibly selling my house, and how does that impact my son?" That was a challenging conversation, but that's the things that we work through.

MARK: And when we think of these at the surface level, almost as initially as a medical situation, but in all those examples you gave, all these situations have kind of profound financial implications for people, right?

BOB: That's right. Yeah, that's exactly correct. No easy answers.

Sometimes I would say, Mark, that, "Well, we can't fix the disability, but we can help you to figure out how to incorporate that and accommodate it within your financial abilities and make adjustments accordingly." So that the conversation is often creative and unique.

MARK: Bob, the financial services industry and the legal profession, they're very good at creating lots of different special accounts and special types of trusts for people in particular unique situations, and one of those is the special needs trust. We talked about it, I don't know, about a year and a half ago on this show very briefly. So maybe just kind of give me the rundown of what is a special needs trust.

BOB: Sure, let's start there. The special needs trust is a unique kind of legal tool that requires an attorney to create. It has quite a bit of complexity around it, but it's a very powerful tool. The importance is—that's a way that the child can have assets, but those assets don't work against the benefit of the child where there are government programs that may be able to create an income for their lives or provide medical insurance for their lives. Often holding assets in a special needs trust is beneficial. So where there are cases where parents may want to set money aside for their son or daughter, they can fund it potentially through a special needs trust.

At the same time, that also means they are now on the hook to understand how to administer a special needs trust. Who's going to be a trustee, and what are all the rules that apply, as well as having costs over time that will have to be incurred just for the taxation of a special needs trust or for any modification. So where it's appropriate, there has to be an attorney involved, usually one who has particular training in the ADA at a national level. They have a whole group of special needs attorneys who do that work and can get one set up where needed. At the same time, there are risks. You don't want to just do that and assume everything will be fine. There are challenges where things that are done in a special needs trust can cause other problems. I probably talk to 50 different attorneys who specialize in special needs issues with disabled people, and they would say there's a time and a place for a special needs trust. Sometimes that's not the greatest tool.

So there are lots of other tools. I'll list a few of them just as a reference. One would be an ABLE account, which is an alternative that was created just around 10 years ago as another way to be able to save money, not lose government benefits, and be way easier to start and to manage. The government runs a really good website that's worth looking at. It's called benefits.gov, benefits.gov. You can go there and run their benefit estimator or calculator and see, based on the disability, are you able to collect some government benefits, some income for life or medical insurance? And it will run through a tool to show you what's possible for you to collect from Social Security, Social Security Disability as an insurance or income tied to Medicare or Supplemental Security Income, run through Social Security at the state level that can also provide some income. But you have to always play whack-a-mole, like I like to say. Sometimes the benefits that people get come with a gotcha, kind of a catch-22, which may lose eligibility of certain benefits if you have too much money, too many assets, too much income.

Let me just add three other tools, maybe four other tools, that sometimes come into play. The first is there may be a need, again, from a legal process to have a guardian, especially when a child is over 18 or over 21. Run at the state level in a local court, it's a finding to say, "Well, our son or daughter with a disability just isn't able to manage themselves or finances or their own accounts." You could become a guardian or a conservator that could manage those things. That's a request to a court, and the court would go through that. Often again an attorney would be involved because it is a legal process.

The last three I would mention is—there are things that are called a life care plan. That is, if someone stepped in, if something happened to me, and someone had to step into my shoes, now my wife would obviously be able to handle things. But even she would admit she doesn't know everything that I do or have all the information I have to take care of our son. So a life care plan could be literally 50 or 60 pages of every detail of what we're doing to take care of our individual with disabilities. Now it's hard to do; that's almost too much detail. So from a life care plan, it's gotten scaled down where some people have what we would refer to as a letter of intent. If something happened to me, here's what I'd like to happen for my son or daughter that has a disability. Much shorter, two or three pages. It's like a final letter of intent.

But the one that I want to specifically mention, in the last three or four years, this has been one that I really see tremendous value in. It's not real long, but it is also highly tailored to the individual and their needs, and it brings in—what's their living situation, what's their healthcare situation, how are they connected in the local community, and who's going to be providing support if needed? That's referred to now as a personal support plan. It's meant to be reviewed every year and see what works for them. So it's not just theoretically how things are going to go and somebody should look at it, that's put on a shelf. But this is really a working document uniquely tailored to them based on what works for them. So that might be eight to 10 pages. And again, that's a much more modern version of how to best care for somebody.

MARK RIEPE: So Bob, life care plan, letter of intent, personal support plan—are these legal documents or are these kind of, you know, sort of guidebooks, but they're not, you know, kind of legally binding in the same way, you know, that a will might be?

BOB: Yeah, exactly. Yeah, these are more guidance documents. It's really a parent saying, "OK, look, here's what I'm doing. Here's what the situation is. Eventually, I'm not going to be here, right?" That's the whole, you know, dynamic of a will. So it's really the handoff, whether it's a guardianship, which would be a legal connection. I have to report every year to the courts in my role as a guardian, right? And attorneys would have to be involved if there's going to be unique changes there. My son could even appear to court and have his own attorney if he thought that I was doing something that was inappropriate for him. So some of those have legal oversight and require legal construction. But in general, that adds a level of complexity. So where possible, it'd be great if it could be easier and less costly.

MARK: How do you go about selecting a guardian in a case like, you know—I 've got kids. We put together, you know, some estate-planning documents. It was fairly easy to figure out the guardian situation if that were to come to pass. My guessing it may be a little bit more complex in the situations we're discussing here. So what's your advice there?

BOB: Yeah, I would certainly, you know, touch base with an attorney. This is their wheelhouse, and they will walk through the pros and cons, what makes a good one, what doesn't make a good one. There was a whole bunch of training I had to go through to understand the process. And you have to legally petition the court and request to take control over this person's rights. And so we argued because of the disability that our son had, this was the right thing to do. And with all the forms and the proceedings and, you know, it could be six to twelve months of wrangling through even an appearance in court with our son where they give that as discretion and freedom that was transferred, but theoretically it could go back to him if that was not needed anymore. So I have to re-prove that on a regular basis. It could be parents. It could be an attorney. It could be someone who you just trust, who understands and is willing to make that kind of commitment. There are people who are professionals that do this, but there is a cost for doing that.

MARK: I'm going to go back to the back to the ABLE account. Maybe give me a little bit of detail as to what you think the profile is for someone where that type of account makes sense.

BOB: Yeah, that's a great question. Literally, this was created as an offshoot. There was some individuals who were saying, "You know what? I just don't have a lot of money, but if I have over $2,000 in a checking account, I lose my eligibility for SSI benefits." And it's like, that shouldn't be something that's right. They require now, again, people who are disabled to go and try to work to be able to be eligible for benefits, but you can't earn too much money, otherwise you become ineligible for those benefits. What a catch-22 for people.

So an ABLE account was created to keep it simple, to keep it low cost, to keep it out of the legal framework, and to say, "How could I save money just by setting up an account that would have those kinds of protections?" This is something that's run at a state level. It's very similar to what some people know as a 529 account. This is a college savings account where you could put money in an account up to a certain amount every year. You can't just jam a million dollars in this if you're a rich person for your kids. But up to a certain amount, you can save money. And like a 529 educational savings account, if you spend that money for educational, qualified expenses, then the money that was donated and the growth of that money is basically tax free. So in a 529, that's great. So they leverage the 529 model, and it's now referred to as a 529A account, which is an ABLE account—that stands for Achieving a Better Life Experience.

It's able to use money to pay for things like housing and food of the disabled person. You can do that from an ABLE account, whereas from a special needs trust, if you make what are called in-kind support and maintenance, that is periodically give money to the beneficiary of a special needs trust, that is counted as income and can make them ineligible for getting government benefits. But from an ABLE account you can do that.

Last couple things I'll say again, you know, the tax benefits are there. Anyone can make contributions—mom, dad, grandma, friends—you throw money in the account. It's run at a state level. Most states will have these. And even if a state didn't have one, they could get one in a state that has one. So for us, somebody who was living in Idaho, which may not have, actually I don't think they do have a state-based ABLE account, they could start an ABLE account for their child who's disabled with a Colorado ABLE account that's recognized in Idaho. So up to a certain level, you can put money into those, but the government also puts limits on how much those accounts can hold. And if you—catch-22—have over $100,000 in that account, sorry, you're going to lose some of your government benefits. That's just the limit that they apply.

MARK: Bob, let's imagine I'm the primary caretaker of a person with disabilities or a person with special needs. I've made an appointment with a financial advisor. What should I put on my checklist? How should I prepare for that conversation in a way that's going to be the most productive?

BOB: What I would say first of all—all people should have a financial plan and lay the groundwork for the basics. So this is things like have your career on track, have a budget, be living within your budget, have some emergency savings, keep your debt in check. Save for retirement, right? These are real basic stuff, right? One of the facts that we often run into as a financial planner like myself, the statistic is—of all the people that die in the United States, about half of them don't even have a will. That is a big issue, and it creates legal problems and how you transfer assets. So we would say get those basic things in place because you never know when they will be important and what will be needed.

But I would say this—the unique aspect that comes into play for someone where there is an individual with a disability living there is, which of the income or the savings or checking or investment account or the assets that you have, we can easily put that into your financial plan. But are those your assets or are they assets of the disabled person? Often these things are co-mingled. On the surface it seems to not be an issue. But, for example, with Social Security Disability Income, a parent may be named as a designated beneficiary receiving government benefits on behalf of the individual who's disabled. They often count that as their money. Theoretically, they're using it for the benefit of the son or the daughter. And so it often gets entangled. It's often gray. So I would say just be aware that there are some things that are yours. There are some things that are theirs. And even, and this is a stretch for some parents to realize, your son or daughter may have their own goals that aren't your goals in life. Your own financial goals and your own non-financial goals may be living independently or traveling or having a pet. We have to also respect those. Those don't all fall neatly into one bucket and one financial plan.

The last thing I would say is—this is a really important point—and that is people often have a time horizon on investments that they're making or even their life expectancy. That's how we build financial plans. When there is an individual with a disability living with you, you have to stretch that timeline. You have to plan for what's going to be happening and money that will be available or income or a living circumstance after I'm dead. That should be built into your financial plan for the benefit of your son or daughter. That's not usually done. Even software sometimes doesn't include the ability to do that. That has to be included.

MARK: Last question, Bob. We knew this was a big topic when we put this on the schedule, and just based on this conversation, it's an even bigger topic. What's the most important thing we didn't cover that you think we could end with that you want to convey to people?

BOB: Here, I'll share this. When our son Jason was going through middle school, sixth to eighth grade, we were really struggling with all just the daily living circumstances of him and his injuries and our lives and so forth. He was put into a class that was called a special ed class. And I quickly learned that was not a good environment. But that's the way schools used to run. They would create a separate-but-equal environment. And now we have learned, and schools have dismantled those. Those are not a good way to treat people. There is no real separate-but-equal when it comes to education. And just broaden out that mental model into society. Separate-but-equal, that kind of discrimination isn't healthy.

In our case, we would say thanks to our son and thanks for his disability because it's contributed so much to our family and his life story and our success overall. People can succeed and thrive, have their own goals and with the right opportunities, the right support, can be thriving members of a community. And ultimately, I think it's a credit and benefit to society.

MARK: Bob Dilaura is a senior financial planner at Schwab and he's a Chartered Special Needs Consultant. And Bob, this has just been a real eye-opening episode, so I really appreciate you taking the time to talk to us.

BOB: Yeah, thanks, Mark, was a lot of fun.

MARK: For many people, investing and financial planning are primarily about working to make sure we'll have enough money when we retire. As part of that process, we try to anticipate what expenses we'll have and plan accordingly.

One big expense is healthcare. And as much as we all hope to avoid disabling illness or injury to ourselves or our loved ones, the fact is, it happens. And while having medical and disability insurance helps a lot, Bob’s story shows that there many other ramifications.

Our interview with Bob was packed with a lot of details, and it was probably hard to take it all in while listening to the episode while driving.

Not all is lost, though. You can get a transcript of every episode on our website, Schwab.com/FinancialDecoder, in case you want to go back and refer to the information we discussed today.

Of course, there are many other big life events that may or may not happen to you that have big financial implications. A good place to start getting grounded in these events is at Schwab.com/FinancialPlanning.

You can also call us at 1-877-519-1403. That's 1-877-519-1403. And if you go to Schwab.com/ContactUs—that's all one word, Schwab.com/ContactUs—you can live-chat with an agent or find a branch near you.

To hear more from me, you can follow me on Twitter @MarkRiepe. M-A-R-K-R-I-E-P-E or check out my LinkedIn page.

Thanks for listening. If you've enjoyed the show, please leave us a rating or review on Apple Podcasts.

And if you know someone who might like the show, please tell them about it and how they can also follow us for free in their favorite podcasting app.

For important disclosures, see the show notes and Schwab.com/FinancialDecoder.

MIKE TOWNSEND: At the beginning of 2023, like a lot of people, I had never heard of ChatGPT. The artificial intelligence-powered natural language processing tool, better known as a chatbot, was launched just last November. It allows people to have human-like conversations on just about any topic imaginable.

By January, it had 100 million users. Now it gets more than 1.5 billion visits per month.

ChatGPT can write essays and articles, give you instructions, edit your term paper, tell mostly bad jokes, craft a poem, provide advice, design a website, plan your weekly menu based on what's in your refrigerator—and it can do it in any language, in any style that you can think of.

Search the internet today, and you can disappear down a rabbit hole of the crazy questions people have put into ChatGPT and the even funnier responses it has produced. My favorite is the user who asked ChatGPT to explain in the style of the King James Bible how to remove a peanut butter sandwich from a VCR. Look it up—it's hilarious.

But there's a dark side to ChatGPT, too. It can make mistakes but insist that it's correct. It can spread misinformation. It can aid criminals in their scams. Some users worry that it could eventually make many human jobs obsolete or even wipe out humanity entirely.

ChatGPT may still be fairly new, but artificial intelligence has been around for decades. But the interest in AI as a technology has exploded in the last few months. And investors have noticed that some companies that have bet on AI technologies have risen to the top of the markets.

But what is AI? How is it being used? How will it be used in the future? And how worried should we be?

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to.

Today's episode is the first of a two-part series focusing on artificial intelligence. In just a few minutes, I'm going to welcome Bashar Abouseido, the chief information security officer here at Charles Schwab, to walk us through the rapidly changing artificial intelligence landscape and discuss the power and perils of this technology.

In Part 2, which will be available in two weeks, we'll explore the investing side of the equation, examining the opportunities and risks for investors looking to capitalize on AI's momentum in the markets.

But first a quick update on some of the issues making headlines right now here in Washington.

Congress returned to the Capitol this week after the two-week July Fourth recess and will have a busy three weeks before breaking again for the annual August recess. Here are three things I'm watching during this Congressional work period.

First, the government funding process is picking up speed. Both the House and Senate are working on their versions of the 12 appropriations bills that fund every government agency and every federal program. Those bills need to be approved by the start of the government's fiscal year on October 1, or there's a risk of a government shutdown.

That risk is going up because the two chambers are starting this process in totally different places. As part of the debt ceiling deal that was reached last month, President Biden and House Speaker Kevin McCarthy agreed to freeze non-defense spending for next year at roughly 2023 levels. No increases due to inflation or other factors. But House Republicans, frustrated that the agreement did not produce a larger government spending reduction, are crafting bills that fund the government at 2022 levels, which represents about a $120 billion cut to discretionary spending.

A funding gap of that size sets up a standoff between the Republican-controlled House and the Democrat-controlled Senate. Ultimately, both chambers have to pass the same bills, so how these differences are going to get resolved―it's anyone's guess. The real drama will come in September, when the clock is really ticking toward a government shutdown. This is starting to feel a lot like the debt ceiling drama, where the two parties were stuck for months and only reached a resolution at the last possible moment. Look for both Republicans and Democrats to be jockeying for position this month in anticipation of a high-stakes showdown in September.

Second, this week the House Financial Services Committee launched what it is calling "ESG Month." The committee will be examining environmental, social, and governance-focused investing with a series of six hearings. Toward the end of the month, the panel is expected to consider one or more bills related to ESG investing, though exactly what that legislation will look like is up in the air. One possibility is a bill that would require money managers to ensure that a client's financial returns are always the priority over any non-monetary factors when making investment decisions.

ESG investing has become a political hot potato over the last few years, particularly at the state level. Republicans have said that the trend is helping investors and asset managers to push companies into political battles that may be at odds with the goal of securing the highest possible returns. Democrats say that ESG investing allows investors to make their own choices about whether they want to use their investments to send a message about their values and priorities.

The fight is also playing out in the regulatory arena. The SEC, for instance, has found itself at the center of a huge controversy since it proposed a rule last year that would require public companies to disclose more to investors about the risks climate change poses for them, as well as how they're actually contributing to climate change. At the Department of Labor, there has been a long-running battle over whether companies should be permitted to offer ESG funds among the investing options for employees in a company's 401(k) plan. A rule permitting these options is in effect as of January but is currently facing a court challenge.

Any bills that emerge from "ESG Month" in the House of Representatives are likely to face stiff opposition from the Democrat-controlled Senate. But it's a symptom of a larger battle that I expect will remain front and center all the way through next year's elections over whether ESG represents investor choice or the politicization of investing.

And the third thing I am watching right now is the likely confirmation of the president's nominees to the Federal Reserve Board of Governors. Earlier this week, the Senate Banking Committee voted to approve the nomination of World Bank economist Adriana Kugler to fill the open seat at the seven-member board. Kugler would be the first Hispanic ever to serve as a Fed governor.

The committee also voted to advance the nomination of current governor Philip Jefferson, who was nominated to move up to the vice chair seat, and the nomination of current governor Lisa Cook to her own 14-year term. She's been filling an unexpired term that is set to expire in January.

The final step is confirmation votes on the Senate floor for each of the three nominees, which may happen before Congress adjourns for the August break.

All three nominees appear to be on track for confirmation. I don't expect any big changes in terms of the Fed's monetary policy direction or its plans for toughening regulations for big banks, which is the Fed's other priority right now. But the confirmations will ensure that the Fed has its full complement of seven governors as it heads toward tricky decisions about when to stop hiking interest rates and what other steps can be taken to keep inflation moving on its downward path.

On my Deeper Dive today, I want to focus on a topic that has become the center of an enormous debate, artificial intelligence, or AI. Interest in AI has exploded in 2023 with the launch of ChatGPT and other tools that allow ordinary people to explore AI in a way that perhaps they have never done before. AI is also one of the hottest investing topics, as investors are increasingly looking at companies that might be positioned to take advantage of changes that are coming as a result of AI. But there's also plenty of concern about the risks with AI, such as if it's used for nefarious purposes or the potential problems that could arise if this technology is allowed to develop without appropriate oversight.

''I want to begin today's discussion by getting a better understanding of what's been happening in the artificial intelligence space. To help me sort through a lot of information, I'm pleased to welcome to the podcast Bashar Abouseido, managing director and chief information security officer here at Charles Schwab. Thanks for joining me, Bashar.

BASHAR ABOUSEIDO: Great to be here, Mike.

MIKE: Well, Bashar, with all the buzz that's going on around about AI, it would be easy to think that it's something completely new, but in truth, neither the term "artificial intelligence" nor the technology itself is new. But what is new is the wide range and sheer number of ideas that are being put forth on how to apply AI. I know you've been a keen observer of what's happening in the AI space for a long time. So let's just start with the most basic of questions. What is AI, and how is it currently being used that we may not have even noticed?

BASHAR: Let me start with what AI isn't. AI is not magic, Mike. Basically, we leverage computers and machines to turn everything into mathematical formulas, run complex mathematical problems, in an attempt to predict the next number. So we use lots of math, science, and probability to try to predict that next outcome that's going to happen from a math perspective. So AI, itself, as a science, is not new. ''

Let me give you some examples. We've seen that technology used in planes, as we see very large, complex planes travel fully automated, leveraging computers, leveraging and processing the data, and being able to basically safely take us from one place to another. We've seen it also leveraged in robots in manufacturing, so we can improve productivity and efficiency and allow humans to be leveraged for better things, instead of the standard manual labor that we had in the past. We've seen it even in movies and articles about Deep Blue and how Watson and the various computer models were able to actually work and play the chess game against the top chess players in the world. And it was fascinating to see that, actually, the computers were prevailing in many situations where we thought it was impossible, but it was mimicking the human behavior. So it's been there for a while.

I think what's fascinating, in my opinion, is the fact that we've seen some tangible and important advancements that have come to light in the last 10 to 20 years, making AI more accessible at the individual level. In the past, it was only accessible to large, commercial corporations that were able to afford getting access to that data. But now, with the variety of different advances that we've seen around natural language processing—being able to speak to it with a simplicity of just asking a question and getting very, very interesting, valuable, meaningful responses in a very timely fashion—those type of advancements have made this a lot more tangible to the regular person, for you and I. In addition to that, there are many factors involved, as well. We're seeing lots of advances in technology from chip manufacturers doing things faster, better, more processing power, more accessibility, and commercially reasonable solutions in the backend from a computing perspective, and many areas where we've been also gaining quite a bit at collecting more information where we can make better decisions leveraging these capabilities.

Overall, we are in a very, very fascinating stage of getting access to that technology.

MIKE: Yeah, Bashar, I think it's really interesting here in 2023, as I have traveled around the country talking to investors over the last six or eight months, this has risen to right at the top of the questions that I'm getting. And when I talk to people, it feels like there are kind of two main reactions. One, is people immediately think of the entertainment side, you know, the crazy things that people have asked ChatGPT, the funny responses that have come back. The other reaction seems very negative and very extreme. There's a big contingent of people out there who are worried that AI is going to make their job obsolete or worse, that machines are going to rise up and wipe out humanity in, you know, an Arnold Schwarzenegger movie-type scenario.

What has not received very much attention and what I think people are still trying to get their arms around are the business applications that will offer real benefits to ordinary consumers. So as you watch where this is all headed, what do you see as some of the near-term applications that businesses are embracing, and what are those key benefits to consumers that we can look forward to?

BASHAR: There are areas where AI can influence innovation and accelerate knowledge across many organizations. In particular, the biggest and interesting part is what I call the blank page kind of challenge that we have. What's interesting is if I can leverage AI by asking AI to help me with some ideas in particular spaces. For example, if I want to write a new email, if I want to start a new marketing campaign, to write a contract or even a software program, wouldn't it be really nice to be able to ask AI about what's possible here, where should I start, and get some ideas that will allow me to get going so I can get a head start, instead of starting from scratch?

But I think there are other ideas and areas where we can leverage AI to help us improve in the day-to-day and in terms of different areas of our economy and our society. I think, in particular, we can leverage it, just like we've seen the use of technology to allow us to gain significant and substantial productivity within the economy. The whole science of AI is about making machines think and process data like the human brain does. If we're able to do that, to offload many of the repetitive lower-level things to machines to do that work for us, that will make us a lot more productive. It will save us a ton of time, and it will reserve that important human brain for bigger and more complex and innovative challenges.

The second part, in my opinion, is also we will address the talent and skill level challenge that we have in so many areas of the economy. For example, you require a significant level of skill and education to get into healthcare, to be able to respond to the demands within the healthcare system. If I'm able to allow machines to process the majority of the data and help me with some of the decisions, that means I can take more of the resources that don’t have those skills and allow them to leverage AI to produce the same outcomes. And so on and so forth. We can apply that to finance. We can apply that to manufacturing. We can apply it to customer service. If we look at the big picture, the possibilities and potentials are limitless in my opinion, but that comes with both cost benefits and some downside, as well.

MIKE: Bashar, "transformational" is a word often associated with AI. It's kind of one of the buzzwords that you're hearing right now. Are there certain parts of our economy, certain types of businesses, where you think AI will really be transformational?

BASHAR: Yes, I believe that's the case, Mike. AI can be transformational. I'll give you a few examples. In customer service, AI can aid human customer service agents to support and provide helpful resources or solutions to customer questions and do that a lot faster. AI can supplement high call volumes, so more customers can get that answer that they're looking for a lot faster. It can be leveraged in music and creative arts. For example, AI can create or suggest a music or art design to appeal to our preferences. A new Marvel streaming series can use an AI-built animation for its opening credit sequence. AI can write a song preferred by humans, for example. We can leverage it in healthcare, travel, and culture. Imagine AI being able … or ask your AI assistant to translate not just English language, but just help you converse real-time with a voice with anybody in any country.

Build a full and complete travel plan for you, including active assistance, based on the length of the vacation and what country you want to visit, and what preferences you have and interests you have.

Personal assistant for making appointments for you, to call your dentist and be able to kind of negotiate a time and date to do the services that you want.

You can have many of these interactions that we have and be able to be a lot more productive, versus the fairly robotic, inefficient way we get today from customer service, or anytime we deal with voice, it just feels unsatisfying, unproductive, it's not what we want to be.

We can also apply that to financial planning, for example.' Your AI assistant will be able to look at your portfolio, look for opportunities based on your age, your goals, where you want to be, and identify those opportunities within the context of the marketplace to say, "Hey, listen, I think you should look at these possibilities of maybe changing your structure of portfolio, some opportunities and ideas for you to discuss in the next meeting that you have with your financial advisor." And now, instead of going with a blank kind of set of objectives to your advisor, you can have specific questions and ideas you want to discuss so you can gain more productivity for the time that you use with your financial advisor or wealth advisor.

Again, the ideas are limitless, the possibilities are great, and that's why I think this is going to be very transformational.

MIKE: Well, let's talk a little bit about the downside, because I certainly think there's a lot of attention being paid right now to the potential danger points of AI, and that's where you start to get people with this reaction of AI is going to take over. So what about this sort of keeps you awake at night?

BASHAR: What I worry about is that this is getting so accessible that we're just sometimes so fascinated by what the upside of this type of technology is, and we don't realize that there are some significant downsides, as well. For example, we need to understand exactly what type of data are being kind of fed to the models and to the data science behind AI and machine learning, so we understand how the computer or AI was able to generate some of the recommendation. So we need a little bit more of that transparency. We also know that models and computers basically get trained by humans, and eventually what you'll see is that they will produce some biases or occasionally come back with the wrong answer. How do we account and be prepared to understand when what the computer is producing is a good outcome or is a questionable outcome? And are we careful enough in terms of the decisions we base on the recommendations and predictions generated by AI, are we able to understand whether there is a bias associated with that or not? Are we aware of the type of risks that we're dealing with? Because even in perfect conditions in applications of AI, like we've had with planes or manufacturing or autopilots and cars, we still see accidents. But the frequency of those occurrences can be highly mitigated by continuing to train the computer and putting controls around the usage of what type of decisions and how do we override these models.

So humans, ultimately, have the accountability for what decision's being made, and we're very well aware from a risk appetite perspective, how much risk we're willing to take versus the productivity that we gain. All of that is a fascinating point of views that we need to consider and look at and evaluate as a society as we continue to leverage that science and continue to try to get more of the upside and minimize the downside of that science.

MIKE: Bashar, one of the aspects of, I think, what you're talking about that has already started to play out is that it's becoming more and more difficult to tell what content, for instance, is AI-generated versus what's human-generated. And we've seen this play out in, you know, written articles on the internet. We've seen it play out on music where there was an AI-generated song that purportedly was by Drake and the Weeknd and fooled everybody until they said, 'We didn't record this song.' So what kind of dangers do you see there? And how are we going to address the question of being able to determine for ourselves what's AI-generated and what's not? And I think that goes to what you mentioned about knowing whether something is coming up with the correct answer.

BASHAR: That's a great question, Mike, because I think, as we continue to see the benefits of AI and realize the benefits of AI, we're also going to see the lines blurring between the human-created content and the decisions made by human versus the machine. That's why I said it's important that we have better visibility across the board. If you look at the various studies that were made in the last 10 years or 20 years, computers with AI are able to mimic the human behavior in a way that is hard to differentiate at some point in time. They had a study, I believe, where they created a piece of music, a music note versus one that was created by human, and they gave it to a random sampling of people, and they said, which one was machine created versus human created. Most of the people that got surveyed picked the computer generated as the human version. They did the same thing with an article that was written by a human versus a machine, and people consistently picked the article written by the machine as the version that was written by a human.

So, yes, it is very interesting. That's why I continue to focus on the need to provide oversight to understand the differences between what's public, like ChatGPT, where everybody is having access to it. It gets access to a vast amount of data that is determined by the creators of ChatGPT, versus commercial private use of AI, where we control the amount of data and the type of data that gets fed to the model, and we stand behind the accuracy and the decisions or recommendations that are created by that model that is supervised, supported, and trained by that corporation.

So there are different sets of use cases, and we have to differentiate that not all AI models are going to search the internet and process everything. There are many cases where we can take a limited set that is only relevant for a use case that adds value to our customer, and that's the limitation. And we should have more trust in the outcome with that because it gets tested a lot more frequently, a lot more thoroughly, versus the public ChatGPT-like model, which is just offering you, basically, assistance and a variety of different wide range of topics.

MIKE: So I think, then, the next logical follow on is government regulation. And here in Washington, you know, we're already seeing Congress start to think seriously about how to put some guardrails around the development of AI technology, at least the AI technology that we're talking about that has a broad accessibility to the public. But we also know from experience that Congress and regulators tend to be way, way behind in developing those parameters and those regulations. You know, we've seen this play out right now in cryptocurrency, where Congress is still struggling to put any real parameters around that. So how important do you think it is to have government guardrails in place before this technology gets developed any further? And, you know, at the explosive pace that AI appears to be moving, do you think policymakers can even get ahead of any of these problems?

BASHAR: I don't know if they can get ahead of these problems, Mike, but I think some type of guardrails are necessary, as well. I think it's important, but let's remember, we're still in the early innings of learning about the science and the development of the science, and how we apply that science to various sectors of the economy, as well. So if we over rotate on the regulatory front, we may inhibit the upside of that technology, and we need to be careful.

But I think it's appropriate to also recognize that there are certain downsides and certain risks associated with the science that we need to be careful of. 'But I would definitely think of ideas to establish appropriate governance and oversight and registration and allow for more transparency on how the technology is being used and what's being fed into that technology.

MIKE: What about international cooperation? I was interested to learn just recently that there are more ChatGPT users outside of the United States than there are in the United States. So that would speak to perhaps some kind of, you know, sort of global framework which, again, we know is really, really hard. How important do you think that is?

BASHAR: I think it's very important. This is something that everybody on this planet earth is going to be using and leveraging. Just like we've seen with, again, technology, the internet, what you're going to see with AI is something similar. That level of supplementing talent and skill and productivity is going to be applied across the board—everybody wants to leverage this. And it's appropriate to have that level of coordination and collaboration around how do we want to get the best out of this without certainly impacting society in a negative way.

But it's also interesting to know that if we're not careful in how we collaborate on this, we're not going to be able to stop certain countries from advancing their own usage of it and their own kind of agenda that are built on leveraging that science for competitive reasons.

Now, sometimes also that has an upside and a downside to it. So it's important, just like anything else that impacts all aspects of society and humanity, we need to have a discussion on how do we appropriately use it to allow us to get the upside and work together to manage the downside. And I think there are many elements of that downside that we need to think of and be prepared for, and possible impact that we need to consider as we continue to advance in our usage of that technology.

MIKE: Bashar, this is a fascinating conversation. I think I could talk about this all day, but I'll wrap up with this. As you look at your role as a chief information security officer, what are the main risks and challenges that you and your peers, both inside the financial services world and at other types of businesses, are facing in order to kind of balance improving the customer experience, which I think everybody agrees is a potential big benefit of AI, with protecting customers? How do you strike that balance, and what are you focused on today to try to make that happen?

BASHAR: The key, in my opinion, is to make sure that we understand how the science works and the type of applications and use cases we have that we can get value from. But we have to also realize that the bad guys, let me just say for example in cybersecurity, the concern I have is the bad guys will also get access to the same level of capabilities. I'll just give you a quick nugget of information here. When we have a digital process and we put it on the internet, it used to take anywhere between four weeks to six weeks for the bad guys to map the digital process, to understand the technology we use, and to find weaknesses in trying to exploit that level of vulnerability or weakness they identified. Now with technology and all the tooling and capabilities and public cloud, takes them less than five minutes to recognize, map the process, and exploit the process. So they're leveraging AI and machine learning just like we do. And it will help them also be more efficient, and it will help them accelerate the bad things that they want to do to get around the controls and processes and the good mission that we have.

We have to always be aware that computers will have biases. We have to be aware that computers will have to have some transparency and guidance from us. So the question here is how do we get the best out of that technology…by putting appropriate governance and be able to be fully transparent in reporting what goes to the machine versus where the human is taking the accountability for the decisions that we make. And we have to differentiate between public AI capabilities and private AI capabilities, and how those are being controlled to allow us to achieve the positive outcomes that we want from that technology.

MIKE: Well, Bashar, thanks so much for your time today. Really interesting conversation, and I appreciate you sharing your perspective.

BASHAR: Thank you, Mike.

MIKE: That's Bashar Abouseido, managing director and chief information security officer here at Charles Schwab.

Well that's all for this week's episode of WashingtonWise. We'll be back with Part 2 of our two-part special in two weeks. Take a moment now to follow the show in your listening app so you don't miss an episode. And if you like what you've heard, leave us a rating or a review—that really helps new listeners discover the show.

For important disclosures, see the show notes or schwab.com/washingtonwise, where you can also find a transcript.

I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy and keep investing wisely.

MIKE TOWNSEND: I have always loved a good heist movie. The entire Ocean's Eleven series. The Italian Job. The Thomas Crown Affair. The Sting. A clever robbery, the matching of wits between the perpetrator and someone trying to unravel the crime, a tidy ending.

But today's heists don't involve temporarily disabling the motion detectors while the criminal rappels down an elevator shaft, and the criminals are not stealing from some faceless bank, or another criminal, or an uber wealthy individual. Instead, today's crimes often involve a guy sitting in his basement with a computer in a country 10 time zones away, insidiously trying to get you and me―regular folks―to transfer them $500, or a $1,000, or tens of thousands of dollars.

Today, financial fraud is everywhere. And I still find myself fascinated by the stories. I recently read a crazy one where the writer was scammed out of $30,000, supposedly by the guy who was going to build him a swimming pool―only it turned out that a criminal was impersonating the swimming pool builder, who wasn't even aware that someone had hacked his email account and was pretending to be him.

I read these stories with this kind of dark fascination, wondering how people could possibly be so gullible, so trusting, so careless with their money. And probably like a lot of you, I think, "That will never be me."

But it's not true. It might very well be me someday. Or you, dear listener, because the level of sophistication of financial scammers, especially with the increasing use of artificial intelligence, is going up at an exponential pace. And none of us are immune.

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to.

Coming up in just a few minutes, I am going to dig into the ever-changing landscape of financial fraud with DJ Johnson, managing director for financial crimes risk management here at Charles Schwab. I think you'll find this a really interesting conversation, as DJ and I discuss the latest kinds of scams and smart steps we can all take to help ensure that we don't become victims.

But first, a quick look at some of the issues making headlines right now here in Washington.

Topping the list is the latest scramble on Capitol Hill to avert a government shutdown. New House Speaker Mike Johnson finds himself squarely on the hot seat just three weeks into his Speakership as he tries to avoid a government shutdown on November 17. He announced a two-tiered approach last weekend, which would extend funding for some federal agencies until mid-January and funding for the rest of the government through early February. It's an unusual approach that some on Capitol Hill find unnecessarily complicated. But Johnson did not include any controversial policy provisions or spending cuts in the proposal in order to attract some Democrats. And he did not include emergency aid for Israel, Ukraine, or border security in the package, something that probably won him some Republican support, since Republicans would prefer separate debates on those requests. A straight extension of funding until early 2024 is the likely back-up plan.

This all continues to be a very fluid situation, but there is one powerful driving force that has been pushing a grudging Congress toward a deal: the Thanksgiving holiday. No one wants to be here in Washington next week.

As I record this mid-week, nothing was certain, but the growing consensus is that the real fight over government spending―and the risk of a government shutdown―will be pushed to early 2024.

Elsewhere, President Biden met Wednesday with Chinese President Xi Jinping on the sidelines of this week's Asia-Pacific Economic Cooperation conference in San Francisco. It was the first direct communication between the two leaders in exactly a year, since a November 14, 2022, meeting in Indonesia during last year's Group of 20 summit. Since then, relations between the two countries hit a new low when a Chinese spy balloon floated across the United States in early 2023 before being shot down by the U.S. Air Force.

But in recent months, there's been a slow but persistent movement towards a thawing of U.S.-China relations. A parade of senior U.S. diplomats have been to Beijing to lay the groundwork for a Biden-Xi meeting, including Secretary of State Antony Blinken, Defense Secretary Lloyd Austin, Commerce Secretary Gina Raimondo, and Treasury Secretary Janet Yellen.

This week's meeting yielded few dramatic breakthroughs, but it was an important meeting, nevertheless. Biden and Xi discussed a host of issues, including Ukraine, Israel, and Taiwan, as well as economic and trade issues, including a discussion on artificial intelligence that could be an area where the two countries can build cooperation and trust.

Finally, even though the 2024 campaign has been underway for months, it feels like last week's off-year elections were kind of the official kick-off of the run to November 5 next year. While Democrats had a good night last week with key wins in states like Kentucky, Ohio, and Virginia, off-year elections are almost entirely focused on local issues. It can be tempting to try to extrapolate what they might mean for a national election next year, but they're rarely much of a predictor.

On the presidential front, South Carolina Senator Tim Scott surprised a lot of people last weekend when he announced that he was suspending his campaign. Scott had raised a lot of money and had campaigned tirelessly in Iowa, but he was never able to move his polling numbers out of the low single digits. Scott will continue to serve in the Senate―in fact, he is not up for re-election until 2028. And he's the top Republican on the Senate Banking Committee, which means he's in line to become chairman in 2025 if, as many analysts expect, Republicans recapture the Senate next November.

It will be interesting to see whether Scott leaving the race has any benefit for his South Carolina colleague, Nikki Haley, who has seen an uptick in her polling numbers over the last three months, though she still trails former President Trump by 30 or more points in national polls.

Recapturing the Senate became significantly easier for Republicans last week, when Democratic Senator Joe Manchin of West Virginia announced he would not be running for re-election. Manchin has always been a bit of an electoral outlier, a moderate Democrat representing a ruby red state that gave former President Trump his second-largest margin of victory of any state in 2020. Manchin's seat is virtually certain to flip to the Republicans next year, with popular two-term Governor Jim Justice the most likely winner. That would mean Republicans would need to flip only one more Democrat-held seat in the Senate to recapture the majority. With extremely close races shaping up for Democrat seats in Ohio, Montana, Nevada, Pennsylvania, and Wisconsin, as well as the seat held by Independent Senator Kyrsten Sinema in Arizona, Republicans are confident that they will take back the Senate next year.

On my deeper dive today, I want to explore the world of fraud and scams that are, unfortunately, an all-too-common reality of today's globally interconnected financial world. To do that, I'm really pleased to welcome to the podcast DJ Johnson, who is the managing director for financial crimes risk management here at Charles Schwab. In that role, he is responsible for the firm's anti-money laundering, anti-bribery, cybercrime, and fraud prevention efforts. Prior to joining Schwab, he spent more than 25 years with the FBI, serving as a senior executive in the agency's Criminal, Cyber, Response, and Services Branch, overseeing worldwide investigations. He has unparalleled experience in understanding the ever-changing landscape of financial fraud and what can be done about it. So thanks so much for joining me, DJ.

DJ JOHNSON: Hey, super glad to be here, Mike. Thanks for having me.

MIKE: Well, let's begin with just getting your perspective on the scope of this problem. How much money is lost to financial fraud each year, and how many people are victimized?

DJ: Big scope and big losses. So I'll reference a couple of annual reports. 2022 is the latest complete annual reports that we have. The first is from the Federal Trade Commission. They reported 3.7 million fraud and identity theft reports, and about $8.8 billion in fraud losses in 2022. The FBI's Internet Crime Complaint Center, or IC3, received a little more than 800,000 reports of fraud, and estimated fraud losses were around $10.3 billion, so very significant. To bring you up to date, in 2023, the FTC is reporting year-to-date 2.6 million fraud and identity theft reports, 6.3 billion in fraud losses.

I'd like to provide some context around those numbers and note that generally when it comes to reporting fraud, we know people are not going to report every time they are victimized by a fraudster. And so I believe it's fair to say that these numbers are probably on the lower end of the range.

MIKE: That is absolutely a lot of money. But I'm guessing that while there are undoubtedly some very big scams, the bulk are likely thousands of smaller incidents, right?

DJ: Yeah. So the vast majority of fraud are isolated incidents. Average loss per report to the FTC is around $1,300. Phishing and imposter scams are the most prevalent.

Let me just take a minute and talk a little bit about phishing. I think most people are going to know what it is, but in the event not everybody does, phishing really is the practice of sending fraudulent communications that appear to come from a legitimate and reputable source, usually through email, text messaging. Typically, those emails will include an attachment or a link for folks to click on. The attacker's goal really is to steal money, gain access to sensitive data and login information, or to install malware, or malicious software, on the victim's device.

Let me talk a little bit about imposter fraud here. So there are a couple of different variants of imposter fraud that I'd like to highlight here. The first is where the fraudster impersonates the customer to obtain information. So an example of this is where the fraudster calls a financial institution call center and impersonates a customer to collect or change data. Another example is where a fraudster will call a financial institution call center and impersonate the customer to initiate or complete a financial transaction.

Investment scams are the costliest version of fraudulent schemes, per the Federal Trade Commission and IC3. The average loss there is about $5,000. In this type of scam or fraud, the bad actor presents themselves as investment brokers and convince customers to send money, typically by wire, for phony or illegal investments that offer high and/or guaranteed rates of return.

Cryptocurrency investment scams are very popular these days. Why? A couple of different reasons. One is, I don't think a lot of people truly understand a lot about cryptocurrency, and the bad actors know that it is an easy way for them to extract money from clients. And they know it's difficult or more difficult for law enforcement to trace and recover those funds.

MIKE: Well, let's talk about who are the targets here. Certainly, we read and hear a lot about elder fraud, in particular, where scammers prey on older people who perhaps aren't as technologically proficient, or who are more isolated and maybe don't hear much about scams, or don't have a family member that they can talk to and warn them off of something. But with the numbers you've cited, it must be a much wider group of people who are being scammed.

DJ: It is very wide, very broad. So individuals in the 30 to 39 age bracket, they account for the most reports to the IC3, and they account for about $1.3 billion in losses. However, seniors, those that are 60 and older, have fewer reports, but the losses are much more significant, $3.1 billion in 2022.

So, really, everyone is being scammed, but seniors are losing the most money, on average, per scam. And why is that the case? So going back to my FBI days, I'll quote the famous bank robber Willie Sutton. So when he was asked why he robbed banks, his response was, "That's where the money is." And that's where the money is today, too, with our senior population, as they hold the majority of financial assets in the United States.

I touched a little bit about phishing, the most common type of scam reported to the IC3. It covers all age groups due to the prevalence of emails and texts, and how many people use those particular communication techniques.

Older clients are more typically targeted by tech support or customer support scams more than any other age group. What we see here is that an imposter who is representing themselves as a tech support or customer support person will contact the victim and basically convince them that they need to fix something on their computer or provide a particular service to them. And when they are given access to the computer, the bad guys will either install malicious software, malware, or sometimes they'll even gain remote control access to the machine to glean whatever they can that would be of value to them.

Senior investors are quite often taken advantage due to their unfamiliarity with online banking and technology, and they also could be suffering from diminished financial capacity. So this population is so important to Schwab that we have developed a special team to investigate fraudulent activity involving our elderly clients. We believe that is absolutely the right thing to do to protect our clients here at Schwab.

MIKE: I absolutely agree with that. One of the things that's always fascinated me when I read stories about financial fraud, you know, a lot of the victims are quite sophisticated, and they're savvy people. They're sort of people that make you wonder how could they possibly have fallen for that. So why does that seem to happen so often?

DJ: A couple of different thoughts here and perspectives. So, first, the fraudsters will play on people's emotions, and many of these types of scams evoke a sense of urgency, which causes individuals to act quickly or impulsively. If a victim believes someone they care about is in trouble, such as in a grandparent scam, or they are personally in trouble with authorities, such as in a government impersonation scam, they're likely to provide payment, as opposed to risking the potential consequences. So I am a big fan of hitting the pause button. It's always a good idea if you think you're potentially being the victim of fraud.

The phishing scams I mentioned earlier, easy to fall for, as people are often distracted. They want to expedite a transaction or transfer, and, therefore, they don't always verify the request for information. It's common to receive requests from financial institutions and other businesses asking for information. So we ask our clients to be diligent in verifying any email, text, or phone call which requests personal information.

Second, bad actors are leveraging technology and constantly adapting and improving their craft. The complexity of the techniques and schemes has increased over time, and this makes it more difficult for victims to differentiate between a legitimate actor and a fraudster.

MIKE: You mentioned that these criminals are often evolving very quickly. You know, you talked about phishing. You talked about some of the other scams. Are there other kinds of fraud and scams that you're seeing most frequently right now? Like kind of what are the hot things that are going on right now?

DJ: In terms of channel across the industry, we see a lot of fraud around wire fraud. And those involve fraudulent wires that are sent due to a client's online credentials being compromised. We're also seeing a lot of fraud around certain payment platforms. I'll just highlight Zelle as one of those. They're becoming more popular for fraudsters because they're becoming more popular for clients and for individuals to use. It's easy, it's faster, and they've just become more popular over time.

With regard to scams, we've already talked about the computer and the technology scams, we see a lot of those. We continue to see a lot of romance and emergency scams. So in these types of situations, the fraudster tricks the victim into believing the parties have a relationship, so the victim will act. A lot of the information that is used to social engineer the victim may come from social media, like a networking or gaming or dating site. And the bad actors will typically present themselves as a U.S. citizen located overseas, or a U.S. military member deployed overseas, or a known or mutual connection in need. And what the bad actors do is they leverage the relationship to persuade the victim to send money, or provide sensitive information, or purchase something.

We talked a little bit about investment scams. Those continue to be very popular.

That's a good chunk of what we're seeing today.

MIKE: Well, DJ, I wanted to ask you about AI. Artificial intelligence has, obviously, exploded into the mainstream in 2023, with lots of people using ChatGPT and other types of tools. But that, of course, means that AI is starting to be used for nefarious purposes as well. My wife actually asked me recently about this ability of some scammers to use AI to make exact replicas of your voice just based on manipulating a recording of a few words you said somewhere. And as someone who has got like 100 podcasts out there in the ether, there's a lot of my voice that people can find. So my wife was not excited about that when she read something about this type of scam. But to what degree are you seeing artificial intelligence play an increasing role in financial fraud, and how are you thinking about combating that?

DJ: Super important topic these days, Mike, as you know. We're thinking about AI every day, all day long. It's one of those generational technology leaps that will really impact the world. And much good will come from it, and we also know that bad actors will try and leverage that technology, like you said, to do nefarious things.

To give you an example, shortly after the release of ChatGPT last year, cybersecurity experts found criminals discussing various ways to use that software to generate phishing emails and text messages to potentially scam victims, as well as have that program write scripts for malware, malicious software, as well as ransomware.

So very much a significant area of potential concern for financial institutions moving forward, in particular, looking at the use of AI to bypass voice biometric authentication, as well as the technology being used against clients to pose as family or friends to perpetrate scams.

Here at Schwab, we're continuously evaluating our security measures against any emerging threat, real or perceived, and AI is no exception. We also ask our clients to continue to employ the diligence that they do today, and have in the past, to verify emails, verify text, verify phone calls, and be on high alert due to this new technology being used for social engineering.

MIKE: DJ, as you know, one of the big challenges in this space, and you mentioned this earlier, is that victims are often reluctant to come forward, and often that's just because of embarrassment. But we also frequently hear that even when they do come forward, they have trouble getting anyone to pay attention to them, and the fraud department at their financial institution is maybe overwhelmed, local police don't have the resources, and while the FBI is interested in these scams, I think a of people feel like their scam, what they're a victim of, is probably too small for the FBI to bother with. So what should victims do? Who should they call?

DJ: Yeah, if someone believes they're a victim of a fraud or a scam, no loss is too insignificant. They just have to report it, right? And there are a couple of different places that I would recommend they report it.

So let's start with time is of the essence. There is no value in delay here. As soon as somebody feels like they might be the victim of a fraud, they got to report. If they're a Schwab client, and if they believe they have sent money from a Schwab account to a fraudster, then they should reach out to Schwab. Whether it's the 800 number or to an FC in a branch, just report it, please. The sooner we have the information, the sooner we can act, and the sooner, if money went outside of the firm, we can try and recover those funds. Timing is really, really important.

Reporting also should be made to law enforcement. Local law enforcement, should be contacted. Mike, you mentioned the FBI's IC3. Again, that is another place to report that information. What they do is they connect the dots, they analyze the information, and they aggregate that reporting, and they disseminate it to the appropriate agency or organization for further action.

And then a couple of other thoughts in terms of places to report is the Federal Trade Commission, or FTC; the attorney general's office in the state that a person resides; and then the U.S. Postal Inspection Service.

Now, I'm not advocating that individuals report to all of these agencies, but certainly if you're a Schwab client and you've sent money outside of Schwab, let Schwab know. Let your local police department know, and let the FBI know, at a minimum.

MIKE: Well, DJ, when someone calls you at Schwab, or calls the Schwab team, and reports the situation, how do you handle that? What does Schwab do? And, also, what is Schwab doing to prevent them from happening in the first place?

DJ: We take security very seriously here at Schwab, Mike, and as part of our commitment to that security, we're always updating our technology stack, updating our skillset of our people and our protocols to keep our clients personal and financial information safe.

Although I can't share the details of our security measures, here are a few ways we protect our clients. One, we're constantly monitoring the traffic coming into Schwab, and we're protecting and preventing access to that information as appropriate. We often use the analogy of the castle with a moat and fences, and that's the type of defense and depth and layered approach that we take to our security here at Schwab. A couple of other examples of these fences, if you will, or moats, would be encryption and risk-based security technology. Those all add to our security posture here.

And then behind all of that, we have a lot of different teams that are really focused on this particular issue. Just to highlight a few of them, our Fraud Risk Management Team is responsible for a series of controls to mitigate fraud risk, to protect our clients and the firm. They look to prevent fraud whenever possible. They identify potential fraudulent activity on our platform, and when they can, they stop that activity. And just to highlight something here, if somebody is calling into Schwab to send out a wire transfer or a transaction, and one of our employees pauses to ask questions, it goes back to that sense of urgency idea that I brought up earlier, right. We're hitting the pause button because we want to take a minute to make sure that you are who you say you are, and you have the authority and the ability to send those funds outside of Schwab. So  I know how those questions can be frustrating at times, but at the end of the day, we're just doing that to protect you, to protect our clients, and to protect our firm. So please be patient with us. It's super important.

Sort of adding onto the additional teams here, we have a team of fraud investigators who conduct investigations, recover funds, and file reports that we're required to file by our regulators. And as I mentioned previously, we have a dedicated team focused specifically on fraud related to our senior client base.

Let me wrap up by just highlighting the Schwab Security Guarantee here. So the Schwab Security Guarantee covers losses in any of your Schwab accounts due to unauthorized activity. And I would encourage all of our clients to visit schwab.com/schwabsafe to familiarize yourself with the terms and conditions that apply to that guarantee.

MIKE: Well, DJ, this is great. It's been really, really interesting to get this kind of in-depth look at how you battle these different and evolving scams. But I want to end by getting your thoughts on what we should all be doing to protect ourselves. You're obviously on the front lines of this fight at Schwab, so you see what's happening, and how quickly the bad guys are changing their game. What do you do to protect yourself?

DJ: I do a few pretty simple things that I feel are adequate to protect myself from a cybersecurity perspective. But before we get to those, let me just give you a couple of other highlights in terms of how I think about cybersecurity, and how I protect myself sort of generally from fraud.

So first and foremost, I view cybersecurity as a partnership. It is a collective effort. We all have roles to play and responsibilities to bear. We can't do it by ourselves.

Second, education is key. We've been chatting a little bit about how quickly fraudsters are adapting their tactics, how they leverage technology to employ more complex techniques to commit fraud. So staying abreast of technology enhancements and tactics and schemes is extremely important.

Third, we have some free tools for our clients to employ and protect themselves. And here are a couple of those that I use, as well.

Two-factor authentication. I highly recommend it to all our clients. After you enroll in two-factor authentication, every time you login, you'll be provided with a one-time password that you will also enter in that provides just additional protection to your accounts and makes life a lot more difficult for fraudsters.

I'd also recommend that clients set up security alerts. These allow you to receive notifications so you'll know immediately when activity occurs in your accounts. This is important because the faster you know, the faster you can report, and the faster we can take action if we need to protect your assets.

And a couple other things that are available to clients: You can sign up for voice ID and add a verbal password for additional layers of protection. And then I'm going to go back to really simple, good cyber hygiene techniques, super basic fundamentals here―start with utilizing unique and different passwords across different websites. I know that makes life a little bit more complicated, but a very valuable technique. Consider utilizing a password manager to manage your passwords. That just makes your life a lot easier. It makes my life a lot easier as someone with way too many passwords. And then I would say utilize quality antivirus software on all of your devices and install updates immediately.

So these are all super simple things I do, not that difficult to do, not expensive, most are free, and it's just a fundamental way for me to protect myself, and I think our clients should do the same. To find more information about these tips and techniques please visit schwab.com/schwabsafe. Let me repeat that one more time, schwab.com/schwabsafe.

MIKE: Well, that's great advice, very simple advice. I certainly confess, I'm one of those people who uses the same password on far too many websites, and I'm going to vow to change that based on this conversation. So, as you said, there's lots of things that we can do, and that's one to very easily protect ourselves. And, you know, it may come at the cost of a small, minor inconvenience, but, obviously, a small price to pay compared with what any of us stands to lose if we fall victim to one of these frauds.

So, DJ, really appreciate you sharing your perspective and making the time to be with me today.

DJ: My pleasure, Mike. Thanks for having me.

MIKE: That's DJ Johnson, Schwab's managing director for financial crimes risk management.

Well, that's all for this week's episode of WashingtonWise. We're going to take a little break for the Thanksgiving holiday, so we'll be back with a new episode on December 7. Take a moment now to follow the show in your listening app so you don't miss an episode. And if you like what you've heard, leave us a rating or a review—those really help new listeners discover the show.

For important disclosures, see the show notes or schwab.com/washingtonwise, where you can also find a transcript.

I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, have a very happy Thanksgiving, and keep investing wisely.