RPF0651-Can_You_Invest_Better_Than_a_Hedge_Fund

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00:00:15.880 | Welcome to Radical Personal Finance, a show dedicated to providing you with the knowledge,

00:00:18.840 | skills, insight, and encouragement you need to live a rich and meaningful life now while

00:00:23.560 | building a plan for financial freedom in 10 years or less.

00:00:27.360 | Today we tackle a subject on the show that we have not tackled adequately for some time,

00:00:31.800 | and that is investing wisely.

00:00:38.040 | The subject of investing is massive and can be applied to many aspects of life, but specifically

00:00:44.120 | today we're going to talk about stock market investing with somebody who is actively involved

00:00:48.920 | in the business.

00:00:49.920 | My guest is John Medford.

00:00:51.400 | John, go ahead and take a moment and introduce yourself, please.

00:00:54.680 | Share a little bit about the work that you are currently involved in.

00:00:56.960 | So my audience can get a context of how you're coming to this conversation, please.

00:01:02.120 | Sure.

00:01:03.120 | So thanks for having me.

00:01:06.360 | I am a partner at an investment firm that invests entirely in publicly traded stocks

00:01:16.720 | in the US and in Europe.

00:01:18.720 | We've been in business for about 15 years.

00:01:21.880 | We manage about a billion dollars mostly for high net worth individuals, endowments.

00:01:28.400 | We're more specifically a hedge fund, which is a dirty word, but basically just means

00:01:34.440 | because we're really good at what we do, we're able to charge more in fees, but it doesn't

00:01:39.600 | have perhaps connotations that typically are associated with it.

00:01:43.120 | So John Medford is not the name that John was born with by his parents, and that's what's

00:01:48.040 | giving us the opportunity to dig into some of the things that we're going to dig into.

00:01:51.240 | So the reason that I wanted to have John on is because in this context, we can talk with

00:01:56.580 | somebody who's actively involved in the business.

00:02:00.240 | It's a real challenge for somebody like me, who is a podcast host, to try to find interesting

00:02:05.800 | guests who are able to bring an honest inside look to the marketplace without having a significant

00:02:15.080 | conflict of interest.

00:02:16.760 | Generally interviews have to be run through the legal team for compliance reasons.

00:02:22.240 | Generally people who are on the show are actively pitching something.

00:02:25.600 | It's just a challenge for me to give inside information.

00:02:28.800 | And so John is on the show here, and again, John is not the name that his parents dubbed

00:02:32.800 | him with, and that gives us the opportunity to chat inside about what's actually going

00:02:37.320 | on from somebody who's working in the business.

00:02:40.080 | First John, I'd like to start with just a quick intro on how important returns are and

00:02:47.000 | what this benefit is.

00:02:48.600 | Because in personal finance, at this point in time, the safe solution for me as a broadcaster,

00:02:54.120 | as somebody who's encouraging people to be thoughtful and careful with their money, the

00:02:58.320 | safe solution that won't result in my getting fired is to recommend to all of my listeners

00:03:03.600 | that they take all of their money and that they invest it into index funds.

00:03:08.200 | And certainly I don't think that's an ineffective solution, but I also always look at those

00:03:14.160 | returns, and I always think, "But if you could get a little bit higher, it could do a little

00:03:19.400 | bit better."

00:03:20.400 | So talk for just a moment about how, when you're working in your hedge fund, what your

00:03:25.560 | returns have been and how they compare to your competitive returns that you're being

00:03:31.040 | measured against, your benchmarks.

00:03:32.680 | Sure.

00:03:33.680 | So, look, most funds don't do a good job.

00:03:40.720 | The vast majority of funds are going to underperform their benchmarks, which is why index funds

00:03:46.400 | are so popular, and rightfully so.

00:03:48.040 | I think Warren Buffett's been asked what he'd recommend folks do, and he always recommends,

00:03:53.960 | "Unless you're going to do it professionally, you invest in index funds."

00:03:58.680 | And I think he had a famous bet with some prominent people that ran hedge fund funds

00:04:04.160 | that the index would outperform their five or ten best chosen hedge funds over time,

00:04:10.520 | and lo and behold, he's won that bet pretty handily.

00:04:13.960 | So in terms of our returns historically, look, we were, for a long period of time, a smaller

00:04:21.320 | firm.

00:04:22.960 | We do a lot of quirky stuff.

00:04:25.240 | We're exceptionally passionate about what we do.

00:04:27.240 | We spend almost all our time doing it.

00:04:30.200 | I love what I do.

00:04:31.200 | I find it really fun, like, so engaging.

00:04:33.400 | I've been doing it for ten years at this point, but doing it informally since I was

00:04:39.600 | probably closer to 20 years.

00:04:42.240 | My partner who founded the business has been doing this professionally about 15 years,

00:04:46.960 | and our track record's really good.

00:04:47.960 | So we've compounded our capital since inception at about 18% a year.

00:04:57.000 | The market over that time has delivered, call it, 80-ish percent, roughly.

00:05:05.800 | Now that said, that's our gross return, so that's what, as investors in the fund, we

00:05:11.680 | would get on our capital invested in it.

00:05:13.440 | If you were to look at an external investor who has to pay fees, that number gets closer

00:05:18.920 | to about 12.5%.

00:05:22.760 | The reason that Delta's so high is essentially, call it a 5.5% expense ratio.

00:05:29.320 | But the reason we can charge that is we're generating excess return, and so some of that

00:05:33.760 | comes to investors and some of it comes to ourselves.

00:05:37.160 | Even despite charging those fees, we still have an attractive product with a lot less

00:05:40.840 | volatility.

00:05:41.840 | Here is why I think these numbers are so important, and I wanted to lead with them.

00:05:46.320 | I think that in many ways, people like me in the personal finance space have become

00:05:51.880 | cavalier about returns and their impact on people's wealth.

00:05:56.040 | I'm very nervous using high predicted rates of return because I don't know how to tell

00:06:00.280 | a broad audience of people, "Here's how you get these returns."

00:06:05.120 | And the other thing that's challenging is doing this at various points in the market

00:06:08.760 | cycle.

00:06:09.760 | I think over the last few years, almost anything has done well, but it's not always that way.

00:06:15.920 | But if we look out over a lifetime of investing, rate of return is massively important, and

00:06:20.640 | it's especially important as your wealth grows.

00:06:23.300 | In the beginning, the most important number is how much you save, and that's for most

00:06:26.880 | people going to be driven by your income.

00:06:28.920 | But quickly, as your investments grow, you quickly get to the point where the most important

00:06:33.480 | return number is the investment rate.

00:06:36.600 | And so here's to put this into context, how important this conversation is for the average

00:06:41.000 | person.

00:06:42.000 | Let's say you're investing over a 40-year career from 25 to 65, and you're putting aside

00:06:47.280 | just a measly $5,000 per year.

00:06:50.180 | You're making a Roth IRA contribution at $5,000 per year, starting with nothing.

00:06:55.280 | At an 8% annualized return, your investment portfolio at age 65 would be expected to be

00:07:02.000 | about $1.4 million.

00:07:04.800 | Not bad, especially for putting aside $5,000 per year.

00:07:08.560 | But at an 18% rate of return at 65, your investment portfolio would be $24.5 million.

00:07:17.200 | Now let's use the retail rate of 12.5% for somebody who is investing with you, John,

00:07:22.280 | not you.

00:07:23.280 | It's $5 million.

00:07:24.680 | There is a huge, meaningful difference for actual spendable income, actual impact between

00:07:32.480 | $1.4 million and $5 million, and there's an even bigger impact between that and $24.5

00:07:40.800 | million.

00:07:41.920 | So this matters hugely.

00:07:43.960 | And I get really bothered because I've succumbed to this idea of saying, well, you can't get

00:07:49.080 | returns, market's efficient, et cetera.

00:07:51.680 | And yet it's too important to just leave alone.

00:07:54.480 | So to begin with, John, I don't want you to get into details, but let's say that you were

00:07:57.800 | advising me, and knowing that you can't just say, well, buy my fund, because that's not

00:08:03.040 | an opportunity in this context, how do you advise me to think about my stock market investing

00:08:08.040 | dollars, knowing that I really want return, but I don't know how to get it?

00:08:14.200 | Even though I'm doing this not under the name my parents gave me, I will give the usual

00:08:20.240 | disclaimer that I just pick stocks, and I've done that for a long time, and I have my opinions

00:08:25.360 | about the way people might do things, but you should reach your own conclusions on that.

00:08:30.960 | But I can opine on that with that caveat.

00:08:34.560 | Look, you said this on your show, I think it's a really interesting concept.

00:08:41.480 | I'm good at what I do.

00:08:43.160 | I'm very bad at lots of things in life.

00:08:46.960 | I happen to be good at this, and I love it.

00:08:50.760 | And it so happens that I believe if you devote yourself to one thing, and try and become

00:08:56.560 | very good at it, and you're of reasonable intelligence, and you are humble, and you

00:09:04.600 | have a lust of learning and curiosity, I think you can be good at it.

00:09:11.040 | I think if you don't do that, you might be able to also be good at it, but it's a lot

00:09:16.360 | harder.

00:09:17.360 | So I would say in many respects, I'm not good at very many things, but it happens to

00:09:21.080 | be one thing I'm good at.

00:09:22.440 | And so for that reason, I think it makes sense to do it.

00:09:28.120 | My choice is basically investing in stocks.

00:09:30.160 | Now it's horribly tax inefficient.

00:09:32.320 | If I think from a standpoint of if I was just maximizing my wealth, I wish I would have

00:09:36.560 | spent more time understanding real estate, given the tax characteristics of that.

00:09:41.680 | I think ultimately, the first question is, is there anything that you happen to be really

00:09:46.880 | good at or can develop a skill at?

00:09:49.480 | And if it is, I think that tends to be the best place to put your money.

00:09:53.920 | Now, realistically, if you have a full time job, and that job doesn't involve investing,

00:09:59.960 | it's difficult to develop that competency, at least right away.

00:10:04.000 | So a couple of things I can say on this.

00:10:07.200 | So one, generally index funds are probably the best, but there's some huge caveats to

00:10:13.040 | that.

00:10:14.040 | When you invest matters a lot.

00:10:15.600 | In general, the market returns have been, call it 7%.

00:10:19.520 | I don't know where the numbers are, roughly 7% over a very long period of time.

00:10:24.960 | But depending on when you invested, that return can be very different.

00:10:27.640 | So for example, if you happen to invest at the top of the internet bust to today, your

00:10:34.120 | returns would still actually be pretty decent, but they'd be much less good than if you started

00:10:39.440 | your investing in 2009.

00:10:41.040 | Now, this isn't an issue if you're putting $5,000 a year, but to the degree you have

00:10:46.680 | a meaningful bonus or inheritance or something like that, and you decide to put all your

00:10:51.480 | money into index funds at one point in time, that can result in some pretty bad scenarios.

00:11:00.520 | So look, if you're going to invest in a stock market, I think index funds are definitely

00:11:05.360 | reasonable.

00:11:06.360 | I think one just needs to be careful about the returns that one underwrites.

00:11:10.640 | I think from today, my personal opinion, is that it's not going to be as good as it has

00:11:15.200 | been historically, even if you look out over a 20 or 30 year period, at least on a real

00:11:19.440 | basis.

00:11:22.000 | But I've been wrong on that, and that's not an area of confidence of mine.

00:11:25.640 | If you do actually want to invest personally in a stock market, I think it's great to try

00:11:31.360 | to build a competency.

00:11:32.360 | I strongly believe that someone that really devotes themselves to stock analysis can actually

00:11:40.480 | build a skill and make money, especially in smaller companies, but it's just something

00:11:44.120 | that takes a lot of time.

00:11:45.120 | And so when I started investing in college, I'd say the first eight years I was in this

00:11:50.280 | business, even before I was doing it professionally, I didn't know what I was doing.

00:11:55.040 | And I had basically had 90% of my money in index funds.

00:11:58.200 | I think at that time, index funds weren't as popular, so maybe it was actually mutual

00:12:01.560 | funds, which in retrospect, I wouldn't have done.

00:12:03.640 | And I had 5% or 10% in individual stocks, and I treated that 5% to 10% as not necessarily

00:12:10.200 | gambling money, but as experimental money.

00:12:12.400 | And then I watched my returns, and I thought about, I tried to be honest with myself about

00:12:17.760 | my capabilities, and if I thought I was doing a good job.

00:12:21.800 | And as time went on, I devoted more time to it, I decided to put more and more money away

00:12:26.660 | from ETF and into individual stocks.

00:12:28.760 | But had I not devoted myself to my profession in that way, I wouldn't have done it.

00:12:33.560 | I would have found something else that I could have compounded money at in a better way.

00:12:38.400 | >>DAVE Well, just as a personal finance observer,

00:12:41.800 | I would illustrate, with your being the partner, an investing partner in an almost billion

00:12:50.040 | dollar hedge fund, you can do both things.

00:12:53.160 | You have an incredible synergy in that position of being able to earn a lot of personal income

00:12:59.540 | using a form of synthetic equity, using other people's money, and to invest at the very

00:13:04.720 | highest rates, and to invest a lot of money by using other people's money.

00:13:08.840 | That's why so many intelligent, bright people go to the investment marketplace.

00:13:12.840 | So you're doing great for you, but I'm going to go back to for the rest of us.

00:13:18.560 | So I agree with you in terms of it seems to be a, it's not a consensus, it seems to be

00:13:23.880 | a highly echoed prognostication that future returns will not, over coming decades, for

00:13:31.560 | the market in general, would probably not be as generous as they have been for some

00:13:36.920 | of the past decades.

00:13:38.960 | What's the argument though?

00:13:40.320 | What are the headwinds that are causing so many people to believe that, and Warren Buffett,

00:13:46.160 | just to pick on the most commonly thrown around name, many people are saying there are major

00:13:51.760 | headwinds.

00:13:52.960 | What's the argument for that position?

00:13:54.520 | >>JASON Okay.

00:13:55.520 | So I'm going to narrow this a little bit.

00:13:58.760 | So I'm going to say developed markets, I'd say US and developed Europe, I'm going to

00:14:06.680 | ignore emerging markets.

00:14:08.880 | I don't have a strong opinion on emerging markets.

00:14:11.520 | My bias would be that those might do better.

00:14:15.360 | But if you look at developed economies, a few different things.

00:14:19.440 | One is in general, we're moving towards a society, we've had a two and a half to 3%

00:14:25.400 | tailwind as an economy from more people being born in most developed countries, especially

00:14:32.280 | countries that speak English, that tailwind is starting to reduce.

00:14:36.440 | In certain countries like Japan, it's become a headwind.

00:14:40.920 | So it's harder to grow your economy when you're not growing your people.

00:14:46.240 | The second thing I'd say, if you think about the US kind of where we were 50 or 75 years

00:14:50.360 | ago, it's just a different environment than we have today.

00:14:54.880 | That's one.

00:14:55.880 | Two, stocks are, this is going to get a little bit technical, I assume it's okay if I get

00:15:02.120 | slightly technical.

00:15:03.120 | >>COREY Go ahead.

00:15:04.120 | >>JASON All right.

00:15:05.120 | So when you own a stock, you own a portion of a business and that business has a price

00:15:12.160 | attached to it.

00:15:13.640 | There are X number of shares and so you get a price per share based on the total value

00:15:19.360 | of the enterprise and how many shares there are.

00:15:21.840 | That company, let's assume the company has earnings to make things simple.

00:15:25.360 | The company has earnings.

00:15:27.520 | People generally value stocks based on their earnings, not entirely, but let's just make

00:15:31.800 | that simplified assumption as well.

00:15:34.240 | And so when you're investing in the market, which is really just a collection of stocks,

00:15:39.540 | you have X amount of investment that's producing Y earnings and there's a multiple that's attached

00:15:48.280 | to that.

00:15:49.280 | So let's say for simplicity's sake, that multiple today are different numbers, but let's call

00:15:53.560 | it 18.

00:15:55.320 | So I have the stock, I have my index fund, let's just use, I'm going to assume we'll

00:16:02.560 | call it S&P, let's assume S&P just to make numbers simple is 100.

00:16:05.880 | So 100, I have, gosh, let's make it even more simple, so 20 times earnings.

00:16:11.720 | So let's say I have $5 earnings.

00:16:15.960 | Now over time, the investment grows a few different ways.

00:16:21.600 | One, that earnings can grow so that $5 can go to 510, 525 to the degree that earnings

00:16:28.480 | grow and the multiple stays the same, the investment grows.

00:16:32.120 | Now over time, my impression is that the earnings growth has been, call it 2% or 3% a year.

00:16:37.320 | So you have that.

00:16:38.680 | Secondly, you have capital return, which in the form of dividends.

00:16:43.200 | Dividend yield across full stock market right now is something like 2%.

00:16:47.160 | I think it's varied over time, but let's call it 2%.

00:16:49.560 | So you have kind of 5% of your return that I actually think you can feel decent about.

00:16:55.760 | Dividends are what they are.

00:16:57.920 | And earnings growth over a long period of time, I don't think there's any reason to

00:17:01.920 | think that that's changing particularly.

00:17:04.960 | Now the third factor is the multiple you put on those earnings.

00:17:08.600 | And that number varies wildly.

00:17:11.200 | And that number has a huge impact on what your return is going to give in a year.

00:17:15.320 | So simplistically, if you think about certain market environments, so 2009, I think you

00:17:21.840 | had that multiple.

00:17:22.840 | And again, these are going to be rough numbers, illustrative.

00:17:25.680 | That multiple may have dropped to nine.

00:17:28.400 | And here we are today, that multiple's call it 18, 19.

00:17:32.960 | Your return that you've gotten from the quote unquote predictable things, earnings and dividend

00:17:38.080 | yields, that's not really...

00:17:40.080 | I mean, it's rebounded some, but it's not what's driven the returns.

00:17:42.600 | What's driven the returns is people instead of willing to pay nine times that number,

00:17:46.480 | now willing to pay 18 times that number.

00:17:48.560 | And if you look over a very long period of time, there's an argument that folks make,

00:17:52.840 | which is basically you can rely on that call it 5%.

00:17:57.800 | And that multiple expansion, it's just hard to know, but all else being equal, you're

00:18:02.760 | better off when you're buying at a lower stock multiple than when you're buying a higher

00:18:06.880 | stock multiple.

00:18:07.880 | And so very simply, and you can do some math around this, if you assume over, I think,

00:18:12.520 | a 10 year period, that earnings grows, call it 5% a year, or earnings dividend gets you

00:18:18.200 | 5% return a year, but the multiple falls in half.

00:18:22.480 | I don't know exactly where that math works out.

00:18:25.080 | And Josh, I'm sure you can put something together on this, but basically you would end up with

00:18:27.760 | something that basically has no return.

00:18:29.920 | And so the real variable that moves things a lot isn't actually the underlying performance

00:18:35.160 | of the businesses.

00:18:36.160 | It tends to more be people's feeling or multiple they're willing to ascribe to those earnings.

00:18:41.680 | Yeah.

00:18:42.680 | And that's what I don't understand about many of the...

00:18:48.440 | There are some businesses that I understand that make sense.

00:18:51.880 | The company is profitable.

00:18:53.560 | They have a compelling value proposition.

00:18:56.040 | They have real customers.

00:18:59.680 | They really work.

00:19:01.280 | And I would be happy and proud to be a marginal owner of those businesses.

00:19:06.160 | There are other businesses that it seems to me have massive stratospheric desire by investment

00:19:15.920 | managers that I just simply don't understand.

00:19:18.400 | I was looking at Uber recently, and I don't want to...

00:19:22.000 | Obviously I don't want to get into individual things, but I'm just looking at this company

00:19:24.640 | and saying, massive company that can't seem to make money, basically.

00:19:29.560 | How do these things happen?

00:19:31.960 | And you look at so many of the modern companies, I don't know how to connect them to reality.

00:19:37.160 | And so I don't know if there's something that's broken with me that I'm just old fashioned

00:19:42.080 | and we're in a new world where the old rules don't make sense and the goal is to get as

00:19:45.740 | big as possible and lose money all the way through as some of the leading companies seem

00:19:49.760 | to do, or if there's something old.

00:19:52.700 | And so it causes me to be very insecure about decisions like that, especially when then

00:20:00.660 | I look at what's happening in the world.

00:20:02.420 | And as you say, the difference between nine and 18 is major.

00:20:06.040 | If you're going to value things at nine times, that's going to be a very different number

00:20:10.400 | than at 18 times.

00:20:12.100 | But then I look at the world being a wash in money, and it almost seems like do the

00:20:18.420 | old rules still apply?

00:20:20.620 | I don't know the answer.

00:20:21.620 | I'm stymied by the problem.

00:20:26.220 | I don't know the answer either.

00:20:28.340 | And I think what we do as a, this isn't maybe super satisfying, but as a firm, or just as

00:20:34.220 | a person, there are certain things I know the answer to and I feel like I'm good at.

00:20:38.660 | That's analyzing individual stocks.

00:20:41.620 | There are other things that are a lot more complicated and require a very different skill

00:20:45.340 | set.

00:20:46.340 | Like for example, trying to predict where the economy is going or trying to predict

00:20:51.140 | the multiple that people will apply to those earnings streams across a broad number of

00:20:55.500 | companies.

00:20:56.500 | That is a totally different skill set.

00:20:57.660 | I have no idea how to do that.

00:21:00.420 | That said, I can be aware it exists and I can try and carve out a niche for myself where

00:21:06.580 | I'm focused more on businesses I can understand that have been valued for better or worse

00:21:12.740 | somewhat consistently over time.

00:21:14.380 | And so what I would say, the nice thing is at least if you're investing in, I know S&P

00:21:20.460 | 500, some of the bigger indexes, there's also IVN, which I think is the Russell 2000 value

00:21:28.460 | index.

00:21:29.740 | You can avoid some of those stocks.

00:21:33.540 | Now there's an argument to me that those stocks are very attractive.

00:21:37.060 | I'm not going to make that, but I think, look, people can make money a lot of different ways.

00:21:40.820 | I mean, there are venture capital firms that invest very early in stuff and have had amazing

00:21:45.740 | returns and they literally do like two hours of work before they make a half a million

00:21:50.620 | or a million dollar investment.

00:21:51.820 | It's pretty amazing, but you have one success there.

00:21:53.940 | You find Facebook and it's paid for every mistake you're going to make.

00:21:57.820 | But look, I mean, ultimately with the stock market, it just gets very complicated when

00:22:02.700 | you start to get into little stocks.

00:22:03.940 | I think to the degree that you don't want to bet on eToys in 1999 having a $30 billion

00:22:10.780 | valuation and people think it's going to be worth that.

00:22:12.780 | And if you can find parallels today, the way you avoid that is you basically avoid, to

00:22:17.740 | the degree the more specific ETFs that have a lot of names like that in them that aren't

00:22:23.620 | generating earnings, you can generally avoid those and you do a pretty good job of that

00:22:27.020 | by choosing more boring indexes like the S&P, Dow, or potentially a value skewed index,

00:22:34.820 | which there are plenty of.

00:22:36.660 | So do you think that normal people with an above average interest in money should simply

00:22:43.780 | give up and say, "I'm just going to take market returns," or do you think that normal people

00:22:49.180 | with an above average interest in money and investing should seek to become competent

00:22:54.100 | DIY investors buying publicly traded securities?

00:22:57.500 | That's a very good question.

00:23:03.700 | It's really hard to do that, but you can do it.

00:23:09.460 | But if you're going to do that, it's a job.

00:23:12.860 | To spend two hours a week doing something, you're just not going to be competent at it.

00:23:20.540 | I don't know, to the degree you're a surgeon, someone tries to be a surgeon a couple hours

00:23:25.060 | a week, it's probably not going to go very well.

00:23:28.900 | And the thing is, if you start to spend that much time on it, I think there are probably...

00:23:32.780 | I can only speak to investing, I think it's possible to do.

00:23:35.820 | I know people that have done it.

00:23:38.460 | There are probably easier ways to do it than putting your time in stocks.

00:23:43.380 | So what I would say generally is, look, if you have a 401(k) and that's your option,

00:23:48.940 | putting it in ETFs is probably a fine thing to do.

00:23:52.940 | I think generally you shouldn't make bets about where the market is, even though it's

00:23:56.940 | going to have a big impact in returns.

00:23:58.540 | You just put in the amount that you have every year, you're just 65, you're probably in this

00:24:04.140 | with something that's okay because that money will be put in over a long period of time.

00:24:09.820 | But to the degree that you can develop a competency in something, whether it be investing or real

00:24:16.100 | estate or something else, I think you're going to find, or starting a business, I think you're

00:24:19.740 | going to find a lot more attractive returns there than you are just putting your money

00:24:26.380 | in an ETF.

00:24:27.940 | So let me hone in on something then, because I want to understand the difference between

00:24:35.340 | your abilities as a professional hedge fund manager versus mine.

00:24:40.100 | The thing that bothers me about stock market investing, just to use what I mean is purchasing

00:24:46.740 | publicly traded securities for large companies.

00:24:51.180 | The thing that bothers me in trying to choose, do I want to put together a portfolio of blue

00:24:55.140 | chip stocks or this kind of thing?

00:24:57.660 | What bothers me is I don't see where my competitive advantage is in that market.

00:25:02.420 | Let's stick with real estate versus stocks.

00:25:04.380 | I can understand where my competitive market is to find, or my competitive advantage is

00:25:09.420 | to find a below value property in a neighborhood in my town, because I can understand which

00:25:17.540 | neighborhoods are coming up, which neighborhoods are going down.

00:25:20.300 | And I can go out on a Tuesday evening and drive around with my children in the back

00:25:24.460 | seat and I can look for houses that look dilapidated, that look like there might be something happening,

00:25:30.580 | and I can start to go and knock on doors and ask people if they know anyone on the street

00:25:34.140 | that they might want to sell their house.

00:25:36.220 | I'm doing work that is in such a tiny market that it's very reasonable that I could be

00:25:44.500 | one of, if any others, one of only a few other people who are actually canvassing that market.

00:25:54.300 | But if I go to US listed securities exchanges, there are, I don't know the number, at least

00:26:00.940 | hundreds of thousands of people who are scouring these same handful of some few thousands of

00:26:06.980 | companies and I don't see the competitive advantage I have.

00:26:10.940 | So what do you have as an investor that I don't have sitting at home on Yahoo Finance?

00:26:17.860 | So it's not higher intellect.

00:26:20.620 | It's more time and more resources and more focus.

00:26:24.540 | So the analogy you have is interesting.

00:26:26.500 | So you said something I think really insightful, which is you can focus on a small neighborhood

00:26:33.580 | where you do a lot of work, right?

00:26:35.460 | You know the ins and outs of that neighborhood.

00:26:38.740 | You drive around and do on the ground diligence.

00:26:41.700 | It's not just looking up on Zillow and buying a home in Nebraska when you live in Florida.

00:26:50.140 | You do it in a neighborhood that you understand.

00:26:52.300 | Stock investing isn't really too dissimilar.

00:26:55.820 | So a couple of things I'd say.

00:26:57.860 | One is as a firm, we spend probably about a million dollars a year on research.

00:27:06.140 | Now that research comes in a couple of different flavors.

00:27:10.380 | A relatively small amount of it frankly is off the shelf research.

00:27:13.540 | A fairly large part of it is what would be called proprietary research.

00:27:17.600 | So for example, if I'm researching a company, and the other thing I'd say just to make it

00:27:23.740 | simple as well is I'm not going to look at things that a thousand other smart people

00:27:29.380 | are looking at.

00:27:30.380 | I want to look in markets that are inefficient where there's lots of fear.

00:27:34.540 | These tend to be companies that aren't very well followed.

00:27:40.460 | They're not kind of popular household names or if they were popular household names, they

00:27:46.060 | no longer are and have a stigma associated with them.

00:27:48.980 | So first you start going to those areas as you would say that are inefficient.

00:27:54.220 | And the second thing is you throw a lot of intellect and time and money trying to figure

00:28:00.980 | out those neighborhoods better than anyone else.

00:28:05.300 | And that's what we do.

00:28:06.300 | So as I said, we spend a million dollars a year on research.

00:28:08.340 | What does that mean?

00:28:09.500 | That means I do, gosh, I personally probably do about 300 phone calls a year with former

00:28:16.060 | employees, competitors, customers, industry experts of businesses we're considering investing

00:28:20.980 | in.

00:28:21.980 | What else do we do?

00:28:24.100 | I can actually talk to management teams of the companies that we're investing in because

00:28:28.580 | we have access to that because we're of a scale that we can do that.

00:28:31.700 | That can help us well.

00:28:33.460 | I've been doing this for a long time now.

00:28:35.820 | So I have tremendous experiential knowledge.

00:28:38.860 | For example, we do a lot of investing in software.

00:28:41.420 | I've just have a very good sense of that market.

00:28:44.300 | I've seen a lot of patterns in terms of why people panic and sometimes sell software stocks

00:28:49.500 | that they shouldn't.

00:28:51.300 | There are whole interesting little things about that that I could talk about endlessly,

00:28:54.900 | but just from doing it for a long period of time, you see pattern recognition.

00:28:58.300 | I imagine if you're good at real estate, you would see a set of patterns that would make

00:29:04.660 | you be attracted in a deal.

00:29:06.100 | I'm making this up, but maybe it could be someone who's lived in the house for a long

00:29:10.100 | time.

00:29:11.100 | The house is not very well kept.

00:29:14.620 | Maybe it's really dirty.

00:29:15.620 | It's messy, but those are things.

00:29:17.880 | Maybe they're not using a broker or not using a good broker.

00:29:20.940 | Maybe it's on the market for a long time.

00:29:23.060 | You just see these patterns of things that tend to result in people that aren't as sophisticated

00:29:28.580 | as you haven't done it as much, that they might value those things.

00:29:31.940 | They might value the dirt on the floor at negative $10,000 on the house.

00:29:36.380 | Psychologically, you can see how that makes sense.

00:29:38.940 | Realistically, with experience, you can buy a $5 cleaner and fix it with an hour of work.

00:29:46.220 | It's not very different than getting good at anything.

00:29:51.180 | I think the challenge with the stock market is it's just like the world's casino.

00:29:58.620 | People tell you it's investing.

00:30:00.060 | I think people convince themselves sometimes investing is actually gambling, and then you

00:30:03.260 | get into a whole list of other issues.

00:30:04.860 | But chances are, unless you spend a lot of time on it, unless you have specific knowledge

00:30:10.180 | about a company or an industry, you probably don't know what you're doing, and you're probably

00:30:15.020 | going to do substantially worse than just an index.

00:30:17.620 | Let me ask you about risk.

00:30:20.700 | I personally have what I perceive to be a fairly high tolerance for risk.

00:30:27.580 | Let me define that term in two ways.

00:30:29.660 | First, volatility.

00:30:31.060 | My personal theory that I practice and encourage others to practice is keep your personal finances

00:30:39.140 | separate from your investments in this way.

00:30:41.980 | I don't know how to control for the volatility of an investment portfolio, but I do know

00:30:47.220 | how to calculate how much money I need every year and make sure that I have money that's

00:30:52.420 | not going to be volatile to provide for my expenses.

00:30:55.620 | So then, in looking at an investment portfolio, if I say this portfolio here is likely to

00:31:00.580 | be this volatile based upon historical understandings, and so therefore if I keep three years of

00:31:06.820 | cash outside of the portfolio, I could afford to leave that portfolio alone completely for

00:31:11.500 | three years, which would get me through 72.6% of the problems, something like that.

00:31:17.000 | So I segregate investing from personal finance.

00:31:20.100 | I don't want my life or my lifestyle to be subject to the risk of investment volatility.

00:31:26.860 | That helps me to be more comfortable with risk.

00:31:29.700 | A lot of people have this sense, however, that investing in the market is just this

00:31:34.960 | intensely risky thing.

00:31:37.420 | I'm a little bit more cavalier about that concept of risk, thinking that somehow if

00:31:42.460 | I buy this company, it'll go to zero.

00:31:44.860 | I'm a little cavalier because, one, I think the market is very efficient.

00:31:50.100 | There are a lot of people who are looking for things, and it's hard to believe that

00:31:53.900 | if this company were headed to zero, there wouldn't be some indications of that.

00:31:59.740 | There are a lot of people trying to find that information out.

00:32:02.260 | So yes, there are spectacular bankruptcies.

00:32:05.260 | There are spectacular failures that come from nowhere, but those are pretty few and far

00:32:09.700 | between compared to the most of the companies that just don't generally do well.

00:32:13.220 | The risk of a company going to zero is very, very modest.

00:32:18.660 | Companies have a lot of assets.

00:32:19.660 | Now, it's a little different to look at a company that's very heavily on this whole

00:32:24.100 | asset as intellectual property or an idea or an app.

00:32:27.260 | I don't know what Uber's assets are other than its user base and its app.

00:32:31.700 | I don't seem to see what their moat is that they can put against competition, considering

00:32:38.020 | that most Uber drivers are running three apps at a time, and most Uber riders also have

00:32:43.540 | two or three apps on their phone.

00:32:44.660 | So I don't see what this moat is other than early mover advantage and brand recognition.

00:32:50.700 | But when I look at a company like, I don't know, my favorite, Walmart, I look at Walmart

00:32:54.580 | and I look at it and say, "Man, you've got millions of customers on a global basis.

00:32:58.300 | You've got diversified streams of income.

00:33:00.860 | You've got tremendous physical plants, infrastructure, et cetera.

00:33:03.660 | There's real value here."

00:33:05.100 | And so no matter what, obviously that value needs to be properly assessed based upon the

00:33:10.540 | formula of earnings, profitability, et cetera, and some multiple.

00:33:15.240 | But this is not that risky.

00:33:16.900 | So I'm not worried.

00:33:17.900 | If the dollar plummets, here's a company that earns money in all kinds of currencies all

00:33:21.420 | around the world.

00:33:22.600 | So I just don't see large companies or reasonable companies with professional management as

00:33:29.600 | all that risky.

00:33:30.600 | It seems far riskier to me to own a house on the corner that could be wiped out by a

00:33:37.200 | zoning change or could be wiped out by a law change or something like that than it does

00:33:41.440 | to own shares of a large global corporation.

00:33:44.840 | Where am I wrong?

00:33:45.840 | What am I missing in that kind of ambivalence about risk?

00:33:49.640 | Well, so the first thing you said is something I wholeheartedly agree with.

00:33:54.760 | So even though I can get very attractive returns on my funds, it's not particularly useful

00:34:00.440 | if I have to dip into that.

00:34:03.560 | At definition, it would probably be the worst time.

00:34:05.160 | If the market's down a lot, funds down a lot, I'm not making so much income.

00:34:08.600 | I might have to dip into savings to do that.

00:34:10.640 | So having cash just provides a buffer that allows you to never have to call yourself

00:34:14.560 | out.

00:34:15.560 | So that totally makes sense.

00:34:16.560 | I think you're also generally correct.

00:34:18.280 | Look, the more businesses you have, the things that that's harder to...

00:34:20.880 | If you buy Walmart, you're not really buying one business.

00:34:23.200 | You're buying one type of business all over the world and such that one thing can go bad

00:34:30.640 | in one region and you could still probably be okay.

00:34:32.960 | That said, simplistically, I would not take much of any comfort in any signaling just

00:34:41.000 | because it's a big company you've heard of and the stock's gone up or other things like

00:34:44.200 | that.

00:34:45.200 | I think it's probably safer, but you'd be surprised at the level of...

00:34:55.880 | Enron, for example, there are lots of examples of those companies.

00:34:58.880 | Valiant, all different kinds of companies that we're seeing as these big, good companies

00:35:03.600 | that end up having a lot of issues that you wouldn't be able to diagnose logically, sometimes

00:35:07.960 | outright fraud or anything like that.

00:35:08.960 | So in general, even being a professional investor, spending tremendous amounts of time on every

00:35:13.960 | company research, we typically in our portfolio don't have more than 5% of the portfolio in

00:35:21.680 | one investment.

00:35:22.680 | Personally, when I did things myself, I had my own portfolio, I'd be comfortable going

00:35:27.320 | to 10 to 15, but even in that case, it'd be things that I knew tremendously.

00:35:31.000 | I would never make the assumption that just because a company is big and has professional

00:35:37.080 | management and it has a stock price with a big valuation that it's safe.

00:35:42.480 | I can give a bunch of examples of that, but maybe another way to tackle this is within

00:35:48.520 | the investment community, there are lots of people that have very different jobs.

00:35:51.880 | So why individual investor or why small firms can actually do quite well in the market is

00:35:58.520 | due to a whole host of structural issues with the way investments are managed.

00:36:03.560 | So if you think about the stock market and the investors in it, right now you have, I

00:36:07.920 | don't know if the numbers did 25 or 30% of money, which literally just goes into whatever

00:36:14.440 | stocks are in an index in the composition that they happen to be in.

00:36:18.840 | There's no lens of value, there's no lens of interesting things happening in the business.

00:36:23.720 | It is just formulaically put to work in indices, which is actually creating more opportunities

00:36:29.840 | for people that can do a lot of work.

00:36:32.280 | You then have the vast majority of money that's managed, which is managed still by mutual

00:36:38.520 | funds or institutional investors.

00:36:40.760 | Making these numbers up, let's call it 30% ETFs and then you have 60% mutual funds.

00:36:47.800 | Those mutual funds get compensated almost entirely on a percent of assets.

00:36:52.560 | They don't get rewarded very much for doing substantially better than the market because

00:36:57.920 | they don't get a percent of profits, they just get their management fee.

00:37:00.280 | They want to do just well enough not to be fired.

00:37:03.160 | And so those people basically try and track the market and make some small adjustments

00:37:08.960 | around the edges to try and maybe outperform it by 50 or 100 basis points.

00:37:14.080 | But in reality, a lot of them don't do that and so they'll tend to lag by roughly their

00:37:18.640 | fees.

00:37:19.640 | And then you have a much smaller portion of the market with people that are getting paid

00:37:25.440 | substantially more as a percent of the assets they manage with tremendous incentives to

00:37:32.120 | find stocks that perform and to have no correlation.

00:37:36.080 | And those people are throwing massive amounts of resources and employees at companies that

00:37:42.560 | other people aren't looking at in detail.

00:37:44.600 | So I can't tell you how many times I go to conferences or other things like that and

00:37:49.280 | you just see people that, you know, there's one analyst maybe who covers 100 stocks and

00:37:55.840 | covers 100 stocks.

00:37:57.400 | Each one is a 50 basis point position or 25 basis point position for the company he works

00:38:03.200 | for.

00:38:04.200 | No matter how smart that person is, you just can't divide your time in such a way to be

00:38:11.020 | expert on 100 companies.

00:38:13.600 | And he can be expert on like 10 or 12 or 13 at any one time.

00:38:19.440 | And so the math just becomes very unfavorable.

00:38:22.480 | So what you have to have happen is occasionally you'll see these spectacular failures where

00:38:27.960 | the businesses were owned by a whole host of people.

00:38:31.120 | It was seen as a very safe company.

00:38:33.160 | And lo and behold, the thing goes under.

00:38:35.200 | Now, interestingly, in many cases that that happens, I'd argue in most cases that that

00:38:40.200 | happens, there are short sellers that tend to be employed, hedge funds that are doing

00:38:47.360 | work trying to uncover frauds or businesses that have presented themselves in one way

00:38:53.440 | that actually aren't what they think, what they make themselves to be.

00:38:57.720 | And in most cases, we have this spectacular failures.

00:39:00.760 | You have people like me that will be betting on them failing because they've uncovered

00:39:05.320 | through massive amounts of on the ground diligence, other things of that nature might find a fraud

00:39:12.200 | that's there that people have missed.

00:39:13.680 | So I think it's very dangerous to ever have assume any investment is inherently safe.

00:39:19.320 | Certainly there are ones that are going to be more safe than others, but there's that,

00:39:22.840 | there's leverage, there's all different kinds of factors that come into play that might

00:39:25.640 | not be obvious unless you do this as a Russian.

00:39:30.200 | And you very briefly there at the very end alluded to just even all the different tools

00:39:36.160 | and different ways of playing a hunch or playing a bet, whether that bet is up, down, all of

00:39:44.560 | the ways to ensure your bet, et cetera, which are effective, but are largely opaque to a

00:39:50.440 | retail investor.

00:39:53.120 | Here's what bugs me, which I want to try to figure out how to do.

00:39:56.740 | To your comments, it seems to me from having sort of worked in the investment business,

00:40:04.660 | there is, I don't know what cliche to spout out here, but you won't get, what was the

00:40:13.160 | old thing about IBM?

00:40:14.160 | They said you won't get fired if you choose IBM.

00:40:16.600 | Basically, it's a safe choice.

00:40:20.000 | Yeah, it might not do very well, but you're not going to get fired.

00:40:23.360 | And as you just pointed out, in the investment business, the majority of people are just

00:40:28.400 | trying not to get fired.

00:40:30.040 | And even though at this point in time, I have no allegiance, I have no conflict of interest,

00:40:39.320 | I have nothing that is in any way to my opinions, I still don't want to get fired.

00:40:48.240 | I still don't want to make a crazy prediction that turns out to be wrong.

00:40:51.520 | And so I always go back to, "Index funds are safe.

00:40:54.480 | How can I be the guy that says, 'No, you should try to go and find John Medford and

00:40:59.040 | invest in his hedge fund because this is too important.'"

00:41:02.120 | And I run the math and I quietly do things myself in my own private life, but when it

00:41:06.560 | comes time to putting my reputation on the line, then it's very hard to put my reputation

00:41:11.660 | on the line for something that's not safe, that's not deniable, that I couldn't defend.

00:41:17.080 | Now at every level of the investment business, you have the same thing.

00:41:21.960 | If I were, when I was a financial advisor actively managing money, you had exactly the

00:41:26.400 | same thing.

00:41:27.680 | You would get very little return for a massive outperformance if there were some way for

00:41:34.640 | an individual retail advisor to provide massive outperformance.

00:41:39.480 | You get very little return, but you'll suffer massively if you're out of line with the benchmarks

00:41:45.240 | by too much of a degree.

00:41:46.880 | Because you can at least defend how, "Well, we're in line with everything's down.

00:41:50.520 | Yeah, your portfolio is down, but look, look at what the S&P 500 is doing and you can see

00:41:54.200 | that we're actually doing only a little bit worse or only a little bit better."

00:41:57.920 | And then as you say, at the mutual fund, you have the mutual fund managers, the portfolio

00:42:01.480 | managers, basically every single level.

00:42:04.500 | So about the only people who have enough incentive seem to be guys like you, hedge fund managers,

00:42:10.520 | where there's enough upside that you have the incentive to swing for the fences for

00:42:17.760 | returns to invest the money, but the press is so bad and I don't know how to find you.

00:42:24.680 | So how do I find you is the point and how do I find a good you, not a loser?

00:42:32.760 | So you would be substantially better off, anyone would be substantially better off,

00:42:38.600 | I think, investing in the average ETF or investing in the average mutual fund than investing

00:42:45.760 | in the average hedge fund.

00:42:47.040 | And the reason for this is very simple.

00:42:49.880 | If you are a mutual fund, you're just not going to veer that far from the market.

00:42:54.440 | You're going to, they charge 1%, they're not going to swing for the fences, they're also

00:42:59.040 | not going to destroy you.

00:43:01.280 | Hedge funds have a terrible reputation.

00:43:02.280 | There are lots of types of hedge funds.

00:43:05.400 | There are lots of hedge funds, I have no idea what they do or how they make money.

00:43:09.200 | There are lots of hedge funds that are terrible.

00:43:10.720 | There are lots of hedge funds run by miserable people.

00:43:12.760 | There are lots of hedge funds run by actually, I think, quite good people.

00:43:16.720 | Hedge fund is just a fee structure and a legal structure.

00:43:19.560 | So hedge fund is different, but the axiom used to be you charge a 2% management fee

00:43:24.520 | and then 20% of profits.

00:43:26.720 | That number has come down some.

00:43:27.960 | There are lots of flavors of that.

00:43:30.120 | When you have an incentive structure like that, you can imagine the amount of resources

00:43:33.000 | and incentives someone has to try and perform.

00:43:35.280 | At the same time, you wake up January 1st every year and you know you have to outperform

00:43:41.720 | whatever your benchmark is by 2% until you even start to compare to them.

00:43:50.200 | And so it's logical to think, again, it's just a fee structure.

00:43:55.600 | People often choose hedge fund managers like they choose any investor, they choose them

00:43:59.040 | on the big names that they don't think they'll get fired for.

00:44:01.760 | And lo and behold, the investor at the average hedge fund is probably better than the average

00:44:06.200 | investor at a mutual fund.

00:44:08.640 | But I'm not sure it justifies the fee differential.

00:44:11.160 | And so if you look at hedge fund indices, the hedge fund indices are even worse than

00:44:15.560 | mutual funds in aggregate.

00:44:17.120 | But what that masks is a smaller subset of funds that happen to be very good.

00:44:22.120 | Now, how do you find that?

00:44:24.960 | Look, it's hard.

00:44:26.840 | I mean, I don't know you're looking for any life hacks.

00:44:30.880 | The reality is almost definitionally, I would argue, it has to be a smaller fund.

00:44:35.600 | I would say it has to be a fund that's somewhere between kind of $50 million and $1 billion.

00:44:41.800 | Ideally, it would be one where most of the capital is capital partners that has been

00:44:47.000 | in business for a few years that seems to care more about compounding their own money

00:44:53.400 | than growing their business.

00:44:55.840 | Most common things that happens in hedge funds, hopefully this won't happen to us, but it

00:44:59.120 | has happened with most of them out there.

00:45:02.680 | If you don't close to your investors and you keep getting bigger, it becomes harder and

00:45:07.360 | harder to generate good returns.

00:45:09.800 | But there's a massive incentive to do that because every dollar you take in generally

00:45:13.360 | just falls to the bottom line.

00:45:15.000 | And so what tends to happen is the folks that are good grow, and they pretty much keep growing

00:45:21.240 | until they're no longer any good, or they're just trying to not get fired because now their

00:45:27.040 | incentives are to swing for the fences and generate good returns to hold on to their

00:45:30.800 | money empire that they built.

00:45:33.520 | So it's exceptionally difficult.

00:45:36.320 | In my case, it's like anything.

00:45:38.720 | I imagine if you're doing real estate investing, you run into people in your neighborhood and

00:45:42.560 | you know that this person is really talented.

00:45:44.680 | I don't know a way to do that other than being an expert in what you do.

00:45:49.880 | So if you're not an expert in stocks, you probably shouldn't try and find me or anyone

00:45:56.260 | that's good because you're not going to know what to look for.

00:45:59.920 | Whereas if you're looking in something you know a lot about, real estate or whatever

00:46:03.840 | it happens to be, you're probably going to be a better judge of that.

00:46:07.240 | And I'd say given how expensive hedge funds are, I would dissuade anyone from thinking

00:46:12.400 | that the average hedge fund is going to be good.

00:46:13.960 | The average hedge fund is terrible.

00:46:15.920 | It just comes down to if you find people that are good in a niche, have a good track record

00:46:20.440 | of doing that, are trustworthy, are honest, seem to make sense, what they do make sense.

00:46:26.680 | You can understand, they can explain to you how they make money.

00:46:29.920 | That's a good starting point.

00:46:30.920 | But I just think it's very hard to do that unless you have the knowledge.

00:46:33.920 | Well, at the very least, you are basically affirming the way that I've affected it or

00:46:40.200 | addressed it in the sense that I can't deny the academic data on the whole, but I also

00:46:48.220 | can't deny the individual examples that are there, but I can't tell you how to get them.

00:46:53.640 | So you basically said what I say, which is things are largely efficient.

00:46:58.320 | The safe solution is buy an ETF, Eaton Dex fund.

00:47:02.680 | And yet that doesn't mean that outperformance is not possible.

00:47:06.120 | I just don't know necessarily how to tell you to get there.

00:47:10.600 | You repeated what I have repeated, right?

00:47:12.440 | We pretty much agree?

00:47:13.640 | Look, if you want to talk for two hours about everything that we do that's different, I

00:47:18.700 | can start to give a clearer sense of that.

00:47:20.700 | But I assume that'd be true of anyone that does anything well.

00:47:24.700 | The conclusion I have from this is less anything related to stocks.

00:47:29.140 | I think the thing that gets me excited is exactly what you said.

00:47:32.820 | You chose an example in your life where you feel like you can get an advantage because

00:47:36.540 | you live in the area, you know the neighborhood, you know that.

00:47:39.660 | And if you dedicate time to it, you can probably do substantially better than that than the

00:47:45.340 | average person who probably is trying to find a new place to live, has time pressure, has

00:47:52.140 | work, isn't just focused on it the way you are.

00:47:55.460 | And so for me, the conclusion isn't, frankly, the conclusion is more you should find something

00:48:00.340 | where you feel like you have an advantage and put your money there.

00:48:02.540 | And I don't think that's stocks unless you devote yourself to it.

00:48:05.260 | Now, obviously stocks are easy and realistically for a lot of people, it's one of the easiest

00:48:09.100 | ways to spend money.

00:48:10.100 | But if you want to have great returns, probably not going to be an ETF.

00:48:13.460 | It's probably going to be doing something that you become expert in where you look at

00:48:17.180 | the other people doing it and you understand why you have an advantage.

00:48:20.060 | >>AJ: I've been disconnected from the professional world of money, anything, no licenses, no

00:48:26.820 | anything for I think almost five years now.

00:48:29.500 | And over those years, I have really tried to ask myself, what do I believe now that

00:48:36.060 | I still believe that I believed then?

00:48:39.700 | Now that enough of my loyalties and allegiances and conflicts of interest and whatnot have

00:48:45.500 | dissipated, what did I fool myself?

00:48:47.140 | What did I think I believed then, but I only believed in it because it was buttering my

00:48:51.540 | bread?

00:48:52.540 | And one of the things that I believed then, but I didn't know necessarily how to articulate,

00:48:59.420 | was basically that you shouldn't look to investing, if we think of investing as buying something

00:49:06.580 | like just buying a Roth IRA and putting stocks in there, you shouldn't look at that as the

00:49:11.480 | path to wealth because you don't have a competitive advantage.

00:49:15.100 | You're not knowledgeable about the market and you don't have enough money to make a

00:49:17.900 | difference.

00:49:18.900 | So if you're only making a $5,000 investment, that $5,000, you can probably find something

00:49:23.900 | in your personal life.

00:49:24.900 | I don't know what it is.

00:49:25.900 | Maybe it's solar panels on your roof.

00:49:27.580 | Maybe it's cash for your next car.

00:49:29.480 | Maybe it's discounts on bulk buying of your groceries.

00:49:32.580 | Maybe it's a discount on new equipment for your business or something.

00:49:36.200 | You could probably find a better way close to you to put $5,000 than in the stock market.

00:49:42.560 | Same thing when we go up at $50,000 or $100,000 or a few hundred thousand dollars.

00:49:47.280 | If you've got $100,000, you can start to get, you can swing your weight around very effectively

00:49:51.960 | in your local community.

00:49:53.460 | You can find enough opportunities where you can really get outperformance.

00:49:58.040 | But then you face a problem where it's hard to invest your capital more and more.

00:50:02.280 | You get to a million and millions of dollars.

00:50:04.600 | Unless you're an established entrepreneur or a very experienced investor who's willing

00:50:09.360 | to buy a 20-unit apartment building or something like that, it gets hard to invest significant

00:50:15.740 | amounts of money.

00:50:17.520 | And I think that's where, just speaking generally, the stock market can easily absorb a million

00:50:23.560 | dollars.

00:50:24.560 | The stock market can easily absorb $5 million without becoming a problem.

00:50:29.480 | Now a billion dollars is very hard to invest, but a million dollars can make a big difference.

00:50:34.580 | And so somebody who has a million, somebody who has a couple million, can easily come

00:50:38.840 | to a modestly-sized firm or something like yours where you're not managing a $100 billion

00:50:44.720 | portfolio.

00:50:45.720 | You can come in and there are then those opportunities for outperformance.

00:50:49.680 | And it's almost like the next logical step.

00:50:53.040 | You keep outgrowing one market and you've got to figure out how to get into another

00:50:56.320 | market.

00:50:57.320 | And to me, that seems like the best value, the best argument in favor of working with

00:51:05.000 | somebody like you.

00:51:06.400 | Now that's not to deny – go ahead and respond to that.

00:51:08.920 | I'm sorry.

00:51:09.920 | >>Trevor: Yeah.

00:51:10.920 | So it's interesting because I would hate for people to take away from this.

00:51:15.280 | It's actually possible to beat the market if you can only find the right person.

00:51:20.640 | Look, you shouldn't trust anything I'm saying.

00:51:22.480 | I'm an anonymous person and there's no reason to trust this.

00:51:25.960 | You have to use your own judgment as to whether or not I'm making sense.

00:51:28.240 | But you don't want to – there are so many people that have such strong incentives to

00:51:34.480 | convince you that they do something special that's going to get you more money than putting

00:51:40.120 | an index on.

00:51:42.200 | I go back to it, unless you're an expert in stocks or in choosing managers or have really

00:51:50.040 | strong personal recommendations from people who actually work in the industry that you

00:51:54.120 | think are competent, I would generally just put money in ETFs, especially if you have

00:51:59.840 | a lot of money.

00:52:00.840 | Look, if you have a lot of money, if you have two, three, four, five million dollars, your

00:52:04.680 | expenses are modest, you don't need to return 10%.

00:52:08.320 | If you want to maximize your wealth, maybe you do, but you'd be perfectly fine with something

00:52:12.880 | that's boring.

00:52:13.880 | You put it in an ETF, you know no one's going to steal it from you, you know that no one

00:52:18.200 | is going to have sold you a pipe dream that they won't be able to deliver.

00:52:22.680 | It is really hard to outperform the market and most people that do it, you've never heard

00:52:30.040 | of.

00:52:32.000 | And if they claim they do and you have heard of them, in many cases they're lying because

00:52:39.520 | the people that are slickest salesmen tend to be, it tends to be an inverse correlation.

00:52:44.880 | Most people I know that outperform the market have modest forms of Asperger's syndrome and

00:52:49.160 | autism.

00:52:50.160 | They are people that can function very well in the real world, which is why they spend

00:52:54.800 | all their days reading 10Ks.

00:52:58.000 | The person, for years I read Joshua Kennan's website and he writes a lot less now that

00:53:03.800 | he and his partner have launched a fund.

00:53:07.000 | But I used to read his website and he was such a good writer that I thought this is

00:53:12.840 | an insight into somebody who, I don't think he's autistic, but into somebody who's just

00:53:17.960 | a freak.

00:53:18.960 | Like he likes this stuff and it convinced me to entirely walk away from any interest

00:53:24.260 | in market investing because the kind of person, I would imagine you, John, the kind of person

00:53:29.760 | that enjoys this stuff is weird.

00:53:34.360 | You're weird and you enjoy things that most people don't enjoy.

00:53:37.560 | Now my interests are totally weird, but they're weird in my direction.

00:53:43.280 | And so I think the key is to recognize what your interest is in.

00:53:48.960 | I don't want to read 10Ks, but I love reading tax law.

00:53:53.420 | It's weird, but that's my thing.

00:53:55.320 | So I want to pivot here.

00:53:56.320 | I didn't tell you I was going to do this, but I want to ask you about your personal

00:54:00.160 | financial advancement.

00:54:02.440 | Not asking you for all the details, just simply pointing out the path that you have taken

00:54:07.400 | towards wealth.

00:54:08.860 | Did you come from a wealthy family?

00:54:10.760 | Yes.

00:54:11.760 | Okay.

00:54:12.760 | And how did your parents invest in you?

00:54:15.200 | What worked and what didn't?

00:54:21.200 | They paid for my education, which I'm eternally grateful for.

00:54:30.320 | What did that education look like?

00:54:33.680 | Four-year university.

00:54:34.680 | I have no graduate degree at all.

00:54:36.080 | I don't think it's useful.

00:54:37.400 | Was it elite, Ivy League?

00:54:38.760 | Was it general, mass market?

00:54:42.080 | It was slightly below Ivy League.

00:54:43.760 | It was a very good school, but not actually much of a brand name.

00:54:47.240 | And how did that benefit you?

00:54:51.560 | I met really interesting people and found things I'm passionate about, and I had space

00:54:55.360 | to do that.

00:54:56.360 | I didn't take a class that changed my life or allowed me to.

00:55:00.080 | I think it was just the social environment.

00:55:03.040 | I met fascinating people.

00:55:04.040 | I had room to explore what I wanted to do.

00:55:05.880 | The other thing my parents did, so they had set aside money for college, I had expressed

00:55:10.920 | an interest in stock investing.

00:55:11.920 | I've generally been prudent and conservative over time.

00:55:14.920 | They, when I turned 21, there was still money left in that account.

00:55:18.400 | They turned it over to me and they told me, "This is it.

00:55:22.240 | You can invest it, but if you mess it up, there's not more."

00:55:26.440 | And that started, and I put a lot of time and effort.

00:55:29.560 | I think my junior or senior year of college, I just consumed everything I could, really,

00:55:34.480 | at the stocks.

00:55:36.600 | Got lucky, frankly.

00:55:37.600 | I don't think I was particularly good.

00:55:39.160 | Got lucky, I think it was 2003, which happened to be the bottom of the stock market cycle.

00:55:43.960 | And lo and behold, 2005, I have the same amount of money in the account that I had when I

00:55:50.720 | was a junior.

00:55:51.720 | I also decided to go part-time my senior year, which saved me 20 grand.

00:55:57.280 | And I came out of college with a couple hundred thousand dollars in an account, and that started

00:56:04.000 | to compound my whole life.

00:56:06.200 | And then I was exceptionally frugal for a very long period of time.

00:56:10.760 | Why were you frugal?

00:56:11.760 | How did you learn that?

00:56:12.760 | Who taught you that?

00:56:13.760 | This is interesting, actually.

00:56:19.800 | My father was a very successful entrepreneur.

00:56:22.880 | He built a business that, at one point, was worth, I don't know, $50 or $100 million,

00:56:30.800 | and he owned maybe 20% of that.

00:56:34.800 | And we had a very nice lifestyle.

00:56:37.160 | We had a big house, and I never understood why we had a big house, because there was

00:56:40.400 | half the house we didn't use, and it just made no sense to me.

00:56:42.880 | I don't know why that appealed to me, but it was.

00:56:45.120 | And then something happened such that that business imploded, and he went from having

00:56:50.560 | lots of paper wealth to not very much.

00:56:53.360 | Sorry, lots of paper wealth to still lots of paper wealth, but not as much as he was

00:56:57.600 | used to having.

00:56:58.600 | And then that paper wealth was invested very poorly, and he was left with half of that.

00:57:01.840 | And he was still in a good place, but nowhere near what he was.

00:57:04.880 | And for lack of a better word, it just got him depressed for about 15 years until things

00:57:09.240 | kind of finally got better.

00:57:10.360 | And so I just grew up assuming bad things would happen.

00:57:16.000 | So I didn't have a pretty simplistic person.

00:57:18.920 | I had things I like and I need.

00:57:20.640 | I'm not particularly social seeking, data seeking.

00:57:23.760 | I just like the food I like.

00:57:26.800 | I wear clothes until they have big holes in them that are unsightly.

00:57:30.800 | I'm just the way I am.

00:57:32.360 | And as time went on, I've had to learn to spend money.

00:57:34.680 | I mean, I married a wife who is very frugal herself, and that's just kind of the way I

00:57:40.520 | did it, but it wasn't really a choice.

00:57:42.840 | It was just the natural consequence of probably seeing what happened to my parents, who weren't,

00:57:47.840 | by the way, very frugal at all.

00:57:49.840 | Yeah, but I don't know how that happened.

00:57:52.360 | I'm not sure it was them that instilled that in me as much as it was just me watching what

00:57:55.480 | happened to my family as they rode up and down with wealth.

00:58:00.320 | Well, to me, it's obvious.

00:58:02.280 | Sometimes we learn from somebody training us and us believing the person, that the person

00:58:06.880 | who's training us knows what they're talking about and choosing to obey them.

00:58:11.060 | Sometimes we learn just by simply watching an unfortunate example, example of disaster

00:58:15.280 | or catastrophe or just malaise and saying, "Hey, I see the problem.

00:58:19.440 | I don't want to repeat that."

00:58:21.020 | And it sounds like your personal example was a negative example, not a bad, but just simply,

00:58:27.640 | "Oh, that wasn't a good thing.

00:58:29.880 | If my parents had been more frugal, then they wouldn't have experienced such severe depression

00:58:33.720 | when their wealth was severely diminished."

00:58:36.480 | Then when you got into the investment marketplace, you graduated from college, you were managing,

00:58:40.680 | in essence, a couple hundred thousand dollars of your own money, addicted to it.

00:58:44.600 | When did you decide to go into that field professionally and what was your path into

00:58:48.840 | it?

00:58:49.840 | It's unusual.

00:58:50.840 | I decided it wasn't the right thing for me.

00:58:59.560 | And lo and behold, I went back to...

00:59:03.520 | I didn't have any hedge funds at that time.

00:59:06.440 | There weren't any that were hiring.

00:59:09.960 | When I then came back into the market, which was not in a good economic environment, and

00:59:15.160 | then I just kind of was scrappy and I started writing on a blog some of my investing ideas

00:59:24.000 | and the work I was doing.

00:59:25.920 | And someone read it who managed money and he gave me a job.

00:59:29.440 | He first offered me my salary, which I believe was $32,000 a year.

00:59:34.440 | I got him up a little bit, but not much.

00:59:36.600 | And I just kind of grinded it out.

00:59:38.120 | I was really scrappy.

00:59:39.120 | I moved on from there to another firm that I met by working there.

00:59:44.120 | I did a lot of in-depth stock research, loved talking to people.

00:59:49.240 | I just networked a bunch.

00:59:50.240 | I don't call it networking.

00:59:51.440 | I just love investing and it's very fun for me to talk to people and I like talking to

00:59:55.440 | people that are good at it.

00:59:56.440 | So over time, I would talk to people that were good at it and some of them would think

01:00:00.480 | I was good and some of them would think I wasn't.

01:00:02.040 | And the ones that thought I was good and I thought they were good and I thought they

01:00:04.560 | were reasonable people, we would connect and chat and we'd then occasionally make money

01:00:08.520 | together and lo and behold, what happened with my career, it's not worth going into

01:00:12.440 | too much detail on and I don't want to reveal myself, but I ended up meeting someone through

01:00:17.560 | that process that I then joined in his business.

01:00:24.840 | And I happen to think he was very good.

01:00:27.320 | I walked away from a more lucrative job to take a chance on a startup.

01:00:32.320 | I bet on the team that we had at the time of which I was a big part and he was a big

01:00:37.560 | part and things went well.

01:00:41.000 | And they continue to go well.

01:00:42.000 | At some point, they won't go well, but basically, I was at more established firms and then found

01:00:47.280 | an entrepreneurial opportunity where I wanted to make a bet and take a swing and that's

01:00:51.280 | what I did.

01:00:52.280 | >>Corey: And so people who are in similar jobs like yours with similar responsibilities

01:01:00.240 | like you have would earn on average about how much per year at this point in time?

01:01:06.520 | >>Jeremy: It varies dramatically depending on the fund size.

01:01:12.000 | I mean, I can give some illustrative-

01:01:15.640 | >>Corey: Just range.

01:01:16.640 | >>Jeremy: Yeah.

01:01:17.640 | Look, so if you're a partner, if you're the founder of call it a billion dollar hedge

01:01:23.480 | fund, in an average year, you probably make 10 to $20 million.

01:01:29.560 | That's if you're the founder.

01:01:30.880 | If you are a partner that has been with the firm for a while, it depends at the place,

01:01:40.760 | but call it anywhere between $1 to $5 million depending on the fund and individual performance.

01:01:48.000 | That's kind of at partner level and then investment analyst level can be very good as well depending

01:01:53.640 | on how your ideas go and how generous the person in charge is.

01:01:56.840 | >>Corey: So my point is not to probe too deeply on your personal experience, but to point

01:02:02.160 | out as a financial planner how incredibly valuable your path is.

01:02:09.480 | Because at this point, and about how many years out of college are you?

01:02:13.400 | >>Jeremy: Between 10 to 15.

01:02:18.480 | >>Corey: Okay.

01:02:19.760 | So 10 to 15 years out of college, you have come from a place where, let's just say you're

01:02:25.480 | making, what was the number you said, $32,000, right?

01:02:28.120 | So you started with varying experiences, but $32,000 to earning in excess of 10 times that

01:02:36.560 | today in 10 to 15 years.

01:02:38.840 | But yet you're in a business where it aligns with your personal interests, gives you enough

01:02:44.640 | ownership, enough autonomy to be connected with so that you can live your life.

01:02:49.040 | But this is what you did when it was just your own interest.

01:02:52.000 | But yet you found a way to make a lot of money that way.

01:02:54.960 | And this is the perfect example of for somebody like you, it's a win-win-win because you are

01:03:00.720 | investing your own money in your own firm.

01:03:03.240 | Thus, you have the opportunity to earn basically the gross number of 18% basically, instead

01:03:11.680 | of 12.5%.

01:03:13.160 | But you're also generating enormous fees for yourself on your management of other people's

01:03:18.440 | money.

01:03:19.440 | So your income from here can basically increase, assuming that you don't mess it all up, it

01:03:24.600 | can basically increase almost exponentially over the coming decades.

01:03:28.640 | And yet it's well aligned with something that you are interested in.

01:03:31.840 | So I point that out because what I have observed is the most important examples for us generally

01:03:37.280 | to look at in personal finance are people's career paths and how their money and their

01:03:41.400 | career are interrelated.

01:03:43.360 | Not just on how do I find the best hedge fund manager or how do I find somebody to get me

01:03:46.920 | a lot of money in my portfolio, but who are the people who are doing it most effectively.

01:03:51.200 | And so you're in a business where you risked relatively little in terms of capital, but

01:03:57.560 | you exerted yourself in interest and in study and for years built up and accumulated the

01:04:05.320 | benefit of that and then parlayed that into a place where you have exponential returns.

01:04:10.640 | Because the returns that you can get from managing other people's money where you can

01:04:13.880 | generate as you say, an extra one to $15 million of annual fees based upon whether you're a

01:04:19.440 | partner or founder of a hedge fund.

01:04:21.440 | But when you can generate a million dollars per year reliably and consistently, and be

01:04:25.560 | doing that while you're simultaneously investing your money, then you're in the stratosphere

01:04:30.120 | of opportunities for wealth.

01:04:31.720 | Now many of us have opportunities similar to that, but it's important to understand

01:04:36.320 | what's happening.

01:04:37.320 | It was the same thing I tried to show people when I was a financial advisor.

01:04:39.800 | The financial advisor doesn't get, the retail financial advisor doesn't become wealthy because

01:04:45.200 | they give excellent financial, give great investment advice.

01:04:49.000 | That's the biggest misconception that the financial advice industry has successfully

01:04:52.320 | sold to people.

01:04:53.380 | The financial advisor gets wealthy because they accumulate a set of knowledge and then

01:04:59.820 | they build, they use the, they borrow the assets of other people to generate profit.

01:05:08.380 | So as a financial advisor borrows money from other people, says I'll manage this money

01:05:13.520 | for you, generates fees, and those fees then go to the financial advisor's bottom line

01:05:17.980 | and then they generate income, they pay for some expenses out of it and then they invest

01:05:22.220 | the money hopefully themselves.

01:05:24.060 | Hedge fund managers do the same thing but on a much bigger scale, but then you can do

01:05:27.580 | the same thing at a smaller scale.

01:05:28.940 | I used to have, Curtis Stone was on the show a couple years ago and he borrows people's

01:05:33.540 | backyards and uses them to generate lots of money.

01:05:36.100 | So the key thing is if you really want to grow wealthy, you've got to find ways to leverage

01:05:40.340 | equity including the equities that most people don't see and how do you use other people's

01:05:44.940 | money, other people's skills, other people's talents in a way that enriches you but provides

01:05:49.860 | a useful and important service to them.

01:05:52.160 | So does that make anything to add, John, from your inside experience to that?

01:05:58.980 | I can only speak to what I do.

01:06:00.820 | I feel incredibly fortunate to live in a society that massively overvalues what I do economically

01:06:07.060 | and to enjoy doing it, to have a life that is good from that.

01:06:11.580 | I have a lot of concerns and things I'm not good at.

01:06:13.900 | Thankfully this is now my life.

01:06:14.900 | I don't have to worry about it as much but I hope that people can find things, at the

01:06:21.460 | very least, that are fulfilling.

01:06:22.460 | I mean I'd probably do this even if I made quite a bit of money just because I like it

01:06:26.700 | but that I can have the other benefits is certainly attractive and unusual.

01:06:32.100 | I appreciate your humility.

01:06:33.900 | I'm not trying to push you too far out but just trying to show that to my audience because

01:06:38.140 | here's what I see.

01:06:39.140 | We're in 2019.

01:06:42.300 | The niche that I'm doing right now is something that could hardly have happened 20 years ago

01:06:50.580 | but yet the number of specialized areas of knowledge and skill 20 years from now is going

01:06:58.820 | to be incredibly exponentially higher than today, exponentially higher.

01:07:04.580 | And we're in a world of increasing specialization.

01:07:07.980 | And so if somebody understands the blueprint of basically how these things work, how does

01:07:12.980 | somebody go the path that you have gone, then they can see the clues and yet apply it in

01:07:19.460 | a totally different scenario.

01:07:21.500 | So that's all I'm trying to point out is this is the personal finance lesson.

01:07:24.300 | We're in a world of increasing specialization.

01:07:26.900 | All of our careers will become increasingly specialized so we need to understand the pattern

01:07:30.740 | so we can recognize them.

01:07:32.420 | You apply pattern recognition in stock investing.

01:07:34.980 | We all need to do that in our own careers.

01:07:37.380 | I was just trying to use the example to show you.

01:07:39.820 | John, that's all the questions I have.

01:07:41.700 | Is there anything that I've missed that I should have asked you about that you really

01:07:44.580 | wish I had touched on?

01:07:47.660 | No, I don't think so.

01:07:52.060 | Maybe a couple random things.

01:07:53.980 | I would say one is things are much more complicated than they seem in the high level.

01:07:59.620 | I would argue there are lots of not very good people that run hedge funds in the same way

01:08:06.620 | there are lots of many not good people who do all different kinds of things.

01:08:09.820 | I happen to think there's a part of the community of hedge fund investors that are curious,

01:08:17.420 | passionate people that like finding the truth and enjoy being in a profession where they

01:08:22.660 | can get rewarded for being right and taking chances.

01:08:27.180 | Is it saving the planet?

01:08:28.780 | Is it the most meaningful thing one can do for society?

01:08:32.460 | No, I would argue it's not actively bad.

01:08:35.020 | I can make an argument it's modestly beneficial but I think the reputation that the whole

01:08:41.100 | industry has gotten as a whole is inflated.

01:08:46.700 | I think the only other thing I'd just say too just to make sure and know in certain

01:08:50.220 | terms it's really hard to outperform the stock market in general.

01:08:54.460 | I don't know in good conscience how to advise someone to do that themselves or to find someone

01:08:59.180 | that could do it without doing it as a profession and becoming an expert at it.

01:09:04.100 | So ETFs are probably the best thing to do.

01:09:09.340 | Probably the best thing to do but frankly probably the best thing if you want to do

01:09:11.700 | stocks but probably the best thing to do is to find whatever example is in your life something

01:09:14.860 | you're passionate about that you feel like you are particularly good at that aligns your

01:09:19.300 | skill sets that you find you do even if you didn't get paid for it and throw all your

01:09:23.980 | energy into becoming as good as that you could possibly be and you'll probably have a reasonably

01:09:30.500 | happy work life which is more than the vast majority of people can say and you may also

01:09:34.420 | happen to be in a place where you can get financially free quicker than you might think.

01:09:39.340 | John, thank you for coming on the show.

01:09:42.260 | I always close with this question.

01:09:44.340 | Give us your best hot stock pick that we can go right out and invest in today.

01:09:48.860 | What's your best hot stock pick, John?

01:09:50.580 | Lay it on us.

01:09:51.580 | As you know, I will not be sharing that.

01:09:58.220 | Thanks for coming on, John.

01:09:59.220 | I really appreciate it.

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