Why Is the Bond Market Screaming Recession?

00:00:00.000 | Welcome back to Portfolio Rescue. Each week we get tons of questions from our audience

00:00:20.120 | on personal finance, investing, taxes, markets, crypto, financial planning, everything in

00:00:24.800 | general. This show answers those questions. Remember, email us, askthecompoundshow@gmail.com.

00:00:30.520 | Today's sponsor is AcreTrader. AcreTrader allows you to invest in farmland across the

00:00:35.220 | country. One of the benefits of investing in farmland, while it has little to no correlation

00:00:38.800 | with stocks and bonds, does have a positive correlation with inflation. Duncan, this

00:00:42.320 | week on Animal Spirits, we were talking about maybe inflation is going to be a little stickier,

00:00:45.400 | a little higher, 4 to 5 percent, potentially going forward. Maybe this is kind of one of

00:00:51.280 | those things. We haven't had to worry about inflation in a long time, and farmland is

00:00:53.560 | one of those things. Remember, AcreTrader makes it easy to simply invest in professionally

00:00:57.320 | managed farmland. So visit AcreTrader.com to learn more and to learn more about the

00:01:00.420 | risks involved. That's AcreTrader.com/company/terms. Duncan, you and I were on the road this week

00:01:07.480 | in Texas. We were, yeah. Speaking of inflation, we kind of made the point that before there

00:01:13.720 | was like New York and maybe LA inflation and then everywhere else, when you go to restaurants,

00:01:18.120 | bars and such, it seems like that just permeates the whole country now. Everything's kind of

00:01:23.040 | just expensive everywhere these days. Yeah. No, I bought a thing of whole bean coffee

00:01:27.520 | at a coffee shop near the hotel. It was $20. Okay. That seems fair. See, that's why I don't

00:01:32.480 | drink coffee. But that's like Brooklyn prices. That's what I would pay in Brooklyn. Yeah.

00:01:36.240 | This is Houston, you know? Yeah. It is just interesting how long until the consumer revolts

00:01:40.880 | because it doesn't seem like anyone minds. Every flight I was on, everyone, "Get on quickly.

00:01:46.240 | Stow your stuff up top because this flight is full." People are still spending money.

00:01:49.880 | I wonder when we're going to start fighting it. Anyway, let's do some questions.

00:01:54.000 | Cool. Yeah. Thanks, everyone in Texas. It was a good time. It was my first time in Texas.

00:01:59.080 | I thought everyone was nice, had a good time. Nice weather.

00:02:01.800 | It was fun. Yeah. Everyone was very nice down there. It was great.

00:02:04.960 | Yeah. Okay. First up today, we have a question from Yajur, I think is the best pronunciation

00:02:12.480 | I can do. "Hey, guys. Love the show. Question for you. People are saying that the bond market

00:02:17.680 | is screaming recession. Has the bond market ever been wrong? Any notable examples? If

00:02:22.600 | so, why was it wrong?"

00:02:25.240 | The bond market generally is known to be smarter than the stock market. But yes, the bond market

00:02:29.560 | gets it wrong. You don't have to go back very far in history to figure this out. The bond

00:02:32.760 | market totally missed inflation, much like most people. The bond market did not see this

00:02:38.560 | pandemic-induced inflation coming just like the Fed. Think about it. At the end of 2021,

00:02:42.420 | this is less than a year ago, the 10-year treasure was still yielding 1.5%. By that

00:02:46.920 | point, inflation was already 7%, going higher. So the bond market was completely off sides.

00:02:51.520 | And I think that's one of the biggest reasons we've had this huge adjustment in rates this

00:02:54.740 | year is because the bond market had to play catch-up. Now, you could blame the Fed for

00:02:58.080 | that stuff, right? The Fed was telling us all that inflation was going to be transitory.

00:03:02.480 | It wasn't going to last very long. It wasn't supposed to stick around at these high levels

00:03:05.160 | for this long. So maybe the bond market was taking its marching orders from the Feds.

00:03:08.800 | But I guess if you're in the camp that rates are all manipulated by the Fed and the Fed

00:03:12.840 | is doing all this stuff, can you really look to the bond market to be this predictor of

00:03:17.200 | what's going to happen in the economy? I don't know. I think it can be helpful to understand

00:03:20.800 | what causes yields to change in bonds in the first place. So sure, the Fed controls short-term

00:03:25.160 | yields, right? But that's only on the very short end of the curve. You also have to think

00:03:29.080 | of things like supply and demand for bonds and based on investor demand for those. And

00:03:33.640 | there are inflation expectations and expectations for future Fed moves, expectations for economic

00:03:39.160 | growth and maybe some price yield trends that's going on if you're a technical trader, I guess.

00:03:45.240 | I think if you add all this up, one of the things that's confusing for people who don't

00:03:48.160 | pay attention to the bond market is, you get bond yields moving, but they don't always

00:03:51.960 | move in the same direction at the same magnitude, right? So John, throw on the chart of 10-year

00:03:55.960 | Treasury yields versus 3-month T-bills. So this is over time. You can see directionally

00:03:59.560 | they're fairly similar. So 3-month T-bills are essentially, think of them as like savings

00:04:04.800 | account yields. It's kind of a good proxy for the Fed funds rate that they use to sort

00:04:09.360 | of do monetary policy by raising and lowering rates. But this is like a savings account

00:04:13.520 | yield, or a CD rate. You can see right now, at like 4.3%, 3-month T-bills are yielding

00:04:19.200 | almost 80 basis points more than the 10-year Treasury yield. That, we talked about in an

00:04:23.840 | inverted yield curve last week. In terms of risk and reward, that shouldn't make sense

00:04:28.320 | where ultra-short-term, 3-month, government-backed T-bills, which mature in a very short period

00:04:33.200 | of time, shouldn't yield that much more than something that goes 10 years out on the risk

00:04:37.560 | curve, right? So this is not normal. The hard part here is the Fed is effectively inverting

00:04:44.360 | the yield curve, right? They're raising short-term rates, and the long end of the curve is saying,

00:04:48.120 | "I don't care," right? Because the Fed is trying to snuff out inflation. So is the bond

00:04:52.720 | market predicting a recession, or is the Fed simply going to cause one? It's kind of like,

00:04:56.480 | is the bond market really doing stuff here, or is it really just the Fed saying, "No,

00:05:00.480 | no, no. We're showing you we're going to do it, because we're raising short-term rates"?

00:05:04.440 | It's also interesting to see how the yield curve has changed over the past year or so.

00:05:07.360 | So, John, throw this next curve up. This is a one-year difference in 3-month T-bill yields,

00:05:12.120 | 2-year Treasury yields, 10-year Treasury yields, and 30-year Treasury yields. You can see that

00:05:16.400 | the longer-term bonds have moved up. The 30-year went from 1.9 to 3.5 or so. The 10-year again

00:05:22.120 | went from 1.5 to 3.5. But look at how much. 3-month T-bills, this is a year ago, not that

00:05:27.080 | long ago, went from basically nothing, 7 basis points, to 4.3%. Even 2-year Treasuries went

00:05:32.880 | from less than 70 basis points to 4.3%. So we've had a huge move in the bottom. There's

00:05:38.200 | been slight move up in longer-term rates, but not nearly as much. And so, I guess the

00:05:44.160 | yield curve could be telling us a bunch of different things. We don't know. It can't

00:05:47.240 | communicate. But it could be saying, "The long end of the curve doesn't believe inflation's

00:05:49.920 | going to be here to stay." Which, if you think the bond market is smart, yeah, maybe we believe

00:05:53.880 | them, but is the bond market really that smart? I don't know. Traders maybe assume the Fed

00:05:57.680 | is going to have to cut rates in the next 12 to 18 months, right? That's why those longer-term

00:06:01.360 | rates aren't moving down yet, or are staying put, because they don't believe that the Fed

00:06:06.360 | is going to keep rates this high. And again, the short end of the curve is maybe helping

00:06:10.800 | the Fed orchestrate retirement, because that's all they can do, or recession. Retirement,

00:06:14.400 | yeah, that'd be fun if we could retire the Fed. Because that's all the Fed can do to

00:06:18.200 | slow inflation, right? So, I don't know. Maybe economic growth is going to slow in coming

00:06:21.560 | years. That's what the bond is telling us. And maybe just we should realize that predicting

00:06:24.800 | the future of the economy in the path of growth and inflation, interest rates, and all these

00:06:28.880 | things is really difficult for the bond market or the Fed. So, my biggest reservation about

00:06:33.760 | using the bond market to try to predict what's going to happen in the economy right now is

00:06:37.000 | just that the Fed is so involved in these markets. And I don't know if the bond market

00:06:40.560 | is telling us something, or they're just doing what the Fed is telling them.

00:06:45.400 | In general, do you think, are bond people having like a renaissance right now? Are they

00:06:48.780 | just like rolling up in a Rolls Royce and getting out with sunglasses on? I feel like

00:06:52.920 | they have to be feeling good these days.

00:06:54.520 | Well, not yet, because if you look at past performance, bonds have gotten killed this

00:06:57.920 | year. Going forward, they should be doing better, because rates are finally higher,

00:07:01.520 | but-

00:07:02.520 | I just mean for years, it was like no one cared anything about bonds, and now everyone's

00:07:05.800 | talking about bonds.

00:07:06.800 | Yeah, to your point, we've been mentioning this for a few weeks. We get tons of questions

00:07:10.040 | on bonds these days. We got another one in this very episode. But yes, I just think,

00:07:16.640 | I don't want to argue with historical relationships, but I also think that the Fed being so heavily

00:07:22.020 | handed and involved here makes it much harder to understand what's going on.

00:07:26.380 | Yeah. Yeah, I find it all confusing, and that's a good segue to the next question, because

00:07:31.360 | ... Yeah, this one and the third question, actually. I find a lot of this bond stuff

00:07:36.340 | a little confusing.

00:07:37.340 | Let's do it.

00:07:38.340 | Yeah. All right. Up next, we have a question from Jacob. "My wife and I just got married

00:07:41.900 | in September. We both have good jobs and are trying to save up for a new house in the next

00:07:45.740 | few years. We currently have $50,000 in savings for a house, along with a $10,000 emergency

00:07:50.980 | fund, which we hold at a local credit union in a savings account at a 3% yield. We are

00:07:56.500 | wondering if short-term, three- to 12-month T-bills yielding between 4.25% and 4.75% would

00:08:02.520 | be a better option than a high-yield savings account for these funds."

00:08:06.340 | Another question we received for years and years in a low-rate environment was, "We're

00:08:11.060 | saving up to buy a house, but there is no yield anywhere. What do we do?" Savers of

00:08:14.820 | the world can finally rejoice. There is finally somewhere to put your money, and you have

00:08:18.020 | multiple options. The great thing is, there's not only yield again, but it's yield on the

00:08:22.180 | short end of the curve, because if you're trying to match that down payment in a house,

00:08:26.780 | say, like I have three years until I'm going to buy a house, or two years, you can match

00:08:30.020 | those assets and liabilities and match the time horizon of when you're going to do this.

00:08:35.060 | If you bought a three-year treasury today, knowing that you're going to try to buy a

00:08:39.100 | house in three years, you could essentially set your maturity date for then, and it takes

00:08:42.860 | a lot of the risk off the table.

00:08:45.140 | I actually think for the first time in a long time, young people could have a better chance.

00:08:49.980 | If you have a good credit score and you have a down payment saved, in the coming years,

00:08:53.260 | I think you're going to have a chance to have much better negotiating power for a home,

00:08:57.500 | and maybe much better price action, if prices do fall 10%, 15%, 20%, like some people think

00:09:02.580 | they could. I think if mortgage rates just came down to, like, 5% or so, it would make

00:09:07.860 | things a lot better for people. And if they don't, if they stay in the 6% to 7% range,

00:09:12.140 | the prices are going to have to come down.

00:09:13.200 | So I think, again, if you're waiting in the wings now, it might not be as good of a time

00:09:17.080 | as it was three, four, five years ago, but I think it's going to get better.

00:09:20.380 | So as far as where to save that short-term cash, an online savings account is going to

00:09:24.420 | be easier. I use Marcus. I'm getting 3% right now. That should hopefully be 3.25 or 3.5

00:09:30.660 | by the end of the year, because the Fed is going to raise rates at their meeting next

00:09:33.100 | week again. They said probably another 50 basis points, maybe 75, if they want to get

00:09:37.780 | it. 3% is not bad. So you have this person has $60,000 in savings, right? That's what

00:09:41.820 | they say, $50,000 and then $10,000 in emergency savings. That's $1,800 a year in interest

00:09:46.820 | at 3%. If we get to 3.5%, we're talking more than $2,000 a year. That's pretty good.

00:09:52.100 | Now, to their point, short-term treasuries can earn a higher yield right now. I looked

00:09:56.500 | at the average maturity on the one to three-year treasury ETF for iShares. It's 4.3%. If you

00:10:01.300 | go to the Vanguard short-term bond fund, I think that actually has some more corporates

00:10:04.980 | than all governments, but that's 4.8%. So with those kind of yields, we're talking more

00:10:08.740 | like $2,600, $2,900 a year, if those rates stay the same. That's pretty good. Now, the

00:10:14.820 | thing is, these yields, it's not like they just get to a level and then they stay there.

00:10:18.020 | But if the Fed's going to keep raising rates and try to fight inflation, those short-term

00:10:20.740 | rates should stay higher for a little longer, assuming the Fed doesn't destroy the economy

00:10:25.300 | and then have to lower rates just to save us again.

00:10:28.700 | I talk a lot about the tolerance for complexity on this show, and I think that probably comes

00:10:32.540 | down to ease of access here. So in an online savings account, you might get a little bit

00:10:36.500 | lower yield, but it's super easy to transfer in and especially transfer out. It's not that

00:10:42.620 | bad if you have to go to a brokerage account, but if you're buying these short-term treasuries

00:10:45.700 | or treasury ETFs, you have to go to the brokerage account, you have to put the money in, then

00:10:48.980 | you have to make the purchase, and then you have to make the sale, and then you might

00:10:51.500 | have to wait a couple of days for the trade to settle to get your cash out. So it's not

00:10:54.540 | the end of the world, but it's one extra step to get that extra yield. I honestly think

00:10:58.500 | either route probably makes sense these days. You could maybe even split the difference

00:11:01.020 | and have a little bit in each, because if rates do start moving, and treasury yields

00:11:04.380 | are moving different than the Fed funds rate or the savings rates, you could maybe go back

00:11:08.300 | and forth to one another. I just think once you pick whatever route you're going to take,

00:11:12.540 | I would just stick with it and not try to go back and forth and earn an extra 10 basis

00:11:15.580 | points here or 20 basis points there. In the grand scheme of things, that's probably not

00:11:18.900 | going to matter much. The good news is, you already know how to save. This person has

00:11:22.460 | $60,000 saved, they're well on their way to having a healthy down payment, and if and

00:11:25.900 | when home prices drop from here, they could actually be in a pretty good position to buy.

00:11:29.900 | Yeah, yeah. I mean, let's hope so. For those of us that don't own homes yet, it would be

00:11:36.700 | nice to see this.

00:11:37.700 | This is you potentially, right Duncan?

00:11:38.700 | Yeah, right, yeah.

00:11:39.700 | So if you're saving for down payment now, what would you feel more comfortable doing?

00:11:43.740 | Honestly I would probably Google the highest yielding stocks and buy those and lose half

00:11:47.380 | of it by next year.

00:11:48.900 | So you would take dividend stocks for your down payment?

00:11:52.980 | Yeah. I'm just telling you honestly what I would probably end up doing, but yeah.

00:11:59.060 | You can lead a horse to water. You know, here's the thing. I don't mind having some stocks

00:12:03.940 | in your down payment fund, but I would right size it and maybe put 20% in there, 30% because

00:12:11.380 | you just don't want those stocks to crash right when you need the money and go from

00:12:15.300 | I'm going to have $70,000 for a down payment to wait, it's $60,000 because I had one awful

00:12:20.580 | month in the stock market.

00:12:21.820 | Right, yeah. Yeah, in all seriousness about the question, I would probably be more likely

00:12:27.460 | to have a savings account just because of what you're saying, the convenience factor.

00:12:30.260 | It is, it's easier. Now you have some yields.

00:12:32.420 | You're kind of paying a fee for convenience I guess, right?

00:12:34.060 | Let's do another one. Yeah, I didn't even realize we did the first three ones are all

00:12:36.500 | about bonds here.

00:12:37.500 | Right, yeah. No, I'm learning a lot today.

00:12:39.580 | All right.

00:12:40.580 | Okay, so up next we have a question from Mitch and this is the most confusing thing to me.

00:12:45.180 | I keep saying bond math. I don't know. Maybe you can make it make more sense.

00:12:49.700 | In the past I hesitated to allocate to bonds since you get killed on principle while collecting

00:12:53.940 | low rates of interest. Now that we've got a substantial allocation of bonds or a more

00:12:58.860 | substantial allocation of bonds than ever before, I'd like to get more clarity on the

00:13:02.460 | impact that rate changes have on principle value. For instance, if rates double, does

00:13:06.620 | that mean the principle has dropped in half? I think it would be helpful for people to

00:13:10.260 | better understand the scale of value changes with rates to get more comfortable with the

00:13:14.620 | risk or benefits of future bond value changes.

00:13:18.020 | Great question on the basics of bonds that most people either didn't know, didn't want

00:13:22.140 | to know, or maybe didn't care to learn about until this year. All right, so the first things

00:13:25.020 | to know about bonds and prices and bonds and rates. There's an inverse relationship between

00:13:29.620 | bond prices and rates. John threw up my handy Tom Cruise here. Easy. Inverse, right? We've

00:13:33.580 | been using a lot of inversion lately. Tom Cruise explains it the best.

00:13:38.140 | So there's an inverse relationship, meaning when interest rates rise, bond prices fall.

00:13:42.600 | When interest rates fall, bond prices rise. This makes sense. Let's look through a simple

00:13:45.700 | example, Duncan. So let's think about the relative attractiveness. If you own a 4% bond

00:13:50.100 | right now and rates go to 5%, your 4% bond has to be worth less if you want someone else

00:13:55.980 | to buy it because you can get 5% of the market. So you're going to get less interest, so you're

00:14:00.140 | going to have to charge a discount if someone wants to buy that to give them a higher implicit

00:14:04.380 | rate, right? Now let's say rates go to 3%. Well, now your 4% bond is going to be worth

00:14:08.660 | more relatively because you have a higher rate. So people are going to give you a premium

00:14:12.540 | for that bond, right? So it makes sense when you think about it in terms of the rates that

00:14:17.820 | you could get, right? Now the real question is how much do bonds fall when rates rise?

00:14:23.700 | That's what everyone wants to know, right? And this is getting into a little bit of nerdy

00:14:27.420 | bond math territory, but I think it can really help set expectations if you're buying bonds

00:14:30.980 | for your portfolio. So duration is this number that measures the relationship between bond

00:14:34.540 | prices and yield changes. It's expressed in years, right? So you'll see 8-year duration.

00:14:39.420 | And it's typically pretty close to maturity of a bond, but not exactly the same thing.

00:14:42.780 | It basically takes into account the maturity of the bond, but also how long it takes to

00:14:47.180 | get your money back. Because if you're earning a yield, you're technically going to get your

00:14:49.500 | money back before the end of it, right? That make sense? Okay. So the most important thing

00:14:53.420 | you need to know about duration is the higher the number, the more volatility in your bonds,

00:14:56.300 | all else equal. So let's say you have a bond portfolio with a 5-year duration. What this

00:15:00.620 | tells us is that you can expect a 5% change in price for every 1% change in yield. Yield

00:15:07.180 | goes up 1%, you should expect your bond to roughly go down 5%. Yield goes down 1%, you

00:15:12.420 | should expect your bond to go up roughly 5%. It's not exactly that, but it's pretty

00:15:17.140 | darn close. There's some other intricacies involved in here, but that's the gist of it.

00:15:21.780 | Okay. So higher duration means bigger drawdowns in a rising rate environment and bigger gains

00:15:26.140 | in a falling rate environment. John, let's do a chart on a zero coupon bond to show an

00:15:29.500 | example here. This is the extremes. Zero coupon bonds are all duration because you don't get

00:15:34.500 | paid income over time. You buy it at a heavy discount and you get paid back your principal

00:15:38.820 | at maturity. So there's no regular income payment. So zero coupon bonds are literally

00:15:41.540 | all duration. This is the 25 plus year PIMCO one. You can see it's rallied lately, but

00:15:45.940 | it's down 34% this year. That's more than the stock market. And then we compare that

00:15:49.420 | to one to three year treasuries that are down 3.8%. So again, higher duration when rates

00:15:55.300 | rise is going to get smacked way more than lower duration, which makes sense because

00:16:00.580 | one to three year treasuries have like 1.9 year duration, right? So they're not getting

00:16:04.420 | hit as bad. Now the other side of this can be seen in the first six months of 2020. John,

00:16:08.460 | do the next chart. This is the first six months of 2020. Zero coupon bonds were up more than

00:16:13.220 | 30%. One to three year treasuries were up 3%. This is like two sides. It's two sides

00:16:17.340 | of the extreme coin and it's rarely going to be this much extreme involved, but that's

00:16:22.580 | the trade off here. So the question for you as an investor, I don't think there's a right

00:16:26.700 | or wrong answer, but it's do you want to accept more volatility in your bonds when rates fall?

00:16:31.180 | You want to get bigger gains and rates rise, you're going to get bigger losses. Or do you

00:16:34.320 | want to like try to predict how they will work in the economy if rates are going to

00:16:37.180 | fall because economic growth or the fed or recession, then you want to like go on along

00:16:40.660 | into the curve to get more bang for your buck. Or if you're worried rates are going to rise,

00:16:44.380 | then you're going to go in shorter term and you want to be more tactical. Or do you just

00:16:47.220 | want more safety and predictability? Do you want to take the volatility out of the equation?

00:16:50.700 | My way of thinking about it personally has always been I'm going to accept volatility

00:16:54.580 | where I'm getting paid for it and that's in the stock market. I don't want to take much

00:16:58.180 | volatility in the bond market, but it really depends on what you're trying to get. What

00:17:01.660 | do you think? How's my explanation here, Duncan? I mean, I feel like the Zach Galifianakis

00:17:07.220 | gif with all the numbers flying by me. Again, the biggest thing you need to know is that

00:17:11.180 | the duration tells you. So if it's a 10-year duration and rates go up 1%, you're probably

00:17:15.220 | going to lose 10%-ish. That's your relationship. So if it's a 50 basis point move, you're going

00:17:22.380 | to lose 5%. That's kind of the relative relationship. Okay. I think I got it. I think I'm getting

00:17:30.180 | it. So if we go into recession and interest rates get cut in half here, long duration

00:17:34.060 | bonds are going to do much better, right? Because they have a much higher duration.

00:17:38.060 | Got it. Let us know, Mitch. Let us know if that explains it and helps you understand

00:17:43.260 | it. All right. Let's do another one. Okay. Up next we have a question from... Actually,

00:17:48.820 | I'm not going to save your name in case this question makes them have an awkward conversation

00:17:53.500 | with their wealth manager. Okay. Long-time listener of Animal Spirits. I'm 49 with three

00:17:57.700 | kids, retired and married. For all intents and purposes, I'm rich-ish. That is comfortable

00:18:03.140 | but can't afford a yacht. I hired a wealth manager and he brought me this fund of uncorrelated

00:18:08.620 | assets with a 10-year walk up. I trust my manager implicitly, but he claims that it's

00:18:13.820 | exclusive and not everyone has access to this private equity fund. I think I'd be better

00:18:18.260 | off buying Vanguard ETFs, but for what it's worth, he's a professional wealth manager

00:18:23.180 | and I'm just another guy on the street. I don't know if he means on the street or like

00:18:27.340 | the street. You know what I mean? I think just a guy. Okay. Guy on the street. Someone

00:18:30.620 | in the comments here asked how I have three kids and a house that's so white. You know

00:18:34.740 | those magic eraser things? I'm constantly washing the walls here. Fingerprints, crayons,

00:18:39.740 | everything. Is that like a long call for Procter & Gamble or who makes those? I don't know

00:18:44.940 | who does make them. It's got to be one of those consumer staples, but yeah. Or OX. Yeah.

00:18:48.620 | I get those every three months from Amazon because I go through so many of them. Internet

00:18:54.060 | down in my office today. I was down hard. No internet when I got to the office. They

00:18:57.220 | canceled my account for some reason. I said this week I'm not feeling so great about AI.

00:19:04.620 | It took me 45 minutes to get a person on the phone. AI doesn't understand. Talk to an operator.

00:19:09.700 | Talk to an operator. I just say it over and over again until someone talks to me.

00:19:12.980 | Right. Yeah. That's the future, but I like the Christmas vibes. I appreciate that.

00:19:17.700 | My wife is big into big decoration. Okay. My view here is that there are a lot of ways

00:19:20.500 | to be successful as an investor. I have my way of doing things, but I'm not delusional

00:19:23.940 | enough to think that my way is the only way to invest. Having said that, if you're going

00:19:30.940 | to see through a long-term investment plan, you have to be able to understand what you're

00:19:34.780 | doing and why you're doing it. We get a lot of questions about hiring an advisor. I think

00:19:39.980 | you can outsource your investment plan and your financial plan and your portfolio management,

00:19:43.260 | but you can't outsource your understanding. Let's actually bring in a financial advisor

00:19:46.940 | because I think this is better for someone who's working with clients on a daily basis.

00:19:49.820 | Alex Palumbo. Hey, Alex. Hi. How are you? Alex, you've implemented a lot of plans. You've

00:19:57.180 | worked with a lot of clients. You've talked to a lot of prospects. Now, one of the big

00:19:59.980 | things for us at RDWM is fit, and that's fit between the client and our way of doing things

00:20:05.380 | and then our way of doing things and the client. I mean, if someone comes to you and wants

00:20:11.040 | you to do something for them that we simply can't or won't do, how does that work? Alternatively,

00:20:17.120 | you have a client who comes to you and they say, "I just don't agree with the way that

00:20:20.520 | you invest, but I still need a financial advisor." How does that work and how do you work through

00:20:25.360 | those sort of challenges? Yeah. It's interesting when people want to work with a financial

00:20:32.560 | advisor or a financial planner and then don't want you managing their portfolio or they

00:20:38.840 | don't trust the things you say. It seems like a very non-mutually beneficial relationship.

00:20:43.800 | Like, "Why are you going to pay me money for advice that you don't then take?" Regarding

00:20:49.200 | this particular listener, I mean, first of all, 49-years-old, three kids and retired,

00:20:55.920 | rich-ish. I don't know a lot of 49-year-olds that are retired with three kids that are

00:21:00.680 | in fact rich-ish. Very impressive. Just because they don't have a yacht, yes. No, to be honest,

00:21:06.720 | that is impressive. So we could assume that you're listening to Animal Spirits. You're

00:21:10.440 | somewhat financially savvy, you would say. I mean, these illiquid investments are like

00:21:15.260 | the bane of my existence as someone who previously worked in the broker world selling a lot of

00:21:20.480 | these typically subpar products. And listen, it's exclusive. Not everyone has access to

00:21:26.760 | it. It's a private equity fund. He's probably right, but that exclusivity doesn't necessarily

00:21:31.820 | mean better outcomes. And you're paying a steep premium for it in the fact that you

00:21:36.520 | can't touch this investment for 10 years. So if you trust your wealth manager and you

00:21:42.360 | like to add diversification to your situation, then it's most likely fine with a very small

00:21:47.880 | portion of your portfolio to take that leap into the private equity fund. However, within

00:21:53.480 | the financial plan that you're monitoring with your financial advisor, I would categorize

00:21:58.360 | this investment as not funding goals. So don't rely on using any of these funds towards the

00:22:04.960 | achievement of your financial goals. You're essentially increasing variance in an attempt

00:22:09.600 | to hit home runs, which is fine if you understand the risk-reward relationship.

00:22:13.080 | Right. And you know if it's a 10-year lockup, and sometimes these private equity funds,

00:22:16.280 | I know from experience, can extend and be way longer than 10 years. It could be 15,

00:22:20.240 | 20 years to get all your money back. And so understand, you're right, that this is untouchable

00:22:24.720 | money for a long time. So if you're retired at a young age, you're not taking in Social

00:22:28.360 | Security yet, you're living off your investments, where else is that liquidity coming from?

00:22:32.520 | And do you have the ability to take 5%, 10%, 15% of your portfolio and put it in something

00:22:36.960 | liquid and still have the ability to fund your lifestyle in the meantime?

00:22:40.680 | You know, we have products that, not products, we have strategies we offer clients that very

00:22:45.880 | small portion of their overall portfolio, "Hey, I think this could make sense for your

00:22:50.760 | particular situation. Definitely not mandatory. What are your thoughts?" But then we have

00:22:56.200 | our core bread and butter strategies that saying, "Hey, when you become a client, these

00:23:01.480 | are the 1, 2, 3 strategies that you are going to utilize inside of these accounts. So this

00:23:07.720 | isn't like a buffet. You can come and get anything you want because that's a very nonproductive

00:23:12.880 | relationship in my opinion. So there's a difference between like small percentage of your assets.

00:23:18.480 | Let's try to hit home runs, but we're not going to mess with the bread and butter, the

00:23:21.640 | core competency of how you and your family are going to grow your assets over time and

00:23:25.360 | achieve your goals."

00:23:26.360 | And I do think, not trying to like, you know, take out this guy's advisor here, but if you're

00:23:31.640 | saying, "I think I'd be better off with Vanguard ETFs and this advisor keeps pushing private

00:23:35.560 | stuff and illiquid stuff because they're exclusive and all this other stuff." I think that's

00:23:40.400 | at the point where you start having a conversation with someone else, just see what else is out

00:23:43.200 | there because if it's really not something that you can stick with, even if it's a great

00:23:47.800 | investment and it's not going to work for you, like it's not suitable for you, then

00:23:52.080 | you're never going to be able to stick with it and you're going to want to leave eventually

00:23:54.240 | anyway. And by the way, breaking up with an advisor with a bunch of illiquid stuff in

00:23:57.720 | your portfolio, as Alex you can attest to, is not an easy thing to do. It's much easier

00:24:02.720 | to cut bait when you have a more liquid portfolio.

00:24:04.760 | Yeah, that is brutal. I interpreted this question as, "I already own a high percentage of Vanguard

00:24:10.680 | ETFs. Now he's coming to me with this little portion of my portfolio that maybe I should

00:24:15.760 | use in this private equity fund." But if your interpretation is correct, Ben, and this guy

00:24:20.840 | is talking negatively on Vanguard ETFs or recommending a very high percentage in this

00:24:25.480 | investment, then I think that's a much bigger issue and you should not proceed with using

00:24:30.200 | this advisor.

00:24:31.200 | Right. Okay, let's do another one, Duncan.

00:24:33.400 | I have one follow-up, one new boil question maybe, but what's the point of a 10-year lockup?

00:24:39.040 | Why would you be okay with that?

00:24:40.440 | Well, it's a private equity fund, so that's just an illiquid fund structure that you're

00:24:43.840 | going to be investing in these things. And they assume by the time you buy into some

00:24:47.160 | of these investments, turn them around operationally, and then have some sort of liquidity event,

00:24:51.800 | it's going to take 10 years probably.

00:24:53.240 | Okay, okay. So they just don't want to be pestered after three years about getting money

00:24:57.040 | back when it hasn't had a chance to do what they're trying to do with it?

00:25:00.560 | Yeah.

00:25:01.560 | Okay.

00:25:02.560 | Duncan's like, "Why would I need 10 years of a lockup in an investment when I can lose

00:25:05.560 | all my money in Oatly in six months? I don't really understand."

00:25:08.520 | When I can lose 40% in a year, why do I want a 10-year lockup? Okay, so last but not least,

00:25:14.840 | we have the following. "I'm in my mid-20s and just got my CFP. I've been an advisor

00:25:21.400 | for a couple of years now, but I'm having trouble relating to our firm's clients since

00:25:25.560 | most of them are retired or approaching retirement. I'm worried they don't trust me since I'm

00:25:29.920 | much younger than they are, and I don't have a ton of experience. Do you have any advice

00:25:34.840 | for a young advisor?" Well, we actually do.

00:25:38.120 | Great, great question. Alex, I'm not sure you know this, but I look a lot younger than

00:25:41.640 | my 41 years of age, right? I have three kids, and I go to the store and I still get carded

00:25:45.640 | sometimes.

00:25:46.640 | Do you really?

00:25:47.640 | On occasion.

00:25:48.640 | That's got to be flattering at this point.

00:25:50.440 | One of the first meetings I ever had with Chris Venn and one of our clients that reached

00:25:53.800 | out when I first joined Ritholtz was a guy in his mid-50s, and he kind of made the point

00:25:57.720 | to both of us immediately that, "I don't know if I can handle this age difference because

00:26:01.240 | you guys are so much younger than me." It can be tough because there is a huge difference

00:26:06.400 | between experience and expertise and all these things, but a lot of people you come into

00:26:10.520 | contact with who have the most money are going to be older. Alex, you came to us at, what,

00:26:15.400 | 24 years old? Is that about right?

00:26:17.480 | Yeah, I was 23 when I first started here.

00:26:20.360 | 23. How did you navigate that as a young, up-and-coming advisor and then building a

00:26:24.080 | book of business?

00:26:25.080 | Yes. Well, now that I'm old and crusty and in my 30s, I can give a very seasoned answer

00:26:30.720 | to this question. First and foremost, I did a previous interview with the one and only

00:26:35.520 | Josh Brown on this exact topic, which you can see here, being a younger financial advisor.

00:26:41.080 | But yeah, it's actually a really good question. I think it's pretty nuanced, to be honest.

00:26:47.460 | First and foremost, I would say to this listener's question, your clients are not your friends.

00:26:54.880 | They're paying you for a very serious service that you should be efficient and adequate

00:27:00.000 | in delivering. So when you mentioned I'm having trouble relating to them, to me, it makes

00:27:04.320 | me think you're viewing your relationship in the wrong context.

00:27:07.780 | Now I'm very close with a lot of my clients. Some send me yearly holiday cards, not going

00:27:12.720 | to give out names. A lot of them send me wedding gifts when I got married. We are very close,

00:27:17.940 | but this closeness is not based on us watching the same TV shows or having the same friends.

00:27:23.400 | It's based on the mutual respect of our financial planning relationships and then adding in

00:27:28.840 | layers of humanity, personality, and bonding based on this core financial planning concept.

00:27:36.400 | So first and foremost, you have to understand their perspective. Trust me, when you're 50,

00:27:40.520 | 60, and 70 to this listener, and you're going to be talking to 25 year old, you're going

00:27:45.400 | to be thinking they're like your kids or even worse, your grandkids. But your job is to

00:27:49.600 | have such a deep level of competency and technical expertise that these prospective clients or

00:27:56.040 | your clients are forced to look past your age because your age is not what defines you.

00:28:02.080 | To Ben's point, a 55 year old broker could be doing terrible work for their clients for

00:28:07.640 | 30 years, and a phenomenal advisor can be doing exceptional work for your clients for

00:28:12.360 | five years, and in a vacuum, you'd want the 25 year old every time.

00:28:17.360 | Do you think the remote work thing actually works in a young person's favor when you're

00:28:23.480 | not having to sit across the table from someone, and it's a little harder to tell the age gap

00:28:28.440 | or experience it?

00:28:29.440 | That's definitely so. When I first started here, we didn't even do like Google Meets.

00:28:33.860 | It was all phone calls and screen shares. And I did feel that helped me a lot as a 23,

00:28:42.440 | 24, 25 year old advisor because I still look kind of young. So they couldn't see that.

00:28:47.720 | I do think that helps a lot. One other piece of advice, you have a team on your side, right?

00:28:53.460 | It's okay to leverage your team and say that you don't have all the answers yourself from

00:28:58.280 | an investment management perspective, from a portfolio allocation perspective, from a

00:29:02.120 | tax insurance estate perspective. You have people in your firm that should have decades

00:29:07.280 | or combined decades of experience, and it's okay to leverage that.

00:29:11.360 | Yeah, I think that helps make a lot of people more comfortable if they know that there's

00:29:15.300 | a team behind you. Here's our tax expert or insurance expert. It's not just me. I'm your

00:29:19.580 | first level of communication and I'm your relationship manager and all these things

00:29:24.080 | and I'm helping you to plan, but there's more people here than just me.

00:29:27.360 | And like me, I'm here. I'm always happy to help, you know? Portfolio construction.

00:29:32.180 | To be honest, I've probably spoken with the most prospective clients out of anyone that's

00:29:38.240 | 31 years old that's in this industry. Thousands of people. And I can count on my hands.

00:29:42.760 | That's a not to brag right there, Duncan.

00:29:44.240 | Yeah, that's definitely a not to brag.

00:29:45.880 | That's a not to brag. I've talked to many, many people. I can count on the amount of

00:29:50.440 | hands, the amount of hands that I have, the fingers on my hands, the amount of people

00:29:55.300 | that have actually said, "Hey, you are too young. Let me chat with someone more experienced."

00:30:01.340 | And you know what, Ben Carlson and Duncan Hill, we do that, of course. Make sense? Yeah.

00:30:06.740 | Chat with Gary, chat with Bill. Not one of them have become client because if someone's

00:30:11.700 | coming into that meeting with this preconceived notion about it, they're probably not the

00:30:16.420 | best fit. And the second thing that I'll add is there are certain clients or prospective

00:30:21.500 | clients who think the opposite. Hey, I want to work with someone who's younger, more eager.

00:30:26.440 | They're in the new school of advisory work, not going to shove me in some investment unit

00:30:30.900 | trust. I like the ETFs, the new school way. So don't always project some of those insecurities

00:30:36.500 | even though some of them are real.

00:30:38.300 | And that comes back to our first question about fit. And it's going to figure out if

00:30:41.980 | you want to work with that person or not, it's a two-way street. So also, I just wanted

00:30:46.260 | to say, Alex, I've never seen Duncan in a worse drawdown than we went to a nice restaurant

00:30:51.780 | in Houston and the maitre d' told him to take off his hat. There's no hats involved.

00:30:58.340 | Yeah. I probably would have left if I wasn't with all of you guys.

00:31:01.900 | He was in an immediate bear market, immediate bear market.

00:31:03.340 | One time we were in the office and Duncan didn't have his hat on and Cameron looked

00:31:06.940 | at him and he goes, "Is Duncan wearing a wig?"

00:31:09.900 | Yeah. No one knows what my hair looks like.

00:31:13.340 | All right. Thanks, Alex, for joining us again, offering your expertise as a more seasoned

00:31:17.220 | advisor now that you have a beard.

00:31:18.980 | I know. I always had the beard. Thank you so much for having me. May I make a quick

00:31:22.900 | plug, a product placement? Compound water, tastes like Barry, for the intellect, for

00:31:29.060 | the trader, for the daredevil inside you.

00:31:31.740 | All right. Don't do that again.

00:31:33.220 | Hold that bottle up a little closer so people can see. It's a real thing. We actually made

00:31:36.140 | a ...

00:31:37.140 | This is Compound Water, Ben. Did you know this?

00:31:39.060 | A listener.

00:31:40.060 | Yes.

00:31:41.060 | A listener is like a bottle of water person. Yeah, we made some bottles.

00:31:45.380 | May or may not cause you to wear deep V-neck spandex style.

00:31:48.380 | All right. If you're listening in podcast form, leave us a review. Remember, leave us

00:31:51.380 | a comment in the YouTube comments here. If you have a question, email us, askthecompoundshow@gmail.com.

00:31:55.580 | We will see you next time.

00:31:57.500 | See you, everyone.

00:31:59.100 | Bye-bye.

00:32:00.100 | Bye-bye.

00:32:01.100 | Bye-bye.

00:32:02.100 | Bye-bye.

00:32:03.100 | Bye-bye.

00:32:08.100 | Bye-bye.

00:32:13.100 | Bye-bye.

00:32:18.100 | Bye-bye.

00:32:23.100 | Bye-bye.

Why Is the Bond Market Screaming Recession?

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