Struggling with your electric bill? Get an energy assist from SDG&E and SAFE. You may qualify for an 18% discount. Visit sdge.com/fera to find out more. Welcome to Radical Personal Finance, a show dedicated to providing you with the knowledge, skills, insight, and encouragement you need to live a rich and meaningful life now while building a plan for financial freedom in 10 years or less.

Today we tackle a subject on the show that we have not tackled adequately for some time, and that is investing wisely. The subject of investing is massive and can be applied to many aspects of life, but specifically today we're going to talk about stock market investing with somebody who is actively involved in the business.

My guest is John Medford. John, go ahead and take a moment and introduce yourself, please. Share a little bit about the work that you are currently involved in. So my audience can get a context of how you're coming to this conversation, please. Sure. So thanks for having me. I am a partner at an investment firm that invests entirely in publicly traded stocks in the US and in Europe.

We've been in business for about 15 years. We manage about a billion dollars mostly for high net worth individuals, endowments. We're more specifically a hedge fund, which is a dirty word, but basically just means because we're really good at what we do, we're able to charge more in fees, but it doesn't have perhaps connotations that typically are associated with it.

So John Medford is not the name that John was born with by his parents, and that's what's giving us the opportunity to dig into some of the things that we're going to dig into. So the reason that I wanted to have John on is because in this context, we can talk with somebody who's actively involved in the business.

It's a real challenge for somebody like me, who is a podcast host, to try to find interesting guests who are able to bring an honest inside look to the marketplace without having a significant conflict of interest. Generally interviews have to be run through the legal team for compliance reasons.

Generally people who are on the show are actively pitching something. It's just a challenge for me to give inside information. And so John is on the show here, and again, John is not the name that his parents dubbed him with, and that gives us the opportunity to chat inside about what's actually going on from somebody who's working in the business.

First John, I'd like to start with just a quick intro on how important returns are and what this benefit is. Because in personal finance, at this point in time, the safe solution for me as a broadcaster, as somebody who's encouraging people to be thoughtful and careful with their money, the safe solution that won't result in my getting fired is to recommend to all of my listeners that they take all of their money and that they invest it into index funds.

And certainly I don't think that's an ineffective solution, but I also always look at those returns, and I always think, "But if you could get a little bit higher, it could do a little bit better." So talk for just a moment about how, when you're working in your hedge fund, what your returns have been and how they compare to your competitive returns that you're being measured against, your benchmarks.

Sure. So, look, most funds don't do a good job. The vast majority of funds are going to underperform their benchmarks, which is why index funds are so popular, and rightfully so. I think Warren Buffett's been asked what he'd recommend folks do, and he always recommends, "Unless you're going to do it professionally, you invest in index funds." And I think he had a famous bet with some prominent people that ran hedge fund funds that the index would outperform their five or ten best chosen hedge funds over time, and lo and behold, he's won that bet pretty handily.

So in terms of our returns historically, look, we were, for a long period of time, a smaller firm. We do a lot of quirky stuff. We're exceptionally passionate about what we do. We spend almost all our time doing it. I love what I do. I find it really fun, like, so engaging.

I've been doing it for ten years at this point, but doing it informally since I was probably closer to 20 years. My partner who founded the business has been doing this professionally about 15 years, and our track record's really good. So we've compounded our capital since inception at about 18% a year.

The market over that time has delivered, call it, 80-ish percent, roughly. Now that said, that's our gross return, so that's what, as investors in the fund, we would get on our capital invested in it. If you were to look at an external investor who has to pay fees, that number gets closer to about 12.5%.

The reason that Delta's so high is essentially, call it a 5.5% expense ratio. But the reason we can charge that is we're generating excess return, and so some of that comes to investors and some of it comes to ourselves. Even despite charging those fees, we still have an attractive product with a lot less volatility.

Here is why I think these numbers are so important, and I wanted to lead with them. I think that in many ways, people like me in the personal finance space have become cavalier about returns and their impact on people's wealth. I'm very nervous using high predicted rates of return because I don't know how to tell a broad audience of people, "Here's how you get these returns." And the other thing that's challenging is doing this at various points in the market cycle.

I think over the last few years, almost anything has done well, but it's not always that way. But if we look out over a lifetime of investing, rate of return is massively important, and it's especially important as your wealth grows. In the beginning, the most important number is how much you save, and that's for most people going to be driven by your income.

But quickly, as your investments grow, you quickly get to the point where the most important return number is the investment rate. And so here's to put this into context, how important this conversation is for the average person. Let's say you're investing over a 40-year career from 25 to 65, and you're putting aside just a measly $5,000 per year.

You're making a Roth IRA contribution at $5,000 per year, starting with nothing. At an 8% annualized return, your investment portfolio at age 65 would be expected to be about $1.4 million. Not bad, especially for putting aside $5,000 per year. But at an 18% rate of return at 65, your investment portfolio would be $24.5 million.

Now let's use the retail rate of 12.5% for somebody who is investing with you, John, not you. It's $5 million. There is a huge, meaningful difference for actual spendable income, actual impact between $1.4 million and $5 million, and there's an even bigger impact between that and $24.5 million. So this matters hugely.

And I get really bothered because I've succumbed to this idea of saying, well, you can't get returns, market's efficient, et cetera. And yet it's too important to just leave alone. So to begin with, John, I don't want you to get into details, but let's say that you were advising me, and knowing that you can't just say, well, buy my fund, because that's not an opportunity in this context, how do you advise me to think about my stock market investing dollars, knowing that I really want return, but I don't know how to get it?

Even though I'm doing this not under the name my parents gave me, I will give the usual disclaimer that I just pick stocks, and I've done that for a long time, and I have my opinions about the way people might do things, but you should reach your own conclusions on that.

But I can opine on that with that caveat. Look, you said this on your show, I think it's a really interesting concept. I'm good at what I do. I'm very bad at lots of things in life. I happen to be good at this, and I love it. And it so happens that I believe if you devote yourself to one thing, and try and become very good at it, and you're of reasonable intelligence, and you are humble, and you have a lust of learning and curiosity, I think you can be good at it.

I think if you don't do that, you might be able to also be good at it, but it's a lot harder. So I would say in many respects, I'm not good at very many things, but it happens to be one thing I'm good at. And so for that reason, I think it makes sense to do it.

My choice is basically investing in stocks. Now it's horribly tax inefficient. If I think from a standpoint of if I was just maximizing my wealth, I wish I would have spent more time understanding real estate, given the tax characteristics of that. I think ultimately, the first question is, is there anything that you happen to be really good at or can develop a skill at?

And if it is, I think that tends to be the best place to put your money. Now, realistically, if you have a full time job, and that job doesn't involve investing, it's difficult to develop that competency, at least right away. So a couple of things I can say on this.

So one, generally index funds are probably the best, but there's some huge caveats to that. When you invest matters a lot. In general, the market returns have been, call it 7%. I don't know where the numbers are, roughly 7% over a very long period of time. But depending on when you invested, that return can be very different.

So for example, if you happen to invest at the top of the internet bust to today, your returns would still actually be pretty decent, but they'd be much less good than if you started your investing in 2009. Now, this isn't an issue if you're putting $5,000 a year, but to the degree you have a meaningful bonus or inheritance or something like that, and you decide to put all your money into index funds at one point in time, that can result in some pretty bad scenarios.

So look, if you're going to invest in a stock market, I think index funds are definitely reasonable. I think one just needs to be careful about the returns that one underwrites. I think from today, my personal opinion, is that it's not going to be as good as it has been historically, even if you look out over a 20 or 30 year period, at least on a real basis.

But I've been wrong on that, and that's not an area of confidence of mine. If you do actually want to invest personally in a stock market, I think it's great to try to build a competency. I strongly believe that someone that really devotes themselves to stock analysis can actually build a skill and make money, especially in smaller companies, but it's just something that takes a lot of time.

And so when I started investing in college, I'd say the first eight years I was in this business, even before I was doing it professionally, I didn't know what I was doing. And I had basically had 90% of my money in index funds. I think at that time, index funds weren't as popular, so maybe it was actually mutual funds, which in retrospect, I wouldn't have done.

And I had 5% or 10% in individual stocks, and I treated that 5% to 10% as not necessarily gambling money, but as experimental money. And then I watched my returns, and I thought about, I tried to be honest with myself about my capabilities, and if I thought I was doing a good job.

And as time went on, I devoted more time to it, I decided to put more and more money away from ETF and into individual stocks. But had I not devoted myself to my profession in that way, I wouldn't have done it. I would have found something else that I could have compounded money at in a better way.

>>DAVE Well, just as a personal finance observer, I would illustrate, with your being the partner, an investing partner in an almost billion dollar hedge fund, you can do both things. You have an incredible synergy in that position of being able to earn a lot of personal income using a form of synthetic equity, using other people's money, and to invest at the very highest rates, and to invest a lot of money by using other people's money.

That's why so many intelligent, bright people go to the investment marketplace. So you're doing great for you, but I'm going to go back to for the rest of us. So I agree with you in terms of it seems to be a, it's not a consensus, it seems to be a highly echoed prognostication that future returns will not, over coming decades, for the market in general, would probably not be as generous as they have been for some of the past decades.

What's the argument though? What are the headwinds that are causing so many people to believe that, and Warren Buffett, just to pick on the most commonly thrown around name, many people are saying there are major headwinds. What's the argument for that position? >>JASON Okay. So I'm going to narrow this a little bit.

So I'm going to say developed markets, I'd say US and developed Europe, I'm going to ignore emerging markets. I don't have a strong opinion on emerging markets. My bias would be that those might do better. But if you look at developed economies, a few different things. One is in general, we're moving towards a society, we've had a two and a half to 3% tailwind as an economy from more people being born in most developed countries, especially countries that speak English, that tailwind is starting to reduce.

In certain countries like Japan, it's become a headwind. So it's harder to grow your economy when you're not growing your people. The second thing I'd say, if you think about the US kind of where we were 50 or 75 years ago, it's just a different environment than we have today.

That's one. Two, stocks are, this is going to get a little bit technical, I assume it's okay if I get slightly technical. >>COREY Go ahead. >>JASON All right. So when you own a stock, you own a portion of a business and that business has a price attached to it.

There are X number of shares and so you get a price per share based on the total value of the enterprise and how many shares there are. That company, let's assume the company has earnings to make things simple. The company has earnings. People generally value stocks based on their earnings, not entirely, but let's just make that simplified assumption as well.

And so when you're investing in the market, which is really just a collection of stocks, you have X amount of investment that's producing Y earnings and there's a multiple that's attached to that. So let's say for simplicity's sake, that multiple today are different numbers, but let's call it 18.

So I have the stock, I have my index fund, let's just use, I'm going to assume we'll call it S&P, let's assume S&P just to make numbers simple is 100. So 100, I have, gosh, let's make it even more simple, so 20 times earnings. So let's say I have $5 earnings.

Now over time, the investment grows a few different ways. One, that earnings can grow so that $5 can go to 510, 525 to the degree that earnings grow and the multiple stays the same, the investment grows. Now over time, my impression is that the earnings growth has been, call it 2% or 3% a year.

So you have that. Secondly, you have capital return, which in the form of dividends. Dividend yield across full stock market right now is something like 2%. I think it's varied over time, but let's call it 2%. So you have kind of 5% of your return that I actually think you can feel decent about.

Dividends are what they are. And earnings growth over a long period of time, I don't think there's any reason to think that that's changing particularly. Now the third factor is the multiple you put on those earnings. And that number varies wildly. And that number has a huge impact on what your return is going to give in a year.

So simplistically, if you think about certain market environments, so 2009, I think you had that multiple. And again, these are going to be rough numbers, illustrative. That multiple may have dropped to nine. And here we are today, that multiple's call it 18, 19. Your return that you've gotten from the quote unquote predictable things, earnings and dividend yields, that's not really...

I mean, it's rebounded some, but it's not what's driven the returns. What's driven the returns is people instead of willing to pay nine times that number, now willing to pay 18 times that number. And if you look over a very long period of time, there's an argument that folks make, which is basically you can rely on that call it 5%.

And that multiple expansion, it's just hard to know, but all else being equal, you're better off when you're buying at a lower stock multiple than when you're buying a higher stock multiple. And so very simply, and you can do some math around this, if you assume over, I think, a 10 year period, that earnings grows, call it 5% a year, or earnings dividend gets you 5% return a year, but the multiple falls in half.

I don't know exactly where that math works out. And Josh, I'm sure you can put something together on this, but basically you would end up with something that basically has no return. And so the real variable that moves things a lot isn't actually the underlying performance of the businesses.

It tends to more be people's feeling or multiple they're willing to ascribe to those earnings. Yeah. And that's what I don't understand about many of the... There are some businesses that I understand that make sense. The company is profitable. They have a compelling value proposition. They have real customers.

They really work. And I would be happy and proud to be a marginal owner of those businesses. There are other businesses that it seems to me have massive stratospheric desire by investment managers that I just simply don't understand. I was looking at Uber recently, and I don't want to...

Obviously I don't want to get into individual things, but I'm just looking at this company and saying, massive company that can't seem to make money, basically. How do these things happen? And you look at so many of the modern companies, I don't know how to connect them to reality.

And so I don't know if there's something that's broken with me that I'm just old fashioned and we're in a new world where the old rules don't make sense and the goal is to get as big as possible and lose money all the way through as some of the leading companies seem to do, or if there's something old.

And so it causes me to be very insecure about decisions like that, especially when then I look at what's happening in the world. And as you say, the difference between nine and 18 is major. If you're going to value things at nine times, that's going to be a very different number than at 18 times.

But then I look at the world being a wash in money, and it almost seems like do the old rules still apply? I don't know the answer. I'm stymied by the problem. I don't know the answer either. And I think what we do as a, this isn't maybe super satisfying, but as a firm, or just as a person, there are certain things I know the answer to and I feel like I'm good at.

That's analyzing individual stocks. There are other things that are a lot more complicated and require a very different skill set. Like for example, trying to predict where the economy is going or trying to predict the multiple that people will apply to those earnings streams across a broad number of companies.

That is a totally different skill set. I have no idea how to do that. That said, I can be aware it exists and I can try and carve out a niche for myself where I'm focused more on businesses I can understand that have been valued for better or worse somewhat consistently over time.

And so what I would say, the nice thing is at least if you're investing in, I know S&P 500, some of the bigger indexes, there's also IVN, which I think is the Russell 2000 value index. You can avoid some of those stocks. Now there's an argument to me that those stocks are very attractive.

I'm not going to make that, but I think, look, people can make money a lot of different ways. I mean, there are venture capital firms that invest very early in stuff and have had amazing returns and they literally do like two hours of work before they make a half a million or a million dollar investment.

It's pretty amazing, but you have one success there. You find Facebook and it's paid for every mistake you're going to make. But look, I mean, ultimately with the stock market, it just gets very complicated when you start to get into little stocks. I think to the degree that you don't want to bet on eToys in 1999 having a $30 billion valuation and people think it's going to be worth that.

And if you can find parallels today, the way you avoid that is you basically avoid, to the degree the more specific ETFs that have a lot of names like that in them that aren't generating earnings, you can generally avoid those and you do a pretty good job of that by choosing more boring indexes like the S&P, Dow, or potentially a value skewed index, which there are plenty of.

So do you think that normal people with an above average interest in money should simply give up and say, "I'm just going to take market returns," or do you think that normal people with an above average interest in money and investing should seek to become competent DIY investors buying publicly traded securities?

That's a very good question. It's really hard to do that, but you can do it. But if you're going to do that, it's a job. To spend two hours a week doing something, you're just not going to be competent at it. I don't know, to the degree you're a surgeon, someone tries to be a surgeon a couple hours a week, it's probably not going to go very well.

And the thing is, if you start to spend that much time on it, I think there are probably... I can only speak to investing, I think it's possible to do. I know people that have done it. There are probably easier ways to do it than putting your time in stocks.

So what I would say generally is, look, if you have a 401(k) and that's your option, putting it in ETFs is probably a fine thing to do. I think generally you shouldn't make bets about where the market is, even though it's going to have a big impact in returns.

You just put in the amount that you have every year, you're just 65, you're probably in this with something that's okay because that money will be put in over a long period of time. But to the degree that you can develop a competency in something, whether it be investing or real estate or something else, I think you're going to find, or starting a business, I think you're going to find a lot more attractive returns there than you are just putting your money in an ETF.

So let me hone in on something then, because I want to understand the difference between your abilities as a professional hedge fund manager versus mine. The thing that bothers me about stock market investing, just to use what I mean is purchasing publicly traded securities for large companies. The thing that bothers me in trying to choose, do I want to put together a portfolio of blue chip stocks or this kind of thing?

What bothers me is I don't see where my competitive advantage is in that market. Let's stick with real estate versus stocks. I can understand where my competitive market is to find, or my competitive advantage is to find a below value property in a neighborhood in my town, because I can understand which neighborhoods are coming up, which neighborhoods are going down.

And I can go out on a Tuesday evening and drive around with my children in the back seat and I can look for houses that look dilapidated, that look like there might be something happening, and I can start to go and knock on doors and ask people if they know anyone on the street that they might want to sell their house.

I'm doing work that is in such a tiny market that it's very reasonable that I could be one of, if any others, one of only a few other people who are actually canvassing that market. But if I go to US listed securities exchanges, there are, I don't know the number, at least hundreds of thousands of people who are scouring these same handful of some few thousands of companies and I don't see the competitive advantage I have.

So what do you have as an investor that I don't have sitting at home on Yahoo Finance? So it's not higher intellect. It's more time and more resources and more focus. So the analogy you have is interesting. So you said something I think really insightful, which is you can focus on a small neighborhood where you do a lot of work, right?

You know the ins and outs of that neighborhood. You drive around and do on the ground diligence. It's not just looking up on Zillow and buying a home in Nebraska when you live in Florida. You do it in a neighborhood that you understand. Stock investing isn't really too dissimilar.

So a couple of things I'd say. One is as a firm, we spend probably about a million dollars a year on research. Now that research comes in a couple of different flavors. A relatively small amount of it frankly is off the shelf research. A fairly large part of it is what would be called proprietary research.

So for example, if I'm researching a company, and the other thing I'd say just to make it simple as well is I'm not going to look at things that a thousand other smart people are looking at. I want to look in markets that are inefficient where there's lots of fear.

These tend to be companies that aren't very well followed. They're not kind of popular household names or if they were popular household names, they no longer are and have a stigma associated with them. So first you start going to those areas as you would say that are inefficient. And the second thing is you throw a lot of intellect and time and money trying to figure out those neighborhoods better than anyone else.

And that's what we do. So as I said, we spend a million dollars a year on research. What does that mean? That means I do, gosh, I personally probably do about 300 phone calls a year with former employees, competitors, customers, industry experts of businesses we're considering investing in. What else do we do?

I can actually talk to management teams of the companies that we're investing in because we have access to that because we're of a scale that we can do that. That can help us well. I've been doing this for a long time now. So I have tremendous experiential knowledge. For example, we do a lot of investing in software.

I've just have a very good sense of that market. I've seen a lot of patterns in terms of why people panic and sometimes sell software stocks that they shouldn't. There are whole interesting little things about that that I could talk about endlessly, but just from doing it for a long period of time, you see pattern recognition.

I imagine if you're good at real estate, you would see a set of patterns that would make you be attracted in a deal. I'm making this up, but maybe it could be someone who's lived in the house for a long time. The house is not very well kept. Maybe it's really dirty.

It's messy, but those are things. Maybe they're not using a broker or not using a good broker. Maybe it's on the market for a long time. You just see these patterns of things that tend to result in people that aren't as sophisticated as you haven't done it as much, that they might value those things.

They might value the dirt on the floor at negative $10,000 on the house. Psychologically, you can see how that makes sense. Realistically, with experience, you can buy a $5 cleaner and fix it with an hour of work. It's not very different than getting good at anything. I think the challenge with the stock market is it's just like the world's casino.

People tell you it's investing. I think people convince themselves sometimes investing is actually gambling, and then you get into a whole list of other issues. But chances are, unless you spend a lot of time on it, unless you have specific knowledge about a company or an industry, you probably don't know what you're doing, and you're probably going to do substantially worse than just an index.

Let me ask you about risk. I personally have what I perceive to be a fairly high tolerance for risk. Let me define that term in two ways. First, volatility. My personal theory that I practice and encourage others to practice is keep your personal finances separate from your investments in this way.

I don't know how to control for the volatility of an investment portfolio, but I do know how to calculate how much money I need every year and make sure that I have money that's not going to be volatile to provide for my expenses. So then, in looking at an investment portfolio, if I say this portfolio here is likely to be this volatile based upon historical understandings, and so therefore if I keep three years of cash outside of the portfolio, I could afford to leave that portfolio alone completely for three years, which would get me through 72.6% of the problems, something like that.

So I segregate investing from personal finance. I don't want my life or my lifestyle to be subject to the risk of investment volatility. That helps me to be more comfortable with risk. A lot of people have this sense, however, that investing in the market is just this intensely risky thing.

I'm a little bit more cavalier about that concept of risk, thinking that somehow if I buy this company, it'll go to zero. I'm a little cavalier because, one, I think the market is very efficient. There are a lot of people who are looking for things, and it's hard to believe that if this company were headed to zero, there wouldn't be some indications of that.

There are a lot of people trying to find that information out. So yes, there are spectacular bankruptcies. There are spectacular failures that come from nowhere, but those are pretty few and far between compared to the most of the companies that just don't generally do well. The risk of a company going to zero is very, very modest.

Companies have a lot of assets. Now, it's a little different to look at a company that's very heavily on this whole asset as intellectual property or an idea or an app. I don't know what Uber's assets are other than its user base and its app. I don't seem to see what their moat is that they can put against competition, considering that most Uber drivers are running three apps at a time, and most Uber riders also have two or three apps on their phone.

So I don't see what this moat is other than early mover advantage and brand recognition. But when I look at a company like, I don't know, my favorite, Walmart, I look at Walmart and I look at it and say, "Man, you've got millions of customers on a global basis.

You've got diversified streams of income. You've got tremendous physical plants, infrastructure, et cetera. There's real value here." And so no matter what, obviously that value needs to be properly assessed based upon the formula of earnings, profitability, et cetera, and some multiple. But this is not that risky. So I'm not worried.

If the dollar plummets, here's a company that earns money in all kinds of currencies all around the world. So I just don't see large companies or reasonable companies with professional management as all that risky. It seems far riskier to me to own a house on the corner that could be wiped out by a zoning change or could be wiped out by a law change or something like that than it does to own shares of a large global corporation.

Where am I wrong? What am I missing in that kind of ambivalence about risk? Well, so the first thing you said is something I wholeheartedly agree with. So even though I can get very attractive returns on my funds, it's not particularly useful if I have to dip into that.

At definition, it would probably be the worst time. If the market's down a lot, funds down a lot, I'm not making so much income. I might have to dip into savings to do that. So having cash just provides a buffer that allows you to never have to call yourself out.

So that totally makes sense. I think you're also generally correct. Look, the more businesses you have, the things that that's harder to... If you buy Walmart, you're not really buying one business. You're buying one type of business all over the world and such that one thing can go bad in one region and you could still probably be okay.

That said, simplistically, I would not take much of any comfort in any signaling just because it's a big company you've heard of and the stock's gone up or other things like that. I think it's probably safer, but you'd be surprised at the level of... Enron, for example, there are lots of examples of those companies.

Valiant, all different kinds of companies that we're seeing as these big, good companies that end up having a lot of issues that you wouldn't be able to diagnose logically, sometimes outright fraud or anything like that. So in general, even being a professional investor, spending tremendous amounts of time on every company research, we typically in our portfolio don't have more than 5% of the portfolio in one investment.

Personally, when I did things myself, I had my own portfolio, I'd be comfortable going to 10 to 15, but even in that case, it'd be things that I knew tremendously. I would never make the assumption that just because a company is big and has professional management and it has a stock price with a big valuation that it's safe.

I can give a bunch of examples of that, but maybe another way to tackle this is within the investment community, there are lots of people that have very different jobs. So why individual investor or why small firms can actually do quite well in the market is due to a whole host of structural issues with the way investments are managed.

So if you think about the stock market and the investors in it, right now you have, I don't know if the numbers did 25 or 30% of money, which literally just goes into whatever stocks are in an index in the composition that they happen to be in. There's no lens of value, there's no lens of interesting things happening in the business.

It is just formulaically put to work in indices, which is actually creating more opportunities for people that can do a lot of work. You then have the vast majority of money that's managed, which is managed still by mutual funds or institutional investors. Making these numbers up, let's call it 30% ETFs and then you have 60% mutual funds.

Those mutual funds get compensated almost entirely on a percent of assets. They don't get rewarded very much for doing substantially better than the market because they don't get a percent of profits, they just get their management fee. They want to do just well enough not to be fired. And so those people basically try and track the market and make some small adjustments around the edges to try and maybe outperform it by 50 or 100 basis points.

But in reality, a lot of them don't do that and so they'll tend to lag by roughly their fees. And then you have a much smaller portion of the market with people that are getting paid substantially more as a percent of the assets they manage with tremendous incentives to find stocks that perform and to have no correlation.

And those people are throwing massive amounts of resources and employees at companies that other people aren't looking at in detail. So I can't tell you how many times I go to conferences or other things like that and you just see people that, you know, there's one analyst maybe who covers 100 stocks and covers 100 stocks.

Each one is a 50 basis point position or 25 basis point position for the company he works for. No matter how smart that person is, you just can't divide your time in such a way to be expert on 100 companies. And he can be expert on like 10 or 12 or 13 at any one time.

And so the math just becomes very unfavorable. So what you have to have happen is occasionally you'll see these spectacular failures where the businesses were owned by a whole host of people. It was seen as a very safe company. And lo and behold, the thing goes under. Now, interestingly, in many cases that that happens, I'd argue in most cases that that happens, there are short sellers that tend to be employed, hedge funds that are doing work trying to uncover frauds or businesses that have presented themselves in one way that actually aren't what they think, what they make themselves to be.

And in most cases, we have this spectacular failures. You have people like me that will be betting on them failing because they've uncovered through massive amounts of on the ground diligence, other things of that nature might find a fraud that's there that people have missed. So I think it's very dangerous to ever have assume any investment is inherently safe.

Certainly there are ones that are going to be more safe than others, but there's that, there's leverage, there's all different kinds of factors that come into play that might not be obvious unless you do this as a Russian. And you very briefly there at the very end alluded to just even all the different tools and different ways of playing a hunch or playing a bet, whether that bet is up, down, all of the ways to ensure your bet, et cetera, which are effective, but are largely opaque to a retail investor.

Here's what bugs me, which I want to try to figure out how to do. To your comments, it seems to me from having sort of worked in the investment business, there is, I don't know what cliche to spout out here, but you won't get, what was the old thing about IBM?

They said you won't get fired if you choose IBM. Basically, it's a safe choice. Yeah, it might not do very well, but you're not going to get fired. And as you just pointed out, in the investment business, the majority of people are just trying not to get fired. And even though at this point in time, I have no allegiance, I have no conflict of interest, I have nothing that is in any way to my opinions, I still don't want to get fired.

I still don't want to make a crazy prediction that turns out to be wrong. And so I always go back to, "Index funds are safe. How can I be the guy that says, 'No, you should try to go and find John Medford and invest in his hedge fund because this is too important.'" And I run the math and I quietly do things myself in my own private life, but when it comes time to putting my reputation on the line, then it's very hard to put my reputation on the line for something that's not safe, that's not deniable, that I couldn't defend.

Now at every level of the investment business, you have the same thing. If I were, when I was a financial advisor actively managing money, you had exactly the same thing. You would get very little return for a massive outperformance if there were some way for an individual retail advisor to provide massive outperformance.

You get very little return, but you'll suffer massively if you're out of line with the benchmarks by too much of a degree. Because you can at least defend how, "Well, we're in line with everything's down. Yeah, your portfolio is down, but look, look at what the S&P 500 is doing and you can see that we're actually doing only a little bit worse or only a little bit better." And then as you say, at the mutual fund, you have the mutual fund managers, the portfolio managers, basically every single level.

So about the only people who have enough incentive seem to be guys like you, hedge fund managers, where there's enough upside that you have the incentive to swing for the fences for returns to invest the money, but the press is so bad and I don't know how to find you.

So how do I find you is the point and how do I find a good you, not a loser? So you would be substantially better off, anyone would be substantially better off, I think, investing in the average ETF or investing in the average mutual fund than investing in the average hedge fund.

And the reason for this is very simple. If you are a mutual fund, you're just not going to veer that far from the market. You're going to, they charge 1%, they're not going to swing for the fences, they're also not going to destroy you. Hedge funds have a terrible reputation.

There are lots of types of hedge funds. There are lots of hedge funds, I have no idea what they do or how they make money. There are lots of hedge funds that are terrible. There are lots of hedge funds run by miserable people. There are lots of hedge funds run by actually, I think, quite good people.

Hedge fund is just a fee structure and a legal structure. So hedge fund is different, but the axiom used to be you charge a 2% management fee and then 20% of profits. That number has come down some. There are lots of flavors of that. When you have an incentive structure like that, you can imagine the amount of resources and incentives someone has to try and perform.

At the same time, you wake up January 1st every year and you know you have to outperform whatever your benchmark is by 2% until you even start to compare to them. And so it's logical to think, again, it's just a fee structure. People often choose hedge fund managers like they choose any investor, they choose them on the big names that they don't think they'll get fired for.

And lo and behold, the investor at the average hedge fund is probably better than the average investor at a mutual fund. But I'm not sure it justifies the fee differential. And so if you look at hedge fund indices, the hedge fund indices are even worse than mutual funds in aggregate.

But what that masks is a smaller subset of funds that happen to be very good. Now, how do you find that? Look, it's hard. I mean, I don't know you're looking for any life hacks. The reality is almost definitionally, I would argue, it has to be a smaller fund.

I would say it has to be a fund that's somewhere between kind of $50 million and $1 billion. Ideally, it would be one where most of the capital is capital partners that has been in business for a few years that seems to care more about compounding their own money than growing their business.

Most common things that happens in hedge funds, hopefully this won't happen to us, but it has happened with most of them out there. If you don't close to your investors and you keep getting bigger, it becomes harder and harder to generate good returns. But there's a massive incentive to do that because every dollar you take in generally just falls to the bottom line.

And so what tends to happen is the folks that are good grow, and they pretty much keep growing until they're no longer any good, or they're just trying to not get fired because now their incentives are to swing for the fences and generate good returns to hold on to their money empire that they built.

So it's exceptionally difficult. In my case, it's like anything. I imagine if you're doing real estate investing, you run into people in your neighborhood and you know that this person is really talented. I don't know a way to do that other than being an expert in what you do.

So if you're not an expert in stocks, you probably shouldn't try and find me or anyone that's good because you're not going to know what to look for. Whereas if you're looking in something you know a lot about, real estate or whatever it happens to be, you're probably going to be a better judge of that.

And I'd say given how expensive hedge funds are, I would dissuade anyone from thinking that the average hedge fund is going to be good. The average hedge fund is terrible. It just comes down to if you find people that are good in a niche, have a good track record of doing that, are trustworthy, are honest, seem to make sense, what they do make sense.

You can understand, they can explain to you how they make money. That's a good starting point. But I just think it's very hard to do that unless you have the knowledge. Well, at the very least, you are basically affirming the way that I've affected it or addressed it in the sense that I can't deny the academic data on the whole, but I also can't deny the individual examples that are there, but I can't tell you how to get them.

So you basically said what I say, which is things are largely efficient. The safe solution is buy an ETF, Eaton Dex fund. And yet that doesn't mean that outperformance is not possible. I just don't know necessarily how to tell you to get there. You repeated what I have repeated, right?

We pretty much agree? Look, if you want to talk for two hours about everything that we do that's different, I can start to give a clearer sense of that. But I assume that'd be true of anyone that does anything well. The conclusion I have from this is less anything related to stocks.

I think the thing that gets me excited is exactly what you said. You chose an example in your life where you feel like you can get an advantage because you live in the area, you know the neighborhood, you know that. And if you dedicate time to it, you can probably do substantially better than that than the average person who probably is trying to find a new place to live, has time pressure, has work, isn't just focused on it the way you are.

And so for me, the conclusion isn't, frankly, the conclusion is more you should find something where you feel like you have an advantage and put your money there. And I don't think that's stocks unless you devote yourself to it. Now, obviously stocks are easy and realistically for a lot of people, it's one of the easiest ways to spend money.

But if you want to have great returns, probably not going to be an ETF. It's probably going to be doing something that you become expert in where you look at the other people doing it and you understand why you have an advantage. >>AJ: I've been disconnected from the professional world of money, anything, no licenses, no anything for I think almost five years now.

And over those years, I have really tried to ask myself, what do I believe now that I still believe that I believed then? Now that enough of my loyalties and allegiances and conflicts of interest and whatnot have dissipated, what did I fool myself? What did I think I believed then, but I only believed in it because it was buttering my bread?

And one of the things that I believed then, but I didn't know necessarily how to articulate, was basically that you shouldn't look to investing, if we think of investing as buying something like just buying a Roth IRA and putting stocks in there, you shouldn't look at that as the path to wealth because you don't have a competitive advantage.

You're not knowledgeable about the market and you don't have enough money to make a difference. So if you're only making a $5,000 investment, that $5,000, you can probably find something in your personal life. I don't know what it is. Maybe it's solar panels on your roof. Maybe it's cash for your next car.

Maybe it's discounts on bulk buying of your groceries. Maybe it's a discount on new equipment for your business or something. You could probably find a better way close to you to put $5,000 than in the stock market. Same thing when we go up at $50,000 or $100,000 or a few hundred thousand dollars.

If you've got $100,000, you can start to get, you can swing your weight around very effectively in your local community. You can find enough opportunities where you can really get outperformance. But then you face a problem where it's hard to invest your capital more and more. You get to a million and millions of dollars.

Unless you're an established entrepreneur or a very experienced investor who's willing to buy a 20-unit apartment building or something like that, it gets hard to invest significant amounts of money. And I think that's where, just speaking generally, the stock market can easily absorb a million dollars. The stock market can easily absorb $5 million without becoming a problem.

Now a billion dollars is very hard to invest, but a million dollars can make a big difference. And so somebody who has a million, somebody who has a couple million, can easily come to a modestly-sized firm or something like yours where you're not managing a $100 billion portfolio. You can come in and there are then those opportunities for outperformance.

And it's almost like the next logical step. You keep outgrowing one market and you've got to figure out how to get into another market. And to me, that seems like the best value, the best argument in favor of working with somebody like you. Now that's not to deny – go ahead and respond to that.

I'm sorry. >>Trevor: Yeah. So it's interesting because I would hate for people to take away from this. It's actually possible to beat the market if you can only find the right person. Look, you shouldn't trust anything I'm saying. I'm an anonymous person and there's no reason to trust this.

You have to use your own judgment as to whether or not I'm making sense. But you don't want to – there are so many people that have such strong incentives to convince you that they do something special that's going to get you more money than putting an index on.

I go back to it, unless you're an expert in stocks or in choosing managers or have really strong personal recommendations from people who actually work in the industry that you think are competent, I would generally just put money in ETFs, especially if you have a lot of money. Look, if you have a lot of money, if you have two, three, four, five million dollars, your expenses are modest, you don't need to return 10%.

If you want to maximize your wealth, maybe you do, but you'd be perfectly fine with something that's boring. You put it in an ETF, you know no one's going to steal it from you, you know that no one is going to have sold you a pipe dream that they won't be able to deliver.

It is really hard to outperform the market and most people that do it, you've never heard of. And if they claim they do and you have heard of them, in many cases they're lying because the people that are slickest salesmen tend to be, it tends to be an inverse correlation.

Most people I know that outperform the market have modest forms of Asperger's syndrome and autism. They are people that can function very well in the real world, which is why they spend all their days reading 10Ks. The person, for years I read Joshua Kennan's website and he writes a lot less now that he and his partner have launched a fund.

But I used to read his website and he was such a good writer that I thought this is an insight into somebody who, I don't think he's autistic, but into somebody who's just a freak. Like he likes this stuff and it convinced me to entirely walk away from any interest in market investing because the kind of person, I would imagine you, John, the kind of person that enjoys this stuff is weird.

You're weird and you enjoy things that most people don't enjoy. Now my interests are totally weird, but they're weird in my direction. And so I think the key is to recognize what your interest is in. I don't want to read 10Ks, but I love reading tax law. It's weird, but that's my thing.

So I want to pivot here. I didn't tell you I was going to do this, but I want to ask you about your personal financial advancement. Not asking you for all the details, just simply pointing out the path that you have taken towards wealth. Did you come from a wealthy family?

Yes. Okay. And how did your parents invest in you? What worked and what didn't? They paid for my education, which I'm eternally grateful for. What did that education look like? Four-year university. I have no graduate degree at all. I don't think it's useful. Was it elite, Ivy League? Was it general, mass market?

It was slightly below Ivy League. It was a very good school, but not actually much of a brand name. And how did that benefit you? I met really interesting people and found things I'm passionate about, and I had space to do that. I didn't take a class that changed my life or allowed me to.

I think it was just the social environment. I met fascinating people. I had room to explore what I wanted to do. The other thing my parents did, so they had set aside money for college, I had expressed an interest in stock investing. I've generally been prudent and conservative over time.

They, when I turned 21, there was still money left in that account. They turned it over to me and they told me, "This is it. You can invest it, but if you mess it up, there's not more." And that started, and I put a lot of time and effort.

I think my junior or senior year of college, I just consumed everything I could, really, at the stocks. Got lucky, frankly. I don't think I was particularly good. Got lucky, I think it was 2003, which happened to be the bottom of the stock market cycle. And lo and behold, 2005, I have the same amount of money in the account that I had when I was a junior.

I also decided to go part-time my senior year, which saved me 20 grand. And I came out of college with a couple hundred thousand dollars in an account, and that started to compound my whole life. And then I was exceptionally frugal for a very long period of time. Why were you frugal?

How did you learn that? Who taught you that? This is interesting, actually. My father was a very successful entrepreneur. He built a business that, at one point, was worth, I don't know, $50 or $100 million, and he owned maybe 20% of that. And we had a very nice lifestyle.

We had a big house, and I never understood why we had a big house, because there was half the house we didn't use, and it just made no sense to me. I don't know why that appealed to me, but it was. And then something happened such that that business imploded, and he went from having lots of paper wealth to not very much.

Sorry, lots of paper wealth to still lots of paper wealth, but not as much as he was used to having. And then that paper wealth was invested very poorly, and he was left with half of that. And he was still in a good place, but nowhere near what he was.

And for lack of a better word, it just got him depressed for about 15 years until things kind of finally got better. And so I just grew up assuming bad things would happen. So I didn't have a pretty simplistic person. I had things I like and I need. I'm not particularly social seeking, data seeking.

I just like the food I like. I wear clothes until they have big holes in them that are unsightly. I'm just the way I am. And as time went on, I've had to learn to spend money. I mean, I married a wife who is very frugal herself, and that's just kind of the way I did it, but it wasn't really a choice.

It was just the natural consequence of probably seeing what happened to my parents, who weren't, by the way, very frugal at all. Yeah, but I don't know how that happened. I'm not sure it was them that instilled that in me as much as it was just me watching what happened to my family as they rode up and down with wealth.

Well, to me, it's obvious. Sometimes we learn from somebody training us and us believing the person, that the person who's training us knows what they're talking about and choosing to obey them. Sometimes we learn just by simply watching an unfortunate example, example of disaster or catastrophe or just malaise and saying, "Hey, I see the problem.

I don't want to repeat that." And it sounds like your personal example was a negative example, not a bad, but just simply, "Oh, that wasn't a good thing. If my parents had been more frugal, then they wouldn't have experienced such severe depression when their wealth was severely diminished." Then when you got into the investment marketplace, you graduated from college, you were managing, in essence, a couple hundred thousand dollars of your own money, addicted to it.

When did you decide to go into that field professionally and what was your path into it? It's unusual. I decided it wasn't the right thing for me. And lo and behold, I went back to... I didn't have any hedge funds at that time. There weren't any that were hiring.

When I then came back into the market, which was not in a good economic environment, and then I just kind of was scrappy and I started writing on a blog some of my investing ideas and the work I was doing. And someone read it who managed money and he gave me a job.

He first offered me my salary, which I believe was $32,000 a year. I got him up a little bit, but not much. And I just kind of grinded it out. I was really scrappy. I moved on from there to another firm that I met by working there. I did a lot of in-depth stock research, loved talking to people.

I just networked a bunch. I don't call it networking. I just love investing and it's very fun for me to talk to people and I like talking to people that are good at it. So over time, I would talk to people that were good at it and some of them would think I was good and some of them would think I wasn't.

And the ones that thought I was good and I thought they were good and I thought they were reasonable people, we would connect and chat and we'd then occasionally make money together and lo and behold, what happened with my career, it's not worth going into too much detail on and I don't want to reveal myself, but I ended up meeting someone through that process that I then joined in his business.

And I happen to think he was very good. I walked away from a more lucrative job to take a chance on a startup. I bet on the team that we had at the time of which I was a big part and he was a big part and things went well.

And they continue to go well. At some point, they won't go well, but basically, I was at more established firms and then found an entrepreneurial opportunity where I wanted to make a bet and take a swing and that's what I did. >>Corey: And so people who are in similar jobs like yours with similar responsibilities like you have would earn on average about how much per year at this point in time?

>>Jeremy: It varies dramatically depending on the fund size. I mean, I can give some illustrative- >>Corey: Just range. >>Jeremy: Yeah. Look, so if you're a partner, if you're the founder of call it a billion dollar hedge fund, in an average year, you probably make 10 to $20 million. That's if you're the founder.

If you are a partner that has been with the firm for a while, it depends at the place, but call it anywhere between $1 to $5 million depending on the fund and individual performance. That's kind of at partner level and then investment analyst level can be very good as well depending on how your ideas go and how generous the person in charge is.

>>Corey: So my point is not to probe too deeply on your personal experience, but to point out as a financial planner how incredibly valuable your path is. Because at this point, and about how many years out of college are you? >>Jeremy: Between 10 to 15. >>Corey: Okay. So 10 to 15 years out of college, you have come from a place where, let's just say you're making, what was the number you said, $32,000, right?

So you started with varying experiences, but $32,000 to earning in excess of 10 times that today in 10 to 15 years. But yet you're in a business where it aligns with your personal interests, gives you enough ownership, enough autonomy to be connected with so that you can live your life.

But this is what you did when it was just your own interest. But yet you found a way to make a lot of money that way. And this is the perfect example of for somebody like you, it's a win-win-win because you are investing your own money in your own firm.

Thus, you have the opportunity to earn basically the gross number of 18% basically, instead of 12.5%. But you're also generating enormous fees for yourself on your management of other people's money. So your income from here can basically increase, assuming that you don't mess it all up, it can basically increase almost exponentially over the coming decades.

And yet it's well aligned with something that you are interested in. So I point that out because what I have observed is the most important examples for us generally to look at in personal finance are people's career paths and how their money and their career are interrelated. Not just on how do I find the best hedge fund manager or how do I find somebody to get me a lot of money in my portfolio, but who are the people who are doing it most effectively.

And so you're in a business where you risked relatively little in terms of capital, but you exerted yourself in interest and in study and for years built up and accumulated the benefit of that and then parlayed that into a place where you have exponential returns. Because the returns that you can get from managing other people's money where you can generate as you say, an extra one to $15 million of annual fees based upon whether you're a partner or founder of a hedge fund.

But when you can generate a million dollars per year reliably and consistently, and be doing that while you're simultaneously investing your money, then you're in the stratosphere of opportunities for wealth. Now many of us have opportunities similar to that, but it's important to understand what's happening. It was the same thing I tried to show people when I was a financial advisor.

The financial advisor doesn't get, the retail financial advisor doesn't become wealthy because they give excellent financial, give great investment advice. That's the biggest misconception that the financial advice industry has successfully sold to people. The financial advisor gets wealthy because they accumulate a set of knowledge and then they build, they use the, they borrow the assets of other people to generate profit.

So as a financial advisor borrows money from other people, says I'll manage this money for you, generates fees, and those fees then go to the financial advisor's bottom line and then they generate income, they pay for some expenses out of it and then they invest the money hopefully themselves.

Hedge fund managers do the same thing but on a much bigger scale, but then you can do the same thing at a smaller scale. I used to have, Curtis Stone was on the show a couple years ago and he borrows people's backyards and uses them to generate lots of money.

So the key thing is if you really want to grow wealthy, you've got to find ways to leverage equity including the equities that most people don't see and how do you use other people's money, other people's skills, other people's talents in a way that enriches you but provides a useful and important service to them.

So does that make anything to add, John, from your inside experience to that? I can only speak to what I do. I feel incredibly fortunate to live in a society that massively overvalues what I do economically and to enjoy doing it, to have a life that is good from that.

I have a lot of concerns and things I'm not good at. Thankfully this is now my life. I don't have to worry about it as much but I hope that people can find things, at the very least, that are fulfilling. I mean I'd probably do this even if I made quite a bit of money just because I like it but that I can have the other benefits is certainly attractive and unusual.

I appreciate your humility. I'm not trying to push you too far out but just trying to show that to my audience because here's what I see. We're in 2019. The niche that I'm doing right now is something that could hardly have happened 20 years ago but yet the number of specialized areas of knowledge and skill 20 years from now is going to be incredibly exponentially higher than today, exponentially higher.

And we're in a world of increasing specialization. And so if somebody understands the blueprint of basically how these things work, how does somebody go the path that you have gone, then they can see the clues and yet apply it in a totally different scenario. So that's all I'm trying to point out is this is the personal finance lesson.

We're in a world of increasing specialization. All of our careers will become increasingly specialized so we need to understand the pattern so we can recognize them. You apply pattern recognition in stock investing. We all need to do that in our own careers. I was just trying to use the example to show you.

John, that's all the questions I have. Is there anything that I've missed that I should have asked you about that you really wish I had touched on? No, I don't think so. Maybe a couple random things. I would say one is things are much more complicated than they seem in the high level.

I would argue there are lots of not very good people that run hedge funds in the same way there are lots of many not good people who do all different kinds of things. I happen to think there's a part of the community of hedge fund investors that are curious, passionate people that like finding the truth and enjoy being in a profession where they can get rewarded for being right and taking chances.

Is it saving the planet? Is it the most meaningful thing one can do for society? No, I would argue it's not actively bad. I can make an argument it's modestly beneficial but I think the reputation that the whole industry has gotten as a whole is inflated. I think the only other thing I'd just say too just to make sure and know in certain terms it's really hard to outperform the stock market in general.

I don't know in good conscience how to advise someone to do that themselves or to find someone that could do it without doing it as a profession and becoming an expert at it. So ETFs are probably the best thing to do. Probably the best thing to do but frankly probably the best thing if you want to do stocks but probably the best thing to do is to find whatever example is in your life something you're passionate about that you feel like you are particularly good at that aligns your skill sets that you find you do even if you didn't get paid for it and throw all your energy into becoming as good as that you could possibly be and you'll probably have a reasonably happy work life which is more than the vast majority of people can say and you may also happen to be in a place where you can get financially free quicker than you might think.

John, thank you for coming on the show. I always close with this question. Give us your best hot stock pick that we can go right out and invest in today. What's your best hot stock pick, John? Lay it on us. As you know, I will not be sharing that.

Thanks for coming on, John. I really appreciate it. With Kroger brand products from Ralphs, you can make all your favorite things this holiday season because Kroger brands proven quality products come at exceptionally low prices and with a money back quality guarantee, every dish is sure to be a favorite.

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