Paul Winkler: Welcome to “The Investor Coaching Show.” I’m Paul Winkler, talking about money and investing, retirement planning, and understanding the news of the day. Sometimes it’s just stuff that people ask me about here in the office during the week.
Answering Questions
I’ll just say, “Hey, this is a topic that came up this week” or “Somebody asked a question so I want to share with you how we answer these things.” We also have another way of asking questions too. The other way is to go to paulwinkler.com/question.
Here is the question: Is it proper for a quality financial advisor to suggest that I sell a piece of residential rental property real estate and invest the proceeds in his financial group? On the surface, is that a conflict of interest? Thanks. I’d give them about $200,000 of equity at this point.”
Really good question. So when you look at conflicts of interest, it’s almost like you can’t go through life without some, right?
There’s always something out there that could be a conflict of interest and could cause issues.
I’ll give you another example. We manage assets too, right. We do that on a fee basis. We try to keep the conflicts down where we align our client interests with ours. So in essence, if the portfolio goes up, they benefit and we benefit.
But here’s the thing that happens. You can have a situation where somebody has some assets, they’ve got a mortgage and they’re thinking, Do I take the money out of the assets and pay off the mortgage? Oh, because if they do that, the assets under management go down, then you get rid of the mortgage.
The way I approach this is I look at the person’s situation and go, “Here are the issues for you. Here are all the things that you need to know to make a good decision.” I will not make this decision for you, but I always like to have a partnership anyway, because if you’re engaged in this relationship and I’m making those decisions, that’s blind trust and that’s nasty bad stuff.
Real Estate Investments
If you say “Hey, you’ll make this much money on this thing,” versus you look at it and say, “Hey, your mortgage is literally 2% or 3%,. Some of these people, these old mortgages at only 3%. And look, the stock market is a 10% return and your investment has done this.” And you go, “Well, yeah, that’s great. What’s it going to do in the future?” Well, they don’t know that, right?
So here are the statistics on a portfolio. This is the expected return, this is the standard deviation. Here’s what could happen. Here are the pros and here are the cons. Here are the risks and the dangers in your particular situation. I think it’s only right that a person actually explains all of the pros and cons.
If you’re looking at real estate, for example, think about it. You may be thinking, Well, do I sell this piece of property to invest the proceeds? Well, are you going to continue in real estate? Do you like the business of real estate, is a question I like to ask. Do you like doing that? A lot of people are like, “No, I’m sick and tired of it. I don’t like doing it. It’s become a hassle.”
If interest rates go up and real estate prices go down or real estate, let’s say that all of a sudden the vacancy rates go up, how’s that going to affect you? Is that something that’s going to be a problem?
You may live in an area where the real estate market is hot, but then all of a sudden companies decide that they’re going to move away or the tax laws change. I remember in 1986, you had the tax law changes and literally destroyed the real estate industry.
Is this something that could be a problem? Because I like what Jonathan says.
Recognize that a piece of real estate is a non-diversified asset.
Is that a problem? Can it be a problem? And here are the issues. Here are the cycles of real estate. If you take a diversified portfolio and you look at how, if I put this together academically, what kind of income can be taken and how does that compare to the real estate that I’m running it for?
Real Estate Questions
My father used to actually charge way below market levels for the real estate. He hated real estate. My mom loved it. My mother was like, “If you own real estate, you’ve made it.” And it was personal upbringing.
So I had to look at that. When you look at that for a couple is if there’s something, is there an emotional attachment to the real estate? Are you really financially dependent upon it? What are the tax ramifications for selling the real estate? How much recapture do you have?
Some people will go and do 1031 exchanges from one piece of real estate to another, and then they end up perpetually in real estate. And it’s like the Hotel California, they can check out any time they like, but they can never leave. They can’t get out of it.
Think about what you own.
Does that bother you? Does it bug you that you know could be tied to this property? How old is the person? Are they up there in age where if they sell the property they may be missing out on a step up in basis to the next generation? You may as well just hang onto it.
I actually gave that piece of advice to somebody. She was in her 80s. The choice was to hang onto the property and not sell it in that particular instance. And that’s kind of the way I approach it.
Now, another big thing is what are they investing in? How confident are you in what they’re investing in? Do you get it? Do you understand? You should think about it when you own, let’s say companies, stocks, you’ve got a lot of exposure to real estate right there because companies own real estate. Is it better just to be concentrated in one property?
Some people have properties that are actually attached to their own personal residences and that could affect their own personal residence if they sell the property. Now they don’t own it and now people can build or do anything in that property. You see, there are so many different variables. I think the job of the advisor is to bring everything in there, including the emotional, the taxes, and the returns.
Making Fully Informed Investing Decisions
Now the issues of as we get older, is this something you’re going to want to be managing as you get older? Is it going to be a hassle when it goes vacant? Is it a hassle when somebody calls you at all times?
I’ve owned real estate. I do, and I always tell people that, too. When people ask me this question, do you own any real estate? Yeah, I’ve got a commercial property, that’s where my business is.
I have another piece of commercial property a couple doors down. Now in my particular case, I have residential properties that are attached to my personal residence. And yes, there would be a negative impact if I sold, as far as I’m concerned. I don’t want that.
But if you ask me if it is a great investment, I would tell you no. But I don’t care. If it went unrented, I’m not dependent upon it. Most of my personal stuff is in stock market bonds. I have our clients do the same exact stuff.
So in reality I have very little exposure to real estate as a percentage of everything because I’ve been financial planning for almost 35 years or something like that. So in that way I have diversified myself so much that lack of diversification in real estate is not a big deal.
Don’t make a decision based on what is likely to happen in the future.
I use myself as an example to show that this is something that can be very personal. But the goal is to make sure that the investor is making a decision fully informed of everything. Then I would rather they make that decision based on all the facts.
I like to make sure that the facts come from academic research so it’s not the sales process. What are the asset classes hold? And what is the expected return? Why are the expected returns what they are?
I don’t care that large U.S. stocks have a history of 10% return from 1926 until now and every 30-year period is within spitting distance of 10%. I don’t care that that’s what happened in the past. Is that likely to happen in the future? Because that’s what I’m making a decision on. I’m making a decision on what is likely to happen in the future.
The Advisor’s Job
Quite frankly, we really don’t want what actually is going to happen with real estate or large U.S. stocks or small U.S. stocks or anything because you could have global thermonuclear war and everything’s called off.
So a lot of it’s not even the financial side. A lot of it is really what do you want out of life? And a lot of it, I always tell people, having all the answers isn’t necessarily the most important thing. But the advisor’s job is to ask the right questions of you and provide answers as far as what are the blank spots.
What do you need to know more about? And what are things that you’re not considering? You’ve heard it a million times, you need to think outside the box. Well, as I always like to tell people:
If you are the box, then it’s really hard to think outside yourself.
As you know, “There’s safety in the multitude of counselors.” It’s the idea that we want lots of different input so we make the best decisions. So there’s more safety when I’m getting information from a lot of sources.
If I’m the only source of information and I don’t know everything and there’s a lot of stuff that I don’t know, I can make a really bad decision. So the advisor’s job is to bring information to you that you may not know to help you make a good decision. And I think this is absolutely a critical question. I think it’s so good because I think this ought to be a collaborative relationship. Work together so that you make a better decision for you.
Now let’s face it, there are things that the advisor’s going to do and there’ll be a conflict if you sell the property and put the money with the advisor, obviously. But the way I like to avoid that is through educating and then you make the decision. So I hope that helps.
Really I would just encourage you, make sure you get, really get what they’re investing. I always tell people there are four things: What am I doing? Why am I doing it? What can I expect? What are the expenses?
Millionaires and Investing
Because what to expect in returns-wise, you can only say what’s expected. You can’t say, “This is definitely what’s going to happen.” When you have that level of understanding, I think you have a better level of confidence and you’re now not blindly trusting the advisor.
So there’s something that I saw this week. I was perusing the internet articles. MarketWatch had an article, “We’ve never seen this before.” And I’m like, yeah, I probably have. But a lot of times you never ever see it’s a younger person probably writing an article, I’m guessing. I don’t know, because it is like nothing new under the sun.
Millionaires are doing something unusual to preserve their wealth and you can do the same. Now, number one, you may have heard my viewpoint on watching what millionaires do.
It’s very tempting to watch what millionaires do with their money and do the same.
Because people can think, Well, they’re millionaires, they’ve got to be smarter, they have to be better informed. They better really have their ducks in a row or they wouldn’t have gotten to be millionaires, right?
Well, what we don’t think about is that most millionaires got there through some inheritance, the majority don’t inherit it. If you read the Millionaire Next Door, they tend to be savers. They tend to be really good savers. So you’ll have people with investment portfolios that are terrible, but they just saved a lot.
I mean, so just despite themselves or another big source, a big one is business ownership. And that’s why I always tell people the stock market’s so cool. You get to be a business owner. You get to own a company without the hassle of running the company. So that’s kind of cool when you think about it that way.
With owning a business, you might build this business up and it’s worth millions of dollars. Then you sell the company and now you’re a multimillionaire many times over. I was having a conversation with somebody this week about this topic.
They asked me about ideal clients for our firm. I said, “Well, I don’t typically, I don’t relish the idea of working with somebody that doesn’t have a long history of investing and working with different investment firms and brokerage firms or mutual fund companies.”
The Ideal Client
They asked why. I said, “Well, you think about it, they haven’t been burnt enough. I’m really just adamant that you have to have been burnt many times to really appreciate what we do.”
Because I have found so many times, and I’ve seen this where somebody owns a business, they sell the business, they come to us and they go, “I’ve been listening to you on the radio for years and I’ve got this bunch of money and I want to invest it.” Some people are fine when they do that. They’re really good, they’re really disciplined.
But I found that some people all of a sudden hear something else, the siren call of something else. Oh my goodness, I love to hear what this person says they’re doing over here. And then they jump ship and they lose discipline and they jump into something that I have preached against for as long as they’ve listened to me talk on the radio. They don’t realize that and realize that they’re falling for something really bad.
Let me just explain to you why this is a big deal to me. There is a concept in psychology I was taught which I think was brilliant. Insight does not create change very fast. Because I learn, I learn and I learn, but the reality of it is I just don’t retain it that well when I’m learning by insight.
You know what really gets our attention? Emotion. Let’s say that you screw up and you have a really bad circumstance with investing. Guess who never forgets that lesson? You never forget it because you have an emotional attachment. And the lesson was learned with deep emotion.
When a lesson is learned with deep emotion, your likelihood of forgetting it is somewhere next to nothing.
Think about stuff that happened when you were eight years old. You wonder why do psychologists go back to when you were a kid? Why do they do that all the time? It’s because you’ll remember stuff that was emotionally laden and it’s still affecting you today. That’s why. Okay, that’s why that works.
Millionaires Underperform
So here’s what happens, somebody that has been burnt will remember that and then they learn the lesson. So this is why this is such a critical thing to me. So if we look at millionaires and we say, “Well, so they got there, many of them by running businesses. They saved a lot of money. Are they great investors?” No, I’m just going to submit. No, they’re not.
And there’s the Forbes book. They actually went through millionaires and they compared in one of the charts they had it was like 25 people or something like that, or 25 years. I forgot how many there were. They compared the growth of the wealth of the wealthiest people in the world compared to just what the stock market had grown at over the same period of time.
They found that most of these millionaires actually underperformed. Even though they were smart and they had these businesses and they had done so well in how wealthy they were, they weren’t very good investors. They just really weren’t the point that they were making.
Millionaires may be smart businesspeople, but that doesn’t make them excellent investors.
Now here in this article, it says, “We’ve never seen this before. Millionaires are doing something unusual to preserve their wealth.” And you go, okay, what are they doing? Normally I don’t click on this stuff, click bait, I don’t look at it, but I was just like, I’m a moth to the flame. I got to click on this, and I did.
So it has a picture of a wealthy person sitting in front of their pool at their beautiful Pasha estate. And they’re talking about what it is that these high net worth individuals are doing? Well, what they’re doing is they have stored 34% of their wealth in cash and cash equivalents.
Now, number one, think about that. If they were really all that confident about what they were doing, they would be putting all their money in cash. Now, you look at this thing and they’re investing in the very thing, cash at banks that people are really kind of scared about because they’ve been hearing a lot of the negative news about banks.
Investing in Equities and Cash
That’s a little bit of an inconsistency right there. They’re putting their money in banks that we’ve been hearing news about having problems. That’s a little bit weird. The bank is an intermediary.
The bank takes your money and invests it someplace else.
So you think about that, what are they doing? They’re investing in banks that are investing their money in different types of loans backed by what? Businesses and real estate and all of that stuff. And you go, this is a little kind of funny, isn’t it?
But I digress. So they’re holding off on investing in equities was one of the headlines. Oh, the wealthy are holding off on investing inequities. Maybe I should do the same, not investing.
Now the equities vary. They’ll have 20% and then 31% and 25% in another period of time, and then 31%. And what I looked at was this, how much money do they have in cash that they say they’re investing right now? They have the percentage there and they’re saying it’s fairly high.
Their chart actually points out how much they have in cash in various years. So apparently they’ve been doing this survey for quite a while. And the last time that they had a lot of cash was in 2002. Well, what happened in 2003? Because they had lots of cash, they must have been thinking things were going to be bad.
Well, the estimate, and I’m not going to even talk about diversified portfolios, because other areas of the market actually went up more than this, but I’m just using this for simplicity’s sake. I’m going to use the S&P 500 just to make the point.
In 2003, the year after they had a lot of cash, 28.7% return for the S&P 500. Then in 2006, after the big return, their cash holdings, this is a few years later, their cash holdings went way down. So what they did is they had more invested in the stock market just before bad stuff happened.
Millionaires Appear to Be Smarter Investors
Oh, that’s brilliant. Way to go wealthy people. And then you go, when’s the next time? When did they increase their mix to cash again? Oh, they increased their cash holdings by about 50% by 2008. They had increased it just in time for the market downturn. And then what happened? But they didn’t increase it that much and they actually increased equities, too.
So that they did, oh, that looks pretty good. Then they increased it again. But what happened when they had the most cash next time? So it may look like they were smarter, but they really weren’t because they only had 21% of their portfolio is what they said here in this particular article. That was it. Then in 2018, they had almost 30% of their portfolio in cash again. Was that a good idea? No, because the S&P 500 went up 31.5% the next year. Blew it again.
Then again, when do they have lots of cash? According to this chart in 2020 and of course, 2020, the first part of the year went down, but it ended up pretty well. And then in 2021, yet a 28.7% return. So you look at that and go, whoa, that wasn’t so hot either, was it? No.
Then the cash drops down some, and now they’re holding record levels of cash. If I were a market timer, and I am not, I would be inclined to go and invest in stocks because the rich are investing in cash right now and their track record of good investing really stinks. But I’m not a market timer.
Here’s the reality. I don’t change my asset mix much at all.
Keep things in balance.
Yes, there’s re-optimization that happens based on correlations, all kinds of complicated stuff. But I do not engage in tactical asset allocation, which is just another form of market timing.
I’m telling you, this is weird. Investment firms very rarely don’t engage in that. Matter of fact, you read the ADV or the disclosure, the government disclosure on investment firms, you’ll see strategic asset allocation is one type of thing. Tactical asset allocation is the one you see all the time, which is a form of market timing.
Don’t Follow the Folly
You’ll see technical analysis. They do technical analysis, and the company, they’ll look bottom up or top down or they’ll use all of this language that’s really complex sounding, but it’s literally just market timing and stock picking in disguise.
We see it all the time. You have the concept of the accredited investor, and an accredited investor can do anything. If they invest in hedge funds, they can go anywhere and do this and buy this and sell that and move to this area and short this area of the market and go along this area of the market.
Don’t play the game of trying to beat the market.
And what they’re doing is gambling with a portfolio and the government looks at it and goes, “Hey, you’re an accredited investor. You got enough money, you could afford to lose it. No big deal. You go do what you want.” I look at it and go, no, I’m not playing that game.
I’m not playing that game and I am not going to follow the folly of wealthy investors thinking that they’ve got a better beat on things when they simply do not. History shows that they’re just not that good at this.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
