Paul Winkler: Welcome. This is “The Investor Coaching Show.” We talk about money, investing, financial planning, and retirement planning.
I’m here with Michael Sharpnack, chartered financial consultant and retirement income certified professional, and just in general kind of a nice guy.
Michael Sharpnack: Emphasis on the last part.
Returns on Retirement Accounts
PW: So my favorite article recently is this one from The Retirement Weekly, which says that your standard of living in retirement is largely determined by this surprising thing: making sure that you have return on your investments, that you have not totally messed that up.
Stock and bond market returns are basically what they say. In other words, make sure that you had decent returns on your retirement accounts. That’s not what you often hear people talk about, which is just amazing to me.
They’re usually talking about this tax, and we do talk about taxes and social security, and strategy and things like that, but there is not a lot when it comes down to really just focusing on what academic research, which is outside of the sales process, has to say about investing.
It’s typically about what annuity you ought to buy, and why you ought to buy that, and why you should buy this real estate investment trust, and what’s going on in the market, and what the DowJones and the S&P 500 did today.
I just hear that over and over again, and it makes me nuts.
So that is one of the reasons that we spend so much time just educating and dripping on you about education on investing, because the more you understand this stuff, the less likely you are to be taken advantage of.
Diversification
Now, we had a workshop, and we repeated it, and for people that couldn’t catch the first time, we’re going to put it on the website as well just because it’s something that, I think, everybody needs to see. It’s about diversification, and we refer to it as the delusion.
Most people think they’re diversified, but I would quite like to differ on my opinion as to whether people are really diversified, especially when you look at how retirement plans at work are invested, target-date funds, and things like that. They’re just not.
They are not by any academic definition well diversified when you look at the target-date funds. Now, there may be an exception out there that I have never seen in my many years of doing this for a living, but I’m waiting. I’m still waiting.
MS: Yeah. I mean, I’ve been here about six years now. Probably looked at a couple hundred 401(k) plans, or at least close to it.
I’ve never seen a plan that is as fully diversified as it should be.
PW: One academic who won the Nobel Prize for Economics was asked that question one time, and he said he was looking at the portfolios that we use, and the person running the portfolio says, “I believe this is as diversified as any Fortune 500 pension plan out there,” and he stands up and he goes, “I beg to differ.”
You’re thinking, “Oh, no. The Nobel Prize-winning economist is begging to differ with something I said,” but what he said was, “I think it’s more diversified than anything that I have ever seen.”
Here’s where it really gets down, where the rubber meets the road.
Most of the plans do not have very good exposure to small companies, they don’t have very good exposure to value companies, and they don’t have very good exposure to international companies, especially in the areas of smaller companies and more value-oriented companies.
If you look back at the history of investing, and you look at people like Warren Buffett, where he made his claim to fame was in value investing, but you don’t see it at all.
So we ran that workshop.
MS: Yeah, you can find it under the webinar section on the website, and it’ll be under past webinars.
PW: Fantastic.
MS: We put all the webinars that we’ve done that are still relevant on there. If anything’s out of date, we’ll take it down obviously, but anything that’s still relevant, you can find under that past webinar section there.
PW: Okay, so that’s paulwinkler.com.
Now, one of the things that we often talk about is if you have a question on one of those webinars, we’ll cover it here on the show, and there was a question that somebody asked in the webinar.
MS: Yeah, on the most recent one, we were talking about going through some of the biggest fund companies out there and asking the question, “Are they diversified?” And we were just looking at their websites.
So many of these companies on their website are saying they’re doing active management, saying they’re trying to make predictions about the market in the future.
They’re breaking the rules of investing. They’re not diversified.
A SAM Account
So someone said, “Well, I have this particular account.” I’m paraphrasing the question here, but they called it a SAM account from LPL, and they said, “Do you know if those accounts are typically diversified?”
PW: Okay, SAM is an acronym.
MS: Yeah. I had to look it up. I didn’t know it off the top of my head, but I looked it up, and it stands for Strategic Asset Management, which is a particular product that LPL has that allows advisors to use prebuilt portfolios from LPL.
PW: So when I worked as a broker like that and worked for a broker dealer, one of the things we would do is we’d go to conventions all over the place, and they would have this huge, monster room where you would have all these vendors.
Typically, what happened at these conferences is these companies would actually pay for us to be there. They would pay for their hotel rooms; they would pay for our meals in exchange for having the ability to market to us.
So you would go up and down the aisles, and you’d get squeeze balls, and you get little pens, and you get all the little trinkets that they had at these things, and you were given free rein to walk through.
What we would do is we would go and sit through a workshop on a certain topic, whatever it may be, some tax law or something like that, and then you would be given two or three hours just to wander, and they were great fun.
I always enjoyed these conferences. It was really fun just to talk with people and mix around. Especially as a young advisor, I didn’t know anything. I didn’t even pretend to know anything, so it was a learning experience.
What would happen is you’d have these companies trying to market to you. This would be an example of such a company, and they would market to you. Who is this one particular one?
MS: LPL.
PW: LPL. Linsco and Private Ledger. So yeah, that would be a company that you would go to, and they would have these products.
So one of the things they would do is say, “Hey, this is one of our preferred vendors out there. Check it out,” and you may want to recommend their products to your clients, and then they’ll educate you about their products.
So that was what they’re talking about here, an asset management program. Sometimes we call them turnkey asset management programs, TAMPs.
Basically, what happens is that you are recommending this to your clients. Now, the questions are, “What are you choosing? How, as the advisor, how are they choosing? What do they know? What is their philosophy of investing, going into this?”
Markets Fail
So Michael, basically, the two investment philosophies that we talk about for people are what?
MS: The first, which is what most in the investment industry are following, is called markets fail, and it basically means, “Okay, if there’s mispricings in the market, the market is not pricing stocks correctly, then you can go out and find those mispricings, and you can make predictions about where it’s going to go and what’s going to happen, and you can move your money around to take advantage of that.”
PW: Yeah, and the idea is that there is a mispricing, and you have better information because of whatever. You have better intel, and then you’re going to take that information that you have, and you’re going to apply it in order to buy that thing at a lower price than what it’s really worth, and when the market finally figures it out and goes, “Huh, by George Michael was right,” then all of a sudden, the price goes up to what it’s actually supposed to be worth, then you’ve made money.
That’s the idea of markets fail, that we can go out and do research, and we can figure out what is selling for less than what it’s really worth, or what’s selling for more than it’s worth, and get rid of the things that are selling for more than what they’re worth and make money that way. So that’s one.
MS: Right, and it’s based on that idea that you are smarter than everyone else in the market out there.
PW: Yeah, and there’s no ego involved, though.
Markets Work
MS: Right, right. I say that a little bit facetiously, but that leads into the second view of the market, the markets work, which is simply that markets are efficient. They price things correctly. All the information out there is built into the prices, and so that means that we just ride the waves of it.
PW: Yeah, so you’ll have strong and weak form. What we don’t believe in is a strong form, which is that there are absolutely never mispricings anyplace because obviously, something happens where information comes out and says, “Oh, you know what? We were wrong about that,” and that can happen.
A good example of that would be the year 2000, the tech bubble. There was really no talk that things were overpriced by any stretch of the imagination because technology was doubling every 18 months, and because of that, the sky was the limit as to what earnings could grow to.
It wasn’t until new information came out, and they said, “No, that’s not going to happen,” but it was only after the fact, two, three, four years, five years, hence, that people said, “Oh, it was obviously overpriced at that particular point in time.”
So that would be strong form.
Weak form would say, “It’s only after the fact that we know,” and what’s the evidence behind that? Professional managers and their inability to get returns that are above markets. So those are the differences between those two.
Okay. So this is a long answer to a short question, but what were the types of things that you found, Michael, when you were looking through the program brochure regarding this particular asset and strategic asset management?
Number one, when I hear that term, let me just say that it’s a red flag to me already. You’ll have tactical asset allocation, which is market timing in disguise, as we call it. That can be loaded.
Red Flag #1: Strategic
Sometimes it may be strategic. Sometimes you’ll do something that’s strategic, which is rebalancing a portfolio strategically, and that’s okay. There’s nothing wrong with that. So you really have to dig into the program brochure to determine what they believe their job is. So what did you find when you were looking through this?
MS: Well, the first thing is that there’s a lot of options available. So it’s hard to just lump the program as a whole into one blanket statement.
The advisor has a lot of different options available, so it’s really going to depend a lot on that particular advisor’s view, like we talked about, and what their philosophy is and how they’re utilizing the products available within the program.
PW: So they have different things, and they seem to be nuanced.
I think this is instructive for people, not only looking at this program, but I just think in general when you are reading one of these programs.
We’re just going to walk through some of the language that is in this, and if you see language that is similar, that should be a red flag too. So this is a way of you actually going in and looking for things. People always say, “I don’t even know what to look for.” Well, this is part of it.
If you’re looking for red flags in regards to whether the investment philosophy is a “markets fail”—a gambling type of an approach, as I would put it—to investing, here are some of the red flags.
Red Flags of a “Markets Fail” Approach
So number one, they’re talking about how they’re going to be providing investment advice and management of assets on the account. Now, they have a strategic program, and in here, they have a three- to five-year time horizon, is what they say.
So Michael, what were the red flags in this language in this particular paragraph to you?
MS: Yeah. One of the things they’re saying here is they’re going to take advantage of market opportunities that LPL research believes will occur or persist throughout that timeframe.
PW: So lots of weasel words right there. Opportunities, we’re looking for opportunities. We’re looking for something that is selling for less—kind of read between the lines—than what it’s really worth, and we’re going to jump in and buy it because it’s an opportunity. Think of it that way, that they believe it will occur.
So what is that? A prediction about the future. It can’t get any more clear than that, is really what we’re saying right there, or that they’re going to persist throughout the timeframe.
Well, what’s the timeframe? Big whoop, three to five years. That’s a pretty short timeframe.
Number one, big red flag right there, and let’s just keep going because there are a few other things.
Be instructive when you’re reading brochures and the prospectus.
One of the talk show hosts on TN said to me one day, “But I’m not going to read that.” I know you’re not, but I’m going to tell you, if you’re not going to read it, I want you to know it’s there, and it’s buyer beware if you didn’t read it.
You’ll go through what I think you’re going to end up going through when you deal with active management, because the statistics are bad. About 95% of professional managers are getting lower returns, taking more risks, and sometimes the return differences are huge.
So here’s one of the things I did that I was talking about with Evan. I was walking through what I was looking for in a particular fund, and I found the alpha data that was -6. I said, “That’s fate basically telling you your return should have been 6% higher based on the risk that was being taken.” That was one fund.
One fund was over 7%. The best fund among what the person actually owned was a negative alpha of just under 1%. That was the best.
So in effect, what you don’t really realize until it’s too late is that your returns were down, and you take a 2% difference over a 20-year period.
You’re talking about a 40% difference in accumulation. Think about your income, whatever it is. Let’s say that it’s $50,000, just to use a nice round number, and if your income is 40% less, you’re at $30,000, okay?
So just think in terms of that, saying, “What if …”
Now, it’s not just 2%. A six. Oh my goodness. Insane. Huge deal.
Red Flag #2: Tactical
So that was one, strategic. The second one was tactical. That’s what they said here, and let’s talk about that.
MS: Yeah. So it says they’re using tactical strategies. They’re designed to help take advantage of short-term, mid-term, long-term, one week, and as long as five years.
PW: Yeah, I liked the beginning of the sentence, in that they’re more flexible.
MS: They’re more flexible, yeah.
PW: Yeah. That sounds good, doesn’t it? I mean, blessed are they flexible for they will not be broken. Wait a minute, I think maybe I would take exception in this particular case because you can be, maybe not broken, but broke.
MS: Yeah. There you go..
PW: So go ahead.
MS: They use a lot of words like that, that sound good, right? To that point of reading the prospectus, it’s like, if you know what to look for, you can kind of skim it. You don’t have to read every detail, but you can skim it and see.
They’re talking about taking advantage of these short and midterm.
Well, if you’re making moves based on even one year, even—they say—up to five years, that sounds like a long time.
In the grand scheme of market history, you should be basing your moves on hundreds of years, not five years.
PW: Yeah, the first one was the “strategic” one, which is the one we would say had less trading, and it had all the red flags as well, but this one’s even worse.
It’s using the word “tactical,” which is—as we often teach in the workshops that we teach—code for market timing. That’s what they’re saying in here is trading is notably more frequent.
That is it right there. Anytime you see trading like that, you think, “Oh, they’re buying and selling. Who’s paying for that?”
A lot of that cost is not going to be in your management fee. It is going to be over and above your management fee.
Markups
They actually talked about bid offer spread costs because they have to. They have to disclose it in this, but you may go, “I don’t know what that is.”
Well, think about when you go to a store and you buy a product. When you buy that product, you’re paying a higher price than the store did because they’ve got to make a profit.
So what happens is that every time you buy and sell, in this particular instance, you are actually paying a markup, or you’re getting a markdown because they know they’re going to have to resell it, so they’re going to mark it down for you.
It’s like those commercials for when you look at gold and things like that. You got all these commercials and they’re saying, “The whole world’s going to fall apart and you need to buy gold.”
Well, if the whole world’s going to fall apart, why are you selling gold? Why don’t you guys just keep it for yourself? Because they make a markup, and you know what? They kind of like the dollars that they make when they make that markup on selling you that gold. So they’re looking for short-term opportunities.
I don’t care who your investments are with or what investment firm. I want you to understand how to read these brochures. They’re designed to be understood by the general public.
It is not above your head.
We’ll make it even a little bit easier for you because I think that’s what we do well.
Strategic Asset Management Program
PW: Paul Winkler and Michael Sharpnack here, and we are talking about money and investing, specifically talking about a question that came up at a workshop that I taught.
It was about a specific asset management program, and it was called Strategic Asset Management Program. It was offered by a big investment firm that is out there.
What happens is, you go to an investment advisor, and the investment advisor says, “Hey, I don’t necessarily study markets all the time, but we have people that are really good and that’s exactly what they do. You can just put your money with these people, and then they will move it where they think it needs to be moved based on what’s going on in the market, market conditions, and things that are happening.”
Now, when they’re doing that based on market conditions, remember they’re selling something and then they’re buying something else from somebody who thinks they’re buying something else from somebody who thinks that that thing is going to go down in value lots of times. Then they’re buying something that the other person thinks is going to go down.
So what ends up happening is one of the two of those people is going to be wrong, is the way I put that.
So in this program, they had types of investments and risks, and I think it’s important to walk through some of these things because I’ve taught workshops for many, many, many years.
I used to go out to various trade groups. I would speak to investing groups.
That was the worst thing for me, when people would say, “Hey, Paul, you can come speak to our investing group.” I would be like, “Your investing group’s going to break up when I finish. If they actually believe what I tell them, there’ll be no reason for being there.”
Or I would go to these clubs, Lions Clubs, Kiwanis Clubs, those types of things, I would go speak at those things. I bring that up because the very first thing on this list of types of investments and risks in this program was one of the things that I didn’t know a whole lot about until I spoke in front of one of these groups and then got asked about it. This is many, many, many, many years ago.
I went and researched it and I found, “Ooh, this is a problem.” So go ahead, Michael, what do you see in here as far as types of investments and risks that were red flags to you?
Red Flag #3: A Long List of Options
MS: Yeah, so the first thing, again, is that it’s a really long list of different options, which is a little bit of a red flag right there because that tells you a little bit about how they might be moving in and out between those types of options. They have to list everything to cover their bases.
So they’re already making predictions there. But then digging even more in some of the more concerning ones: start with options.
PW: So one of the first options is options.
MS: Right. Right.
PW: Okay.
MS: Exactly. Hedge funds, managed futures.
PW: Well, talk real quick about what the issues with options are.
MS: Yeah, well, the main problem with an option is you’re going to have to predict what the market is going to do in the future, usually in the very short term, the very near future.
PW: So you might put an option to sell at a certain price. It’ll be out of the money when you buy it. So in other words, the stock will be selling for $50 and maybe the put option is that you’ll be able to sell it for $46.
Well, I’m not going to exercise it because I could sell it right now for $50. I’m only going to exercise the option if it goes below $46. That’s the idea behind it. It’s a protective type of purchase. In other words, you’re protecting your downside risk.
The issue is that these things become expensive, and even more expensive with more volatility.
So in English, what I just said is that when you’re most worried about this thing possibly dropping in value below the strike price—which is $46, which is the price that I can sell it for—that is when they are most expensive. Therefore, if it doesn’t do that, it basically expires worthless, and it takes away your upside return.
That’s the issue with options. You’ve got to be right on the direction, then call the option to buy.
Now there are people that do late night things, and they teach you how great it is, and the money that you can make on these and on covered calls and all of those types of things, but recognize that it is a gamble, as Michael is talking about right there.
Red Flag #4: Hedge Funds
MS: Right. So then we’ve got hedge funds. We’ve got managed futures.
PW: So let’s talk about hedge funds for a second. Go ahead.
MS: Well, the problem with hedge funds is you have a big fund managed by this expert investment manager, and you really don’t get a lot of detail on what they’re doing. That’s one problem.
PW: They can go anywhere, yeah.
MS: And the fees are really high.
PW: So what does that mean? I said 2 and 20. So you’ve got a 2% management fee and then 20% of the upside. So let’s say it goes up 30%. Now 20%—because I said 2 and 20—of 30% is 6%. So you got your 2% management fee plus another 6%, so that’s the 2 and 20.
So that’s why you see these people in huge beautiful houses off of Lake Michigan. This is really, really lucrative for the hedge fund.
Now what’s attractive about it is that they can go anywhere. If somebody believes that stock picking and market timing are a valid way of managing money, then I want a fund that can go anywhere and do anything. I want no holds barred.
They can do private equity. They can do options. They can do hedging strategies. They can do anything, even short selling if they want to do it, whatever.
So the issue with hedge funds is that they can go anywhere. Because they can go anywhere, we just look at it and go, “No stock picking and market timing, just demonstrably not a good way of managing money. We want to stay away from it.”
So anyway, that’s the detail on the hedge funds.
MS: Right. The only reason you invest in a hedge fund is if you believe the manager can beat the market, otherwise, you don’t invest in it. So you’re already admitting that you’re gambling with your money by investing it in the first place.
PW: Some of the biggest customers of Bernie Madoff were hedge funds. It was just kind of eye-opening, just a little. I hate to throw cold water on it.
So you’ll have to be an accredited investor to be able to get into one, which means you have to be rich enough that the government doesn’t care if you lose money. That’s my way of defining that particular term.
Red Flag #5: Managed Futures
Then you have your managed futures. Let me just throw this out there. Futures actually have a history that makes some sense. You think about when you were putting out a crop, let’s say you’re a farmer in the Midwest and you’re not positive.
So what happens is you’re going, “I don’t really know if it’s going to be rainy or if it’s going to be too dry. So let’s do this: I’m going to sell my crop at a very, very low price to somebody with big, deep pockets that is willing to take a bet on whether the crop is good or not.”
Now, if the crop is horrible, they lose. They lose because they paid this price that was a low price, but it wasn’t low enough because the crop ended up not coming in. It was just a bad, bad harvest and didn’t work out well.
Then if you have a bumper crop and you’re knocking at debt, it’s really great. Well, the person who took the bet and bought that crop bought the rights to that crop at a lower price, and they won.
So what ends up happening is you end up with a situation where you have lost a ton of money if you overpaid, but you made a tremendous amount of money if it really does well.
So this is really where the problem is. You end up in this situation where you are betting on the future, and that’s the issue. We don’t have the future.
We don’t know what is going to happen in the future.
So anything you’re dealing with, managed futures recognize that markets fail. We can predict the future and we can profit off of that prediction about the future.
I know I went on a rant, but that one is just a hot button for me because I have seen it over and over again where people will read about this stuff, they hear about it, and they just don’t even know what it is.
They don’t recognize that it was actually invented for purposes that were actually pretty good, and it was something that you did want to use. If you were a farmer, it could save your back end in one of those years that wasn’t so good.
I think as an investor, you want to know how to read these program brochures. These are things that are required by the investment managers to put out there so that you can be buyer beware.
They are written in layman’s terms sort of, but recognize what we just did is we just defined some things that may be layman’s terms to somebody, but it may not be layman’s terms to you.
This is why it’s so important to be educated regarding this because buyer beware doesn’t protect you when you don’t have enough money down the road.
Understand the Fine Print
PW: We’re actually referring back to one question that came in the workshop that is really a good question.
Somebody asking about a specific program out there, and we don’t often get questions like that. So, it gives us an opportunity to walk through something.
This is what’s called a SAM program, a strategic asset management program. A general term “strategic asset management” can be okay. It actually can be used for laudable purposes when you’re managing a portfolio based on academic principles, rebalancing, what kind of rebalancing strategy that you use, and what kind of asset management mix between stocks, bonds, large companies, small companies, value companies.
You’re looking at correlations between asset categories and how things move together and how they move separately.
It can be decent. That’s what makes this tricky.
You read that word and you go, “Oh, strategic. I’ve heard Paul say that that’s okay.” It is okay depending on how it’s used. In this particular instance, in this program, it’s not. You’ve got to read the fine print and you got to understand the fine print, which is not so easy. That can be a challenge.
So, they have this list of things that are types of investments and risks that were inside this program. And in general, these are buzzwords, so watch out for this stuff.
Hedge funds, we’ve talked about, and managed futures. What are some of the other things in here, Michael, that you saw?
Red Flag #6: Private Equity
MS: Yeah, another one they have is private equity.
PW: Okay, so talk about that for a second.
MS: Yeah, the problem with private equity is that it’s the opposite of public equity, a public company. First of all, they don’t have the same kind of reporting requirements, so you don’t get the same kind of information, which makes it much more risky to really know what’s going on with the company.
And there’s less volume trading on those types of companies. When you have a public company that’s easily traded, the mass amount of investors that are looking at this company—
PW: Millions of shares a day.
MS: Right, right. That makes the price really accurate, that process.
PW: That is a really, really good point that he’s making right there.
Part of market efficiency, this whole idea of this, went back to the 1700s with Adam Smith’s The Wealth of Nations.
Literally, the United States economy was built on this fundamental principle that you have an invisible hand and that people, when buying and selling things, would do things that are in their own best interest.
When I buy something, if I have a lot of different people I can buy it from, I’m going to go, “What will you sell it to me for? Oh, you’ll sell it to me for this, so I’ll buy it from you because you’re the cheapest price.”
But you’re going to look at quality. You’re going to look at how quick delivery comes in. You’re going to look at, “Is it the same thing?” Are they going to back it? Is there going to be a warranty behind it? All of those types of things.
And what happens is you’ll pay a price that is commensurate with the value that you’re getting.
It is based on the idea that the consumer is bright enough to figure out what’s in their own best interest.
It’s a pretty decent premise, I think. I mean it built the most successful economy in the entire world, and other countries are actually emulating it. So, that’s the idea behind market efficiency.
Basically, with private equity, the issue that you run into is that you have less trading, so you’re not able to know necessarily. You don’t have as much information, especially if they’re keeping the information private because they can. Hence, that word “private” in there.
So, what happens is, right off the bat, you don’t really know what you’re getting, and you may be getting into risks. And there have been articles I’ve talked about where people have gone into private equity and they’re going, “Oops, didn’t expect this.” So, that’s another one.
Next thing on the list was?
Red Flag #7: Real Estate Investment Trusts
MS: Yeah, next thing is REITs, so real estate investment trust. It’s a way to invest in real estate as a packaged product. It might be commercial. It could be—
PW: Malls.
MS: Yeah.
PW: Ouch.
MS: Yeah, don’t want to invest in that. That’s a declining area, for sure.
PW: There was a big article about that in the Wall Street Journal, and they just had this visual and they’re showing a top-down—I guess maybe a drone—view of the malls, and it was just abysmal, just empty. And those are just one of the areas.
Other things, like for example, with COVID: Who on earth knew that commercial properties would go unrented because people weren’t going to work from a business anymore? They were going to work so much from home and there was going to be a demand drop, a huge demand drop.
And that has basically put a stake in the heart of so many real estate investment trusts, and that’s exactly what they’re investing in here. The reality of it is, did they know that before? No.
But again, it’s a method of gambling with somebody’s money, betting on these things. When you own stock, you already have lots of exposure to real estate. So, that was it.
MS: Yeah, and the other big problem related to that is they can be great for a period of time when rents are great and the real estate economy is booming, but you’re locked in with these types of products. And so, when things go south—the economy goes through cycles, and it usually goes south at some point—you’re stuck in it and you can’t get out. That’s where the problem really comes in.
PW: There was a recent article talking about that, and I was talking about it here on the show, and it was this massive exodus, people just yanking their money out of these products because they’re recognizing what Michael’s talking about right there.
It’s just a huge run-out, and then that’s it. You end up with a drop in value that was pretty doggone significant, and we told some stories about that.
Risks
Okay, so under the program brochure, there were things that they talked about here, Michael. They say it’s market risk. They talk about credit risk and liquidity risk that you might have.
Market risk is general. You’re going to have that no matter where you are because markets go up and markets go down.
Interest rate risk, you’re going to have that in your bonds. If interest rates go up, bond prices can go down. That’s the issue with that.
Credit risk, this is important, because if you’re lending to somebody that may not be able to repay the money that they borrowed, now you’ve got credit risk. And then all of a sudden it goes down in value because the person borrowing, their ability to repay has dropped.
When you see this type of stuff in a brochure, you see it in a prospectus, don’t just gloss over it. It means something. This is important.
This is the difference between being able to do the stuff you want to do in retirement and maybe not being able to do much of anything that you wanted to do in retirement.
Concentration Risk
MS: Yeah. So they go through a lot of different risks. You were hitting that in the last segment, and I think it’s partly that they have to cover all their bases, all the different types of risk.
PW: But there were a couple that you actually highlighted that you thought were important to discuss even further. So what are some of those?
MS: Yeah. One of them, they’re calling concentration risk, which we might call “overconcentration” risk. It’s when you’re moving into one specific area of the market because you think that area is going to do better. So let’s get all our money over here so we can benefit from it.
So even just in the name there, you’re automatically making a prediction. You’re thinking that markets fail.
You’re not thinking that markets are efficient. You’re gambling with the money.
PW: As much as we think that that’s a bad thing to do, it’s actually integrity. There’s integrity here because they’re actually putting their money—your money—where their mouth is. That’s funny. That’d be a good commercial.
MS: Your money where their mouth is.
PW: That’s actually really funny. I crack myself up.
So think of it this way. This is why it’s so funny to me.
Let’s say if I truly believe that markets are mispricing things, how many mutual funds do I need to own? One, because all the other stuff isn’t going to do as well as the one that I’m going to manage here.
And then in that mutual fund, if I really, really think there are mispricings, how many stocks do I need to have inside of it? Now, technically, you can’t legally do this where you only have one stock, but that’s all you’d need. You would just need the one company that you know is under priced and it’s going to do better than everything else. And you would concentrate on that.
Well, where do you draw the line? Where do you draw the line? Do you draw the line at 10 stocks? Do you draw the line at 20 stocks? Do you draw it at 30? Do you draw it at 40, 50? Where do you draw the line?
MS: Right. Because once you add in more, you’re admitting that you really don’t know what’s going to happen; you’re just guessing. And you think it’s a good guess, but now you really don’t know.
PW: Yeah, exactly. So they are actually stepping up to the plate to some extent with their language here, but they’re still missing the boat.
Alternative Strategy Mutual Funds
MS: So then they talk about alternative strategy mutual funds, so different types of mutual funds that can invest in different types of things. Commodities is one of the main ones they’re talking about there.
PW: I’m just laughing. I’m kind of smiling because I’m thinking, “My marriage isn’t working out so well. What’s an alternative strategy?”
MS: Alternative strategy marriage. Yeah.
PW: It’s like having an escape hatch out there for you to somehow have something else that you can go to, as if the tens of thousands of mutual funds aren’t any good and they’re not worth actually going into, so you need some other strategy.
And that’s basically what they’re doing. They’re talking about commodities, they’re talking about leveraging. Borrowing to try to magnify gains and losses is what you’re doing there. Selling security short. We already talked about shorting. Use of derivatives. They talk about potential liquidity.
Too Many Red Flags
So I think the short version of this, to the person who asked this question, is this: I would stay away from this investment program, the strategic asset management program, the SAM program. Too many red flags for us.
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.
