Welcome to our listener-supported podcast, Money Talk, unpromised absolute financial truths behind financial perceptions with hosts Ed Sutkowski and Chuck LeFebvre. Let’s listen in.
Chuck: Ready. Welcome to MoneyTalk, I’m Chuck.
Ed: I’m Ed.
Chuck: Ed, today we’re well, what are we going to talk about you?
Ed: Really my favorite topic of all the topics we’ve talked about. My favorite topic is Skin in the Game by Nassim Nicholas Taleb.
Chuck: You did a good job, as I would. We probably are supposed to know how to pronounce people’s names.
Ed: Not yet but they’ve got to be Polish, or I can’t do it. Anyway, the book is Skin in the Game, the author of the Black Swan. And so, it’s a question of economic failure potential.
Ed: Berkshire Hathaway.
Chuck: Berkshire Hathaway. This is in The Wall Street Journal on Monday, May 8th, an article that’s titled “Buffet Retains His Optimism” and then next to it, a companion article talking about this Charlie Munger, who’s a top executive there at Berkshire, “Calling Berkshire leader’s take on banks, AI”. I love this quote from Munger. It says this is in the article, it says “having a huge proportion of the young and brilliant people all going into wealth management is a crazy development in terms of its natural consequences for American civilization. We don’t need as many wealth managers as we have.” He added “I don’t think a bunch of bankers all of whom are trying to get rich leads to good things.”
Ed: Wow. Of course, why do people go into investment banking or registered investment advisors, wealth management. Why is that, Chuck?
Chuck: It’s the best money to play with is other people’s money.
Ed: There’s no downside. That’s the skin of the game issue. You have skin in the game, if there’s a downside, if you share in the losses. It’s one thing to charge a percentage of something. I recall early on in my day job, this thing was some investment advisor in Minnesota. I said, “Well, you want 2% on the upside, what about well how’s that? Well, we’re kind of partners.” I said, “Okay, well then what about the downside?” “Oh no, no, no.”
Chuck: What’s your capital contribution to this partnership, Mister?
Ed: His answer was, “That’s not permitted by SEC rules.”
Chuck: Of course not.
Ed: I thought, “Oh this is a great–” but everyone’s flocking to investment advisors. Historically, you threw a rock up in the air 50/50, it hit a realtor.
Chuck: You know what, we have to sidebar at some point, maybe do an episode about how regulations really end up protecting the industry they regulate rather than protecting the consumers. That’s a great example, right? It’s like somehow, we couldn’t possibly share in the downside of regulators won’t let us.
Ed: That’s right. It would be too risky. What?
Ed: It goes on, and on, and on. So, getting back to that 50/50 hits a realtor, more recently, 50/50 hits a lawyer, but now it’s 50/50 hits a registered investment advisor.
Chuck: They’re all over the place.
Ed: I mean, they’re ubiquitous. It’s just like they’re more than McDonald’s and Dairy Queen combined.
Ed: And they have no economic potential, no potential loss.
Ed: They just have this percentage charge.
Chuck: They would argue otherwise. They would say well, if your investments go down, my charge, which is based on a percentage of the investments, that goes down too. What you’re saying is making less is not the same as losing money.
Ed: Yea. I recall vividly a discussion with a gentleman on a board I was on, and the question was the deferred comp arrangements for the directors. You could have your stock in this arrangement, your director fee could be in the form of deferred stock. I said, we’ll call him Charlie, since we have Charlie Munger here. “Charlie, there’s a difference between not receiving income, and having that lose income you never received, and borrowing money to buy the stock.”
Ed: He then said, “Oh. mathematically it’s the same.”
Chuck: Oh, my goodness. This must be that new math they’re talking about.
Ed: This guy was a big deal with a big company, and I said, “Well, I must tell you I didn’t major in math, but that doesn’t sound right to me.
Ed: Because I get the dividends, but I can’t have your potential for a capital gain on the upside? Capital loss on the downside, you have neither of those.”
Ed: “Oh, well that’s the same, let’s go onto a different topic.” Anyway, so the issue is whether you’re talking about registered investment advisors, whether you’re talking about politicians, whether you’re talking about professors, I don’t care what it is. It is what’s the downside if you have no chance of losing your money. Guess what, you pay more attention.
Chuck: Right, right, exactly. Well, this is one version of a phenomenon that we see where there are certain people, who are able to insulate themselves. Actually, Steven Brills has a book. I’m drawing a mental block on the name of this book now, that talks about this too, about how people build moats around themselves. You make it up the ladder a certain amount, and it’s not that you necessarily pull up the ladder, but you build a moat around to make sure that, that you are insulated from losses at that point.
You see this with the corporate executives. You see this with these bankers and investment advisors. They’re protected from consequences. You see this with government employees, bureaucrats, there’s lawyers, we might as well throw right part of this.
Ed: No, it’s absolutely right.
Chuck: There’s so many people that have the ability, have a lot of control and influence over the lives of other people, and are insulated from really having to suffer losses. They might have consequences in the form of less income, but they’re really insulated from ever suffering losses if they make mistakes or do a bad job.
Ed: I think a directors on the not-for-profit board. I was visiting with someone on this topic, and he said, “Well, the threat litigation” On a not-for-profit? Well, you’re not charging a fee, you’re insulated under, at least in Illinois not-for-profit law. Not only that, but you’re afraid of litigation?
Ed: Wait a minute, is that a threat? The company is going to handle it for you. It’s not your money. You’re not losing money
Ed: But you’re going to be able to put this on your obituary, and people are constantly building their obituaries. They want to be on all these organizations regionally and be – are they a big deal? Are you a big deal the more of these that you have, Chuck?
Chuck: I hope not because I have not gotten started on my obituary yet. Apparently, I really should.
Ed: Well, I’m not sure you should, but anyway, I want to go to an example of the absence of skin in the game, and what happens.
Chuck: Our favorite example, financial advisors.
Ed: By the way, there are a lot of good ones. I want to understand that there’s some good lawyers, bad lawyers. The bell curves on both ends of the tail, they’re good people. I’m not suggesting this is terrible industry-wide, especially if one of the advisors happens to be my son but, in any event,–
Check: Or your daughter.
Ed: Or my daughter. yes. This is a real-life example, I have it in my hands. This is a situation of a trust with a registered national advisor, a national organization.
One beneficiary, a son who’s autistic, the trustee for whatever reason, is the mother who is not financially savvy. And so, guess what, we have a total of 84 issues. And I don’t know among them there are probably 40 that aren’t rated. That is, they’re in Poland, and Germany, and Philippines or whatever, and the amounts involved are market value $530. The total market value here is a$1,000,000 with 84 issues.
Chuck: That’s just incredible. Well, really regardless of the size of the account, I would object to 84 issues regardless of what they were. It just seems like that’s almost always overkill, more than you need. Typically, when you have one of these investment advisors working in an office, that person can’t convince me that person is actually keeping track of and understands what’s going on with each of those companies. Especially when you’re talking about smaller companies, foreign organizations, things where there’s a currency exchange that’s part of the way the pricing works. It’s one of the reasons why I’ve never personally done any investments in foreign companies for myself.
Because I always feel like even if I hear about something that’s in China or in Europe, and I’m thinking, “Boy, this looks like there’s a lot of potential there,” I always stop myself because where I stop is at the border. I have no idea what exchange rates are going to do to this investment. I challenge whether a person managing an account like this has any idea either. You get a lot of exposure to the international markets by investing in US companies that are engaged in activities overseas. Right?
Ed: That’s my view. Oh, the contrast is a friend that I’ve known for years, we talked about concentration versus diversification. Just for whatever, he asked me to look at his two accounts, and one is an IRA and the other is he calls it a margin loan, margin account, has a lot of margin debt. This guy’s probably going to die and go to heaven or heaven the other way, but in any event, it doesn’t seem to bother him. He’s got 70% equity and 30% debt. That situation, he has four stocks, four stocks.
Chuck: See, that’s perfect, as far as I’m concerned.
Ed: Then as IRA, he’s really gone crazy. He has five. And by the way, they’re essentially the same stocks.
Ed: They’re all dividend-producing and they’re all A-rated. The point I’m trying to make here is that why is the world working this way? If you are really doing what’s in the best interests of your client, you’d do it on a first and hourly basis, you wouldn’t do a percentage.
Chuck: Right, and I have never heard a convincing argument or that– I’ve engaged into this argument with lots and lots of different investment advisors. Why don’t you just charge hourly? If you’re not really going to have skin in the game, theme of today’s podcast, if you’re not really going to share in the downside because you should be compensated for your services, regardless of whether the assets perform or not. Well then it seems to me like the way you get compensated for your services is you charge directly for your services by having an hourly fee.
I have never had someone give me a convincing response to that. I’ve had several that have given a little bit of getting back to this regulatory thing, getting had this wishy-washy sort of, “Well, I’m not sure if I’m allowed to charge hourly based on the regulations.” Which seems like a very convenient regulation to be able to call.
Ed: For example, to braid hair, you have to have, if I understand it, 200 hours of braiding. Well, this is an opportunity to make sure no one else gets into it. Getting back to this hourly charge, you see, there’s a very important part of the counseling that is emulated by what I think we as lawyers do every day, it’s counseling. How do you measure value? The best way is if you charged for every conversation.
Ed: And we want to go out for lunch, Let’s go out for lunch, but I’m going to be charging you because I’m holding your hand and I’m doing the role of a psychiatrist, but I’m charging for it. “What’s your rate?” “$400 an hour.” “Wow, that’s a lot of money.” What’s the value?
Ed: That gets to the question of how you value fees, costing, expenses, but if there was an hourly charge based upon not only the investing, but the handholding and the counseling, that makes some sense to me, but apparently it doesn’t make any sense to anyone you talk to.
Chuck: Right. No. I’ve never been able to convince them to do it.
Ed: Then I also ask, which is an amazing.
Chuck: Can I back up? Here’s what they say. They say, “Well, I spend a lot of time doing research that then applies to all of my clients. I wouldn’t really have a way of knowing how to allocate that time.” You know who else does that? Lawyers, we spend a lot of time just being educated about the law, generally. We don’t charge that to our clients. That’s what justifies us having, for instance, a $400 hourly rate, that makes the time that you do charge more valuable.
Ed: Yes. I have 30 hours of CLE work to do by the end of June. I will tell you, I’ve been doing this for 80 years and I’m going to– Anyway, but the point is-
Chuck: That’s not really where you learn, right? I mean, the CLE hours are the hours you have to put in, in order to get the certificate saying you’ve got continuing legal education. You spend a lot more than 30 hours engaged in activities you don’t bill to clients, that are just bolstering and augmenting your legal knowledge.
Ed: Are you counting any time that you don’t sleep-
Ed: -and worry about these clients?
Chuck: Yes, and reading legal news and following up on discussions about activities and so on. It’s all part of your education. You’re not billing all that to clients.
Ed: I can’t possibly.
Chuck: I bill a typical day, less than half the time I spend to clients.
Ed: Yes. I wish I could do seven hours. If I can do seven hours, that’s probably, I’m involved in litigation or something. It’s just not possible, but that’s okay. I signed up for this. I have no reservation about it. Getting–
Chuck: What I’m saying is that what you do is you make yourself more skillful with that time, which then the way you bill that to your clients is that you’re billing more for the time that is allocated for a specific task to a specific client. There’s no reason why investment advisors couldn’t engage in the same philosophy. They could just say, “Look, I only have three or four hours a day that’s really specific to a particular client, so the hourly rate has to reflect the fact that behind the hour or so I spent with the client is several hours of essentially un-allocable time that drives up that allocated rate.” It works.
Ed: The CPAs, actuaries, they all charge on an hourly basis and the rate is a function of your expertise.
Ed: The idea is never hire a young lawyer or an old actor.
Chuck: Auto mechanics, you’ve really, most work that’s personal service kind of translates to hourly time, even if that’s not the increment that it’s billed at. If you go to a tailor to have a suit repair done or some tailoring done to a suit, they’ll charge you a fee. That fee is based on how much of their time they think they’re going to have to expend on that.
Ed: Why this isn’t the case in the investment advising area is because of the control. The advertising, whether it’s on TV, or radio, or the internet, it’s that we are holistic. We will take care of your problems.
Chuck: There’s a mythology that is used to drive the profits in that industry. The mythology is that this is too complicated for people to understand on their own. You need to invest all of your trust in me. Only I, only somebody with my level of expertise could be able to figure out how to come up with 87 different securities to put this trust account in.
Ed: Okay, Charlie, Chuck, let’s assume you’re the RIA. You’re soliciting my business of x millions of dollars. Let’s pretend I’ve got $2 million. I say, “Okay let’s see your balance sheet for the last five years. Let’s see how you’ve done.”
Ed: What’s your response? You’re the RIA.
Chuck: Am I play acting what an RIA would do?
Chuck: I would say, “Oh, that doesn’t matter, what really matters are my assets under management and you can–
Ed: Oh, wait a minute. How have you done, and for you the last five years, how have you done?
Chuck: No one’s ever going to tell you that.
Ed: That’s exactly right.
Ed: You go to a heart surgeon and say, “Hey, Peter, I know you want to cut me up, just one question. How many times have you done this?”
Ed: “Oh, well, yes, not really. This would be my first time.” I’m not sure that I’ll be using you.
Ed: I see this.
Chuck: Well, but the other thing is that, let’s say you got $2 million to invest and I’m charging you 1% of the assets that you’re investing. So, that’s around $20,000 a year. Right? I can’t say, “Well, for $20,000 a year I’m going to buy four stocks and never trade them.” You’re going to look at that. At some point, you’re going to say, “Wait a minute, I can do that on my own.”
Ed: That’s right.
Chuck: I have to have a bunch of gobbledygook. I have to have a spiel. I have to have a bunch of things you’ve never heard of that you’re buying. It’s required, otherwise–
Ed: It’s a mystery.
Chuck: Yes, otherwise, you’re going to look at this account, and you’re going to be like, “Wait a minute, I’m spending $20,000 a year. That’s when I started. Now it’s grown a little bit, now I’m spending $30,000 a year.” It’s the same four stocks you bought four years ago? You haven’t traded anything?
Ed: Wait a minute, here.
Chuck: Chuck, how are you earning your money?
Ed: Well, you see it, those four stocks have beaten any benchmark. They’re up 120%.
Chuck: Oh, great. I’ll hold onto them. I don’t need you anymore.
Ed: You know what? I think we’re right. You don’t need me, and you know what? I don’t need you.
Chuck: Right. Do you see what I mean? I mean, that’s why you have all of this trading going on. You have all these securities in Poland, and Russia, and Bolivia. And you’ve got these mutual funds that you’ve never heard of and these annuity products. It has to look like something that the customer couldn’t have done on their own.
Ed: Well, because the advisor is the smartest person in the room.
Ed: You asked them, let’s see your balance sheet, and guess what
Chuck: They’re going to say, no.
Ed: It’s not relevant. I’ve had this up, by the way, and I’ve asked them. Let’s see, no, that’s not relevant.
Chuck: Well, I’ve been in conversations with you and these investment advisors. I remember one who said, “Yea, sure, I’ll that to you.” They never did. [laughs]
Ed: That’s right. He never came back. He never came back.
Chuck: He never came back. Then of course you have the ones that will say, “You know what, this investment stuff, it’s not that complicated. We’re not going to overwork it. We’re going to have a fairly simple portfolio.” Oh, great. How much are you going to show? “Oh, well, 1% just like everybody else.” Well, how do you justify that then? Well, then it’s the spiel about why we do with all these other services.
Ed: We’ll plan your estate. We’ll do your income tax returns. We’ll clean your teeth. We’ll wash your car.
Ed: It goes on and on and on. We’ll assign this person with, and you can call this person and they’ll tell you how the weather.
Ed: It’s an amazing facade and people believe it.
Chuck: They do.
Ed: You know the worst offenders? The licensed professionals.
Chuck: Oh. Absolutely.
Ed: The worst of the breed are lawyers, doctors, accountants, actuaries.
Chuck: Well, Ed, you know why, right? They kind of have a similar spiel.
Ed: That’s right.
Chuck: They might be making it up just almost as much.
Ed: The fear, I’ve heard.
Chuck: The easiest person to BS is a BS artist.
Ed: I know. My favorite topic with lawyers. I’ve involved in, let’s say, I’ve been doing this for a while and working with some lawyers on the other side of a transaction. It’s if, well, you haven’t considered if it rains frogs, how are we going to handle this, if it rains frogs? I said, “Well, in the middle of the Saudi Arabian desert, I don’t think it’s going to rain frogs.” Well, we got to cover it. Then it’s all of a sudden, there’s three associates on this, “What is going on here?”
Ed: We had that even this morning where this attorney was, no, I won’t, the frustration is, could you make a decision? What is your recommendation?
Ed: Well, I got to think about it. Well, it’s been a year. You got to think about it. I don’t know, Chuck. We are castigating lawyers, but–
Chuck: Well, we’re coming from an honest place when we castigate everybody else, because our profession, a lot of people are very frustrated with lawyers, and I get it. They should be.
Ed: The other side of that is, this is the way the country is, it’s doing not too bad with lawyers.
Chuck: Oh, yeah.
Ed: Think of what it would be like without lawyers ever. It would be, I guess who’s got the biggest axe or something to cut your head off. It is–
Chuck: Without a legal system.
Ed: That’s, and you need a lawyer.
Chuck: What’s the Shakespeare play that people quote? “The first thing you do kill all the lawyers.” That was actually part of plotting a coup. Those were the bad guys who are saying, “First thing you do is kill all the lawyers.” They were wanting to overthrow the government.
Ed: The point of this discussion today is that we are really coming down hard on these licensed professionals.
Chuck: Maybe we are in a bad mood today. We could have done it in front of everybody. Nobody is exempt.
Ed: Well, I’ve been doing this too long. I’ve seen too many of these. When you get someone in they’re saying, “Oh, this is my friend, or my cousin, or my grandchild, and they’re ripping you off.” Well, that’s okay. If you know it, it’s okay, and if you don’t know it, it’s not okay.
Ed: That’s my world. Well, with that, let’s see if my car is still there.
Chuck: It’s still there, but it might have a few more scratches in it than when you parked it.
Ed: No, I don’t have a Tesla. I have a 1994 Buick Century.
Chuck: I know. It’s beautiful.
Ed: Beautiful car.
Chuck: I drove right past it this morning.
Ed: It’s rusting out, but I’ll tell you what, it runs like a top. I get no speeding tickets, by the way.
Chuck: Oh, I bet not.
Ed: Even though I speed. That’s the old–
Chuck: That’s the surprising part of this story.
Ed: That’s the old guy driving. The real problem, to pull up to a stop sign, and these women are knocking onto my window wanting to come in. The only problem, they’re all about 85 years old. With that, we’ll move on.
Chuck: All right.
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