Preston Pysh  5:48  

Awesome. Fantastic. Anything else that you would say that was a takeaway or something that was unique that happened to you, or a good story or anything?

Douglas McCormick  5:56  

Honestly, it’s a lot less about my experience as First Captain, and more about my experiences surviving the four-year marathon, if you will, like every other cadet. I often say, West Point is an undergrad in life. And so for me, it was really a formative experience. I think, the first thing I would say is, it’s designed so that everybody fails. And I think because of that, you learn to embrace failure as a learning opportunity. And you learn to kind of get back up, dust yourself off and work harder. There’s a saying here, I’m sure you’ve heard it, cooperate and graduate. And I think West Point more than almost any other undergraduate institution forces people to learn to work together in very stressful environments to achieve success. And I’m not sure if I learned this one in school or as a junior officer, I think, maybe a little bit of both, but I’m a big fan today. And I know it influences the way I think about business. As the old saying, “a mediocre plan that is well executed is much better than a perfect plan with mediocre execution”. And so I think, West Point by design was somewhat practitioners, doers. And I’ve taken away that experience as well, I think.

Stig Brodersen  7:01  

So, Doug, I know that you have strong family values, both personally and in terms of personal finance. And there’s this story that I absolutely love about your dad helping you out to pick a very first stock at 7 years old. Could you tell me if there is a common theme to what you learn from your parents, and then to what you teach your own kids about maximizing your family’s wealth?

Douglas McCormick  7:23  

So he [Doug’s dad] bought my brother and I our first stock at age seven. Another example is that he took me and my brother on a sabbatical while he was teaching, and he told us at that cross country trip we could each buy one stock of some company that we encountered on our journey. We toured a gold mine out west called Homestake Gold Mining Company. This is 1977, and I walked out of the gold mine, and I said that I want to own gold mine stock. And it was really interesting for me because I could understand that a stock wasn’t a piece of paper, but it was a company, it was assets, it was people, it was a product. And so he really helped me kind of cut through the intimidating factor about investing and realize that this is part of everyday life.

Preston Pysh  8:02  

So I want to talk about gold miner stocks really fast. Since you brought that up. The thing that kind of surprised me with this most recent movement from December 2015, kind of to where we are at right now, we’ve seen gold jump in the commodity price by about 30%, somewhere around there. But the thing that I found really surprising is during that time, you saw a lot of the gold miners jump 100% on that commodity movement. And that’s something that I think is actually a pretty common theme when you see gold and miner-type stocks following the commodity itself, how they can jump that much. And that’s something that I kind of learned just in this past year that I probably should have known before that but something that I did learn. And I want to highlight to the audience that sometimes when you get those big movements on the minor side of the house, you actually see it move quite a bit. And I do want to highlight that billionaire George Soros had an option that he had put on kind of early at that timeframe right before the gold pop. And now I recently read that he is completely out of that position, the Barrick Gold miner position. I guess he’s completely out of that position right now, which I find really interesting because you got all these gold bugs really kind of hitting gold really hard right now with where the Fed set. So I just wanted to highlight that. Our motto for the show is, “we study billionaires” so I want to kind of highlight that while we had the opportunity. 

Alright, so Doug, something really interesting I think about your background is the depth of investing knowledge that runs in your family. So this is really going to surprise a lot of people in our audience. They’re gonna love this one. So for example, your brother is currently the president at Bridgewater Associates and the former Undersecretary of the Treasury. And so, my question to you is, when I think about your expertise in acquisitions and mergers and your brother’s background of working through one of the smartest macro thinkers in the entire world, which is billionaire, Ray Dalio, I would imagine there are some really, really interesting conversations during holiday get-togethers. And so I’m curious what the most hotly debated or number one investing topic is when the two of you get together and you start talking. Is it the 30-year bond bubble? Is it the dollar denominated debt? Foreign dollar reserves? I mean, just pour it on us. We’re dying to know.

Douglas McCormick  10:19  

We’re so busy with kids and family when we get together for our limited time. It ends up usually being too much of that, and not enough of just good quality time between the two of us. But having said that, I think a couple things that are interesting about our experiences. First of all, I’m so proud of Dave, he’s just done amazing things both in service to the country but also in his current position. And Dave has a decade of experiences thinking about big macro movements and kind of calling whether the tides are rising or not. And my experience is very different. I’m kind of a stock picker, if you will. I’m a micro guy, bottoms up. To a certain extent our skills are somewhat different and perhaps complimentary. Dave’s calling the rising tides and I’m trying to pick the fast boats, if you will. And so to a certain extent, we’re coming at the same situations with different perspectives. 

I think the thing that we spend the most time is really kind of a form of entrepreneurship. So we talk a lot at this point about, how can we use our skills, our knowledge, our expertise, our relationships, to deploy our capital in interesting ways. As you know, it’s a very competitive market, and almost everything looks expensive. We can talk about that later. And so I’m a big believer in trying to figure out ways to combine capital with unique insights that give you an angle. And so we’ve done a lot of things together where we’re back in an entrepreneur. In many cases and other, West Point alum that we know and trust. Or in few cases, we’ve done some real estate things. Or areas where in some cases, we’re just trying to get an education. So we’ve made an investment in the cybersecurity business, it’s private. Think highly of the person. But we also think it’s a great way to just get a perspective on a really interesting industry.

Preston Pysh  11:57  

You briefly mentioned real estate. This is, I think a really, really interesting conversation as we look to the next 10 to 20 years just because of where interest rates are at. And, you go back to 1980 to 1981 when interest rates kind of peaked out. And I mean, if you’ve been in the real estate business from that time until now, it’s been an amazing place to be. I mean, you couldn’t be in a better place just because as interest rates go down, that’s just really advantageous place to be from a capital appreciation position on the real estate that you own. So I guess my question for you would be this is, as we look to the next 10, 20 and 30 years, and the potential for interest rates to reverse themselves in this 35-year bond bull market, maybe inverting and starting to swing maybe the other way, do you think that it’s going to be a really difficult time for people in the real estate market because of the impact that interest rates would have going in the opposite direction?

Douglas McCormick  13:02  

Yeah, I personally think it’s a really tough trade. So I think as you look at asset class returns over the last 35 years across the board, I think, in my own mind, I believe you’ve got to acknowledge that there’s been a really strong tailwind associated with decreasing interest rates, driving cap rates across all asset classes. And if you’re in a leveraged asset, obviously, that turns out really well. And on a go forward basis,  I think it’s pretty tough to assume certainly any kind of returns like historic returns. And if I’m going to be in real estate, it’s in a real estate’s situation where I’m very happy with the yield, and not the price appreciation. And I think those situations are probably, you and far between, but I think that’s how I try to play it if I will, because I don’t think you’re gonna see cap rates. It’s almost mathematically impossible. Cap rates gets much better in my mind.

Preston Pysh  13:47  

I think that you have a really strong point there about the yield, is where you’re maybe focusing your attention as opposed to the appreciation in the market price. That’s a really good point.

Stig Brodersen  13:57  

So Doug, let’s transition into your book. In your book, you talked about the struggle you had coming out of the army and deciding to return to Harvard. Going to Harvard is extremely expensive, but you use this as a great discussion. You talked about the idea of your time and labor being viewed as a family asset. Could you elaborate a bit more on that? And also give us the main theme of your book, “Family, Inc”.

Douglas McCormick  14:21  

So the full title is “Family, Inc.: Using Business Principles to Maximize Your Family’s Wealth”. And I think it’s a really interesting framework. Essentially, what we’re saying is that a person or family can look at itself as a business and employ business principles to make informed decisions. And essentially, the game of life, if you will, is simply converting labor assets into financial assets. So when it’s time to retire, you can use those financial assets to satisfy your consumption. And I wrote the book that way because I always struggled personally with trying to figure out ways to define disparate pieces of advice. So I got investment advice from one place. I got advice on education and career from another. And for me, this model of myself as a family kind of provides a guiding compass, if you will, in terms of how to think about all those trade-offs and how those choices fit together. So, investments in education, rear impact your insurance needs, impact your investment profile, etc. 

I also think it’s interesting because I did a lot of thinking on this topic in business. So I use the point about how I struggled at Harvard, and I think it’s a really interesting example of how the book looks at the world a little bit differently than most people do. So I entered into school pretty much with no assets. I was fortunate enough to be eligible for loans. And so over the course of two years, I exited school with debts in excess of $100,000. So, the traditional view of the world would look at that balance sheet and suggest that my net worth has gone down by $100,000. The way “Family, Inc.” looks at that same circumstances, it says that you’ve got to look at all your assets, including your labor. And so that $100,000 investment, I believe dramatically increased my wealth given the opportunities that I was able to tap into because of that experience.

Stig Brodersen  16:08  

And, Doug, how do you estimate that and clear  the outcome of education, say at Harvard. They’re very different from one person to the other, but how do you value, say, the monetary value of an education?

Douglas McCormick  16:20  

So first of all, let’s talk about how to value lifetime labor. It’s really simply a product of how old am I today? How old do I believe I will be when I retire? And what is some ongoing income assumption throughout your career? Now, what I can tell you is when you do that math, it’s absolutely going to be wrong. I think the value in it is less about whether it’s right or wrong and more about that you’re viewing your career as a long term asset that requires investment. And you can think about payback periods in an appropriate time. For example, I think the discussion around education and whether it’s a good investment or not, I personally think is ludicrous. I don’t think people are appropriately evaluating the time horizon under which you’re likely to recoup that investment. And the second thing, I look at income distributions. And what it says to me is that the labor market is somewhat inefficient, because some people come out of school and can generate significant income where others can’t. I believe that’s a product of capabilities and choices, not so much whether education’s a good investment or not.

Preston Pysh  17:23  

And I think a really important part to that is also the degree that you’re actually spending that money on. I mean, everyone’s heard the story of the person who spends $200,000 and gets a degree that’s only going to increase their annual income by $500 a year. Those degrees are totally out there. And I think that it’s an important caveat to add in there that I completely agree with what you’re saying. But I think that you have to add in that last point of, if you’re spending that large sum of money to get that degree, it has to be something that’s going to add to that future cash flow as you’re looking at it.

Douglas McCormick  17:55  

Totally agree. So in the book, there’s a couple different charts that I think are really informative. But one is the distribution around the top highest curriculum in terms of what compensation is post graduation in the bottom 10. And what you see is there’s tremendous disparity like degrees that are STEM-focused. In many cases, yield a multiple’s higher income immediately after college than the degrees that are more Liberal Arts-focused. And the other thing I think is really important is you’ve got to be committed to pursue a career that uses education as a key element to it. And so, you know, I think the worst investment you can make is go to school, spend the money, and deploy labor unproductively, if you will, not to take advantage of it when you get out. So you’re absolutely right. I would say it this way, with the right person, with the aptitude, the interest, I think education is still a tremendous investment.

Stig Brodersen  18:44  

I love that point. And I also want to say, like as a professor, I have some sort of like two different types of students. Like, one student would come in to get the piece of paper where it says so-and-so degree, and then the other person actually comes to the university to learn. I know I may sound like a grumpy old man for saying this, but why do you come here if it’s not to learn? But to some people, this is actually just a question of getting that piece of paper that can get them access to something else. And I think, now that you’re spending so many years here, why not get 100% out of it?

Douglas McCormick  19:17  

I really think this is an interesting national debate where we’re doing our young people a disservice because I don’t think we’re adequately arming high school graduates with good tools and frameworks to think about. Likely the most significant investment they’re going to make, and if it’s not the most significant investment, it’s probably the most influential choice they will make about financial security. And I think we’re underweighting kind of the economic consequences of some of those decisions.

Preston Pysh  19:43  

In your book, Doug, you talk about three major risks that could occur for the family. The first one’s inflation, the next one is shortfall risk, and the other one is financial asset impairment. When I look at these three, the most interesting one for me personally is really this inflation discussion. And when we look at the US market in many global markets, inflation has been decreasing for 35 years. Do you see this trend continuing into the future? And I know this is a really ridiculously hard question. But what are the critical variables that we really need to be aware of? What do we need to be watching for, for that trend to maybe change? I’ve heard some people say that they’re looking at the velocity of money. Whenever that starts picking up that you’re going to maybe see inflation go with it in maybe a rapid way. But I’m curious to hear your thoughts. What are those critical things that you’re looking at that maybe would cue you onto that?

Douglas McCormick  20:35  

I think the first comment would be a little bit of a caveat, which is I think anyone that projects this kind of topic with tremendous certainty, you should view with tremendous skepticism. So having said that, what I can say with certainty is there’s no way this trend that we’ve experienced over the last 35 years can continue. I think it’s basically mathematically impossible, unless you believe that we’re going to be in a deflationary environment, which I think is very unlikely. I would say, I think the risk is not symmetrical. If inflation is a little bit under expectations, I think it’s going to be very modest. And if we’re surprised, I think you’d be surprised, meaningfully, you know, with greater inflation, which is going to really be problematic across all asset classes when you think about valuation. So the consequences of that are significant. 

I think my own view of the world is I don’t see any impetus for near term inflation, and so call that kind of the next several years. And I’m looking at two things. One is the labor markets. I think, it seems to me like the dynamics of the labor markets have changed, transparency of wages, international trade, and what technology is doing to the demand for various types of labor. I think it’s really kind of compressed wage growth in a way that’s going to dampen inflation. In terms of the overall economy, it feels to me that a lot of historic engines of growth. China, Brazil and India have structural problems, and are not posting the same kind of growth numbers that I think have spread inflation throughout the globe. 

And so I see a lot of capacity in a slow growth economic environment that will keep inflation kind of in check here for the next several years. I do think it’s quite possible that we’ll see a new normal. And that historic inflation rates of 2% or 2.5% percent, maybe higher than we see on a go forward basis. The last thing I would say is just tie it back a little bit to kind of the “Family, Inc.” perspective. I think this is a really interesting topic. It’s the hardest risk to kind of insure against, if you will. I think, fortunately, the family, most families are relatively well insulated against some of this risk because we have our labor assets. We have our social security assets. I view both of those as kind of inflation indexed annuities, if you will. And so where it really presents challenge, I think, is for retirees when they’ve exhausted their labor, and they just have less degrees of freedom to manage an inflationary environment.

Preston Pysh  22:55  

On your last point there, I just look at my own parents, and others out there that are retired. And they’re trying to go and get yield anywhere. And I just don’t know where in the world you can find it. And so for people that are retired and not able to really rely on their labor anymore, as you were discussing, what in the world are these people to do? And when you look at the action of central banks, and it just seems like, “hey, let’s just keep doing QE (quantitative easing) until something breaks”. I don’t even know what in the world is a person that’s with an investing media platform. What in the world do we possibly tell these people to invest in without enormous downside risk, and that they can get anything reasonable on a return? I mean, just a couple percent. What do we say?

Douglas McCormick  23:46  

Well, I think answer one is not a good one, but I think it requires incremental cushion in terms of how you think about your financial planning. I believe that it’s kind of you’re picking the least bad alternative, which I still believe to be equities. For me, I think equities in many cases, you could look at it as a bond with an unstated return. You still have fundamental underlying cash flows that are ultimately going to drive kind of a long term kind of yield, if you will. But you’re going to have to manage your kind of yield or your consumption with an equity rich portfolio that you’re harvesting, various assets. And the last thing I would say, which I think is good news is, I think, in many cases, retirees underestimate their duration. And so even if you retire at 65, if you’ve got social security, and you’ve got a nest egg that you plan to deplete, call it over the next 25 years, you still do have duration on your side, and I think you can suffer through a little bit of volatility to generate the right consumption yield.

Stig Brodersen  24:45  

So you talked about equities before. I think equities is also one of the hot topics that we have here on the podcast. And one question I’d like to address is where do you see that we can get a decent yield in equities market? And I were looking at American. MCs *inaudible* are looking at various sectors or you’re looking abroad. Where are you looking? Because Preston and I have a hard time finding it. 

Preston Pysh  25:07  

We’re pretty big bears. 

Stig Brodersen  25:10  

I know you see us smile, but we are very negative people.

Preston Pysh  25:13  

Right now we are.

Douglas McCormick  25:17  

I guess the first thing I would say is, I think I’m bullish only because I keep pushing the view that we all have very long term time horizons. I have tremendous conviction about returns in a 1, 2, 3, 4-year time horizon, I’d have a lot less of it. I’m very attuned to kind of valuations and pricing in the private markets. And when it comes to the public market stuff, I’m much more of a broadly diversified, US emerging markets, developed Europe. And, kind of covering my bets, if you will. I think you can make a pretty good case that the various markets are appropriately valued. I mean, I think Europe looks cheap, but I think there are lots of issues with it.

Preston Pysh  25:54  

So I think you brought up a really interesting point for our audience to understand where you’re talking about the difference between private markets and public markets. And I think that, and this is my guess I’m obviously not dialed into private markets, even remotely to the level that you are, Doug. But I would think that the cap rates for real estate and kind of the discount rates that you’re getting in the private market are much, much better than what you’re seeing in the public market. Just because of the amount of participants and the amount of competing interest of bidding up different prices. So was that a true statement, are you seeing that the yields that you’re getting on the private side is much better than public markets?

Douglas McCormick  26:34  

Yeah, I believe that to be the case. So if you look at historical returns in alternative assets, like private equity, they’ve been some of the best amongst all the various potential asset classes. Candidly, I think success breeds mediocrity. And so what we’re seeing over the course of the last 10 years is a tremendous growth in the asset class. We’re seeing it mature, we’re seeing it become more efficient. Having said that, on a relative basis, I still think it’s much less efficient than public markets for sure. 20 years ago, the private markets, you could make money because you could buy right. In the last 10 years, you could buy reasonably well, but you could finance with a significant leverage, and so you could drive equity returns. And the reason I think that is because we’ve got a tremendous number of owners, families, who, at this point, this has become a disproportion amount of their wealth. They’ve created some significant wealth and have a very different risk profile than an investor like me. So I think to a certain extent, we’re buying businesses that had been managed like an annuity. And we’re figuring out a way to manage them like a growth equity play, because we’re pursuing growth through acquisition through organic investments or through management arbitrage.

Stig Brodersen  27:41  

I’m just super interested in this whole concept of private equity. And what I hear you saying is that you see more interesting options in the private than in the public markets right now. And when I’m looking at all over North America, I see with all the baby boomers retiring. With your company, HCI Equity Partners, you must see a lot of interesting value picks for corporations with no succession plan in place. And well, first of all, would you agree with that thesis? And could you secondly, talk about what type of opportunities that you see up there?

Preston Pysh  28:15  

And Doug, I want to piggyback on Stig’s comment because my question’s kind of related to the same thing that he has. When you’re seeing these companies that you kind of say are coupon-like, if you will, do you see that these families are just kind of like sucking the blood out of it? And it’s maybe poorly managed, and it’s just kind of this thing that’s just droning on because it kind of resembles this Carl Icahn book that we’re reading right now, where he kind of goes in and he can see tons of value in it, but he can see that the management really just doesn’t know how to take it to the next level or tap into the resources and the asset value that’s currently existing on the balance sheet.

Douglas McCormick  28:51  

I think first of all, interesting analogy. Icahn and private equity in general, there is a control level. So all the things that we’re doing were generally buying more than 50% of the business, which comes with the ability to influence trajectory on a go forward basis. So I think that’s a key element. I do think we are buying evaluations that are less than the public markets. But I would argue maybe appropriately so. In many cases, these businesses don’t have the same management depth, they’re much smaller, they have an earnings stream that’s more volatile. But again, where I think the real big opportunity is in the ability to add value. And I don’t view it as, the owners kind of sucking the lifeblood out of the business, but it’s a different risk profile and a different capital base. And so you know, if you think about just for succession. 

First of all, what I love about the business is, there are reasons that someone may want to sell you the business that are unrelated to the fact that it may be the right time to maximize value. There’s a natural reason that they need to do succession planning. They need to diversify assets for the family. So I think that creates an interesting dynamic. And then the second is, you make different investment decisions if this represents 90% of your wealth, versus if this is a small percentage. So one of the things that we do with most of our investors is encourage them to invest a little bit. So we get them liquid on 90% of the value, they put 10% back in with us, they go along for the ride. And if things go well, you’ve got somebody who’s very knowledgeable about the business that has a chance to triple or quadruple their money on the reinvest. 

Preston Pysh  30:18  

Awesome. That sounds like fun.

Douglas McCormick  30:21  

It’s a powerful model when it works well. But it’s sloppy, and it’s never easy. And you know, success is never a straight line. That’s for sure.

Stig Brodersen  30:28  

Quick follow-up question on that. So, whenever you’re taking on the new company, I would assume that either you have a nice stream cash flow or you would resell it, perhaps to another project to fund in rare cases, you might want to go for an IPO. What are your thoughts on the current market? I know it’s probably very different from company to company, but where do you see the private equity market right now in the US? Should you hold on to these annuities as the yield that you can get almost nowhere? Is it more of a game of optimizing and reselling it? So just between the two, and then perhaps you can briefly touch upon the IPO thing. But how do you see that?

Douglas McCormick  31:06  

I think the first thing is, I think in general, the value add of private equity is being able to to proactively manage it. And once you’ve done whatever to create value, whether it be additional consolidation, improving the management team growing organically. I think in this market environment, you should be actively thinking about liquidity, because could it get better? Yeah, but again, I think if asymmetric, it’s likely to get worse than it does get better. So I think, if you don’t have specific value that you think you can bring to the table, it’s a good time to be returning equity. 

The second question relates to kind of sources of exit. There are three basically. You’re selling to a strategic, you’re selling to another sponsor, you’re taking the business public. I think a ponderance of the lower middle market where I play is likely strategic exit. And we see a real appetite by strategics who are essentially looking for organizations like ours to package small assets into an integrated larger asset that they can afford to mobilize a big company to buy. So we’re buying relatively small businesses, call it five minor pre-tax cash flow. And we’re trying to create businesses of 20 or 30, pre tax cash flow. A strategic can look at that business in a way that they can’t look at the three predecessors. And so I think there’s just real value in packaging, subscaling businesses, integrating and positioning those for sale.

Preston Pysh  32:25  

So Stig and I are doing a very poor job of talking about the direction we want to go. Talking about “Family, Inc.”.

Douglas McCormick  32:33  

All good, if you don’t mind.

Preston Pysh  32:35  

We’re having too much fun talking to you, Doug. 

So one of the things I want to highlight and kind of taking it back to your book and some of the resources that you have tied to your book. The thing that I really like is that you provide free tools for people to download off of your site for people to develop their own income statement and balance sheet. And this is so neat. I think this is really awesome. And I just want to provide this discussion to our audience so that they’re aware of this, because one of the things that we’ve found with people that listen to our show and go to our Buffett’s book site is, I think the biggest hurdle and the biggest gap is just terminology. Because not everyone’s gone to business school. Not everyone has these unique opportunities to be immersed in this stuff and deal with it on an everyday basis. But like you talked about in your book, they’re earning profit. They’re earning more money than they’re just spending. And so what do you do with that? Or you go to buy financial assets that are going to create more revenue stream for you. But how do you do that if you really don’t understand the terminology, like a person who’s immersed in finance or in the business sector? 

So, one of the things that we try to tell people is, “hey, create your own income statement, create your own balance sheet for yourself”. And if you do that, you’ll really start to understand the terminology. And then when you go and look at a multi billion dollar company, you’re going to kind of see it in a similar light the way that you were making your own personal income statements and balance sheets. So you have a tool on your website, and I want to give you the opportunity to talk about this, so people can go there and sign up for this.

Douglas McCormick  34:03  

I have a website called familyinc.com. And on that site is essentially a chance to build your own income statement and your own balance sheet. And, to your point, an income statement is simply a budget. And in a budget, you list all your expenses and what’s leftover after your salary. That savings, in company vernacular, that’s profits. And then a balance sheet is simply, all your assets on one side, all your liabilities on the other. And the difference between those is your net worth. 

And so, I think creating the income statement, the balance sheet and seeing how those two tie together is very valuable. I’m kind of a critic of very detailed budgets because what I find is people invest a lot of time tracking information that they do nothing with. And so my view is, if I look at an income statement, I see exactly how much I saved or profited over the course of that period, whether it be a month or a quarter or a year. And if I can compare balance sheets over two time periods, I can see how much my net worth has grown. My balance sheet, unlike most financial balance sheets, forces the user to include your labor value and your social security value. Again, not that you’re likely to estimate those perfectly. But it’s an important asset that I think you need to take into account as you think about asset allocation and your overall wealth creation. I mentioned that a lot of the tools that businesses use can be employed. As you think about your own financial circumstances, and so there are a bunch of analytics to help you think about. Is your asset allocation, right? Do you have the right amount of debt relative to your income? What kind of margin do you have on your earnings? So that you can kind of benchmark yourself over time.

Stig Brodersen  35:40  

Okay, so to piggyback on that. One thing we’d love to do here in the podcast is to debunk financial myth. In some episodes it might be stock investing. We talked a lot about billionaires and we also talk about personal finance. But Doug, which financial myth do you think is most costly when planning for a family’s financial future?

Douglas McCormick  36:00  

There’s two that jumped to mind. So I’ll give you the most costly and maybe the most common. So I think the most costly relates to how we think about measuring performance and risk. So, you know, generally people think about asset classes in some combination of risk return, whether it be Sharpe ratio or something like that. I think many people don’t look at the right performance metric in terms of return. I think we should be looking at after tax, after fee, after inflation returns, and not nominal returns. Now, that’s hard for an advisor to do because they don’t know your tax position. They don’t know exactly what assets you’re holding, but you should be doing it. 

The second is, what’s the appropriate measurement of risk? And most of the metrics that you see do everything on an annual basis, its annual returns, its annual risk. And the appropriate way to think about it is what’s the time horizon under which you’re going to need this capital and think about that return versus a measure of volatility around that same time horizon. I think that’s the most costly because it forces people into very conservative portfolios when their duration would suggest they should be more embracing of risk. I think one of the most common is, I believe a misperception in the value of homeownership. And if you look way back over hundreds of years, real estate has roughly appreciated with inflation. And I think on top of that, people often do not account for all the soft costs. So taking care of the house, paying taxes on the house, paying a realtor when you sell the house, heat, etc. So I think it’s important to look at that asset as a good asset that does not depreciate, as something valuable for the family to be happy and create memories, but not a great investment. 

The last thing I would say, I think it’s really important in the way our labor economy is evolving. Millennials are going to be more mobile than our generation has been. And so while it used to be that we encourage homeownership as a way to promote stability, I think millennials need flexibility to move where labor opportunities are.

Stig Brodersen  37:56  

It’s also an issue about liquidity, buying your own home. I’m not saying it’s necessarily a bad thing because there are so many emotions attached when you own a home. What you’re saying Doug, is that if you do the math, and especially if you put an opportunity cost in terms of time and having your own home, it might not be the best investment in terms of opportunity cost.

Douglas McCormick  38:16  

I think there’s an important distinction about the book in general. And that is that the book advises on what is value maximizing financially. And then we all have to take our own values, our own priorities and overlay, what we choose to do. So I make all kinds of poor financial decisions every day. But I do it knowing that it’s a consumption decision or a value decision, not an investment decision.

Preston Pysh  38:37  

That’s a very important point. 

All right, Doug. So I tried to think of the hardest question I could possibly ask you. And that’s this one here. So in Peter Thiel’s book, he’s the billionaire out in Silicon Valley, he wrote the book, “Zero to One”. He talks about a really important question that he likes to ask each of his job applicants. He asked potential candidates, “what is the one thing that you know about financial markets that you think very few people in the world know or understand?”.

Douglas McCormick  39:08  

Okay, what is a hard question? So I’ll take a stab at it. I don’t know if it’s an understanding or an appropriate application. One of the reasons I wrote the book is because I believe that the quality of thinking around personal finance decisions is way, way behind the quality and the rigorous thinking that happens in investment management. And I think a lot of people are inappropriately applying the lessons of investment management to personal finance. And so what I mean by that is, insurance companies may very appropriately think about certain risk metrics and certain portfolio allocations that makes sense for them. And I don’t believe in many cases, it makes sense for the individual. And so it’s somewhat related to the last topic we talked about where efficient frontier or portfolio theory is often implied on a personal finance basis, and I think it’s done inappropriately. So for example, I think people are using the wrong returns and the wrong measures of risk, and they’re also not including all of their assets. So, I believe the appropriate way to think about asset allocation is to acknowledge that your labor and social security looks a lot like a bond. And think about your financial assets in that context. So I think it’s misapplication of an existing theory to personal finance versus investment management.

Stig Brodersen  40:21  

Great answer. My last question would be, besides your own book, what would you say is the most influential financial read you have ever come across?

Douglas McCormick  40:31  

As you can tell, decisiveness isn’t necessarily a strength of mine. So picking one is going to be really hard. So what I’m what I’m going to do for you, though, I’m gonna go out on a limb and pick one per decade.

These are not necessarily because of the work, but it’s because of how it impacted my thinking. And so as a teenager, I read, “Rich Dad, Poor Dad”, and it was very influential for me. I actually disagree with a lot of what he offers. But the framework and understanding that wealth is really a product of my actions, not my investments was a real key insight and started me down the path of probably thinking about how I think about “Family, Inc.”. 

In my early 20s, I read, “One Up on Wall Street” by Peter Lynch. To this day, I still think that influences the way I think about wealth management because it’s not just about inefficient markets, it’s about what’s my angle. Why am I better to underwrite this business than somebody else? And why am I a better owner, because I can add value in a way that somebody else can’t? And so I think, looking at the world in the context of what skills and insights you bring, other than I’m the smartest guy in the room, which is rarely the case is an important kind of insight.

And then I think in my 30s, I’m a big believer in pattern recognition. Investing is a lot about pattern recognition. That’s not to say, I’m a technical guy. But more so that I think wisdom and judgment is informed by the past. And so for me, “Triumph of the Optimists” is a real solid work, very Jeremy Siegel-ish in terms of stocks for the long run, in terms of laying out really substantive data over long periods of time, and translating that into what it means for investors like us. 

Awesome. All right, Doug. So we can’t thank you enough for taking time out of your busy day to talk to us. I know our audience is going to benefit from this tremendously. If people want to learn more about you or your book, or anything that you want to give them a hand off to, I just want to give you this open floor to really kind of throw it out there to our audience.

It’s all on familyinc.com. And it’s available on Amazon, Barnes and Noble. And so, I hope you enjoy it. Thank you. 

Awesome. So Doug, thanks so much for coming on the show. We just really appreciate it.

Yeah, no, seriously, it’s mutual. You know, I got not a great retail brand. And so for you guys to give me a shot to kind of tell the story and share my insights is much appreciated. So thank you. 

Absolutely. Our pleasure.

Stig Brodersen  42:48  

Okay, guys, that was all we had for this week’s episode. We’ll see each other again next week.

Outro  44:47  

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