Ep443: Gil Baumgarten – Concentrate to Get Wealth but Diversify to Keep It

Andrew Stotz 00:02
Hello fellow risk takers and welcome to my worst investment ever stories of loss to keep you winning. In our community. We know that to win in investing, you must take risks but to win big, you've got to reduce it. To join our community go to my worst investment ever.com and receive the following five free benefits first, you get the risk reduction checklist I've created from the lessons I've learned from all my guests. Second, you get my weekly email to help you increase your investment return. And third, you get a 25% discount on all a Stotz Academy courses. Fourth, you get access to our Facebook community to get to know guests and fellow listeners. And finally, you get my curated list the top 10 favorite episodes of this podcast fellow risk takers, this is your worst podcast hosts Andrew Stotz from a stance Academy and I'm here with featured guests. Gil Baum garden, Gil, are you ready to rock? I am Lay it on me. Yeah. Well, I'm gonna introduce you to the audience. So just one second, let me get this up ladies and gentlemen. Gill bond garden is a 36 year veteran of the investment industry. In 2010. Gil made a break from the brokerage world to start segment, a fully 5g fiduciary firm where the interests of the client and the firm could align. He has since attained a billion dollars in supervised assets. He is a multi year recipient of Barron's top 1200 financial advisors in America distinction, as well as being ranked in the top 50 financial advisors in Texas. Gil, take a minute and Phil any further tidbits about your life.

Gil Baumgarten 01:51
Well, that's pretty much it. You know, I was in the brokerage business for 25 years and have been a fee only fiduciary which your audience may not know what fee only is. But I'm not allowed to earn a commission or have a markup or a spread on any type of vehicle that I purchased for clients. So I'm regulated by the SEC, and the rules of engagement are different than the brokerage industry, which is primarily the reason why I got out of the brokerage business. So that's how I run the business. You know,

Andrew Stotz 02:21
it reminds me of something my father said to me when I talked to him when he was alive about his investments. He says, I can't even understand fees I'm being charged.

Gil Baumgarten 02:33
that's by design, by the way. The brokerage firms, the brokerage firms and the mutual fund industry, I don't like to use the word Cahoots. Your audience may not know what that is. But that's a sort of a slang term for two people who conspire to do harm to a third person. And the mutual fund industry and the brokerage industry are in cahoots to extract fees from clients when they do it in ways that are completely hidden from the client. So much so that the clients many times believe that they pay nothing for those services. That couldn't be further from the truth. So

Andrew Stotz 03:12
and the benefit of fee only is that there are no hidden charges, it's just you pay this fee and you get this service, right?

Gil Baumgarten 03:22
A client would have a very hard time not knowing exactly how I get paid and how much I get paid. My fees are required to show on the client statement as a line item. They can't be buried in a prospectus or disclosure document or hidden in any way. It's a line item on the statement. That's how we get paid. And so a client would have to be completely derelict to avoid finding out exactly how

Andrew Stotz 03:49
I get paid. And in Asia, it's kind of interesting, because you know, we're miles in some ways behind the US in some ways, we're moving fast in some areas faster. But what I can say is that when I started in the industry in 1993, brokerage fees, the transactions that people were paying to buy and sell stocks, and it was mainly institutional clients that I dealt with these fees were something like, commission of 1%. Yep. And that was already, you know, that was pretty high. For Asia and in Asia. What happened is that those commissions fell by 90 plus 95%. Basically, they're down to about point 1% through brokerages in Asia. Sure, though, in the one sense, the one but but the mutual fund industry still has not seen the compression, like the brokerage

Gil Baumgarten 04:44
industry and that's and that's because their fees are easy to hide. What clients or the investors don't really know is that the net asset value of the units of the fund are calculated every night right at the close. We know exactly what the value of those units are. The mutual fund that has a 1% annual fee takes one 360 of their fee, just before they print the net asset value. And so if you stay for one day, you pay one day's worth a fee on a 360 day calculated year. And it goes on day by day, they nip that net asset value every day, before they print the value of the statement. So a client looks at the statement and says, I haven't paid any fee. Well, they have no idea that they unit values were calculated minus the fee every single day that they've been printing the fee, and so are printing the unit value. And so it's easy to get confused by that. And then the brokerage industry will do side deals with the mutual fund industry, to Hey, if you'll we'll provide you research on stocks, if you'll provide trading revenue to us, we're not going to do the trades for $50, we're gonna do them for $50,000. But if you do that, then we'll commit to putting $50 million into your fund. And we'll do some rapid account business with your separately managed account. And we'll run trades across our desk doing they do all of these tit for tat 's that continue to drive fees up and up for the investors who are in those funds.

Andrew Stotz 06:15
And it just one. One thing about that is that when you think of particularly the US, you know, in the US, it's all about free markets, it's about competition. It's about capitalism and all that stuff. And what we learned in school in textbooks was that when there are free markets, what happens is, there's competition, and that type of thing just won't exist, because anybody could just go in and say, I'm not playing ball in that way. And I'm going to do it in a different way. How does it continue to exist in a place like America, that's supposed to be like a free market

Gil Baumgarten 06:47
alliances, so alliances develop inside where you have preferred providers, and a mutual fund industry is just, you know, one I won't keep picking on. But it's just because they have, you know, lots of fodder for me to use, but they do all kinds of side deals. And they're you know, moving the money around behind the scenes is just a hotbed of impropriety. And the mutual funds will pay a fee to be a featured mutual fund provider to, you know, some brokerage firm, and the brokerage firm turns around and charges fees to clients for that. And it's just as a, it's a giant, skimming operation skimming operation.

Andrew Stotz 07:33
And let me ask you one last thing, you've, you've published a book, maybe you can tell us a little bit about it and tell the listener what they can get out of that book. If they go in, you know, download.

Gil Baumgarten 07:44
Sure the book is called foolish. And the side of the subtitle is how investors get worked up and worked over by the system. And there's two real problems with the system. The first problem is the brokerage industry and the side deals and the skimming and the lack of a fiduciary standard and the existence of a suitability standard for care here in the United States. The regulatory environment is suitability for the brokerage industry, and its best interest for the advisor community. So the first 40% of the book is how the brokerages make their money, the side deals they cut, the way the money flows underneath the scenes, the way the mutual fund business, the unit trust business, all of the way all of that works inside the ecosystem. And then the back 60% of the business, or the book is about the self harm tendencies that investors have, essentially responding to the fear stimulus, and the greed stimulus. They are all out of whack on their timing of when they should be making this investment. You know, Warren Buffett is, has been famous for saying the best time to buy is when there's blood in the streets. But when there's blood in the streets, there's also blood in my portfolio. And I'm more apt to be a seller, if I'm relying on my internal engine to determine my internal sense of discernment. I'm going to be hard wired to do the wrong thing at the wrong time. And we use all kinds of biases, confirmation bias, we have all kinds of things that serve our ego need to be right about what it is that we are doing, when it doesn't serve our financial interests in the way we're going about it. And so the back 60% of the book is the exploration of those biases, and our self harm tendencies. And we give some tips on how to counteract some of that.

Andrew Stotz 09:36
That sounds like a really useful book. And I see it's on Amazon. So for the list on Amazon,

Gil Baumgarten 09:43
it's on the target website. It'll be on Audible here in the next couple of weeks.

Andrew Stotz 09:48
Fantastic. Yeah, yeah. So we'll have links to that in the show notes. I think one thing I would mention about the I remember seeing an interesting academic paper where basically if you look at the Return of a an index fund, let's say that owns all stocks in the market, let's just say on average earn 10%, then I believe they had a way I can't remember how they did it. But they were able to, to extract the calculation, basically, to calculate the inflows and outflows to try to identify at what price were the investors buying. Right from that they could say, you know, you have a buy and hold investor, they buy it, they hold it for 10 years, they get average annual return of 10%. But then nobody does that, everybody. That's right. And so they calculated the damage, it wasn't, it wasn't success, you know, timing is not something that the average person does very well. But even institutional people don't do it, you know, institutional fund managers don't do it. Well, what they found was, the damage to the portfolio was something like, you know, I don't know, between like three and 6% damage. So you know, it's already hard enough to just be buying hold would be one thing, but if you decide you're going to buy and sell and trade, what you're going to find is you're not going to get 10%, you're going to get something like 4%, maybe 6%, if you're lucky. Yeah. That's the books gonna help us with that.

Gil Baumgarten 11:06
Yep. that statistic is actually in the book. And I quote that study. And I don't know whether it's the same study, but the one that we quoted is a dowel bar study, yeah, da lbr da, lb AR. And they do something called the quantitative analysis of investor behavior. And they call it the QA, IB, and year, they've been doing it for 30 or 40 years. And every year, the statistic is somewhere between 70 and 80%, of the return that was achievable by the fund was left on the table, the investor only catches that last two or three percentage points of what you're talking about out of a 10% rate of return, because they're all out of whack, about when and how they make their decisions, and even why they make their decisions. A buy and hold philosophy is far better. And that's not even the bad news. The bad news is that the way the tax code works in the United States is you're going to kill your compounded rate of return, even worse by your mere transaction itself. The way taxes work here in the States, you end up having to pay capital gains taxes when you make money, but your capital losses are not deductible when you lose money, only against other gains that you've realized in the same year. And so it's a one way, it's a one way street for the IRS. When you do well, they want their pound of flesh. And when you do poorly, they don't give you the money back. And so the QA IB report doesn't even get into the tax effect, which is surely a negative attribute. And that's one of the biggest parts of the book, we talked about the how taxes work, and all the things you need to be thinking about in the ecosystem that investors are creating for themselves, not just the ecosystem of their existence within the brokerage industry, but the ecosystem of the way they pattern their behaviors, and when when they make their buys and sells and why they do so. And we try to give people some tips of 37 years of watching investors go through the school of hard knocks.

Andrew Stotz 13:08
Fantastic. I mean, it sounds like a great book and a lot of great, you know, valuable insights. So I recommend everybody go out there and get it. Check it out. Yep, links in the show notes. Perfect. Thank you. Yeah. And it's great advice. And you've just to summarize what I've just learned from talking to you is that if the average annual return, let's say we said Oh, that's that was 10% or it's going to be 10%. Your bad timing is going to reduce that 10 down to probably three, your fees that you're going to pay is probably going to reduce it down to one and then the taxes you're gonna pay, you're gonna reduce it down.

Gil Baumgarten 13:41
That's pretty, that's pretty much what happens. Yeah, right there, you've, you've pretty much encompass the entire problem.

Andrew Stotz 13:48
so fantastic. And you've got a solution. So I appreciate that. Yeah, ladies and gentlemen, get the book. Now. It's time to share your worst investment ever. And since no one goes into their worst investment thinking and will be tell us a bit about the circumstances leading up to an Intel is your story.

Gil Baumgarten 14:04
Well, being in the brokerage business and seeing my business develop over the years, I thought, well, you know, I'll be working for a big brokerage firm I worked for astronomer data D flatten, which ultimately became Smith, Barney. And then today it would be considered Morgan Stanley. So I spent 15 years there. And I spent 10 years at Paine Webber. Paine Webber became UBS through a merger in 2002 1001 or so. And so, you know, I thought, well, I'll just, you know, make my living save my money investment money. And, and I'll accumulate some stock in the stock purchase plan from the company. And I'll get some stock options and, you know, I'll make a couple million dollars and I'll use that to retire on when I'm in my 60s. Well, you know, I'll be 62 in September and I have no plans to retire although I'm in much better financial shape today and could have retired some time. ago, my plans at the time were to, you know, have a couple million dollars that I had saved, and I might even have a couple million dollars worth of stock and stock options will come around 2008 2009. Not only did the stock market fall apart, but my UBS shares, dropped from mid 70s down into the teens, and knocked about 80% of the market value of my stock. But Worse yet, it really clobbered my options. So because my options had a 10 to $40 strike price on the way down, my options are losing, some of them lost 100% of their market value. And I had a 10 year time window where if I didn't exercise, those options of they would cease to exist. And so I was backed up against the corner, not only was my practice under assault from, you know, client accounts are down in the market in 2008 was down 1338 or 39%. In one year, my fees were probably down 20, or 25%. Because we maintain diversified accounts, and we don't fully participate in the downside, but my income is under attack, my other stocks are under attack, my diversification measures are under attack, my UBS stock is under attack, and my UBS options are just about to get flushed down the toilet. And so I lost well into six figures in a relatively short period of time. And the vast majority of it was occurring in my shares of Company stock.

Andrew Stotz 16:36
Where were you living at the time? I lived in Houston, here in Houston. And at that time, I mean, I remember it well. And I just curious, like, what was your circumstances? You were living with wife and kids? I mean, did they understand what was going on? Like, what was kind of maybe take us to the moment where that problem really became real in your family too?

Gil Baumgarten 16:59
Well, um, yeah, thank you for asking that. That's an insightful question. You know, obviously, you have you experienced something similar, or at least you have an extremely well rounded view of the world to even ask that kind of question. My family has always been super supportive of me. And the financial problems that we might have at that point in time would have been no real concern of theirs other than the stress that they could see that I was under my house was paid for, I had my kids college money set aside, I was under no financial duress, other than the fact that I saw 40, or 50% of my net worth evaporate. in a relatively short time period. It wasn't as though my, my kids, my kids, were going to go without a meal, or I couldn't buy clothes for them, or I was going to get evicted from my home, I own my home outright. And so and I had assets, but my financial, my sense of financial security was under constant barrage. And I was just getting obliterated, especially on my stock options. And the secondary part of that is that that ultimately sowed the seeds for my departure from the brokerage business, I had investigated, leaving the brokerage business and getting into the advisory side of the business, because I had cobbled together an advisory practice inside of a brokerage firm. But the rules and regulations were not really particularly compatible with an advice only type of business model. And so the advent of really good computers, and really good software that I could buy off the shelf allowed me to compete with what a brokerage firm has cobbled together through its own internal proprietary software engineering. And I thought, well, heck, you know, if my business, my business was down 20 or 30%, but my stock options, many of them were down 100%, and my company stock is down 80%, there must be losses that are occurring within the firm, that have absolutely nothing to do with my business, because my business is not getting obliterated, like the stock is getting obliterated. And so I thought, well, you know, what I really ought to do is I ought to have just the guild bomb garden exposure. And if I had my own advisory practice, the my risks would be how I ran the business. And I think I could run the business a whole lot better than these Yahoo's that have essentially flushed my company stock down the drain. And so I started aligning, I accelerated my departure to get out of the brokerage business. And in October of 2010, I did in fact leave and started an advisory practice and took about $250 million worth of my client money from UBS when I had left and that's since grown to a little over a billion dollars.

Andrew Stotz 19:49
Fantastic. So tell us, how would you summarize the lessons that you learned from this experience?

Gil Baumgarten 19:55
Don't get carried away. Be mindful of the risks that you cannot control? All, you have to accept those. And, you know, concentration is the key to getting wealthy. diversification is the key to keeping your wealth. And at some point, you have to express that trade off one way or another in the way you, you take your risk. And I find that people who are well heeled tend to remain more diversified. And people who are trying to make their mark early, end up taking excessive risks. And normally those risks go bad, I don't think I was being speculative with my UBS stock. But I have seen people who spend the first 20 years of their lives, accumulating money and then losing it, and losing sight of the fact that they could have owned an index fund, that would have given them an eight or 9% rate of return with fantastic tax attributes, if they just simply would have let it pile up. And by the time you get 2020 years into this lesson that you're learning, that's really the most valuable part of the compounding curve. Many people say, hey, I've looked at how money compounds over time, that my million dollars can become 50 million over a 40 year time period with a certain amount of rate of return. Well, if you lop the first 10 years off of the front side, you're actually removing those last 10 years on the compounded return. So while people think, well, I've only got 10,000, or 20,000 $50,000, to invest, I want to take extra risk, in order to accelerate the process, what you tend to find is that people decelerate the process, and they end up cutting those 10 years off, or the end of their compounded return to because they didn't get started early in the process. So that would be the greatest instruction I could give people would be to stop speculating in Bitcoin or meme stocks or, you know, Reddit, whatever. You know, buy an index fund, let it sit, if you're really interested in compounding wealth, if you're interested in entertaining yourself, you're going to choose a different methodology. And then you're going to kick yourself for it later for all the money and opportunity that you lost.

Andrew Stotz 22:08
Yeah. All right. Well, let me Maybe I'll share a few things I take away from your story. I mean, the first thing is, I just want to talk a bit about this concept you talked about about concentration versus diversification. I think it's an important distinction. And the first part about the concentration is that the way people get wealthy is that first of all, they concentrate their energy in improving themselves. And that may be through education that may be through working with, you know, smart people, but they really concentrate and try to improve themselves. That's step one. Absolutely. The second step is finding the right way places to allocate your money. And, you know, one idea is to say, Okay, I got a friend of mine, he's really smart, he's got a great business, I'm going to put all my money with him, Well, okay, that's concentration, but you're bringing on a huge amount of risk. Now, let's take another example of a person that's perfectly diversified. They there may be older, they've got all kinds of different assets, they've got socks, they've got bonds, they've got property, you know, they're very diversify, but they're never going to be able to create a lot of wealth from that they're going to be able to grow their wealth from that. But yeah, you know, so. And it's a hard thing, because you don't want to have too much diversification. At a young age, you want to get exposure, particularly to the stock market, because you need that compounding. But you also don't want to be overly concentrated. I did some research myself That said, if you're going to own individual stocks, my conclusion from that academic research for Asia was 10. Stocks, you gotta own if you're going to own stocks, don't go in on one or two and say I'm concentrated. But you know, maybe you could say five to 15, individual stocks would be concentrated. Now, the second part of that for many people that don't want to own stocks, or don't know how to own stocks, just owning a, a, an index fund as an example and letting it grow is fine, and then concentrate your efforts on creating your wealth, through your business through all the other things that you've got. So I think my I really think that this is a huge lesson out of your story. Is there something that you would add to that about the concentration versus diversification? Absolutely,

Gil Baumgarten 24:28
absolutely. I would add this. Many people think that if they go out and own 10 stocks based on what you just said that they're instantly diversified, but they think that marijuana legalization in the United States is the next big thing. So I'm going to own 10 marijuana stocks, so they are not only stacking their bets just by being concentrated in just a few names. All of the names have the exact same risks associated with them. So that's an overdose of concentration as far as I'm concerned, and people tend to have a Far more riding on the things that they are familiar with, even though that might, in fact give you some type of an advantage. It's normally priced into the marketplace already. And people who loaded up on marijuana stocks four or five years ago, when the timing seemed to be right, many of them lost 90% of their money. So everybody else has to be thinking something different than you, in order for you to be getting some kind of a deal on prices over time. So turned out to be far more speculative than people assumed at the time.

Andrew Stotz 25:31
I like to say that I have an online course I teach, which is how to start building your wealth investing in the stock market. And in that course, I'd like to say that we create, grow and protect our wealth, and create wealth, most people go to the stock market, they think that's where they're going to create wealth. But that's in fact, not where we create wealth. That's where we grow wealth. That's exactly right. And so, for the lesson out there is, you know, figure out where you're going to create wealth. Now, I've come up after many years of looking at, there's really two core ways to create wealth that I can find. The first one is, and it used to be the advice, buy that book, Rich Dad, Poor Dad, and start up your own business and all that. But really, the truth is, this is really bad advice, because the majority of people are not entrepreneurs, and you're bringing on a tremendous amount of risk, telling everybody that you should start your own business. So the second way to build your wealth, and this really applies for everyone out there. And that is that you're going to earn a salary, let's say your salary is $100,000. And if you live your life and you spend at 95,000, you have created wealth, you have created $5,000 in wealth through your efforts. But if you can reduce that spending down to let's say, 60, you've now created wealth of 40,000, through your effort, and it's that wealth that you want to create, and then grow that well. So those are the two ways is there. Is there another way I can't think about it?

Gil Baumgarten 26:58
Yeah, so I, the way I articulate that to the people that I've talked to is that wealth is the sum total of all the money you've never spent. And that's exactly what you're talking about is suppressing your wealth is the sum total of all the money you've never spent. And so you have to create margin you have to create by suppressing your outflow, in order to create a margin, that margin is what you use to apply to a risk curve that will compound over time. And even if they don't start their own business, which is really where all the real money is to be made. If you're not cut out for that, then I think you're right, you're better off just compressing your costs and expanding your margin. And then using that margin to grow. The problem that many people have is that they're fairweather friends, they only want to participate when they think that the getting is good. And the reality is that the getting is always good. It just doesn't seem like it at the time. And so you just have to be engaged with risk over long time periods. And that's where, you know, some pretty significant wealth

Andrew Stotz 28:06
can come from. And I always tell people that you know, ultimately, it's business where you make your money. And I that's exactly right. It's an example I have one of the businesses that I'm a co founder and an investor in but I'm not working in is a coffee coffee business in Thailand called coffee works. And the thing about that business, I own a stake in that company. But I don't work in it. But the management team and the CEO who's my best friend Dale, they are working their butts off. Sure. You know, if prices are going up, they're trying to figure out how to maintain that profit margin. Your revenues are going down. They're trying to figure out how do we reduce costs immediately. They're working so hard. And if you own an index fund, as an example, now the widest index fund that I can find owns about 9000 companies across the world. And if you own 9000 companies as 9000 CEOs, 9000 management teams working their butts off for you. Absolutely back, chillin. Yeah, you want to talk about fun? That's fun. Yes, it is.

Gil Baumgarten 29:09
And that's the safest way to accumulate that extra kick to your rate of return, and also has very good tax implications. Because if you don't have a lot of activity, buying and selling, you won't generate any current tax on that I can really add to compounded return, which is really important after, you know, several decades of accumulation.

Andrew Stotz 29:27
Yeah. So based upon what you learn from this story, and what you continue to learn what one action would you recommend our listeners take to avoid suffering the same fate?

Gil Baumgarten 29:38
Well, the same thing with regard to my UBS stock are the same fate with regard to too much speculation in the typical investor's portfolio.

Andrew Stotz 29:45
Well, we've talked about so much in this I think you can take it home the way you want.

Gil Baumgarten 29:50
Yeah, I would think because it's more universally applicable, I would lean on reducing speculative investments, anything that you're buying With the anticipation that you're going to sell to someone else at a later date for more money, and you have no reason to rely upon why that would be other than their willingness to pay more for it. That's a speculation, as opposed to buying shares in Coca Cola or American Express or any other well established business, you know that they generate a profit margin, you know, how their business operates, and it's a machine that will generate results over time, and you don't have any plans on the future to resell it to somebody else. That's an investment. That's not a speculation. And so anything that you're buying to resell is normally highly speculative. But if you're buying just a stuck socket away and hang on to it for decades, possibly, that's more likely to be an investment. And you will do much better, from a return standpoint, a stability standpoint, a cash flow standpoint and a tax standpoint, if you choose investments over speculations.

Andrew Stotz 30:56
Wow. All right. Great advice. And last question, what's your number one goal for the next 12 months?

Gil Baumgarten 31:02
Well, I'm really excited about the book. So foolish is my book that's on Amazon. We've gotten a lot of traction with it, it made the Amazon bestseller list and people in our community are excited to read it. And hopefully, they'll want to be clients of ours. So that's what I'm excited about.

Andrew Stotz 31:21
And if they're a listener, and they want to be client, where would they go? What's the best place for them to reach out

Gil Baumgarten 31:28
to my firm is called my firm is called segment wealth management. SCG me NT. So my website is segment wm.com. You can go there and find out a lot about me. You can also find out more about my personal life should have the value of charitable giving a stewardship mentality and a lot of other things that are important in life. I'm also an artist. So you can go to Gil Baumgarten calm and you can see my artwork and other things about the book.

Andrew Stotz 31:56
Fantastic. And all the links to that will be in the show notes, ladies and gentlemen, well, listeners, there you have it another story of loss to keep you winning. My number one goal for the next 12 months is to help you my listeners, reduce risk and increase return in your life. To achieve this, I've created our community at my worst investment ever.com. And I look forward to seeing you there. As we conclude, Gil, I want to thank you again for coming on the show. And on behalf of a Stotz Academy, I hereby award you alumni status for turning your worst investment ever into your best teaching moment. Do you have any parting words for the audience?

Gil Baumgarten 32:35
Well, just Thanks for having me. And I look forward to more investments of my own and your audience, hopefully will make better investments for themselves. All right.

Andrew Stotz 32:45
And that's a wrap on another great story to help us create, grow and protect our wealth fellow risk takers. This is your worst podcast hose Andrew Stotz saying. I'll see you on the upside.