Ep806: Jeff Sarti – The Only Way to Learn? Lose Money First (Wisely)

Andrew Stotz 00:01
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 risk, but to win big, you've got to reduce it. Ladies and gentlemen, I'm on a mission to help 1 million people reduce risk in their lives. And thank you for joining this mission, especially our listeners in sunny California, fellow risk takers, this is your worst podcast host, Andrew Stotz from a Stotz Academy, and I'm here with featured guests, Jeff Sarti. Jeff, are you ready to join the mission? I'm ready. Let's do it all right. Let me introduce you to the audience, Jeff, CEO of Morton wealth, leads a firm managing over $3 billion in assets with a mission to empower better investors. Jeff helps clients achieve their financial goals while supporting employees in their career growth. A CFA charter holder, Jeff shares his insights through his prospective newsletter. His emphasis, his expertise, emphasizes challenging the status quo and fostering long term, resilient investment strategies. Jeff, take a moment and tell us about the unique value that you are bringing to this wonderful world. Thanks

Jeff Sarti 01:16
for having me as a starting point. Be really looking forward to this as a starting point, just to put in context, we're a wealth manager, and like many wealth managers, we're typically, you know, the financial quarterback in a client's life, helping them navigate all of the financial decisions they face in their life, from retirement to tax strategies and straight strategies, you name it. That being said, our real differentiation is on the investment side. We look very different. And I'm sure we'll talk about the strategy of how we look different. But more than anything, it starts with mindset. I know that's something that you talk a lot about in your podcast and the books you write. Everything really is around your approach to investing in behavioral finance, and the term I like to use in terms of the type of clientele that we synergize with. It's a healthy skeptic. And maybe I'll start just even quickly saying what's not a healthy skeptic. You mentioned status quo in my bio. What's not as healthy skeptic? Most people are just comfortable with the status quo, right? What's worked in the last 40 years should work in the next 40 years. You know, let's say a 6040, stock, bond portfolio. Nothing wrong with that. And most of our industry caters to that. And there's wonderful solutions for that type of mindset that being said for more of a skeptical mindset someone our clients are typically against skeptics. So they tend to be very smart, they're curious, they're questioning, and they don't take what's thrown at them at face value. And so that shows itself in a couple ways. One is with regards to the markets themselves. Let's say the stock market. They have a lot of questioning and even some distrust of the stock market. Of course, they're going to invest in stocks, but to a lesser degree than most, for a few reasons, they view the stock market somewhat as speculative game, even a casino. You look at like the mean stocks, things of that nature. They question valuations. You know, valuations, to some degree, have, we believe, somewhat untethered from fundamentals, and even just the rise of passive investing, passive investment grade, in a lot of ways, but in so many ways, it's, it's, it's synonymous with mindless investing. And so I think they're, they have a lot of skepticism or question around that, but even more importantly, I think, around policies in general, they're skeptical government policy. Is this really a offshoot of 2008 more than anything else. They question the imbalances, the extremities of 0% interest rates, money printing, and now, in recent years, just the binge on debt that where they believe that, intuitively, maybe they're not economists or clients, but they intuitively believe that there's no free lunch and that there's ultimately going to be a cost to these types of policies. And so as a result of that, they're looking for something different. They're looking to build more of a resilient portfolio. You talk so much about managing risk, first and foremost, we and our clients strongly believe that. So that's the skeptical side. Now I'll just finish on why a healthy skeptic. The danger of being a skeptic too much is you can veer into sort of doomsday land, right, and just want to be doom and gloom, put your cash under mattress, maybe shorting the market, long volatility, you name. It easier said than done to pursue that strategy. I think a healthy skeptic. While they're cautious, they still, they want to participate, right? They want to be invested. They want to be long, the economy, the market, etc. They want to be in the game. But again, they want to do it in just a more thoughtful way than in just a standard, passive, 6040, portfolio. They want to build a more resilient portfolio. And that is the end result of this different mindset it is, is, it is a portfolio that looks meaningfully different, not minor not not to a minor degree, but meaningfully different than sort of a standard, 6040, traditional portfolio,

Andrew Stotz 04:53
interesting. So I think it would be fun to dig into what does meaningful. Different. So let's, let's first start off for the listeners out there that may not know that much about investing, and you mentioned about 6040 let's say that's kind of typical way people maybe benchmark, or think about maybe I'll have 60% in stocks and 40% in bonds. Now in my book, How to start building your wealth investing in the stock market, I always say 110 minus your age is maybe a good guide. In fact, I would probably, at this point in my in my life, say 120 simply because when you're 20 years old, you probably should have 100% in stocks, in the sense that you need that compounding happening and you don't, you know, what's the point of having bonds at the age of 20, when you've got, you know, 40 year time horizon, but the idea of 6040 is that okay? Once you get up to an older age, then you want to have less of the volatility and all of that. So for many people, they see two asset classes, stocks and bonds. Now, in fact, you could argue that, are they really separate asset classes in the sense that they're both coming from a company. Now you could say, okay, government bonds, you could argue is a truly different asset class, or, let's say, the cash flow is generated from a truly different entity. I'm just curious, so how do we think, if we don't think necessarily, 6040, what do we think?

Jeff Sarti 06:23
Great context you put, and I totally agree with you on the risk scale. Age obviously, tremendously matters of how much in terms of risk exposure you should have. But really, at its core, it's really thinking through diversification. And we use the word true diversification to describe how we think about portfolio construction. So starting with stocks, and let's say a standard portfolio might have 60 or 70% in stocks, that's all well and good. The challenge is, as we know, diversification works in flat to up markets, but what happens in down markets, especially really nasty down markets, without getting too technical, but correlations go to one, right? It really doesn't even matter what sector you're in. If you hit a nasty economic environment and or a bear market, all stocks will go down together. So that's sort of the 60% part of the portfolio. Now, what about

Andrew Stotz 07:11
bonds? And just go ahead. So this is an important concept of this correlation, and the reason why we're investing in different assets in different asset classes is because we're trying to take advantage of the idea that there is a minimal correlation between various ones. And when you say basically in times of trouble, correlations go to one in the sense that number one, you mentioned stocks. So let's just say you had two different groups of stocks that really have a low correlation. But all of a sudden, when everything falls, they all fall together, and then the correlation is also in relation to things like, let's say bonds, or maybe gold, like, you know, as an example, where you can see all asset class correlations, go to one which are you talking about? Both of those, or explain what you mean by that. Yeah,

Jeff Sarti 08:01
so starting with the stocks, that's a simple one, right? But then moving on to other asset classes, I guess the way we think about it is what drives movements up in asset prices or down in asset prices with most traditional assets, and it's really two main things. It's the economy. Obviously, a strong economy is healthy for both stocks. And you mentioned bonds, most especially corporate bonds, do well in a good economy, in a recession or tough economy, the opposite happens. That's the first thing. And then the second thing is interest rates. Interest rates just the most important thing that drive prices. We've been in such an incredible we're also spoiled right? Going back 40 years in really a declining interest rate environment, declining interest rates propelled all asset class, all asset prices, up, both stocks and bonds. So when we're looking for other pieces of the pie to mix in with our stock and bond portfolio, it is really looking at things that will behave somewhat unrelated to those two risk factors, both the economy. What things can do okay, can do well, no matter what direction the economy takes. Same with interest rates. What are things that can do okay, potentially even thrive if interest rates rise. So that's where we're looking at truly things, truly things that will behave differently. One last point I'll make, just going to the bond piece you hit, on and on the on the intro part of this discussion, a lot of bonds are actually more correlated stocks, because you're either taking equity in a company or lending to a company, so in both of those instances, you're correlated because you want that company to do well. But then there are other safer bonds you mentioned, like government bonds. Listen, government bonds were wonderful again over the last 40 years in a declining interest rate environment, but one interest once interest rates hit zero, I mean, it made no sense to touch bonds that had zero yield. Now, at least, rates have moved up a little bit. And you could get reasonably paid for buying something like a government bond. But the concern is, even with government bonds, are we in a new paradigm? And I'm you know, maybe the 1970s would be the best example, where inflation changes everything. Inflation is a game changer. Where can we be in more of a quasi, somewhat stagflationary type environment, maybe not the end of the world, but maybe sort of a slow growth environment, but coupled with inflation, where you not only have stocks that are challenged, but now bonds are challenged as well. So bonds that used to be that stalwart ballast of the portfolio that would move counter to stocks, maybe will go down at the same time, we had a little glimpse of that in 2022 both stocks and bonds got really hit hard. Bonds did not do what they were supposed to do. Our concern is no guarantee, but will the next decade look more like that than not? So

Andrew Stotz 10:52
there's two things I want to unpack in the first one you talked about, okay, economy and interest rates. Yeah, technically, let's look at the long term government bond. Let's say 10 year government bond. The composition of the interest rate is, in theory, a combination of economy and inflation. Yeah, when you're talking about economy and interest rates, are you really talking about economy and inflation, or are you talking about economy and interest rates? It's

Jeff Sarti 11:22
so you, you, they're obviously related. I now that you phrase it that way. Yes, it's more economy and inflation. And so we again, we've been so spoiled to be in a mild inflationary environment for most of our careers, lifetimes. We've never been faced the our industry at large, with a more volatile and or rising inflationary environment, where, on a real terms, one if interest rates rise, disastrous for bonds. But even if real interest, if interest rates don't go up, let's say they stay flat. Are you still making enough on a inflation adjusted basis? Because government bonds yielding three 4% Listen, CPI data. We all know inflation is really higher than what is reported by the government, not drastically so. But if you're going to make three 4% over the long run, are you really keeping up with inflation? We have a lot of doubts.

Andrew Stotz 12:21
And when we talk about, you know, you talked about the 40 year decline in interest rates, you know, if we go back to, let's say I graduated from high school in 1983 and you know, right then, Volcker had been squeezing, trying to bring interest rates down from 20% or so at the time. And you know, there was some amazing headwinds that we are never going to get again. And the first one was declining, let's say, declining oil price. Yeah. So we had 20 years of declining oil price number one, the second one was, we had about 700 million people enter the job market between China, Bangladesh, Vietnam and different countries. That all of a sudden, all of a sudden, when I left Ohio, where I originally grew up. I left Ohio in about 1986 there was, you know, there's a vibrant, you know, industrial base, yeah, that's gone. That's all shipped over to Asia, let's say in general, in China, specifically. And what we saw was that it was just impossible to be able to compete with this. 700 million people, low wage earners at the time entering the workforce. So between the combination of falling oil prices and the entrance of this huge influx of low cost labor, yeah, we naturally had a falling interest rate and a falling inflation environment. Now you could say, well, Andrew AI is the next thing that's going to bring us that deflationary, you know, a reduction in inflation. But I'm curious, you know where your thoughts are, because I did hear you on another thing on your LinkedIn. You have a lot of little clips, and I watched some of those. And you know, you talked about this idea of, you know, we had a once in a lifetime period of very low interest rates. But could we be wrong? Could it be that AI is going to bring us, you know, the same type of thing that falling oil prices and 700 million new people into the workforce did for deflation.

Jeff Sarti 14:36
Listen, without a doubt, AI is powerful, and I'm a believer in the technology and productivity can hopefully knock on wood grow as a result of AI. So listen, I'm a believer that being said, we strongly believe that there are more powerful forces at work. Work. A lot of it is around debt levels, the massive one comparing and contrasting us first, let's say the early 80s, where Volcker had a lot of guts to do what he did. That being said, we had such low levels of debt, he was able to do that. So he was able to crush those inflationary pressures. So beyond the dynamics that you talked about, Volcker was a big force in decreasing inflation too, because he was able to Jack interest rates up. It's not possible. We cannot do if inflation, if we get into wage price spirals, if it rears its ugly head, tariff issues we're facing right now. I mean, news just today about supply shipping collapsing out of China, just like literally today. I mean, there could be some real supply crunches here if inflation picks back up the challenges the Fed doesn't have room to massively raise interest rates. Why? Because our debt levels are just on a debt to GDP basis, astronomically higher than what Volcker was facing. Yeah. So listen, there's a lot of moving parts, pros and cons. AI is a great example of it that being said when we think about fundamentals and the biggest concern from a generational point of view that will drive inflation and growth, etc. It's that. It is that government debt we think it's utterly out of control and unsustainable.

Andrew Stotz 16:31
One of the ironies of America is, yeah, I've always been kind of amazed at how Americans are so comfortable with price controls on the cost of money, yeah, but they would never, you know, have be comfortable with price controls on, you know, iPhones as an example, or anything like that. It's just they've been so acclimated to it that it's just like everything hinges on that. Let me ask you another question before we get to the big question of the podcast. But the other question is, how many asset classes are there? For instance, the reason why I asked that is because, yeah, I read some research, and they talk about small cap value, and they call those asset classes, but I've always considered any stock as part of the equity asset class, and then bonds, both government and corporate, part of the, you know, the bond asset class. And then I can come up with commodities, and you could say gold, but truthfully, com, gold is a commodity, sure. So stocks, bonds, commodities. Now someone says, I end up with this private credit. Well, wait a minute, yeah, that's lending, yeah, it's bonds, yeah. So, just out of curiosity, you know, you're allocating all the time. What does it mean when people say these are different asset classes?

Jeff Sarti 18:01
I love that question. I'm going to talk about both sides of my mouth. So as a starting point, you as a starting point, as a starting point, I agree with you. Actually, even though we talk about lots of asset classes, at its core, there's equity and debt ownership, which is higher risk, theoretically some leverage to enhance that. Those returns or bonds you lend on different opportunities, and you're more in a more secure position. Now that being said, the limitation that most face with the 6040, Bond stock bond portfolio is the public markets are only a small slice of the total investable pie in terms of both equity and debt, and it's only through we found maybe there's little, little glimmers within the public markets, but generally, it's only within the private markets that we can find equity and most specifically, debt, debt structures. You mentioned private credit, that will just be very, very different than public bonds, different in a number of ways, covenants much stronger, much better in the way of controls. And most importantly, and we could talk more about our approach to lending, that's where the non correlation comes in the way the lion's share of bond corporate bond investors make loans, it's all based on underlying cash flow or earnings of the underlying company. That's all well and good, and we do some of that too. But when I talk about true, low or non correlation, it's being agnostic to the company you're lending on, and focusing on the underlying collateral, the assets, the assets that you can attach to. So if you're lending to a company, right? You hope the company does well, but that's secondary. The key is, what are you lending on? Are you lending on their inventory, their trucking fleet, their real estate, their cash? And if that's. You're lending on, and this is where our primary focus is on across a variety of industries, focusing on assets as protection, that even if things don't go according to plan, and that's something we strongly believe in. We're very humble in the way of we, we have no crystal ball. We embrace uncertainty, as opposed to trying to have predictions of what's going to happen to the underlying economy or the company we're lending to. So even if things don't go according to plan, knock on wood, we're going to be okay, because we have those assets to lean on. So

Andrew Stotz 20:33
let's imagine that all these private loans are tradable in the stock market, and you could compare the existing and so just for the for the listener and viewer out there that may not completely get that, if we think about corporate bonds that are traded in the stock market, they are, as you said, based upon the cash flow of the entity generally. And basically, that's the benefit of being a large listed company, is because your data is public and people are scrutinizing it, the banks can lend or, sorry, the entity can issue bonds based on cash flow. So now we have this whole set of bonds that are listed in the market that are pretty much all cash flow based, yep. Now let's imagine that there's also a set of bonds that are cash flow and asset based, let's say maybe not 100% asset based, but let's just say that asset, the collateral, plays a role in that. And so now all of those bonds, or, let's say all that lending is in the form of bonds that have asset backing. What we're really talking about now is, in theory, what we're talking about is lower risk lending, yep, to possibly to second tier, not in credit quality, but in, let's say, what is it, you know, because they're listed, let's say, because of the corporate bonds right now are mainly, it's transparency, let's say, but these are, there's more work involved and all that. Yeah, but now we've got this whole group of bonds that are backed by asset as well as cash flow, would those trade at an interest rate above or below the corporate bonds in general that are based only on cash flow?

Jeff Sarti 22:34
Well, I love that you say that because intuitively right, they should trade at a lower yield, because they're safer, without a doubt, they trade at a higher yield and meaningfully So, meaningfully so. And there's, there's some reasons for it. One is there a lot of these companies are they're not publicly traded, right? So then they're the thought is, oh, there's more risk in private companies. But again, many these loans we're making are not one to $5 million loans, there 10 to 50 or even 100 million dollar loans. So these are substantial companies. The other aspect is, I don't want to be completely misleading in that a lot of these companies are not listen if they were, if they were growing like gangbusters, they could go to traditional lenders and get cheaper debt. A lot of them are companies in transition, maybe going sideways. So there is some maybe hair on these companies. But still, one of the reasons it's that there's an supply demand imbalance in terms of the amount of lenders that are willing to make these loans is it's a lot more work if you think about a cash flow loan, like, let's say, Morton wealth, our company, we make nice, consistent cash flow we grow from one year to year. We're even a small company. We're not publicly traded, but if we need to get a loan, we could go to a local organization and get a loan really quickly. They would just look at our last few years of financial statements, bring it to their board and make a decision in a couple weeks, very different than, let's say, another company our size, but maybe didn't have consistent cash flow like we do, but had a huge trucking fleet. How do you value that trucking fleet? It takes a lot of work. You got to go verify those trucks. You got to go really understand the market. If you had to sell those trucks, what type of liquidity appraisers getting involved? It's a messier business that works to our advantage, because the lenders there, there's only specialty lenders that are willing to do that hard work. The end result is they can charge a higher interest rate. Okay,

Andrew Stotz 24:37
so let's compare the loans. Yeah. So let's imagine that all the corporate bonds out there that we could split them in half, and half of them were asset backed as well as cash flow backed. In theory, those bonds would trade at a lower return. But what you're saying is that, well, the because of the size and the challenge and the additional work involved. Involved in all of that, yep, and lack of transparency. So there's a lot more work involved to hold them accountable, and all that that, what you're saying is that the reduction in interest rate caused by having asset backing the loan is not offset. You know, it is you won't experience that lower return, because all of the digital risks, credit risk, as well as extra cost involved in doing it, will bring that return to be a higher return than what we would see from the bonds out in the market. So I think even, like, the

Jeff Sarti 25:38
simple analogy, I mean like, even like, even like, think about stock investing, passive versus active management, right? Passive investing is going to be cheaper, lower cost funds. It makes sense. Why? There's no work. It's easy, right? Name, the firm, BlackRock, can make a fund, and then tomorrow could be 10s of billions of dollars in assets versus active management, really hard, right? You got to hire analysts, a team, etc. You know, there's an extra cost associated with that. Similar, on the asset based side, it's just, yeah, it's, it's not so easy, except the different networks for benefit. On

Andrew Stotz 26:11
the asset backs, on the asset backed side, you're much more likely to get the upside, additional upside, the compensation, whereas on the active side is harder, just because the competition in the market. So I like this conversation, because a lot of times when people talk about private credit, yeah, in the end, what they really just talking about is they're not getting daily price quotes, oh, on that, and then, like, that's low risk, you know? So if a tree falls in the woods and no one hears it, did it actually fall? Well, of course, it fell. There's plenty of risk in that. It's just that it's not being priced on a daily basis. And so is that really risk reduction? I wouldn't say it is. It is vola price volatility reduction, but that's not really risk to me. Couldn't

Jeff Sarti 26:56
agree more. The private industry takes advantage of the lack of pricing, we all know that, right, and inflates risk adjusted returns, sharp ratios, that's all fake. I couldn't care less about that. That's not what I care about. What I care about is true. Downside, really, thinking through scenarios, downside, stress testing, what can break this loan? What? What can happen that, whether in the whether to the company or something out of control, the company's control. We're facing it right now, right with tariff related issues, geopolitical events, you name it, really thinking through downside again, you talk, I know got so much about managing risk. It's, it's the theme of your podcast, and so much you write about, that's our obsession. What is a nasty environment? And in a nasty environment, are we going to get our money back, as opposed to a cash flow loan, all well and good, until, if there are no backing of assets, you know what happens? Knock on wood. Maybe you could get back 80 cents on the dollar, 70 cents on the road. But you know what? That might even go to zero if, if the cash flow goes away, no interest in lending in those types of more extreme situations.

Andrew Stotz 28:06
Okay, so this is a great discussion, and what it comes down to is, so far, we've identified two asset classes, stocks and bonds, and within our stocks and lending, let's call it whether that's through bonds or whether that's through loans, and we've now clearly delineated number one, government bonds, number two, high quality cash flow back, corporate bonds, and number three, private credit, which is generally asset backed and tends to have a higher return. Yeah, so it's a subdivision within the lending area. Now that one of the things that I wrote in my book that I wrote about investing for beginners, I told people, don't, don't bother investing your portfolio in real estate. And I said, for two reasons. Number one, most of what you would be offered in the stock market is really a real estate investment trust. And if you have a broad based exposure to the stock market, let's just say, through a passive fund, as an example, you already have those real estate investment trusts in the index, yep, because it's listed in the market, so you're doubling your exposure to them. However, the second type of investment in real estate, I would argue, is a separate asset class, and that is your home, yeah, and the land that your home is on, yeah? And that, I would say, that land, as opposed to the rental business, that is generally what a REIT is. Land is a separate asset class. Tell me I'm right or wrong.

Jeff Sarti 29:51
I agree with no, I listen. I agree with you. There's a lot more real estate within stocks. And people realize, realize, when you peek under the hood, um. Land is behaves differently. Really is its own animal, as compared to cash flowing real estate. But a couple, a couple of, like, a couple of points to emphasize, we've definitely done Reed investing in the past. The challenge with REITs, though, is it goes back to the correlation. It is not completely, but there are times where it will move more like stocks as opposed to private real estate. And so all that means is sometimes there's opportunities in REITs versus private real estate. But let me go back to maybe one more example now, which has been a core position of ours, going back to 2009 or 10, going back to the lending side. So we talk, you're mainly talking now about equities, ownership of real estate. What about lending on real estate? There's a whole asset class of lending on real estate, again, tends to be smaller niche, so a more inefficient part of the market. Just because it's smaller, the big boys aren't playing there. But the smaller is good because there's less competition, and you could charge higher rates, where typically you can make loans on re Are you familiar with, like, the bridge lending space, like short term loans? Yeah, definitely.

Andrew Stotz 31:07
But I think my audience may not necessarily know all of that, so maybe just explain that briefly. Yeah, one that have been in that business? So, yes,

Jeff Sarti 31:16
I'll give a brief overview. It's been really a wonderful and resilient and consistent asset class for us going back, you know, call it 15 years or so, where a typical story is it might be, let's say a real estate developer who's looking to buy an apartment building. Let's say it's a ten million building, you know, small, four Plex, eight Plex, whatever it is. And they're, they're looking to close quickly on that, so they go to their bank, and they've tried to get a loan, and the loan, the bank says, sure, but it'll take three months. And the guy says, I don't have three months. I want to close on this quickly. So they go to what's called a bridge lender who can close on that loan very quickly, in a week or two. And the bridge lender, the groups that we invest with, they just make a short term loan. So typically, the most common term is 12 months. So that's great as a starting point, because we talk about interest. Rate risk. The biggest risk with interest rates is duration on bonds. These are very short term bonds. That's as a starting point. And the

Andrew Stotz 32:10
bridge lender has access to the collateral if they can't get the full lending or how does that you

Jeff Sarti 32:16
they are? You should think of the bridge lender as the bank. They own the keys, just like the lender does on your home. They are in first position. There is no one ahead of that lender. So that's key, right? You own the collateral. Again, goes down at an example I gave with corporations of the trucking fleet or inventory. If something goes wrong with the real estate or that real estate professional, they can't pay on the loan, you own the keys to that real estate. Now the last key component is, all right, how big of a loan on a loan to value? And the standard in terms of the funds the world that we lend on is basically 60% loan to value. So what that means is, on that 10 million property, they're not lending, let's say 80% maybe, like a bank would lend, they're lending 60% or $6 million so even in a challenging real estate environment, and by the way, we're in one right now, real estate has been challenged in the US with rising interest rates, but you have a 40% cushion in terms of declining interest rate values. And by the way, that happens has to happen within a quick 12 month period for your principal to be threatened. And so it's a place where you're a short duration loan, relatively high interest rate, and backed by collateral, you could be diversified geographically. We are across the country, literally in the funds across 1000s of loans. So it's been a really consistent, resilient asset class for us, where, for example, just it kind of marches to the beat of its own drummer. When things are going well. This does well, but then 2022 great example, when bonds got crushed, you wouldn't even if you looked at the return stream of these things, you wouldn't even noticed. It would have looked like it was marching to the beat of its own drummer. It made just like what it made the year before the year after, because there's no real interest rate sensitivity, because the short the nature of the loans are so short term,

Andrew Stotz 34:08
and if the value of the property went down by 40% you still get your money back.

Jeff Sarti 34:15
Listen, yeah, that's and, and you would still get your money back. Listen, that's where, theoretically, it gets that where it gets a little messy, you might have to foreclose on the property. You might then have to go sell it. There's cost. So listen, there's no issues with situations. You don't want to be in that situation. But that is, listen, it's we've been lucky. Don't get me wrong, we've had tremendous tailwinds over the last 15 years. Real Estate's pretty much gone up outside the last couple years. So we've had very few circumstances where that's happened in recent years that's picked up a little bit where, you know, maybe there's been a foreclosure and you'd have to work something out. But yes, generally speaking, even in really, really bad scenarios, you're principally protected. Um. Um, and because, you know that 40% cushion is very big.

Andrew Stotz 35:02
So now we've kind of built some subdivision within real estate investing. We talked about REITs, we talked about, you know, your own, let's say, your own land and house, which, for many people who aren't rich, that could be a huge allocation of their overall wealth, and therefore they have good exposure to that. And then lending on commercial real estate, the bridge lender type of thing is a subdivision within the real estate asset class. So we've kind of said, Okay, there's stocks, there's equity, there's lending and there's real estate. Certain parts of real estate really behave as a separate asset class. Are there is commodities an asset class

Jeff Sarti 35:43
to you? Yeah, I would say commodities is. Commodities is the one other one that I'd say behaves differently. We dabble in certain commodities that being said, where we've had a meaningful core position, which I quasi call a commodity, and you alluded to this is gold. We've been investing in gold, really, since 2015 for quite some time. And while it has, gold has some features of a commodity. One of the reasons we tend to not have overweights in other commodities, it goes down to the correlation argument. Most commodities are dependent on the economy. Think about copper. You think about other commodities, oil, etc, in growing economies, those will do well in recessions. What happens to commodities? They get crushed. So actually, there's a decent amount of correlation, ultimately, from a long term point of view, to stocks both depend on a growing economy gold, and that's a whole separate discussion that we could potentially dive into. But gold truly marches to the beat of its own drummer, where there's plenty of instances, and listen, we're in it right now, where gold really diverges from other commodities. And that's because we really believe there's a different, different use case, different rationale, and why, why someone is

Andrew Stotz 36:56
would you say? Would you say commodities? And commodities is an asset class, and gold is an asset class.

Jeff Sarti 37:01
I view gold to some degree, as a cash alternative, okay, it's, it's an alternative currency. From my point of view, the lion's share of investors, their net worth, is in the dollar. The dollar is, by its very nature, a debased it's something that's going to debase over time, and gold, we view as the other currency that will theoretically keep its value. It's volatile, don't get me wrong, but over the long term, we'll keep its value, purchasing power as a store of value, especially against $1 where we have a printing press, and we all know what happens with the value of the dollar over time. So

Andrew Stotz 37:41
we've talked about asset classes, let's say stocks or let's say investing companies. We talked about, let's we can use the word bonds, but let's say that's lending to government or lending to companies in various ways. And then we talked about commodities as a separate asset class, although at times it's really driven by the economy. So it's correlation is questionable. And then we've talked about gold, and you've kind of classified it, as you said, as a cash alternative that has a unique correlation or movement relative to the economy. Economic situation. Is there any other asset class?

Jeff Sarti 38:22
My knee jerk reaction is no, I guess I would expand on then, why, how we can create what we going back to the true diversification argument when you think about various examples. And I actually just listened to the podcast you just released with Larry swedro, where he talked about things like reinsurance, things these are various forms of lending, healthcare royalties. We do a lot of healthcare royalty investing. In essence, all you're doing is you're buying, you're lending, you're lending to a biotech company, and in exchange for that working capital, you buy a share of a royalty stream of some sort of pharmaceutical drug or medical device that's just lending too. But again, when we think about risk factors, that's when I think about asset classes, really, what I'm saying is, what are the risk factors that will drive the performance of that underlying investment? And so that's an example of a healthcare royalty, a drug that's fighting some, let's say, an immunology drug that's fighting cancer. That's a loan totally different, completely different than the loan I made to a company that's where the collateral is its trucking fleet. I mean, that's like as night. It's apples and oranges. So I don't make it somewhat simplistic, but those are almost two completely different asset classes. So

Andrew Stotz 39:40
for the people that are listening or viewing that don't fully get what you just said, you could take a portfolio that someone has, let's say, of 100 stocks, yeah. And you could say, okay, they have exposure to various sectors, healthcare, you know, utilities, whatever. And we could say that those. Do is have different exposures. But then what you could also just do is say, what are the risk factors that this portfolio overall is influenced by, and let's say one is inflation, and let's say another one is GDP growth. Let's say, you know, another one is currency, maybe, or the like, and we can list out a series of risk factors, and then we can go back to our portfolio and maybe back test it, and say, what level of exposure do we have to these very risk factors? And you find out, Oh, wait a minute, even though we're diversified across these different asset classes, we're actually really, really overweight or heavily invested in a particular risk factor. Let's say inflation as an example. And then you may say, I don't care about, you know, asset classes. I need assets that will reduce my exposure to any particular risk factor. Is that, is that what you're saying?

Jeff Sarti 40:58
I love how you said that. It really comes down to risk factors. It's really thinking through that's where we spend our time, really poking holes in the various opportunities we're looking at, and thinking through the broader macro risk factors that can break that investment. And to your point, the challenge with so many traditional investments. And of course, we have traditional investments too, but the reason we have so many other pieces of the pie is when you look at those risk factors, the ones we all care about, recession or not, what's going to happen with geopolitical risk, war, etc, inflation, more often than not, those traditional assets have over exposure to those things, As opposed to less exposure to those things.

Andrew Stotz 41:42
Yeah, Okay, last thing, just because of the job that you do and the service that you provide, you talk about long term and I think a lot of people you know understand the importance of setting long term goals, diversifying and all that. So if you're a long term investor, and you wake up one day, and then you see on the news, it says all asset classes have a correlation of one today, right? Um, does it matter? I mean, come on, for 30 years, let's say, prior to today, they didn't have a correlation of one, and within one week, one month, one year, they won't have a correlation of one again. And therefore, I never really got this point of correlation of one, because if, if you say all asset classes have a correlation of one, yeah, oh, my god, uh, now, now we're all correlated one, I got to do something. Yeah, no, actually, it's just a moment in time, yep, where actually one of the best things to do in this type of moment in time is nothing. So I'm just curious, like, what, what? How are we supposed to think about when people say there's a correlation of one?

Jeff Sarti 43:07
Listen, I agree with you. And like, just to give advice to more the traditional investor who is even more in a 6040, portfolio, you should not be panicking and selling at the wrong time. And when correlations do go to one, you got to take your hit and then ride through it, because things will come back. I'm not saying things will go down forever, that being said all moments in time should not be weighted equally again. It comes down to managing risk, which I know you have your like, six tenants, and for us, that's one of our core tenants. It's risk management, and risk management really only matters in those rare times, and I acknowledge this is only five or 10% of the time, but that's where wealth is really destroyed, and bear markets can be nasty, and they happen more often than people realize. Again, we've been spoiled, and snapback has happened so quickly, like the COVID went down 36% it came back, you know, within months, not even years. Really, it's been since, oh, eight. We had a nasty time, and then money printing came and saved the day. That's even a second question, Can money printing save the day the next time? So our concern is that it's about permanent loss of capital. And when I mean permanent, yes, I mean more long term than a moment in time. The 70s were we've had periods of time, right? The 70s were an example. The 30s were an example. Let me. Let me actually, let me make one more point. There's definitely we view stocks because we, of course, have stocks, we just have less, less exposure to stocks than most. But we, to your point, stocks have to be viewed as a long term investment. Without a doubt, we would say longer term than what most people think, more than 10 years, even 15 or 20 years. Because if you look back at, let's say, the last 100 years. So I think you could, you could really break it down into 330 year segments. And in each of those 30 year segments, what you have is about 10 of those 30 years where stocks are flat, losing to inflation, really bad returns. That's from 1929 to 1943 flat, and then the next 20th years, returns were wonderful. Then 1966 to 1974 flat actually took until 1982 to break even with inflation. Talk about long term. That's a that long time to be invested in stocks and weight. Then the lost decade of the 2000s this every people should expect 10 out of every 30 years you're going to have a long, long wait. Now that doesn't mean you don't own stocks. It just means, I strongly believe that should represent, then, an appropriate part of your portfolio. With that description of volatility, I don't think that should represent 60 or 70% of a portfolio. And by the way, valuations matter if, if stocks were trading in the high single digit or low double digit PE ratio, I would be singing a different tune. But that is not the case by almost any objective measure. Mean we're trading maybe not quite at 1999 levels, but near all time highs in terms of PE ratios, etc. That's not a place where you should be backing up the truck and investing a lot, a lot in stocks. One last point, this isn't just me saying this. I mean, you look at all market predictors, it came out a lot last year. I think it was Goldman Sachs predicting their next 10 years of stock returns 3% less than inflation. Morgan Stanley, their CIO came out, and basically he said stocks are gonna be about flattish for the next 10 years. It all comes down to valuation. Again. That doesn't mean you have no stocks, but that's not something I would really lean into and say, Okay, that should be 5060, 70% of my portfolio.

Andrew Stotz 46:49
So is what you're saying is that the 60, let's just imagine that the typical 6040 is suitable for someone at that stage of their life. But what you're telling them is that, well, wait a minute, there's times that that 60 should be 80, and there's times that 60 should be 40.

Jeff Sarti 47:09
Yes, my range would still be a little lower than that, because I think maybe 60 on the upside and much less on the downside. Our typical client right now, because, partly because, driven by valuations. Might have 20 or 25% in stocks, but that's also because we feel like you can have your cake and eat it too in these other areas of the market, and again, they're private, that you're the trade off is some illiquidity you can make stock like returns, knock on wood, at much, much reduced risk, again, where you're the lender, as opposed to the equity owner. So why not? Why not do that? Okay,

Andrew Stotz 47:42
now I got one last thing. I promise this is it before I've enjoyed this. Thank you. I've enjoyed this. Yeah, okay, so for the most, most, most people that would be listening, they're like, Okay, great, Jeff and Andrew, thanks for your fun conversation. But how the hell do I invest in all of this private credit and all that? And this is where I talk a lot with Larry swedroe about, you know, what are the instruments and how can we do it? Or is that can really only be done by a large, you know, or, let's say, mid to large size asset management company, or asset wealth management company that can get access to it, you know, are there ETFs? Are there funds? Or what is it? What does an individual investor do? So

Jeff Sarti 48:24
listen that there's no shortcut you talk about, you talk about doing your research like point number one on your list. We actually have a saying, investing starts with investing in yourself, like we you got to do the work. You got to do the work. Now, I know this will sound self serving, but you should maybe partner up with a financial advisor who has this expertise. But if not, you know, there's research out there and you could do the work. The nice thing is, there has been really a proliferation in the last decade of more instruments that can you can have access to some of these private markets in more user friendly formats. All I can say, and plenty of them, are wonderful, don't get me wrong, but you got to be very, very careful, because the challenge with a lot of these, there's a few challenges, but the main one is a lot of them promise liquidity that really is not appropriate for the underlying illiquidity of the asset class you're investing in. So there's a lot of quarterly liquid investments out there, and many of them are wonderful, and we invest in some of them. But if you're investing in a quarterly liquid instrument where you're buying real estate that really should be a 10 year old and who prices, how do you price real estate? Is it? How do people get in and out of something with that type of opaque pricing, that's a recipe for real issues. We even saw a glimpse of that with the Blackstone REIT, where there was a run, run on run on the bank, if you will. With regards to that, especially in a tough environment, we could see real runs on these funds and illiquidity. Yeah, that could be really problematic. So there's a lot of nuance with this stuff. That being said, there's a lot more, lot more availability now than there used to be. And

Andrew Stotz 50:08
Larry, in the back of his book, talks about some he gives some ETFs or some instruments, let's say that people could consider when constructing their portfolios and under reinsurance, he talks about pioneer and Stone Ridge, Oh sure, yeah, alternative lending, he talks about Cliff water and yeah. One of the things about these, though, is that they're almost all funds, yes. And funds are, you know, probably more suited for this, because you can kind of lock in a little bit more, as opposed to an ETF that's really based upon the inflows and outflows to some, to a large extent, but yeah, are there any ETFs that a person, let's say, seeing in Thailand, that could invest in private credit or something like that, you know, um,

Jeff Sarti 50:50
my short answer is, I don't know, because I think, again, I think there's been some, but this should not be in a daily liquid product. Yeah. So the nature of those firms you mentioned, I'm fans of all of them, is they tend to have appropriate illiquidity. They tend to be quarterly liquid instruments. And again, I'm not sure, depending on the jurisdiction, if the average retail investor can access those, or if you have to go through a wealth manager that I'm not sure, Larry would probably know better than me. But there, there are new ETFs that are popping up that I've seen. My intuition with some of these, again, is I would stay away, because, again, you're investing in illegal, quick, in illiquid assets, in daily liquid structures, and there's just an inappropriate mismatch that

Andrew Stotz 51:38
that really helps explain it. So I appreciate that. Wow, what a discussion with a lot of things that we covered. I really appreciate the time on that. Normally, I don't spend that much time, but I figured we had a good opportunity to do that. So I appreciate that. No, I really enjoyed it. Yeah. So now it's time to share your worst investment ever. And since no one goes into their worst investment thinking it will be, tell us a bit about the circumstances leading up to and then tell us your story. Okay?

Jeff Sarti 52:01
Yeah, that it was early in my career. Probably, like a lot of your guests that I've heard, you know, a lot of the mistakes we make as as young entrance into the industry. I entered the industry in the late 90s, in the.com boom, and so it was 1999 where I, again, it wasn't a lot of money. In the grand scheme of things, I was just starting to make a little bit of money. But what did I do? I bought the.com companies, and I thought I was being safe, because I bought the name brands, right, the Yahoos and EMC and Sun Microsystems. I stayed away from the pets.com so I thought I was being smart and safe. But then we all know what happened, right? All of these dropped 90 plus percent and then some. And that was just a tremendous, tremendous learning experience on so many facets. One is, again, something I know you talk about, you harp on so much, failing to do your research. I should have known better. I was actually just getting my CFA. I was an analyst. I knew these stocks didn't make sense, but I still lean into them. And why it comes down, it's emotions, right? I leaned I embrace my emotions instead of pushing back against them. So it was fear and it was greed, it was FOMO, and it was also, to some degree, even a lack of imagination, where I was like, Oh, sure, these can get hit, but maybe they'll be down 20 or 30 or 40% I had no concept that these things can be down 90 95% and I think I have concerns around the current environment where, I mean, we've even seen it since then, right? Great companies, by the way, companies like zoom and peloton, you name it, have dropped whatever it is, 80 plus 90% when stocks get untold, untethered from fundamentals, and even some of these, the Met The Magnificent Seven stocks, in many ways, some of them have. People are like, oh the so bad if they drop 20 or 30% I think that's a lack of imagination. Of course, they can drop more than that. That doesn't mean they're not amazing companies. They are amazing companies. But, like, Cisco's a great example. What's the largest company in the world in 1999 I just looked it up the other day, so it dropped like 90% its revenue now is triple what it was in 1999 I didn't realize that the company is three times the size. But whereas it's a $200 billion market cap, now it's 1/5 basically 1/4 or 1/5 the size in terms of its stock price, 25 years later, even though it's triple the size. So now it goes back to long term, right? Talk about long term. You wait 25 years, it ain't coming back. So that was, that was a big learning lesson, and obviously shaped a lot of how I think about diversification and correlation and being in things outside of traditional socks. It's interesting

Andrew Stotz 54:45
because for the younger listeners, they didn't know a guy named John Chambers who was running Cisco, and right, you know, he was pumping the story, but he was delivering, you know, and it was, it was the internet boom, and he was into the hardware aspect of it. And so. It was, I was a lot to get excited about.

Jeff Sarti 55:02
There was, he was running an incredible company, but again, at certain point price matters. Yeah, it doesn't matter how amazing that company was, got dislodged from fundamentals. Yeah.

Andrew Stotz 55:12
And I think when, what I would, what I took away from that is something that you said, you said, when, when the prices get untethered from the earnings Yeah. And I think, I think what you actually meant to say was, when they get untenured from earnings growth, in the sense that our expectation of the future is what matters. You know, it's great that, you know Microsoft as an example. Yeah, Amazon, Nvidia, they have grown their earnings massively. And so the PE in relation to current earnings, yeah, you know, you can say it's not like the.com bubble in the sense that there are underlying earnings, but it really is about the earnings expectation, earnings growth expectations, where the untethering really is possibly happening, and those companies will not be able to deliver the growth in the earnings. They may be able to deliver the same level, let's just say, same level of earnings, but without the growth, people will say, Well, I'm going to go somewhere else and get that earnings growth, because that is a major driver of the share price that I don't even need this company to expand its multiple if it can deliver 20% earnings growth, my share price is going to go up by 20% Did you mean perspective earnings

Jeff Sarti 56:32
growth? Without a doubt, people are think rearview mirror and imagine what happened in the last five years will happen in the next five and again, it goes back to Cisco. Great example, Cisco actually delivered. Of course, they had a tough time in oh one and oh two, and their business contracted, but they came roaring back. So they even grew their earnings, and still it's trading at a fraction of what it did 25 years ago. Definitely,

Andrew Stotz 56:57
if you ever decide to write a book on the history of the markets. I think you should write one on Cisco, because what a great story. You know, ride, yeah, and then surviving, and then, as you've just taught us, you know about the idea of, even though they've survived and actually done well, that doesn't mean your share price does well, okay, so based on what you learn from this story and what you continue to learn, let's imagine a young person that gets excited the way you and I did when we first started investing. What's one action you'd recommend our listeners take to avoid suffering the same fate? Oh,

Jeff Sarti 57:31
man, that's a great question. I'm hesitant to recommend anything, because the truth is, the way I learned is I made the mistake. I mean, I did it, and I had money at risk, the

Andrew Stotz 57:43
Nike recommendation,

Jeff Sarti 57:44
right? Yeah, right. Just do it. There is an element, though, like, I do have, like, you know, people and analysts, young people in my company, who are, like, playing in stocks, and I have an options background, so they asked me, and they like making trades and the record, and I give them advice. But a certain point I don't want to give too much advice, because the only way you can really learn is by doing. Learn is by doing it and making mistakes. That being said, it goes back to something we hit on before it's doing the research. You got to do the research. I went afoul of the research that I knew, and the fundamentals and all the stuff I learned in my CFA and Graham and Dodd and all of the fundamentals of investing, and I just ignored it. And so don't take shortcuts, or if you do, at least understand what you're doing, you're gambling, you're speculating. That's different than investment. And okay, that's okay, as long as you know honestly, for being honest with yourself what you're doing, you're speculating and not investing. And there's a time and place for that, and there's $1 allocation for that, so keep that speculative piece of your portfolio small.

Andrew Stotz 58:53
Good advice, if you're going to go to Las Vegas, just do it one week, kind of 52 not 52 weeks, a lot of that. Okay, so what's a research resource, either of yours, or any other you'd recommend for our listeners?

Jeff Sarti 59:08
Yeah, listen, that's a couple things. One is, we do. We really are passionate about financial education, so we put out a lot of content. So our website, Morton wealth.com, ton of we have a weekly podcast. I write quarterly newsletters, lot lots, lots of stuff. But then beyond that, listen lots of listening to podcasts. I'm excited. I connected with you in recent weeks. I've really, I've really listened to some of your stuff. Really enjoyed it. I think there's a lot of synergies. Again, you talk about the six investment mistakes that I are so consistent with some of ours. The last thing I'll think about, I guess, a couple of books that really made a real difference for me, Thinking Fast and Slow, by Daniel Kahneman just really talking about, it's really humbling how much our emotions, again, drive investment decisions. So being able to really compartmental. And really understand those emotions and know those pitfalls. Huge fan of that book. And then I know you've had like Morgan Housel on, I believe, a long time ago, some of his work is great as well.

Andrew Stotz 1:00:10
Yeah, yeah, fantastic. Great resources. And last question, what is your number one goal for the next 12 months?

Jeff Sarti 1:00:18
That's a good question. Honestly, what I'm super excited about is continuing to find some of these uncorrelated opportunities. We're it's all we do. We've been doing it for a long time, but we're continuing to find more opportunities. And I think interesting thing happened a couple years ago with regional banks, like with that whole fiasco, traditional lenders have really left, and they really only focus on cash flow lending. So more interesting, safer stuff is falling in our laps, and otherwise we wouldn't have seen before, again in non correlated areas. So long story short, my investment team and I, we've been traveling the country, uncovering some new niche opportunities, and I'm excited for more that we're going to find great

Andrew Stotz 1:01:04
well, listeners, there you have it. Another story of loss to keep you winning. Remember, I'm on a mission to help 1 million people reduce risk in their lives. As we conclude, Jeff, I want to thank you again for joining our mission. And on behalf of AE 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?

Jeff Sarti 1:01:25
Listen? All I could say is I really enjoyed the conversation. It was a lot of

Andrew Stotz 1:01:28
fun. Yeah, appreciate it. Well, that's a wrap on another great story to help us create, grow and protect our Well, fellow risk takers, let's celebrate that. Today, we added one more person to our mission to help 1 million people reduce risk in their lives. This is your worst podcast host, Andrews dot sing. I'll see you on the upside. You.