Don’t Get Caught Asking this Question About Financial Markets – Episode 98

There’s no such thing as a stupid question. In some cases it might just be the wrong question. And it’s not uncommon for dentists to ask the wrong question about financial markets. In this episode of Dentist Money™, Reese and Ryan explain one fundamental principle of markets a lot of dentists seem to misunderstand. They also explain what a market is by comparing investments to more familiar products we buy in our everyday lives.

Show Notes:
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Podcast Transcript:

Reese Harper: Welcome to the Dentist Money™ Show, where we help dentists make smart financial decisions. I’m your host, Reese Harper, here with my trusty old co-host, Sir Ryan Isaac.

Ryan Isaac: Good. Morning. Reese.

Reese Harper: Overdressed and underpaid, Sir Ryan Isaac.

Ryan Isaac: Eh, they’ve been calling me that since high school, basically.

Reese Harper: No matter how much you get paid for this show, you always claim you’re underpaid.

Ryan Isaac: (laughs) yes. That’s why you get paid more, because I just complain a lot. But good morning anyway!

Reese Harper: You’re doing an excellent job. I don’t mean to be too critical of your wardrobe. I think sometimes, I wish I wasn’t wearing this formal nice shirt, and that I was wear a more casual “I just got out of the gym” shirt.
Ryan Isaac: Oh yeah, I did get out of the gym! I wore this exact theme to the gym. I squatted in these loafers. This is a stretchy material pant so you can get a full depth, below parallel kind of squat.

Reese Harper: In your business casual clothing in the morning before work. No shower, just pop right in.

Ryan Isaac: No, I don’t even sweat!

Reese Harper: For those of you who don’t know, Ryan has a little better workout habit than most of us here in the office, so we’re all trying to follow his example.

Ryan Isaac: And by follow his example, make fun of him.

Reese Harper: Occasionally (laughs).

Ryan Isaac: I like it. I appreciate it.

Reese Harper: Anyway, today’s show has been one that goes back to your roots. I would say it’s your birthright!

Ryan Isaac: It seems like it. I have good memories from that time of my life.

Reese Harper: Ryan grew up in the Northwest, pretty much the only place you can grow up in the Northwest, as they say: the city of Seattle.

Ryan Isaac: Yes! Redmond. Shoutout.

Reese Harper: People in Portland might say, “we’re the Northwest too!” Ryan grew up in Seattle, though—

Ryan Isaac: A piece of the childhood.

Reese Harper: Yeah, a piece of his childhood was there. I’d say the most formative years.

Ryan Isaac: (laughs) yeah, the ones that shaped me the most. That’s so true.

Reese Harper: And he got to the point to where one day, dad took him down to—

Ryan Isaac: Pike Place Market.

Reese Harper: Now, for anyone who has not been there, we’re going to explain it a little bit. The Pike Place Market is on the Seattle waterfront. It’s been there since the early 1900s; I think 1907 was the first year.

Ryan Isaac: Yeah, over 100 years ago.

Reese Harper: It’s world famous; there are over ten million people a year who visit the market. This about it: the entire population of the state of Washington is only like seven-and-a-half million, so there’s—

Ryan Isaac: So, everyone is going there like 1.2 times (laughs).

Reese Harper: Yeah. Everyone is going there at least annually (laughs). Most people are probably just going there every couple of weeks if they live in the city.

Ryan Isaac: It’s a cool place!

Reese Harper: Ryan remembers getting donuts there.

Ryan Isaac: That was my favorite memory! I mean, besides clearly the fish throwing, which everyone talks about and remembers. I mean, I was a kid, but the donuts. They have these little glazed donuts, and that’s what I remember.

Reese Harper: I’ve only been there a few times, and I don’t remember their donuts. I mean, I got slapped in the face with a salmon flying by me. Someone chucked a salmon into the air, and it was kind of flying through the air, and it whipped me in the face with its tail. It just kind of knocked me out, and that’s all I remember. After that, I don’t remember anything. So, it was kind of a crazy day. But, we’re trying to answer a question, for those of you who have never been to the Pike Place Market. I want to ask this question because it’s one we got this week and it relates a lot to our discussion today. We thought the Pike Place Market served as an excellent example to answer this tough question. The question we’re going to ask today is, if someone told you the Pike Place Market is expensive, for those of you who live in Seattle or those of you who have been there before and the listeners listening to that description… Ryan, would that be a very good explanation of the Pike Place Market? Could I say the Pike Place Market is expensive? I mean, you’ve been there.

Ryan Isaac: Yeah, no. It’s not accurate.

Reese Harper: Why is that not an accurate statement?

Ryan Isaac: Because, what are you referring to?

Reese Harper: You said your favorite thing was donuts. I said I was hanging out by the fresh-caught Alaskan salmon.

Ryan Isaac: You were in the fish area. The point is that it’s too general. There are so many things that are sold and created and for all different kinds of prices, there are multiple sellers of the same item. So the point is, saying that the Pike Place Market itself costs too much money— the real question is, well, what part of it? The donuts?

Reese Harper: Yeah. Are you talking about coffee at Storyville? Crumpets at the crumpet shop? Ye old—

Ryan Isaac: (laughs) I wish it was called Ye Old Crumpet Shoppe. And everything had an “e” at the end of it.

Reese Harper: These are some famous things that are there that we’ve noticed: there’s beer in a cold mug at the Athenian— which is supposed to be really cheap— local honey from Bee Works, gourmet chocolate from the chocolate market—

Ryan Isaac: I feel like that’s where you would be.

Reese Harper: I would.

Ryan Isaac: No! There’s a famous indi chocolate place there.

Reese Harper: I love my Caputo’s chocolate up the street from my house.

Ryan Isaac: Yeah. Get some nice cacao. What percent of cacao are you?

Reese Harper: 100 (laughs).

Ryan Isaac: You’re a 100% guy?

Reese Harper: (laughs) just kidding! That’s nuts. Yeah, 100% cacao. That’s me! Clearly. It’s a little heavy, but there are some health benefits that I get from doing it that way. So, of course, there are blanket people; there’s a gypsy that weaves hand-woven blankets. You have wild salmon and Alaskan halibut; king crab, lobster tails, and black cod; you have Alaska weathervane scallops, Chilean sea bass, there might be an occasional—what did I see yesterday? The acclaimed Dorado fish from some place in South America.

Ryan Isaac: The Dorado fish?

Reese Harper: Yeah, it’s like a golden Dorado.

Ryan Isaac: Are they edible?

Reese Harper: People that are fisherman will know, and they will be correcting me in their head right now. You can tell what we’re getting at from this. If someone asks you if the Pike Place Market is expensive, or if they say it’s expensive, you’re probably asking the wrong question, because there are so many shops selling so many different products that not all of them are likely to be expensive. It makes more sense to ask about specific items at specific shops.

Ryan Isaac: Such as the cacao beans at indi chocolate.

Reese Harper: Yeah, or how much is the mac and cheese at Beecher’s Handmade Cheese?

Ryan Isaac: Mmm. I think you would love that! You love a good mac and cheese.

Reese Harper: Like, how much is the wild Alaskan halibut? And that will have a market price. The reason we’re talking about this is, we commonly hear from dentists that the market is expensive, or, “I’m just going to jump in the market when it’s less expensive. I’m going to wait for the correction.” Or, “the market is so expensive right now, as you know Ryan, I would never get into the market, because it’s so expensive.”

Ryan Isaac: Don’t start sentences with “as you know.” Like, I don’t agree with you. Don’t do that! It’s a pet peeve. It’s like saying, “I’m going to go shopping at Pike Place when it gets cheaper.” Like what, the blankets from the gypsy lady, or the donuts, or the fish? Which thing?

Reese Harper: It’s like telling an orthodontist, “as you know, all brackets are the same, doctor.” Right?

Ryan Isaac: Doc, as you clearly know…

Reese Harper: “As you clearly know, it doesn’t really matter which bracket system you use.” Or, “the treatment plan for orthodontics doesn’t really matter. It’s all the same in the end.”

Ryan Isaac: Yeah. Just don’t start like that.

Reese Harper: So, we hear that a lot with this market discussion. I want to start by talking about how the financial market is just like the Pike Place Market in our example. We have all these people running around in the ocean gathering up fish, okay? They’re running around.

Ryan Isaac: (laughs) all these crazy people running through the ocean.

Reese Harper: They’re running around in the ocean, and they’re picking up stuff. Some people pick up crabs, and some people pick up lobsters. Some people are putting fish in a basket, and some people actually have a boat. Some put it in their pocket. So, think of all these people out there: they have all these assets that they’ve accumulated. They’re carrying their fish around, and all of their seafood, but they have to have a way to convert those assets into cash. If they don’t convert those assets into cash, they won’t be able to go buy a house, or go to the store. They don’t want to eat their dang seafood all the time. They want a burger! And so, there’s not a way for a guy to get it converted to a burger without Pike Place.

Ryan Isaac: Without the money! Yeah.

Reese Harper: So, he needs the Pike Place Market to convert his lobster tail into a dollar that he can go and spend at his burger joint of choice. And the financial markets work a lot the same way. Companies—like a small company in Japan has built a manufacturing facility, and they’ve been making clothing and textiles for the last twenty years, and they’re finally getting to a point where there is not enough money for them to raise money from their local community and local banks. They need to grow and build a much larger facility and expand their plant, and so, they decide to raise money through the public market. If they just do it locally in Japan, they might have too many investors that they have to manage directly and talk to. But if they do it through the public market and they go through that process, then people like me and Ryan and the listeners, we can say, “we’d like to invest some money into that manufacturing plant in Japan and be able to help them, because we really think they’re going to continue to grow. The economy is going to help them to be able to be really competitive.” And so, that’s a way that the owners of that textile business can get cash to be able to go and finally build their house they wanted to build, or finally build the manufacturing plant they wanted to build, or hire some more workers, or get some new equipment, or buy the new land that they need. And without the ability to convert physical assets like your business equity—your plant, and your facility, and your products—into cash, then people really can’t live a life that they want to live. It’s just uncomfortable, because you’re accumulating all of these Alaskan halibut in your boat, and then you have to go and trade those fish for other things that you need. It’s just really inefficient. And so, the reason a financial market exists in the first place is because you have lots and lots of people that need to take assets that they have and convert them into cash, and that helps them grow. And it’s a good thing for investors, and it’s a good thing for these companies. So the types of things that you can liquidate in a market, there are a million different things in a market that you can turn from an asset into cash. Let’s say, Ryan, you’re living in Salt Lake City where you and I live, and the city wants to put in a new railroad system across the entire state, and it’s a light rail system that gets rid of some cars and cleans up the environment and lets people travel. Because we have this big old long strip of land across the mountain rand and like one freeway, and if we don’t have a public transit system, so the state says, we’re going to put in a train, right? What happens in that situation so that the city can build the train and then somehow get money and make it all work? Like, how does that usually happen?

Ryan Isaac: Yeah, normally they raise it through what is called a bond, and they get approval—that’s what you’ll see during elections. Vote yes for this bond or vote no for this bond. A bond is just when they’re trying to raise money from the public, so they have terms of an agreement, you know, the bond is going to cost $200,000,000, and it’s going to be paid back over seven years at 5%. So, they just go borrow money, and then they get it approved through a voting process, and then they raise their money through the borrowing, and then they pay it back at a specific interest rate at a specified time, and it’s all payed back.

Reese Harper: And then sometimes, what will happen is you’ll see cities take that bond and they’ll open that up to investors to be able to put money into, right? That’s done through way we call a public market, and those bonds end up being traded. After that initial bonding is done, what can happen in someone can say, “you know what? I was okay initially for giving this city like $500,000, and I’m holding it for ten years and getting paid 3.5%, but I don’t want to do that anymore. I want someone else to do this.” And so, another investor will be able to buy that bond from someone else through the public market. That bond can then be distributed on a public market, and other people can buy or sell it, and continue to have the stream of cash flow that that investment provides.

Ryan Isaac: Well think about how cool this is though to the scale of that. You were talking about this early in your example from a manufacturing company in Japan. Someone wants to build a train system in Salt Lake City, Utah, I as a local resident can do that, but also, you might have people in Alabama, or Florida, or New York City, or California investing in this train system in a state and a city they don’t live in. The market that they get exposed to, that they can get money from, is really big. It’s really broad.

Reese Harper: And the thing about the manufacturing company in Japan that I talked about, they take the company and it goes public, and they get money to expand their facilities, and he gets a little bit of money, because he sold some of his stock to the public market and took some money off the table, because he had been working in that factory for twenty years. Well he takes some of that money, and he invests it in the Utah bond of the train system, and he doesn’t do it through a direct purchase. He does it through a mutual fund that ended up having ownership in that. And it’s just crazy the scale of how many different ways capital and assets—like, things that people own—can be distributed across other investors. I mean, think about the alternative to this! It would be that literally, the manufacturing company has to find people that they can trade their ownership to in exchange for other ownership of other things that are not cash, right? Or, let’s go back to the Pike Place Market. Out on my boat, I have to find people to trade my fish to that have the right amount of burgers, and I have to chop off the precise amount of Alaskan halibut that I would be willing to trade for a burger. And what happens—

Ryan Isaac: Like, a third of a halibut for a good burger? But then you have to go find the potato person! Because you don’t eat a burger without fries.

Justin (Q): What if you want a halibut burger? That gets confusing (laughs).

Reese Harper: (laughs) Q, you always have good insight into this. Let me put a little wrench into this. In that transaction where I have the Alaskan halibut and I want to get a burger, and I’m trying to cut off the precise amount of fish, what will happen is invariably—because no one else is telling me what my Alaskan halibut is worth—I don’t really know what it’s worth, because I just got it out of the ocean and I know what it was a few days ago. I chop off a certain amount of that fish, but it actually is a very inefficient transaction, because I’m either going to pay too much fish for my burger, or probably too little fish, right? What that’s called in public markets is a bid-ask spread, and in a bid-ask spread, it’s something in a market where if you go to buy a stock on a market, there is a price you can buy it for, and there’s a price you can sell it for. Let’s say I own a share of that manufacturing company in Japan, and let’s say it’s trading for ten dollars a share today. You could probably buy it for ten dollars a share, and you could maybe sell it for nine dollars and ninety-nine cents a share. Like, the difference between what you can sell it for and what you can buy it for is really tight. It’s what is called an efficient market, where there are so many people looking at the price of that thing every day that the spread between what it’s worth is so tight that you know you’re getting what we call a fair price or a market price.

Ryan Isaac: That would be the equivalent of you out on the sea with your lone halibut and the burger guy, and you’re just trying to make an exchange, versus you standing in front of a thousand burger guys who are saying, “here’s how much that piece of the fish would be traded for the burger.”

Reese Harper: Well, it would be you standing in front of a thousand burger guys, but it would be a thousand halibut guys standing in front of a thousand burger guys going, “how much?” And everyone is just bidding on it, and writing prices up on the board, and you get to look at the prices that other people are paying and say, “I’m going to offer a little less than that. I’m gonna offer a little more than that.” And eventually, what happens to the price of the burger and the halibut—

Ryan Isaac: And if it’s ten thousand, or if it’s a million, or if it’s ten million people, then—

Reese Harper: Well, what naturally would happen to the price of the burger and the halibut in that scenario? Would it go up or down?

Ryan Isaac: Down.
Reese Harper: It will always go down. It will go down quickly to the point where it’s what we call a fair price, unless there is not enough supply.

Ryan Isaac: All of a sudden, there’s an announcement that there’s no more halibut in the sea for the next six months.

Reese Harper: Yeah, then the price of halibut would go up! But it would only go up to the fair price, because the pressure of all these buyers and sellers would force the price of that fish to sort of stay in lock step that is fair with the quantity. Everyone knows when things start getting really expensive. Just to give some people some feel good about the questions they’ve been feeling in the last few months… I know that a lot of people have probably said that the market is expensive, and we have kind of walked through why that can be a dangerous thing to say. But the market may be expensive in certain segments. It may be! It’s hard to say, because there is a thousand fish and burger guys bidding on it right now. And for whatever reason, those millions of people, they decide that Apple stock is worth that price today, given all the alternatives available in the entire world. All of the local real estate, all of the local development projects, all the things that people could alternatively do with their money, there are a lot of very wealthy people that are determining that that price is fair for that Apple stock. The United States’ market is different than Apple stock, and it might be precise to say, Apple stock right now is the most expensive it has ever been, but it might not be fair to say that Apple stock is expensive, or that it’s overpriced. These things are assets. They are real assets, like a house, or any other real asset like fish, okay? Those are real assets that you can trade and get cash for. And over time, all real assets inflate in value. They get to be worth more money, and businesses are just some of the most creative, organic, developing assets that you can buy. They’re more creative, and they have the ability to create more value than land. They have the ability to create more value than a building, or more value than fish. Businesses can—I mean, I don’t really support this, but I’m just saying, businesses can create genetic tissue to create fish in massive volumes, and so, they are just more dynamic—

Ryan Isaac: Take that, ocean (laughs).

Reese Harper: They’re just more dynamic than fish! And so, I’m a big organic food advocate, okay? My wife is going to kill me for saying that.

Ryan Isaac: You’re not going to eat that. But they could.

Reese Harper: I’m just saying, businesses can do things that real assets cannot.

Ryan Isaac: And they can adjust to conditions in the world and things that change.

Reese Harper: And they are competitive, and there are thousands and thousands of people inside of a company fighting to make it be worth more money. So when people say that the stock market over time is the highest appreciating asset of any asset, it’s just because it’s the most flexible thing that people can create and build. A company has the ability to use real assets and natural resources to create increasing value all the time, where someone who is just trading land, there is a supply and demand for land, which means it will always go up. But you can’t turn land into—like, land is land, right?

Ryan Isaac: Yeah, that’s what it does.

Reese Harper: Uh huh. It holds physical property. But a business can be whatever you want it to be, and it can contain value—

Ryan Isaac: You could start making computers, and then make iPods, and then make phones, and then make cars.

Reese Harper: Or do dentistry! Or provide a service, right? If people are willing to pay for that business’ good or service, then it will increase in value indefinitely.

Ryan Isaac: So, I was going to say that what I take from this too is, I think there’s a distinction. There is a real feeling that people have where you get to a point where you’re like, “that just doesn’t feel worth my money anymore.” It could be a car; it could be a house; it could be a steak dinner; it could be a stock. Like, there is an emotional reaction to a price where you just go, “it’s not worth it for me to pay it.” But you can’t confuse that with, it’s overvalued. Technically, it’s not worth that. You have to separate what you’re feeling, which is an emotional reaction of “that seems expensive, I don’t really want to pay for that” versus, it’s not worth it in the marketplace. Those are two different things.

Reese Harper: Yeah. A lot of people probably struggle with this with their housing. If you’re living in Northern California right now, and a lot of our listeners are, and you’re trying to do new construction or T.I.’s in the peninsula, and you’re trying to—

Justin (Q): T.I. Will you tell us what T.I.’s are?

Reese Harper: Okay. Well, for those of you who do not know, which I think is probably very few of you, tenant improve expenses. But, you know, there are probably a few new dentists out there who probably haven’t heard of that.

Ryan Isaac: Fancy term.

Reese Harper: Thanks, Q, for keeping us in line when we start getting into the deep waters.

Ryan Isaac: All high and mighty.

Reese Harper: So, let’s say you’re going to remodel your office. It probably feels right now a little crazy to do that, because it’s like, “oh my gosh. I’m going to spend $350 a foot to put in some walls? That feels crazy to me. It’s expensive! We must be in a bubble. Like, it’s going to pop.” There is some limiting constraints based on where you live. There is just not any more room, and there is a lot of population demand, and maybe you are in a bubble! Like if interest rates popped and went up really high, the price of real estate in San Francisco would decline somewhat. If interest rates just took a huge move quickly, there is an argument for how prices could decline, because people wouldn’t be able to borrow as much to buy or do their tenant improvement expenses. But you could also make the argument that they are worth what they cost right now, because there is just nowhere else to build, people are going to continue to move there, there is more momentum in Northern California for population growth than maybe there has ever been, technology and startup companies are going to continue to move there, and jobs are growing like crazy still. You may never see a point in time where it’s—like, in ten years from now, will real estate prices be higher in San Francisco than they are today? It’s likely that yes, that will be the case. And I think that’s what we’re saying about any asset. The financial markets are a place where all of these assets and all of these loans– you’ll find real estate in financial markets, you’ll find any kind of loan you ever wanted to think about doing in a financial market, any type of small business venture, any type of startup company, from software, to services, to manufacturing, to industrials… you could invest in clean energy! There are all kinds of different markets that are not priced the same and that don’t move in tandem, and I want to just give you some examples of this. If you look year to date so far, Monday, October 16th, 2017, these are the prices. If you look at this date, these are the prices of different assets. I’m going to start with one of my favorites: the traditional lean hog.

Ryan Isaac: I knew you were going there. How’s the lean hog performing? Now, this is a quarterly number.

Reese Harper: Now, I grew up in Idaho, right next to a very small lean hog farm.

Ryan Isaac: Hold on. What’s the difference between a lean hog and a normal hog?

Reese Harper: What do you think?

Ryan Isaac: I mean, it seems to indicate that it’s a slightly smaller animal?

Justin (Q): It does triathlons.

Reese Harper: It’s just lean!

Ryan Isaac: (laughs) it’s like, concerned about its figure. Like, why would you want a lean hog, though? Don’t you want a big fatty pig? Is that what you want?

Reese Harper: It’s fairly subjective, okay? What is lean?

Ryan Isaac: If I want some bacon, I want some thick bacon. I don’t want a lean bacon.

Reese Harper: Okay, so hogs. I grew up by this pig—

Justin (Q): Lean hogs don’t have any MSG, right? Or nitrates.

Reese Harper: (laughs) so, there are massive agricultural farms of hogs and of cattle and any kind of animal you can think of, and in order for some of these farmers to be able to get liquidity, they have to sell the price of their meat or their vegetables or their grain or their potatoes, they have to sell them in advance of them going through a year. Because if you go through a year and you don’t know what you’re going to get for the crop at the end of the season, it can put you out of business. And so, in the financial markets, you’ll find a lot of vehicles—they’re called commodity futures contracts—where different farmers and different big agricultural operations that either manufacture meat or they manufacture vegetables, right? We’ll call it that. They want to lock in the price of their—

Ryan Isaac: They want to know what they’re going to get paid.

Reese Harper: They want to know what they’re going to get paid at the end of the year. Those prices are quite volatile though, and investors can purchase or own those futures contracts. Now for me, that’s not really an asset, okay? So, I’m just trying to highlight that in the financial markets, there are a lot of things you can do that are not assets. You can bet on the outcome of the Super Bowl, but that’s not the same as taking a piece of Alaskan halibut into Pike’s Place and converting it into cash. You own something! You own a fish. In a futures contract, or a commodities contract, you’re speculating on the price of an item. Now, the price of some items might show consistent price increases over time. Like, some wheat varieties might have more price increase consistency than others. But you don’t own the wheat, okay? When you go onto your Etrade account, all of you traders that listen to this, and you buy lean hogs, you don’t actually own a pig.

Ryan Isaac: To your dismay, you can’t cash them in for pigs (laughs).

Reese Harper: Now if you want to own a pig farm, you’re going to have to buy a stock that does raise lean hogs, okay, and that’s the only way—

Ryan Isaac: Or you have to go Warren Buffet style and show up to the actual farm and offer some money for a stall.

Reese Harper: You say, “I’ll buy this stall from ya.”

Ryan Isaac: And these twelve pigs.

Reese Harper: There is another thing in the financial market called options, okay? Options are essentially the same thing as these farmers are making. They’re trying to get a price locked in for the future so that they can protect their bet of raising the pigs. They raise the pigs, and they want to get paid. An option in the market is when you as an investor say, “I’m going to make a bet on the direction that I think this market is going to move, or the direction this stock is going to move, or the direction that this overall market— like the direction that Japan is going to move, and I want to make a bet on that. I think it’s going to go up, or I think it’s going to go down.” So, you buy an option to lock in a bet on the direction that you think a market is going to move. You don’t actually own anything when you do that. It’s the equivalent of making a bet on the winner of the USC vs. University of Utah game last week.

Ryan Isaac: It’s a pain. You have to bring that up right now?

Reese Harper: One point. I was disappointed really sincerely, man, okay? I’m sorry. It was tough. Shout out to all of our Trojan listeners down there. Congratulations! It was a good game. Sam Darnold is going to have to start tightening up his game, though. Right, Q?

Justin (Q): Yeah, but he has the size and the talent. He’ll be fine.

Reese Harper: Dude. Fifteen days in, and this guy looks like he’s the real deal.

Justin (Q): NFL scouts are drooling, man.

Reese Harper: Totally! I was impressed. Anyway. Congratulations, USC, you have an amazing quarterback for the next few years. Assuming he doesn’t leave (laughs). So, back to the market.

Ryan Isaac: Back to options.

Reese Harper: So, I just want to make sure people realize that not everything in a financial market should be invested in.

Ryan Isaac: Not everything is an asset that has an expected return.

Reese Harper: Yeah. When we say investing in financial markets, there is a right and wrong way to do it. I just think that the fact that people say the market is expensive really just shows how big of a misunderstanding people have about what is in their own accounts, and what they even own. I bump into people all the time who all they own is like— commodity futures positions in lean hogs and wheat and energy positions! They don’t even realize they own no underlying assets. Or, they’re owning currencies; they own currencies in Brazil; they own currencies in Australia. Those aren’t assets, okay? Those are not. They don’t produce anything. They aren’t the same as a fisherman going out into the ocean and making something and selling it. And companies, if you invest in the broad equity market— a broad market, or a broad bond market, or a broad fixed income market— if you just add up all of the possible things that you could invest in, right, in the entire world, there are probably 40+ trillion dollars worth of assets to invest in, of financial value, of economic value, that you can put your money into. And not everything moves the same. Let’s go back to our quick example of the lean hogs. This quarter, you could contrast two things: Greece is down 9% this quarter, and Pakistan is down 12% this quarter. Kansas wheat is down 21% this quarter. Corn is down 10%. Lean hogs are down 11. Commodities in general for the year are at -3%. And if you look at some winners, you could say, well, emerging countries year-to-date— these are what we call the BRIC countries, Brazil, Russia, India, China— a lot of the smaller countries that don’t have really big gross domestic product, they don’t produce as much as the United States or Europe does, those countries, if you collectively group them together, are up 31% as measured by this Morgan Stanley index that we use. 31% year-to-date for those markets. And the United States is up 13% year-to-date. So, two very different parts of the world, one is up a lot, and one is up just a little. So in this case, which one is expensive, Ryan? If you’re a normal client and I say, “one is up 31% this year and one is up 13,” which one would you say is expensive?

Ryan Isaac: Well, the up 31%! The emerging markets. That’s expensive. It’s gone up a lot.

Reese Harper: We’ll you’re wrong! You’re an idiot.

Ryan Isaac: You fool. You fool.

Reese Harper: (laughs) I’m just kidding. But yeah! That’s what I would guess, right? But if you look at these indexes and say, “well, what’s the average return of these markets over a 50-year period, or over a 30-year period?” Both of these markets have a similar annualized expected return; it gets close to around 10%. And so, right now though, if you look at the emerging countries and say, “what is its current ten-year return? Where are those countries at on their ten-year return?” You’re going to see that those countries— at this point, I don’t think the emerging countries are even over 4% on the ten-year return back from today. Where the United States’ ten-year return is getting closer to its 10% mark. It’s probably in the high sevens low eights right now, depending on the index that you’re using. So, even though the US is up 13% this year and emerging countries are up 31, if you look at the last ten years and say, “where are these markets in terms of their average price,” well the one that’s up 31% is still really inexpensive relative to the U.S. But, when people say “I’m investing in the market,” they’re not thinking about these different pieces. And these are massively different parts of the world with entirely different economic ecosystems, products, and company mixes.

Ryan Isaac: Governments, tax structures, economies. Yep.

Reese Harper: Yeah. And people will say, “this year, I’m just going to hold off.” Well by not investing this year, you’re missing out on a massive growth opportunity that happened in emerging markets, and you missed it three years ago! Not now when it’s already there. You missed it! I mean, you missed the biggest bull run that emerging markets have had if you didn’t have money in emerging markets for the last four years. Is there still momentum and room for upside? Yeah, I mean, relative to the U.S. markets, there is still more room. All I’m trying to highlight— and this can get really complicated really quick— is that markets are not one thing. They’re very diverse. There are a lot of things that are going down when other things that are going up. And I think that there are just a few important rules that people need to live by in this. One of them is diversification by giving you proper access to these thousands and thousands of different things at the same time using technology. There is really no investment quite like it in the world. I mean, I can’t think of anything that really gives you the expected return with all of the benefits that come with a financial market. Like, the Pike Place Market is a small ecosystem example of what the financial markets are, but you can’t— as a person in New York, I can’t really access the Pike Place Market and trade fish. It’s just a local small ecosystem. You have to be there, and it’s a small market. But the financial market basically takes things like Pike Place, if Pike Place were to be part of a public company— which it might be, I actually don’t know the ownership structure. But if Pike Place Market were a public company, we could then access it and provide it with capital, it just probably can’t grow very much, so it wouldn’t make sense for them to do that. It’s probably owned by the city. But the public markets, the financial markets, create this massive opportunity for liquidity, which is kind of that second benefit you and I talked about.

Ryan Isaac: Yeah. Well, I was just going to back up, too, on the diversification. The opportunity to diversify, what happens when you diversify is you lower your risk. You lower your risk of concentrating in too much of one area. And it is cool to think that I can participate in the upside of a company with three people in the middle of Australia that are just making their startup happen. I can also participate in the upside of the brainchild of Steve Jobs and the whole legacy that he has created, and everything in between. I can participate in building a bridge in New York, or a railroad in Salt Lake City, and I can lend money to general motors if I want to. Like, you can participate in so many different things so easily at such a low cost, which we’ll talk about, but that’s what diversification brings. It spreads everything out so much, and it lowers your risk, because you’re just not concentrated in one thing.

Reese Harper: It’s funny, though, like for something so powerful like a public market, that is what has created wealth in our country. It’s what has raised the entire average standard of living in this country, is the robust financial markets that we have. And every country wants to have financial markets like we do, because it creates all of this opportunity for businesses and governments local and national to be able to take public wealth, money that people have, and convert it into projects that they couldn’t do otherwise. You just couldn’t— we couldn’t have an infrastructure in our country like we have right now. As broken as it might seem, our infrastructure for schools and roads and public transit and in communications, they would not be able to exist at the scale they exist and improvements couldn’t happen at the pace they happen. And I think a lot of people living here don’t realize how important a financial market has been to the overall stability and growth of our country.

Ryan Isaac: Yeah. Well I was going to say, if you have ever visited a place that when you left you were grateful for something as simple as like a sewage system, you know? You mentioned liquidity, and just the nature of these financial markets provides a piece of investment, like a characteristic of the investment that isn’t found in a lot of other investments. Think about a building, or land, or the practice that you own, and that’s liquidity. That’s what you are talking about, you know? The ability to have expected returns as high as they are and have instant access to your money at any given point is kind of a rare feature in investments. And that’s usually what people will trade. You know, when people are talking about in pure returns, what kind of things have higher returns, usually, when things end up on the spectrum of higher returns, it’s at the expense of liquidity. You just can’t get your money out of that thing, and that’s the cost of why you might get a higher return.

Reese Harper: In private markets, a dentist, in order for him to get capital into his business— if he wanted to open like five locations, he can do it on it with his own money, or he can sell some stock in his practice to an investor and put their money in. But do you think— would you want the deal terms in that deal? Like, let’s say you sold 20% of your practice in exchange for a couple million dollars, because someone believed in your vision to expand into ten operations or ten locations, and you were going to go do this. Would you want the deal terms to be, if you give me the two million dollars, you can get back any amount of money at any time, any day, and in any increment? Name your dollar amount, and I have an open checking account that will give back to you any amount of your stock that you bought, at any point in time, at the price that we agree on right now is always going to be fair, which is a one multiple of our collections, or whatever. And you just have to talk to my assistant. You don’t even have to talk to her! Just send her an email, and she’ll send you the money. You know? Or actually, just push this button and I’ll give you the money; it will just pop into your account. Like, that’s what a public market does. And companies, in order to be able to do that and give that kind of liquidity, I mean, it’s kind of incredible that you’re able to get an ROI on your money that’s as high, arguably the highest ROI of any asset, any real asset in the world, with unlimited amounts of liquidity. You don’t have that in almost anything else.

Ryan Isaac: Yeah, it’s really rare.

Reese Harper: And so, you get liquidity, and being diversified gives you broad access to so many different kinds of things. It lowers your risk a ton. It also saves you a ton of time. I mean, if you’ve ever invested in a rental property like I have, you know how much work it can be. Even if you have a property manager, you still have some pesky work to do quite often. You have to prove things, and approve costs, and put in new appliances, and fix roofs. Like, any kind of investment that gives you a higher return than normal involves some effort. Usually, the way you make the money is you bought it on a song and a dance. It’s not on the appreciation. That’s what’s crazy to me is you can say like, “I can find a deal out there, and I could buy a piece of property, and I could grow my money faster than I could in a public market.” That’s totally true in some cases. But in order for that to be true, you have to find an entry price that is a song and a dance.

Ryan Isaac: Yeah, below market. For some reason, you found it. You had some piece of information or something that allowed you to find it. Yeah.

Reese Harper: Or the timing was just really lucky, or maybe the city that you live in is just a depressed market. And as a financial advisor, we have to be open to that reality. Like, clients often send us projects that we look at and try to evaluate for them. In most cases, these are not good projects. In most cases.

Ryan Isaac: It’s not a song and a dance. It’s a fair market price.

Reese Harper: But in some cases, there is a song and a dance, and it’s a great deal. It’s a great value. And so, the value that you make in a private market is on finding a deal. And all I’m saying is, that takes a lot of time, it takes a lot of expertise, and it takes a lot of effort. And it most cases, you don’t make more money doing it than you would in a public market. And the public market, if you take your money at any given point in time, cheap or expensive, and forecast that forward and say, “what will my return be on this?” The market will return to you, historically, a more compelling return than any asset than you could buy in the private market, and you didn’t have to take any time to think about it.

Ryan Isaac: Well, and we’ve talked about this. You know, we’ve had episodes on what a dentist’s hour is worth. What is a good productive dentist’s time worth? It’s hard to make the argument for that tradeoff to a lot of other things, you know? A decade of school. Hundreds of thousands if not millions of dollars of debt just to be in the position you’re at, and the high dollar-per-hour of— it’s hard to know where that tradeoff is worth it.

Reese Harper: You just don’t have to feel like you’re so locked into one item that you can’t feel like a financial market can— here is what I would like to say just as a closing statement around financial markets.

Ryan Isaac: Closing statements, your honor.

Reese Harper: Financial markets can give you liquidity, diversification, they can save you time, and you don’t have to feel like you’re locked into one thing. It’s not “the market.” I have plenty of clients whose primary risk objective is, “I want to make the highest percentage of return I can,” and I have other people who are like, “I don’t want any volatility, I just want three or four percent a year. I just never want to lose any money, and I don’t want to think about this. I just want to have a stress-free life, because I can save tons of money, and I’m going to retire earlier than I ever thought possible. I just don’t want to lose any money, and I don’t want to stress it. When stocks like Apple are just going down like crazy during 2007-2009, I don’t want to do that. I don’t want to go through that. I just want my nice ride.” And so, I think that the important thing to remember for people is, financial markets give you this diversification and time savings. They are very low barriers to entry. Like we talked about, you can’t shave off just a teeny bit of fish and trade it. It’s hard to shave off a teeny bit of practice and just sell off a teeny bit of it. Or your house. Like, “eh, I just want a teeny bit of my house back.” Well, you have to go around the bank, get a line of credit, you have to do a refinance, if you want a hundred grand, maybe you can’t get it, because your property doesn’t appraise properly. In a public market, it’s like, “sure! Any time you want your money, you can borrow against your money, just like you would a line of credit, or you can just have it back in cash.” It’s just so liquid, and the barrier to entry is so low, you can put a thousand bucks in it in investments.

Ryan Isaac: Mmhmm. And you don’t have to be an expert. You can hire experts for really inexpensive… it’s easy to do.

Reese Harper: Yeah, it’s really inexpensive to outsource that type of work. It’s pretty expensive to have someone go and try to find great private market deals like buying a business for you, or buying a restaurant for you, buying real estate for you… it’s pretty expensive! To get in and out of real estate, most of us are going to pay like 6% on transactions.

Ryan Isaac: But I mean, you have to pay a lot for someone’s expertise to know how to find that song and a dance, like you said.

Reese Harper: Yeah. And it’s worth it in the right situation! I just don’t want people to feel like the market is one thing, because portfolios are custom to your preferences for what you want to invest in. You just have to have enough knowledge about what you own to know that you’re owning something you can have confidence in. And that’s what I worry about with most people is they just don’t know what they own, and they don’t have confidence in what they own. And that’s what makes them not like the public market. It would be like investing in Pike Place and only knowing the name of it, but you really don’t know if it sells fish, or what kind of fish, or what you’re paying for them.

Ryan Isaac: But you had no idea they sell donuts and gypsy blankets and cacao.

Reese Harper: You just live in Seattle, and everyone talks about it, and you put money in this bucket, and it says, “you get Pike Place. You just get it.” And I think that’s how most people feel. It’s like they’re blindly investing in this black box that everyone says you should invest in, and the government set up retirement accounts that give me tax advantages, so okay, I’ll do it! Obligatorily, I’ll put some money in there, because I get a tax deduction. But it’s just not as bleak and as back as people feel!

Ryan Isaac: It’s more diverse. It’s less expensive. It’s more liquid. It’s a higher return. Yeah.

Reese Harper: It’s more like a fish market than you ever thought! It’s a lot more like Pike Place than you ever realized! You just need to know that that’s how it’s functioning. And I think it gives people more confidence to know that a fish market in Seattle is a lot like a financial market.

Ryan Isaac: Alright. Thanks everyone for listening! Thanks, Q, for being here. Another great day in the studio.

Reese Harper: Best co-host in the world.

Ryan Isaac: Yeah, in the whole wide world. Our podcast is now on YouTube! You can find it on The Dentist Money Show on Youtube. Hit the subscribe button. Again, we’re excited to announce that we are the official podcast of the Greater New York Dental Meeting that is coming up this November 26th-29th, just after Thanksgiving. We would love to see you there if you’re in the area. You can get registration details at gnydm.com, and we’ll put the link in the show notes for this episode as well. If you go to our website at dentistadvisors.com, you can click a link at the top and schedule a free consultation. You’ll pick a time that works best for you, and then we can talk about your specific situation and how we can help you make work optional at an earlier age. Or, you can just pick up the phone and call us anytime you want at 833-DDSPLAN. Everyone have a great day.

Reese Harper: Carry on!

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