The Secret Killer of Wealth: Why volatility is destroying your portfolio

No one pays attention to the risk. They pay attention to the headline returns, and, and it just shows people are undisciplined, that you really must pay attention to risk.

Hello, future billionaires! We are back with another episode of the Invest Like a Billionaire podcast. I'm Ellis Hammond once again, your host for this week, because Ben and Bob are here to share another really behind-the-scenes key concept from their new book. So Ben, just to remind folks about the book, when does this come out? Where can they go to find more about this book?

Yeah, we're in pre-order mode right now, so you can go and get access to the first 6 chapters and several other goodies we've got if you help us get the word out ahead of time. It's officially live September 2nd, and you can go to thebillionairebook.org to see all those freebies. So For all of the month of August here, we're giving some behind the scenes, some little previews of what you can expect in the book. This has been a long time in the works that we've put this together. This is not just one of those little ebooks you can download from a site. This is, we believe, an industry-shifting book and want people to get their hands on it because I think it'll be a game changer for you.

Well guys, let's jump right in. I'm just going to ask the question, what is the secret killer of wealth that you talk about in this book.

Yeah, and that's volatility. So what people don't realize is how important it is, how important volatility is. And one of the very first things I show in the book is a guy who takes $100,000 and earns 9% over 30 years, boring, every year, same deal, 9%, what he ends up with. Well, and the answer is about $1.3 million. And then I go through and I say, okay, well, let's say, you know, you've got a youngster who is way smarter than the boring 9% guy. Let's say that's me. And I've got Ben here is way smarter than me. Me, and he knows he can go and get an average of 10% because he's going to be actively trading in the markets. And he goes in, in the first year earns 50% returns, 5-0, beats the puddins out of me and is gloating at Thanksgiving and all that, as you might expect. And I'm like, yeah, I'm just going to stick with my 9%. But then the next year he has a really rough year and loses 30%. That's not too bad because he made 50 before, right? And the average is 10, plus 50 minus 30 averages 10 over 2 2 years. And then he repeats that for 15 years, that 2-year cycle, and he's averaged 10% returns when I've averaged 9%. So I said I would have $1.3 million at the end of, end of 30 years. And how much would Ben have? Well, it's about under $300,000. And why? It's because volatility. And the truth is, the math says that losing money is far more impactful than making money to your returns. And this is why I have a maxim in the book that I say that minimizing losses is far more important than maximizing gains. I see investors all the time, we sell a lot of investments and if we were to say 35% returns, everybody's going to want it. Even if the risks are incredible, right? No one pays attention to the risks, they pay attention to the headline returns. And it just shows, it's just that people are undisciplined, that you really must pay attention to risk. And the more sophisticated investors are, the more they're paying attention to risk. And the risk equates to volatility. What's the risk of this thing dropping and losing money? So it's just far more important not to lose money than it is to make money.

So let me double-click on that because of what I heard you saying, and I want to make sure this is really clear for our audience. Ben, the finance guy, you can help us understand this. So we make an investment and we make 40% that year, but then when next year we have a drawdown and we lose a third of that, like, what is the math there for people to understand that what you have to do to make that back? Break that down for me a little bit more so our listeners get that.

Yeah, you know, a simpler example would be, say you have a 50% loss in one year. Right? So you have $100,000, you lose 50% of it. Well, the gain you have to earn just to get back to breakeven is 100% return, right? You have to double now your $50,000 that you have left just to get back up to $100,000. So on a percentage basis, you have to earn a lot more in positive return than you lost initially. And that's why volatility from a mathematical perspective is so damaging. And a lot of investors don't think about that because they think, Oh, I can just out-earn some of the losses that I'd have in my portfolio, but you're much better served to take a lot less risk and have less volatility and compound at a lower rate. And to Bob Fraser's point, I mean, it's a massive difference over a long period of time. And so this is really important to not overlook the power of minimizing your volatility there.

Yeah.

You all know about the power of compounding, but volatility undoes the power. So if you have volatility, you are not compounding. Right.

I'm so glad you emphasized that. So volatility is essentially the Achilles heel of compounding growth, which is the key to building wealth. So how does this connect to alts? Why are we talking about this and why is this a key point in the book? You know, a book about alternative investments.

Yeah, because alts have far less volatility than the public markets. So the public markets, you know, are just incredibly volatile. In the book, I show the different volatility of the different alts classes. and they're just a lot less and it even gets better than that. So because alts are uncorrelated and that what that means is that when the stock market zigs, alts might zag, right? They don't move in unison. And there's a huge benefit to that portfolio-wise. So it turns out if you have uncorrelated assets, your overall portfolio volatility goes way down. And that's the free lunch that David was talking about. It's called Modern Portfolio Theory. And it's a Nobel Prize-winning mathematician, Markowitz, discovered it in the 1950s and won the Nobel Prize in 1990 for it. So it's just huge. And, you know, the key is one, alts themselves have less volatility. And then two, as part of portfolio, because they zig when everything else zags, and even the alts themselves, zag when the other alt zigs. They're uncorrelated.

Yeah, the way I think about this, like when I open up my iPhone, you know, in the morning, I check the stock charts. It's either all green or all red, right?

Isn't it?

Yeah. I mean, isn't it? It's like a simple way, like literally look at your phone right now if you're listening to this episode and you can kind of get what we mean by correlation. It's not like you can buy Apple and buy some energy stock and then they're diversified. Is that kind of what you're meaning when you say everything's correlated?

Yeah. And what's happened is everything has become correlated to everything in the public markets. And as you pointed out, it's like, okay, so when Apple has a bad earnings and their stock crashes, well, why did the energy company go red? And why does the real estate investment trust go red? It doesn't make any sense, but they all do. And since the great financial crisis, it's gotten way worse that everything is correlated to everything. So when your advisor's telling you, oh, we're going to diversify you. Well, that's a myth. Diversification does not give you uncorrelation because everything's correlated. So yeah, you can buy stocks A, B, and C and D, but if they all zig and zag together, there's no benefit, right? That's the case with the public markets today. And the only way to break that is to get into alternatives.

So investors might think that because they have money in different stuff, they're diversified. But if it's all correlated, then—

Then you're not diversified.

This kind of goes back to the last episode, right? We said, why is the 60/40 portfolio broken? And it's exactly that, because historically, you know, several decades ago, if stocks went up, bonds generally went down, and if stocks went down, bonds generally went up. They were inversely correlated. And so you had some kind of natural, you know, smoothing out of that volatility. But in recent years, we have charts in the book that show— and if you're kind of a nerd and like those kind of charts, it's pretty remarkable to see the correlation, meaning How tightly do these move in unison directionally and by magnitude? And it's impossible now to achieve true diversification by investing only in the public markets. And that's why the old way is broken. You have to invest in private markets to get true diversification, which is the whole point.

And so people think about the way you get diversification is let's buy the S&P 500.

Yeah.

So the S&P 500 is the 500 kind of largest companies in the stock market, and you're getting 5 500 freaking companies, right? So you think, well, I'm getting 500 companies. Well, you can't get more diversified than that, right? But here's the problem with the S&P 500 index. It is a capitalization-weighted index. And in fact, 10 companies, the top 10 companies equate to 33%, a third of that index. So you're buying 10 companies who, by the way, are all correlated anyhow. So you think you're getting diversification and you're actually not. You're buying mostly 10 companies and they're the 10 big companies that everybody knows their names and that all go up and down together anyhow. Right. So you're not getting diversification. And here's why the diversification is broken. So today people aren't buying individual stocks, they buy indexes so that everything moves. Think about it. If I buy an index, the indexing company is going to go buy those 500 shares, right? So if I buy $1 trillion worth of S&P 500, all those 500 companies are going to go up. And if I sell $1 trillion, all those 500 companies are going to go down because I'm buying an index. And the same with futures. People are buying indexes and futures. They're buying ETFs and futures, and they're all trading these, all these 500 stocks at one time. That's why the correlations have gone nuts.

So how do you actually get uncorrelated or non-correlated assets? Can you give us some examples of what you mean of non-correlated assets?

Yeah. I mean, we have our alternative investment continuum we've talked about in the past, and this is really a nice way to frame it. So we have a chart in the book, and most people start stocks and bonds. That's what's easiest to access. Most people are taught is the best way to invest. But as people start to realize, "Hey, this is not the best way. I need to get access to private alternatives," a lot turn to real estate. Real estate's a natural starting point for a lot of folks, and maybe they're doing a rental here or there. They're doing Airbnb and do what we call DIY real estate. But there's challenges there because that's really an active business. It's not passive, it requires effort, and can be a good path for folks who are trying to build net worth. But for those who already have capital to invest, they don't want to go be landlords, they don't want to go and have to fix toilets and deal with bad tenants. So the next level is where most people start is passive investing in real estate, investing in syndications and funds, where professional operators, professional managers are acquiring and operating these investments and allow accredited investors to invest alongside in these investments where a lot of people start, but it doesn't stop there. And, you know, another really big vertical is private credit, investing in debt and in credit-focused opportunities. So where you get lower risk, but you still get really nice yield and you get some benefits of liquidity and current cash flow from those types of investments. Another big vertical for the ultra-wealthy. And as you kind of keep going up this net worth continuum and alternative investment continuum is private equity. This is investing in operating companies. Another offshoot of that is venture capital. These are investing in startups or tech companies that have the potential to have really big outsized returns. And another big vertical is hedge funds. This is another asset class that's invested in a lot by the institutional and family office investors that is newer to a lot of people. But those are some of the core asset classes. And we actually break down and have chapters on each of those why you'd invest in them and the thesis for how they fit in a portfolio in the book.

But here's the way to think about it, and just tying this into your question. So let's say Israel attacks Iran and let's say, you know, Putin invades Ukraine and oil prices go wonky and the stock market does a ginormous dump. And then, you know, Trump talks about tariffs and you're seeing the stock market crash. But let's say you own an apartment complex. And guess what? Did people pay their rent this month? They did. And did that money get sent to me? Yes. It's uncorrelated. That's the key.

Yeah.

Right? And let's say I've got infrastructure or I've got a power plant, right? Or let's say I've got, you know, an oil field that's producing oil and, you know, yeah, it's subject to the price of oil, but it's not subject to Apple's earnings or the bond market or anything else, right? So that's the whole point is you're getting things that are really, really on a different page than, news.

One of the things that I love, and it's one of my favorite charts in the book, I think JP Morgan put it together, but it basically shows at different splits between, you know, 60/40 portfolio, 80/20 stocks, bonds at every level, right? These different splits between stocks and bonds. If you add in alternative investments to these portfolios, in every case, risk goes down substantially. And in nearly every case, returns actually go up.

Right.

So from a very practical standpoint, adding alternatives is a massive way to reduce your risk, which is volatility, right? That's how we're talking about risk and also get improved returns. And this is published work by JP Morgan. This is why it makes sense.

So here's my question for both of you guys, you know, and assuming not everyone is an Aspen investor or part of the Aspen Investor Club, I mean, how does an everyday investor get access to enough of these non-correlating assets to bring down volatility in their portfolio?

Well, just go talk to your brother-in-law and see what he's doing and then throw money at him, you know? Yeah, no, that's what a lot of people do. I mean, that's a, that's a joke, but really it's the best way to source these deals is to go to investor conferences, join investor clubs, investor masterminds, and start to vet sponsors and start to get some deal flow and then make some decisions. But one of the best sources, honestly, are going to be successful alt investors. And by the way, because someone is successful in the public markets does not make them a successful alt investor. When I say a successful alt investor, I mean a successful alt investor, someone who has placed capital into private deals and is good at doing that. Find those guys, mastermind with them, join investor clubs with them, share resources. And the best way to find these kind of guys is going to investor conferences, that kind of thing.

And probably someone who's invested through more than just the last 2 years in alts, right? Because there's cycles to this. There's seasoning to this.

Absolutely. Yeah.

Guys, that's it for this week. Check out the show notes to this episode for a link to preorder the book. And we will be back next week with a very important lesson. Guys, we're going to talk about what financial advisors are not telling you any preview of that.

I think the potential conflicts of interest and misalignment that are built into the financial system. So you do not want to miss that episode.

Stay tuned, guys. We'll see you next week.