Episode 03 | Part One: Investing During a Global Pandemic

Gregory Shepard, an entrepreneur who's built and sold 12 businesses, a recipient of 4 private equity awards, TEDx speaker, and Forbes author. This is The Boss Podcast with Gregory Shepard.

Thanks for joining me for another episode of The Boss Podcast. Over the past 3, 4 months, COVID-19 has caused a lot of havoc for investors and entrepreneurs. Joining me today is the president and chief investment officer of Creative Planning, one of the largest independent wealth management firms in America. His name is Peter Mallouk. He's a financial rock star and has been named the top-ranked independent financial advisor in America by Barron's for 3 years straight. Peter, let's start by talking about your company, Creative Planning. You managed $45 billion for investors when the pandemic hit. How did your investors react?

Well, I think they have a lot of feelings that are the same as every American feels, apprehension, uncertainty around what they can believe, not believe, concerns around how this is going to unfold. They are smart enough to know that when you put a lot of variables into the machine, what comes out of the machine is unknown, but I think they are a little more comfortable than most folks. I think they are more comfortable than most because When you look at people from an investment perspective, which I think is the core of your question, most people, they go, should I buy Apple or not? Should I buy Google or not? Should I buy the airline stocks or not? It's very much about the stock or the bond or the real estate. It's about the investment itself. At Creative Planning, what we're really known for is needs-based investing. So figuring out what does somebody need and when do they need it? There's money you need in the next 6 months. There's money you need in the next 5 years. There's money you need—

Right.

10 years from now, there's money you might not need for 20 years. Some of our clients have money they won't need ever. It's going to be for their kids and grandkids. So we start with that need and then we back into the asset class that matches that need. So as a simple example, if somebody needs money in the next 5 years, it's not in the stock market, right? So our clients aren't awake at 4 in the morning staring at the ceiling wide-eyed thinking, oh my God, you know, I'm all in stocks. I have to sell stocks.

A lot of people doing that right now.

Right. I think that's a good thing for your listeners to think about is it should really start with what do you need and match the asset classes to that need because there's always going to be something. It's not always going to be a pandemic, but there's always going to be something that gets in the way of the best-laid plans.

And so, when you look at the market, you look at these different asset classes, so an allocation. When you look at the pandemic right now and up against timing, so let's say that you have— let's just say that there are 3 classes of investors. There's some that need money in the next 5 years, there's some that need money in the next 10 years, and then after that, right?

Yeah.

If you were to look in those 3 classifications and considering COVID-19 and this frenzy of this, what's going on in the stock market right now, what are you advising these 3 groups of people is the first question. And then the second question, is that up against understanding or at least having some information on whether this is going to be, you know, a V-shaped recession or a W-shaped recession or an L-shaped recession or whatever?

I think what's interesting is most people tend to categorize themselves as I need money now or I need money later, sort of the way you phrased the question.

Okay.

Fair enough. Most people are really all in one because I would say most people, myself included, and most of my clients, they have needs now, they have needs they need to meet over the next 5 years, and they have needs they need to meet from 5 to 10 years, and they have needs further out. That same person should own different investments to match the different needs. So even if you're, say, 64 and you're retiring tomorrow, a lot of people think, oh, I need the money tomorrow and therefore I should be all bonds. Well, or CDs or cash. Well, if you're retiring tomorrow and you're 64, your life expectancy is 25 years. You need money to last for a long time. So you need part of the money invested in a way to meet a year or 2 or 3, part of it to match 5 or 6, part of it to match 10 out. Now, the part that you have in the 2/3, that's in very high-quality bonds. How have those performed this year? Well, they're up. So the money you need in the next couple of years, it's doing just fine. It's actually doing a little better than we would expect it to do. The money you need 5 years from now, well, I mean, we're going to get through this. I mean, I don't know if it's going to be a month or 2 years, but one way or another, we're going to get through this. And 5 years from now, that stock part of your portfolio is probably going to be where you need it to be. And so, I think the key to being effective at that is to realize that each of us, we have a variety of timelines within our own lives. So, we need to really segment out the way we invest because of that.

So, if you look at this article in 2017, New York Times wrote, creative planning is at the vanguard of a profound shift in finance. Why do you think they said that? Does that have to do with the designing that you just talked about?

I think we've been on the cutting edge of certain trends in the industry. One is the difference between brokers and independent advisors. There's 380,000 advisors out there. We're not hurting for financial advisors in America. I read articles about the shortage of advisors and I chuckle. I think there's probably 150,000 too many.

Yeah.

Of those 380,000, about 90,000 are brokers. They work at places like Merrill Lynch, UBS, places like that. And then about 10% are independent advisors. And the main distinction is an independent advisor is a fiduciary. They have got to act in the best interest of their clients all the time. They usually do not own their own products. They cannot make a commission on an investment. Now, the general public has started to figure this out. After the '08-'09 crisis and Bernie Madoff, people just started to say, you know, I am really going to pay more attention to selecting an advisor. I am not necessarily going to go with my friend or my cousin or my neighbor. I am going to look for somebody I think is good. And one of the things they start to learn about is the difference between a fiduciary and someone who isn't. So, if you walk in, if you're dealing with a broker, it can be like going to a doctor that gets paid more if you buy their own medication. So, a lot of people want to go to that independent advisor.

So, if you're at Chase Bank or something like that and then you go invest at Chase, they're making backend money in addition to the override that they're charging you? Yeah.

They have their own mutual funds, for example. And so, you might say, hey, I'm going to pay you a fee, and then they go, great, here are some mutual funds that make sense for you. Or they might get what's called revenue sharing, meaning they put you in funds that then pay them back. It doesn't mean it always happens, but it can happen in the brokerage world. You go to an independent advisor and they don't own the products, they don't make commissions on investments. Now you know, okay, look, I'm paying somebody a fee to advise me, and when he or she advises me, their best interest is to help me do well. They're only gonna make more if my account goes up. They're not gonna be double dipping on these investments. Well, I think in that space where we were one of the first to really emerge as a larger firm, We're also, I think, on the front lines of the trend towards financial planning, this idea that, hey, it really matters what you're trying to accomplish before we get into what you should be invested in. And we early on included a financial plan without a separate fee for our clients because we thought it was the only way we could properly advise them. Now that's become more of an industry norm. And then lastly, to your point, we do a lot of needs-based investing of matching the investments to what you need. Maybe you have all the money you need and it's all about your kids and grandkids, we can be very aggressive.

Right.

But we're very much tied to the need. All of those are major trends in the investment world. I think we were leaders in all of those regards.

So when I think about this, right, I think about the outcome, right? So what you're doing is you're sitting down and saying, okay, what is the outcome of my customer? What do they want to have as an outcome? And then you design around that outcome. One of the things in mid-April, essentially at the height of the COVID-19 pandemic, you suggested that it's time to turn the risk on with your 401. What do you mean by turn the risk on and why do you think that?

So, you know, in that interview with CNBC, they were basically saying, what should investors do now? And I said, you know, the market's, the market's down, it's earlier in the year. And I said, what investors should be doing is they should be investing aggressively in their 401. If you're blessed, you have a job, you have a 401, you can afford to invest, The last thing you should do is gonna is say I'm gonna stop investing now. You know, if everything is if a car is half price, if things at the grocery store at half price, we get excited. Stocks are half price; we don't want to buy them. But if you've got a long-term outlook and a 401k is a long-term investment, it's something that you're saving for for five years from now, ten years from now. You should be excited about buying when there's problems. You know whether it's this or the tech bubble or eight nine crisis or nine eleven, you should be buying through market weakness. Now the headline of you should turn risk on implies. that I am advocating for a shift in investment strategy, which I am not. I think people should have a long-term plan, they should invest for the long term, but sooner is always better than later. A bear market, when you are accumulating in a bear market, is better than accumulating in a bull market. If you think about a younger investor, let us take somebody who is even 40 or 50, they have got decades before they are going to be withdrawing from their 401. People feel better saving as the market is going up, But in reality, one way or another, the market's going to get where it needs to go over the next 10 or 20 years. What you really want as an investor is for the market to stay depressed as long as possible and then rocket at the end. You don't want the steady climb because the steady climb or the fast climb means you're accumulating shares at a higher price. So you want to accumulate shares at a higher price. You want to accumulate them as soon as possible. So You know, what I meant by that is, look, if, if you've got a bear market and it's early in the year, pile into that 401 as much as you can.

Okay. So let me ask you this. So I'm in the private equity space, right? So I invest into businesses. Everybody is wanting to know what is going to happen with the valuations of smaller businesses, mid-sized businesses, you know, because it seems like what happens in the market when valuations drop in the market, AKA, you know, the stock prices drop, that it would be the same effect or mirror that effect in companies that are privately owned. Would you have some comments on that? I mean, this is a question that I get asked probably 5 times a day.

So I think that if you look at— there's a couple of things with small companies. I mean, you look at small companies over the long run, most decades they do better than large companies. That has definitely not been the case the last 10 years, although PEs had a good run. Large US has really, really shined, and mainly because of the anomaly of large-cap tech, the Facebooks, Googles, Apples, Amazons. of the world. Now, if you look at the last 10 recessions, I think it is 9 of them, small-cap stocks have led the way out. That makes sense because small-cap stocks get crushed the most going into them.

Oh.

No one really worries about McDonald's going out of business, but there are a ton of PE firms that own these small emerging restaurant chains that are freaking out right now. I am talking to some of them, I am talking to the people that own those restaurant chains that sold a share to private equity, I'm dealing directly with private equity companies that own some of those little restaurant chains. Is Chipotle gonna be here? Yes. Is that 30-chain place out of Southern California that's going national gonna survive this? You know, maybe not.

Yeah.

So when we come out of the bear market, if those have survived, they tend to rocket because they don't just have built in a slowdown in business, they have built in an existential risk that they're just flat out not gonna make it through this.

For them, it is like a bounce.

Yeah, for them, it is— I would liken it to when the market was plummeting, we had the fear of coronavirus and what it was going to do to the economy. We also had the fear of systemic failure. We had this fear that banks might not be able to meet the demand for cash and the bond market might collapse because everyone is selling everything. The Federal Reserve came out and said, and Congress and the President said, we are backing everything up. Everyone in America goes to the bank, we'll give them the cash. If the bond market's in trouble, we'll buy bonds. And what happened is in the next 2 and a half days, the stock market went up 21%.

Hmm.

It did that because— now it still has had a long way to go to get to recover, but what it said is we're no longer worried about the existential risk of total failure, total collapse. We're just worried about how long this coronavirus thing is going to take and affect the economy. It's the same thing with small stocks in a bear market. You worry about, can these small companies make their— meet their loans? Are they going to survive through this? If they get through that and that existential risk gets removed, it immediately gets repriced to a much better level. If tomorrow they said, we have a vaccine for the coronavirus, and people are going to be able to use it in 3 months, small-cap stocks would go up double digits in one day. They do double probably what large company stocks were doing because the existential risk would be removed.

Okay. And then let's talk about real estate. So how does real estate tag on to this situation? I mean, you, you know, you have people, nobody, nobody's buying or selling anything right now. And everybody that I'm talking to is like, oh, this is going to be a catastrophe for real estate. It's just going to be a little lagging in nature and da da da da da. So what, I mean, what are your thoughts on real estate? I mean, we have so small cap, large cap market. You talked about bonds, uh, you talked about CDs.

What about real estate? So what I love about real estate as an advisor is when you're updating a financial plan with a client, you're building their net worth statement, their real estate never goes down in value. Like if I was meeting somebody today, you know, the stocks would be down and everything would be— but if they own a property that they bought by themselves, like a strip mall or something like that, it was worth $3 million 2 months ago, they'll still leave it at $3 million on their net worth statement. So one of the nice things real estate does psychologically for us is it lets us pretend It doesn't go down in value, right? We never have to really accept that it's gone down in value until we sell it because it's not repriced every second of every day like Google stock is.

Hmm.

But the reality is, if you own a property today and you go sell it, you're going to sell it at a very steep discount. The real estate market is more correlated to the stock market than people think. It's about 83%, 85% correlated. You have less liquidity. Its long-term returns are a little bit less than stocks, but still favorable. I think what we're seeing in the real estate market is very much like what we're seeing in the stock market. You have some stocks doing great, Costco, Walmart, breaking records. That's like Christmas every day there for them. And then you have smaller retail chains on the brink of bankruptcy, Macy's. In the real estate market, you see the same thing. You're seeing some real estate, I think, is gonna come out of this on fire. Like, I think we've learned a lot about the supply chain, and it would be nice if everything wasn't just, just-in-time inventory. Maybe we need more storage of things. Well, maybe storage and industrial spaces are gonna be even more in demand. I think we're gonna see more demand for—

Interesting.

For what holds these server farms. So, you're gonna see a spike there. A lot of people are saying, I can tell you a lot of my business owner clients are going, man, maybe I don't need all this office space. I was thinking about expanding, but maybe some of these people can share spaces, and maybe they can share conference rooms. Maybe I don't need all this space. I think we are going to see— I don't think it's just a thing we're reading about. I think we're really going to see a pullback in commercial real estate where you were renting to, say, businesses. And I think retail is like commercial. That's right.

Got it. What about residential?

Well, and then I'll just add the area that's just going to be devastated is retail strip centers. I mean, the small retailer is already clinging to dear life against Amazon. It's over. I mean, we just declare it now. It's Amazon, Walmart, and Costco, maybe Target, and then everyone else is just going to be hanging on for dear life. So I think you see some doing really well and some doing poorly. I mean, to your question about residential, we really saw that was the story coming out of '08-'09. When we came out of the '08-'09 crisis, real estate really suffered through the crisis. But after we came out of it, residential took a long, long time to recover.

Yeah.

of clients that I personally worked with and encountered, the only ones I really saw suffer bankruptcy were developers of residential real estate that had overextended. But also still in the residential category were apartments, and apartments were amazing. They did amazing, massive demand because no one could buy homes.

Mm-hmm.

So we saw apartment complexes go up in value, and it just shows talking about an asset class, it's not so simple. There's more going on in the asset class than just saying real estate. I mean, to your point, there's homes and there's apartments, there's storage and industrial, there's commercial. And I think in the bond market, I mean, high-quality bonds are up, poor-quality bonds are getting destroyed. So really, quality matters, and the segment with which the economy is moving matters a lot when you get within an asset class. And that's the risks of just having all your eggs in the real estate basket, is you might be in the wrong area of real estate.

Yeah. Oh, very fascinating. So, you do divide it up between like multifamily, single-family, and then you have your commercial and warehouse space and office space. It's all different in terms of its quality depending on what kind of market conditions there are.

That's right. I mean, that market can change in ways we can't imagine. If you look at what changed residential versus apartments in '08, '09, that was almost unimaginable. I mean, housing prices had never gone down in the history of the United States. If we look at now, this moving away from commercial office space, also like something no one was thinking about 90 days ago. I mean, so people generally in my experience take more risk than they realize. And I'll tell you one thing I've learned with investing is everything is okay until it isn't. Everything is okay until it isn't. And so you just, you really have to look at something and it's not enough to say what could go wrong. You have to say something is going to go wrong. So how do I not have everything here?

Yeah, all right, let's take a break right there. I've been talking to Peter Mallouk, the President and Chief Investment Officer of Creative Planning. Coming up in part 2, Peter will tell us how he thinks COVID-19 will affect mergers and acquisitions.

If this takes 3, 4 more quarters, I think we're gonna see what I would call a great, kind of a great economic cleansing. You know, real deep recessions, they create real winners and losers. Thanks for checking out the BOSS Podcast with Gregory Shepard. Get more on Greg's Business Operating Support System, BOSS, at GregoryShepard.com. This has been a production of Forbes Books Radio.