In this episode, Gary Pinkerton interviews Doug Utberg. They talk about the two demons of investing: risk and inflation. Risk is due to uncertain future returns, and investments may have hidden dangers that we don’t notice. Risk can never be eliminated, it can only be managed. Inflation erodes the value of your dollars. Overcoming inflation requires investment in multi-dimensional assets that are optimized to defeat inflation.
Announcer 0:04
Welcome to the heroic investing show. As first responders we risk our lives every day our financial security is under attack. Our pensions are in a state of emergency. A single on duty incident can alter or erase our earning potential instantly and forever. We are the heroes of society. We are self reliant, and we need to take care of our own financial future. The heroic investing show is our toolkit of business and investing tactics on our mission to financial freedom.
Gary Pinkerton 0:39
Hello, and welcome to Episode 113 of the heroic investing show, Episode 113. In this show, we focus on those challenges that are unique to first responders, members of the armed services and veterans. But we also dive into topics that all investors who are looking for some passive income to replace their active w two income or their current career, so that they can get back time with their family, improve their future, and solidify their retirement. We give them tools that enable them to not have their money tied to the stock market, or any other typical challenge that comes with an investment where you’ve handed off your money to another individual to manage out of sight, out of mind and unfortunately, out of responsibility. And so we teach people that it’s not hard that you have the time working a full time job to have a side hustle is my friend lane being says, to have the ability to get a career a calling a side business up and running successfully. And then transition over to it you’re going to hear in my next episode from a gentleman who did that with an operating product business, a gaming business and did a great job of operating it for many years, while active duty in the Air Force. So it is possible, all it takes is the right frame of mind the right connections, and the right systems in place. And so I think all of the gentlemen and ladies that we’ve been interviewing here, are providing us that path right there. They’re showing us the light of how to get down that path. And this guy, Doug Berg is no different. So Doug has been a member of Jason’s team in the past as an investment counselor, he has a full time job he’s about to transition out of, he’s going to join us adventure lions mastermind, I guess, when this airs that will already have happened. But he’s looking into things like short term rentals. He’s just a really interesting individual, but he’s got a great take on the financial industry and the economy. He’s not I don’t believe trained to the level that Dan Ammerman is, but he’s pretty close on his understanding and knowledge. And I went back into the archives to find Doug’s, what I I remember as an infamous discussion, about defending ourselves and defending our investments against the demons of risk and inflation. So this one, I’m purposely putting here to tie to the one two episodes ago from Dan Ammerman, which was Episode 111. And in the prelude to that one, I was making a comparison of what you’ve heard me talk about many times of treading water of preventing yourself from going over the waterfall, which is being overcome by inflation. And that’s the thing that we try to help people a paradigm life with, especially all of our baby boomers that are on fixed income, you know, all of our clients that, that find themselves being impoverished by the deflation of the US dollar. So I talked about it as he’s, you know, not going over a waterfall of inflation, high inflation, Dan arrowmen has a great discussion about boxers in a ring and which is the best boxer to be and that’s the guy with the jab and the hook, right and not the glass jaw. You know, so dugout, Berg then makes the comparison of them being demons and how you overcome them and, and what that means and how you should set yourself up for success. And while this is an episode from a couple of years ago, you know, Jason will be the first to admit that the Federal Reserve has done a decent job of staving off the inflation that has to come. I’ve heard a couple of recent interviews on other podcasts where, you know, with the 2018 tax law with the renewed large budget deficits that are coming, it seems unreasonable that this is going to continue for too much longer. But we’ve all been surprised to this point. My point, though, is if you missed this one when it first came out, and if you missed Dan everman, and you haven’t thought much about inflation, there’s still time because it hasn’t hit you yet. So Doug goes on and on on this one as Doug does, and he gets pretty excited. And it’s it’s a really entertaining, great one. And if you get a lot out of this, why don’t you come Join us in Chicago for venture, excuse me in New York City for venture Alliance. If this happens to air before then, if not catch our replay of venture Alliance, Jason often does creating wealth shows there. And I’m sure you’ll hear the great Doug Berger talking some more. And I have no doubt, he’ll be on many future episodes. He’s a great guy to be around. I really appreciate his insights and his input. And please help me welcome Doug Utberg talking about the demons of risk and risks of inflation.
Doug Utberg 5:41
So the topic today is going to be fighting the demons of investment. And if I do my job, right, by the end of this presentation, you will be extremely angry and be ready to go out and rip apart everything that you see. And you think that I’m joking when I say
Jason Hartman 5:54
He also drinks a lot of coffee, too.
Doug Utberg 5:58
I feel that in order to stay sufficiently angry and motivated, I need to drink coffee more or less all the time. So let’s start out and say why are we fighting these demons of investment anyway. And well, there are really two key demons that I like to point out. The first is the demon of risk. And anybody who’s paid attention, even half of the days to the market knows exactly what I’m talking about. Because especially during during the second half of 2008, one day, the Dow would be up 1000 points, the next day would be down 2000 points, one day, it’s up 500 points every day, it’s down 1500 points, when things get extremely volatile, it gets really, really hard to predict the future of your investments. And needless to say, it’s very difficult to bring yourself to invest when you don’t have the slightest idea where they’re going to be going. And the second is inflation. Jason talks about inflation quite a bit. But inflation is an ever present risk just because it’ll devalue the money that you’re using to invest so. So even if your your stock holdings double, if they only buy half as much, you’re actually worse off than you were before, because you have to pay taxes on all of that gain. So now let’s start by taking a look at the demon of risk. And the thing that’s important to really keep in mind here is that many people are blind to risks that they can’t immediately see, say, for example, you’re looking at a real estate property saying, Okay, well, there may be a risk that the value is going to go down. Okay, well, everybody can see that. But what about the risk that you won’t be able to get a tenant because your rents are too high? Or all kinds of other sorts of things? You know, people say, Oh, well, you know, I see the stock market price might go up, prices might go down. But what about the risk that inflation is going to destroy the value of all of your dollars, so it doesn’t matter whether it goes up or down. So to demonstrate kind of what I’m talking about here, let’s start by taking a look at 1974 to 1994. In this time, this is really one the buy and hold religion of stock market investing got going because as you can see, you have a nice linear growth, all you got to do is just dollar cost averaging at regular intervals, and you’re gonna be fine. Now, let’s fast forward. Yeah, see, we got 8% compound growth rate 10% compound rate if you bought after the 87 dip, but now let’s fast forward to 2009, you have these two gigantic bubble bubbles that collapsed, and then built back up again and collapsed. So your compound growth rate has actually shrunk over this extended time period. But then if you look at what happens during these bubbles, you go up at this fantastic growth rate. But you contract twice as fast, you go up again, at a nice, fantastic growth rate, and you contract twice as fast. So that means in this market, where volatility is the new normal, you not only have to buy and hold, but you have to buy at the right time, and then sell at the right time, otherwise, your goose is cooked. Because if you bought anywhere near the top, that top of the market there, you’re in pretty serious trouble. And a lot of people who did have experienced very, very traumatic losses in their stock market investments. So now I’d like to kind of transition out a little bit. And let’s think back about risk a little bit. So in the world where I come from people think about risk as a linear trade off between your rate of return and your level of risk or volatility. And in the short run this is true. And in order to get these high rates of return, for example, hedge funds and mutual funds will do is they’ll get a whole bunch of leverage, they’ll go out well, but Lehman and Bear Stearns and a lot of the other investment banks did was they go out into the overnight lending market and they borrow a whole bunch of money and then invest that money. You know, a lot of times it would be in the mortgage backed securities, because they could borrow for say 3%. And then they could get six and a half percent and then they’d get a 3% spread. And if we were at 50 to one leverage, you make a lot of money doing that. But what happens is, when you look at it over the long term risk is really more of a bell curve, where over the long term, you start up fairly conservative as your risk goes up, your return goes up, but when you eventually push the risk past that threshold, you increase the probability of incurring a total loss. So in this case, we have conservative and aggressive but as the risk profile increases, you get to insane and then eventually suicidal. And the reason for this is because if you have a high enough level of leverage, you know, I’m not talking 5x leverage or 10x leverage, you know, that’s, you know, that’s prudent leverage on a stable asset. That’s that’s nothing, I think, you know, Lehman and bear, they had 3050 8090 100 to one leverage, just ridiculous, unbelievable levels of leverage, even the smallest little hiccup and values, the slightest little disruption will just send you straight off the cliff nosediving to the point of no return. Unless, of course, you know, Uncle government comes to bail you out. And this is kind of where I get into what I call the post responsibility era. Now, I didn’t want to put this in because at Jason said, well, not Doug, you need to include something about all these bailouts, okay? Because you could take as much risk as you want now, and someone’s going to bail you out. And I’m like, that just feels wrong to me. Because it you’re to me, I’ve always thought that if you take risks, and you’re an idiot, then if you, you know, too much risks, you lose all your money. If you tell people well, we’re going to bail you out, we’re gonna bail out people who act like idiots, oh, you’re gonna get us more idiocy, which is true. But if the government’s bailing people out, if they’re throwing $100 bills in front of your feet, you’d be kind of dumb to not pick it up. And so in the post responsibility era, there are opportunities where even if you have taken risks that have turned out badly, there are chances to not be totally wiped out. Am I saying you should depend on that? No? Am I saying you should be aware of it? Absolutely. Let’s think a little more here about fighting this demon of risk. Now we’ve all seen these cyclical markets. And this is based on the trailing 12 months. So in some of the markets, like La, la actually hasn’t done as bad for the last 12 months, because a lot of the dip has already happened. But let’s say that instead of looking at these cyclical markets, what if you look at a couple of the markets that are a little more on the linear side? Well, so you know, something that would just be crushing. If you’d invested in Vegas, or Phoenix or Miami, you’d instead taken that same money and gone somewhere like Austin or Dallas, or Houston or Indianapolis, it will be either a very, very minimal loss, or some of these have actually appreciated over the last 12 months. Originally, when I did this, I was doing peak to trough and Jason was like, No, just do 12 months. Yeah, Richard asked whether this is based on market value. That is correct. Yeah, if you’re buying a below market value, you can absolutely add that on. And the the metaphor that I like to think of for risk is Hercules fighting the Hydra. Now I’m a little bit of a of an eclectic nerd, and I enjoy mythological images. And you know, for those of you who aren’t familiar with the story of Hercules, he had 10 tasks that he needed to undertake. And one of them was fighting a multi headed Hydra, or this big beast. And what happened was, every time he tried to cut off one of the heads, it will grow to more. And so this is kind of like when someone like Goldman Sachs decides that they’re going to contain the risk by buying credit default swaps from AIG. They’re cutting off that one head, but two more growth. Now, if AIG can’t pay their credit default swaps, well, then they’re in serious trouble. And eventually, what, what Hercules had to do was, he had to, I think, have his cousin cauterize each of the heads after he cut them off. And so what you really need to do is, understand where your risks are, and take actions to mitigate those risks. For example, if you’re taking on leverage, if you use that leverage to purchase the asset that produces cash flow, that will pay for the interest on that leverage, well, now you’ve just really neutralized a lot of that risk. Because even if your value goes down, but you’ve still got cash flow, you can carry that loan forever. And you don’t have to worry about the value going up. At some point, it’ll go up, and you don’t care what it is, because you’ve just cauterized that risk. Now, let’s talk about inflation. This is the nice big 5 million pound gorilla in the room. So what inflation does is flesh in taxes, your wealth by destroying its purchasing power. And I’m just going to go through really, really simple illustration of what causes inflation prices, first of all, are an equilibrium between the amount of money in circulation in the economy, and the amount of goods and services that are produced. And if the amount of money increases, and the goods and services stay the same, the prices have to go up. If you just kind of think about it as two bubbles, right? You know, one bubble is your money. And another bubble is your goods and services. If the goods and services go down, and the money stays the same, prices have to decrease. If the money goes up, and the goods and services stay the same, the prices have to increase. Now, you’ll always have things trading off, commodities go up and down. And if we spend more money for say soybeans or oil, that means there’s less to spend on something else. And then when there’s that less lower demand and the prices will adjust downward, but the only thing that can drive all the prices up at once or all the prices down at once is the supply of money. Now, that’s not totally controlled by the Federal Reserve because one piece is money supply. And another piece is credit supply. And that credit supply is a little more tricky, but it does, generally speaking tend to correlate with your money supply. Now I’d like to talk for a second Jason’s hit on this more than once of your personal rate of inflation. This is a little bit of the Clint of a clincher when it comes to inflation because commodities tend to inflate in a linear manner. Meaning that anything that’s you know the sticks and bricks, your you know your cost Your soybeans, energy, you know, food, energy building materials, all those are commodities that will go up at a linear rate, sometimes a high linear rate depending on what’s happening with money supply. But technology, you know, things like this. Now, I’m sure I’m the only person in the world that has a Google phone instead of an iPhone. But you know, sunlight, stuff like your iPhone or your Google phone. Five years ago, the price of that was infinity, because it didn’t exist, you whereas now everybody can get one for, say, 200 bucks. And so technology has exponential price decreases. And there’s always that technology curve pushing new products, new innovations. But the clincher is that you need to have enough disposable income, after paying for your food, your energy, your place to live to where you can experience the benefits of technology. And when inflation pushes up prices. What it does is it disproportionately impacts people of lower incomes, who have to spend more of their money on things that are denominated commodities, who people will spend more of their income on things like housing on things like energy driving to and from work, like Jason was saying, the most people that work in service sector jobs here in Costa Mesa, don’t live in Costa Mesa. Yeah, they live in Riverside and have to drive for what 40 miles one way or something like that. And so that means that you know, since they have to drive so far to and from work every day, they have to expend a higher percentage of their income on energy just to get to and from work. So now let’s take a look at something that called monetizing the debt and send out any of you heard of the phrase monetizing the debt? Well, Jason, I know you’ve heard of it. Very good. So basically, you just kind of feel free to let us know,
‘Speaker’ 16:34
well, monetizing the debt is what we’re doing. Now, we’re playing a game, we sell bonds to other governments to finance our debt. But the other governments don’t want to buy them now. So we have this little game where we sell them to somebody unknown for a month or so. And then when the Federal Reserve buys him back with dollars we printed,
Doug Utberg 16:53
I don’t think I possibly could have said it better myself. So yeah, so when the market stops buying bonds, we break our normal cycle of the treasury bonds being sold to the market. And then we say, well, instead of the market, buying these bonds, we’re gonna sell to the, to the central bank. And but the way that the central bank buys the bonds is to increase the money supply. And the extreme danger here is that when the central bank increases the money supply, that goes out into bank reserves, and the banks then let you then have the opportunity to loan that money out. I don’t remember what the current reserve ratio is. But it’s something like 10%. So whatever the Federal Reserve pushes out into bank balances, can multiply out by a factor of approximately 10 for effective money out in the economy, which means that if the if the central bank buys too much in bonds, they can explode the size of the money supply. And that’s why they’re hiding it. Yeah. And so now, one of the things I’d like to get into here, and this is the slide that should make all of you extremely angry. Yeah, this is a very important slide. So there are some people who say, Oh, well, you know, there’s actually deflation coming. And I can understand some of the arguments. But let’s, let’s just look why the inflation is going to come. So let’s start with the 11 point 9 trillion national debt is today, I think I made this slide like two weeks ago. So you it’s grown like 200 $200 billion in the last couple of weeks, but our gross domestic product is around $14 trillion. Now bear in mind that for paying all the debt in all of the US, this is it, that $14 trillion is all there is. Now let’s add on our our business and person and consumer credit, and then mortgage debt. So it’s about $4 trillion of business and consumer debt, and then another $14 trillion of mortgage debt. So when everybody says, Oh, well, that that national debt that’s only like 80% of GDP, I go, Okay, yeah, that’s the government side. But people have loans too. And that’s around 30 ish trillion to an all those, that $30 trillion. That all has to be paid out of that $14 trillion of GDP. Oh, wait a second. Now, there’s another piece I forgot to tell you about. We just did this big bailout initiative, where we’re on the hook for about $8 trillion. And we also have these things called entitlements, where we’ve promised to give people a whole bunch of money that we don’t have. And so now, if we if we layer on the bailout liability, which is estimated to be up to about $8 trillion, and then if we add on the entitlement liability from the Government Accountability Office, how many people here know about the difference between cash and accrual accounting? It’s really boring. I know, it’s a number, monkey data nerd kind of thing. So cash accounting just says you only count money as spending when you spend it. accrual accounting says you count money is spent when you incur the liability. Now, the government forces every single publicly traded corporation to do accrual accounting. So, for example, anybody that knew that knew how to look up financial statements knew that United Airlines was in trouble for about 20 years because the liabilities for their pensions exceeded their assets many many times over for years and years and years and years and years. But they didn’t actually go bankrupt until they ran out of cash. But the government does cash accounting. They don’t accrue for liabilities. The Government Accountability Office says, If you force the government to do accounting like they force everybody else to do it, what would it look like? And what it would look like is $63 trillion is the present value of the unfunded liabilities. And this is from March. So it doesn’t include health care doesn’t include the son of the bailout, or the second son of the bailout, or the third set of the bailout and doesn’t include any of the other stuff that’s coming in. So now, when you look at these two graphs, you have to understand that this $14 trillion. That’s it. That’s all that there is to pay for this. This is present value. Travis made a great point is that, so even the present value of all this doesn’t have to be paid in one year, which you’re right, it absolutely doesn’t. But you figure, well, if we were going to take all this out and loans at say, 5%, that’d be $5 trillion, that we’d have to pay an interest, which is a third of GDP, which is a lot of flipping money. And so just Realistically speaking, there’s no possible way the government’s gonna raise $63 trillion in debt, no way, because nobody’s gonna buy it. I mean, China’s already balking at buying What are $12 trillion in debt. So what has to happen? You know, Jason has his six ways that the government tried to eliminate all of its obligations, but you’re not going to steal $63 trillion of oil. I mean, I suppose you could, but it’d be hard, you know, you’re not going to sell $63 trillion of ports, the only real way that you that young, two options you have left are one is to default, and one is to inflate. Just because the sheer magnitude of dollars here is too great for any of the other options to be viable. The purpose of this here is just to say that the total liability is so much greater than current output, that there’s almost no possible choice for when this actually has to get paid. Because this isn’t going to have to be paid. Now, it’s really gonna have to be paid in about 10 or 20 years. And so when that bill finally comes due, the only possible choice is going to be either default or inflate. And, you know, no self respecting politician is ever going to default on an obligation because they never get reelected. And so that means what’s most likely to happen is the government’s going to inflate the money supply to satisfy the nominal obligations. And then everybody who’s getting pensions, annuities, Social Security payments, Medicare, all of those people are going to see the purchasing power of what they’re getting paid, dropped down to almost zero. And then everybody who has inflation favorite assets, like hopefully, everybody in here, is actually going to go on to do quite well, because they’re going to have a natural arbitrage in their loans. That’s why I keep telling JC he needs to Quit whining about the government, you know, government spending so much because they’re going to make them rich. Okay, so now let’s take a look at when is the inflation going to come? And this is really thinking about now all of you have probably heard about the deflation is the people who say, Well, I actually think prices are going to go down in the near future. And the prices may stay down for a little bit, because currently, there’s relatively high unemployment. And now I think the reported unemployment is about 10%, or getting close, but the unemployment plus discouraged workers plus, in voluntarily part time involuntary part time workers is about 17%. And most economists agree that you know, what they call full employment, or basically anybody who really wants to work can find a job is about 5%, because you always have people who are leaving and then restarting new jobs. But since that unemployment is relatively high employments going to have to grow for a very long time before we get back to a full employment situation, where you have wages consistently stepping up. So that means anything that’s involving low skilled labor, or that’s in the service sector is going to have suppressed labor prices for quite a while, in addition to this factory capacity utilization is under 70%. And so the the pricing model for factories is for factory manufacturing goods, is that if your factory is running under full capacity, then what you do is you cut prices to try to fill up the factory because depreciation for a factory hits regardless of whether you produce one unit or not. So I work for the Intel Corporation is my day job. And our factories cost about three to $4 billion a piece to make. And if we’re not producing chips, we still have to pay that depreciation. So that means if our factories go under capacity, all of our pricing managers get calls every day saying, as we say, f t, f, Philip, the fab or f t, f f fill up the something or another fab. The Economics of our business model is keeping that fab full. And so as long as these the under capacity and the unemployment is relative, as long as the capacity utilization is low, and the unemployment relatively high, we’ll be able to hide some of this inflation for a while by pushing down wages and by pushing down prices. But this can’t happen forever, because otherwise nobody will build new factories. And if you push down wages forever, well, then they’re like Jason said, there’s no customers, if nobody’s working, and there’s no customers who’s gonna buy all this stuff. Here’s another one that particularly gets my blood boiling. So for those of you that, you know, have parents of the World War One World War Two generation or know people who are around in this area, the big thing back then was war bonds. They financed the wars with war bonds that paid Two to 4% interest, and they had all these patriotic posters, you know, help America save America buy war bonds. But what happened was, there’s two real interesting things I want you to pay attention to with the war bonds, number 110 years. Number two, not transferable. So what that means is, if you bought a bond from the government during World War One or World War Two, you’re stuck with it for 10 years, and you can’t sell it. And it’s like 2% interest. And by the way, after both world wars, the government devalued the dollar by about 50%. So for example, my father was in the armies and the army, I think, from 1967 in 1970. And, you know, his platoon officer said, Hey, you need to buy savings bonds. So he talked a whole bunch of savings bonds. And when he got off the plane from Vietnam in 1969, you know, he cashed in all these savings bonds, and the purchasing power of the money he got back was less than what he paid. And he had to pay taxes on the interest. And so this is one of the ways that people really, really, really, I’m going to avoid using too crude of metaphors. But really, let’s just say, Get shafted by the government is that what the government will do is it’ll issue this debt at extremely low rates, and then inflate the currency. So the purchasing power of the money you get back from these bonds is worth less than what you paid for the bond. And then you have to pay taxes on the interest. So now let’s say what about gold, Jason’s got his, his thing against gold. And you know what? I agree with him. For those of you that are fans of the daily reckoning, Jason and I both get the daily reckoning. And Bill Bonner, the author of The Daily Record, he’s big, big, big, big gold bug loves gold. But what’s unique about gold? Well, it’s a commodity. So that means it can’t be debased by debased by inflation. But here’s something that’s kind of interesting. So back in the in the in 1929, the Federal Reserve was on a gold standard. And they decided to contract the money supply, which ended up bringing a whole bunch of gold stock into the United States, because everybody was on a on a gold standard back in the 20s and early 30s, up until 1931, because that’s when England went off of it. But when the US depression started, then what it did was the US economy contracted. And then the exports in the US suddenly dried, dried up to all the other countries, and then the other countries sent gold to the US because gold was the settlement asset for trade deficits. Well, then what happens is in 1931, England gets tired of sending gold over to the US and says, Sorry, we’re gonna go off the gold standard. And so now the US has this big stockpile of gold. It’s contracted the money supply. It’s made this big deflationary spiral, a whole bunch of Gold’s poured into the Federal Reserve vaults. And then something interesting happens in 1933. Right after being inaugurated, President Roosevelt issued an executive order that confiscates all privately held gold, and that privately held gold was confiscated at $21 an ounce immediately after that, the pegged rate was increased to $35. Now it’s destroying 70% of the value of all that gold that had just been confiscated. So basically, what the government did in the early 1930s, was basically it confiscated all the privately held gold, re pegged it, then you repack the dollar against the gold, and basically made a profit of $15 per ounce on every ounce of gold that it had sucked out of the economy. Gold can be decent a bit, be a good way to hold value, it’s good money. It doesn’t get debased by inflation. But don’t kid yourself into thinking that the government can’t take it away because it has, and I don’t know if it will, but it can. And so now I just like to do a little kind of a quick chronology of the dollars purchasing power. I’m sure many of you have seen this graph before. But the dollar currently is worth 5% of what it was when the Federal Reserve came into existence in 1913. So the first big devaluation of the dollar came after world war one because generally speaking, the way that governments get rid of debt isn’t usually by paying off, it’s by inflating it away. Like we were just saying, they’ll monetize the debt, they’ll debase the value of their currency and inflate away all the debt. Well, then, after world war one, then the Federal Reserve suddenly wanted to increase their gold stocks. So they decided that they wanted to create the deflationary spiral that started the depression. And then after World War Two, they debase the currency by half again, because they needed to pay off the world war two debt, they had all that all those war bonds that they needed to get rid of. Well, now you get into this the the 60s and 70s. And so you know, like Jason was saying it was saying the other day when I showed him the slide, he said, but though the 50s were great, weren’t they say, well, well, yeah, the 50s were great, because the manufacturing capacity of the whole world was bombed crap. 80% of the manufacturing capacity in the entire world was in the US. I mean, and so basically, anybody that could fog a mirror could get a job because there were no factories anywhere. They’d all been bombed to the ground, but by the next 20 years, they’d been built up. So then suddenly, you know, suddenly there was a much more competitive market and the US is looking, it was in a lot more trouble. And that’s when it started having to inflate the currency again, as we can see in 1971, the government went off The gold standard, the gold standard was artificial, though, because it was pegged at $35 an ounce and nobody was allowed to own gold. So if you can’t own gold, is there really a gold standard? I don’t think so. But that’s mean, you know, the government now now has to finance a large number of social programs that were started in the 40s, and 60s, and then it also has to pay the debt from the Vietnam War. So it continues inflating the currency again, then now the CPI, the consumer price index becomes really important, because everybody says, Well, okay, if the government can control the money supply, well, then then the price level inflation, that that starts to become a big deal. And now every year the CPI changes. And that’s where we get to this, as Alan Greenspan called it, the great the great moderation, the period from about 20 to 25 year period from 1983 until 2008, where you had relatively stable prices. But as we can see, that’s the consumer price index, in and of itself is a little bit of a tricky animal. Because the way it’s calculated is, number one, food and energy is taken out because it’s said to be too volatile. Now, I suppose there’s a case for that because food and energy are volatile, but they’re real, you know, you and I aren’t going to live for very long if we don’t eat and don’t use energy. By pulling those out, it makes prices appear more stable than they actually are. In addition, we have Jason’s favorite, which is hidden tricks hidden, it’s basically says that if my computer gets twice as good as it was last year, the CPI assume that it costs half as soon as it costs half as much, which is partly valid. But for example, let’s say that I’m buying a lower end PC that costs $300, I can’t buy one that’s half as good for $150. They don’t exist, I can’t buy a 1985 equivalent car for $400. They’re not nobody makes them. And so the limit with hedonic is that you can’t necessarily go back and buy quality levels from 10 1520 or 30 years ago, because nobody makes them anymore. But we still assume that those price decreases continue to happen. Now, let’s take a look at some normalized market returns relative to the consumer price index. So from 1974 to 2009, the CPI grew at a growth rate of about four and a half percent. Okay, so now everybody says, Okay, well buy gold, right, you know, gold Gold’s the safest, safest asset, etc, etc. Well, gold hasn’t grown that much more than the CPI. Even even if you take into account its recent price spikes, gold only grows at about 6%, which is probably more like the real the real inflation rate. As you know, Jason and I are fond of saying, if you want to see the real inflation rate, just look at gold prices, that’s a lot closer to what the real inflation rate is, versus what the CPI says. So now let’s say well, what happens if you look at the s&p 500. So the s&p 500 grows a little fat has a little better compound growth rate. But what it does is it peaks up and then crashes down and then peaks up and then crashes down. Well, so now let’s think outside the box a little bit, raise your hands, how many people here have heard that real estate only keeps track of inflation, that that real estate doesn’t have real appreciation that their prices just keep track of inflation to long term? It’s anybody here heard that. And I there’s a couple of my friends that have said that, well, let’s say that that’s true. And let’s say that real estate appreciation only tracks with inflation, but you get to buy it at 5x leverage, you get to put 20% down, and you can use leverage. Well, if you just lever up the CPI by a factor of five, you’re outperforming the gold and s&p 500 for all but about two years. And that, frankly, is the real power of real estate is that even if the appreciation just tracks with inflation, then the leverage lets you beat the returns of almost any other asset class over an extended period of time. So now let’s take a look at what Jason likes to call packaged commodity investing or buying a house it’s made of bricks and sticks. So if we look at the cost breakdown of a typical housing unit, now, this is not including land, but a typical house is split pretty evenly between the labor and material costs, both of which are constantly getting more expensive. Labor prices can be suppressed for a little bit. I know that especially construction Labor has been held pretty flat for a while just because a lot of the immigrant labor has been in the construction industry. But still, labor prices are always going up, material prices are always going up. So one of the things that locking in at a particular price, especially if you lock in below the price of construction, what that lets you do is that lets you experience the linear price increases for all those commodities. Now let’s look at a typical housing cycle. And this is just a theoretical example. But for example, in a market say like Phoenix, or like Orlando or Miami, what happens is, you know, you have this red line, which is your cost of construction, it goes up in a pretty even line. But then when you have a whole bunch of demand the prices rocket up. And then as soon as the prices go up, then all the builders say, okay, we need to start building because we can make a whole bunch of money here. Now, Jason, how long did you say the building? The building cycle is two to four years, right? Two to four years. And now how many people here can guess what are the building cycles out right now fast, slow dead. Stop. almost dead stop. So what that really means and why this concept is so important is that the billing cycle in almost all the markets, especially the bubble markets is at a dead rock stop. And so that means that as soon as value start ticking up, it’s going to be one to two to four years, probably more like 123, before any new inventory hits the market. So that means that as soon as there any kind of real increase in demand, the prices for everybody that already owns houses in these markets is going to go up until new supply hits the market. That’s this piece right here. Because when you have a bubble, and all of a sudden that pops, prices go down, down, they go down below the cost of construction, if you can buy below the cost of construction, then what that means is, you are now buying in at a point where nobody can build for the price you bought it at. And nobody is going to build until the market prices increase above the cost of construction because people don’t build the lose money. You know, most builders don’t say, hey, I want to lose $5 million. Let’s get going. Yeah, exactly. Make it up on volume. So this is I think, especially when you’re talking about markets, like Indianapolis, or Phoenix, or all these markets, they have these foreclosures where you can buy at 67 7060 50%. Yeah, Atlanta. Yeah, all these markets, we combined below the cost of construction, what you’re doing is you’re almost you’re locking in an almost sure arbitrage opportunity, because at some point, there is likely to be demand that pushes the value up back above the price, the cost of construction. And when that happens, then that’s going to trigger the new builds, but they won’t hit the market for about two years. And during that two years before the new supply hits the market, your supplies base is going to be steady, it’s not going to be changing, not going up not going down. So anybody who owns property in a static supply market, while demand is increasing, is going to see prices go up pretty significantly. Now, I don’t know exactly when this is going to happen. I think we can be reasonably confident that it’s going to happen. Excellent question, sir. So the question was what happens when interest rates go up? Now, what typically happens with interest rates is that when interest rates increase, then it will suppress the prices. So the price growth will either slow or the price growth will stay flat. But it will push more people out of the buyer pool and into the renter pool. So this is what Jason and I call the the the heads I win tails, I win bet. Because if interest rates stay where they’re at, or go down, more people buy, your value goes up, you can now sell 1031 exchange into a new deal and trade up. Now if the interest rates go up, it’ll suppress values, but it’ll increase your rents because now there’s more people that need to rent because they can’t afford to buy, your cash flow goes up. And you can just sit on the property and buy and hold it and then refinance in seven years, take the money and go invest it in something else, or buy a toy or something like that. It is the proverbial heads I win tails I win, cannot lose arbitrage argument, which is frankly, what what attracted me to Platinum properties. Let’s take an example. Jc was talking about Indianapolis with its 2%. Its measly, 2.4% appreciation, let’s say you start with that 2% appreciation. But wait, you also have leverage. So now with that leverage, that 2% appreciation turns into a 24% ROI. But you also get cash flow on top of that. So now when you layer on that cash flow, you’re talking another 65%. And then if you qualify, you could also get some tax benefits, which gets you to an ROI. And these are just hypothetical numbers. But they’re not uncommon based on the performance we’ve seen, you can be looking at, actually, yeah, yeah, well, yeah, the properties in my other eye, but actually do better than this, I just want to do. So I bought two properties. in Indianapolis, the first one had an RV ratio of 1.5. And the second one had a measly 1.4 Rv ratio, which is, you know, only double what Jason recommends. But the point is that what real estate does is it lets you realize value from more than one direction. So you’re not totally reliant on appreciation, or totally reliant on cash flow, because for example, if you buy a bond, you’re completely reliant on the cash flow. And if whoever you bought the bond from the government or the company decides they can’t pay, you’re done, you’re finished. If you buy a property based on speculation, and it doesn’t go up in value, that you’re trying to just float all the cash flow, well, then you finish to Well, let’s say that you buy a property below the cost of construction with high quality debt that produces cash flow, maybe even enough cash flow to pay your interest Well, now you can sit on it forever, because you can just count you can just cash the checks every month, wait for it to go up in value. If it rockets up in value, you can sell it out and trade up. It is a absolutely with absolute Win Win opportunity, which is actually what what really attracted me to it in the first place. So now, here’s my piece on really defeating the demon of inflation. So I don’t know about any of you but I love the movie 300 that came out a few years ago with that kingly Unitas in the Spartans. So the first piece that I look at for defeating inflation is your shield, which is the tangible assets. Now, if you’re a gold bug, this is as far as the gold bugs go. They have tangible assets that are shield against inflation. builds are great, but they don’t win wars. So the next piece is cash flow. This is this is your armor. So this is what happens. If you buy a property with cash, you’ve got tangible assets, you’ve got cash flow, but you don’t have that spear, you know, you don’t have that that really great offensive weapon. Well, now, if you have leverage with value appreciation, well, now you get to meet the Spartans, because now now you have that nice shield of tangible assets, you’ve got that cash flow armor protecting you, and you have a long spear, that’s, that’s ready to just poke a big hole in inflation, I would like to say in a brief presentation, but I don’t know how brief I’ve been in a brief amount of time, I hopefully hope that this has been an opportunity to learn a few of the important things just about risk and inflation, because over the long term, you have inflation risk and investment, volatility is all pushing it on your well being. But if you take action, you can push against all of these factors. And you can win, Jason has the formula. He figured it out a little while ago. And he taught it to me. He’s teaching it to everybody here, and he’s gonna teach it to everybody that comes here next time, the real key is whether or not you’re willing to take action, because it doesn’t have to all be at once either because like, for example, I bought my first property. And then I convinced my wife to buy a second one. And now I’m refinancing both of them. Because the cash flow was so great that the market value exceeded our purchase price by a pretty significant margin around I think 20 or $30,000. And so on refinancing both of them at 80% of value. So I can, I’ll be able to pay off all my first loans and pull out cash so that I can reinvest in another property that we all be able to refinance it pull out cash and reinvest in another property. And as long as you just keep doing this one step at a time, one more property one more deal, just continue building your portfolio at some point, you’re not going to need to build it anymore because you won’t have to work and you’ll just be able to cash the checks every month, and then watch your values go up when the government inflates the crap out of the currency because it can’t stop spending. So now, I don’t have an opinion or anything but uh, but anyway, so this is a time for my shameless self promotion. as Jason said, I write a weekly weekly newsletter called the business of life, you can go to business of life LLC, it’s a big mouthful, or you can just go to Doug Berg comm they’ll both take you to the same place, but please feel welcome to subscribe, it’s free. I’m not gonna I’m not gonna spam you not going to sell your address, I just like to, I just like to send out my weekly newsletter and hope that I can enrich people’s lives in some way. So I closed in January of this year. And the second one at my second property, I actually bought with a home equity line of credit on my house, so that I actually purchased it with cash, I sent it I wired a wire to check over to the bank. This one was actually FHA. So I bought a wire to check to the agency. And because of that, since I bought it with cash, the seasoning period for refinances much, much lower than if you buy it with financing. So if any of you have the opportunity to use a line of credit, what you can do is you can buy with cash, and then have the short seasoning period, get your rehabs done, get a renter in, and then refinance it, pay off whatever you whatever you originally loaned, or you can just use the money you got buy another one with cash, season it rehab refinance and build up that way it’s a very effective way to build a build an inflation proof portfolio.
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