PODCAST “Charged Up” about The Financial Rules book


Editor’s note: This podcast recorded last month features an interview between “Charged Up” host Jenny Hoff and me, regarding my book The Financial Rules For New College Graduates: Invest Before Paying Off Debt And Other Tips Your Professors Didn’t Teach You.

You can listen to the audio post here:

You’ve graduated college and you’re ready to start your first job, but are your financial skills sharpened enough to make the right choices early on? Former Goldman Sachs trader1 and current university lecturer and columnist, Michael Taylor, takes you through the most important mathematical concepts you need to know to avoid massive debt and cash in on the amount of time you have to build millions in wealth for retirement.

Let’s get Charged Up! on learning the financial lessons you need to know!


Jenny Hoff:  Michael, thank you so much for joining me today.

Michael Taylor:  Thank you for inviting me. I’m excited.

Hoff:  So first tell us a little bit about your background and what motivated you to write this book.

Taylor:  Sure. Well, I start with my mission which is financial education – only a few people feel like they know enough. So that’s what I’m doing. The way I’m doing it is I have a weekly column, weekly finance column in two Texas papers, Houston Chronicle and San Antonio Express-News. I teach a course at Trinity University in San Antonio.

But how did I come by my mission and my expertise? I worked on Wall Street for six and half years for Goldman Sachs. I sold emerging market bonds and mortgage bonds, in that sense I like to say I sold the products that nearly blew up the world in 2008, but forgive me for that. I’m now doing penance. And then I ran a fund so I have sort of high finance experience and in a sense low finance experience.

And the mission is really from 2008 which was, “Wow, nobody seems to understand finance, not the political leaders, not the bankers, not the ordinary homeowners, and if nobody knows, we got a real problem.” So that’s what I’m working on trying to get the word out in many different formats.

This book is targeted toward 20-somethings, recent graduates who have a unique opportunity to sort of change their life with high leverage decisions that are going to be made in the first couple years after graduating from college.

charged_up_jenny_hoffHoff:  Absolutely, and I really like in your book that you give mathematical concepts and you explain what those concepts are but you put the math in there as well, why is it important for somebody to understand the math and not just kind of the concept?

Taylor:  I am so glad you went straight to my pet peeve, which is I have been a reader of finance books for a long time in order to write my column and to teach. And what typically happens is the author of every other finance book that I’ve read has said, “Hey, reader. There’s some important reasons why when you compound grow your money over long periods of time, hopefully decades, amazing mathematical things happen.” And then what they do is they include a table that shows you how $5,000 over 40 years running 6 percent earns X.

The problem with that is that the reader never gets the sense that there’s anything more than just magic happening. And my super fun pet peeve and the one thing I really wanted out of this book was to be the person who attempted to teach the math so that the smart college graduates can go, “Oh, you mean, wait, I could do this? This isn’t wizardry that my financial guru or my financial adviser or some person on TV is able to grow my money, it’s actually you start with certain basic here’s the amount, here’s how much it grows by, and here’s how much time passes, I can calculate it myself of absolutely how much it’s worth.”

So it’s sort of demystifying, it’s taking away the guru and having a person who can apply I would say junior high level math and go, “Oh, you mean my wealth creation over a decade was really an ordinary result of very ordinary things not wizardry, not guru talk, nothing mysterious. I can actually understand this myself.” There’s a lot that I think flows from that. You hopefully make different decisions. It also might occur to you like, “Hmm, if it’s not wizardry maybe I don’t need to pay as much to Wall Street in all its forms to do a magical mystical thing, maybe I could figure this out myself and pay the right amount.” You got to pay something, but the right amount, hopefully fractions of what people normally think, if you kind of go at it yourself. That would be one good reason to understand the math I’d say.

Hoff:  Yeah, because I think that’s a really good point, I think a lot of people hear of these great ideas, “OK, put your money in the stock market, put it in an index fund, leave it there for 30 years, it’s going to grow by 8 percent or so a year over the next 30 years.” And it’s a great idea, but most people don’t do it because it’s not empowering to them at all, right? It’s OK; that sounds like a good idea but if you don’t really understand it and you don’t feel like, “I could sit down and do these numbers and I made that number come across and now I want that number and I have ownership over it,” that is a much better chance you will actually follow that step because you will feel like, “I know what I’m doing.” I think most people feel scared of still to do it because it’s like, “OK, you told me I should do this, but I don’t really still know why I’m doing that.”

Taylor:  Absolutely. It’s very abstract to say, “Start with a thousand dollars, start with $5,000 and amazing things are going to happen. Trust me. It has to happen over decades, so you’re not going to notice it for the first amount of time.” On the other hand if you were able to, and here’s the thing I keep saying in my book – open up a spreadsheet alongside this book and use this basically as a recipe for learning the math. And I think if you worked with a spreadsheet and learned the math you would go, “Oh, this is not that abstract, this is just a function of time and return and I can understand how it works.”

There are tools now that are able to do that. I’m a big fan of Acors, I don’t know if that’s something you’ve looked at in your life, but they do visualizations of start with a small amount, look at the extraordinary amount it becomes. And something about the visualization I think is very powerful, much more powerful than the abstraction of hand over your thousand dollars and I’ll weave this into gold over a long period of time through wizardry. But the best thing is to figure out that you can actually do the math through a spreadsheet and play with the numbers and go, “Oh, I get how this work. This is not an abstraction. This is something I could do.”

And I think as you were kind of implying it’s hard to just trust in the 30-year process. I guess one of the hard things about investing for the long run is we have monkey minds, which is we focus on the minute to minute and day to day fight or flight responses to financial market moves, and we have to train ourselves to go, “No, no, no, in a sense put on the blinders for 30 years.” So we need tools to do that. One of those I think is learning the math because it helps us do that.

Hoff:  Sure, absolutely and your first question that you post in the book is what’s stopping you from achieving wealth? What do you think is stopping most people from achieving wealth?

Taylor:  Well, I guess that first thing is that we are trained to think in hour to hour, day to day sorts of risks and rewards. And probably the best way to achieve wealth is to somehow train ourselves to think in terms of decades. I mean, there are a small fraction of people who get rich quickly, that’s usually not a sustainable process. Anybody who is getting rich quickly is usually doing a thing that wouldn’t work for the next 20 people who come along and do the same thing.

But getting rich slowly is essentially available to everybody who can generate a small surplus. But it’s a long, slow, decadelong process. So the first thing would be training ourselves away from the monkey mind and into a kind of a decade long thing. It’s super hard to do, it’s probably a lifetime of trying to do that. The next would be we generally don’t get good guidance from professors and parents. A few people, I don’t know, I’ll make up a number, 1 percent to 5 percent of people have parents who are sophisticated about this and they can absorb the lessons. But 95 percent of us don’t have that.

And then third, and this is chapter two of my book, I think as usual media plays a real problematic role. In today’s language I wouldn’t say it’s fake news, but I would say it’s distracting from what we should be doing, because most media is not in the business of calming us down and saying, “Hey, wait 30 years, it’s all going to work out.” Most media is actually in the business of emotions and eyeballs. And we know this but we live in it so it’s hard to separate ourselves from the emotional response to, “Hey, the stock just went up or the stock went down or interest rates are rising or we’re having a trade war with China.” There’s a lot of hourly, daily anxiousness creating things. So I actually hold financial media to blame for a lot of it.

Hoff:  It’s always their fault, huh?

Taylor:  Yeah, it’s all the media’s fault. No, I mean, we ultimately all have personal responsibilities.

Hoff:  No, but I know what you mean. It’s a lot of excitement and it’s not a lot of just be patient, this is the ups and downs. They’ve always happened, they’ve always happened and this will be your average return. Let’s talk about some of the mathematical concepts that you think are the most important for us to understand. You’ve got a bunch in your book, but you definitely talk about compound interest. Let’s start with that, why is compound interest important to understand?

Taylor:  Well, the first concept is really interest rates, and I find even my college students don’t really understand how how interest rates work. Do you multiply the annual percent thing times the amount of money you started with and after a year either you earn more money with your savings and investing, or you owe more money if you’re borrowing? And that interest rate is sort of the building block. But that’s not an obvious thing, and I think financial illiteracy around interest rates is the start. We have to overcome that.

But once you got that down then I think the world opens up and compound interest then becomes a way for people to practically understand how ordinary small amounts of money cannot through magic but just kind of the application of math grow to extraordinary levels. So, a friend of my mom’s is in her seventies sad she had $250 and she bought a stock many years ago. If it grows for 40 years, which it did, over her lifetime, you now have something worth $300,000.

And you go, “That’s impossible.” And then actually if you work backwards with the math you go, “No, she earned a little over 12 percent on those initial stock investments, about $250, and now it’s worth $300,000.” And it’s not magic; it’s just time and an application of a compound return.

You can sort of show that magic trick and you go, “OK, now but can you understand that magic trick?” And it’s really just math, so I think that’s very powerful to say, “You can start in early in your life, in your 20s or maybe your teens if you have a great newspaper delivery job.” But if you put that away and you most importantly probably never sell and you apply a high but realistic interest rate to that you’re going to end up with some extraordinary wealth later in life. Compound interest is the thing that explains the magic trick essentially, which I think is very powerful.

Hoff:  Yeah, absolutely. And talk a little bit more about interest rates, because I think we’re with CreditCards.com obviously that’s a huge topic when you deal with credit cards especially high reward credit cards usually come with high interest rates, what do most people really not understand? They might see a figure 16 percent, 20 percent, but not really think much about it. What do they need to understand really about those interest rates?

Taylor:  Oh, there’s so much. That’s such a good question. There’s an amazing example by this author, Andrew Tobias, and I don’t know if you ever spoke to him. But he’s got a way of demonstrating the difference between 10 percent interest and 20 percent interest, and he starts with a dollar and you sort of add each day 10 percent on the initial thing, and after a month you get to about $29 worth with 10 percent interest. At 20 percent interest if you do that same thing it goes to about $520.

Hoff:  Oh, wow.

Taylor:  Our normal way of applying math instincts would say, “Oh, the difference being 10 percent and 20 percent interest is not that big. It’s only double.” But the result is applying compounding over in the example that Tobias gives, it’s in my book also, and it’s just 30 days but we could extend the same example to say 30 years of compounding.

It’s not twice as much money that you owe if it’s 20 percent versus 10 percent, as we might sort of think. But it’s in fact usually 20 times, it’s not twice, it’s not two times, it’s 20 times or 30 times depending on what the interest rate difference is and how long you go. So it becomes again at the risk of referencing math pictures that people might be aversive to, it’s one of those lines sort of like when you track population growth or you track the spread of viruses, the line goes sort of gradually goes upward and then suddenly it’s shooting straight up in the air. The math term would be asymptotic. But it turns and it curves, and all of a sudden it goes bonkers, it sort of reaches a critical level where it sort of leaves the atmosphere. It’s a rocket analogy.

So when you’re paying 20 percent interest on your credit card there’s a difference between that and 10 percent. The compounding effects of paying that. So that’s the upsetting part, if you need to pay high interest debt. The more positive side is if you are able to earn 10 percent rather than 5 percent, the difference is not two times of the amount over a long period of time, that’s 20 times or 30 times the amount. But just that would be the optimistic side of it.

Hoff:  That’s why at very high levels of wealth when they’re investing you’ll choose between a firm that can deliver even a 0.1 percent increase over another firm you’ll probably go with them, because at very high levels of wealth that makes a huge difference.

Taylor:  Oh, yeah, the move from 4 percent to 5 percent, if you have a hundred million dollars there’s some very big compounding effects of that kind of thing. It’s definitely worth it. But at the ordinary wealth level or the ordinary dealing with debts level, it is sort of I would say a basic financial field to figure out, “OK, do I have to pay 22 percent on my credit cards,” which is not that uncommon. “Can I get that down to 12 percent? Could I in fact figure out a way through a home loan to reduce my debts to 4 percent?” And if you can do that the wealth effects are very substantial. But we have to know to ask the questions – how do I get my interest rates down?

Hoff:  Absolutely. Let’s go on to cash flow. Explain it, how do we apply it in our own lives and why it needs to be front of mind when making financial decisions?

Taylor:  A really good question. I was going two different directions in cash flow, the first would be when I think of investments that are appropriate especially for a young person who is trying to grow wealth. I think you need to focus on things that do produce cash, that means instead of that you’re hoping just the price of the thing goes up, so I’ll just need some quick examples of what I mean. Bonds and stocks produce cash, bonds through interests and stocks through dividends. And they generate cash, and I like to think in compound interest terms that when you generate cash you then get to compound your returns by having the cash that was generated from your investments becomes like little baby cash, and you grow money on your money and that is sort of the process of what compound interest describes.

So you earn 10 percent on your thousand dollars, you have a hundred dollars extra. That hundred dollars is quite, to use a word from biology, second or it produces little baby monies. And that’s a good thing over a long period of time.

In contrast there are things that look like investments or that some people consider investments like gold, or I shudder to say the word bitcoin or other cryptocurrencies, they never generate cash. You are hoping that the price goes up, but in itself gold is essentially a lump of shiny metal and a bitcoin is a fiction of our financial imaginations, but in either case does it ever produce money.

So one of the things I think about cash flow is find investments that produce money. Interestingly enough real estate, there’s two types of real estate – there’s your home which is a form of an investment but does not generate cash, it actually costs a lot of money to live in a home. So I would say your home properly understood does not generate cash, and is not therefore a thing for which compound interest will ignite baby monies that you can grow that turn into big monies.

Commercial real estate or things that are investment real estate, if you can generate cash from that that is a plausible investment that if you have positive cash flow on real estate, which is hard to achieve by the way. It’s easier to have negative cash flow on real estate. It’s hard to get positive cash flow. But if you can that kind of cash then becomes something that can ignite the power of compound interest and make you wealthy over the long run.

I’ll pause there because you might have meant something different about cash flow or maybe that is what you want.

Hoff:  No, that’s great. It’s great. But some people say, OK, they own a house but it’s going to gain in value. You don’t know how much it’s going to gain in value, right? So you’re saying kind of the only thing that you know is if it’s producing money. So the same thing with gold, gold holds its value basically. So gold is kind of a security that you have there in case all else fails and then money tanks then gold is something that can maybe buy you something. But as far as generating new money that is how you have to think of cash flow. So, I’m going to invest in something that will produce more money to either go in my bank account or to reinvest into that property.

Taylor:  Yes, and I feel strongly about that. I think it’s disqualifies gold for most people who need to generate wealth, from my perspective it disqualifies gold as a way to do that. As you said it has a different function which seems to be the thing you hold as last resort, but that’s more of an insurance policy kind of a hedge against everything else in the world going to a bad place, but it’s not a wealth generator, I don’t believe. I don’t think it’s a legitimate wealth generator. I think it is a different function.

And we sometimes confuse that because it fluctuates and you think, “Oh, it just went up, maybe I made money.” Similar to your house often goes up in value or down in value but mostly up over the long run, but it doesn’t generate cash. So it’s a lovely thing to own a house for some reasons and many of the most middle-class people who are homeowners do in the long run make money off their house, but it’s not quite the same category as a cash flow generating thing.

Hoff:  And actually when I spoke to Robert Kiyosaki on this show he kind of said the same thing, he likes to look at things with cash flow. Is more money coming to me every single month? I don’t have to wait for it to gain in value, I don’t have to keep my fingers crossed that it won’t gain in value. I know I’m getting something from it because I’m seeing it come into my bank account every single month.

Taylor:  Yeah.

Hoff:  So also I want to talk about, because I have a lot of things I want to get through, and we don’t have tons more time, so let’s talk about debt. And I think a lot of students get out of college and they say, “OK, my first goal is I want to pay down this student debt. I don’t want debt hanging over me.” Now we know that most people if you get federal loans you’re probably getting a pretty decent interest rate, 4 percent, 5 percent, which is less than obviously credit cards which is 16 or 20 percent. So should they concentrate on taking their first big flow of cash and sticking it to that debt to get rid of it as quickly as possible? Or should they just take their time to pay off that student loan debt as slow as they want to as long as they make those minimum payments and put their money into an index fund or something like that instead?

Taylor:  It’s such a good question and it is a perennial subject for debate. I will say that my answer is somewhat in the subtitle to my book, the main title is “The Financial Rules for New College Graduates” and the subtitle is “Invest before paying off debt and other tips your professors didn’t teach you.”  So embedded in there is I’m saying it is OK, and in fact it’s preferable to start the investment process even before all of your say student loans have gone away.

Also embedded in your question is should you always tackle debt before tackling investments? And the main differentiation there from my perspective is do you have high interest debt, which would be at the worst end payday loans? Or at the more common end many people have credit card balances and those tend to be very high interest debt. Or do you have low interest debt, the main categories there being student loans, usually home mortgage, and often a prime automobile loan?

And if you have low interest debt and in particular to your question the student loan debt coming out, I believe it’s something that doesn’t get in the way of building wealth of 3 to 4 to 5 percent subsidized interest rate loans compared to the opportunity of putting money into say tax advantage retirement accounts like an [individual retirement account] IRA or 401(k) or 403(b), or even a taxable account. There’s a lot of mathematical as well as psychological reasons why you could plausibly and responsibly invest before fully extinguishing your student loan debts.

I’ll give one example of where I’m very certain about the math, and that would be if you have a very good job which offers a 401(k) or 403(b) style employer sponsored matching funds, I think there’s a strong consensus around the idea that if you are able to get matching funds from your employer that’s a 100 percent return on investment immediately. Let’s just to give an example they say your first $3,000 you put into this will match it. There is no other free lunch in the known universe, so do that. Put in the $3,000 before almost doing anything including credit card debt.

Hoff:  Right.

Taylor:  Monies above that that are put into your retirement account you are going to save on taxes immediately, so let’s say you have a reasonably good paying job between $35,000 and $90,000 and you’re in the 25 percent tax bracket. We could say that you will get on a tax adjustment basis a 25 percent return for all monies you put into that retirement account. So again, there’s very few debts that are going to be above that, so that’s a pretty plausible mathematical case for investing before fully paying off even your high interest debt.

So there’s math answers we can give, and I would say against low interest rates, student loans, or home loan or a prime auto loan, yeah, definitely. Start to build some investment nest egg first.

The main response to that just to argue with myself a little bit would be – people have different psychological approaches to the debt. There’s some portion of people who are addicted to debt, and I would never advocate feeding your addiction. And there’s some portion people who can’t have alcohol and some portion of people who can’t have debt, so if you’re in that abuse category I think you got to go cold turkey and that’s a psychological very personal thing and you got to pay down your debt or you have to work on that before anything else.

Then there would be another category of people who don’t have a problem with debt but they do have a psychological aversion to any kind of risk, and those people will tend to pay down their debt quickly anyway but that’s a fine choice. They’ll pay down debt more aggressively, and it’s never bad to pay down debt essentially.

Hoff:  OK, but in general you’re saying it always pays to at least put it in your 401(k) if you have a matching kind of program, and then if you have the only low interest debt even an investment into the stock market or something is probably going to pay you more than kind of what you’re paying in that debt. Just as long as you make your minimum payments on time because then your credit score tanks if you don’t and it becomes another nightmare and another mess. But just as long as you can handle it and you have a plan of action.

Taylor:  Yeah, if you’re not paying your debts very bad things happen. So I would never say invest and not pay your debt, definitely. But if you can carry your debt and you can make the monthly payment, and especially if it’s low interest it is compatible with building wealth in an investment terms I think and therefore I would say you should probably get started early. The advantages to starting early in your retirement are so strong as well as the tax advantage as well as the matching advantages that it becomes a pretty strong case to do it.

Hoff:  Yeah, I mean, I kick myself all the time that at 22 I was the typical 22-year old who thought, “Well, gosh, 50, 60, that’s so old. I’m not going to put my money away for that right now.” And just that money, how would have grown over these years? And it doesn’t even take a significant amount, it won’t change your life at all just to put it in there, you won’t miss that money and yet at the end of the day when you are 50 or 60 which comes a lot sooner than you think suddenly having that win full of money helps out a lot.

Let’s talk now quickly about savings, you kind of have some savings advice in the book. What do you think is the ultimate savings plan that we should be looking at?

Taylor:  Yeah, savings is one of those things that sound simple. It’s sort of like, “I would like to lose 5 or 10 pounds,” and yet the reality of not eating that extra dessert is so difficult that we have a hard time losing 5 to 10 pounds. And savings is in that category of – it doesn’t make sense how hard it is, but it’s so hard. And I just want to say to everyone who’s managed to do it, congratulations. To everybody who’s struggling to do it, of course, I mean, we’re all there. It’s really, really hard to save money.

And I even think that is true if you’re making $30,000 to oddly enough that you’re making $300,000. I worked on Wall Street at Goldman, there are people making more than a million dollars. It’s very hard to save money as strange as it sounds if you make a million dollars because you have friends who have jet ownerships and you need a vacation on St. Barth’s, and it’s very expensive this vacation is a St. Barth’s, so people who make a lot of money also have a hard time saving, so I’m like sympathetic to all levels of it.

I find the most powerful way or at least the advice I’m most confident with when it comes to how do I save money is you basically have to trick yourself. And by that I mean you have to automate the savings some way. There’s a neat app that’s called Qapital with Q, Q-A-P-I-T-A-L, that does this kind of thing where it automatically moves money according to some set triggers. But you could do this with any bank who will set up automated things.

The point is you have to have a way to take money out of your spending account and essentially hide it from yourself, I think, into a hard to spend savings account at a different bank or in the form of Qapital like the app sort of takes the money and puts it in a Wells Fargo account somewhere else where it’s hard to access, because essentially no matter what your income we will expand our lifestyle to fit the income.

Hoff:  That’s true, yeah.

Taylor:  And if the money is there we’ll spend it. So my greatest advice is automating a process to take the money out, probably matching your pay day. So like if you’re paid once a month, on that day move the most amount of money you can plausibly forego and or twice a month, if that’s how you get paid, and move it before you even have it so that you don’t see it and you don’t spend it. I think most of us are not strong enough to see the money in the account and not spend it, and if you’re in that category of most of us you got to trick yourself. That’s the biggest thing.

Hoff:  What’s the number one trick you have for taxes or tip that you have for taxes? Because taxes is one of your chapters in the book, what do you think is the most important thing for people to understand besides paying them?

Taylor:  Oh, yeah, definitely pay them. And I don’t prepare them myself, but that’s sort of a No. 4 tricky. The number one trick from a lifetime perspective of approaching taxes, and this is a thing that is not available to most college graduates at first, but maybe is a thing for which they could shape their financial or working life toward, and I haven’t seen this written or talked about pretty much anywhere, is that the tax system is written for capitalists, which really means labor. If you work for a living as a worker that’s much less tax advantageous than it is if you make money on your money.

So I’m sure a version of this is what Robert Kiyosaki would say which is when you own a business there’s a tremendous amount of tax advantages. So being an entrepreneur or owning your own business, which is really only appropriate for a certain slice of personality type I would say, but if you can do that you will find that the tax code is written for you. And if you work for a living for somebody else as a worker, as an employee the tax code is really not written for you and it is I would say tentative. The rates are higher, you get fewer tax breaks. But if you are an entrepreneur for you there are many more deductions and you have a lower tax burden.

But having said all that entrepreneurship is probably not appropriate for a huge portion of the population, they’re not wired that way. So the next best thing you can do to orient yourself, again, this is over a lifetime, this is not something a college graduate can do. But then you have to think, “Well, the tax efficient way to earn a living or to have money coming to me on a regular basis is to try to make money on my money.” And by that I simply mean the more again over decades, over a lifetime build up a pile of investments those investments will be taxed at a lower tax rate, dividends and interest and capital gains are all tax advantaged when compared to working for a living.

So again, it’s kind of an example of the rich get richer where the tax system is written for capitalists, when you make money on your pile of money it’s much more tax efficient than working for living. For many years many or most people who do this even successfully we’re talking about really in your retirement, you’re making money on your money, you’re not making money on your labor. But if you can shift that forward, if you can get there by the time you’re in your 50s or get there by the time you’re in your 40s, or at least start to replace your labor with your capital from a tax perspective you’ll find yourself taxed less and less. Again, this is not something a 22-year old can see right away.

Hoff:  Sure, but it’s something to consider when they’re making their life plan.

Taylor:  Unless you happen to inherit, try to be taxed as a capitalist not as a laborer is sort of the biggest strategy I would say.

Hoff:  Fantastic. And Michael, of all the things we’ve talked about here, and there’s so much more in your book, what are the three most important things a new graduate could do right now to get on the path to wealth accumulation?

Taylor:  Such a good question. The first one is move, and this is difficult, I’m going to admit right up front this is difficult, but try to move as quickly as humanly possible, maybe it’s going to take you months, it might take you years but try to do it months to move from indebtedness, carrying a balance, or having student loans to a monthly surplus. A monthly surplus is kind of the first goal for somebody who’s graduating. Just whether you’re making 10 bucks more than your spending per month eventually try to make it 100, then make it a thousand.

That move from being in a monthly deficit to a monthly surplus is the thing you have to move to as quickly as possible. And part of the reason it’s hard is because every city where you move, everywhere you move after you graduate from college the costs of living are not built for college graduates, they’re built for 30-year olds and 40-year olds and 50-year old and 60-year olds who have had decades of bonuses and pay raises.

Hoff:  Right.

Taylor:  So every college graduate I would say is expected to be completely underpaid for where you live. It probably doesn’t really work the math of where you can go in your first job. They pay you too little so you have to probably choose a very rice and beans lifestyle unfortunately. So that’s number one is just try to survive a rice and beans lifestyle as quickly as possible to get out of the deficit and into the surplus.

The second related thing is if you can do that start early and start small with investing. I guess, small steps taken early are way more powerful than heroic steps taken a day when it comes to investing, and the math line of that is compound interest, but that’s a thing you should try to do.

And then that the third one is if you really want to get good at this you probably need to read books rather than watch the internet and TV, because I think that somehow properly filtering media is a skill that we have to get better at. So if you want to be a student of investing or a student of personal finance I would say books. Now that happens to be a self-interested statement because I’m selling a book, but that’s the way I learned about it best. Of course I read The Wall Street Journal every day and I read online about finance but that’s never been as useful to me as reading books if you want to be like a student of everything like that.

Hoff:  Yeah, absolutely.

Taylor:  But anyway, move to a surplus, start early and start small, and then read books.

Hoff:  Perfect, and finally our show is called Charged Up, what gets you charged up about breaking down the numbers to make the concept of wealth more accessible?

Taylor:  That’s a good question, and I’m so glad that you’re doing this, and charge up is great. I mean, what is the theme? It is my life’s mission. I mean, I wake up in the morning I go, “How can I be useful?” And the way I can be useful is trying to make the seemingly complex, which is finance, simple to understand. None of the good things we do in finance are necessarily easy to do, but they should be simple to understand. I get charged up about my life’s mission which is to make this stuff understandable.

Hoff:  Fantastic, and you really have, and I mean even though you have a lot of math concepts in the book I hope nobody gets scared off from that because you really break it down, you give examples, you give metaphors, you really try to make it so that even if you don’t have a financial background or a mathematical background it’s not that daunting to figure it out. And I think it’s very empowering once you do grasp a concept much better than just hearing it to put it into practice and to feel like, “OK, I’ve got this. I can build my life. I can build wealth in my life.” Thank you so much, Michael, great talking to you, great book and great advice.

Taylor:  Jenny, thanks so much for the conversation. I really appreciate it.



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  1. Actually, bond salesperson, but ok

Book Review: The ChickenShit Club by Jesse Eisinger

Editor’s Note: I did a podcast with Jesse Eisinger for the finance website Make Change, in which we discuss his book in further detail. I recommend listening to it here!

Nine years after the Great Recession mortgage bond crisis of 2008, no executives with any seniority on Wall Street faced criminal consequences. Although a few suffered civil penalties like fines, the lack of jail time left many asking, why?

chicken_shit_clubSeptember 2017 marks the ninth anniversary of the most explosive month of the Great Recession. Over one dramatic weekend nine years ago, legendary Wall Street firm Lehman Brothers declared bankruptcy, brokerage giant Merrill Lynch threw itself desperately into the arms of Bank of America, and insurance conglomerate AIG became an 80% ward of the federal government. That very bad weekend in mid-September followed hot on the heels of the previous week’s fireworks, in which mortgage giants Fannie Mae and Freddie Mac entered “conservatorship” status with the Federal Housing Finance Agency.

Like a ghost revived from horrors past, on September 11, 2017, the Justice department brought civil charges against Deutsche Bank mortgage bond trader Paul Mangione for fraudulently structuring sub-prime mortgage bonds back in April 2007, more than ten years ago. Mangione doesn’t face jail time, but rather civil penalties such as fines. So, we’re still reaping the consequences of the subprime mortgage debacle more than 10 years later, and still nobody’s going to jail.

My personal, deeply unpopular, view is that financial executives didn’t go to jail from the sub-prime mortgage crisis because they didn’t commit crimes. Poor money management is not a crime, nor is losing money for your firm or investors. Executives were guilty of believing too deeply in a flawed financial model or failing to respond quickly enough to systemic risks, but that’s a series of human errors, not jailable offences. Many observers of the sub-prime mortgage crisis disagree with me.

Jesse Eisinger, a Pulitzer Prize-winning financial journalist, just published a book this summer, called The Chickenshit Club: The Justice Department and Its Failure to Prosecute White-Collar Criminals, disagreeing with me. I mean, he’s not literally rebutting my argument, but rather he’s explaining the complex history of why nobody went to jail for the mortgage sub-prime crisis and the Great Recession more broadly.

As a general rule, I think it’s a tonic to learn from smarter, better-researched people who disagree completely with me. So I recommend the book whether you agree or disagree with me.

Eisinger’s answer to the question of “why no jail time?” as hinted at by his profane title, is that institutional weaknesses in the US justice system, from the SEC to the Justice Department to especially the Southern District of New York, made them unwilling and unable to catch white collar criminals and put them in jail.

Eisinger contrasts the earlier experience of the Enron prosecutions of criminal behavior by executives following the 2001 collapse of the trading giant with the absence of criminal prosecutions of Wall Street executives involved in the sub-prime mortgage collapse. So what changed between 2001 and 2008? In Eisinger’s telling, many factors combined.

First, a backlash developed against the damage caused by the aggressive prosecution of Enron’s accounting firm Arthur Anderson, a former “Big-5” accountancy, which drove them out of business in 2002.

Government prosecutors worried about the kind of collateral damage – to innocent employees, customers, investors – if they took down Wall Street firms, especially given how weak big firms were in the aftermath of 2008.

Second, prosecutors developed a preference for reaching a new kind of agreement called a “Deferred Prosecution Agreement,” (DPA) in which corporations – but importantly not individuals – agreed to pay fines as a result of bad actions. Typically a DPA meant a hefty corporate fine, ultimately paid by shareholders rather than executives, and an agreement to hire an outside monitor against future ongoing bad behavior.

Not incidentally, these monitoring agreements became extremely lucrative for big private law firms, encouraging a kind of Big Law lobby for more DPAs in place of criminal prosecutions.

Next, he describes a classic kind of regulatory revolving door between government prosecutors and lucrative white-collar defense practices. Eisinger believes many ambitious prosecutors want to eventually make ten times more money in private practice defending white collar criminals. So, they might not want to be overly aggressive prosecuting white collar criminals that could be their future private practice employers.

Finally, Eisinger describes prosecuting white collar crime as a particular skill, requiring a certain institutional culture of risk-taking and a consequences-be-damned attitude. Between the Enron/Arthur Anderson backlash and the rise of DPAs, our regulators lost their taste for putting executives behind bars. Running up the score with DPAs and corporate civil fines became easier than the more difficult task of jailing executives.

Interestingly, legal heavyweights making 2017 headlines such as James Comey, Preet Bharara, Eric Holder, Sally Yates, and Bob Mueller make cameos in Eisinger’s book, often in an unflattering, or at least mixed, context.

jesse_eisingerI spoke to Eisinger about his book recently. As a former mortgage and CDO salesman myself, I tried to explain, the actions of Wall Street folks described in civil complaints about sub-prime mortgage securitizations fell within a normal range of activity of how we did our jobs. Eisinger didn’t buy it.

But even reading the September 2017 civil suit about Paul Mangione at Deutsche Bank, I’m struck by how banal the complaint is. Mangione’s emails and phone records show he is deeply skeptical about the quality of mortgage underwriting standards. He neither created those mortgages nor had any real ability to influence their creation. His job was to take the product he received and try to make bonds he could sell out of them. To refuse to do that would be to refuse his way out of a job, at least a job as a sub-prime mortgage trader at Deutsche Bank.

I remain skeptical. Eisinger’s right to point out the troubling weaknesses in our current system of prosecuting white-collar criminals. I stick to my often unpopular stance that the sub-prime mortgage and CDO traders did not commit crimes for which they deserved jail.


a version of this ran in the San Antonio Express News and Houston Chronicle.


Please see related posts:

All Bankers Anonymous Book Reviews in One Place!

Mortgages Part VIII – The causes of the crisis



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Audio Interview: Gary Sernovitz on Fracking Personalities

Note: I reviewed Gary Sernovitz’ book in September, and we did a phone interview back then, which I’ve now posted as an audio interview, Part I – on the big personalities in fracking. Part II – on environmental issues, will follow. I recommend listening to the audio version, but I’ve posted a transcript of our conversation as well.

Mike:               Hi, my name is Mike, and I used to be a banker.

Gary:               And I’m Gary. I guess I’m sort of still a banker, at least a private equity investor.

Mike:               Perhaps more importantly, you’re also ‑‑ full name, Gary Sernovitz the author of, among other things, The Green and the Black: The Complete Story of the Shale Revolution, The Fight Over Fracking and the Future of Energy. Thanks for talking.

Gary:               Thanks for having me.

Mike:               As you know, I read and really enjoyed your book, and I reviewed it on my site. I just want to praise you for doing what I think is my favorite thing, which is taking a complex issue upon which nobody agrees, and everybody thinks the other side is complete fucking idiots, and saying no, we’re not all idiots. We could understand each other. So thank you for doing that. That’s really great.

Gary:               Thanks for the praise and clearly, that is not the dominant mode of American discourse, as evidenced by the discussions heading into November.

Mike:               Yeah, it’s really difficult to not see the other side as either morons or dupes or evil. And I would say if you just say the word “fracking” we’ve already introduced the idea the other side is one or all of those things. I appreciate you describing yourself as a New York liberal. And I described you as deep in enemy territory there for fracking, and yet you have to both answer for your profession, which is to be investors in energy and in oil and gas and fracking, but at the same time, be a thinking person.

Gary Sernovitz

I don’t know who’s more unattractive, oilmen or Wall Street guys, but every once in a while, I’ll say something mildly positive about a Wall Street guy in some column and people will write inevitably “You’re such a jerk talking about the banksters as if they’re not all evil.” Okay, sorry.

Gary:               I manage to work for a private equity firm that invests in the oil and gas business to be the worst of both worlds.

Celebrities of Fracking – Aubrey McClendon

Mike:               Some of the interesting parts about your book are combinations of celebrating capitalism, and ingenuity of the shale revolution, and incremental changes. And then part of that celebrating capitalism is celebrating some of the funny and interesting characters who made good off of the thing.

I’m interested in some of those. Some of them I’ve heard some of their names but don’t particularly know them, but I understand they’re rock stars of your industry. I’d love to chat about those if you don’t mind.

One, your favorite seems to be Aubrey McClendon who I guess died after you’d written the book. I don’t think you referenced his death, or maybe you do?

Gary:               No, he died in what is not terribly clear ‑‑ whether it was self-inflicted or not, but drove about 80 miles an hour into a highway overpass the day after being indicted.1 Obviously, a lot of speculation on the timing of that.

The late Aubrey McClendon, from a 2011 cover story

Mike:               Certainly looks suspicious, as a complete outsider.

Gary:               The conclusions most people have drawn ‑‑ but I think there has been no official word from the investigation one way or the other. Not necessarily that there needs to be, but the funny thing about the book is there was an alternate book that was just sort of a straight biography of McClendon that kind of was impractical to write with my job and with need to write ‑ he’s backed by a firm in his later life that competes against my firm in terms of providing capital to oilmen. I ended up putting that to the side.

Mike:               There’s a book worth or more of Aubrey McClendon stories?

Gary:               Yeah, sort of every chapter you find he’s Zelig of the book. In every chapter he kind of finds his way. There is a small Aubrey biography woven through it unwittingly, just because he is one of the more colorful characters. He kind of harkens back to a different kind of swashbuckling capitalism. Partly he enters the oil business, kind of a wildcatter, and partly he did have a very unusual role just that effectively the company he had, Chesapeake, was thought of as somewhat small, sort of volatile, high risk.

Mike:               A wildcatter spirit of a company versus the more corporate people?

Gary:               And hold onto your seatbelts when you deal with Aubrey and Chesapeake in general. When the shale revolution started ‑‑ it wasn’t really him, it was another company, Mitchell Energy that started it. So when it started, what Aubrey did was really kind of sort of start this competitive frenzy in successive basins where people would discover oil, maybe we have a shale here in north Louisiana or east Texas or North Dakota on the oil side, or Pennsylvania or Ohio. And Aubrey had thousands of guys knocking on doors, and an unlimited appetite for capital and complexity, and everything that just got billions of dollars.

Then everyone looked around and oil companies pursuing more normal course ambition ‑‑ “Well, Aubrey’s going to suck up all the opportunities!” and so he was the catalyst in these basins for this frenzy. Then ultimately, you know what happened was he kind of didn’t fully grasp ‑‑ no one did, how good this was going to be. So he ended up with a lot more gas and crashed the price of gas. So many basins worked, and successively cheaper prices, and that happened on the oil side, and then also just any companies with too much debt heading into a downturn is always going to be in trouble. He kind of got a margin call on his personal account for two billion dollars.

Mike:               I should be so lucky someday. I will be so upset when I get a two-billion-dollar margin call.

FrackingGary:               That’s how much he was worth at the peak. I don’t know what the margin calls was for but my net worth went down by a couple billion dollars. Then he kind of got kicked out of Chesapeake because of all sorts of other somewhat old-school CEO perks that are sort of beyond ‑‑

Mike:               Sort of pledging shares, right, for his own purchases?

Gary:               More like he had the right to buy interests personally in all the oil wells Chesapeake owned, which is a thing ‑‑

Mike:               I see, a conflict of interest.

Gary:               Yeah, just kind of was not done that much anymore. Then he got backed by a private equity firm and they bought eight billion dollars of properties, oil properties right before the oil price collapsed. The bigger issue facing him was not really this indictment, which is somewhat on a pretty secondary issue, but really was on financial difficulties, and five or six different companies all bleeding cash, and all big debt problems.

Just sort of the world coming in ‑‑ he owned 20% of the Oklahoma Thunder and he had pledged that for a loan. I think maybe it was last weekend [September 2016] for some reason he needed to have the largest collection of Bordeaux in the world. So that’s being auctioned off now by his estate. Somewhat in bad form, and got a lot of bad publicity. He had pledged 20 million dollars to Duke his alma mater.

The_Green_and_the_blackMike:               I read about that, that Duke said “where’s our 20 [million]?,” and the heirs didn’t find that tasteful.

Gary:               Oh, the Duke alumni, the Duke community ‑‑ just say yeah, that’s a charitable donation. It is unclear what will happen, but it is definitely a very 19th century or very early 20th century, Dreiser story of rising and falling and rising and falling.

Mike:               Captain of Industry or Robber Baron type.

Gary:             Outside the realms of normal corporate America or the norms of it. Obviously kind of very entertaining but did have an impact on it. He was known to be an extremely nice guy.

Mike:               Presumably a gregarious salesman type.

Gary:               Yeah, he wasn’t cynical. His margin call was on buying – insatiably – stock in his own company, so he obviously believed in it. He was not a dark figure but an irresponsible figure, then left a lot of obviously shareholders, partners, and everything holding the bag, based on sort of a wild irresponsibility in terms of how he built his business.

Mount Rushmore of Fracking – Lucky or Good?

Mike:               What I liked about your ‑‑ on the one hand celebration of capitalism and innovation and in a sense “here’s the new shale billionaires” ‑‑ you have a “Mount Rushmore” of four of them, who rose above the others. On the one hand, we have a tradition in the United States of celebrating these people as paragons of capitalism and far-seeing geniuses, of which Aubrey is included with that, with Mark Papa from EOG and this guy Harold Hamm, and I guess George Mitchell, one of the originators of the techniques.

Sernovitz has a "Mount Rushmore" of fracking
Sernovitz has a “Mount Rushmore” of fracking

But then I appreciate that you also say there’s an aspect of the story which is these guys have just sort of dumb luck combined with bizarre personalities, like you’re describing with McClendon with his appetite for risk and appetite for everything ‑‑ I appreciate it. And then trying to figure out: Are these guys just beholden to their own personalities and limitations and that’s why they did these odd, risky, crazy things, which turned out to be “right place, right time,” at the right scale? Which is obviously huge they all did that.

There’s this awesome passage which I’d also like to read, which is among my favorites of the whole book, which is describing Aubrey:

“Aubrey feels sometimes like seeing the country’s best restaurant critic blissfully eating from a box of day-old donuts. People respect the critic for the sensitivity of his palate, but maybe the man just likes to eat.”

I really liked that.

Gary:               That’s brilliant.

Mike:               It is really. It encapsulates that we celebrate these capitalists for their amazing talent and yet I don’t know, maybe the guy’s slightly insane and just has no taste at all. It’s just awesome, but of course, I love day-old donuts too. I can relate.

Gary:               I think people in the oil business are very fond, and this is probably in any business, “My successes are because I’m smart; his successes are because he’s lucky.” Being in a business one gets a bit more color on who was lucky, who was smart. Most people are some combination thereof. But I think the thing to remember about the entire industry is before the shale revolution the US onshore ‑‑ we had a company in Corpus [Christi] working in South Texas, about drilling wells for 400,000 dollars to find 2 million dollars’ worth of gas.

Mike:               Scratch and peck kind of little tiny companies.

Gary:               Yeah. And anyone in the oil business, like Exxon, which looked in contempt at the US onshore business as a bunch of losers who couldn’t make it doing big international stuff in Kazakhstan or offshore Angola or Equatorial Guinea. There was a certain very admirable hustle, that kind of never-say-die that kept ‑‑ people shouldn’t have been drilling before ’98 in the US if you think about where were the best reserves of oil and gas.

It was just – globally – it was just the infrastructure wasn’t there to displace it. Then the shale revolution came and suddenly ‑‑ the amazing thing wasn’t just that actually underneath the stuff that these guys were scratching and pecking, as you say, were an amazing volume of oil and gas but actually oil and gas was a lot cheaper to extract than the stuff Exxon was doing.

Mark Papa

It’s one of these stories of “the first shall be last, last shall be first” that really came out of nowhere. And everyone got caught up in it. Then there’s all these micro stores because there’s a lot of basins that have risen. Think about there in Eagle Ford, which is the one closest to you guys. Eagle Ford now is – the most shale wells have been drilled in Eagle Ford. It’s now kind of a mature basin. It was really developed by EOG, gets a lot of the credit ‑‑ Mark Papa.

Mark Papa left EOG in 2013

And kind of was one where it was a stealth play. And then there’s this mad rush for the Eagle Ford. Now the Eagle Ford is kind of considered well, there’s A) it’s drilled up a lot, and some of it’s more natural gas, and some of it’s more natural gas liquids, and it’s not that good. And by the way, if you go to West Texas, the Permian, there’s an Eagle Ford stacked on top of another Eagle Ford. There’s all these thousands of feet of different benches you can drill horizontal wells in.

Eagle Ford is now considered okay, a little mature, maybe some opportunities, but you’re only interested in moving back there if you can’t find anything in the Permian in West Texas and New Mexico. There’s dozens of different kinds of stories of rises and falls and the business ‑‑ there’s not just a lot of amazing oilmen who picked exactly the rise and fall correctly. There were some who were just there in a basin that ended up rising. And there are some that did guess it correctly. There are some who came in too late and ended up losing a lot of money.

Mike:               There’s a bunch of things I want to follow up on that. One is the Permian which I don’t know much about but a month ago [September 2016] the general newspaper readership got a sense that Apache Energy had a huge find. I want to follow up on the “genius capitalists” of the thing.

There’s a local guy who I don’t know personally, but was celebrated around the discovery of the Eagle Ford. Suddenly this guy I hadn’t heard of before, named Rod Lewis became a known shale revolution gas billionaire. Part of his legend – and I don’t think he appears in your book, is as a very blue-collar guy checking old oil wells and then ‑‑ sudden success is always overnight and it took 20 years that we didn’t know about…

But you do describe a guy, and I don’t know if you have stories about him or his thing, but you do have a thing that sounded very similar to that, in your book. Terry Pegula, who sounds similarly this blue-collar guy in the business of helping plug old oil wells and then suddenly seems to, out of nowhere, have acquired a massive amount of leases, which is then first worth a billion and then three or four billion a couple years later. Do you know the Rod Lewis story to tell? Local people might be interested. I’ve only heard basically what I just told you.

Terry Pegula

Gary:               Petro-Lewis is a very well respected company and definitely considered one of the Eagle Ford’s central private play. I don’t know his story particularly, but Terry Pegula, who now owns the Bills2 and Sabers and the savior of Buffalo was definitely almost like a hoarder of leases.

Terry Pegula and wife Kim

Mike:               Clean your stuff out, man. We’re going to call the cops on you. He was that guy?

Gary:               Yeah, and would take them from other companies with the agreement that I will plug these wells ‑‑ a natural gas well sometimes can produce for a century maybe, at very low volumes, but it gives you the right, based on the lease, to actually drill beneath it. Even if you have a well producing 50 dollars a day of stuff, it does give you the optionality ‑‑

Mike:               Vertically you can go below that existing small-producing well.

Gary:               Yeah. He didn’t do that on purpose. No one thought when he was hoarding these leases that there was going – Qatar was going to be in Pennsylvania and eastern Ohio. He was just doing it because he liked doing it. I think also as a car dealer once said to my wife his view, “If it’s free, it’s for me.” People would just give it to him because it took liabilities off their hands. I don’t know the Petro-Lewis story but that’s one of those kind of amazing stories, sort of the wheels of markets and capitalism and fortune and luck and idiosyncratic histories that people like to wrap up sometimes in a more heroic narrative.

Mike:               We love the narrative of the blue-collar guy making good. That’s a pleasing capitalist ‑‑ it’s terrible when the rich remain rich. It’s great when the poor suddenly make it rich.

Harold Hamm: Humble, but sensitive, Trump supporter

Gary:               That’s why Harold Hamm, hearing him getting offended by “fracking,” he is the single person who’s gotten richest individually off the shale revolution. He is one of 13 kids, a sharecropper in Oklahoma, who barely graduated high school. Never went to college. Didn’t have shoes until he was six. A story out of a different century and now is the 70th richest man in the world. He signed a giving pledge with Bill Gates.

Mike:               I think you described him getting into North Dakota because he was one of these losers who had no other chance.

Continental Resources CEO Harold Hamm endorsed Republican Presidential front runner Donald Turmp.

Gary:               Exactly. He admits it. He’s a humble guy in some ways. He kind of admits “I couldn’t afford what we were paying” ‑‑ basically you’re paying option value for leases in North Dakota.

And I heard Harold Hamm speak, and he gave a very pro-Trump soliloquy, like 45 minutes long with slides, more of a presentation. He talked about a very obscure argument. I don’t even know what happened, but Trump came to Colorado and also said basically the same thing Hillary said, which is communities should be allowed to regulate fracking in their backyard.

And Hamm’s like: “Forgive my friend Donald. He didn’t know what he was saying. He agrees with me.” Even the word “fracking.” He’s one of Trump’s chief supporters. And he made it clear that if you use the word fracking around him, the conversation is over, because it is an insulting term to describe hydraulic fracturing.

Mike:               Okay, words matter and that’s a hurtful word for him.

Gary:               Yes.

Mike:               Okay. He sounds a little sensitive, but anyway.

Gary:               You’d think 70th richest man in the world and 12 billion dollars would make you less sensitive. Apparently,  that’s not the case.

Mike:               Words have power and he’s a man who can be hurt by that word.


Please see related audio post (upcoming)

Part II with Gary Sernovitz – on the environmental issues of fracking

Before becoming an oil private equity guy, Gary Sernovitz was the next F. Scott Fitzgerald, and authored two novels, Great American Plain, and The Contrarians.

Please also see related posts:

Book Review: The Green And the Black: The Complete Story of the Shale Revolution, The Fight Over Fracking, and The Future of Energy  by Gary Sernovitz

Natural Gas Revolution – Corporate, Well-capitalized

Mad Max Bizarro World – South Texas

Audio Interview with Bryant on Fracking, and Regrets



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  1. The indictment came down in March 2016
  2. Just found this story from 2014 and Trump’s tweets about getting beaten by Pegula in a bidding war for the Bills. Trump, ever the petulant child.

Audio Post – Credit Fraud

I just really enjoyed this episode of the podcast “Criminal,” episode 51, so decided to repost it here. Most people with bad credit are not victims of identity theft. But for those who are victims of identity, its obviously a nightmare. The nightmare described in this podcast is even worse than most.

The Money Tree” on the Criminal podcast.



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Interview: What the %#@! is a Fund of Funds?

Please click above to listen to full interview.

I spoke with an old friend Trevor, a former Director of Research at a Hedge Fund of Funds.  In college, a mutual friend of ours imaged a radio show named “What the Fuck Do you Do?” in which he interviewed people in jobs that nobody else understood the name of, or the function of.  This interview is in that spirit.  He spoke about the business, lucking into one of the best bosses in finance, and then leaving it all.  This interview is also in the spirit of Trevor himself, a recovering banker trying to figure out what’s next for him.

What is a Fund of Funds?

Trevor:  Hi my name is Trevor and I used to be the director of research for a fund of funds.

Michael:   Trevor, thank you for agreeing to be part of Bankers Anonymous. I’m wondering when you said you’re a fund of funds manager, what percentage of people that you ever talk to, who you identify yourself as a fund of funds manager say, “Oh, I know exactly what that is,” or do people have no idea what you’re talking about?

Trevor: People have no idea what I’m talking about.

Michael: What do you usually say?

Trevor:  And it’s usually a stultifying opener when I say – people say what do you do and I say, “I work for a fund of funds, fund of hedge funds.” Three-quarters of the time there’s a blank stare and then one-quarter of the time people actually ask a follow-up question about what it is. But the topic of finance generally sends people running away from the conversation. So I usually lie now when I tell people what I do.

Michael:  What’s your backup answer now, zoo keeper?

Trevor: I raise bees, African honey bees which produce a very spicy variety of honey.

Michael: Awesome. I know what a fund of funds business is more or less, although I’ve not worked at one, but is it easy to describe what that means?

Trevor: It is. It is a collection of funds run by other people managed by the fund of funds operator. Usually I give people the analogy of mutual funds because most people know what mutual funds are. The business model is if I was going to create a fund of mutual funds, so instead of you investing in mutual funds directly and picking ten mutual funds, you could invest in Trevor’s fund of mutual funds and by investing in my one fund you get exposure to however many underlying mutual funds I choose to put in the portfolio.

The fund of hedge funds is the same idea but instead of underlying investments being in mutual funds, the investments are in hedge funds. That’s usually when people freak out because they’re like “Oh my god, hedge funds; now you’ve lost me. Aren’t those all terrible?”

Michael: Are you part of the evil hedge-fund world?

Trevor: Yeah.

Michael: I’m familiar with that, where people hear fund of funds and suddenly there’s a blank stare and everybody’s like “Oh my God look shiny object over there.”

Trevor: And, to interrupt you, then the smart people say, “Oh, so that’s an extra layer of fees, so basically you pay fees to the hedge funds and then I pay fees to you, and then there’s multiple layers of fees. So it’s not really a business, it’s just a set of fees.” That’s what the savvy, cynical, smart people usually observe right away.

Michael: The classic criticism of hedge funds themselves is they’re not really an asset class but a compensation scheme.  As a derivative of a hedge fund you could be a compensation scheme on top of a compensation scheme.

Trevor: Yes.

Michael: But having been in the world, do you think the added expense is worth it?

Trevor: The firm that I worked at launched multiple products going back over the last twenty years and their long-term results easily beat the S&P500 with better performance characteristics, as net of all fees.

Michael:  Performance characteristics: Volatility, Return, what else am I worried about – draw down I guess; how much did you lose in a bad year?

Trevor:  Yup, and then one more which is correlation to the index.  If the index is going one way the fund of funds is not necessarily having the same pattern. So there are fund of funds which have been able to outperform the broad-based market net of all fees over a five, ten, fifteen, twenty-year time frame.

Michael: And your fund did that?

Trevor:   Yes.

Michael:  So post-credit crisis in 2012 is the world different for fund of funds?

Trevor:    I think there will always be a need for fund of funds because institutional investors want access to alternative investments and part of that is access to hedge funds. A lot of those programs don’t have the resources to research hedge funds, and invest in them, and monitor them. So if you’re a 200 million dollar endowment for a secondary school or small university,

Michael:  Basically, tiny.

Trevor:  And you allocate twenty percent to hedge funds, so you have 40 million dollars going into hedge funds. And of that, you have half of that going into long/short equity hedge funds, you can’t hire the staff to adequately research and monitor it. So middle-sized endowments will always have a need for a gatekeeper to help them.

Then a lot of larger institutions often hire funds of funds to create a starter kit and they will put together fund of funds for the larger college endowment, and then the endowment will eventually take it over once they’ve learned the ropes.

And the last category that’s probably never going away is if you’re a high net-worth individual but you’re not super, ultra-rich, you can’t afford to create your own diversified portfolio hedge fund because they generally have a one million dollar to five million dollar minimum, so if you, say, only have ten million dollars to invest and you put twenty percent in hedge funds which is two million dollars, you can invest in two hedge funds, maybe, which as everyone knows you don’t want to take on concentration risk in really any asset class. So the high-net individual but not ultra high-net will always need a fund of funds to create a diversified pool.

Michael:  Is that essentially the customer base of your business, medium-size endowments and high but not ultra high-net worth individuals?

Trevor:  When the firm first launched it was mostly high net-worth individuals, which I think is if you go around to your friends and say, “Hey I’m starting this business, will you invest?” And then over time they generate the track record and credibility, their shift was towards institutional clients. The current composition is ninety-five percent institutional and five percent individuals.

Michael: I’m sorry, ninety-five percent institutional and five percent individuals?

Trevor:  Right, so the shift over time was dramatically towards institutional money meaning pension plans, charities, endowments, foundations as opposed to individual investors.

Michael: I obviously know you quite well and I know you have a mathematical background but can you describe what it’s like to work for a fund of funds? What’s the main skill set that’s useful?

Trevor:  I think everybody approaches selecting managers differently and there are places that run Monte Carlo simulations and all sorts of back testing and modeling and then there’s people on the totally other end of the spectrum who just meet with a manager and think, “I like that guy.”

Michael:  More a feel on what’s a good manager or good investor.

Trevor:  Yeah, and both approaches probably work fine, as long as you do the one that makes sense to you. Our firm fell somewhere in the middle where we did a lot of number crunching and we would look at past track records and look at when managers had losses how did they respond to those losses. Hedge funds generally have access to leverage so when the economic environment deteriorates does the manager double down to take on more risk in hopes of making all this money back quickly; or if they have losses and a bad environment do they reduce exposure and risk and crawl back slowly? Looking at quantitative information to assess how a manager responds to risk and how much risk they take on.

Michael:  So it’s a mix. It doesn’t sound like rocket-science math.

Trevor: No, there’s some standard deviation and draw downs but probably high school level math.

How Do You Get a Job at a Fund of Funds?

Michael:  In 2002 you were not in the financial world.  How does one get a job at a fund of funds shop?

Trevor: I think it’s a strange path. Probably very few people coming out of college have heard of this industry. So I happened to get into it by a sequence of events where my uncle had worked for a guy who ran the company and he hired me to do some software programming. Then I joined running operations and gradually made a transition to the investment side while doing the CFA program. It was a very idiosyncratic route.

Michael:  The work environment was somewhat idiosyncratic also?

Trevor:  Yes, I think I worked for one of the nicest people in finance, certainly shocking and refreshing to find someone who is very principled and fair and entertaining. I remember an early conversation where the boss said, “You know, I’d really like to take Fridays off in the summer, but if I take Fridays off what am I going to do about all the employees? Maybe they can work half a day. Oh fuck it, just everybody gets Friday off.” But that was also tempered with if you made a mistake he would come down very hard on you. It was very high expectations but it was a very fair environment.

One great memory which is that my boss used to come into my office and he would say, “You know, when I had my first consulting job, my boss would come in and he would say, ‘I’m going to give you six months to work on this, and if it turns out well you get full credit. And if it goes badly, you’re fired.'” And I’d think ha-ha that’s great, good story.  He told me this anecdote maybe three or four times over the course of two weeks, and the fourth time it dawned on me; those are the rules. If it goes well, I get full credit, and if it goes poorly, I’m fired.

Walking Away From It All

Michael:  Okay, you’re no longer fulltime with the same fund of funds and as I understand it you’re interested in other things. Why would you do that?

Trevor:   Great question. A friend of mine told me he would come up to New York and shoot me if I lived there for more than five years.

Michael:  So it was fear that drove you away.

Trevor: At year eight I was getting worried that would actually happen.

I love spending time out of doors and I love farmers markets and I love a slightly slower pace of life. It’s very hard to achieve that in New York where your apartment can be very small and dark unless you’re extremely successful. People don’t generally host dinner parties or hang out in their apartments which I think is why I think a lot of the public spaces in New York are so great. Peoples’ existence in their own apartments is not a great hosting venue. But all that being said, I wanted to move out West and have access to the out of doors.

Michael: While maintaining your anonymity for this program, we’ll just say you’re in California, somewhere in California. They’ll have to try to find you. I think I’m hearing you say actually when it came down to money versus friendships you found the friendship part more compelling. This sounds very un-banker-like of you.

Trevor: Certainly I would rather have more money than less money. I did have this idea I would work hard and save up money for a while and then leave and do something else. I’m in the process of executing that transition and certainly some days I wake up and I think what an idiot; if I had stayed and followed the traditional succession plans, I’d be a gazillionaire.

Michael:  But even making the choice to leave and get into a different mode of life, it’s still hard to think: “Wow, but I could have had this money!”

Trevor: I think it’s hard to take a path where you’re relatively senior and successful and basically go into another industry or set of interests where you don’t have any credibility or expertise necessarily, but you think it’s a more satisfying and rewarding way to spend your time. I’ve discussed this with my former boss and he wisely wrote back and said, “Money means nothing if you are unhappy.”

Michael: Wise words.

Trevor: If it’s a calling that’s good for you, and there are certainly plenty of people in finance who genuinely enjoy it.  Then I think it’s a great career track. But money corrupts and it’s an industry that can lead people to stay working in it when they don’t get a whole lot of meaning out of it.

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