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048: Gil Baumgarten – Disrupting the Wealth Management Industry

Gil Baumgarten is a disruptive wealth management pioneer. After battling UBS in defense of 100% ETF portfolios, a direct assault on the firm’s fee-rich mutual fund business, he was on the original beta-test team of six advisors permitted to run discretionary ETF portfolios in 2002. He has since been named one of the “Top-20 ETF Thought Leaders in the U.S.” by Barron’s and The Wall Street Journal . Gil’s fee-only fiduciary firm, Segment Wealth Management, is a top-15 firm in Houston as ranked by the Houston Business Journal . Gil is perennially named a top-50 advisor in Texas by Barron’s , out of the state’s estimated 26,002 registrants. Gil is also the best- selling author of FOOLISH: How Investors Get Worked Up and Worked Over by the System.

Today, Gil joins the show to discuss his background in the financial services industry, the difference between fiduciary and non-fiduciary standards, and the psychology behind investing.

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Key Takeaways

00:57 – Jonathan introduces today’s guest, Gil Baumgarten, who joins the show to talk about financial trauma, share his experience in the financial services industry, and why he decided to pivot

08:39 – Leaving to start his own firm

10:50 – Gil talks about his book, FOOLISH:How Investors Get Worked Up and Worked Over by the System

13:10 – The Slaughterhouse Example

16:29 – Breaking into the brokerage industry and the major players out there

23:41 – The fiduciary and non-fiduciary standards and recent legislation

27:18 – Performance and return on investment

35:01 – Investor psychology and ‘cognitive bias’

42:29 – One piece of investment advice to heed and one thing to completely ignore

50:07 – The last thing Gil changed his mind about and the one question he would like to know the answer to

51:37 – Jonathan thanks Gil for joining the show today and lets listeners know where to connect with him

Tweetable Quotes

“They say that you’ll stay in a situation until the pain of leaving is less than the pain of staying. And, so I kinda reached that point with touch-point after touch-point that I was getting in conflict over some issue with the firm. It was always about what was best for the client. And I just had enough and decided I wasn’t going to do it anymore.” (08:50) (Gil)

“When you start to dissect the brokerage industry, they understand how sticky the relationship is between the advisor and the client. And they will position themselves in such a way to monetize that. They will sell information. They will sell order flow. They know that you’re going to stick with a mutual fund for a certain period of time. They also know that clients like for fees to be hidden from them. They like to understand that people in the brokerage industry are getting paid; they just don’t want to see it.” (13:52) (Gil)

“Anybody in the world can give you investment advice. Not everybody can charge for it. If you’re charging for it, you have to have registration.” (20:32) (Gil)

“Many people say the brokerage industry should be regulated out of existence and only SEC- registered fiduciaries – or a fiduciary standard – should apply to all brokerages. I say, ‘no way!’ There’s a lot of reasons why somebody would not want to do business on a platform like mine.” (26:37) (Gil)

“The purest form of beta would normally be an index fund and would have very little taxes associated with it and would have very little fees attached to it. And over a very long time period, you’re going to end up outrunning everybody who is pursuing Alpha, most often because people hop at the wrong time. They don’t buy the lowest performer off the list; they buy the highest performer. And when the market flips around and changes, they’re gonna end up buying high, selling low, buying high, selling low. Rinse and repeat.” (29:01) (Gil)

“Warren Buffet says that, ‘Minimal securities prices come with maximum uncertainty, and maximum securities prices come with minimum uncertainty.’” (36:06) (Gil)

Guest Resources

Gil’s LinkedIn

Gil’s Website

Gil’s Book, FOOLISH

Gil’s Musings

Segment Wealth Management Website

Important Disclosure

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Episode Transcription

Jonathan DeYoe: Hello, and welcome back to the Mindful Money podcast. On this episode, I’m chatting with Gil Baumgarten. Gil has been in the financial services industry for 38 years. That’s 13 years longer than me. In 2010, Gil left the brokerage world to start segment wealth management. It’s a, uh, leading fiduciary firm founded on the belief that. I totally agree with that low taxes, low fees, tax efficiency, and long term perspective are the keys to financial success. According to barons, he’s one of the top 1200 advisors in America. He’s been called a top 20 exchange traded fund thought leader as well. I had to sort of read that to get it all straight. I wanted to have Gil on the podcast to talk about his Amazon bestseller. His book the foolish how Investors get worked up and worked over by the system, was published in 2021. Gil, welcome to the Mindful Money podcast.

Gil Baumgarten: Thanks for having me. Glad to be here.

Jonathan DeYoe: Yeah, I’m excited to have you. So just to, uh, start off, where are you calling in from? Where do you call home?

Gil Baumgarten: I’m in Houston.

Jonathan DeYoe: Okay. Where’d you grow up?

Gil Baumgarten: I grew up right here. Lived in New Orleans for a couple of years when I graduated college, moved back home in 1984, and went to work for E. F. Hutton as a stockbroker.

Jonathan DeYoe: Wow. Yeah, I think we all started out as stockbroker. Anyone that’s been in the industry more than 20 years had to start out as a stockbroker. Almost.

Gil Baumgarten: Pretty much, yeah.

Jonathan DeYoe: What did you learn? Just growing up. Growing up at home before your 15th birthday, what did you learn about money?

Gil Baumgarten: Very interesting that you would ask that question, because in the book, I talk about how I got selected to go into management at e, uh, F. Hutton. Right. When Hutton got bought by Shearson in 1988. And I did a study for the firm, trying to isolate the top characteristics of their top advisors. And the most common characteristic among the 100 top advisors at the firm was financial trauma as a teenager and the resilience that they gained from learning how to navigate whatever financial problem. Dad losing his job, getting evicted, home, repossessed, whatever the issue was. And I had some of that in my family too, created enough resilience to cause them to want to do more with their lives and learn a lot about how money works, which is exactly what happened to me. My parents were divorced when I was young, ten or eleven, and we had some financial trauma in my family, and I had to pull myself up by my bootstraps and figure out how to get out of that hole. So that’s what I did.

Jonathan DeYoe: I’ve never, ever heard that. I’ve sort of anecdotally thought it because I compared myself to a bunch of peers who grew up with silver spoons. We grew up really poor. I coveted everything my friends had, but I’ve never heard that expressed that way. That is so interesting. Can you point to, like, a single experience as a kid that becomes integral to your, um, money story later in life?

Gil Baumgarten: Well, when my parents got divorced, my mother’s 1959 Mercedes convertible got repossessed, and that would be a very expensive car today. So my dad didn’t make payments on it and it got repossessed. My dad did not file a tax return for eight years. And then when my parents got divorced, he tried to stick my mom with the tax liability that had been eight years brewing. And, ah, just those kind of things were just really tough on me and my brother and my mom too. And I grew up in a very wealthy part of town, but I was on the kind of the opposite, not the bad part of town, but there were some very wealthy people that lived nearby, and I went to public high school. One of my best friend’s dad was a very famous orthopedic surgeon and had new ferraris in the garage and lived in the best part of town and went on the most exotic vacations. And the widow of that doctor is now my client, and I’ve known them for 50 years. Uh, so I just saw how good it could be and I wanted something more than what I had.

Jonathan DeYoe: Yeah. Similar backstory. I want to dig into the book, and I think that’s why we’re here. But just before we do that, can you tell the mindful money audience a little about your career? I know, you started at EF Hutton, but what led you to the point where you were separate? You had your own independent firm, and you wanted to write the book.

Gil Baumgarten: Well, I always thought that in the brokerage industry, that if the client was paying me routinely, not necessarily whether a commission, but a fee, and for the most part, the type of business that I did would generate client fees and not commissions, I felt like I, uh, owed a certain amount of allegiance to the client’s interests. And the firms that I worked for, UbS, Smith Barney, and E. F. Hutton, through various mergers, always wanted to fight with me over who owned the gray area. That comes up from time to time. And the firm felt like my job as an employee of the firm was to wrestle that gray area away from the client. That’s a gray area being, do we charge for this? Do we not charge for it? Can you give it away? Should you give it away? Whose interest should you look out here? What do you have to disclose to the client? What do you not have to disclose? That’s the gray area. And the firm always tried to position itself in a way that it would own that gray area. And I always tried to position my client in such a way that they would own that gray area. And I figured that if I was getting paid by the client, that I owed the client the allegiance of making sure that they owned as much of that gray area as possible. And I had an aha moment when I kind of cornered my boss in the hallway and told him that the firm was making me do something that I didn’t want to do. I thought it jeopardized the client’s position. And he told me that my problem was that I didn’t understand who I worked for and that the sooner I realized that I worked for the firm and not the client, the sooner my life would be easier. And I’ve determined at that moment in time that he and I weren’t even in the same business. And so at that moment in time, it took me about a year to get my ducks in a row, and I positioned myself to be able to depart and take my clients with me. And I left almost nothing behind when we kind of went scorched earth on my former employer, and there was almost nothing left. So that was about $300 million of client money. That was in October of 2010. We have $1.3 billion today. And that’s all organic growth, either through growth of the assets being profitable over that 13 year time period or new money finding its way into our supervision.

Jonathan DeYoe: Yeah, that’s a great story. I’m curious, what was the manager asking you to do that you didn’t want to do? Because I have a similar story I’ll share with you.

Gil Baumgarten: I don’t even remember what it was. It was some little probably they wanted me to open a checking account for every client that we were going to charge them $50 a year for. And I had 1100 account numbers. And the firm is chomping its lips or licking its lips over all the extra revenue that they’re going to have, which they’re not going to pay me on, by the way. Those are incremental costs to the client that do not generate any revenue that’s payable to me. And they’re probably expecting me to do a bunch of work to get their paperwork done so that we could sell clients on whatever concept it was that I didn’t think was beneficial to the client. So probably something like that.

Jonathan DeYoe: Yeah. It was 2001, and I went on my. So you left after the great recession? I left after I did bust. Right. And it’s the similar problem for the firms. Right. We need to generate revenue. Revenues are off. So how do we generate more revenue? And my manager at the time said, jonathan, we need you to sell more annuities and b share mutual funds. And I had to solve a b share mutual fund or an annuity my entire career. I’m like, all right, I’m out of here.

Gil Baumgarten: Probably two of the least client centric products you could be recommended to sell to your clients.

Jonathan DeYoe: Totally. And being told by your manager, the guy that signs your paycheck, that you have to do it. Yeah, it didn’t take me long to leave at that point.

Gil Baumgarten: Yeah. Those account things that I didn’t have much tolerance for.

Jonathan DeYoe: Totally. How hard was it leaving and starting up your own firm?

Gil Baumgarten: The worst part of it was the uncertainty about my level of discomfort. They say that you’ll stay in a situation until the pain of leaving is less than the pain of staying. And so I kind of reached that point with touch point after touch point that I was getting in conflict over some issue with the firm. It was always about what was best for the client, and I just had enough and decided I wasn’t going to do it anymore. The same boss who told me that I needed to be doing this or that once told me that the firm also owned the client relationships. And so for your listeners out there who don’t understand the brokerage industry, not a single client really ever comes by way of a reassignment. I was not taking clients that the firm was giving to me. All of the people that I consider to be my clients are relationships that I’ve made in the community and I’m bringing to put them onto the brokerage firm’s platform. And that’s where the equity value of these tradable stocks, Goldman Sachs and whatever, for the most part, what that is, is the value of the stickiness of those client relationships in many cases. And that’s what the firm is trying to wrestle away for a commission payout. To me, they’re trying to wrestle away the equity value of what they can sell that for in the marketplace. And the firm is always trying to establish itself as the owner of those relationships, despite the fact they don’t even know the client. And the client could care less about which firm it is. And my boss told me that if I was getting any bright ideas about leaving to go somewhere else, that the firm owned all those relationships. And I said, unfortunately for you, you’re going to get a chance to prove that theory, because one of these days it’s going to come down to you and me. And uh, I don’t think you’re going to be able to keep any of these clients. And that’s exactly the way it turned out.

Jonathan DeYoe: Yes. And I know that right now there’s a lot of discussion of the elimination of those non compete clauses because I know that you were subject to a pretty stringent non compete. I’ve been subject to lots of non competes. They don’t actually hold up that well. But getting rid of them is probably also a good idea. So let’s dig into the book, because you just begun the process of, you write about the first section of the book. I just love this. I’ve never had anyone write out what you wrote out. I’ve always thought that maybe I should. So first of all, loved it. In reading it, uh, you seem to dig into two different things, wall street and all of its problems. And then towards the end, investor psychology and all those problems. I get that vision about, right?

Gil Baumgarten: Yeah, that’s right. About the first 40% of the book is how Wall street operates. The things they do, the things they probably shouldn’t be doing, how they make their money, how they split that money with the broker, what that ecosystem looks like, what a kickback looks like, what kind of gray area is out there, and, um, what, uh, dark corners do they operate in? Selling payment for order flow and other nuanced ways that they make, uh, the revenue and giving payment for order flow, the credit that it is due, because it’s not all bad. I’m not so sure how moral it is, but there are some side benefits to clients, which I also acknowledge in the book as a benefit. But if you just look at it as an unbiased observer, there are things that happen inside of a so called trusting relationship that, uh, probably wouldn’t be as trusting if you really understood how it all worked. So that’s the first 40%. The back 60% is all the mental baggage that we’ve got. Self justification, ego issues, the way we like to play our own story back about how we view how smart we are. We don’t pay attention to the mistakes that we’ve made. The mistakes we’ve made are probably always bigger than the successes that we’ve had. But that’s not the way we remember it. It’s the way we self justify all that which reinforces our poor decision making and only makes it, um, certain that we’re going to do it again. And so it’s just kind of get all that stuff out on the table. And if you really wanted good results, how, if you deconstructed the entire decision making process, considering fees and taxes and all the ways taxes get levied, you would probably choose a different methodology than just hopping from idea to idea, hoping, uh, to be affirmed by what you perceive as the best results.

Jonathan DeYoe: Well said. So, starting in your very first chapter, you tell the unvarnished truth, which I really appreciate. I think there’s only maybe one other book out there that talks about this stuff, so we should read it for sure, just so they can understand. But starting with that very first chapter, you go into the difference between broker and advisor, and you use kind of a slaughterhouse metaphor, which cracked me up. So tell us about the slaughterhouse.

Gil Baumgarten: Well, in a slaughterhouse, they kill the cows and they drain the blood and they skin it, and they cut off the hooves, and they salvage everything. They make fish bait and fish food and dog food out of the blood, all the components. The bones get ground up into meal, and that gets fed to livestock and, uh, goes into the pet food industry. The meat comes through and all the trimmings, pretty much all of the components except the contents of the stomach of a cow, gets used. And when you start to dissect the brokerage industry, they understand how sticky the relationship is between the client and the, uh, advisor and the client. And they will position themselves in such a way to monetize that they will sell information, they will sell order flow. They know that you’re going to stick with a mutual fund for a certain period of time. They also know that clients like for fees to be hidden from them. They like to understand that people in the brokerage industry are getting paid. They just don’t want to see it. I had a client take money away from me one time as, uh, an advisor later out of the brokerage industry, because she could actually see the fees on her statement. And they were half of the fees that she had previously been paying in the brokerage world. And she wanted to move her money back to her girlfriend from the country club, who was a broker, because that person would hide all of her fees for her. The broker industry understands that you preferred not to know that the fees are there. So they will jack them up on the vehicles that the fees are hidden from you, and then they’ll hide behind their disclosure document that they send it out to you. It’s 43 pages long. Good luck reading it and figuring it out. Twelve b ones are kickbacks, where the mutual fund industry and the brokerage industry are in cahoots to hide fees from clients, augment those fees, and then turn around and kick those fees back to the brokerage firm. That happens to custody the shares. So if your XYZ mutual fund is sitting on Merrill Lynch’s platform, Merrill lynch is getting a fee for that. If it’s a twelve b one mutual fund, the hedge fund business is in cahoots. The, uh, managed account department at the brokerage firm will cut a side deal with mutual fund managers that also run funds. So separate accounts would be, you’re hiring Tom Smith to trade your account for a fee. And Tom Smith also runs a mutual fund for fidelity. And they will trade order flow off of the mutual funds business to compensate the brokerage firm for doing separate account business with them. And they’ll run the separate account trades across that desk, and they’ll get payment for order flow. There’s eight or nine different ways that they can make money out of every dollar. And the clients have no concept that these firm just stack these fees one on top of another, as opposed to you’re just paying one straightforward fee and pretty much everything else is taken care of. The, uh, brokerage firm is slicing all of that relationship up behind the scenes and trying to monetize it. Just like the slaughterhouse that would sell the toenails off of the cow if they can.

Jonathan DeYoe: You actually said this in the book, that it’s not that the advisors are bad people. There’s really good, wise, intelligent, well meaning people that are brokers at some of these Wall street firms, big brokers, but they’re in a system that is working against them and against the client. Can you kind of break into that.

Gil Baumgarten: A little bit more?

Jonathan DeYoe: Explain that a little bit more?

Gil Baumgarten: Yeah. So it’s relatively easy to get into the brokerage business. And back to the resilience thing. If you want to make a lot of money and you’ve grown up in tough times, um, one of the easiest ways to make good money is to be a stockbroker. It doesn’t require any investment. It requires no capital. You basically are coming in and picking up a phone and start dialing and making relationships and trying to parlay those over the years into some type of a fee revenue. And so it’s relatively easy to get into the brokerage business, and people choose that as a path to monetize the expertise that they’ve got, usually with math or with relationship skills. So it’s just an easy way to put yourself in a position to have a relatively high earnings potential. So I don’t know if that answers your question well enough, but phrase it if you want more than that.

Jonathan DeYoe: Yeah. So there’s a couple of things that are going through my mind. One, can you tell us who we’re talking about? Because I don’t think that consumers generally understand who is part of the Wall street firms and then who is part of sort of, uh, you and I will recognize the RIA space. Can you define the difference for people?

Gil Baumgarten: Yeah. So I would put fidelity, the asset custody business. So if you carry stocks on your statement, Fidelity, formerly TD Ameritrade, which is now owned by Schwab, Charles Schwab, Pershing securities, some of fidelity, uh, custom clearing services. Those types of companies, what I would consider to be a discount broker, very reliable, inexpensive. They don’t really have any commissionable salespeople that work for them. Contrast that, and I use those services in my business today. Contrast that with a Merrill lynch or a Goldman Sachs or, ah, a JPMorgan or a Morgan Stanley or a UBS. That’s 80% of the full service brokerage industry right there in those five or six names. And so those are the companies that have much higher fees and support a salesman network of tens of thousands of employees per firm that are out there trying to establish relationships with people and are, uh, processing that business on what is normally a much more expensive platform and creating a way for the firm to make money, and the providers make money provider, being a mutual fund or a hedge fund or unit trust or some type of a product creation department. And there’s a bunch of mid level managers who don’t generate any fee revenue that are out there every day trying to figure out how they can get their brokerage team to pull the horses just a little bit faster. And so that’s the ecosystem that I’m talking about, is those full service brokerage firms.

Jonathan DeYoe: There’s two sort of categories I don’t think you included. I don’t know if it’s intentional or if they’re just smaller. That’s like the Wells Fargo’s, the b of A’s, the bank brokers, and then the other one is like the LPL, sort of the independent BDS. I went independent with LPL before I did the full RAA thing. So I’m just curious what you think about those.

Gil Baumgarten: I’m an LPL shareholder and I’ve never done business with LPL, but I like them. Um, I sold a company to LPL, and I’m a Goldman Sachs shareholder, so my company owns shares of those two companies. I’m not sure if that requires disclosure or not, but I’ll say it. Raymond James and LPL are a little bit different breed than, uh, the other typical full service. They will allow RIA registration to cohabitate with a commissionable environment. And so let’s back up for a second for the edification of your listeners. Anybody in the world can give you investment advice, not everybody can charge for it. If you’re charging for it, you have to have registration, and depending on how you get paid for it, there’s really only two paths. You can either be FINRA regulated, and FINRA is the financial industry regulatory authority, used to be called the NASD, and that’s the self governing body of the brokerages that with oversight from the SEC, established their own rules and regulations that they will comply with about how they can hide money from clients. What is allowed to be hidden from a client, what is not allowed, what’s required to be on a disclosure document. The stack of rules and regulations inside of FINRA would be at least 3ft tall. Because there’s all kinds of conflicts of interest that exist inside of that self governing body. Now, it does that with the oversight of the SEC, but it’s not the same standard as direct registration with the SEC as a fiduciary. You cannot be a fiduciary and be in the brokerage business. You can only be a fiduciary if you are SEC registered. So I always coveted the SEC registration, because back to my original statement, that I thought I owed the clients a certain amount of allegiance. That allegiance is fiduciary and that’s what my brokerage firm never wanted me to have. And in the SEC form of registration, that’s what you’re required to have. And the regulations are much simpler and much less because I can’t trade against a client. I can’t steal anything from a client, I can’t hide anything from a client. I can’t trade behind a client. There’s all these rules about what you cannot do. It’s the brokerage industry’s desire to do those things that leads to all the regulations inside of FINRA. And I always felt like since I was running such a clean, as clean of a business as I could possibly run it on a brokerage platform, I was really already trying to adhere to SEC standards, but never able to fully get there. I was way better off just moving my clients to a simple SEC registration because I didn’t want to trade against the clients anyway. And then the business exploded. That’s where that other billion dollars worth of assets came from. When my clients started understanding what I had done for them, they felt much more comfortable giving me a lot more money. My average client size at UBS was a little over a million dollars, and it’s a little over $7 million today. I had six relationships bigger than 15 million. And today, my top 65 households average more than 15 million. So it’s the big relationships which has really been the growth of my business. And the comfort level that those people have with what it is that I’m doing for them is much higher on, uh, an SEC regulated platform than a FINRA regulated platform.

Jonathan DeYoe: Totally makes sense. I’m just realizing that we are throwing out all kinds of acronyms and all kinds of inside baseball talk at this point. I would just really recommend, if you’re curious, if you’re listening and you’re curious, you really should get the book and read that. 1st 40% because it’s described in a way that anyone can understand it in there. I think that’s intentional. And it’s really an important lesson for people to learn, even if they’re not thinking about getting an advisor, even if they’re doing it themselves, just to know where all these fees and things are. Can you put a name to the two different standards? I think you’ve named one of the standards. Can you name the, uh, other one and then sort of contrast them?

Gil Baumgarten: Well, I would call the SEC registration to be the fiduciary standard, and then I would call the brokerage side of it to be the non fiduciary standard, only to be further complicated by the fact recent legislation has come down to try to muddy the water. I don’t think it was intended to muddy the water, but, uh, there was a rule passed two years ago called the best interest standard that the brokerages have to agree, but it’s not best interest. There are four touch points inside of the best interest standard, none of which requires them to look out for the client’s best interest. If they cannot find a best interest alternative, they have to either disclose it or disclose why they can’t meet the best interest standard. It is not, uh, an elimination of conflicts of interest, despite the fact that it’s well meaning. And don’t get me wrong, I don’t think that all clients should do their business on a fiduciary platform. I can think of dozens of different situations where the business that needs to be taken care of would be better off to be done on a full service brokerage platform. And I’ll give you an example. Let’s say that Uncle Tom dies and leaves a $5 million estate to seven grandkids. Each one of them is going to get 800 grand, 820,000, whatever the number is. I can’t open up an account of that size. I have way too many liabilities. Way too much fiduciary responsibility. Way too much. I have to learn about what everybody wants. And if I’m charging them by the know the number of days that it would take me to bring in Uncle Tom’s money, open up seven households, all the account numbers, IRAs, SCPs, Roth IRAs, uh, you know, trust accounts, whatever, and get that money moved over and liquidated so that they can go on their way. I would never be able to charge enough money for such a little narrow window of burst of responsibility. And I clearly could not accept the fiduciary responsibility of actually knowing who these people are and what they needed to be doing with the money, that type of transaction to unwind Uncle Tom’s estate should be done on a full service brokerage platform. You could go into a Merrill lynch or a firm like that. They would love to have that $5 million. You break it up into all those account numbers, there’s going to be some transactional business and many thousands of dollars of revenue later, which I’m not allowed to earn a commission of any type. So I could not match that level of service and what they would be willing to do for the descendants of Uncle Tom. That’s a, uh, great example of where a full service brokerage firm could give you tons of advice and you could be very satisfied with the services. So many people know the brokerage industry should be regulated out of existence, and only SEC registered fiduciaries or a fiduciary standard should apply to all brokerages. I say no way. There’s a lot of reasons why somebody would not want to do business on a platform like mine. But if you wanted somebody to take care of you and to be in your corner and to look out for you and anticipate what’s going to happen next and guide you through taxes and other issues, that wouldn’t compensate me giving advice for a commission, that type of relationship is probably going to be happier on an SEC regulated fiduciary platform like mine.

Jonathan DeYoe: Yeah, I want to switch gears a little bit here. So, at the nexus between the financial industry and the client is this promise of returns. Clients need returns. Advisors often promise returns. So the reason our service exists, at least in part, is and, um, brings the client to the table, is the need for and promise of these returns. Can you tell us if someone is promising performance or alpha, how reliable is that promise?

Gil Baumgarten: It’s not very likely at all. Alpha is the concept of getting something more out of stock market returns. If the stock market is up 15% for the year and you’re up 18, only if you didn’t take more risk did you actually generate alpha. Uh, and the Wall street is very good juicing risk up having you, uh, outperform by three percentage points, and then tell you that you outperformed without a very sharp pencil, you would be deceived into believing that for taking two times as much risk, you only ended up with 20% more return in that example. And so then that knife is going to cut the other way. As soon as the market falls by 20%, you’ve taken two times the risk, and you could very easily lose 40%, which was far greater than the three percentage points that you picked up on the way up. So people tend to lose sight of the fact that the market is going to have a return, irrespective of what you do with your money, and it is going to pull you along. The rising tide lifts all boats, and in the end, the purest form of what you can extract from the market being beta, which is just your correlation to stock returns. The purest form of beta would normally be an index fund and would have very little tax friction associated with it and have very few fees attached to it. And over a very long time period, you’re going to end up outrunning everybody who’s pursuing alpha. Most often because people hop at the wrong time. They don’t buy the lowest performer off the list. They buy the highest performer off the list. And when the market flips around and changes, they’re going to end up buying high, selling low, buying high, selling low, rinse and repeat. And then they look up 15 years from now and they go, oh, my gosh, I didn’t even get a market return out of this. And I paid fees and I paid taxes. That’s typically the way that goes down.

Jonathan DeYoe: But have you ever experienced clients that are sort of comparison shopping for performance?

Gil Baumgarten: I experience prospects that do that. I don’t experience prospects exactly. It tends to manifest itself in a conversation, which, this is a profiling business, and, uh, I’ve been doing this for almost 40 years. You can kind of spot them coming. The first couple of words out of their mouth is, well, I fired my last advisor because of this or that. Uh, okay, all right, here we go. I fired my last advisor. Tell me what it was that he or she disappointed you. And when you start getting into it, it’s almost always about unmet expectations. And either the advisor set the expectations incorrectly, or this person thinks that. I have met a lot of people who think this, that all I’ve got to do is hire some smart advisor who’s just smarter than everybody else and will give me a stock market return. But I want bond market risk. That’s really not that too much to ask. I should get a 10% rate of return. Taking a level five volatility, and everybody else who’s a dummy and not as smart as me won’t get that. Well. What they’re losing sight of is that this is a closed ecosystem and everybody is just swapping dollars. Your ability to out trade the next guy when they’re after the same thing is really not very good. And by the time you look at the tax friction and the fee friction of the very process that you’re engaging in, chances are you’re going to be digging yourself a hole. There’s just a whole lot better methodologies that are most likely going to produce a much better rate of return over time.

Jonathan DeYoe: This is the same question worded a different way, so bear with me. I want to hear your answer to it. But we know that someone’s going to outperform. Shouldn’t we at least try to find.

Gil Baumgarten: Them and use them? Well, that’s a very good question. Here’s the tough part. The person who outperforms this year is not the same person who’s going to outperform next year. And your assumption about what long term outperformance looks like makes the assumption that either the one smart advisor for this year who just happens to have outperformed is going to outperform in all years, which he will not, or that you’re somehow magically going to be able to predict who or what it is in the future beforehand. You can swap from one vehicle to another, and you can parlay your way through this and navigate it in such a way, and by the way, that you never make any mistakes along the way, that you’re never going to encounter a short term capital gain which has a 42% tax attached to it, or that you’re not going to make some mistake that takes all your previous alpha and sucks it right down the toilet. There’s just all these, uh, cross currents that people don’t realize will apply to them. And you’re way better off to have a much broader, diversified portfolio. And frankly, I wouldn’t even argue that the index fund, which it is very near the top of the heap, it is not at the top of the heap. The top of the heap is an index methodology that owns individual securities with the intent of producing beta and not alpha. And the reason why I say that is the very top of the heap. And we, the vast majority of the money that we manage for clients is done this way. We try to replicate an index’s return by using the individual components of those stocks. So 40 to 50 names can give you a very high correlation. And the reason why it’s better is that the fees will go to zero, because you’re not paying any commissions you would otherwise be paying in some index funds, um, 16 basis points, or eight or nine or whatever. So we can take that fee erosion down to zero, because we’re providing a wealth management process with asset management tucked into it, for which we’re not charging a second fee. So that second layer of service doesn’t have a cost associated with it, as far as I’m concerned, but more importantly, tax management. So you’d be able to sell your losers in strategic ways to take losses that could offset gains from real estate transactions and other things. You’d be able to, 31 days later, buy the same securities back again. We use index funds as placeholders in that case to make sure that clients are not uninvested during that time period. Then you would be able to take your biggest gainers out of the bottom of that portfolio, which for us is for the most part, Home Depot and Apple shares, is what we have. Some of our biggest gains. And we use that to fund the clients charitable endeavors, giving them to donor advised funds, or putting them in a, uh, personal family foundation and scraping the capital gains out of that, and then using cash to buy those same securities back again. That tax management can add more alpha to the process than any of the decision making about whether we were going to sell this share or buy that share, which, by the way, has tax and fee friction that these other things don’t have. It’s just a different methodology that is tilted towards providing excess returns just simply because of the math of how it works. It’s not related to the individual decisions of what we’re buying and selling. It’s how we have the portfolio structured that leans towards putting the clients in the top 10% of all performers, just because they don’t have the friction from doing it the other ways.

Jonathan DeYoe: Yeah. Win by not losing. Right. You don’t make, uh, smart decisions. You make less bad decisions.

Gil Baumgarten: That’s exactly right. That’s a very good way to say it.

Jonathan DeYoe: So, let’s talk about the second topic in the book, the investor psychology. Uh, you’ve touched it, uh, a bit on it in former discussion, but can you lay out sort of the fundamental problem presented by cognitive and emotional biases that we’re all subject to?

Gil Baumgarten: Most people don’t want to do something without rational reasons why. And rational reasons why to them, is a history of wishing they had already done it. So we don’t decide we want to buy Home Depot when it’s $50 a share. We kind of want it when it’s $75 a share. We really want it when it’s $100 a share. But we’re scared of it. And then we give up and buy it at $125 a share. So we don’t really do what we should do at the time. We’re really only doing what we should have already done. And for the most part, all the real juice of making good decisions are made when you have no idea what’s going to happen next. And that puts you in the maximum risky or perceived risky position. Warren Buffett says that minimum securities prices come with maximum uncertainty, and maximum security prices come with minimum uncertainty. And so you find yourself with people who are willing to pay a whole lot more because they just feel better about it. And people are much like moth to flame. They tend to gravitate towards the things that they should have already done. They’re not really anticipatory of anything. They only are looking for affirmation for the decision. So when they feel good about something. That means that somebody else has already made money doing that. And so that’s the biggest hurdle that people have to overcome, is having no real justification for doing what you want to do, except that it’s mathematically the highest ods outcome, and that’s very difficult for people to have good hunches about.

Jonathan DeYoe: So let’s say we know that that’s the case. We understand. I know I’ve got these biases. Does knowing I have the biases, does that help me or enable me in any way to avoid the biases?

Gil Baumgarten: Uh, that’s a good question. Yes. I think that if you know you have those, just being aware of them can help you combat it. Whether you’re going to be any good at that, I’m not so certain. And, hey, I don’t mean to speak like an authority on this, because I’ve made tons of mistakes in my career. Hopefully, I’ve learned a few things, and I still continue to have to battle the emotionalism of these same issues. It’s not anything you’re ever going to conquer. It’s just a matter of getting a little bit better at it. One of the things that people can do is buy their mutual funds off the poorest performing list and not off the best performing list. That’s one thing that you can do. The calend table of periodic returns can be a spectacular place to start your portfolio selection process. But be mindful that you should not be. Uh, Calend is a spreadsheet that shows you every year which asset class did the best. And you’ll also often find that last year’s best performer is this year’s worst performer, is next year’s best performer, is next year’s worst performer. And if you really wanted to play it correctly, you’d be building your portfolio off of the poorest ones, and you’d be liquidating whatever is the best one. And that’s the exact opposite of the way most people do it. They feel good about, oh, my gosh, this was up 38% last year. I guess I better buy that. Well, if you want to ride it all the way to the bottom, then, yes, that’s exactly what you should do. But that’s really not a money making methodology.

Jonathan DeYoe: So I don’t want to have listeners leave thinking that the best thing to do is to buy the thing that’s the least performing and then sell the thing that’s most performing and rotate 100% in and out of things, whether it’s sector rotation, classroom.

Gil Baumgarten: Yeah, I’m talking about trimming rebalancing the way we do it. So we run an all ETF core satellite portfolio. 60% of the portfolio is broad market s and P 500, Nasdaq one hundred. S and p one hundred. Russell 1000 value index. Russell 1000 growth index. It’s those big cross sections. Why do we do it that way? A couple of reasons. One, we don’t want to be making constant adjustments to that that defers our gains the longest and gets the best compounding for a client. And those vehicles tend to have the lowest internal fees. I think our average fee in that 60% is under nine basis points annually. And then the 40% periphery could be an overweight to healthcare, overweight to energy, overweight to aerospace and defense, buying cross section of the marketplace, which we do rotate through and realize gains periodically and losses periodically. And there are higher fees in those more selective industry types of exchange traded funds. But when you take the 60 40 blend of high fee, low fee, high turnover, low turnover, you end up with a very fee efficient 19 basis points on average and a very tax efficient outcome because that 60% is not getting traded. When I talk about buying off the top of the list and off of the bottom of the list, I’m only talking as to that 40% periphery, not the 60% core. So, yes, it’s not traded. Our turnover at our firm over the past five years is probably less than 20% in aggregate. And, um, eight percentage points of that 20 was last year. So we did have more activity last year, but 4% per year turnover would be about average for us. So 20 percentage points spread over five years.

Jonathan DeYoe: So I think you’re just pointing, you’re pointing to a very specific point I think you ought to make. What is the advisor’s most important role in a client’s life?

Gil Baumgarten: Well, John Bogle says that an advisor’s most important role is to keep an investor in their seat, keep them from wandering out of the investment process when they are most disgusted. But that is the highest ODS payoff. I’m sure longtime listeners of this will understand that when the market is in crash mode, let’s call it March of 2020, markets down 30% in 90 days. And then on March the 24th of 2020, as it’s in free fall mode, it absolutely reverses and is up 14 or 15 percentage points in two days. That means 50% of all the losses that had occurred in the prior 90 days, which are very aberrational, were recovered if you were invested at the bottom, if you were liquidating at that bottom, because you could feel the rug being pulled out from underneath you, you would have missed that recovery. And that’s where the sweetest part of the recovery actually is. So you cannot wait for. Wait and see how things improve. Well, you’re going to miss it because it’s going to happen so fast. You cannot make decisions after the fact. So that’s the reason why people have to stay invested, and that’s why Bogle was such a fond of saying that an advisor’s most pure and most beneficial role is to keep investors invested.

Jonathan DeYoe: Essentially, uh, that speaks to the 4% turnover. We’re not doing things just because we want you to see us doing things we’re not doing. And that’s the best thing for you, right? That’s, um. Right. There’s a ton of noise, ton of noise out there in every one of these episodes. I like to get a few very specific tips. So just a couple of things. First, what is one thing that an investor can do that, if they did it religiously, would absolutely lead to greater financial success?

Gil Baumgarten: Pay closer attention to taxes because commissions have gotten so low and are, for the most part, pretty much zero. At least in the do it yourself marketplace. People believe that they don’t really have any friction of moving from one investment to another. And if you’re paying taxes by swapping your Coca Cola shares for Home Depot shares, because you know Home Depot is going to have some stellar earnings release, and you’re going to try to parlay that, the friction of the process of swapping from one name to another will deteriorate your return so greatly. Uh, likelihood that you’re going to be correct is not very good to begin with. Your timing is probably off. People also lose sight of the fact that if they have some insight, everybody else has that insight, too. You’re not the only one with the thought that x, y, or z is coming next. And whatever the aggregate thought is of hundreds of thousands, if not millions of people playing this game, their perception of that exact same fact has been factored in to what they’re currently going to pay for those securities. And if you’re late to the game about legalization of marijuana seems like a done deal, well, you should have been buying marijuana stocks five years before, not when you have the sudden aha moment when Tilray is trading for $200 a share in 2015 or 16, and it’s like $4 today. So everybody is late to the party because they believe that what they believe is insightful? Probably not. The marketplace has an uncanny ability to price in all the things that you already believe. And if other people are overpaying for it, so are you. So it’s just, uh, very difficult. And the opportunity set is not that great. And the real opportunity set is to defer taxes. And most people are unaware that a step up in basis would be tax free for them at the death of this first spouse. And so I think if you looked at the way the tax code was built, you would choose, most people would choose a different methodology than hopping from investment to investment. And they would acknowledge that hopping around like that is really more of an egocentric trying to place your bets and see how you do, when in reality it’s a method of decay, probably should not be engaged in. Um.

Jonathan DeYoe: I love the vision of trading as return decay. I think that’s a really good way to put it. I want to give people who do that a little bit of the benefit of the doubt, because as an industry, we’re relatively new as an industry to the idea of the importance of planning and asset allocation and rental press still talks about what’s the hot thing to do. The Forbes list is still ten stocks you should buy this year. Yahoo finance is still, what do you buy today? So there’s still a lot of financial pornography out there, stuff that doesn’t help people.

Gil Baumgarten: That’s a good term for it. Well, they’re in the business of selling or satiating people’s desire for information, and it’s just not valuable with regard to being able to trade on it and make some money off of it. So, yeah, financial pornography, I think, is a very good term for it.

Jonathan DeYoe: It’s not my term. I borrowed it from somebody else.

Gil Baumgarten: Uh, okay, well, fair enough.

Jonathan DeYoe: Yeah, give them credit. So, second part of that question is, name one thing that people think they’re told press that they think they should focus on, but usually it’s somebody trying to sell them something that they can just ignore it and not worry about it. IRA 401K.

Gil Baumgarten: You’re talking about IrrA 401K? Yes, partially. But more importantly, annuity sales. You will have somebody who could create an illustration that shows you how an annuity, or an indexed annuity in particular, will give you all the upside of the stock market, none of the downside. They’ve got this mathematical algorithm and you get tax deferral and presto, change o bam, here’s your rabbit coming out of the hat. It just does not work out that way. And the commissions inside of annuities are generally so high, the costs are expensive. The value of the deferral really isn’t all that great. Now there are people who probably should buy an annuity. And who are those people? It’s the person who’s maybe made mid level income, let’s call it 70,000, $80,000 a year, and they’ve saved for years. They’re 65 years old, and they’ve got $500,000 in their 401. They don’t have any kids, and they need the comfort that they can’t outlive their money. And if I were to get 7% distributed to me off of my $500,000 for the rest of my life, then I wouldn’t have any real financial problems. Well, there’s very few vehicles, even in today’s higher interest rate world, that could compete with that. And it’s really the apportionment of your own corpus, plus the likelihood that you make money over time, which is the reason why an, uh, annuity company would guarantee that, because you’re not going to really run out of money until the pool that the $500,000 is gone. But a risk averse investor, which I would imagine that person would be, really couldn’t afford to do anything other than sit in fixed income vehicles, and they would never make 7%. So it’s the apportionment of your corpus and the insurance company’s, uh, ability to withstand the risk that you actually do run out of money inside of your lifetime, and the checks will continue. That’s the risk that most people can’t afford to take. And so it could put somebody in a position of owning variable vehicles, like stock market mutual funds, inside of a variable annuity contract when they otherwise wouldn’t have had that appetite for risk. And it’s probably the one thing that would save their portfolio over time. But as a tax deferral vehicle for a high net worth person, no taxes are too high, the fees are too high, the liquidity is too poor. It’s just not a very good vehicle.

Jonathan DeYoe: Just to summarize that, it sounds like that the only people that should think about an annuity for return are people that are really risk averse and wouldn’t own equities otherwise.

Gil Baumgarten: I hate to use the word only, but that would be the prime candidate. But I would also add to that people who do not have concerns about having to take care of their kids financially, because what’s happening is you are shifting your current income reliance into a fee mechanism that is more than likely going to diminish your corpus over time, and you are getting permanence of income back as the trade off. But what the other trade off is, is that you’re more than likely going to have less money in your estate down the road, which would jeopardize the corpus to a, uh, next generation. So the real candidate is the person who hasn’t quite saved enough, who doesn’t really have a healthy appetite for risk and does not have children or some other group of people to be thinking of about how to optimize what they leave behind at the end of their life. They’re trying to optimize cash flow and risk aversion during the remainder of their life, and that’s going to be the best candidate for an annuity.

Jonathan DeYoe: All right, I appreciate, uh, the clarification. Just for your wrap up, we’re coming up on an hour here. I want to come back to the personal and just ask you two questions. One, what was the last thing you changed your mind about?

Gil Baumgarten: Oh, boy. Well, I have an affinity for english cars, which I never would have thought that I would have changed my mind about english cars. I have a Range Rover, and I have another more premium brand. And so I have always been a german car guy, and I really like my english cars. And so I would say that that’s something that I changed my mind on, because if you would have told me ten years ago that I’d be driving english cars, I would have said, no way. That’s something that I’ve changed my mind about.

Jonathan DeYoe: Great. I, uh, hear all kinds of answers to that, so that’s a good one. Uh, second question is, it’s maybe a little bit more difficult to think through, but if you could get the truth, the absolute truth about any single question about your life in the future, and all you had to do is ask, what question would you ask?

Gil Baumgarten: I guess I would want to know how long I would live, because my time, I think probably differently than going through the unknown of how long I would live. But then again, that would be awfully intimidating to also know that. So given the option of knowing, I’m not so sure that I would know when God would take me. But that’s one thing that would solve a lot of variables about how I view risk, time periods and the like. So I don’t know if I would want to know that, but that would be an important thing to know.

Jonathan DeYoe: Maybe you could ask it so that your planner knows that I don’t want to know it, but maybe my planner.

Gil Baumgarten: You know, but don’t tell me. Exactly.

Jonathan DeYoe: So tell us how people can connect with you. Thanks for coming on, but I want people to know how to connect with you.

Gil Baumgarten: So, uh, they can go to gilbombgarden.com. So G-I-L-B-A-U-M-M-G-A-R-T-E-N. Um, I do a bunch of artwork. I paint, I do sculpture, I do all kinds of things. So on my personal website, they can see some of that. My firm is called segment Wealth Management. Segment segmentwm.com. You can visit there. I write a blog. You can see the history of things that I’ve written about and predicted in the past. We keep all of our blog posts on there. Uh, nobody’s ever going to reach out to you. We don’t follow up on. It’s just a free blog. You can sign up for it there. Whatever we write, which is usually about every two weeks, we just come to your inbox. My book is called Foolish. You can find it on Amazon or audible or on Target’s website. So just type in foolish book and it’ll come up. It’s a yellow book with a ladder on the front of it. And it’s just about the brokerage industry and the uphill battle of finding good performance in everybody’s journey along the way. So just kind of the school of hard knocks that I’ve been through.

Jonathan DeYoe: Yeah. Joe, thanks so much for being on the Money podcast. All of that stuff will be in the show notes. Really appreciate your time.

Gil Baumgarten: Thank you. Appreciate it.

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