A hearty welcome to “Grandma’s Wealth Wisdom” with your neighborly hosts, Brandon and Amanda Neely. This is the only podcast that helps you take charge of your cash flow and leverage your assets, simply and sustainably, the way Grandma used to.
Amanda: Hi, and welcome to our Grandma's Wealth Wisdom. We're super excited about our conversation today with Lester Himel. I'm going to keep intros really short here because I know Lester has a lot of value to bring to today's conversation. We could say a lot about Lester, but just so you know, he's got a broad financial background and some real-life experiences to back up the value that he's going to share today. We put a full link to his bio in the description.
Just personally, Brandon and I have learned a lot from him, so if you've been checking out our podcast or YouTube channel, you'll see a lot of his fingerprints, but you don't know that they're his unless we've attributed them to him, which we've done a couple of times.
But today we're super excited to have him as a guest on the show. Welcome, Lester. [01:08.0]
Lester: Thank you. It's good to be here.
Amanda: Can you give our audience a little bit more about your background?
Lester: After grad school, I went on to Wall Street and worked in administration compliance operations of all sorts. I was a bond trader. I ran trading desks. I got involved with dotcom here and there, emerging markets, corporate bonds mostly, anything and everything, and by accident, bringing it full scale, ended up in this business. That's sort of an accident.
Amanda: Can you tell us a little bit about that story of what that transition was like?
Lester: What brought it about was I have a son who was in college. It was a senior year and my wife and I were invited to senior weekend out on the West Coast and, coincidentally, two weeks before that, I was offered a position at an insurance company, which I turned down, thinking, Me? Insurance? No, I'm a wall Streeter. [02:04.8]
The visit to the west coast resulted in my wife and I each attending different seminars. The professors were, of course, showing what the students go through and how wonderful school was there. This seminar I attended had to do with a professor by the name of Steel, who was discussing, describing the study he and colleagues had done. It had to do with discomfort in a given business environment, which applied to me 100%. I was involved in credit derivatives at the time on Wall Street and it was a very uncomfortable experience for me, so this was fitting into I guess my psychological needs. My wife attended the lecture given by a neuropsychologist and he was saying that, every 10 years, no matter what you do in life, you need a change. You need a learning curve.
So, there I was, after all those years on Wall Street, listening to what she was excited having heard and what I was hearing from Steel, so I called the insurance company back and said, “I've reconsidered what's our next step,” and here I am. [03:08.6]
Amanda: Wow. Wow.
Brandon: That probably sounded like a big crisis of, I don't know, you probably went through almost a personal crisis at that point of, Hey, I've learned all this stuff, and then this clash probably came internally for you, do you think?
Lester: I would say, that's fair, yeah. I certainly needed that learning curve that I mentioned, but I also certainly needed a change overall to give myself a sense of accomplishment or maybe a challenge. I'm not sure how that really ratio-wise came into my life, but I definitely needed something.
I started with an insurance company that is one of the largest in the world and it's a very publicly-traded company. It's also very focused on such things as what we call universal life insurance. I learned all about how wonderful that was, and then, over the course of time, found my way into a mutual insurance company and found out about whole life and how that played into the realities, and eventually went independent a number of years ago. [04:08.2]
Brandon: I want you the listeners to get, when he said universal life insurance, how wonderful it is, it was a little more on the sarcastic side. If you did not catch that, he was being a bit sarcastic.
Lester: Yeah, I can expand on that. Back in my rookie days, one of my positions on Wall Street was to recreate and redesign the Wall Street firm I was working at in every department from A to Z. That sounds a little odd, but that's exactly what my role was in the second year at that firm.
In going from one department to another, I ended up meeting a man by the name of Jack Barter. Now, that's important because he's the man that designed universal life insurance and he tried to sell me one of the very first policies. There I was, a kid, and he was trying to get me to buy something in life insurance. Me? “I’m a 20-something. What do I need that for?” and I didn't understand the design anyway. [05:06.3]
But over the course of time, I’ve got to know more and more about it, because I'm a parent, because I needed insurance, because I’ve got into the business. When I went to this public company that I mentioned and learned about the wonderfulness of universal life, it was to the … let's call it, the criticisms that were constant toward whole life.
Now, there's a very large story behind all of that, but in summary, universal life is a very dangerous piece of insurance and it's only called insurance because it happens to take advantage of the IRS, the tax code, and in so doing, it just leans on the fact that, if it has life insurance, then it gets certain tax benefits, if there's a death benefit, I should say. [05:57.4]
It is my position, knowing what I know about it, that, number one, it's dangerous for the client that owns it. Number two, it should be in the Wall Street arena, not in the insurance arena. If you look up what a life insurance company is supposed to do, what the purpose of the company is, it's to transfer risks off the shoulders of the client onto the shoulders, proverbial shoulders, of the insurance company, and take on the opportunity to work with what's called the law of large numbers, spread the risk among many people.
Universal life does not do that. It leaves the responsibility for success and the likelihood squarely on the shoulders of the owner of the policy. That's not what life insurance companies are supposed to do, so I have a real problem with it at every level.
Amanda: Yeah, that was really well said, Lester, hundred% agree. I know you've got some really strong opinions. I love that you're sharing them and bringing them to the conversation today. I know one of your biggest opinions is about volatility and how it's understood by most people. Can you tell us a little bit more about that? [07:05.0]
Lester: Sure. We can start with an example of what happens with the public. A man walks into an investment advisor's office and says, “I have $10,000 to invest,” and the advisor, of course, says, “That's great and we have the following opportunities. What would you like to buy?”
He's investing, and then a year later comes back to the advisor and says, “How did I do?” and the advisor says, “Hey, you're up 10%.” Sounds great. The man leaves, a year later, comes back and asks the same question again. “How did I do?” He says, “You're down 10%.”
The normal thought process there is, Hey, I'm even. At least I didn't lose money. There's still an opportunity to do more next year. The reality is that's not true. If I take $100 and I go up to 10% in a year, I have $110. Next year, if I go down 10%, I don't have 100. I have 99. 10% of 110 is 11; 11 subtracted from 110 is 99. [08:03.4]
We get a little bit steamier with it when we talk about bigger changes. Let's imagine that my investment in the first year goes up 100%, and then in the second year it goes down 50%. The man-on-the-street thought is, Okay, up 100 in Year 1. Down 50 in Year 2. That gives me a net of 50 and I have two years to average it over, so 15 divided by two is a 25% return. Hey, that's not bad.
Brandon: Sounds awesome.
Lester: Yeah. Let's do it with real numbers. I put $100 to work. It goes up 100% in Year 1. I have $200. My $200 goes down 50% in Year 2. I have $100. Where’s my 25% return? Nowhere.
Lester: So, why is that important to go through that? Because here's what happens with the professionals and I'm truly critical of most of the professionals. Remember, my first job on Wall Street, I actually had to test all those professionals, all those stockbrokers as they were called in those days to see if they knew their business and so on. [09:05.8]
Here's what happens. The market goes up 10% in Year 1, down 3% in Year 2, up 17% in Year 3, down 27% in Year 4, and so on. You take those numbers, you get the sum. You divide by the number of years and that gives you your average return over those years. Very simple formula. Now, I've given this lecture structure, the explanation, to professionals, 100 at a time, and they'll come up with, yeah, that's exactly the way it works. Okay. That is no different from what I just said with up 100, down 50, divided by two. It’s the same arithmetic.
Here's the humorous side of the story and this is where volatility comes in. A 22-year-old just out of college walks into an HR department at his first employer and they sit him down. Here's a clipboard loaded with papers. “Sign off on all these things you have to sign. By the way, we're going to sign you up for the 401(k) program here. You really ought to sign up for the 401(k).” [10:09.3]
The response, of course, is, “Yeah, my dad told me to do that. I'm going to do that. That's not a problem. 401(k) sounds like a good idea.”
The HR person says, “Okay, you're going to sign up for the 401(k). Let's see. Over the last 25 years, the stock market has returned an average of 7.3%, so if we take that 7.3 and look forward from here … Wait a minute, let's be conservative. Let's use 6.3 just to be conservative. How does that sound? Good?”
“7.3, looking forward six. Wait a minute. Wait a minute. How old are you? You're 22? Okay, when are you going to retire? 65? You're going to retire at 65? That sounds like a good idea. Okay, we'll just use 65. That's 43 years, and how much are you making? Hold on. You're making … Can you contribute $212? That's before tax. Can you put $212 pre-tax into your 401(k)? Because if you can with every paycheck, at the age of 65, you're going to have $1.33 million. How does that sound?” and of course it's like, Sounds great. Why wouldn't it sound great? Yeah. [11:11.5]
What just happened there is this. Looking back at the 7.3 average return over 25 years is incorrect. How do I know it's incorrect without even knowing the numbers? Because what they've used as return is actually change. That goes back to what I said about up 100, down 50. That's percentage change. That's not a return. As soon as you go from one year to another, it's that change.
When you take that 7.3 average change over 25 years, you've ignored the volatility of reality, reality and real numbers. Then if I look forward, going to 7.3 or 6.3, I can be as conservative as I want, it doesn't matter. If I look forward with that straight line projection as it's called, I've ignored the potential for volatility. I've ignored the possibility that I might lose something and need a recovery it to get back to where I started. That being the case, the numbers are fiction. [12:06.8]
Now, it doesn't mean that I'm going to do better. It doesn't mean I'm going to do worse, although, statistically, you will do worse, but the reality of volatility now starts to sink in, I hope.
Lester: The next question you're going to ask me is, okay, so this 82 thing, what will you do with the 82?
Amanda: Yeah, that’s exactly where I was going?
Lester: Here's what I ask my prospects and clients to consider. Imagine yourself to be 82 years old.
Amanda: That's hard.
Lester: It is hard. You need an imagination. It's very hard. You get to 82 years old and I say, Are you living at that point off your investments? Likely, right?
Amanda: I hope so.
Lester: And if your investments are an IRA or Merrill Lynch account, a broker dealer of some sort, it doesn't matter. You're living off your investments. Now, you're doing something, taking money out of the investment account to pay your bills, and then the market goes down 35%, which it has done three times in the last 20 years, and what do you do? Do you still pay your bills? Do you get nervous? Do you worry about outliving your money? [13:12.3]
What you've just experienced is volatility. Volatility means up and down, and in this case, down a lot. What you now need at age 82, remember you're 82, now you need to see recovery. From the year 2000 to the year 2011 and a half was the recovery from that first collapse in the year 2000, almost 12 years’ worth of recovery requirement. What do you do during that period? You don't know how long recovery is going to take, but volatility. Underline that word for a moment.
Now that you've experienced, at least in your imagination, the volatility at age 82, did you have options? Were you able to go back to work? Were you able to drain some other savings somewhere else maybe or lean on relatives, or who knows what? [14:04.8]
Now that you've experienced 82 volatility, now let’s move back to when you're 45 or 50 or 38. Did you experience in your savings, in your 401(k), in your investments, volatility? Then chances are really good you did. Why didn't it affect you? And the reality is it didn't affect you because you had an income. You were surrounded by people saying, Don't worry. You have time. You'll make it up. You know the market always goes up over time, right? All of the truisms that come out, all of the textbook answers and “let's keep the money invested here” kind of answer.
Once you understand the volatility was a problem at 82, then we can start analyzing how much of a problem that really is in your growth and your savings when you're 38, 45 and 50? Put them together and you start to get a sense of what volatility really can mean to you, and it's never a positive, never, no matter what they throw at you whether dollar-cost averaging and you know you're going to be able to buy this over here. [15:14.0]
No, dollar-cost averaging is a rationalization for taking advantage of the ups and the downs, mostly the downs, of volatility. Consider if you're at the lows and you're buying stocks at a cheap price. At the highs, you're going to be buying stocks at a high price. What's the balance there? The whole idea of volatility is a massive negative and, in particular, when you're helpless in your later years, so we have to get our arms around that completely.
Amanda: Yeah. [15:42.2]
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Amanda: Let's say someone is like, Okay, I'm willing to say maybe possibly I need to do something here to counterbalance any volatility in my portfolio. What do they do? What’s the solution? What's the strategy to pursue?
Lester: Then I can give you an easy answer and a complicated answer, and I'm going to try to get in between the two.
Lester: The first answer is unique consistency in your growth and in your earnings, and in your continued growth presumably in your retirement years. There are very few, if any, instruments that provide that, certainly no Wall Street instruments. The textbook approach to all of that is to use what's called modern portfolio theory, which came about in the mid-1950s, 1956, I believe. [17:04.8]
What that does is it takes stocks and bonds, and maybe some alternatives such as wheat futures, or who knows what, silver, gold, puts it together in a portfolio, and you're supposed to make some sort of a reasonable mixture out of all of these things, ratio of this and versus that, to give yourself some sort of consistent growth and balance off the volatility that is part and parcel of that whole thing.
Here's the problem. Number one, we know stocks are volatile, so they’re doing this all the time, all over the place. The idea of bonds introduced in the portfolio is poorly understood, more so than the stock side. Bonds are supposed to be less volatile, which they are, so I show people, this is the stock side, this is the bond side, stock side, bond side. But bonds do one thing in particular that stocks cannot do or don't by design do, and that is a constant income stream, a constant interest rate, a “constant coupon”, as it's called, into the portfolio. [18:08.3]
So, the question should be why is that important? And the answer is because that's an income that offsets, in particular, the losses of stocks, so if stocks go down, you still have an income giving you a buffer of sorts against what your losses actually could come out to be.
The reality of life, side point here, when I have a new client and I go into “Okay, what does your portfolio look like?” if they have a portfolio and they say, I've got the stocks and I've got this, and I've got that and I've got this over here. Do you have any bonds? Typically, somewhere between zero and 7% of the portfolio is bonds. It's supposed to be, depending on how you believe all those portfolio structuring to be worthwhile, 75:25 or 60:40, or 50:50, some meaningful number. It's rarely the case with the people I've worked with. Does it exist out there? I guess so somewhere, but it's not the standard. [19:09.0]
The idea of what to do with all of this, looking for consistency, doesn't play well with bonds and there's another reason for that. Number one, in today's interest-rate environment, bonds have very little in the way of interest. The interest rate-environment we're in is very low, so how much income could possibly come into the portfolio to offset stock losses if they show up? Very little.
What does that do for bonds? It makes them dangerous, because not only is there little income coming in, but when interest rates do eventually rise, the principal value of a bond to offset the lack of interest that they're currently earning drops like a rock. That is principal risk added to the portfolio, so the idea of consistency, we haven't gotten there yet. We're still dealing with a portfolio that has some tough times ahead. [20:03.8]
What we look for, what I look for, is what's called a business model, not a Wall Street model. The business model that I'm referring to is, for example, in using whole life insurance, it's not that I have a vested interest in selling whole life insurance because that's the only thing I know. It's that I look at the portfolios that have stocks and bonds and I think, first of all, mutual funds and I are not friendly, but they don't do anything for me at all. That's what's called micro diversification. It's not helpful, which we can get to in a minute. But the idea of the Wall Street model is inherently volatile. Stocks and bonds are volatile.
What we want to do is get away from that and the way to do that is to find, again, a business model that gives you fairly consistent earnings and here's, step-by-step, what I look for or what I've found. Number one, a regimented or regulated industry. Where is that? Insurance. [21:05.0]
Now, banks are regulated, but not to the same degree and not for the same reason. The idea of the insurance industry being regulated, it certainly is possible. The regulators want these insurance companies to last consistently into the next millennium. Try that with any other industry. Number one.
Number two, the idea of the companies, if we can find a company that is consistently profitable for many, many years, not last year, not last quarter, not seven quarters in a row, but over 100 years, we're doing ourselves a favor. We can’t guarantee consistency for the next 100 years, but we have to take a best guess, an insightful intellectual guess, maybe not so much a guess, based on history and see if we can take that into the next century.
Number three, we want a business model that is not reliant on the interest-rate environment or, more accurately, the economy per se, whether its ups and downs. Wall Street can do that. We don't care about that. We don't want that. [22:04.3]
With that, what we end up with is mutual insurance companies, and a mutual insurance company, and this has to be clear, is not owned by stockholders. It is owned by policyholders. If I buy a policy, a whole life policy, in a mutual insurance company, I'm an owner of the company.
What does that do for me? It means that when there's a profit at year end and that profit gets distributed, who does it get distributed to? Me and all the other policyholders like me. The bigger my policy is, the older my policy is, the more money I make. That's the whole idea.
So, we want a company that is historically profitable without missing a beat, hopefully. We want a company that is regulated, consistent, and persistently giving out profits to me. Now, the business model, what is the business model of these insurance companies? It is not investments, although that's part of their game, for sure, but the business model is selling insurance, collecting premiums, paying claims. [23:11.4]
Now, remember they're regulated, so the idea of the difference between premiums and claims is presumed to be the profit. I want that model. I want to invest in that model. If I can take advantage of that to my betterment, why shouldn't I?
To step to the side for a moment, it doesn't mean that my only approach to investments should only be insurance, although I think it should be the centerpiece of every portfolio. What people seem to miss way too frequently, it's that we should enter into a casino environment for our entire savings and financial life, but we should enter into something that gives us some certainty in the middle, and if we want to play and speculate on the edges, fine—we all want excitement in life. We all go to Las Vegas at some point—but the idea of making that the way we create that role-- Pardon me? [24:10.3]
Brandon: I'm going to go to Vegas.
Lester: I'm not a big better. But the idea of making sure that you have something that you can rely on is no small thing, and people tend to think that an investment advisor at some broker dealer is the closest thing they can get to heaven because this guy is promising this or saying that. There's a reason, there's a big reason that Wall Street cannot guarantee results and that is because they can't guarantee results. We can, yeah.
Amanda: Yeah. We do have a comment here that I wanted to throw out at you. Totally say pass. James Pollard is asking or he's saying one of the ways he protects himself from volatility is through dividend stocks, because then he's not dependent on investment growth. I guess, presumably he's getting those dividends instead. What do you say about that? [25:08.0]
Lester: I think dividends are a nice thing to have, but the underlying principal value of the stocks that provide those dividends cannot be counted on. Long term, they cannot be counted on. Short term, maybe. Maybe they'll have a good quarter, a good year.
Think of it this way. Dividends were at their highs in the late-90s and then they dropped. What happens in dividend with dividends in the next 10 years? And here's a bigger challenge, the question: name any five companies that you are confident will be around in 10 years. There's a challenge.
I don't know which companies will be around in 10 years, aside from the insurance industry, which I do have a bit more confidence in. But the idea of will IBM be there in 10 years? Will Facebook be there in 10 years? Will GE? Look what happened to GE over the last 10 years, the idea of consistency and certainty. [26:00.0]
To the question, let me pose this. We don't deal the way Wall Street does in one- and two-year game plans. When you walk into your advisor or broker dealer and you say, What do you think is going to happen in the next year? that's how they play. They have an analyst. They have an economist. They have a team of analysts and economists, and they'll tell you, What we think on the next year and the interest rates are going to be, and this and this and this, and that's great.
But when you come to me, to us, what you're really trying to accomplish is not a one- and two-year game plan. That's basically a wet finger to the wind, which way do I think the wind is blowing now? What we have to deal with is 50-year game plans. Someone that's 25 has a 75-year game plan. We have to deal with something that gives us some level of certainty long-term and we can't be dissuaded from that direction, not if we're doing the right thing for our clients. So, the idea of, yes, dividends are important, yes, the stocks and the companies that provide the dividends are cool, but for 50 years? [27:04.2]
One of the implications is when you look forward to where you're going to be financially in 10 years, 20 years, 30 years, and 40 years, when you're young, when you're 25 and 35 and so on, you tend to put together what I would characterize as a complicated portfolio. There are three silos in the financial industry, in my view. One is banking. One is investments and one is insurance.
Brandon: They talk to each other.
Lester: They talk to each other a certain way, but by competing, right? The idea, in 1999, when the Glass-Steagall act was repealed, was that all three of those were going to eat each other's business and they quickly found out that it's not as easy as it sounds or looks. [27:55.4]
But here's the key: over the course of time, they have become and they've shown themselves to be very, very adept at creating new products to sell. They are terrible at showing you how those products work together and, frankly, they don't care. They've got this department that sells CDS and then they've got this department over here that sells life insurance, and this department over here that handles mutual funds and so on. All they want to do is in each department show their P&L, get paid at the end of the year, and off they go.
What we have to do is make your life financially simple, and when you're 35 years old, you've got kids, you have to have a 529. You've got kids, you have to have term life insurance. You've got kids, you've got to invest for the future. Wait a minute, you have a spouse. You've got to start retirement savings. Wait a minute, you need a car, you need this. It just compounds and it gets more complicated, and by the time you reach near or at retirement age, you've got all this stuff and then you have to start figuring out how it all works together. Now what are you going to do? Who are you going to call? [29:02.5]
It's funny that the number of people that I see and that we see in our practice that are between the ages of 55 and 70, it's not that that's a sweet spot. That's the complaint spot. That's where people come in and say, I'm thinking of retiring. I just don't think I have enough money, or I was hoping I'd have 1.33 million by now. I've only got 347,000. I don't know what happened. Do you have any suggestions?
What they really end up with, what we end up with is, more often than not, and for all those people that don't have the wherewithal to come in and ask the question, they end up reaching the age of 65, 70 and 75, and they become what I call a discarded client, discarded by the advisors that they've had in the past, either because they outlive them or the advisor doesn't care for their business anymore because there's no new profit in it, nothing to sell. The idea of someone being in their seventies and eighties and not any longer knowing what they have and what to do with it, or how it might work against or for each other is all too common. [30:12.2]
The idea of simplifying your financial life goes way back to what you should be doing way before that happens, so that you don't have to rely on “Which stocks do I sell? Which bonds do I sell? Which fund is the right fund to buy? What do I do with all this complicated stuff if it turns out to be a complicated affair?”
Again, people don't know what questions to ask. They really don't, especially when it comes to finance. They don't think about finance every day. They don't study it. They don't get involved with the nitty-gritty the way we do.
Amanda: Lester, you mentioned people don't know what the right questions are to ask. Can you give us some of the questions that people should be asking? Whoever the financial professional they're working with or maybe they're doing it themselves, what questions should they ask themselves about their financial futures?
Join us next time to hear Lester’s response to the question I just asked and how you can decide if you want to do something and do something better. [31:11.3]
The topics presented in this podcast are for general information only and not for the purposes of providing legal, accounting or investment advice. On such matters, please consult a professional who knows your specific situation.
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