Ep #155 - Illiquid Investments: Smart Strategy or Expensive Mistake?

[00:00:00] Ben Haas: Hi everyone, and welcome to AB Conversations, where we will help you CFP your way out of it. A podcast where you get into the minds of a couple certified financial planners on how we think and feel about everyday financial planning questions, and what should really matter most to you. A healthier financial life starts now. 

Adam Werner: So today we're gonna talk about when maybe an investment sounds too good to be true or, or too good to ignore, and where we kind of see that play out in our world or where, where we see their clients already own something or are being pitched, you know, kind of a, a private investment, an alternative investment to the world of, you know, our typical stocks and bonds and, you know, cash CDs, like instruments. These private investments. 

There's ways to kind of get into them. And they can run the gamut from, 

[00:00:58] Ben Haas: yeah, 

[00:00:59] Adam Werner: this is, this is truly fraud. And worst case scenario, you lose your money to, these are legitimate investments. They can have a role in somebody's portfolio, but they come with a whole host of different, different issues or just different things to be aware of. 

Right. Yeah. And they're certainly not a fit for everybody. 

[00:01:20] Ben Haas: Yeah. I think it's gonna be really important for us to touch on that, that there are certainly legitimate private placements. You know, as, as investors, you sometimes are looking for something different, something that's not correlated to the stock market or the bond market. 

We hear this a lot. People do get introduced to certain investments like this, and maybe we should just start with why people are drawn to that and, and let me just piggyback on what I was just saying. Sometimes it is just because it's, it's different, right? It's maybe gonna perform differently in a certain market, or I'll hit on a lot of these kind of, I, I don't wanna say promise, but they're pitched as something that's gonna pay you more, give you an income, give you a yield, you're gonna participate in something different. 

[00:02:04] Adam Werner: Yeah. And, and so where we see that often, kind of manifest itself is these private type investments are often tied to like some sort of other business or some sort of like tangible thing, right? Think real, real estate, real estate is, is one of like the originals where you can, you're, you're pulling your assets with a whole bunch of other investors and, and there's a company out there that's now going to take all of these dollars that have been pulled together and we're gonna go buy, buy the real estate. 

[00:02:33] Ben Haas: Golf courses. Golf, yeah. Amusement parks. 

[00:02:35] Adam Werner: And I think that's how a lot of these private type investments are illustrated or, or you know, they're kind of meant to operate in a way that is, if you wanted to go do this on your own, not only would it take a heck of a lot of capital, but it would require a heck of a lot of, you know, research, and due diligence and all of that. But hey, you just give us a portion of your money, we'll do all of the heavy lifting and we'll give you a, you know, a portion of the returns for that. But in, in those areas that again, our brain can say, I understand there's a building, somebody's paying rent. Like I just get a piece of that. 

Versus, I know I own stocks, I know I own bonds I know that they go up over time, but how does that really work? You know, kind of the, the behind the scenes, it feels more tangible. 

[00:03:17] Ben Haas: Well, and there's, I'm glad you said there's a psychological side to it too, because I think sometimes when we hear these things from clients, it almost comes across like they feel like they're invited into something that feels exclusive. 

Mm. Like not, I know somebody that's in this and my friend's making 12% yield and not everyone gets access to this, so, mm-hmm. I now feel connected, special, sophisticated. Yeah. I mean, you heard the word words here and that is sometimes why we're just drawn to the opportunity. 

[00:03:46] Adam Werner: Yeah, and and we've certainly heard from clients too that they just, and you, you said it earlier, right? Things that are not correlated to maybe some of my other investments, meaning they're, they're not going to act the same in the same market environment. So when stocks and bonds are zigging, maybe I have this other investment that is zagging. And we've, we've heard from clients that is, well, I have a lot of my money tied up in the stock market or the bond market, right? 

Yeah. So maybe I just want access to something different just to have another layer of diversification, which again. Can absolutely be an an okay way of going about it, but we would just want to make sure that there are enough other liquid investments or their situation can survive maybe a portion of it not being liquid or not accessible for a period of time. 

[00:04:33] Ben Haas: Right, because this is maybe where we can pivot, Adam, into some like real, real stories. Yeah. Things that we know happen to people that we are close with. Mm-hmm. And because of the way that these are structured, and I won't go too deep into like the legal side of it. Sure. Sometimes the transparency isn't there and sometimes that's where fraud can happen. 

Right? I'm remembering very early in my career, a couple very close to where we, our office sits, they were paying a mortgage to an institution that they thought was legitimate, that was not, it was mortgage fraud, right? They were literally thinking that this company was a bank and they weren't really operating as a bank and think about years of payments that really actually went nowhere. 

Sure, there was some restitution, but that's just a, a horrible reality because they thought they were getting a, a different deal or you know, something better than what, what they could have gotten at a traditional bank. That's certainly regulated. 

[00:05:27] Adam Werner: Yeah. And that, as I said earlier, all those are like in the worst case camp of I'm either investing money or in your example there, like I'm paying my mortgage. I, I am going through this process. I believe it's going in the right space. Turns out, yeah, it is just true outright fraud. These dollars are gone. There's a legal process to now go through, and that is just, yeah, a nightmare. To the other end of, we, we've had a client very recently that had a couple of non-publicly traded investments that are held in a brokerage account at another, you know, big investment institutions. 

So these are legitimate investments, but it's the, the illiquid nature, meaning it's not like a mutual fund or an ETF or a stock that you can go and say, you know what, I, I wanna get outta this. I click the button. And I'll have cash in my account, you know, in a matter of days. There are often big restrictions on access. 

Yeah. You know, we've certainly seen it different at different, different products are all different, but you may be only to submit for a redemption quarterly or semi-annually, or there's an annual window to just get a portion of your dollars back. But again, it can kind of run the gamut of, so the, the one that we're looking at now, even when they are legitimate investments. 

It is still that transparency issue, right? You're not really sure, sure what you own when you can get access to it. When will it go public? And now I can turn it into real dollars and actually feel like it was worthwhile. 

[00:06:54] Ben Haas: And what is it worth? 

[00:06:56] Adam Werner: So that's the key point. You know, over time. Mutual again, I'll, I'll say again. 

Mutual funds and ETFs, they are required, they're heavily regulated in that there needs to be regular reporting, not only on what the fund owns, but the valuation. So like you just said, what is it worth? Those things, revalue every night. These usually these types of non-liquid or non-transparent investments, they're not held to that same standard. 

They can basically value themselves and they're kind of doing their own valuation. Over different time periods. So again, you just, you lose some of that transparency on what is this investment worth at any given point in time. So all of this to say, I'll stop talking. I promise. 

Even when there are these legitimate investments, you may put $10,000 in, you know, upfront and over time. And this specific example for this client that is in my head, we're now at the point where that investment fully went through the process. It is publicly listed, is now a stock that can be sold. But here's the bad news over that course of a decade or so, for this to get to a liquid point. 

That valuation has fallen over time. And then when it goes public, you have a whole bunch of investors probably like ourselves, who would say, oh, I can finally get some value back outta that. I'm going to sell. 

[00:08:15] Ben Haas: Yeah. 

[00:08:16] Adam Werner: And repurpose these dollars. So you, you get kind of this, this run for the exit and that selling begets more selling. 

The price goes down, and here you are with a legitimate investment over a period of time. And not only. Hopefully you've made some money, but in our anecdotal experience, oftentimes the dollars you end up with are significantly less than what you started with. And by the way, you've now lost out on some opportunity over whatever that time period it is, for those dollars to have been invested elsewhere and actually grow. 

So it's kind of a, a double compounding effect, even when they are legitimate investment vehicles. 

[00:08:51] Ben Haas: Right? And I guess that's the point when, when you are stuck in a spot where you can't liquidate, not only is that sometimes not great, for as advisors to clients who need flexibility. But that lack of transparency on value is one thing. 

The other is, I'm gonna go back to the really negative side where fraud just exists. Yeah. Where this is pooled money and funds are sometimes used to pay earlier investors when the returns aren't there, or this is. Again, we all know the stories. This is how Ponzi schemes exist. 

[00:09:19] Adam Werner: Yeah. 

[00:09:19] Ben Haas: Right? Gentlemen in Lancaster right now going into court because it's, it was ATM machines, it's storage facilities. 

Yeah. It could be anything, right? Yeah. Big equipment. We've seen 'em all. Mm-hmm. But if money wasn't being handled the right way and it's not reported the right way. This is where investors, they don't even know what's going on behind the scenes. To be able to get themselves out of something that doesn't, that isn't going to go well. 

You know, because fraud's involved. So it's not to pick on people that end up in that situation either. Let's be very clear. To your point, there are legitimate ways to go about this. These, the victims of these things are, it's not that they're not intelligent, successful, you know, right-minded people. Yeah. 

It's not about that. Sometimes it's just, you know, we trust that things are gonna go well and without understanding the mechanisms behind the scenes and the regulations and the reporting and the oversight, we kind of enter something that we had. We known all those things, we probably wouldn't have. 

[00:10:13] Adam Werner: And you think back to at least, you know, I, I think this way sometimes. Where, where you think of these. These areas of investment fraud. And, and you know, the one that always comes to mind is the whole Bernie Madoff situation, right? Oh, right. And you, and you think, yeah. And these are massive, massive schemes. 

But you think that they are centered around kind of financial hubs, right? New York City, Los Angeles, yeah. Miami, like these big centers of influence, right. 

You know, financially, and you think, well, but I'm in, I'm in Berks County, Pennsylvania. I'm gonna, but, and I'm not that far from Lancaster. I can buy this access to this investment. 

What are the odds that this is gonna happen? You know, kind of in my backyard. But the more and more that we've been around and we've seen it is just it, it kind of blows my mind that these things are happening. Not only just in our area, but to the degree in which they are happening. These are not right, these are not small, you know, amounts of fraud. 

Again, we're, we're not saying that that is happening in all of these circumstances, but I think just to drive home, the point for me is, yeah, we're not, we're not immune to this in our little neck of the woods here. Even just being in, in Pennsylvania. Yeah, so I, I realize a lot of this is probably coming across like we're, we have a strong bias against these alternative investments, so let's, sure, let's present the other side of the coin. 

[00:11:32] Ben Haas: The coin. You, you said it, well, there is a segment of our client base that this would be okay for, right? In the, sure. In the spirit of diversification, but that usually means you do have more in assets and that you're looking to take a smaller segment of your pie, and use this as more of a diversification or a satellite like, right? 

Yeah. When we think alternative investments you're better at the stuff than me, Adam, you can fill in the blank. That's 5%, 10% of your holdings. You know, we're not, we're not taking half your life savings and banking it in something that either is becoming or illiquid or again, just we may not be as comfortable with long term. 

[00:12:13] Adam Werner: I think there would have to be either a strong desire on the client's end, or we would have to have a really good reason as to why we would, we would desire that higher level of diversification. But you're right, this is, this would not be a, an all or nothing decision. This would not be, Hey, let's put half of your, you know, investible assets into this, right, into this thing. 

It is, it is a satellite. As, as you said, we would, we would wanna isolate it in that way and in the same way that we would treat, you know, even just individual stocks for any of our clients that we, we just, we don't like that idea of having a high amount of concentration risk, right? Putting too many of your eggs in one basket, and this would certainly fall into that camp. 

And the thought process there again, just being what, why we would say it could fit in that situation is that if the worst were to come to pass. We're, we're kind of isolating this and, and putting it in its box that if, if this 5% portion went to zero and it disappeared tomorrow, it is not completely derailing somebody's financial life. 

Right? They, they are not relying on that portion. For income to sustain their, their lifestyle in retirement, right? These are just, these are ways to maybe either increase the return potential, decrease the correlation, right? How your, how your investments work together. Maybe you're, you're trying to decrease your risk to some degree. 

But yeah, I think we certainly, you wouldn't want to invest in something like this. If it really was tied to your retirement success, right. Either tied to your income or if you, may needed access to dollars later. 

[00:13:50] Ben Haas: Yeah. 

[00:13:50] Adam Werner: Right. You wouldn't want that tied up in a spot that you just couldn't get access to. 

[00:13:54] Ben Haas: Yeah. And again, maybe we're speaking to a the audience that listens to us the most where, you know, we're not gonna be the ones kind of presenting these very different ideas, mm-hmm. And that's just because for most people that we come across liquidity. Transparency, you know, the ability to understand what you own and what it's worth like that usually is more than enough to feel confident and comfortable with the way you're going about structuring your retirement portfolio and your retirement income. 

So if you're in the camp of doing something a little bit different, in this case, alternative investments, that's fine. But again I think you hit on the main point that I wanted to, it can't be people that don't have an emergency reserve or they'd be borrowing money to do it, or somebody that, you know, wouldn't really understand what they're getting into. 

[00:14:42] Adam Werner: Yeah. And, and, and even still, I think we, we would wanna just look at it through the lens of what, what are we truly accomplishing by adding something like that? Is it, does it truly feel worth it, again, for, for that specific situation? 

[00:14:56] Ben Haas: Yeah. I really appreciate you bringing this topic to us, 'cause it is something we've seen a couple times now, good, bad, and sometimes very ugly. 

So it's good to just put the education out there. There's a space for it. But we gotta be very careful about understanding what it is and how it's gonna be regulated and whether it's liquid or not. 

[00:15:16] Adam Werner: Yeah. And I think just maybe that, to put a bow on all of it, I think just as we are, as we are seeing and as as clients are kind of hearing the headlines on just the market, consolidating right to these smaller and smaller handful of companies kind of driving the overall returns. 

It's very enticing to say, but I own all of these things. I wanna go do something different, give myself a different experience. It is that allure, right? The fear of missing out, that there's something else out there that I, that I, that could be doing better for me than just what everybody else is doing. 

And we would just caution anybody that is. Do your due diligence. Well, let's just make sure that it fits. 

[00:15:55] Ben Haas: Right 

[00:15:56] Adam Werner: and that it checks all the boxes that, yeah, if things go sideways, it's not going to completely derail your financial life. 

[00:16:03] Ben Haas: Can I give you one last soft softball before we sign off? 

[00:16:06] Adam Werner: Sure. 

[00:16:07] Ben Haas: You can invest in alternative investments that are liquid. 

[00:16:10] Adam Werner: Yes. Yeah. Yes, there are liquid alts and non-liquid alts. And yeah, I guess to your point that that's kind of what we're, we've been focused on, this is, is the non-liquid side. But yes, there are liquid alternatives. There are mutual funds and ETFs that can give you access to some alternative investments. 

Yes, that is a, that's like dipping your toe in the water rather than, you know, jumping in with two feet into a, you know, a private investment, you know, in your local area that. Again, you're just, you're not quite sure. You have as much transparency on. 

[00:16:41] Ben Haas: Appreciate your insight as always. 

[00:16:43] Adam Werner: All right, thank you. 

[00:16:44] Ben Haas: Till next time. 

[00:16:45] Adam Werner: Bye. 

Hey everyone, Adam and I really appreciate you tuning in. Please note that the opinions we voiced in the show are for general information only, and are not intended to provide specific recommendations for any individual. To determine which strategies or investments may be most appropriate for you, consult with your attorney, your accountant, and financial advisor, or tax advisor prior to making any decisions or investing. Thanks for listening. 

Investment Advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Haas Financial Investment Advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Haas Financial Group are separate entities. This is not intended to be used as tax or legal advice. Please consult a tax or legal professional for specific information and advice. are separate entities. This is not intended to be used as tax or legal advice. Please consult a tax or legal professional for specific information and advice. 

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