Chinese stocks are down 14% so far this year, and in this episode of Motley Fool Answers, Motley Fool analyst Ben Ra joins us to explain why. The Ascent's Brian Frey shares the red flags of a pyramid scheme, and we answer a question on which types of stocks belong in which types of accounts.

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This video was recorded on September 21, 2021.

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, Personal Finance Expert here at The Motley Fool. Hi, Bro.

Robert Brokamp: Hello, Alison. Hello.

Southwick: On this week's show, we're going to talk about the very fine line between multilevel marketing and a pyramid scheme. Curious why your international stock funds haven't done so well this year? It might be because they hold stocks in Chinese companies which are down 14% so far in 2021. Motley Fool analyst Ben Ra explains why. Finally, we answer the question about which stocks should go in which accounts. All that and more on this week's episode of Motley Fools Answers.

Before we get to the show -- you thought we were going to go right into the show. No. But before we do, it's that time of year again where I ask listeners like you for a favor. That's because the Motley Fool's great, big, annual all-company event is coming up, and I'm looking for a few volunteers to help me with a project so that Fool employees can get to know our members better. Pretty please, if you're willing to work with us to share your story as a Fool member, drop me a line at [email protected]. All you have to do is say, how can I help, and I'll be in touch with the next steps. Pretty please, just send me an email. Back to the show. It's 2016 and you stumble upon a live stream. Maybe you're on Facebook or YouTube, and it's a heavyset, middle-aged man, bearded, a bit like Santa on summer vacation. He's sitting in front of a wall, stacked brightly colored fabric, and he's selling a pair of women's leggings, holding them up to the camera and describing them as butter is soft. In an easygoing draw, this one's got a cute little kitty cat pattern on it. No one wants to buy it. What is going on? Again, it's 2016 and you were witnessing, or maybe me, one of the fastest-growing companies at the time, growing 24% a month on its way to $2.3 billion in revenue the following year. The company is LulaRoe, and it's the subject of a new documentary series on Amazon Prime. I won't give away too much. But LuLaRoe is a multilevel marketing company. Although a few lawsuits and legal actions, The Washington Post pegs it at around 50, claiming that they are much more like a pyramid scheme. Now, it seems like a good time to talk about multilevel marketing and how to tell if you're actually in a pyramid scheme or a cult as one woman in the documentary describes it. Multilevel marketing companies are a $35 billion industry.

An AARP estimates that one in 13 Americans have participated in one at some point. Sometimes called network marketing. It's a form of direct selling; Avon, Mary Kay, Tupperware, and Amway might come to mind. But there are hundreds of them operating in the U.S. alone, selling everything from candles and cosmetics to jewelry, vitamin supplements, and kitchen tools. What makes an MLM company an MLM company? As Robert Fitzgerald said in the Luther rich series, multi-level marketing turns a company's sales force into its customers. That's because the people who are selling the products, often directly to friends and family, and on Facebook, to people they haven't seen since high school, they have to first purchase inventory from the company. While the fee for getting started could be as low as $100, you may need to make a minimum investment that's much, much more expensive than that to buy all these products, which brings us to our first red flag. For this, I'm looking to Brian Frey from The Motley Fool's Ascent team, which helps people make more informed personal finance decisions such as choosing the right credit card or a broker. Here is Brian.

Brian Frey: You might be in a pyramid scheme if you hear the words, be your own boss. That should raise an eyebrow. When I was in college, I was pitched a gig to paint houses and I was told I could be my own boss, set my own hours, and that came with a lot of responsibilities, like buying paint and tools, most of which would cost thousands of dollars. But you had to buy these from, you guessed it, the company rep who recruited you. If it's thousands of dollars to buy upfront, especially from the company who recruits you, whether it be painting tools or paying a mandatory training or membership fee, you might be in a pyramid scheme.

Southwick: Another unique aspect of multilevel marketing is that as a salesperson, you recruit more salespeople to be under you or down line, and then you get a commission or cut of their sales. If they recruit people under them, you get a commission or a cut of their sales too. The more people you have under you, the more money you make, which brings us to our next red flags.

Frey: Once you've joined, you might be in a pyramid scheme, if there's an emphasis on recruiting overselling products. See, one of the big money makers for pyramid schemes is recruiting people to buy in to get started, and they often get commissions or paid bonuses based on this fact, like in the horror movie it follows, the only way to survive is to pass the curse onto the next person. This isn't a great business model.

Southwick: According to the Direct Sales Association, 75% of multilevel marketing representatives or salespeople are women and often stay-at-home moms, who are enticed to join because of the promise of being able to make a ton of money on your own time after you've put the kids to bed. As Casey Bond writing for The Huffington Post puts it, these MLMs encourage women to market heavily to their existing social networks under the guise of female empowerment. You're encouraged to create a sense of FOMO by showing off that empowerment and wealth, and on social media in order to drive new recruits using hashtags like boss babe, or CEO, or entrepreneur. You thought that Hans were a nomadic people of Central Asia? But Hans are now a derogatory term for aggressive women trying to recruit you into their downline with cheaper DMs like, "Hey, hun. I have an amazing opportunity to share with you", which brings us to another red flag.

Frey: If you're pressured to attend an event before being hired, that can be a canary in the coal mine for pyramid schemes. They put on these events for one simple reason. They work. They hype up the crowd with stories of wealth and success, and often bring in big-name speakers to draw attention and they want to give you a taste of this fancy lifestyle. But they're often a little shaky on the details. You might walk away feeling good. But you have no idea what it is you're actually supposed to do. A lot of people claiming to make millions actually do so by selling materials on how to make millions, not through the actual products themselves.

Southwick: Some people will argue that all multilevel marketing companies are scams. If you were to ask the FTC, they'd probably tell you that they don't love an MLM. But they do draw a line between legally operating multilevel marketing companies and pyramid schemes. Legal or no, making money selling for an MLM is not easy. The key is to begin at the top of the pyramid, which is rarified air. The Consumer Awareness Institute, whose research has been touted by the FTC, they found that 99% of people who participate in an MLM lose money. AARP is more generous and they estimate that 75% of people lose money. Of the one-fourth of participants who make a profit, half make less than $5,000, way less than the hundreds of thousands a month you might be told you could make. When financial times are tough, MLM and pyramid schemes find fertile ground to grow. The pandemic was no different. Five million women lost their jobs and two million never returned to the workforce. As Bridget Read writing for The Cut puts it, multilevel marketing companies looked at these unemployed women and saw potential recruits, and jumped at the opportunity. This includes pressuring people to use their stimulus checks to get started. It got so bad that in 2020, TikTok actually became the first social media platform to ban all MLM content.

The Direct Selling Association estimates that there are about 1,100 MLM companies in operation, but they admit it's hard to keep track. As they put it on their website, many companies may even come and go before they could be counted. One last red flag for me. As I said, a multilevel marketing company turns the salesperson into a customer. A pyramid scheme turns its victims and perpetrators. This is because as a sales rep to be successful in a pyramid scheme, you are under constant pressure to make money by recruiting more people under you. In turn, you pressure those people to recruit people, who pressure more people, who pressure more people under them. If parading people to claw your way up the pyramid sounds a great way to make money, it also sounds an excellent way to alienate everyone around you. Also, you might get a gig on a documentary one day. That's cool.


Robert Brokamp: The S&P 500 up 20% so far in 2021. It's been a good year for investors. Well, it depends on what you own. One group of investments that has not had such a good 2021 is stock in Chinese companies. The iShares MSCI China ETF is down more than 14% so far this year, and some of the biggest stocks, such as Baidu, Alibaba, Tencent are down even more. Here to explain what's going on in the world's most populous country with the second biggest economy is Ben Ra, an investment analyst with Motley Fool, and my former cubicle neighbor when we worked in the office in the pre-pandemic days. Ben, welcome to Motley Fool Answers. Do you miss my dancing and air drumming while you try to work?

Ben Ra: I was going to talk about that. But since you mentioned it, we can go into that. I miss it and I do.

Brokamp: Well, I miss you and I miss being in the office. But we still have many months until they're going to let us back in. But anyways, let's get right to it. What the heck is going on with Chinese stocks?

Ra: There's a confluence of many different things. There's this famous quote by Machiavelli that a ruler should do all of the bad things, all of the cruel things, all the punishments he should do at one time, whereas benefit should be handed out piece by piece so that people can enjoy it more. All of the things that the Chinese government really wants to crack down on when it comes to businesses, so education companies, gaming companies, data, big tech, all of these things are happening at the same time. They're not necessarily all related. But this is an opportunity where the Chinese government says, "Well, this is the time to crack down." Let's bring all of the things that we wanted to crack down on and do it all at the same time, instead of just dragging it out over the years. It's going to be a time of pain for a lot of different companies that from the viewpoint of the Chinese government, they see problems. But at the same time, I think it's wrong to see it purely from a Western viewpoint where it's a government cracking down on business. I think we do have to understand also that a lot of these business leaders, especially the most powerful ones, they're all part of the Communist Party. Jack Ma, Pony Ma, Richard Liu, they're all part of the Communist Party.

I think the better way to characterize it is the political wing of China's leaders asserting control over the business wing of China's leaders, which over the last 20, 30 years, the business leaders have been ascended. They've gotten hold of Western capital. They're able to build these businesses according to Beijing, according to the political leaders today, especially under Xi Jinping, they see these businesses as predatory rent-seeking businesses that are doing these things, making a lot of money for the benefit of outside investors. Let's face it, a lot of these companies do have a very considerable Western foreign investor base. We do have to realize although from the outside it's hard to see, but a lot of business activities in China, there are some things that, especially us Fools, it's not always a co-share . There's a lot of anti-monopolistic activity where a company like a Tencent, or a Meituan, or an Alibaba would use their monopolistic position to say, force merchants to only use their platform and cancel their presence on the other platforms, those kinds of things. We, in the U.S. and the West, we've moved away from through regulations, through convention over a long period of capitalistic development. We've developed lines that you don't cross. In China, things have happened so fast in the last 20, 30 years that those lines didn't really have a chance to develop. These companies became so powerful so fast. This is a way for the government to catch up, if you will.

Brokamp: Anyone who invests in any country, you have to factor in differences between their markets, their regulations, and what happens in the U.S. With China in particular, there's this question of how much the government will intervene. But there's also questionable financials. We saw that last year with Luckin Coffee a stock that went from $50 to a dollar after some shenanigans were uncovered. In your opinion, is one of those risks bigger than the other or are they about equal?

Ra: I don't know if I can answer that one as directly as maybe you would wish. But the questionable financials, I think over time, that's bound to improve. Actually, even up until now, it's improved. If you go back to 2014, I remember seeing tons of Chinese companies that showed amazing value, amazing numbers, it just couldn't have been so perfect, and a lot of them turned out to be just falsified. There's still a lot of falsification going on. But at the same time, we do have to remember that the direction most likely is going to be toward improvement, because they started out from a low base of transparency, of honesty, and now they're working their way up. If you look at the history of say like Korea, it's the same thing. I remember back in the '90s, in the Korean business, there were so many shenanigans going on, so many things that would not be allowed today. But there's improvement over time.

In a way, the Chinese government is on your side when it comes to that as investors, because they're trying to follow this extreme pace of change that's gone on over the last 20, 30 years. This is one of the things that they always talk about in the government circles. The change is just so fast, and the regulations have to catch up with that. They're attempting to do that now. I see that problem as something that gradually over time, you're going to see improvements when it comes to transparency. When it comes to the Chinese government cracking down, we do have to understand that the relationship between government and business in the U.S. and China are completely different. We have this idea in the West of government and civil society as being two separate things.

A lot of our political discourse actually revolves around how much the government actually interferes into civil society? How much is right? How much should they mandate mass, for instance? That's a good example that's going on right now. In China, it is a completely different paradigm where there isn't that separation. The government is actually almost seen as the head of a national family. It's almost like the father of a family. Think of it yourself as a parent, you're going to interfere into the moral lives of your kids, because you want your kids to develop a certain way. The same thing for the government in China. That's not entirely unnatural in Confucian societies. China is a little bit more extreme, I would say. But it's something that would be understood in say, a South Korea or Japan, although maybe not to the same degree.

Brokamp: One thing that U.S. investors may not be fully aware of is that it's actually against Chinese law for foreigners to own many types of companies, yet somehow Americans can own stock in Chinese companies. How is that possible?

Ra: You're referring to the famous VIE structure. When you buy a Chinese stock, you're not actually buying a share of that actual company. You're buying a share of something like a Shell Company that's located mostly in the Cayman Islands. The design is that you, as the shareholder of that company, get the economic benefits. But at the same time, you don't really have any shareholder rights as you will consider than here in the U.S. in terms of voting rights, and such. That company is going to be wholly controlled mostly by the founders and other insiders in China. If you look at it by the letter of the law, it's illegal. But the Chinese government has turned the blind eye because this was seen as a way for these companies to raise capital.

Now, what you see today is the Chinese government is cracking down on foreign IPOs. The funny thing is you find the Chinese government and you find a considerable amount or a considerable majority of Congress on the same page, because both of them want to restrict Chinese companies from IPOing here in the U.S. for different reasons. From the point of view of the U.S, we're saying we don't want American capital going into Chinese companies. From the point of view of the Chinese, it's much more complex. But what they do want, I think, is for a lot of these companies that use the IPO here in the U.S, they want those companies to IPO either in Hong Kong, or in Shanghai, or in Shenzhen. From the American viewpoint, it's something that we have to think about, which really serves our national interest. From the point of view of American investors at Global Partners, we've always recommended that to prefer Chinese companies that list in China. If you're going to buy a share of a Chinese company, then go for the one that's listed in Hong Kong rather than the one that's listed here in the U.S.

Brokamp: By Global Partners, you mean the Motley Fool service that you work on. You also mentioned VIE earlier. VIE stands for Variable Interest Entities. It's something interesting to look into if you are interested in investing in Chinese stocks because it is something a little different. Are there any challenges confronting China as a country that investors should be aware of? A few that come to mind is that you hear more talk about a real estate bubble, and Evergrande, one of the biggest real estate developers in China having some problems servicing its debt. China has some significant demographic challenges. Thanks to its one-child policy. Although it's led up to that policy in the last few years. Then there's President Xi Jinping, who turned 68 in June, which is the customary retirement age for the Communist Party's top leaders. But there are indications that he's not interested in stepping down. Are any of these issues costly concerned or is there something else that U.S. investors should know about?

Ra: I think if you look back in history just over the last 20, 30 years, at every point since the early '90's, well, let's say from like since 1978, right around when China started to reform and open up, at every point, there were risks that were pointed out by both the Chinese and Western people about the situation in China. In the '90's, it was bank debts. There's always these risks that people point out, and the risks always change. Right now, there are serious risks. There's serious indebtedness in the real estate sector, the population demographics, there are challenges. But at the same time, when you look at those problems 20, 30 years ago, things change either through luck or through the actions of the leadership. They manage somehow to overcome these challenges. I will not underestimate the ability of the leadership structure to overcome these challenges. We should be aware that they are very aware, they're even more aware of those challenges than we are. As much as we may worry about what's going on, they know the situation much better. The Communist Party when you look at it, people always think of it as a political party. It's 95 million members. It's larger than the population of any European Country.

I always describe the Chinese Communist Party as a network of China's leaders. You'll find in there business leaders, entertainment leaders. People from all walks of society are accepted into this club. It's really the path to leadership in China in whatever field. Whatever we may see about this Chinese Communist Party, one thing that they've done really well is they've been able to attract a lot of smart people. Meaning if you're top of your class at Beida, Beijing University, most likely you're going to be in the Communist Party. You have to be at that level to be accepted into the party. The future leaders of China are in that party. They've managed to get together the smartest people. If you think of the United States, the people in Silicon Valley, people on Wall Street, they're going to be part of that party if we had something similar. I would not underestimate their ability to manage these challenges. 10 years later, 20 years later, there's going to be a new set of challenges. China is a huge country, and huge countries have huge challenges. But at the same time, I would not underestimate, as I said, their ability to overcome that.

Brokamp: Let's get to the bottom line here. Should investors avoid China or is this recent slap a buying opportunity?

Ra: I've kept all my Chinese stocks. I'm not giving personal financial advice which we can't do. But it hasn't really scared me to tell you the truth. Maybe they haven't done enough, maybe they're going to do a bit more. I think it's very likely that they're going to crack down even more. But I think one thing that investors should consider, we've considered a lot of the downside risks of what might happen when the government cracks down. We've seen some of it, especially with the education sector. A lot of those stocks have really, I'm talking about 90%, tanked. But when you look at a Tencent or an Alibaba, what's the government trying to do? They're trying to get the massive amounts of data that an AliPay or WeChat Pay, these huge platforms have managed to collect in China. They're trying to use it, they're trying to get a hold of it, and they are trying to create what they call a Social Credit System. I don't want to get into too much. I don't think we have time for that. But they are trying to create an integration of business in government at a level that we really haven't seen, I don't think, in the West.

One thing I think we should consider is that in this scenario, if they succeed, Alibaba and Tencent become even more important to Chinese society than they were before. While we do consider the downside risks, maybe we haven't considered enough the upside risks, and also the possibility that because they've become so important, it actually eliminates some of the downside risks because they become in a way national institutions, because whatever the government does, they can't recreate an AliPay. They can't recreate an Alibaba or a WeChat. They can only destroy, they can really only hurt. They're using their power of hurting to get control over these resources. But actually, the source of those resources will always be Tencent and Alibaba.

Brokamp: Like [...] real quickly with an article you wrote last summer, and it was entitled China And The Truth. I thought it was a fascinating article. Explain how we, in the U.S, and people in China see the truth differently.

Ra: Maybe this is a controversial scene. I've lived in Korea for a while in my youth, so I see things from both sides as both a Western and an Eastern. But if you look at especially the U.S, you can really see the influence of a single, we call them Abrahamic religions, so a Christianity, really forming the laws and the moral, the fiber of the society. There is this idea of this single dominant truth in the West. At different times, it's different things. Back in the day, it was Christianity and that was considered uncontested. Right now, it's probably science. But you have people searching for that single dominant truth, and there's that idea of this overarching truth that exists somewhere, and people are always searching for it. In the East, that kind of thinking has never really taken hold. Truth and false are not inseparable entities. They are in fact related just like good and evil. F

rom the Eastern viewpoint, God and Satan are in the way best friends. They're not opposites, they're not enemies, they're both sides of the same coin. There's a range between good and evil. There's never been an attempt in Eastern philosophy to incorporate all of the things that we call good, loyalty, generosity, all these different qualities under this one thing called good, which is represented by a God. There hasn't been that history in the East. It's a totally different way of seeing the world. If you stare at the Yin Yang symbol for a long time, I think that's the best way to actually get into the mind of how the Eastern world thinks about these fundamental questions, because if you look at that symbol, you see that black and white. Black is actually strongest where white is strongest, and white is strongest where black is strongest. The actual message of that symbol is that black and white are the same, which is a logical contradiction. It's almost like you have to rewire your brain to actually see things from their point of view, because our brains have been wired over a couple of thousand years of education and history, that's very difficult to do.

Brokamp: The example you used in the article was really the start of the coronavirus, which we here in the West think that China wasn't truthful, wasn't honest, wasn't forthcoming about what happened. Whereas in the article, explain how people in China feel like, no, actually, we told you pretty much everything you needed to know, and it's not really our obligation to tell foreigners the truth.

Ra: You see communication is different, especially in a place like Japan. I think it's actually more difficult in Japan than it is in China. A lot of communication happens through implication, through even an expression, through things that are not said as much as things that are said, and you're obligated in a way to get the message. Here, you have to spell things out clearly to people. There, communication happens through implication, through the tone of your voice, through things that are not said versus what is said. I think if you're American and you go to Japan, you'll have a lot of difficulty mixing into society because of that. But that's, I think, that's not something that is just Chinese. I think actually Japan-U.S. communication has been just as difficult as China-U.S. communication.

Brokamp: It's a very insightful article, I highly recommend it. It's published on, so it's free, titled China And The Truth, written by our guest today, Ben Ra. Ben, thanks so much for joining us.

Ra: Thanks a lot.

Southwick: Well, hey, it's time for Answers answers. This week's story comes from Adam. I have a 401(k) and I make my contributions to a Roth account. The company match goes into the pre-tax account. I recently found out that I can rollover a portion of my money. Since my 401(k) doesn't allow me to pick individual stocks, I rolled over the pre-tax portion to a traditional IRA and the Roth portion to a Roth IRA. Now, I have cash for individual stocks and those two IRAs, as well as in a taxable brokerage account. How do I decide what type of stocks to buy in each account? I had some stocks that pay dividends, and some stocks that don't and probably won't anytime soon. Make sense of that for me. That was a lot of accounts getting thrown around.

Brokamp: I'm going to actually open up by using Adam's question as an opportunity to highlight a few features about the 401(k) and really retirement plans in general, that maybe some people may not know about. First off, most 401(k)'s these days offer the Roth option. It's around 75% of the plans. If your plan doesn't offer it, just ask maybe they'll change their minds. 403(b) is going to also offer the Roth. It's available in the biggest employer sponsored retirement plan in the country, which is the Thrift Savings Plan for federal employees, which is almost like $800 billion in assets and more than six million participants. The only types of plans that can't be Roths are the simple IRA and the SEP IRA, which are generally offered by the self-employed and business owners, so avoid those plans if you like the idea of Roth. The great thing about employer sponsored Roth accounts, unlike the Roth IRA, is that there are no income limits. Anyone can contribute. Why would you want to?

Well, with the Roth, you don't get a tax break on contributions, but the money grows tax free as long as you follow all the rules. With traditional pre-tax contributions, it's the other way around. You essentially get a deduction on your contributions, but you do pay taxes when you take the money out. These days with tax rates at historically low levels, with plenty of discussions about higher tax rates in the future, many people would prefer to give up a tax break this year in exchange for tax free income in retirement. But as Adam points out, even if you contribute to a Roth, the employer match, if you get one, goes into a traditional pre-tax account, so you'll have both types. Now, once the money's in the account, you generally have to wait until you leave the company to take it out, either you switch jobs or you're retired. At that point, you can roll it over to an IRA which if done properly, is a tax-free and penalty-free event. I'll just emphasize the do-it-properly part because there are some ways that you can mess up and end up paying taxes and penalties. However, Adam is highlighting another lesser known feature. Around 70% of plans allow for something called an in-service distribution, which allows you to roll over the money even while you're still working for the company. Why would you want to do that? Well, generally it's because your 401(k) has high fees and/or limited investment choices.

Unfortunately, in most cases, in-service distributions are only allowed for those who are 59.5 or older, but ask your plan provider about the rules for your 401(k). Now, let's get to Adam's question about which investments should go into which accounts. The answer depends on many factors unique to you. But here are a few guiding principles. First, you want your Roth to grow the most because it's the tax free account. To the extent that you feel you can rank your investments according to the highest potential return, use the Roth for the investments with what you believe to be the greatest growth opportunities. You might use your taxable brokerage account for a stock that doesn't pay a dividend and that you plan to hold onto for a long time. We're talking about several years, maybe decades. You don't have to worry about paying taxes until you sell, at which point, you paid lower long-term capital gains rates. For the traditional pre-tax account, that leaves investments for which you have maybe more modest expectations and/or that you don't plan to hold onto for a long time. As for dividends, if you're many years from retirement, then consider putting dividend paying stocks in your tax advantage accounts. Otherwise, your old taxes on the dividends you receive each year, even if you reinvest them, and that would gradually erode how much you can invest. However, once you retire and rely on your portfolio for income, it might make sense to keep dividend payers in a taxable brokerage account, because qualified dividends are taxed at a lower rate than withdrawals from your traditional retirement accounts.

Adam doesn't give his age, but since most plans only allow in-service distributions for those who are at least 59.5, it's a good bet he's that age or older. If that's true, then he could be within a decade of retirement. That's definitely a good time to gradually build up what we call an income cushion, which is three to five years worth of portfolio provided retirement income that has kept out of the stock market, and you put it in my cash or short-term bonds, CDs, something like that. He might want to hold on to some of the cash he has. Again, this is presuming that he is a few years from retirement or so. Since most studies indicate that the first account that you should tap in retirement is your taxable brokerage account, that might be the place where he holds on to some of the cash that he has. There is much more to this topic including guidance on where to put things like mutual funds, bonds, options, and Real Estate Investment Trust. The dividends from which are generally not qualified, and thus taxed at a higher rate than other dividends. Do an online search for the term asset location, not allocation, but location, and you'll get more tips and tricks.

Southwick: That's the show. It's edited buttery softly by Rick Engdahl. You can get all those answers at Remember, I'm looking for a few volunteers who'd be willing to help me out. Again, I'll really appreciate it. E-mail me at [email protected] and just say "I'm here to help," and you'll be my best friend. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.