Emotional Stake In Investing
By Rob Wrubel CFP® AIF®
Recently, I spoke to several people who had similar issues in their investments. These people held one or several stocks they could not sell because of what the stock(s) represented in their lives.
Some of these people have stocks they inherited from a parent. Personally, I own two stocks in my portfolio that were gifts from my grandparents.
Other people have stocks that represent a milestone of some sort in life. Usually, these are stocks of a company where that person worked and earned the stock as part of a compensation package.
These discussions lead in the same directions with the same questions. Should I keep these stocks? Can you please not sell these stocks? Are these companies any good? The answers were different depending on the people, their overall portfolios and their goals.
The emotions behind investing can help us achieve our goals.
Intellectually, we know we “should” save and invest over time. We know that the money we need to use for retirement, buying a house or any future goal needs to be sitting in an account with the hopes of generating income and return. Somehow, the thought of saving does not seem to generate too much excitement for most people.
Emotions help us accomplish our savings goals. The more we feel the pleasure of living in our dream houses, retiring comfortably, playing golf, walking on the beach or enjoying the graduation ceremony of our children and grandchildren, the more likely we are to fund accounts and not touch them over time. We may also be motivated by the feeling of loss if we do not achieve those goals which can keep us on track.
Unfortunately, that same emotional side of our hearts and minds may hurt us when it comes to investing. Take the case of holding on to a stock that you have as a result of a gift, inheritance or working for a company with a stock plan.
There are a few important issues to consider. Concentration. Risk. Tax. Opportunity.
1. Concentration. Often, the stock we hold represents a significant part of the overall portfolio. Many people who have worked for one company for a long time have most of their net worth in this one company. They may even hold the company stock in both retirement and taxable accounts. They may have received options that have vested or will vest, bumping up their total amount in that company even more.
I have worked with some clients who were Qwest employees. Many of the people became my clients after the tech bubble popped last decade. On paper, these people were worth more than they ever thought they would reach and more than their parents or families had achieved. This was before the bubble popped. They came to me after the value was cut to almost nothing, trying to figure out what had happened and what to do next. Others owned stock in companies that have fluctuated over time and they cannot tell if they have done well or not by staying with the company investment.
Concentration can work over time to grow wealth. It has worked for Bill Gates (Microsoft), Howard Schultz (Starbucks) and Warren Buffet (Berkshire Hathaway). These people started and owned companies that have been incredible wealth generators. They have been involved in the running these companies and making them successful. Other public investors have not held their wealth due to over-concentration in their own companies. Jimmy Cayne of Bear Stearns reportedly lost a billion dollars when the company collapsed. Many dot com CEOs kept shares of their companies through the rise and fall of that era and were left with little.
2. Risk. Money managers generally have position limits for any individual security in a portfolio. It is not uncommon to see a maximum of 5% limit to one position. Some managers use this as a beginning limit with 10% being at the upper range.
Of course, if you hold one stock that represents 25%, 50% or more of your overall net worth you need to actively manage the risk. You have the risk of your one company going out of business and taking away your entire investment. The 5% position limit requires you to hold at least 20 individual stocks. This decreases the overall risk of your portfolio if one business fails. We recommend more broadly diversified risk and may use mutual funds or index funds to decrease individual stock risk. Risk can also be managed with the use of options.
One way to help you get a “gut” feel for risk is to ask yourself how much you are willing to lose. Your stock has been through swings in value but what if it went to zero? It could happen with poor management, a dislocation in the industry or some other unforeseen event. GM stockholders lost their investments when the company went bankrupt a few years ago. If your answer is that you could lose the entire investment without blinking then you do not need to take any action. If it is something else, then begin a plan to reduce your concentration and protect the downside.
3. Taxes. Once you have made the decision to reduce your concentration you will want to be aware of taxes. Stocks you have owned for a long time likely have significant capital gains tax to be paid. The tax rate for capital gains is currently low compared to history and you may want to use that to your advantage. Otherwise, you might want to look to a multi-year strategy to sell your concentrated position to minimize gains taxes.
4. Opportunity. Most likely, you could have done better by paying some attention to the collection of stocks you have come to own by default. Over the past 10 years, the S&P 500 returned 2.64%. The Barclay’s Capital Aggregate Bond Index returned 5.82%. The S&P was up more than 26% during two of those 10 years. Rebalancing your portfolio on a regular basis to your target asset allocation forces you to sell and buy at times that may lead to improved performance of the portfolio over time. Rebalancing forces the sale of some positions even if emotions are fighting against it.
Of course, the math and basic understanding of the risk of concentration is easy to explain. Making the switch to balancing the portfolio may be more difficult. In these cases, think through a few scenarios to help you change your emotional stance.
Do not sell all of your stock in this company. Keep some shares – even if it is only one. You will have the same reminder of a family member or your times at the company if you see the name and ticker symbol in the portfolio.
Compare your return versus a more diversified portfolio designed to meet your needs. You can review the expected return, past return and volatility. Most likely, you would have either done better over time or experienced fewer big swings with a more diversified portfolio. This is a big motivator to rebalance your portfolio.
Revisit your attachment. You may have received stock from a parent or grandparent. That person might have only owned the stock a few months or years before giving it to you. You might not have seen that he or she was not attached to the company and only owned it because it represented good opportunity at the time.
Remember that companies do not last forever. Companies go out of business, change names and get bought. AT&T became US West in my area, which got bought by Qwest which got bought by CenturyTel. Management has changed, the business model has changed and the name has changed. Why should I keep one company even though it is vastly different than the one I bought, worked for or was gifted?
Your current portfolio is not set in stone. The companies, managers and assumptions change over time and should be reviewed regularly. Your plans and need for growth, income and security also change. A strong plan will help you keep perspective as you seek to grow, maintain and pass along wealth.
Rob Wrubel, CFP® AIF® is a Senior Investment Consultant with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.