Don’t Ask Your Portfolio To Do More Than It Is Designed To Do.

John J. Hohn and dog Jessie

Some people want more from their investment portfolios than gains and income. Like other major arenas in life—some load more baggage onto a portfolio than it is designed to carry.

Making more money guarantees nothing except it will make a person wealthier. An unhappy person will be an unhappy investor. Assuming grinding poverty is not the cause of a person’s unhappiness, money can do nothing to change anyone’s self-esteem or restore perfect mental and physical health. This is a very simple, almost self-evident, truth but many of us fail to integrate an understanding of it into our lives.

If you want to make good investment decisions, know why you are investing. Define your goals. Write them down. Make sure that they are realistic and most important, monitor your own thoughts as you complete your list.

A legitimate goal might include funding college education for your children but accompanying that goal may be thoughts like:

“Then they won’t have the dead-end job I’ve had all these years.”

Or, “Maybe they will appreciate what I’ve done for them then.”

Or, “That’s a chance I never had.”

A legitimate goal might include retiring early, but accompanying that goal may be thoughts like:

“Then I am out of this damn rat race.”

Or, “Then she will finally agree that I can quit.”

Or, “Then the boss will know how much I was needed.”

The examples only illustrate a point. They represent the attitudes, feelings and aspirations that are part of the goals that are being set. They amplify the satisfaction or the dissatisfaction with the results that are eventually achieved, and the next question to ask is whether the success of your investment strategy needs to be burdened with issues that should be worked out elsewhere in your life–with your spouse, your children, your boss.

Your financial advisor is not a psychologist nor an expert at intervening in a personal crisis. He or she has limited training in helping clients overcome negative feelings about losses, missed opportunities, or the failure to do better let alone about disappointments in marriage, children, jobs, and life itself.

The financial industry attracts predominantly two personality types—the stridently confident, self-absorbed extrovert and the pensive, analytical, technically oriented introvert. Neither type is trained to handle clients who are upset, or angry, or sad, or whatever. They don’t want to be burdened with helping anyone define what is really troubling in life.

You may, over the course of time working with an advisor, find that one has become a friend and the scope of your relationship broadens to the point that discussion personal issues is appropriate. But do not expect that to happen, just as you would not with your physician.

A story may illustrate the point. One couple, clients of mine, owned a successful small business. They worked out of their home. Both were aggressive about making money. They had no children and financial success became a focal point in their lives. Their aggressiveness spilled over into their investment style during the craze of the 1990’s, and they bought large blocks of Silicon Valley start ups that soared with the trend.

When the speculative surge collapsed, their huge profits vanished. Stocks worth 100 times the price they paid to acquire tumbled to become virtually worthless.

They had more than dollars riding on those losses. She had made most of the stock picks initially. Admitting that they had failed to sell with a profit was beyond her. So she put her ego into the portfolio.

They measured their loses from “peak to trough”—from the highest point an issue achieved to the lowest level to which it had fallen. They believed that their losses were in the hundreds of thousands. They loaded those huge disappointments in to the portfolio.

She blamed him for not selling when the time was right. Tranquility in the home was another matter for the portfolio and it got piled into the mix.

At this point, they came to see me. I did not immediately see the anger and bitterness in their concerns, only that they felt defeated and discouraged. Even with their losses, they were prosperous. None of their life goals were threatened. But that was not their game. Zero was their adversary. They wanted to defeat it by the largest score attainable. When you don’t know what you want, no amount is ever enough.

The told me that they didn’t want to be involved in making investment decisions any longer. Rather than deal with the trouble, they decided to turn everything over to me and thus escape it. Bad idea.

She never forgot that they missed a chance at making huge profits. She never forgave him for not making the right call on selling. (The decision to sell, by the way, is far more difficult to make than the decision to buy.) He took me aside one day and asked me to go easy on selling all the big losers in their portfolio because it just brought the whole subject up again between them and he was weary of the conflict.

I made a sale one day that generated a capital gains tax bill of $25,000—the maximum long-term capital gains tax rate at the time was 15%. Doing the math, the couple had gains in one issue of $166,667. Not bad for a day’s work. The forecast for the stock was negative. I felt that I had finally taken them out of a position at the right time. That’s when the other shoe dropped.

We had discussed capital gains taxes, of course, and I proposed using losses to offset gains in other successful positions. Perhaps a product of their disappointment was a lack of focus on the topics being discussed, because what I found out following this highly profitable sale was that they really wanted to avoid capital gain taxes completely! Although they benefited more than most from living in a free enterprise, capitalistic economy, they did not want to pay anything whenever they profited.

The couple had created a double bind for me, and more importantly, for themselves. Profits mean paying taxes. The profits that they whined about missing by not selling in a timely manner would have generated a huge tax bill—one commensurate with their gains. They held to mutually exclusive goals that guaranteed an unhappy outcome no matter what.

My relationship with them came to an abrupt and angry end when the tax bill came due. Stocks with large losses were still in the portfolio—stocks that I could have sold to offset their capital gains. Stocks that I did not sell because, beaten up as they were, they still held out the potential of regaining their strength, and I wanted to avoid provoking trouble at home by calling their attention to the companies by selling any one of them.

Their long-term goals no longer mattered. Reinvesting the profits did not matter. The continuum of working forward in time to make the future even brighter was not part of the agenda any longer. Everything ended with the tax bill. The game was up. All that was important is that they had to pay $25,000 in capital gains tax. She left a long, vicious message on my answering machine that destroyed any chance of appealing to them on the basis of friendship.

The couple went to every attorney in town and got none to accept their case. They harangued my compliance officer, who pointed out that they would have lost much more had the stock in question not been sold. Not placated, he finally told them that they were free to take their complaint to an arbitration panel—a step most wire houses want to prevent. That was the last I ever heard of the case. That was also the last I ever saw of the couple.

They probably took their problem marriage and their inability to accept the consequences of their own decisions to another unsuspecting financial advisor. They will begin all over again. The unresolved difficulties in their lives will eventually surface in a destructive way again.

Human psychology is a serious, sophisticated subject. It is beyond the scope of any postings I plan except to note some relatively simple steps to take to  take the mystery out of the investing process. My note today is make sure that goals are realistic, well defined, written down, and shared.

I could illustrate this point again and again with other stories, but the thrust would be that money has a limited and important role in life. Managing it successfully is not difficult. It is a broad subject, but one of very little depth. Keeping a clear head for making decisions is very important. Loading up the portfolio with expectations that need to be realized elsewhere burdens it beyond its nature to carry. The minute one tries to make wealth do something that it cannot, decisions become flawed and success become less and less likely.