#stockmarket #investing #capitalgains #portfolio
Market downturns bring out the worst in some. People may not know it, but they often want more from their investment portfolio than gains and income. Like other major arenas in life—some load more baggage onto a portfolio than it was designed to carry.
Making more money guarantees nothing except make a person wealthier. Assuming grinding poverty is not the cause of unhappiness, money can do nothing to change anyone’s self-esteem. An unhappy person will be an unhappy investor. When the market is going up, they are not making enough. When it is dropping, they are losing too much.
If you want to make good investment decisions, define your goals. Write them down and review them from time to time.
A legitimate goal on the list might be funding college education for your children but not “help me overcome my disappointment with my children.” A legitimate goal might be to retire early but not “help me get my spouse to agree on when to retire.” Sound silly? Truth is that these unarticulated goals lurk in the darker recesses of the subconscious, just beyond the investor’s awareness. They draw life and breath from all the unhappy, worrisome areas in an investor’s life. They surface when things don’t go well, especially a market downturn. They are the stuff of panic.
A financial advisor is not a psychologist, no expert at intervening in a personal crisis. He or she has limited training in helping a client overcome negative feelings about losses, missed opportunities, or the failure to do better let alone about disappointments in past losses, a troubled marriage, rebellious children, wearisome job, or life itself.
The financial industry attracts predominantly two personality types—the stridently confident, self-absorbed extrovert and the pensive, analytical, technically oriented introvert. Neither receives much training in handling clients who are upset, or angry, or sad, or whatever. They don’t want to be burdened with helping a client define what is really wrong with life. The client may not think he or she is presenting the advisor with such a loaded agenda, but the energy driving the client’s side of the discussion — the worry, the anger, the disappointment — often is disproportionate to what is happening in the dollar-and-cents world of the portfolio.
A story may illustrate the point. One couple, clients of mine, owned a successful small business. They worked out of their home. They had no children and financial success became a focal point in their lives. Their aggressiveness spilled over into their investment style. During the dot.com craze of the 1990’s, they bought large blocks of Silicon Valley startups that soared with the trend.
A Loaded Agenda . . .
When the speculative surge collapsed, their portfolio took a terrible tumble . She had made most of the stock picks initially, giddy over the projections that analysts were making in what was then dubbed the “new economy.” It was beyond her to admit that they had been carried away by the hype and failed to harvest their profits in a timely manner. Their stocks were always going to up no matter what. She did not want to acknowledge she had created a long list of failing choices.
She and her husband measured their loses from “peak to trough”—from the highest point an issue achieved to the lowest level to which it had fallen. Forget that at any given moment at least ten percent at either end of the scale is usually not supported by the fundamental value of the company. Stocks are almost always over or under valued. One that has run up dramatically is probably over bought; one that crashes, over sold. But according to their way of looking at things, they had sustained real dollar-and-cent losses that totaled hundreds of thousands. Their portfolio became an album of misery and lost fortune. As if that wasn’t enough, with the market downturn she blamed him for not selling when the time was right. Tranquility at home got tossed onto the pile of losses.
At this point, they came to see me. I did not see the anger and bitterness in their concerns, only that they felt defeated and discouraged. Despite their losses, they were wealthy by any measure. None of their life goals were threatened. But that was not their game. They had one rule; make as much money as possible. It was unrelated to anything they wanted in life like, say, a trip around the world, a home at Lake Tahoe, or an art collection. They wanted wealth for the sake of wealth. When a person doesn’t know what is sufficient, no amount is ever enough.
Discouraged, they told me that they didn’t want to make investment decisions any longer. I took them at their word. Rather than deal with their trouble, they decided to turn everything over to me and thus escape from 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 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. The forecast for the stock had turned negative. I felt that I had finally taken them out of a position at the right time. The couple received a confirmation of the sale in the mail. Their monthly statements provided all the detail about their gains and losses.
Relative terms . . .
When we had discussed capital gains taxes, I proposed that using losses to offset gains in other successful positions would minimize their capital gains tax bill. Minimize and maximize are relative terms. Precision is needed to avoid misunderstanding. Capital gains, for example, might be expressed in as a percentage of the total portfolio. Thus 5% of a million dollar portfolio would direct the advisor to not exceed $50,000 in net capital gains. Doing so would limit the taxes due at the end of the year to $7,500 at the maximum rate of 15 percent. Taxes are always a consideration but should not override other tenets of sound portfolio management. Profits generate taxes. It’s that simple. Nevertheless, this couple wanted to avoid all capital gain taxes. They benefited more than most from living in a free-enterprise, capitalistic economy, but they did not want to pay anything whenever they profited. They were experienced investors and yet never understood the avoiding taxes was impossible if profits were to be taken at the most opportune times.
They didn’t read the confirmation of the sale when it was mailed to them. They didn’t read their monthly statements that reported the capital gains and losses for the month and the year-to-date. So when their accountant called to report that they needed to write a check to the IRS, it came as a huge surprise. My relationship with them came to an abrupt and angry end. 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, even beaten up as badly as they were, they still held out the potential of regaining their strength. A market drop is rarely measured and rational. A lot of good companies get caught in it along with the troubled issues in the outgoing tide. Furthermore, I wanted to respect the husband’s wishes by not calling their attention them.
The game was up . . .
She left a long, vicious message on my answering machine that destroyed any chance of appealing to them on the basis of friendship. The proceeds could be reinvested in stocks with more promise that would make up for the amount spent on taxes. Given any period of time, they could have continued to enjoy growth in the market, but in the uproar over the taxes, time was lost in discussing the issues. As a final proposal, my compliance officer offered to reverse the sale, even though it was months later. The clients realized, of course, that their losses in value would be far greater than the amount of the capital gains taxes. Not placated, the compliance office finally told them that they were free to take their complaint to an arbitration panel—a step most brokerage houses want to prevent. That was the last I ever heard of the case and the last I ever saw of the couple.They went to every attorney in town and got none to accept their case.
They took their problem marriage and their inability to set realistic goals to another unsuspecting financial advisor. The saga will play out all over again when conditions are ripe.
Investing is always on a continuum. Just as it is nearly impossible to foretell the end of a movie by viewing a still shot of one scene, standing dead still with a view of the market as if it were a snapshot is also a mistake. The market and the economy are dynamic. Good investors stay poised to act as conditions change. They realize that the real challenge is to have the money they need at a given point in time; i.e. to start a business, for retirement, or other life goal. Human psychology is a serious, sophisticated subject. It is beyond the scope of any postings I ever plan to make except to note some relatively simple steps to take the intrigue out of the investing process. Make sure that goals are realistic, well defined, written down, and shared.
Money has a limited, important role in life. Managing it successfully is not difficult. It may be a broad subject, but one with very little depth to it. Keeping a clear head for making decisions is very important. Loading up the portfolio with expectations that need to be addressed or realized elsewhere in life burdens a portfolio 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.