Everyone saw it coming except my client. Big Dan pulled up stakes and left. My client had backed him until her million dollar nest egg was severely depleted and her own well being in jeopardy. The margin loan (See Part I) was not being repaid. It was on the books at a rate of 8.50%. Advisors are often compensated for promoting use of margin loans. They can get paid a few basis points on the interest. My policy was to avoid margin. My reasoning went as follows:
- The interest charged on margin loans is difficult to beat with a return on investments.
- The rate is usually higher than what a bank might offer.
- Borrowing money to bolster portfolio performance is inherently risky and usually reflects a lack of planning. If a client doesn’t have enough money to make a plan work, the goals have not been set realistically
- Borrowing is addictive. Once an investor takes out a margin loan, additional borrowings become easier and easier.
- Planning becomes much more complicated with the additional task of retiring the loan to be worked into it.
- Borrowing on margin is almost always justified because the investor wants to make a high-risk purchase. A sure thing is almost always a long shot and when it doesn’t pay, the loss is twice as painful because the loan is still on the books.
- Most investors would not borrow money from a bank or mortgage company to fund an investment purchase, as it seems too risky. A margin loan is no less risky, just more convenient, so much so investors do not stop to think.
True to form, my client called one day to tell me that she wanted to buy stock in a local software company that planned to put all the books ever published on the Internet and allow anyone with a computer to access them. No. This wasn’t Google. It was a local start-up that was being put together by a man who had one failure notched in his belt already—a robotics company that never got off the ground and lost thousands for scores of local investors.
“Everybody is getting in,” she insisted. “We’re friends. I see him at the club all of the time.”
I asked her if she had seen any literature, a statement from an investment banker, or anything of the sort. “He’s not going to delay things by jumping through all of the bureaucratic hoops. He says business is over regulated by the government anyway.” I realized that she could write check on her account any day that she wanted, so I thanked her for calling, promised to look into the situation, and call her back.
Research is Part of a Financial Advisor’s Service
I was curious. But I also believed that primary research is part of the package of services I offered my clients. Clients often take a narrow view a financial advisor’s service. The advisor gets slotted into a role as a stocks and bonds broker who buys and sells for them and little else. The advisor may do little to discourage the client. Research does not always end up with a recommendation to buy or sell anything. The advisor will see the time as unproductive, and if the advisor is being paid on a per-trade basis, research is not necessarily income generating. It can lead to other investment ideas or help build loyalty because it is a value-added dimension of the relationship with the client, but the payoffs are not as immediate as many advisors might like.
I discovered that the founder of the new company was not following the usual protocol in making an initial public offering. I was unable to reach him by phone and he never returned my calls. I asked other financial advisors in town for whatever information they had on the company and everyone reported the same results. I called my client to let her know what I had found.
“Oh, I knew all of that,” she chimed. “He is only going to sell as many shares as he needs to get started.” (Where had I heard this before?)
“He should at least declare how many shares of stock are available, otherwise there is no limit. He can keep selling as long as he wants and every time he does, the stockholders already on the books will have their shares diluted.”
“I know. He only wants to sell enough to get started. I don’t think that it matters.”
“It matters. This man has not taken any of the usual steps to protect his investors. He is not issuing certificates on a defined number of shares. You do not want to do this.”
My client and I continued to argue until I told her that her account was perilously close to the limit on the margin loan. If she continued to borrow against it and the stock market took a tumble, she would be asked to repay some of the margin loan. She was disappointed but finally conceded that she did not want to borrow any more money. “I want to have a nice Christmas for my boys,” she concluded, apparently satisfied to let matters ride.
Several days later I received a call from a young woman who said that she was a friend of my client. “Oh no,” I thought, “I don’t need another one.” She asked whether she could come see me and I agreed.
Help Arrives, Maybe
When she arrived she had to two older gentlemen with her. She looked to be about the same age as my client, mid-30’s. The two men looked older.
“This is my father,” she said introducing one of the men. “And this is Mr. Johnson (not his real name). We are all acquainted with (name withheld) who we understand is a client of yours. We know one another through church and we wanted to talk to you on her behalf.”
“I am glad to meet you but you should know that I am bound by confidentiality with regard to my client,” I replied. They nodded and followed me into my office and took seats facing across from my desk.
“We don’t need to know anything about her finances,” one of the gentlemen began. “She’s a sweet girl, but she just doesn’t understand money and finances. We wanted to see you to make sure that you understood her current situation. We felt that if you knew what was going on then you could do more to help her, and we could help you in anything that you wanted to do.”
I assured them that I did know a great deal about my client’s situation, and I agreed that she probably could use the help in dealing with matters. But, I insisted, I was not at liberty to discuss her account with me or her current or past financial status.
The Christian Thing To Do
“I’ll get right to the point,” the same gentleman continued. “She was living with a man who induced her to spend way too much money on her home. Not only that, she backed him in his own contracting business that has failed as far as we know. The man moved out and left town. I ran my own business here in town before I retired, and my friend here is a retired accountant. We want to help her. We feel it is Christian thing to do ”
“I am pleased that you have taken an interest in her situation,” I replied. “I would like to see her get as much help as she needs. She has never held a job. She has no experience. But if you want to include me in whatever you do, you need to come into my office with her so that I am sure I have her permission to discuss her situation with you.
“She doesn’t know that we are here,” the young woman replied. “She’s heartbroken over Dan leaving her. Her parents and her brother have moved in with her. She’s promised to support them until the get on their feet. We just want to know if she is in a position to do that.”
“I can only repeat what I have already said. I can discuss her situation with you only if she is present and gives me the permission to do so. If you want to arrange a meeting where we are all together, I will be glad to participate.”
“We’ll see what we can co,” the young woman said.
“How do you plan to tell her that we were here?” I heard one man ask the other two as they made their way through the reception room toward the door.
TO BE CONTINUED
A week of birthday festivities has thrown me off my Sunday-Tuesday-Friday posting schedule. I apologize to my faithful readers for any inconvenience. I will get reestablished with my timing this week.
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