A Tale of Dilemma





In the late 1960s, my father recognized he needed to start allocating money to the stock market in order to achieve higher returns than those earned with bonds or savings accounts.  He, however, was at a loss on how to go about doing it intelligently.  Like many, he understood that investing in the stock market was, over the long term, likely to produce substantially higher rates of return than investing in less volatile investments.  He also had taken the time to educate himself on the general concepts behind these things called stocks and bonds.  He correctly understood that safety was an elusive concept that has more to do with time invested in something than something invested in time.  He understood stocks were creatures that morphed over time.  They went from short-term risky compared to bonds to long-term safe.  He also recognized he wouldn’t be able to develop the type of expertise to make stock market investing work for him without hiring an advisor.

So, how did my father go about finding a stock market expert or experts?  He wasn’t an expert himself.  He didn’t even know enough to evaluate what an expert would look or act like.  He didn’t even have an idea of how to determine if the expert was doing his job correctly after he hired him.  This was quite a dilemma and one that faces almost everyone that wants to achieve higher returns but lacks expertise.  He was fortunate, however, compared to today’s rookie stock market investor.  He was lucky because he had less choice, so his approach could be simpler.  The world back then was less complicated for the average investor, and so your options were limited.  Behaviorists will tell you that limiting choices lets people act.  It is why today, we see so many people afraid of investing.  We have too many choices, and so the situation seems hopelessly complex.  Limited choices made the problem easier to solve.

In the 1960s, if you were an average investor and wanted to invest in stocks, you only had three choices.  You could hire a national or regional 100% commission-based broker from a firm such as Merrill Lynch or Legg and Company.  You could pay a commission or load to hire a mutual fund manager to manage your money.  Lastly, you could pay a commission to buy a stock directly and enroll in the company’s dividend re-investment program.

I know it is hard to believe.  This era was before Charles Schwab created the discount brokerage model, or Jack Bogle popularized the notion of low-cost index investing at Vanguard, or Fidelity promoted the Star money manager and catapulted to success on the back of Peter Lynch,  It was also before the growth of these new things called the 401(k) and the IRA.  There were no exchange-traded funds, and access to private money managers was the exclusive domain of the ultra-wealthy.  However, you could still invest in stocks.  You just had to figure out how to do it, and there were only three ways.

It’s ironic.  Although the landscape has changed due to packaging and the introduction of fee-based compensation as an alternative to commission-based compensation, the choices remain the same today.  You buy stocks, individually or packaged, from a person who speaks with you or from one that doesn’t.  Furthermore, if you speak with them, they in turn buy stocks, individually or packaged, directly from a person who speaks with them or from one that doesn’t.  The implicit message your advisor is sending is, “You should hire me to hire investment managers who won’t speak with me either because you can’t successfully do it yourself.”  That is nonsense.  You can absolutely identify the same types of investment managers they can and you can gain access.  You may not know in what combination or in what proportion, but the information on the individual investment managers is readily available.  This information is a commodity.  Beware, information is not knowledge.  There is a reason why people pay investment advisors to select investment managers.

Given this backdrop, I think the most intelligent thing my father did when hiring a financial advisor to manage his stock portfolio was to accept facts and define the problem as it pertained to him.  He knew that as a physician it was unlikely he would receive a windfall from selling a business or inventing a product.  He knew there was no future inheritance coming his way.  He knew he paid taxes on all of his income, was still responsible for his money and that he would never be an expert on investing in the stock market.  He defined the problem and solved it based on his situation.  He was realistic and didn’t lie to himself.  He understood expertise, but had no way to evaluate if the advisor he was giving his money to was an expert.

His journey started the same as most.  At first, he tried to see if there was some type of financial-equivalent designation to his medical degree.  If he could find this type of advisor, he would be set.  Sadly, he learned that none existed.  It still doesn’t, and I doubt it ever will.  Although there are numerous financial designations bestowed on advisors to make them appear as experts, the vast majority of advisors are anything but what they say they are.  He quickly recognized this landscape and understood that the financial services industry did not have the same rigorous standards as the medical profession.  He then redefined his problem to include the very real possibility that the advisor he hired would not be an expert.  This was unacceptable in his mind.  So he read extensively and continued his education.  He read his financial bible magazine called Medical Economics and every reputable personal finance book he could find.  He asked his colleagues for advice and referrals.  He consulted with his insurance agent, his accountant, his attorney and most importantly with his wife.  After this process, he didn’t interview multiple advisors because he thought that was silly.  He had no way of evaluating the advisor he would hire so he hired an advisor based on a referral.

After all of this, did it work?  Of course not.  The 1973 to 1974 recession and subsequent approximate 50% decline in the stock market eliminated a substantial percentage of the money my father had with the advisor whose firm was perpetually “Bullish on America.”  In 2008, the firm became “Disgraced in America” after they were bought out by Bank of America.  Like many before him, at or near the end of the 50% decline, my father decided to get out of the market.  Did my father make a mistake?  Probably.  Was it the advisor’s fault?  Probably.  Was it a collaborative mistake?  Probably.  It is hard to tell what compels investors to sell their holdings near stock market lows and buy near stock market highs.  But we witness it time and time again, in every stock market cycle.  What can we learn from my father’s behavior?  These tales will help you understand this behavioral flaw built into our primitive brain.  The fight-or-flight instinct is so strong that we must reprogram our thinking to become successful investors.  I personally don’t blame either my father or his advisor.  I blame human nature.

Was there a saving grace to this chain of events? The answer is yes.  My father, through his own initiative and rudimentary ideas about diversification and taking personal responsibility, had only invested one-third of his money with an “I can talk to him” advisor.  He had invested another one-third with an “I can’t talk to him” advisor in the form of several stock mutual funds and the last one-third with a different type of “I can’t talk to him” advisor in the form of several well-known individual stocks.  He had effectively set up three equal piles of money devoted to stock market investing with three types of advisors.  He could talk to one of them but not to the other two.  He wanted to cover all his bases.  He called it, “Diversification for the dumb” since he considered himself dumb in this arena.  His reasoning was that everything he read said that you needed to diversify, and because he didn’t know how to set up a diversified portfolio himself, he created an alternative form of diversification.  He hypothesized that the person who ran the mutual fund had to be an expert, otherwise they wouldn’t be running the mutual fund.  He also hypothesized that the executives who ran large publicly traded corporations were also experts.  If they weren’t, he reasoned, why would they be running large enterprises?  He practiced his own form of diversification.  Furthermore, he remembered the rich Cubans who had all their eggs in one basket and lost it all when Fidel Castro nationalized the country.  He didn’t want all his money in the custody of only one “Bullish on America” firm.  He wanted it spread around, and so he set it up that way. 

As of this writing, he still owns these mutual funds and shares of stocks in these companies, and even though I am in the business of managing money, I have never consolidated them under one custodian.  The original investments have multiplied in value many times.  It’s hard to believe how many times money can multiply in 50 years, but these mutual funds and individual shares are living proof.  Money multiplication or compound interest is a powerful force.  I would also note the following: His idea of diversification is dated today since most of the literature calls for an asset allocation to include bond and cash holdings.  He thought the idea of investing in “safe” assets such as bonds and cash was a silly notion because he had a long-term horizon and his objective was to create wealth in the most rapid and probable way possible, and that meant an “all in” stock allocation. 

I asked my father why he didn’t sell his mutual funds and individual shares in 1974 when he sold out of his portfolio with his “I can talk to him” advisor.  As far as I was concerned, he didn’t have a satisfactory answer.  He said that it was just easier to make one call to his by-this-time “Not so Bullish” advisor and tell him to get out of everything.  He had also grown attached to the mutual funds and shares that he had selected.  Furthermore, he needed to make multiple calls and write multiple letters in order to liquidate, so he just left them alone.  He also indicated that he was interested in buying a second home at a local beach resort and that the money he had left with the “I can talk to him” advisor was the perfect amount to make a 20% down payment on the beach house, so he took it from there.  I was amazed at his reasoning.  It wasn’t exactly sound and analytic thinking.  Nevertheless, in hindsight it worked very well.  He kept his mutual funds and stocks.  To this day, he still owns his beach property and it too has increased in value by many multiples.

This leads us to another lesson you will learn.  One of the biggest problems faced by investors today is the ease with which they can transact sales and purchases in the stock market.  It’s as easy as putting money in a slot machine.  I suspect the generation before low or no-cost commissions had better performance than we do today because they left things alone.

What can we learn from this tale?  We learn once again that individuals are responsible or accountable for their money.  They are in charge of how they allocate their money or capital.  Furthermore, we learn individuals can recover from investment mistakes and that they must understand the investments they own.  We also learn the age-old adage of “don’t put all your eggs in one basket,” since when my father decided that he needed stock exposure in his portfolio he actually hired three types of advisors.  He hired a person that he could speak to, a mutual fund manager with a pedigree and executives at companies paid to allocate money for their shareholders.

This tale teaches us five more things.  We learn that despite the best efforts to hire an advisor, there is currently no perfect method, but good methods do exist.  We also learn everyone is susceptible to the fear and greed cycle that always characterizes the stock market, and that my father was no different since he sold out near a market bottom in 1974.  There is a behavioral reason for this because stock market investing gets emotional at times.  We also learn there is an element of luck associated with the investments you make as well as the investments you keep.  Next, we learn that despite how complicated the world seems to have become, at its core, it is still the same.  Finally, and if you ask my father, most importantly, we learn that in order to make good decisions you have to surround yourself with a team of advisors.  Although you are still accountable, a team approach lets you see different sides of the situation.

Let me leave you with a visual.  When I was a boy, I spent countless hours watching a cartoon called Rocky and Bullwinkle.  One of the characters in the show was Snidely Whiplash.  His character parodied the silent film villain who took great pleasure tying damsels in distress to a railroad track.  He wore a black cape and black top hat.  My visual is simple.  If this character was to approach you with an investment idea, you would grab your wallet and run.  With this in mind, recognize that the person who approaches you with an investment idea will never look like Snidely Whiplash.  He will come correctly packaged.  He will be a pillar of society.  When you meet this person, ask a simple question—What can go wrong?  Also ask the question—How can I lose all or part of my money?  You are accountable.

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