Facing Down Risk
IN REFLECTING ON his life, Apple founder Steve Jobs noted that, ���You can only connect the dots looking backward.��� When we���re the authors of our own story, it���s all too easy to connect those dots in a way that���s most flattering to ourselves. But to be useful to the reader, a narrative must be honest���and it should start at the beginning.
My first money memory dates to the early 1980s. I was maybe 10 years old and sitting at the kitchen table with my father, who was looking over some papers. It was his office���s new retirement plan, he said. My dad was a lawyer. He explained that, with this new plan, employees were going to be allowed to choose their own investments. That sounded interesting and like a good idea���for about one second.
Then my dad described how difficult it was for each person to be his or her own investment manager, picking and choosing from among all the options. Especially after the 1970s���a dreary decade for stock investors���it was hardly clear that the right move at that time would be to invest heavily in the market. With the benefit of hindsight, of course, that was the perfect time to jump into stocks with both feet. But no one knew then that a two-decade-long bull market was just getting started.
At the time, I didn���t even have a savings account. But I could understand the challenge my dad was describing, suddenly being put in the position of being his own investment manager. It was no different from asking an investment manager to become his own lawyer. It didn���t make a lot of sense. The same was true for my father���s colleagues���fellow lawyers, secretaries, IT folks. All were experts in their respective fields, but not in investments. The task seemed difficult, if not completely unreasonable. But that was only part of what made it difficult.
In every family, there are subjects that aren���t talked about very much. They aren���t necessarily secrets, but they simply aren���t anyone���s favorite topic. That was certainly the case in my family. The story goes back to the 1890s, when my great-grandfather emigrated to the U.S. Soon after arriving, he began selling odds and ends off a horse-drawn wagon. Over time, that evolved into a chain of stores selling lumber and building materials. All went well until the late 1960s, when the family decided to sell to a larger retail chain.
What happened next was unfortunate: Like a lot of acquisitions, the larger company paid mostly in stock. In the doldrums of the 1970s, the larger company���s stock lost much of its value. If I had to guess���and I���m only speculating���that unpleasant experience factored into my dad���s thinking that day as he considered how much risk to take in his new retirement plan.
This early memory from the kitchen table has always stuck with me. It was the first time I had learned anything about the stock market, and it didn���t seem like a lot of fun. Over the years, I���ve learned much more, and it���s now part of my job. But to be honest, I still view the market as a hall of mirrors���and that���s on a good day. I���m probably giving my 10-year-old self too much credit, but it may have been on that day, at the kitchen table, that I started getting interested in investments.
Aside from that experience, I didn���t think a lot about financial matters as a kid. I did start a business in high school���selling sunglasses via mail order. But the years up through college were otherwise uneventful from a financial point of view. College tuition was high, but it hadn���t yet reached today���s absurd level, and I was able to graduate with no debt. For that, I���m eternally grateful to my parents.
Things changed, though, when I finished college. Instead of pursuing a traditional job or going to grad school, I instead decided to start a business. I had enjoyed the experience in high school of creating something from nothing, and I wanted to try it again. Thus started the next phase of my financial life, which couldn���t have been more different from the tranquil financial life I had enjoyed up until then. It was a rollercoaster.
Left with a name. The business I started was a software company���a sort of internal social network for large companies. It was a reasonable enough idea, and I had some success selling the product. Customers included law firms, hospitals and companies like Johnson & Johnson. In the late 1990s, I raised one round of financing. But in the end, I wasn���t able to build it into a large enough business before the 2000 dot-com crash.
Being in my 20s, this wasn���t a big deal. I���d learned a lot from the business and I was happy to try something new. There was just one problem: At the moment when I wanted to lean on my savings, they evaporated. What happened? During the 1990s, I had started working with a stockbroker. He seemed like a good choice. He was a family friend. He worked for a well-known firm. He seemed experienced. And he had a DeLorean in his driveway, which seemed to indicate success.
For a time, I thought things were going well. He had built a portfolio of stocks for me and, through the late 1990s, it grew. What I understood only later was that it was barely diversified. The bulk of it was invested in a handful of technology stocks, which all dropped at the same time. On top of that, because the broker had suggested I borrow against my stock holdings to buy a car, the whole portfolio went, more or less, to zero.
From a financial point of view, this was a disaster. I wondered why this experienced financial professional had stacked the cards this way. The silver lining: It helped plant the seed for my later career as a financial planner. It motivated me to want to help others in all the ways that my stockbroker had not. In fact, in my work today, I mostly just do the opposite of what I experienced as a client back then. I work to understand a client���s needs in detail before designing a portfolio. Instead of picking stocks and building a concentrated portfolio, I diversify with funds. Instead of using high-cost funds with sales charges, I stick with low-cost index funds. Instead of betting too heavily on a rising stock market, I���m always preparing for a rainy day. And I���m wary of leverage.
It���s a cliche to say that, when one door closes, another opens. But sometimes, that happens right on cue. In the aftermath of the dot-com crash, as I was reassessing my business, I received an inquiry. It turned out that this other startup wasn���t that interested in my company. Instead, it wanted to buy my company���s domain name. We almost had a deal���for an amount that might have paid for a (modest) new car. But the prospective buyer backed out when he found that another startup had filed a trademark application that would have posed a conflict.
On the advice of a quick-thinking lawyer, I reached out to the other startup using the ���contact��� link on the company���s website. The email I received in response came from the young company���s founder, who turned out to be a college student. It took some time, but we eventually reached an agreement. Because his company was just getting started, he didn���t have a lot of cash to offer. At the same time, his early results seemed promising, so we agreed that the deal would include some stock.
For a time, that stock was no more meaningful than a piece of paper in the back of a file drawer. But over time, the company enjoyed impressive growth and eventually it went public, making its early employees and their backers very wealthy. Ironically, this was the sort of bet that my old stockbroker was pursuing���buying tech stocks and hoping to catch lightning in a bottle. In a funny kind of way, it validated his strategy. But I draw the opposite conclusion: I view the startup that bought my domain name as the exception that proves the rule. Sure, there are stocks that go to the moon. But the number is small compared to all of the companies started each year, and it���s small even compared to all the companies that are currently public.
Decision time. For a variety of reasons, I���m not going to name the company involved and, in any case, it���s not that important. What is important: The decision I had to make. What did I do with the stock after it went public?
The data say that investors are better off, on average, going with index funds than trying to pick stocks. At the same time, I have a healthy respect for the entertainment that stock-picking can provide. It���s far more fun to pick stocks than to invest in index funds. But it���s important to separate entertainment from investing, and to recognize the odds associated with each. I don���t look at individual stocks as poison, to be avoided at all costs���just as I don���t look at the occasional Powerball ticket as completely reckless. That's why my recommendation to the families I work with is this: If you want to pick stocks, do it in a separate account, with a fixed���and small���percentage of your portfolio.
So what did I do with the stock after the startup went public? The answer: I took my own advice. I sold a lot of my shares and diversified. Because I���m still working, with a number of years until retirement, I kept most of the money invested in the stock market. But instead of one stock, I chose a set of Vanguard Group index funds that cover most of the world���s markets. In the U.S., this includes the S&P 500 and the extended market index. The latter includes everything outside of the S&P 500. Together, these are the equivalent of a total stock market index, but I bought them separately so that I could control the mix, tilting toward mid- and small-caps. Also in the U.S., I chose Vanguard���s large-cap value and small-cap value index funds. In overweighting small-cap and value stocks, I���m acknowledging their record of long-term historical outperformance.
Ten years later, what���s been the result of this effort to diversify? There���s no doubt that, if I���d just held the one stock from the IPO, it would have been a better move financially. Still, I don���t regret diversifying. In fact, I don���t think investors should ever regret spreading their investment bets widely. The reason: Even with all the antacid in the world, it���s simply too nerve-racking to have the majority of your net worth tied to the fate of any one company. As I write this, the company���s stock is down almost 50%. Because I sold most of my shares, I haven���t lost much sleep over the decline. That, I think, is how it should be with any investment portfolio. Harry Markowitz, father of Modern Portfolio Theory, once described diversification as the only free lunch in the world of investing. Others have observed that the optimal portfolio isn���t the one that has the greatest growth potential. Rather, it���s the one you can live with. I agree with both sentiments.
Measuring success. My grandfather, who ran the family���s retail business, was an unconventional guy. One side of his business card, which was bright orange, included just the word ���SMILE��� in large block letters. On the other side, it carried this quote: ���Success is never final, failure is never fatal.��� That line is sometimes attributed to Winston Churchill. It certainly applies to personal finance.
As I said at the outset of this essay, we���re each the author of our own story. We can connect the dots in any way we wish. The story I���ve presented here is factual. But I���ve probably left out a few of the less flattering detours along my financial journey. The reality is, anyone who has ever been involved in a startup can romanticize the experience and later laugh about the financial gymnastics required to keep things going. But I���m sure I have more gray hair than if I���d taken a more conventional road.
Research has shown that, once a family���s annual income exceeds a threshold of around $75,000, happiness doesn���t necessarily continue increasing along with income. I have to agree with this. At a certain point, many people reach what the late Jack Bogle, founder of Vanguard, called ���enough.��� That���s why the investment benchmark I use isn���t the S&P 500. Instead, it���s a concept that���s more fundamental: contentment and peace of mind. That may not sound very rigorous, but I believe it���s true.
What brings people happiness? Here���s what I���ve observed among folks later in life: It���s things like living within walking distance of adult children. Taking grandchildren for bicycle rides. Taking a camper up to the mountains or loading the kids in the car for a trip to the beach. Training for a marathon. Working part-time, just for the enjoyment of it.
I know that when I say this, I run the risk of sounding like an idealist. I���m not suggesting that we all become ascetics. There���s no doubt that more money in the bank carries many benefits. Among them: the option of early retirement, the chance to explore the wider world and the opportunity to engage in philanthropy on a grander scale. In the end, of course, it���s a balance. As the title of this collection of essays suggests, it���s a journey. And that���s probably as it should be.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman��and check out his earlier articles.The post Facing Down Risk appeared first on HumbleDollar.
