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Don’t Fall in Love

Andrew Small

MY FATHER WAS BORN in 1936 in Brooklyn. He attended Erasmus High School, earned a degree in chemical engineering from Brooklyn Polytechnic High School and then went on to study dentistry at New York University. He was a strong bridge player and loved tennis, golf and—most of all—downhill skiing. Just about everything my father wanted to do, he did well. But he wasn’t without flaws.

In the late 1960s and early 1970s, my father had a stockbroker friend through whom he bought shares, mostly in blue-chip drug companies that he admired. At various times, he owned Bristol Myers, Glaxo, Pfizer and Schering-Plough. But he always held an outsized position in his beloved stock, Merck.

After 30 years of dentistry and before turning age 60, he gave up fulltime practice to move to Vermont, where he had a second home. Around this time—in the mid-1990s—my father told me that, to his shock, his brokerage account had just hit the magic $1 million number. He never dreamed he’d see that figure, which—to him—meant security for the rest of his life.

I don’t take joy in killing a party mood. But the CPA in me had to ask him if he was prudently diversified. He said about 75% or more of his assets were in Merck shares. Even if he wanted to diversify, he said, he couldn’t sell because he didn’t know his cost basis. Besides, he had no interest in paying capital gains taxes.

My father rode Merck’s precipitous stock rise to glory. He retired earlier than all of his friends, and enjoyed his newfound freedom in the hills of Vermont. But he wasn’t alone in his good fortune.

One of my dad’s best friends, Bob, was a successful attorney. His portfolio also was heavily skewed to one blue-chip favorite, General Electric. I’ll never forget one warm summer day when the three of us were chatting. The drinks were flowing, we were all glowing from a day of boating and the stock market was ripping.

Dad and Bob—a.k.a. Merck and GE—started talking about the stock market. I was a newly minted CPA. I was married with two small kids and had just taken on the role of CFO of an investment advisory firm. When they asked me what I liked to invest in, you should have seen their faces when I told them I loved broad-based index funds.

I was a John Bogle disciple and had read his book Common Sense on Mutual Funds. I’d also read William Bernstein’s The Four Pillars of Investing, another book that waves the flag for index investing. I can only imagine what went through their heads when they heard me talk. I’m sure they chalked it up to being young and clueless. I definitely recall being told that I was on a path to average, which they insisted was a life of mediocrity.

I had many conversations with my father about his use of margin and his love of options trading. I’d talk about diversification and warn him that a single stock is fraught with risks. I tried to explain that the risk he was running was greater than its potential reward.

I explained that the capitalization-weighted index funds I favored were heavily invested in exceptional winners. Meanwhile, most publicly traded stocks don’t perform as well as Treasurys over the long haul, and so get little or no weighting. I also noted that the Nifty Fifty growth stocks from the 1960s—such as Eastman Kodak, Digital Equipment, JC Penney, Polaroid and Sears—later often went bankrupt, defunct or were merged out of existence.

What happened to Merck and GE, and to Dad and Bob? Between 1985 and 2000, Merck stock soared more than 3,500%. In the following decade, however, while Dad was retired, Merck’s price collapsed. One of its top-selling drugs lost patent exclusivity in 2000 and 2001. Even worse, Merck had to withdraw its blockbuster arthritis drug Vioxx from the market in 2001 after studies found that the drug doubled the risk of heart attacks and strokes in long-term users.

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Merck stock fell 27% on the day of the Vioxx announcement. It eventually bounced back after acquiring Schering-Plough, but it took years. By that time, my father had been forced to sell shares to keep food on the table. His portfolio was crushed and, in many ways, so was he.

This dark period for him was marked by increased drinking and thoughts of suicide. He eventually became financially dependent on me, his son, in his 70s. I’d call that a parent’s worst nightmare.

What about Bob and GE? When Bob was all-in on GE, it was run by legendary CEO Jack Welch. Welch, a former chemical engineer, orchestrated the acquisition of RCA, NBC and expanded GE into financial services. The stock price rose 40-fold under his tenure. During the dot-com crash of 2000, however, GE shares nosedived. Welch retired on Sept. 7, 2001.

Under his successor, Jeff Immelt, GE’s stock price stabilized somewhat. But then, in 2008, the financial crisis hit GE hard. Shares fell 42% that year when it became clear that GE was overstretched. Warren Buffett stepped in with funds to stabilize GE’s operations, and the company also received $139 billion in government loan guarantees. But its troubles didn’t end with the financial crisis.

After years of decline, GE was removed from the Dow Jones Industrial Average in June 2018. I heard bits and pieces about Dad’s friend Bob. I know his retirement didn’t happen as planned, and that he worked well into his 70s. He was forced to sell real estate holdings that he otherwise would have kept.

I write not to brag about my foresight but to offer a lesson. Investing is strange. The smartest people don’t necessarily make the best investors. The best investors may not be the ones who pore over the financials and understand the minutiae of complex drugs, complex systems or complex corporations. Human behaviors—like overconfidence in your judgment or confusing skill with luck—play an outsized role. That’s why behavioral finance has become such a popular field of study.

Warren Buffett’s edge is that he never has to sell. His favorite holding period is forever. We can’t all be like Buffett, but we can learn from the mistakes that far too many investors make.

As for myself, I’ve never deviated in my ways. My portfolio of several decades consists largely of broad-based stock index funds. Like my father, I don’t want to sell because my cost basis is so low. But unlike my father, I don’t have to.

Andrew Small was the CFO of Archstone Partnerships from 1994 to 2019. Archstone returned its capital to its investors, leaving Andrew with more time to spend road cycling, learning to draw and paint, traveling and spending time with his family. His pet portraits and other paintings can be found at www.AndySmallArt.com.

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Barry Nirmal-Tiwary
Barry Nirmal-Tiwary
5 months ago

This article is good but the author is trying to find fault with his own father and that too in a public forum. He could have mentioned “a close relative” rather than his dad and still his article would have been as much forceful in conveying his message. But by mentioning the truth this article no doubt is more effective. When a man has to depend on his son in his seventies, this is tragic.
I am 75 and I have lost around 100K or 200K on several occasions in last 25 years. But for some reason I am still financially well off and I support my sons rather than they support me. I also helped my two brothers in India with money to become financially well off.
This is all due to God’s blessings.

Barry Nirmal-Tiwary
Barry Nirmal-Tiwary
5 months ago

I am a living example of the correctness preached in this article, that individual stocks are risky and so are options. Recently I lost 200K in my investments in COIN and in Bitcoin and Etherium. I put too much faith in the words of “experts” like Cathy Wood, and Elon Musk. Also the media fools you by telling that Bitcoin will reach one million or five million as stated by Cathy and Musk. These guys have millions to play with. I lost some $110 K ten years ago when I invested in PUT options after reading that bad article on finance website. Before that I lost $100 K when I invested in Bank of America. I knew that one must be well diversified and I had decided a few years ago to stay away from stock markets but I did not follow my own advice.

Barry Nirmal-Tiwary
Barry Nirmal-Tiwary
5 months ago

Very good article. I recently lost too much money because I invested in one stock COIN due to too much faith in one lady named Cathy. I wish I had invested in an index fund or just in short term CD.

macropundit
macropundit
7 months ago

There’s a lot going on in the Merc story. It went up by 3500% but you don’t say where it ended up nor comment about your father’s overall retirement strategy. 1 million isn’t much, especially for a dentist. Seems like there could be some important lessons beyond concentration about the story other than the one you highlighted.

macropundit
macropundit
7 months ago

I don’t think any individual investor, employee or not, had any business investing in GE since the 60’s at least. Simply because it was a conglomerate, which is opaque by nature. By design. It was impossible to know what you were investing in. Not only should no one have concentrated in it since it was a conglomerate, for the same reason no individual investors should have owned even a small percentage of their portfolio except in an index since you had no choice there. So arcane were there business dealings and for so long, it’s not even clear those managing it now have been able to learn enough about it to know what’s really going on. It’s ironic the craziest part is also the most obvious. But financial advisors never lose an opportunity to use fear as motivation rather than education.

macropundit
macropundit
7 months ago

>>  “I also noted that the Nifty Fifty growth stocks from the 1960s—such as Eastman Kodak, Digital Equipment, JC Penney, Polaroid and Sears—later often went bankrupt, defunct or were merged out of existence.”

This isn’t the slam dunk that you think. Read this Morningstar article to find out about Voya fund, which bought shares in 30 companies in 1935 and never sold to this day.

https://www.morningstar.com/articles/960641/the-strange-and-happy-tale-of-voya-corporate-leaders-trust

I’m not saying go do this or anything, but simply that because leading companies on various metrics shift over the decades doesn’t argue for any particular investment strategy. Why people think it does always amazes me. I do think it shows that Buffett is right. Namely, that investing in the market ultimately rests on a political bet in the US relative to the rest of the world.

rayanmiller6303
rayanmiller6303
7 months ago

I think it was Bill Maher who said , Greed, Laziness or Stupidity is responsible for much of the problems people face.

Marjorie Kondrack
Marjorie Kondrack
7 months ago

”the smartest people don’t necessarily make the best investors”. How true. It does take a certain canny ability, which many try to copy, but is essentially a gift. Enjoyed your article very much.

Andrew Forsythe
Andrew Forsythe
7 months ago

Andrew, thanks for this. True life stories are a strong way to reinforce what most HD readers believe and practice—indexing and diversification. And I like your dog portraits! andysmallart

OldITGuy
OldITGuy
7 months ago

Very good reminder of the importance of diversification and the folly of falling in love with a stock. Yeah, we might all “know” this but it bears repeating. Thanks for sharing!

SanLouisKid
SanLouisKid
7 months ago

One of my favorite Frank and Ernest cartoons shows a blackboard with an exotic series of calculations and the bottom-line number is zero. Frank says, “Correct Ernie, but anticlimactic.” I feel that way about active vs passive. It seems like a lot of work to go to and end up not even beating the average most of the time.

Jeff Bond
Jeff Bond
7 months ago

“. . . confusing skill with luck . . .” My Dad was lucky. His majority holdings were AT&T (he worked for Ma Bell for 40 years) and Pepsi. His mantra was to never sell the stocks. Over time, through stock splits, he did very well and his consistency was rewarded. He watched AT&T be split into numerous smaller telecom companies (and therefore held stock in all of them), and then saw them recombine into three or four larger companies. When I inherited my share of them, I liquidated everything over time into a basket of low-cost index funds and ETFs. I leave all of them alone, reinvesting dividends. I live off my IRA, which mirrors my investment account. If I exhaust my IRA, then I’ll draw off the investment account.

parkslope
parkslope
7 months ago
Reply to  Jeff Bond

My wife also worked for AT&T before divestiture. I got her to liquidate the spinoffs, but not before she watched Lucent lose all of its value.

Steve Spinella
Steve Spinella
7 months ago

This is a great story about attachment. Right now I think a significant number of people are attached to gold or their cryptocurrencies!
It’s also a story about deferred taxes. I have read often about deferred taxes as something that is almost free money. For myself I find that deferred taxes are the worst kind–a debt that hangs over me and gets bigger and bigger. It is also a debt that can be raised in value by some government not yet elected, concerned about matters other than my own future.

Larry Sayler
Larry Sayler
7 months ago

Excellent article.

I worked for GE (finance). My brother-in-law worked for GE (research & development). We both left in the 1990s. We have always assumed that GE’s downfall was due to the fact that we left.

Realistically, as you point out, GE’s collapse has more to do with Jack Welch leaving and Jeff Immelt taking over.

macropundit
macropundit
7 months ago
Reply to  Larry Sayler

>> “GE’s collapse has more to do with Jack Welch leaving and Jeff Immelt taking over.”

This has been called the “stupid manager” theory of a companies downfall. For major corporations I think it’s usually not true.

Guest
Guest
7 months ago
Reply to  Larry Sayler

The family and friends I have who worked at GE for a long time put most of the blame on Welch. They say all he cared about was hitting the earnings forecast numbers and that hid a lot of problems that only surfaced after he left.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
7 months ago
Reply to  Larry Sayler

Jack Welch was able to cover up a lot of problems and Jeff Immelt was left to pretend everything was fine. GE finance took advantage of their AAA ratings to make bad acquisitions. And don’t forget GE’s Genworth (LTC insurance) is the black hole that still is spilling red ink.

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