Painful Diversification

[yakers]

On another thread "looking For suggestions" I liked Nords posting about his FIL/MIL using mostly CDs and the issue of lack of diversification. Nords analytic tools are great, we just need to remember that we are talking about averages and statistics not absolute truth.
We would consider it crazy but for many years a lot of people worked for one company and bought that company stock and it worked for them. Seems to work less well lately. My FIL worked for Richfield which became Atlantic-Richfield/ARCO which was merged with BP. For 30+ years starting in the 50s as just a professional level employee he amassed the maximum shares he could get under the profit sharing plan. That stock went from strength to strength to strength all those years and is still going strong. Boy did that stock work for him and it is still spinning off dividends and growing for my MIL. After forceful advice from a financial advisor he diversified only a couple years back before he died from one stock it is now maybe 25% of MILs holdings and the rest are diversified funds. But if my MIL was holding just BP it probably would be beating the pants off the diversified portfolio. Sleep at night, well maybe it was confidence or ignorance but they slept pretty well. I know there are cases like Enron and I would advise anyone including my kids to diversify. But it is not the only way. Sometimes real estate works, sometimes someone’s own business and sometimes a single stock can work. It is really necessary to acknowledge the risk but having a few stocks or even one which you really know has worked for some people.
Me, I’m expecting a pension and have the Federal TSP program which is all index funds. And a few DRIPs. And while I agree with Modern Portfolio theory and admire analytical ability like Nords I really cried when that BP stock was sold. How much confidence does one have to have to sell off a solid stock to diversify and watch that diversified portfolio not out perform the single stock for a long time, maybe a lifetime. Diversification in this case is more insurance than maximum portfolio performance but it sure felt like expensive insurance to me.

 

[brewer12345]

yakers, the point of my investing is not to maximize the account balance, it is to get me to FIRE and keep me there. If everything in a single stock is the best way to do that, then great. Since it does not appear to be so, that's all the ruminations I need about diversfication.

 

[Nords]

It is really necessary to acknowledge the risk but having a few stocks or even one which you really know has worked for some people.

Me, I’m expecting a pension and have the Federal TSP program which is all index funds. And a few DRIPs. And while I agree with Modern Portfolio theory and admire analytical ability like Nords I really cried when that BP stock was sold. How much confidence does one have to have to sell off a solid stock to diversify and watch that diversified portfolio not out perform the single stock for a long time, maybe a lifetime. Diversification in this case is more insurance than maximum portfolio performance but it sure felt like expensive insurance to me.

While I have a lot of faith in Warren Buffett (about a third of our retirement portfolio), we do have a high-quality pension and other investments. I'd never be able to put the same amount of faith in a bunch of executive suits, even if they're the next Jack Welch or John Rockefeller. Heck, even today we're with Buffett more for the company's breakup value than for his investing acumen.

I think that many of these portfolios fail when the brilliant investor becomes unable to manage their affairs or even dies. For a family/survivor's sake it's probably much better to have a portfolio that doesn't require such a high amount of work/vigilance. Spouse says that if I wake up dead one morning she'd just continue the withdrawal plan we've set up, but then she has a high-quality pension of her own coming in 17 years and doesn't necessarily have to make the portfolio last for a lifetime.

It sounds like the BP stock did more than its share of the heavy lifting with far more compensation than could normally be expected. At some point the best investors have to throw down their cards and cash in their chips, or at least back away from the $500 blackjack table. I think planning for family safety/stability is more important than the difference between being "well off" and "filthy rich".

 

[MDW]

Yakers,

I understand what you are saying. If I had diversified instead of staying with my company stock plan I would have half the value of my portfolio. I am close to FIRE because of a single solid stock. I know it is not the safe approach for the long run and I don't recommend it to others, however, it's tough to leave a solid performer - especially when it is getting you to your goal.

Diversification is in my near future when I implement my early retirement plans. Life is a bell curve - on average diversification is the best way - however there is life on either side of average.

MDW

 

[unclemick]

Postscript - page 288 - 4th ed - Benjamin Graham's - The Intelligent Investor.

I know two - offhand - one with Johnson and Johnson and another with Home Depot.

A third - held Chrysler for over thirty years and diversified after Iaccoca - took 55 and out. The long down years were painful - but he was still working. An aside - he's one that that got sucked into helping his son and daughter's small businesses while in retirement.

More than one way to skin a cat. Also one who moved back to Colorado bought raw land for over thirty years(RE and CD stuff only - no stocks). Turned out one chunk near Denver - formed the bulk of his gains.

 

[SteveR]

Single stock retirement can be the kiss of death too.

My former employer was a drug company that had a good record of slow gain in price and then splits every 3-5 years ever since it started in the late 1920's. My late wife and I both worked for the same company. When we married later in life, she had 100% of her 401(k) in the company stock. I almost had a heart attack! She had been working for 20+ years when we got married so she had a nice chunk in there. As soon as I could, I started moving some of it into index funds in her account with her kicking and screaming the whole way. That is until the company was hit with some major legal issues in 1999 and early 2000. Consequently the stock took a nose dive and even after moving a big chunk of her stock we both took a big hit of over 30%.

The stock price is still depressed and has no prospects of going anywhere very fast so on top of it all, my stock options are and continue to be underwater so I am not counting them for ER. Too bad too... I would have been ERd a couple of years ago if they were worth anything. It looks like they will expire long before they breath air again.

Beware having too much faith in your company stock. It can be very painful when it heads South.

 

[greg]

SteveR: Sounds like you made enough 'brownie points' to last you and DW forever.

--Greg

 

[SteveR]

Greg,

The 30+% drop in value has finally been made up so I am now back to where the value was 5 years ago. My options that I carred over in to "retirement" expire in a few years and there is little hope they will ever be worth anything. My current employer has little to offer in the way of retirement other than a paycheck (reduced from my previous one) and a 401(k) with a 4% match. I keep running the numbers with my current expenses and know that I can make it with some belt tightening but the new wife still has 23 months left so I am sticking it out here both for her at to pay down the mortgage as much as possible while supporting a kid in college and investing in my IRA.

Not sure about the Brownie points but we think we can ER (again) in 2007.

 

[REWahoo]

The stock price is still depressed and has no prospects of going anywhere very fast so on top of it all, my stock options are and continue to be underwater so I am not counting them for ER.

SteveR, you can never tell what will happen when it comes to stock options. I was in a similar situation, with no propects for my options to ever pay off so I totally excluded them from my ER plans. One month before I retired my company was sold and the options miraculously floated to the surface. It wasn't a huge sum of money, but it was really nice icing on the cake and gave me a real sense of security and an extra margin of safety on my planned SWR.

REW

 

[greg]

SteveR: I had a big fight with my brother a couple of years back over Vanguard's Healthcare Fund. He's a financial planner (please don't tell anyone!), and I tried to pursuade him to get the heck out. I don't know where the pill portion of health care stocks is going for sure, but I don't see it as up--except for the price of pills. But I suspect most of their monetary gains may end up in litigation payments--dang lawyers.

--Greg

 

[SteveR]

REW,

My previous company is an old (120+years) big Pharma. worth $80B so any kind of take over would be pretty remote.  My only hope is that they get rid of the current CEO and change direction.  That is unlikely as he "owns" the Board and keeps trickling earnings increases just enough to keep his job.  

My new company has options but you can't take them into retirement and they have a 5 year vesting so with me leaving in less than two, that does not leave much on the table especially since I have only been here 3 years and my original options are under water too.  :  

My boss had a meeting with me today to give me my options for this year.  I just smiled and said I hope you don't expect me to be motivated by these.   8)  

 

[Arif]

But I suspect most of their monetary gains may end up in litigation payments--dang lawyers.     

Maybe someone should start an ETF that invests in trial lawyers. :

 

[tryan]

I hear ya ... Still have over 1/2 my networth tied up in real estate.  And every time I sell something I loose 25% to taxes and xfer fees.  Ouch!

One of these days I'll get 1/3 RE, 1/3 stocks, 1/3 bonds.  But that day is a few years out.

 

[greg]

I hear ya ... Still have over 1/2 my networth lied up in real estate. And every time I sell something I loose 25% to taxes and xfer fees. Ouch!

One of these days I'll get 1/3 RE, 1/3 stocks, 1/3 bonds. But that day is a few years out.

Not if the housing bubble pops! I'm in a risky RE situation too, created recently by mee.

 

[SteveR]

Drug stocks will continue to move sideways for a looooong time.  Price controls by countries outside of the US drive lower prices worldwide.  The US market is paying for R&D because of this.  As the new Medicare Part D comes on-line, you will see further price pressure on US companies.  

The biggest threat is from India and China.  Those two countries are rapidly getting into the generic drug market is a very big way.  Many generic companies will have to do some major scrambling to keep their prices down and offer some type of service that the other companies cannot provide to survive.  

Big Pharma is not done with acquisitions and I believe more are on the way.  The problem with these massive companies is that it is very difficult to find major block buster drugs that will generate $1B in sales per year to keep the engine going in these huge companies.  The facts of life are that the "easy" compounds have already been found.  The rate of new drug development and approvals has slowed down.  FDA is becoming more and more difficult to work with and the delays in approvals and requirements for "more data" increase the costs while decreasing the time available to market a new drug.  Patents are 20 years but it takes 10 or more to get one to market and a cool $800M for each one.  Add to that the failure rate of over 20% of new drugs to make it to market and you have a ton of $$ in R&D that go no where but in the crapper.  

No drug is completely safe.  FDA would not allow Aspirin to be approved in today's climate.  Drugs cost a lot because it costs a lot to get one to market and then deal with the legal feeding frenzy that happens when known side effects get to a hysterical level...think Merk and Vioxx.  

By the way....a little history lessen in FDA, lawyers and greed.  Everyone remembers the stories about silicone breast implants and women becoming sick with autoimmune diseases and all sorts of other ailments.  Dow Corning was sued and lost.  The rest of the industry stopped making them and went to saline instead.  The lawyers made a killing on the various trials and the medical device manufactures spent a ton of $$ defending themselves......Flash forward.  There has never been a proved medical condition associated with silicone implants.  The "expert" witnesses never produced a study where the results could be reproduced.  The FDA even admitted years later that there was no valid evidence.  

Ok, getting off my soap box....but don't believe all you hear or read in the media or from FDA.  There are a lot of hidden agenda out there.

 

[greg]

Maybe someone should start an ETF that invests in trial lawyers. :

I don't think widows should invest in such a scheme fund.

 

[tryan]

Not if the housing bubble pops!  I'm in a risky RE situation too, created recently by mee.

That's my nightmare ... but I am pretty confident I could cut my RE holdings in half within a year.  Some tenants have been pushing me to sell.   Been stalling (selling one/year) so I don't get hit with ALT MIN tax (again).

 

[Nords]

I had a big fight with my brother a couple of years back over Vanguard's Healthcare Fund. He's a financial planner (please don't tell anyone!), and I tried to pursuade him to get the heck out.

It pains me to take the side of a FP, but I can see why he'd fight back...

 

[wildcat]

My only problem/concern with the Vanguard Healthcare Fund is its popularity and asset bloat.

 

[greg]

Nords: You're right. But I should have put the argument in its proper context. We both had about $10K in the HC fund at that time. I chose a different path:

http://finance.yahoo.com/q/bc?t=5y&s=VGPMX&l=on&z=m&q=l&c=vghcx

--Greg

 

[greg]

That's my nightmare ... but I am pretty confident I could cut my RE holdings in half within a year. Some tenants have been pushing me to sell. Been stalling (selling one/year) so I don't get hit with ALT MIN tax (again).

AMT is my middle name and by proxy DW's. Read somewhere that investment decisions (or disinvestment decisions) shouldn't be made based on tax considerations. This for me is just one too many parts to worry about. See Occam's Law. KISG (keep it simple Greg). Unless, of course, the thing is a dirty little mess that needs close examination to solve. Some things are more or less than grey--find the black parts and the white parts. The cook should always watch his/her own porfolio most carefully--for boil overs or some horrible stench that might be in the making. IMO

--Greg