March 2018

Debbie’s Brother was Trustworthy, But …

By Ray Mullaney
Originally published in Senior Digest

A few months after her 67th birthday, Debbie retired after 30 years in the accounting department of a large bank. One of three children raised by Depression-era parents, Debbie, like her two brothers, was very good with numbers. Bert, her older brother was a wizard with numbers and became a very successful financial adviser on Wall Street. Debbie married young and had three children. Her husband Ed made a good living, but when her children were old enough, she returned to work.

Sadly, Debbie’s husband, Ed, died shortly before Debbie’s retirement. At the time of his death, she and Ed had saved $488,659 in CDs and government bonds. Their three children, grown and now parents themselves, were also doing pretty well.

Debbie felt all set financially; she felt no need to risk her security for “more” money. Debbie trusted and respected Bert. But Debbie and Ed had done pretty well, always safely investing in CDs and government bonds.

For years, Bert had explained to Debbie how much better off she would be investing in stocks. At the end of 1999, after the holidays, Bert and Debbie sat down for a serious meeting. Bert showed her exactly how much better off  she would have been if she just invested some of her money in the largest and “safest” companies in America. He showed her how they performed over that past five years. Bert was, in fact, completely honest. He told her what he believed was true. He said, “there would be bad years, but that “Blue Chip” stocks were safe and after the bad years, long-term investors always did well.”

At their meeting, Bert showed Debbie how well stocks had done. The “facts” he showed her were very compelling and she was sold. Unfortunately for Debbie (and all investors), those were not all the facts (which I will discuss in a bit). In the 5 years prior to January 2000, here are the gains investors would have seen in these Blue-Chip stocks:

Citigroup, rose 251%.
IBM, rose 185%.

General Electric, rose 188%.
Exxon-Mobil, rose 101%.

Microsoft, rose 323%.
Johnson & Johnson, rose 141%.

So, in early 2000, Debbie became a long-term investor. She invested $200,000, $10,000 into 20 of the largest and most popular Blue-Chips. Bert charged her a discounted fee of only 1% per year. Debbie left $200,000 in 6.5% long-term government bonds and kept the remaining $88,659.29 in bank CDs.

Here’s how Debbie’s investment statements looked over the years:

By January of 2005, after 5 years, her $200,000 in stocks were worth $159,805.
By July of 2009, 9 1/2 years later, her $200,000 in stocks had fallen to $116,772!
At the end of 2014, after 15 years, her account was now worth only $208,750!

If Debbie had put that $200,000 into bonds instead of stocks, she would have accumulated nearly $1 million dollars, rather than only about $700,000.

Bert was honest, he truly wanted to protect her savings and see it grow. But Bert’s advice to invest after the market had risen so much was just bad advice. He failed to realize just how much a person can lose when they hold stocks after a major and protracted stock market increase. This advice was very costly to Debbie (and all investors in those years). If Debbie knew the ABC’s of safe investment principles, she would have made very different decisions, decisions that would have greatly benefited herself and her family.

The ABC’s of Safe Investing
A Retiree’s Safe Investing Manifesto

  1. Timing is everything. Be patient. Wait for the best and safest times to invest. Buying low and selling high is the only rational objective when investing. Stocks do not rise forever, nor do they fall forever. Therefore, the prudent investor buys stocks only after major market declines and sells his stocks after he is satisfied with the profit he has earned, or he sees evidence that most stocks have risen beyond prudent, low-risk price levels. He is a very disciplined, discriminating buyer. When he can’t find bargains, he keeps most of his money in Treasury bills. This may well be as much as half of his investing lifetime. Because he is risk-averse and highly discriminating, he very rarely loses a significant portion of his investments. Warning: It is impossible for anyone to predict future prices or the future direction of the market. However, by waiting for the market to fall, you will buy stocks at much lower prices. Therefore, if the stocks you purchase do recover and advance, you will not only have far greater profits, but you will have avoided experiencing great paper losses as well!
  2. Invest in “Safer” companies. Knowing when to buy is only the first step. Once the time is right, you can reduce your risks further if you buy companies with lots of cash, whose revenues appear stable and whose debts are either very small or declining. The more durable a company’s balance sheet, the “safer” it is. However, the strength of the balance sheet is just one measure of the risk of a stock. There is one more, and that is:
  3. The best measure of the risk of a stock is what you pay for a stock, relative to a conservative and reliable estimate of that company’s minimum value. The more conservative you are in your analysis and selection of stocks, the less likely you will lose money investing. One of the most reliable measures of the risk and probability of a stock’s decline is simply this: the greater the difference between the price of a stock and a conservative and prudent estimate of the company’s minimum “net present value”, the lower the probability that you will lose money on that investment. If a reliable and conservative estimate of a company’s value is, say, $4 billion, then if the stock’s price drops below $4 billion, it is likely to be bought, and its price stabilized, by “value” investors and private equity firms. But if its current very high price is based on the belief that future financial results will be extremely positive, if extremely positive financial results fail to materialize, that stock’s price is doomed to fall, maybe greatly. Ask your advisor to show you exactly how he calculates a “minimum estimate” of a company’s “net present value”. If he does not have a clear, reliable and conservative method of calculating a minimum estimate of the value of a company, how would he know how to estimate the risk of buying it, or estimate its potential loss?
  4. The 3 major determining factors in your long term financial security are:
    1. Your advisor’s competence,
    2. How you manage the irreconcilable conflicts-of-interest between your success and his income, and
    3. The degree to which your advisors fee structure penalizes him, if the assets he manages for you falls below the funds you gave him. I will be happy to provide any retiree with language that you can ask your attorney to review and add to the contract your advisor asks you to sign. The language we provide adds protection clauses for YOU, not the investment advisor.

Next month our column will focus on these three elements of selecting an investment advisor.

Unless you’ve lost a great deal in previous markets, you have no idea how much you can lose in the current market. The risks are very high right now. Anyone who says they are not is a salesperson, a promoter or simply lacks the ability to objectively and realistically measure investment risk.