My father was born in 1936 in Brooklyn. He attended Erasmus High School, earned a chemical engineering degree from Brooklyn Polytechnic High School, then studied dentistry at New York University. He was an excellent bridge player and enjoyed tennis, golf and, above all, downhill skiing. Pretty much everything my dad wanted to do, he did well. But he was not without flaws.
In the late 1960s and early 1970s, my father had a stockbroker friend through whom he bought stocks, mostly in blue chip pharmaceutical companies he admired. On several occasions he owned Bristol Myers BMY,
Glaxo, Pfizer PFE,
and Schering-Plough. But he still held an outsized position in his beloved stock, Merck MRK,
After 30 years of dentistry and before reaching the age of 60, he gave up full-time practice to move to Vermont, where he had a second home. Around this time, in the mid-1990s, my dad told me that to his surprise, his brokerage account had just reached the magic number of $1 million. He never imagined he would see this figure, which – to him – meant safety for the rest of his life.
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I don’t take pleasure in killing a party vibe. But the CPA in me had to ask him if he was being cautiously diversified. He said about 75% or more of his assets are in Merck stock. Even if he wanted to diversify, he says, he couldn’t sell because he didn’t know his cost base. Moreover, he had no interest in paying capital gains taxes.
My dad rode Merck’s meteoric ride to fame. He retired earlier than all his friends and enjoyed his newfound freedom in the hills of Vermont. He was not alone in his good fortune.
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One of my father’s best friends, Bob, was a successful lawyer. His portfolio was also heavily skewed towards blue-chip favorite General Electric GE,
I will never forget a hot summer day when the three of us were talking. The drinks were flowing, we were all beaming from a day of sailing and the stock market was booming.
Dad and Bob, aka Merck and GE, started talking about the stock market. I was a new CPA. I was married with two small children 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 love diversified index funds.
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I was a disciple of John Bogle and had read his book Common sense about mutual funds. I had also read William Bernstein The four pillars of investing, another book that waves the flag for index investing. I can only imagine what went through their minds when they heard me speak. I’m sure they attributed it to being young and ignorant. I vividly remember being told I was on the path to average, which they said was a life of mediocrity.
I had many conversations with my dad about his use of margin and his love of options trading. I would talk to him about diversification and warn him that a single stock is risky. I tried to explain that the risk he was running was greater than his potential reward.
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I explained that the cap-weighted index funds I favored were heavily invested in exceptional winners. Meanwhile, most publicly traded stocks don’t perform as well as Treasuries over the long term, and therefore get little or no weighting. I also noted that 1960s Nifty Fifty growth stocks, such as Eastman Kodak, Digital Equipment, J.C. Penney, Polaroid, and Sears, often went bankrupt, disappeared, or merged.
What happened to Merck and GE, and Dad and Bob? Between 1985 and 2000, Merck stock soared more than 3,500%. Over the next decade, however, as Dad retired, Merck’s price crashed. One of its best-selling drugs lost patent exclusivity in 2000 and 2001. Worse still, Merck had to pull its flagship arthritis drug, Vioxx, from the market in 2001 after studies revealed that the drug doubled the risk of long-term heart attacks and strokes. users.
Merck shares fell 27% the day Vioxx was announced. It finally bounced back after the Schering-Plough acquisition, but it took years. At that time, my father had been forced to sell stocks to keep food on the table. His wallet was crushed, and in many ways he was too.
This dark period for him was marked by increased alcohol consumption and suicidal thoughts. He eventually became financially dependent on me, his 70-year-old son. I would call it a parent’s worst nightmare.
What about Bob and GE? When Bob was all-in on GE, he was led by legendary CEO Jack Welch. Welch, a former chemical engineer, orchestrated the acquisition of RCA, NBC and expanded GE into financial services. The share price increased 40 times under his tenure. During the dot-com crash of 2000, however, GE shares plunged. Welch retired on September 7, 2001.
Under his successor, Jeff Immelt, GE’s share 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 overloaded. Warren Buffett stepped in with funds to stabilize GE’s operations, and the company also received $139 billion in government loan guarantees. But its problems did not end with the financial crisis.
After years of decline, GE was removed from the Dow Jones Industrial Average in June 2018. I heard tidbits about dad’s friend Bob. I know that his retirement did not go as planned and that he worked well until his 70s. He was forced to sell real estate he would otherwise have kept.
I do not write 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 those who look at finances and understand the details of complex drugs, complex systems, or complex companies. Human behaviors, such as overconfidence in your judgment or confusion between skill and luck, play an outsized role. This is why behavioral finance has become such a popular field of study.
Warren Buffett’s advantage 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 me, I have never deviated from my habits. My decades-long portfolio largely consists of broad-based equity index funds. Like my father, I don’t want to sell because my base costs are so low. But unlike my father, I don’t have to.
This column first appeared on Humble Dollar. It has been republished with permission.
Andrew Small was Chief Financial Officer of Archstone Partnerships from 1994 to 2019. Archstone returned his capital to his investors, leaving Andrew more time to spend road biking, 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.