By Adrian Colarusso, CFA, CFP®
May 28, 2023
Before diving in, I’d like to invite you to our event on Tax-Efficient Charitable Giving, to be held on Sunday, June 11 at 4pm at Springdale Golf Club here in Princeton. We’ll share how we help our clients maximize their support of their favorite non-profits by minimizing their taxes. (Disclosure: just like the newsletter below, it won’t be tax or investment advice, merely education!)
We’ll discuss Donor Advised Funds, appreciated stock, and more. You can RSVP here. Hope you can make it.
Let’s talk appreciated stock
If the following bristles against your sensibilities to hang onto a particular company’s stock… good.
You know the company. The one that dominates your investment portfolio and mind share. Maybe it’s an employer’s stock, former or current. Maybe it was given to you by your dear old granny. It might be encumbered by taxes, discouraging you from selling.
We believe in diversification as a bedrock principle of any sensible investment strategy. We want you to thoughtfully redeploy the wealth held in your single stock toward a higher purpose. We don’t necessarily have a view on your stock, but decades of academic research and our experience underscores the risk of concentrated exposure. And we have solutions to help manage the tax implications of making a change.
What’s the risk?
Most people think of “too many eggs in one basket” as risk of catastrophic failure. That is indeed a huge risk – a BlackRock study found that over the last 40 years, 39% of publicly traded companies suffered a catastrophic loss (defined as more than 50%) and never recovered to more than half its peak value. Wild.
However, today we want to discuss the risk of quiet but chronic underperformance. The same BlackRock paper found that extreme winners in one decade went on to achieve at best middling returns the next.
The road to hell is paved in good intentions; the road to tragic underachievement in your investment portfolio is paved with “good companies”.
Let’s look at a few. Here’s BlackRock, my old firm. Great company. Plenty of my former colleagues are on this list and own the stock. Have you noticed that it has underperformed the S&P 500 over the past five years?
Here’s Johnson and Johnson, a big Princeton-area employer that pays in stock. Over the last 10 years, it has trailed the S&P 500 returns by a cumulative 63%. Your $10,000 in JNJ stock from 10 years ago is now worth $23,670, but an investment in the S&P 500 would have delivered $30,200.
And I know plenty of you have bounced between JNJ and your healthcare industry neighbor Bristol Myers Squibb (BMY), where the picture is even worse over the last decade.
I can go on. Here’s GE, which, in the beginning of this chart was on its way to becoming the largest company in the world (a title currently held by Apple – read our thoughts). Ask Chat GPT to “summarize investor attitudes about GE Stock in the 1990s”. Spoiler alert – they loved it. Now look:
These are all “good companies”
Nothing is “wrong” with these companies or their stocks. In all these examples, there wasn’t one event we could point to that explains where it all went wrong.
Since there is so much noise in short-term market movements, there’s never any impetus to pick up your head and realize how much your concentrated stock position has cost you over a period of years or decades.
It reminds me of the collapse of the Roman Empire. Or putting my kids to bed. Underperformance is a process, not an event.
What should I do instead?
We want to be clear that the S&P 500 isn’t the magic investment solution that you should own instead of your company. The S&P 500 does not a complete portfolio make. But it’s a useful benchmark.
Second, if you are sitting on a major tax liability, it’s best to proceed with extreme caution before making any moves. After all, if you sell, the tax bill is a sure thing, while underperformance going forward is merely a (strong) possibility.
Third, we hope you’ll clear your head of the notion that you know something about the value of your stock that the market doesn’t.
Have you conducted deep fundamental due diligence on your stock, established an investment thesis, a price target, and a sell discipline, understood its valuation metrics and risk factor exposures, analyzed a broad universe of alternative uses of capital, and appropriately sized your bet in the context of your overall portfolio?
Lastly, we hope you’ll attend our upcoming event on Tax-Efficient Charitable Giving, where one possible outlet for that pesky tax encumbrance and concentrated risk might be your favorite non-profit. We’ll share detailed information about how to think about minimizing your “after-tax cost of generosity” depending on your situation.
While we can’t deliver investment advice in a newsletter, we hope we’ve caught your attention and you’ll book some time to talk about your unique “stock story”.