Are You Holding An Asset from Sentimentality

OLYMPUS DIGITAL CAMERASentimentality is a powerful emotion.  My family laughed when I insisted we pass by the home I grew up in not once, but twice the last time I went back to my home city.  I’ll also swing by old apartments, schools, campsites, and other places where I spent a significant amount of time or even a memorable evening.  When I proposed to my wife, I wanted to do it on Shelter Island in San Diego at a gazebo where we had danced to music from my boombox a couple of years before.  The gazebo apparently was in disrepair and had caution tape around it — it’s actually gone now — so I got down on one knee beside it.

One issue with sentimentality is that it often causes us to keep things long after we should have let them go.  This can clutter up our homes, cause us to have two of many things, and sometimes cause us to use items long after their lifetime has expired when we could have a new, shiny one for a few dollars.  With investing, holding on to an asset through sentimentality can be devastating.

My father once told me to never fall in love with a stock.  While long-term investing is good, sometimes when we’ve owned a stock for a long time we become sentimental about the stock (or other asset).  We then become blind to the fact that the company has changed and hold a large position in a company right from the peak down to the ashes.  We also might become  so convinced that the company is good and will turn around that we’ll continue to plow money into it even as it is going under.  Despite giving me this advice, even my father fell into this trap, holding onto a company that he had seen double for years and years after a new CEO was appointed that radically changed the company and drove it into the ground.

Probably the most dangerous time where many people fall into the sentimentality trap is when there is a death.  Watch an episode of Hoarders and you’ll see that many of the people who now have paths through their homes among piles of possessions started their hoarding after a death.  They ended up keeping everything the person had in an effort to hold onto their memory.

While many people keep clothes and personal items out of sentimentality, which results in clutter and full closets, keeping assets out of sentimentality can cause financial damage.  For example, we keep our parents home and rent it out, even though we live in another state, and end up paying all kinds of money to travel to the home and deal with the issues that require us to be at the home.  We would never buy a home in another state in order to rent it, but we hold onto our parent’s home because we’re sentimental, and in doing so make a bad financial decision to have a rental property that is hard to manage and possibly a bad rental property as well.

Another thing that might happen is that a relative has a lot of shares in a stock that we end up inheriting.  Because the stock reminds us of that relative, we hold onto the stock even though it is way too much money to have in one stock.  If something goes wrong at the company, we risk losing the full value of that stock.  If we had sold instead, we could have used the money for something useful, or even invested the money so wisely so that it would pay us income for the rest of our lives.  The issue is that by having the stock, we remember that relative and we want to hold onto the stock to hold onto a part of him or her.  If we sell it and spend it, or even sell it and just add the cash to our regular portfolio, we lose that connection.

Probably the best thing to do in this situation is to still keep the money together to keep the memory, but either spend it in such a way that you can preserve the memory or invest it together in a way where you still reduce the risk.  One way to spend the money but still hold the memory is to buy something permanent with the money such as pay  in off your home, make a home upgrade, or even buy a vacation home or other luxury.  That way each time you see the item, it will remind you of the person.  If you are going to invest, you could buy a less risky single asset, such as a local rental property, or a single asset that is diversified in itself such as shares of a mutual fund.

One of the best things you can do with an inheritance such as this is create a separate asset for which you use the income for a special purpose.  For example, you could buy shares of a mutual fund and then sell off 10% of the mutual fund each year for a home improvement.  Maybe replace a floor one year, then buy a new couch the next, and so in.  In this way it is like the relative is giving you a gift each year.  As long as the amount you take out each year is modest (maybe between 5-10% from a mutual fund), the relative will keep “giving you gifts” for many years.

In our case, I received money from my Uncle David from a life insurance policy.  Rather than putting the money into our portfolio where it might get lost, I put it into an index mutual fund.  Each year we withdraw 10% and take a special vacation we call the “Uncle David Trip.”  It is not a huge amount of money, but enough for maybe a weekend at a nice hotel or even a week on the road staying in low-cost motels.  By doing this, we can share time as a family and remember my uncle while doing so.  This is much better than an holding onto an old shirt.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on investment strategies, stock picking, and other matters relevant to the investor. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Should you Buy Single Stocks?

In some of the funniest radio I’ve heard in a long time, Dave Ramsey (of the Dave Ramsey Show) responded to an emailer’s question, in which the caller asked what she should do with her BP shares, now that they have declined. He screamed into the radio, to paraphrase, “I don’t buy single stocks, because you never know when the company you buy will dig a hole into the bottom of the ocean and kill everything in the vicinity!!!”

For those who don’t know, Dave Ramsey is the author of a series of books and the host of a popular radio show. The theme of the show and the books is getting out of debt and generally getting your financial house in order. Clips can be heard at their website, . He offers great advice on setting yourself up into a position where you can start investing and growing wealth (by getting rid of all of your debt and spending less than you make so you can invest).

Mr. Ramsey’s shuns individual stocks. His investing style is to buy mutual funds. Specifically, he spreads his investments over mutual funds in the categories of growth, growth and income, aggressive growth, and international. He does not buy individual stocks because he believes the risk to be too great. And as he said, you never know what will happen with any one stock you own. It may actually drill a hole in the bottom of the ocean. Or it may just really misread demographics and see earnings implode.

While I do not agree that mutual funds are the only way to go, ownership of only one stock is not advisable, and the number of stocks owned should grow as one’s tolerance for risk declines. To invest in individual stocks, one must understand their behavior and plan accordingly. The price of individual stocks changes rapidly, and sometimes for no good reason. The current price offered reflects people’s feelings about the near-term prospects for the future, what the market is doing, what people expect others to do, where other investments are priced, other events in people’s lives, and recent movements in price. One cannot buy a stock and expect 10% to be added to their bank account year after year just like a savings account. Some years it will double, other years it will fall by 50%. Some years it will move up or down by 2%. Bad things do happen to good companies as well, and sometimes individual stocks fall rapidly in price, sometimes never to recover.

Because of this, placing large amounts in only one stock or even just a few stocks is foolish. There were many retirees from GE who watched their life savings implode along with the price of GE stock during the last recession. If you have large sums of money, you should spread it out over a number of stocks, and even into different sectors and asset categories (stocks, bonds, treasuries, etc…).

For those who do not have a lot of money, however, concentration in a few stocks can be a good thing. If one is a fairly good stock picker, or even picks one huge winner out of five, one can do very well. The difference is that if one has a lot of money, the risk of losing a large sum outweighs the potential rewards that can be gained through concentration. If one only has a small sum to invest, however, it is worth the risk of suffering a loss. If one only has $1000 and it grows at 10% per year, one would only have $2000 after 7 years. It is worth the risk of losing the $1000 for the potential to have $10,000 after those same seven years.

That said, you should be contributing to retirement accounts like 401Ks (10-15% of your paycheck if you want to be assured of a comfortable retirement) and investing that money in mutual funds.  You don’t want to risk your retirement on your stock picking.  You also want to start diversifying into mutual funds as your portfolio value grows.  As some of your positions get large, sell a few shares and buy shares in a fund to start to protect your gains.  The greater the portion of your portfolio that you have in mutual funds, the less volatility (meaning how much your portfolio value moves up or down) you’ll see.  You’ll also be reducing your potential rate of return, however, so holding onto a few single stocks is often worth the risk.  Hopefully you’ll do so well that while the percentage of individual stocks you own declines as you get older, the absolute value will stay the same or even grow because your portfolio will just get that much larger than when you started.

Here are the rules I generally use in determining the maximum size of individual stock positions:

1. Never have more in one position then you are willing to lose. If you cannot afford a loss of $1000, you do not belong in individual stocks. Very few people (except multi-millionaires) could afford to lose $100,000, so positions that grow so large should be split up into smaller positions.

2. On the other hand, make sure positions are large enough that if one is right about a stock, one make’s a good profit. It does no good to be right about a stock that goes from $20 top $40 if one only has $500 invested, since only $500 will be made. Make sure to take large enough positions so that your winners will result in a large return.

3. The more money you have, and the shorter your time horizon, the more diversification you should have. If you have a significant amount of money, or if you do not have much time to recover from a setback, your level of risk should drop. A person who will retire in five years and plans to live off of his savings should not have his money invested such that a drop in a few stocks would affect his plans.

4. Have money that is really needed in the next five-ten years in cash. Again, if you will be retiring soon, there is nothing like having enough to live on for five years in cash. It was sad to hear of so many putting off retirement because of the recent recession. These individuals should have been sitting on a pile of cash such that they could care less about the stock market drop.

Like what you’re reading? Keep the blog going – Refer a friend –

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.