We field a fair number of conversations from clients who ask about owning a particular stock. They may have heard about an opportunity from a friend, a YouTube video, Squawkbox, or a radio show (the last one is still oddly popular). For many of them, taking a chance with 1-2% of their portfolio isn't going to materially affect their plans. The conversation tends to go two ways.
Some clients resist the urge. One memorably likened it to using a sledgehammer for hammering a nail into your wall to hang a photo. It could work great--it could also smash a hole in your wall. Sure, your house still works great, he said, “But you walk past that hole in the wall when you look at your account and just kick yourself”.
Other clients are excited. Their motivations range across curiosity, a sense of adventure, fear of missing out, bragging rights if things go well, and even the basic expression of being different. Some are unusually confident from their personal experience or because they deeply trust the source of the idea. Still others personally align with the values of the company.
What do I tell them? Of course, it depends. Some advisors say "go play in a sandbox somewhere else". They think the accounts they manage have no place for the thing–they don’t want their performance besmirched by a client’s random idea. To be fair, this doesn’t have to be a snobby response: some clients really enjoy having a small account of their own that scratches their itch. Especially if they keep the amount small and embrace it as fun, it can be a perfectly fine solution.
Other advisors admit that they immediately cave because they want to appease the client–even if they think it’s a bad idea. “It’s their money,” I’ve heard. I’ve even heard some advisors liken it to underage drinking or smoking: “I would rather they do it where I can see it.”
No. Our clients are not immature teens with partially formed prefrontal cortexes. They are successful families, accomplished business owners, and retirees with tremendous life experience. They deserve respect, great advice, and the best outcome we can possibly give them.
The devil is in the details. Sometimes clients may not realize they already own something in their account because it is in a fund. I have had clients ask to own Nvidia not realizing it was already 4% of their portfolio and one of their largest holdings. Sometimes they change their mind when they realize their diversified portfolio contains wonderful companies with tremendous growth prospects.
I do draw a hard line in some circumstances. Penny stocks with no fundamental basis beyond speculation shouldn’t be in a portfolio here. We invest for financial success and repeatable, long term outcomes–we are not in the business of gambling. And if a client is approaching from the position of speculating or short term timing, that doesn’t align with our values as a company. We are investing to help clients reach their goals for a wonderful life–we are not a casino.
That said, there are times when a client wants to own something and we are happy to accommodate the position within the portfolio. If the position is a great company with excellent potential, a demonstrated product set with real revenue, a reasonable
valuation relative to its growth trajectory, and supported by the client approaching the holding as a long term business owner, now we are talking.
Clients don’t pay us to always say yes. They depend on us to care enough, be brave enough, and be steady (stubborn?) enough to say no too. We are fiduciaries: we have to act in clients’ best interest, even when it means having an uncomfortable conversation.
This plays out across all kinds of different scenarios beyond wanting to own a certain company. Clients count on us to call them out on bad ideas. Buying a house that is too expensive, taking too much money out per month, claiming Social Security at the wrong time, getting too aggressive with Roth conversions, renting a house that doesn’t cash flow properly, retiring too soon, or selling stock while things are down…there are many examples where clients have depended on us to politely but steadfastly say no.
And just by the nature of markets, clients often ask about companies when they are at all-time highs and attracting attention. That can also be the worst time to hop on the bandwagon and own a company. Assuming the position is a quality company and appropriate for a client’s circumstance, we also need to measure the valuation. Great companies can be poor investments if their valuation is too far ahead of itself.
I find most clients are less attuned to valuation–they are more attuned to the idea of the company and the addressable market for its product. Competition is something many clients tend to overlook as well; you can love the idea of a company that is building drones, but investing in that company means you believe it is the best choice out of all the companies flying to the space. Yes, pun intended. Even if you are right about a blossoming industry, you also have to be right about who emerges as a leader in that industry–and that is exceedingly difficult to predict with any repeatable success.
And if we are going to evaluate a company’s valuation, we cannot simply look at the current price of the company, look at its all-time high, and conclude it is expensive or cheap to own. A classic example: General Electric’s share price in September of 2000 reached $299. Two years later, its price had fallen to $122. It was the classic example of a value trap: the shares had fallen in value because of fundamental problems, and so the price change was warranted. Investors who tried to speculate on price alone and buy a “great deal” would have watched the company stutter, struggle, and eventually fall all the way to $35 per share by 2009. Even by 2020, the share price was still down at $30 per share. Meanwhile, the broader market roared merrily on by comparison.
We are incredibly fortunate to have wonderful clients--by and large, they are financially and personally successful, intelligent, and grounded in great habits. As a result, we get to say yes most of the time. The times I have said no stand out in my mind because they are rare. Important, but rare.
But the even more fortunate reality: clients value our advice. They trust our judgement enough to almost always listen when we advise not to do something.
And to clients’ credit: even if the choice is hard and instinctively they want to do something anyway, their trust coupled with their willpower to set aside tempting choices is typically enough to keep them on the path to success.
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