This is written on September 17, 2008 the day of a 500 point drop in the Dow Jones Industrial Average and a little more than a week after two of the largest financial institutions in America entered government receivership. Two of our best established investment banks have disappeared and a little more than twelve months after the 2007 mortgage crisis came into focus, it is still not clear whether we are headed into the storm or the worst is behind us.
As attorneys we have little to offer by way of predictions. But it seems fairly clear that market price volatility will continue for the near term. This requires that saner heads to prevail and precautions should be taken to preserve wealth. Clients may be in the middle of separation or divorce. But even in war, there are common interests that need to be attended. Failure to do so threatens the financial health of both spouses with rare exceptions.
It is not unusual for modern couples to know very little about the investments they have made. Sadly, we are taught very little about modern finance and the recent events in world financial markets make it clear that even the experts can fall prey to what Allen Greenspan coined as “irrational exuberance.”
Whether you are in the process of marital dissolution or not, Rule 1 is to review what you own and understand the product. If you don’t understand the product, reach out to find out about it. It may seem embarrassing but unless you are willing to join the ranks of the hundreds of thousands of Americans who will lose their homes to variable rate mortgages or hedge fund investments they did not understand.
Rule 2 is to understand the importance of diversification. Seven years have passed since the collapse of this nation’s largest energy company. With Enron’s demise tens of thousands of employees saw most if not all of their life savings disappear because their entire investment pool including their retirement was entirely invested in one security. We still see clients who come to us with investment portfolios where 50% or more of family wealth is concentrated in one or two stocks; usually those of their employers or assets passed from generation to generation as a legacy. As recently as two years ago a portfolio of blue chip bank and automotive stocks would be considered the solid foundation of any portfolio. Today that portfolio could be said to have lost half or more of its value. Even traditionally risk adverse havens such as precious metals are experiencing stunning levels of volatility. In May of this year we wrote about gold prices of $1000 an ounce. Since reaching that high, they have declined by 30% in just a few weeks. Today, gold shot up 10% on the basis that the stock market was so hard hit. There is no single safe investment with the possible exception of US Treasuries or insured bank accounts.
It does not make sense on a long term basis to invest entirely in savings institutions and treasury offerings. The rates of return are often at or below the rate of inflation. But there is a fair distance between risk free investment and concentrated investment. The point is to be judicious and balanced in your investment planning.
Rule 3 is to actually pay some attention to what is in your portfolio, especially if is not professionally managed by mutual fund managers. Certainly, funds are not immune from losses or excessive expenses but they at least offer the benefit that “someone is watching” your investment pool on an hourly basis. Most of us have neither the time nor the inclination to manage these assets as they should be managed. There may be a temptation to avoid selling because the market is down. But, as noted above, we don’t know whether the market has bottomed or not. Many Bear Stearns shareholders could not stomach a sale of stock at half what they paid for it. Many of those same shareholders saw that half reduced to -0- in the weeks following their decision to defer selling. This does not endorse panic sales. But if dollar cost averaging is a smart way to build a portfolio, a similar routine is probably a smart way to unwind an investment.
If you are in the process of dissolving your marriage there is a Rule 4. Make certain that any agreement you have to divide investments takes into consideration the investment experience of what you are dividing. Even if you had invested in a broad based index fund if your investment was $500,000 and you were equally dividing it by an agreement made in May, 2008, that division could be considerably less today. If I held the fund in May and promised to pay my spouse $250,000, the risk of the loss fell entirely to me. This can be especially important with ERISA based retirement assets for while most such plans move money relatively quickly retirement plans have a statutory right to take as long as eighteen months to approve the instruments which allow the asset to be transferred on a tax deferred basis.
If you are selling appreciated assets (where there have been gains) it may make sense to sell them jointly and share the tax consequence. If I sell an asset which has appreciated by $200,000 so that I can make a lump sum payment to my spouse of $200,000, I will be paying the tax on the gain. If I transfer the asset into joint title, we will each share half the tax burden upon sale.
Once again, attorneys should not be relied upon to choose investments. Our training has nothing to do with that field of endeavor. But while we lack the wisdom to decide what to buy experience has taught us that clients tend to not fully understand their holdings or to so concentrate them as to create rather than minimize risk. In markets as volatile as those we have experience in the past twelve months, prudence dictates that all of us need to better understand and evaluate those things we have assembled in our portfolio of investments.