As the President of a financial advising firm in Champaign, Illinois, it is my job to look out for the best interest of my clients. My decades of building wealth have taught me valuable lessons of how to act in a mostly rational manner during times of massive uncertainty. Experience dictates how to build effective portfolios and financial plans that not only create wealth but preserve it for the future.
The Covid pandemic has shifted industry needs worldwide, causing some investment sectors to be hit quite hard while causing other sectors to boom. Many small and medium sized companies have failed or will fail. For investors, this unprecedented moment in time creates an opportunity to consider not only wealth creation but to think carefully about wealth preservation in the context of your financial plan.
Without proper financial knowledge, investing in this volatile market can appear to be a minefield. Bet too heavily on the wrong stock or sector, or fail to diversify your portfolio, and millions could be lost. Yet there are still opportunities for wealth creation and preservation. Wealth preservation may involve cash flow planning to avoid overspending, estate planning to lower taxes, or portfolio management to reduce concentrated stock risk.
Ride the wave of today’s growth while having enough wealth off the table to avoid a dramatic financial hit on your future’s lifestyle, comfort, and security needs.
Through the course of this article I will briefly look at today’s stock market sectors to provide some context on market risk. We will consider individual companies that have fared well and poorly during the pandemic. Most importantly, we will discuss when wealth created primarily from a single stock should be considered for diversification and how diversification is accomplished. The critical question is whether your level of wealth can support your lifestyle in perpetuity when invested in a diversified portfolio.
What sectors have done well and which have fared poorly in 2020?
Due to oil demand tanking from Covid, energy is down 48% this year while technology is up 29% due to demand for devices, video conferencing and high performance computing applications. It bears noting that many folks believe that the technology sector is overpriced today. Earnings may not grow enough to maintain today’s lofty stock valuations. I’m not suggesting investors should avoid technology exposure, but recognize that returns in the sector may be lower in the future as investors rotate to other sectors with more attractive valuations.
The broader US equity market measured by the S&P 500 has gained 6% during 2020. While lower than the lofty technology returns year to date, consider the ten year period returned almost 14% annually. If you had parked $10 million of family wealth in the S&P 500 index for the past ten years it would’ve turned into $36 million. Many would be thrilled with that level of growth in their wealth.
In terms of sector recommendations today, healthcare looks reasonably valued. Forward price to earnings valuations are in line with the 20 year average and analysts forecast just over a 10% earnings growth rate. Couple this with a population that is living longer with chronic conditions such as diabetes and high cholesterol and the sector should perform well in the coming decade.
What individual stocks have done well and which have fared poorly in 2020?
Let’s consider company level returns for a moment. The chart below looks at four companies that have performed very well during the past 10 years and four that have not performed as well as the broader S&P 500 US market index. It shows how much $1 million invested ten years ago would be worth at the end of September.
Drug delivery, medical devices, software engineering services, and chip makers have done very well during the past ten years and held up during the coronavirus pandemic. While airlines, shopping malls, cruise lines and copiers have done worse than the broader S&P 500 market index largely due to a big drop since Covid 19. While some public health experts warned of the pandemic, it would have been nearly impossible to accurately predict the timing. Investors with wealth concentrated in a single stock should be wary of unpredictable events.
Should you leave your wealth concentrated in the single stock that made you rich?
The general answer is No. Let me explain.
Let’s say you invested $1 million in West Pharmaceuticals and now have $17.6 million. $17 million invested in a diversified portfolio could generate $600k a year in income in perpetuity for your family today and for future generations.
The normal response to diversification is for investors to avoid selling highly appreciated stock due to a) the erroneous belief that their stock will go up forever, and b) paying taxes to diversify shares.
While taxes may be the cost of diversification, consider the alternative. Let’s say instead of West Pharmaceuticals, you had invested $1 million in Delta stock ten years ago. At the beginning of 2020 you had $6 million of Delta stock. $6 million could easily generate $200k a year in perpetuity when properly diversified. Instead of selling, you hang on because Delta management is doing a great job and the shares keep going higher. Then coronavirus hits and your wealth at the end of September is down to $3 million. How would you feel about losing $3 million in nine months? The airline industry may take a decade to recover from coronavirus. Do you have a decade to weather the recovery?
Once you are wealthy and can generate enough income in perpetuity to support your lifestyle, consider diversification of your wealth. Your financial advisor can model the tax implications and in the majority of cases, the tax paid is a lot lower than market fluctuation on a single concentrated stock position.
Diversification means you take all or a portion of highly appreciated stock and move it into less risky funds that have the ability to generate income while preserving and growing your wealth.
What is diversification?
If you have highly concentrated stock positions with enough for you to retire happily, then ask yourself whether diversification is the best option for keeping what you’ve gained. Diversification means you take all or a portion of highly appreciated stock and move it into less risky funds that have the ability to generate income while preserving and growing your wealth. Today that might be an investment in the S&P 500 Index with a tilt toward industries or sectors that could perform well in the next decade. Some investment grade bonds could be mixed in to temper the stock market fluctuations impacting your wealth.
Final thought.
I coach individuals who have built their wealth through concentrated stock ownership on managing wealth for retirement income and securing wealth for the next generation. If you are interested in learning more about wealth preservation and have more than $2 million saved, the Peak Wealth Planning team can assist.
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About the Author
Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.
Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning guidance. Peak Wealth Planning is a fee-based financial advisor based in Chicago, Illinois, and Colorado.
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