Rick and Phil had been friends for over 30 years. It was their tradition to have lunch together to celebrate the New Year, and they did so in early January of 2002. Inevitably, the conversation turned to investing. Now, Rick and Phil shared the same stockbroker, Stuart, who was also a mutual long-time friend. The following conversation took place.
Rick: How did you do last year?
Phil: I did okay, I guess.
Rick: No, specifically, I mean what rate of return did you earn?
Phil: You know, I have no idea.
Rick: And what’s been your rate of return over the last 10 years?
Phil: I have no idea.
Rick: I never knew either until I finally decided to calculate the return on my investments. And I can tell you I was very unhappy with what I found. I think the bull market of the late 90s made us complacent. We enjoyed returns that were exceptional from a historical perspective. I learned, however, that the stocks and mutual funds I owned provided well-below-market returns. While I did okay, I should have done much better. And that was just on a pretax basis. When I went back and looked at my 1099s and took into account the taxes I paid each year, I learned that while I was taking all the risks, our broker and good friend Stuart was getting wealthy. “Luckily,” the losses of the last few years caused me to take a serious look at the results. I’ve decided to find another adviser. I asked for recommendations from co-workers and friends who’d experienced better results and were happy with their financial adviser. I’ve already set up several interviews.
Phil: You mean you’re actually going to fire Stuart?
Rick: Yes.
Phil: Phil, how can you do that? You’ve been friends for a long time. That will be tough.
Rick: Yes, I know it’ll be tough. But the way I look at it is this: If Stuart is truly my friend, he should want what’s best for me. And if his friendship is based solely on the fact that he’s my stockbroker, then he really isn’t my friend anyway. If the price of friendship—all the commissions and fees I’ve paid to his firm—is putting at risk my ability to retire and live the lifestyle I want, then the price is simply too high.
Phil: I hear you, but I just don’t think I could do it.
The following year Rick and Phil got together again, and again the conversation turned to investing. Rick told Phil he’d hired a financial advisory firm he was very pleased with. And this was despite the fact that the equity portion of his portfolio had lost about 18 percent. He pointed out there were two reasons he was pleased with his decision to change advisers. The first was that for the first time in his life, he actually had a financial plan in place. It was tailored to his unique situation, and it was integrated into a well-thought-out estate and tax plan as well. Rick said the change in investment advisers also came with a change in strategy that had improved the quality of his life. The advisory firm used a strategy that Rick explained was based on the belief that while stock-picking and market-timing efforts provided the possibility of market-beating results, the odds of success were so low it just wasn’t prudent to try. Rick explained that the firm had shown him the historical evidence to support this claim, and his own experience with Stuart convinced him to believe it was true. The advisory firm thus adopted a strategy of investing in mutual funds that basically bought all the stocks in an asset class and held them. And they built a globally diversified portfolio so that not all of his eggs were in one basket, reducing the odds he would experience the kinds of swings in value he’d once experienced that had caused him to lose sleep. He added that in 2002 the global portion of the portfolio had reduced his losses: While the S&P 500 lost about 22 percent, the international portion lost only about 15 percent. Rick did add that he knew diversification had helped in 2002 and that would not always be the case. However, he believed it was prudent to diversify risk.
The second reason Rick was pleased with his decision was that now that he’d adopted this passive investment strategy, he was no longer paying attention to the stock market. That meant he was no longer worrying about the market. It allowed him to pay more attention to his golf game and his wife—and as a result he’d been doing much better with both of them!
Phil then asked Rick how it had gone when he told Stuart he was no longer going to be his investment adviser. The following conversation took place.
Rick: Stuart was very upset. In fact, we’re no longer friends and we no longer talk to each other. I learned that our supposed friendship was only a result of my business relationship with him — a relationship that helped pay for his lifestyle. Phil, how’d you do last year?
Phil: Talking about it is painful. Let’s just say that losing a quarter of my portfolio would have been a good year for me. I was still invested mostly in technology and other growth stocks and funds that were invested in those types of stocks.
Rick: So why don’t you do something about the situation?
Phil: I’d find it really hard to fire Stuart. He’s a long-time friend. And besides, he’s also the coach of my daughter’s soccer team.
Rick: Phil, I just told you that friendships can’t be based solely on a business relationship that benefits only one party, and there are plenty of other good soccer teams in the area. Just think how much your friendship cost you in returns last year alone.
Phil: But Stuart also takes me to some of the best sporting events. I’ve gone with him to the Super Bowl and the Final Four.
Rick: Do you think he took you out of friendship? Or was it because you’ve been providing him and his firm with a good income all these years? Just think how much those tickets are really costing you. I’ve learned that the only free lunch in investing is diversification because done properly, it is designed to lower risk without reducing long-term returns. There are no free tickets to sporting events.
By the way, I brought with me a book my adviser gave me, . It explains in very easy-to-understand terms why the strategy you’re following is called the loser’s game and shows why passive investing is the winner’s game. It also shows how to implement the passive strategy. Why don’t you take it home and read it? You can return it whenever you’re finished. My adviser’s name and contact information are in the book in case you’re interested.
Phil: Thanks for the book. I promise to read it.
Phil read the book, and while it made lots of sense to him, he still did nothing. It was just too hard to fire a friend, and he was worried about his daughter’s position on the soccer team. And 2003 was turning out to be a much better year. In addition, he did enjoy those tickets to the Super Bowl.
January 2004 rolled around, and it was time for their annual lunch. This time the wives joined them. When the conversation turned to investing, Rick asked Phil if he’d made any decision about his adviser. Phil said he hadn’t but that he’d had a much better year in 2003. His equity portfolio was up about 25 percent. Rick pointed out that while that was a great number, the S&P 500 had returned almost 29 percent and international stocks about 40 percent, so his globally diversified portfolio had done much better. Phil’s wife, Phyllis, then asked Rick to explain more about his approach, which he proceeded to do, emphasising the part about having a well-thought-out plan for the first time. Rick’s wife added that she was much happier too because Rick no longer spent time watching CNBC or reading financial publications.
When they got home, Phyllis asked Phil about their investments and the difference between the performance of Rick’s portfolio and their own. It was the first time she’d ever asked Phil to review their portfolio. Despite the important role investments played in her ability to retire comfortably, because the stock market did not interest her, Phyllis had never before paid attention to their investments. Phil went over the entire performance history. When he’d finished, she told Phil she was calling Rick’s adviser to set up a meeting and she was going to attend.
They met the next week, and Phil and Phyllis were both impressed with the logic of the investment strategy and the competence of the adviser. They shook hands with him and said they’d get back to him shortly. When they got home, Phyllis told Phil she was very impressed and thought they should change advisers immediately. Phil agreed that he was impressed, but he just couldn’t face Stuart to tell him he was no longer going to be his adviser. The conversation continued.
Phyllis: What are you afraid of? If he’s truly your friend, which I doubt based on Rick’s experience, then he’ll still be your friend. If he ceases to be your friend, then he never was in the first place.
Phil: But what about our daughter? Stuart is the coach of her team. He might take it out on her.
Phyllis: There are plenty of other good soccer teams. And given our investment expenses, it has cost us a small fortune to have her play on that team, if that was the price. And by the way, if you’re worried about losing access to free tickets to those sporting events, forget about it. You can either watch them on television or buy tickets to them for a hell of a lot less than what his advice has cost us in lost opportunity. If you can’t fire Stuart, I will.
Phil: Thanks, honey, for the offer. You can call him tomorrow.
All too often investors continue to work with advisers despite poor results, often caused by high expenses, because it is difficult to fire an adviser who is also a friend, and even more difficult to fire one who is a relative. While Rick’s international assets continued to outperform the S&P 500 for several more years, he knew it was likely that wouldn’t always be the case. He was also convinced that diversification was the prudent strategy, and he was prepared to stay the course when international stocks underperformed over the decade 2010-2019. Over this period the S&P 500 Index returned 12.6 percent per year versus just 4.5 percent per year for the MSCI EAFE Index.
The moral of this story is that you are best served by evaluating the real cost of relationships, keeping in mind that a true friend wants what is best for you and does not put their self-interest above your own. A secondary moral is that there are no free tickets.