A Question of Objectives and Asset Allocation

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I recently received a question accompanied by an interesting description of an asset allocation debate.  It gets to the nub of several investment principles underlying Bite-Sized Investing.  To put my response in perspective, I quote  from the communication.

“A few years ago, I bought stock for my retirement account in one of the great computer-related companies – let’s call it HAL – at somewhere around $55 [a share] and watched it grow to about $140.  I was pleased with myself.  But in my year-end meeting with my broker [. . .] we discussed my retirement accounts (an IRA and one other) [. . .]  The broker wanted me to buy some bonds, which I reluctantly acceded to, but they also pressed me to sell all of my HAL stock and take my profits.  I resisted: I didn’t need cash, and because I still work [. . .] I only withdraw the minimum from my retirement accounts as dictated by law.  But they pushed me to sell, and we finally compromised that I would sell half the stock.  I did, and the stock has now gone past $180 [a share]. (I realize that the stock – any stock – could have gone south.)  I feel that I let myself be talked into a decision that I now regret.  The broker I deem to be a good guy, though not perhaps a brilliant stock-picker.  I don’t think he acted for the purposes of churning my account, but . . . I also have a friend who says that when he buys a stock, he does so without any intention to sell, because the market, in the end, prevails.

“Thoughts?  Advice?”

 There is a lot going on here.  Before suggesting a course of action, here are four relevant points:

  1. I agree with you that your broker was not trying to churn your account. If he were doing so, he would have suggested many more trades, something like diversifying your HAL holdings into several other stocks or making many more changes than he did. On the contrary, as I will make clear in the following points, I believe he was acting from the best of motives, perhaps misplaced, but otherwise honest and in some ways quite reasonable.
  2. I have always stressed diversification, which makes me sympathetic to your broker’s suggestion to sell all or part of the “HAL” holding. Rather than an outright sale, I would have sought diversification by bringing down your “HAL” exposure to no more than 5 percent of your assets.  If you have an abundance of assets relative to your needs (and so could afford to risk a greater part of them) I would have upped that percentage to 10 percent, but not more.
  3. Your broker could have been reacting to the designation of your account as a retirement vehicle, especially because of the legal requirement that you must draw on your IRA after your 70th+ birthday (now 73). Typically, as a person nears retirement, investment advisors of all kinds will recommend selling stock, especially the more volatile ones, in favor of bonds and more stable, higher dividend-paying stocks.  This way, the portfolio will throw off the income a person presumably will need in retirement, and because it is more stable, the portfolio will also avoid the risk that the owner will have to sell when prices are deeply depressed. There can be little doubt that your broker had these needs in mind when he gave the advice to move from “HAL” into bonds, even though you are still working, have no need to draw on these assets for living expenses, and do not expect to have that need anytime soon.
  4. Your broker may have been under some pressure from his headquarters as well. Not too long ago, the Department of Labor threatened to designate brokers as fiduciaries, something that would have made them liable for legal action should their advice have resulted in a loss.  At the same time, the Labor Department offered guidance about what policies might be acceptable and so presumably might have protected the brokers from legal problems.  Those policies included the kind of retirement account strategy described in the point above. Though the Labor Department ultimately decided against this approach, brokers no doubt worry that the regulators will return to such thinking and so in the meantime strive to keep their advice in line with what the Department once considered acceptable.  And they might do so regardless of a client’s specific needs or desires.

I recommend two ways to cope with this situation:

  1. Make your particular circumstances clear to your broker. He should have no confusion that you have no intention of retiring anytime soon and that as a consequence he should, despite your age, treat your retirement account as he would that of a younger individual with plenty of time remaining before needing to draw income from the assets.  You might explain that you have no intention of ever retiring and that, whatever the label on the account, you mean it as a legacy for your children or other heirs.  It might help to clarify this arrangement in writing so that he can attach it to your account.  That way he can save himself from pressure from his firm, either on policy or legal grounds, and also bind his successors and assistants to your intention.
  2. You might also set up a separate account for the after-tax proceeds of what you are legally required to sell from these retirement accounts. Because such an account would not carry the retirement designation, it would avoid all the seeming requirements pressing on your broker with your other two accounts, thus relieving him of any need to follow company policy on retirement accounts or Department of Labor direction.  In this separate account you could:
    • Repurchase some or all of the “HAL” or Hal-like stocks sold from your retirement account.
    • Because the sale from your retirement account would be free of capital gains taxes, this transaction would not incur tax liability.And while you would benefit from taking all the earlier gains from your retirement account(s) tax free, the new, higher price in this new account would set a higher price base so that the taxable capital gain from any future sale would be lower than if you had to calculate it from the original price you paid when you bought it for your retirement account.
    • As a further safeguard, make this account strictly non-discretionary so that your broker can only act on your instructions.