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Simple steps can help survivors when estate planning

by Don Gould

A family friend (I’ll call him Sol) recently passed away in his late 90s. He outlived his wife and both his children, so it fell to me to act as the administrator of his estate. Sol got things right financially over his long life. He also neglected some easy steps that would have made life easier for his survivors. Both provide a learning opportunity.

Let’s start with the plus side of the ledger, which I should say substantially exceeds the minus side. Sol was a saver. Like so many of those raised during the Great Depression, Sol prized financial security, never taking good economic times for granted. Sol was a civil engineer who spent his entire career working for California state and county agencies, probably attracted by the job security and generous pensions.

As a civil servant, Sol’s salary was never extravagant. But he and his family lived well within their means and saved a steady amount each month. Through time and compounding, Sol’s portfolio had grown to more than $2 million by the time he died. Contributing greatly to this outcome was Sol’s heavy allocation to stocks (about 80 percent of his assets). Stocks, of course, are far more volatile than bonds, and bear markets can be downright terrifying; US stocks dropped more than 50 percent during the 2000-2002 “tech wreck” and the 2007-2009 great recession.

But over the long term, stock investors like Sol have been well compensated for the added risk they take on. According to Ibbotson/Morningstar, $1,000 invested in an index of US large cap stocks at the beginning of 1926 would have grown to $7,030,000 (yes, $7 million!) by the end of 2018. This assumes reinvestment of all dividends and cash distributions, and ignores the impact of taxes, but you get the idea. Over the same period, $1,000 invested in more stable US government bonds would have grown to $143,000. In other words, by the end of the period, stocks had accumulated nearly 50 times as much wealth as bonds.

Of course, past performance is no guarantee of the future. Very few people can or should tolerate the risk of a portfolio invested solely in stocks. In Sol’s case, however, he and his wife lived in retirement off his state pension and Social Security, enabling them to allocate more to stocks and ride out the market’s ups and downs without having to liquidate in a downturn.

Sadly, defined benefit pension plans such as Sol’s are increasingly rare, having been mostly replaced by defined contribution plans like 401(k)’s that put the burden of market risk on the employee.

Lessons Learned

Now for things Sol might have done differently that likely would have increased his wealth and certainly made things easier on his heirs.

Reviewing Sol’s holdings, I discovered he owned more than 200 individual stocks! Many were held in a brokerage account, but dozens more were held in the form of ornate stock certificates in his safe deposit box, and more still through the issuing companies’ in-house stock registries.

It was clear Sol liked to buy stocks but rarely sold any. In his safe deposit box, I found many worthless certificates; some famous, some obscure. Streaking comets like Enron and long-lived dowagers like Bethlehem Steel. In their heydays, no one could imagine the demise of these companies, just as we cannot today imagine the disappearance of Google or Apple. Yet the sobering truth is that all companies eventually pass from this earth. Some through acquisition, but a remarkable percentage simply go broke, like Eastman Kodak. which dominated for over a century, as well as misfires like pets.com, which went in just 24 months.

According to JP Morgan, 320 of the 500 companies in the S&P 500 in 1980 have been deleted from the index due to bankruptcy or substantial declines in market value. Harvard economist Joseph Schumpeter called the process “creative destruction.” The more contemporary term is “disruption”—in a prime example, Uber and Lyft have nearly obliterated the taxi business.

Updating the Plan

If Sol were starting out today, I’d advise the following:

Buy index funds rather than individual stocks. An index fund, in a single investment, represents ownership in an entire index of securities, such as the S&P 500. Three important benefits:

• Portfolio Dynamism—Sol’s habit of permanently holding stocks led to a stagnant portfolio that not only held many bankrupt issues, but more importantly, owned little of the top-performing stocks of our era, such as Amazon and Microsoft. As the composition of a stock index steadily adjusts over time to reflect the changing fortunes of public companies, index funds automatically rebalance one’s holdings (and subsequent additions) toward those companies that are creating wealth today.

• Diversification—Even with over 200 stocks, Sol’s portfolio was not nearly as well diversified as it could have been. He was heavily weighted towards energy stocks, which cost the portfolio in recent years. An S&P 500 index fund would have given Sol exposure to an evolving and more balanced mix of 500 stocks in a single investment.

• Simplicity—Holding 200 stocks meant Sol received 200 proxy statements per year. He received about 100 dividend checks to deposit annually and about 35 Form 1099s each tax season. An index fund could have reduced all this to almost zero.

Create a will and a living trust. Sol did not have either. As a result, his estate was subject to a lengthy and expensive legal process known as probate. But even more important, without a will or trust, Sol had no say in how his large estate was distributed after his death. Rather than going to relatives and charities, his estate was distributed according to formulas set forth in California’s laws of “intestate succession.”

Keep stocks, bonds and mutual funds in a brokerage account. Do your heirs a favor and consolidate your investments in accounts at one or two brokerage firms. Disposing of shares held in certificate form (or held directly with the issuing company) is a messy, time-consuming, and complex legal process. And it’s unnecessary.

Don Gould is president and chief investment officer of Gould Asset Management of Claremont.