We Only Get to Experience One Version of Reality

This morning, a story about General Electric retirees seeing destruction in their retirement portfolios in the Wall Street Journal:

The rapid unraveling of GE has wiped out roughly $140 billion in stock-market wealth in the past year, not just at big Wall Street firms but among small investors. The industrial giant is one of the most widely held U.S. stocks.

By comparison, the stock value lost by GE in the past 12 months is twice the amount that vanished when Enron Corp. collapsed in 2001—and more than the combined market capitalization erased by the bankruptcies of Lehman Brothers and General Motors during the financial crisis. Longer term, GE’s market capitalization has fallen more than $460 billion since its 2000 peak.

It’s obvious to point out that people working at GE, a company that did not undergo some sort of Lehman-esque catastrophic scandal, probably should have thought about this concentrated risk they had in advance. But just because a risk is obvious, that doesn’t mean the solution is.

When I first became interested in the stock market in the mid-1990’s, one of the most oft-repeated stories was the one about the secretary from Microsoft who had become a multi-millionaire because of her investment in the company’s ballooning stock price. Over the years, I’d also heard a different version, this time it was not the secretary but the janitor who swept up every night. But the message was consistent – being in the right place, at the right time, and then holding on.

Here’s Tim Egan, writing about the origin of the “Unlikely Millionaires” of Microsoft for the New York Times in 1992…(emphasis mine)

Well before the company went public, Microsoft’s chairman, William H. Gates 3d, allowed many employees to buy stock for $1 a share. When the company did go public in March 1986, it was at $25.75 a share. A year later, it hit $90, sending out the first wave of millionaires…

Microsoft turns cautionary at the dropping of figures, but a distinguished Wall Street research firm estimates that at least 2,200 employees at Microsoft’s Redmond headquarters east of here — nearly one in five — are millionaires. Not even the height of the Wall Street takeover frenzy of the mid-1980’s made as many instant millionaires as did simple employment at Microsoft for the last five years, analysts say.

At the time, most of the people the article talks about are still under 30 years old. It’s almost thirty years later, so they’ll be approaching their sixties now. It’s safe to say that most of them probably sold some shares in the ensuing years, but that the shares remaining still make up a disproportionate amount of each of their personal assets. How could it not? Over the last 30 years, Microsoft shares have returned an astounding 38,000%.

In a May 2005 piece, the New York Times checked in with the Microsoft Millionaires, many of whom were then in their forties.

From 1986 to 1996, Microsoft’s stock soared more than a hundredfold as the company’s Windows operating system and Office applications dominated the PC industry. That explosive climb made millionaires of employees who had accepted options as a substantial part of their compensation for 60-hour workweeks fueled by a diet of Twinkies, Coca-Cola and marshmallow Peeps. The sudden riches led many to refer to themselves as “lottery winners.”

Some had sold out and gone on to other ventures, like starting investment funds or buying bowling alleys. But the fact remains that:

“While the exact number is not known, it is reasonable to assume that there were approximately 10,000 Microsoft millionaires created by the year 2000,” said Richard S. Conway Jr., a Seattle economist whom Microsoft hired to study its impact on Washington State. “The wealth that has come to this area is staggering.”

In the version of reality we’ve experienced, things have turned out nicely for the employees of Microsoft. They changed the world and, in the process, earned shares in an investment that has outperformed virtually anything else they could have had their retirement assets in.

Sometimes things work out.

And sometimes they don’t.

When the conversation turns to concentration risk that retirees are taking by owning too much of their company’s own stock, the cautionary tale that is Enron will always be brought up within a minute or so.

Here’s Richard Oppel Jr. at the Wall Street Journal in November of 2001, after the fall.

The rapid decline of the Enron Corporation has devastated its employees’ retirement plan, which was heavy with company stock, and has infuriated workers, who were prohibited from changing their investments as the stock plunged.

Through the 401(k) retirement plan, employees chose to put much of their savings in Enron shares, and the company made contributions in company stock as well. But around the time Enron disclosed serious financial problems last month, the company froze the assets in the plan because of an administrative change. For several weeks, as the stock lost much of its value, workers stood by helplessly as their retirement savings evaporated. They were not allowed to switch investments at all — even though the plan had far less risky choices.

The unfortunate timing caps a year of pain for Enron’s workers. At the end of last year, the 401(k) plan had $2.1 billion in assets. More than half was invested in Enron, an energy conglomerate. Since then, the stock has lost 94 percent of its value.

The asset freeze just adds a poisonous twist to something that was already bad enough. It should be pointed out that many of Enron’s employees had not been hired there – they had worked at plain vanilla, boring old utility companies that Enron had used its mammoth market capitalization to acquire, like Portland General Electric.

While executives cashed out of fabulous amounts of stock, workers were receiving more and more shares as part of their 401(k) match, which was no problem so long as the stock kept rising. But then the accusations of fraud hit and the investigations began.

On October 17th, 2001, the assets of the company’s retirement plan were frozen, making rank and file employees (and their futures) essentially a hostage to the situation. The stock was trading at $32.20 at the time of the freeze. Within less than a month it was changing hands at $5.

This was a wound that ran deep and many of the former employees of the company still hadn’t been able to let it go years later, despite the fact that tens of millions of dollars had been confiscated from the executives and used to compensate them (and their lawyers) for the losses. When Jeff Skilling, Enron’s CEO at the time of the fraud, was up for early release from prison, the workers weren’t having it.

CNN Money in 2013:

News that former Enron Chief Executive Jeffrey Skilling may get out of prison early isn’t sitting well with some of the company’s former employees.

Skilling has cut a deal with the Justice Department that could see his 24-year sentence for his role in Enron’s collapse cut by almost 10 years.

For some employees — who collectively lost more than $2 billion in retirement funds — that just isn’t right.

“It’s been seven years for him, but there’s no way I or many of the other people that lost money will ever get that back,” said Diana Peters, a former technology specialist at the now-defunct energy company.

Stories of early employees of companies like Google, Apple and Microsoft, as just three examples, frequently laud them for their foresight in not selling, or in keeping enough of their shares to become incredibly wealthy as the companies came to dominate the landscape. In the version of reality we’ve experienced, they turned out to be the smart ones and Enron’s employees turned out to be the stupid ones.

Only it’s not true. Being smart or stupid didn’t necessarily determine the outcome. It’s just the way things worked out.

One of the core tenets of our money management philosophy is to talk about concentrated investments in terms of regret minimization. When we speak with the employees of companies like Amazon or Google who reach out to us, our job is to frame the issue in terms of what would hurt you more, both emotionally and financially – diversifying away from the company’s stock and watching it soar, or holding on through a company-specific catastrophe. Presenting the pros and cons this way allows for our client to think in terms of two different realities that may or may not occur. We often make a break-through with this technique, but not always.

There will always be people who simply cannot reconcile the idea that their company is kicking ass these days with the potential for things to be different in a few years from now.

Regret minimization discussions in the investing realm introduce the concept of What If? Michael wrote a great thing on all the What If’s in the markets and in life.

What if Yahoo had bought Google in 1998? What if the US government had killed Bin Laden when he first hit our radar screen as a major threat, before 9/11?

And then think about all of the What If’s in your own life – what if you hadn’t met that person who changed the course of your career, or became the most important client you’ve ever taken on, or who, gasp, became your husband or wife? You can drive yourself crazy all day by thinking about all of the fortuitous or ruinous things that may have happened to you as a matter of randomness. Could things have turned out radically different? Or were some of these things meant to happen, in defiance of the vicissitudes of chance?

The asset allocator cannot know whether or not their client is an employee of the next Microsoft or the next Enron. Nor can they conceivably know which outcome would produce the most regret in the person, without getting to know them and introducing the conversation. It’s hard to give people a black and white answer when future outcomes are so unknowable.

Back to GE:

Among those hard hit by GE stock losses have been company retirees, including former factory workers who took advantage of a stock-ownership plan to build their savings. For decades, the company has had a program that encourages employees to buy GE shares by offering to match 50% of worker contributions, which were taken directly from paychecks.

Okay, this is bad. But it’s the version of reality we ended up experiencing. The retirees, however, did have the ability to experience a different one. A reality in which they had sold down shares of GE as they were distributed and gradually allocated toward other assets – either within the retirement plan or once assets were rolled over.

We cannot predict what is going to happen, but we absolutely can gain a good sense of how we’d respond to different outcomes. And then we can make our own plans accordingly. In some versions, we will experience some regret and in others we won’t.