Common Investment Mistakes: Using Cost Basis to Determine Asset Allocation
Throughout our ongoing discussion on common investment mistakes, you may have noticed how these errors often overlap and intertwine. Today, I want to delve into a particularly troublesome mistake—using cost basis to determine asset allocation—while also touching on under-diversification and emotional attachment.
A Tale from Early in My Career
Early in my career, I met a nice couple. The husband had worked for Inland Container in the '60s and '70s, a company that allowed employees to purchase stock through payroll deductions. He had wisely taken advantage of this incentive and, since retiring, had been living off the dividends. This stock wasn't just a part of their portfolio; it was the bulk of it.
A Brief History
In the late '70s, Inland Container was purchased by Time, which later merged with Warner. Then, in January 2000, America Online announced plans to acquire Time Warner, leading to one of the largest media mergers in history, forming AOL Time Warner.
A Crucial Meeting
I sat across from them in early 2000, at a time when they owned nearly 28,000 shares of Time Warner stock. Despite my persistent advice to diversify these holdings, the husband was reluctant. He was unsure of the cost basis of the stock but estimated it was around $40,000. His refusal to sell, even after learning that AOL did not pay dividends and amid a tech bust, was primarily because he couldn't bear the thought of writing a check for $300,000 in capital gains taxes to repatriate the $1,700,000 into a diversified portfolio.
The Aftermath
Tragically, the AOL stock plummeted not long after our meeting. Years later, the couple’s daughter told me her father had regretted not following my advice. He had become emotionally attached to the stock—a common theme I’ve seen repeated with investments in companies like Enron, Merck, KV Pharmaceutical, and Edison Brothers Shoes.
The Moral
The crucial takeaway from this story is that determining your investment allocation based on cost basis can lead to significant errors. While the husband might not have admitted it, emotional attachment likely played a key role in his decision-making process.
Key Takeawy: Don't Let Emotions Cloud Your Financial Judgment
As your advisor, my role is to help navigate these emotional waters to ensure your investment decisions are sound and beneficial in the long run. If you're holding on to investments for emotional reasons or because of their historical cost, it might be time for a review.
Are you ready to take a closer look at your portfolio? Let’s ensure your investments truly reflect your current financial goals and not just past decisions. Contact us today for a comprehensive review and start securing a prosperous financial future for you and your heirs.
You can also catch up on our previous blog posts on Other Common Investment Mistakes:
Common Investment Mistakes: Investing for Yield
Common Investment Mistakes: Panic
Common Investment Mistakes: Overconfidence and Speculation Trading
Common Investment Mistakes: Using Politics to Make Investment Decisions
Common Investment Mistakes: Under-Diversification
Common Investment Mistakes: Overdiversification
Disclaimer: Asset allocation is an investment strategy that will not guarantee a profit or protect you from loss.