If you frequently read articles about personal finance, every columnist, pundit, and article writer will list as abstract advice that you must practice diversification. At some point, though, diversification became such a buzzword that it became devoid of meaning and no longer discussed diligently.
For instance, I view diversification as a sliding scale in which owning diversified cash-generating streams become more important as you age and take on permanent obligations that carry significant fixed costs (kids, mortgage, etc.). Furthermore, the consequences of failure need to be taken into account as well—an eighty year-old woman losing 40% of her net worth is going to have much more significant lifestyle ramifications than a twenty-five year old dealing with the same percentage loss. That’s why I’d react much more differently to a single thirty-something telling me that he has 35% of his wealth in Visa stock compared to a retiree telling me the same thing.
When you are trying to build wealth—that is, turn $200 dividend checks into $1,000 dividend checks, and then turn $1,000 dividend checks into $10,000 dividend checks—it is okay to be more aggressive and make big bets, provided you understand the probability of loss and can make peace with that. It’s intelligent risk-taking with a purpose: you have a clear idea of the substantial differences in lifestyle between generating $45,000 in dividend income compared to $4,000 in annual dividend income, and the probability of the failure that comes with focused investing is a necessary risk to accomplishing your goal.
However, once you’ve made it, which I loosely define as having a portfolio that generates $30,000-$45,000 (in which simply reinvesting the dividends adds $1,000+ to your annual income without even assuming any dividend growth, rental income growth, or something of that sort), your orientation towards investing should change. That’s the point when wealth preservation should start to be a primary consideration over wealth creation—your attitude towards beverages should be “give me Coca-Cola, PepsiCo, and Dr. Pepper,” your attitude towards healthcare should be, “Give me Johnson & Johnson, Merck, Bristol-Myers Squibb, GlaxoSmithKline, Abbvie, and Abbott Laboratories.” Your attitude towards energy should be, “Give me Exxon, Chevron, Conoco, Total SA, Royal Dutch, and BP.” Your attitude towards food should be, “Give me Nestle, Kraft, Mondelez, and General Mills.” Your attitude towards brewing should be, “Give me Anheuser-Busch, Brown Forman, Diageo, and Heineken.”
And across the sectors it goes. You should be entering fortress mode, in which case the focus should be on acquiring the forty or fifty highest quality names in business rather than worrying about the academic concern of trying to beat the S&P 500 by a point or two. NO, you’re in a position to have an awesome life as long as you don’t make a big bet and fail—the interest of not being stupid should replace the interest of trying to be particularly clever.
It’s probably easy to read something like this and agree in the abstract, “Of course, if you have $2,000,000, you shouldn’t put it all in stock X.” It’s harder if you’re in the moment. It’s harder if you’ve put all of your money into a business you started, and you successfully grew sales to $200,000 then $800,000 and then $1.6 million. You can always see that next avenue of growth ahead, and unless you’re the kind of person who takes long walks to come up with deliberate life strategies, it can be hard to know when to draw a line in the sand and say, “It’s time to diversify even if it means less future growth.”
You don’t want to be like the Stroh brewing family.
In 1980, Stroh’s became the third largest brewing business in the United States when Bernhard’s great great grandson Peter Stroh became CEO and purchased F&M Schaefer and Joseph Schlitz Brewing. The family’s new fortune saw them make the Forbes list of the richest families in the country, worth $700 million in 1988.
But then something went wrong.
Family members confessed to Forbes that acquiring Schlitz, a beer company with six plants to Stroh’s one, overwhelmed the business and they didn’t have the marketing prowess to keep so many different brands up with rivals Anheuser Busch and Miller.
According to Forbes, Peter Stroh continued his disastrous acquisition spree among other moves but still the company failed…
By 1999, the company was worried it wouldn’t even be able to make the interest payments on its debt, so it sold itself for scraps, brand by brand.
Miller Brewing bought some, while Pabst bought the rest at around $350 million. Some $250 million went into debt service and employee pension fund liabilities while the remaining $100 million went into a fund for the family, but ran out in 2008.
You had this terrible situation where all of these escalation tendencies started to reinforce each other—Peter Stroh was overwhelmed by the Schlitz purchase, so he sought to make it right by taking out lots of debt to make real estate and biotechnology investments. The problem is: these were desperate beer barrons calling the shots, and when the real estate and biotech investments didn’t produce cash flow, the debt proved ominous. It swallowed up a fortune that was approaching $1 billion.
If you are acquiring something you can’t handle, you: (1) look to outsource the merger to someone who can handle it, and accept the partial loss of power, (2) you spin-off the Schlitz brewing company you just acquired, and even though you’ll get made fun of a bit, shareholders ultimately love receiving another “free” company as a spinoff, so they’ll forgive you, (3) if the first two don’t work, you sell the brewer you had just bought. Yeah, it looks bad and raises questions about your competency, but I’d rather be mocked and have $700 million than be broke and open the local newspaper to see which Shakespeare character I’m being compared to today.
What you shouldn’t do is try to undo your mistake by acquiring businesses outside your core competency, and take on substantial debt to put your family’s wealth that had been built up over the centuries on the line.
This money didn’t have to be blown. There is a point at which you stop investing into the business—even if it’s the family business—and stop so that you can inventory your profits and build a portfolio of blue-chip stocks and government bonds (that offered much better rates than what you’d get today). There aren’t a whole lot of things you can buy with $100 million that you can’t get with $50 million, or that you can get with $500 million that you can’t get with $250 million. Diversification is the premise upon which wealth preservation is built, and generally, those with family businesses that have been historically successful are the least likely of the affluent to appreciate that lesson. Money is a tool to a better life, and once the good life is achieved, the shield rather than the sword should become your weapon of choice.
Originally posted 2014-10-10 08:00:01.