Several years ago, I took on an estate-planning client, “Kevin,” who had worked at the Eastman Kodak Company for his entire adult life. He had earned stock bonuses in the company over the years, so that by his retirement a significant portion of his net worth consisted of Kodak stock. Kevin asked me to draft a revocable trust for him, and as part of the work, I interacted with his financial advisors to make sure that his portfolio would be transferred to his trust.
Because so much of Kevin’s net worth was tied up in one stock – Kodak – I remember the financial advisors continually urging Kevin to diversify. “You shouldn’t have all of your eggs in the Kodak basket,” they warned.
Kevin scoffed at the notion. In 1976 Kodak accounted for 90% of film and 95% of camera sales in America. Until the 1990s, it was regularly rated one of the world’s five most valuable brands. In 1988, Kodak employed over 145,000 workers worldwide, and in 1996 its sales peaked at $16 billion, with a market capitalization of $28 billion. They were an effective category monopoly.
“Why should I sell the stock of a company that has been so good to me over the years and continues to perform so well?” he said. “Besides, if I sell the shares I will end up paying the IRS substantial capital gains taxes, and lose any future dividends and chance at appreciation on those shares.”
So Kevin held firm.
He died in 1999. By then, a gadget called a “digital camera” appeared. Because digital cameras were clunky with limited clarity and storage capacity, Kodak didn’t see them as a major threat.
When Kevin died, the financial advisors again urged his son, “Ed”, who served as Kevin’s successor trustee to administer the estate, to sell the Kodak shares from the estate portfolio. “You are in a short term market now,” they said, “meaning that between the date of your father’s death and the date that his estate administration winds up and is distributed to the family, the stock could take a precipitous drop in value. Since the estate taxes are based on the date of death value, it doesn’t make any sense to have a portfolio so over-weighted in one company’s stock.”
The financial advisors pointed out that one of the reasons Kevin did not sell his Kodak shares – because he didn’t want to pay a capital gains tax – no longer existed. As of Kevin’s date of death, his portfolio received a “step-up” in its tax cost basis equal to the fair market value. Selling the Kodak shares would have resulted in minimal, if any, capital gains.
Ed didn’t budge. “Our family has an emotional attachment to Kodak,” he explained. “It’s where Dad worked. He loved that company. I just can’t sell it.”
By 2005, digital cameras became more ubiquitous and better equipped. People loved taking pictures that they could instantly see and only print those that came out well. They no longer had to develop rolls of film hoping that some of the shots would be worthwhile.
By 2007, Kodak was losing money, and in 2008 the iPhone included a built-in digital camera. Kodak’s sales plummeted.
In 2012, the company declared bankruptcy, with its workforce reduced to 14,800. In that same year, Instagram– a startup company that created digital picture applications used on iPhones and Androids – was bought byFacebook for $1 billion. Instagram had thirteen employees at the time.
Let this be a warning to all who believe that having a portfolio heavy in just one or a few securities is prudent. When someone passes away with such a portfolio, the step-up in tax cost basis usually eliminates or sharply reduces the impact of capital gains taxes. So the reason many families won’t sell is therefore largely due to emotional attachments, or the feeling that the company they invest in isn’t vulnerable like Kodak was.
If you feel this way, allow me to leave you with this thought. A generation ago, the average duration of a company that landed on the Fortune 500 list was 57 years. By 2005, that duration was reduced to 17 years, and by 2020, pundits believe that the average company will rotate off the Fortune 500 list in less than seven years.
We live in a world of rapidly changing technologies and business practices. Competition isn’t from around the block; rather, it’s from around the globe.
When a surviving spouse or other family member depends upon the viability and health of a financial portfolio, it only makes sense to take emotion out of the equation, and make decisions based on present facts and circumstances. The tax laws work in our favor to so accomplish. Don’t let emotion sway prudent investment decisions.
©2015 Craig R. Hersch