Can I Sue My Parent's Broker? A Question from a Reader

Response to Reader Regarding 35% Drop in Portfolio Value

Can I Sue My Stock Broker?
What happens if an account you have managed by a stock broker generates significant, permanent losses? Can you sue them? Probably not absent some fairly high hurdles that demonstrate fraud or misconduct. John Labbe / The Image Bank / Getty Images

Although it is generally a rule of thumb that a good asset allocation calls for the percentage of a portfolio invested in bonds being equivalent to the age of the investor (i.e., a 70-year-old would have 30% other assets such as stocks and 70% bonds), that is just a broad outline and doesn't take into consideration the individual finances of people. Many seniors continue to have significant equity exposure if they have substantial assets, no need to live on them other than the dividends and maintain a comfortable lifestyle.

There are members of my own family that are around the same age that have near total equity exposure because they don't need the funds for day-to-day expenses as a result of their pension income and social security checks so they focus on the long-term to maximize the value of the estate for those who will inherit after they've passed away.  This is especially true if the elderly investor wants to take advantage of the stepped-up basis loophole for heirs.

The bigger concern is your focus on short-term market fluctuations. You are confusing volatility with value. Historically, stocks lose 1/3rd of their value from peak at least once every 36 months.  It's the nature of the asset class.

Yes, the Dow Jones Industrial Average has been hit hard this year. But time and time again, for more than one hundred and fifty years, blue chip equities, when bought on a diversified basis with dividends reinvested, have crushed every other asset class.

In fact, at these lower prices, a very strong argument can be made for those who hold their stocks because the dividends that are being reinvested are purchasing far more shares due to depressed stock prices. You need to get a copy of Ivy League Wharton Professor Jeremy Siegel's book, The Future for Investors: Why the Tried and True Beat the Bold and New.

It will open your eyes. His research is magnificent. Stock prices are the greatest asset class for building wealth for the average man or woman but the gains don't come in gradually upward sloping markets. They are jagged ups, downs, sideways, drops, skyrockets, and more. Find a chart of the Dow over the past 100 years (recognizing that stock market charts are inherently useless under most conditions) and you'll see even the Great Depression was a blip on the chart (when you factor in reinvested dividends, it was even smaller). Despite war, famine, the threat of nuclear annihilation, a Presidential assassination and resignation, the advent of the Internet, space travel, planes, trains, and automobiles, biomedicine, civil rights movements, and more, ownership of businesses has proven to be the most lucrative long-term proposition from someone looking to grow their capital. The ride is bumpy so it requires you to stick to your guns, buy quality, and ignore fluctuations! Otherwise, you'll just be handing your hard earned money to professional traders and businessmen/women who buy for their own brokerage accounts.

Please understand that in most cases, when I get these types of letters, they seem to come from adult children with parents who have built up substantially more assets than they currently have.

Many times, the sons and daughters are legitimately concerned about their parents, but equally as concerned about the value of any potential assets they will inherit. They fail to realize that the very reason their parents often have money and they don't is because mom and dad have diligently invested in high-quality stocks for decades, ignoring market fluctuations and profiting from the well-documented real growth in equity valuations on an after-inflation basis. What is especially frustrating is that people often look at the high water mark of their portfolio and say they need to "get back to there." Instead, they fail to realize that if they've been investing for long enough (say, 20 years), they already have many, many times (literally multiples) the money they would have had by parking it in bonds or the bank.

Yet, even though they are richer on a net basis, they feel the psychological sting of a perceived paper loss. For professionals, it's baffling because you're still better off than you would have been. It's like the people that sue a doctor who broke one of their ribs despite saving their life in a restaurant by performing the Heimlich maneuver.

What do you propose now? You seem to be suggesting that they sell out of their stocks and switch into more conservative investments at the very time when stocks appear to be the most attractively priced in many, many decades. I can't offer you financial advice or give you any recommendations. All I can tell you is that the "super investors" such as Warren Buffett are pouring their personal resources into American stocks at this time, even going so far as to publicly declare it. Much of my personal capital came in the aftermath of the September 11th stock market crash when people panicked after massive drops, allowing me to buy up shares that I had been watching for years. I've invested more money in the past six months than I have in my entire life.

My opinion is that you have only a handful of options. 

1. Continue to hold the blue chip stocks, reinvest the dividends, and let America, Inc. get stronger and more profitable just like it has for the past two hundred plus years. The stock market will eventually follow but when we get back to break even DJIA 14,000+/-, the portfolio value could be higher due to reinvested dividends. In fact, the longer the market stays at these levels, the better for both them and whoever will inherit their money.

Dividend reinvestment is currently adding 7% to many top-name firms! That's just unbelievable. Even if the stocks go nowhere for three years, you could have a compounded annual rate of return of roughly 22.5% over that time!

2. Suck up the loss, sell the portfolio holdings, and move to more conservative assets. When things calm down, you have no chance of recovering that money, however, because certificates of deposits and Treasury bills cannot keep pace with equity ownership over the long-run. It may be three months, it may be five years, but you will have to watch the value of stocks skyrocket as your account stays at the lower, permanent level you forced it into as a result of your asset sales. For some people, this is still the right call due to their emotional disposition and financial position. (If this were my aunt or grandmother asking, to sell out now - and park the money in accounts paying only 0.01% interest - especially when the United States is printing dollars to try to stave off the credit crisis (which will eventually lead to inflation) seems idiotic to me, but honestly if they need the money to live on, you don't have a choice.)

I'm not a lawyer. What I can say is that based on my own opinion and the information you gave me, your parents would be wrong for claiming that the broker was at fault on a layman's common-sense test. Could you get a settlement? I don't know - maybe? But it seems like a fairly immoral thing to do given that you were willing to take all of the upside of the market yet when the inevitable volatility happens, want to lay blame off on a third party.

It's not like the broker was having them write naked puts or something (which would almost certainly be irresponsible for the situation you described).

My response, however, is predicated on your statement that they own high quality Dow Jones type stocks. If they are well-off, can live comfortably on their social security checks, and have a long history of investing in the stock market, all equity exposure could have been a perfectly reasonable and rational portfolio allocation. Stocks are not like a savings account. You can't tell "how you're doing" by looking at the statement each month. Instead, you take a 3-5 year rolling basis and, frankly, we are just now at the 2004 stock levels meaning that your family is just as well off now as they were a few years ago, plus they have the benefits of reinvested dividends so it's highly likely that they are better off than if the money had been parked in a savings account. After all - what would have happened if your parents had sold out during the crash just before the original Gulf War in the 1990's? Or the 1987 stock market crash? They'd be much, much poorer than they are today. You're effectively suggesting they do the same thing now.

Take it for what it's worth.