Last Updated: June 8, 2009
On the surface, it may appear as if the Chapter 11 bankruptcy case of General Motors Corp. (GM) — a company founded by a high school dropout in 1908 and became one of the world's largest companies — might not affect you and your financial plan. However, financial planners say average Americans have plenty to consider as the bankruptcy of GM and other companies play out in these curious times.
Active vs. Passive Investing
The debate about active vs. passive investing has been going on for years, continues today, and will likely go on for many more years to come. "The investment management world of today can be divided into two broad categories, each reflecting a fundamentally different belief system regarding how modern capital markets behave," Weston J. Willington wrote in the February 1997 issue of the Journal of Financial Planning. "These two schools of thought are generally referred to as active and passive. Active management is the traditional way of building a stock portfolio, and includes a wide variety of strategies for identifying companies believed to offer above-average prospects. Regardless of their individual approach, all active managers share a common thread: they purchase securities selectively based on some forecast of future events. Passive managers, including index funds, make no forecasts of the stock market or the economy, and no effort to distinguish "attractive" from "unattractive" securities in a specific universe."
As the names imply, active is active and passive is passive. But what does the debate about active vs. passive investment management have to do with GM and Chrysler and your financial plan? Precisely this. GM was — up until recently — a component of the Dow Jones industrial average and Standard & Poor's 500 index. And it's likely if not certain that many passively managed mutual funds and ETFs owned shares of GM to the bitter end, until S&P removed GM as a component.
According to FPA member, Denise Wilcox, CFP®, of Financial Solutions Inc. the bankruptcy of GM illustrates the negative aspects of passive investing and why investors ought to consider active investing. "First, why did the index funds own (GM) all the way down?" she asked.
She suggested that passive investing is a way of owning "yesterday's heroes and not tomorrow's heroes." By contrast, she said, "an actively managed portfolio cannot own something that falls by 99 percent in a couple of years, as did GM. S&P may return GM to its index but only after it has rebounded fairly magnificently, if it rebounds at all."
Shares in GM no longer trade on the New York Stock Exchange and are essentially worthless. Shares are trading on the Pink Sheets, an electronic quotation system for companies that do not meet the listing standards for the stock exchanges. "Should GM emerge from bankruptcy, it's likely that a new share class will be issued and the shareholders of the old shares will be wiped out," FPA member, Warren F. McIntyre, CFP® said in published reports.
Company Life Cycles
The bankruptcies of GM, Chrysler and many other firms in recent months serve to remind us that all companies, just like products, go through life cycles. Companies are born, they grow, they mature, and — if they don't merge or get acquired — they decline and disappear. For all investors, the bankruptcy of GM "shows that even the biggest and strongest companies have a life cycle that will end in obsolescence and death," said Wilcox. "Only companies that adapt and change, that reinvent themselves periodically will survive."
Diversify
"The bankruptcy of GM is also a reminder to all employees, not just GM's 244,000 employees, that no matter how strong the company you work for seems to be, never put all your eggs in that basket. You already depend on this company for your livelihood, and if you have a defined benefit pension for your retirement, don't also risk all your other assets in that company," Wilcox suggested.
Indeed, many financial planners suggest that when you create an investment portfolio, be sure to consider your financial, human and social capital. This can be complicated and often requires talking to a qualified financial planner. For instance, it's quite possible that you participate in a 401(k) plan at work that matches your contribution with company stock. In some cases, financial planners may suggest that you sell those holdings when possible to reduce your allocation in your employer. In other cases, it might make sense to hold the company stock in your 401(k) to take advantage of net unrealized appreciation rules. A financial planner can help you weigh your options and suggest the most prudent approach. Find a financial planner.
Buying a Car
If you plan to purchase a car from GM or Chrysler take comfort in at least one fact. The Treasury Department said it will stand behind warranties for cars purchased during the restructuring period for both GM and Chrysler. It also said it would honor existing warranties. Learn more about GM and Chrysler warranties.
