What’s the worst that can happen?Posted: 2015-05-27
We investors take risks, right? But our human aversion to losses is well documented. In my case, one way it manifests itself is as a paranoia about various ‘disasters’ that could befall my investment portfolio. As somebody with a sizeable portfolio, one which I am totally dependent on to maintain my standard of living, I want to make sure I consider what can go wrong with it and take any practical steps to reduce the chance of disappointment.
The obvious things to worry about are falls in share prices. But that is not what this post is about. Stocks are volatile, and I am buying much more than I am selling, so at some level or other price drops are just good news for me for quite a while yet.
I have been investing for over 20 years and in that time have seen some truly horrifying examples of things going wrong.
- I remember when interest rates were put up to 15%. I’m not that old; Black Wednesday wasn’t that long ago.
I am truly thankful that I don’t need a mortgage, but I do actually have two mortgages, and interest rises would turn these from cheap money into a hole in the head quite quickly.
- I have seen three stock market falls of 30% or more. I was too young to understand the 1987 crash, but I was firmly in the middle of the tech boom/bust of 2000, and didn’t see the crash coming at all – no matter how obvious it seemed afterwards. In 2008 I had plenty of tipoffs from friends in the leveraged buyout industry about the credit crisis, but flat out disagreed with them about the impact on the wider economy – more fool me. At least I held on to my nerve in the stock market crash that ensued, and in fact I started trying to buy stocks as much as I could in early 2009, which proved to be the right call.
- I’ve seen a major pension provider, Equitable Life, collapse. This pension provider was founded in 1762. But it collapsed in 2000, causing an awful lot of bother and plenty of media headlines for years. I haven’t followed it in any detail, but it took ten years to resolve and 1m policyholders were out of pocket – some severely. A friend’s father was nearing retirement when this happened and I remember hearing of many sleepless nights, and how in fact his (only) pension dropped by something like 25% from what he expected. I think he was relatively lucky in the scheme of things. It made me resolve never to treat any financial institution as invincible.
- I’ve had a six figure investment wiped out within months. Soon after my first big financial windfall, I stupidly got talked into investing a decent chunk of it into a private banker’s latest wheeze. That wheeze was a tech fund, just before the tech bust in 2000. This investment got pretty much completely wiped out, and I took a mortgage-sized hit. It was a useful lesson for me in stock market volatility and private banks.
- I’ve seen major banks fail. For me the most frightening moment in 2008 was not Lehmans failing, nor the bank run at Northern Rock, but it was a phone call in October 2008 with an entrepreneurial friend of mine.
My friend had his own business’ £5m+ cash funds in Lloyds Bank. I had over a million pounds worth of assets with another major UK bank. He rang me to ask which bank I considered was safe for this sort of amount of money. Horrible (and true) stories were circulating about even such bluechip names as Goldman Sachs, Fidelity Investments, AIG, Halifax Bank of Scotland and Abbey National. I found myself realising that basically *none* of the major UK clearing banks could be considered safe, and that the financial compensation amounts of less than £100k were almost useless. Fortunately for us when the dust settled some months later all our funds were safe, but it was a terrifying time.
- I’ve seen fraud hit a brokerage firm I was using. I had a small amount of money invested with MF Global in 2011.
MF Global went bust. No problem, I thought, as it had its clients’ money separated from its own. Alas there was a tiny amount of ‘co-mingling’ (i.e. mixing up MF’s money with clients’ money), and as a result *all* client funds were suspended for years. Literally years – I eventually got my money (a small amount much less than the regulatory compensation limit) back a few months ago. This taught me to treat client money separation as a notional concept only.
- Selftrade landed itself in a right mess with the FSA. Selftrade is one of my major brokers. And Selftrade got itself into such a mess that it wasn’t accepting new customers for over a year, and had a load of existing customers complaining at not being able to withdraw funds – despite having done nothing wrong. I was fortunate that this didn’t affect me, but if I had needed that money during that period I could have had a major problem.
- Sony has been the victim of an appalling systems breach. This hasn’t affected me at all. But what if the victim had been my online stockbroker? Or my clearing bank? Or Vanguard? This could have been a disaster.
- I’ve seen several properties burn down. Three close friends of mine have had buildings ruined by fire.
Another had its basement flooded. Another was banned from his office for weeks after the Buncefield oil refinery accident. I never heard about this sort of stuff happening as a kid, but I now know that those fire engines we see rushing around every so often are not just for rescuing cats from trees. The disruption caused by these events is hard to imagine.
- I couldn’t sell my biggest asset. I was fortunate a few years ago to hold a shareholding in a private company which became worth a lot of money – enough that this holding was my biggest asset. However, I had no way of selling any of it to create liquidity. Eventually the company was sold and I got my money, but in the meantime I learnt how highly to prize liquidity.
The list above is not some hypothetical list of risk factors. This stuff has happened, during my investing lifetime. Sh*t really does happen. More sh*t will definitely happen on my watch. And with a net worth that is a multiple of the Financial Services Compensation Scheme limit, nobody is going to bail me out. How best to protect myself from the worst happening? Things I do include:
- Diversify across multiple accounts. This is a pain, but this makes me feel safe. No one provider has more than 25% of my net worth invested.
- Diversify across providers. For example, I use Vanguard’s VUKE, iShares’ ISF, and L&G’s Unit Trust to invest in the FTSE-100. I have not consolidated my (tiny) company pensions, nor my ISAs. Vanguard worries me because their offering is so good that I can foresee wanting to have half my assets with them in the long term, yet they are as vulnerable as the Lloyds / Goldman Sachs / etc of the world to several of the risks discussed above.
- Diversify my holdings. My two biggest directly held holdings are about 10% of my investment portfolio each. I have over 200 underlying holdings.
- Stay liquid. By liquid I mean that a holding can be sold very quickly – within a week – with minimal penalties / price movement. While I do have some private company investments, they constitute a small portion of my portfolio, because I am well aware that they can’t be used to buy beers. The vast majority of my investments are those that have buy/sell prices quoted daily.
- Own bricks and mortar. As well as my investment portfolio, I own some commercial and residential property. These are last resort holdings for me; I think even if there is complete financial meltdown or hyperinflation or fraud (devastation, as CanIRetireYet would put it) then I should be able to rely on the bricks and mortar that I own directly.
- Maintain strong online security. I love two factor authentication. I don’t use the same passwords. And I keep my PCs up to date and clean from viruses or other spyware as best as I can.
- Archive everything into the cloud. I scan all my financial post, and back up all my financial records online into the cloud. This allows me to pull out records quickly; if God forbid my house ever went up in smoke, I would hope to have almost all my records intact.
What have I forgotten? Is there anything else I could do reduce the risks we all face?