Sunday, January 6, 2019

Live to fight another investor day

Yesterday, I wrote about the chance to ‘lose it all’. This is the fear of most investors, but if you diversify your investments the chance that will happen is very small.  The main risks of ‘losing it all’ lie in NOT-diversifying and in arrogance or stupidity (something we all are from time to time).

Yes, there are some investments where your loss can be 100%.  Example: when you buy options. Or… when you put all your eggs in one basket: One company that ‘cannot lose’ and that subsequently bites the dust. Or… lack of investment savvy. It happened to my, now deceased, father who was his entire life an entrepreneur. He took over my grandfather’s company when it was not much more than a tax-liability. My father transformed it in a source of retirement income for my grandmother and a way to pay for his own family – my mother; my sisters; my father; and myself – to lead a pleasant life style; pay for our education and finally to provide an impressive amount of money for him and my mom to retire on.

The problem: he was an excellent businessman but not a very good investor. I introduced him to the stock market and helped him to build a conservative portfolio with enough dividend income for a comfortable retirement. He lived in Europe and I lived here in Canada. The deal was, that he would talk with me before making moves in his portfolio. Then came the high-tech boom. His portfolio did well and he thought he was a smart investor who didn’t need to talk to me about his portfolio. He invested in high-tech investment funds and abandoned the dividend strategy. He did very well until… the end of the high-tech bubble.  That was the crash from 2000-2002. His portfolio was literally wiped out!  Thank God, the Dutch social network was very good in those days. He financially muddled on based on the Dutch State Pension and his pension as a Dutch army veteran until he passed at the ripe age of 93. Overall, my father had a good life, including his final years but he died as poor as a church mouse. His health and his money gone.

Yes, it is possible to lose all or nearly lose it all. My father still lucked out and had a pleasant retirement but not the golden years from the life insurance ads as were clearly within his grasp. The secret is to have enough funds to live another investor day. To do that you first and most need to have a diversified portfolio where when one thing fails something else makes up for it. For everything you invest in, try to have an exit strategy so you don’t lose it all and have funds to live another investor day. For some investments such as real estate that is not always easy. You can bet that when you need to sell the market is down.  That is where cash comes in – most downturns last a couple of years – the current downturn in Calgary’s oil and gas industry being one of the exceptions. For me that downturn has now been going on for close to 4 years.  But that doesn’t mean that I go or will go broke. But I do need more than one income stream: a job or business; rent; dividend; capital gains and; for what it is currently worth, interest income.   If you do not have a predictable and reliable income stream then you must have a cash reserve that can finance your life style for at least during the down turn, i.e. around two years.

If you don’t, you may face a forced sale of your assets to have enough cash to live off. The problem is that when you need cash or cashflow the most. That is probably during down markets; that is a bit like dying from the flue. Here in Canada, most people live relatively healthy lives. But when you are weak after a significant illness or injury or you are old and you didn’t take a flue-shot, an unexpected bout of flue can kill you in a matter of days!  Having cash is like a bit of physical reserves augmented with a flue shot to get through those few critical days of weakness. If you survive those few days of severe flue you likely will live many years thereafter. 

As an investor, you always need to know how to get through the nasty days of financial life. It is like an emergency evacuation plan for you and your family when escaping a potentially burning house. How do you get out to live another day if you never cared about an evacuation plan for your house?  At the start of a new investment year sit down and worry how to get through in case hardly none of your investments seem to work out. Create a get away from the ‘black-swan’ plan. Then put it in a box within your brain and hope you will never need to use it. Update the plan every six to 12 months.

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