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A long time ago, an interesting email from someone who found themselves worrying over catastrophes impacting their portfolio hit my inbox. To him, the basic theme of my investing advice was always to invest gradually over the long term. But what worried him was that a global depression or a war could come and wipe out his wealth. He wanted to know how he could protect his wealth under such situations.
This worry is justified. There have been few parts of the world that have not gone through the twentieth century without a major economic, political, or social dislocation. We can't just assume that our lives will pass without anything like that happening. In fact, right now, the world seems like a breeding ground for a wide-ranging catastrophe. From modern-day imperialism to an oil crisis to disastrous climate change, you can pick a favourite one from a choice of catastrophes.
By the way, that phrase, 'A Choice of Catastrophes', is the title of an interesting book that Isaac Asimov wrote on a somewhat related topic.
Now, is there truly a way to guard one's financial well-being through such events? The classic way of guarding against adverse circumstances is something that any investor should be doing anyway, which is diversification coupled with a sensible asset allocation.
The basic idea of diversification is that every kind of investment doesn't do badly simultaneously. One should spread one's investment across different kinds of assets (stocks, fixed income, gold, real estate, bank deposits, etc.) as well as different industries and different parts of the world. Closely coupled with this are the ideas of booking profits and reallocating investments between different investments.
Asset reallocation means that as the riskier (and hopefully higher return) investments make money, one should keep booking profits in them and putting the money into safer investments so that one never gets over-exposed to excessive risk.
Asset reallocation is essentially about maintaining diversification. An example would be someone who keeps 70 per cent of his money in stocks and 30 per cent in bank FDs. Whenever stocks are earning more, and their 70 per cent share rises, the investor shifts some money into the FDs to restore the percentage.
Can such a simple method actually protect against catastrophes? I think it can protect against most catastrophes. Of course, the word 'protect' here is relative. If the world economy goes into a deep depression, then your investments are going to fall in value. With proper diversification, they'll fall less, hopefully a lot less than they would have otherwise. If you've invested gradually into well-chosen investments, then hopefully you would have gained enough already, and the fall would only reduce your returns rather than eat into your capital.
However, there are no guarantees. The only way to be perfectly insulated from an investment crash is to not invest. If you want to participate in the rewards of an investment, you must participate in its risks also. That is a given.
Also read: It's your life, and your investments.
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