Save your friends from financial ruin

On a recent trip through South Africa, I met an Australian expat whose entire family nest egg, absent their home, is threatened by the collapse of Gold Coast-based LM First Mortgage Income Fund.

She'd been put into the fund by a (non-Australian, offshore-based) financial planner, who encouraged them to move their money (all of it) from several balanced funds into this mortgage fund because of 'higher, safe returns'. It worked well for a while, until the unexpected happened. The financial planner collected significant fees from LM.

Admirably stoic about the whole experience, this poor lady nonetheless had quite a few questions for me: How can something that is safe collapse? (It was never safe, it was just made to look so). How can the government let 20,000 retirees or near retirees lose their money? (How can they bail out every reach-for-yield scheme that goes bad without encouraging their proliferation?) How could my financial planner have done this? (They were paid handsomely to do so). She'd so far been unable to get any answers to her family's predicament, and thought I might be able to help because I worked 'in finance'.

Unfortunately, other than to point out it might be time to seek legal advice, I couldn't help her. I don't know much about the fund and it's not my area of expertise. Nor could I help any of the other characters in half a dozen similar heart-breaking stories I've been told face to face over the past decade working at Intelligent Investor, caused by collapses like LM and Storm Financial. When the liquidators are in, it's too late.

But what I—what we—might be able to do is save someone else from making the same mistake. Perhaps we could save a whole bunch of people. Let's start with your family and friends.

Being an investor to the core, my first instinct was to list the dozen or more preconditions necessary to losing most of one's wealth in such a collapse. This family made many mistakes on the way to this loss, and we could dissect those matters.

The problem is that only financially-interested folk (you lot, for example) would lap that up, and they're not the people at risk. The people that most need our help are those who don't know much about the investment world, would rather not have to invest the time and effort to learn about it and just want someone else to make sound decisions on their behalf. This is a completely understandable wish, and no different from when I seek the services of a plumber.

But there's a massive difference between a wet kitchen floor and personal financial ruin. So here are two simple rules of thumb everyone should use to avoid financial ruin from a single corporate collapse:

1.       Diversification is your own personal responsibility – my new acquaintance wished to outsource the entire investment process. But her financial advisor, who would have made good money out of the whole ordeal, is not going to be there to help if her family runs out of money down the track. The consequences of financial decisions—good and bad—are felt by you and your family alone. Therefore, you must know the big principles. Diversification is the most important investor protection available—understand it, practice it and ensure your advisors practice it also. Grab whatever cliché you need to remember ('Don't put all your eggs in the one basket' is the most popular one). The tragic error of this expat wasn't to lose money in a mortgage fund collapse, mistakes happen time and again. Rather, it was to lose all her money in any one investment. If you practice diversification, you can make a lot of failed investments without ending up on the bread line. Diversify among different asset classes, among different individual investments and among different structures (putting all your money into five different Storm Financial products, for example, is not adequate diversification).

2.       If your advisor ever suggests you break rule 1, fire them immediately. I don't care if they're your sibling, your partner or Warren Buffett. If anyone ever encourages you to move all your wealth into one investment or a cluster of investments in one asset class, they're compromised. They're almost certainly suffering from incentive-caused bias, the result of a stream of fees from the product seller, and may even believe they're working in your best interest. But they're delusional at best. If they're a friend, be polite at dinner parties but don't discuss money with them ever again. If you need it, seek better advice (preferably fee for service).

The first rule of thumb alone will, if followed, prevent any of your friends or family from ever going through the heartache of losing everything through one financial collapse. The second seemed like a necessary addition. In gaining accreditation, Australian financial planners have the principles of diversification solidly rammed down their throats, so breaches should be rare. But be on guard nonetheless. Doubly so if you're getting advice from offshore.

Collapses like LM Mortgage and Storm aren't one-offs, they happen with every economic cycle. I'd love to click my fingers and prevent every hard-working saver from losing their nest egg in the next financial collapse.

Unfortunately, the solution isn't that simple. But it is simple enough. Please pass on this blog post or share its general message with everyone you know who is saving for their retirement but otherwise uninterested in the world of investing. You might save yourself a painful conversation after the next corporate collapse, and you'll be saving them so much more.