9 Single Points of Failure in Your Investment Portfolio and What to Do About It
I was recently looking at some photos from NASA’s new James Webb Telescope. I’m no astronomer, but this thing is pretty cool! It can take pictures of galaxies and nebulas that were never possible to capture before.
But what also piqued my interest was the fact that this telescope has 344 single points of failure. If any one of those 344 things goes wrong, the whole thing fails.
I don’t need to be an aerospace engineer to know that that’s a lot of things that can go wrong!
And it got me thinking about money—are there any single points of failure in an investment portfolio? Is there one thing that can go wrong and ruin your financial goals?
Turns out there are nine. Or at least that’s how many I could come up with right now—there may be others. These points of “failure” don’t necessarily mean losing all your money, but capture a broad scope of negative outcomes, including an underperforming portfolio.
I discuss these nine portfolio risks on episode 54 of The Canadian Money Roadmap podcast. Go have a listen to it, or read on here to understand common risks in your investment portfolio and what to do about them.
9 Single Points of Failure for Your Investment Portfolio
Individual stock holdings
There’s nothing inherently wrong with holding individual stocks. But when you hold stocks from just one or a few companies, it can become a single point of failure.
The reality is that companies go bankrupt all the time. And even if a company doesn’t go bankrupt, the volatility of one company might be more than you feel comfortable with. By putting all your eggs in one company’s basket, there is no protection against them going bankrupt and your portfolio losing its value.
How to avoid it: Portfolio diversification. If you are investing in a broader scope of assets, your portfolio can better handle losses from a company going bankrupt. They just make up a portion of your total portfolio, so the impact is not as devastating in the worst case scenario.
2. Owning stocks from one country
Similar to individual stock holdings, owning stocks from just one country also is a single point of failure. For example, Japan’s stock market crashed in 1989 and didn’t recover for 30 years. If you’d only been invested in the Japanese market, it would have been a long time to recoup your losses.
How to avoid it: Diversification… again. Make sure you hold assets from more than just one country (even a large one like the US!).
3. Investing in only one sector
Every few years there’s a new, trendy sector to invest in. Most recently it’s been technology. But consider how quickly new technologies come out and make old ones obsolete. If you put all of your investment into a single sector, you’re taking on a lot of risk.
How to avoid it: Rule of thumb is to keep investments in any one sector to a maximum of 25% of your total portfolio.
4. Speculative investments
All investments are speculative to some extent, as you hope that they will increase over time. Some assets, though, are based on the idea that the only way it makes money is if someone buys them for more than you paid.
For me, crypto and gold both fit into this category of speculative investments. In contrast, this differs from an investment like real estate or dividend-paying stocks, both of which can produce income.
How to avoid it: Be cautious of speculative investments and minimize them in your portfolio.
5. Not having enough upside in your investment portfolio
This potential single point of failure has to do with being too conservative with your investments to meet your goals. Being conservative is not a problem in and of itself, but if you’re not matching your savings rate with that level of caution, then meeting your objectives will be very difficult.
How to avoid it: Understand your risk tolerance and build a plan and strategy that matches it. Talk to a financial advisor or planner if you’re unsure how to do this on your own.
6. Only using an RRSP
If you have a portfolio exclusively in RRSPs (or other tax deferred accounts), you’ll eventually be taxed on every single dollar you take out of it in retirement. And while this is not a single point of failure that blows up your portfolio, the tax bill can really sting if you’re not prepared for it.
How to avoid it: Consider including a TFSA as part of your retirement income strategy to limit lifetime taxes and improve income flexibility.
7. Lack of insurance
Insurance protects you when the unexpected happens. Disability insurance can protect you financially in case of injury or illness, and life insurance will protect your family and loved ones.
Not having the right types of insurance is a single point of failure because you may not be able to navigate these kinds of unexpected circumstances without it.
How to avoid it: Many people have disability insurance or life insurance through their work benefits. But, this often does not cover very much, so get some clarity on what your plan covers. Especially if you are self-employed, look into options and purchase your own insurance.
8. Overspending on subscription services
Overspending in general is the easiest way to upend your finances but overspending is much harder to avoid when using too many subscription services.
Subscription services are the business model de jour. Today you can purchase everything from furniture to media on a monthly payment plan. The problem with this model is that you never really own anything, but you’re always paying for it.
This model isn’t wrong, but it’s easy to overspend—a potential point of failure in your financial life.
How to avoid it: Be wary of subscription-based spending and keep it in check.
9. Purchasing a more expensive house than you can afford
A lot of Canadians are “house rich, asset poor,” because they’ve purchased more than they could really afford. Especially with rising interest rates, many people struggle to make their mortgage payments. This is because they didn’t account for any margin in their budget and account for increased expenses.
How to avoid it: Carefully consider and plan what you can afford, making sure to leave a margin in your budget for unexpected expenses related to your house and a growing family.
How to Reduce Single Points of Failure in Your Investment Portfolio
These are the nine most common single points of failure I see in a lot of people’s financial lives. The good news is that there are ways to reduce this risk and ensure your portfolio is as robust and stable as possible.
To reduce the points of failure in your investment portfolio, consider these three steps:
Diversify: Make sure your portfolio is diversified amongst the types of assets as well as the sector and country. A well-diversified portfolio is your best line of defense against volatile markets and changing economic landscapes.
Insurance: After a diversified portfolio, insurance is the way to protect yourself and loved ones from unexpected circumstances.
Plan strategically and rebalance your portfolio: Finally, make time to build a solid financial and investment plan around your goals. Then, regularly assess and rebalance your portfolio to make sure it’s still working for you.
We covered a lot here regarding reducing single points of failure in your investment portfolio. Feel free to listen to Episode 54 of The Canadian Money Roadmap podcast to hear more about each risk in detail.
And, if you’re unsure about your portfolio, just getting started, or have some questions, make sure to reach out to your financial advisor or financial planner. A personalized portfolio is the best way to mitigate risk and build an investment plan to reach your goals. If you’re nearing retirement, consider downloading my Retirement Readiness Checklist, or contact me directly for any other questions you may have.
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Evan Neufeld is a CERTIFIED FINANCIAL PLANNER® professional in Saskatoon, Saskatchewan and offers both investing and fee-only financial planning services.
*Disclaimer: Any numbers or rates of returns are used for illustration purposes only and should not be taken as fact. Note that the information in this article is current to the time of writing but is not guaranteed as up-to-date past then.
This article and accompanying podcast do not constitute personal financial advice. Evan Neufeld is a CERTIFIED FINANCIAL PLANNER professional in Saskatoon, Saskatchewan, and provides this Canadian personal finance content for educational purposes to the public. You are welcome to contact Evan to receive personalized fee-only financial planning or investment portfolio management.