I assume every investment I make could leave me with nothing.

I don’t expect it – in the case of cash and UK gilts I think it’s extremely unlikely – but I don’t bank on 100% guarantees.

Apparently sensible people complain on TV watchdog shows about losing all their money on corked wine funds or punts on plots of greenbelt land or timeshare apartments without plumbing or an airport within 50 miles.

And we who-know-better feel sorry for them…

…but we also snicker a bit at their gullibility.

Didn’t they see the risks?

Wasn’t it obviously a gamble?

Well, yes. Yet you still see supposedly sophisticated investors calling for criminal investigations when any old high stakes blue sky penny share goes bust.

Or retired people on Radio 4 admitting they lost half their net worth when their shares in RBS or Barclays went into the dunk tank in the financial crisis.

Very often such people were employees at the companies during their working lives.

They’d never normally dream of putting so much money into one company. But their familiarity with its logo and the office wallpaper of yesteryear makes them contemptuous of the risks today.

I even see smart passive investors putting all their money into one fund, or one broker, or into the hands of one adviser.

Sure the risks of something going wrong seem tiny.

Yes your money should be ring-fenced, segregated, held in your own name if everything is properly in order.

But why take the risk that it isn’t?

Every investment can fail you

When I buy individual shares, I assume the company can go bust – even if it is one of the largest companies in the world.

But my prudent paranoia goes much further than that.

Here are just a few examples of how seemingly safe and widely-used financial products could conceivably damage your wealth:

• Stock markets can and will crash. (Obviously… but people seemed to forget it during the last crash).

• Inflation can devastate long-term bond returns. (Obviously… but people today are buying German 30-year bonds yielding 0.65%).

• ETF providers could get into trouble, putting ETF investments into jeopardy at worst, or at least disrupting their smooth trade.

• Banks who are not members of your country’s compensation scheme can go bust or suffer a bank run.

• Investment companies can perpetuate fraud, from dipping their hands in the till right up to a Madoff-style Ponzi scheme.

• Banks and other financial companies can fail, with knock-on consequences for the investment products they stand behind.

• Electronic brokers or registrars could get into difficulties or suffer some form of collapse that destroys or renders inaccessible a record of who owns what.

• Ring-fenced assets might not have been properly – legally – ring-fenced.

• Safeguards against these or other failures can break or be unable to deliver. Or – more likely – there can be big delays in getting restitution.

• Insurance schemes set up to compensate you can run out of money.

• You may not even be as well-protected as you thought because that harmless-sounding ETF you bought was actually domiciled overseas.

• Cash under the mattress can be stolen.

• A government could appropriate the money in government-backed bank accounts, or default on repaying its own bonds, or make holding gold illegal.

• Your country’s currency could be devalued, so that even though your nominal net worth remains the same, your wealth is diminished compared to your overseas peers.

• Your country could suffer an economic collapse, even if the rest of the world chugs along fine.

• The communists could take over and outlaw all private property.

Clearly some of these events are far more likely than others – most are very unlikely – and there are some real Black Swans in there.

(Good luck guarding against a revolution that starts in Surbiton!)

But it’s vital to consider all risks – however vanishingly remote – in order to appreciate the potential value of the safeguards against them.

How then can we protect our wealth?

Everything from portfolio diversification and investing overseas to dividing your cash savings between different banks are sensible steps towards protecting your wealth.

I use a few different stock brokers, for instance, and have cash in several different bank accounts.

However I know I am running risks.

I only have a paper share certificate in one company (a non-listed one). Everything else is held electronically with online brokers in nominee accounts.

If the electronic record system collapsed for some reason, my share investments could be in peril.

I have also held synthetic ETFs in the past – and would do so again in moderation – despite the risks of synthetic ETFs versus physical ones.

Indeed I have very few physical or real-world assets.

I don’t even own my own home – the one kind of asset that almost all flavours of government tend to treat more reverentially than they do ‘fat cat’ assets like shares, bonds, and cash (at least until you reach genuine fat cat levels and your house has a front lawn they can really park their tanks upon).

I do have a pitifully small amount of gold tucked away in a vault, but despite my best intentions I haven’t added to it.

I think there is a case too for keeping a few gold coins or similar fungible assets somewhere secure near to hand that you can access in a crisis.

Don’t be a loser

Ultimately, you have to be pragmatic and live in the real world.

Accept that every time you invest, you take a risk with your money.

Do all you can to minimize those risks. Work through the alternatives. Spread your wealth around. Look for antifragile opportunities. And banish the word ‘guaranteed’ from your mind.

If you do all that then hopefully we’ll never have to hear on the radio how you lost the lot, never have to sigh, and never have to feel guilty for snickering at your foolishness.

Study the table of asset class returns below. It is one of the most important graphics you’ll ever see in investing.

Created by Vanguard, the table ranks several of the main asset classes by historical performance – from best to worst – for each of the past 15 years.

• For instance, you can see that in 2014 North American equities were the best performer, delivering a return of 19.6%.

• The worst performer that year, and thus at the bottom of the 2014 column, were European equities. They returned just 0.2%.

The different asset classes are differentiated by colour.

Source: Vanguard

Hunting high and low

Even without enlarging it you can see the table looks like a patchwork quilt embroidered by a drunken colourblind sailor in the dark.

One year’s winners can be bottom of the class just a year or two later.

Yet equally, sometimes the best performers continue to do better for several years in a row.

This volatility is what makes tactical asset allocation – that is, trying to chop and change ahead of the market – so tempting, and yet equally so difficult.

It’s also why most people are better of not bothering with such second guessing.

A bit of what you fancy does you good

With a well-diversified and occasionally rebalanced passive portfolio, you’ll always have some money invested in the best performing assets in any particular year – albeit at the cost of holding some losers.

And by tweaking your allocations according to your risk appetite – as opposed to doing so to chase higher returns – you can influence the overall volatility.

The big win of this balanced portfolio approach is if you avoid being the schmuck who sells everything when your ultra-risky portfolio plunges in a rough year.

The table shows many instances when hot money would have had a bucket of cold water thrown over it in the following 12 months, scaring many investors into selling – only for the asset class to bounce back the year after that.

It’s the reason for the so-called behaviour gap, which is the repeated observation that real-world investors do much worse than asset class returns would imply.

It’s all due to their woeful attempts at market timing their way in and out of the best investments.

Look at the table again and imagine trying to actively dance your way through its highs and lows.

Do you feel lucky? Well, do you?

Note: I’ll be back later this week with more thoughts on the asset class returns table and tactical allocation strategies, so I am turning the comments off until then.

Good reads from around the Web.

The road to knowing a lot about investing is paved with knowing a little bit.

And as we all know, a little bit of knowledge is a dangerous thing.

I’ve seen the pattern on this very website. A new actively-minded reader will discover Monevator, often via one of my more actively focused articles, and then start commentating on other posts around the site.

They’ll usually state how they’re not stupid enough to put money into bonds or how they’re very cleverly positioned in the investing theme de jour (dividends, gold, and emerging markets at various points over the past few years).

Or, if you go back far enough, you’ll find them saying how unlike those other lemmings they aren’t being fooled by the bull market at all.

(Indeed the Armageddon-blog Zero Hedge now seems to be a support group for these particular people.)

Damascus is lovely at any time of the year

Anyway in time the market does what it does, which is punish over-confidence and piss on hubris.

Usually we don’t hear much from these chastened geniuses again, but a few have become regulars on my co-blogger The Accumulator’s articles. As best I can tell they’ve become largely passive converts.

I don’t point this out to mock them, but rather to applaud them.

For most people true wisdom in investing means coming to understand how little is knowable – especially if you need to slap timing onto the reckoning sheet – and instead focusing on what is controllable (costs, taxes, asset allocation, and your personal savings rate).

If like me you do carry on active investing (and my allusion to the famous old movies is entirely deliberate) then you had best be doing it with a mug of humility on the desk next to you.

It is happening again

One of the most consistent newish investor foibles is a belief that they can perceive market tops that somehow everyone else has missed.

They’ve all seen an asset crash or two and read all the quotes, and they can’t wait to opine that “this time is never different” or “We’ve seen this movie before and it ends badly”.

But we usually haven’t seen exactly this movie. To offer another over-exposed quote, history doesn’t repeat itself, it rhymes.

Markets rise and fall, but if the moves were as easily forecast by people who’ve done little more than read a few articles on Warren Buffett, we wouldn’t get stock market bubbles or busts.

Reality is far trickier, except with hindsight.

The continuing advance of both the US stock market and the bond market are current examples; the strength of London property a longer-standing one that’s totally humbled yours truly.

People have been wrong about these markets for years. Each will someday decline, but someday is another matter.

Boringly true

The brilliant blogger Ben Carlson points out that the quote “I’ve seen this movie before and it ends badly” is almost invariably used by doomster pundits, who are wrong far more frequently than they’re right.

It’s potent because it sounds so sassy and dark.

In reality, anyone who has seen the movie of the markets before knows that – over anything other than the short-term – it mostly doesn’t end badly.

As Carlson says:

No one ever says, “I’ve seen this movie before and it ends with higher dividend yields, lower prices, better valuations and higher expected returns.”

Over the long-term, investing in Western stock markets hasn’t been anything like a movie, but more like a long-running soap opera.

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