What if my account goes to zero? It’s a question I’ve heard more than once in the past 6 months. It seems to come from a place of fear, and extreme emotional aversion to loss. There’s likely a lack of understanding too. An understanding of what one owns within the equity portion of an investment account.
Perhaps in this article we can rationalize how this could even happen. How could an investment account “go to zero?” Then touch on how unlikely or likely it could be depending on the composition of an investment account, and how to avoid a negative outcome through diversification.
The Dollar Figure Is Not So
It’s as though folks often look at their investment account, and only see a dollar figure, nothing else. Go on! Go ahead. See for yourself. Log into your workplace retirement plan or open up your IRA custodian’s portal. I’ll wait.
What is the first thing you notice about your account once you have successfully supplied the correct username and password? Is it a monetary figure represented in US dollars that stands out?
I concede, you may hold some cash in your investment account, but most of your account is made up of something other than US dollars. That dollar amount you see represents the value of all the assets in the account if you were to sell them that day, at the current market price. But you didn’t sell them, and so the figure will be different tomorrow and the next day.
So, what is in your investment account? What do you own?
For most of the folks that we serve, their investment accounts contain a mix of either individual stocks or exchange traded funds (ETFs). We’ll address both later, but it’s important to know that they represent shares of companies. Companies that make things or offer services that people need or want to purchase.
There may be a few folks we serve that have some fixed-income, or bond positions, in their portfolio. However, for most of our clients we’ve chosen to use other strategies outside of their investment accounts to take the traditional place of fixed income assets within a balanced portfolio. We won’t cover the reason why in this article. We’ve done so in previous publications on our website.
For today though let’s just stay focused on addressing the first question that started this whole topic. “What if my account value goes to zero.” Is that even a rational question? Is it within the realm of possibility that somebody’s investment account value could drop all the way to zero because of market conditions? Yes, yes it could happen!
Single Stock Investing Can Be Risky
Let’s say for a moment that you own an investment account, and only holds a single stock position. We’re not talking about speculative penny stock, but rather a profitable company that makes products that millions of people worldwide want to buy. By all accounts it’s good solid company. We’ll use Apple stock as an example.
Apple is a great company, and they make products and offer services that folks are willing to pay for. No doubt about it, as of the writing of this article they’ve been profitable for a long time, and a leader in their market.
If all you own in your investment account is Apple stock, is it possible that the account value could go to zero? The answer is, absolutely!
A single company, even one as admired as Apple, could find itself and its business model disrupted by some external player that I did not see coming. There are many companies throughout history who were market leaders at the height of their success and found themselves out of business long after their heyday. In hindsight it’s easy to spot them. Blockbuster and Toy’s R Us are just two of the more recent examples. However, it’s very difficult to predict which companies might experience a similar fate.
This thought exercise demonstrates why it is so important to hold a portfolio that is well diversified. We would not recommend holding a single position no matter how much we or you admire that company. If it’s the only investment in your portfolio the risk is too much and could jeopardies your future. The company could go out of business for a number of reasons. In that event, it would be possible that your account could go to zero.
Two Stocks is Better Than One, But Not Enough
What if you own two stocks? Well, that’s better than one perhaps. Now both companies would have to go out of business for your account value to go to zero. How about 5, or 10? Well, that’s better than 2. All of them would have to fail for that to happen. You’re spreading your risk.
Let’s examine the contents of one of our frequently used portfolios. It’s called the Equity Dividend strategy. The composition of the strategy may change from time to time, but it generally is made up of around 40 different individual stock positions that happen to be selected for their consistent and attractive dividend yield. We’re not here to talk about performance, but just composition and how diversification can reduce the risk that your account goes to zero. So, what are the holdings in the Equity Dividend strategy? As of 9/30/22 the strategy held 41 individual stock positions. The top 15 holdings were:
- 3M Co (ticker MMM)
- Lamar Advertising (LAMR)
- Blackstone Inc (BX)
- ONEOK Inc (OKE)
- Cisco Systems Inc (CSCO)
- Duke Energy Corp (DUK)
- Proctor & Gamble (PG)
- Kimberly-Clark Corp (KMB)
- Johnson & Johnson (JNJ)
- Amgen Inc (AMGN)
- Microsoft Corp (MSFT)
- Intel Corp (INTC)
- McDonald’s Corp (MCD)
- Phillip 66 (PSX)
- Qualcomm Inc (QCOM)
Let me be clear. The listing of these stocks is not a recommendation to buy or sell. I’m not endorsing any of them or highlighting their performance. That is not the point of this discussion.
The questions to ask however are.
- Do any of these companies ring a bell?
- Do you personally use any of the services or products offered by these organizations, or no someone who does?
- Do any of these companies impact your life in one way or another?
It is possible that one of these companies could find that its business model has been completely disrupted, or the business so grossly mismanaged, that it goes out of business and the share value goes to zero. Yes. It’s always a risk.
Is it likely that all 15 of these companies would fail at the same time? How about the other 2/3 of the companies inside of this one strategy? It’s extremely unlikely.
While the share value of each individual company may rise and fall, because of there being more sellers and buyers, if they stay in business and are profitable their share price will not likely drop to zero. Therefore, the account value in which they reside will not go to zero.
Diversifying Using Exchange Traded Funds (ETFs)
Let’s examine another strategy we often use. This one is called RFM Strategic ETF Growth. This strategy is made up of exchange traded funds, or ETFs for short. It is a completely different strategy managed for future growth potential rather than a dividend yield. Each ETF in the strategy is selected based on the potential for future appreciation of the share price of the underlying investments. As of 9/30/22 there were 13 different ETFs in this strategy.
Again, we’re not talking about performance here, just composition. So, let’s open up three exchange traded funds, and examine the top 3 holdings in each one.
Invesco QQQ Trust (Ticker QQQ) – holds over 100 individual investment holdings and makes up 15% of the strategy.
Top 3 Holdings as of 10/7/22:
- Apple Inc (APPL) = 13.33%
- Microsoft (MSFT) = 10.50%
- com Inc (AMZN) = 6.99%
iShares US Healthcare ETF (Ticker IYH) – holds 116 individual investment holdings and makes up 15% of the strategy.
Top 3 Holdings as of 10/7/22:
- UnitedHealth Group (UNH) = 10.01%
- Johnson & Johnson (JNJ) = 8.78%
- Eli Lilly (LLY) = 5.78%
Energy Select Sector SPDR ETF (XLE) – holds approximatley 25 different investment holdings and makes up 7% of the strategy.
Top 3 Holdings as of 10/7/22:
- Exxon Mobile Corp (XOM) = 25%
- Chevron Corp (CVX) = 19.18%
- Pioneer Natural Res. Co (PXD) 4.6%
For these exchange traded funds to become completely worthless all the companies inside of them would have to fail at one time. It’s just not a likely ending to the story.
A single ETF position helps eliminate single stock investment risk but may not be adequate to diversify across all major market sectors. That is why it is often wise to hold a basket of ETFs. However, by the nature of an ETF they already reduce the risk of an account becoming completely worthless due to the failure of a single specific company.
Blending Strategies for A Tailored Fit
There are many different strategies managed by our team at Royal Fund Management. We have the privilege of being able to pick and choose, and even blend some of them together to tailor equity holdings to our clients’ long-term investment objectives. We’ve only talked about a couple of strategies that we commonly use. They were selected for demonstration purposes only, not as a reflection of market performance relative to any of the other strategies that we manage.
The point we wanted to make with this article was that if your portfolio is well diversified, and your account value somehow “went to zero” we’re all going to be facing much larger problems. That would mean we’re living in a world in which all these well recognized and established publicly traded companies that provide services and products that consumers or other business either need or want to buy have all failed simultaneously. They’re all out of business rendering their stock value worthless. It just is not a likely scenario.
However, if you’re holding an individual company’s equity shares isolated in an account by itself the reality is your account could go to zero. If that company’s business model is disrupted, or the company is grossly mismanaged to the point where it runs out of the capital or the will to continue operations your shares could become worth nothing, and your account value goes to zero. Therefore, diversification is so important.
Determine The Dosage Before Investing
We would also like to point out just how important it is to properly identify what portion of the assets within your portfolio are appropriate for equity, or stock market, investing. Determining the proper dosage is critical. Not every dollar within your retirement assets is a good fit for purchasing equities. Before making any investments in the stock market, you really should nail this down.
A great place to begin is to know the purpose and timeline of each dollar within your retirement plan. Drafting a well written comprehensive retirement plan that organizes your retirement resources, both income and assets, and sets them against a spending plan that reflects your desired lifestyle is a first step. Then adjust the spending plan for inflation, taxes, and healthcare. Now you can begin to assign dollars based on current and future cashflow needs. When will they be needed, and for what purpose will they be used. This is the backbone of our Purpose and Timeline 5 Step Retirement Planning Process (PT5 for short).
Some of your retirement resources may need to be spent within the next 12 to 24 months. We suggest that those dollars would not be appropriate for investing in equities. We’d argue that retirement assets needed within the next 3 to 10 years may not be appropriate either. We have seen, and could see again, a market drawdown lasting several years followed by a multi-year recovery. However, dollars that are not necessarily needed to supplement your retirement income in the next 10 years or longer could be appropriate for taking managed equity risk.
We believe that your equity investments should have a long-term investment time frame. Market values will fluctuate. Share prices will increase and decrease due to a multitude of factors. Historically however, time is on your side. If your equity positions make up your long-term investment strategy and reflect capital that you will not need in your financial plan for many years to come, you are more likely to have success then you are if you are investing your short-term capital. They are likely better strategies for your short-term and near-term cash flow needs, but that’s a story for another day.
Conclusion
Back to the question that started this whole discussion. “What if my account goes to zero?” Hopefully by now you could answer this question with authority if one of your fearful friends utter the phrase. When strategically diversified across many well-established companies from various market sectors that make products or offer services that the marketplace needs or want to buy, the chance that your equity investment account “goes to zero,” is slim. We’d most likely be living in some science fictional post apolitical world at that point. The share price of your investments won’t be of much concern when you’re fighting zombies! “What if my account goes to zero?” The thinking behind this question is either not rational or not well informed. Perhaps both. Maybe now you can confidently explain why if indeed someone asks it within earshot.