Avoid a Single Point of Failure

​As a pilot I am often asked, “What if something goes wrong?” Things do go wrong sometimes, but passengers rarely hear of it. They go wrong for commercial pilots too. In one funny exchange I heard a commercial pilot announce an urgent landing due to a “strange smell in the cockpit.” That definitely generated a few chuckles.
 
So, if things regularly go wrong why are accidents so rare? It is because aircraft engineers understand that everything will eventually fail so they design planes with several layers of backup. Planning for failures by having contingency plans makes most problems non-events.
 
On one flight my altitude indicator quit, but I had four more. When I landed safely, I had the instrument repaired. A challenge for aircraft engineers is, what if a single event takes out everything? This is known as a single point of failure. For example, a lightning strike might create a surge that disables all electronic equipment. To protect against this, engineers design redundancy in such a way to reduce the risk of a single point of failure. For this reason, I have backup instruments that are not powered by electricity.
 
Investors face the risk of failure. Occasionally stocks fall, real estate slumps and bonds default. We must accept that upfront. My opinion is that one of the greatest risks to investors is a single point of failure. In 2008 many people suffered terrible financial losses because a single economic event took their whole portfolio down, and most importantly, they did not have sufficient backup in place to get them through while the markets were being repaired.
 
An airplane is an amazing tool and a great blessing to humankind. Parts of it fail occasionally but that does not eliminate its value or justify avoiding its use. It is just a reminder to have backup as well as a plan to avoid a single point of failure. Wise investing has also brought many benefits to countless individuals. Things fail sometimes but that does not eliminate its value or justify avoiding its use. It’s a reminder to have a backup plan that also attempts to protect against a single point of failure.  I frequently discuss the power of diversification with my customers, since assets can react differently to an economic event.
 
If a person could have bought the DOW Jones index* in 1892, its 127-year average returns would have likely put a smile on their face. Yet all of the original DOW members are gone except General Electric, which is clinging to life. This most famous of market indexes has succeeded despite regular individual failures.
 
Manage your portfolio like an aircraft engineer. Accept that occasional failure is normal. Have backup plans to keep you flying. And try to diversify in such a way to avoid, if possible, a single point of failure. Avoiding some failures is not possible, or even necessary. Continuing to move forward in spite of them should be the goal.