Who really controls your money?

Right now, there are plenty of risks to your money.

Brexit, Covid-19, the lockdowns, negative interest rates and plenty more.

But they’re very different risks to the sort I want to focus on today.

How many people do you rely on, just to get your hands on your money?

It’s a surprisingly long list, isn’t it?

Bankers, stockbrokers, stockmarkets, ATM machines, pension fund managers, annuity providers, fund managers, financial advisers, exchange intermediaries, the managers of the companies you receive dividends from, insurance companies, the Bank of England, lawyers who hold your money in trust, payment processing companies like Visa, accountants, HMRC and plenty more.

Now, we live in the UK. We don’t really worry about any of those people failing to show up with our cash, right? We just trust they’ll do the right thing.

Of course, there are the occasional stumbles. Famous fund manager Neil Woodford invested in things that were hard to sell fast at good prices. So, when his investors wanted their money out… well, they didn’t end up getting it all.

Then there was Northern Rock. Did you know that your bank deposits are classed as loans to the bank under the law? When you place your money in your bank account, it’s legally no longer yours, but the bank’s. The bank merely owes it to you, as a debt. A debt they could default on…

Regulations are in place so that the next time a systemically important bank in the UK fails, the depositors’ money (over and above the amount of “protected deposits” – currently £85,000 for individuals and up to £1m in some cases) could be taken to fund the bailout. They call it a bail-in.

To be clear, it’s a remote possibility. And, even if it does happen, many guarantees and buffers are in place to protect depositors, including deposit insurance and protection for temporarily high balances. But the law is still there on the books…

And what about the companies which cut their dividends during the Covid-19 crisis? And the interest you get… used to get… on your savings? And internet banking crashes? ATM outages? Pension cuts? And claim-dodging insurance companies?

Hmmm. This is starting to add up a bit, isn’t it? Perhaps your money isn’t so safe in other people’s hands after all?

Perhaps it’s not even “yours” if you can’t get it back when you want it.

My point today is that you need to start worrying about a type of risk which no financial adviser will mention. Outside of their small print, of course.

This simple risk is the first reason we at Fortune & Freedom believe you should take back control of your money.

What is this risk I’m talking about?

It’s known as counterparty risk.

This isn’t jargon. It’s a simple term you need to understand to start on your journey to being the master of your own financial destiny.

So let me walk you through it…

In any transaction, your counterparties are the people on the other side of the transaction. The people you rely on to do their job. If you are buying or selling shares, for example, this includes the banks that your accounts are with, the payment processing company, the stock exchange, the company whose shares you’re buying and the seller of the shares.

Like I said, most people never consider the risk of being let down by any of these big institutions. When they buy shares, they don’t even consider the risk of their bank failing, the stockmarket being shut down, the company engaging in accounting fraud, or whoever else may fail you.

But those risks are very real. Every now and then, banks fail, stock exchanges are frozen, accounting scandals are exposed and payment companies experience outages.

But how do you actually address any of this? I mean, short of becoming a hermit in a cave, it’s tough to avoid banks. And you can’t invest in shares without being exposed to the stockmarket as a counterparty.

So, yes, it’s impossible to eliminate counterparty risk.

But you can reduce it.

And I believe you can reduce it dramatically by following just a few simple rules that won’t take up much time. They’re the first steps in taking back control of your money.

Hold in your hand wealth

The first is simple. Own some assets that don’t have counterparty risk. Meaning nobody can disappoint you in any way. You don’t rely on anyone else to get your hands on them.

The obvious one is cash. And I don’t mean in a bank account.

When Greece imposed ATM withdrawal limits in June 2015, cash suddenly became incredibly valuable. When I travelled through Greece in 2016, I spoke to people who told me about what life was like back then. One story stuck with me, not only because I heard many variations of it.

Mistrustful Greek grandmothers who remembered the bad old days of the drachma never fully trusted the new euro banking system either. They kept stashes of euro literally under their mattress. And their grandchildren laughed at their backwardness.

Until the cash withdrawal limits hit. Suddenly, Greek grandmothers were worth more than bitcoin.

There are a few other cash-shortage stories I could tell you. Like when I got stuck in an Australian desert and the internet cut out. The petrol station’s electronic payment systems stopped working. And I didn’t have enough cash to fill up the tank enough to make it to the next petrol station on the far side of the desert.

Eventually we discovered the cash stash my father-in-law had given my wife “for emergencies”. I haven’t heard the end of it since.

Or the time my mentor had to grab his emergency cash stash to secure a bank cheque for me. It was the only way to pay a deposit on my rental property. My own bank didn’t provide such cheques.

The examples are instructive. I’ve learned my lesson, even if it took three reminders.

But what’s the principle at work here? Well, having physical cash to hand makes you counterparty risk-proof in the short term, at least. Cash in your hand doesn’t rely on anyone else to do their bit. Having cash beats having to rely on your father-in-law in an emergency too.

There are other, similar assets without counterparty risk. Some provide decent investment returns, too. The key thing they have in common is the lack of a counterparty.

You own them directly, usually in your very hands. We’ll discuss a few of them in coming days, right here in Fortune & Freedom.

Lots of eggs, lots of baskets

Another rule to follow, if you want to minimise your counterparty risk, is diversification. And not the sort you’ll hear your financial adviser talk about.

Your share portfolio might have a number of different stocks to diversify the risk. But what about the risk of that brokerage company or exchange being shut during a stockmarket crash or technical problem?

You need to diversify your counterparties too.

For example, having your stock brokerage account, pension, ISA, personal banking and mortgage all with the same bank could be dangerous. Your entire financial life could be frozen from the failure of a single firm.

Think about how you can avoid being overexposed to a single company in your financial life. It may be convenient to have all your eggs in one basket. But it also might be too much counterparty risk.

Investing your money with a fund, instead of directly in companies’ shares, means you’re adding another counterparty. One more counterparty than necessary, who may or may not be doing the right thing.

By taking back control of your money, you can cut out such middlemen.

Not just their costs, but the risk of them failing you in some way.

Hopefully following some of these suggestions will make you sleep better at night.

That’s the real aim – peace of mind. If you don’t handle your money to improve the quality of life for you and your family… well, what’s the point in having any?

Being aware of the risks, taking care of them as best you can, that is an important step most people never take. But one that can have a transformative impact.

If you’d like to go on living your life as though the risk didn’t exist, then my apologies for the interruption…

But if you’ve realised it’s time to take back control of your money, thinking about counterparty risk is the best place to start.

So, who do you rely on to get your hands on your money?

Many thanks,

Nickolai Hubble
Editor, Fortune & Freedom

PS Instead of us just writing to you, we’d like your voice to be part of this project, too. Let’s hear from you!

Should anything cross your mind or you have questions for us, you can always write in to our mailbox – [email protected]