Would you invest all of your pension fund in just one stock?

At Bluewater, we have a clearly defined investment philosophy. One of our key investment principles is diversification. As property mania has taken hold in Ireland again, investors are losing their investment discipline and taking more investment risk by rejecting diversification in favour of concentration and debt.

What is diversification?

Taken from our investment philosophy:

Diversification is the principle of spreading your investment risk around. Our investment portfolios therefore hold the shares and bonds of many companies and governments in many countries around the world. Because we believe in the power of capital markets rather than individual predictions or judgements, we are able to invest our clients’ assets in many thousands of individual investments. This means the negative and positive influence of each individual investment is reduced, producing, on aggregate, less risk in our portfolios.

There is no predictable pattern of the best or worst performing region or assets class over decades of results and it shows us why it is pointless to try to predict which country will be at the top next year or the year after.

Would you invest all of your pension in IBM?

IBM was founded 107 years ago in 1911. It is the 9th largest technology company in the world with annual revenue of $79.14bn. 30 years ago, IBM shares were valued at €28.72 and they are valued at €129.10 today, which equates to annualised growth of 5% per annum over that period. They also pay a regular dividend which is currently at a yield of 4.9%. I think we can agree that they are a well established company with a global reach and which pays a regular income. Also, by being a shareholder in IBM, I can leave the running of the company to the Board, I don’t have to do anything.

What if I suggested to you to not only invest your entire pension fund in this company but to also borrow and additional 25% of the fund value and plough that into IBM shares too? You’d think I was mad! What if something happened to IBM?!!! I could lose my money and I’d still owe the bank. It’s just too risky.

Would you invest all your pension in a property?

Property prices are increasing in Ireland, especially Dublin. The supply simply isn’t there and so rental prices are also shooting up. Say I have €330,000 plus the cash for expenses in my pension and I borrow another €100,000, I can buy a 4 bedroom semi detached house in Dublin 24 for €430,000. I can charge rent of €2,200 a month. This represents a yield of 6%.

I have to pay for the management of the property, which will come from my rental income (If it is through a pension, you are not allowed manage the property yourself). There is also the risk of bad tenants who will damage the property and I will have to pay for the repair. The rental income I receive will be used to pay down the debt. There is a risk however, that the property will be vacant at different times dues to change over in tenants or if tenants can’t be found (there won’t always be such high demand on rental properties). The bank will still have to be paid during these vacant periods so I may have to make pension contributions to meet the bank repayments if there isn’t sufficient cash in the pension bank account.

While there is a chance that IBM will go bust, there is little chance that your property will be worth nothing. But what would happen if the property is vacant and you are unable to make pension contributions to pay the mortgage? There will be a forced sale by the bank. This may take over a year to sell and the interest owed to the bank is compounding, reducing the money you will get back from the sale after debts are paid.

Don’t be in a hurry

If you have built a pension pot big enough to buy a property, it is likely that you will have an even bigger pension pot in the future. You can then buy a property that will form part of your pension portfolio, not your WHOLE pension portfolio with the increased risk of borrowing. With the ability to transfer a property into the post retirement ARF structure, you can keep the property for the rest of your life if you wish, so putting it off a few years now can save you a lot of money for decades to come.

What do you think? Is there a difference between investing all your money in a property versus buying stock in a one well established company? Let me know what you think at steven@bluewaterfp.ie