Despite our best efforts to plan for the unexpected, sometimes surprises hit with catastrophic force in ways that we cannot possibly foresee, laying waste to even the strongest financial foundations. A prime example: shares in any of the Dubai companies whose executives or employees have come under investigation for fraud and embezzlement. Deyaar, the Dubai property developer whose chief executive was jailed in April, has lost 18.3 per cent of its value since the arrest. Dubai Islamic Bank's stock price has declined 17.3 per cent since a former vice president was arrested as part of a widening investigation. And Tamweel stock has lost more than 27 per cent in the past few weeks as a couple of former employees also came under a cloud of suspicion. This is exactly the brand of surprise that is difficult to plan for. Nobody expects allegations of fraud or embezzlement. Just ask investors in Enron, the Houston energy giant where massive fraud in 2001 caused the company's stock to go from US$90 (Dh330) a share to nothing in the span of a few months. Clearly, surprise is no joke. And although rare, such financial bombshells can have an outiszed effect on your life. Nassim Nicholas Taleb, a professor at New York University who specialises in studying randomness, argued last year in his bestseller The Black Swan that people often base decisions on a distortedly logical vision of the past and a flawed expectation that perceived patterns will repeat themselves. He is right, of course. And we also often ignore that it is not the everyday array of unforeseen events, but the big random events - financial and otherwise - that most shape the way we live and act. All this means that your ability to cope with unknown hazards is hampered precisely by the nature of those hazards: they are unforeseeable. Nevertheless, it is not as if you are powerless in the face of a bolt from the blue. Follow the five guidelines below, and you can at least guarantee yourself a better than average chance of pulling through unscathed.
The first element of your financial safety net is an emergency fund - also known as a rainy-day fund or a buffer fund. The experts say that you should have about three or four months' salary saved up in case of emergency, the idea being that this cash stash would tide you over if you lost your job or ran into major medical difficulty. Put the money into an interest bearing account where it is easy to access in case of an emergency. A money-market account is ideal because the yield you earn will be higher than a regular savings account at a bank.
If you have talked even once to a broker or financial planner or read an article or two about managing a portfolio, you have probably already heard about diversification. The point of it is to reduce "non-systemic risk" from your portfolio by investing in a diverse range of stocks, bonds and other assets that act in distinct ways. You take a certain amount of "systemic" risk by merely investing, and there is little you can do about this. But by diversifying, you limit your exposure to surprises like those at Deyaar and Tamweel. If you had invested Dh100 in Deyaar in April, you would now have Dh81.7. If you had divided that money equally between Deyaar and First Gulf Bank, which rose 13.8 per cent since April 17, you would almost break even, despite Deyaar's troubles, and end up with Dh97.8. That is a simple example of how diversification works.
Short-term thinking can bring about disaster if it means you are essentially gambling away your money. More often than not, though, it worsens catastrophes as they unfold. Investors who panic when stock markets tank may miss the pain when the misery sets in, but they miss out even more when markets start to rebound, as they inevitably do. Staying out of investments, in fact, is more of a disaster than holding onto them during the bad times, simply because stock markets have tended to go up in the long run. According to statistics from the brokerage firm Charles Schwab, investors who put their money in the Standard & Poor's 500 stock index in 1997 made an average return of 8.4 per cent per year by 2007. If they had been out of the market on the 40 best days, they would actually have lost 6.4 per cent per year on average.
Disaster readiness is the purpose of insurance, and you should have it if anyone depends on you for their sustenance. If you have children, for example, or an elderly relative you are caring for, get an amount of insurance that would compensate for your lost income if you were to die. There is no set formula for how much life insurance you should have, but the experts say you should make sure it is more than enough to keep things going until your children become adults or for the expected life span of any older people in your household.
Nothing complicates a death more than the absence of a clear will. Siblings inevitably fight over money and property, fracturing their relationships. Probate courts often need to get involved, increasing the cost of executing the estate. If you are an expatriate with assets located in the UAE, where inheritance is governed by Sharia law, you may find that it takes longer than you would like for your inheritors to get possession of your property. With a will, however, and a plan that includes locating large assets offshore so that they are not subject to the UAE's inheritance laws, dealing with an estate will not be an added burden for your family as they cope with your death. afitch@thenational.ae
