It may sound a little insensitive but there are some really important investment lessons we can all learn from what is happening at AMP (ASX: AMP).
As is well known now, AMP recently performed a brutal downsizing by cutting 190 of its smaller aligned financial planners by the end of October and has also slashed the amount it would pay them for their business.
Instead of getting four times the annual earnings of their businesses under the “buyer of last resort” or BOLR system, AMP overnight changed that to just 2.5 times annual earnings.
That has left these unfortunate AMP financial planners – who have been some of the most loyal people in the company – not only without a job from the end of the month but also facing massive financial problems given that many have taken out AMP Bank loans to buy these businesses based on a BOLR of four times.
Bad times for financial planners, how are we meant to cope?
So, if highly skilled financial planners can end up in such serious circumstances in which they face losing their homes and a lot of financial security, what hope is there for the rest of us?
Well, it turns out there are several investment lessons that we can all draw from this debacle, apart from the obvious one that when times get tough, big companies can be absolutely ruthless with the “little guys”, even when they have done absolutely nothing wrong.
Debt can be very dangerous
It may seem obvious but it is a lesson that never seems to sink in that debts (sometimes called leverage) can be extremely dangerous and the higher they are, the more dangerous things get.
As legendary investor Warren Buffett once said, quoting his business partner Charlie Munger, “There are only three ways a smart person can go broke: liquor, ladies and leverage.”
“Now the truth is — the first two he just added because they started with L — it’s leverage.”
All debt is designed to be repaid and it represents a mortgage on your future — something that must be repaid no matter what else happens in your life.
In this case, when they first took it out the financial planners would have thought this debt was secured by a rock-solid investment, backed by one of the most trusted names in Australian financial planning.
If anything went wrong, at the very least they could sell the business back to AMP and pay down the debt straight away.
That has turned out to be absolutely wrong, although it should be stressed through no fault caused by the financial planners.
At the time of maximum crisis for the planners, when they have effectively lost their livelihood, they are also faced with the prospect of meeting repayments on what is usually a very substantial loan.
While the terms of the departure offer from AMP are individual and confidential, we can assume by the significant protest from the planners that they are far from generous and in many cases threaten retirement plans, savings and homes of the individuals involved.
Getting the loan from the AMP Bank is no benefit either – they will be insisting on the repayment of the loan either in a lump sum or over time using the existing repayment plan.
That will be a seriously tough ask for many of the planners and could result in having to sell other assets like the family home or even to declare bankruptcy in the more serious cases.
The lesson for all of us out of this is to think really seriously before taking on debts, either large or small.
Ask yourself questions such as “what is the security underlying the loan?”, “how would I cope if the sale price of that asset were to fall suddenly and remain lower than it was at the time I took out the loan?” and “what impact on my life would this loan have if I lost my job at the most inconvenient time?’’
These may seem serious questions to ask but consistently during difficult economic times, debt is the key issue that brings people undone.
Asset values can change quickly
Another valuable lesson we can learn from the AMP debacle is that asset values can change literally overnight and those changes can bring significant financial pain.
In this case, the actual sale value of the financial planning business that AMP is buying back has roughly halved.
In actual terms compared to the initial cost of the business the loss could be much greater than that, given that the market for financial planning has been quite difficult for some years now.
Most of these financial planners would have gone into this investment thinking that they would sell it at a significant profit to a larger planning group and that the AMP BOLR offer was merely a reassuring backstop if things really turned pear shaped.
Now, after AMP was savaged by the Hayne Royal Commission for numerous indiscretions including repeatedly lying to regulators and charging dead people for financial advice, AMP itself is fighting for its survival.
Loyal shareholders such as Australian Foundation Investment Company (ASX: AFI) have entirely sold out of AMP, something that would have been unthinkable just a few years ago.
Customers are leaving in droves at the same time as AMP has been forced to analyse large parts of its business to reimburse and compensate customers.
Downsizing its tied financial planners is just one part of a large restructure of the entire AMP business but it leaves the planners in the invidious position of being forced sellers of their business at the worst possible time with AMP and its greatly reduced BOLR as the only viable buyer.
It is precisely the same position many investors find themselves after a share market or property crash – being a forced seller at the worst possible time, with large debts adding another layer of urgency to the distressed asset sale.
The lesson for all of us is to always consider the effect of a large fall in asset values for our investments.
Would you become a forced seller at the least opportune time? Could you tough it out and hope for better prices down the track and do you have cash or other assets that could keep you going through a crisis?
They are all good questions but people seldom ask it of themselves, instead hoping that things will just carry on as they have in the past.
One of the most often repeated but most ignored rules of investment is to not keep all of your eggs in one basket.
In slightly more sophisticated terms this means diversifying your investments across various asset types such as shares, property, bonds and cash asset classes as well as diversifying them within those asset classes.
Using property as an example, diversification might include owning your own home and shares in a number of different property trusts across the major property classes of industrial, office, retail and residential.
Buying a basket of property trusts through a low-cost exchange traded fund is another way of achieving diversification within the property portfolio, as would buying an interstate or even offshore investment property.
At a glance you can see that the diversified property portfolio is much safer than the concentrated one.
Should circumstances change, you can sell part or all of the more liquid property trusts or, say, an investment property.
A concentrated portfolio of, say, your own home is much less flexible – it is only in one area and one type of property – residential – and can only be sold as one big lump.
You can’t easily carve off a bedroom and sell that – it is an all or nothing property sale that is large and lumpy.
AMP planners concentrated in a number of ways
It is a very similar situation to the AMP planners who are concentrated in many ways – they have in investment not just restricted to financial planning but to AMP financial planning specifically so that if something happens to AMP then they are at immediate financial and reputational risk.
In this situation you could be the best financial planner in Australia but due to the misdeeds of AMP, customers would be wary of dealing with you and your investment is devalued.
Many people take similar risks, concentrating their efforts into their own small business and investing in it heavily and repeatedly.
Concentrating your investments can work well if they perform strongly but AMP is a salient reminder that concentration also carries risks which are sometimes much greater than we may have imagined.
Diversification within and across asset classes is a really important discipline and we all ignore it at our peril.
Relying on outside parties is difficult
Finally, the lessons we can all learn from the AMP debacle is that it is always dangerous to rely on any outside party, even one with a solid reputation.
We all do that to a certain extent relying on our employer to keep us in a job and to succeed in a certain industry.
We can also do it buying investment properties with “rental guarantees” or investing in our own small business which is usually locked in a single area and in a single industry.
However, we all need to ask ourselves the “what if’’ questions and keep investing in our own skills to increase our employment chances if the worst happens and the industry we work in hits hard times or the economy as a whole hits the skids.
We all need to ask questions such as:
- how would I survive if my job disappeared tomorrow?
- how diversified are my investments?
- do I have an emergency fund that I can access if the unexpected happens and I need to retrain?
Hopefully, most of the AMP financial planners will land on their feet and get over this significant and unexpected life hurdle, although for many of them their future life will be very different from what they had imagined.
The most we can all do is to assure them of our sympathies and to really absorb the lessons of debt, diversification, concentration risk and the need to always plan for the worst and hope for the best.