Pacific Gas and Electric Company announced Monday that is planning on filing for bankruptcy protection due to the liabilities they will be facing from the 2017 and 2018 California wildfires. This was somewhat shocking news, as even after acknowledging they may be at fault for the most recent wildfire, the stock price had “only” fallen from the upper $40’s to the $20’s. It was thought that PCG and the state of California would work out some kind of deal to avoid bankruptcy. That appears to not be the case. The other reason the PCG bankruptcy is shocking is because it is a regulated utility – a traditionally safe asset class. Regulated utilities can generally be counted on for medium to high yields but not much growth and they are widely considered to be safe because their profit is literally baked in to the price the allowed to charge.
This is an important reminder that it is always important to assess potential risks before making an investment and that unforeseen circumstances do happen. It is also why it is so important to build a balanced portfolio. You can insulate yourself from wipeout risk. When I say balanced, I mean 4 – 8 foundational holdings, ideally from different sectors, along with another 12 – 16 additional stocks. Once you are able to build up positions in around 20 stocks, you lower your risk of having and one disaster scenario, such as the California wildfire, wipe you out.
Consider if you had a portfolio with 5 foundational holdings, let’s say worth $10,000 each and then 15 other holdings worth $5,000 each. One of those other holdings is PCG. Now instead of a wipeout event, the PCG bankruptcy is only going to lower the value of your portfolio by 4%! We are taking about a worst case scenario here, where a company experiences an extreme liability event and the value of the equity goes to zero. Conservatively assuming the rest of your portfolio has a historically average year and grows by 7%, you will actually end the year with a 3.4% gain. This is the power of having a diversified income portfolio. The resiliency allows you to make an investing mistake or two, and still grow your portfolio.