The Largest Risk to Your Investment Portfolio Isn't a Market Crash

A Bear Market Shouldn't Be Your Biggest Fear

As we’ve seen in both 2000 and 2008, a major drop in the stock market can eat away a significant portion of your wealth in a single year. Sensational articles about looming recessions and market crashes have been a constant mainstay of the media, including over the near decade it's been since the last major market downturn. 

Whether we’ve just been through a bear market or it’s been years since the last one, investors are often predominantly concerned with the coming of the next crash. This leads many to consider short-term strategies including market timing, changing their asset allocation, and getting out of the market altogether. Academic research has shown each of these has the effect of lowering wealth-building over the long-term. 

Unfortunately, focusing on protecting your portfolio from a market downturn is often a case of fighting the wrong dragon. The biggest risk to your investment portfolio and your wealth isn’t a stock market crash, it’s a lawsuit.

The Devastation of a Lawsuit

Many people have a fear of being drug into a lawsuit. In fact, it has its own phobia: liticaphobia is the medical term for the fear of lawsuits. There is good reason for this fear to exist, as a legal battle brings with it enormous financial, time, and emotional costs.

We run the risk of being subject to a lawsuit every time we drive our car, invite people over to our homes, offer professional advice, or do anything which could potentially harm another.

Damages or Settlements Can Result In a Massive Payout

Damages are what the court awards the person who sued you, while a settlement allows you to end the court case. In either case, you can be responsible for paying a significant amount of money. A large auto accident or a serious accident in your home could result in a lawsuit measured in the hundreds of thousands of dollars.  Even small accidents can result in payouts of tens of thousands of dollars. A lawsuit doesn’t put you on the hook for just damage to property or medical bills.

You can also be liable for lost wages, pain and suffering, and punitive damages. It's actually these three which more often result in the massive settlements and payouts you hear about. Injuring a surgeon's hand in a car accident could easily leave you liable for a million dollars of lost pay over the surgeon's remaining working years. (Think $100,000 reduction in salary times ten years). 

Even if You Win You Lose

But let’s assume you are going to win your case. Even with a win you may be on the hook for tens of thousands to hundreds of thousands of dollars in attorney fees defending the lawsuit. At $200 per hour (a cheap lawyer in most urban and suburban areas), it doesn’t take long to rack up significant legal fees.

One Mistake Can Wipe You Out

Considering the massive costs of a lawsuit, it is easy to see how one suit could wipe out decades of hard-earned savings and investments. Fortunately, your 401(k) investments are protected from lawsuits under the ERISA laws, but your IRA may or may not be depending on the state you are in.

The Purpose of Property and Liability Insurance

Although many view property and liability insurance as a ‘necessary evil’ required by their mortgage holder or the state, this type of insurance is actually a key component of a wealth building and preservation strategy.

Paying for Damages or Settlement

A major value property and liability insurance provides is whether you lose the lawsuit or settle, the insurance company will pay the other person instead of you. You will still be responsible for amounts above the insurance coverage limits, but having sufficient insurance coverage can greatly reduce your risk.

Pay for Your Lawyer

Of equal value is the insurance company’s duty to defend. The duty to defend means the insurance company has a legal obligation to defend you from the lawsuit. This means your insurance will be responsible for hiring, managing, and paying for the lawyers needed to defend you. Having lots of coverage increases the insurance company's incentive to fight hard in your defense, because they will be on the hook if you lose.

The Core 3

There are a dozens of insurance options available to cover with every potential lawsuit, including professional liability insurance (think medical or legal malpractice insurance), business liability insurance, and even private airplane liability insurance.

For most, however, there is a core of three insurance policies which should cover the typical liability exposure. These include [1] auto insurance (unless you never drive), [2] home-owner’s insurance (whether you rent or own), and [3] an umbrella policy. If you are missing one of these three, consider revisiting your insurance coverage.

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Joshua Escalante Troesh.jpg

Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at