Asset custody is one of those topics that the typical investor doesn't give much attention. Most of us are more interested in the rate of return on our investments than some out of sight/out of mind back office activities. Yet, it's critically important to understand who is actually responsible for the safekeeping of your assets. After all, it doesn't do you much good to have a great return on an asset, only to have the asset itself disappear due to fraud or negligence.
The cryptocurrency world has provided many examples in recent years of why this is a legitimate area of interest. The latest major example is QuadrigaCX, a Canadian cryptocurrency broker who recently reported that its CEO died on a trip to India and supposedly he was the only one with the password to access approximately $145 million of client cryptocurrencies! If they are unable to crack the password, those assets will have literally disappeared. We'll note that some are speculating that there is fraud going on here and not just an unfortunate series of events, but either way it points to a failure by the company's clients to consider the importance of custody and, if it's not fraudulent, a colossal failure by the company to protect its clients.
Some of the most basic requirements of a good custody arrangement are missing here, such as the custodian being an independent third party that is subject to external audits and regulation. Compare this to your a typical employer retirement plan [e.g., 401(k), 403(b)]. A regulated third party is generally responsible to maintain custody and account for those assets. If instead, your employer said they'd stick your money in an account and let you know how much it's worth, how would you know for sure whether the money was really there? Not having an independent third party has been a key issue in some of the largest frauds of all time, including Bernie Madoff's decades-long Ponzi scheme.
The same custody issues apply when working with a financial advisor. SWA, for example, manages accounts for clients at Schwab. If you want to make a deposit to your account, the money is sent directly to Schwab, not to SWA (although we can assist clients with depositing checks and transferring from bank accounts). You always have the ability to go to Schwab directly to verify amounts, transact, or withdraw from your accounts if you chose to do so.
As always, we need to share some disclaimers. Having a third party custodian as we've described does not guarantee that your assets will never be lost or stolen, but we believe the risk is greatly reduced compared to the alternative. It also says nothing about whether your investments themselves gain or lose money and does not protect you from market losses.
The bottom line is if you have assets or are considering investing in something that does not have a third-party custodian (which could include certain partnership investments), think carefully about whether you can verify proof of ownership and accessibility to the assets. Consider whether a potentially higher return is worth the risk of the loss of the asset itself.