It’s Time to Diversify How We Think About Diversification

When it comes to diversification and personal finances, most people immediately think of investments. But in many ways, that’s too narrow a definition. A broader application of diversification may be what’s missing in your financial plan.

Here are four ways to consider the idea of “diversification” as it applies to your money:

1) Diversification of Investments – This is the most common form of “diversification” and what many of us associate with the term. Having diversified investments typically means more than just holding different investments in your portfolio. To have a truly diversified investment portfolio, you need to hold investments that are “uncorrelated” – meaning that, statistically and historically, they tend to “move” and react differently based on market conditions. Therefore, some assets would rise while other decrease in value, making your overall portfolio less volatile over time.

Have several U.S. large company stocks, for example, would not be considered a well-diversified portfolio. Although it’s better than, say, holding one stock, U.S. large company stocks generally tend to rise and fall together under similar market circumstances.

It’s like having a bunch of bananas – while some may be ripe and some less sweet, you’re still just eating bananas. Like the picture included, it’s often better to hold a larger selection of “fruits” or assets.

To truly diversify your investment portfolio, you would want to hold, not only a broad basket of U.S. large stocks, but also some smaller company U.S. stocks (“U.S. small cap”), various bonds (possibly including municipal, inflation-protected bonds, government and corporate bonds, high-yield bonds, etc.), global stocks and bonds (both developed and emerging markets), REITS, and possibly some alternative investments. For accounts that are smaller, you may be able to accomplish this type of diversification through holding a broad basket mutual fund or target date retirement fund.

2) Diversification of Accounts – In addition to have a range of uncorrelated investments in your portfolio, you also might benefit from having different types of accounts. Specifically, it’s often a good idea to have both taxable accounts as well as tax-deferred retirement accounts, such as a 401(k) or IRA.

While it’s tempting to maximize your retirement contributions in order to take advantage of the tax deferrals, this is not always the best strategy, especially if you do not have sufficient savings in a taxable. Putting too much in a retirement account, especially ones such as a 401(k) or traditional IRA that has a minimum required distribution, at the expense of building up taxable savings could put a strain on your later years when you are suddenly hit with a huge tax bill when you’re required by law to withdraw from the account (the exception being a Roth IRA, which does not have RMDs and in which you contribute after-tax dollars and thus will not owe taxes on the back-end).

It’s good to build up some money in a taxable account also to use for both emergency savings, as well as short- and long-term spending. Depending upon your situation, you may want to maximize your contributions up to an employer match if you have one, and then increase your taxable savings or contribute to a Roth IRA.

3) Diversification of Income – The definition of diversification should also apply to your income! Having more than one income source during your earning years and beyond is a fantastic way to build success and peace of mind into your financial plan.

Having investments is one way to diversify your income. But, there are so many other ways! If you are married or in a partnership, this might mean having dual income – that is, where both partners work to avoid over-dependence on one person’s employment. Or it could mean something more creative, like having a side gig or two that generates passive or extra income.

Recently, I stumbled upon a great podcast by Chris Guillebeau called “Side Hustle School.” It highlights people creating second businesses generating thousands of extra dollars in income, while still holding a “day” job. Check it out for some inspiration!

4) Diversification of Habits – Finally, what’s a blog from me without a discussion on habits? Another way to consider diversification as it applies to your money is to think about diversifying your habits.

When it comes to your personal finances, what are you doing currently that working? Are you saving and tracking your expenses? Are you regularly rebalancing your portfolio? Are you reading personal finance blogs (like this one!) or getting more organized with your paperwork?

Awesome! After you’re done patting yourself on the back, think about what’s NOT working. What is one small habit that you could start implementing today (or, for that matter, a bad habit that you could STOP doing) that could affect your money matters positively and significantly?

One of my favorite quotes is “How you spend your days is how you spend your life.” (A. Dillard).As a corollary, how you can diversify your financial habits so your financial life is that much better a year from today?

Have we chatted yet about your personal finances? Do you need help with budgeting or figuring out what you need to do with your money? Let’s talk. Schedule a complimentary call at jennifer@financialwealthbeing.com.