Factor In Your Income Sources When Seeking Diversification
When it comes to diversification, you have to look at your entire life and not just your portfolio. Several years ago there was a book I really enjoyed that dealt with this topic called Are You a Stock or a Bond?: Create Your Own Pension Plan for a Secure Financial Future.
It explained some professions, like tenured professors, are similar to bonds – there is little risk of you ever losing your job, the pay it steady and almost fixed with small incremental increases based upon inflation, and you can project how many years you have remaining. Other professions, like an small business owner, are stocks because the earnings fluctuate wildly from year-to-year, sometimes bringing great riches and sometimes ruin.
The premise of the book was that those who have “bond professions” should invest most of their money in stocks because they could take advantage of collapsing markets and those who have “stock professions” should put most of their money in bonds and fixed income investments because when things were going south, they would need access to their cash. The underlying theory was something I’ve said countless times at my Investing for Beginners site – you must diversify your income sources as well as your assets. I would never want to be in a position having to rely on a salary from one or two employers to pay the bills. It puts you at the mercy of other people.
How We Apply This Diversification Principle In My Own Family
Most of you know that my family has a considerable portion of its net worth in domestic manufacturing. We like making things in America, hiring American workers, and selling to fellow Americans in light of the jobs that had been previously lost in the manufacturing sector. Of course, I have my businesses but my parents still own and operate the company they founded, going to work every day, and paying themselves a small salary so they can reinvest almost everything.
How do they protect against the troubles in domestic manufacturing? One way is to take virtually all of the retirement assets they dutifully save each year (not the brokerage accounts or other investments but the money that is regularly put aside each year in tax-advantaged accounts and plans) and invest the money internationally by buying global equities. Most of this is hedged back to the dollar to protect our purchasing power because, after all, we pay our bills in greenbacks.
Of the stock portion of the retirement plans, diversification is truly a global affair: Although all of the assets are held in American based accounts, roughly 15% of the equities are high-quality, blue chip stocks with attractive dividends from Switzerland (companies like Nestle, Roche, and Novartis), nearly 14% is in Germany (companies like Henkel, Linde, and Axel Springer), 9.5% is in The Netherlands, 7% is in Great Britain, 6% in France, 5.5% split between South Korea and Singapore, 5.5% in Mexico, 6.5% in Japan, 3% in Finland, etc. These companies sell everything from insurance and production machinery to chocolate, beer and soap.
The Global Diversification Plan Started Small
Years ago, when my parents first started investing in international stocks for the sake of diversification, they researched plans and began by contributing $500 per month each, or $1,000 between the two of them. Several of their employees opened accounts, as well (the smart ones had the money taken out of their bank account each month so during the global credit crisis and collapse, as they continued working in the Midwest, part of their money was going to buy up the stocks around the world everyone else was forced to sell). I still remember us all sitting around the older (much smaller) factory and filling out the paperwork together.
This is why it is important, even in your diversification plan, to not “despise the day of small beginnings”. Every giant Redwood on the planet started out as a tiny seed. Back in those days, the objective wasn’t to get rich, it was just to put something aside in savings for retirement. It seemed like common sense that if all of our money was at risk in the United States manufacturing sector, we should want to have our safety net working in high quality companies with little to no connection or correlation so we could rely on it if things went south (thank God, they never did but when you have a small company, you are constantly worrying about keeping the lights on and the doors unlocked).
This approach to diversification is designed to reduce risk. If you work for a cereal maker, why would you want all of your retirement assets invested in the food industry? If you were to lose your job, it would likely be at a time when food stocks were getting hammered because of problems in the industry. All of this should factor into your risk management decisions.