Diversification: "Old Wall" vs. "New World"

"Don't put all your eggs in one basket!"

"Old Wall" is a common Twitter hashtag (#OldWall).  It is used to describe Wall Street investment bankers, traders and advisors who are steeped in tradition, supposedly out of touch with the modern trading trading environment (e.g. where trades are executed in milliseconds), people who spend large amounts on their personal appearance to be able to present as successful bankers - you get the picture!

"New World" has no such description; I simply made it up to imply the inverse, or opposite, of #OldWall.

Investment advisors have traditionally, and quite correctly, advised their clients to diversify.  This often meant that the client's savings would be distributed across different asset classes, or investment vehicles, in order to help mitigate risk of losses.  

For example: let's say you had investments of $1,000 each in gold, healthcare and energy: Oil went up while a little, the price of gold remained static, and healthcare stocks 'took a bit of a hit' because of new legislation.  Spread equally - or diversified across all three - the investor may have avoided a gross loss, because her gold is still worth $1,000; perhaps the energy stocks are now trading at $1,100, and the healthcare investment is worth $950.

"Don't put all your eggs in one basket, and diversify each basket even further!"

So... here's the "New World" philosophy:

Not only do you place your eggs in more than one basket, but you also place a variety of different eggs in each different basket.  

Let me explain a little further... if we assume each basket in the image immediately above (respectively) equals the one, single basket at the top, then I am able to diversify even further. If one of the little baskets above holds equity (stocks, bonds, ETFs) spread across different assets (like energy, healthcare & gold in my example above), I still have two baskets remaining to diversify and mitigate my investment risk even further.

I would imagine that a second basket may hold a mix of liquid assets, like cash (and variations of cash, e.g. interest-baring savings bonds or certificates).  One can diversify cash in many different ways, including deposits held in a stable currency (e.g. British Pound Sterling) if you live in a country with a volatile currency.  Holding at least 6-months worth of cash to cover the possible risk of unexpected illness or loss of a job makes reasonable sense.  More would be better!

A third basket is then available for illiquid assets (e.g. investment properties), an annuity, and perhaps even some higher risk, greater return stocks - or investments in faster growing companies than Dow blue-chips that typically average 7% annually.  Note that higher risk, higher returns also exposes you to higher risk, greater losses, but now you're down to 5-10% of you entire portfolio.

Note that a house you live in would typically not be viewed as an investment, unless e.g. you're renting out rooms to tenants while you live there.  Anything that costs you money on a regular basis is not an investment (except perhaps in accounting terms), but a current liability.  If you live in a house and your income from that "investment" is $0 monthly; and your property tax, utilities, maintenance, etc. costs you $1,000 monthly - this represents a $1,000 ongoing current liability.

If - in the future - you were to sell your house that you had been living in for some time, for an amount that is significantly greater than what you had paid for it originally (compounded at say >5% per annually; because you can do better than that in the stock market), it may then be view as an investment, at the time of sale, that delivered a (hopefully) positive return.

Challenge: Do a time value calculation to determine if a $350,000 house bought in 2002, that is sold for $500,000 in 2012 is a good investment, or not.  If you need help, ask me!

In investment terms, assets deliver continuous passive income, not continuous cost!  Take caution so as not to confuse fixed assets (the house you live in) with investments (that generate income).

A new world diversified portfolio does not only spread investments across different types of equities (or similar), but across different asset classes too.  An investment advisor may not want you to become a landlord, or have too much money in the bank (of course, you may not want either, but you have choices and alternatives to consider).  The reason for the aforesaid is simply because an investment advisor typically earns commission on trades made on your behalf, and she cannot earn commission on e.g. your investment property income or on your interest on cash deposits

When someone offers you investment advice for a fee, and you want to trust them with your hard-earned cash, always limit the access you give them for managing your wealth to a portion (e.g. one small basket) and not the entire portfolio.

Have fun... because investing should be fun.  And if it isn't fun... then change the way in which you're managing your investments!