Too much
gold… too much cash… too great a holding in your employer’s stock…
Diversification
is as old as investing itself. At its
most basic definition, diversification simply means that you should diversify
your investments over a few different asset classes, rather than one (or a
few).
Many US
homeowners lost all their equity (assuming they had any to begin with)
during the recent housing market collapse.
The simple math behind this investment dilemma is that homeowners
‘bought’ more house than they needed,
and for more money than what they were able to afford… with the bank’s
money. Stupid home buyers propped up by
stupid bankers!
How could
you lose “all your equity” on a residential home, you may ask? Well, you may have bought the house with 3%
(FHA) down, or put down 30% of your hard earned, saved cash. Either way, you didn’t
buy the home - the party that contributed the balance of the purchase price that you did not have,
bought the house for you, and you rented it from that financier (the mortgage company, or bank), regardless of whose name appeared
on the title deed.
Also, if
you bought a house and your were paying $x monthly for the mortgage, $y for annual property tax and $z dollars for upkeep and maintenance… you didn’t have an
asset to begin with, but a recurring, ongoing, monthly liability!
Add to
these woes a stock market that’s been up and down, frequently by >1% in one
day, a collapse in the price of gold, ‘high yield’ bonds delivering low yields,
employees losing their jobs (and not being able to find work when unemployed),
general lack of political will and direction, overinvestment in one investment vehicle
or class… and you end up with a recipe for a really disgusting minestrone!
Employees
often benefit from buying their employers’ stock at a discount, or may even be
given stock in lieu of cash. This ranges
from large, publicly traded companies offering their employees a discount of
e.g. 15% of the market value of the company’s stock, to start-ups that have no
money... and give employees company stock because the start-up may not have enough cash to pay its people.
The
concepts above are attractive to most people.
Unfortunately, many ‘middle class’ members may own too much of their
employer's stock AND live in a house that is owned by the bank (did you miss the section
3 paragraphs above?). Regardless of the
fact that this may represent a somewhat diversified investment strategy – property and
equity – you may inadvertently have ended up with a concentrated position, i.e.
an equity position in your employer’s stock, while you spend most of your
monthly income paying rent (to the lender of your mortgage on your house).
How to
diversify then?
Firstly,
debt is the classic middle class trap – student loans, home loans, credit card
debt, cars on leases, etc. Get rid of
it. Secondly, manage yourself out of your
concentrated positions.
If you own
too much of your employer’s stock, sell some and move that cash elsewhere, e.g.
into other stocks. If you live in a
mortgaged house and servicing that debt costs you e.g. more than 30% of your net
income, get out of that concentrated liability position by downsizing, renting
out a basement room, refinancing, etc.
Stop living above your means – this is your greatest financial risk; causing you to run the risk of not
being able to service your debt, should your circumstances change
unexpectedly!
There is no
singular safe investment. Cash declines daily, even if only as a result of
inflation. Gold – an investment with
fundamentals based entirely on shiny – is only a psychological safe haven
until the next crash. Equities are volatile, constantly going up and
down. Safe paper investments
(treasuries, municipal bonds, etc.) offer returns commensurate with bank savings
accounts, i.e. almost nothing.
Work to
create a truly diversified investment position, mixing some property with
equities, cash and other investments (anything of appreciating value). Feel like buying gold because it's suddenly cheap again - maybe allocate 5% of your portfolio to a gold ETF, perhaps by reducing your cash position from 15% down to 10%.
Good luck
managing your financial risk, diversifying your investments... and may your returns be stellar!
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