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!