Diversification Definition

Here is the real reason why you should care about Diversification. If you look up the definition of Diversification by Merriam Webster it meansto balance (as an investment portfolio) defensively by dividing funds among securities of different industries or of different classes. The takeaway from that definition is “different industry” and “classes” don’t get hung up on the traditional term of securities as just the public stock market. You can actually be in the same industry and very diversified with the various classes within an industry.

Take a look at John McAfee from McAfee anti-virus worth nearly $100 million dollars and was pounded with the recent wall street onslaught. Unfortunately, to add insult to injury Mr. McAfee was also heavily invested in luxury real estate which was annihilated in the last five years as well. Mr. McAfee was diversified into two industries, public securities and luxury real estate. Diversification requires placing investments in multiple industries and drilling down into classes within those industries. Mr. McAfee chose a luxury real estate class but could have also diversified into retail, office, industrial and multi-family properties. As far as the stock market is concerned, if you are only long in public securities your time horizon should be 15 – 20+ years otherwise hedging with options and shorts across several industries is a more prudent decision.

It is hard enough to earn and invest after-tax dollars in this world and if little consideration is paid to diversification it will lead to poor investment decisions or loss of principal investment.

The fundamental problem we have as humans is Diversification. The definition doesn’t even resonate with how modern day culture has breed us. We all tend to be the Hare instead of the tortoise.

What are ways you can diversify today:

Commodities
Mutual funds, stocks & bonds
Commercial real estate
Residential real estate
Rental equipment
Retirement accounts 401K & Roth 401K
Currency

Once you decide on an approach and lay out a diversification plan be sure to pay particular attention to the following areas:

1. Tax implications
When planning out your diversification plan taxes will be an essential consideration. Just one tax law policy change like Capital gains tax could drastically reduce any wealth one builds in a lifetime. Imagine if long term capital gains tax went from 15% to be treated as ordinary income (25% -38%) depending on your bracket. If you have retirement accounts like a Roth IRA where you place after-tax dollars into accounts for a tax-free withdrawal and tax deferred retirement accounts.

2. Political implications
Government involvement in certain industries could be a huge investment problem. If your investments are with companies that are do business in one country as opposed to being a global enterprise your risk will be drastically increased if politically strife breaks out.

3. Income Diversification
Be sure to generate multiple streams of income particularity passive income. Passive income is when you are no longer trading hours for dollars. Rental property, stock dividends etc. are various forms of passive income. This doesn’t mean give up your day job but supplement passive income until to longer need to work your day job.

Trying to find the magic formula as fast as you can that will make you millions is probably the wrong approach. Creating multiple income streams from various diversified sources is a much better approach. Making steady, smart investment decisions will pay off in the long run and as the cliche goes don’t put all your eggs in one basket.