Diversification

You’ve probably heard the phrase ‘don’t put all your eggs in one basket’ before. And that’s essentially what diversification is all about.

Diversification‘ is a risk management strategy, usually applied to investment portfolios. But it’s important for us to consider as individuals as well, in relation to our income.

Consider two couples. Abby and Bobby run a business, from which they bring home $132,000 a year ($50k in salaries each, plus $32k in profits).

Carrie on the other hand earns a $45k salary (working for Abby and Bobby), and $1k selling handprinted t-shirts. Carrie’s partner Derrie earns $25k at a part-time job, and together they earn $2k an year in dividends. Their total income is $66,000.

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How diversified is your income?

You don’t need to be a maths whizz to know that Abby and Bobby earn a lot more than Carrie and Derrie. (Twice as much, in fact).

But Carrie and Derrie have four sources of income. Abby and Bobby have only one.

If Abby and Bobby’s store closes, Carrie and Derrie will suffer, too. Their income will be reduced from $66k to $21k.

But Abby and Bobby will be left penniless.

In this respect, even though Abby and Bobby have more money than Carrie and Derrie, their financial situation is more precarious. (You can read more about income diversification on Enrichmentality)

Activity:

Diversifying your finances

If you’ve been looking at your Financial Foundations and discovered that all or most of your income comes from a single source, then there are a range of actions you can take to make your situation more robust. Here are some ideas:

  • Make a list of your assets, and identify those you could easily turn into cash. Make a reasonable estimate of what you could sell these assets for quickly, if you had to, in an emergency. I’m not suggestion you actually sell these items (unless you discover some you aren’t using and would be better of transformed into cash!). It is simply good to know what safety nets you have in case you ever need them.
    The Net Worth Calculator on Enrichmentality may help you in preparing your list.
  • Consider whether you might need income protection insurance. This is especially important if you have any outstanding debts like a home or car loan, which you may be unable to make payments on if your income disappeared. Ensure that you obtain trustworthy, unbiased advice (i.e. not from someone selling insurance or who will receive a commission), and that you read the fine print carefully. Some kinds of insurance are of limited use to certain individuals, for example, they won’t pay out if you are already ahead in your mortgage payments. It is also possible that you’re already covered. You may find the post ‘Do I need insurance?‘ on Enrichmentality useful.
  • Think about other income options. Could you get a part-time job? Work online? Make and sell things? Start your own business?

Activity:

Applying diversification elsewhere

The concept of diversification is important in other contexts as well. Consider the following questions

Do you have all of your money in the one account?
If so, would it be a good idea to invest some elsewhere?

Are you considering any big purchases or upgrades?
If so, would buying a smaller apartment to live in, and one as an investment, be more sensible than ‘upgrading’ your home?

And it’s not just financial situations that diversification is applicable to.

You can apply it to your creative work, as well.

For example, I wanted to pick up a musical instrument after almost two decades of not playing. My first choice was to go straight back to the violin. And I did. But then, as soon as my husband and I decided to start traveling, violin was no longer an option for me, and I lost all ability to play music.

At least, until I diversified – I picked up a fife made of lightweight, strong plastic, in the same key as a violin – perfect for traveling, and for keeping up my music-reading practice.

In engineering, this is referred to as a redundancy. The goal is to look for critical components of your life, and build in a backup or fail-safe which performs the same functions, but is distinct from the original component.

Your boss giving you a pay raise is great, but unless you’re investing the extra cash in something that will provide an additional income stream, it won’t make you any less fragile. Backing up your novel on an external drive… that you keep in next to your computer… won’t save your work if there’s a fire in your office. And buying a second drum kit won’t give you any more opportunity to practice – especially if your neighbors complain. You would have been better off getting an electronic set.

Jot down now three ways that you can improve the diversification in your life, to strengthen your economic and creative foundations.

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