The key to managing your savings is diversification. Diversification is the spreading of you assets to ensure safety and security of the entire portfolio from the up and downs experienced in each asset class. In short, diversification is the thinning out of the peak and valley nature of certain investments. Diversification does not mean boring. It does not mean buying only stable small gaining assets. Instead, its the avoidance of putting all your eggs in one basket. At the end of the day, you diversify your assets so you have simple peace of mind that nothing will cause a dramatic change in your portfolio, that your savings are safe.
In my opinion, diversification should take place at each level of your savings. Its not just about investing in different stocks, its the spreading your assets in each pool of investments and should end up looking like a pyramid.
So think of a hypothetical amount of NET Savings (all your assets less all your liabilities). This amount of money should be spread out over several investment devices. I'm not going to stipulate at what percentage this breakout should be, but the more even you keep it, the more insulation you should typically have. If your savings are all in your house's equity and the value of your house drops 25%, well you just took a hickey to your whole portfolio. If you put it all into stocks and the market has a sudden drop of 5%, that is a lot of wealth to lose in one day. So think about all these different savings options.
1. Real Estate - This doesn't have to be just your house. You like fixing up houses? Consider a rental property. You like hunting and fishing, think about a ranch of sorts. You can also invest in REITs (Real Estate Investment Trusts) which is like investing in a stock of real estate type assets that pay a "dividend" based on the earnings of the trust assets on a regular basis.
2. Cash - I'm not a big proponent of sitting on a lot of cash as you risk inflation diminishing the value of your paper and earns essentially nothing, but keeping cash on hand for a rainy day is always a good strategy as it is your most liquid asset. Also think about splitting it over two banking institutions on the very off chance something happens to one of them. The FDIC (a government entity) insures your deposits up to a certain amount (I believe its a quarter of a million dollars) but why even worry about it. If you have cash sitting there, maybe you split it into different currencies. Think the dollar will tank with all this debt we have? Well, take some of that cash and put it into Euro's, Yen or Canadian Dollars. Should you need the cash its easily convertable and you insulated this asset class from significant devaluation.
3. Bonds - There are tons of bond types out there from US Treasuries, to municipal and corporate bonds. They each provide a different return on investment, tax strategies and relative safety which we can talk about more later, but at the end of the day, bonds are designed to pay you an interest rate for lending your money. It typically brings a lower return than you would find in other investment classes, but provides relatively more safety. One theory is that the closer you get to retirement, the more assets you should take from riskier stock assets and put more into "safer" cash flow earning bonds. Within bonds, you should diversify over different bond types should any one default (not pay) on their bonds.
4. Commodities - Commodities can be both tangible and intangible assets. Buy some gold coins or silver bars and stick them in a safe. Or buy future contracts on barrels of oil. The going theory with commodities are they are a safe haven during times of inflation as they are priced in currency prices (value of the dollar goes down, you lose value in your cash, but the price of gold goes up) so they are a good hedge against inflation. Additionally, tangible assets give you some comfort during extreme liquidity crises. A commodity is just a good that could be bought and sold and can range from cotton to pork bellies to copper to gasoline. At the end of the day I believe the most positive reason for owning commodities is to protect from inflation.
5. Stocks - Most people think of this first when you hear someone talk about investments. There are countless strategies to own stock. You can buy a share in a single company or you could buy a share in a mutual fund which is a grouping of many stocks. When it comes to diversifying your stock portfolio, my only recommendation is that you purchase several different companies or a few different funds and you focus on multiple different industries. For example, you are not really diversifying well if you buy five different stocks or 3 different funds, but they are all financial institutions. Think about spreading the wealth over several groups such as consumer staples, defense companies, health care, etc.
There is no right answer when it comes to diversifying your assets. There are many more investment opportunities than those listed but the point is you should mix it up a little bit. Spend some time to understand the pros and cons of each class and then proactively develop and execute a plan to diversify over several investment tools. At the end of the day you want to be able to sleep easy knowing that your savings are safeguarded to the best of your ability. Additionally, in taking part in this activity on a regular basis, it allows you to take stock (no pun intended) of your portfolio and act as a catalyst for your continued task of building your wealth.
Sincerely,
Coco
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