When the market goes up and down like this, all we hear about is « patience » and « diversification ». While it is sometimes a bit annoying to hear the same broken record over and over again, this is sound advice. If you are too concentrated in a specific sector (Techno in the 90’s and financials in 2008 just to name two examples!) you will suffer a lot more than other investors.
Besides fixed income and equities or sectorial and geographic diversification, are there any other ways you can look at your portfolio to make sure it is well diversified? There are a few other things to consider while building your portfolio. I’ve discussed how I manage my asset allocation but there are other types of diversification that are considered uncommon. I think it’s important to consider the big picture when it comes to looking at your personal finances.
#1 Your Job
As an individual, you are definitely your biggest asset. You are indeed the asset producing the most income in your portfolio. This is why it is important to consider the type of job you have in your asset allocation. For example, traders and brokers will have a higher tendency of investing in safer assets when it comes to their own portfolio. They know that their income is fairly variable and that they can be fired in a heartbeat. Therefore, they need to rely on something liquid and safe if they ever need money at the end of the month. On the other hand, government employees, teachers and other professionals could take more risk in their portfolio as they will most likely keep their jobs for a long time. In my own situation (I’m a financial planner in a bank), I don’t fear being fired as there is a lack of financial planners in my market. This is why I can take more risk with my portfolio. As you can see, your job can be counted on both sides; fixed income or equity!
#2 Real Estate
This is probably one of the most common types of investments for people who don’t like stock market fluctuations. Depending on the investor’s perspective, Real Estate can be seen as fixed income and equity as well. Some people will by condos in order to generate capital gains. This is called speculation and it is as risky as the stock market in my opinion. It is probably even more risky when you invest most of your money in a single opportunity! On the other hand, if you buy a well maintained triplex and earn rental income from it, chances are that you will consider your property as fixed income. Even then, some investors consider real estate like good dividend stock payers. Don’t forget that you have to factor in the cost of maintenance along with your time required to take care of your building.
#3 Pension Plan
When you adjust your asset allocation, it is very important that you consider all types of account you may have. Great employers offer different types of pension plans to their employees. If you have one, you should consider it to understand the big picture. If it is a defined benefit pension plan (i.e. you have no control over the fund management and the employer is fully responsible to give you’re a predetermined pension), this should be considered as fixed income. If you are in a defined contribution plan (i.e. you and your employer’s contributions but no pension payment is determined upon retirement; you get what’s in the pot), you should include the way the pension plan is invested in your asset allocation. You can have a riskier portfolio in your pension plan since you know you won’t be withdrawing money from this account until you retire.
#4 Private company shares
If you are self employed, have your own company or are a silent partner in another business, this participation should count in your asset allocation as well. It will most likely be considered as equity as the business, even if you know it pretty well, is as risky as any other shares on the stock market. It is challenging to value the company shares when it is a private entity. You should consider looking for an accountant’s help and also determine the level of liquidity. Some company shares are completely illiquid. This is why you should always remain highly conservative when valuing share worth. It isn’t worth what you think it worth, it worth how much someone else is willing to pay for it.
Considering the big picture before making a move
You will rarely see a financial advisor considering the above mentioned points as they are harder to assess. But I think it is important to consider them before you make any investment moves. As an example, back in 2008, all Canadian banks shares dropped by more than 50%. I was tempted to invest an additional 10K in them since I thought that they were devalued for the wrong reason (panic on the market). However, after considering the big picture (I work in a bank, I have my pension plan there and I already have bank shares in my portfolio), I decided to not make the move. While it’s easy to say that I missed a great opportunity after the fact, if things went the other way around, it would have been a very big mistake! Have you ever consider more than your portfolio in your diversification?