Blog | Personal Finance

Bring Focus to the Diversification of Your Portfolio

Use this guide to discover how you can diversify your portfolio (or not)

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I have a friend who loves woodworking so much, he can get lost in it for hours before realizing any time has passed. He’ll “pop into his shop” for 5 minutes to tighten a screw on something and emerge three hours later with an impromptu spice rack because he was so caught up in his work.

When was the last time that happened to you — that you were so absorbed in a task that you lost track of time? That’s a sure sign of being completely in sync with what you love.

Conversely, if you’re not interested in something, then every moment you are forced to spend on it will feel like drudgery.

This concept holds true when it comes to selecting assets to invest in, as there are several asset classes from which to choose. It’s crucial you choose the asset that best suits your personality, values, and lifestyle if you want to feel connected to and enjoy dedicating time to maintaining your those assets.

The Five Primary Asset Classes

While there are many assets you can choose to invest in, I’d like to discuss the five primary asset classes today. They are:

  1. Business

    If you are considering starting a business, then you can use your own money, raise money from private individuals or borrow money from a traditional lender in order to get started. The purpose of the money you invest, no matter where it comes from, is to generate a return on that investment — which will go back to you, the business, and your investors and/or lender.

    Now, let’s say a friend comes to you seeking an investment in his/her business idea or gives you a hot tip on an investment they are making in someone else’s business. You may choose to invest in this private business or company — after first doing your due diligence to determine if the opportunity is right for you, of course. Since the business and the owners may or may not be familiar to you, you’ll need to do your homework on:

    • The project (the business itself),

    • The partners,

    • The financing, and

    • The business and management team.

  2. Real Estate

    There are two main reasons to invest in real estate: for cash flow from rental properties and for capital gains when you buy and sell (flip) properties. I invest primarily in rental real estate because cash flow fits my formula for financial independence. You’ll decide which model works best for your goals and situation.

    Real estate investing is not a one-size-fits-all solution. There are many investment options when it comes to this asset class: single family, duplex, triplex, apartment buildings, office buildings, retail strip malls and shopping centers, and industrial properties such as warehouses, hotels and mobile-home parks. It’s best to start small in the beginning, but the sky is literally the limit — maybe someday you’ll own a skyscraper!

    One of the biggest benefits of real estate is the concept of leverage. Leverage is the ability to use OPM (or Other People’s Money) to purchase the asset. A property that is highly leveraged means there is a lot of debt on the property compared to equity (equity means the current market value minus the debt.) A property that has a debt of 90 percent (which means the owners and investors put down 10 percent) is more highly leveraged than a property that borrowed 70 percent and put 30 percent cash into it. The higher the debt on the property, the lower the cash flow. The lower the debt, the higher the cash flow. You can learn more about using other people’s money to invest here.

  3. Paper Assets

    Most people are already familiar with traditional paper assets, which include stocks, bonds, mutual funds, and retirement accounts. You can also invest in stock options, stock futures, and foreign exchange. Paper assets include REITs (real estate investment trusts), which are funds that only invest in real estate. Paper assets also include ETFs (exchange-traded funds).

    This asset class is typically capital-gains investments (versus cash flow). However, stock dividends are taxed as cash flow. Once you learn the language of paper assets, you can jump right into investing.

  4. Commodities

    The next asset class is commodities — metals such as gold, silver, and copper; food such as grains, corn, coffee, and sugar; and raw materials such as oil, gas, and cotton. The price of commodities is typically driven by supply and demand. If there is a bumper year of corn, then prices are low since the supply of corn is high. If, on the other hand, there is a shortage of corn due to a drought and unfavorable weather conditions, then the price of corn will be high.

    You can buy commodities such as gold and silver at your local precious-metals dealer. Or you can buy what are called future contracts of any commodity through the futures exchanges.

    Commodities are generally a capital-gains (or loss) asset instead of cash flow situation.

  5. Cryptocurrency

    The final asset class is cryptocurrency, a decentralized digital currency that you can buy, sell or exchange directly — and it’s not backed by the government or any issuing institution. It seems everyone is talking about digital currencies like Bitcoin, Ethereum, Tron, and Litecoin (there are more than 5,000 cryptocurrencies in existence today) these days. And why not? With massive fluctuations in value and short-term gains in the 1000% range, it’s very exciting and enticing stuff.

    Some people are turning to bitcoin and other cryptocurrencies as an alternative investment, helping to diversify their portfolio. There are two main types of investors: those who buy and hold it long term and those who buy and sell after a price rally. But just like with the stock market, if you don’t know what you’re doing, you’re bound to get burned.

    Yes, if you haven’t done your due diligence, there’s a potentially dangerous side to the game of cryptocurrency. How so? Here’s an unfortunate list of would-be crypto-millionaires who lost their passwords and got locked out of their own fortunes. And here’s the story of a man who owns $321 million in bitcoin, but can’t access it. Ouch. Also, there are unpredictable crashes, just like with the stock market — like this 11% one-day drop earlier this week.

    Another word of caution, while I’m at it: Cryptocurrency is not an asset, because it does not put money in your pocket. Because it is exploding in value, many people feel rich, but they are not. Bitcoin and other cryptocurrencies are not useful for commerce, so the only way to realize value is to sell. Only then, if you make a profit, do they become an asset.

    And yes, there are plenty of women getting in on the crypto craze as we begin to break down the barriers of the crypto-fraternity mentality. And there’s plenty of room for you, too!

Focus and Diversify — an Oxymoron?

If you absolutely have no interest in the price of silver or think bonds are boring, then you won’t enjoy the day-to-day work associated with managing those asset classes. Although it’s important to primarily invest in the things you’re most passionate about, it’s also important to be diversified. But what does that mean?

You’ve probably heard a financial planner preach about the importance of a “diversified portfolio” at some point — but what exactly is their definition of diversification?

When most financial planners and advisers tell you to have a diversified portfolio, they are usually referring just to your stock portfolio.

When most financial planners and advisers tell you to have a diversified portfolio, they are usually referring just to your stock portfolio. Diversification to them means investing across the various stock sectors, such as large cap, small cap, blended, blue chip, high tech, or alternative energy.

But here’s a little hint: To truly be diversified means to diversify beyond paper assets, across all asset classes.

Today Robert and I are invested in all five asset classes. Each asset class reacts to the markets differently, and each asset within each class may respond differently as well. Time and time again, we’ve witness how putting all your money in one basket may not reward you with the financial security you desire. So it’s wise to get comfortable with each asset class and become a well-rounded investor.

Original publish date: March 13, 2014

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