Financial Diversification in 5 Flavours

GroWiser flavours of financial diversification

Financial diversification is a fairly predictable topic for Easter Sunday. The abundance of Easter eggs and baskets gives us the ideal opportunity to ponder some flavours of financial risk.

“Don’t put all your eggs in one basket” is an ancient proverb, believed to be of Spanish or Italian origin. It’s commonly attributed to the book “Don Quixote” written by Miguel de Cervantes in the early 1600s.

In the world of personal finance, the phrase is often used to remind us that our investments should be spread over many different companies and asset classes to diversify risk.

This ancient wisdom can be applied to a wider range of scenarios than just investment though. Let’s take a look at some flavours of diversification.

Mint chocolate: The “too much safely in the bank” basket

Keeping the bulk of your savings in the bank may feel safe. You cash balance is stable, and you can withdraw pretty much whenever you like.

Maybe you’ve done well to accumulate a decent pile of cash over the years. Or perhaps you’ve received an inheritance, won the lottery, sold a business or received a redundancy pay-out.

But how can “too much cash” even be a thing? There are a couple of key risks that are often overlooked.

Unlikely as it is that a bank will fail, they are not always 100% safe. Think back to 2008 when Northern Rock had to be nationalised due to the banking crisis. Remember the queues of people on TV, lining up to withdraw cash from the troubled bank?

The Financial Services Compensation Scheme offers some protection, but it’s not absolute. Try to visualise your bank, building society or credit union as an egg within your savings basket.

The scheme will protect those eggs up to the value of £85,000 each. That limit is per person, so bank accounts in joint names will be covered up to £170,000. If your ‘eggs’ are bigger than that, you could lose out if your bank fails.

The other danger of “too much cash” is the hidden risk of inflation over the long term. Even in times of higher interest rates, bank deposits will struggle to keep up with the cost of living. This means that the spending power of cash in the bank will usually reduce over the years.

It’s generally best to diversify your savings over different asset classes. This means not just having several different eggs in the one basket. It means having a selection of different baskets, such as investments in shares, bonds and property.

Milk chocolate: The “Too little investment diversification” basket

Milk chocolate Easter Egg

This is the classic definition of diversification. A well-balanced investment portfolio will be spread across different asset classes, geographical regions, sectors and sizes of companies.

This helps to spread the risk and can reduce the volatility of your overall investment portfolio.

This is where financial advisers and investment managers will focus some of their expertise. They can construct portfolios that align with your own, personal risk profile or “attitude to risk”. You can read more at the government’s money advice service.

Nowadays, it’s possible to build your own well-diversified portfolio with a little bit of effort. Automated advice websites and apps, or “robo-advisers”, are becoming commonplace. Boring Money provides some independent commentary on the most popular robo-advisers and investment apps.

White chocolate: The “too much concentrated personal development” basket

This one is not really about money. Think about how you develop your own knowledge and skills. Is your investment in you diversified enough?

We will always need specialists, like brain surgeons and scientific researchers. Some people focus on their chosen passion and become true experts in their field. You could be one of them.

But generalist careers can also be very rewarding. Things are always changing and people need to adapt. Many popular jobs that we take for granted now will not exist in the future. That presents a risk to future earnings potential for some.

Maybe you have a hobby or a side hustle that could be developed into a future career. Or maybe you just need to think carefully about how your existing job might change in the future. Start preparing now and stay ahead of the game.

This article by careeraddict.com suggests some well-established careers that could disappear by 2030. Bank tellers, posties and travel agents beware, among others!

Orange chocolate : The “too much reliance on one source of income” basket

Most of us start out with one source of income when we begin our first job. That’s ok, and it was definitely the norm for those of us over 40.

But lifestyle trends change and ‘portfolio careers’ are becoming more popular. This means working in a variety of roles. It could be a mixture of part time employment, freelancing and running a small business.

This approach reduces the reliance on any one source of income. It can also provide a more varied working life.

Forced redundancy has had a crippling effect on many families. Others have felt disappointment in retirement as their sole pension fund has run into trouble.

Consider how you can build up multiple income streams for future financial security. Here are some tips from thecareerpsychologist.com.

Dark chocolate: The “too much faith in your employer” basket

My least favourite flavour. I’ve met too many loyal employees of big firms who build up significant holdings of shares in their company. It could be through Save As Your Earn schemes, share options and bonus schemes. It’s happened to myself in the banking world.

You think your company is solid and nothing could ever go wrong. Then something unexpected happens and the share value plummets, like the banking crisis of 2008.

Don’t get me wrong. This is not suggesting that company share scheme are not good. They are. In fact, they can be a valuable employee benefit. But once the schemes mature and you’ve benefitted from the tax advantages etc, consider your options. Don’t just default to the easiest choice of letting your company shares build and build.

Too many employees have held on to all of their company shares, only to lose thousands when a crisis happens.

Summary

Financial diversification is a big topic and maybe it can be over-done. Perhaps if we diversify our lives too much, we end up with another cliché: “Jack of all trades and master of none”. But it remains an important principle for personal finance and wealth creation.

Financial advice can help you avoid too much concentration in one or two of the Easter baskets outlined above. But be aware that financial advice itself can often be focussed on too narrow an area of your life. The best advisers will act as a concierge, where they bring in specialists for different aspects of your finances.

Financial coaching does not involve regulated advice. It helps encourage a much wider perspective on your lifestyle and your emotional relationship with money.

Sometimes taking a step back from the detail of financial products and looking at the big picture makes sense. Easter and the onset of spring is a good time to pause, take a breather and think about all the baskets you have in your life. Happy Easter!

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