5 tasty tips to improve your financial diversification

Flavours of financial diversification

Financial diversification is usually discussed in the context of investments. It tends to focus on spreading investment risk over different sectors, geographical regions and asset classes. Since it’s Easter, let’s drop the financial jargon and talk flavours of chocolate eggs instead.

“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 you that investments should be spread over many different companies and asset classes to diversify risk. You can apply this ancient wisdom to a wider range of scenarios than just investment though. Here are five flavours of financial diversification:

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

If you keep the bulk of your savings in bank accounts, it may help you feel safe. Your cash balance is stable, you can easily make withdrawals and you enjoy some guarantees.

So how can “too much cash” even be a thing? Well, there are a couple of key risks that are often overlooked.

Unlikely as it is that your bank will go bust, it’s not 100% guaranteed. 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 a mint chocolate egg in your Easter 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. Just this week, the Consumer Price Index rose to 7%, way above the interest rate on your savings. Even in times of higher interest rates, bank deposits will struggle to keep up with the cost of living. This means the spending power of your cash in the bank will reduce over time.

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

Milk chocolate: The “Too little investment diversification” basket

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

Lack of financial diversification
A lack of financial diversification can lead to a broken financial plan

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 about this at the government’s money advice service.

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

White chocolate: The “too little personal development” basket

This one is not so much about cash assets, but rather, the equally important focus on intangible assets. It’s about how you develop your own knowledge, skills and experience. Is your investment in you diversified enough?

The world 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. Society and lifestyles 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 perhaps 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 with our first job. It was certainly the norm for those of us over the age of 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.

A portfolio career can create multiple income sources

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

Forced redundancy can have a crippling effect on you and your family if it’s unexpected and unprepared for. But it can also be an opportunity to re-invent yourself and create an exciting new chapter in your working life.

Consider how you can build up multiple income streams for future financial security. Here are some tips on building a portfolio career from Careershifters.

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

This is my least favourite flavour. I’ve come across many loyal employees of big firms who build up significant holdings of their company’s shares, only to regret it later. It could be through Save As Your Earn schemes, share options or bonus schemes.

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 bad. They can be a really valuable employee benefit. But once the schemes mature and you’ve benefitted from any tax advantages or loyalty bonuses, consider your options. Don’t just default to the easiest choice of letting your company shares build and build, without careful consideration.

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

Summary

Financial diversification is a big topic and it can sometimes feel as though the financial industry is obsessive about it. 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. Be aware, however, that financial advice itself will often focus on too narrow an area of your life. Good financial planners will take a holistic view of your situation and act as a concierge, where they bring together different specialists where necessary.

Financial coaching can also help you develop a wider perspective on your lifestyle and on your relationship with money.

Sometimes, taking a step back from the detail of financial products can help paint an exciting bigger picture. Easter and the onset of spring is a good time to pause and reflect on all the baskets you have in your life, rather than worrying about individual eggs. Happy Easter!

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