Diversification: The Path to Financial Independence

The power of focus has been onside and working for us this week!

So... the world is currently fixated on the US debt ceiling ($31.4trn OMG!), recession risks, and artificial intelligence.

It’s an interesting contrast. With debt concerns and recessionary fears causing asset prices to fall, and yet artificial intelligence (AI) related stocks continue to rip higher bucking the broader trend.

Different assets move in different patterns, at different times, and at different speeds.

This year in 2023, if you owned stocks in Credit Suisse, you lost -80% of your money and sleep for the year as a “Thank You!” for investing in one of the world’s largest banks. As an employee at the bank, no matter how well you performed, there’s a high probability you’ll be fired with your employee share plans decimated. Oh dear.

Conversely, if you owned NVIDIA, a chip maker, you’d be sitting pretty on +175% gains over the same period. Perhaps eyeing up the next Rolex or a nice trip to the Maldives with the Mrs – look out!

Wherever you are, whatever you're doing, you are exposed to risks whether you understand them or not.

I met an interesting guy this week, that decided 15yrs ago to quit his job at Microsoft and join the AI revolution in early stages and is now at the centre of the universe. What a rockstar! Another great example is that Jeff Bezos quit a six-figure finance job to start Amazon on the basis that the internet was growing at 2300% per year and he needed to be exposed to it.

Simply working hard is rarely the route to financial freedom. Rather, we need to be exposed to the right risks, at the right times, and be systematic when it comes to managing those risks. There are so many ways to do it. But we must do it.

As a bank market maker, we’d manage portfolios with 100s of assets exposed to different geographies, sectors, and various idiosyncrasies. We’d group and manage these risks in different ways, but ultimately events and new information would send prices flying. “Better lucky, than smart” was a favourite saying when things went our way!

So, how can we position ourselves to get lucky and avoid getting unlucky? The answer: Diversification.

let’s discuss diversification in today’s post.

The Problem:

It’s not that you didn’t work hard enough. It’s not that you need to try harder. It’s not that you need more degrees. It's not that you need more time. It’s not that you aren’t the founder of Amazon (ok well maybe it is).

The problem is that most people have full focus and reliance on a single asset over their lifetime. Their job! The rest of the world is changing everyday.

When a company relies heavily on a single product, and there’s a shift in technology or trend, they quickly go out of business. The marketplace takes no prisoners. Just ask Blockbuster after they failed to innovate or accept a partnership with Netflix in 2000.

Why would we stop at a single asset for personal income?

On the road to financial freedom, diversifying personal assets is among the most crucial strategies for building long term wealth. Here are some of the benefits and strategies:

Benefits of Diversification

1. Risk Mitigation: Diversification allows you to spread your investments across various assets that may react differently to market conditions. If one investment performs poorly, others in your portfolio may offset the losses, reducing the overall impact on your wealth.

2. Consistent Returns: Different asset classes tend to perform differently under varying market conditions. By diversifying, you can capture gains from various sectors and investment types, potentially generating more consistent returns over time.

3. Opportunity for Growth: Diversification enables you to tap into different industries, geographic regions, and investment vehicles that have the potential for growth. This approach can increase your chances of benefiting from emerging trends and market opportunities.

Strategies for Diversification

1. Asset Allocation: Allocate your investments across different asset classes such as stocks, bonds, real estate, commodities, and cash. The specific allocation will depend on your risk tolerance, financial goals, and investment horizon. A well-diversified portfolio typically includes a mix of these assets, which can help balance risk and return.

2. Geographic Diversification: Invest in companies and markets across different countries and regions. This approach allows you to leverage global growth opportunities while reducing the impact of any single country's economic or political risks.

3. Sector Allocation: Spread your investments across various industries such as technology, healthcare, finance, consumer goods, and energy. Different sectors perform differently at different stages of the economic cycle, so diversifying within sectors can help manage risk and capture growth potential.

4. Investment Vehicles: Explore different investment vehicles, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs), and alternative investments like private equity or venture capital. Each vehicle has its own risk and return characteristics, and diversifying across them can help optimize your portfolio.

5. Regular Review and Rebalancing: Regularly review your portfolio's performance and adjust your allocations as needed. Rebalancing involves selling or buying assets to maintain your desired asset allocation. This ensures that your investments stay aligned with your financial goals and risk tolerance.

A Call to Action:

For me, diversifying passive incomes away from an employer is the single most important goal to get financially independent and prevent trading time for money.

So far, I've done it by building portfolios in real estate, stocks, bonds, commodities, and crypto. Trading also provides active income but requires resources, skills, and high-risk appetite.

In real estate, multiple properties in different locations help keep stable/consistent cashflow and reduce the impact of a vacancy. With recent interest rate moves I've reduced mortgages to avoid high interest expenses. Whilst returns aren’t mind-blowing, and liquidity is generally poor in real estate as an asset class. It does provide a backbone to monthly income that'll likely keep up with inflation over time.

In stocks, bonds, and commodities: I’ve diversified exposures using low-cost equity index ETFs across both developed and emerging markets which lowers idiosyncratic risks. These are liquid and cheap to rebalance regularly.

In attempt to boost overall asset performance: I've added exposure to innovative sectors with focus on Global Technology, Healthcare Innovation, Artificial Intelligence, Robotics, Battery value-chain and Cyber Security.

To boost dividend cash flows: I've added exposure to high dividend ETFs, and high yielding single name stocks.

With single name stocks, I've kept to <20 names so far to enable easy monitoring and still mitigate risk with diversification.

I rebalance monthly. Specifically for equity market volatility, as I've found it more profitable to take advantage of outsized short-term price fluctuations.

Here are some examples of ETFs that facilitate diversification across geography, sector, and cash flow:

iShares Core FTSE 100 UCITS ETF

Vanguard S&P 500 UCITS ETF

iShares Core MSCI EM IMI UCITS ETF

iShares MSCI EM UCITS ETF

iShares Healthcare Innovation UCITS ETF

L&G Artificial Intelligence UCITS ETF

L&G Battery Value-Chain UCITS ETF

L&G Cyber Security UCITS ETF

SPDR® S&P® U.S. Technology Select Sector UCITS ETF

Legal & General Global Technology Index Trust

iShares UK Dividend UCITS ETF

I'll continue to paste this link as a great resource for finding ETFs that suit investment goals:

https://www.justetf.com/uk/

With passive investments doing their job to grow wealth while you sleep, more attention can be focussed on impactful goals and living on your own terms.

How are you creating and diversifying incomes?

Where else do we need to be exposed from here?

Message me.

The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of financial advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.