What Does It Mean to Be Diversified?

by Aug 12, 2021Personal Finance

There is a financial myth (which is now almost a joke) that says that to be diversified and “safe,” 60% of your portfolio should be invested in stocks and 40% in bonds. 

Sadly, this is an unfortunate oversimplification. Those percentages depend on your age, your risk tolerance, your other investments etc. 

You can do much better than that. 

Sticking to stocks and bonds is a little bit like restricting your diet to meat and potatoes – 3 meals per day. That’s boring and not good for you… so it’s risky. 

Diversification is putting your eggs (no pun intended) in different baskets to protect them. That means having your money in investments that are not strongly correlated: some zig when others zag. 

Here is the idea: different types of investments usually behave differently in different market conditions:

  • If the stock market is choppy, the stability of one type of investment will lessen the loss from the other types.
  • If there is a financial crash and you’re 100% invested in stocks, you risk losing a large portion of your nest egg.

In other words, by diversifying, you decrease the volatility of your portfolio. Not only will it help you build wealth in the long run, it will help you sleep better at night during uncertain times. 

This is also called asset allocation: you allocate your assets, or invest them, in different financial options.

Here are some thoughts (not recommendations) to help you diversify:

  • Investing in stocks is very vague. Stocks can be domestic or international. They can be in various sectors, such as computers, or banking, or cars, or oil, or housing. They can be giant companies or small ones (start-ups). They can pay regular dividends or not. They can grow quickly (growth) or be “on sale” (value). You can invest in individual stocks or via mutual funds.
  • Investing in bonds is also very vague. They can be of different “qualities” or risk levels. They can be domestic or international. They can be municipal or corporate. They can be short-term or long-term. You can invest in individual bonds or through mutual funds.

But limiting investing to stocks and bonds is just scratching the surface. Here are more options (again, not recommendations):

  • Cash, aka “dry powder,” in the form of bills under your mattress (does anybody actually do that?), in a checking account, a savings account or a money market mutual fund.
  • Stores of value like gold and silver.
  • Businesses… including a vet practice.
  • Bitcoin (which some consider gambling and others, a store of value) and other cryptos.
  • Currencies.
  • Real estate, which is very vague since there are many ways to do it. Cash flow investing might be a better expression.
  • Collectibles, such as rare coins, rare paintings, rare books, fancy wine or rare cars.

There are literally hundreds of mathematical models to help you diversify. Every financial firm, every financial advisor, every author, can offer suggestions. It’s the Holy Grail of investing. 

Asset allocation can seem boring and difficult. But properly diversifying is THE most important decision (to the tune of 90%) in your path to financial success.

Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit