If you have ever received advice on investing your money, chances are you’ve had the benefits of diversification drilled into your brain. “Diversify and rule” was my college economics professor’s one-line strategy for managing his retirement portfolio. Corny but true. The virtues of diversifying your investments have been borne out by mathematics, finance and plain old personal experience.
While you may be diligently diversifying away your risk by investing in stocks, bonds and super-safe CDs, there is a good chance that you are forgetting to include the most important asset you own: You! Or more specifically, your future earnings potential, the big bucks you can (and hopefully will) generate in the future.
The nature of your career greatly affects your ability to take on risk and should be a major factor in deciding the mix of investments that will work for you. For example, consider my economics professor. He was in his early 40s and tenured which meant his job security was pretty ironclad. While we did detect a trace of bitterness in his anecdotes about ex-colleagues who left to take up lucrative consulting gigs, his salary and perks were definitely more stable and predictable. And yet, he was a big believer in bonds, loving their steady, dependable trickle of coupon payments. If you pretend that the stream of his future paychecks is an actual investable asset, he was overly invested in steady, fixed-income bonds. His portfolio would have benefited from taking on the risk of the more volatile returns of the stock market, thereby diversifying his dependable but not-so-lucrative wages.
On the other hand, consider someone who is also in their early 40s and employed as a software consultant to major IT companies. While she makes a good amount of income from her programming projects, the flow of work is unreliable. Projects dry up when the economy is not doing well, and during boom times her phone rings off the hook with client requests. The stream of the software consultant’s future earnings is rather volatile and correlated to economic conditions, just like stock prices, and her portfolio would be well-served by being weighted towards steady, fixed income assets such as bonds.
Bottom line, diversify your paycheck with your portfolio. If your paychecks flow like the stock market, with happy highs and nasty lows, consider buying the protection of bonds. If your paychecks come in like clockwork but don’t get bumped up during economic boom times, consider weighting your portfolio towards stocks. Always consider the whole picture of your finances when deciding where to put your money.
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