My grandma used to say, “Don’t put your eggs in one basket.” That’s a simple way to coach portfolio diversification. Portfolio diversification is a strategy taught by all legitimate financial planners and coaches. The concept was also mentioned by King Solomon in the book of Ecclesiastes.
Ecclesiastes 11:1-2 (NLT) Send your grain across the seas, and in time, profits will flow back to you. But divide your investments among many places, for you do not know what risks might lie ahead.
Portfolio diversification minimizes risk. It’s the practice of balancing assets to limit exposure to any one single asset type. Portfolio diversification should offer protection as well as higher yields. A diverse portfolio is a key piece to a healthy financial plan and reflects faithful stewardship.
There are many unique types of asset classes. In this article, I will share the ones that are easily available to the Average Joe investor. There are others that are complex and overly risky. We at The Profit Dare focus on simple financial solutions and faithful stewardship.
According to Ecclesiastes 11:1-2 diversification is a wise practice.
“Money is like manure, its only good if you spread it around.”
Francis Bacon
A Tragic and Cautionary Tale — Enron
Enron was #5 on the Fortune 500 list at one time. It appeared to be an unstoppable juggernaut of a stock. Regrettably, it was smoke and mirrors.
Speculators earned double-digit returns on Enron stock. Thousands put all of ther eggs in the Enron basket. Many refused to diversify and were left holding a worthless stock.
Holding one asset class is dangerous. Holding one individual component of that asset class is reckless.
Many Enron employees kept their entire retirement savings in company stock. The hype was embraced and greed blossomed.
It’s estimated that over $1 billion in retirement funds evaporated.
Employees who diversified fared much better.
Practice portfolio diversification.
Major Asset Classes
- Equities (Stocks, Exchange Traded Funds, Mutual Funds)
- Fixed Income (Bonds)
- Cash (Savings, Money Market Accounts)
- Real Estate and Tangible Assets
- Private Businesses
- Cryptocurrency
#1 Portfolio Diversification — Equities (Stocks)
Mutual Funds
A mutual fund is collection of individual stocks. Often they’re categorized as small-cap (small companies) mid-cap (medium sized companies), large-cap (big companies), or international.
One example of a small-cap company is Texas Roadhouse. An example of a mid-cap company is Williams-Sonoma. Large-cap companies are more obvious. Apple, Wal-Mart, and Coca Cola are all examples of large-cap companies.
Mutual funds provide instant portfolio diversification.
We’re invested in eight separate mutual funds. If one company, like Enron, goes bankrupt we are adequately diversified. Even if a sector has a bad run we should be okay.
Employee sponsored retirement plans (401k, etc.) typically have a handful of mutual fund options available.
Always consider the fund expenses. Personally, I invest primarily in index funds. The fees are low and the returns are acceptable.
Fees matter.
Exchange Traded Funds (ETF)
Exchange-traded funds (ETF) are similar to mutual funds. ETFs are pooled investment with hundreds or thousands of equities inside the fund. Instant diversification is realized when investing in an ETF.
One of the key differences is that an ETF can be purchased like a stock. Another difference is that the price of an ETF ebbs and flows throughout the day.
ETFs, like other investments, have inherent risks. Do your due diligence. Talk to your money pro. Stay within your own personal risk tolerance zone.
There are many great ETFs on the market. I’m invested in only one at this time — the Fidelity High Dividend ETF (HDVV). I have my eyes on a few others but this one provides a great dividend yield and additional diversification.
Individual Stocks
Should Christians invest in individual stocks? I resoundingly say “YES!” but with a few conditions.
I enjoy investing in individual dividend stocks — if they pay dividends. The due diligence required is time-consuming. Read the above article for additional information.
If you have a good handle on things proceed with caution.
Just don’t fall for the Enron-type hype and hold only one or two stocks. If you’re only going to own individual stocks you need at least thirty and probably much more.
Index funds regularly beat the market. Most should stick with mutual funds or ETFs.
We dabble in individual stocks. They’re all inside of a Roth IRA. Currently, we have twenty-eight individual stocks and one ETF in that fund.
We only invest in companies paying a dividend that’s much larger than the S&P 500 average.
#2 Portfolio Diversification — Fixed Income (Bonds)
A bond is simply an IOU issued by a company, government agency, or municipality.
Bonds are used to raise money by one of these three agencies. Why? Sometimes it’s less expensive to issue a bond than to borrow from a lender.
Investors like them because they’re often viewed as lower-risk investment vehicles.
Bonds are purchased at a certain value. A set amount of interest is paid (often quarterly) to the investor. At the end of the agreed-upon time the company, government agency, or municipality repays the principal.
Let’s say a school district needs a new high school building. The cost of the project is $10,000,000. It’s more cost beneficial to sell bonds that pay 5% than borrow from a bank. The bond’s term is ten years.
Interest in this situation is only paid annually. The district pays the bondholders $500,000 in interest annually for ten years. At the end of ten years, the $10,000,000 in principal is repaid as well.
Bonds, like other investments, have their own set of risks. They can fail just like other investments.
Most investment professionals recommend a portion of a portfolio be in bonds.
Talk to your RIA or another investment pro about how much you should have in bonds.
I use a bond index fund. This offers additional diversification within the fixed income section of my plan and low costs.
#3 Portfolio Diversification — Cash
We all should have cash in our portfolio. Cash comes before stocks and bonds.
How much cash should one have?
Most money professionals suggest having at least three to six months of expenses on hand in cash. I’m a bit more conservative than that.
There should be adequate cash to cover an unexpected job loss. Additionally, various sinking funds should be established to replace things like cars, appliances, and furniture.
Savings Account
I recommend keeping your excess money in an online savings account. Retail banks and credit unions are paying next to nothing in interest.
Companies such as Synchrony, CIT Bank, and SoFi are paying exponentially more in interest than brick and mortar banks.
Allow your money to work on your behalf. Perhaps the interest will only be $20 or $50 a year. If you found a $20 or a $50 would you pick it up?
Of course you would.
#4 Portfolio Diversification — Real Estate
I’ve recently read that real estate churns out 90% of the world’s millionaires. That quote is attributed to Andrew Carnegie and it is anecdotal at best.
Real estate is a fabulous investment and is a legitimate piece of a solid financial plan.
Private Residence
Home ownership is a great way to build wealth. Home values historically increase. The amount owed should decrease each month. The difference between the value and the mortgage is your equity.
Our first home helped us get into our second home. That home helped us get into our third home. The equity is increasing in this home and our next will probably be a downsize.
Personal homes are a simple way to diversify.
Rentals
I have friends in the rental business. It’s an amazing business model and a great way to practice portfolio diversification — for the right person.
There are many moving parts to the rental business. The rental world is not for the faint of heart. Dealing with tenants can be stressful. Rental laws are constantly changing.
Long-term rentals are one method. This could be a single-family home, duplexes, or apartments.
Short-term rentals are another way. This would be an Airbnb VRBO or similar type thing.
Rentals could be a great way to diversify your portfolio.
Flipping Houses
CAVEAT EMPTOR!
HGTV popularized house-flipping. The stars on HGTV made it look super easy but it’s not.
Despite the difficulties, it’s still a legitimate way to earn money and diversify one’s investments.
REITs
Real estate investment trusts (REITs) are a hands-off way to diversify into real estate. A REIT is a company that owns and operates income-generating real estate (reit.com). It’s similar to a mutual fund. Investors buy shares. They authorize dividend distributions.
Dividends are the key component to a REIT. REITs should pay out 90% of their taxable income in dividends.
We invest in two specific REITs — Medical Properties Trust (MPW) and Store Capital Corp (STOR).
#5 Portfolio Diversification — Private Businesses
Profitable businesses have value.
The business can be as simple as a dog-walking business or as complex as a manufacturer of hospital equipment.
Treat your business or side hustle like a business. Stop treating it like a hobby. Calculate the positive cash flow at least annually. Determine the business net worth annually as well.
Scale the business if possible. Keeping it small is fine as well.
#6 Cryptocurrency — BEWARE!
Reluctantly I will include cryptocurrency. It’s super easy to obtain and it’s intriguing. Most have zero clue as to what it is or what it does.
There are wars on both sides of the crypto fence. People that I trust and admire are on both sides slinging mud.
What’s a person to do?
Buy crypto sparingly. I have a self-imposed 1% rule. If it surges I might make a few bucks and if it continues to crater I won’t lose my shirt.
We invest in Bitcoin and Ethereum and stay well below the 1% rule.
Portfolio Diversification and Faithful Stewardship
Christians should save and invest. We have the wisdom of God available and should leverage it all the time. Solomon encouraged us to diversify our investments. It’s vital that we heed his wisdom.
Let’s take a peek at what Wisdom tells us in the book of Proverbs:
Proverbs 8:17-21 I love those who love me, and those who search for me find me. With me are riches and honor, lasting wealth and righteousness. My fruit is better than solid gold, and my harvest than pure silver. I walk in the ways of righteousness, along the paths of justice, giving wealth as an inheritance to those who love me, and filling their treasuries.