The Yin and Yang of Investing - To diversify or not to diversify
We've all been told to diversify your investments and never put all of your eggs in one basket. Here is the yin and yang of investing. Because though it is generally safer to to diversify your net worth, you can also grow your assets much faster if you put all your eggs in one basket. Particularly if that basket proves to be a good investment. One of my financial hipster tips is to put all your eggs into one basket and then move to another basket. This doesn't make sense all the time but using this advice wisely will yield great results. Here are some examples of the yin and yang of investment diversification.
Savings is all that matters vs. I want a 1,000% return on my money
Savings is what grows wealth. That being said, I have had stocks that returned 10x my original investment. FB and TSLA to name a couple. So you might be thinking why I would need to work again? Well I probably wouldn't if I would have put a few hundred thousands of dollars in those stocks. However, investing is also about risk and for me I wasn't willing to put all my money into either of those companies at the time.
While some individuals have gained significant wealth by betting big on a single company, it is not the common occurrence. In most cases, I’d worry a bit less about chasing your 10x returns and just make sure you’re consistently putting enough money into investments. Consistent and continued increases in your investments is the surest way to build wealth over time. In the previously example, sure you could 10x your money, or you could lose it all.
The greater amount of money you have the more safely you can make those bets chasing those 10x returns and when they pay off you’ll have great net gains and if you lose it, you’ll still be okay. That’s how venture capitalist can hedge $1 million on an idea. Because they have enough money that they can bet that same amount on ten others and they likely fail to see that return 9 out of 10 times.
However, one or two might make it big and they will make up for the rest. Point is, these types of investments should be made by weighing your overall risk. It's not the way to handle your average investment, particularly if you are newer to investing.
Allocation is the single most important piece of investing vs. putting all your eggs in one basket
As an investor, it is a good idea to make sure you don’t have all your eggs in one basket. Now, before you think I’ll preach the standard allocation of diversified mutual funds and stocks, I realize there is more than that. There are times when putting a lot of your eggs in one basket can make you very wealthy or minimally, gain significant returns on that investment. These choices need to be weighed with risk and how much you are willing to lose. For example, paying for your house in cash could be viewed as a bad idea.
When you do that, you most likely put a significant portion of your net worth in your house. However, that's exactly what we chose to do. Within one year our appraised value went up almost 20%. Not a bad return on that money. Now, you could argue that if we only put 20% down (40k) into our home we would have seen a return of over 100% on that money. This is where allocation and choosing to weigh risk becomes a personal choice. And life isn’t lived on a spreadsheet. Without a mortgage I am able to put 6-10k that I would have been spending year in and year on a house and instead fund my children's 529 college account. But what about the mortgage tax write off? This discussion is a post within itself, but bottom line is I would not have that capital available if it wasn’t for that investment decision.
By eliminating a house payment, I potentially reduced the amount of return on that money compounded over the next 30 years but I opened up future cash flow by not paying interest. Now I can use that to buy more assets. Its really more a question of weighted risk and desired allocation. For us, knocking out the house payment and knowing we only owe property taxes and freeing up the excess income for future financial goals was worth it for us and fell in line with our values. It's also how we plan to build an early working retirement. Others may feel it's more appropriate to keep their net worth more allocated towards their 401k and other investments/stocks. There isn't anything wrong with that, its a personal choice. We made this decision also based on the fact that we didn't liquidate all our investments to put into our house. We had a good amount saved for retirement that we can continue to add to over the next 30 to 35 years before we are retirement age.
This is why one of my Financial Hipster tips is to put all your eggs in one basket and then move to another basket. I don't mean put everything into a single stock, but it can be wise decision to put all your resources and time into achieving one financial goal at a time. If you need to get out of debt. Knock it out! The only exception to this is getting your free company match in your 401k. You don't have to get too caught up on net worth allocation all the time.
There will be a time that the age old standard asset allocation will make sense, but to build wealth you sometimes have to be overweighted in certain assets. When we bought our house, we had almost 70 percent of our total net worth in our home, but with our continued savings we have been able to invest more heavily into other investments and now we are already 50/50 with stocks/home equity in only two years. And our percent of equity to net worth ratio will only get less and less over the years.
A story of putting all your eggs in one basket: It can work, but know what your risking
Perhaps you are interesting in putting all your money into a single stock and trying to make a huge return. You can do that, but know the risks. For example, I know a guy who leveraged his house and threw everything he had into Ford when it was hit hard in 2008. He bought 100k of stock at $1.50. Within the next couple years it went up over 10x. He was a millionaire fairly quickly, on paper at least. How he decides to allocate that wealth and make future decisions will greatly impact his long term sustained wealth. Point here is allocation is always important to consider. Slow and steady investing in the standard recommended allocation is by far the safest bet but will also take quite some time to achieve financial freedom. However, throwing all your money into a single investment can get you there faster. It may take a little longer with standard allocations and index funds but it's more of a guarantee for as much as anyone can guarantee an investment strategy.
The person mentioned above could have potentially lost his house and his whole retirement fund (invested almost his entire net worth in Ford). Better to make that mistake when you’re young but that's why investing basically comes down to your risk tolerance and deciding how much to allocate to certain investments that could span from conservative (bonds) to a penny stock or an IPO or even a personal business. There is not much that is completely right or wrong in investing, as much as you have to choose a strategy and stick to it. Are you a high risk high reward investor or a slow and steady investor? Do you like to invest in income properties or stocks? Or perhaps you have a skill that you are willing to bet on yourself with your time and money to grow a business that you work in.
Discovering your relationship with money and how you and your family will best operate within these constraints and factor is the most crucial part of your financial lives. Learn to live within your risk tolerance, level of desired certainty, and where and when you want to take high risk if you desire a certain reward. For a quick example, risking ¼ of your retirement investment portfolio to flip a house with high risk that would likely not bring you more than a 15-20% return but also possibly flop would not be a decision I would make; but hey the west wasn’t won with bows & arrows, go for it Cowboy!
Now you know why investing can be so controversial and confusing. It's okay to feel a little lost.
Here is what I do:
Putting the majority of our net worth in our home for me was an easy decision. It was actually very conservative because taking away appreciation (which is not predictable) it was a very safe investment. I viewed it as essentially a bond investment. It yielded a guaranteed 4% return from not having to pay the interest payments on a mortgage, plus the loan origination fees. That's been the only time I've put so much money into a single asset. But I would do it again and again. I did the same thing coming out of school with almost no money. I put literally everything I had into my first car so I had a new reliable vehicle to go to work. Though it took almost all my money it set the foundation for our future. That's why I always promote paying cash foreverything if you can. It frees up all your future cash to pay for your next financial goal.
As for my stock investments, I've never thrown more than 10% of my net worth into a single stock and that's worked out well for me. I do recommend taking some risks when it comes to investing in stocks, but I wouldn't put more than 10% of what you have available in a single stock, because though that next 10x stock is out there the chances you find it is low. But, it could also flop.
As for investments outside of stocks, such as real estate or your own business, I would say these are good opportunities to put more of your eggs into one basket. You know what you're capable of and if you know what you're doing with your business it's okay to dive in and put more of your net worth into those investmenets. You have the control and if you are confident in your abilities, make it happen! Financial Hipster has been one of the most rewarding efforts of my life. So now that you know how I go about investing. What about you?