Sunday, June 7, 2015

What Does it Mean to be Diversified?

This blog post will be a little different. In this post I want to ask readers to consider the question -- What Does it Mean to be Diversified? 

Most people in the US and the West in general think of a diversified portfolio as having an allocation between various stocks and bonds. Some wealthier investors might add in real estate, producing land, or venture capital investments in promising start up companies. But is this a truly diversified portfolio for the average person? Let's look at it.


The first thing to say on this topic is that virtually all respected financial advisers recommend that people diversify their holdings as best they can. The fundamental basis of this idea is that if you over allocate too much to any one area of investment, you are taking too much risk of catastrophic loss with not enough other assets to offset the hit you take in one area.

What is interesting though when you think about this topic is that there is a big difference between how the average person in the eastern part of the world looks at this versus how the average person in the west looks at it.

It's also important to think about the average person because this is where most of us live. The ultra wealthy have always known how to protect their assets and how to diversify. They also have much more to work with to accomplish that goal. So this article will focus on the average person instead.

In the west, the average person believes they are diversified if they own some stock and bond funds that allocate their money across various sectors in the economy. The various tax deferred savings vehicles mostly offer these kinds of alternatives. And this can achieve a level of diversification, but not a complete level of diversification

In the eastern part of the world, there is long held understanding that unless you have assets that are tangible and accessible during a period of crisis, you are NOT truly fully diversified. This is why many people in this part of the world value allocating a portion of their savings to precious metals. This is a tradition that has been held for generations and continues today.

There are some pockets in the west where this concept is also well understood. Nations like Germany know what it is like to see your currency go up in the smoke of hyperinflation.

A question that readers in the US and the west should ask themselves is:

If something happened to the banking system that caused me to lose access to my digital savings or investments (stock market crash, banking crisis that leads to banking holiday, cyber attack, any disruption in the global digital system for any reason, etc), do I have any assets I can access to ride out the storm?

If the answer is no, then you are NOT truly diversified. It's really that simple. Adding an allocation to your savings that includes some tangible assets you can access in a crisis is not extreme thinking. You don't have to be a doomsday prepper who believes the world as we know it will cease to exist any day now to understand that owning some tangible assets you can directly access is a good idea.

It is entirely possible that we will be fortunate enough to live out the rest of our lives without a crisis that would make us unable to access digital forms of our assets (which is where most people in the west have ALL of their savings located) . In fact, I can see the potential for a world where new digital technologies could make the system more stable and accessible for everyone. Some of the brightest among us are working on it (including some friends of this blog).

But no one can be sure of this and it is very clear from all the information we have covered on this blog for over a year that even those who preside over the current system cannot be sure of it either. They acknowledge there are serious risks in the present system. They know there are "blind spots" in the present system.

The average person living in the globally connected, highly leveraged system we have today needs to work on being fully diversified. There is a need to have some assets on hand outside the system in case of systemic breakdown. 

Those who do this are much more fully diversified than those who don't regardless of prevailing views on diversification in the west. The more people we have that are fully diversified, the better we can withstand a crisis if we do get one in the future. Even if there isn't a global financial crisis, there are still local events like natural disasters where the same type of assets might be helpful.

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