To build wealth, the first piece of the puzzle is to acquire assets. As a refresher, assets are anything you buy that puts money to work for you. This can range from the stock market, to real estate, to crypto and beyond. There are many viable asset classes out there, and creative people are always coming up with new ways to put their money to work for them. However, an issue may arise when you put all of your eggs in one basket so to speak. By putting all of your money into one specific thing, you are taking higher risk than someone who has investing in multiple asset classes. There is nothing wrong with having all of your money in one specific asset class, it all depends on risk tolerance. Diversifying assets over different asset classes will allow those who are risk adverse or who just want to protect their investments the best they can to hedge against one of their assets having a pullback or failing completely. Now, it isn’t likely that something like the stock market will fail completely, but there have been many instances of recessions and pullbacks. Having your money spread out across other assets such as say real estate could serve as a hedge against potential losses in the stock market. Asset diversification is all about personal preference, so choosing the path you want is completely up to you. It is just important to understand the risks of investing in certain ways, and what that may mean for your portfolio.
Investing conservatively for the long-term
The conservative investor hates risks and will do anything they can to avoid it. Diversification makes up a big part of their portfolio, and they have dipped their toes in quite a few different asset classes. For the sake of this post, what asset classes this investor may have invested in is not important. What is important to understand is that they are spread widely across many different viable asset classes. There are both pros and cons to this approach. A huge pro, and one of if not the biggest reason conservative investors are conservative is that this approach mitigates risk to as low as possible. Their money for the most part is safe, and their investments will likely go up over time even if one of their asset classes has a dip or even fails completely. While this is a powerful positive, there are some drawbacks to this approach as well. The biggest drawback is that with your assets spread thinly over many different asset classes, it is hard if not impossible to capitalize significantly on the upside of your best and most sound investments. For example, if your assets are spread over many classes and there is a spike in real estate, you will not be able to capitalize on that upside as much as you could have if you had more capital invested in real estate. With safety and security comes less upside. If this is a tradeoff you are willing to make, this may be an approach you choose. Many people, including myself are not satisfied with limited upside. This is because like me, you may be young and willing to take more risk because great financial loss would not be as catastrophic for someone in their 20s as it would for someone in their 60s. This is because the ability of one to recapture that capital is much greater at 20 than 60. This approach may be for the risk adverse and aging, and is a sound approach that will allow money to grow slowly without much risk.
The aggressive approach
This approach may be taken on by someone in their 20s or 30s who are willing to take heavier risk because of the upside certain assets have to offer. One of the biggest examples of this we have seen over the last few years is cryptocurrency. So many young people have dumped their savings into cryptocurrency recently, and the values on some of the coins such as Bitcoin and Ethereum have skyrocketed. However, with this massive upside there is great potential for loss and volatility. Crypto has had some major pullbacks which has concerned many people over its long-term stability. When taking advantage of great upside, there is always potential for great loss. Knowing and understanding the risks of putting all of your eggs in one basket is crucial to making sound investments. If an asset you have all of your capital in goes to zero, you have lost all of your money. This is a real risk for things like crypto, but many people do it anyway because they believe in its long-term viability. Although unlikely, crypto, real estate, stocks, and any other asset you invest in all have the potential to go to 0. If you are a risk-taking investor and want to put all of your capital into one or just a few assets to capitalize on calculated upside, understanding the risks of this before doing so will ensure that you are investing rather than speculating and trying to get rich quick on hype. Always do your research and make sure your investments are sound before choosing this route, and investing in general. So far, we have discussed the conservative and aggressive approaches to investing, but for people who are like me and like to use elements of both approaches, there is a middle ground of diversifying assets.
finding a middle ground
This middle ground is where I myself stand along with many other people who want to take advantage of aspects from both sides. This approach entails investing aggressively in what you most believe in, but leaving some capital liquid to put into “safer” investments to hedge against losses. For example, in my portfolio, I hedge against my stock investments by purchasing smaller amounts of treasury and municipal bonds. Stocks and bonds work inversely, and each are better to invest in depending on the economic cycle and interest rates. Right now, my stock holdings are much higher than my bond ones. Because of inflation and low interest rates, stock prices are booming and bond returns are limited. If something catastrophic were to happen and the stock market collapsed, then bonds would protect me from total loss due to their counterintuitive nature to stocks. This is just one small example of asset diversification, as there are unlimited ways you can take advantage of both approaches to investing and get great returns. This is personally the category in which I am in and probably where the majority of other people fall into as well. Any approach you choose can be effective if you do your due diligence, gauge your risk tolerance, and make the right decision for you. Don’t invest in something because some online guru said to, and don’t second guess any sound decisions you make after fundamental analysis based off of fear. Always do what makes the most sense for you and your goals. You can always change your approach as you age or as your mindset shifts, but it is important to start somewhere and everything begins with mindset. What asset classes will you invest in, and which investing approach will you choose?