Diversification Through Asset Classes (2024)

Blog | Personal Finance

The key to financial freedom is strategic diversification. Which asset class is right for you?

Whether you’ve already set out on your path toward financial freedom or are just beginning to make a plan to get there, you have five main asset classes to choose from. Each asset class has pros and cons and requires different levels of time, effort and education.

But here’s a hint: You’ll want to learn about and invest in more than one. Why? Because diversification is the name of the game, and that means investing in more than just one asset class.

Is diversification good or bad?

First things first, what most people consider as diversification isn't really diversification. Let’s clear that up.

Why “diversification” is bad advice

Some people consider diversification the spreading of money across a single asset class. For example, stocks, bonds, and mutual funds are all part of the same asset class-paper assets. A 401K that invests in primarily index funds is an investment vehicle that simply spreads money across one type of investment: stocks. That is not true diversification.

That is actually specialization, and if you’re doing it blind, you’re exposed to great risk. In the event of a total collapse of the paper asset sector (i.e., a deep recession or depression), all your assets will sink. And if the timing is bad, it can be devastating—just ask the retirees who went through the Great Recession.

Why understanding true diversification is important

There are actually five asset classes: paper assets, commodities, business, cryptocurrency, and real estate. We’ll dive into these a bit later. But note, a truly diverse portfolio would have stakes in all or most of these.

If you’re planning on using diversification as a hedge strategy, at least do it right and make sure you’re diversified over all five asset classes, not just in paper assets. This is a true investment strategy, and it will at least protect you from a total loss of your wealth should one asset class crash.

Diversification, systemic risk, and non-systemic risk

The reason diversification is a high-risk way to invest becomes clear when you consider systemic and non-systemic risk.

A number of years ago, British Petroleum (BP) suffered a major oil spill. During that time the company’s stock dropped by over 50%. This did not impact the market, however, and things carried on as if nothing happened in other stocks, the real estate market, etc.

That is an example of non-systemic risk. If you had all your money in BP stock, you would have been hurt, losing half your wealth. But it would be isolated to that one company. The rest of the market investors would be fine.

Amateur investors try to manage the type of risk that would come from focusing on one stock, in this case BP, by diversification across the stock market. The problem is that they then get exposed to systemic risk, which is much riskier.

An example of systemic risk is the subprime mortgage meltdown. Brokers handed out mortgages like candy, approving zero down, stated income, no documentation loans. When millions of people who lied to get a house they couldn’t afford stopped paying those loans, the entire system was impacted. The S&P 500 index dropped by over 50%.

When it comes to systemic risk, diversification won’t help you. And systemic risk is always a matter of not if, but when. If you’re lucky, it hits when you still have time to recover. If not, well then you’re screwed. It’s a big gamble when there are other strategies you can put into place that will not only protect you better but also make you far richer...if you have the financial education needed to execute on them.

What are the top five asset classes?

There are numerous ways to invest and build wealth. And once you increase your financial education, you’ll have a better understanding of the best investments for you. But to help you get started, here are some of the most popular asset classes:

For this, you’ll definitely want to learn how to invest using other people’s money. And here’s an interesting tidbit you may not know: You can use cryptocurrency to purchase real estate!

Focus and Diversify — an Oxymoron?

If you absolutely have no interest in the price of silver or think bonds are boring, then you won’t enjoy the day-to-day work associated with managing those asset classes. Although it’s important to primarily invest in the things you’re most passionate about, it’s also important to be diversified. But what does that mean?

You’ve probably heard a financial planner preach about the importance of a “diversified portfolio” at some point — but they are usually just referring to your stock portfolio.

Remember, true diversification means to diversify beyond paper assets, across all asset classes. Each asset class will react to the market differently, and each asset within each class may respond differently, as well. As a nation, we’ve witnessed time and time again how putting all your money in one basket may not reward you with the financial security you desire. So wise up, and get comfortable with each asset class to become a well-rounded investor.

Taking next steps

While it might be overwhelming at first, start small. Set your goals, research and increase your financial education and then take action.

What one step are you going to take today on your journey to financial freedom?

If you’d like some help pinpointing your next step, here are some suggestions:

Commit to taking just one action today, and then another tomorrow. Once you gain more knowledge and some momentum, you’ll find the asset classes that are perfect for you.

• Many people don’t know what true diversification looks like

• We have our top five asset classes for investors to diversify across.

• Diversification can yield high reward, if it’s strategic.

  
  Just be sure to do your due diligence and analyze the project, the partners, the financing, and the business and management team before making a business investment — these are the things a lender or investor really wants.

  
  Though they trade similar to paper assets, cryptocurrencies have more in common with traditional forms of money because they are a means of exchange, they store wealth, provide a unit of account, are divisible and transferable.

  1. Paper Assets. Paper assets include stocks, bonds, mutual funds, and retirement accounts where you can invest in stock options, stock futures and foreign exchange. Paper assets also include real estate investment trusts, or REITs, and exchange-traded funds (ETFs).

     
     Whether you are investing for capital gains or for cash flow via stock dividends, there are many paper assets from which to choose. That’s why most people invest in paper assets, or the stock market — these are the easiest assets to get in and out of. And even though your financial planner or advisor may tell you that your retirement funds or 401K investments are diversified, they really aren’t. You still need to diversify amongst the various asset classes.

  2. Commodities . Commodities include metals (gold, silver, copper, etc.) food (grains, corn, coffee, and sugar) and raw materials (oil, gas, cotton, etc.). Commodities are generally a capital gains (or loss) investment, and you can buy future contracts of any commodity through the future exchanges. If you are a new investor, start small and build your financial education.

     For example, start by purchasing a single silver coin and then watch its value increase or decrease in your daily news. Your financial IQ will go up exponentially by having a little skin in the game and paying attention to what happens to that coin.

     We’ll touch on cryptocurrency a bit later, but it’s worth noting now: You may already be familiar with the term Bitcoin, which is one type of virtual currency (or cryptocurrency). As of today, one Bitcoin equals $28,348.31 — thankfully you can also start small here by buying a fraction of a Bitcoin instead of committing to a whole one.

  3. Business. This is an asset that people have become more aware of thanks to television shows like “The Apprentice” and “Shark Tank.” Within this class, there are two routes to take: 1) invest in your own business or 2) invest in someone else’s private business or company. The whole point is to generate a return back to you, the business and your investors and/or lender.
  4. Cryptocurrencies. Cryptocurrencies like Bitcoin, Ethereum, and Litecoin are the new assets on the block(chain). Rich dad considers cryptocurrency to be the People’s money because it’s created by and for the people separate from any government entity. And unlike other forms of digital currency like credit cards and wire transfers, cryptocurrencies are impossible to steal or counterfeit.
  5. Real Estate. Real estate investments either provide cash-flow from rental properties (the overage you make each month from rent once all your costs are paid) or capital gains (a one-time profit from buying and selling a property). With real estate, you use leverage, or the ability to use other people’s money (OPM) to purchase the asset. As Kim Kiyosaki discusses in “It’s Rising Time!”, “A property that is highly leveraged means there is a lot of debt on the property compared to the equity, or current market value minus the debt. The higher the debt on the property, the lower the cash flow. The lower the debt, the higher the cash flow.”

     the ability to use other people’s money (OPM) to purchase the asset. As Kim Kiyosaki discusses in “ It’s Rising Time! ”, “A property that is highly leveraged means there is a lot of debt on the property compared to the equity, or current market value minus the debt. The higher the debt on the property, the lower the cash flow. The lower the debt, the higher the cash flow.”

  For this, you’ll definitely want to learn how to invest using other people’s money. And here’s an interesting tidbit you may not know: You can use cryptocurrency to purchase real estate!

Focus and Diversify — an Oxymoron?

If you absolutely have no interest in the price of silver or think bonds are boring, then you won’t enjoy the day-to-day work associated with managing those asset classes. Although it’s important to primarily invest in the things you’re most passionate about, it’s also important to be diversified. But what does that mean?

You’ve probably heard a financial planner preach about the importance of a “diversified portfolio” at some point — but they are usually just referring to your stock portfolio.

Remember, true diversification means to diversify beyond paper assets, across all asset classes. Each asset class will react to the market differently, and each asset within each class may respond differently, as well. As a nation, we’ve witnessed time and time again how putting all your money in one basket may not reward you with the financial security you desire. So wise up, and get comfortable with each asset class to become a well-rounded investor.

Taking next steps

While it might be overwhelming at first, start small. Set your goals, research and increase your financial education and then take action.

What one step are you going to take today on your journey to financial freedom?

If you’d like some help pinpointing your next step, here are some suggestions:

1. To get more information and inspiration from others as you start your journey to financial freedom, check out Rich Dad investing classes.
2. Explore working with a personal finance coach on such topics as real estate, stock trading and personal finance.
3. Stop making excuses and learn how to get started in real estate by first debunking the myths that are holding you back and then creating a plan to move forward.
4. Learn more about Bitcoin and other cryptocurrencies from crypto expert Jeff Wang.
5. Discover everything that falls under the “commodities” umbrella, including silver, gold, oil and gas — and which are the easiest to start with.

Commit to taking just one action today, and then another tomorrow. Once you gain more knowledge and some momentum, you’ll find the asset classes that are perfect for you.

Original publish date: May 09, 2013