How does diversification add resilience?

17 May, 2024 - 00:05 0 Views
How does diversification add resilience? Image: Shutterstock

eBusiness Weekly

In nature, one sign of a robust ecosystem is biodiversity — not only is it common sense, but there are plenty of lessons we can learn from it and adapt to managing our wealth.

By having that diversity, one event, even a small event, cannot destroy the entire ecosystem. We often see the catastrophic effects of non-diversity in agriculture, where a new virus, drought or even lack of bees can wipe out a harvest.

Even if there is a catastrophic event, there will be enough diversity for the ecosystem to revive itself, even if it is in a different form.

Did you know, for example, that the only way California has become the largest producer of almonds in the world (to feed the voracious appetite of the vegan/vegetarian population’s ‘need’ for almond milk) is through substantial irrigation and by bussing/flying/trucking in bees by their billions from all over the US?

This is a potentially high risk to the almond crop, but also to the bees that suddenly have just one source of pollen. The potato famine (caused by a fungus) in Ireland in 1845 resulted in a mass migration of the Irish, many across the pond, to the US.

When weeds enter the scene

In freshly disturbed soil, which is allowed to do its own thing, you usually see the rapid appearance of so-called weeds. There are two types of weeds: alien invaders that have found a new niche and can quickly crowd out the indigenous plants that have been there for millennia.

These are often escapees from gardens, and plants as striking as jacaranda, agapanthus, and lantana are cases in point. The other weeds are just local plants that have not deliberately been planted and, hence, are discriminated against because they are not pretty.

When you have got a virgin field of wealth, in other words, you have found some funds that can be invested — what should you do?

Left to its own devices or managed by inexperienced investors, wealth can quickly grow weeds.

Diversification of wealth is not putting small sums of money in a bunch of different service providers, making it much harder to track and analyse.

If you are brand new to this game and you’ve got decades to figure out what your wealth ecosystem will look like, it really doesn’t matter how you invest, so long as you start early and make your mistakes early.

You might be tempted to go to the top of the food chain and find the biggest hothouse orchid/new share class/crypto structure/meme share of the month. Go for it.

Burning your fingers early in your career can be a good life lesson. New ecosystems crash and burn all the time early on and learn from their mistakes the hard way.

If you come to the end of your working life, when that carefully tended ecosystem has to start producing a harvest instead of needing your constant input, then chancing it without experience is going to hurt, and you won’t have time to recover.

That is why it is prudent to have a game farm manager/trust financial advisor to keep an eye on your wealth biome when you’re busy doing whatever you’re good at so it can thrive. Sure that isn’t going to be free — but I have written another blog on just that topic here.

So, how do you build that diversity and resilience in your wealth ecosystem?

Understand the lifecycle and volatility of the various asset classes. In nature, you have short-term perennials that have to be grown from seed every year (but still give you a good harvest like mealies).

These are the fixed-income assets in your portfolio. Some have a slightly longer term (and produce a better harvest) than others but can be mixed and matched.

In my opinion, this is an underappreciated asset class (especially bonds). Because of their healthy harvest/yield, they are great at producing income in a portfolio without having to sacrifice capital/cut down the tree.

Even in portfolios that don’t have to produce income (yet), they are good at muting the volatility. If, for example, you have an equity block in your portfolio with 25 percent upside and downside potential, and mix it, say 50 percent, with bonds, you not only reduce the overall portfolio’s volatility but can also be the beneficiary of the income produced by the bonds.

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