The Importance of Diversification: Part 2

This is part 2 of a two-part series where I discuss the importance of diversification in finances. In part 1, we saw the importance of diversification when it comes to investments and how the risk mitigates by selecting investments from various asset classes, sectors and geographical regions. This article will focus on the diversification of income. 
Income is the single biggest factor in wealth build up. To ensure that the build up can accelerate or simply to protect from unforeseen circumstances, you can employ various strategies to protect yourself from risks which could affect your future earnings.
What is diversified income?
Diversification of income can come in various forms. Income is generally classified as active income when you have to work for it and trade your time for a monetary compensation. This is usually the largest source of income in a person’s life. Secondary active incomes can be added by working part-time, what is generally termed side hustles in the media. A passive income is an income that is sourced without or minimal input from you. Investment income is generally a common source of passive income but there are plenty of other sources. I have discovered that passive income can be a grey area on the active-passive scale and depends on the source and the type/method. I have captured the various forms and ranked them in what I call Passivity Index.
Diversified income sources provide with many benefits. If you are married or living with a partner, having both partners earning brings income diversification immediately and protects you in case of emergencies such as temporal or permanent loss of employment. It comes as no surprise that married couples tend to be richer and separations/divorces have the exact negative effect – taking one of the worst tolls on personal finances.
Why diversify?
The popular saying of “Never put all eggs in one basket” not only applies to investments, but also to income. The need to diversify arises not only to mitigate risk due to external factors but also as a cushion for better living standards. Some reasons to diversify income are:
  1. Unforeseen circumstances such as job loss, disability, death of partner. This could be devastating financially and emotionally. Ensuring that your income is diversified can protect you from such factors.
  2. Financial independence: A diversified income can provide you with financial independence.
  3. Freedom to indulge in your passion: Like it or not, a majority of the people end up in professions which they do not like, or simply dislike the work environment or lifestyle. Alternatively, even if they loved something early in their career, tastes change and people long for career changes or the need for something different. A diversified income source allows people to dip their toes or quit their job allowing them to follow their passions.
  4. The health factor: It is not just about the wealth though. Being financially secure also results in a healthier lifestyle. Various studies have concluded that income and social status are the highest determinant in the health of a person and family. There are multiple explanations for the reasons including: reduced stress, better diet, better access to health & medical care, safer neighborhoods, more free time for exercising etc.

Have you diversified your income sources? How dependable are your side hustles and/or passive income streams?

6 thoughts on “The Importance of Diversification: Part 2

  1. Hi roadmap2retire,

    This is very timely for me, as I am currently considering the idea of investing in a select group of companies I like, or add more, “less interesting companies” to ensure proper diversification.

    The first approach might give better returns, but since I intend to use the income at some point in my life, the safety comes first I guess.

    Also, I found this very interesting: “Various studies have concluded that income and social status are the highest determinant in the health of a person and family.”

    • Hi DividendVenture,
      Thanks for stopping by and commenting. I just discovered your blog yesterday and I like picks.
      Absolutely right – safety should come first when it comes to your investments. You can always have a small portion of gambling money in the market, which can give you more of a rush but its easy to get carried away. The boring investments are the best ones.

      I can see how the income and social status results in the health of a person. I read another interesting study recently (similar to the one linked above) on how the successful people are able to live healthier and more productive life based on living environment – taking the example of living in a more affluent downtown-ish location where they can walk to work, walk to stores, access to parks etc. The key point was that they didnt spend 1-2 hrs commuting to work – like most people do, and instead spent that time connecting more with people and loved ones resulting in better overall health.

      Best wishes with your journey. I’ll be sure to follow along. Happy investing!

      R2R

  2. R2R,

    I plan on diversifying my income once I build up my investment portfolio. I’d like to eventually try out Prosper or Lending Club as another passive income source. These peer-2-peer lending options aren’t an option in my state in the U.S., but I found a service called FOLIOfn that serves as a third-party to allow people in restricted states to participate. I need to do more research on this but right now I’m focused on stock investments.

    Thanks for the article.

    -Dear Dividend

    • DearDividend,
      P2P lending has worked for a lot of people and I havent been able to use that method as we dont have that option available in Canada. Interesting that theres a workaround service for you – all I have to suggest is to make sure its safe and protect your hard earned money. Sometimes its better to settle for slightly lower returns in order to preserve capital and keep your cash safer.
      I’d be curious to find out what the return rates are…Ive seen some people turn 6-7% by P2P lending in the past, which one can still find in the stock market these days. Even though its hard and the investments are probably riskier than stocks that pay 2%, I’d look at the risk-reward comparison between the options.

      Best wishes
      R2R

  3. I’ve diversified my income. I have blog income, rental income and investment income. Of course I am looking to increase each of these as I go. Right now my focus is on investment and blog income so I can have a down payment for another rental property.

    • Congrats Jon. That income diversification should provide you with plenty of cushion to quit or your job (if you want to), or make it a bit easier when the time comes to retire.
      I just have my rental income and the blog income is starting to trickle in. Hoping to grow that in the coming months/years. Rental property – Its in my next 5-year plan. Hopefully we will be able to get something before that.

      Thanks for stopping by and the comment. Wishing you a great week
      R2R

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