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.
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:
- 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.
- Financial independence: A diversified income can provide you with financial independence.
- 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.
- 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?