The year is 2007 and my buddy Fred is apparently financially set for life. Fred has a really good paying job making $200,000 a year and a $1,000,000 retirement plan with his money in the company’s stock. Fred is not worried though, the company is really doing well and they just had a 2 for 1 stock split. Real estate is expensive in his area so Fred is renting a really nice apartment. Things are great.
Unfortunately the company Fred works for is Lehman Brothers, and within two years his job, his company and his retirement plan will all be gone.
The way to potentially make the most money is to concentrate our funds in a very few areas. Unfortunately that’s a risk that most of us just cannot take. If things go badly like they did for Fred, we’re wiped out.
That’s why we need a diversified financial portfolio. I like that analogy of a mosaic made of a lot of little tiles. We need all of the tiles to get the complete picture. We want cash available if we have an immediate expense. Bonds so that we have a steady stream of income. Some real estate. Some other assets that protect against inflation. And some money that has the potential to really grow, whether that’s part ownership of some small businesses, or stocks.
We won’t make the most money that way. The cash and the bonds, particularly now, won’t do much for us. Cash and bonds were pretty nice though in 2008 when everything fell apart. To the extent that we can, we want to create a mosaic of assets so that we can be safe (or safer anyway) and not have too big a chance of being Fred.