Diversification is a method of avoiding non-systemic risk. Non-systemic risk is the kind of risk that involves uncertainty of individual components. Systemic risk is the kind of risk that involves uncertainty of all the components taken together. Indexing for investing is a typical example. Diversifying avoids the risk of individual stocks but it does not avoid the risk of the entire index (market) tanking.
Here I am not going to talk about investment diversification. Rather I am going to talk about income diversification. I believe this is important but widely underappreciated.
People speak of losing their job as a disaster and this is usually the main reason why people have emergency funds. Most people have most of their income staked on a single source – typically their career if they are working or their retirement savings if they are retired(*). Thus if they lose their job or their savings, they are deeply troubled.
(*) In case of retirement, there are often two sources: savings and social security. However, being less than 50 years old, I’m not counting on getting my SS contributions back when I finally become eligible.
One of the hallmarks of generation X and certainly generation Y – and I’m right in between these generation – is entrepreneurism. The reason is that we are used to job insecurity and not having any promise of continued employment due to outsourcing, lay offs or limited contracts. Since steady employment from the baby-boomer managers is not a given, a lot of us have decided to abandon the previously implicitly assumed loyalty to our one employer and instead start our own business as a consultant, contractor or a small business.
Now your financial advisor is probably a baby boomer and he just might not get it.
When you own a business, you no longer have just one stream of income. You have hundreds or at least one from every customer. To illustrate the associated risk, I could post a blog on something controversial (religion, stem cells, abortion, …) and probably lose 10% of my readers. This would not be a big problem though since I would retain 90% of the rest. Conversely, if I do something controversial on a job, I could lose 100% of the job.
This is why diversifying sources of income is wise. It is also why being a specialist could be an increasingly tenuous position. I for one am not betting my financial security on that concept. Better to be a jack of all trades these days.
Originally posted 2008-03-21 07:24:20.