"An investment in knowledge pays the best interest." - Benjamin Franklin
"Invest in yourself. Your career is the engine of your wealth." - Paul Clitheroe
Dear Friends and Family,
The Complete Portfolio includes everything that impacts your future financial health.
Many investors make the mistake of thinking that financial assets like stocks and bonds should be considered in a vacuum...without consideration of realities like where you work, your financial goals, what country you live in, the health of your marriage, hard assets like your house, and everything else that materially impacts your financial situation. The Complete Portfolio includes all of these and recognizing this can have profound impacts on how we allocate our time and money.
In this article we share our views on how and why thinking in terms of the Complete Portfolio can lead to improved financial health. This is a prerequisite to our next post on True Diversification.
Commonly overlooked dimensions of the Complete Portfolio include:
Country of Residence
Let us take each in turn...
1. Career (YouCorp)
Investing involves more than just money. It also includes how we invest our time, and much of our time is spent on our career. Our careers provide some uncertain future stream of income in the same way that companies do. In that sense, our job is like having equity in our own company. We call that company YouCorp.
YouCorp will vary a great deal from person to person. Young people working a desk job probably expect to make a decent salary that will likely grow over time. A middle aged entrepreneur is willing to take a chance on making it big, but will typically fail and have to start over again. Older people reliant on a pension for income will likely keep getting checks, but might lose it. All career paths have some uncertain future income stream… even if it’s uncomfortable to accept.
Careers vary in terms of their sensitivity to economic growth. Most jobs are pro-cyclical meaning that they tend to have higher incomes during periods of strong economic growth. Industries like the arts and marketing luxury goods like Yachts are extremely sensitive to recessions. A tenured professor is probably more insulated. There are also a few careers that are acyclical, meaning that demand rises during periods of economic stress such as risk managers and bankruptcy lawyers.
One of the biggest mistakes we can make is to ignore the correlations between our financial assets and our time (i.e. YouCorp). For example, if you work at Facebook and are rewarded equity compensation, then your YouCorp stock is going to be highly correlated with your job security. This opens up a common source of financial ruin...losing one’s job and financial assets because your company fails.
YouCorp creates a challenge for young investors because it is typically the largest stock in their portfolio. Financial assets are typically small compared to the stream of expected future income. This makes diversification practically impossible as YouCorp might make up 95% of your whole portfolio. As a result … maximizing the expected present value of that future income is often a much more prudent use of time than focusing on your financial assets.
YouCorp also creates opportunities for diversification. The easiest way to do this is to diversify your skills. YouCorp should be nimble and resilient...learning and improving over time. Just like a company...people that do this will survive and thrive while those that fail to do this will likely end up broke.
Those that invest in themselves will be more willing and able to take calculated risks...both financially and with their time. If you know that your stock in YouCorp is valuable than you can afford to invest a bit more in that tech company you believe or your friend's startup. Unfortunately, those that can least afford to do so also seem to be the most willing to gamble with their money.
In short, consider your job and future career prospects when deciding how to structure your retirement savings. This is especially true for young and middle-age investors because they still have many years to work, making their stock in YouCorp an outsized part of their portfolio.
Investing in relationships is often more profitable than investing in stocks. The best relationships build compound interest over time...characterized by deeper trust and an ability to work more effectively together. Strong marriages are good examples of this as well as close family ties.
If you are married (and expect to stay married) then YouCorp is going to be less risky because of the added diversification of your spouse's expected future income. Even if your spouse doesn’t work, they can still provide insights and otherwise support you so you can take advantage of career opportunities. Unfortunately, the opposite is also true. Unhappy marriages drain our ability to seize opportunities and bring many to financial ruin.
Strong families can provide a safety net, allowing us to take more risk with our careers. I personally know several entrepreneurs that only felt they could take huge risks with their careers because they knew their family was there to help them if they failed. Close friends and communities like churches can sometimes provide a similar type of support. Governments can do this as well through unemployment insurance and other assistance to those who fall on hard times.
3. Hard Assets
Our home is the most common form of hard asset that many often overlook when thinking about their financial investments. Sometimes this is on purpose...so they create a false sense of feeling more poor than they actually are...allowing them to avoid spending as much money. But our homes are an important part of our wealth and should be acknowledged as part of the complete portfolio.
Real estate values as a group are quite sensitive to the economy, but your home’s value is highly highly unpredictable and dependent on its location. You are also less likely to panic sell your home because even if its value drops you can’t check the price every day so its largely out of sight and out of mind. These are big reasons why many people ignore their home when allocating their cash.
But equity in a home provides a valuable diversifier and forced savings that may allow some investors to take more calculated risks. Would be entrepreneurs can potentially draw upon home equity to get through a recession. Long term investors should, all else equal, feel more willing to take calculated risks in stocks and private equity if they have more wealth built into their homes.
In some countries it’s customary to keep more savings into gold, silver, and real estate. These assets as a group are thought to be hedges against currency depreciations. To the extent that this is true...investors holding more hard assets may feel more comfortable investing their cash in other assets that are more sensitive to currency devaluations like bonds and CDs.
In short, hard assets can provide a valuable tool for diversifying and a cushion that allows for more calculated risk taking...all else equal.
Insurance is a useful way to mitigate many sources of financial ruin such as having your house burn down and an unexpected medical emergency. Businesses should also include getting sued in this category.
Risks to insure against typically have two things in common...they are infrequent and have high severity. In other words...they don’t happen often but if they did happen they would be devastating.
Thankfully many have access to affordable insurance. If you do then taking advantage of insurance can provide yet another means of justified risk taking in one’s retirement account. If you don’t then taking big risks with your investments open up more scenarios for financial ruin.
5. Country of Residence
The last overlooked dimension of the Complete Portfolio is the stability and currency of our country of residence. Many Americans do this. But every country and every currency carries risks that should be recognized and accounted for.
The United States has benefited tremendously from the current world order...one that started just after WWII. The US dollar is the largest global reserve currency, a fact that has kept borrowing costs low and our purchasing power high relative to the rest of the world.
There are many reasons for the strength of the US economy and stock market over the past 100 years. A big one is geography. We have the largest set of navagitable rivers interconnecting the largest bread basket in the world. We are also surrounded by two 6,000 mile moats on either side of our country; known formally as the Atlantic and Paficic Oceans. We have friendly neighbors to the north and the south, with our southern border conveniently located on a large swath of desert which made it easier to defend.
Throughout history our geographic advantages and diverse economy allowed us the option, but not the obligation, of engaging in international affairs. The USA has oscillated between engagement and isolation in part because we had the choice. Most countries don’t have a choice. Germany is a great example...involved in both world wars in large part because of their situation between other global powers, not because of some cultural preference for war.
But the world is always changing, and many of these changes shift power toward countries that have historically been disadvantaged by geography. Technology is leveling the playing field...making education systems and friendly relations with other countries more important than mountains and oceans.
The United States is not really disadvantaged by these realities, but we have a long way to fall. The US dollar is used to denominate 70% of the world’s financial assets. Our stock market is roughly equal to the rest of the world combined, and our economy is 25% of the globes. This despite our population being a mere 5% and our education and healthcare systems failing many compared to other industrialized countries.
Change is the only constant when investing...and investors that bet it all in their home country open themselves up to more possibilities for significant underperformance and financial ruin than those that don’t.
Investors should consider much more than their 401k when making investing decisions. Those that consider their Complete Portfolio will be better able to diversify and hedge against financial ruin. Those that do will also be better able to take justified and calculated risks that improve their chances for financial independence.