Insulate Your Income Through Diversification

by Tax Guy - Burlington Accountant on April 22, 2008 Print This Post Print This Post

The seasoned investor knows that by diversifying their portfolio they can reduce their risk of loss (and also gain) if one or more of their investments does not perform as well as the entire portfolio.  By investing in a basket of securities your risk can be reduced to no more than market risk.

For example, if you were to hold 10 stocks in 10 different companies and one of these companies failed, you would still have the returns from the remaining 9 stocks and your overall portfolio return would not be lost.

The concept of diversification works in the business world as well.  Smart companies do not rely on a single vendor but rather many vendors to reduce the risk production will be impacted should one of their vendors be unable to supply inputs.  Companies also reduce risk by diversifying over different markets (a toy manufacturer may also manufacture small farm equipment) or by diversifying operations (operating manufacturing plants in California and Georgia).

This concept can be applied to your personal life as well.

Does all of your income come from one source?

For many of us our jobs are a large component of our income.  To diversify our personal risk we should take steps to seek alternative sources of income should our main source fail (i.e. we lose our job).  This can be achieved through a systematic and comprehensive plan to invest our savings and produce income through capital appreciation, interest income, and dividends.

Does this mean that we need to spend the income from alternative sources?

No.  We can reinvest these funds to fuel the income engine.  If some day there is an event that courses us to rely on our alternative income, then we can draw on it.

What types of events would cause us to draw on our alternative income?  Temporary job loss and retirement are but two examples of life such events.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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