The Best Financial Plans Have Four Legs

Although I talked about side hustles as a form of diversification in my last post, often when we use the D word, eyes glaze over. Although a key to safe and healthy investing, the nebulous idea of diversification can stifle new investors and personal finance novices. How much is enough? What qualifies as diversified? The questions abound. In order to make the concept more clear, I like to look at my financial framework as a tabletop. When it comes to revenue streams, at least, the best financial plans have four legs to insure stability. Any less than this, and your table is likely to topple over. More than four can add stability but is less visually appealing and can lead to overkill.

Let’s take a closer look.

The Flamingo

The one-legged plan is the most dangerous of all. It is the ultimate in lazy diversification. It’s so lazy, in fact, that it is usually based on a single concept: the W2 wage. Like the flamingo standing atop one leg, its solidity can be knocked out with one single blow.

What does the flamingo financial plan look like?

This is the ride or die company man whose only income is his paycheck. Whose retirement money is tied up in a defined benefit pension. And who invests every extra cent he comes across in company shares. Bought at a discount, of course.

This is the most unstable of situations. With all the eggs in one basket, he is one scandal away from bankruptcy a la Enron style.

The best financial plans have four legs. Not one.

The Two-Legger

The two-legger is slightly better. But not much. Take our flamingo from the last and instead of investing in company stock, he puts extra cash in a broadly indexed, low fee mutual fund (and bonds). Now we are getting some stability. Right?

Kind of. It is true that unlike the flamingo, the most basic of breezes will not topple this financial plan over. However, very foreseeable problems exist in this allocation mix. What happens, let’s say, if we enter a recession.

Well, you know, the market crashes, and businesses fail. And unlucky people get laid off.

So now not only has our poor guy lost his job, but he will have to liquidate his slumping portfolio because he needs the cash for daily expenses.

Again, two are better than one. But the best financial plans have four legs.

The Three Legged Stool

Now we are getting some stability. If, in fact, our two legger than adds some real estate holdings he will be starting to create a more concrete footing to stand on. One can argue whether this means owning rental properties, REITs, or crowdfunding.

I tend to focus on owning and renting real estate because it is least correlated with market returns. REITS and crowdfunding have higher correlation coefficients.

The three-legged stool is an improvement, but I would still say that the best financial plans have four legs.

If your real estate holdings go south, it’s like sawing off one leg of the stool. Now you have a highly unstable structure ready to topple over at anytime.

The Dining Room Table

The dining room table is an American institution. Rightly so, it is the most stable of structures. When it comes to revenue streams, this means adding in side hustles to our already multi-pronged approach. In review:

Leg 1: W2, company stock, pension

Leg 2: Broadly indexed, low-cost mutual funds (and bonds)

Leg 3: Real estate exposure

Leg 4: Side hustle

knock a leg off a dining room table, weight redistributes, and it continues to stand until the damaged area can be reinforced.

Just like a great financial plan.

In Summary

The best financial plans have four legs. Could you go for more? Of course you could, but it’s not necessary. Eventually, all those legs will start to trip over each other.

Could you substitute, let’s say, real estate for some other asset class? You bet you could.

The point is that financial independence requires a multifaceted approach to revenue streams in order to be bulletproof.

Even after retirement, these rules hold. For instance, one could exchange the W2 leg with a good insurance policy like an SPIA or start taking distributions from tax-deferred holdings.

The possibilities are endless. So don’t let the vagaries of diversification throw you off.

Just build something stable enough to keep standing.