Tuesday, February 19, 2019

The Importance of Income Diversification

As someone who is striving to be financially independent by the age of 35, I need to diversify my income away from my day job and into passive income, as well as other more active income streams such as Seeking Alpha. As such, I'll discuss the 3 reasons that I believe income diversification is of utmost importance to not just those that are aiming to achieve FIRE, but for everyone.

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Reason #1: Financial Peace Of Mind In Times Of Emergency

If you're like the vast majority of Americans, you're probably reliant upon a paycheck to cover your expenses. According to CNBC, 78% of Americans indicated that they live paycheck to paycheck. The even more terrifying statistic is that nearly 10% of Americans that earn more than $100,000 per year are living paycheck to paycheck. 

This is the precise reason that I believe this country faces a major financial illiteracy crisis. When you're earning over $100,000 a year and you can't at least have an emergency fund to get you through a few months of being laid off or whatever the emergency is, you are in need of a reality check.

When half the world lives on less than $5.50 a day and you're complaining about how hard life is while sipping on your $5-6 Starbucks Ultra Caramel Frappuccino, you need to realize that you're the 1% of the world and check your privilege at the door. You're living better than 99.9% of humanity has lived and yet you're still living paycheck to paycheck. 

Many people here in the United States like to tear apart the 1% in our country, while not even realizing that those around the world would be tearing into them as they are the 1% of the world. It's the textbook definition of hypocrisy. Sure, I'll admit that there are flaws in our country, but let's face the facts and realize that there is arguably no better country in the world to create wealth than in the United States. Despite our flaws, I truly believe we are still the land of opportunity.

Aside from this rant, income diversification is paramount to your financial peace of mind. If you are laid off, you receive your paycheck a couple days late, have to purchase new tires for your car, etc., you will be in a state of financial bliss while others are panicking about how they're going to pay for these emergencies. 

If we take my case for example, I have streams of income from my employer, Seeking Alpha, and the 57 companies and 1 mutual fund that I own (33 in Robinhood and an additional 24 different names in my M1 Finance account). Although I'm still in the early stages of my journey to diversify my income, around 13% of my income originates from Seeking Alpha and dividends. This is 13% of my income that is completely independent or free from the whims of my employer. As long as I continue to write content for Seeking Alpha that provides value to readers and as long as I continue to hold my ownership stakes in my dividend paying companies, I'll continue to receive this income.

When you are diversified and have multiple streams of income, you are less reliant on the less stable income sources (i.e. an employer) to support your livelihood. This leads me into my next point.

Reason #2: Autonomy From An Employer

As I briefly alluded to above, I consider an employer to be one of the least stable sources of income, which necessitates income diversification all the more. As employees, we are subject to the whims of an employer that is trying to increase their profits while hedging their risk. This means that employers are constantly trying to find ways to automate our positions to realize cost savings. 

According to CNN, 38% of jobs are in danger of being replaced by robots and AI by 2032.  While this will create opportunity for high skilled workers, it does mean that many in the financial services sector in the United States could be replaced in the next 10 or so years. With AI capable of doing even tasks we never thought possible before (i.e. composing music), AI and robots replacing a sizable portion of the workforce in the next decade is very viable.

When you're on the other end of this trend, you're benefiting considerably. We all know that as an employee, your employer can fire you for whatever reason they'd like (i.e. you don't fit the company culture, your boss simply doesn't like you, etc). 

This is a stark contrast to when you are an investor. The CEO of Exxon Mobil isn't going to fire you because "you don't fit the culture here." They work for you, the investor. They are going to be working for you and doing everything they can to ensure that Exxon Mobil becomes more efficient of a business and more profitable in the future. 

When you reach a point that your passive income within your taxable accounts is approaching your living expenses, you are able to pursue the passions of your choice. Perhaps there is a job that you would like to take in the future that you would find more purpose in, but it pays less. When your passive income comes close to your expenses, you simply have more autonomy from your employer.

It's that gradual shift from an employee to an investor that enables you eventual autonomy from your employer, allowing you the ability to create the purpose in your life rather than having your employer create your purpose.

Reason #3: A Decline In One Income Source Could Be Offset By Other Income Sources

Building off of the first reason, it is necessary to have income diversification because when you do reach a point in which you're relatively independent of your active income source to support your lifestyle, you need to be reasonably sure that your passive income is safe and will grow at least in line with inflation.

Diversification is a necessary component of a sound financial plan because investments like General Electric are bound to happen eventually. From a fundamental standpoint, the cut from General Electric could be predicted. However, what happens when a dividend paying company such as MercadoLibre decides it would be better off eliminating its dividend to focus on growth? 

Even though MercadoLibre was a dividend safety score of 79 per Simply Safe Dividends prior to the suspension of its dividend, sometimes you just can't predict a mercurial change in capital allocation policy like that. Although you could probably sell off the position at a slight loss and buy into another dividend paying company, it's very comforting when you limit a position to no more than 3-4% of your dividend income. As such, this outright elimination would probably be easily replaced by other consistent dividend raises in your portfolio from Johnson & Johnson, Pepsico, and Genuine Parts Company. 

One could suffer a dividend elimination like that, resulting in a 3-4% reduction in their total income, but benefit from raises from other companies to the tune of 6-7% and still walk away from that dividend suspension richer than they were the year before. 

This speaks volumes of the power and safety of mind in the diversification of your passive income. Even though a far from ideal result occurred, you still ended up better off than you were the year before.

Summary: Income Diversification Is Necessary For Everyone

Whether you're aiming for FIRE like I am or you're planning for a more traditional retirement, one thing is for certain: income diversification is a necessary component to either strategy. When you have several streams of income, events that are often emergencies to others become nonevents to you. Moreover, you're not completely bound to your day job as most Americans are. To make matters even worse for Americans, most generally dislike their jobs. Finally, a decline in one income source doesn't spell financial turbulence for you as it would for most. It is for the aforementioned reasons that I believe income diversification is a necessary piece of any strategy to achieve financial peace of mind.


What are your thoughts on income diversification? How much of your total income originates from non-employer related sources? As always, thanks for reading my thoughts and I look forward to reading and replying to your thoughts in the comment section below.

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