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Typically one of the first buzzwords you encounter when you first start exploring personal finance is diversification.
There are actually two schools of thought:
- Be well diversified and have various asset classes make up your portfolio.
- Have all of your eggs in one basket but watch that basket like a hawk.
The vast majority of us choose the first option because most of us do not have the time or energy to stay atop of current events that could drastically impact a one-basket portfolio.
The premise behind having a well-diversified portfolio is sound.
The Callan Periodic Table of Investments is a great visual representation of how the “winning asset class” changes almost every year.
An asset class that may be a leader in returns for a particular year may be the worst performing class in a subsequent year.
Because none of us have a working crystal ball, the best way to capture the market returns is to be well diversified and have exposure to each asset class.
So after reading countless blogs, books and listening to multiple podcasts, you come up with a diversified portfolio that is the envy of others.
You are set, right?
Wrong.
Unfortunately a well diversified portfolio does not come with an iron-clad guarantee that you will have a reliable income stream when you need it.
Just because you have your precious eggs in multiple baskets does not mean you can not experience a catastrophic “black swan” event that topples every basket over at the same time.
Weaving My Baskets.
I am still in the accumulation phase of my financial life cycle.
As such I have constructed the following financial baskets that help keep my household financially on track:
- W-2 Income Basket.
- This is by far the biggest financial contributor to my household, accounting for around 85-90% of total income in normal years.
- 2019 was an anomaly due to the proceeds from selling my medical office building which made it the overwhelming biggest contributor.
- This is by far the biggest financial contributor to my household, accounting for around 85-90% of total income in normal years.
- Real Estate Income Basket.
- Approximately 2/3 of my investment portfolio is attributable to real estate (not including REITS).
- This is the asset class that I have been directing all my discretionary dollars towards since May 2017 (apart from my retirement vehicles which I max out each year).
- Primarily consists of various syndications I have invested in.
- Approximately 2/3 of my investment portfolio is attributable to real estate (not including REITS).
- Stock/Bond Market Basket.
- Subdivided into Brokerage & Retirement Baskets.
- Vast majority is in index funds.
My personal preview of a Black Swan Basket-Shattering Event.
I was quite pleased with my progress carefully constructing a diversified, multiple basket, portfolio during my accumulation phase.
I was rewarded handsomely in 2019 as the income generated by these baskets, most notably the real estate one with the above mentioned sale of my medical building, allowed me to hit my “number” a full 4 years ahead of schedule.
Yup I was Little Red Riding hood, merrily skipping my way through the financial forest with not one, not two but 3 baskets brimming full of goodies on my way to the Early Retirement House.
And then the big bad Corona Wolf came.
The world-wide phenomenon of COVID-19 wreaked havoc on the global economy.
COVID-19 did not care that I had diversified my investments into various baskets.
Nope, COVID-19 decided to topple them over all at once.
- W-2 Income Basket.
- It seems paradoxical that a global health scare would financially impact someone in the healthcare profession but it certainly did.
- My previously rock-solid income as a radiologist was jeopardized as shelter-in-place orders dried up revenue sources from “bread and butter” outpatient studies and forced me to take a 60% pay cut and even do a self-imposed furlough.
- Real Estate Income Basket.
- The positive cashflow I was achieving with my real estate syndications with fairly reliable quarterly distributions was also in jeopardy from the economic shut down.
- Many renters were no longer earning income and there was a risk that rents would not be collected in a timely matter.
- One of my syndications took the cautious approach of suspending the Q1 distribution I was set to receive in April.
- In all fairness, after analyzing rents collected from March and April, the syndicator decided that the financial impact was not as severe as feared and decided to release the full distribution one month later, at the end of May.
- Stock/Bond Market Basket.
- In March it truly seemed like the sky was falling as Chicken Little took over the Dow Jones, resulting in the largest 1 day drop recorded.
- This resulted in $600k of net worth being vaporized in a single day (which was easy to keep track of thanks to the free online tool at Personal Capital).
Financial Disaster Averted.
This black swan event could have been crippling for me financially if I was retired and living on a fixed income.
I was incredibly fortunate that even with a markedly reduced salary draw, I was able to settle all financial obligations without going into debt.
If I was an early retiree and truly relied on portfolio generated income I would either have to tighten my belt considerably or start selling assets, and thus locking in losses, to make up the financial gap.
As an early retiree any suspended distributions from my real estate portfolio would be financially devastating as this would have been my main source of positive cashflow.
So how do you turn a black swan into a grey one?
In times when chaos is reigning supreme the one thing that can be a beacon in the darkness is cash.
It is true that cash is king.
Even though there are some negatives, such as cash drag, when sitting on a pile of money, you will be glad you have that pile as everything else is tanking.
I was quite fortunate that I had a sizeable emergency fund during the current COVID-19 crisis that helped ease my mind.
That peace of mind was far more valuable than any potential amount I lost from cash drag.
The importance of cash/cash equivalents in retirement is the principle driving force of the popular three bucket retirement system.
Having anywhere from 2-3 years of retirement living expenses in the first bucket would certainly ease my mind and make me far more comfortable when a black swan event is no longer a practice one like this current one was for me in 2020.
Note:
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Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
-Xrayvsn
NOTE: The website XRAYVSN contains affiliate links and thus receives compensation whenever a purchase through these links is made (at no further cost to you). As an Amazon Associate I earn from qualifying purchases. Although these proceeds help keep this site going they do not have any bearing on the reviews of any products I endorse which are from my own honest experiences. Thank you- XRAYVSN
I think a lot of people, doctors included, began to appreciate a cash emergency fund this spring. I was very grateful for my emergency fund this spring.
I hope some of your black swans have flown away by now.
I agree about the emergency fund. I was very cavalier about it before thinking I could cash flow any emergency via my paycheck. Then my pay got reduced 60% and the cushion was reduced considerably.
I hope the black swans are gone too to never return (but I know that’s wishful thinking).
Have a great day
This event really shows the importance of a big cash cushion for early retirees. I used to think 2 years of cash is too much, but now that’s barely enough. With 2 years of cash, you can power through most of these black swan events. More would be even better.
I agree that a big cash cushion most definitely softens the blow of a black swan event. I was hoping to shoot for 3 years of living expense cash cushion when I pull the plug. Glad your plan has worked remarkably for you.
I’m in a similar boat.
Fairly diversified, but still vulnerable when EVERYTHING goes down at once.
I knew each risky asset could go down, but I didn’t think my surgery centers, apartments, job income, and other investments would all take a hit at once. Doing fine so far.
I love how you and I are probably technically “FI” but consider ourselves in “Accumulation Mode.”
Keep Grinding!
LOL. As long as I am pulling in a W2 paycheck, I consider myself “accumulation phase” despite being FI. LOL
Once I hang up the MRI machine, the interesting decumulation phase will begin.
Glad you are doing fine. The helicopter money the feds threw at the market certainly helped the stock rebound portion (but also worries me whether or not this is a facade as stock performance currently not in sync with economic reality).
Hi xrayvsn, Thanks for your insights on this blog. Right now I am learning financial concepts such as Sharpe ratio , Efficient Fronter , Equity Beta , Alpha , sequence of returns risk etc. Can you recommend any blog , podcast , book , video etc that does meticulous DIY investment analysis (with graphs and charts) and also could teach us how to perform similar DIY investment analysis simulations? Also , a blog(s) by someone who is regarded somewhat as a gadfly , contrarian or miscreant that dares to question conventional financial wisdom? Thanks a million for all you are… Read more »
Thank you for the comments. Yeah I don’t know what happened with that one post and why that background is different from my standard dark one. I might just have to delete it and redo it but would hate to lose all the comments from it. As for recommended blogs, if you haven’t come across it yet, early retirement now (ERN) is a great resource with tons of analysis. It’s like taking a financial course and is pretty easy to read. I met the blogger who runs it and he is super down to earth. As for the contrarian blogger… Read more »
good post. To clarify, in order to lose 600k in the stock market in that one Single day, you would have had to have 4.8MM in an S&P index fund since it was a 12% drop. If /3 of your investment portfolio is in RE, then that’s going to be in the ballpark of 10MM. Throwing in emergency funds, home equity, etc, your NW is between 15-20MM (or more)? Impressive.
2/3* of your investment portfolio is in RE
Thanks CBThree for the comment. Your math makes sense which had me scratching my head because my net worth is not quite where your numbers place it. I logged back on Personal Capital and I indeed show a drop of almost $600k in one day so I’m not sure what happened. I know some index investing I did is in sectors that may have been hit worse (plus still had some individual stocks that got hit). Not even sure if it was an error on Personal Capital side if that day they didn’t have an account populate the data for… Read more »
Everyone poo-poo’s cash when the economy is great, but when the s**t hit the fan I was really glad to be sitting on my large cash pile.
Hope things are beginning to look up for you!
Appreciate that Mr Tako. Because of the turnaround in the market my net worth quickly climbed back to pre Covid levels. Having a cash pile certainly made things much less stressful during the whole process. Have a great day!
Your blog is very good as it seems that a professional blog has written.thanks for sharing this information.
Helpful post for us. I really agree with you. Emergency funds really help us.
Appreciate it. Yes emergency funds are not sexy/glamorous but really useful when you need it
I’ve actually taken a different approach here. I don’t have a formal ’emergency fund’. But I do have liquid assets that can be turned into cash in an emergency. At the same time, I’ve focused on a zero debt lifestyle – no mortgage, no student loans, no car payments, etc. Yes, I could have done well to invest in the market rather than paying off my 2.75% mortgage, but the peace of mind of not having any recurring monthly bills is priceless to me. And, I happen to do pretty well in the market too. I would also encourage investors… Read more »
I agree 100% about the benefits of a zero-debt lifestyle. I think the peace of mind trumps whatever gains you could have made from investing.
Risk mitigation/capital preservation is the stage where I am at now. I think I do have enough for what I anticipate I will need (plus I am buffering it even more by continuing to work despite being FI). Hopefully the only issues I will have are estate issues.
Have a great day and thanks for stopping by!