h/t to my friend Mitchell Cohen for the idea to write this post. Given the length, it’ll be a two-parter.

If you have been reading this blog for a while, you may think that my main message is “take more risk, take more risk.” While I do believe that most of us don’t take enough risk, I also think that maximizing risk in all areas of life at all times is extremely unwise. Rather, we want to be diversified between high- and low-risk opportunities.

The essential lesson of diversification is that a set of assets with different characteristics—risk level, asset life span or holding period, industry exposure, geographic location, etc.—will outperform a single type of asset over the long term, because life and the markets are unpredictable. The goal is to build a diversified “portfolio” that can withstand a range of economic and market conditions.

In this post, I want to show how we can take the principle of diversification and apply it to building a personal “portfolio” of projects, and why a diversified personal portfolio is often better (for most people) than a concentrated one.

Classic Financial Diversification: An Example

Here’s an example of what a diversified financial portfolio might look like for a 30-something:

·       50% stocks[1]

·       20% bonds

·       20% real estate

·       10% other (gold, crypto, private investments)

Without going into the math, a portfolio like this provides better returns at lower risk than a portfolio that is made up of 100% stocks, even though stocks outperform bonds most of the time. Looking more deeply, all of these investments have different characteristics:

·       Stocks – medium risk, medium return; if the economy does really well, stocks will do well, and you will get more dividends (cash flow) over time. If the economy does poorly, companies are at risk of going bankrupt and you can lose all of your money.

·       Bonds – low risk, low return, especially government bonds; if the economy does well, you lose out on potential returns by being overinvested in bonds. Inflation also destroys bond value over time, and very rarely governments also go bankrupt. However, if the economy tanks and you absolutely need $ for an emergency medical procedure or whatever, your bonds are likely to hold value and will bail you out in a difficult moment.

·       Real estate – higher risk than stocks, but not necessarily higher return. Everyone needs a place to live so buying a property that you live in is a way to “hedge” your living expenses. If you end up selling the house at a profit, great, if not, well, you still had a place to live that you hopefully enjoyed. Still, sometimes housing will do well at times that other asset classes do poorly so there is diversification benefit.

·       Gold – high risk, no returns (e.g., no cash flow). Gold is a hard asset that has always held value in human societies since the beginning of civilization, so it offers diversification benefit in the event that economic turmoil and uncertainty becomes very high (like now).

·       Private assets – very high risk, very high potential returns. This is investing in your friend’s startup or your college roommate’s food truck. Most likely, you will lose all of your money. But if your friend is lucky (or good), you may see returns of 30-10,000%.

Let’s see how this maps to personal matters.

Personal Diversification: An Example

I’ll use myself as the example.

I am a failed (?)[2] entrepreneur. I left a cozy and reasonably well-compensated position at the Federal Reserve (low risk, medium return) to try my hand at entrepreneurship (high risk, negative return). While you may say that I made a mistake trading medium returns for negative returns, in my view that wasn’t the mistake—the mistake was going from a 100% investment in “bonds” (working at the Fed) to a 100% investment in “private assets” (working on a startup). Neither position was diversified.

Contrast that to my “portfolio” today:

·       Part-time job teaching at UT – low risk, low return; provides baseline stability (e.g. health insurance!) and structure to my day, and it sounds like the University wants me to stick around for a while

·       Content creation – low risk, zero return at present, but high potential upside (I was not allowed to publish finance content under my own name while I was at the Fed, and this was one of the major reasons why I left. As a University professor, they want me to be publishing stuff)

·       Energy advisory business – low risk, medium return for the time spent

·       Random inbound consulting work – low risk, high return for the time spent (I would not have been able to take this work when I was at the Fed)

·       Two nascent startup ideas I am fleshing out – very high risk, very high potential return, and don’t require 100% full-time effort at the beginning

Even though I still make less money than I made at the Fed, I feel my overall portfolio is better because 1) my baseline needs are being met and 2) I have a number of high-upside “irons in the fire,” which I would not have been allowed to work on in my previous job.

The Importance of Meeting Your Baseline Needs

Although I “burned the boats behind me” by quitting my job cold turkey to launch a startup with no income, I would not recommend this approach to 99% of people, knowing what I know now.

The issue—which I didn’t anticipate at the time—was that the reality of having no income put me into a fear-based survival mode. Even though I had ~2.5 years of runway from my savings, I became very tight with my spending and probably passed up good opportunities like conferences and seminars because I felt like I had to hang on to every last dollar in order to stay alive. Watching the bank balance dwindle every month wasn’t a good feeling.

In essence, I gave up the “government bond” portion of my personal portfolio—the low-risk, stable thing (often a W-2 job) that provides the baseline low return needed to stay alive. While I think the pressure of a dwindling bank balance can be good for an entrepreneur in some cases, in my case, being totally new to the space, it wasn’t the best way to go about it. (One benefit that I did gain from doing things that way was confronting my fear—since I started my entrepreneurial journey in the scariest way possible, I am a lot less scared of all kinds of stuff now.)

Although necessity is the mother of invention, my current feeling is that fear-based survival isn’t the best place from which to do creative work. That’s the same emotion we experience when we have a term paper due tomorrow and scramble to crank out 20 pages in one evening. That procrastination-driven burst of energy can produce acceptable work, but I doubt it produces great work.

The goal isn’t to take or avoid risk—it’s to take the right amount of risk, in the right areas, at the right time. When our baseline needs aren’t met, our projects all feel like life-or-death situations (and good investors avoid life-or-death situations whenever possible), and that doesn’t usually bring out our best thinking. Once we have built a stable base, we can afford to take bigger bets, and that’s what we’ll go into in Part 2.

Part 2

In Part 2 next week, I’ll talk about the importance of high-risk, high-return projects, when to go all-in on a 100% concentrated position, as well as building synergies into the portfolio that raise the expected value of all projects in an inter-related way.

Exercise

Journal on the following or discuss with a friend.

1)      Noticing

When I reflect on my baseline needs, to what extent does it feel like they are being met? Am I in a fear-based survival mode, or do I have breathing room?

2)      Portfolio analysis—"bonds”

How does my current portfolio of projects feel from a risk standpoint? Do I have a mix of stable, income-generating projects (including a W-2) job, and projects with high upside? Or am I over-allocated to one or the other?

If you are in survival mode, you probably don’t have enough “bonds” in your portfolio of projects. By contrast, if your W-2 job feels draining and all-consuming, you probably are overindexed to a “low-risk, low-return” project like a job.

3)      Action

What is the smallest step I can take to rebalance my portfolio?

If I am a struggling creative, maybe it’s making an active decision to spend some time and energy on getting a part-time job. If I’m at an all-consuming W-2 job that offers low upside in the long term (e.g., hard to get promoted), maybe it’s finding ways to scale back on job responsibilities.

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[1] The stock allocation could vary based on your estimate of valuations. Despite the turmoil of recent weeks, I think the U.S. stock market remains overvalued and has much more room to fall. I personally am defensive in my asset allocation at the moment.

[2] To be clear, I say this facetiously. Failure is temporary, lessons are permanent. I don’t regret my decision to quit my job at all.