Asset Diversification the Right Way
As Featured on
Contents
- Asset Diversification = Risk Management
- Key Parts of Asset Diversification
- Political and Economic Risk
- Bank System versus Private Assets
- Liquidity Risk
- Other Risks
- What Assets Go into an Asset Diversification Plan?
- Stocks
- Bonds
- Real Estate
- Precious Metals
- Crypto
- Alternative Investments
- Case Study in Asset Diversification
- Common Asset Diversification Mistakes
- Frequently Asked Questions
- How asset diversification fits into a proper Plan B
Asset diversification is one of those topics that three people can look at and come up with three different answers.
In some ways, it’s tied to the idea of asset allocation — what percentage of your assets go into which asset classes. But it’s more than that.
It’s about creating a strategy that allows your nest egg to grow no matter what’s going on at home or in the world.
In this article, we’ll talk about the big picture of asset diversification, what it means as part of your Plan B, and how to start building it into your strategy.
Asset Diversification = Risk Management
You may have heard from your financial planner that building wealth is not only about growing your money; it’s also about minimizing losses as much as possible.
The way we avoid losses is by managing risk.
Because the truth is, no matter what you invest in, there’s always a risk. For certain speculations like non-fungible tokens (NFTs), the risk is obvious. But even “safe” assets like Treasury bonds carry risk as we learned in 2022.
In that case, those bonds were exposed to the fastest rise in interest rates in 40 years. As the rates someone could get on new bonds went up, the value of the existing bonds went down. This created massive paper losses that caused a number of banks to fail in 2023.
And that’s only one kind of risk. Depending on the bond type, there’s sovereign risk (when a country refuses to meet its debt obligations), corporate credit risk (when a company can’t repay its bonds), and inflation risk (when the bond loses value over time, even after the yield is added). And so on.
What we do as investors is look for ways to manage that risk.
Key Parts of Asset Diversification
Now, many of our clients give more thought to certain risks than others. And although we are not (currently) licensed to offer personalized investment advice, our planning often involves building solutions that deal with risk.
Here are the themes that come up most often:
Political and Economic Risk
Like many people, you might be concerned about having all your assets subject to the whims of one government, one currency, and one economy.
For our clients, that’s the US. And given the deep concerns about the economic prospects in this country — no matter who’s in the White House — that makes a lot of sense.
Record deficits and a record debt need to be dealt with at some point. Maybe that will be in a year. Maybe a decade. Maybe even longer… But it will eventually come. And it’s going to be very painful for the people caught up in it.
If you have assets outside the country, you’re able to protect that part of your assets against this threat.
Bank System versus Private Assets
Clients often ask us to plan around bank risk. We saw last year how fast banks can fail. And, understandably, our clients don’t want to be caught up in a bank failure.
That said, we did have clients at both Silicon Valley and First Republic, and although things worked out that time, there’s no guarantee.
So when we’re asked to manage banking risk, we will often use a mix of insurance protection, internationalization to safer banks overseas, and the buildup of assets outside the banking system entirely.
Liquidity Risk
Liquidity is also a concern for some clients, though most don’t bring it up directly. We often identify it during asset mix reviews.
This often comes up in the form of significant real estate holdings, a lot of equity in a private business exposed to creditors, or alternative investments with a very thin market.
All of these are illiquid. In a proper asset diversification strategy, you need a good mix of both.
Liquid assets — cash, stocks, bonds, bigger cryptos like Bitcoin or Ethereum — can be quickly liquidated in a crunch. The flip side is they’re easier to take from you.
Illiquid assets are harder to seize. But if you have to sell them in a crunch, you’re likely to lose on the deal.
Like many things, it’s a balancing act.
Other Risks
There are other risks, of course. And because everyone’s situation is unique, the specific ways in which you manage these risks are important. Here are a few.
Taxation Risk: How will changes in tax policy affect your plan? Retirement accounts that plan over decades are especially exposed to this.
Creditor Claim Risk: How likely are you to be sued? Risk management in this area is especially important for business owners and real estate investors.
Currency Risk: How likely is the dollar to lose value against other currencies, to lose reserve currency status, or to collapse entirely? And when? Your beliefs about the timeline will inform how little or much of your assets you need to get out of the US dollar.
Estate Planning Risk: How likely is an estate plan to work the way you hope? Often we’re asked to help avoid probate and limit the chance that someone unwanted has to claim a piece of the property. That needs to be properly managed.
Inflation Risk: How likely inflation is going to eat away at the purchasing power of your savings? This is a real and present danger for clients on fixed income.
Counterparty Risk: How likely is it that the company holding assets on your behalf goes bankrupt and, through the process, loses your assets? You might be surprised.
What Assets Go into an Asset Diversification Plan?
As mentioned above, asset diversification is more than just a question of choosing the right asset mix — what professionals call asset allocation.
Still though, the asset mix is important. Here are some of the asset classes most popular among our clients:
Stocks
Publicly traded stocks tend to play a major part in client portfolios. Sometimes held directly. Sometimes held through mutual funds and ETFs.
The biggest advantages here are liquidity (usually) and the ability to benefit from growth in the entire economy or certain sectors (depending on your holdings). The biggest disadvantage is exposure to the whims of the market.
Over the long-term, that usually isn’t a problem. But timing can be a real challenge — if you’re unfortunate enough to have to cash out after a market crash, you have to lock in that loss permanently.
Bonds
Bonds are usually seen as an offset to a volatile stock portfolio. As you get older, standard portfolio design builds in more exposure to bonds for a reason. However, as we painfully learned in 2022, they carry a risk of their own.
Most notable, they are exposed to interest rate fluctuations. That’s not a problem when interest rates are high and dropping. But it’s a huge issue when interest rates are low and going up.
Real Estate
Many of clients like real estate. Some of them own properties domestically, some internationally, often both.
On the domestic front, liquidity is usually decent. Yes, there are costs — especially high real estate agent fees. But if you need to sell, there’s usually someone ready to buy.
Holdings do tend to suffer from more political risk — it’s a fixed asset stuck wherever it happens to be. That’s fine if you’re in Texas or Florida, but less so if you’re in California.
On the international side of things, foreign real estate planning can be a real challenge. In certain countries, mild racism against Americans can be a problem (the “gringo tax”). And liquidity tends to be lower.
But, on the flip side, foreign property is typically more private than US holdings. They are harder to seize than anything in the States. And, they can serve as a useful bolthole should you ever need to leave the country. Plus, they can be used as a way to qualify for the right to live and work in a country too.
Precious Metals
Unsurprisingly given our history, precious metals often play a part in our planning. Sometimes in physical form. Sometimes held on the balance sheet of a gold repository. Sometimes domestically. Sometimes internationally.
The nice thing about precious metals — and gold specifically — is that there’s a lot of flexibility to suit any risk considerations. The downside is that, depending on form, liquidity can be an issue.
Crypto
Unlike many international planners, we’re old hat when it comes to cryptocurrencies. I was first introduced to Bitcoin in 2013 when the price was $15. Even did a bit of mining on an old desktop computer at one point.
We’ve also had the good fortune of working with a number of self-made crypto billionaires.
It can be a great addition to an asset diversification strategy. It doesn’t suffer from counterparty risk if you hold it in cold storage. For a while, it didn’t move in step with other asset types like the stock market.
But it’s very speculative. At least one client I’m aware of lost most of his money (98%) piling into an alt coin. We’ve seen leveraged bets on crypto in general and Bitcoin specifically go spectacularly wrong.
If you can ride that volatility, or keep your position to a few percent at best, it’s worth a look. But for most clients, it’s not a great idea.
Interestingly enough, the clients who made a fortune with Bitcoin or an alt coin — Ethereum mostly — usually quickly diversify their coins into other assets after a big run up. A client once even paid for his Citizenship by Investment application in Bitcoin.
Alternative Investments
It’s no secret that accredited investors have access to investments that the broader market does not. These “private marketplaces” can offer better returns for lower risk that investors in the stock market can only dream of. And they do it more consistently.
But, they do tend to suffer from liquidity issues — you have to be willing to lock in your investment for years, with limited options to cash out early.
They also can be a tax problem if they rely on short-term trades to create higher returns. (Those gains are taxed as ordinary income instead of capital gains if held less than a year.) This is especially true with hedge fund plays.
Still, if you are an accredited investor, they may have a place as part of a proper asset diversification strategy.
Case Study in Asset Diversification
We had a client I’ll call Don. I’ve changed some facts of his story for privacy.
“Don” is a single US taxpayer currently living in the US. He’s worked all over the world but doesn’t like the way the country is going and doesn’t think it matters who’s in the White House.
So he plans to leave in the next few years. He’ll likely give up his US citizenship some years after that.
At the moment, most of his assets are based in the US. He wants to diversify his assets and a key part of that will be moving them offshore. His plan is to purchase multiple properties in multiple countries with a focus on places that will qualify him for permanent residency based on the investment.
Through our Discovery process (the first step in our planning), we’ve identified the following risks:
Estate Planning: He doesn’t want his heirs to have to deal with probate in another country.
Political Risk: He’s now having to deal with multiple jurisdictions and systems, most of whom don’t speak English as their native language.
Tax Risk: If the planning isn’t done properly, he could actually pay more taxes each year until he renounces his US citizenship.
Regulatory Risk: He will need to comply with foreign reporting requirements on the assets, which needs to be done properly to avoid fines and penalties from Uncle Sam.
He was aware of some of them, but not all.
Through our planning, we work through them. As you build your own Plan B, you need to think about this too.
(If you aren’t sure, book in a free call with an Associate to review your case. The call is free and there’s no obligation to move forward with a planning engagement.)
Common Asset Diversification Mistakes
Of course, this is easy to get wrong, and many people do. Here are some of the bigger mistakes we see clients make related to asset diversification.
Mistake #1: They protect against a risk they don't have.
A client recently came to me with the news that someone tried to sell him an offshore trust. But it was a solution to a problem he didn’t have. Both he and his wife are W2 employees with a low risk profile. An offshore trust is an asset protection tool for high-risk clients.
In his case, it would have created new risks (tax risk and regulatory risk) and cost a pretty penny to set up and maintain. Good for the guy trying to sell it but less so for my client.
Mistake #2: They throw the baby out with the bath water.
Plenty of clients are not a fan of the stock market. You can make a pretty credible case for manipulation. They suffer from counterparty risk, especially in the US.
So they pull their assets out of the system. But where to put them?
It has happened that the destination is riskier than if they had just bought the S&P 500. Liquidity risk. Concentration risk. Counterparty risk. And they lose it all.
Mistake #3: They introduce new risks they don't understand.
I hate to keep picking on offshore trusts but I first learned about something called Trustee Risk from a review of one of them.
The client came to us because something didn’t smell right with his new offshore trust. Because the attorney in question is still practicing and, to my knowledge, hasn’t specifically been charged with any crime related to such things, I won’t mention his name.
But this provider made himself both the trustee AND the protector of the trust. Legally speaking, any assets the client moved in could be used by the lawyer with virtually no recourse.
Unfortunately, we see this risk regularly… if you’re going to move assets to be controlled by a third party, be sure you understand the terms of the deal. And work with a reputable firm.
Frequently Asked Questions
How is asset allocation different from diversification?
Asset allocation is about the types of assets you hold. It usually doesn’t take into account where they are held, the structures around them, or whether they’re in the system or not.
Asset diversification, on the other hand, is about balancing risk on a more holistic level. Across jurisdictions, currencies, legal systems, and structures.
What is a key factor you should consider when determining asset allocation and diversification?
Honestly, they’re different topics. Asset allocation is a key part of asset diversification. If you are strictly planning around market risk — how to get the most from your investments while keeping losses low, asset allocation is a good place to start.
But if you’re trying to protect your assets against all threats — all sorts of risks — a holistic asset diversification strategy is more important.
What's the best asset diversification strategy?
There’s no such thing. Rather, there’s only the best asset diversification strategy for your situation and your needs.
But, that said, for a place to start, we’ve recommended the Permanent Portfolio for years. Designed by an early mentor of our founder Mark Nestmann, it’s proven its ability to maintain and grow assets for decades.
It’s easy to put together, easy to manage (rebalance it once per year) and can cost very little depending on how you set it up.
How asset diversification fits into a proper Plan B
As mentioned, when we talk about asset diversification, we are taking a holistic approach. It’s not just about the types of assets you hold — it matters where you hold them, in what form and structure you hold them, and what specific risks you’re trying to protect against.
We take that into account throughout the planning process. We are not SEC registered advisors and we don’t tell you which assets to buy. Rather we create the conditions to help you reduce the risk around those assets. And if you do need specific investment recommendations, we work with some of the best international asset managers.
To learn more, or for a free no-obligation review of your case, you can book in a call with one of our Associates.
About The Author
Need Help?
We have 40+ years experience helping Americans move, live and invest internationally…
Need Help?
We have 40+ years experience helping Americans move, live and invest internationally…
As Featured on
