The Best Financial Plans Have Four Legs
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.
By your definitions I only have three. My wife’s business, our investments, and my w2. I’d technically argue bonds, or at least cds are not the same as your stock leg. I’d also potentially split out pensions since their is government protections. Risk free is different then risky.
By your three stool measurement any of the legs could basically run our current expenses. I don’t hold real estate beyond my own home and some REIT stock exposure.
My point I guess is your post basically forces someone to have real estate as an asset class. But I don’t feel real estate is a must for security.
Well, you do say that you have REITs which I do think qualifies. I am a big fan of four legs. I think you could sub in something else for real estate. I’m not a big fan of collectibles or gold but some believe in it. Some become business or angel investors. There are other options.
What you really mean is that you don’t have a table. You have a three legged bar stool.
Personally, I like sitting in a bar stool just fine! Great place to hang out with friends. 😋
TPP
Should I say “Look, Ma, no hands”? I’ve got 2 legs though, with mutual funds and real estate. Wait, my husband also has a small pension. Oh, and even though we have not started it, he is eligible for Social Security next year at 62. So, I guess even us retired folk can say that great line from Animal Farm…”four legs good, two legs bad!”.
Oh, yeah, by the end of that book is has completely gone back full circle. And that horse ended up at the glue factory. What does that mean?
It means that animal farms got nothing on personal finance blogs.
Very clear description. Thank you! Some of us are still getting our legs in shape. And there’s the once in a while topple over . But, Always good exercise !
It’s definitely a stepwise process.
And today’s cute puppy image , adorable ! Who doesn’t love puppies .
I know, right?
“The dining room table is an American institution. Rightly so, it is the most stable of structures.”
Very true. Extremely stable indeed. In fact, so stable that here in California we are taught to “Duck and cover!” under the dining room table during an earthquake at a very young age. I remember earthquake drills in elementary school! I’m sure you don’t have those out there in Chicago 😉
Btw, that Flamingo ride or die company man has a rare commodity — defined benefit pension plans are hard to come by these days.
Not sure how many legs I have. W2 income, wife’s W2 income, investments, real estate (I count our house due to appreciation and potential for house hacking if desperate), and side hustles (travel hacking, consulting, blogging at this point is more hobby than side hustle, etc.).
Back to your point… Yes, a four legged financial plan is very stable and should be able to withstand any financial catastrophe. (Maybe even an earth shattering, ground breaking, 9.2 on the richter scale financial earthquake.)
I like the earthquake analogy. 4 legs help protect you from Financial earthquakes.
I like the 4 legged earthquake proof portfolio concept and metaphor. Feels like I have 2.5 now and am growing a 1.5 leg.
Growing a 1.5 leg. Ha!
I prefer bikes so I’m a two-wheeler type guy! Great analogy
But does your bike have four wheels?
Instead of legs I think spokes. If a net worth is shaped like a wheel you need spokes to hold the rim. Spokes are non correlated assets. The center of the wheel is the origin and the spokes are vectors having both direction and magnitude. Equity spokes point in a differenent direction from bond spokes, than real estate, than side gigs, than main gigs, than SS, than pensions. The point of the spokes is to maintain and expand the area of the wheel aka net worth. In a down turn some spokes will retract toward the origion. Some spokes will not. During expansion some spokes will grow maybe excessively. A portion of those spokes can be redistributed and rebalanced, for examaple from equities to bonds. In the down turn some of the redistribute bonds can be converted back o cheap equities keeping the area of the wheel more or less constant. Side gigs main gigs etc also can be distributed into stocks and bonds to try and keep the wheel round. It’s not perfect but it is a visual for non correlation and rebalancing
Spokes…dammit! That’s a better metaphor.
How about a four-legged plan with 3 training wheels that gives you 7 Pillars of Wealth? 😉
Ha! I never turn down training wheels.
Just found your site and am loving it. Found you thanks to a referral from Retire by 40. Glad to have found your site and look forward to exploring and learning more. I inherited a commercial property with 11 rentals and have been fighting it for 10 years now. Finally learning there are other things I want to invest in. Thank you for some useful information.
11 rentals is a lot! Thanks for reading.
Great post! Don’t forget the 5th leg of a 2 active income partnership!;)