Just about everyone will tell you that it’s important to diversify your investments. It’s pretty standard advice. Building an investment portfolio based on a diversified basket helps to ensure that if there is a significant down turn in an asset class, sector, or national economy you are less likely to experience a crippling loss of investment capital. It’s about investment resiliency.
There are far fewer people who talk about income diversification. But for people who are looking to be financially independent (financial freedom fighters like you and I) – income diversification is an absolute must.
What does “diversify your income” mean?
Well it’s pretty simple really. It means having multiple sources of revenue making up your annual income. It means not depending on one revenue source, like a job, for all of your income. For many people income diversification takes the form of multiple jobs. This could mean having two income earners in a household or having a second or even a third job. This level of diversification is a good start – however it’s important that you not stop there. To explore this a bit deeper, lets look at the fundamental sources of revenue.
The Four Factors of Production
Economists have grouped all forms of goods and service production into four basic categories: Land, Labour, Capital and Entrepreneurship. Each of these four basic forms offers the potential for income.
Land is a broad reference to the “gifts of nature” that is to say, natural resources. This grouping includes actual land but also includes things like minerals, oil, water, trees, animals, fish, etc.
Labour is the time and effort that people devote to producing a good or service. Labour includes the mental and physical effort that goes into growing food, building, manufacturing, providing services and everything else you do to earn a wage.
Capital is the physical and financial assets that are used to produce goods and services. This includes tools, machines, stocks, bonds, cash, etc.
Entrepreneurship is the organization of the other three factors into a productive enterprise. It’s the development of new ideas for goods and services and realizing those ideas by sourcing and coordinating the land, labour and capital factors needed.
Why income diversification is important?
Diversifying your income is important for a lot of reasons. The three most important are financial resiliency, increased flexibility and choices, and bringing in more money.
By having multiple sources of income, you are less dependent on any one source and therefore can handle the loss of any source better. A household with two wage earners is much better positioned to manage a financial crisis like a job loss.
Many people who end up in severe financial distress are there as a result of an interruption to their primary source of income. Having multiple, independent sources of income helps to ensure that even if you lose your job you are not forced to depend on debt or the sale of assets to keep food on the table and a roof over your head.
Having more than one revenue source provides you with more flexibility in your choices. If financial disaster should strike, like you lose your job or a tenant moves out, you have the resources to pick the best response for you. If you lost your job, you’ll have the other income to pay bills while you look for suitable new job rather than taking the first thing that comes because you’re about to have the power turned off.
More Money for Your Goals
Multiple sources of income can provide an important boost to achieving your financial goals. Many people working towards financial independence have second jobs or “side hustles” to supplement their incomes, helping them save more or pay down debt faster.
Diversifying Income Across the Four Factors of Production
Part of having a truly diversified income is having revenue sources that come from more than one of the four factors. Each factor offers a HUGE range of options for revenue:
|Land||Land earns rent||Rental properties, farm land rental, resource extraction, farming, etc|
|Labour||Labour earns wages||Your current job, your second job, your last job, your next job….|
|Capital||Capital earns interest||Stock dividends, bond interest, capital gains (through asset sale), etc|
|Entrepreneurship||Entrepreneurship earns profit||Opening a store, consulting, running a cleaning service, etc|
Diversifying Income Within the Four Factors of Production
You can diversify your income within each of the four factors too. For example, within the Labour factor, a diversification tactic would be to make sure that you and your partner work at different companies or within different fields. Doing this prevents disaster should the company you’re working for fail or the industry you work within suffers a downturn. Within the Land factor, diversification could mean that you have both residential and commercial rental properties, or that you own properties in different neighbourhoods or even different communities. Within capital it means that you diversify your portfolio, not depending on one asset class or one stock for all of your income. And in entrepreneurship it means having more than one venture on the go….sort of like bloggers with multiple revenue generating sites.
How we’ve diversified our income
Years ago I lost my primary job and had it not been for my second job we would have been in dire straights. I had the financial resilience to keep the mortgage paid and the flexibility to explore entrepreneurship. Because of that situation, I can’t image not having a diversified income, both across the factors of production and within.
Jane and I both work, in different fields and for different employers. Also I have a well paid second job. Next, we have invested in two rental homes which are in different neighbourhoods in our city. And finally we have a diversified investment portfolio that returns a monthly income. While we reinvest that income today – it could be used to pay bills if needed. Finally we also use our yard as a source of revenue by vegetable gardening. In the summer months we actually produce a substantial amount of food saving us from having to purchase it in the grocery store. Best part about this revenue source…it’s tax free!
In the future I hope to diversify our income even more. I’d like to purchase more rental property and have been looking at both commercial and farm land. I’d also like to have a small side hustle once I’m done with school. I’ve been thinking about re-starting my consultancy business. This serves two purposes really – one, a new independent source of revenue, and two it establishes the business I hope to run when I’m “retired” from the wage-slavery racket.
If either Jane or myself lose our job tomorrow, we’d be fine. We’d change our spending habits a bit and we’d live on the reduced income. Right now, the additional revenue our multiple streams bring in gets directed to investments and debt repayment. The security and confidence we feel as a result is absolutely priceless.
How do you diversify your income?