Time for More Baskets!

Diversification is, at its root, a response to the ancient admonition you might have learned from Grandma: don’t put all of your eggs in one basket. If that basket drops, they could all break, ruining your and Grandma's breakfast! This proverb can be traced back to the seventeenth century and was popularized by Cervantes in Don Quixote. (Later, Mark Twain, ever the contrarian, proposed the exact opposite: “Put all your eggs in the one basket and—watch that basket!”)

The wisdom of Cervantes goes nearly unquestioned today. Virtually every reputable financial firm teaches people about diversification, extolling the importance of spreading out risk. But—and this is an important but—we contend that however well intentioned, Wall Street's version suffers from two major omissions: first, Wall Streeters focus solely on one's financial instruments; second, they cannot model the possibilities of breakdown/breakthrough, so they presume that we will muddle through for the foreseeable future.

These blind spots have led investors to focus nearly all of their attention on investments made within a single zone on the RIM (zone 8: financial assets/global economy). A good financial advisor will ensure that you are diversified within that basket and might even offer advice on real estate (zone 4: tangible assets/close to home), but this is far different from being offered enough baskets to fill the RIM. A more accurate metaphor is a bunch of small dividers (subcategories of types of stocks and bonds) placed within the basket that contains Wall Street's financial instruments.

So instead of following Grandma's wise advice, people are unwittingly using Mark Twain's approach, one that was meant to be a parody! We are putting everything into one large basket, hoping and praying that we don’t trip and that nothing bad happens to the global economy, either of which could send our eggs tumbling. This may sound humorous, but it leaves people far more vulnerable than they have been led to believe.

Resilient investing takes the virtue of well-considered asset allocation and applies it to a wider set of holdings. Obviously, there is so much that will not fit in Twain's single container, including all of your personal assets and most of your tangible ones—the very investments that will serve to buoy you through the ups and downs of your financial holdings. We are making the case for creating a truly balanced portfolio that includes much more than you will ever find on a brokerage statement.

And what happens if the future is not simply an extrapolation of muddling through? Wall Street's methods have worked well during many market cycles, but they offer scant protection from systemic risk—the risk of collapse of the overall market, not just a particular company or industry. In financial-speak, another word for systemic risk is undiversifiable risk, which essentially says that there is nothing in the global economy basket that will keep you afloat when the ship goes down.

The recent financial crisis provided a glimpse of what this could look like. Real estate values collapsed, uprooting homeowners who had been lulled into a fantasy world where prices only go up. Bond prices gyrated, as the risk of default by corporations and municipalities rose, causing great distress among older investors who thought they were invested conservatively. Even gold, regarded as a safe haven by many, sank 25 percent during the worst of the 2008 crisis. Investors had no place to hide except under the mattress.

Nobody knows when the next shock will hit the financial system, but if there was one lesson to learn, it was that investors need to update their risk management toolbox. We are not willing to accept that there is no way to address systemic risks, and neither should you. A resilient investing plan will enrich your life in today's world while hedging against—or, if you choose, preparing for—the possibility that our fundamental social, economic, and environmental reality could shift in profound ways. Of course, while resilient investing may reduce exposure to systemic risk, we also must remain diligent and conscious of managing (and balancing) the range of specific risks inherent in our actions across the RIM; this is addressed in brief in Resource 2: The Investor's Eye (at the back of the book) and in more detail on ResilientInvestor.com.

Our nine different baskets offer a much wider array of places to entrust your investments. Remember that baskets are one of humanity's oldest inventions—practical, sturdy, beautiful, even (dare we say) resilient containers—and have been put to myriad uses through the ages. As you make your way through the next three chapters, you are bound to realize that you have already been putting some eggs into many of these resilient investing baskets but lacked a framework for seeing how they fit into your overall picture. The RIM helps us be mindful about all of our investments—including those made with our time and attention.

Diversification may not be an elegant term, but it comes from diversify, which means to expand and broaden our horizons. Now it's time to do exactly that, as we escape from the box that limits most investors to mainstream financial offerings. Let's unfold the Resilient Investing Map and set off on our journey of discovery!