What It Means to Diversify Your Income and How to Do It
Think like a millionaire, diversify your income for financial freedom
No matter how long you have been at a company, or where you are in your career, losing your job is always a possibility with full-time employment. Whether it's because of industry changes, market downturns, COVID-19, or a disagreement with your boss, the impact still can be devastating. How can you protect yourself financially? One way is to diversify your sources of income.
What Does It Mean to Diversify Income?
A diversified income has more than one source. You may be familiar with the concept of a diversified investment portfolio, which is recommended to limit risk. A diversified portfolio has investments in different asset categories, such as equities, fixed income, commodities, and cash. It also spreads out the holdings within each asset category.
The same idea of spreading your exposure can also apply to the ways you earn money, even while holding down a full-time job. Whether you are early in your career, are thinking about leaving a full-time job to start your own business, or are nearing retirement, there are plenty of ways to diversify your income.
Benefits of Diversifying Your Income
Angela Moore, a Certified Financial Planner, is the founder of Modern Money Advisor, a fee-only financial planning firm. "Diversifying your income can help provide stability and hedge against income loss due to layoffs, illness, disability, discrimination, and more,” Moore said in an email interview. “In addition, having multiple streams of income can have an incredible impact on your ability to build wealth and/or fund retirement."
Diversification in a Recession
Recent events would certainly support that advice. According to the Pew Research Center in May 2020, almost 30% of U.S. workers on average either lost their job or took a pay cut because of the COVID-19 pandemic. In June 2020 the National Bureau of Economic Research (NBER), which monitors the economy and evaluates its health, made it official: The country had entered a recession in February.
Beyond providing some "income insurance" if you lose your primary employment, creating multiple streams of income can be a path to financial independence. According to Sarah Stanley Fallaw, co-author of “The Next Millionaire Next Door,” "looking for multiple sources of income is a prototypical millionaire-next-door type of behavior."
No matter what your financial position is today, there are plenty of opportunities to explore.
The dividends and interest from an investment portfolio, rental income, and a part-time side job are all ways to diversify your income.
Active and Passive Income
There are a number of different types of income, but they all fall into two categories.
Active income is earned from a job with an employer or from running your own business.
Passive income, such as from rental property, royalties, or investment income, pays you even while you sleep. Here's why the second category is important for you to consider for diversifying your cash flow.
If you are diversifying by making extra active income, there is an ongoing time commitment. Side hustles like driving for a ride-sharing company, pet-sitting, or consulting all require you to labor to supplement your primary paycheck in off-hours.
However, if you are diversifying with passive income, you can still pursue your primary line of work while earning money at the same time. Be aware that building passive income may involve a significant initial investment of time or money. Rental income for example, is passive, but it requires buying a property and ongoing maintenance and administration.
Not everyone has the financial resources or time to invest in real estate or to derive income from managing an investment portfolio.
What You Can Do to Diversify
Web-based businesses are one low-cost way to build passive income. Creating your own website can be a tool to generate passive income from advertising, referral fees, and the sale of products and services. Platforms like Shopify make it easy and affordable for anyone to create and manage an online store. The big investment is the initial time it takes to research your idea and build a plan.
Helen Buttery, who leads special operations for American Writers & Artists Institute (AWAI), a company that helps people to develop content-writing and online business-building skills, explained this model.
"Web-based businesses can be a great source of supplemental income. You can create the site at home and let it work while you are employed or working on other projects. The site can be on any topic, so you can pick subject matter that matches your interests,” Buttery said in an email interview.
“The key to success is matching your interests with a large-enough internet audience and making it easy for them to find you," she said.
Drawbacks of Income Diversification
One of the few constants in life is that there are only 24 hours in a day. If you take on a part-time job, such as being a ride-share or food-delivery driver, to diversify your income, you are going to have less free time for other things. It also doesn’t pay to diversify your income if the effort costs you your full-time job and you need that salary to survive. Make sure the added demands of your part-time job or other passive business activities don’t negatively affect your job performance or endanger your health.
If you have the resources to invest in real estate or become a silent partner in a business, but not the expertise or time to research prospects, consult a professional advisor to get started to avoid placing yourself in financial peril.
The economic climate can have an impact on secondary income streams, especially with investments in businesses and rental properties. It's hard to know, for example, what the permanent impact of COVID-19 will be on commercial office space and bricks-and-mortar retail locations. But, according to an April 2020 article by consulting firm McKinsey & Co., consumers have increased online purchasing across many categories, and may continue to do so after the pandemic, which opens up further opportunities for starting an e-commerce business.
The Bottom Line
- Think like the experts say a millionaire would as you look for ways to diversify your earnings away from a single source or employer. Passive income can work for you while you sleep, and might potentially be a source for building wealth.
- A diversified income can provide some financial protection against losing your primary job or economic downturns.
- Diversifying by adding active income like driving for a ride-share company or other "side hustles" is a way to pay off debt or save money, but it requires an ongoing commitment of your time.
- Investing in the financial markets, owning rental property, and creating web-based businesses are opportunities to build passive income, but it pays to do your research.
- Be jealous of your time. Don’t let your side-income streams jeopardize your full-time job unless you can survive financially without it.