When asked about what the most important concept in investment is, many - if not most - investors would point to diversification. Diversifying your investments is a very important thing indeed. And yet, there's another kind of diversification that's actually more important and not everyone practises it. I'm talking about the diversification of your life.
In these times of uncertainty, many people find their careers stagnant or shaky at a certain point. Generally, they find it hard to switch to another industry which has better prospects. That's because after a decade or so of working in a kind of a job, you become good at it, but you also become its prisoner. In my observation, people who have good savings accumulated at this point generally manage to weather the crisis and adjust their career path to something better. They are able to diversify their life. In a very real sense, your investments provide you with this ability to diversify your life.
This is something that should be thought about and planned out consciously because there can be some pitfalls. Some years ago, a friend of mine hit a crisis which first made me realise the nature of this problem. This couple both worked in a large IT company. Predictably, a good amount of their investments are in the form of their own company's stock options. On top of that, because they thought they understood the industry well, they also had a good amount of equity investments in other technology stocks.
You can guess the rest. Gradually, at a certain point, the utter lack of diversification in their lives came home to them. Over the years when the tech industry declined from being a permanent sunrise sector, realisation dawned that the long-term bright future that their industry was supposed to have may not exist. And, at the same time, their investments in their own employer declined to less than half in little more than a year. During the time, like all its peers, their employer's stock too hardly rose when the markets were rising but fell with great speed when the markets fell.
This point is not a commonly realised one. Diversification is supposed to be the most important part of any investment strategy. You are supposed to spread your investments spread across different sectors and industries so that bad times in one may be offset by another. However, diversification must start with diversifying one's life, not just one's investments. Your career is tied up with a particular industry, so your stock investments must necessarily be as far diversified from that industry as possible.
However, for a variety of reasons, the reverse seems to be true. One of the biggest reasons seems to be that many of the employees of companies who receive ESOPs are otherwise not stock investors. They never buy too many other stocks or mutual funds, and thus most of their investments are in their own company. What's worse, I hear that some companies have a culture of bias against selling ESOPs and employees face a subtle pressure against selling. Even worse, talking to some ESOP-holders about their investments, I've realised that even when they diversify, they have a tendency to buy the stock of other companies in the same industry, probably because they feel they understand the industry or they admire another company in the same industry. This is illusory diversification. Maruti employees buying Tata Motors stock or Infosys employees buying TCS stock may feel like they are diversifying but they are not.
Tying up both your career and your savings to the well-being of the same company (or the same industry) is clearly a case of putting all your eggs in one basket. And that's never a good idea. What's more, consciously diversifying your investments away from the rest of your life will help you in ways that you may not have anticipated.