Geographical diversification

The world is your oyster! Gosh I can't believe I'm saying that (obvious if you know my diet). Today, I'm gonna put a spin on a topic that has been beaten to death on practically every personal finance blog out there. Diversification!

I'm not even gonna bother defining this 'only free lunch' in the investing world (just Wikipedia it). What I will do though, is to use my good sense of Geography to talk about why you should care about diversifying across continents. This applies to not just investments and your income (though that'll be my focus), but also your backups, your news sources, maybe even food!

To be honest, I almost swore to myself that I won't write about this. But then, two things sort of happened this weekend.

• Saturday - I was doing my fortnightly-ish spending tracking and net-worth calculation, and wondering where on earth I'm going to put that next $10,000 or $100,000 I'm aiming to save in the next two years. It so happens that I was browsing through the personalfinancenz subreddit and stumbled on this thread that casually mentioned a new fintech platform!
• Sunday - Went to that said platform's beta website in the morning, didn't seem to have much, but signed up for waitlist and went on with rest of my day. That evening, after a long day consuming all sorts of articles on side hustling that sounds like too much work, I checked my email and realized I had access to the beta platform!

Imagine having lived your whole life on an island, with filtered access to what's out there in the world. There's maybe less than 50 index funds/Exchange Traded Funds (ETFs) available in New Zealand, most are duplicates, and there's probably only a handful that are worth considering.

Well, I got on this new platform, and my heart skipped two beats. As of 23 Sep 2018, they have 3242 'shares' listed, of which 525 are ETFs, more than 10 freaking times more than what I'm used to!!!

So I got to work researching. Maybe I should mention that I don't actually know if I can use the platform yet since I don't have an NZ Passport or Drivers License. But the answer to this faq is giving me some hope. Edit: They got back to me and said it's still early days, but they've put it in as a feature request so fingers crossed!

I'm not actually gonna review this platform (maybe some other day?), but it opened up a lot of questions in my mind:

• What have I been missing?
• How am I even gonna decide what to choose?!!

Enter the holy tenet called diversification. And because I like Geography, the name of the game shall be Geographical Diversification.

Disclaimer: I really need to come up with a proper disclaimer. Do your homework, just as I have done/should do mine!

Backups

As I write this sentence out on my almost 10 year old laptop, I'm reminded of the necessity of backups. It's all well to save your work every minute, but I know that no device lasts forever. For my PhD research, I use Git heavily and duplicate my work at 3 main places:

1. My laptop
2. My university computer/servers
3. The 'cloud'

Usually my laptop stays at home, and if it were to break, I would have my university computer as a backup. However, being in an earthquake prone area, I'm fully aware that all my files could disappear if buildings start toppling over. So I save my work in the cloud, github or otherwise, and that allows me to access it anywhere.

It's not 100% foolproof, but I like to think that this setup is as good as it gets. Sure even the cloud could go down, and I might be maimed or whatever. But compared to just keeping everything secret on my hard drive, I feel better having most of my work out in the open. So that even if anything were to happen to me, at least my research won't go too waste.

At least three

Somewhere in the Talmud Bavli in Bava Metzia, it was stated:

A person should always divide his money into three: one third in land, one third in commerce, and one third at hand.

In today's terms, that means property, shares, and cash respectively. Now I don't necessarily agree with that exact ratio. Since I'm young, I'm biased more towards the productive assets (i.e. shares), with enough cash savings to get by emergencies and daily life. Property isn't something I directly consider, though some of my investments might dip into it somewhat tangentially.

We could argue on some perfect ratio but really, it's personal. The key bit is that you don't want everything to go down at the same time. Assuming a 50/50 chance of any one thing going down at the same time:

You get the idea. However, there's a key assumption above. We're assuming all of those are mutually exclusive, non-interdependent, one does not affect/is not affected by the other.

When diversifying, you want your three or more buckets to be as uncorrelated as possible. From a geographical standpoint, that means you don't want your three buckets to be located in the same place, made by the same person, and designed the same way.

But we live in an interconnected world you say! So how do we resolve this?

Everything is related, but...

Geography as a discipline doesn't have many laws. Maybe two, but the First Law of Geography is this:

"Everything is related to everything else, but near things are more related than distant things."

~Waldo R. Tobler

Granted, you would need to define what distance means. That's the beauty of Geography, you can choose spatial distance, 'cultural' distance, 'political' distance, or whatever. Typically though, the closer you are in space (i.e. kilometres/miles), the more related. Neighbouring countries will be more similar than two countries located on the opposite ends of the Earth.

Sure, you could argue that it doesn't make sense to buy into every country in the world. Not every economy is a super performer, and it would be also be a lot of work! But I'm not here to suggest who is going to win or lose, which one is better or worse.

Like food, it's just a matter of preference sometimes. Some people like Japanese food, others are into Indian maybe, and then there's all the delicacies in Europe, the aromatic Latin America dishes, etc. If you walk in blindly to a restaurant, you can't just expect them to only serve rice and demand for it! There needs to be an Option B or C even.

For example, I walked into this Ethiopian restaurant once with my girlfriend. No rice, no noodles, not even mashed potatoes! They did have this sourdough pancake like thing called Injera though, and so we ate that with a lentil curry called Misir I think.

Investments have a country of origin too! Now I am simplifiying this a whole lot, since there are multinational companies that span regions and continents. Perhaps smaller businesses are more local? Who knows, but yeah, quite often you'll hear suggestions to have a home bias (your go-to dish) while diversifying internationally.

You are more familiar with local tastes, so you go with that and maybe avoid the exotic spicy/sour/salty extremes. Now that sounds intuitive, but when you think about it, is that a sound way to think about protecting your capital? On that note, let's start with home.

Home bias

For many working people, their main source of income would be from one job. Think about it for a second. More often than not, that one job is connected to your local economy. Typically, people also live near their work.

Back in my corporate job, when we merged into this big company, there was this option to buy company stock. Now there are pros and cons of doing this, but I'm going to offer my perspective on this:

Don't buy it. Or if you want to buy it, don't buy too much.

I don't know about you, but I'd prefer not to have too many of my assets concentrated in the same one company/industry/place I work in. Where do I start? See, if the company starts losing money for whatever reason, that company stock will lose value, and maybe start cutting people, one of whom might be you! Double whammy.

In New Zealand, housing happens to be a thing, a big part of many people's assets. As I mentioned, earthquakes are a risk here. Now if some natural disaster were to strike and flatten your home and stop you from going to work, how would that make you feel?

The probability of these worst case scenarios happening is low, but they can happen. Sounds like a good time for me to recommend some insurance company! Nah, seriously though, I do think there's merit in spreading the risk a bit more over the place.

Having a home bias is okay as long as it is not too biased. Usually people have a home bias because it's just easier that way, more tax efficient, plus other factors like patriotism or whatever. Granted, this diversification business is something you might only consider when you start to have handle money in the 5 or 6 digits.

If you're in the (cough, privilleged) position to have to worry about geographical diversification though...

Going international

Like I said, the world is your oyster! Make use of what's out there in the big world!

Now I'll try to be as politically correct as possible and not mention potentially sensitive terms like developed/emerging/developing markets. Oops, I just did.

Right, I'm just gonna go out on a limb and say put your money as feasibly and as equally as possible into all seven continents. Yes seven, not six, because Antarctica needs you(r funding)! Oops, forgot to disclaim that my Geography PhD is in Antarctic science.

In case you need reminding what the seven continents are: "North America, South America, Europe, Africa, Asia, Oceania, Antarctica."

But isn't <\insert some continent> much better/profitable you say?!

Yes you could be right, or you could be wrong. I'm not a fortune teller!

Now I'm not saying the above example is a practical example. It's probably too complicated to buy 7 funds for each geographic region if I'm honest with you.

You could buy an ETF which cover the whole world, but check if it's heavily biased towards some region in particular. If possible, try to buy one that specifically excludes or isn't heavily weighted towards your home region.

Then, check if it's biased towards some particular economy. Maybe buy yet another one to remove that bias in your portfolio. I would say 2 international ETFs (as a minimum) or 3 would do the trick.

The main idea is to mitigate against some of the risk some political event might create in some region. Don't quite know what's going to happen next in the world, but I'm sure the politicians will be jumping in on it, and that'll affect the markets!

Say you have 3 ETFs covering uncorrelated regions X, Y and Z. If some election destabilizes region Y and stocks fall, you rebalance your holdings from X and Z into Y.

Again, there's a lot of oversimplication, and you should definitely do your due dilligence, it's your money after all! Hopefully though, this gives you a bit of a start on how you can approach geographical diversification. Try not to be too biased to your home region, and seek out the world using 2 or 3 ETFs that focus on parts of the world that are uncorrelated with your home region as well as with each other.

Conclusion?

If there's one thing to take home reading this post, it's this: "You could be living in a bubble that can pop anytime, so diversify!"

Ok, maybe that sounds a bit depressing. Perhaps I'm just biased myself. Investing your money in something, be it a share fund, a charity, or your loved one's education, means that you want it to do well. Sure I'd like New Zealand to thrive, I'd like Southeast Asia to do better too. Geographical diversification to me though, is sort of like throwing my money out into the world and saying: "I want the whole world to be better!"

It could be pennies in just one company I actually hold a fraction of a share of. I'm the kind of guy who would go to a farmer's market and buy my carrots from one the Fijian stall, greens from a Chinese gardener, and fruit from yet another farmer. Yes my one dollar here and there doesn't matter much on the grand scheme of things, but I'd like to think I'm supporting many instead of just a few. Plus maybe it's a way to avoid poisoning (jokes).

Well there you have it. Share the love and diversify geographically!