Diversifying your retirement portfolio means spreading your investments across a variety of different asset classes, industries and geographical regions. For many investors, the primary goal of diversification is to reduce risk, but a wisely diversified portfolio may also help maximize potential returns.
Diversification ensures the failure or underperformance of any single investment or market downturn won’t have a catastrophic effect on your overall portfolio. By maintaining a diverse mix of investment types (stocks, bonds, real estate, commodities, etc.), you can take advantage of different market conditions and minimize the likelihood that a poor-performing investment will severely impact your retirement savings.
Types of Diversification
Asset class diversification: Asset classes include things like stocks, bonds, real estate, cash/money market accounts, precious metals and commodities. Each asset class has its own risk-return profile and can perform differently under various market conditions.
Industry diversification: Maintaining diversity within each asset class can also provide balance and prevent sector-specific conditions from having an overly deleterious effect on your holdings. This can be especially important for stocks where retirement savers can easily invest in industries or sectors such as technology, healthcare, consumer goods and financial services. Certain sectors have a reputation for being high growth but also high risk whereas others are known for maintaining their value even during downturns but are less likely to experience rapid or exponential growth. A balance of equities gives your investments a chance to grow during good times and be resilient during times of high volatility or bear markets.
Geographic diversification: We live in a fully globalized economy, and there are often lucrative investment opportunities in other parts of the world. Regional or country-specific markets carry their own sets of risks and potential for growth. Retirement savers may benefit from staying apprised of economic and financial trends abroad and looking for opportunities for diversification. Investing in securities from different countries and regions may reduce your portfolio’s exposure to risks specific to one country or region, helping mitigate the impact of regional economic downturns or political instability.
Investment strategy diversification: At different times in your life your investment advisor and/or broadly accepted industry wisdom may recommend pursuing a specific investment strategy. For example, young workers may benefit from implementing a more aggressive, higher-risk investment strategy while people nearing retirement may benefit from less lucrative low-risk strategies.
However, there’s no rule that requires you to put all your eggs in one investment strategy basket. You can pursue a mix of growth, value and income investing to capitalize on various market conditions throughout your life.
Time diversification: Time is always an important factor to account for when investing. Certain investment classes, like bonds, are highly dependent on time. When you plan to retire or how many years you have before adopting a lower risk tolerance may also inform some of your investment decisions.
Periodically reviewing and adjusting your retirement portfolio to ensure it remains diversified and aligns with your current risk tolerance, financial goals and time horizon can be beneficial for all retirement savers. Time diversification doesn’t guarantee profitable investments, but it can help to manage risks and potentially improve returns over the long term.
The Benefits of Diversification
Manage Risk While Pursuing Higher Returns
A thoroughly diversified mix of asset classes, industries and regional investments can reduce the overall risk associated with your retirement portfolio. Diversification may allow you to pursue more aggressive, high-return strategies with peace of mind knowing you have significant low-risk assets in reserve.
Adaptability to Changing Goals and Circumstances
Retirement savings is one of a handful of constants people experience throughout their entire working life. It should be viewed as a 40 or 50-year journey – not a sprint to the finish line. Any project with that kind of time horizon will experience significant changes along the way.
Portfolio diversification enables investors to easily (and rapidly if necessary) adjust their investments based on current market conditions and their risk tolerance.
Less Stressful Investment Experience
Retirement savings get increasingly more stressful as you get older. When you’re young there’s virtually no immediate retirement saving repercussions when markets hit turbulence. You have time to wait it out. An argument can be made that diversification gets more important as you get closer to retirement age or when you have more assets to lose. This is especially true if you’re relying on things like dividends or proceeds from the sale of equities for income in retirement.
Risk reduction leads to less stress in virtually every aspect of life, but especially when it comes to investing. In that regard, diversification can be a valuable way to decrease your overall anxiety about the future.
Inflation Protection and Financial Security
Societal concerns about the ebb and flow of inflation will never truly vanish. A well-diversified portfolio can help protect your retirement savings from the eroding effects of inflation. This is especially important when inflation is coupled with sector-specific challenges. By including investments that tend to perform well during inflationary periods and holding some assets that aren’t being impacted by current volatility, you can simultaneously maintain your purchasing power while also mitigating class-specific losses.
Are Your Investments Adequately Diversified?
At the end of the day diversification can help ensure that you simultaneously preserve multiple sources of income while maintaining capital growth during retirement. A diversified portfolio may increase your financial security while providing a safety net in case of unexpected expenses or financial setbacks.
Speak with the retirement planners and investment managers at Fullerton Financial Planning by calling (623) 974-0300 and learn how you can diversify your portfolio and safeguard your retirement.
