We've said it before and we'll say it again: Diversify your portfolio! This practice is designed to help reduce the volatility of your portfolio over time. Let's take a deeper look.
What does it mean to have a diversified portfolio? And why is it important? Diversifying your investments is a complicated process that requires spreading out your money into different types of investment vehicles. By diversifying your portfolio you are reducing your chances of risk and allowing your money to grow.
In life, you have probably heard the saying “Don't put all your eggs in one basket.” Essentially, don't put your money all in one investment, because if it fails, you’ll lose it. Diversification is part of long-term investing strategy and should be taken with a balanced approach in order to build your wealth for the years to come.
Here is what you need to know about creating a diversified portfolio for retirement with Agemy Financial Strategies.
Why is Diversification Important?
One reason why most financial advisors suggest diversification is because it reduces your chances of risk. When it comes to investing there will always be some sort of risk involved. However, by having different types of investments you can still grow your money without destroying your financial future if one investment turns out poorly.
Here is an example. If you put retirement savings into one stock, what happens when the company goes under? Your investments are gone, and you can't get them back. That is why investing in single stocks is not the best option.
Diversification by Assets
When it comes to diversification, having various types of asset classes in your portfolio is a good strategy to implement. Here are the most common types of investments:
- Mutual Funds
- Single Stocks
- Index Funds
- Real Estate
Second, be sure your stock investments are diversified. You can achieve this in a few different ways:
- Invest in companies across different stock market sectors
- Invest in companies of different sizes (large-cap, mid-cap, and small-cap)
- Invest in both domestic and international stocks
If you own your home, you are already taking part in diversification. Being a homeowner is a great way to build equity outside of traditional investing options. There are also many ways to invest in real estate. Investing in mutual funds is also another great approach in diversifying your portfolio.
Here are some reasons why mutual funds are slightly better than traditional asset classes:
- Mutual funds are naturally diversified
- Long term government bonds yield between 5-6%, while mutual funds will double the rate of return
- Index funds and EFTs try to mirror the market, but by picking the right mutual funds, you can beat the markets growth
Now that you know a little about why diversification is important, we can take a look at ways to implement diversification into your portfolio for retirement.
Choose Your Account
You probably already know that spreading your 401(k) account balance across a variety of investment types makes good sense. If you're still in the workforce, get started by opening your 401(k) or 403(b) at work and see what mutual fund options you have. Workplace retirement plans like these have many advantages—they give you a tax break, they can be automated through your payroll deduction, and your employer most likely offers a match.
If you don’t have access to a retirement account, then your best option is a Roth IRA. Using a Roth is an added bonus as your money will grow tax-free!
Diversify Through International Funds
As you explore your account, you’ll see a list and description of your fund options. Here are the four types of mutual funds you should spread your investments into:
- Growth and Income: This fund is a good choice if you want to invest in large companies without taking on a lot of risk. These funds are almost guaranteed to make money while offering less volatility than other funds.
- Growth: These funds are made up of stocks from growing companies and tend to have higher returns than other types of funds. They often earn more money than growth and income funds but less than aggressive growth funds.
- Aggressive Growth: This fund has the highest risk, but also the potential for the greatest financial rewards. It's run by professional fund managers who buy the stocks of different companies at a low price, and sell them at a high price. This is because these stocks are risky and volatile, but have high growth potential once they have been established.
- International: A globally diversified portfolio is an ideal way to reduce your risk and gain exposure to different parts of the world. By owning these types of investments, it can help stabilize your portfolio in times when the market dips domestically.
In order to diversify your portfolio, it’s important to put your money in different funds and classes. That way, if one type of fund isn’t doing well, the other three can balance it out.
Never Forget Risks Involved
As mentioned, the primary goal of diversification is to spread out your risk so that the performance of one investment doesn’t necessarily correlate to the performance of your entire portfolio. Diversified portfolio or not - always remember there is risk involved.
- Market risk: How the movements of the overall stock market affect your returns.
This is also known as systemic risk and is unavoidable if you're investing in assets other than cash.
- Interest rate risk: How changes in interest rates affect your returns and yields, especially for fixed-income assets (for example, how long-term Treasurys suffer when rates rise).
- Geographical risk: How changes in political or social regimes affect the equities and fixed-income assets of a particular market (for example, in the recent Russian stock market collapse).
- Idiosyncratic risk: How specific changes in the fundamentals of a particular company can affect the returns of its stock (for example, if you were invested in Enron before it declared bankruptcy).
In general, the more assets your portfolio holds, the more diversified and resilient to different types of risk it is.
Let's Talk Strategy!
You've probably got lots of questions about how to get started diversifying your portfolio. The investment professionals at Agemy Financial Strategies can help you make sure your investments and assets are mixed to create a balanced plan for retirement.
We provide solutions for your specific financial situation. Whether it's helping you strategize asset allocations to help stomach inflation, or revising your current plan to make helpful amendments –we are here to help.