Diversify Your Retirement Accounts

When we talk about setting goals and seeing them through, that can also apply to diversifying our portfolios. Sometimes, when we set goals for our retirement accounts, we concentrate only on the potential for positive returns. Then, we find ourselves ready to change our minds when the road gets a little rough. It is important to truly understand what diversification is in order to properly set up our investment accounts in a way that enables us to remain comfortable over the long term.

What is diversification?

Diversification happens when we spread our monies out over various investment choices. Spreading our monies into several mutual funds does not necessarily mean that we are diversified.

True diversification means investing domestically as well as internationally. It includes equities (stocks) as well as cash and bonds. There should be exposure to different sectors and industries. We should include some investments in real estate and precious metals.

We also need to ensure that our cash has been allocated to several asset classes, such as value, blend, and growth. We want to invest in large, mid, and small caps.

There is not a one-size-fits-all approach to diversification. Every investor is different. Asset allocations should be designed according to the investor's risk tolerance level, as well as the goal that the account is working toward.

Why do we diversify?

The idea behind diversification follows the old adage of not putting all of our eggs in one basket. If we spread our cash over multiple investments, the chances of losing everything are reduced. It is highly unlikely that every asset class and every industry will suffer hard times at the exact same time. Diversification helps reduce our risk.

Diversification does not eliminate risk

Some investors misunderstand diversification and expect to eliminate risk. This is not possible. Diversification, though, does allow for other possibilities.

A diversified portfolio can help improve returns with less risk. For example, by adding fixed income investments to our equity holdings, we may be able to achieve returns similar to the overall market (such as the S&P 500) with less volatility. That means our account values will fluctuate less than what is expected in the market.

Diversified portfolios can also have more risk than the market. Including international equities to our portfolios may slightly increase our overall risk. On the other hand, if we choose high quality investment options, we should find that the additional risk allows for additional returns.

What do we do moving forward?

Many people were seriously impacted by the last two years. The unfortunate fact is that some of the losses occurred strictly from a sense of complacency. This could have been on the part of the investor, the advisor, or both.

The market is not "messed up." If we look back in time, we see several market fluctuations. Small ones are very frequent. Large fluctuations are less frequent but still present. The market will experience spikes, but it will adjust to correct itself. We should expect these cycles and prepare for them.

After years of positive returns, we falsely assumed that things were OK. We stopped checking on the quality of our funds and we put off rebalancing our accounts. Whether times are good or bad, our habits should not change.

Moving forward, we should put our habits back in place. We need to monitor the quality of the investments that are in our portfolios. We need to rebalance our accounts to maintain our chosen asset allocation. We need to make changes as our life circumstances change.

Investing can work. Diversification is an important part of investing. Let's move away from complacency and back toward being an active participant in our investment accounts.