If you’ve had any conversation about investing and building portfolios, you’ve probably heard the topic of diversification come up. This term is thrown around consistently, but what does it actually mean to diversify?
When most people consider diversification, they tend to think of the old reliable 60/40 stock-to-bond split for pre-retirees/retirees, which is intended to help buffer their money in the event of a market downturn. While this is one diversification strategy, it’s important to realize that diversification can be successfully implemented in different ways across all portfolios in all sections of a financial plan. Let’s dive in…
When it comes to “wealth accumulation” in early adulthood, the horizon for your money is long. With the long horizon, paired with the easy access to mutual funds and data in today’s investing world, it’s easy for young investors to simply pick one or two high-performing funds and not consider their choices any further.
Sometimes keeping things simple is best. There is opportunity for gains and there’s a reason historically positive funds have performed well. However, with this tactic, you’re missing out on potential protection from volatility in the market in your early years while you maintain an aggressive growth mindset. To put it plainly: if you’re too concentrated in just a few assets, you could have big losses if those assets experience sharp decline. Be mindful to not put too many eggs in one basket.
For example, tech is the hot ticket item in today’s market, often showing big returns. But it’s not the only sector performing well, and tech volatility has been highlighted over the past year. You may want to consider whether now is the time to move some funds to other growth sectors, both domestic and international, that could gain when tech is down.
Putting in some work to explore growth sectors outside the main heavy hitters of today’s market could pay great dividends for young investors in the years to come.
Moving on to the “wealth preservation” phase: this is where we see the more traditional aspects of diversification come into play. As I mentioned, most investors have heard of the 60/40 split and its benefits. As you move closer to retirement, it is crucial to protect your assets more from volatility. Gradually moving from growth sectors toward lower-risk assets (such as dividend/income generating stock, the bond market, and even treasuries) lets us begin preserving capital while allowing for moderate growth.
This is not something that should be done all in one movement. This diversification should happen gradually as you progress toward retirement, allowing you to maximize return efficiently while being protected. As a result, you take care of your nest egg for retirement but still take advantage of those last years of growth.
Finally, we reach the “wealth distribution” phase. You have worked your whole life to provide the retirement of your dreams. Diversification allows you to maximize the income generated from those years of hard work and saving. In this phase, it’s more crucial than ever to have a portfolio built upon solid diversified assets.
People tend to invest most conservatively in retirement because they depend on the assets for their income. That doesn’t mean you still can’t see volatility, although mitigated, amongst conservative assets. Diversifying well within some income-generating conservative asset sectors ensures that no single event can dramatically impact your income. This acts as the final piece of the diversification puzzle and allows retired investors to sleep easy knowing they can rely on their portfolio to provide income.
If you want to learn more about implementing diversification strategies, please reach out to our team of investment professionals at Rea Wealth Management. We are happy to assist with your retirement journey and look forward to answering any questions you may have!
By Max W. Feller
Financial Advisor
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation. Diversification does not assure a profit or protect against loss in declining markets, and cannot guarantee that any objective or goal will be achieved. Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results.
Securities and advisory services offered through Commonwealth Financial Network®, member FINRA/SIPC, a Registered Investment Adviser. Additional advisory services offered by Rea Wealth Management, a Registered Investment Adviser, and fixed insurance products and services are separate and unrelated to Commonwealth.