What is Diversification?
Diversification is all about risk and preparing for it! It is easy in times like now to want to put all of your marbles in one jar, especially if that jar is the S&P 500! However, as we build portfolios for retirement, we have to go back to the time-tested investment principal of diversification. Diversification is a pillar in investing that focuses on maximizing return and mitigating risk by spreading investment decisions across different vehicles, sectors, industries and companies to ensure we achieve our financial goals. The wisdom of diversification actually dates back to Biblical times and is not something that is only a recent understanding in modern portfolio construction.
Why is Diversification Needed?
We would love to, in every season, ensure that each position in our clients’ accounts always went up and to the right every time, but that only works if one can predict the future accurately, time after time after time. We know this isn’t possible which is why diversification can help. When we diversify, we spread investment decisions over lots of key areas to prevent unwanted risk to our client’s portfolio and retirement plan. Risk is not a bad thing, but it is a concept we have to work hard to make sure we are educated on. That way, when that risk shows up, we have a plan in place to navigate through it! Part of that plan, is having the correct diversification in a portfolio to soften the volatility of that risk.
Diversification Done Right Softens Volatility of Risk
We strongly believe in the United States and our economy, but cannot put all our eggs in one basket, one sector, or one company. We have to be prudent and prepare for seasons where US markets and certain sectors will not be the highest performing investments. Different investments change values at different times. The world economy has different stages and different events that constantly evolve. If diversification is done right, there should be different assets in a portfolio in place to take advantage of the changing tides. In others words, we want certain positions to zig, while others are zagging! That truly shows diversification in a portfolio.
How SRP Approaches Diversification
When we build our portfolios as Strategic Retirement Plans, we have a team of up to 25 people constantly evaluating and testing our investment holdings to prepare for risk in markets and the economy. We naturally have a higher bent toward US Large-Cap stocks, but remain diligent to spread investments across many other sectors/locations. We have funds focused on European developed markets as well as Emerging Market Country stocks. We utilize Gold holdings, real-estate holdings and bonds to further spread investment decisions. Each of these funds perform differently under different market conditions. The idea is that by having diversification, we have a higher probability of having different holdings performing better at certain times, as our clients need money/income off of their portfolios. We need to prepare our portfolios to always be able to pay our clients in retirement. Similar to a paycheck coming from an employer, we need to be able to go through stock markets pull-backs, corrections and recessions and still make sure our clients receive their paycheck.
Time in the Market: Stay Invested and Diversified
No one on the planet can accurately time markets because you have to be able to predict future events precisely and then understand how the market will react to each new event. We have preached to all of our clients, it is not about timing the market, but time in the market! If the over-arching plan is to stay invested, than we have to build portfolios that can still produce income in the midst of those market pull-backs, and that is what diversification allows for.
Different Types of Diversification
There are many different types of diversification to consider, the most popular and important being asset allocation. This includes major classes like stocks, bonds, real estate, gold, cash, and commodities. From there, you can diversify within a majority of those areas by drilling down into different classes/sectors. You can hold Large cap companies, mid-cap companies, or small cap companies. You can look at US stocks, European stocks or other International Developed Country stocks. You can look at emerging markets like India, China and Brazil. You can look at different sectors like technology, defensive, financials, consumer discretionary. You can buy individual stocks or spread out amongst lots of companies with Mutual funds and ETF’s. All of these decisions, help build out a time-tested diversified portfolio, built to stand during the ups and downs of markets and lives for our retirees.
Diversification is Important
The bottom line is that diversification can help us achieve our investing goals, while helping our clients manage risk and reduce volatility in their portfolios. All risk can never be completely eliminated, and so we have to always balance rate-of-return expectations with our own appetite for risk. Diversification helps in that process. At Strategic Retirement Plans, we are working constantly to build the best diversified portfolios for our clients to navigate the ever-changing landscape of markets and world economies.
***Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.
International and emerging market investments may involve higher risks than investments from developed countries and also involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation.
Investments involve risk, including loss of principal amount invested. The precious metals, rare coin, and rare currency markets are speculative, unregulated, and volatile, and prices for these items may rise or fall over time. These investments may not be suitable for all investors, and there is no guarantee that any investment will be able to sell for a profit in the future. The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Past performance is no guarantee of future results.
