When you first were setting up your retirement accounts, you probably were careful to make sure you had appropriate amounts of your money diversified among mutual funds, stocks and bonds. And each year, you hopefully evaluate your investments and make changes, just in case they became unbalanced due to uneven growth or loss in the markets. So you’re diversified, right?
The technical answer is yes, and good job for the careful attention you pay to your finances. In reality, you may not be diversified enough.
To truly embrace a diversified portfolio, you need to go beyond investing in stocks and bonds and other major asset classes. In fact, I recommend you step way back and do a full review of your financial goals, your asset allocation, your risk tolerance and the amount of time you have to invest. It’s also a good idea to narrow down your diversification practice to the detail of assessing the size of the companies and types of specialty assets with which you’re invested. At U.S. Bank, when we meet with clients to discuss diversifying their investments, we’re essentially creating a very personalized portfolio to address all of these items.
Let’s talk more in-depth about diversification. Diversification is important because it may allow your portfolio to be flexible during times when the markets experience negativity. With a diverse portfolio, you have a better chance of achieving your financial goals over time. By taking this approach, you should expect some assets will perform better than others, and that’s the whole point.
The intention is essentially to increase the probability of your investments weathering a downturn or recession, while also positioning you to potentially benefit from eventual rising markets. So, how do you know if your asset allocation is diversified enough? First, you need to determine your goals and how to best achieve them. It’s a good time to meet with your financial advisor to plan and discuss this strategy together. Keep in mind, this process will be different for every person. There’s no one size fits all here.
Diversification has been shown to pay off over the long run, and in the short run diversification can cushion the impact of market volatility. For example, from Dec. 1, 2015, to Jan. 15, 2016, the S&P 500 was down nearly 11 percent, but a diversified portfolio with 55 percent invested in the S&P and 45 percent invested in a broad bond index was down less than 6 percent. As stocks and bonds tend to respond differently to market environments, a combination of the two can produce a more stable, lower risk portfolio. However, diversification and asset allocation do not guarantee returns or protect against losses.
You should consider diversifying not just between the broad classes of “stocks” and “bonds,” but also among the different types of each. For example, from Jan. 1, 2016, to Jan. 1, 2017, long-term government bonds declined about 1 percent, while high-yield corporate bonds rose over 7 percent. Investing in only one type of bond may not be the best approach for you in the long run, any more than investing in only one type of stock.
If you’re only diversified in stocks and bonds, here are some specific steps to become more diversified with all of your investments:
Financial planning: set risk tolerance and goals
You need to have an understanding of your objectives, goals and dreams. What does the future look like for you and how will you plan for it? A good financial planner will have a process to guide your finances through life’s ups and downs. He or she will help you with your goals of growing assets, creating reliable income, asset protection and legacy planning.
Asset allocation: make a determination based on goals and risk
Once you and your advisor have an understanding of your goals, you’ll work together to create an asset allocation model that is suitable for you. It’s important to remember that this will change as your life changes.
Determine the depth of diversification based on risk tolerances and long-term investments
An asset allocation model should encompass all of your assets, not all of which may be in an investment portfolio. You may have rental property, retirement plans through an employer, as well as other alternative investments. Your financial plan will take all of these into account when helping you plan for your future.
Diversification is ultimately a powerful tool to potentially achieve your financial objectives. We do not know what the future will hold, and what has done well in the past has no guarantee of doing well in the future. To hedge risk, a disciplined investor will diversify holdings in a multitude of ways, which may help ensure they’ll be able to navigate the ups and downs of markets successfully.
Cindy Luckman is senior vice president for The Private Client Reserve of U.S. Bank in Vancouver. You can follow her on LinkedIn at https://www.linkedin.com/in/cindyluckman.