Reasons Why You Should Diversify Your Retirement Portfolio
The term “diversification” refers to the act of putting your investments in multiple places so that your exposure to risk is limited. Thus, if one investment starts to go downhill, you still have the rest to fall back on. Diversifying your portfolio can be difficult, but it’s a necessary part of retirement planning.
The Goal of Diversification
Many people mistakenly believe that the goal of diversification is maximizing returns on investments, but this is not the case. The actual goal is to limit the impact that a volatile market might have on your investments. For example, if you put all of your money in bonds, you may not earn a large enough return to support your lifestyle after retirement. If you put all of your money in domestic stock, then the volatility of the stock market may cause you to lose most of your nest egg at some point. The goal of diversifying is to spread your assets across several different places, which allows you to reduce risk while earning reasonable profit.
Reason #1 – The Whole offers Less Risk than its Parts
Let’s say you’re interested in investing in some risky places that have a potential to give you an insane return. It’s always fun – and sometimes exciting – to imagine your investments paying off beyond your wildest dreams. At the same time, though, it’s important to make sure that you are putting some money in safe places, such as IRA accounts and bonds. When you diversify in this way, the risk you can expect is far less than the risk associated with the individual parts of your portfolio. You get to take some chances, but you have your dependable investments to back you up.
Reason #2 – It Puts a Limit on Losses
When you invest, your ultimate goal should involve keeping up with the market averages and ensuring that you will have the funds you will need at the end of your time horizon. In doing this, you’ll need to focus not only on your gains, but also on the potential for losses. A giant loss can set you back several years in your time horizon. Essentially, the more diversified (and the better diversified) your portfolio, the less you stand to lose in the long run, and the less time it will take you to make up for any losses you incur.
Reason #3 – It Helps You Stay On Track
Rebalancing is also important to diversification. Essentially, rebalancing refers to the act of allocating funds between different types of stock in order to find the perfect balance between conservatism and risk. As an example, you may decide to spend 25% of your entire stock investing budget on foreign stocks, 5% on real estate, 25% for high-value stock, etc. Then, once per year, go back and take a look at how your balance performs, then talk to a professional to help you decide if some rebalancing is necessary. This will help you stay on track over the long term and meet your retirement goals.
Diversifying your portfolio does far more than ensure you get the best possible returns. It also helps you lessen your risk of exposure, puts a limit on your losses if and when they occur, and helps you stay on the right track to earn the amount of money you want during your time horizon.