With the stock market’s extensive growth period stalling this February, it was easy to start to worry about the future of our retirement savings. After all, we all went through the recession of 2008-2009 and it’s not something we’re eager to return to.
What if I told you there was a way to be prepared to pursue your goals, even despite a volatile stock market? And it’s something that many of you are already doing, at least in part.
It’s called diversification and if you do it right, it can save you from unnecessary risks. Here's how to tell if your portfolio is effectively diversified.
Diversifying by Asset Allocation
If you wanted to make a lot of money really fast, it could be smart to jump into the stock market. But the ability to earn big usually correlates with a lot of risk. So, sure, there’s the possibility that you pick the right stocks at the right times and earn plenty of interest in a short period. But it’s equally likely that you’ll lose big on those investments, leaving you in a tough spot.
That’s where asset allocation diversification comes in handy. While there is always risk involved when you’re investing, having a good mix of stocks, bonds and other asset classes’ can help you be more confident that in the case of a market downturn.
This is especially important to think about when you are nearing retirement. Everyone’s goals and investment strategies are different, and so are their portfolio makeups. By moving de-risking your portfolio and moving the money you’ll need soon from investments back into your savings accounts, you feel confident that market changes won’t leave you high and dry.
Diversifying by Company Risk
This is one of the biggest risks that investors don’t realize they’re vulnerable to. Let’s say your financial advisor shows you what your investments look like in a pie chart. You see lots of different colors in different slices of that pie that represent different types of assets in your portfolio.
But what you don’t see is that 60% of those slices belong to the same parent company. Now imagine that company goes out of business. That means 60% of your portfolio just took a nose dive and you’re likely in big trouble. This is one of the hidden risks of investing, and of investing with someone who isn’t spending the necessary time looking out for you and your financial future.
But these aren’t all of the risks you have to think about. You have to consider the skill of your investment manager, interest rates and the possibility of rising inflation, too. But having a team of advisors and specialists behind you can help you feel more confident in your investing strategy in the event of a market correction.
Being invested in anything comes with an inherent risk, but if you follow these steps, you can be more prepared for volatility. Work with your financial advisor to uncover any hidden risks in your portfolio so you can feel confident no matter where the markets land tomorrow.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
This article was first published on 2/26/2017 in the Des Moines Register.
Jim Sandager has an extensive retirement income planning background and has written several personal finance columns for The Des Moines Register. Jim studied at the University of Minnesota and Bowling Green State University.