Individuals investing for retirement need are continually faced with questions about what assets to purchase and how to best build a portfolio for retirement. Investors need to regularly assess their portfolio to ensure that it meets both their financial goals and psychological needs. Portfolio maintenance, including asset allocation and diversification, is the key to success and well-being.
Don’t Put Your “Eggs In One Basket”
Portfolio diversification is an approach to investment that reduces risk by spreading your investment dollars across a variety of investment categories. Diversification is commonly agreed as an approach to weather specific short-term negative events in an investment sector. By not putting all your “eggs in one basket” you allow your portfolio to reach its long-term goals. If you have all your retirement dollars in a specific stock or industry, and those share prices plummet, then your entire portfolio crashes.
However, if you spread your investment dollars across multiple industries and various financial instruments, you provide a path to long-term wealth accumulation while reducing the risk to your overall portfolio. In essence, the more uncorrelated your investments are, the better diversified your portfolio.
While many investors diversify only across stocks and bonds, there are other approaches. With self-directed IRAs, many individual investors are taking control of their investment dollars and diversifying into real estate, precious metals, tax liens, and other non-traditional assets as a way to build wealth. These alternate assets carry their own risk and any investment choices require proper due diligence from the investor. With all financial decisions, the key is to make choices that best fit with your own goals and tolerance for risk.
Do What’s Best for You
Your personality is one key to your risk tolerance. You want to make the best choice for your own comfort level. If you are willing to risk money for greater return, then you may be able to weather short-term dips in value for the potential of long-term gain. Others find the roller-coaster discomforting and prefer more conservative approaches with less volatility and, by extension, less chance for larger growth.
The key step is to know yourself: understand your current finances and your future needs; assess your risk tolerance; and determine the ideal asset allocation within your portfolio. You cannot eliminate risk entirely and, in fact, younger investors will want to use the power of time on their hand to build wealth through greater risk exposure.
Older investors tend to focus more on protecting wealth and will reduce their exposure to risk. Additionally, your portfolio will change over time. You will want to periodically evaluate your asset allocation and adjust according to your evolving self.
As you can see, diversification is a broad approach to creating stability in your portfolio, but it does not prevent loss. The financial markets are unpredictable so some loss may occur, but diversification can reduce the impact of unforeseen events on your overall portfolio performance. As with all financial decisions, the critical steps include understanding your own personality and needs, then making the investment choices that best meet your financial needs as well as allow you to sleep soundly at night.
Jeremy Davis was a councilor for financial expenses for years. He now enjoy his retirement by writing blogs to help with the difficulties of financial issues and retirement. Aside from writing blogs Jeremy enjoys walks with his wife, gardening and tutoring young children in math and history as part of his retirement routines.