In his 1605 novel Don Quixote, Cervantes cautioned readers against putting all of their eggs in one basket. The maxim remains relevant today – particularly for investors working toward financial well-being. Diversifying your investments has proven to be a sound strategy regardless of your time horizon, risk profile or investment objective. However, these factors play an important role in allocating your assets. In other words, "diversification" does not mean the same thing to everyone. And it shouldn't.
Traditionally, diversifying portfolio assets has been associated with helping to reduce risk while also increasing returns. In theory, and often anecdotally, this remains a valid investment strategy. Still, with the introduction of new investment vehicles and rapid changes in economic conditions, the traditional portfolio allocation of 60 percent stocks and 40 percent bonds (60/40) may no longer serve certain investors. Indeed, the high-interest-rate environment of the past few years saw cash and cash equivalent holdings perform relatively well.
Diversified portfolios are not a “set it and forget it” exercise. Regular adjustments, based on changes to your needs, goals and life situation, are critical. For example, it’s recommended that investors gradually reduce risk as they approach retirement. Why? Should the value of a portfolio go down, there is less time to recoup losses before exiting the workforce.
Maximizing Return and Reducing Risk
When it comes to investing, risk cannot be avoided, but it can be managed. Understanding the risk-return characteristics of asset classes is important, though it is also important to remember there are no guarantees regarding how a particular holding or asset class will perform. A good rule of thumb: the higher the return potential, the higher the risk.
How do you decide what’s right for you?
The popular "100 minus your age" rule involves subtracting your age from 100 to determine how much of your portfolio should be in stocks, with the balance in bonds and safer assets. For example, a 45-year-old would invest 55 percent of their assets in stocks (100-45 = 55), with the remaining 45 percent in bonds and/or cash.
Most investors are unlikely to rest their financial foundation on a math trick. An alternative to taking your chances is to engage a financial advisor to help guide your decision.
Working with a financial professional well-versed in the fundamentals of asset management is essential to develop a diversification strategy. It’s also imperative that this financial advisor understands your risk tolerance, timeframe, your current circumstances and what you hope to achieve over time.
Remember, what's "right" for you is not static. It will change over time, either because you've changed, your circumstances or goals have changed, or the investing environment has changed. Even if all of these elements remain the same, your investment window grows shorter as time passes.
Meeting regularly with your financial advisor to discuss rebalancing your portfolio not only keeps your investments aligned with your risk tolerance and goals but can also broaden your investment options as new products become available to you. For example, until recently, alternative investments were generally not available to individual investors. Now, investors have more opportunities to include these holdings in their portfolios.
Choosing an independent financial advisor who acts as a fiduciary and always has your best interests in mind is key to capturing the investment opportunities that best align with your goals and your risk profile. To speak with a SageView advisor in your area who can discuss your situation and help you assess your options, visit our Find an Advisor page.