“Diversify.” You have heard the advice over and over again. But what does it mean, and how much should an investor diversify? We do not have any easy answers for you; after all, we are not a financial advisor that will tell you exactly what your portfolio should look like. But we are a Self-Directed IRA administration firm, and we have some thoughts on what true diversification in a retirement portfolio might look like.
Defining Diversification for Retirement Investing
Let’s start with a simple definition, courtesy of Investopedia:
Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio.
In other words, let us say you have a basket of eggs. If all of your eggs are in that basket and the basket drops, you’re in trouble. But if you keep your eggs in multiple baskets, any disaster that befalls one basket is not going to affect the others.
Diversification is, in short, a method of spreading out the risk so that your retirement portfolio remains strong in a wide variety of situations and economic circumstances.
But there is a problem with diversification as most people perceive it. Many people take it to mean “diversifying within the same asset class.” In other words, what if you wanted more than just eggs in your basket? What if you wanted bread and fresh produce too?
That is where the Self-Directed IRA comes in.
Expanding Beyond One Asset Classes
Let us be honest: the way most people invest is to keep money in the stock or bond market, leave it there for a long time, and hope for the best. But unfortunately, this limits retirement investors to just two asset classes: stocks and bonds.
Can you get away with such a portfolio if no major economic calamity occurs before you retire? You can. But diversification is not about relying on that kind of situation to occur. Diversification is about planning for such a situation to occur and arranging a portfolio that way.
The best way to diversify your portfolio is to go beyond one asset. For example, an individual who holds a real estate investment beyond the stock market may continue to generate great returns with the income that the real estate generates—even if it has not been a good year in the markets.
Another asset class to consider is that of precious metals. Precious metals have the advantage of hedging against inflation, which makes it easier for retirement investors to hold on to the wealth in their portfolio when inflation runs rampant. It has been a long time since inflation has been a headline-worthy problem in the United States, but it is worth noting that this history does not eliminate the risk of inflation.
Making a Well-Diversified Portfolio Work within a Self-Directed IRA
A Self-Directed IRA is an ideal vehicle for anyone who wants more diversity in their portfolio. Not only does it allow investors to widen the range of assets they hold, but it makes the process of diversification simpler. It also means that diverse assets can have the same retirement protections anyone else has.
Holding real estate within an IRA, for example, means that the value in that real estate will grow tax-deferred or tax-free, depending on the type of account. For investors who want more diversification within their portfolio, that is a major upgrade to the traditional path of investing for retirement investors around the world.