Putting all your retirement money into one investment or closely correlated asset types is risky. You can decrease your risk by investing in multiple asset classes. Spreading your investments this way is called diversification.
A mix of traditional and alternative investments can better position you to achieve your retirement planning and savings goals. If you already have a retirement account but are worried your portfolio isn’t diversified enough, you can make changes to increase diversification. Learn about various investment strategies and risks you should be aware of when investing.
Understanding Portfolio Diversification and Asset Allocation
Diversify your retirement account by investing in multiple assets within a class or in different asset classes. Allocating your investments among different assets reduces risk and can increase growth potential.
Investments with different correlations are less likely to move in the same direction, so if one asset class loses value, another may remain steady or even increase. For example, equities may be down while real estate is up. Over time, diversification smooths volatility and can offer more reliable returns.
The best asset mix for retirement depends on how long you have until you retire. Many people tolerate higher risk when they are younger. They are more focused on growth and have time to recover from losses. As people get closer to retirement, they focus more on preserving what they have and earning interest for income.
Assess your own risk tolerance and create an investor profile to help you decide how to diversify your account.
Key Investment Strategies and Types for Retirement Accounts
Learn more about diversification strategies and the types of assets you can choose to ensure a well-diversified portfolio:
Diversifying Across Asset Classes
Choosing different asset types is an excellent way to diversify your portfolio. Generally, you want to invest in stocks, bonds and cash. Stocks offer the most growth, while bonds are more stable investments. Cash or equivalents are liquid, allowing you to be flexible and take advantage of unexpected opportunities. However, cash will likely lose value over time due to inflation, so avoid keeping too much in this category.
In addition to stocks and bonds, traditional types of investments include annuities, certificates of deposit (CDs), exchange-traded funds (ETFs), mutual funds and index funds. Bonds, annuities and CDs can provide guaranteed income.
Mutual funds and ETFs offer access to many different types of stocks and bonds without you having to vet each one individually. ETFs act more like stocks, with their prices changing throughout the day, while mutual funds only trade once per day. Index funds are mutual funds or ETFs that aim to match the performance of a specific market index, such as the S&P 500. These funds may diversify narrowly, such as focusing on a particular industry, or broadly, such as a national market fund.
Diversifying Within Asset Classes
One common way to diversify is to invest in multiple assets within the same asset class. For example, you might buy stocks in several companies and include index funds to ensure a range of high- and low-risk assets in several industries.
Within asset classes, you can diversify in a few ways:
- Market cap: Invest in companies of different sizes based on their market capitalization. These categories are large-, mid- and small-cap. Larger, more established businesses may offer more stability, while smaller, growing companies can provide a higher return.
- Industry: Invest in various industries, from tech, energy and financials to entertainment, health care and agriculture. Look at how different sectors are correlated, choosing complementary industries that move in opposite directions.
- Geography: Invest in local, national and international companies. Include both developed and emerging markets. If a particular industry in your country is performing poorly, it may be stronger in another country. Before you invest internationally, note that there may be different rules, regulations and processes for investment. The right administrator can ensure you comply with any rules.
Diversifying With Alternative Investments
You can diversify even more by investing in alternative assets. Unlike traditional assets, which generally trade in a public market, alternative investments are available on private markets and may be unregulated.
Alternative assets typically have a low correlation with traditional investments. For example, if your stocks lose value, your alternative investments may be stable or increasing in value. Alternative assets are not allowed in conventional individual retirement accounts (IRAs) but are possible with self-directed IRAs (SDIRAs).
With an SDIRA, you can invest in alternative assets, including:
- Real estate
- Private equity
- Cryptocurrency
- Precious metals
Active or Passive Management
You can choose who manages your portfolio and how involved you want to be. Some investment platforms can make suggestions based on your risk profile and goals. You might want to use these suggestions and only reassess your portfolio annually. Robo-advisors are digital platforms that manage and adjust your investments according to your profile and market activity.
You can hire a financial or investment advisor to handle everything for you and adjust your holdings when they think it is advantageous. If you want the most control over your investments and the range of assets you can invest in, open a self-directed IRA.
Managing Risks and Maximizing Portfolio Value
Understanding risks helps you manage your risk exposure and maximize your account’s value. All investments carry risk, but alternative assets are more prone to credit and drawdown risks:
- Credit risk: Investing in loans or debts exposes you to credit risk — the chance that the borrower will default and not pay the lender back.
- Drawdown risk: Drawdown is a significant loss of value due to asset or market downturns. While applicable to all asset classes, drawdown risk is especially concerning with volatile and illiquid assets, like cryptocurrency.
Following diversification guidelines or rules can help you minimize risk. Here are some common rules:
- 12/20/80 rule: A well-diversified portfolio should contain at least 12 different holdings. No single asset should exceed 20% of your portfolio, and your top three should not exceed 80%.
- 5% rule: No more than 5% of your portfolio should be invested in any single nontraditional or high-risk asset.
- 70/30 rule: If you have a moderate risk tolerance, a suggested split is 70% stocks or higher-risk investments and 30% bonds or lower-risk investments. A more aggressive, growth-oriented split is 90/10, while a more conservative split is 50/50.
Even if you follow one of these splits, it is important to check your portfolio occasionally to ensure it is still in your desired range. Your ratio of investment types will naturally change as markets fluctuate, and neglecting to rebalance can lead to you taking more risk than you want. For example, if you start with a 70/30 split and your stocks perform very well, your portfolio might shift to an 80/20 ratio overall. Regular review helps you stay at your desired risk tolerance and maintain your overall investment strategy.
Tax Diversification and Retirement Income Planning
You can further diversify your retirement savings by holding them in accounts with different tax advantages. Traditional IRAs are tax-deferred, meaning you contribute pretax funds and pay income tax when you withdraw. With Roth IRAs, you contribute after paying taxes, so growth and withdrawals are tax-free. Brokerage accounts are generally taxable but can allow for certain capital gains and loss strategies.
Different accounts allow you more flexibility when taking distributions. It is generally best to withdraw from taxable accounts first to enable tax-advantaged funds to keep growing. Though you likely want to withdraw from tax-deferred accounts next, you might withdraw from tax-free accounts if tax-deferred distributions will increase your taxable income enough to push you into a higher tax bracket. Note that traditional IRAs have required minimum distributions after you turn 73.
A professional can help you leverage Roth conversions and coordinate with other benefits, like Social Security, to minimize the tax impact.
Open an SDIRA With Accuplan Benefits Services
If you want to diversify your retirement savings by investing in alternative assets, Accuplan Benefits Services can help. We are a leading administrator for self-directed IRAs and have helped thousands of investors. We have many years of experience, and our dedicated experts are here to guide you.
Ready to optimize your retirement strategy? We designed our platform specifically for self-direction, so you can invest how you want in various traditional and alternative assets. Contact Accuplan Benefits Services to open a self-directed IRA and receive expert financial advisory support tailored to your goals.
Our information shouldn’t be relied upon for investment advice but simply for information and educational purposes only. It is not intended to provide, nor should it be relied upon for accounting, legal, tax or investment advice.
