Diversification is a critical strategy for anyone looking to retire successfully, but what does that word really mean? Sure, diversifying your assets in your investment portfolio is important, but what if the market takes a hit when you’re already retired?
When that happens, you’re forced to sell low. Even though you’re diversified within your investment portfolio, you’re tied to it — you have no options to turn to when the market isn’t cooperating.
Market downturns are always bad, but a downturn during retirement — especially if you’re still carrying some high-risk or even medium-risk investments — can be truly devastating. The same downturn you might have been able to recover from if you were 10 years out from retirement might be catastrophic 2 years into retirement.
That’s why you need to think in terms of your entire portfolio and how to diversify this, not just your investment portfolio.
When you combine this strategy with indexing, you end up with a much more stable retirement strategy that can weather financial storms, no matter how bad they are.
What Is True Diversification?
True diversification simply means you hold assets targeted for retirement outside your investment portfolio. This lets you pivot to another source of income when the market is down, avoiding the dangers of selling low.
Even though the 30-year average return on the S&P is 10.65%, the return for the average investor is only 3.75% thanks to the need to sell low during market downturns in retirement.
However, if you have assets waiting in the wings that can provide income during hard times, you can keep your money in the market and wait for it to improve — which it always does sooner or later.
What About Indexing?
Indexing is another effective strategy for reducing the effects of market volatility on your portfolio. Indexing just means tying your investments to an equity index like the S&P 500.
The value of this strategy is that, when the index goes up, you participate in the upswing to a good extent. However, when the index goes down, you do not lose any of your principal. This ratchets down your risk and, over time, keeps your retirement safer.
Reducing Risk Is Key to a Successful Retirement
A good retirement strategy is focused on risk reduction for the investments and assets that will form your principal source of income.
By using these strategies, you can reduce that risk significantly, make your retirement much safer, and still leave room for taking on riskier investments along the way if you want to.