Asset allocation has been a proven investment strategy for half a century. You can choose from a number of retirement plans, including the popular choice of an employer-sponsored retirement plan. However, very few plans offer the virtues of diversification as a Self-Directed retirement plan, such as the Solo 401(k) for owner-only businesses, and the Self-Directed IRA for everyone else. In this article, we will explain how retirement investors can achieve retirement portfolio diversity the right way.
Why is Investment Diversity Important?
While investors may know the importance of diversification, not all know how to correctly achieve retirement portfolio diversity. But before we get into that, what is diversification and why is it so important?
Let us explain:
Diversification is a risk mitigation strategy. It combines a wide variety of investments within a portfolio (for example, a retirement portfolio) that have different correlation aspects, or in other words, do not move in the same direction. That way, as one investment falls, the other investment may rise.
Brad Blazar, a contributor to Real Assets Adviser and alternative investment expert, explains the premise of investment diversification. “When some investments zig, the others will zag…balancing the portfolio’s volatility over time and providing more stable, predictable returns.”
Blazar goes on to say that “zig zag” refers to the non-correlation of assets. For example, if the US equities markets are underperforming, the real estate sector may be on the rise.
“The fact that one sector is doing well while another is lagging tends to mitigate downside risk,” explains Blazar, “and more evenly balance long-term returns.”
How You Can Benefit with a Self-Directed Retirement Plan
Investors who establish a Self-Directed retirement plan with a passive custodian will have the ability to invest in popular asset categories, such as stocks and bonds, but also mitigate risk with alternative investments, such as private equity, precious metals and hard assets, like real estate and gold. Ultimately, you have a greater chance of achieving retirement portfolio diversity.
Whereas, if you establish a Self-Directed retirement plan at a bank or financial institution, your asset allocation will be limited to the financial products they sell. This includes stocks, bonds, mutual funds and ETFs. If you wish to invest in cryptocurrency, you would not be able to do so with most banks/financial institutions because they do not sell cryptocurrency. Additionally, if you want to invest in real-estate, or have rental income, your local bank will not allow you to have these investments in your retirement account.
Asset Allocation – It’s a Tricky Practice
The Wrong Way to Diversify Your Investments
A fairly common misconception among investors is, by owning hundreds of different stocks, or owning several mutual funds, they have achieved retirement portfolio diversification.
“What [industry experts] find is a tremendous overlay of similar holdings,” says Blazar. “[Investors] might have two or three mutual funds…thinking that having three provides greater diversification.”
However, this is not the way to achieve retirement portfolio diversity correctly. And here’s why:
By purchasing, for example, two funds in the same sector, both funds will essentially own the same securities, says Blazar. For example, Fund A may hold Apple and Fund B may hold Microsoft. Fund A and Fund B hold virtually the same securities because they are within the same sector. Now here’s how you should diversify your retirement portfolio:
Correctly Achieve Retirement Portfolio Diversity
True diversification comes from the types of investments you purchase. Rather than investing in three mutual funds, purchase only one. Utilize your additional retirement funds to invest in real estate, private equities, natural resources, etc.
Blazar also recommends looking to the “Endowment Model” for systemic risk management. The endowment model illustrates the importance of using retirement funds, such as a Self-Directed IRA to purchase stocks and mutual funds, but also asset classes outside of this sector (real estate, cryptocurrency, venture capital, etc.). This will reduce the risk of correlation, thus your retirement portfolio has a greater chance of performing successfully.
Steps to Achieve Retirement Portfolio Diversity Correctly:
- Invest in multiple sectors – Don’t purchase multiple mutual funds, instead, diversify into other investments, such as precious metals, tax liens or real estate.
- Avoid Banks and Financial Institutions – If you want true control over the types of investments you can make with your retirement funds, such as the ability to make alternative investments, re-consider working with a bank, such as Wells Fargo, or financial institution, like Fidelity.
- Establish a Self-Directed retirement plan – It is possible to achieve retirement portfolio diversity correctly with a flexible plan that allows for traditional and alternative investments, like the Solo 401(k) or Self-Directed IRA.
Related: Open a Self-Directed IRA Online
*Before opening a Self-Directed IRA, we recommend that you checkout fees, and what alternative investments the company offers. IRA Financial offers a true Self-Directed IRA, allowing you countless investment options. We also charge a flat fee per year, with no transaction fees or account valuation fees.
Self-Directed IRA and Solo 401(k) Retirement Plans
At IRA Financial, we offer two self-directed retirement plans that give investors the freedom to use their retirement funds to make almost any type of investment:
- Solo 401(k), which is uniquely designed for owner-only businesses and individuals who generate some form of self-employment income.
- Self-Directed IRA, which allows all other investors to utilize retirement funds for both traditional and non-traditional investments in a tax-advantaged manner.
With both self-directed retirement plans, you have the ability to effectively allocate your assets in a wide range of classes and categories. Learn more about the Solo 401(k) if you’re self-employed. If you are not self-employed, discover the advantages of the Self-Directed IRA.
Work with IRA Financial
When you work with IRA Financial, we will guide you through the IRS prohibited transaction rules so you do not risk being taxed or penalized for engaging in a transaction under IRC sections 408 and 4975.
The professionals at IRA Financial do not sell investments or offer investment advice, but we will ensure that your Self-Directed retirement plan remains IRS compliant, giving you the freedom to yield high returns on your investments stress-free.