Balance the Risks of Investing through Diversity

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Investment-RiskA little diversity is always good throughout life, and investing is no different. However, how much diversity you have in your investments generally depends on your age, your proximity to your goal and how much risk you are comfortable with taking on. Each of these factors has an impact on your financial choices and whether you are investing your money in the most efficient way.

Determining Diversity

The question that is often asked when talking to a financial planner is, "How diverse should my asset allocation be?" However it isn't quite that easy. A variety of factors go into deciding how diverse your asset allocation should be, making it nearly impossible to create a one size fits all answer to such a question. It really depends on where you are in life as far as age, as well as your proximity to the financial goals you are trying to reach.

For younger clients, the argument can be made that they should own nothing but stocks. For older clients who are closer to reaching their goals, a mix of stocks, cash and bonds becomes important. At this stage we are usually trying to control the volatility of our portfolio and trying to generate more consistent returns with lower fluctuation.

Market Strategy

Financial planners do not usually advise basing your asset allocation strategy off of the economy's status. However, if you are going to do it anyways, the general rule of thumb for people trying to "time" the market is that when the macro-economic environment is expanding, then that is usually a good time to overweight stocks. When it is contracting, bonds are typically the better investment. However, the macro-economic picture usually doesn't impact asset allocation recommendations as much as you might think. As noted above, because of the cyclical nature of the economy it is often more effective to pay attention other variables that are specific to each client. For the most part, the asset allocations created for clients are more closely tied to their age, risk tolerance and the amount of time until they reach their goal.

Maximizing Assets

The concern for most people who are investing is whether or not they are maximizing their assets. It is difficult to pinpoint an exact way to tell, because again, it comes back to each client's unique set of variables. For example, for an older client who has been stuck in CD's earning less than a quarter of a percent, a triple A corporate bond has the same maturity as their old CD, but pays 3 percent is a perfect example of them maximizing their assets. However, if you show that same 3 percent bond to a client with a higher risk tolerance and a longer time frame and is making 10-12 percent in the equity markets, they are going to feel less than maximized.

Financial planners usually offer small tweaks, rather than major surgeries, to help maximize the return on their client's assets. Those tweaks usually entail assuming a higher level of risk than what they might have been investing before. This means you need to make sure to have a conversation about whether or not each incremental unit of return is worth it as related to the corresponding increase in risk.

In the end, diversity depends on each individual person. As discussed, age, proximity to goals, and risk tolerance are usually the more important factors to focus on when determining how diverse your investments are. Working with a financial planner will help you discover if you are maximizing your assets and getting the most out of your investments.

Author: Gregory M. Reed, CFP®, 3201 S. Providence Road, Ste. 102, Columbia, MO 65203, 573-777-1934, Raymond James Financial Services, Inc. raymondjames.com/gregoryreed

A post by Gregory Reed (2 Posts)

Gregory Reed is author at LeraBlog. The author's views are entirely his/her own and may not reflect the views and opinions of LeraBlog staff.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Gregory M. Reed, CFP® and not necessarily those of RJFS or Raymond James.

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