Is Your IRA Asset Allocation Too Extreme?
When it comes to investing, many of us have heard of the 60-40 approach to risk allocation—you put 60% of your portfolio in stocks and 40% in bonds to build a balanced portfolio.
While it’s questionable whether this 60-40 approach still holds, new research from the Employee Benefit Research Institute (EBRI) shows many IRA investors are ignoring this ideology and holding “extreme allocations” in their IRAs.
According to EBRI, extreme asset allocation means an investor is either holding less than 10% or more than 90% of their IRA in a selected asset category. In 2016, the most recent year for which data is available, EBRI found:
- Almost 29% of IRAs had less than a 10% allocation to equities
- Nearly 27% of IRAs held more than 90% in equities
According to EBRI, Roth IRAs had the highest percentage of accounts with more than 90% in equities while Traditional-Rollover IRAs had the lowest rate of accounts with more than 90% in equities.
In the words of EBRI, “There is room for improvement in allocation behavior of IRA owners to reach a better diversification of assets.” At PENSCO, where we custody alternative assets for our clients’ self-directed IRAs, it is ultimately our clients decision on how to allocate their portfolios but we believe an educated investor is an empowered investor.
Understanding the power of a diversified portfolio
Portfolio diversification can help retirement investors reduce risk by allocating investments across different asset classes, especially ones that are not highly correlated—or move in the same direction as—stocks and bonds. This helps mitigate the risk of significant losses by spreading money around. Diversifying your asset allocation may help insulate your IRA from severe market swings, like those witnessed during the 2008 global financial crisis or in 2015 and early 2016, when market volatility reared its ugly head.
Investing in alternative assets, like private equity, real estate and promissory notes, is one way to diversify an IRA. While many investors mistakenly believe retirement accounts can only invest in traditional assets, like stocks, bonds or mutual funds, self-directed IRAs allow account owners to own alternative assets.
Data has shown that alternative assets have the potential to move independently of stocks and bonds, and they may increase in value if stocks and bonds fall. This correlation was on display ten years ago during the financial crisis when—much to the surprise of many investors—stock and bond portfolios both suffered heavy losses.
Expanding your asset allocation to include alternative assets
According to McKinsey & Co, the market meltdown caused by the financial crisis left its mark on investors. Many are now exploring how alternative assets can provide consistent, risk-adjusted returns that are uncorrelated to the market. They are also using alternatives to help with inflation protection and income generation.
In a separate report, PwC predicts that by 2020 alternative assets will be mainstream in some parts of the world and be included in the investment toolset used by investors seeking to generate returns while protecting against market volatility. PwC estimates that alternative assets will grow by roughly 9.3% per year between now and 2020, to reach $13 trillion.
Global Alternative Asset Projections for 2020
When planning and investing for retirement, every investor must make his or her own asset allocation decisions based on personal risk tolerance and income requirements. But these “extreme allocation” IRAs can serve as a reminder of the importance of taking portfolio diversification into account when building a nest egg.
The PENSCO blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.