Portfolio Diversification: Volatility Reminds Us Investing Solely in “Safe” Assets May be Risky
The stock market volatility that remained dormant for much of 2017 viciously reared its head in the second week of February (2018), sending stocks into wild gyrations that almost pushed the market in correction territory.
This rollercoaster ride is a fresh reminder for retirement investors of the importance of portfolio diversification. Those saving for retirement may be tempted to build their IRA portfolio only with exchange-traded assets like stocks and bonds which many perceive to be “safe”. But market volatility shows that limiting your portfolio to perceived “safe” assets can be riskier than you think—overlooking the power of portfolio diversification and alternative assets to potentially limit risk and enhance returns.
The Power of Portfolio Diversification
Well before this recent bout of market volatility, Bloomberg News published a story called, “How 'Safe' Investments Could Destroy Your Portfolio.” It discussed how solely following conservative investment strategies could unintentionally put a portfolio at risk.
The article highlighted an analysis of 300,000 portfolios that showed most income-focused clients relied on only a handful of dividend-paying stocks to deliver that income. Among investors age 40 and older, roughly half held three or fewer stocks. Nearly one-third relied on a single stock for income. In this example, Bloomberg said a seemingly “safe” investment—dividend paying stocks—is made risky by violating a cardinal rule of investing: diversification. The heavy concentration in a few stocks means the investor is missing out on an opportunity to mitigate the risk of big losses by spreading money around.
Portfolio diversification can help retirement investors reduce portfolio risk by allocating investments into different asset classes, especially ones that are not highly correlated—or move in the same direction as—stocks and bonds. Diversifying your portfolio may help insulate your retirement savings from severe market swings, like the ones witnessed in the first half of February.
Funding Your Retirement with Alternative Assets
Investing in alternative assets, such as private equity, real estate and precious metals, is one way to diversify a portfolio. While many investors mistakenly believe IRAs can only own traditional assets, like stocks or bonds, self-directed IRAs allow account owners to purchase alternative assets.
As Investopedia explains, alternative investments generally correlate negatively to most traditional investments—meaning they tend to outperform when the overall stock market is volatile or performs poorly. For example, alternative assets outperformed traditional investments during the financial crisis from October 2007 to April 2009. During that time, the only traditional investment to register a positive gain were investment-grade bonds. While the overall US stock market suffered losses, Investopedia says some alternative investments, like gold, produced double-digit gains.
Seeking Alternative Assets to Battle Market Volatility
PENSCO's clients are well aware of the importance of portfolio diversification. Our latest client survey found that 59% of respondents plan to maintain or increase their allocation to non-traded alternative assets over the next five years. That is in contrast to the 13% who said they will likely decrease their exposure to alternatives.
Why are self-directed IRA clients choosing alternative investments? In part, we believe it's to mitigate market volatility. But it also may be because they value the ability of alternative assets to improve the overall risk and return characteristics of their self-directed IRA.
Do alternative assets belong in your self-directed IRA? Every investor has to make his or her own decisions based on personal risk tolerance and income requirements. A financial professional can help you learn more about alternatives and whether they have a place in your retirement portfolio.
This 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.