Diversification — the mixing of various investments in a financial portfolio to minimize risk. Investing does come with inherent risks. Utilizing risk management strategies and gaining a greater understanding of the rise and fall of the stock market through history can bring about a sense of predictability to your portfolio.
Let’s dig into risk management through diversification, a bit of stock market history, and real-world examples. It can be easy to shy away from risk, but having a solid baseline understanding of these principles can help you invest with confidence.
Risk Management Through Diversification
Stocks, bonds, cash, CDs, real estate — a diversified investment portfolio will include a mix (or all) of these options. The list is truly endless when it comes to how to diversify with the thousands of options within the stock market, gold, types of bonds, real estate options, etc.
In the case of retirement planning, the goal is to not only create steady growth and future income but to minimize the risk associated with each investment. To meet your retirement goals, you want your portfolio maximized for growth while providing a sense of security that your funds will be available when you need them.
When it comes to the stock market, you can choose to take on more risk by investing in up-and-coming technology or play it safe by putting your money CDs, bonds, or in stock of companies with a long history of success. Where one investment may provide consistent gains, others may go through constant ebbs and flows.
At the end of the day, it's a balancing act. Investing in various industries or commodities along with a long-term mindset is important. While downturns in the economy happen, those who understand the stock market realize the earning potential associated with the inevitable market rebound.
History of the Stock Market
The S&P 500 is often used to gauge the performance of the stock market as a whole. Since its inception in the 1920s, the average rate of return has hovered around 10%.
What that does not mean, is that you can expect about a 10% return each year. What it does mean is that there are years the S&P has experienced overall loss, and there are years the gains have exceeded 30%. But because the historical average return is 10%, if you play the long game, you more than likely come out ahead.
Many of today’s savings accounts offer less than 1% interest, and most are even less than 0.5%. While keeping an emergency fund of cash on hand is important, you’re simply missing out on making your money work on your behalf by leaving it all in a bank or safe.
Learn From the Pandemic
The Covid-19 pandemic has provided a first-hand lesson on volatility, why not to pull out when the stock market falls, and how a long-term view is necessary to meet long-term goals.
Take a look at the last 5 years for Walt Disney Co. A very established well known company whose stock had very little volatility until the shutdowns of March 2020. The stock price fell dramatically. The economic impact was felt on some level through every industry. Now imagine you had sold your stock out of fear? You would have missed the rally this stock experienced in the later part of 2020.
*Photo credit: Google Finance
Now take a look at Shopify — an e-commerce website hosting platform that makes selling online easy for business owners. If you purchased this stock back in 2018-2019, you may have been feeling like you were on the front end of new technology, and your fingers were crossed for success. Then, with a swift change of buying habits, the stock took off as online sales skyrocketed in 2020. Now only time will tell if the rise will continue.
*Photo credit: Google Finance
Now imagine having a stock like Sears in our portfolio — once a leading retailer that simply dissolved over time. Hopefully, your portfolio was balanced out with the likes of Disney and Shopify. You get the picture, diversification allows you to mitigate much of the risk associated with putting all your eggs in one basket.
*Photo credit: Google Finance
How to Choose
If studying the stock market and scouring financial reports isn’t your thing, utilizing a financial advisor certainly can pay off over time in both returns and time saved. While helping you select your initial investments and building a diversified portfolio is very beneficial, the real benefit often comes when changes to your portfolio are made.
Many Do It Yourself (DIY) investors put a bunch of time into creating the perfect portfolio. While we’re not doubting their capabilities, many will set it and forget it. What if you had invested in Sears back in their prime and then just forgot about it? You’d be pretty disappointed by the time you pulled the old stock certificates out of your safety deposit box.
At Integrated Wealth Management, we provide integrated planning to guide you confidently through the three stages of retirement and navigate the highs and lows of the future. If you’re interested in learning more, gaining confidence in your investment selection, and ultimately reaching your personal finance and retirement goals — reach out to our advisory team today.