Whether your money is invested in a retirement plan like a 401(k) or IRA, or if it is invested in non-tax-advantaged investment vehicles, a diverse portfolio is important. Individuals whose retirement savings are in 401(k)s and IRAs have the ability to choose between an array of investment vehicles, and these may be classified as conservative, balanced, or aggressive. Depending on how close a person is to retirement, they may lean more toward conservative or aggressive, but over time the best strategy has been shown to be a diverse, or mixed, portfolio.
Conservative investments are those in which the year-to-year return does not vary considerably, such as bonds and other short-term investments. More aggressive investments would be heavily invested in individual stocks. Since stocks are known to be volatile in their returns in the short-term, the potential to lose money in any given year is real. However, it is also ill-advised to invest all of ones money in short-term “cash only” investments because their rate of return is much smaller, and the opportunity to earn money is lost.
Overall, the reason to diversify is not to increase performance, because diversity cannot guarantee against losses. Rather, it spreads risk over time so that, in the long run, losses are balanced out by gains.
About the author: Tony Ehinger is the recently retired Co-Head of Global Securities at Credit Suisse. He has worked in the finance industry for more than 25 years, where he built a reputation as a leader in financial services.