Am I Diversified?

When it comes to investing we are taught to have a “diversified” portfolio.  This concept grew in importance back when companies gave employees company stock in their pensions. Unfortunately, not every company continues to thrive and if the stock loses value there can be little left for retirement.  Thus the concept of portfolio diversification gained traction as a simple way to keep from having “all your eggs in one basket.”

Statutory Guidance

As a fiduciary for several ERISA based retirement plans (i.e. 401(k)’s), my portfolio recommendations are guided by the Uniform Prudent Investor Act (UPIA).  Enacted in its current form in 1995, the UPIA places a primary duty of suitability, meaning that the investments must be suitable for the purposes of the trust.  Section 3 specifically creates the Duty to Diversify, which is why the investment options in your retirement plan are likely a series of mutual funds which by their nature are diversified because each one will hold multiple stocks or bonds in accordance with the objectives of the fund.

Studies have shown that a portfolio of just a handful of stocks creates diversification benefits.  Since every stock represents an ownership stake in a company, there are many ways to diversify within this asset class.   The stocks of large companies move differently from start-ups, technology companies act different than utilities, etc.  This is why it is a good idea to select multiple funds or a target date fund in your retirement plan. The past decade has seen the rise of passive index funds, where a single fund will mimic an index hundreds of stocks like the S&P 500 or the Russell 2000.

Multiple Baskets

But even if your proverbial eggs are spread amongst multiple baskets, such a diet may be bad for your cholesterol.  We thus should consider diversifying our diet by looking for foods that reduce cholesterol.  In investing parlance, this means looking for asset classes that are “non-correlated” to stocks that will move differently over time.  In retirement plans specifically, this means a mixture of both stocks and bonds, with a higher concentration of stocks (which are considered riskier) earlier in life, and shifting to more bonds (considered safer) as one gets closer to retirement.  This is exactly how the target-date funds in your retirement plan work.

Alternative Investments

Nowadays, retirement plans and investment accounts can use funds to hold a broader array of asset classes than ever.  The assets underlying these funds include precious metals, minerals, real estate, currencies, commodities, mortgages, private equity and even Bitcoin.  All of these investments are possible without owning or possessing the physical asset.

That being said, do not forget physical assets which themselves provide further diversification and the benefit of tactile enjoyment.  The most common of them is owning a home, which for many is the largest asset on their balance sheet.

Traditionally reserved for higher end investors, collectibles such as art, jewelry and classic cars have been wise investments.  Social media however has significantly expanded the market for collectibles, minting millionaires from collections of everything from sneakers to Pokemon cards and video games.