VIDEO: Retirement Investing Pitfall #4 – Underestimating Market Risk and Not Properly Diversifying

 

In this video I am going to cover Pitfall Number 4 – underestimating market risk by not properly diversifying. As you probably know, a disciplined approach to your money can help buffer you against turbulence and uncertainty in the market. Obviously, there are plenty of approaches you can take to investing for your retirement, and there are also a number of pitfalls that can interfere with that approach. Underestimating market risk and not properly diversifying your investments, is one of those pitfalls.

While the stock market has historically offered better performance than other asset classes such as government and corporate bonds, this type of performance does come with a drawback: higher risk. And of course, this makes sense when the following investment principle is considered: along with the potential for higher returns, comes higher risk. I’ve met with many retirees over the years who are, in my opinion, overly aggressive, and have placed a substantial portion of their retirement savings in riskier market-related investments. By doing this, they run the risk of a market crash adversely affecting their retirement income plan, because there often isn’t enough time for their investments to come back from the big declines. While there are many variables to consider when addressing risk, like time horizons, risk tolerance, goals, and other assets, you really want to aim to achieve an appropriate balance of risk in your investments, as discussed in Chapter 10.

This is why it’s crucial to understand when planning for retirement, simply diversifying among different stocks or ETFs may not be sufficient, especially if all of these investments are part of the same market, sector or asset class. Diversification is simply a risk management technique that involves spreading your money amongst many different asset classes, and investing into a wide variety of financial products within those asset classes, with the goal of preventing your entire portfolio from suffering losses all at once. This strategy should help smooth out portfolio volatility over the long haul. Another important aspect of becoming fully diversified is to invest in global markets. This enables you to reduce the risk of the U.S. market underperforming overseas markets, thus hurting your overall returns. Global diversification has also been proven to lessen a portfolio’s volatility, as it shouldn’t be as sensitive to returns from any single market. I know the ideas of diversification and asset allocation can often seem confusing and a bit overwhelming. Perhaps getting more education on these topics by sitting down with a financial advisor may help you better navigate these waters.