Diversifying Your Retirement Portfolio For the Best Yield
"Diversify" is a term we’ve all heard about investment portfolios, but it’s important to understand exactly what it means to our portfolio, in order to do it properly.
While it can mean different things for different investment portfolios, here, we’ll be specifically talking about retirement portfolios. The goal of that type of portfolio is to provide a reliable, steady (and hopefully, growing) stream of income. Therefore, it’s important to build a network of investments that will compensate for the ups and downs of the others. So what do we do first?
Determine your spending rate. This refers to your living expenses… the amount of cash you need to take out of the portfolio each year, adjusted for inflation.
If, for instance, you have a portfolio with a total market value (TMV) of $500,000, and a $50,000 spending rate, you will need to build an investment plan that will give you a ten percent net yield, which is an ambitious package.
However, if your TMV is $1,000,000, then you could maintain the same spending rate with a five percent net yield. That means you would not have to undertake investments of such a high risk level. As you can see, the larger the TMV, the more flexibility you will have.
Next, examine the risk profiles of different investments. In order to achieve an adequate spending rate, for instance, many retirees opt to carry around half their portfolio in equities. These carry a better yield, but their downside is a higher risk factor. The remainder of their portfolio will be spread amongst lower risk and lower yield investments, of a diverse nature.
This second half of the portfolio will typically be broken up into much smaller individual investments, spread across various investment classes and markets. The idea is to structure your investments such that when any one investment falls in value, at least one other will rise an equal amount, compensating for it. The equity portion of your portfolio is making the most money, while the remainder is providing stability.
Diversification, however, does not offer complete protection against a market downturn. It simply mitigates the effect, which effectively gives you more time to take corrective action. Your broker can help you select a good cross section of investments, in the value or growth, small, mid or large classes, in order to ensure a positive growth of your portfolio, often even in a bear market.