Is My Retirement Portfolio Allocation Diversified?

A diversified stock or retirement portfolio allocation is critical to meeting your financial goals and retiring in comfort.

TV personality and former hedge-fund manager Jim Cramer can be a polarizing figure for investors, but I’m a fan of the guy. In fact, for several years, I wrote for TheStreet, which he co-founded. We had a few interactions over those years, and he was always very encouraging and helpful. I bring him up today because of the segment on his Mad Money TV show, “Am I Diversified?” A caller will tell Jim what stocks he or she owns, and he’ll give feedback on whether the portfolio is too concentrated in one sector or industry, or whether the caller’s stock or retirement portfolio allocation is diversified.

Jim Cramer’s approach to diversification, in the context of his show anyway, is a good start, but nowhere near a complete strategy. I understand the difference between financial advice and entertainment, and Jim’s comments to viewers fall mostly into the latter category, although he offers some valuable nuggets of insight.

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Nearly every investor will tacitly agree that diversification in your retirement portfolio allocation is good and desirable, but implementing true diversification, in the form of a balanced portfolio, is not easy.

The concept is simple: If all your investments are moving in the same direction at the same time, you don’t have an allocation; you have a bet.

Asset allocation is a deliberate process, hand-tailored to your unique financial goals. The majority of the time, the longer-term goal is retirement, although others, such as college funding, may also play a role.

The problems with stock and retirement portfolio allocation begin with home-country bias, which means concentrating your investments in your home country.

The Vanguard Group has conducted extensive research on this topic and found that investors in developed nations including the U.S., Canada, Germany, Japan and Australia all tend to focus on stocks and bonds from their home countries.

That hurts U.S. investors less than others, as the domestic economy is unusually well diversified, in terms of industries and sectors. Canadian investors, for example, are not so fortunate, in that their home-country stocks are heavily concentrated in the energy and minerals industries.

Proper diversification involves some detail work. You can’t just pick five stocks from five sectors and call it a day.

You’ll need stocks from all market caps, sectors and various global regions. In addition to the typical developed-market stocks, I advocate for a small holding in emerging markets, as these stocks outperform developed markets over time, but are more volatile.

Avoid so-called “frontier markets,” as these nations do not yet have well-regulated or stable financial and banking systems and are extremely risky assets. There’s no reason to introduce this level of risk to your portfolio earmarked for retirement.

Before you jump into retirement portfolio allocation, do a thorough review of your situation. Here are some points to consider:

  • Your planned retirement date: Don’t get too locked into a specific date, particularly if you are in your 30s or 40s, but that’s even true if you’re in your 50s. This date is a guideline to help you understand how much you’ll need to save to achieve your goal.
  • Your current spending: Forget those tropes about spending going down in retirement. That’s 100% false. I’ve worked with hundreds of people who made the leap from accumulation to the withdrawal stage, and I’ve never seen an instance where spending dropped off sharply just because a client was in her 60s, 70s or even 80s. You’ll still want an enjoyable lifestyle that doesn’t involve scrimping and cutting costs every step of the way. Factor this into your investment plan.
  • Your expected return: This is where some science comes in. Don’t just make up a number, like 10% or 7% or whatever. Don’t assume you can purchase risky assets and juice up your return. Financial planning doesn’t work that way. You’ll need to understand the amount you need to invest, and what return you need to generate income for your post-working years.

Can you just go into a simple retirement portfolio allocation like 60% into an S&P 500 fund and 40% into a fund tracking the Barclays Aggregate Bond Index? Sure. It’s better than randomly picking stocks and hoping for the best.

Your hypothetical random stock portfolio may, at times, outperform this basic 60-40 portfolio by a wide margin, but it’s likely to underperform at times.

To smooth volatility and design a portfolio that’s more likely to achieve your stated goals, you’ll need to introduce some other asset classes, such as foreign stocks and bonds, and domestic and foreign stocks representing different market caps.

It’s true that U.S. investors had reason to question broad diversification over recent years, as domestic stocks outperformed other developed-market stocks by a wide margin. You do have the option of “tactical” retirement portfolio allocation, which means swapping out better-performing asset classes, or giving them a heavier weighting in your portfolio. I suggest using portfolio models to make this determination, or, even better, work with a financial planner to help address the factors noted above, and to construct a portfolio designed to achieve your goals.

It’s definitely fun and more exciting to pick individual stocks and (hopefully) watch them rise. I’m not against that at all. But those speculative portfolios should complement your broad asset allocation, or, in some cases, be considered totally extraneous “fun money.”

But if you think holding five, 10 or 20 different stocks makes for a diversified retirement portfolio allocation, you are probably putting yourself at greater risk than necessary.

Are you comfortable with your current level of diversification?

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