Why Diversification Matters

You’ve probably heard the saying, “Don’t put all your eggs in one basket,” but what exactly does that mean for retirement planning? Or, put a different way: Why should you care about diversifying your investments?

I’ve had a number of conversations lately with my clients who have a concentrated portfolio (sometimes through no fault of their own), and thankfully the past decade has rewarded many of them. Either because of how they’re compensated (i.e., RSUs) or through a laid-back approach to rebalancing, I’ve seen a lot of portfolios with a large allocation to one or a handful of stocks. Mostly, it’s been a concentration in tech stocks (e.g., AMZN, MSFT, GOOG, FB, SNAP, TSLA, etc.), but because of how the recent bull market has been a success story for many large growth companies, I’ve seen lots of different variations all with a common theme: A lot of eggs, all in one basket.

First, we need to understand the importance of diversification. Building a portfolio with lots of different types of investments spreads the risk around. Technically speaking, to have a well-diversified portfolio means you have different assets that are as uncorrelated to each other as possible. It’s not necessarily a quantity-over-quality metric. You can easily have a portfolio made up of dozens or hundreds of different stocks/mutual funds/ETFs and still be undiversified if all of those investments behave very similarly. Proper diversification can be achieved by investing in asset classes that are made up of different types of investments (stocks, bonds, real estate, commodities, cash, etc.), by investing in the same type of investment (small-sized company stock vs large-sized company stock), and by investing in different geographic regions (US vs International). Obviously, this is a high-level overview, and there’s a lot of research and effort that goes into building a thoughtfully diversified portfolio.

Now, back to why you should care. There’s another famous saying that goes something like this: Wealth can be built with concentration, but it should be protected with diversification. A realistic investment philosophy should be built with planning at its core. I often tell my clients (or anyone that will listen) that it’s impossible to predict what’s going to happen in the market, but we can prepare for the unexpected.

“While we can’t predict the markets, we can prepare for them.”

If you’ve built up a concentrated portfolio and because of that concentrated allocation you’re closer to retirement than you might have been otherwise: Congrats! I’m not here to chastise anyone for successfully building their wealth. Instead, I’d be remiss if I didn’t ask: What’s next? Or better put: What’s your plan to protect your hard-earned wealth? This is where diversification can make a huge impact on your future retirement plans. A well-constructed and professionally managed portfolio should be able to weather the ups and the downs of different market cycles. It’s very important that I point out that a diversified portfolio is in no way immune to losses, but with the right amount of guidance and discipline, diversification can be the key to long lasting financial freedom.

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such.