Diversification based on your age is often cited as critical yet this is extremely fraught with misconceptions. Diversification is absolutely critical to a good investment plan but it should be based on a number of factors, not just your age.
Age based diversification is just another way of saying, “I think I am going to live a long time” or “I don’t have much time left.” Or it’s like a batter coming up against Nolan Ryan or Greg Maddux with either an “oh well” attitude or an “I can hit this guy” attitude.
Some of the keys to diversification are:
• Term: are your investments for the long-term, short-term, mid-term or a mix?
But don’t confuse these “terms” with how long you will be investing; rather they are terms that describe how long you typically expect to hold a position (stock, ETF or fund). If you are going to trade daily then long-term positions are not very likely. On the other hand if you only want to trade occasionally or monthly then most of your positions will generally be mid-term or long-term.
o How you determine the length of your average holdings will be decided by how much time and how frequently you can manage your investment portfolio, AND what are your goals, your objectives.
• Type: where are you going to place your investment dollars? In other words do you favor stocks or ETFs or mutual funds or perhaps a little of all?
o Stocks can offer the greatest opportunity for gain, for profit because you are investing in on particular company. Investing in stocks also allows you to buy and sell just about any day at any time. However stocks tend to be more susceptible to the ups and downs of the markets and world events.
o Mutual Funds offer diversification by their very nature. Each fund is composed of many individual stocks of the same type or objective, utilities or large corporations, for example. Because a fund contains stock in many companies it is not as dependent on any one company for it success in producing gains or increase value. While funds are less susceptible to major losses they are equally less likely to achieve soaring gains.
o ETFs are kind of a cross-breed between mutual funds and individual stocks. Like funds each ETF (Exchange Traded Fund) contains investments in many similar companies, but unlike a fund there is no active management involving switching stocks. ETFs have become extremely popular in recent years because they don’t have the fees and holding requirements of funds and can be traded at any time like stocks.
• Safety: balancing risk is a key component to diversifying your investments. You can do this by creating different groups you are willing to invest your money into, for example:
o High Dividend paying
o USA companies
o Foreign companies
o Bonds
o ‘Select’ type funds
o Industry sectors
o Asset strength
By investing in six to eight different groups or types of investments it is easy to achieve diversification and still have your portfolio easily manageable. The groups can be all ETFs, for example, or a mix of stocks, ETF and mutual fund groups. If you are using a mix of the three types of investments it is important that each one is unique; in other words don’t have a utility ETF and a utility fund.
With proper diversification you can maintain safety because it is rare that all types of investments will suffer a decline at the same time, and also have the opportunity for substantial gains.