Finance One thing that should jump out immediately is how varied the chart is: the performance of the various asset classes is literally all over the place, with several instances of the “winning” asset in one year falling down to the bottom of the pile the very next year. That’s a pretty good rationale for the reason we need assets that zig when others zag – because sooner or later, every asset does just that. The other major point which the chart makes obvious is how much performance in any one year can diverge from the long-term average. Just to pick one example – U.S. large cap stocks have put in a dominant performance over the past decade or so, with a fantastic average return of 14.1%. But that number doesn’t really do justice to the impact (either financial or emotional) which investors experienced with a -18.6% return in 2022. For retirees (and the soon-to-be-retired), this is why a diversified portfolio is almost always a smart idea. Once you’re retired, your financial goals shift from maximizing wealth to protecting what you already have, and maintaining a stable, steady source of income throughout your golden years. Diversification can play a key role here, smoothing out some of the dramatic swings which you see in the asset return chart, and eliminating some of the stress that you’d experience if you saw the bulk of your portfolio drop by almost 20% in a single calendar year. Types of diversification Investors can diversify a portfolio along several different avenues in order to reduce risk and improve long-term stability. Here are some of the most common, along with a brief description of some of the forms that diversification can take within each avenue. Asset class diversification Perhaps the most well-known way to diversify is between different assets. Each asset type performs differently in different market conditions, and can play a different role in balancing overall portfolio volatility and generating income throughout retirement. Some of the more common asset classes include: Equities - Equities (or stocks) is the name for direct ownership stakes in operating businesses. While there are many different types, spanning all kinds of industries and sectors, generally speaking, stocks often offer more potential for growth than do many other asset types – an essential quality for retirees who want their portfolios to keep up with the rising cost of living during retirement. Fixed income - Bonds, guaranteed investment certificates (GICs) and similar investments all offer predictable interest income along with lower volatility than stocks typically do. While there’s a wide spectrum of volatility and return within the broader category (government bonds generally experience much lower volatility than corporate bonds, for example), as an asset class, they offer greater stability than stocks. That makes them an attractive option for conservative retirees. Real assets - A broad label that describes tangible, physical assets: real estate, infrastructure such as airports and toll roads, and commodities such as oil, industrial metals and agricultural products. Historically, holding such assets (or investing in funds, ETFs or listed companies which invest in them) has offered an excellent degree of diversification from stocks and bonds, particularly during times of inflation. Cash - Cash and other short-term investments (money market funds, certificates of deposit and so on) aren’t just for emergencies or present-day spending needs – these can also act as a ballast for other portions of your portfolio when the economic seas get rough, and can protect you from having to sell other investments at an inopportune time. Alternative investments - Hedge funds, private equity or credit, and venture capital have historically been the territory of large institutions, endowments and high-net-worth investors, but they’ve become increasingly popular among “average” investors in recent years. Their performance is often quite uncorrelated to public securities, but their complexity and liquidity restrictions make them best suited for sophisticated, experienced investors. Precious metals - Historically, gold (and, to a lesser extent, silver and platinum) has offered investors a safe haven in times of high inflation, as its value generally increases when the relative value of currency (particularly the U.S. dollar) drops. It also tends to have a low correlation with the performance of other assets, which can help to reduce overall portfolio volatility during times of political and economic turmoil. 28 | www.snowbirds.org
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