The Hidden Risk to Your Retirement
Is your retirement portfolio at risk?
Yeah, I know, that's a melodramatic question. But here's the thing: Lots of folks are at risk. If you built your retirement portfolio by buying stocks and funds you know and like, without worrying too much about an overall strategy to guide your choices, you might be among them.
Now, it's true that if you're good at picking stocks, a "buy what you know" strategy can work out quite well. An average return of 10% or 15% a year can really add up over time.
But even if you're good at picking stocks and really know your stuff, there's a hidden risk in that approach.
"Buy what you know" can work...up to a point
"Buy what you know" can be a tremendously effective investment strategy -- that's why superstar fund manager Peter Lynch has long advocated that approach. When you choose investments using your own specialized knowledge, you have an advantage over the Wall Street pros who might lack your understanding of the dynamics of a particular industry.
The problem -- the hidden risk -- comes when you do too much of that: You know banks inside and out, so your portfolio has big positions in Bank of America (NYS: BAC) and Wells Fargo (NYS: WFC) ...and then 2008 happens. Wells Fargo's price has largely recovered, and the stock might actually be a good value buy right now. But Bank of America is still trading at roughly one-fifth of its price before the crisis, as investors continue to worry about potential disasters lurking in the bank's holdings.
More to the point, if you had needed to retire in 2009, having much of your wealth invested in bank stocks (or auto stocks, for that matter) could have been a problem.
Why diversification matters
That's why diversification matters. Diversification, simply put, is about having multiple baskets for your investing eggs. By spreading your wealth among different stocks, different sectors, or even different types of investments, you reduce the damage that one big crisis -- or one good idea that went bad -- can do to your portfolio.
When you're well-diversified, crises that hit one sector, or a group of sectors, won't put your whole retirement at risk. Adding diversification doesn't have to be hard, or particularly time-consuming: Buying a good ETF that covers a particular type of stock -- say, iShares Dow Jones Select Dividend Index for large-cap value -- can give you instant exposure to areas of the stock market where you don't have any special expertise, or great investment ideas.
But what if you want to move beyond stocks and other traditional investments?
Looking past ordinary stocks
In the new issue of the Fool's Rule Your Retirement newsletter, lead advisor Robert Brokamp looks at that very question -- but answers it in a way you might not expect.
While a few companies offer special IRAs that let you invest in art or real estate or just about anything else, most of us have ordinary retirement accounts with discount brokers. Fortunately, as Robert points out, you can buy stocks and ETFs that give you exposure -- and the corresponding risk/reward profile -- to asset classes beyond stocks. These classes often move in ways that don't track the major stock indexes, which can help limit the damage to your portfolio during those periods when Mr. Market goes off his meds.
For instance, want precious metals exposure? You could look at gold or silver ETFs, but you could also buy stock in a major gold miner like Goldcorp (NYS: GG) , a favorite of Fool precious metals analyst Christopher Barker. Interested in real estate, but with a twist? Consider a real estate investment trust such as Health Care REIT (NYS: HCN) , which invests in nursing homes and assisted-living facilities and has done well over the last year, with a dividend yield over 5%; or American Tower (NYS: AMT) , a high-flier that owns and manages antenna towers and combines growth with a modest dividend.
Want more ideas along these lines? Check out Robert's article in the new issue of Rule Your Retirement, where he presents four great "hard asset" investment ideas that are all favorites of Fool analysts for new money now.
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At the time this article was published Fool contributor John Rosevear holds no position in any company mentioned. The Motley Fool owns shares of Bank of America. The Fool owns shares of and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo, American Tower, and Health Care REIT. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.