What Does Diversification Mean to You?
Written by Andy Roth, Operations Manager
The phrase “Don’t put all your eggs in one basket” is something many of us were taught as children. Not being reliant on one outcome keeps our options open so we can adapt to the future. In the world of financial planning this concept is translated as diversification. If you Google this, the first page of results are nearly all money management related.
So how do we define diversification? When we diversify, our goal is to build portfolios that spread the investment among multiple asset classes with the goal of finding portfolios less correlated to the “market”. This involves using stocks and bonds, both domestic and international, and occasionally alternatives, with the aim of reducing risk. The goal is to make success less dependent on the outcomes of one corner of the global market.
Some people perceive complexity as diversification. This involves spreading accounts among multiple institutions as they attempt to diversify, but it can have unforeseen consequences. As an example, maybe you’ve got two different retirement accounts left over from employer changes, or multiple brokerage accounts. You might ask, but if spreading my money among different asset classes is a good idea, why wouldn’t I want to spread it between organizations, or even professionals? In our experience this adds complication to the execution of a financial plan and can actually increase risk.
For starters, risk can be duplicated. If I hold multiple large cap investments at different institutions, this may look like diversification, but in reality, they are likely correlated to a single benchmark. This means they’ll deliver similar experiences during the same market cycles. We frequently see this phenomenon when we meet with new clients and realize there is more risk on the table than originally thought.
Secondly, coordination can be difficult. If tax management is a goal, the benefit of one management style can be offset by the trading activity and distributions of another. If required minimum distributions come from multiple places it can be tough to track if this obligation is met. Additionally, the idea of getting multiple statements and prospectuses can be downright overwhelming.
Finally, when accounts are spread among multiple institutions, creating and implementing a financial plan is a challenge. It’s tough to conceptualize where money comes from to fund retirement, or how you’ll be able to accomplish your other goals. Individuals seek the advice of financial planners to provide clarity and assurance as they tackle life’s milestones—trying to translate varied advice can degrade the value of these relationships. How do you know where to go when you’re being provided with two different maps? When you distribute partial information to multiple parties, you have essentially hired yourself to coordinate your own financial planning, and having money scattered in different places can lead to sub-par outcomes and extra uncertainty.
Remember to not put all your eggs in one basket but try to keep a clear and organized vision of where you’re carrying them!
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.
