Don’t Put All Your Eggs in One Basket.
One of the most widely-accepted investment guidelines is the importance of diversification. It means spreading your financial assets among a number of different investment portfolios, such as stocks, bonds, real estate, fixed or variable annuities, mutual funds, and cash or cash equivalents.
If you put all your assets in just one or two investments or investment categories, you risk taking a big hit if the performance of your particular choice falters. For example, if you have most of your mutual fund assets invested in small company growth, and that sector is in a down period, the value of your holdings could shrink.
One of the hardest problems of diversification is that people have limited assets with which to diversify. When investing for retirement purposes, choosing a number of different portfolios offered through variable annuities is one way you can get diversification even if the value of the contract is relatively small.
Levels of Diversification
With variable annuities, it is possible to achieve substantial diversification since each contract offers a number of different portfolios, each of which is diversified as well. In putting some of your money into a growth portfolio that invests in large U.S. companies, for example, your return may reflect the performance of 100 or more companies. If, in addition, you put money into portfolios that invests in:
- small companies,
- international companies and
- technology companies,
Your assets will not only be spread across an even larger number of companies but you will be positioned to benefit from those that tend to react positively to market conditions that may adversely affect stocks of large U.S. companies. Your variable annuities contract could also include a fixed account giving you even more diversity.
How You Choose
There’s no hard and fast rule about the number of investment portfolios it takes to be diversified. There is general agreement, though, about selecting a healthy overall portfolio:
- Since growth is important to achieving long-term goals, you should consider equity portfolios for a significant portion of your principal
- It makes more sense to choose portfolios with different investment objectives than it does to choose them with the same objective
- Be careful about spreading your assets too thinly. The more substantial your holdings in any given portfolio, the more rapidly it can compound from potential upswings thus offering the opportunity for higher returns
Other Ways to Diversify
If choosing a number of different portfolios seems overwhelming, you might choose a balanced or an asset allocation portfolio, or use one or more index portfolios, or equity indexed annuities.
With a balanced portfolio, which invests in both equities and bonds, you enjoy the dual benefits of growth potential and income potential. While balanced portfolios may not achieve the same return as those that focus solely on equities, they maybe likely to retain more of their value in a down market.
Index portfolios make investments with an objective to mirror the performance of a market index such as the Standard & Poor’s 500-stock index. The risk, of course, is that in a falling stock market the decline in the portfolio’s value would not be offset by holdings in bonds or cash equivalents as they could be in a balanced portfolio.
Another alternative might be equity indexed annuities where your account is credited with the minimum rate your annuities contract provides rather than declining. There is no guarantee that an index portfolio will match the performance of the index.
Think About Allocation
With variable annuities, you can assign a percentage to each underlying portfolio. Each one will react differently to changing economic conditions, with some performing better in certain circumstances than others. If you’ve spread your assets around carefully, there’s a better chance that at least some of them will perform well even if others decline at any given time.