6 Creative Ways of Diversifying your Retirement Portfolio

When you think of a secure retirement, building a strong retirement corpus is your primary focus. You could rely on your Social Security benefits and pension, but it may likely not be enough to sustain your expenses during the non-working years of your life. For 2020, the average Social Security cheque was only about $1,500. This is significantly low to sustain the expenses of an average retiree. As per experts, you would need approximately 60-80% of your pre-retirement monthly income during retirement. For early retirement, the figures are much higher. And if you follow the 80% thumb rule and your pre-retirement expenses are $50,000, you would need a retirement income of at least $40,000. Even if you and your spouse can maximize your Social Security benefits and receive $2,000 a month (or $24,000 per year) from Social Security, you would still require $16,000 a year from other sources.

A great way to bridge the income gap during retirement is to create a strong portfolio that offers lucrative returns. Every retirement portfolio is different because it depends on your risk preference, investment horizon, and retirement goals. Irrespective of the type of portfolio, it is important to note that your portfolio incorporates different kinds of investments. This optimal diversification can help you evade big losses and also tap on profitable opportunities. A professional financial advisor who has expertise in portfolio management can help ensure that your portfolio is well diversified and suited to your financial needs.

It is quite common to think that the best way to diversify your retirement portfolio is by choosing the right allocation of stocks and bonds. However, this is not a failproof strategy. Other factors such as asset classes, market exposure, etc. play a critical role in portfolio diversification. Moreover, if your securities are not optimally spread across different asset classes or are not timed to take advantage of the market boom, you may not be able to get the full potential of a diversified portfolio.

One of the best methods to create an optimally diversified portfolio is by understanding what kind of diversity you need and then choosing the appropriate holdings. A creative way to diversify your portfolio is to include opportunities outside a typical market, such as alternative investments. Such investments can help you hedge against market downturns as well as provide more exposure to industries and asset classes while providing passive retirement income simultaneously.

But before you begin investing, it is prudent to identify what level of diversification you need.

How to assess the right kind of diversification for your portfolio?

Before beginning to invest in different securities, it is advisable to determine the kind of diversification you need. A well-diversified portfolio can help you mitigate losses and tap growth opportunities. Each portfolio can be diversified in several ways. The optimal method of diversification is to spread your assets across holdings, such as mutual funds, exchange-traded funds (ETFs), certificates of deposits (CDs), target-date funds, and individual stocks and bonds. But even in this categorization, it is vital to choose the right kind of diversification. For example, if you are not close to retirement and choose to invest half of your funds in stocks, generally you should also limit your number of stock holdings between 25 and 30. This number decreases when you allocate a smaller portion in stock holdings.

Also, be careful and understand how you want to grow our money. If you are risk-averse, nearing retirement, or prefer secure returns over fast money, you should ideally invest less in stocks and more in bonds and other safe options. However, if you are looking for short-term gains, you can rely on a heavy stock portfolio rather than a more conservative and fund-heavy portfolio. But an off-the-shelf diversification strategy in stocks and bonds might not be the right strategy for a secure retirement. Staying within this defined realm of equities and bonds is not an ideal diversification. It is wise to understand the overlap between these investment types and how one can be leveraged to offset the negative movement of the other. For instance, if the stock market suffers a slow growth, no growth, or a complete loss, it is difficult for stocks to cater to your needs alone. Even though bonds can offer safe cash in such a situation, they will not yield more than the specified interest, which is generally low. Hence, it is important to be creative and include the right mix of investments in your retirement portfolio. A simple portfolio with stocks, bonds, and fund-heavy holdings can drag down the entire value of a portfolio in situations like the COVID-19 pandemic of 2020. Therefore, diversification does not have to be a mere method to protect your gains, but also the right strategy to build your assets.

Here are six creative ways to diversify your retirement portfolio:

1. Choose equities for higher returns compared to other asset classes: It is important to understand the role of equity investment in your retirement portfolio. Stock holdings have proven to offer high returns than many other asset classes. In the historical investment period between 1926 and 2010, the S&P 500 Index grossed an annual return of 9.9%. The U.S. bonds returned 5.5% for the same period. The rate of inflation was 3%. So, when accounted for inflation, the portfolios with stocks (6.9%) were in a better position than the ones with bonds (2.5%). This does not mean that your retirement portfolio should be stock biased, but it can be beneficial to invest a certain portion of your assets in stocks to provide a hike to your portfolio. The stock allocation can be based on your risk tolerance, age, and retirement goals. Moreover, your stock allocation should also be further diversified. You should spread across large-, mid-, small-, or micro-cap stocks. A classic diversified portfolio comprises 60% stocks and 40% bonds. But this is not a foolproof strategy. Hence, it is beneficial to consider and include other options like futures, real-estate, and forex investments to achieve optimal diversification.
2. Balance with bonds for low risk and guaranteed returns: Bonds are one of the safest investment assets. So, they occupy a major role in a retirement portfolio. Bonds carry less risk and generate assured returns. When you invest in a bond, you are typically lending money to the government, municipality, or a corporation. These institutions, in return, promise to pay you a pre-defined interest on maturity along with the principal. Even though this interest is fairly low, it is not advisable to completely ignore bonds because of this reason. By including bonds in your retirement portfolio, you will get a regular income stream for your post-work life, provided you create a bond ladder by opting for bonds with a different maturity date. You can rely on bonds to provide you with assured returns and financial security but if you aspire for growth, the ratio of bonds in your portfolio should be on the lower side.
3. Opt for exchange-traded funds (ETFs) for low-cost diversified access to a specific area of the market: A creative way to diversify your retirement portfolio is to allocate a reasonable portion of your asset holdings in ETFs. ETFs consist of a mix of securities that are traded on a recognized exchange. When you buy an ETF, you get low-cost and diversified access to a specific area of the market. ETFs primarily comprise stocks, bonds, commodities, currencies, or a balance of them all. By investing in an ETF, you buy a basket of securities, rather than buying each one separately. Your return is proportional to the growth of your security basket. ETFs function like a mutual fund but offer trading ease. You can invest in an ETF from a brokerage account just like you buy a share. So, ETFs provide you with the option to enjoy trading like a share while earning mutual funds benefits. ETFs also come with low administrative costs and diversified index fund management. As of 2020, there were more than 2,204 ETFs in the United States, clearly depicting their growing popularity. However, an ETF is a clever investment only if you have 10 or more years until retirement. Also, be careful when allocating your percentage in ETFs. Balance it well with individual stock and bond holdings.
4. Invest in real assets for diversifying your portfolio: Real assets like real estate holdings and natural resources and utilities can be the right medium for diversifying your portfolio. Such alternative investment options do not come with high entry costs and have the potential to provide outsized returns as per the nature of the investment. This also applies to other asset options like vintage coin collections. However, the appraisal of the portfolio in such cases is solely dependent on the rise in the value of your holdings. In terms of real estate, you can consider renting out a property to generate a good income stream for the future. However, this requires you to have a strong knowledge of the real estate market. Alternatively, you can evaluate investing in REITs (Real estate investment trusts) if you do not wish to invest a large amount directly in real estate but want high profits. REITs are like mutual funds that own real estate. These trusts are inclusive of real estate holdings like apartments, vacation homes, hotels/motels, commercial spaces, etc., and manage them end-to-end. You have to pay a fee to hire a professional for your fund. The professional will manage the properties, get tenants, collect rent, and also cover maintenance costs. Your profit is generated after deducting all expenses. You can invest in a publicly traded REIT or a private REIT.
5. Select annuities if investing over a longer period of time: If you are a long-term investor and want to create a sturdier foundation for your retirement, you can keep annuities in your retirement portfolio. In an annuity, you pay a recurring amount over a defined period and the annuity pays you back once you are ready to retire. There are different kinds of annuities, fixed-, variable-, and equity-indexed annuities, especially from the view of diversification. Fixed annuities provide you with fixed payments as well as fixed returns on your investment. Variable annuities allow you to choose your investments and then offer you returns as per the performance of the underlying investments. Indexed annuities work just like variable annuities, except that they are pegged against a stock market index (like S&P 500). Your earnings depend on the performance of the specified index.
6. Invest in foreign stocks for diversification and benefit from overseas growth: A lot of investors restrict themselves to investing in domestic securities only. However, to build a well-diversified portfolio, you should also consider getting some international exposure for your portfolio. You can include international stocks in your retirement portfolio to benefit from growth overseas. This becomes even more critical when the U.S. economy suffers or is stagnant. Further, as more and more economies around the world develop and grow, investing in such stocks is likely to become more profitable. Many experts consider foreign stocks a healthy addition to a portfolio. As a conservative investor, you can allocate anywhere between 5% and 10% of your assets in foreign stocks. However, if you are an aggressive investor, you can consider investing up to 25% in foreign securities. You can access foreign stocks through foreign direct investment, global mutual funds, ETFs, American Depository Receipts (ADRs), Global Depository Receipts (GDRs), and Multinational Corporations (MNCs). That said, as an investor, it is important that you know the political and economic condition of the country you invest in. This is crucial because it will help you determine factors that can potentially impact your portfolio returns. Moreover, your foreign stock allocation should ideally be based on your investment objective, cost, returns as well as risk tolerance.

To sum it up

By applying the above-mentioned tactics, it is possible to create a well-diversified portfolio as per your risk appetite, age, and financial objectives. But simply creating a diversified portfolio does not guarantee optimum results. As a wise investor, you should aim to regularly rebalance your portfolio. Rebalancing your portfolio will enable you to adjust your asset allocation as per your desires and market circumstances. To get the right investment guidance, you can also consult a professional financial advisor who has expertise in portfolio management and other related areas, and can adequately help you create an ideal retirement portfolio as per your needs.