Diversify, diversify, diversify - we hear this all the time from the so-called personal finance experts. However, achieving all your investment goals is not as simple as buying the market in a low-cost index fund, owning foreign currency, or considering to add gold to your portfolio. More importantly, each of your investments must target a specific goal and be appropriately diversified to maximize the probability of successful outcomes.
The notion of “the portfolio” is bogus. Because we each save and invest for a range of goals, it is madness to simply think of a single portfolio as a means of achieving all financial goals.
The main differentiating factor for our goals is time. A long-term goal like retirement should be diversified very differently to short-term goals, like a real estate deposit. To lump all your resources into a single investment, no matter how diversified, wouldn’t efficiently achieve all your objectives.
Short-Term Targeted Diversification
For financial goals within the 12-month time-frame, you should consider low-volatility and liquid investment vehicles. If you aim to purchase a car, take a vacation, or make a deposit on your dream home, then you simply must have those resources available to you when you need them.
High-yield deposit accounts, CD’s, and money-market accounts are examples of liquid stores of cash where you have very little chance of losing your capital to any sort of volatility. With interest rates currently at record lows there’s a good chance that your yield will be close to zero, and this carries a risk of you losing some purchasing power to inflation. However, you can be confident of having the money you need, when you need it.
Medium-Term Targeted Diversification
Goals in the 2-15 year range lie somewhere between short and long-term objectives. Saving for a child’s college education is a good example. In this range we can accept more volatility with our investments as market gyrations won’t impact our ability to meet this objective in the short-term. In fact, greater volatility will increase the chance of capital growth over the mid-term, helping us achieve our targeted goal.
However, as we approach the target date it is critical to transition to less-volatile investments and lock-in our gains. For example, within 5 years of your goal it may be prudent to move from stocks to bonds, and from bonds to cash equivalents.
Long-Term Targeted Diversification
With an extended investment time-frame we can accept volatility, knowing that this movement will help our invested capital grow towards achieving our goals. We can confidently invest in the stock market, and international stock markets to chase the growth necessary to build a nest-egg that will be with us throughout life.
Again, it is critical to reduce volatility as we approach the time that we need to access these funds. However, balancing immediate retirement needs and not outliving our money may require accepting some volatility well into retirement. Discuss this with you financial advisor, but it really is not necessary to convert your entire retirement portfolio into income producing assets.
Multiple Portfolios Within Our Total Portfolio
To successfully achieve each financial goal, we need to think of our portfolio as a group of targeted investments. Each pool of money needs to be invested and diversified according to the goal. Specifically, diversification should be tuned to match the time-frame of your goal to ensure the funds you need will be there when you need them.
