Demystifying Portfolio Diversification

To begin our discussion on portfolio diversification we will need to define some common terms. If you are already familiar with these terms feel free to skip to the next paragraph; however, a quick skim couldn't hurt.

Portfolio- For our purposes a portfolio represents all the individual investments you participate in

Diversification- Financial assets of many different varieties within your portfolio

Asset Class- An individual investment within your portfolio

Asset Allocation- The amount of investment into a specific asset class

Balanced- The process of measuring your investments to balance your overall risk; how balanced your portfolio is has a lot to do with your investment timeline and your risk tolerance.

Risk Tolerance- This is your risk temperature and is used to determine your overall portfolio goals and timeline to reach these goals. For example, are you primarily conservative, moderate, or aggressive.

Index- An index is an investment product that is based on the overall performance of a pre-defined market or a mix of markets. For example, S&P 500®, NASDAQ®, Russell 2000®, Dow Jones/Dow Jones Euro Stoxx 50®, etc. Indexes have specifically designed crediting methods and usually offer an interest floor and a cap. Both the floor and cap are designed to offer protection against market fluctuations.

A well diversified portfolio will include a variety of asset classes including, but not limited to: stocks, bonds, annuities, life insurance, real estate, business investments, etc.

Ideally you want your portfolio to contain a mix of fixed and flexible assets, both in and out of non-qualified plans with a range of moderate to aggressive investments. For instance, stock assets can be more on the aggressive side while bonds are considered conservative. Annuities and life insurance can be both aggressive and moderate. Real estate is an aggressive long term asset because of its unpredictable nature. Other investments may hold more or less risk, like investing directly in a business.

Portfolio development is as individual as each person. The key is to create a mix of investments that give you the best chance at achieving your overall financial goals.

Step one is defining your overall financial goal – and sorry, but you can’t just say “to be rich” – I know, I’m a killjoy! Seriously though, defining your goals is no quick process and there are many things to consider. Here is a list of some of the basics:

1. At what age would you like to retire?


2. How much annual income will you need during retirement?


3. What is the timeline from today to your desired retirement age?


4. Is your timeline realistic considering the following:

• How much can you put into your retirement plan each year? This is a discussion around what you’re WILLING to save V.S. what you NEED to save - not always an easy discussion to have.


• Will income taxes be lower or higher when you retire? (Take into consideration that current income tax rates are at an all time low.)


• What might your estate taxes look like?


• If you have children, how much are you willing to invest in their higher education? Pay for it all (which may limit your timeline for accruing your retirement funds). Pay for some and supplement with grants, loans and your child working part time. Not paying for college, they will have to make it on their own.

5. Do you want to leave behind a financial legacy?

• Inheritance for your children or other relatives?


• Donations to charities, political organizations, or other organizations?

Of course there are many additional conversations you may need and/or want to have. The list above is designed to get your creative juices flowing. I also recommend getting referrals for a good financial planner. Make sure they are certified (not certifiable) and check references – at least three.

Step two is determining your risk tolerance. How much risk are you comfortable with? If you are not very comfortable with risk, then your portfolio may be more on the moderate side. Of course, if you are more comfortable with risk, your portfolio will be more aggressive.

When choosing what investments you will make, start by assigning priority levels. For instance, if you have children, own a home and are the sole and/or partial provider for your family’s needs, one of your first goals may be to purchase life insurance. But what type of product will fit best within your overall portfolio.

What type of life insurance you choose depend on many factors.

First is to understand that life insurance is a financial tool designed to protect your assets and/or potentially grow them. There are many positive applications for life insurance as an asset class within your balanced portfolio.

Keep in mind that term insurance is not an investment vehicle. It provides asset protection. There is no cash value accumulation within a term plan and the cost is usually relatively low V.S. whole or universal life because of the shortened time span for coverage.

I would suggest talking to a life insurance specialist to learn more about adding life insurance as an asset within your balanced portfolio. Don’t know a life insurance specialist? Want to find one? I would be more than happy to work with you.

Step three is to take action and build your portfolio. This is where you really want to make sure you have the right professionals helping you along the way. It may be that you will work with 3 or 4 different professionals to complete the process. Don’t let that scare you. Work with people you, a) trust, b) like and c) have the qualifications to get the job done. Then you can sit back and enjoy the returns.

Step four is to review and reallocate once a year. This should be done with a financial professional; preferably the one(s) who helped you set up your portfolio. Remember, they are not just service providers. An excellent investment advisor partners with you in achieving your goals and realizing your dreams.

Once your portfolio is established, and you have your yearly reallocation mechanisms in place, I promise you will be amazed by the security and sense of accomplishment you will feel. You have just done something that most others have not. You will walk around with a self-satisfied look on your face. Others will take notice and then you will have the opportunity to potentially help transform someone else’s life, by sharing your story and “paying it forward!”

Six Month Series on Investement Strategies

For the next six months I am going to write a series of articles under the overarching title of investment strategies.

The idea behind these articles is to put “conventional wisdom” to the test based on current economic events, and to expand on new concepts and ideas.

Most of us, whether Baby Boomers looking retirement in the face, or those of us with 25 or more years to go NEED to re-evaluate our current thoughts and actions on how to accumulate enough money to support us through retirement.

Additionally we will ALL need to look at what we are willing, able and/or want to leave behind as a legacy to our children, loved one; and charitable organization.

Not that investing has ever been simple; but I can promise you it is only going to get more complex. With rising income taxes, huge national debt, a failing health care system, and equally if not greater failing educational system (at least in California), it is inevitable that our ability to save for the future will be challenged.

However, don’t get me wrong, I don’t think it’s a bleak picture at all! Actually, I think we all have a tremendous opportunity to take control of our financial lives in a way we have never been able to before. Through education and due diligence we will not only attain our goals, but in many cases surpass our expectations. Most of all, we will be left feeling empowered and not powerless! Anyone been feeling powerless lately? Doesn’t feel good does it.

My commitment in the next six months of posts is to help put you on a path moving towards financial freedom.

I believe working together sharing information is the path to empowerment. If you feel the same read on to see what topics will be covered.

Also, when you go to my blog, sign up as a “follower” and you will get these posts automatically. I will not be putting the full articles into my monthly email reminders but I will always provide a link to my blog to view them.

The topics will be as follows:

1) Demystifying Portfolio Diversification – What does a balanced portfolio really look like? (This article will post sometime before the end of the week.)

2) Stock Market Volatility – What to do when the stock market is up and when it’s down.

3) Excuses that Block Savings for Retirement – What are you doing that may be preventing you from saving the appropriate amount of money for your retirement?

4) Kids and Money – More tips and tricks for helping your children learn the value of money and the habit of saving it! (This article will expand on my earlier post and incorporate some of the lessons learned so far from the current economic downturn.)

5) How Often should you Review Your Portfolio – An in-depth look at how, why and when you should be reviewing your asset allocation portfolio (The first article will cover the definition of asset allocation).

6) How Much is Enough for an Emergency Fund – Do you have money set aside for a “raining day?”