Why Properly Diversifying Your Savings for Retirement is Critical (Especially Early On)

When your golden years arrive, and it’s time to retire, you’re going to need to rely (at least partly) on your retirement savings, your “nest egg.”

Of course, Social Security can help, but it’s only meant to replace about 40% of someone’s retirement income. New retirees have the opportunity to make up the rest through a properly diversified retirement portfolio.

Having a balanced portfolio is a broad subject which would require volumes to cover completely, so today we’re going to briefly cover two specific types of risk: sequence-of-returns and volatility.

Both of these ideas are critical to savers, especially when they reach the first few years of retirement.

Ready?

“When” is Just as Critical as “How Much”

If you’ve saved enough that you can get by on your Social Security and “interest-only” income from your savings, then congratulations! If you never touch your principal, sequence of returns risk is less critical to your long-term security. You’re probably more concerned with leaving a legacy for your heirs than paying medical bills. (According to this Investments & Wealth Monitor report, 17%, about 1 of every 6 retired Americans, are able to do this.)

On the other hand, the vast majority of retirees simply don’t have enough savings to live on interest only. (Especially today, with an S&P 500 dividend yield of 1.47%, a 10-year Treasury yield of 1.73%, and ominous inflationary prospects…) In this situation, in order to survive, retirees must draw on principal.

And therein lie the risks…

Depending on market conditions, you might have to sell assets at a loss.

And, while that’s bad enough, for every dollar withdrawn from principal, you lose all future opportunities for profit on that dollar.

Frank Diana at Kiplinger does a great job defining the basics of sequence of returns risk:

When you retire and start withdrawing money from your accounts, your portfolio balance can be affected not just by how much your investments go up or down, but by when they go up or down.

That’s sequence risk in a nutshell. If you’re forced by necessity to sell when prices are low, you’ve lost both money and future income or growth opportunities.

With increasing life expectancy in the U.S. compared to 50 years ago, a retirement saver will have to not only make their retirement dollars last longer, but also be prepared to face a wider variety of economic conditions.

As Diana explains, the main idea especially for the first few years of retirement is to guard your nest egg against the effects of a bear market. But no strategy is perfect.

Diversification Takes the Edge Off Volatility

For our purposes, volatility means big changes in price, either up or down. And as we’ve seen, this is a critical concern for retirees who rely on their principal. “Reducing the ups and downs can significantly increase the odds that your money will last through your life expectancy,” according to The Balance.

And that same volatility is why having a mix of assets is important. Proper diversification of your savings often smooths out periods of market volatility. Dr. William Bernstein describes this quite well in his book Skating Where the Puck Was, which is excerpted here.

In order to counteract volatility, Dr. Bernstein says that savings should include a variety of “non-correlated” assets. “Non-correlated” means their prices tend to go in different directions at the same time. The classic example is stocks and bonds: usually, when stocks go up, bonds tend to go down (and vice versa).

You don’t want one of your assets to become an “anchor” for another one, argues Dr. Bernstein, and you definitely want to avoid a situation where everything declines in value at the same time. It’s a nice feeling when, even on really bad days, you hold one asset that isn’t plummeting.

The whole idea of diversification confuses some savers, according to The Street:

Many investors own an S&P 500 index fund and think, “I own 500 different stocks. I’m diversified.” Of course, dividing your assets into many stocks in the same asset class isn’t quite enough. There is a big difference between having a diversified stock portfolio and a diversified investment portfolio.

So thorough diversification can help you avoid both sequence of returns and volatility risks.

Gold and Silver Can Diversify Your Savings

Imagine if you begin the first few of your “golden years,” and something outside of your control happens. Maybe it’s a market crash, maybe it’s unexpected price inflation, or maybe it’s something you never anticipated.

That could be a dicey situation to navigate. But diversified retirement savings can help prepare you for the unexpected. Ralph Wakerly points out some benefits to diversifying with gold:

Gold has positive diversification effects in a portfolio. Its historical correlation with stocks hovers around zero. It has a very low correlation with bonds also. Even though gold is by its nature a more volatile asset than bonds, by swapping out a small amount of bonds for gold, there is a tangible reduction in portfolio volatility. Gold provides protection during times of market stress, e.g. wars, natural disasters and financial crises such as 2008.

Consider adding non-paper, hard assets like physical gold and silver. Both have a history of acting as a “safe haven” during market turmoil, and may make a perfect, non-correlated addition to any well-diversified nest egg.

2021, diversification, gold as investment, retirement savings