18 September, 2023
5 Top Reasons to Diversify Your 401(k) Account
Diversifying or otherwise, spreading your 401(k) account balance across various investments, makes financial sense, and with good reason. Here is a look at five top reasons to critically think about asset allocation as a way of diversifying your 401(k) investments.
1. Better Risk Management
Spreading the balance on your 401(k) across different investment types spreads out your risk. When you have a mix of asset classes-bonds, stocks, cash, commodities and more, your account seeks to protect against the concentrated risk of a downturn in any one of the asset classes.
In other words, even if one of the asset classes you have invested your account balance into underperforms, the other asset classes that may be performing better will cushion against there being a significant impact on your overall portfolio. In this sense, diversification of your 401(k) balance will mitigate against asset volatility and significant losses.
2. Balance Risk vs. Returns
In addition to having varying levels of risk, the various asset classes also have varying return potential. Diversifying your 401(k) account balance based on factors such as investment goals, risk tolerance, and timelines allows you to capture and balance returns from the mix of various assets.
As your risk tolerance grows and your investment goals change, you may look into increasing your investment in these various assets. You stand to balance your returns even further in the long-term when you invest in less volatile investments that have real potential for growth.
3. Balance Risk and Return
Diversification enables you to strike the elusive balance between risk and return as best matches your financial goals. In your younger years, your risk tolerance was no doubt higher and you could eagerly invest in stocks and other growth-oriented stocks.
In your older years, however, a more conservative and risk-averse approach comes almost naturally. Your priority will be to preserve capital. Diversification of your 401(k) gets you to that place of balance. You will be taking calculated risks and hopefully getting a good return for so doing.
4. Mitigate Market Volatility
Economic, geopolitical, and a myriad of other factors contribute to the volatility of financial markets. While you may not have any control of these factors, diversifying your portfolio across various asset classes can help to mitigate this volatility.
You may see even better results when you invest in asset classes that don't exactly correlate. The idea being that any volatility in one class will have little to no impact on the other classes. In this sense, you will have some cushion when there is a downturn in one of the asset classes.
5. Long-Term Stability
Diversification of your portfolio and rebalancing it regularly strives for more consistent long- term performance. Rebalancing simply means periodically adjusting your asset allocation to align with your financial objectives.
Selling high-performance, overweighted assets and buying underweighted and underperforming assets can be excellent strategies for rebalancing your portfolio. And as you do, you work towards stability by getting to that balance of risk and return that you desire your portfolio to have.
Over time, you may get to a place of such great stability that any further rebalancing and moving things around will no longer be necessary. Then, you will be able to sit back and let the investments from your 401(k) balance potentially bring in a good yield.
Like any other strategy, asset allocation and diversifying your 401(k) balance are not foolproof. That said, it is a strategy with great potential and worth it, given the potential benefits as highlighted. Are you thinking of diversifying your 401(k)? It is always best to speak to an investment professional for personalized advice on what would affect your account’s balance and how best to go about diversification based on your current financial situation and your future financial goals.
The opinions voiced in this material are for general information only and are not intended to provide specific advice
or recommendations for any individual.
Investing involves risk including loss of principal. No strategy assures success or protects against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified
portfolio. Diversification does not protect against market risk.