What is diversification?

Merriam Webster defines it as giving variety to something.

Variety is good. 

It’s good in life, in business, and particularly with our savings.

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The idea of diversifying has been around a long time.

With today’s market volatility, it’s increasingly important to answer the question – what is diversification – through the use of four different lenses.

An acronym is helpful to understand the lens:

What is Diversification from the P.I.T.T.?

1. Product

What is diversification of products?

Diversification of products simply means that you utilize a variety of investment vehicles.

Some products offer guaranteed rates, others offer guaranteed income (with fees of course).

Other products offer downside protection. 

Products are designed with different functions.  It’s important to have a variety of products when it comes to our retirement savings.

2. Investment

What is diversification of investments? 

This means you diversify across asset classes with stocks, bonds, and alternative investments.

You also want to look at diversifying within those asset classes both by different types of stocks, but also diversifying with numbers of stocks.

An example of diversifying within asset classes would be choosing defensive positions during difficult times like dividend-paying stocks, consumer staples, or precious metals.

This is a key to adding additional returns during difficult markets.

3. Time 

How do you diversify through a time lens?

This means you have short, medium, and long-term investments.

If you have an emergency fund and something happens to your job, you won’t have to take an early IRA withdrawal.

You will be able to weather that storm because you’ll have short-term investments.

Some products with guarantees may have time schedules that you must keep to avoid charges.

Having shorter term investment money is a wise diversification move.

4. Tax

What is diversification for taxes?

Diversification from a tax standpoint means that you work at balancing tax deferred, “taxed now”, and tax-free accounts.

In other words you intentionally build tax-deferred assets like IRAs and  401ks.

You also think about building regular brokerage accounts or what would be called non-qualified money.

And lastly, you think about building tax free money with a Roth IRA or Roth 401k.

Following these guidelines does not insure investor success, however, diversifying your savings from these standpoints can help reduce risk and generate more consistent returns over the long run.

As always, be sure to consult with a tax advisor when making tax decisions.

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Readers, post your comments:

• What is diversification to you?
• Do you diversify from the PITT? 
• What other diversification have you done (like income?)

Success! Wikipedia defines it as:

The achievement of an objective or a goal.

When it comes to saving for retirement many of us naturally want to achieve our goals.  The fact is, for most of us retirement is a marathon race and not a sprint so it’s important to have some ideas in mind to keep you on the right track.   Here’s a look at seven tips to successfully achieve your retirement goal:

Start Now!

“But I didn’t get an early jump on retirement saving when I was younger, so what’s the point”.  It doesn’t matter.  If you haven’t saved anything yet – you need to start saving retirement ASAP!

If you have started saving already – reevaluate the amount you’re putting away and determine if you can begin putting an extra $50 or $100 (or whatever amount you can).

Define Your Goals

Of course you have to know what target you’re aiming for if you’re going to hit it.  If you don’t have some defined goals you’ll really have no idea how to evaluate your progress.

This is Planning 101.  What do you want to achieve?  When do you want to achieve it?  Maybe it’s a certain dollar figure in your 401k or a goal to retire at a certain age.  Or, maybe it’s to have enough money to do short-term missions trips or serve at homeless shelters.

Sit down and jot some ideas on a piece of paper with your loved one so you can get a taste of what you’d like to do.

Determine Your Time Frame

Now that you’ve got some idea of what you want to accomplish and perhaps the age at when you’d like to retire determine how many years you have to make that happen.

If you want to retire in five years, but you’re not really saving much right now and you’re strapped with debt – maybe you need to reconsider.

Realistically determine your time frame and keep this number in the back of your head as you make other decisions regarding retirement.  If you need to start putting more away, sit down and take a look at expenses you can cut out or cut down on and make a huge effort to save more.

Determine Your Risk Tolerance

Now that you have your time frame set and your goals in mind – you can determine how much risk you should be taking.

Generally speaking, the shorter your time frame – the less risk you should be taking.  If you’re in your 30′s and you’ve got 30 years til retirement you have some time to make up any losses.

However, if you’re in your mid 50′s and you’ve got less than 10 years you may want to pull the reigns in a little and shift to a less aggressive portfolio mix.

Comfort level with your risk plays a big role in determining your tolerance as well as knowing how much you need to retire. If you don’t need that much more to achieve your goal – you can scale back the risk.  If you need more – you may need to dial it up a bit to get some gains.

Diversify Yourself

Diversification comes in three areas:

1. Investment – Diversify your portfolio and your asset classes.  You don’t want all your eggs in one basket as the old cliche goes. The reason is because you don’t know what’s going up or down from one year to the next.
2. Time – Diversification from a time standpoint essentially means that you have some shorter term investments as well as longer term investments.  It also means you plan for the unexpected (think short life span) as well as longevity.
3. Tax – This means you spread your savings among taxable; tax-deferred and tax-free accounts to take advantage of the unique tax benefits of each.

Become Debt Free

To me, this is huge.  If you can become debt free before you retire you free up opportunities to give more during retirement, you releive the stress of needing to have a bigger nest egg or larger monthly income stream.

Debt can be bondage.  Ideally, you’ll be in a much better position if you can pay off all your debts including your mortgage.

Now I know some will argue that there will be lost tax benefits.  Sure, that might be, but some of that can be made up from charitable deductions (goal: give away the amount you’d pay in mortgage interest!).

Freedom from debt is liberating – and you’ll be glad you wiped them out before you retired.

Review Your Goals Often

In order to save retirement and stay on track you need to have set reviews.  These can be done annually or semi-annually.  The point is to schedule time to sit down and revisit your goals, check your progress and determine if any changes need to be made.

You won’t know how far off course you are if you don’t review.

Hopefully these tips will give you a start in achieving your retirement success.

How about you?  What other tips would you add to the list?

Runners, take your marks!

Your heart pounds as you anxiously await the starting gun.

With your fingers touching the ground, you get your legs in position ready to spring out of the gate.

You’re ready for the race of your life.

You hear the sound of the gun and get a good jump!

Your early lead seems to be holding.  You kick it into full gear - there is no one in front of you!

Yes!  You pass the 100-yard marker and begin to slow down.  You did it!  You just won the biggest race of your life!

With your arms raised in the air and your eyes closed you celebrate this great moment.

And suddenly you feel other runners passing you.

Get out of the way!!

What’s going on?   You ask one of the judges what is happening and he informs you that this is not a 100-yard sprint, this is a marathon.

Embarrassed and completely winded you start to run again, but it’s hard to get back on track.

Ok.  So this is an unlikely scenario, but when it comes to retirement there are many folks who are doing this very thing.

They start out of the gate early with good intentions of saving and investing for their retirement goal, but fail to keep up with the plan after a few years.

Some get a good jump by investing aggressively without knowing their risk tolerance thinking they will make a lot of money only to have their hopes dashed by a market correction.

The retirement race is a marathon - not a sprint.

Marathon runners pace themselves for a long distance – sprinters shoot out of the gate with a blast of speed for a short run.

Here are 5 ways to win the marathon race to retirement:

1. Save Early and Save Often

The sooner you get started with saving for retirement the better off you’ll be.

With a good mix of investments and compounding interest working,  your accounts should grow very well for you over time.

This takes the pressure off of having to make up for lost time by taking on too much risk for your investments and exposing yourself to a potential downturn.

2. Dollar Cost Average

Dollar cost averaging (DCA) is a simple investing strategy that invests equal dollar amounts on a regular basis over time.

For example, saving $100 monthly into your Roth IRA is dollar cost averaging.  By doing so you buy more shares when prices are low and fewer shares when prices are high.

The result is a lower average cost per share in the investment over time.  Although there is debate on how well this strategy works in a rising market, it’s clear that in a volatile market it is difficult to know when to buy in.

DCA is a way to take the worry and stress out of trying to time the market for the short term and rather focus on regular savings over time.

3. Diversify, Diversify, Diversify

A lack of a properly diversified portfolio is one of the common mistakes people make with their investments.

Why?  Because we don’t know what goes up or down from one year to the next, so spreading your investments over various asset classes is key to a long-term retirement strategy.

Finding a good model portfolio within your risk tolerance will help reduce the risk of exposure to a poor asset class or security in a given year.

4. Don’t Borrow From Your 401k

Your 401k should be the last place you get money from if you need it.

Many people think that it’s not such a bad idea.  After all, you are paying yourself back with interest right?

Theoretically yes, but the opportunity costs and the risks are too great.

First the opportunity costs.  You may pay yourself back with say 6% interest, however, if the market goes through a great stretch like we’ve just seen from March through September 2009 where the S&P 500 is up over 50% you not only lose out on that loan money earning interest, but also the compounding affect that could have been helping you.

The risks associated with a 401k loan are too great as well.

If you lose your job, quit or retire while the loan is still outstanding you are required  to:

• Pay back the loan in as little as 30 days, or
• Pay income tax on the borrowed amount at your marginal tax rate
• Pay a 10% penalty if you are younger than 59 1/2

A 401k loan can ruin your momentum for the retirement race.

5. Define Your Goals and Review Them Regularly

You can’t just set it and forget it when it comes to retirement.  Face it, economies, situations and goals change.

It’s important to define your goals so you have something to shoot for.  After all, you can’t hit a target when it doesn’t exist.

Secondly, you should review those goals regularly so that you can make any tweaks and adjustments as necessary along the way.

With some discipline and hard work you too can win the race to retirement!

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We all make mistakes – some of them are just more costly than others.

When it comes to our retirement savings there’s a host of mistakes that could cost you.

Because companies are shifting the responsibility of retirement on the employees, it’s vital to correct any of these mistakes as quickly as you can.

1. Bad Methods for Choosing Funds

I’m just not sure which funds to choose so I picked what did well last year

Perhaps you’ve found yourself saying that before.  Picking funds based on past performance is a losing proposition because past performance is no guarantee of future results.

An all-star fund could turn into a dog for a variety of reasons.  Don’t rely only on past performance to make your decisions.  

I didn’t know what to pick so I asked my co-worker what he did.

Bob might be a great guy, but he could be a total goofball when it comes to investing.  Sure, he talks a good game, but your needs and goals are different.  Don’t base your investments on someone else.

I figured I’m aggressive so I just went with a more risky stock fund

It’s OK to be aggressive, but using only one or two funds will typically increase your volatility and expose you to greater risk.  You need to diversify the holdings.

2. Not Diversifying Your Investments

Don’t put all your eggs in one basket. 

Diversification simply means spreading your money over various types of funds and asset classes (i.e. small, mid, and large sized stocks etc.).

The reason you want to diversify is because we don’t know what will go up or down in any given year.  You can take advantage of rising stars and also soften the blow on investments that are stinking it up.

Check out MSN Money’s Asset Allocator tool, which is a good start if you are unsure what type of allocation to use to diversify your account.

3. Not Knowing Your Risk Tolerance

I want to make big returns in my 401k without much risk

Really?  Let me know when you find something like that because I’d like to use that too!

Of course we all want to make good returns without much risk, but those investments don’t exist – if they do, they are typically too good to be true.  (Can you say – Bernie Madoff?)

You need to understand your risk profile and how that impacts your decision-making with your 401k funds.

For guidance in this area, here are five questions to help determine your risk tolerance.

4. Not Paying Attention to Company Match

 Although the recession has led many companies to forego their 401k matching programs, there are still some who offer some sort of match. 

A big mistake often made is not knowing what kind of match the company is offering resulting in leaving free money on the table.

If a company is matching dollar for dollar up to – say five percent, it’s silly to only put in three.  You’re leaving an additional two percent out there that could be matched.

At the very least you should be putting enough into your 401k to take full advantage of any money they are going to give you.

Pay attention to the details of your company’s matching program and by all means take what they are willing to give you!

Reaching retirement is up to you, so make sure you are doing all you can to correct mistakes early so you can reach your goals.