Investing Lessons From 'The Three Little Pigs': Ways to Help Build a Portfolio the Big Bad Wolf Can't Blow Down
Is your portfolio as well built and diversified as you think? If you're worried it won't help keep you safe in retirement, it could be time for some renovations, starting from the ground up.
Most portfolios are diversified on paper, but not in behavior.
Diversification isn't just about how many things you have in your portfolio. It's about how those different assets are likely to perform when exposed to various types of risk — when the market stumbles or inflation spikes or interest rates fluctuate.
Some people think they're diversified because they own a few different mutual funds, variable annuities and/or ETFs. But if everything you own reacts the same way to market volatility or other economic disruptions, you may not be as protected as you think.
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The primary goal of diversification is to limit your nest egg's vulnerability to risk. And that requires building a balanced mix across asset categories, including some investments that move independently of popular stock market indices, such as the S&P 500 or the Dow Jones Industrial Average.
Creating a thoughtful blueprint for retirement
Remember the story The Three Little Pigs and their encounters with the Big Bad Wolf? In the end, it was the third little piggy's thoughtful preparation and choice of building materials that saved the day.
And so it is with retirement planning and building your "fiscal house." If you're worried about how your money will hold up when you're no longer earning a paycheck, it could be that your portfolio and overall financial plan are in need of some renovations. Consider approaching those renovations this way:
Start with a stable foundation. Although no investment is completely without risk, the foundation of your retirement plan should include assets you expect to stay solid and keep you safe.
Even when the economy (or your own financial situation) is feeling shaky, these basic building blocks are meant to help provide steady, reliable income.
CDs (which are protected by the FDIC), Treasury bonds (backed by the U.S. government) and fixed annuities (when purchased from a reputable insurance company) can be good choices for this level of your plan.
Next, build sturdy walls. The walls of your fiscal house should be durable enough to withstand most storms, but they should also allow for some moderate growth to help keep pace with inflation. That means there will be a bit more risk here than in your foundation.
Your walls may bend or even crumble if things get especially rough. But if necessary, walls can be repaired or reinforced, and you'll still have your foundation in place.
Investments at this level could include options that provide income and add to the diversity of your portfolio, such as bonds, real estate, private equity and dividend stocks.
Top it off with a roof. Your fiscal house's roof will be made up of investments that are exposed to the most risk (moderate to high, based on your tolerance) with the goal of growing your money.
Of course, you'll still want to be careful as you choose what your roof is made of. But if it does fail, and the rest of the house is solid, you can remain confident that your plan's entire structure won't be compromised.
Investments like stocks, ETFs, mutual funds and variable annuities are commonly held within the roof category.
Is your design diversified?
Have you ever driven through a neighborhood where all the homes look the same or where there are at most three or four models? Often, that's what investing looks like, with cookie-cutter retirement plans and portfolios that use the same basic — and limited — asset mix.
But a good retirement plan — one that can help you feel secure even on the stormiest days — takes thought, creativity and purpose. And that requires true diversification.
Not just horizontal diversification, with a variety of assets that are all at or near the same level of risk, but also vertical diversification, with assets in different accounts and account types with different levels of risk (including some that are not going to react to the general market at all).
One significant reason diversification is important for retirees is sequence of returns risk. Sequence of returns risk involves the possibility that investment losses early in retirement, combined with regular withdrawals, can deplete your portfolio much more quickly than you would have expected.
In fact, two retirees with identical portfolios and withdrawals could have significantly different outcomes based on the timing of when they retire. Someone who enjoys big market gains early in retirement can better endure losses to their portfolio later on.
Someone who faces a down market at the start of retirement may see the value of their portfolio drop so much that they never get the chance to benefit from the gains when the market recovers.
If you feel anxious when the market wobbles, it may be time to take a step back and evaluate your plan. What's in your portfolio? How will the mix come together to help protect your retirement and provide the lifestyle you desire? Are the assets you're holding now still relevant to your needs?
The good news for today's retirees is that there are several investment options that can help them diversify, including gold and silver or real estate investment trusts (REITs).
But a well-built retirement plan isn't just diversified — it's designed with purpose. Every component should work together to support income, manage risk and adapt to changing conditions.
If you're unsure how your current portfolio would hold up under real-world pressure, it may be worth taking a closer look at how it's structured and whether each piece is truly serving a purpose.
You don't want to wait for that real-world pressure to reveal the gaps in your plan, though. Connect with an adviser to help ensure your portfolio is structured for the long haul.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
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