Why it is important to diversify your retirement investment portfolio

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Every financial planner will tell you putting all your eggs in one basket is risky.

The idea is that when you keep a single asset class, you're stuck with the performance of that asset.

On the other hand, holding various investments offsets the poor performance of just a single investment, potentially leading to a more consistent return.

This technique is known as diversification, and it involves keeping investments across different asset classes that are not highly correlated with one another to reduce the risk of your retirement portfolio.

Holding cash or cash equivalents is crucial for short-term financial stability and risk management.

Money offers a sense of security and consistency, but if you have the means, it can also be wise to ensure that a portion of your retirement funds grows better than your country's inflation rate.

Inflation rate refers to the increase in prices over time. Investments that outpace inflation help combat the decline in purchasing power caused by rising prices.

However, investing comes with risks, with some asset classes posing more risks than others. Generally, riskier investments offer better returns.

Typically, investors face two types of risk.

The first is systematic risk, affecting all industries and resulting from exchange rate fluctuations and inflation rates.

This type of risk isn't unique to any industry and can't be mitigated through diversification; it's an inherent part of investing that all investors must acknowledge.

The second type of risk is unsystematic risk associated with asset classes. Investors can reduce this risk through smart portfolio allocation and diversification.

Diversification aims to guard against this kind of setback.

It is even more critical for retirees or individuals nearing retirement age who strive to maintain their wealth. It is an investment strategy designed to lower the likelihood of facing losses.

By distributing your investments across assets, you decrease the risk of losing your portfolio due to a single adverse event affecting that particular investment.

Instead, your portfolio is diversified across asset classes and businesses, safeguarding your funds and improving your risk-adjusted returns.

Asset allocation often accomplishes diversification. It can be a worthwhile strategy to include a variety of investment assets in your holdings.

Diversification is crucial to owning investments that react differently in market conditions.

For instance, when stock prices increase, bond yields typically decrease. Professionals refer to this as a correlation between stocks and bonds.

When stocks and bond yields move in the same direction (both gaining or both losing), stocks generally exhibit higher volatility, meaning they experience more considerable gains or losses than bonds.

Additionally, markets, such as the forex market, allow you to profit in both rising and falling markets.

Since forex trading involves the simultaneous buying and selling of currency pairs, investors can profit even from the declining prices of a currency.

Here are some of the best ways to diversify your retirement portfolio:

Shares, also known as stocks, represent ownership stakes in a company. When someone buys stocks, they become a shareholder in that company.

Investing in a company allows you to vote on management and share profits. It offers potential returns through capital appreciation and dividend income.

The average return for Australian shares over the last ten years has been 6.5 per cent per year.

However, it comes with a high risk and requires a long-term investment horizon, typically at least five years.

Fixed interest includes government bonds, corporate bonds, debentures, and capital notes.

These are used to earn a steady rate of income and diversify a portfolio. The average return over the last ten years for fixed-interest investments has been 3-4 per cent per year.

They offer a low risk of losing money and are generally suitable for short-term investments ranging from one to three years.

One of the safest investment options to consider for retirement is bonds.

Bonds are loans made to governments, corporations, or other entities. In exchange for lending the money, the bond issuer pays interest to the bondholder.

Bonds can be a great way to generate income in retirement because they can provide a known, steady stream of interest payments over a determined time and are generally less volatile than stocks.

After recent increases in interest rates, bond funds are more attractive now than over the last decade.

Consider the different types of bonds and choose the ones best suited to your circumstances.

Additionally, it takes a lot of work to beat the tax benefits of owning real estate.

Real estate includes owning residential or commercial property for personal use or as income-generating property.

You can also buy Real Estate Investment Trusts (REITs), allowing you to invest in real estate without owning and operating a property.

Real estate investments are used to earn a steady rate of income through rent and offer capital growth.

The average return over the last ten years has been 6.3 per cent per year, with a risk level ranging from medium to high.

Commodities include energy resources like oil and natural gas, industrial metals like copper and aluminium, agricultural products including corn, wheat, soybeans, and other natural resources.

Different ways to invest in commodities include:

Cash investments include bank accounts, high-interest savings accounts, and term deposits. These are used to protect wealth and diversify a portfolio.

Over the last ten years, the average return for cash investments has been 3 per cent per year.

They offer a shallow risk of losing money and are generally suitable for short-term investments ranging from zero to three years.

Forex trading provides an additional income stream that can supplement traditional retirement savings.

Its flexibility allows retirees to participate 24/7, giving them freedom and the opportunity to enjoy their retirement years to the fullest.

Moreover, forex trading offers the potential for higher returns compared to traditional investment options, and you may profit regardless of how the economy is doing.

Forex is more hands-on and can be an opportunity to discover a new hobby while making money. The risk level for forex trading is medium to high.

Remember that a pivotal aspect of honing your strategy is selecting the right platform for success.

If you're going in cold with a Google search for "trading platform Australia," consider seeking advice from trading platforms, such as the Oanda trade platform.

Different investments have advantages and risks, so it's important to consider your goals, how much time you have until retirement, and how comfortable you are with taking risks.

By spreading out your investments across assets and making sure you have a mix, you not only reduce the impacts of the ups and downs of the market but also protect your portfolio from unexpected economic challenges or negative events.

This balanced approach can give you the confidence and financial security you need to maximise your investments.

This information is of a general nature only and should not be regarded as specific to any particular situation. Readers are encouraged to seek appropriate professional advice based on their personal circumstances.