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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome to how to retire on time, a show that answers your retirement questions. Say goodbye to that oversimplified advice you've heard hundreds of times. This show is all about getting into the nitty gritty. Now that said, remember this is just a show, not financial advice, so do your research. As always, you can text your questions to (913) 363-1234, and we'll feature them on the show.
Mike:David, what do we got today?
David:Hey, Mike. Is there such thing as too much diversification?
Mike:Well, too much of anything is too much by definition. That's why t o o. Right? I gotta remember how to spell things.
David:Oh, yeah.
Mike:I would suggest yes, except we need to define certain things in certain ways. So what's the purpose of diversification? For many people, it's to lower their risk. Well, if you diversify with too many different stocks, well, okay, then you're lowering your growth potential too. So do you wanna grow your money, or do you want just more stable, consistent kind of returns?
Mike:I mean, look at a an ETF where you're gonna see the total market. Right? So around three thousand stocks versus the S and P 500 stocks or the Nasdaq 100 stocks. The concentration or less of those stocks, the fewer stocks, the higher the growth potential, but when things go down, they go down pretty hard.
David:Okay.
Mike:So the point of diversification is to get rid of some of the upside to lower the downside risk. That's the idea.
David:Yeah. It seems to make sense.
Mike:But when people say, well, I wanna beat the market. Well, okay. You can't buy the entire market and expect to beat 500 stocks of the entire market. Do you see that that contradiction there? Yeah.
Mike:Now that's just one asset class. And the more stocks you have in a portfolio or exposure to stocks, the less growth you'll probably have. That's just how it works. Not everyone gets a trophy in the stock market.
David:Yeah. Very few do, in fact. Right? There's a very small amount of
Mike:There's like ten, twenty stocks that actually grow in the S and P five hundred. I think half of the S and P five hundred might keep up with a treasury
David:Uh-huh. Return. Might. That's kinda wild to think about.
Mike:But, yeah, you don't assume, oh, these are the winners. Uh-huh. Not really.
David:Yep. Standard and poor, they both know how to pick them. Those people.
Mike:Yeah. Alright. So then you incorporate other asset classes. Okay. Now I define it a little bit differently.
Mike:You've got your stocks. Everyone talks about stocks. You've got your bond market. The bond market is a different market, and you have this crazy thing that won a Nobel Prize called the stock bond fund sixty forty split. Mhmm.
Mike:Well, bond funds, which are not bonds, they're bond funds, so they're actively trading bonds. They'll average around two, three, 4% year over year if you go back over thirty years, which is an appropriate timeline for your sample size. Don't look at the last two years or five years or ten years. Look at thirty years long term. And if you realize that, adjusted for inflation, bond funds might make 1% or so, the normal bond fund mix.
Mike:So if you add bond funds to your portfolio, what are you really doing? You're lowering your growth potential, but you're increasing your stabilization or decreasing volatility. That's the fancy way of saying that you're not on as big of a roller coaster. Do you want growth, or do you want to diversify your assets to try to stabilize it so that you can stomach the ups and downs. For some people, it's more of a growth game.
Mike:For others, it's more of how much could you handle, you know, emotions kinda game.
David:Because when you have money invested, it's gonna go up and down. You gotta be able
Mike:An investment can go up and down.
David:Yeah. Can you withstand that? Can you stomach it? Is it okay? Some people might be fine.
David:Others, no.
Mike:I'm convinced investing has more to do with emotions than actual investments. Stock. You can quantify a bond fund. You can do all sorts of things, and there's risk. You can't predict the future.
Mike:It's not that easy, but you can do a strategy. There's many different strategies, but your ability to stay consistent with that strategy, to have several strategies, that's where people fail. I think, oh, I have a diversified actual portfolio. Well, you bought and held a portfolio based on the idea of diversification where it's misplaced, and you really bought a product, and you're just walking through it. Because in my mind, the strategy would be able to adjust based on conditions adjusting, but a lot of people didn't do that.
Mike:And here's my case in point. After the two thousand eight financial crisis, the Fed dropped their interest rates very, very low, and the ten year treasury or bonds in general, treasuries in general, also went low. They're not necessarily correlated. They just rhyme, and they both happen to go to historic lows. Okay.
Mike:Fine. But now why are you putting 40 plus percent of your assets in bond funds now averaging, what, 2%? Oh. Oh, well, it's the sixty forty splits, what you're supposed to do. Yeah.
Mike:Why? When you ask questions, you start to get answers. It makes sense in certain economic environments to maybe have some bond funds. It may not make sense to have bond funds as a part of your portfolio in different economic environments. So blind diversification or following these rules of thumb may or may not be appropriate.
Mike:And then you can diversify. This is interesting in other markets. So you've got the stock market, the bond market. You've got the Fed driven market. So that's the cash and cash equivalents market.
Mike:Because the Fed really controls high yield savings or, like, money markets. They influence those more than others. Sure. You've got your real estate market, and you don't need to be a landlord to be in the real estate market. They have these things called REITs, real estate investment trusts, that may be appropriate for your portfolio.
Mike:They may not. But what you're doing is you're diversifying your assets, and JPMorgan did an interesting study on this. What they found was take your eighty, twenty, sixty, forty, forty, 60, whatever blend of stocks and bond funds, and then carve out 30% and put in alternative investments. Alternative investments being real estate, private equity, private credit, these these alternative markets.
David:Okay.
Mike:And they found that you could potentially, historically speaking, increased the returns and decrease the roller coaster.
David:But how do people even know about some of those alternatives?
Mike:Well, yeah, these are the ones you have to go through a financial adviser to get. Okay. You might say, oh, well, it's very convenient for you to say that. You don't need to do this strategy. There's other ways to solve absolutely do this on your own.
Mike:My point being is, why are you diversifying? And what are you diversifying in? I've looked at many portfolios that were growth portfolios, and they bought this growth, the QQQ, and then they bought the S and P 500 and some ETF, IVV or VOL or whatever, and then they bought the mega cap growth, and they bought the the this, that, and the other, and and they had like 10 to 20 different ETFs. So in their mind, they were diversified. When I looked under the hood, half their portfolio was in like 10 stocks.
Mike:Because they bought the same thing just repackaged in different ways.
David:Oh, right.
Mike:And I see this all the time. Someone's got 10 different cities from 10 different banks. Well, I'm diversified by bank risk.
David:So if one of those banks failed, well, they have
Mike:They have other banks. Yeah. So you have to ask yourself, why are you diversified? What are you diversified in? I I do agree you shouldn't put all your assets in one stock or maybe one ETF.
Mike:I don't think that's a good idea, but too much means that you went beyond the mark. You missed the principle. You missed the learning opportunity here. You're not applying what's being taught, and you kinda went to the extreme.
David:Okay. So how do we know if we're too diversified? Is there like a hey. If you're in more than 10 equity positions there, is it that simple, black and white?
Mike:Yeah. Let me answer this. This is a very profound question. Okay. When you go to Thai food, how spicy is too spicy for you?
David:I mean, me personally, like anything over hot is too much. Really?
Mike:Yeah. I just I thought you're more of like a mild medium.
David:I'm probably gonna get medium when I go, but if someone ordered a big chair for the table, I I guess I could dabble in hot. But Thai hot? No.
Mike:See, I'll dabble in Thai hot. Oh. My wife, mild.
David:Ah, yeah. Okay.
Mike:How much diversification is too much diversification? It's a question of risk, and how much can you stomach? How much are you willing to take on? What are your growth goals? What are your lifestyle goals?
Mike:What are your legacy goals? And don't say, well, I think I could stomach a 50% crash. Like, look at your assets and then run a simulation, and now cut them in half. What do you do? Mhmm.
Mike:You need to really understand. You have to want the consequences of what you want.
David:So you you should maybe a good self exercise. If I have 500 k in my IRA, would I be able to stomach it being valued at only 250 k?
Mike:Or if you've got $5,000,000, you're now at 2,000,500. Yeah. You've gotta understand stock market can be cut in half. And then if you're diversified by buying a bunch of stocks, but not, you know, the total market, not like an ETF, like you bought, like, 30 or 40 stocks, and those stocks went under or went down, you could be way worse than the stock market because you're more concentrated on fewer positions.
David:Mhmm.
Mike:So the point being is understanding risk, and then how do you use diversification to get the right type of risk? But also when it comes to diversification, you've got to ask yourself, what strategy are you implementing and why is that? Yeah. I I don't like bond funds as a diversification strategy for retiree. I think it's oversimplified to have sluggish potential returns, and it's just some buy and hold shenanigan where someone can collect one one and a half percent of your assets.
Mike:If you really want a sixty forty split, go do it on your own. Don't pay a financial adviser to sit and watch it with you.
David:Sure.
Mike:Your pain is one for a strategy. Now that's not a criticism to the entire industry, but that is a criticism to the financial professionals who don't do anything. They made their clients into their annuity, because they get 1% for life as long as they stay. Yeah. Is that sting a little bit?
Mike:Yeah. A little bit. Blue shots fired. But if you're paying a financial adviser, it's for the strategy. It's for the understanding of how things shift.
Mike:Maybe you're in bond funds today, which that's fine. But what are you gonna do when markets change? Are you gonna go more into bond funds because of how the Fed is reacting to the situation? Are you going more against it? Are you implementing alternatives?
Mike:Are you looking at privately traded REITs? Are you gonna dabble in structured notes? Instead of bond funds, are you doing private credit? I don't love private credit, but I I'm giving you options here. It's the strategy that matters.
Mike:So let me let me say it a little bit differently. Whenever you're playing a game, a board game, or whatever it might be, you don't just have one strategy. You've got the starting strategy, and then you evolve over time. Mhmm. Because the environment shifts.
Mike:Whether it's chess, whether you're playing hearts, whether you're playing there's a Catan. I don't care. Yeah. Your strategy has to evolve. You can't double down on one singular thing.
Mike:Treat diversification as the understanding of multiple asset classes based on a singular strategy that you can shift over time based on the environment and how it changes. So can you be too diversified? Yes. You can, but you have to define what does diversification mean to you, and what does it mean from a risk standpoint and from a strategy standpoint. And there's layers to that that need to be explored for your specific situation.
Mike:That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility.
Mike:This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date, go to ww.yourwealthanalysis.com today to learn more and get started.