Everyone talks about being “diversified” but what does that really mean? Diversification is a broad term that covers multiple areas of your finances. In this post we’ll look into the three most important types of diversification.

Investment Mix
You’ve likely heard the phrase: “Don’t put all your eggs in one basket.” What would happen if you accidentally dropped that basket? You’d lose all your eggs in an instant. The same principle applies to investing. If you put all your savings into a single investment, what happens if there is a sudden downturn or if the company goes bankrupt? Your hard-earned savings could disappear quickly.

Diversification helps protect against such risks. Spreading your investments across different asset classes—such as stocks, bonds, and real estate—you can reduce the impact of market volatility. If one asset performs poorly, others may perform better, balancing out your overall returns. This way, your portfolio is more likely to weather financial storms and provide steady growth over time.

Asset Location
When it comes to retirement planning, diversification isn’t just about the assets you choose but also the types of accounts you use. By strategically allocating retirement savings across traditional IRAs, Roth IRAs, and taxable brokerage accounts, you can optimize your tax situation both before and during retirement.

Investing in accounts with different tax treatments allows for greater flexibility. For example, you can withdraw from a Roth IRA tax-free, while traditional IRA withdrawals are taxed as ordinary income. By having investments in various accounts, you can manage your tax bracket more effectively and have better control over when and how you are taxed.

Liquidity
Liquidity refers to how easily you can access your cash. Liquid assets, like the money in your checking and savings accounts, can be quickly converted into cash. On the other hand, assets like real estate are less liquid, as they take longer to sell and convert into cash.

Understanding your liquidity needs is an important part of your financial plan. By knowing how much cash you need readily available, you can meet your current financial obligations and plan for future goals. Balancing liquid and illiquid assets ensures you have enough flexibility to cover emergencies without disrupting your long-term investment strategy.

Bottom Line
Diversification isn’t a one-size-fits-all approach. It involves spreading your investments across different assets, accounts, and liquidity based on your specific needs and circumstances. By understanding and applying these three types of diversification, you can create a more resilient financial plan.

George Maroudas, CFP®

George Maroudas, CFP®

847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor

Disclaimer:

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.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Bonds are subject to availability, change in price, call features and credit risk

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

Contributions to a Roth IRA are taxed in the contribution year. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Stock investing includes risks, including fluctuating prices and loss or principal. We suggest speaking with your financial professional about your situation prior to investing.