Using diversification to protect your retirement

One of the risky habits we have is to place too much trust and money into something we feel "we know”. In Singapore, for example, our experience with a booming property market leads many to count on their flat or condo as a means of retirement, with few other assets. Similarly, there are enthusiasts who bet most or all of their retirement on a single asset type, such as gold, cryptocurrencies, or a single family business. This can be very risky, as a downturn in the asset could derail your retirement. Instead, consider using diversification to reduce risk and improve the overall stability of your portfolio. Here’s how:

Why do you need to diversify?
Imagine a coffee shop that only has one kind of food, or an electronics shop that only sells one type of phone. The business would be quite volatile: if it turns out that particular dish or phone is popular, the profits would be very high. But if the dish or phone is unpopular even for a few months (or if people just get tired of it), the entire business may close down.

In the same way, a retirement portfolio with only one asset can be volatile and risky. If your entire plan involves selling your property to right-size into a smaller flat, for example, then a dip in property prices close to your retirement could destabilise your plans. Likewise, if all your investments are in one sector, such as bank or finance stocks, then a downturn in this sector could have an outsized, detrimental effect on your portfolio.

For a long-term plan like retirement, it’s advisable to have a balanced, well-diversified portfolio across various asset types. This way, you can see more consistent performance, and ensure your savings are protected even if some investments underperform.

How to diversify your portfolio:

1. Use trust funds, indexed funds, or other products that diversify your investments for you

Some insurance products allow you to customise your investment portfolio, or can automatically diversify your investments over different sectors. This can result in a more balanced mix, such as equities for growth, bonds for stability, and assets in many different countries or sectors to avoid over-exposure.

There are also indexed funds that track or mirror the wider market, and unit trusts where diversification is handled by professional managers. There are a wide variety of options, so it’s best to speak to a qualified financial representative, to pick the ones that meet your retirement goals.

2. Use strategic asset allocation, and rebalance often

An example of an asset allocation, for someone in their 30s, might be 70% equities, 20% bonds, and 10% cash. This provides sufficient room for growth (as there’s around 35 years to retirement), with bonds providing a stable bedrock in volatile times. Meanwhile, the cash portion might stay accessible for emergencies.

The asset allocation may change as you get older, or face new life circumstances. For example, an investor aged 55 may hold as much as 50 to 60% in bonds or cash, as they have only around 10 years to retirement; this could make it risky to have too much invested in faster growing but riskier stocks.

Because this sort of allocation is not a one-time move, it’s best to have a long-term relationship with a financial expert, who can help you adjust the allocation as needed.

3. Diversify in a way that maintains liquidity

Avoid investing too much in illiquid assets (i.e., assets that cannot be easily converted to cash in a short time, without serious losses). An example of an illiquid asset would be your home, as it’s usually not feasible or possible to sell it within the span of weeks.

Likewise, be wary of locking up too much in financial products with a long maturity date, such as fixed deposits or vanilla bonds.

If you can’t access your money when you need it, you may be forced to sell off other assets, or incur penalties and losses to liquidate what you have. This can disrupt the long term retirement plan. Aim instead to keep six months of expenses as an emergency fund, and have some flexible assets. Singapore Savings Bonds (SSBs), for example, can be cashed out within a month, without the loss of accrued interest.

By maintaining a balanced portfolio, and properly rebalancing or changing it as you age, you can ensure a stable, hassle-free path to retirement.