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Diversification

I covered the main ways of diagnosing your financial health in this past post.  I’ve been using Wednesdays to go further in depth on each point since I truly believe that financial health leads to less stress and happier lives.

I have already covered the first four points – Spend Less Than You Earn, start an Emergency Fund, review Retirement Savings, and Debt.  The fifth point was to diversify your investments.  This means making a list of your investments and the amount invested in each one.

Type of Accounts

First, I’d highly suggest investing in different types of accounts.  For example, compound interest in a 401k is taxable when you start making your retirement withdrawals since you contribute pre-tax income.  The compound interest of a Roth IRA is not taxable since you contribute post-tax money.  By investing in taxable and non-taxable accounts for retirement, you can balance your withdrawals to stay in the lowest tax bracket possible in your later years. We invest in a 401k and a Roth IRA (hopefully two soon) in order to cover our retirement years along with my husband’s pension.  We also make investments in individual stocks in a Scottrade account to cover the years between our target retirement age of 52 and our “normal retirement age”. By diversifying accounts, I hope we have our retirement bases covered.

Type of Investments

The second really important part of diversification is to make sure that you aren’t too heavily invested in any one company.  CNN Money and countless blogs suggest never investing more than 10% in any one company/stock.  I agree with never putting all your eggs in one basket, so this seems like fantastic advice.  Honestly, do you want your retirement on the line if a company doesn’t do as well as expected or crashes completely?

We are invested in about 15 different individual stocks in our Scottrade account right now.  We are currently breaking the 10% rule for Johnson and Johnson and Pepsi since their prices had crashed low enough to really gorge, but a combination of investing more elsewhere and selling some for profit will rectify this situation within the next year.

The 401k and Roth IRA are in separate target date mutual funds that are spread out through a ton of domestic and foreign stocks and a few bonds.  We’re in our mid-late 20’s, so our retirement accounts are heavily invested in equities.  As we near retirement, our investments will be moved to less risky categories since we want our money to be safely waiting for us down the road. By diversifying in as many categories as possible, all of your money as a whole will be safer in general.

Are you safely diversified?  Or are you in a similar Pepsi or J&J-loving position as us?

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10 comments to Diversification

  • Over time, we will be overly invested in the company my husband works at because they give a great discount on their stock purchase plan. However, the plan is to sell some of that stock after a year of holding and invest it elsewhere. So we will be overly invested for just a short period of time.

    My biggest problem is probably being over-weighted in equities. I am getting older and need to look at shifting some of my retirement and other money into bond funds.

  • Wow….that’s a great idea, to invest in both Roth IRA and traditional due to the tax situation at the time of withdrawal. I had never thought of that. Great idea, that I plan to implement! I, currently, only have a traditional IRA.

  • MikeS

    I have both a regular 401k and a Roth 401k to help with the tax diversity. I contribute enough in the regular 401k to get the company match and after that, everything else goes into the Roth.

    Just have a little bit of company stock at the moment. Their stock purchase plan was too good to pass up last year. I will probably sell it next year. All my other holdings are mutual funds or etf’s. I don’t hold any individual stocks.

  • Debbie

    Too much of my net worth (50%) is in my house. However, I don’t plan to fix that. I got the smallest, cheapest house I could actually like. And I am going to pay it off.

    Other than that, I’m pretty good. My pension is taxable, so all my other investments are in Roth accounts. I’m in the process of splitting my investments among 10 different mostly non-intersecting mutual funds (such as a large-cap value and a European fund) plus inflation-protected bonds.

  • BFS

    Everyday Tips, yeah, it’s impossible to pass up great stock deals. The key is just selling some of it every once in a while so you’re not stuck holding an empty bag if the single stock crashes, like you said. :-)

    Since we plan to retire by 52, our current plan is that we’ll be at least 90% stocks until 35, then 75-80% til 40, 60-70% til 45, and 50% or less after that. Obviously things could change, but we want to make sure that we can indeed live on our retirement savings without worrying about markets as much.

    Young Mogul, that is the same exact reaction I had when a coworker told me about Roth IRA’s 3 years ago! Neat, huh? :-)

    MikeS, your investments sound balanced and diversified…very cool. Individual stocks scare me, which is why I leave it to hubby. He seems pretty sure that he’ll be able to make a solid fund to cover age 52 to 59 1/2, so I’m letting him loose and closing my eyes, lol. Actually, I check on our Scottrade account pretty dang often and constantly ask how we are doing…I think I annoy the crud out of hubby, but he understands that it’s just uneasiness talking. We’ll see how it works out.

    Debbie, your investments sound well-rounded. Our house is roughly a third of our net worth…it’s not hard since our net worth isn’t huge yet and we got a deal on our house.

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