Diversification goes beyond multiple investments

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Paul Kirk is vice president and senior portfolio manager with Commerce Trust Company.|ret||ret||tab|

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Stressing the importance of investment diversification in planning for retirement is not a new concept. Investing outside a company's 401(k) plan isn't either. Yet, investors can overlook both concepts, and the results can be devastating. |ret||ret||tab|

Given this year's spotlight on 401(k) plans, diversification may now hold a deeper meaning for the public than simply varying investments within one investment class. For example, if a retirement plan is based solely on a company's 401(k), the investor is, in effect, relying on one investment to make retirement dreams materialize. |ret||ret||tab|

Additionally, if an investor has investments in a 401(k) plan and a mutual fund, examine the mutual fund to see that its investments differ. Investors may think they have a diversified portfolio, but a deeper look could uncover similar or the same investments in different investment categories.|ret||ret||tab|

When planning a diversification strategy, it's important to avoid duplication and to be sure the portfolio includes not only different investments, but also different types of investments.|ret||ret||tab|

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Overall asset allocation|ret||ret||tab|

Understanding how diversified a retirement plan is begins with examining overall asset allocation. |ret||ret||tab|

Asset allocation means spreading investment money among a variety of asset classes, which broadly includes stocks, bonds and cash. Each asset class has different risks and return potential, and may respond differently to market conditions such as inflation and interest rate changes.|ret||ret||tab|

While moving through different stages in life, the asset allocation model that best fits a situation will likely change. Because of this, investors may want to rebalance their portfolios periodically to fit current financial needs, goals and risk tolerance.|ret||ret||tab|

Various studies have indicated that as much as 85 percent of the eventual degree of satisfaction with an investment program is directly tied to the asset mix decision. (Source: Brinson, Hood & Beebower)|ret||ret||tab|

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Determining retirement needs|ret||ret||tab|

In addition to asset allocation, there are other components to consider when predicting retirement needs, and thus, investment selection. Consider retirement age, retirement lifestyle, inflation and risk tolerance.|ret||ret||tab|

Investors should determine a projected retirement age and lifestyle. Many financial planners estimate a person will need about 70 percent to 80 percent of his or her current income to retire at the same standard of living. Investors need to keep in mind that some expenses, such as mortgage, taxes and other work-related expenses may go down, while others such, as health care, travel or entertainment, may go up.|ret||ret||tab|

Every investment carries some kind of risk. Investors need to develop an investment strategy that corresponds to a comfortable risk level, whether it is conservative, moderate or aggressive.|ret||ret||tab|

There are several retirement planning worksheets and calculators available in books, online or from a financial planning professional. These worksheets or calculators can help investors get a feel for the overall retirement picture in a short time.|ret||ret||tab|

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Structuring the retirement plan|ret||ret||tab|

When asking for investment advice, the most common response is, "Don't put all your eggs in one basket." Again, remember, diversification holds a deeper meaning than simply varying investments within one investment class. This is the point to examine additional investments for a retirement plan beyond the company 401(k).|ret||ret||tab|

Equities, or stocks, are investments that give ownership interest in the company issuing the stock. Investors should make sure they buy stock across industries of the economy for diversification purposes. Check investments against the S&P 500, which is an index that tracks the stocks of 500 leading companies in all major industries. |ret||ret||tab|

Bonds are debt securities, similar to IOUs. When investors purchase a bond, they are lending money to an issuer a government, corporation or federal agency, for example. In return, the issuer promises to pay a specified rate of interest for the life of the bond and to repay the principal or face value when the bond matures. The promise to repay principal is part of the obligation, but only if the issuer has the ability so there are some risks even with bonds.|ret||ret||tab|

Mutual funds refer to an investment company that pools the money of many individual investors and uses it to buy a diversified portfolio of securities. Mutual funds could include individual equities, individual bonds or a combination of both. |ret||ret||tab|

Be sure to ask about the fees associated with the fund. All mutual funds have associated fees and some are paid when the fund is purchased and charge when the fund is sold. Get a list of fees in writing in case any difficulties arise at a later date.|ret||ret||tab|

There are limits as to how much an individual can contribute to his or her company 401(k) plan. Therefore, an individual retirement account (IRA) is another investment account in which you can contribute toward your retirement nest egg. Be sure to examine the IRA to see that its investments differ from your 401(k) plan.|ret||ret||tab|

IRAs give investors the chance to set up a tax-favored retirement account. Each year, individuals can make IRA contributions that are invested until its time to receive them in retirement. With a traditional IRA, investors can contribute up to $2,000 per tax year. Contribution(s) may be tax-deductible, and any earnings grow tax-deferred. With a Roth IRA, investors can contribute up to $2,000 per tax year. Contributions will not be tax-deductible; however, earnings grow tax free, and distributions are generally tax free in the year received provided certain requirements are met. |ret||ret||tab|

Having a clear understanding of retirement investments is a huge step in watching retirement objectives materialize. Remember there are a number of investment options for retirement planning and the 401(k) is just one. Above all, do not hesitate to ask questions regarding investment options.|ret||ret||tab|

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