Diversification in your IRA can work similarly; regardless of economic conditions, you can increase your likelihood of owning an asset that's doing relatively well if you hold a diverse set of assets.
Different investments do well in different economic environments. If growth is booming in China, emerging market stocks do well. If US growth is falling, US bonds perform well. There are countless factors that impact investments of course, so at FutureAdvisor, we construct portfolios from an optimized balance of 12 different assets classes, which we believe maximizes your return while hedging risk. We use a set of low-cost ETFs to construct your diversified portfolio - you can see our personalized recommendations using our free interactive site.
Diversification works on two levels:
1. Diversify by asset class
Different asset classes perform well in different situations. The fundamental asset classes in which we invest at FutureAdvisor are stocks, bonds, real estate and inflation protected securities. Together these offer growth, but also the opportunity to preserve capital during weaker markets. We define a target allocation based on your age and risk tolerance, and we rebalance your portfolio periodically over time, to ensure that your allocations do not drift from strategic goals. Generally, if you have over 20 years until retirement, stocks should make up the majority of your portfolio - historically, stocks have offered strong returns. However, make sure to balance your stock exposure with bonds, TIPS (Treasury Inflation Protected Securities) and Real Estate Investment Trusts (REITs).
2. Diversify by geography
Macroeconomic conditions may be great in China, but bad in France. Broad international exposure can help manage this risk, exposing you to bull markets, wherever they may occur. An internationally diversified portfolio is likely to experience smoother returns than a portfolio exposed only to a single country. Investors typically hold over 80% of their stock exposure in their home country, which can be insufficient to effectively manage risk. At FutureAdvisor, we recommend that no more than half of your stock exposure be domestic. The remaining exposure should be split between developed markets, emerging markets and international real estate stocks, roughly in descending order of exposure. Your bond holdings should be internationally diversified too.
So, when constructing your IRA, we believe you should aim to diversify by both asset class and geography, while keeping your investing costs low. Generally, we recommend passive funds with fees under 0.6%, and ideally a lot lower for mainstream investments, such as the S&P 500. See our site for a personalized allocation based on these tenets.