I was having a discussion about retirement the other day with a friend, and he said something that made my jaw drop. He said “I try to stay diversified, that’s why I have a 401k and a Roth IRA.”
Now, my jaw didn’t actually drop, at least I don’t think it did, but if you’re nodding right along with my friend and don’t understand why I was alarmed, this post is for you.
We hear investment lingo thrown around often enough that most of the time, we understand it. Or we think we do. Even if we don’t take the time to look a word up, context clues are usually enough. Diversify is one of these words. On it’s face, it’s a simple concept: Don’t put all of your money in one spot. Or, if you prefer the common metaphor, don’t put all of your eggs in one basket.
The problem is that you could have money in a Roth IRA, Traditional IRA, SEP IRA, 401k, 403b, and every other retirement account out there, and still not be diversified. Why? How is that possible?
Because none of those accounts are investments. They contain investments. You buy investments from within those accounts, but the accounts themselves are almost meaningless outside of their tax implications.
Ready for another metaphor? Think of this like cookies. If you have a red cookie jar, a purple cookie jar, and a blue cookie jar, and you put five chocolate chip cookies inside each jar, your cookies are not diversified. You have fifteen chocolate chip cookies, and you’ll be out of luck when you offer a cookie to someone who hates chocolate. The jar they’re in is irrelevant.
If, instead, you have one yellow cookie jar, and inside it you put two chocolate chip cookies, one peanut butter cookie, one sugar cookie, and a butterscotch scotchie, now your cookies are diversified. You own multiple different quantities of several different cookies. Your chocolate averse friend will find something they like.
This is exactly the same as your retirement accounts. If you have an IRA and a 401k, and within each account you hold shares of nothing but AAPL (that’s Apple, by the way), you are not diversified. I don’t advise you own single stocks at all, because that feels more like gambling than investing to me, but even if you own an S&P 500 index fund, which tracks the market as a whole, you’re not fully diversified. Those funds are made up of a small subset of companies that are representative of the market as a whole, but they are not the whole market.
The bottom line is that diversification means holding different investments, not that you have multiple different accounts.
If you were confused about that, I hope this helped. If you already knew this, what are you doing to diversify your investments?
I use a company called WealthFront for my retirement investing. They handle all of the diversification across seven different market categories. They charge a very small percentage, 0.25%, to manage your account. If you want to check them out, you can use my link to sign up and we’ll both get $5,000 managed for free: https://www.wealthfront.com/c/affiliates/invited/AFFA-JULO-FM5C-I5DP