Why is Diversification Across Asset Classes So Important?

We’ve all heard the ancient wisdom warning against putting all of your eggs in a single basket – and the same is true when it comes to investing. In order to protect your 401(k) savings and give your funds a chance to grow, diversification is essential. It’s unwise to throw all of your 401(k) savings into a single proverbial fund basket.

Prudent Fiduciaries Choose a Diversified Fund Lineup

One of the five main IRS-defined fiduciary duties is diversifying 401(k) plan investments. Part of being a prudent fiduciary and protecting yourself from fiduciary risk is choosing assets spread across all major asset classes. Diversification is always in the interest of your employees – and it’s a great step toward avoiding costly lawsuits and giving your plan participants the best chance at retirement readiness.

Past Performance is No Guarantee of Future Returns

No matter how positive or negative a fund’s performance has been over time, it’s impossible to be certain of how it will perform in the future. Yes, a high performing investment may continue to perform well. However, imagine that one of your employees puts their entire retirement savings into that fund and it crashes, leaving an insufficient retirement nest egg.

On the other hand, a moderately performing fund could make an unpredictable turn toward higher returns. The bottom line is this: You can’t be certain of how funds will perform, so how can you choose the right funds and diversify your 401(k) fund lineup?

The Basics of Asset Classes

To choose a diverse array of 401(k) investments, you must first understand different fund asset classes and how they have performed over time.  According to Investopedia, an asset class is “a group of securities that exhibits similar characteristics, behaves similarly in the marketplace, and is subject to the same laws and regulations.”

There are three main asset classes – equities (stocks), fixed income (bonds), and cash equivalents (money market). Each class has different risk and return qualities, and diversification across different asset classes can minimize risk and maximize return based on a given investor’s risk tolerance, age, and a variety of other factors.

Refer to the Callan Periodic Table of Investment Returns

One way to get insight into fund performance is to refer to the Callan Periodic Table of Investment Returns. This “periodic table” lists the performance of 8 major asset classes over the last 20 years. The table is updated every year, and the most recent version can be found on Callan’s website.  The table lists the asset classes top-down, from best performing to worst by year. The table is also sorted by color, so you can tell how certain asset classes have performed over time at a glance.

Hire a 401(k) Registered Investment Advisor

If you’re not comfortable choosing your 401(k) plan’s diversified fund lineup on your own, you have the option to hire a professional 401(k) Registered Investment Advisor (RIA) like Plan Strategies, Inc. Hiring RIA takes a significant amount of fiduciary liability off of your shoulders, and turning to an expert can help you give your employees the best possible chance at retirement readiness.

When it comes to choosing the best funds for your retirement plan, remember the importance of asset class diversification. Spreading your 401(k) plan’s savings across a variety of funds in different asset classes will protect your nest egg and maximize your potential investment returns.

 

Located in Denver, Colorado, Plan Strategies, Inc. is an SEC-registered 401(k) investment advisor to small and mid-sized businesses. PSI is focused on decreasing the 401(k) fiduciary risk facing employers offering retirement plans.

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