We write often in this space about the importance of diversification.
By diversification, we mean more than buying some stocks and some bonds. We mean that you should diversify based on the underlying risk associated with the asset, whether that be interest rate risk, company risk or inflation risk. It's our view that diversifying based on these different risk factors is a good idea for investors to follow.
Is it also important for investors to diversify based on who the money manager is when it comes to certain investments? In other words, if Company ABC is a money manager of a number of different investments spanning a broad array of asset classes, is it OK to solely use ABC's investments?
Investing in an IRA
When you invest in an IRA, you have practically no limits on the investment options you'll have access to. Unlike your employer's plan that may have around 15-25 investment options, you'll have thousands of different investments available to you. This means you'll have no issue being as diversified as you want to be.
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This means that you'll have the opportunity to work with multiple money managers, and we generally think it's a good idea to research different money managers for different investments. The reason is that there is no one money manager that is the best when it comes to every asset class. There may be a money manager who excels at offering, say, U.S. corporate bonds, but they may be inferior to another manager when it comes to emerging market stocks.
That's why it's generally a good idea to work with multiple money managers so that you can potentially choose to work with the best money manager within each asset class.
Investing in an Employer-Sponsored Plan
As we mentioned earlier, you have a limited number of choices when investing in an employer-sponsored plan. Because of these limited options, you may have to use a single money manager for a number of investment options.
While that's probably not the ideal outcome for the reasons we outlined earlier, that doesn't mean you should avoid contributing to your employer-sponsored plan. These plans typically have a matching contribution component that is almost assuredly going to provide you significant long-term benefits, regardless of how limited your investment options may be. It's not necessarily a bad thing to use a single money manager for a number of different investment options, it just may not be the best strategy.
The bottom line is that, when identifying where to invest, it takes research to evaluate what your options are. It's not always obvious what your choices are, nor is it always immediately clear what your best option is, but by taking the time to do your homework, you may be able to benefit by reaping potentially higher long-term returns.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
