How Diversified Should Your Wealth Be?

One of the main goals of wealth management planning is to ensure that a client's assets and money are stable and growing. For a wealth management advisor, diversification is an essential tool for achieving this goal.

Most people have a general sense of what diversification is in terms of not leaving too much of their portfolios in any particular asset class. However, that doesn't give you a great sense of how diversified your wealth should. A wealth management professional will look at the issue in the following four ways.

Client's Age

Roughly speaking, a client's portfolio will become less diverse as they get older. That's at least the case in terms of the types of asset classes they should own. A client will pull money from higher-risk assets as they approach retirement and move into more of a wealth maintenance mode.

The reverse is also true. A younger client should consider a number of high-risk and high-reward assets. The net effect is that they will usually be more diversified, especially with assets like stocks, options, and bonds.

Risk Appetite

Everyone tolerates risk differently. If you're someone who doesn't want or need to get into high-risk investments, you may want to diversify across several low-risk classes. The logic here is that it's highly unlikely that all of the assets will go bust at once, even in the worst-case scenario.

Similarly, some folks who are very comfortable with risk may have less diverse portfolios. A young person might drop a good chunk of their wealth into commodities' futures, for example, as bets on where the market is headed. This offers them a high upside on aggressive bets, and they often can keep their costs down by either eating losses on or selling expiring bad bets.

Need for Available Capital

While diversification is great, there is a risk that some wealth management planning strategies may put your money out of reach when you need it. If you might want to start a business in the next 5 years, for example, you don't want to have your wealth tied up in long-term bonds. The ability to access capital when you need it is important, and you should structure your portfolio accordingly.

Near-Future Risks

A wealth management advisor will try to avoid diversification for its own sake. That's especially the case if near-future expected returns and risks aren't great. This means that a wealth management plan is never fire-and-forget. You and your advisor will have to make adjustments as circumstances shift.