Diversification is important in investing because… well, diversified investments are your retirement’s foundation

Diversified investments and self-directed IRAs seem to go hand in hand. Using a self-directed IRA with a custodian such as Quest IRA will give you the flexibility to invest in alternative asset classes like real estate developments and precious metals. Diversification is important in investing because it will help strengthen and protect your retirement savings plan. Here are some diversified investment concepts that you need to take into account within the context of your self-directed IRA.

Why diversified investments matter. The rationale behind having diversified investments in your portfolio is to lessen the likelihood that a significant decline in the value of one particular asset will have a catastrophic effect on your overall wealth. Having different types of assets in your account makes it less likely that a significant negative event will destroy your portfolio. Unfortunately, there are countless examples of individuals who suffered devastating losses from having too much of their retirement savings invested in a single company; employees of Lehman Brothers, WorldCom and Enron who loaded their 401(k)s with their company stock lost nearly all of their accounts. Diversified investments could have helped to protect their assets.

Diversified investments and your non-IRA assets. The most complete — and arguably the most useful — approach to diversified investments takes into account your entire investment and savings portfolio. This means that when you’re looking to see if your portfolio is appropriately diversified, you should also include your non-IRA assets in your analysis. If your IRA is diversified but it only represents 10% of your investment portfolio and the remaining 90% in your taxable accounts is heavily concentrated in a single asset, then you may not be appropriately diversified.

Consider how far you are from retirement. The earlier you begin investing in a self-directed IRA, the longer you have to recover from any losses you may suffer due to a lack of diversified investments. Simply put, younger retirement savers can afford a bit less diversification, assuming that the lack of diversification carries with it a greater likelihood of larger investment gains.

Consider tax diversification issues. It’s not uncommon for an individual to have multiple retirement accounts (including IRAs, 401(k)s, employer-sponsored pensions and annuities) and even different types of the same account (such as both traditional and Roth IRAs). The tax implications of these accounts vary, so it’s important to make sure that your annual contribution decisions, as well as your ongoing investment decisions, minimize both your current and future tax burdens. These tax diversification issues also come into play as you consider investments that you make in your taxable investment accounts. For example, investments that are themselves tax-free — such as municipal bonds — should almost never be held in a tax-preferred account such as yourself directed IRA.

Finally, don’t forget to periodically evaluate the diversification within your self-directed IRA. As some assets gain in value and others decline in value, you may wish to readjust the respective amounts of those holdings in order to meet your diversified investments goals.

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