Column ‘Big Joe’ Clark: The risk of having too many chefs in the kitchen | Columns
Conventional wisdom in the investment world dictates that when you reach retirement age your investments should become more conservative. A retired person can no longer handle market fluctuations.
In theory, this seems like a reasonable idea. Trustees, however, know that many other factors, besides retirement age, should guide decisions about the allocation of investments.
Diversification is essential to mitigate risk in retirement. Some investors believe that having their savings in one mutual fund or multiple mutual funds means that they have diversified their investments. Unfortunately, it is not that simple. The average person who owns a mutual fund owns various mutual funds for even more diversification, or so they think so.
What happens is similar to having multiple chefs who all used the same ingredients. When you look at the top 10 holdings of each mutual fund, you’ll find some similarities. Owning the same stocks in several portfolios is not diversification. How much of each asset class you own, whether it’s stocks, bonds, or cash equivalents, such as money market funds, is a critical piece of the puzzle. Investors have limited control over what goes on inside their mutual funds at any given time.
The primary purpose of saving and accumulating is to replace your standard of living in retirement. When you separate from the workforce, happiness depends on sustaining the life you had while working, not sustaining the income you earned. Believing that you can diversify risk by holding multiple investments, or conversely, investing entirely in cash investments, is risky business. Your allowance build should be about the financial need to replace your lifestyle rather than your current age.
Knowing the asset allocation and taking the appropriate risk in your portfolio is essential, but ideally all of your family’s assets work together. With too many chefs in the kitchen, such as multiple advisors, fund managers, or mutual funds, there is no guarantee that all of the investor’s funds are working together.
The main example is when two spouses each have 401k plans. Often, the allocation of each plan is chosen without taking into account the other plan, thus deciding in silos.
Siled investing or siled decision making is the process of looking at a particular investment and making that decision without considering what other assets you own. The financial risk decreases as the number of chefs in the kitchen decreases.
If an investor has multiple advisors making money-based decisions in a single silo without knowing the full picture, critical errors are likely to occur. Great chefs and great fund managers are readily available, but that doesn’t mean they all have to work for you in separate silos at the same time. Consider reducing and simplifying whenever you have the chance.
Working with a trustee can help you take into account the many decisions that arise as you approach retirement. Your pursuit of clarity and security is noble, but investing is not as easy as it sounds. Examine all of your opportunities to coordinate the best strategy.
Joseph “Big Joe” Clark, whose column is published on Saturdays, is a certified financial planner. He can be reached at [email protected] or 765-640-1524.