Diversifying Your IRA: What You Need To Know

by Andrea Norris-McKnight

Diversification can greatly benefit your IRA as long as it is done correctly. We talk with a CFP to find out what you need to know about diversifying your IRA.

Cynthia is confused where to invest her IRA. She doesn’t know that much about investing and she’s not sure who can give her good, sound advice.

Since investment choices are vitally important to IRA performance, we wanted to find out how diversification can impact an IRA. To help us navigate the options and questions you might have about diversifying your IRA portfolio, we reached out to Steve Van Wie, CFP® and owner of Van Wie Financial in Jacksonville Beach, FL.

Here’s what he had to say about IRA diversification:

Q: At what age should one begin considering diversifying an IRA portfolio beyond typical offerings like stocks or funds?

Mr. Van Wie: There are seven main classes of assets, including Cash and Equivalents, Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Real Estate, and Hedges, which include commodities. I believe that all of them have their place in virtually any portfolio of any significant size. The proportions vary according to account size and risk tolerance.

With that being said, the real estate category within an IRA only makes sense to me by using a Real Estate Investment Trust or REIT. REITs come in three major classes, namely mortgage REITs that own the financial backing on the properties, Equity REITs that own the actual properties, and Hybrid REITs that own a combination. I prefer Equity REITs, as the others fall into the subcategory of Financials, which muddies the asset allocation waters.

A good financial planner will analyze the investment wants and needs of a potential client, as well as the long-term goals and risk tolerance. The portfolio should be designed and implemented individually to best serve the client’s profile. There is no optimal time for beginning to diversify an IRA portfolio except the day it is conceived and funded.

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Q: Are there optimum market times when diversifying an IRA with real estate might be a good option?

Mr. Van Wie: Real estate is one of the seven most volatile investment classes, and yes, I meant that to refer to my first point. While we all (with real estate) like to “buy low and sell high,” is there any asset class to which that would not apply? No, there is no “optimum” time to diversify with real estate.

Q: And what about when it may not be such a good option? Are there signs that investors can watch for to determine when it might not be a good fit?

Mr. Van Wie: Real estate is like any other asset class in that the percentage used is part of portfolio design and is based on expected portfolio return (yield) and risk (variability). There is no one clue or sign that real estate is a bad or good fit for an investor.

Expert Interview: Choosing Beneficiaries for Your Retirement Plans

Q: Are there other options for diversifying an IRA portfolio beyond real estate offerings?

Mr. Van Wie: There are many ways to diversify a portfolio, IRA or otherwise, within the confines of the seven main asset classes. Commodities are particularly interesting at times and especially during periods of great uncertainty. But, like everything else, their use should be planned, measured, and disciplined. Foreign stocks and bonds can also be good diversifiers, and there is a place for cash as an asset class. Unfortunately, cash yields are currently so low that it forces investors to over-expose their accounts to riskier assets.

Q: Regarding diversifying an IRA portfolio, are there some issues that can come up that people tend to forget to consider? What are some of those?

Mr. Van Wie: The concept of diversifying an IRA is fundamentally simple. You diversify to reduce risk. It is the risk factor that too many people misunderstand. Risk can mean many things when discussed in differing contexts, but in investing, it merely means “variability of returns.” When downside risk is decreased, upside risk (variability) is equally reduced. They are inseparable. This is too often misunderstood.

Generally, my lack of enthusiasm for owning physical real estate in an IRA is mirrored by my opinion of physical ownership of precious metals within the IRA. It has to be kept separate from the owner’s other IRA(s) that hold more conventional assets. These alternative IRAs are expensive to start and own, and they are nowhere near liquid. Further, penalties await the unsuspecting investor who does not fully understand the potential penalties for “self-dealing.”

Diversification is not only wonderful, but it is also absolutely essential to long-term success. Just be careful how it is done.

About the Expert

Steven H. Van Wie has been a Certified Financial Planner® since 2001. He is the founder and President of Van Wie Financial, as well as its parent company, Steven H Van Wie, LLC, a fee-only financial advisory in Jacksonville Beach, FL. He is the co-host, along with his son Adam D. Van Wie, CFP®, of The Van Wie Financial Hour radio program, heard every Saturday morning. Van Wie Financial offers comprehensive financial planning, issue-based consulting, and asset allocation and portfolio management services to the firm’s clients.