Diversification key to successful investing

Defined contribution members can take advantage through target date funds

By Michael Pramik, Ohio Public Employees Retirement System

Sept. 27, 2023 – Investing for the future is challenging. The market is unpredictable, so how is one to know what to invest in, and when? The truth is, no one knows for sure which asset class (stocks, bonds, commodities or other investments) will produce positive returns and which ones will not at any given time.

OPERS investment professionals manage this uncertainty through diversification. It’s the concept of not putting all your eggs in one basket. The idea is fairly simple. If you invest in a variety of assets, you will have less risk in your overall portfolio because some of those assets are likely to be doing well while others are not. And since you never know which asset will perform well at any particular time, it’s important to invest in a cross-section of assets. Ideally, the performance of those assets will be uncorrelated. In other words, some will zig while others zag.

To illustrate this concept with a simple example, consider two extremes: a portfolio consisting of a single stock and a portfolio consisting of 500 stocks. If you own one stock, your risk is very high because if that stock loses value, so does your entire portfolio. It’s easy to see how a portfolio with 500 stocks greatly reduces your overall risk. You have 500 chances of seeing a gain in your investment as opposed to one.

This example illustrates why mutual funds are good options for investors with less experience. By definition, they hold a diversified portfolio of stocks (or bonds). One diversified mutual fund should have a lower risk profile than a single stock.

Of course, the principle of adding additional assets to a portfolio to reduce risk isn’t something that continues indefinitely. Adding a tenth mutual fund is unlikely to provide the same diversification benefit as adding a second one, especially if there is overlap in the types of investments the funds make.

This is why target date funds are included as part of your OPERS defined contribution plan investment options. Each target date fund invests in several funds (so it is instantly diversified to an appropriate level) and is designed as a one-stop investment that puts retirement savings on autopilot. In this case, investors are meant to put their nest egg in one well-diversified fund based on the year they plan to retire.

The target date fund will automatically shift its holdings from more-risky funds to less-risky funds as the member nears retirement. The investor doesn’t need any additional funds in a retirement portfolio – the target date fund does it all by providing a fully appropriate asset allocation for the investor at every career point.

If you’re a member of the OPERS defined contribution plan, we encourage you to log in to your account at opers.org and make sure your current allocation and future investments are aligned with your retirement goals.