The Five Percent Limit

Bad things can happen to really good companies. Your company’s generous retirement contributions may have made you rich on paper while you were still working, but the game is how to remain financially comfortable after you retire. Placing all your bets on one company, no matter how storied their reputation may be, is often a recipe for retirement failure.

You need to diversify in retirement, and this is where our Five Percent Limit comes in. The principle is that no one investment should make up more than five percent of your portfolio. Diversifying doesn’t necessarily guarantee a profit or protect you against a loss, but it is a technique designed to limit the potential for catastrophic loss.


Twenty Times More Comfort

In a simple example of the Five Percent Limit, a portfolio is built of individual stocks. The investor could abide by the Five Percent Limit by building a portfolio of 20 stocks. When no single growth investment makes up more than five percent of your portfolio, you are provided with the comfort of knowing your portfolio will manage through good times and bad – whether that’s due to the economy or any particular holding.

The more your portfolio is made up of non-correlated investments, the better your portfolio’s ability to smooth out the ride. As one zigs, another zags. This creates a strong sense of stability and comfort.


Two Views of Diversification

One of the benefits of mutual funds is that they simplify this process – but this simplicity can come at a cost. One common mistake with mutual funds is not staying conscious of the fund's holdings. For example, a mutual fund investor can easily achieve the Five Percent Limit by investing in an S&P 500 Index fund. However, some mutual funds have heavy concentrations of stocks, bonds or other assets, such as precious metals. Investors may not be aware unless they read the fund's prospectus or use one of the online sites to research mutual funds.

At Oxford, we look at diversification in two ways – across asset classes and within them. The three major asset classes are stocks, bonds and cash, and you can divide your holdings across those classes for a level of diversification. In diversifying across asset classes, we may determine that 15 percent of your overall portfolio should be in large U.S. stocks. That’s still a big portion of the portfolio, but we actually have several holdings making up that 15 percent.

You also need to diversify your holdings within an asset class. You can slice and dice them in a wide variety of ways. With stocks, for example, you have large, medium and small companies and you have international and domestic. Similarly, with bonds, you have corporates, government and international.

The result of all this diversification is much higher levels of comfort and greater levels of stability during retirement. Are you interested in learning how to take full advantage of the Five Percent Limit in your retirement? Get a copy of Power of Five Investing today!