For years, investors have been told that owning an S&P 500 index fund is one of the simplest ways to build a diversified portfolio. After all, you’re investing across 500 of America’s largest companies.

But there’s an important question for anyone approaching retirement: How diversified is that portfolio really?

Today, a relatively small number of very large companies make up a significant portion of the S&P 500. Many of those companies have benefited enormously from enthusiasm surrounding artificial intelligence, technology and related industries. As their valuations have grown, so has their influence on the overall index.  

That concentration has certainly helped investors enjoy strong returns. But it can also create additional risk.

Diversification Doesn’t Eliminate Every Risk

Owning hundreds of stocks can reduce the risk associated with any one individual company. But it doesn’t necessarily protect you when a major event affects the entire market.

Economic shocks, geopolitical events, supply-chain disruptions, tariffs and other broad developments can impact many companies at the same time. In other words, you may have diversified away some individual company risk without eliminating systemic market risk.  

That distinction becomes particularly important as you get closer to retirement.

When you’re working and regularly contributing to your retirement accounts, market declines can actually provide opportunities to buy investments at lower prices. You may also have years—or decades—for your portfolio to recover.

Retirement changes the equation.

Why Market Losses Can Hurt More in Retirement

Once you begin withdrawing money from your portfolio to pay living expenses, the timing of market returns matters much more.

Imagine your portfolio gains 10% in a year and you withdraw 4% for living expenses. You’ve still experienced positive growth.

Now imagine the market falls 10% and you still need that same 4% withdrawal. Instead of simply absorbing the market decline, you’re removing additional money from an already reduced portfolio.

Your effective loss becomes much harder to recover from. If that happens repeatedly during the early years of retirement, it can potentially create a lasting hole in your retirement plan.  

This is commonly referred to as sequence-of-returns risk, and it is one reason retirement investing requires a different mindset than investing during your working years.

Can You Participate in Growth While Limiting Downside?

Protecting against risk doesn’t necessarily mean abandoning the stock market.

There are investment approaches intended to allow investors to participate in some market growth while placing defined parameters around potential losses. These can include strategies such as buffer ETFs, structured notes and market-linked CDs. Each works differently, and each involves its own tradeoffs, costs and risks.  

The goal isn’t necessarily to eliminate every possible loss. It’s to understand how much risk you actually need to take to accomplish your retirement goals.

That question matters because the highest possible return isn’t always the most important objective in retirement.

If your financial plan shows that you can comfortably support your desired lifestyle without taking extreme investment risk, accepting additional volatility simply to pursue a little more return may not improve your retirement very much.

Your portfolio should ultimately support your life—not keep you awake worrying about the next market decline.

If you’re approaching retirement and aren’t sure whether your current investments provide the right balance of growth, income and downside protection, it may be worth taking a closer look at your strategy.

Schedule a consultation with Leibel Sternbach to discuss your retirement plan:
https://www.yields4u.com/pages/book