Modern portfolio theory states that a diversified portfolio has lower overall
risk than a portfolio that is invested in a single asset or asset class. The reason
for this is that different types of assets react (i.e. experience changes in value)
differently to external factors. For example, when conditions are favorable for the stock market, the bond market often declines. Therefore, according to
modern portfolio theory, an investment portfolio that comprises both stocks and
bonds will have lower overall risk than a portfolio of stocks alone.
The same can be said for a retirement portfolio. Consider a retirement portfolio to consist of all the assets that may provide income during retirement: social security payments, 401(k) accounts, pension plans, individual retirement accounts (“IRAs”), the equity in a home, a possible inheritance, investment accounts, etc. The risk that retirement income will suffer significant fluctuations due to external
factors can be reduced by relying on a variety of sources for retirement income instead of just one. This is because each source of retirement income provides unique benefits and reacts differently to external factors.
