Investing in a stock or type of investment can work very well or very badly for you depending on the year. And from year to year, different investments will end up as best performers, worst performers, or somewhere in the middle. For example, real estate investments earned 42.1% in 2006; In 2008 they lost 48.2%; and in 2013 they earned 3.7%.
Unfortunately, there is no way of knowing which year will result in which type of return. Because of this, diversifying and owning a little bit of everything is a great way to lower your overall risk and avoid getting into the emotional ups and downs of any particular investment.
For a big event like retirement, you can reduce your equity exposure in your retirement accounts. However, in a year like 2008, with a moderate portfolio of 50% bonds and 50% stocks, you could still suffer a significant loss of 31.76%. If you then made a 4% distribution, your accounts would be 35.8% smaller by the end of the year.
An emergency fund that covers at least a year of your expenses in cash or cash equivalents can mean you don’t have to liquidate any securities for living expenses. Instead, you can leave the money you invested and have losses offset while you use your available money to cover the expenses.