Balance Your Portfolio Through Diversification
Current global events should motivate you to focus on certain pressing questions. Here is one of the most vital questions to consider:
Is my investment portfolio balanced and resilient enough to withstand market volatility or do I need to diversify more fully?
This article will:
- Give an overview of the importance of diversification
- Encourage you to consider adding real estate investment to your portfolio to add stability
- Explain how you can diversify your investments even within the sphere of real estate
Investment Diversification – An Overview
Why is diversification of your investments so important?
Diversification is one of the best ways to minimize risk. Every investor has different investment goals and it is important to have a clear view of your own, whether it is saving for retirement or for more short-term goals, focusing on your ultimate aims will enable success.
Of course, differing investment goals also means different risk tolerances which will have an impact on your investment portfolio. Whether your investment goals allow you to tolerate slightly more risk or not, it is important to analyze risk reduction strategies. Diversification is an excellent way to add stability and reduce risk while not affecting a portfolio’s wealth building capacity.
How does diversification achieve this risk reduction?
This is mainly achieved by ensuring your portfolio is spread across different types of investments that will each react differently to the same event.
The key with diversification is to try to limit the correlation between your investments. Simply investing in more financial assets does not mean better diversification if those assets are strongly related. For example, buying stocks in multiple companies of the same type is risky because a single event may cause all of those stocks to devalue. Due to globalization, asset classes are also becoming more correlated than in the past.
In view of the fact that unexpected events can impact investment, you should certainly consider adding real estate to diversify and stabilize your investment portfolio. This reduces exposure to unsystematic risk by diversifying your investments and ensuring that they are not closely correlated to one another.
See the article, Investing In Real Estate Vs. The Stock Market
Add Stability to Your Portfolio by Investing in Real Estate
Many investors shy away from diversifying their portfolio with a real estate investment because of their inability to liquidate that investment quickly. In actual fact, it is this illiquid quality of real estate investment that can anchor and stabilize your investment portfolio!
Real estate is a tangible asset and as such for many investors, feels more real. It is an asset that engenders confidence. A great appeal of this type of investment is its stability. For many millions of people, this kind of investment has generated consistent wealth and long-term appreciation.
Real estate investment provides passive investors with very consistent and stable rental income. Having a home is a vital necessity for all people, and as a result, rental investors are relatively protected even during economic downturns.
As we have seen, your portfolio’s long term resilience lies in diversification across different asset classes.
Due to the different buying and selling dynamics of the private market, private real estate investment benefits from low correlation to the performance of stocks and bonds unlike publicly traded real estate investment trusts aka (REITs). That is why they are great options for diversification against unsystematic risk and are thus considered crucial to a clear strategy for diversification.
Even within the percentage of your portfolio that includes real estate investment we encourage further diversification subsequently reducing risk even further.
Diversification in Your Real Estate Investments
How can you create a diversified real estate investment portfolio?
There are three main areas where we encourage diversification. These are:
- Asset Class
Although the risk is relatively small, having all your real estate investments in one geographic location is like having all your eggs in one basket.
A real estate investment in a certain area affected by extreme weather for example, might typically perform well, but would it be wise to have all of your real estate investments in that one area?
Aside from weather issues, there are economic factors such as one area being heavily dependent on one particular employer or one particular type of employer.
Although it would likely be wise to invest in that area in certain circumstances, if there is a major issue that affects that one industry or employer than that area might become vulnerable.
For these reasons, it is wise to spread your investments in real estate over a wide and varied geographical area as your portfolio grows.
Asset Class Diversification
When it comes to investing in multifamily properties, certain asset classes perform better in a growing economy while others weather a downturn more effectively.
As your portfolio expands try to diversify as much as possible within the range of risk that you are comfortable with. (Some asset classes such as hotels may be too high risk for your liking.) The goal is for your cash flow/returns to remain consistent.
As a passive investor in a multifamily syndication, you are putting trust in the operator of the deal. Since the day to day running of the operation is taken care of by the operator this leaves you free to diversify and invest in multiple syndication deals. By doing so, you will not have 100% of your real estate investment capital with any one operator.
To summarize, advanced diversification affords investors the opportunity to increase return potential and reduce portfolio volatility. This is particularly true when diversifying into real estate investing, when investing across various geographical locations, investing in different asset classes and with more than one operator. While the detail of the diversification is down to you, you can be sure that the more advanced and carefully planned the diversification, the stronger and safer your investment will be!