Why Portfolio Diversification Matters to Your Investing & How to Achieve it
No matter what your investment strategy is, you will undoubtedly be advised about the importance of having a diversified portfolio. Portfolio diversification is often advised by financial advisors, fund managers, and various other financial professionals as the best way to lower risk, protect your investments and have a better overall return.
We will go over ways you can begin to explore that may help you diversify your portfolio with the caveat that we are not providing advisory services, legal advice, investment advice, financial advice, or tax advice. With any of the information you learn today, we encourage you to always consult with your investment advisor before making any investment. We had to get that out of the way. Phew! Onward!
Portfolio Diversification: What Is It And Why It Matters
Diversification is the practice of reducing market volatility and financial risk by investing in different assets in various industries. It could be the approach of investing in different companies in different industries or different asset types in the same sector. Asset allocation is designed to help you achieve your financial goals within a specified time frame that takes into account your personal risk tolerance.
Diversifying your portfolio can achieve two main objectives:
- Your investments can be better protected from market risk if you don’t have all of your “eggs in one basket” so to speak
- With your total investments diversified there is a strong correlation that you can have a higher average annual return
While there is never any guarantee of future results, with proper diversification into different types of investments, in at least part of your portfolio, you should see better returns and less risk than if you had not diversified at all. That is why diversification matters.
What Is In A Diversified Portfolio?
A diversified portfolio is comprised of an array of different investment vehicles such as stocks, bonds, real estate, real estate investment trusts (REITs), or various other asset types.
Many investment professionals may advise long-term investors to follow what is called a “60/40 rule”, whereby 60 percent of an investment portfolio is comprised of stocks and 40 percent of an investment portfolio is in fixed-income investments. Individual investors, however, all have very individual needs and individual risk tolerance, so it is always best to consult with your financial advisor as to what would be the best investment advice for you.
How Do You Diversify Your Investment Portfolio?
Diversification can mean different things to different people. It is always important before making investment decisions to understand your investment goals and what you want in the short term and what you want in the long run as well. And having those goals defined and laid out can help you better understand how and where to diversify your portfolio and place your capital.
But first, you should have an understanding of some of the types of investments that you can diversify into:
- Stocks: units of stocks are shares of a corporation, which can provide a steady return and the value can be quite significant over time. However, there is an enormous amount of market volatility around stocks and the stock market that should be considered. Stocks are not considered to be conservative investments – they can be quite volatile and pose risk, depending on the stock, of course.
- Funds: An investment fund is a pooling of capital by numerous investors used to collectively purchase securities while each investor retains ownership and control of their own shares. Types of investment funds include mutual funds, exchange-traded funds, money market funds, and hedge funds. Another type of fund that we will discuss is a real estate syndication fund, which is an excellent vehicle to invest in if you are investing with the right deal sponsor and team.
- Bonds: Bonds are issued so that loans can be made to a government municipality or a corporation. Bonds can be a fixed-income vehicle, and are usually considered to be a “safe” investment but will typically have lower returns.
- Commodities: This is a raw material, often agricultural goods that can be bought and sold such as crude oil, beef, wheat, copper, etc.
Investing in Real Estate
- Real Estate: Our favorite of course. It’s important to put investment dollars into highly appreciating assets that have amazing tax advantages as well. Real estate syndications, for example, can provide high returns and it is a physical, tangible asset unlike some of the other asset types available.
These are just some of the different ways you can diversify your portfolio, but again, your financial planner can help you narrow down a strategy once you have a better understanding of your goals.
Rules of Thumb When Diversifying Your Portfolio
Here are some guidelines for diversifying your portfolio:
- You don’t want to diversify too much: Diversification in and of itself is not an investment strategy, and it doesn’t give you complete protection from risk. Also, keep in mind that you can be overly invested in “safe” investments. With less risk exposure, those assets may provide far lower returns, and you could lose the opportunity to have the growth you need to meet your goals.
- Vet Your Financial Advisor Carefully: Be careful of the commissions and fees that you are being charged and that you understand exactly why you’re being charged, how often you will be charged and the percentage of your returns you are being charged.
- Keep Growing Your Portfolio: After you have met some of your financial goals and your portfolio is generating good returns, you will want to be sure that you are looking at opportunities to reinvest that capital to keep your portfolio growing.
5 Ways Real Estate Can Maximize Portfolio Growth Through Diversification
A very simplistic way to look at diversification is to look at the behavior of squirrels. Yep, squirrels. I live in the Rocky Mountains of Colorado and every fall season I watch these busy little creatures gathering nuts feverishly with every ounce of energy they have and burying them in what must be hundreds of different locations. Why wouldn’t they just put them in one place? Certainly a heck of a lot easier to remember, right? But they do that as a way to prepare for possible loss. They know they may lose some, but if they spread out their “assets” enough, they will always have what they need to survive and thrive.
They understand the power of diversification. It is a way to expect the unexpected and reduce your risk.
Diversifying Your Real Estate Portfolio
Similarly, it’s important that investors learn to expect the unexpected with their commercial real estate portfolio. Although we cannot predict what real estate market conditions will be like in the future, we can look at past performance and historical data and know to expect the ups and downs of cycles. Global markets and local financial markets have recessions. Real estate markets have corrections. That’s why it is so imperative that you know the importance of diversification to mitigate inevitable fluctuations and weather these economic cycles.
By diversifying your real estate portfolio into different investments and different types of assets, you can lower the risk overall.
Here are 5 ways you can do this:
#1 – Asset Types
There are a variety of real estate investments and asset types you can invest in. You can invest in mobile home parks, self-storage facilities, assisted living facilities, industrial complexes, office buildings, and our favorite – multifamily housing communities, and much more. By varying the type of investment you target and the different asset classes, over the long term, you can hedge fluctuations in the market and the economy as a whole.
#2 – Location Location Location
At any given time, one real estate market may be booming while another nearby city or town in the same general geographic area may be stagnating. Savvy real estate investors always research real estate markets to see how well they are growing and what their anticipated growth will be depending on various factors and metrics.
By diversifying each particular investment across multiple geographic areas of the united states, you are essentially hedging your bet that if one area or type of asset doesn’t perform to expectations at that particular time in the market cycle, then you have an array of other solid assets in growing markets to offset that market correction.
The challenge many investors have in investing in various geographical locations and investing in various asset types is the lack of high-level market research, analytics, expertise, connections, and the additional information needed to locate deal sponsors who have prospective opportunities in these outstanding markets for you to be able to invest in confidently. This is why passive investing is such an amazing way to grow your wealth. You are able to leverage a deal sponsorship team of people – a syndication team – who have the expertise, market knowledge, systems, and ability to acquire these assets FOR YOU to be able to invest in these opportunities alongside the sponsor team in each of these markets.
#3 – Asset Classes
In addition to asset type, you also have asset class, which is essentially a spectrum of low-end (Class D) to high-end (Class A) assets within each asset type.
For example, a multifamily apartment community that is a Class B or a Class C will usually perform better during economic downturns than a Class D or a Class A. The luxury Class A properties perform better during economic boom times. This is why it is important to work with a team that understands the market cycles, the strong asset classes, the asset types, and the real estate market within which you are investing so that your portfolio is diversified and poised to grow through that diversification.
#4 – Hold Terms
Real estate syndication investments typically have hold terms that range between 3 years and 10 years (possibly more). What you may consider is to vary the hold terms of your investments. For example, invest in one syndication that is exiting in 3 years, and invest in another syndication that is exiting in 7 years and another that is exiting in 10 years, and so on. This strategy can help you capitalize on the various fluctuations in the market cycles.
#5 – Real Estate Investment Funds
You may consider a real estate investment fund. Instead of investing in one-off real estate syndication deals, an easy way to diversify rapidly is to invest in a real estate syndication fund. A real estate syndication fund will pool the investors’ capital and acquire targeted assets within a specified time period. Funds can be categorized and specified by asset class, asset type, unit size, market location, and various other factors.
Just know that there will be times in any real estate market cycle when it will seem that the market will never come back, and conversely, other times it may feel like the market will never slow. Historically, we know that neither of those scenarios will last forever, so the best way to mitigate loss and capitalize on growth and returns is to diversify your portfolio in anticipation of the next phase of the cycle.
No matter where we are in the market cycle, you can still make money if you know where to find the opportunities. Always consider these 5 ways to diversify when exploring real estate investments.
Ready to Learn More?
The best way for you to learn more about passive investment opportunities in commercial real estate syndications is to join the PCRP Passive Investor Club.
Through the PCRP Passive Investor Club, you’ll get a priority review of all the deals we offer. We’ll work with you to determine your investing goals and then present you with the best deals to meet those goals. We’ll then guide you every step of the way as you invest in those deals.
So if you’re ready to start investing passively in institutional-grade, commercial real estate in fast-growing, climate-resilient markets in the U.S., join the PCRP Passive Investor Club – IT’S FREE! – and get started on your path to EARN PASSIVELY and LIVE ABUNDANTLY!
If you would like to know more about what we do and how it may be of value to you, please reach out to us anytime. We’re always happy to help!