I recently attended the Mom 2.0 Conference in Austin, TX, where one of the sponsors was WaterWipes. They were giving away packets of individual wet wipes. You parents out there know how incredibly valuable wipes can be, especially in unexpected moments of vomit/poop/snot/crumbs/sand/paint/etc.
So what did I do? I hoarded as many of these individual wipes as I could, and once I got home, I put a few everywhere. In the car, in my to-go bag, in the kids’ backpacks, in the kitchen, between the couch cushions… You name the place, and I could probably reach a wipe without standing up.
The purpose, of course, was to prepare for those unexpected moments. You don’t know what they’ll be or when they’ll happen, but you know they’re coming.
Why It’s Important To Diversify Your Portfolio
It’s important to do the same thing with your money. Just like I stashed wipes everywhere one could imagine, creating a diversified portfolio is like stashing cash in every corner of the market. This way, no matter what’s going on in the stock market or with interest rates, you’ve got a portion of your investment making money and creating positive growth for you.
The main benefits of creating and maintaining diversified investment portfolios is improving your overall potential returns and mitigating risk. By creating an asset allocation plan in which your investment money spreads across financial instruments, you’ll yield more stable results.
As an example, lately, stocks have once again proven volatile, causing many investors to panic. Meanwhile, bond prices increase as interest rates rise, and real estate just keeps steadily growing. Because each specific investment asset class performs differently, if you were invested in all three of these things evenly, your result would be somewhat of an average of the returns from all three classes.
Why Should You Diversify Your Portfolio?
All markets are cyclical – that includes foreign markets, fixed income markets, the stock market, the real estate market – all of them. It’s important to note that diversification within a market (let’s take the stock market, for example) reduces asset-specific risk but doesn’t eliminate market risk. This means when you diversify your portfolio across index funds, you’re protecting yourself from owning too much of one stock or going in too heavy on a single index fund relative to other investments.
“But what if the market crashes? or we enter a recession?!” you say.
Well, to protect yourself from market risk, you have to diversify across markets. This is generally where investors explore fixed-income investments and alternative investments (those that aren’t reliant upon or tied to Wall Street) like real estate, private equity, commodities, and collectibles, to name a few.
By investing in a variety of markets, in addition to spreading your capital across multiple long and short-term investments within each market, you’re able to choose investments that are by themselves risky but that average out to be well within your preferred risk tolerance for your portfolio.
This is why here at Goodegg Investments, we openly discuss and emphasize diversification strategies within real estate. By investing in various real estate assets, each with a varying time horizon, can lower your overall risk and increase your chances of higher long-term returns.
5 Ways To Diversify Within Your Real Estate Investment Strategy
Don’t just quit after stashing wipes in every corner and creating a diversified stock portfolio. It’s important to do the same thing for your real estate portfolio. We don’t know what will happen in the future, but based on the economy’s past performance, we know that corrections and recessions happen in cycles, so if we’re not in one now, one will be coming up. Thus, it’s important to do everything possible to hedge your bets and prepare to weather those storms.
Portfolio diversification is one of the most powerful strategies to maximize your long-term financial growth. From a high level, a well-diversified investment portfolio includes stocks, bonds, funds, international stocks, and alternative investments like real estate. Then, within each of the different asset classes, you can further your portfolio diversification by selecting different investments within that sector based on asset size, industry, strategy, or location.
A solid diversification strategy prevents you from putting all your eggs in one basket and helps balance out your natural tendency to lean toward only investing your money in various industries and locations where you’re most comfortable (like your own company stock, for example). While all investing involves risk, spreading a percentage of your cash across an investment portfolio instead of in a single investment vehicle helps protect you from market volatility.
Let’s talk about the top 5 ways to diversify your real estate portfolio so that you can protect your investments.
#1 – Asset Type
The variety of different asset types is one of the things that makes real estate investing so fun. You can choose to invest in anything from single-family homes to small multiunit properties to large apartment complexes. You can invest in retail, industrial, office space, self-storage, and more.
There’s value to be added and money to be made in all asset types. By investing in different types of assets, you are hedging against broader macro changes to the economy, like the shift we’re currently seeing in the retail space with the growth of e-commerce.
#2 – Location
Real estate is hyperlocal, meaning that one city might be booming, while a neighboring town might be experiencing a slowdown. As a real estate investor, you want to invest in areas that are growing or have the most potential for growth. By diversifying across different geographies, you can take advantage of the ups and downs of various financial markets and hedge your bets against a major correction in any one location or region.
If all your real estate holdings were within one market, and that market were to hit a slowdown, your overall portfolio would be in jeopardy. However, if you had one investment in Dallas, another in Orlando, another in Charlotte, and so on, the impact to your overall portfolio would be much less pronounced.
The problem is it’s easy to think about diversifying across different markets, but another thing entirely to actually invest in multiple markets. After all, for each market, you have to do a significant amount of market research, connect with local brokers, perhaps fly out to see properties and more.
This is what makes passive real estate investing (also called pooled investments) so attractive, as you can leverage the experience and connections of the sponsor team to get you into each market. You would still need to do your own due diligence, but you wouldn’t have to start from scratch in each new market.
#3 – Asset Classes
When diversifying across asset classes, it’s important to understand a bit of human behavior during booms and busts. Let’s use apartments as an example. In good market conditions, people rent bigger, more luxurious apartments in nicer areas. In tough times consumers behave differently cutting back on housing costs. They might need to downsize, find a more moderately priced apartment, or move across town.
There are asset classes that fare well in good times and asset classes that fare well in bad times. Because real estate is cyclical and because no one knows when the next recession will hit, it’s important to diversify across asset classes to ensure your portfolio is profitable in all parts of the market cycle.
#4 – Hold Length
For real estate syndications, a great way of diversifying your portfolio is through the length of the hold time. Many of the real estate syndication deals that we do come with a 5-year hold. However, we’ve also done some with a 7-year hold or longer.
Reduce risk by considering the hold length and timing of the investments’ planned sales to ensure that you’re not simultaneously entering or exiting a bunch of individual investments.
#5 – Syndication Funds
A very easy way to build a diversified portfolio quickly is to invest in a real estate syndication fund. Unlike a syndication for a single asset which carries more risk, a fund pools together investor money to buy various assets within a specified period of time.
Typically, the fund is defined by certain geographies, asset types, and asset classes. If you find a fund that fits your investing criteria and with a great sponsor, this could be a great option for portfolio diversification.
Creating a Diversified Portfolio is Easier Than You Think!
We’ve been in an up market for several years now. It seems that virtually any piece of real estate you touch turns to gold. But as history has shown us, market risk is always present. The real estate market and the stock market are cyclical. What goes up must come down. Sooner or later, we will hit a correction, and it’s important that you diversify your portfolio before that happens.
Key Takeaways? Diversification is for everyone, no matter how much or how little you have invested and no matter which types of investments you prefer. Personal finance can get as complicated as you let it, so mitigate risk by researching and selecting your own investments that carry lower risk and will pay out according to a time horizon that aligns with your personal and financial goals.
Before making any big moves, consult your financial advisor or investment professional. Assuming they understand your risk tolerance and financial goals, they can help you allocate all your money wisely, including traditional assets like stocks, index funds, and mutual funds, and alternative investments like real estate syndications and funds.
Whether you create a diversified portfolio through asset type, location, asset class, hold length, or by investing in funds, the choice is up to you. As you evaluate different investment opportunities, having these five ways you can diversify your investments in the back of your mind will help you balance and diversify your portfolio.