No matter how strong your investment portfolio is, periods of loss are a part of the long journey of investing. Most investors know diversifying their portfolio can help mitigate those losses, but what does it mean to diversify, and how can this strategy truly protect from major losses when markets react negatively? This post will help you understand what diversification is, why it’s important for your portfolio, and how diversifying with real estate investments offers one of the strongest returns over time.
What is diversification?
Diversification is the practice of investing in a variety of asset classes, especially ones that are not highly correlated. This tactic is used to improve the stability of your investments overall, as volatility decreases when investments are not all in related assets that would drop together with market changes. By creating a portfolio with less volatility, the potential earnings can be more predictable and steadier over time. Rather than being rocked by every wave of the market, diversified investors can generally enjoy a calmer, more reliable investment path.
The most robust diversification strategies work to maximize risk-adjusted returns. This means choosing to invest where your preferred risk level offers the highest returns. Depending on how long you intend to stay invested in a particular asset, or what life changes you are preparing for, the level of risk you are willing to accept will fluctuate.
Why you need a diversified portfolio?
One common and useful rule regarding diversification is the “30+ rule” which essentially means at least 30% of your portfolio should be invested in alternative assets to enjoy maximum potential returns. More than 20 years of data show that individual portfolios that follow this metric have outperformed portfolios of just stocks and bonds.
Compared to pension plans and endowments, individual investors are less exposed to alternative investments (6% for individual investors, compared to 10% for average pensions and 28% for average endowments), meaning the average individual investor today is highly exposed to public markets and more likely to experience the swings and shifts of a volatile market. But this can change! The availability of alternative investments has grown dramatically since the financial crisis of 2008, democratizing finance in a way that allows individual investors more access to participate in the growth opportunity of alternatives. Investing in any alternatives requires education in that asset, and here we will provide just a few of the reasons why real estate makes an excellent alt investment.
Why you should diversify in real estate investments?
True diversification requires investing in assets that are not highly correlated; so, when markets swing, not all your investments are affected. But what alternatives to the stock market provide the stability that investors are looking for? Some factors that play into this are liquidity, efficiency, and how much information is shared between parties.
Stocks and bonds can be easily bought and sold daily, making public markets highly liquid. But with this high liquidity comes the potential for high volatility as well, with efficiencies in buying and selling opening the possibility for rapid, sometimes overnight changes to occur. When around five billion shares are publicly traded on the stock market each day, it is very difficult to have more knowledge as an average investor or earn above-average returns, no matter how much time you spend reading about Tesla or Microsoft. Real estate, however, is considered illiquid. Private market real estate is a hard asset that sees returns gained slowly over time, maximized by buying and holding for appreciation and income generation. Buying and selling this asset class is considered less efficient, with fewer transactions and less information shared between buyers and sellers — but in a positive way that can be helpful to investors. These factors allow real estate to be negotiable, providing space for educated investors with resources and skills to earn those above-average returns and beat the market.
Strategic diversification is a key component of any investor’s portfolio. It allows you to reduce risk and increase returns by adding alternative investments like real estate. When these assets are purchased wisely and properly managed, they can provide long-term gains that can help offset losses in other parts of your portfolio during tough times.