In today’s rapidly-changing investment scene, diversification is essential for every investor. It’s common advice from financial advisors to not put all your eggs in one basket. No matter how many times you hear it, many investors tendency is to ignore the advice.
When investing, investors should prioritize diversification as it reduces risk and provides new opportunities for success. If you’ve new to investing, a key question is how you can diversify your investment portfolio and put different investment vehicles to good use. In this article, we provide a few quick steps on diversifying your investments.
Step 1: Emergency Cash
Before building your investment portfolio, the first step is to always ensure you have enough liquidity to handle unexpected expenses for the curves life tends to throw at you. On average, it is recommended that you maintain a cash buffer equal to 6 months of your expenses. If you estimate your mortgage payments plus other expenses is around $10,000 per month, you should set aside $60,000 in a separate savings account. Maybe even put it in a different bank to ensure that access to the funds is just a little harder than your normal bank.
Step 2: Create your Asset Class Mix
After setting aside your cash buffer, you can now look at what is remaining to start building your investment portfolio. Take, for example, you have $500,000 to invest between retirement accounts and non-retirement accounts.
Instead of randomly selecting opportunities, the logical next step is to decide how much to allocate to different asset classes. The primary asset classes are stocks, bonds, real estate and alternatives like cryptocurrencies. Stockbrokers provide mixes like 70%/30% between stocks and bonds but don't discuss real estate. Why? Because they don't get compensated on real estate recommendations. First determine your asset class mix. If you are very knowledgeable in real estate, you may target 50% real estate, 40% stocks, 10% bonds. If you are not familiar with real estate but comfortable with the public markets, a mix strategy could be 70% stocks, 20% real estate, 10% bonds. There is no right or wrong answer. Its more about your comfort level with the asset class.
Step 3: Determine your risk level
Inside every asset class (stocks, bonds and real estate), there are investment options that include safe predictable investments, moderate risk investments, and high-risk investments. Unfortunately today, the low-interest-rate environment is forcing many investors into the high risk spectrum. Based on your personal situation, it's important to determine what risk level you are willing to accept and don't just follow the crowd.
Once you determine your risk level, apply it across the asset classes. So whether you are evaluating stocks, bonds or real estate, stay within your risk appetite and don't chase projected returns.
Step 4: Diversify within asset classes
After you determine how to split your capital across the asset classes (stocks, bonds, real estate, alternatives), the next step is to determine how to diversify within the asset class. You should also think about if you are seeking regular income or capital gains. Inside of each asset class, you will find investment opportunities that provide income & others focus on capital gains.
We are fortunate to live in an era where you have access to a wide range of investment opportunities.
Reasons to diversify into real estate
Sometimes, it can be difficult to understand why real estate is an important asset class. Numerous studies have shown that real estate investments outperform all other asset classes with much lower risk.
1. Generate Cash Flow
A major benefit of investing in real estate is that it enhances your ability to generate cash flow. In the real estate business, cash flow is the net income you receive after paying your operating expenses and mortgage payments. Over time, you can generate greater cash flow by increasing rents for a property. For instance, you can acquire an under-performing property and align the lease with the market rent.
2. Capital gains & depreciation
Land and building values have historically increased over time. Unlike the stock market, real estate values increase at a more predictable rate. By investing in real estate, you get long term capital gains. Additionally, real estate provides an investor the ability to take depreciation as an expense. This shifts the tax burden from short term income to long term capital gains.
3. Real Estate Leverage
Finally, the real estate business includes leverage for most investors. Leverage means that you can enhance returns on your investments. Real estate offers numerous financing opportunities. This means you can rely on this tangible asset as collateral to increase your returns.
A diversified real estate portfolio is usually spread across multiple geographies and asset classes, including student housing, multifamily, self-storage, and industrial sector.
These assets are far more resilient to all types of market conditions than a diversified set of stocks. When it comes to real estate, it is very unlikely that all asset classes will crash at the same time. People always need a place to live and start a business. For instance, they will require a location for the warehouse and workplace. However, it is possible that rent may go down temporarily but since real estate is illiquid, its highly unlikely there will be a stampede to sell. This makes it different from the stock market, where everyone can head for the exits at the same time.
Ways to Invest in Real Estate
There are various real estate investing options. Each choice has different tradeoffs. You can buy individual family rentals but you will have to hire a property manager or manage the property yourself. It is also not very liquid. Another option is to buy publicly traded REITs. A major advantage of REITs is that they are very liquid but many of them have the same volatility as the stock market. Furthermore, they do not offer the same level of depreciation benefits associated with owning real estate. One of the better ways to invest in the market is through syndication deals that allow you to own a slice of commercial real estate. This way, you can avoid having to manage properties yourself. You can see a lot more details in our article on syndication deals.
The problem with syndication deals is that you have to spend a lot of time researching the deal. Also, the minimum investment in each deal can range from $25,000 to $100,000.
So where do you go from here to get the help you need to build your real estate portfolio? At Avestor, we may be able to help you. We focus on helping investors build a diversified real estate portfolio working with professionals in the field.
Whether you are new to the world of investing or a seasoned pro, don't forget the old saying - "don't put all your eggs in one basket". Diversification is key to risk reduction and opening the door to more opportunities. We hope the very simple steps that we provided will help you take that first step and diversify your portfolio whether its $100,000 or $10,000,000.
Good luck investing!