What is diversification?
If you are new to investing, you may not be familiar with the idea of diversifying your investments. Diversification is not a training that your Human Resources office makes you do once a year. To diversify your investment portfolio, you are trying to mitigate potential risks of market fluctuations. Investors look to diversify so that if one investment is losing money another one is making money and overall, the investor is in a positive position. In general, the main way people diversify their investments is to invest in many different investments instead of only holding investments in one item.
Specialization Versus Diversification
Warren Buffet, one of the individuals most widely recognized for his shrewd stock investment acumen doesn’t suggest getting a portfolio of diversified assets. As he notes, the best returns come from making a concentrated investment choice in something that you have high conviction that this investment will outperform other areas. A diversified portfolio will rise about in line with the overall market, but one that is concentrated will provided outsized return. The opposite is also true. If you are concentrated in the wrong investments, you will also have outsized losses.
Specialization also brings with it the benefit of deeper and more profound knowledge of the specific area you have decided to concentrate in. You have probably heard the saying “jack of all trades and master of none.” Specialization allows you to become a master and ultimately from that expertise you can invest wiser.
Now we are not all Warren Buffet when it comes to investing so it may help to take a more measured approach. For those who are risk averse, or perhaps have already realized enough gains from a concentrated approach and are now focused on just retaining the wealth already built, diversification is the right move.
Ways to diversify your investment portfolio
There are many ways to diversify your investment portfolio even if everything is invested in real estate. In this article we will look at a few ways to diversify your investments in real estate. This applies whether you are passively investing or actively investing in real estate.
The ways to diversify you real estate investment portfolio are via varied:
Investment strategies
Investment vehicles
Geographic locations
Asset Types
Deal Sponsors
Tenant populations
Investment Strategies
There are many different types of investment strategies out there to invest in real estate. The volume of different ways to invest in real estate itself provide a means of diversification. Within each strategy there are also various niches to further diversify. For example, if you are investing in real estate you can choose to invest in fix and flips or to invest in “buy and hold” real estate. Within buy and hold real estate you can-do short-term rentals, mid-term rentals or long term rentals. In the name of diversification, you could do them all. Every strategy has its benefits and disadvantages, but it would be worth considering the different strategies of investing available before settling on one.
On a more macro level the main strategies related to real estate investing range from turnkey, low return, low risk options to deeply distressed, high risk, high return options. As markets change there may be more benefit in weighting your portfolio of investments to one side of the spectrum.
Investment Vehicles
Using different investment vehicles to invest in real estate and gain exposure to real estate investing is a great way to gain diversity. You can invest in a syndication, publicly traded REIT, private lending, direct ownership, and many more ways. With the different investment vehicles, you have varying levels of ownership, risk, responsibilities, tax benefits, downside risk protection etc. By choosing to invest in different ways you can keep options open with continued deal flow and investment opportunities.
Geographic Locations
Location is everything in real estate. This is true as well in the diversification of your real estate investments. That could mean investing in different parts of the world on the grandest scale to investing in different parts of your city on a more micro scale. Different locations tend to go through their economic cycles at different times. If you have all your investments in the southeast of the united states for example and there is a natural disaster, economic down turn or some other issue, your entire portfolio may be wiped out. If you have your assets located both in the southeast and northwest however, then only a part of your portfolio would be impacted.
Asset Types
In real estate there are various types of asset classes you can invest in. This includes office, logistic centers, health, and medical, self-storage, multifamily, single family, retail, hospitality and much more. Within these asset types there are also different asset classes from more high-end properties to lower end properties. What you choose to invest in here will likely align with you overall diversification of investment strategies.
Deal Sponsors
The deal sponsors are the people who lead the deals you invest with. Even the best deal sponsors may make a bad investment decision. It is even worse if you are investing with a sponsor that turns out to be unethical or fraudulent. Investing with only one sponsor can create a key person risk and if that sponsor’s portfolio takes a dive, guess whose investments are going to go down with it. Yep, yours. Investing with various individuals can help you stay aware of the market, learn new things, and keep your investments portfolio protected!
Tenant Populations
Investing with tenants from various populations helps to provide security in the case of buy and hold rental real estate. In the case of real estate held for resale you may consider different end users. If you are renting to all tech companies, or tech employees then a wider market crash in the tech industry may leave your rental income exposed to potential risk. If you have tenants from various industries however then the losses would be limited.
Investing In Funds For Diversification
All the ways mentioned above are great ways to diversify your portfolio. That may be too much work for you to investigate all of those dimensions of diversification. One shortcut to achieve diversification quickly is to invest in a fund. As funds typically hold several assets there is a natural diversification that occurs. Of course, it is not perfectly diversified as you would only be invested with whoever the fund provider is. Using the fund investing approach may be a quick way to gain some diversification in your portfolio if you choose to be more specialized in other areas.
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