Diversification should be an essential component to every investor’s strategy. It mitigates risk and enhances the possibility of achieving a good profit. Here’s how diversification works and the key considerations you should make when deciding where to invest and spread your money.
Markowitz’s theory of diversification won him the Nobel Prize in 1990. He explained that it is possible for investors to create a buffer against risk by investing in multiple industries or asset classes. According to his theory, losses in one area of the portfolio are balanced out by gains in another.
This theory has since become the foundation of any robust portfolio. Political, social and geographical events can all have enormous negative impacts on certain areas of the investment market. Diversification safeguards investors from the damaging effects of unforeseen events so that if one area suffers a blow, other areas are likely to see positive market impacts and will outperform it.
What is the best way to diversify your portfolio?
There are a few ways to build a diversified portfolio. Here are our top five:
1. Diversify by sectors
When investing, choose a range of sectors, whether that’s tech, healthcare, construction, commerce, tourism or another lucrative space. Market sentiment for sectors can fluctuate and affect values, so it is a good idea to mitigate against these variables.
2. Choose a range of asset classes
Different asset classes present different levels of risk and return. Investing in a range of asset classes enables you to achieve the higher returns with the added security of lower-risk investments to fall back on.
David Swensen’s Yale Model suggests investing equally in six different asset classes to create a balanced and profitable long-term portfolio. He also points out the benefits of tangible investments, such as real estate, that tend to remain more or less stable. For a new investor with not much capital to invest, spreading the funds between six or more asset classes can seem impossible, but there are various schemes that enable you to pool your money with other investors.
3. Select different locations
Natural disasters and geopolitical tensions are major disruptors of economies around the world, and they are largely dictated by location. People mitigate against these market losses by choosing investments in locations across the world. For real estate, that means buying properties in a range of countries. To be strategic, it helps to keep a close eye on political developments, which can be a sign of future market volatility.
4. Look for stable currencies
Another benefit of diversifying by location is being able to invest in different currencies, but it’s important to choose wisely. Some currencies are well known for providing stability. The US Dollar, for example, is the reserve currency used for international trade deals, making it a relatively safe bet.
5. Avoid investing large sums upfront
Another of David Swensen’s recommendations is to build your investment in each area over time, little by little. Investing lump sums up front is a risky strategy that can result in large losses if a market suddenly drops.
Pooling your money with other investors is one way to invest smaller amounts in lots of different opportunities. Real estate crowdfunding, for example, allows you to invest as little as USD 1,000 in a property to share the equity, leaving your other capital free to invest elsewhere. It solves the problem traditionally created by real estate investment – that it requires large amounts of capital – and instead makes this lucrative market available to regular people.
At Bricksave, we’re on a mission to make diversifying investment portfolios using real estate easy. Not only are the small investment amounts enabling greater accessibility, the platform itself is straightforward and transparent. See how it works for yourself.
January 20, 2021
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