Financial professionals agree that any good investment strategy should involve some level of diversification in terms of asset allocation. Savvy investors have been diversifying their assets for about as long as they’ve been investing, which historically speaking amounts to a few thousand years (evidence of diversified investment strategies can be found in early Talmudic passages from roughly 2000 years ago). The reason diversification is so essential is that it lowers the overall risk profile of a portfolio, helping to mitigate debt and increase cash-flow.
In investment nomenclature, diversification refers to the practice of spreading money across different asset types in order to minimize risk. Investing heavily in one particular company in one industry is ill-advised because if that company fails then your entire investment goes with it; if, on the other hand, you diversify and split your money across multiple companies in multiple different sectors, then the decline of that one company will be balanced out by rises in other areas of your portfolio, therefore reducing the risk of losses in your overall investment strategy. This is what is referred to as a risk-adjusted approach.
In property, diversification is sometimes overlooked – investors are often too distracted by the idea of simply getting on the property ladder to realise the potential dangers of investing in just one property. Like any other investment, property portfolios should be diversified to avoid an “eggs in one basket” situation where your investment is entirely reliant on just one piece of real estate.
Diversification in property investment comes down to a few key factors that you’ll need to consider: property type (residential, commercial etc.), property location, property investment strategy (core, core plus etc.), and desired investment horizon (long term vs. short term, fix-and-flip etc.). To achieve the highest possible chance of good returns, your investment should be spread across a number of different combinations of the above categories. A quick example would be to take a core plus approach and invest one portion of money into luxury residential properties in New York, and another portion into commercial real estate in London, aiming for a long-term (i.e. a few years, not a few months) investment horizon in both cases – here there is an adequate variation in location and property type to boost the potential for strong returns.
Diversification, though often forgotten about in the property sphere, is an important part of investment in any market. It makes up a key component of proper portfolio management, helping to defend against risk and potentially increase overall portfolio value.
October 13, 2016
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