Why you Should Diversify Your Portfolio with Real Estate
Diversification is a technique that reduces investment risk by allocating investments among various financial asset classes. Portfolio diversification aims to maximize returns by investing in different areas that would each react differently to the same event.
A good example of portfolio diversification is the Swenson Model portfolio:
Diversification is a key building block to anyone's financial plan, including understanding what diversification does and how it helps an individual's overall financial position. It is crucial that investors know the difference between systematic and unsystematic risk, as well as understand that by diversifying among asset classes, they can mitigate exposure to systematic risk.
Diversification can enable a portfolio to grow both when markets boom or when they crash. Investors who have had 100% equity portfolios over the past eleven years have likely seen very poor returns. If these investors had diversified their portfolios to include investing in real estate their portfolios would have experienced greater returns. Diversification gives an investor the chance to achieve positive returns in one market when another market is generating negative returns.
Investors who fail to diversify amongst asset classes are far too exposed to stock market risk. Diversifying into safer fixed income assets or real estate will help reduce risk and maximize returns. Using capital preservation and diversification as investment strategies can also reduce investment portfolio risk.
Real estate has a relatively low correlation with the stock market. Using real estate as an asset to diversify a portfolio is an excellent and practical investment, largely due to the fact that many people are already invested in the real estate market in some form or another through their homes or otherwise.
Many people overlook the investment potential of real estate as an asset class due to their lack of experience, understanding, or fear of the unknown. Investing in real estate doesn't necessarily mean directly buying properties, becoming a landlord or even any hands on real estate related activities. Although that is a viable option for entering this market, there are more effective approaches to diversifying your portfolio with real estate.
As an alternative to a direct property purchase, individuals can invest in the real estate market through a real estate investment trust or fund. A Fund sells like stocks and they invest directly in real estate through properties or mortgages. Because of the real estate market’s relatively low correlation with the stock market, by investing in a fund, an individual can diversify away some the stock market's inherent risk.
Real estate most likely will not sidestep an entire bear market, but it can definitely benefit investors during a downturn in certain scenarios. If a bear market coincides with a period of a high inflation like it did in the 1970s, real estate is probably a good bet. Bonds, which most people use as a hedge against a bear market, performed very poorly during the 1970s.
Real estate investment funds are becoming increasingly popular due to the even greater diversification they offer potential investors. Real estate funds, like Ettro Capital Opportunity Fund, invests in multiple real estate projects across various markets of different sizes and asset classes, further diversifying your real estate investment, minimizing overall investment risk, and maximizing potential returns.