Step Up Your Investing game With Portfolio Diversification

By
Telukunta Sai Kinnera,
Step Up Your Investing game With Portfolio Diversification

Markets are never promising and stagnant. There may be a sudden boom or there might be a sudden downfall. In such instances, it does not become an intelligent decision to invest all your money into one single asset class. Diversification in investment portfolios might come as a savior in such instances. The central thesis of this concept lies in the quote “never put all your eggs into the same basket.”

Investment Portfolio Diversification is the practice of spreading your investments in dissimilar markets i.e spreading your eggs in different baskets so that your exposure to any one specific type of asset is limited. This practice is designed to help decrease the volatility of your portfolio over time.

Benefits Of Diversifying Investment Portfolio

  • It is a risk management strategy i.e it reduces the risk of investment.
  • Holding a variety of non-correlated assets can closely eliminate unsystematic risk (specific risk).
  • Diversifying decreases the volatility of the portfolio because different assets rise and fall at different times, therefore, make a way for decent returns of the portfolio as a whole.
  • Diversification of non-correlated assets can decrease the losses in bear markets, preserving the capital amount for investment in bull markets.
  • The portfolios which are diversified in their investments are much more reliable by any financial institution to fund ( may be required for real estate investments) because of the fact that they are risk diversified.

Tips For Diversifying Your Portfolio

Spread Your Wealth Across Various Markets

Firstly, you must find what your ideal asset class would be. You must consider all the factors like your financial status, age, risking capacity, the time period you can invest in i.e either long term or short term, the strategic changes you need opt according to changing markets, avoiding over-diversification, etc. Also, you must thoroughly research the market asset classes and decide what’s best for you to invest in. Here are some investment options.

  1. Exchange-Traded Funds (ETFs) and Mutual Funds (MFs)- ETFs and MFs act as a basket of different stocks and give you instant diversification. They trade differently, so you have to research in detail before buying them. But they’re an excellent method to diversify without getting overly complicated.
  2. Index Funds - Index funds are another excellent option as they include stocks that mirror a particular index such as the S&P 500. Diversification here may be a little limited, but it’s still a good option to consider. It’s a portfolio of stocks or bonds.
  3. You can also invest in commodities, various types of real estate like commercial real estate, residential real estate and in various emerging real estate modules like REITs, fractional ownership, co-working, co-living, senior-living, and many more.

Before proceeding with further tips, here is a quick bit for how to diversify your real estate portfolio.

The first step in building a diversified real estate portfolio is to understand the various real estate strategy buckets. Investors can spread and mitigate their risk by making allocations across these various categories.

Geography

Location can be defined and evaluated by a neighborhood, city, state, region, or country. It also can be defined by the usual size of the market, such as primary or gateway markets, secondary markets, and smaller tertiary markets. You can mix all of these to get a diversified portfolio.

Asset Diversification

Major asset classes include office, retail, industrial, multifamily, hospitality, senior housing, and storage like a garage or a godown. Real estate markets have periodic ups and downs that have the potential to affect all asset classes or may affect few classes more and others less. One way to overcome this cyclical risk is to invest across asset classes and hence, diversify.

Income Generation

Some properties generate steady, and predictable cash flow, while other investment types target upside at an exit at the expense of little or even no yield until the property is actually sold. To create diversification, blend income-generating opportunities with equity multiple driven ones.

Business Model

Each deal usually has its own unique business strategy, such as a new development, a long-term holding period intended to clip a steady coupon or a value-added scenario with small cash flow but is predominantly back end loaded. So, when investing, blend your strategy.

Debt vs Equity vs both

Investors can invest at various points in the capital stack on a real estate deal. Debt and equity deals have quite different characteristics and each comes with different risks and return expectations. Some investors may favor one over the other, while a few others choose to keep capital in both debt and equity deals. By investing up and down the capital stack, you can diversify the risk accordingly.

Risk Diversification

The risk of a project usually falls into one of the four categories: starting with low-risk, stable core investments-known as “core” strategies and moving further out on the risk curve to core-plus, value-added and opportunistic at the far end which carries the highest risk.

When investing in real estate, be cautious. While you chase the highest returns, they may end you up with a portfolio of high-risk real estate assets that can depend on speculative business plans. Clever investors very well know that not all IRR’s are created equal.

Holding Period

Short-term holding periods not only offer better specificity from a real estate cycle perspective but also potentiate time risk since the business plan will unveil rapidly in order to hit targets. Also, it is much difficult to provide substantial equity multiples.

Mid-term holding periods reduce intensified time risk but might re-bounce at the end of a cycle. Long-term holding periods not only reduce these risks but also typically bring lower targeted annualized returns.

Amalgamating these different holding periods helps to ensure you eliminate the possibility of having all of your exits come at the same time and most probably the “wrong” time. Also, even in good times, exiting your holdings at the same time will present you-the reinvestment risk. So, it is always beneficial to keep a fusion of holding periods in your portfolio.

Sponsorship

Some investors build a long-term relationship with one sponsor while others may prefer to spread their holdings among different developers, operators, or capital/fund providers. Few others still prefer to invest with multiple sponsors for a certain period of time and then re-invest with a selected few after narrowing the field through experience. By diversifying across multiple sponsors you limit risks associated with the sponsorship aspect.

At last, keep in mind that a tenured sponsor has learned many lessons over the years and can use this information to protect investors. Sponsors with less experience may be more error-prone but they might be ones who offer better terms to investors to compensate for their lack of comparative experience. These aspects make for good reasons to opt for investing with different sponsors.

So, considering all these aspects or rather categories, you can make a fused real estate portfolio which is far more beneficial than a non-diversified portfolio.

Benefits of Diversified Real Estate Portfolio

Creating a diverse real estate portfolio, made up of various assets posing different levels of risk, allows you to balance the dependable, low-maintenance, low-risk possessing properties that offer lower returns with high risk possessing, high-demanding properties that promise lucrative returns.

Continue Building Your Portfolio

Continue adding to your investment portfolio on a regular basis so that you can diversify it. In this way, you can smooth out the ups and downs created by market volatility. The idea behind this is to cut down on your investment risk by investing the same amount of money over various assets over a certain period of time.

Know When To Exit

Stay alert with your investments and be vigilant of any changes in overall market conditions. You should know what is happening to the companies you invest in. By doing so, you'll also be able to predict when it's the time for you to cut your losses, sell or move on to your next investment.

Summary

Having said all that, it’s high time that investment enthusiasts understand the potential of portfolio diversification and hence consider this smart investment strategy to diversify their risk and benefit despite the worst times in the market.

The best-diversified portfolio includes stocks, bonds, MFs, ETFs, and of course the champ of all time which provides high profits, stable rentals, high capital appreciation, and is a lower risk investment option - the real estate.

Assetmonk offers residential real estates and also commercial real estate modules like co-living, senior living which are highly valuable and curated projects. Investing in them would count for a smart decision and make you a smart investor.

FAQs:

Investment portfolio diversification is the practice that allows you to spread your investments in dissimilar markets so that your exposure doesn’t remain limited to one asset class and therefore, reduces the risk of investment.

The purposes of diversifying a portfolio:

  • To reduce the risk.
  • Decreases the volatility of the portfolio because different assets rise and fall at different times, therefore, make a way for good returns of the portfolio as a whole.
  • Decreases the losses in bear markets and preserves the capital money for investment in bull markets.
  • Here are a few investment options that will help you diversify your portfolio:

  • ETFs
  • MFs
  • Real estate
  • Commodities
  • Index funds - portfolio includes stocks and bonds
  • You may consider the following categories:

  • Geography
  • Asset class
  • Income generation
  • Risk diversification
  • Holding periods
  • Debt or Equity or both
  • Sponsorship
  • Business plan/strategy
  • If you create a diversified real estate portfolio which consists of various assets and those which possess different levels of risk, diversification allows you to balance the dependable, lower risk, low-maintenance properties that offer lower returns with high risk, high-demanding properties that promise higher returns.