The Importance of Diversifying your Portfolio



There is money to be made in property; everyone with an interest in it knows this. People need buildings, commercial and personal alike. Without them, we would have no homes, no business premises, no factories, farms, schools, hospitals, banks or building societies. Bricks and mortar hold our civilisation together, and this essential need for them is woven into the very fabric of our lives.

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But building a successful property portfolio is not as simple as this might make it seem. Yes, there will always be a market for real estate, but it fluctuates like any other. Prices rise and fall, demand surges and wanes, and if you don’t prepare for the bad times, then you won’t be left standing when the good ones come back around.

This is where diversification enters the equation. Essential to any investment strategy, whether your interests lay in property, forex, the stock markets, or all of the above, diversification lowers your risk level, balances your portfolio, and acts as a safeguard when your good fortune deserts you. Here, we look at just a few of the reasons why it’s essential to any successful real estate investor’s methodology…

What is Diversification?

You can only understand the necessity of diversification if you first understand what it is: a risk management technique. In its most basic form, it means building a portfolio constructed from a wide variety of different investments, in order to spread your risks and increase your chances of a successful yield. In doing so, you neutralise the negative performance of some investments with the positive performance of others, helping to preserve your profits in the face of adversity.

For example, let’s imagine that we have a property portfolio consisting of three houses in London. If the London housing market takes a turn for the worse, your portfolio will be negatively impacted, its value decreasing in an instant.

If we theorise, instead, that you have these three houses in London, plus two in Madrid, three in Paris, and a number of shares in construction companies to boot, a downturn in London would have a significantly less dramatic impact, and your portfolio would be better able to absorb the fallout from a downturn.

Of course, this only works if the securities in your portfolio are not perfectly correlated, so the wider the range of assets you can add to it, the more successful your attempt at risk reduction will be.

Indeed, studies show that portfolios continuing 25-30 assets are the most successful, with higher average yields and lower risks than more specialised concerns.

Investing in Different Types of Property

One way to reduce your risks and diversify your portfolio is to look at investing in various types of property, and the first difference that should be drawn is between commercial concerns and private residences. Although both can be impacted by the performance of the economy, one can often stagnate without the other, or equally boom when the other remains static.

Let’s imagine, for example, that you have three residential properties and three commercial office buildings in an up-and-coming city. An injection of capital by the council in order to promote business within the area could quickly boost the value of the former.

At the same time, imagine that a major industrial plant relocates to another nearby city, and that many of the denizens also choose to move, leaving lots of empty housing, without enough workers drawn in by the aforementioned regeneration project to fill them. As supply falls, so too will their value.

Yet your portfolio is safe: the positive performance of one type of property outweighs the negative decline in value of the other.

This is particularly important for those whose current portfolios are overrepresented by a single specialist sector, such as farms. Should the farming community suffer a run of bad fortune, the value of your holdings could massively decrease, without any other interests present in your portfolio to buoy it up. Such a result could be disastrous for your finances.

Investing in Different Locations

It is also important to try and invest in a number of different locations; different cities are a good start, but different countries are even better. Spain offers a prime example. Although it is now stabilising, the recession decimated the country’s economy, and the value of its housing market plummeted. For those who solely catered to the expat community over there, the fallout was disastrous.

However, those who had interests in other countries as well found themselves with a welcome cushion to fall back on. Although the property markets of other nations also lost ground due to the financial crisis, few were as badly affected as Spain, so those real estate investors with diverse portfolios were far less adversely affected than their less prepared counterparts.

Investing in Different Assets

Investing in different locations, and in different types of property, is a wonderful start to diversifying your portfolio, but it shouldn’t be the end of your endeavours. The property markets tend to be joined, to greater or lesser degrees, so if real estate is your sole concern, you might not be as protected as you like.

Investing in different assets is the way forward. Whether it’s forex, shares, futures, exchange-traded funds, or spread betting with a broker like ETX Capital, you can choose investment instruments that complement your aims and decrease your risk levels.

Wherever you can, look for those securities that don’t correlate, so that you’re safe in the knowledge that just because the bottom falls out of one market, it doesn’t mean it will fall out of the rest of them.

The beauty of diversification lies in its near-magical ability to reduce your risks of a negatively performing portfolio, and an old adage rings true in the world of investing – that you should never put your eggs in one basket. The more you can spread them between different receptacles, the more chance you have of turning a profit, being successful, and maintaining your toehold in the market that you’re truly interested in: property.