The Benefits of Diversification

The Benefits of Diversification
 

Most of us are familiar with the concept of diversification relative to investments within a portfolio. A wide variety of investments are mixed in order to manage risk. The thinking behind this approach is that a portfolio made up of different types of investments will, on average, give higher returns and present a lower risk than any one investment held in the portfolio.

Diversification can be done at many levels across pretty much all investment platforms. The same risk management technique can be applied to property. Diversification can take place both within a given sector of the investment property industry, (e.g. commercial, residential, industrial) and across the sector itself.

Many of us want to avoid or at least limit uncertainty when it comes to buying rental properties, and it is possible to reduce risk through diversification. There are plenty of opportunities to diversify such as in the number of properties held, and the type of property such as residential buy-to-let, commercial use and homes of multiple occupancy (HMOs) where a number of tenants pay rent.

Location of holdings within a portfolio also contribute to the degree of its diversification. Benefits can be gained by owning properties in various cities. This is a tactic which allows you to minimise voids. Diversifying in this way will also serve to protect you as you are essentially ‘hedging’, lowering risk to you and your investments. Geographical diversification helps spread your risk, and a mix of real estate across different cities would suggest a well-diversified portfolio. Conversely, properties concentrated within a single town indicates a portfolio with limited diversification.

If an investor purchases two buy to let flats in London, they are placing all their capital in one market. Although they have purchased two properties, they are in the same location, and they are relying on only one market to be successful. If the London rental market falls, the investor would have no other asset in their property portfolio that would be profitable. Investing in one buy to let in London and another in Manchester, allows for different locations, giving the investor exposure to more opportunities.

The components of an investment portfolio depends on several factors, including the investor’s risk tolerance, the length of time an investor expects to hold a portfolio, and the amount invested.

If you have a sizeable net worth and substantial funds for investment, diversifying will be easier in a high cost per unit sector. Although more challenging, diversification within a smaller portfolio should be considered where possible. Plenty of unique property investment opportunities and strategies exist.

Many options are available to the real estate investor today, many which were not an option even a few years ago. Crowdfunding can provide access to real estate investment and financing. Crowdfunded real estate investment is a relatively new concept, and provides a way to diversify and monitor your portfolio. Crowdfunding as a marketplace has grown substantially, and enables all levels of investors and project owners to meet. This type of diversification smooths out the risk associated with real estate investment. It allows you to pool your investments with other people, reducing your personal exposure to risk.

If one part of your property portfolio performs poorly and another is performing well you are going to achieve a better result than if the portfolio just contained the poor performer. It boils down to investor protection and knowledge. By diversifying, you allow a margin of error within your investment decisions by covering as many angles as you can.

Real estate investment can provide excellent yields. It can also carry a high level of risk. If you’re looking to invest in property it’s extremely prudent to make your portfolio diverse to ensure you always have money coming in.

Diversification done well, will benefit you by creating more consistency and improving overall portfolio performance.

To find out more about Diversifying your portfolio with crowdfunded real estate investments, visit www.mercycrowd.com

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