Diversify: Mitigate Risk, Maximize Profit with Real Estate
I once heard a story of a man who instantly fell in love with a house next to a beautiful golf course. The living room had a gorgeous view of the course and he was certain that this was where he was meant to be. He purchased the house. After about a week of living in his new home, the man returned one day to find the large front window broken and lying in the middle of the pile of shattered glass, was a bright, white golf ball. A repair shop was called and a repairman replaced the window. This unfortunate event repeated itself several more times, and the man was determined to find a solution. He spoke to the glass repairman as he was putting in the new window for the fourth time. “Do you repair many windows in this neighborhood?” the man asked. “All the time sir,” the repairman responded. “Is this just part of living next to a golf course?” the man inquired. The repairman stepped away from the broken window and pointed at a neighbor’s house down the street. “Have you seen their front window?” he asked. The man looked up and saw a mullioned style window. Instead of one large pane of glass it was composed of many smaller windows set within a lovely wooden trim. “When one of those little windows breaks, it doesn’t cost very much to fix. We simply remove what’s left of the broken pane and put in a new one. The repairs aren’t very expensive and we can get the job done a lot faster.” The man had his large window replaced with many small ones and learned a valuable lesson in diversification.
Why You Should Have A Diversified Portfolio
Diversification is one of those terms that gets thrown around all too often. The common assumption is that we should all “diversify” but there doesn’t seem to be a clear answer about what that means. In the average investment portfolio, financial advisors would tell you that you need a wide variety of stocks and mutual funds. While you can spread your finances amongst shares of some of the most popular brand names, they all tend to follow the same market trends. Many investors can remember the financial and economic woes of 2008. The market took a significant dive from where it had been in previous years and even if you had diversified your stocks across multiple industries, your portfolio still took a hit.
What Diversification Really Means
Putting all your eggs in one basket is never a good thing. Much like the broken window on the golf course, minimizing risk is really what diversification is all about. Despite the many opinions of the “talking head” experts on all the major financial news networks, no one can say with 100% certainty what the stock market will do in the future. Your portfolio should not only be diversified across a variety of stocks, but also among several kinds of assets like real estate.
The Balanced Portfolio
The goal of most successful investors is to have a balanced portfolio. Though the definition of “balanced” differs from person to person, it generally involves creating a portfolio of stocks, bonds, commodities, cash, and other assets like real estate. Although there are many schools of thought on how a portfolio should be allocated, the final decision is up to you. Adding an asset class that isn’t tied to the stock market is an advantage and can help you stay profitable if and when the stock market has another downturn.
Diversification Rule of Thumb: Subtract your age from 100 to get the percent you should put into stocks and mutual funds. For example, if you are 40 years old, you would subtract that from 100, leaving you with 60. Thus 60% would be invested in stocks and mutual funds, while the remaining 40% would consist of other assets like real estate, bonds, cash, etc.
Why Real Estate?
- Cash Flow: Generate monthly income from tenants
- Appreciation: Build wealth through appreciation in your investment property
- Leverage: Use other people’s money to help you maximize returns
- Hedge Against Inflation: Protect your capital against inflation by owning real estate
- Tangible Asset: Real estate is a physical asset that you own
- Negative Correlation to the Stock Market: Real estate isn’t tied to the stock market, and can diversify your portfolio
There are plenty of companies that will tell you grand stories disguised as get-rich-quick schemes while investing in the asset classes they are proposing. The fact of the matter is that successful investing is really about taking the time to let your assets grow. It takes time to build a nest egg and additional time and diversification for its stable and successful growth. By choosing to add real estate to your portfolio, you’ll be diversifying away from the stock market and the volatility associated with it. Real estate, especially when viewed through the eyes of a typical bank, is a far more stable investment than single stocks or mutual funds. Why is real estate considered more stable? First and foremost, the bank isn’t going to give you a loan to purchase shares of a company, but acquiring a loan for an investment property is easily attainable. Best of all, real estate is a tangible asset and has value in the actual structure and the land it resides upon.
Although real estate is still subject to risk, it isn’t nearly as volatile as the stock market. As you can see in the graph below, real estate does have times of ebb and flow, but not on the same level as the stock market. Simply looking at the span of the last 15 years or so, the stock market experienced two serious downturns and numerous other serious fluctuations. However, real estate during this time frame has only one serious downward trend in pricing and a nice rebound over the past several years.
If you owned income property during the downtrend you could still remain profitable. As the graph indicates below, those with rental properties saw their returns grow because they continued to collect rent during the dips in the real estate market. In fact, many saw their returns soar because rents have increased dramatically over the same time period.
Types of Real Estate To Invest In
There are several different kinds of real estate to invest in,such as commercial, single family rentals, and some people could even include REITs (Real Estate Investment Trusts) in this category. While REITs are usually the most accessible with a very small investment up front, they are still tied to the stock market. As you can see in the graph below there is a strong correlation between how the stock market performed compared to the performance of the REITs. In terms of a diversified portfolio, if you invest in REITs, most of your eggs are still in one basket and REITs don’t provide protection in the event of a serious downturn in the stock market. Investors also look at commercial real estate as a place for diversification and a way to build an asset. While not directly tied to the stock market, commercial real estate is still very much connected to the economy. In a down economy where businesses are struggling to stay afloat, it could be an extremely difficult time for commercial real estate owners. Additionally, the cost of entry into commercial real estate is very high often with minimum investments running into the hundreds of thousands of dollars.
Single family rentals are one of the best choices you can make when investing in real estate because they are not tied to the stock market and have a lower cost of entry. By choosing the right markets and neighborhoods, you can maximize your returns through the collection of rent that will generate cash flow, and the appreciation of the property’s value, even through a rough economy. Best of all, investing in real estate is easier than ever. Synergy Redevelopers makes it possible for you to earn a solid return and generate passive income from the comfort of your living room.