• A diversified investment portfolio allocates capital across a mix of assets and within asset classes to reduce risk and dampen volatility.
• Diversification reduces the correlation between investments by absorbing some of the losses in one with gains or lower losses in another.
• As a passive investor, diversification both protects your capital and grows it.
What do successful real estate developers, day traders, and farmers all have in common? Well, it can be argued they would benefit most from having a crystal ball—but since they can’t predict the future (or the weather), they all rely on the power of diversification.
- The developer knows to pursue multiple projects at once; there are too many unknowns to rely on a single development for their ROIs.
- The day trader has seen certain industries crash while the prices of others jump through the roof; to balance these swings, they buy and sell across sectors (the practical ones do, at least).
- The farmer may specialize in one crop like corn, but they don’t rely on it completely; they may raise livestock or grow soybeans too—and they rotate crops every few years to replenish the soil’s nutrients.
In investing, a diversified portfolio allocates capital across a mix of assets and within asset classes to reduce risk and dampen volatility. Harry Markowitz once said that diversification is one of investing’s rare opportunities for a “free lunch.” Having founded modern portfolio theory and winning the Nobel Prize for Economics, he would know.
A concentrated portfolio is essentially gambling. Now is not the time to leave your money up to luck, especially when there are sensible diversification strategies to earn consistent returns without the risk of a massive, unpredictable failure. These are the top two reasons you need to diversify your passive investments: protect your capital and grow your capital.
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PROTECT YOUR CAPITAL
By spreading dollars across many investments, the risk associated with any one is reduced or entirely offset by the others. Diversification essentially creates a portfolio where the combined risk is lower than the risk of its individual parts.
Diversification reduces the correlation (how certain investments respond to market shocks in the same way) between investments by absorbing some of the losses in one with gains or lower losses in another, helping avoid costly mistakes and cushion major market swings. To better understand how correlation works, let’s examine this real-life example:
GROW YOUR CAPITAL:
Nine times out of ten, a diversified portfolio will perform better, have less volatility, and provide higher returns than one that is not. An investor can reallocate those higher returns to scale and further diversify their portfolio, leading to exponential growth in the long run.
Note that diversification in and of itself does not directly produce higher returns—but it would be extremely rare for a diverse portfolio to suffer the catastrophic losses that affect a concentrated portfolio.
DIVERSIFY YOUR PORTFOLIO WITH PRIVATE REAL ESTATE:
While diversifying beyond stocks and bonds was once reserved for the ultra-wealthy and institutional investors, options are becoming attainable to a new class of investors. One of those options is private real estate, the third-largest asset class after fixed income (bonds/debt) and equities (stocks). Here are a few reasons why real estate is a stellar diversification strategy:
- Backed by physical assets, real estate is a highly stable investment vehicle with a low correlation to the stock market.
- Investors can diversify with real estate assets AND diversify within real estate asset classes like multifamily, industrial, retail, and healthcare.
- Unlike the stock market, real estate investments provide unrivaled tax shelters to simultaneously protect, grow, and control your net worth—without lining someone else’s pockets.