Some experts believe that if you don’t diversify your portfolio across multiple asset classes, you’re overexposing yourself to risk with every market dip and wasting money over the long term.
A diverse portfolio is the strong foundation that helps your assets withstand disruption. Financial markets are highly correlated, which means that when one of their components fails, there is a domino effect whose consequences are felt worldwide.
But real estate is a tangible asset. While a stock market crash can completely deplete your capital, making your stock holdings worthless in perpetuity, a commercial or residential property will still exist as an asset, even if you can afford less until the economy picks up.
Furthermore, real estate investments pay off at a time when the benefits are most needed, when opportunities for growth in consumption are limited. They are also predictable.
David Swenson of the Yale Investment Office has introduced the very popular 20% rule, which states that at least 20% of your portfolio should be diversified into alternatives to the stock market, often real estate. For example, a sample portfolio based on this rule would look like this: 30% domestic stocks; 30% bonds and securities; 20% real estate; 15% developed markets abroad; and 5% developing markets.
However, experts advise that investments differ based on current economic conditions and your own financial situation.
Even within real estate, you can diversify your portfolio by spreading it across a variety of asset classes. One possibility is commercial real estate (office buildings, factories, etc.) that offer a steady and profitable cash flow, as well as asset appreciation. But due to the large amount of money required, it has remained in the realm of HNI (High Net Worth Individuals) and Ultra HNI. Another option is a real estate investment trust (REIT). Consequently, REIT investors earn a combination of rental income, proceeds from properties sold, and mortgage-backed securities loan payments. They also make capital gains; But the most attractive aspect is the monthly dividend, which often comprises 90% or more of total income.
Some other advantages of investing in real estate include the assured cash flow. For example, if you invest in a rental property, you have a guaranteed monthly income and will likely have year-round tenants. Another is the leverage it provides to the investor, where real estate can be used as collateral to obtain loans that can be used for additional investments. Incorporating real estate into a mixed asset portfolio provides significant diversification and inflation hedge benefits. With the right mix of assets, a well-constructed real estate portfolio can provide a relatively steady stream of income despite the ups and downs of the market.
The writer is Director, Goel Ganga Developments.