Where Does Real Estate Belong in a Balanced Investment Portfolio? How to go about figuring out the correct allocation of your money and correct diversification of holdings.
If you want to be a successful investor, you need to learn the fundamentals of portfolio balancing. In other words, you need to figure out the correct allocation of your money and the correct diversification of your holdings.
Real estate is often suggested as one of the most important asset classes to consider when balancing your portfolio. But why is this the case? And how do you balance an investment portfolio around real estate adequately?
Balancing an Investment Portfolio
Balancing and investment portfolio serves many important purposes simultaneously. First, it’s a way of hedging risk; this is an opportunity to avoid overinvesting in any one asset, so you aren’t excessively exposed to any particular types of risks. Second, it’s a way of securing more stable returns, so your portfolio generates income and gains much more reliably.
Third, balancing a portfolio is an opportunity to assess the performance of your current holdings and adjust them as your needs and goals change. For example, as you get older, you’ll generally become more risk averse, requiring divestment from riskier assets and toward safer ones.
Why Real Estate?
Why is real estate so favored in investment portfolios?
Relative safety. Many investors appreciate real estate because of its relative safety. A startup tech company might become obsolete next year, but housing is always going to be necessary, and therefore, valuable. Housing markets can crash, and the value of a home can decrease, but generally speaking, real estate is a relatively safe haven.
Passive income. If you rent out the properties you buy, you can generate passive income from your real estate investments. With the help of a property management company, you can go almost totally hands-off, allowing your property managers to handle tasks like rent collection and property maintenance. Passive income is especially important to retirees, who need stable, recurring dividends to live off of.
Long-term appreciation. Rental income is nice, but it’s not the only way that property investing can make you money. Assuming you choose good properties and growing areas, you should also benefit from long-term appreciation. In other words, your properties should increase in price over time.
Insulation from the stock market. The real estate market is somewhat isolated from the stock market. There are times when these markets can influence each other, but more commonly, they function somewhat independently. If the stock market crashes, your real estate can continue performing well.
Financial leverage. In finance, leverage is a critical advantage (if you know how to wield it). Essentially, leverage is all about using borrowed money to invest. It can help you multiply your investing power without requiring anything additional from you. If you aren’t careful, excessive leverage can work against you, but if properly calculated and calibrated, it can be a decisive advantage for your portfolio.
Functional utility. Some property investors appreciate real estate for its functional utility. You can live in these properties. You can give them to your children. You can use them for other purposes, if so inclined.
Finite availability. Real estate is also valuable in part because of its finite supply. There’s a lot of land in our country, and there’s always room for new developments, but as our population increases, the existing supply of homes naturally becomes more and more valuable.
How to Strike the Right Portfolio Balance
How can you be sure that you’re striking the right portfolio balance?
Articulate your goals. Without goals, your investment strategy is rudderless. In fact, there’s no way to know how to balance a portfolio unless you know what goals you’re trying to achieve. Accordingly, you should start by articulating and solidifying your most important goals.
Define your process and parameters. What approach are you going to use to balance your portfolio? How often are you going to rebalance it? How are you going to judge the strength and appropriateness of each holding in your portfolio?
Consider a wide range of options. Maintaining a good portfolio balance means looking beyond stocks, bonds, and real estate. These asset pillars are the most popular options for a reason, but it’s often valuable to invest in alternative holdings as well.
Reassess periodically. Finally, make it a point to reassess your portfolio balance periodically. At least once a year, check in to see how your assets are performing and make any necessary changes. Depending on the scope of your portfolio, rebalancing more frequently may become advisable.
Balancing a portfolio looks a little different for everyone, since each individual investor has unique goals, perspectives, and resources. Still, real estate is a valuable holding in most investment portfolios, and it’s well worth considering if you want to maximize your gains while minimizing risk.
