The golden rule of investment is
“Never put all your eggs in one basket.”
Remember that profit is the return to risk – no investment is totally risk-free. Therefore we need to make investment choices that align with our situation, goals, time horizon and preferences and importantly, our tolerance for risk.
Diversification is essentially a risk management tool.
Having all your ‘eggs in one basket’ whether that is all in shares or all in property leaves you open to the possibility that should there be a downturn in either market, you will suffer a loss across your entire portfolio.
Diversification increases your chances of maximizing gains and minimizing losses.
Having a diverse portfolio increases your chances of smoothing out the variations around the growth trend line and makes you less exposed to single economic events. For example, if you have all your money invested in mining shares and China’s economy slows, your share prices may fall as large mining companies lose orders. While demand fluctuates over time and is to be expected, the impact may be more significant if it happens at a time when you want to divest and collect the anticipated benefits. (retirement perhaps)
Psychology and the media play a role too. If panic sets in and lots of people sell, thinking prices will go even lower; a raging ‘bear’ market may become a devastating reality! Having a diverse mix of shares may allow you to wait for the sliding ones to recover before cashing in.
The same applies to a property portfolio; again, diversity is wise. It means not necessarily buying in your ‘backyard’ just because it is familiar – Australia is a big place and the ‘Property Market’ is a misnomer. Some states, or locations within those states, can be stalling while others are shifting into a higher gear. That’s why it’s important to choose based on facts and figures and not on what the crowd is doing.
Looking beyond familiar territory and considering other locations can mean taking advantage of demographic changes in one part of the country, or exogenous factors like a recovery in China’s demand for our resources, stimulating jobs growth in another. Depending on your strategy, the relative affordability and rent yield of one location compared to another may be a determinant of the area chosen.
Demand for different types of housing is also a factor to consider. There is no one perfect investment property type. It very much depends on your circumstances, budget, time frames, tax position and also on the features of the property and how it matches the demographics and demand in the area.
Remember the section on Asset Classes – some are defensive, like cash and term deposits. These are low risk but low return and all about preserving capital which becomes increasingly important as the investor approaches retirement as you have limited time to recover from any erosion of your wealth.
Growth assets, like shares and property, carry higher risk but also the possibility of higher reward.
Property investment is a relatively stable, long term growth strategy. It is not a ‘get rich quick scheme’, so it’s important to buy based on facts and not emotion and to do so sustainably – don’t over commit.