Some experts believe that if you do not diversify your portfolio over numerous asset classes, you are overexposing yourself to risk with each fall in the market, and wasting money in the long run.
A diverse portfolio is the solid foundation that helps your assets withstand disruptions. Financial markets are highly correlated, which means that when even one of its components malfunctions, there is a ripple effect whose consequences are felt globally.
But real estate is a tangible asset. While a stock market crash may completely deplete your equity, rendering your stock holdings worthless in perpetuity, a commercial or residential property will continue to exist as an asset, even if it may pay less until the economy recovers.
Furthermore, real estate investments pay off at a time when the benefits are most needed — when consumption growth opportunities are limited. They are also predictable.
Rule of thumb
David Swenson from the Yale Investment Office has come up with the widely 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% overseas developed markets; and 5% developing markets.
However, experts advise that investments should differ according to current economic conditions and your own financial situation.
Even within real estate, you can diversify your portfolio by spreading it out across a variety of asset classes. One possibility is commercial real estate — office buildings, factories etc. — which offers steady, profitable cash flow as well as asset appreciation. But because of the large amount of money required, it has remained the ambit of HNIs (High-net-worth individuals) and Ultra HNIs. Another option is a real estate investment trust (REIT). Consequently, REIT investors get a combination of rental income, gains from sold properties, and payments on mortgage-backed securities loans. They get capital gains as well; but the most enticing aspect is the monthly dividend, which often comprises 90% or more of the total income.
Guaranteed income
Some other advantages of investing in real estate include assured cash flow. For instance, if you invest in a rental property, you are guaranteed monthly income, and will likely have tenants throughout the year. Another is the leverage it provides the investor, where real estate can be used as collateral to obtain loans that can be used for additional investments. Incorporating real estate in a mixed-asset portfolio provides important diversification and inflation-hedging benefits. With the correct asset mix, a well-built real estate portfolio can provide a relatively constant income stream despite market ups and downs.
The writer is Director, Goel Ganga Developments.
