You may have savings invested and you are beginning to question the relationship between risk and reward. What once seemed like a sound decision has had doubt cast upon it through recent changes. Now, for the first time, you may be researching your options and are considering more diversified investments. If this sounds like you, or you want to know how property can reduce your investment risk, follow us as we explore diversification.
What are Diversified Investments?
Diversification is an important consideration during every step of your investment journey. As the name suggests, diversified investments spread your risks over multiple financial vehicles, industries and categories. Rather than investing in a single business for example, diversification involves investing smaller amounts across a variety of investments. If you have a pension, it is likely that your funds will be diversified over various stocks, shares and bonds.
Investing in a single market will undoubtedly involve relatively high levels of risk. In the event that your market crashes, you could face significant financial problems. Therefore, it is prudent to diversify your investments to better safeguard your earning potential. Although it will not safeguard against loss, having your investments diversified will mean your risk will be reduced through the losses being limited to only one element of a wider strategy.
As an example, let’s say you have a portfolio that only invests in airline company stocks. One day an event happens that prevents people travelling by plane. Overnight you would expect to see a noticeable drop in value. However, if you had more diversified investments that spread your stocks over tech communications companies also for instance, an uptake in those businesses from people not travelling could help to balance your losses.
Some industries may be correlated, meaning that a single event could negatively affect both. Think of storage companies and haulage companies. Anything that would impact the ability of haulage to operate would also have a knock-on effect to the trading of storage facilities. Diversifying not just across industries but also across asset classes will be important to minimise your risks also. So what types of assets can you invest in?
Types of Investments
There are many types of assets for investment purposes and they can be broadly categorised into a handful of classes. Stocks, shares and bonds are commonly used as these will likely make up the majority of your pension fund. Investment funds can also incorporate commodities like metals, agricultural products such as grain or livestock and also natural resources like oil and gas. Then there are the many cryptocurrencies that have emerged. Finally we have property as an asset class, which stands alone through investing in land and buildings.
As touched on earlier, investment funds will often diversify across stocks, shares and bonds to reduce risk to an accepted level. The nature of the asset class will always carry more risk than investing in physical assets because unexpected circumstances can cause stock market crashes and there is always the risk that businesses will cease to exist.
This is why some investors like to diversify into commodities. Gold, as an example, will fluctuate in price but will always retain value and have further uses as a physical item. Property is another great example. The bricks-and-mortar of property may seem like something much more tangible than stocks and shares, and something that you can have much more control over. If you already invest through a pension or elsewhere, property may be a valuable asset with which to diversify and spread your risks.
Why diversify with Property?
Compared to stocks, shares, commodities and funds, property is relatively simple to understand. We are constantly surrounded by property of many different types, be that buildings or land. Without even giving it much thought, people understand that property will always have value because people will always need somewhere to live and to do business.
The fundamentals of property investing are therefore easy to grasp; buy low sell high or buy low and rent out. It is also easy to understand why property investing is comparatively low risk. While demand for commodities and businesses will see large scale fluctuations, demand for housing has been steadily increasing. It is a fact that not enough homes are being created and the growing need for housing is being fuelled by an ever increasing population and separated families.
Great opportunity for diversified investments exists with property itself. For example, there are many different ways of tailoring a buy-to-let strategy to meet changing needs, such as HMO’s, social housing, holiday lets or student accommodation. Each one is geared towards a different area of the market. On top of this we also have a myriad of commercial opportunities including conversions to residential.
Property prices obviously go up, go down and crash completely. However, as a long term investment strategy, house prices have increased far above the rate of inflation. It is this capital growth that reduces the risks associated with property and provides an opportunity to benefit if you stay in the game long enough. Broadly speaking, rental prices also change with the economy, reducing the risks to the investor.
The combination of capital growth and also rental income is a very appealing proposition. Not only can the investor own an asset that will gain in value, the same asset can also produce an income. There is no need to wait to reap the rewards from an asset and if done the right way, it can cashflow today.
As part of a portfolio of diversified investments, property can provide reduced risk, flexibility and income. Because of this too many people rush into property investing blind and make uneducated choices that minimise their returns or even lead to failure. As passionate advocates of success stories, we want to give you the knowledge to not make big mistakes when investing in property. It will also be essential to seek professional advice if you are considering diversifying your investments, as again, there are pitfalls we want you to avoid. Want to learn more about property investing, check out our blog post ‘Why Invest in Property’?