Top Myths of Diversifying Your Investment Portfolio
In a conversation about diversifying your investment portfolio, it's inevitable you'll hear the phrase: “Don’t put all your eggs in one basket.”
You’ve heard the famous proverb and understand the basic principle of diversifying, but have you taken the time to develop a diversification strategy?
Do you have your investments in a variety of smart investment vehicles, or are you betting your entire financial future on one or two types of investments?
Although the logic of diversifying investments is understood, it’s not as easy to execute. You want to diversify, but you don’t want to spend a lot of time learning something new. In order to effectively diversify investments, you need a strategy that makes sense for you and doesn't create a distraction.
Let’s start by clearly defining what diversifying your portfolio actually means.
What is diversifying your investment portfolio?
Investopedia defines diversification as “a risk management strategy that mixes a wide variety of investments within a portfolio.” Diversifying your investment portfolio is the act of strategically mitigating risk or reducing the volatility of your assets. If one of the types of investments you’ve chosen to invest in crashes to the ground, it won'd be devastating.
The concept isn’t complicated, but there is a lot of noise in the world of investing. This noise tries to guide you towards certain types of investments whether or not it’s in your best interest. And while we focus on real estate investing and earning monthly passive income here at Madison Investing, we would never attempt to guide you to put all of your assets into real estate.
Before discussing how to diversify your portfolio by investing in real estate, we need to dispel three myths about investment portfolio diversification.
Myth 1: Investing in a wide group of stocks is diversifying your portfolio.
If all of your investments are tied up in stocks, regardless of if you invest in 10 stocks or 500, you are not diversified. Stock market advocates may advise you to invest the majority of your assets in the stock market as long as it’s “diversified” into different industries and spread out among small caps, blue chip stocks, and industry leaders. But what happens when fear about the economy hits the stock market? All stocks fall in value regardless of industry or the market capitalization of the company.
Make no mistake about it, investing in stocks should be part of your long-term investment strategy, but it’s one basket no matter how many different types of stocks you own.
Myth 2: Mutual funds are always safer than stocks and the primary way to diversify your investment portfolio.
While searching on Google how to diversify your portfolio, you’ve come across a lot of information about mutual funds. Whether in your 401k, IRA, or other investment portfolio, you likely already have a portion of your assets invested in mutual funds. So this means that you’re diversified, right?
Not necessarily.
Mutual funds, like all investments, are not without risks. They feel safe and like a solid way of diversifying your portfolio because they contain a variety of stocks and possibly other types of securities. Although you may have a variety of mutual funds that are comprised of hundreds or thousands of different stocks – variety is not diversification.
Myth 3: Diversifying your investment portfolio is difficult and takes too much time.
Managing your investment portfolio is an important part of dictating your financial future and achieving long-term financial freedom. Technology and investment companies that focus on educating investors have made it easier than ever to learn about opportunities and to diversify.
To diversify, you will need to learn about each basket that will become part of your portfolio, develop relationships with trustworthy companies and knowledgeable experts, create a plan, and take action.
Diversification basics
As we’ve covered in-depth in this article, adding different types of baskets is key to being diversified. But what are the different baskets? Although this is not an all-inclusive list, here are several of the most popular investment vehicles to use when effectively diversifying your portfolio.
Stocks: A claim on the assets of a company. As the value or expected value of the company grows based on the opinions and actions of the market and stockholders, so does the value of the stock.
Bonds: Bonds are a loan that you make to a company or organization. In return, you receive interest payments and your money back once the bond has matured (ended).
Cash: Simply put, some investment portfolios contain a percentage of cash. While growth will be non-existent unless incurring interest, having cash in your portfolio can lessen your overall exposure to risk.
Mutual Funds: Unlike a stock or bond, a mutual fund is a pooled asset – meaning it’s a compilation of investments. A mutual fund can include stocks, bond, cash, REITs, and other types of investments. This fund is managed by an individual or group and fees are paid by investors in return for management of the fund.
Futures: Investing in futures includes purchasing or selling an asset at a set price by an expiration date. As the price of that asset increases or declines, so does the value of this contract.
Commodities: Buying and selling commodities, unlike stock investing where you are purchasing a claim on the assets of a company, involves purchasing a claim on an unprocessed good (wheat, corn, livestock, etc.) or precious metal.
Cryptocurrencies: While considered to be a highly volatile and unregulated asset, cryptocurrencies are a type of investment gaining interest over the past decade. Led by Bitcoin, cryptocurrencies are digital assets that can be used and traded similar to currencies.
ETFs: Exchange-traded funds (ETFs) are managed investments that act similar to mutual funds but can be traded on stock exchanges like stocks. They traditionally have lower fees than mutual funds.
REITs: REITs are often recommended investments for investors who want to dip their feet into real estate investing. For those of you asking, “What are REITs?” REITs are real estate investment trusts. These trusts include a pool of investors who purchase properties. REITs are traded in the same manner as stocks on stock exchanges. REITs often pay dividends based on the income they generate.
Hedge Funds: Hedge funds are an exclusive alternative investment that are also a pooled investment consisting of the assets of a group of investors. A hedge fund can consist of many types of securities, similar to a mutual fund, but are considered to be riskier due to taking short positions (betting against a stock’s performance), investing in derivatives (options and futures trading), and using leverage (investing with money that is borrowed).
Real Estate Syndication: Real estate syndication is a pooled investment where money from a group of investors is used to purchase properties. Investors earn passive income through real estate syndication based on the income earned from these properties.
Madison Investing focuses on investing in commercial real estate syndications. If you were to purchase a single-family rental home, this would require a significant amount of time and money. Instead of single-family homes, we concentrate on helping a group of investors invest passively in commercial properties where dozens or hundreds of units are available to renters. This provides each investor with income each month from the rental fees collected on each property and lowers their risk.
How to diversify by adding real estate investments to your newly diverse portfolio
Now that you know the basics of diversifying your investment portfolio and how commercial real estate syndication works, let’s discuss how to become part of a commercial real estate syndication.
Due to SEC regulations, not just anyone can participate in commercial real estate syndication investments. Explained in-depth in the How It Works section of our home page, commercial syndication opportunities are available to Accredited investors, who are eligible to participate in all projects, and Sophisticated investors, who are eligible to participate in select projects.
If you’re not sure if you’re an Accredited or Sophisticated investor, check here.
Once you are verified as an Accredited or Sophisticated investor, you will chat with the team at Madison Investing so they can better understand your goals. You will then be able to invest in a syndication, which pays returns on a monthly or quarterly basis throughout the entire life of the project. The amount required to become part of a real estate syndication depends on the management group.
What’s the importance of passive income in my investment portfolio?
Whether receiving quarterly dividends from a stock or mutual fund or monthly disbursements from a real estate syndication investment, adding streams of passive income to your investment portfolio is a way to achieve long-term financial freedom.
Passive income is a form of consistent earnings that you’re not actively involved in managing. If investing in real estate, passive income means that you’re not the one managing properties and ensuring renters pay their monthly fees. Instead, you’re focused on your life while benefiting from your investment in the form of monthly earnings.
Incorporating forms of passive income into your portfolio allows you to increase your holding in cash. You can use this money to invest more in real estate, to diversify further in other investment vehicles, save for a rainy day, or to supplement your income. Passive income gives you more freedom without increasing your commitments and responsibilities, which isn’t possible if purchasing a single rental home that you then manage.
If you’re interested in achieving financial freedom and exploring commercial real estate syndication, we would like to invite you to learn more about what we’re doing here at Madison Investing.
What is Madison Investing?
We help busy people like you build passive income streams and real wealth so you can live life on your terms. Whether you’re looking forward to living comfortably after retiring in 20-30 years or planning to put your children through college, the guidance we provide and opportunities we connect you with can help you get there.
How does partnering with Madison Investing work?
We simplify diversifying your portfolio and help you benefit from investing in real estate. Our process includes four simple steps outlined in detail in the how it works section of our home page..
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