Every decent investor knows that diversification is the most important rule in investing, and that it is the only free lunch you get. By making sure that you do not put too many of your eggs in one basket, you greatly reduce your risks with only a minimal trade-off in returns. But just what does a properly diversified portfolio look like?
The ideal portfolio is different for everyone, as people have varying degrees of risk tolerance and investment goals. With that said, there are several things you should consider.
With Australia’s booming property market, real estate should always have a place in your portfolio. You can make money from it through rental income, capital growth, and tax benefits. But there are plenty of important choices to make:
• Location – Do you invest in Perth or Sydney? Near the CBD or in the suburbs? Real estate performance depends on location by a huge amount.
• Type – Rental properties come in many different flavours: apartments, family homes, commercial properties, and so on. Each has its own advantages and drawbacks.
• Tenants – Finding high quality tenants is always essential, so you will need to decide what characteristics your ideal tenant should have.
For those who favour a more hands-off approach, investment firms like Sentinel Property Group will allow you to add real estate to your portfolio without the hassles of actually managing the property. Unless you have extensive experience in the real estate industry, this is usually a safer option.
The bread and butter of your portfolio, these usually make up the largest allocation. But do you primarily focus on the stable, long term appreciation of blue chip stocks? Or the more speculative small caps that have enormous room for growth? Plus, don’t forget that the stock market is global; you can invest a few percent in emerging markets to hedge your bets.
Finally, bonds add a much needed element of stability to your portfolio, with their reliable income generation over time and strong resistance to market fluctuations. Some investors also sell them during bear markets to buy up stocks at bargain prices. How much you should invest here depends entirely on your risk tolerance; anything from 10% to half of the portfolio is fairly common.
Keep in mind that regular portfolio rebalancing with predefined thresholds is also an integral part of diversification. Without maintaining your ideal asset allocation, your portfolio’s characteristics will change sharply after some time, and will expose you to unnecessary risks.