The key to any successful portfolio is diversification. Without getting into the details of modern day portfolio theory, it’s important to understand that by holding a combination of different asset types, an investor can achieve higher risk-adjusted returns. In other words, a portfolio of just stocks or bonds is not optimal. If the stock market crashes or interest rates spike, investors holding just those assets are going to be hurt far more than an investor who has a diversified portfolio. A simple example below:
- Investor 1: Holds 100% stocks that are expected to return 8%
- Investor 2: 50% stocks and 50% real estate – both assets expected to return 8%
Both these investors are expected to achieve an 8% return, but what if the stock market actually returns 0% or 16%. The returns of Investor 1 are far more volatile. Because the stock market and real estate are not terribly correlated (A 2010 study by CXO Financial Advisory Group actually found a slight negative correlation), we can say that Investor 2 is more likely to achieve a return closer to 8%. On a risk-adjusted basis, Investor 2 is in a better position and because investors demand higher returns for greater risk, Investor 2 acutally has a BETTER portfolio than Investor 1.
Hopefully you’re convinced that a diversified portfolio is better. And the more diversified the portfolio, the lower the risk. So yes, holding stocks AND bonds is better than just stocks or bonds, but holding stocks, bonds, AND real estate is even better. At some point you do need to factor in the costs of diversification (e.g. transaction costs, etc), especially if your portfolio is not large, but for the vast majority of investors, adding more asset types is better.
But you may be thinking that’s it’s fairly straightforward to buy and hold stocks and bonds, but it’s challenging to buy and hold real estate. There are options like publicly-traded REITS, but we’re strong believers in direct ownership since you’re cutting out the middlemen. Direct ownership isn’t for everyone as it’s more complicated and demanding, but the returns are generally significantly higher. And that’s where SpendTree comes in. We’re here to help make finding, analyzing, and buying direct real estate relatively easy. Take a look at some of our other posts for how to get started in real estate and with SpendTree, and make sure to give the tool a try!