Diversification in wealth creation – and if so, when?

You have probably heard that to be a successful investor you need to diversify.

The old saying goes, “don’t put all your eggs in one basket”.

Diversification can occur with different types of assets, but also within those asset classes.

It’s suggested that this is a way to minimise risks and maximise your returns over the longer term.

But, as a property investor, how do you go about diversifying, and how best can it be achieved?

And since there is also a group of people that have become very, very successful without ever diversifying, is it even necessary?

Understanding what it is you have set out to achieve and the different stages of investing is an important place to start.

You are then able to look at the different options and invest more strategically for a superior outcome.

Here are my thoughts…

Should I diversify

The short answer is yes.

The average investor will need to create multiple streams of income to become financially independent.

I know there are people out there that may not follow this philosophy.

This is likely due to the fact they probably specialise in a certain industry or field and have what I call an unfair advantage.

Think of a share or a property professional, who has fine-tuned a certain strategy or system and dedicated their life to their profession.

The need for them to diversify away from what they do best may not be necessary.

For the rest of us mere mortals who do not have decades of experience or the systems and strategies in place, diversification could be crucial for investment success.

There are many different asset classes and ways to invest, but perhaps the most common are shares and property.

One could argue that if you already own property and have some Superannuation, you are already diversifying as most superannuation funds are heavily weighted toward shares.

But generally, that will not be enough to reach your longer-term financial goals.

Property vs shares?

I have written previously on the Property vs Shares argument and in short, believe both are essential to building substantial wealth.

In my opinion, there is no argument.

There will always be advocates for both, but over the longer term, both assets have given a similar return.

While there are always markets within markets, I do not feel there is enough of a differential to say one or the other will perform better.

As I explained in my article though, I felt property had the edge due to two main factors:

1. You can leverage more of your own money into property

I could use $100,000 to buy a property worth anywhere from $500,000 to $1mil in some cases.

Using the same $100,000 to buy shares will only generally result in an overall budget of $200,000 - $300,000 if I leverage it into a share portfolio.

2. You have the ability to add value to the property

I have added value through renovations and development in my own portfolio and have clearly seen the benefits of greater equity and rental returns.

With that in mind, we still advocate diversifying your investment portfolio, but it should be done at the right time.

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How to build wealth

In my mind, there are 3 major steps to becoming wealthy.

You first need to build an asset base in the accumulation phase, before consolidating and finally living off your portfolio.

Most make the mistake of focussing on making cash flow a priority too soon.

If we used the example of someone who earns $150,000 and wants to replace their income in 20 years, they tend to focus on cash flow first.

However, if we look at the big picture, they will likely need around $5mill worth of assets, giving them a 3% return.

It is highly unlikely that they will be able to save enough cash to build this amount of wealth and will never be able to purchase enough assets to make it work either.

They would be far better off focussing on quality, high-growth assets to do the heavy lifting for them.

They should set aside the first 8 – 10 years for accumulating enough high-growth assets to get them halfway, to $2.5mil.

They would now have the next 10 – 12 years for their assets to continue to grow and potentially get them the rest of the way to their $5mil goal.

The second decade would be focused on consolidating and paying down as much debt as possible.

Once they are ready to retire, they can remove the rest of the debt by using other income like their Super, shares, or maybe an inheritance.

Finally, they can live off the income from the property portfolio and have a legacy to leave their family.

Timing

I have personally found that property best suits the accumulation stage of building wealth.

During this stage, your single primary focus must be growing your asset base and this is where leverage does the heavy lifting.

The ability to use more of the bank’s money to leverage higher valued, growth assets like property will be crucial.

Then, by adding value, you are also able to speed the process up, rather than simply relying on what the market is doing.

I see shares playing a vital role as a top-up on the accumulation phase or in the second, consolidation stage and as an additional income stream come retirement.

Considering there is reduced leverage available with banks when investing in shares, it may be a slower way to initially build an asset base.

Strategically using these funds will be critical for retirement.

It may be better to build the asset base first property and then commence diversifying into shares.

Most successful people have up to 7 streams of income, so there needs to be room for both in my mind.

There are other ways of diversifying

Many of our clients at Metropole diversify their property portfolio by:

1. Diversifying locations – Including investing in other states to take advantage of each state's individual property cycle

2. Diversifying property types. They invest in houses, townhouses, apartments, and villa units and many of our sophisticated clients own commercial, industrial or retail property as well as residential property.

3. Strategic investors also protect themselves by diversifying their loan portfolio - some loans having variable interest rates and some being fixed. And these fixed-rate loans will expire at different times.

In conclusion

Unless you are an expert in the field of wealth creation, diversification will play a key role in building wealth.

So understanding the key stages of building your wealth and when to acquire various assets will be important.

History shows that shares and property performance have performed almost identical over time and this will likely be the case moving forward.

However, the property offers the ability for greater leverage and combined with the ability to add value, will assist you to build your asset base faster.

This is so critical when you start investing as your main goal is to widen your asset base.

With that achieved, putting more of your money into shares to build for retirement makes sense while your assets continue to grow.

The ability to have more than one income stream and not have all of your eggs in one basket will greatly enhance your ability to create financial freedom.