"Diversification is key for any individual and any business"
What is Diversification?
Diversification is a method that reduces risk by distributing investments among various financial instruments, industries and other categories. It aims to minimize risk by investing in different areas that should each react differently to negative changes in market conditions.
Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-term financial goals while minimizing risk. Let’s take a look at why this is true and how to accomplish diversification in your portfolio.
TYPES OF RISK
Investors face two main types of risk when investing:
This is also known as "systematic" or "market risk". Undiversifiable risk is associated with every company, industry and investment class. Causes could be things like inflation rates, exchange rates, interest rates, political instability and war. This type of risk is not specific to a particular company or industry, and it cannot be eliminated or reduced through diversification; it is just a risk that investors must accept.
This risk is also known as "unsystematic risk" and it is specific to a company, industry, market, economy or country; it can be reduced through diversification. The most common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so that they will not all be affected the same way by market events.
WHY SHOULD YOU DIVERSIFY?
The Pros and Cons:
Say you have a portfolio of single-family homes in one specific neighborhood. If a major employer in that region announces that they are moving their offices to a different part of the country this may cause a significant percentage of the local community to relocate and deter further growth for many years in the future. Your portfolio will experience a noticeable drop in value.
If, however, you counterbalanced your investments with single-family houses in different areas around the country, only part of your portfolio would be affected. In fact, there is a good chance that some of your properties in different areas would appreciate in value, as people turn to other parts of the country to seek new employment opportunities.
But you could diversify even further, as there are many risks that affect all single-family houses on a national level, because they are all in the residential sector. An event that affects the residential market in general could negatively impact all of your investments at once.
So, to achieve a higher level of diversification, you would want to diversify across the board, not only in different areas but also different sectors. The lower the correlation of your assets, the safer your portfolio is.
The same is true when investing in syndication deals. Investing numerous times with one sponsor could leave you exposed to the risk of the sponsor or management company facing financial difficulties, performance issues, litigation problems and other complications that might arise. This could be avoided by further diversifying and investing with a variety of different sponsors.
Unfortunately, even the best analysis of an investment cannot guarantee that it won’t be a losing investment. Diversification will not prevent a loss, but it may reduce the impact of underperformance or a loss of value to your entire portfolio.
Diversification may help an investor manage risk and reduce the volatility of an asset’s performance. Remember though, that no matter how diversified your portfolio is, risk can never be eliminated completely.
You can reduce risk associated with specific investments, but general market risks affect nearly every investment, it is therefore also important to diversify among different asset classes. The key is to find a medium between risk and return; this helps ensure that you achieve your financial goals while still getting a good night's sleep.
While there are many benefits to diversification, there are definitely some disadvantages as well. It may be somewhat cumbersome to manage a diverse portfolio, especially if you have multiple holdings and investments. Secondly, it can put a dent in your bottom line. Not all investment vehicles cost the same, so buying and selling may be expensive, especially with many of the high-quality investments requiring a substantial minimum investment. Many of the opportunities that do have a lower barrier to entry have a higher risk-factor or other variables that make them undesirable.
At Bridgehall Group, we know that you face these challenges. Balancing your investment choices to achieve the right combination of diversification without impacting performance of your portfolio can be challenging, even to the most sophisticated investors.
This is why we offer a wide range of investments across many states and in different market sectors, to ensure that you can diversify properly. With our low barrier to entry, you can now participate in numerous opportunities at once without having to compromise on the quality of your investments.
Additionally, we have established a relationship with a diverse group of partners with whom we collaborate to provide you with yet another layer of diversification.