Why is Diversification Important in An Investment Portfolio? (Plus My Asset Allocation Plan)

In this post, let’s find out exactly why diversification is important in an investment portfolio.

But first, a cautionary tale…

It was the party of all 40th parties. I threw an epic 2-night party and brought it in with all my family, friends, and teams. 

Both nights were incredible, with an open bar, off the charts food, impressive entertainment (I flew two improv rappers in from Orlando), and most importantly, having fun surrounded by all the people I loved.

Just when I thought 2018 was going to be one helluva year, disaster hit.

A little over a month later, I woke up one morning with my phone absolutely blowing up from investors who had just received their property rental statements. These were investors that I had simply referred to buy turnkey properties that had real strong cash flow returns.

The news hit: Their rent had dropped in many cases 70-80%, overnight.

How is that even possible, for every single investor’s tenants to all of a sudden either stop paying or vacate their properties the same month? Well, in simple terms, it isn’t.

My growing suspicions were confirmed – the turnkey operator had been paying out fake rents and operating a Ponzi scheme. A Ponzi is when you need to bring in new investor money to pay out the older investors. 

Eventually, all Ponzi schemes collapse because they’re a ticking time bomb – there’s no fundamentals and sustainability so when the new sales/revenue dries up, the entire thing quickly collapses as there is no longer new money to pay out and keep the house of cards from collapsing.

And collapse it did. My 15 units, along with 130 investor units, were in shambles. There wasn’t a single unit once we finally analyzed all of them that actually had functional plumbing, heat, or electricity – and sometimes missing all 3. 

There were squatters in many of the properties. Many of them were completely trashed out, with falling ceilings, graffiti, water damage and a host of issues.

You see, the turnkey operator didn’t actually do the rehabs he was paid to do. He took the rehab cash and used that to pay out fake rents, to lure investors into buying more properties.

What is Diversification in Investing?

Diversification in investing is like having a variety pack of snacks instead of putting all your chips in one flavor. It’s a smart strategy that involves spreading out your investments across different types of assets, like stocks, bonds, and real estate. 

By doing so, you’re reducing the risk of losing all your money if one investment goes sour. It’s like having a safety net that helps balance out the ups and downs of the market and increases your chances of long-term financial success.

Diversification and Risk

Now, I certainly don’t want to scare you away from real estate or turnkey rental property investing. Despite that major setback, I’ve still been able to build some substantial wealth with turnkey properties. You can certainly avoid this type of situation by doing business with trusted parties and utilizing 3rd party inspections to verify work performed. 

I was naive, too trusting, and didn’t realize the hidden dangers. But about my story, we ended up fixing up all the properties and, through natural appreciation, we were able to get most of them back into profit. 

One lady was not so lucky. But she made a huge mistake. She invested all of her available funds with this company, simply because the initial returns she got were so strong and so much better than any other options she had. 

This is a huge mistake, my friend. Had she properly diversified her asset allocation, yes it would have stung, but it wouldn’t have been a huge life-altering ordeal that it ended up becoming.

Benefits of a Diversified Portfolio

Having a properly diversified portfolio has a number of really important benefits:

– Cushions against volatility: Diversification acts like a financial cushion, protecting you from the unpredictable ups and downs of the market. Just like having different layers of clothing on a chilly day, spreading your investments across various assets helps smooth out the impact of any single investment’s performance.

– Reduces risk: By not putting all your eggs in one basket, you’re lowering the risk of losing a significant portion of your investment if one particular asset takes a hit. It’s like having multiple backup plans in case one falls through. You’ll have peace of mind knowing that your overall portfolio isn’t solely reliant on the success or failure of a single investment.

– Enhances potential returns: Diversification isn’t just about playing defense; it also plays offense. By allocating your funds across different asset classes, industries, or regions, you increase the chances of capturing positive returns from various sources. It’s like planting different seeds in a garden and reaping a diverse harvest.

– Expands opportunities: A diversified portfolio opens up doors to a broader range of investment opportunities. You can explore different industries, sectors, or even global markets, giving you exposure to emerging trends and potential high-growth areas. It’s like having a colorful palette of options to choose from, allowing you to tailor your investments to your financial goals and interests.

– Smooths out the bumps: Diversification can help smooth out the bumps caused by economic downturns or market fluctuations. While one investment may suffer, others may still perform well, balancing out any losses. It’s like having shock absorbers on your financial journey, minimizing the impact of bumps along the way.

– Enhances long-term stability: A well-diversified portfolio is built for the long haul. By spreading your investments across different asset classes and holding them over time, you’re positioning yourself for long-term stability and growth. It’s like building a sturdy foundation for your financial future, with a diverse range of assets working together to provide stability and potential growth.

Remember, diversification is like having a financial safety net that protects and strengthens your overall investment strategy. By embracing the power of diversification, you’re putting yourself in a better position to navigate the ever-changing world of investments and increase your chances of long-term financial success.

Why is Diversification Important in an Investment Portfolio?

Diversification is important in an investment portfolio because… 

If you don’t learn from your mistakes, you’re bound to repeat them. If you don’t teach someone else how to avoid your mistakes, you’ve really missed an opportunity to help others.

So here’s one of the lessons I learned: If you were to give me some free time and tell me to go do anything I want to do, within an hour you’d find me at the highest stakes poker table I can find. I fell in love with the game back in my college dorm room days, staying up all night with the guys betting quarters and quoting Matt Damon from the cult classic “Rounders”. I love the strategy, the competition, reading people, the math, odds, but most importantly, I love winning.

And this was winning money. I know, shocking right? Despite what the ESPN highlight videos might show you, the best poker players in the world very much try to avoid going all in. They prefer to get involved in smaller pots so that they can gradually accumulate chips and create an advantage by bullying the other players off their hand. This term is called “fold equity”, which means you may not have the best hand, but by potentially forcing a better hand to fold, you gain an edge.

The best players don’t like to be in a position where they have to risk all of their chips. Why?  Because even with the best hand and with 2 or even 1 card to come, they face the chance of being knocked out of the game. It’s the worst feeling for a poker player to see their chips disappear and realize that they can’t play anymore. 

Even when they’re running good and everything is going their way, that is, they’re making the right moves at the right times and catching good cards, good players don’t like to go all in, and they certainly don’t like it when other players go all-in on them, even when they’re pretty sure they have the best hand.

Just like a skilled poker player, you want to avoid going all-in on any one investment at all costs. Even when it’s running so well. Even when it appears there’s NO WAY it could drop. There’s always that chance no matter how solid it is, if it tanks, you’re out of the game.

Last year, I was definitely tempted to go all in on crypto. I was up over $400,000 in less than 8 months. That’s obviously an incredible pop. Around that time, I had sold some properties, got a bonus check, and was sitting on quite a bit of cash. I had to make a choice:

1. Invest a chunk of funds into boring, entirely predictable self-storage, or,
2. Continue to buy more crypto and keep cranking out 100% plus annual returns.

Crypto had so much momentum it seemed like the party would never end. As good as cryptocurrency was going, as staggering as the returns predicted, and as quickly as this asset went up, I had learned my lessons – I was not going all in. And that principle of mine never changed. It was, after all, a highly volatile asset! 

So I plowed the money instead to self-storage to stay the course with my portfolio allocations. And if you’ve followed the crypto markets even a little, you’ll know that was a wise decision, because crypto dropped from its highs in November 2021 down over 65% in just a few months.

Bottomline: What goes up quickly can come down just as quickly.

A Good Asset Allocation Plan For Diversification

So what does a good asset allocation plan look like? How do you figure out what amounts to invest into each asset?

I’ll start by saying that there is no exact science to this, and I’m not one to get things exact. I hate details. I’m a big picture guy. In addition, things can change quickly. There may be times where I skew a bit more in a certain direction if I like the trends, the risk/reward is strong, and the asset is undervalued by the markets.

For example, for a long time I’ve had very little invested in stocks. I simply didn’t like the valuations, I thought that the market was overvalued and the risk/return was not in my favor. When stocks crashed and particularly tech stocks got hammered in the last market crash, there were great companies that were unfairly punished. 

To say the market is always rational, isn’t very rational. Then I doubled my tech and growth stocks. When Bitcoin mining machines went on sale when China put a national ban on all mining, I increased my crypto exposure well past my typical 10% allocation to this crazy risk on asset. 

I was comfortable doing that because mining is a way to cash flow the crypto markets, and it creates a layer of safety since your cost per mined coin over time is so much cheaper than buying it at the market price.

Here is how I’ve structured my portfolio:

• At a high level view, I want 80% of my principal capital in safe cash flowing investments, which is predominantly real estate related.
• Since I don’t want to miss out on growth opportunities, I don’t like 100% into safe assets. We need to have some exposure to investments that can grow in value quickly.
• So the other 20% is in crypto, pre-IPOs, and tech stocks. As income comes in from my cash flow assets, I can take that income and speculate with it by buying more growth assets.

I have a few options for you as well.

Option 1: Turnkey Property

If you haven’t invested in real estate before, I’m sure that’s a bit overwhelming. Where do you even begin? There are so many ways to play the real estate game, it can be pretty difficult to determine where to effectively deploy your hard earned capital.

If you’re new to real estate, I’d suggest you start like I did with a turnkey property. A great turnkey provider will find, acquire, rehab, and place a tenant for you. You own the property and retain full 100% control, but the heavy lifting is done on your behalf by established teams. 

You typically need at least $25,000 cash to buy a property, since you’ll need 25% down and I don’t generally recommend properties under $100k – they’ll have too many issues.

Option 2: Syndication

Not quite ready for that? I get it. Not only could you not have the funds quite yet, but you also may not want any distractions. Early stage business owners should stay 100% focused on growing their business, in my opinion. 

You can set up a Fundrise account, which is crowdfunding. You’re buying small pieces of a property with hundreds or potentially thousands of other investors.

If you’re accredited (earning over $200k annually), then your best bet is to do syndication. This is very similar to crowdfunding, but with a much smaller pool of investors that are putting a larger amount in, typically minimum $50-$100k. 

To better help you determine which assets will be good for you right now, I created this free guide to walk you through 5 great ways to buy passive income investments.

FAQs

Here are some of the most common questions people ask me about diversifying their investment portfolios:

What should be in a diversified portfolio?

When it comes to cash management, diversifying your portfolio is key. By investing in a variety of different types of assets, you not only reduce risk but also increase your potential for growth. Diversification should include stocks and bonds, as well as real estate investments and commodities like gold and oil. As with any investment strategy, understanding the risks associated with each asset and the potential return on investment can help you make informed decisions and better manage your cash. Additionally, tracking your investments and portfolio performance over time is essential for making sure your portfolio remains diversified. Taking steps to properly manage your cash is a great way to achieve financial security and prosperity in the long run.

What happens when you diversify your investments?

When you diversify your investments, you spread your money out amongst a variety of different assets. This helps to reduce risk, as the performance of one type of asset won’t significantly impact the overall portfolio value. Additionally, investing in different types of assets also increases the potential for growth over time. Each asset class has its own set of risks and rewards associated with it, and understanding these can help you make wise decisions when creating your portfolio.

Finally, diversifying your investments also helps to spread out potential losses should one asset fail to perform the way you had hoped. This reduces the impact of any single bad investment on your overall portfolio and provides more of a safety net for your finances in the long run. With careful planning

Wrapping It Up

I hope this article has clearly illustrated why diversification is important in an investment portfolio.

I understand the desire to keep things simple. It’s far easier to just put all your money into one asset class like stocks. 

You don’t have to think about it much, and as new investable income flows in, you don’t have to make many decisions. It all depends on what kind of ride you want to have along the way. 

You could choose a relatively smooth ride with small drops in your net worth, or times where it drops by 30%, 40%, sometimes even 50%. But you’ll be welcoming drops of 80% or more if everything you have is in crypto.

A diversified portfolio largely made up of cash flowing assets with a steadily growing stack of high growth assets as your investment income continues to grow will provide a strong combination of safety, income, and growth.

Asset allocation, although not sexy and fun like crypto, is how we win the game at Indestructible Wealth.