Diversification

Diversification is a commonly tossed around term that is often misunderstood and difficult to achieve. Diversification is the process of diluting risk without diluting value. People who often think they have achieved diversification, actually end up diluting value more than they have diluted risk.

Why is diversification important?

Diversification is important because it helps investors control their potential losses. For investors seeking to protect their wealth, diversification is the foundation of a strong portfolio. As the old adage says, "don't put all your eggs in one basket." There are many investment products, which investors can invest in to build a diversified portfolio. A short list and guide to them can be found here Here

Correlation

Correlation is how likely two different asset prices are likely to move in the same direction and to the same degree. Lyft and Uber are considered highly correlated because they are both ridesharing companies and any material effect on one may affect the other. Cotton and real estate are considered to have low correlation because if the price of cotton were to change, it is unlikely that the price of real estate would change.

To create a properly diversified portfolio, you need to have multiple assets with low correlation to each other. It is easy to fall into the trap that investing in a mutual fund or total market ETF is enough to be considered diversified. In reality, you are just paying fees to fund managers for a portfolio that isn’t as diversified as you think. For example, let’s take a look at Vanguard’s Total Stock Market Index Fund (VTSAX). As of this writing it’s top ten holdings, which accounts for 22.9% of the portfolio, are Apple, Microsoft, Amazon, Alphabet, Facebook, Tesla, Berkshire Hathaway, JP Morgan Chase, Johnson & Johnson, and Visa. It’s top 5 holdings are tech companies with high correlation, which makes the fund more susceptible to risk than you might think.

So if a total market fund doesn’t qualify as diversified, what does? As a matter of fact, no asset class on its own is considered diversified. You must not only diversify within an asset class such as stocks, but you must also be invested in other types of assets such as real estate, bonds, or commodities. Read our article on portfolio management to learn about the current theories for how to balance a portfolio.

Conclusion

In conclusion, while diversification is difficult to achieve, it is not impossible to achieve. PeerInvest seeks to make it easier for investors to include real estate in their portfolio by lowering the cash requirement, removing credit score requirements, and managing the properties for investors.

Traditional real estate investmenting methods have limited investors to properties near where they live and a few properties account for a large portion of their real estate portfolio. This creates an outsized risk, but PeerInvest helps investors manage this risk by allowing investors to diversify their real estate portfolio through partial ownership of multiple properties across many locales.

Disclaimer: PeerInvest is not a financial advisor and this post is for informational purposes only. Please consult a financial advisor before acting on the information in this post.