You may have heard the saying “When you’re on a good thing, stick to it.”
While this should be applied to relationships, restaurants and a cold beer on a summer’s day, when it comes to property investing, I prefer the tried-and-true phrase, “Don’t put all your eggs in one basket.”
But despite this advice, there have been plenty of investors who push past the good sense and tie themselves to one strategy or location.
Unfortunately, avoiding diversification is a monstrous disservice to their future wealth position.
As a species, we are biased toward the comfort of familiarity and loss aversion.
First up, we love to select options with which we’re familiar.
Choosing to invest in your home suburb is incredibly popular – particularly for first timers. They feel like they already understand what drives their suburb’s real estate prices. In addition, if their investment underperforms, they’ll rationalise the downside and hang tight for the comeback like a cheer squad at a football match.
The other influence that causes us to ‘stay the path’ is loss aversion bias.
Put simply, an investor might pick a winning suburb and yield a good result, but when they’re later presented other locations with all the hallmarks of potential success, they can’t bring themselves to make the jump. They’re totally convinced their first suburb will just keep on delivering, no matter what.
The crux is that our biases work in tandem with our emotions and lead to substandard decisions.
I can tell you from experience – emotion has no place in the successful investor’s playbook.
Savvy operators who’ve trod the investment journey will confirm – diversification works.
But what type of diversification are we talking about?
Firstly, locational diversity is essential.
Again, you’ll have heard it repeated ad nauseum that Australia isn’t a single property market. It’s a collective of submarkets all operating at different speeds and pushed by varying drivers such as local economy and population demographic.
You cannot simply pick one suburb and pour your money into snapping up assets in expectation of maximising your wealth building. What you must do instead is be prepared to purchase in areas which have the right metrics for growth, rental demand and liquidity at any given time.
An excellent example is the mining boom earlier this century which saw millions of dollars poured into locations like Moranbah QLD where rental returns were skyrocketing as a seemingly endless stream of mining workers snapped up available space at exorbitant rents.
Anyone who threw their money holus-bolus into this market is now living a financial nightmare with the phrase, “If only I’d diversified!” ringing in their ears.
Instead, select locations where you feel the time is ripe for sustained capital growth and strong rental demand, but be prepared to pivot into the next promising growth zone as well. By progressively acquiring assets in growth markets, you’ll build a self-servicing portfolio with solid foundations for the future.
And while the mining bust may have been predictable, diversification can also mitigate the downsides from entirely unforeseeable events as well.
There’s never been a more prescient example than what’s happening with property markets and COVID right now.
Investors who have holdings in Melbourne – where a combination of spiking infections and non-existent international migration are hitting the market hard – would be sweating. But those who diversified in Brisbane as their portfolio grew are looking much safer.
A further factor in applying diversification is looking for holdings that best suit the particular stage of your personal investment cycle.
For example, if you’re young and starting out in a career, you have time on your side. You might choose assets with extraordinarily good long-term growth potential but at a price point where the rent and your income can easily service the loan.
Conversely, more mature inventors might leverage equity off their existing portfolio and seek higher cashflow from their assets in preparation for a pending retirement.
If you don’t flex and diversify to suit your stage of the journey, you will not be maximising your wealth outcomes.
Diversification is a shark net
There one other benefit in understanding diversification. It can be used as a litmus test for choosing a reputable property investment advisor.
If an advisor suggests only buying new units in a particular development (or from a specific developer) in the one location, run away quickly.
Great advisors want to personalise the investment journey to suit your needs, not line their pockets via inflated commissions.
Make sure your team are considering all the options available across our broad brown land and presenting you with convincing evidence as to why a particular asset will suit your strategy.
Diversification is essential. Make it part of your philosophy so you can look forward to successful investing in markets right across our nation.
Richard Crabb, ASPIRE Property Advisor Network, 24 July 2020