Why Portfolio Diversification is Important to a Growing a Portfolio....

Hi All

I must warn everyone this is going to be lengthy post...

I thought I would post this as a lot of people keep asking me why portfolio diversification.

A lot of people have asked why I would spread my portfolio across multiple cities across in Australia...they ask me would it not be better off to just do it in your backyard..i.e. Sydney. My response is that you need the diversification to continually and steadily to grow a reasonable portfolio. It will take most people 10-20 years before they get a decent income...particularly if they enter mid cycle. Obviously...i am taking about buy and holds. Having said that it is also important that people buying and selling according to cycles ...will find this relevant as one market bottoms you will need a new market to continue to make money.

Lets look at 2 examples...one is JoeOneHit (JOH) and JennySteadyEddy( JSE):

JOH's portfolio looks like this and earns 100k:
4 units bought in Western Sydney at an average of 200k (total cost 800k and loans of 750k)...now worth 325k each ($1.3m)
4 houses bought in Western Sydney at an average of $250k (total cost $1m and loan of $950k)...now worth $425k each ($1.7m) total.

JSE's portfolio looks like this and earns 90k:
2 houses bought in Western Sydney at and average of $250k each (total cost of 500k and loan of 400k) ...two worth 850k now.
1 house bought in Central Coast at $220k with 200k loan and worth $450k
2 houses in Perth bought for 300k each (600k total and loan of 500k)..now worth 400k each post mining for a total of $800k
3 houses in Melbourne bought for $225k each (225k total loan of 600k) and now worth $900.

So in summary:
JOH has a total portfolio of $3.0m today with loans of $1.7m..so JOH has an equity of $1.3m today.
JSE has a total portfolio of $3.0m today with loans of $1.75m so JSE also has ane equirt of $1.3m.

By 2016 the Sydney market corrects by 16% in Western Sydney and 10% in the Central Coast and Melborne flat lines for now with growth potential, so now:

JOH's 4 units in Western Sydney is now worth $275k each or total of $1.1m and debt is still 750k
The 4 houses are now worth $355k each or a total of $1.42m debt is still $950k.

JSE''s portfolio in Western Sydney is now worth $710k and loan is 500k. The central coast is now 400k with a 200k loan. WA properties do not change and are still worth $800k with 500k owing no change. Melbourne has no change also so 900k with 600k owing.

SO after one cycle in Sydney....
JOH has a portfolio of worth 2.52m with 1.7m debt so equity is now 852k and LVR is 67% with very little prospects of growth for the next 7 years or so. JOH still have about 300k in equity but will be limited as banks may undervalue his portfolio further if Sydney is out of cycle.

JSE has portfolio $2.81m...with $1.7m owing...so equity is now $1.1m and LVR of 60% with prospects of growth in WA and some in Melbourne.

I would pick JSE's portfolio as this allows you to pull equity out as it is not exposed to one market...and when it flat lines other markets can still grow.

This is what happens with my portfolio.......

 

Yup different places are at different points in their cycles.

 

Not a bad idea if you can spread portfolio across different countries to increase diversification further, although I understand that isn't for everyone.

 

Different countries relies heavily on ur understanding of market and especially forex. While it might be attractive to do that there are risks associated with investing overseas which relies on relationships and networks especially property manager

 

Always risks involved with investing, plenty of people have got themselves in a real mess investing in their own backyard.

 

That is exactly what I was going to say...dealing with FOREX can be a nightmare particularly when it moves against you.

 

Another benefit of diversifying across different states is land tax savings.

 

Well for those in it it's ok as AUD has gone down but to buy in it still requires more due diligence

Otherwise u can hedge it with options depending on how much you have borrowed

 

Well they are some who do combo of dev, passive cashflow plus waiting on capital growth.
So the amount of properties does not necessarily matter as incoming capital will enable ability to purchase more. If u're hands on in renovation and want to supervise imagine travelling

Then again there are pros and cons to everything.

 

Another helpful post sash, thanks mate!

 

This is very true, and can make a world of difference.

Beat me to it! Land Tax is nasty.

Even though I agree wholeheartedly with diversification, I can also see merits of holding some close, and it all depends on each person's situation and appetite for risk. There are a lot of ways to be a successful investor, and what might suit me, may not necessarily suit someone else.

 

I had a colleague who bought a few heavily negatively geared properties in WA. They bought lots of toys and didn't even try to pay any more than the minimum repayments. I did try to tell them to consider the risks in this. Not sure how they're doing now. Diversification and paying down debt are obviously important to give your portfolio a strong foundation that allows it to weather the ups and downs of property cycles. Each to their own though.

 

Is JOH RetireRich101?
I would love to meet him one day.

 

Sash's example is great because it highlights one of several benefits of diversifying geo-graphically.

I'd also add to this; diversity in terms of the type of stock you hold, too. There are many ways to invest and many kinds of property stock within the residential category (and of course, many within the commercial too!).

 

I just read the thread title, thanks for the warning @sash!

You don't need to invest in your back yard, one there is a tenants in and you have a PM running the show there is no need for you to be within xkm of the property/s. Unless you want to save $3 and do repairs yourself go for it, but once tenants are in and doing their thing all you'll do is drive passed and day "....yep, still there "
Provided you found a pm with a telephone you'll be the first one to know if it burns down!

With technological advances you can get photos and reports emailed, I've also heard mobile phones can send pictures now! What a world we live in.
Follow the numbers, diversify and sow your seeds!

 

It's yet another reason I love NRAS. It buys me 10 years where I dont need to fund any of the debt from my pocket, and in all probability it buys me CF+ for life - even after the 10 years, so I can be very aggressive deleveraging with the surplus money and create equity via debt reduction no matter what any market is doing, growth wise. And if as I suspect, growth cycles slow quite a bit, I can wait because I'm making money without them, and expanding my footprint without them. Of course, I have used NRAS to purchase in multiple different markets including regional, to ensure I have a strong chance of something within the portfolio being in growth phase at any point in time. But my portfolio can survive zero growth and still make me very wealthy, and give me a passive income for life

 

Astute share investors diversify - so why wouldn't we as astute property investors? Investing is about making money, but it's also about minimising risks along the way. Properties in different locations (as already stated) can provide land tax savings and also dilutes exposure to any one particular state government. State government popularity (as we all know) can go up and down like a yo-yo. Popularity in local, state or federal governments creates confidence which in turn can drive property markets. Without confidence, people are less likely to put their hands in their pocket and pay hundreds of thousands of dollars for property.

Importantly though, it isn't just about diversifying into different locations. You also need to focus on diversifying on the industries which drive the respective locations which you are investing in. For example, an astute share investor wouldn't say, 'I've currently got NAB shares so I'm going to diversify and buy CBA shares'. Yes - they are different shares, but ultimately they are still both driven by the financial services sector. So why as property investors wouldn't we consider the industries that drive a particular location. If we bought two properties, in completely different locations, in different states, but both were heavily influenced by tourism for example, we aren't really diversifying our portfolio as well as possible.

Certainly heaps to think about.

 

Nah!! No one on this forum would have paid $250K average for a house in Mt Druitt.
LOL

 

So would I...I have a little present for him/her.