As anyone who's been in the investment game for even a small amount of time knows, industry jargon gets thrown around at a lightning pace. However, one word may stick out above all others: diversification.
Experts and newcomers alike talk about the importance of diversification when constructing an investment portfolio. But why?
Advantages of diversification
"By diversifying your portfolio, you are spreading your wealth around, thereby reducing risk."
Since you were a little kid, chances are people have told you not to put all your eggs in one basket. Diversification teaches the same lesson, only this time it's your hard-earned money at stake.
By diversifying your portfolio, you are spreading your wealth around, thereby reducing risk.
If you were to put all your money into one investment – say, stocks or bonds – and that particular vehicle fails, there's nothing you can do. However, by diversifying your portfolio by putting money into multiple investments, you can still see profits from some even if others perform poorly.
Put simply, diversification is all about spreading your risk so even if one basket falls, not all your eggs will be cracked.
In an article for U.S. News & World Report, financial advisor Roger Wohlner talked about how diversification can be used to meet your own specific investment objectives.¹
"Your allocation to each of these broad categories should be based upon your investment goals, your tolerance for risk, and your time horizon for needing the use of the money," he said. "In short, your asset allocation should be an outgrowth of your financial plan."
Another benefit of diversification is less time and energy spent watching and moving your investments. Since diversified portfolios are more stable, you can leave your money in different investments without constantly having to maintain them, freeing up more time to focus on the pursuits you're passionate about and actually enjoy the returns you're seeing.
Diversifying through private lending
If the whole point of diversifying your portfolio is reducing risk, it only makes sense to focus on investment opportunities that are safer.
While no investment is absolutely risk-free, private lending is arguably one of the safer choices at your disposal. It's for this reason that banks are able to generate high returns regardless of which way the market is headed.
This is partly because you're ultimately in control of how the loans are structured. You can fine-tune the loans you make available to minimize risk and maximize profit.
Additionally, as George Antone outlines in The Banker's Code, private lending is one investment strategy that requires much less hassle.²
"Investors have to buy physical structures, such as properties or businesses, to use as collateral to get leverage (borrowed money) so they can generate cash flow," Antone said. "Then they are forced to deal with the aggravations of these assets, such as tenant problems, overflowing toilets, employee hassles, inevitable lawsuits, and a myriad of other nightmare scenarios. Bankers simply print a piece of paper – a mortgage – and as long as someone is willing to sign it as a borrower, it serves as the collateral for borrowed money."
In short, private lending is a proven way to create cash flow without many of the same headaches seen in other investments.
A world of opportunity
The simple truth is, it's become much more difficult for individuals to secure the financing they need for investments. This has created a substantial need for private lending.
By becoming a private lender yourself, you will be able to take advantage of this market and help borrowers who are willing to pay premium prices for the money they require.
Not only can you diversify your own portfolio while generating high returns, you can also help others like you secure their own financing to put an investment strategy into action.
It's a win-win for the market, and an ideal way to lessen your own portfolio risk.
1. "Here's Why Diversification Matters," Roger Wohlner, 2013, U.S. News & World Report.
2. "The Banker's Code," George Antone, 2012, WealthClassesPublishing.