First things first, what is asset allocation? Asset allocation is a term used to describe a certain type of investment strategy and it focuses on putting different buckets of money into different assets to balance risk and return. An example of an asset is a stock, a bond, gold, or even real estate. Each asset has a difference risk/return profile. Some are riskier than others. According to Modern Portfolio Theory, the riskier an investment, the higher the projected return. Conversely, the less risky the investment, the lower the projected return. Most investment advisers and financial advisers coach their clients to spread their money among a variety of assets.
David Swensen, a highly regarded investment guru and manager for the Yale Endowment advises investors to invest 20% of their investable monies into real estate in his book "Pioneering Portfolio Management" (note: this is outside the value of your primary home).
|Asset Class||Policy Target|
|Foreign Developed Equity||15%|
|Emerging Market Equity||5%|
|U.S. Treasury Bonds||15%|
|U.S. Treasury Inflation-Protected Securities||15%|
Within real estate, you can allocate investable assets across different geographies, different property types (such as apartment buildings, retail strip malls, office buildings, warehouses and even industrial facilities) and also by investment type.
The two investment types are debt and equity. You can think of debt like acting as the bank. Banks lend money on real estate, whether it is to a home buyer or an investor who is purchasing a building to generate income from rents. In an equity investment, you own a slice of the property and share in the benefits of that ownership including upside from an eventual sale.
By investing in different regions and across real estate types, investors can avoid huge losses in the event of a boom or bust. It's all about diversification!