3 Asset Classes & Why Warren Buffett Doesn't Choose Just One

Most people feel that being diversified in their investments is the intelligent thing to do. But, as Sharon L. Lechter (Rich Dad Poor Dad co-author and CPA) describes the various asset classes to invest in, she says, “Many people think they are diversifying, but all their money is in mutual funds.” What she’s really pointing out is that you’re not really diversified if you’re only in one asset class.

So, let’s look at the different asset classes and some of their pros and cons.

The 3 Types of Asset Classes: Pros & Cons

1. Businesses

Pro: This is the asset class that offers the highest of all returns on investments, especially if you invest in a start-up that really takes off, like Instagram or Microsoft did. Also, if you really think about it, many tax laws were written to favor business owners, and many everyday expenses can be run through a business. For me, my business is PPR.

Con: Businesses are the toughest asset class to own, develop, and maintain.

2. Real Estate

Pro: Real estate is the easiest of asset classes to leverage. It’s easier to borrow money for real estate than it is for a business or paper assets.

Con: For the smaller investor, real estate can be far more capital intensive than investing in paper assets. (I can invest $25 in Lending Club, a paper asset in the form of an unsecured note, but it’s hard to invest $25 in a piece of real estate.)

3. Paper Assets

Pro: Paper assets are the easiest of all asset classes to get in and out of. An example for me is that I can sell a note in less than 30 minutes. I’m not so sure I could sell a piece of real estate that quickly. I could also trade a stock option in seconds or minutes.

Con: You probably have the least financial control. There are definitely fewer tax advantages, and they can be highly volatile.

As you and I think about our investment plans for the upcoming year and any new tax implications, instead of just thinking about diversifying within one asset class, let’s think about what kind of synergy we can create amongst the asset classes we decide to invest in.

According to Robert Kiyosaki, author of Rich Dad Poor Dad, the average investors invest in a particular asset class, but the folks who get the best returns invest in multiple classes simultaneously (see “Who Took My Money”).

For example, Donald Trump created synergy between business and real estate. Warren Buffett, on the other hand, created it between business and paper assets. I intend to continue to do so between business and paper assets as well.

So, the first questions to think about are what kind of investor are you, and then what type of asset classes do you want to consider: businesses, real estate, or paper assets?

While you’re figuring out what type of investor you are, it may help to determine if you are risk-averse, if you are investing for the long haul, or if you are interested solely in cash flow. Some high income earners who aren’t necessarily concerned with cash flow may be looking for high-end rentals that will appreciate and be worth more later on. For others, they may be looking for both cash flow and appreciation. In a perfect world, everyone wants a little bit of both.

And let’s look at how much time commitment you’re willing to devote because we all know that “time is money.”

But, before answering the second question of what to invest in, you may need to take into account a quick overview of the current market. For this, I’ve always liked John Mauldin from www.InvestorsInsight.com.

For me, although I personally invest in all three asset classes, I’m looking into making some adjustments to my portfolio. For example, I’m transitioning from ARMs (Adjustable Rate Mortgages) to fixed-rate mortgages, either by refinancing or selling off a few properties. In the new year, one of my goals is also to build my portfolio of performing notes to the point that the passive income from those assets is the same or higher than my current earned income. Overall, I just want to keep reinvesting my capital and keep the money moving.

So, how do you plan to create synergy with your investments this year?

Let me know your thoughts with a comment.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.