Investment planning brings excitement to the financial planning process. Building an investment portfolio provides opportunities to earn healthy returns on your hard-earned money and sometimes to speculate on a penny stock that may become the next Microsoft. Some households get to taken with investing that they mistake an investment portfolio for financial planning, which could be costly in the long term.

There are a number of steps you need to follow for investments planning that are worth mentioning. These steps help establish the criteria for building an investment portfolio. Included in this portfolio are the usual suspects – stocks, bonds, and mutual funds.

Step 1: Define Property Investment Goals
Step 2: Establish Investment Priorities
Step 3: Determine Investment Time Horizon
Step 4: Determine Level of Risk Taking
Step 5: Determine Level of Diversification
Step 6: Determine Acceptable Property Investments
Step 7: Determine a Method of Investing / Financing

The focus here is to add real estate to your investment portfolio. To accomplish this, we need to review how these seven steps help establish criteria for building a real estate portfolio within your investment portfolio.

Step 1: Define Property Investment Goals

Is your objective to become rich by age forty, or are you willing to wait until retirement age to cash in on your investments? With regard to real estate, your purchase goals depend heavily on age. Young households are just looking to save enough money for a down payment on a starter home, while established households are hoping to trade up into their dream home. But savvy property investors are looking to build a real estate portfolio that will play a major role in both their investment and retirement portfolios.

Step 2:  Establish Investment Priorities

With regard to real estate, your number-one priority is to purchase a primary residence (probably a starter home). After owning a primary residence, you need to review your property expansion plans by prioritizing the following options: home improvement, trading up, vacation property, and rental property.

Step 3: Determine Investment Time Horizon

How long you intend to hold on to a property is an important decision. Depending on the property type, location, and local market performance, a holding period could be as short as 6 months (flipping), 1-5 years (short term), or more than 5 years (long term). Fixer-uppers and foreclosure properties are potential flip opportunities, vacation properties could be a long-term hold, while the holdings horizon for rental properties depends on market conditions.

Step 4: Determine Level of Risk Taking

Real estate covers a wide spectrum with regard to risk. You need to determine your level of acceptable risk taking for real estate properties. First, decide on a property type – single-family or condo; vacation property or rental property. Condos usually pose less risk since there are lower maintenance costs, while single-family detached homes pose greater risk due to the higher maintenance costs. Vacation properties pose a great deal of risk, since you are likely to be absent from the property for long periods of time, and there may be little rent to cover the expenses associated with financing and maintaining the property. Rental properties also pose a relatively high level of risk due to tenant uncertainty, maintenance costs, and so on. Within rental properties, you could purchase foreclosures and fixer-uppers, which potentially pose the greatest risk (but highest return) of all property types.

With regard to location, some locations are riskier than others, depending on local population and economic and housing conditions. You need to decide how much risk you are willing to assume with the financing of the property (e.g., variable or fixed-rate loan, size of down payment).

Step 5: Determine Level of Diversification

Everyone knows the expression “You don’t put all your eggs in one basket”. If the basket falls, you may lose all your eggs. Similarly, you don’t put all your hard-earned money into one real estate investment. If this investment turns sour, you could lose a great of money. This is why I recommend that households expand their real estate investments beyond their own home.

I would recommend that you diversify your property portfolio in one of tow ways: diversify amount property types; or more important, diversify among geographic location. Investing in the same property type brings simplicity and some economies of scale (e.g., if you purchase three one-bedroom condo units in the same building), but you need to be careful not to become too dependent on a specific property type. However, if you have found a successful formula for investing in only one-bedroom condos, do not use diversification as a reason to change direction. Diversifying amount geographic locations is preferable, in theory, but sometimes difficult to implement. For example, ideally you would diversify a portfolio of rental properties among different locations across a metro area, but it may be difficult for you to logistically monitor and service those properties.

An investment portfolio with property holdings is a more diversified portfolio. Below is an example of an investment portfolio with real estate holdings:

Investment Portfolio with Real Estate Holdings
Stocks
 IBM
 General Motors
 Exxon Mobil
 Microsoft
Bonds
 CDs
 10-year Treasury
Mutual Funds
 Fidelity
Real Estate
 Rental Property 1
 Rental Property 2
 Vacation Property

In the above investment portfolio, the rental properties generate annual cash flow (via rent) and, thus, annual returns, similar to stocks and bonds. The vacation home probably generates little cash flow, if any, but it is housed in the investment portfolio because its value is expected to rise over time. Unrealized price gains from the vacation property raise the overall value of the investment portfolio. The portfolio share of real estate versus stocks and bonds depends heavily on two factors: risk and liquidity. How much risk are you willing to assume in property investments? Rental properties are associated with high returns, but greater risk than most stock and bond investments due to tenant and maintenance risk. Given those risks, you need to determine how many rental properties you are willing to take on in the investment portfolio. In addition, property investments are less liquid than stock and bonds. Liquidity concerns come into play as your investment time horizon shortens.

Step 6: Determine Acceptable Property Investments

Once you develop a property – investment strategy, make sure the properties you choose don’t leave you stranded. Depending on your investment focus, determine which property type and location is best suited for your needs. The most constructive strategy is to make a list of the acceptable property types for your investment portfolio . Here are some examples:

• Primary residence. Obviously acceptable (though, I would allocate this to your retirement portfolio).
• Primary home improvements. The risk here is under your control since you determine the funds going into it, but you need to be willing to accept contractor problems and a temporary disruption in your daily living.

• Vacation Property. Somewhat under your control if you can manage the extra financial burdens of a second mortgage.

• Rental properties. These are the high-risk investments in your property investment portfolio. You can manage the risks more effectively by purchasing only less risky condos within thirty miles of your primary residence so you can service them on a timely and manageable basis.
•Indirect property vehicles such as REITs and real estate mutual funds.

Step 7: Determine a Method of Investing / Financing

This is an important last step. I recommend that you establish some criteria for the method of investing in properties. Let me give you an example of what I mean.

Investment / financing Criteria for Rental Properties
• Property type: one- or two- bedroom condo units
• Location: Washington, D.C., metro area
• Negative cash flow (expenses minus rental income) not to exceed $400 per month
• Down payment not to exceed 30 percent
• Financing based on 30-year amortization schedule
• Property needs to be tenant occupied
• Condo association fees not to exceed $350 per month
• Price appreciation projections not to exceed 5 percent