Diversification is a fundamental strategy that every investor should employ, but what's best to add to your asset menu depends on what you already own. In this segment of Motley Fool Answers, Alison Southwick and Robert Brokamp discuss what having a large fraction of your net worth in income-producing buildings means for your investment strategy, how it effects your risk profile, and more.
A full transcript follows the video.

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This podcast was recorded on Sept. 13, 2016

Alison Southwick: This one comes from Bruce. Now you told me to edit this down, and you left out some of the praise that Bruce had for you, but I stuck it back in.

Robert Brokamp: OK.

Southwick: Bruce says: "Love the show. I listen every week and I also have read every word that Bro has written for Rule Your Retirement."

Brokamp: That is more than 12 years' worth of issues, so good for you, Bruce.

Southwick: God bless you, Bruce. His question is: "I have a substantial amount of investable assets in income-producing rental real estate -- close to half, as I started investing in real estate at a very young age. I have been ignoring this in my allocations but, after thinking about it for a while, realized that is pretty dumb. What is your recommendation for considering these properties in my investment allocation and in creating a model portfolio?"

Brokamp: Well, Bruce, the question you would ask with any non-portfolio asset (including your human capital, which is your ability to earn a paycheck) is how it affects the risk profile of your overall household finances. So if you have rental properties, and they're cash flow positive, that adds diversification to your overall household portfolio, because you've got an asset that can increase in value, and it's producing income.

Because it is adding this diversification, it lowers your overall risk profile (which means you can take more risk) in your investment portfolio. You might have more stocks than you otherwise would have.

You do have to look at the properties themselves. For example, just like stocks, you want to make sure you are diversified. If all your properties are in the same area serving the same sort of people, they're not quite as diversified as if you had properties in other locations. Maybe you have rental properties that are at the beach, or rental properties on a lake. You want to look at the location of the properties. Is that location economically diversified? Is it in a place like Detroit that was very reliant on the auto industry, or is it in a place like the Washington, D.C., area which has a diversified economy?

Then the other question people often bring up when it comes to real estate and their portfolio is, "I have a house. I have rental properties. Maybe I don't need to invest in things like real estate investment trusts," which is a good type of stock to have in a diversified portfolio.

But REITs are very different than rental properties and your house, because REITs invest in companies like hospitals, storage facilities, or office buildings, so they perform very differently than rental real estate or your own house. Just because you have rental property doesn't necessarily mean you should not have REITs. Overall, I think having real estate is a great idea and allows you to take more risk in your portfolio.