Diversifying with Real Estate Investment Trusts (REIT)
Investors have a number of different options when working to build a solid portfolio. The most important aspect is ensuring that you have an asset allocation that meets the risk levels you are comfortable with. In short, the higher the percentage of stocks in a portfolio the higher the risk.
However, when building an asset allocation, most investors typically stick to the common three: Stocks, Bonds and Treasuries. This may meet some investor’s needs. However, for people who want to see potentially higher growth and income in their portfolios an asset class to consider is Real Estate Investment Trusts (REITs).
What are REITs?
A real estate investment trust is an asset class that invests in a portfolio of real estate assets. These assets are pool together under one company. It is then offered to investors as shares. This essentially provides shareholders with ownership of all of those real estate investments. In other words, a shareholder in a REIT is diversifying their portfolio into real estate.
Benefits of REITs
The primary benefit of a REIT is that it provides the investor with diversification benefits. Instead of only investing in stocks, bonds and cash, an investor can further diversify their portfolio by buying real estate. Most of the time, REITs are not 100% correlated with the market. This means that when stocks are heading down, REITs may not be as impacted.
The second benefit of a REIT is that it often provides good income in the form of distributions to shareholders. As the properties within the REIT earn rent or are sold, funds from these transactions are pass onto shareholders. Like dividends, these distributions are a solid way to add income to a portfolio. It can help to enhance returns and potentially fund retirement.
How Much to Allocate to REITs?
The question about how much of a portfolio to allocate to REITs is complex. It will differ depending on each investors risk profile and the goals of their portfolio (growth versus income for example).
However, when reviewing the literature and suggestions from investment experts like William Bernstein, the common suggestion is to target approximately 5% to 10% to REITs. This amount is big enough to make a difference to most portfolios but small enough not to dominate it.
It will not be prudent to place too much of your portfolio into REITs. This is simply because they are not a massive part of the market. They have performed well historically, but not well enough to dominate a portfolio.
What Are Some of the Best REIT Investments to Consider?
As with all investment selections, it is always a good idea to make sure you are investing in REITs in the most cost effective manner. This also includes one that provides good diversification. Individual REITs can be risky on their own, but by buying a basket of them that risk is reduced greatly.
To do that, buying an index fund that tracks the REIT index is a great strategy. This give you the diversification of owning a lot of REITs, using a low cost tool.
The first REIT based index fund to consider it the Vanguard REIT ETF. With a very low expense ratio of 0.12% the fund gives you ownership in some of the best run REITs, including Simon Property Group, Public Storage and Equity Residential. Add on the current yield of 4.05% and this can be strong investment over the long term.
The second option is the iShares Global REIT ETF which provides exposure to REITs around the world. It has a lower yield at 3.87% but does give the investor access to a global portfolio of real estate holdings.
As a whole, REITs should be a solid part of a well built asset allocation. They bring diversification and income to a portfolio which over the long term can help increase an investor’s wealth. If you don’t already invest in REITs, it may be the time to consider opening a position with a diversified low cost index fund to do that.
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