If you don’t have REITs as a permanent asset class in your allocation, you should. And if you do own REITs, you should probably own more.
These are bold statements, but I’m here to back them up with facts. REITs are a fantastic asset class and are appropriate for every investor—from the youngest and most aggressive to those already decades into retirement.
REITs may not always be attractively priced, and there may be times when it makes sense to underweight them or to make a short-term tactical move to be out of them altogether. But these times are few and far between, and under normal conditions an allocation of 10%-20% in REITs is completely appropriate.
Today, we’re going to count the reasons why REITs belong in your portfolio.
#1 Diversification
Let’s start with one of the fundamental concepts of modern portfolio management: diversification. The alchemy of modern finance is that you can improve returns and reduce risk simply by holding the right mix of securities and rebalancing regularly.
But there is a difference between “diversification†and “de-worse-ification.†Loading up your portfolio with exotic asset classes only makes sense if you expect those asset classes to generate competitive returns over time. Otherwise, you’re simply diluting your portfolio with lousy assets that will drag down your long-term returns. Unfortunately, this is the case with bonds at today’s pitifully low yields.
As I’ll show in the next section, REIT returns are very competitive with those of mainstream stocks.
But importantly, for diversification to work its magic, returns are not enough. You also need those returns to be “non-perfectly correlated.†In other words, while you expect all of your asset classes to do well over time, you need some of them to zig while others zag.
Luckily, this is very much the case with REITs and mainstream stocks. Over the past six months, the correlation between the returns of the Vanguard REIT ETF (VNQ) and the S&P 500 SPDR (SPY) was only 0.51 (1.00 would suggest they move in lockstep). As we saw during the 2013 “taper tantrum,†REITs and mainstream equities can move in opposite directions for months at a time.
