Dear Mr. Market
Raise your hand if you would like the opportunity to increase the returns in your
portfolio without taking on more risk? There is indeed a way to help accomplish this and it’s not just by balancing between the two major asset classes of stocks and bonds; take a look at the third largest asset class there is: REITs (Real Estate Investment Trusts)
Most investors have little to zero exposure to REITs and they may be surprised to learn how important they can be to a healthy portfolio. This article will give you a better understanding of why adding REITs into your portfolio could improve your diversification, dividends, and ultimately your portfolio performance.
What are REITs and why use them?
Investopedia defines REITs as “a type of security that invests in real estate through property or mortgages and often trades on major exchanges like a stock. REITs provide investors with an extremely liquid stake in real estate. They receive special tax considerations and typically offer high dividend yields.”
Through some resources from Morningstar and NAREIT (National Association of Real Estate Investment Trusts) we will help educate you on four reasons you may want to have some exposure to REITs:
- Increase Returns without Increasing Risk
REITs are perhaps the most underutilized and misunderstood asset class. Although even a novice investor knows that they should diversify their investments, very few use REITs and remain underexposed. Adding REITs to a portfolio has proven to increase the risk-adjusted returns of portfolios over almost all stretches of markets.
Click here to see a graphic showing how adding a 10% allocation to REITs in a typical stock and bond portfolio increases returns and not risk over 3, 5, and 10 year periods. Adding 20% exposure to REITs increased the returns from 10.0% to 10.3% and still did not add more risk.
Adding REITs to your portfolio is an effective way to diversify as they don’t behave and react the same as other asset classes. Since 1990 REITs have had a 0.55 correlation to stocks and 0.19 correlation to bonds.
- Best Returning Asset Class over the past 45 years
Even though individual investors have been underexposed to REITs there is a very compelling and simple reason institutional investors (pension plans, endowments, foundations etc) have long embraced them: performance!
Since the Great Recession REITs have returned 20% an annualized basis versus 15% for the S&P 500. Over the past 15 years they have also easily been the best performing asset class averaging 12% per year and still maintain reasonable valuations.
Click here to see how REITs have performed relative to stocks, bonds, and Treasury Bills over a longer time frame (1972-2016). REITs provide strong dividends along with the potential for moderate long-term appreciation which can be appealing to both income and growth investors; especially in such a low interest rate environment.
- Stable Income even through Inflation and Volatility
Speaking of interest rates…what happens when rates increase? It’s normal and easy to get spooked into thinking that current and future interest rate hikes will adversely affect REITs. Conventional wisdom tells us that rising rates will hurt REITs but don’t just assume they do down because someone told you so. As a matter of fact REIT prices have more often increased than decreased in times of rising interest rates! Over 16 periods since 1995 when interest rates rose significantly, REITs had positive returns in 12 of them.
Don’t try and time your exposure to REITs but rather use them as part of your long-term allocation and adjust accordingly. It wasn’t that long ago in 2013 when all the “experts” recommended selling REITs only to see 2014 come in with returns of about 30%!
Keep in mind that returns are a combination of price and income. Click here to see how REITs have performed in periods of normal and high inflation. While stock and REIT prices can be volatile, their strong dividends provide stability in total return which may provide far better inflation protection than bonds.
- Extend how long a Portfolio can last in Retirement
We have good news and bad news about your retirement! The good news is that we’re all living longer and the bad news is that we’re all living longer…
Regardless of the percentage of your portfolio you are or will be withdrawing in retirement, adding REITs to your investment mix can definitely extend the life of how long your money will last.
For a great graphic on what three simple scenarios could look like, click here. You’ll see portfolios with different percentage exposures to REITS and how adding them to your portfolio extends how long the money could last. Take for example the most common and historically recommended withdrawal rate of 4%. If you retired at 65 years of age and had 45% exposure to Stocks, 45% to Bonds, 10% to Cash, and 0% exposure to REITS, it would last until you’re 92. Adding just 10% exposure to REITs (by reducing 5% from Stocks and 5% from Bonds in Portfolio 2) makes your money last three years longer; and keep in mind your risk level never increased.
Now obviously REITs are not the magical fairly dust that you sprinkle on a portfolio and everything becomes perfect; we’re just suggesting that most investors are uneducated and underexposed to this asset class and its potential benefits. We have a minimum exposure of 5% for every portfolio but depending on the individual goals and time horizon that is adjusted upwards.
If you’re curious what this could look like for you, contact us today to see what the appropriate amount is for your portfolio and to also learn how to specifically incorporate REITs into your overall mix.