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Should you invest in REITs?

May 30, 2012

Historically low correlations (see matrix below) among real estate investment trusts (REITs) and other asset classes would suggest that they have potential diversification benefits within a globally diversified portfolio. Although REITs have generally been more volatile than stocks in the past, including a separate allocation to them would have actually helped to reduce the risk of your overall portfolio.

Correlation Matrix: January 1998–December 2011

Sources: Dimensional Fund Advisors, Morningstar EnCorr

So how much of your portfolio should be in REITs?

As with any discussion about asset allocation, the optimal amount of REITs to include in a portfolio is more art than science – there is no hard and fast rule. Here is what some industry experts have suggested in the past:

  • David Swensen: 15% of your overall portfolio
  • Larry Swedroe: 5% to 15% of your overall stock allocation
  • Rick Ferri: 10% of your overall stock allocation

I would generally consider starting with 10% of your stock allocation; whatever your portfolio allocation to stocks, carve out 10% from that amount and allocate this portion to Canadian, U.S., and International REITs. In the example below, I’ve taken the historical returns of a typical balanced “Couch Potato” portfolio (Portfolio 1: 40% bonds, 60% stocks) and carved out 10% of the stock allocation (or 6%) and allocated it evenly between three REIT indices (Portfolio 2: 40% bonds, 6% REITs, 54% stocks).

Sources: Dimensional Fund Advisors, Morningstar EnCorr

Sources: Dimensional Fund Advisors, Morningstar EnCorr

With a modest addition of REITs to the portfolio, the overall return actually increased (5.4% versus 5.2%) while the standard deviation decreased (8.0% versus 8.2%).

If you decide to include REITs as a separate asset class in your overall portfolio, understand that there may be lengthy periods when REITs will underperform the broad stock market; it is at these times that you will need to avoid any knee-jerk reactions and stick to your original investment plan.


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