Allocating a portion to real estate investment trusts (REITs) is one way to diversify your investment portfolio and reduce risk. But you might be wondering, what is the best REIT portfolio allocation? We did some research and are here to share what we found.
All About REITs
Despite the market conditions, commercial real estate continues to be a core asset with unique investment attributes and return drivers.
This has been shown throughout time, and it is for this reason that 83% of US financial advisors suggest including REITs in a well-diversified portfolio.
A real estate investment trust (REIT) is a special type of company that owns, operates, or finances income-producing real estate.
Publicly traded REITs are required by law to distribute at least 90% of their taxable income to shareholders as dividends.
This makes them an attractive investment for income-seeking investors in the real estate market.
There are four main types of REITs:
- Equity REITs – own and operate income-producing real estate, such as office buildings, shopping centers, and apartments
- Mortgage REITs – provide financing for income-producing real estate by originating and/or investing in loans and mortgage-backed securities
- Hybrid REITs – combine aspects of both equity and mortgage REITs
- Foreign (non-US) REITs – engage in real estate activities outside of the United States.
What Is the Best REIT Portfolio Allocation?
Most experts recommend allocating 5% – 15% of your overall portfolio to REITs.
But on a personal scale, the best asset allocation for you will depend on your individual circumstances, including your investment goals, risk tolerance, and time horizon.
Overall Portfolio Allocation
When determining how much of your portfolio should be allocated to REITs, it’s important to consider your overall asset allocation.
For example, if you have a well-diversified portfolio that includes a mix of stocks, bonds, and other assets, you may want to allocate a smaller portion of your portfolio to REITs.
On the other hand, if your portfolio is heavily weighted toward stocks, you may want to allocate a larger portion to REITs.
Risk Tolerance
REITs can be a volatile asset class, so it’s best to consider your risk tolerance when determining your allocation.
If you’re an investor who is comfortable with a higher degree of volatility and real estate exposure, you may want to allocate a larger portion of your portfolio to REITs.
However, if you’re an investor who prefers a more conservative approach, you may want to allocate a smaller portion of your portfolio to REITs.
Time Horizon
Your time horizon is also important when determining your REIT portfolio allocation.
If you’re an investor with a long-term time horizon, you may be able to tolerate a higher degree of volatility. You may want to allocate a larger portion of your portfolio to REITs.
But if you’re one of the institutional and retail investors with a shorter time horizon, you may want to allocate a smaller portion of your portfolio to REIT stocks.
Investment Goals
Finally, your investment goals must be considered when determining your REIT portfolio allocation.
For example, if you’re looking for income from real estate companies, you may want to allocate a larger portion of your portfolio to REITs.
On the other hand, if you’re looking for capital appreciation, you may want to allocate a smaller portion of your portfolio to REITs.
Should You Include REITs in Your Portfolio?
Yes, investing in REITs can be a great way to diversify your portfolio and earn extra income. Commercial real estate is the third largest asset class in the US, after equities and bonds.
In fact, most financial advisors in the US recommend including REITs in your overall investment portfolio. And there’s a good reason for that.
REITs offer several benefits, including:
- Diversification: REITs offer investors diversification away from the stock market and into a unique asset class with its own return drivers.
- Income: Equity REITs are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends, making them an attractive investment for income-seeking investors.
- Growth potential: In addition to providing income, REITs offer the potential for capital appreciation as properties are bought, sold, or redeveloped.
- Liquidity: Publicly traded REITs are highly liquid and can be bought and sold easily on major stock exchanges.
Related: What Are The Taxes On REIT Dividends?
What Other Asset Classes Are Worth Considering?
When it comes to portfolio allocation, there are a variety of asset classes worth considering. Here’s a look at some of the most popular asset options:
Stocks
A stock is a share in the ownership of a company. When you buy stock, you become a partial owner of the company and are entitled to a portion of its profits or losses.
Publicly traded companies have their stock listed on exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq, where it can be bought and sold by investors.
Stocks offer the potential for high returns but also have higher risks. If you’re comfortable taking on more risk, stocks could be a good option.
Related: The 5 Best Value Stocks for Inflation
Bonds
Bonds are debt instruments that are issued by governments and corporations. They typically offer lower returns than equities but are also less risky.
For example, bondholders generally get their money back before shareholders if a company goes bankrupt.
Bonds tend to be less volatile than stocks, which makes them a good choice for investors who want to minimize risk.
However, bonds typically offer lower returns than stocks, so they may not be the best choice if you’re looking to maximize your investment gains.
Cash
Cash is often considered the simplest asset class, but it can be an important part of a diversified portfolio and is considered the safest investment option.
While cash may not offer the potential for high returns, it does provide stability and liquidity, which can be valuable during periods of market volatility.
What Are the Benefits of Portfolio Diversification?
Portfolio diversification is an important investing strategy that can help mitigate risk and maximize returns.
By investing in a mix of asset classes, sectors, and geographies, investors can reduce their exposure to any single economic or political event.
Diversification can also help smooth out the ups and downs of the market, as different asset classes tend to perform differently at different times. This diversification benefit is often referred to as a “negative correlation.”
For example, when stocks are struggling, bonds may be doing well. And when the domestic economy is weak, international investments may be strong.
By diversifying your portfolio, you can participate in the upside of different markets while protecting yourself from the downside risk of any one market.
Of course, there is no guaranteed way to completely eliminate risk from your portfolio. But diversification is one of the most effective tools investors have to manage risk and improve returns over the long term.
Final Thoughts
In conclusion, allocating a portion of your investment portfolio to REITs is a smart move that can provide you with increased stability and the potential for higher returns.
How much of your portfolio you allocate to REITs is up to you, but most experts recommend allocating between 5% – 15%. When making this decision, it’s important to consider your overall investment goals and risk tolerance.
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