Portfolio Allocation Feedback - TIPS & Too Much REITS?

[abuss368]

Bogleheads,

We wanted to receive some feedback and opinions related to REITS and our overall portfolio:

No need for tax, asset location, emergency funds, debt, etc. so no reason to post in the preferred format.

It appears that many of the largest fortunes in our country were built on Real Estate. I once read, that outside of oil (which only went on for a small time frame and only for a select few), real estate has been the biggest driver of wealth with the stock market.

Current Equity Allocation:

1) Total Stock Index - 50% of equity
2) Total International Index - 30% of equity
3) US REIT - 20% of equity

I am fine with a 30% allocation to International and do not plan to change. My question is related to the Total Stock Market and US REIT allocation. Either 50% TSM and 20% REIT or 40% TSM and 30% REIT. For the moment and arguements sake, I have no interest in a less than 20% of equity allocation to REITs. Without arguing, I am of the opinion anything less will have minimal to no impact and an investor should not bother at all. However, a 30% of equity allocation to REIT, is about 42% of US holdings.

With 20% of equity allcoated to REIT, that equates to about 15% of the overall portfolio. In the great book, "Bogle on Mutual Funds", Jack's "accumulation portfolio" recommendation allocates 15% of the portfolio to a specialty/sector fund. I am glad to have read Jack Bogle's thoughts on this. David Swensen's revised portfolio also included a 15% of the portfolio allocation to REIT.

That said, let's assume years down the road, a $1,000,000 portfolio with a 35% allcoation to stock and 65% allocation to bonds. That means $350,000 in equities at 20% of equity for REIT is $70,000. A $70,000 allocation to REIT on a $1 million portfolio is only 7%. Will this have much of an impact?

Along the lines of David Swensen's original recommendation (before being revised down from 20% overall REIT to 15% overall REIT at the portfolio level), if I went with a 20% overall portfolio allocation to REIT (which is approximately 30% of equities), the allocation on the $350,000 in equity would be $105,000. On a $1 million portfolio, that is 10%. That would have a lot more impact good or bad.

That said, if I directly invested in real estate, where there was no longer any depreciation benefit for tax purposes, and the mortgage was paid off, I would be paying tax on all profits at ordinary tax rates (i.e. same as REITs held in a taxable account). In addition, the allocation of total assets would probably be greater than 20% - 30% with direct real estate included.

I am considering adjusting the equity allocation to:
1) Total Stock Index - 40% of equity
2) Total International Index - 30% of equity
3) US REIT - 30% of equity

For the moment, I have no interest in International REIT/Real Estate for many of the reasons I have posted on the forum - high fees, restrictive, no endorsement by Jack Bogle, David Swensen, Rick Ferri, etc, not a 100% pure REIT fund, too much in Asia, tax/foreign tax credit debate, etc. For purposes of this post, let's exclude them for the moment.

I have looked at the backtested results over 40 years, and it appears REIT have beat the S&P since 1970 for all periods. I understand past performance is no guarantee, but that makes one take notice. This allocation is also based on David Swensen's Unconventional Success Portfolio (before the revised allocation decreasing REITs). I know this fund is volitile and dropped the same as TSM in 2008 (what didn't).

Further in reading many books on the REIT King himself Sam Zell, Wayne Huizenga of Fort Lauderdale/Waste Mgmt/Blockbuster/Auto Nation/ Swisher, even The Donald himself Trump, they all have made fortunes in REITs and Real Estate. I watched an interview with Donald Trump recently where he is telling Jim Cramer (yes I know) to include REITs in a portfolio. He stated REITs provide great access to property with awesome management teams.

My second question relates to Fixed Income allocation in the context of the above equity allocations.

We presently allocate our bonds as 100% Total Bond Market. We may be considering Inflation bonds again in the future (i.e. no interest in I Bonds, individual TIPS, CD's, etc.). If we do, we are considering a 30% allocation to the Intermediate Term Inflation Protected Bond Fund. The question is, with a higher % of equity allocated to REITs, would we be wise to allocate 30% of bonds to Inflation Bonds?

I understand the search for the perfect plan is the enemy of a good plan and that past results do not reflect future outcomes.

Any thoughts and feedback are appreciated.

Thank you everyone and have a great and safe holiday.

[scone]

I looked at REITs, and asked myself, what percentage of my total net worth is already in American real estate, e.g., home, rental properties, etc.? Hmmm. And have you considered how TIPS and REITS will react with each other, in terms of correlation and volatility? Just a thought.

[Occupier]

The first thing I noticed was your cite to Zell. He sold his REITS in 2006 because he thought they were overvalued. I think a 20% allocation to REITS is unwise and 30% worse. 1) Lets start the analysis at the beginning. Fama/French noted that REITS were a distinct asset class in that their performance does not correlate with other equities. 2) If you buy uncorrelated assets you can increase risk without additional volatility. More simply put, if you buy assets that won't go up or down at the same time your portfolio is less likely to sink or soar at any one time to your detriment. 3) What makes REITS different? Traditionally they are leveraged. In inflationary times rents - their income - goes up but their biggest expense, fixed rate mortgages do not go up, and in deflationary times people still pay their rent and mortgages can be refinanced at lower rates, so the two economic disasters that hit bonds hard - inflation, or equities hard - deflation and recession, don't have as much affect on REITS. What kills REITS is overbuilding. In the 1980's when everything else was doing well, REITS experienced the affect of overbuilding. You could see through the empty skyscrapers in may cities. They did poorly at that time which is what makes them uncorrelated. 4) Now when I first got into REITS in the late 90's they were selling for less than the book value of their buildings. Now they are closer to twice the book value of their buildings. You can be cocky about their performance in the last 10 years, but your just being a sucker for recency. REITS belong in your portfolio but they don't belong to be one of the biggest parts of your portfolio. At the old board we used to read posts in about 2000 about how a large allocation to tech was warranted. you don't hear that much anymore. So you ask what I think. I think you sound like the tech people did in 2000. Dave

[nisiprius]

Just to make certain you know the obvious. You don't say how long you've been holding 20% REITS or what vehicle you used, but let's assume it was Vanguard REIT Index Fund, VGSIX. Were you holding it through 2008-2009?

The increased return of VGSIX over Total Stock, over the lifetime of VGSIX, has been impressive: $52,000 versus $22,000.


The increased risk was equally impressive. When it is charted together with the stock market's sickening plunge of 2008-2009, VGSIX's plunge makes Total Stock's look like a little bump in the road. More than 2/3 of your investment--gone! Did that happen to you?

So when you say "it appears REIT have beat the S&P since 1970 for all periods" I have no idea what you're thinking about, because it sure didn't beat the S&P in 2008, and it sure didn't beat the S&P in 1998 and 1999, when it was going down while the S&P was going up.

As for "diversification," I suspect some people may have been fooled by VGSIX's shining hour, circled in green, into forgetting that "Diversification does not protect an investor from market risk and does not ensure a profit." A low-correlation asset may sometimes help, as it did then, but may also make things worse, as it did during the two periods circled in red. Would you have had any problem sticking with VGSIX for two years, watching it do nothing but go down while the stock market did nothing but go up?
.

It seems to me that if I were going to increase my REIT allocation, I would want to reduce my overall stock allocation.

[pascalwager]

Actually, REIT = 30% of equities is virtually the amount used in Swensen's book: (20/70) x 100% = 28.6% of equities

[abuss368]

The first thing I noticed was your cite to Zell. He sold his REITS in 2006 because he thought they were overvalued.

Hi Dave,

This is correct but there is more to the story. Sam Zell sold his one REIT, the largest Office Space REIT (i.e. Equity Office) to Blackstone. However, Sam Zell is presently operating two very large REITS (i.e. Equity Residential - the largest apartment REIT in the country & Equity Lifestyle). In fact, a review of the most recent financial statements details a very large holding of REIT shares by Zell. The dividend income alone was amazing - in the millions each quarter!

I read a recent interview with Sam Zell, and posted thoughts on another thread. Basically, Zell said he is higher on REITs now than private real estate. He noted the field has changed in his eyes since 1990. He prefers REITs as an investment going forward over the private market. Interesting.

[abuss368]

Just to make certain you know the obvious. You don't say how long you've been holding 20% REITS or what vehicle you used, but let's assume it was Vanguard REIT Index Fund, VGSIX. Were you holding it through 2008-2009?

Hi nisiprius,

I should have noted on my original posts, yes I invest in the Vanguard REIT Index Fund for many years including the 2008 - 2009 period. I just DCA all the way down and up. The return (and ride) was incredible.

I used to invest directly in equity and mortgage REITs "back in the day" and read tons of annual reports (all for nothing in terms of security selection - I now know better). I have also read Ralph Blocks "Investing in REITS" book and recommend it for anyone who would like to further educate themselves on REITS.

As for the Inflation Bond fund, I am still debating. Maybe one day again in the future.

[abuss368]

Actually, REIT = 30% of equities is virtually the amount used in Swensen's book: (20/70) x 100% = 28.6% of equities

Hi pascalwager,

Correct. I included this in the original post.

Thanks.

[pascalwager]

As for "diversification," I suspect some people may have been fooled by VGSIX's shining hour, circled in green, into forgetting that "Diversification does not protect an investor from market risk and does not ensure a profit." A low-correlation asset may sometimes help, as it did then, but may also make things worse, as it did during the two periods circled in red. Would you have had any problem sticking with VGSIX for two years, watching it do nothing but go down while the stock market did nothing but go up?

This is why Larry Swedroe advises us not to focus on any single (declining) fund, but instead consider the overall portfolio, although that would have provided little consolation in 2008.

I only have REIT = 6% of equities, mainly because that's the size of my ROTH. Rick Ferri advises no more than 10% because of the narrow sector.

But abuss has already shown his ability to ignore the limbic brain (see Bernstein's "Investor's Manifesto") and ride out the dips.

[LH]

I have 14 percent of portfolio in REIT. More given I have scv...

20 is fine, at 30 percent, you are near the Talmud 1/3 land.

I do not think this is per bad, I just think that there are multiple ways to diversify,that a full third may be a bit high.

I would look at net worth, how much of your net worth is in re, house plus REIT? Now, this is not end all be all per se, but you should at least look at it. Like if your REIT + home worth greater than 50 percent already, that would make me less likely to increase REIT.

[kramer]

I have 14 percent of portfolio in REIT. More given I have scv...

20 is fine, at 30 percent, you are near the Talmud 1/3 land.

Don't forget that a lot of Total Stock Market is in real estate, just not real estate focused companies. Real estate forms a significant portion of book value of virtually all large companies and affects their valuation over time. This goes for Total International, also.

So if someone has, say, 20% of their equity portfolio invested in REITs, they have much more than 20% of their portfolio invested in real estate.

[Occupier]

Here is the problem with a really big REIT allocation. They consist of about 2% of the total market. So having 10% allocation is a overweight of five. The reason why you might want to take a tilt to REIT is that the are not correlated with the total US market. So are international small stocks, and investment grade bonds, and commodities. That means if you hold, say 10% in each of those things, they wont go up, or more importantly down, at the same time. But if you take any one of those low correlation assets and really overweight them then your total portfolio returns are going to go up or down in sequence with the overweight uncorrelated asset. I can see your deciding that some uncorrelated asset is going to do well into the future and getting an even bigger share than what is generally advised, but at this time the valuations of REIT are at historic highs. Do you really think they are going to outperform indefinitely into the future? dave

[abuss368]

I have 14 percent of portfolio in REIT. More given I have scv...

20 is fine, at 30 percent, you are near the Talmud 1/3 land.

I do not think this is per bad, I just think that there are multiple ways to diversify,that a full third may be a bit high.

I would look at net worth, how much of your net worth is in re, house plus REIT? Now, this is not end all be all per se, but you should at least look at it. Like if your REIT + home worth greater than 50 percent already, that would make me less likely to increase REIT.

Hi LH,

Thank you for your response. I hope my original post was not confusing. I am considering 20% of the portfolio (30% of equity). Not 30% of the overall portfolio. Of course, as bonds increase each year, the 20% of overall portfolio will decrease (even though I would keep the allocation of equity at 30%).

Does that change your response?

I would have thought I would get a little better response regarding the TIPS bond fund.

[abuss368]

Overall good feedback.

Thank you everyone.

[Phineas J. Whoopee]

Bogleheads,

We wanted to receive some feedback and opinions related to REITS and our overall portfolio:
...
With 20% of equity allcoated to REIT, that equates to about 15% of the overall portfolio. In the great book, "Bogle on Mutual Funds", Jack's "accumulation portfolio" recommendation allocates 15% of the portfolio to a specialty/sector fund. I am glad to have read Jack Bogle's thoughts on this. David Swensen's revised portfolio also included a 15% of the portfolio allocation to REIT.
...

Hi abuss368,

I would suggest you not pull the trigger on this change until you can cite at least as many authors who recommend against holding any REITs and explain their reasoning. Reading and paying attention only to those you already agree with and who will tell you to do what you wanted to do in the first place can be dangerous.

I don't see any reason why increasing your REIT percentage would trigger a change in fixed income toward TIPS. Inflation protected bonds are either suited for you or they are not. If you want some in your portfolio, then make the swap.

PJW

[pascalwager]

With 20% of equity allcoated to REIT, that equates to about 15% of the overall portfolio. In the great book, "Bogle on Mutual Funds", Jack's "accumulation portfolio" recommendation allocates 15% of the portfolio to a specialty/sector fund. I am glad to have read Jack Bogle's thoughts on this. David Swensen's revised portfolio also included a 15% of the portfolio allocation to REIT.

Recently, Mr. Bogle has been critical of Vanguard's sector fund lineup, and certainly doesn't promote REITs.

I exchanged my REIT fund for a broader index fund this morning. After looking at the data provided by Rick Ferri in Asset Allocation (he promotes REITs), I decided that REITs had little to offer, especially at my mere 6% allocation. Over a 30-year period the return and risk benefits compared to a 100% TSM AA seemed minimal, even for a 20% allocation. I also considered Jerry Lee's information in recent posts, comparing portfolios with and without REITs.

[abuss368]

Recently, Mr. Bogle has been critical of Vanguard's sector fund lineup, and certainly doesn't promote REITs.

I exchanged my REIT fund for a broader index fund this morning. After looking at the data provided by Rick Ferri in Asset Allocation (he promotes REITs), I decided that REITs had little to offer, especially at my mere 6% allocation. Over a 30-year period the return and risk benefits compared to a 100% TSM AA seemed minimal, even for a 20% allocation. I also considered Jerry Lee's information in recent posts, comparing portfolios with and without REITs.

Hi pascal wager,

I did read an interview with Mr. Bogle a little while back where he stated he did not like the sector funds, but he could see a 10% of equity allocation to REITs.

I would be very interested in reading the interview you noted where he is critical of Vanguard's sector funds. Would you happen to have a link?

Best.

[tomd37]

We all make our own choices and decisions. I am happy with my current twenty-nine percent of stock and twelve percent of total portfolio allocation to the Vanguard REIT Index Fund (VGSLX) and have held that percentage or more for a number of years now. I recognize that the Total Stock Market Index fund hold about three percent in REITs. I do consider taking my RMD from VGSLX each year.

I was interested to note that Burton Malkiel continues to cite a fifteen percent allocation to REITs for investors in their late 60s and beyond to give some income growth to cope with inflation along with twenty-five percent to reqular stocks.

As my mother used to say, we have chocolate and vanilla so that we can make a choice.

[pascalwager]

abuss, here's one link with quote:

"But things changed after Mr. Bogle returned with a new heart and renewed vigor. Now with the title of “senior chairman,” Mr. Bogle found that he disagreed with some of Mr. Brennan’s decisions, and said so openly. He criticized Mr. Brennan’s interest in starting narrowly focused sector equity funds."

http://www.nytimes.com/2012/08/12/busin ... wanted=all

[abuss368]

I was interested to note that Burton Malkiel continues to cite a fifteen percent allocation to REITs for investors in their late 60s and beyond to give some income growth to cope with inflation along with twenty-five percent to reqular stocks.

Interesting that he has a high recommendation to REIT much like David Swenson.

[nedsaid]

I like REITS a lot and have owned REITs for many years. It is amazing how volatile those darned things are. I went to a couple presentations by the Merriman folks which solidified my thinking on REITS. They pointed out that REITs actually outperformed the S&P 500 a bit and had yet low correlations with the Stock Market.

My thinking is that like Small Cap Value, REITS are a very volatile asset class and a useful addition to the portfolio. Just don't overdo it. Probably 10-15 percent of REITS maximum in a stock portfolio.

[abuss368]

I like REITS a lot and have owned REITs for many years. It is amazing how volatile those darned things are. I went to a couple presentations by the Merriman folks which solidified my thinking on REITS. They pointed out that REITs actually outperformed the S&P 500 a bit and had yet low correlations with the Stock Market.

My thinking is that like Small Cap Value, REITS are a very volatile asset class and a useful addition to the portfolio. Just don't overdo it. Probably 10-15 percent of REITS maximum in a stock portfolio.

Would that be 10 - 15 percent of a portfolio or equity?

[abuss368]

At the old board we used to read posts in about 2000 about how a large allocation to tech was warranted. you don't hear that much anymore. So you ask what I think. I think you sound like the tech people did in 2000. Dave

Hi Dave,

I hear you. My only counter point is REITs may be considered a separate asset class where technology would not be. I realize we could argue that concept all day as well.

When I read any experts recommend any sectors, it is almost always REIT. I have yet to see any other sector noted.

[abuss368]

I don't see any reason why increasing your REIT percentage would trigger a change in fixed income toward TIPS. Inflation protected bonds are either suited for you or they are not. If you want some in your portfolio, then make the swap.

PJW

Hi PJW,

I read the excellent book Unconventional Success by David Swensen and highly recommend it. In addition, I have met Dr. Swensen. He recommends a high REIT and TIPS allocation for maximum inflation protection.

[nedsaid]

When I said 10-15 percent, that would be 10-15 percent of an equity portfolio. I would not go overboard on these.

[abuss368]

Thank you everyone for the excellent feedback.

I hope to continue to receive additional thoughts and feedback.

[midareff]

Abuss... there are many roads to Rome. The right route for you is the one you sleep best on.