The Core Four

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need403bhelp
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Re: The Core Four

Post by need403bhelp » Fri Aug 11, 2017 8:52 pm

Thank you, all, for a great thread!

I am thinking of adding a 10% of equities allocation to REITs in my 3 fund portfolio as per Rick Ferri's "All About Asset Allocation," 2nd edition and Burton Malkiel's "A Random Walk Down Wall Street," 11th edition.

Both mention that, historically, (a) REITs have had a variable but sometimes low correlation with stocks while (b) having reasonable returns (Ferri specifically contrasts this with commodities such as gold, which don't have real returns above inflation in the long run).

I noticed, however, a lot of negative posts with respect to REITs in this forum: e.g., viewtopic.php?t=219746 .

Has the thinking about REITs as a portfolio diversifier to maintain return while reducing risk changed since Rick's (2010) and Malkiel's (2014) books?

Also, my REIT allocation would be entirely within my backdoor Roth IRA, to which I lump sum yearly. The other fund in the Roth is Vanguard's Total Stock Market. I rebalance based on 5/25 bands checked roughly twice a month. Would this create significant rebalancing problem (as I would likely need to rebalance with existing funds rather than rebalancing with new funds, as I do in my retirement accounts)? E.g., I am thinking specifically of Vanguard's Frequent-trading policy, etc.

Thank you!

EDIT: My somewhat simplified breakdown of the advantages/disadvantages:

The (domestic) stock market already has a 3.4% allocation to REITs based on market weight (price per share * shares outstanding).

Thus, the question is whether to overweight REITs in our portfolio OVER the 3.4% market weight allocation that we already have by investing in the total US stock market.

Argument FOR overweighing ("REITs are inherently a separate asset class"): available historical data from 1994-2017 suggests that including up to 10% of stocks as REITs slightly increases portfolio return while decreasing portfolio risk (standard deviation). This is likely because of an at times low correlation between REITs and stocks. However, just because it helped in the past, doesn't mean that it will help in the future. Also, although REITs have had a high return in the period 1994-2017, it doesn't mean that they will continue to have a high return in the future (and some argue that they are now overvalued).

Argument AGAINST overweighing ("REITs are just a stock sector like healthcare, technology, energy"): the market has already "priced" REITs at 3.4% of the total US stock market. By allocation an additional 7% to REITs, we are basically going against the wisdom of the market, which has already priced in all available data about REITs, just like it does about other types of stocks. Further, in order to guarantee market results, we should just buy & hold a portfolio of US & international stocks based on market weights/market capitalization.

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willthrill81
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Re: The Core Four

Post by willthrill81 » Fri Aug 11, 2017 9:45 pm

A 10% allocation to REITs will neither sink your portfolio nor save it. Historically, it's been of some value as a means of diversification if nothing else.
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Re: The Core Four

Post by abuss368 » Fri Aug 11, 2017 10:41 pm

need403bhelp wrote:Thank you, all, for a great thread!

I am thinking of adding a 10% of equities allocation to REITs in my 3 fund portfolio as per Rick Ferri's "All About Asset Allocation," 2nd edition and Burton Malkiel's "A Random Walk Down Wall Street," 11th edition.

Both mention that, historically, (a) REITs have had a variable but sometimes low correlation with stocks while (b) having reasonable returns (Ferri specifically contrasts this with commodities such as gold, which don't have real returns above inflation in the long run).

I noticed, however, a lot of negative posts with respect to REITs in this forum: e.g., viewtopic.php?t=219746 .

Has the thinking about REITs as a portfolio diversifier to maintain return while reducing risk changed since Rick's (2010) and Malkiel's (2014) books?

Also, my REIT allocation would be entirely within my backdoor Roth IRA, to which I lump sum yearly. The other fund in the Roth is Vanguard's Total Stock Market. I rebalance based on 5/25 bands checked roughly twice a month. Would this create significant rebalancing problem (as I would likely need to rebalance with existing funds rather than rebalancing with new funds, as I do in my retirement accounts)? E.g., I am thinking specifically of Vanguard's Frequent-trading policy, etc.

Thank you!

EDIT: My somewhat simplified breakdown of the advantages/disadvantages:

The (domestic) stock market already has a 3.4% allocation to REITs based on market weight (price per share * shares outstanding).

Thus, the question is whether to overweight REITs in our portfolio OVER the 3.4% market weight allocation that we already have by investing in the total US stock market.

Argument FOR overweighing ("REITs are inherently a separate asset class"): available historical data from 1994-2017 suggests that including up to 10% of stocks as REITs slightly increases portfolio return while decreasing portfolio risk (standard deviation). This is likely because of an at times low correlation between REITs and stocks. However, just because it helped in the past, doesn't mean that it will help in the future. Also, although REITs have had a high return in the period 1994-2017, it doesn't mean that they will continue to have a high return in the future (and some argue that they are now overvalued).

Argument AGAINST overweighing ("REITs are just a stock sector like healthcare, technology, energy"): the market has already "priced" REITs at 3.4% of the total US stock market. By allocation an additional 7% to REITs, we are basically going against the wisdom of the market, which has already priced in all available data about REITs, just like it does about other types of stocks. Further, in order to guarantee market results, we should just buy & hold a portfolio of US & international stocks based on market weights/market capitalization.

Hi need403bhelp -

The Core Four as designed and recommended by Rick Ferri includes a 10% of equity allocation to U.S. REITs. This is an excellent investment portfolio and you will be fine with Rick's allocations.

I would recommend trying the U.S. REIT fund at the percentages recommended by Rick.

Best.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: The Core Four

Post by retiredjg » Sat Aug 12, 2017 7:19 am

need403bhelp wrote:Has the thinking about REITs as a portfolio diversifier to maintain return while reducing risk changed since Rick's (2010) and Malkiel's (2014) books?
There seem to be many opinions, but I don't think anybody really knows.

As I recall, the author of that article in the link you posted (Larry Swedroe) was never in agreement with Rick Ferri about extra REIT. The fact that he is not in favor now may not mean anything new.

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Re: The Core Four

Post by abuss368 » Sat Aug 12, 2017 7:50 am

retiredjg wrote:
need403bhelp wrote:Has the thinking about REITs as a portfolio diversifier to maintain return while reducing risk changed since Rick's (2010) and Malkiel's (2014) books?
There seem to be many opinions, but I don't think anybody really knows.

As I recall, the author of that article in the link you posted (Larry Swedroe) was never in agreement with Rick Ferri about extra REIT. The fact that he is not in favor now may not mean anything new.
I believe Larry recommended Small Value. If one includes REITs is there an argument you are getting to the same place?
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: The Core Four

Post by retiredjg » Sat Aug 12, 2017 8:11 am

My guess is "no". The REIT I'm familiar with (Vanguard's REIT Index) is more mid cap blend. I think Larry likes really small (not just small) and value (not blend). I remember REIT being smaller and more valuey several years ago, but I'm not sure my memory is correct on that.

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Re: The Core Four

Post by LadyGeek » Sat Aug 12, 2017 8:12 am

Here's what we have in the wiki: Lazy portfolios (Core four portfolios)
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need403bhelp
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Re: The Core Four

Post by need403bhelp » Sat Aug 12, 2017 8:42 am

Thank you, willthrill81, abuss368, and retiredjg for your helpful comments. Thank you, LadyGeek, for the helpful Wiki link.

One final, somewhat nitpicky, question.

I realize that Vanguard's Total Stock Market (TSM) fund now includes ~3.4% REITs.

I assume that, in 2007, when Rick Ferri wrote the original post in this thread with the outline of the portfolio, TSM has fewer or ?no REITs.

As such, do most people just use Core Four with Vanguard REIT Index Fund as 10% of REITs (and thus actually have ~12% of equities as REITs), or do they adjust it down to ~8% (in order to actually have 10% of equities as REITs)?

Thank you!

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Re: The Core Four

Post by LadyGeek » Sat Aug 12, 2017 8:47 am

As noted in the above wiki link:
Rick stresses that the exact allocation percentages aren't important, to the nearest 5% is fine.[4]
which is the advice we give to investors asking about asset allocation percentages.

(Here's info from 2010: Percentages of REITs present in Vanguard index funds)
To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

need403bhelp
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Re: The Core Four

Post by need403bhelp » Sat Aug 12, 2017 9:43 am

LadyGeek wrote:
Sat Aug 12, 2017 8:47 am
As noted in the above wiki link:
Rick stresses that the exact allocation percentages aren't important, to the nearest 5% is fine.[4]
which is the advice we give to investors asking about asset allocation percentages.

(Here's info from 2010: Percentages of REITs present in Vanguard index funds)
Makes sense - thank you so much! (My percentages of a fund owned are calculated by a spreadsheet which is why I asked, and so often aren't "nice round numbers" [but I don't really look at them as it tells me when I need to rebalance per 5/25 and I just need to play with % of contributions to each fund to make it balanced again], but it makes sense that probably it doesn't really matter either way with such a small difference.)

Thank you again!

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Re: The Core Four

Post by retiredjg » Sat Aug 12, 2017 9:46 am

need403bhelp wrote:
Sat Aug 12, 2017 8:42 am
I assume that, in 2007, when Rick Ferri wrote the original post in this thread with the outline of the portfolio, TSM has fewer or ?no REITs.
No. TSM did include a small percentage of REIT back then as well.

Some people believe that adding extra of certain sectors (such as REIT) might give the portfolio a little boost. Some people believe that REIT is not adequately represented in the TSM. Some people just believe it is different enough from "ordinary stocks" that adding a little extra might be helpful.


As such, do most people just use Core Four with Vanguard REIT Index Fund as 10% of REITs (and thus actually have ~12% of equities as REITs), or do they adjust it down to ~8% (in order to actually have 10% of equities as REITs)?
I don't know that anybody knows what "most do".

I think Rick was suggesting 10% of the stocks - so if you have 80% stock, then 8% of the portfolio would be REIT.


Keep in mind that nobody knows if adding extra REIT will help or hurt or be neutral in the future. If you decide to do it, plan to do it for the long haul - 5 or 10 years may not be enough to get the benefit (if there will even be a benefit).

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Re: The Core Four

Post by indexonlyplease » Sat Aug 12, 2017 9:57 am

LadyGeek wrote:
Sat Aug 12, 2017 8:47 am
As noted in the above wiki link:
Rick stresses that the exact allocation percentages aren't important, to the nearest 5% is fine.[4]
which is the advice we give to investors asking about asset allocation percentages.

(Here's info from 2010: Percentages of REITs present in Vanguard index funds)
Question:
If someone would add a REIT, value fund, etc. Does it matter in what percent? Meaning it could be 5,10,15 percent. You just have to keep the AA balanced like 60/40 or whatever it is.

Yes of course this would effect what returns you have I believe if you went heavy on one area??

Another question: REITs have low market correlation but higher stdev to the total stock market. And have returned higher % dating back to 1997. Is this correct and why someone would use REIT.

Using Portfolio Advisor: remember I am learning. Hope I said the above correct.

need403bhelp
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Re: The Core Four

Post by need403bhelp » Sat Aug 12, 2017 10:39 am

retiredjg wrote:
Sat Aug 12, 2017 9:46 am
need403bhelp wrote:
Sat Aug 12, 2017 8:42 am
I assume that, in 2007, when Rick Ferri wrote the original post in this thread with the outline of the portfolio, TSM has fewer or ?no REITs.
No. TSM did include a small percentage of REIT back then as well.

Some people believe that adding extra of certain sectors (such as REIT) might give the portfolio a little boost. Some people believe that REIT is not adequately represented in the TSM. Some people just believe it is different enough from "ordinary stocks" that adding a little extra might be helpful.
Thank you so much for your thoughtful comments. I think my reasons for adding REITs (as articulated by Burton Malkiel and Rick Ferri) are:
- big picture: try to diversify into real estate, which is underrepresented in TSM (whether or not REITs are more real estate-like or stock-like seems to remain an open question; clearly, they have some differences from other stocks and some relationship to real estate)
- specific advantage: in historic portfolios, again mostly per Rick Ferri, they have slightly increased returns while lowering risk due to sometimes low correlation with stocks. Of course, whether they do so in the future is anyone's guess.
retiredjg wrote:
Sat Aug 12, 2017 9:46 am
As such, do most people just use Core Four with Vanguard REIT Index Fund as 10% of REITs (and thus actually have ~12% of equities as REITs), or do they adjust it down to ~8% (in order to actually have 10% of equities as REITs)?
I don't know that anybody knows what "most do".

I think Rick was suggesting 10% of the stocks - so if you have 80% stock, then 8% of the portfolio would be REIT.


Keep in mind that nobody knows if adding extra REIT will help or hurt or be neutral in the future. If you decide to do it, plan to do it for the long haul - 5 or 10 years may not be enough to get the benefit (if there will even be a benefit).
Thank you for your helpful note that Rick was suggesting just to do 10% of the stocks.

I definitely plan to "buy and hold" so don't plan to change REIT allocation in the next 5-10 years (although, as my % equities gets smaller, my % REITs as far as total portfolio will also get smaller).

I guess, for me, there is an intuitive difference between "tilting" towards REITs vs "tilting" toward small value. REITs have a unique tax structure and at least have something to do with real estate, which is a separate asset class. On the other hand, small value is just another type of stock that has NO differences in tax structure and is not related to a separate asset class.

Hence, I am (mostly) ok with tilting to REITs but not as ok with tilting to small value.

need403bhelp
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Re: The Core Four

Post by need403bhelp » Sat Aug 12, 2017 10:42 am

indexonlyplease wrote:
Sat Aug 12, 2017 9:57 am
LadyGeek wrote:
Sat Aug 12, 2017 8:47 am
As noted in the above wiki link:
Rick stresses that the exact allocation percentages aren't important, to the nearest 5% is fine.[4]
which is the advice we give to investors asking about asset allocation percentages.

(Here's info from 2010: Percentages of REITs present in Vanguard index funds)
Question:
If someone would add a REIT, value fund, etc. Does it matter in what percent? Meaning it could be 5,10,15 percent. You just have to keep the AA balanced like 60/40 or whatever it is.

Yes of course this would effect what returns you have I believe if you went heavy on one area??

Another question: REITs have low market correlation but higher stdev to the total stock market. And have returned higher % dating back to 1997. Is this correct and why someone would use REIT.

Using Portfolio Advisor: remember I am learning. Hope I said the above correct.
Rick Ferri's argument from his "All About Asset Allocation" book, 2nd edition for adding ANY asset class (to my understanding), seems to be:
1. The asset class must, at least at times, have low correlation with equities (REITs fit here historically, although not always - e.g., 2008).
2. The asset class must generate a real return above inflation (this is Rick's argument for why commodities are NOT a good diversifier - they have low correlation with equities but their rate of real return = return - inflation is about 0%).

Given the higher standard deviation of REITs compared to equities, at least historically, one would be increasing the risk of their portfolio if they add a significant percentage (let's say 50%) to REITs. I think most recommendations on the forum are ~10% of equities or so to REITs, but I'm sure people have their own opinions.

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Re: The Core Four

Post by indexonlyplease » Sat Aug 12, 2017 10:59 am

need403bhelp wrote:
Sat Aug 12, 2017 10:42 am
indexonlyplease wrote:
Sat Aug 12, 2017 9:57 am
LadyGeek wrote:
Sat Aug 12, 2017 8:47 am
As noted in the above wiki link:
Rick stresses that the exact allocation percentages aren't important, to the nearest 5% is fine.[4]
which is the advice we give to investors asking about asset allocation percentages.

(Here's info from 2010: Percentages of REITs present in Vanguard index funds)
Question:
If someone would add a REIT, value fund, etc. Does it matter in what percent? Meaning it could be 5,10,15 percent. You just have to keep the AA balanced like 60/40 or whatever it is.

Yes of course this would effect what returns you have I believe if you went heavy on one area??

Another question: REITs have low market correlation but higher stdev to the total stock market. And have returned higher % dating back to 1997. Is this correct and why someone would use REIT.

Using Portfolio Advisor: remember I am learning. Hope I said the above correct.
Rick Ferri's argument from his "All About Asset Allocation" book, 2nd edition for adding ANY asset class (to my understanding), seems to be:
1. The asset class must, at least at times, have low correlation with equities (REITs fit here historically, although not always - e.g., 2008).
2. The asset class must generate a real return above inflation (this is Rick's argument for why commodities are NOT a good diversifier - they have low correlation with equities but their rate of real return = return - inflation is about 0%).

Given the higher standard deviation of REITs compared to equities, at least historically, one would be increasing the risk of their portfolio if they add a significant percentage (let's say 50%) to REITs. I think most recommendations on the forum are ~10% of equities or so to REITs, but I'm sure people have their own opinions.

Thanks

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Taylor Larimore
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Adding funds to total market index funds?

Post by Taylor Larimore » Sat Aug 12, 2017 9:59 pm

Bogleheads:

REIT's are very tax inefficient and use-up room in tax-advantaged accounts where REITs belong. Homeowners already own significant real estate. In my opinion, the benefit of adding small funds (and complexity) to a mix of total market index funds which already own the market weight in a category (like REIT) is questionable.

Keep investing simple.

The Three-Fund Portfolio

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

need403bhelp
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Re: Adding funds to total market index funds?

Post by need403bhelp » Sun Aug 13, 2017 11:03 am

Taylor Larimore wrote:
Sat Aug 12, 2017 9:59 pm
Bogleheads:

REIT's are very tax inefficient and use-up room in tax-advantaged accounts where REITs belong. Homeowners already own significant real estate. In my opinion, the benefit of adding small funds (and complexity) to a mix of total market index funds which already own the market weight in a category (like REIT) is questionable.

Keep investing simple.

The Three-Fund Portfolio

Best wishes.
Taylor
Taylor:

Thank you so much for your wise words.

What do you think of the following as a justification for our IPS for why we are NOT over-weighing REITs above market weight:
We will not plan to overweight any stock market sectors, including Real Estate Investment Trusts (REITs), based on the "Keep it Simple, Stupid" (KISS) principle, efficient market hypothesis (EMH), and reversion to the mean (RTM). Basically, according to the EMH, the market has already priced in all available information, and thus the market weight of REITs is the appropriate percentage at which to own them. RTM means that, over time, any trends away from mean market return will revert back to the mean - in other words, even though REITs may have had a slight historical advantage, over the long term, their return should revert to that of the overall market. In order for REITs to revert to market return they will need to have decreased returns compared to the overall market at some point in the future. Note, that this may not be strictly true if REITs actually are more risky than the overall equity market, but a riskier allocation can be more simply accomplished by increasing overall percentage of equities rather than by overweighing a market sector.
Specifically, I am most unsure of my explanation of RTM with respect to REITs. In addition to having something to look over to "stay the course," this is also a way for me to help my DW understand our investing plan, as well as for me to make sure that I understood everything that I read recently about investing by trying to explain it succinctly.

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over-weighting REITs

Post by Taylor Larimore » Sun Aug 13, 2017 4:18 pm

need403bhelp:
What do you think of the following as a justification for our IPS for why we are NOT over-weighing REITs above market weight:
Your "justification" is better than mine.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: over-weighting REITs

Post by need403bhelp » Sun Aug 13, 2017 4:29 pm

Taylor Larimore wrote:
Sun Aug 13, 2017 4:18 pm
need403bhelp:
What do you think of the following as a justification for our IPS for why we are NOT over-weighing REITs above market weight:
Your "justification" is better than mine.

Best wishes.
Taylor
Taylor:

Thank you so much for your thoughts and very humble reply.

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