REIT Index Fund?

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At what point do I want to add a REIT Index Fund to my portfolio? Do I want to add a REIT Index Fund to my portfolio?

I would want it to be 10% of my stocks allocation or 9% of my overall allocation. Since Vanguard requires a minimum of $3,000 to invest in a fund, my total portfolio would have to be valued at $3,000 / 9% = $33,333.33, which will definitely happen this year.

If I want to add a REIT index fund to my portfolio this year, then using my Roth IRA contribution for that would be perfect since I should keep the REITs not in taxable.

It looks like Vanguard charges a 1% fee to redeem shares of their REIT Index Fund before you’ve held them for one year, which means that I should be reasonably confident about this choice before making the purchase.

Since the fund would go in my Roth IRA, I have some time to think it over before I need to make a decision.

What are the cons that I can think of for investing in a REIT index fund:

  1. My current investment strategy attempts to replicate the market’s proportions, but this would be over-weighting a specific sector.
  2. This would add additional complexity to my portfolio since it’s another asset class in my asset allocating/re-balancing spreadsheet and another fund in the implementation.
  3. It isn’t in my 401(k) plan and most likely wouldn’t be in future employers’ 401(k) offerings either, meaning that I would need to be able to keep it in either my Roth IRA or a future Rollover IRA.
  4. I’m buying a condo, which is adding a real estate asset. Do I want to put money into more real estate?
  5. I already have some REITs in the other index funds I own – as of 9/30, Vanguard’s S&P 500 Index fund was at 1.78% real estate and their Extended Market Index fund was at 7.39% real estate. (This means that I currently have about 1.5% of my portfolio in real estate.)

Well, that doesn’t make this sound like a very good idea. What are some pros to investing in a REIT index fund?

  1. My real estate holdings would be more diversified than just my single condo in a single city in the US.
  2. It would add commercial real estate holdings to my assets.
  3. The returns of Vanguard’s REIT Index Fund seem to be completely different from the returns of the US stock market overall.
I think at this point, I’m leaning towards not adding it and maybe I will re-evaluate next year.

Readers, do you have an REIT index in your asset allocation? At what point did you add it?

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8 thoughts on “REIT Index Fund?

  1. I have toyed with the idea of adding a specific REIT index (like you, I have a small percentage of REIT in other index funds) since I do not currently hold any physical real estate, but have not been conviced yet that the additional complexity would yield sufficient benefit. Might need to revisit the idea when we rebalance this spring…curious to hear where you (and others!) net out.

    • I think at this point, I’m not ready for the complexity. My Roth IRA is still small enough that I don’t think it’s worth it – it’d probably just end up being a crazy hassle. I’ll re-evaluate when my Roth IRA is worth over $25,000 or maybe when I have a Rollover IRA. Like nicoleandmaggie below though, I might also wait until my mortgage is paid off.

  2. I am personally content with holding the market cap of REIT’s. It’s the same reason I don’t invest directly in Small Cap Value, Emerging Markets, or any specific sector or region index fund. I do arbitrarily hold more domestic than international, but I might want to rethink that strategy. I’m not sure why I do what I do. Home country bias?

    I’m not sure that tilting to small value, real estate, etc, actually works. I know people do it – but I definitely think it’s a gamble that certain sectors will do better than the broad markets.

    Especially since the Vanguard REIT index only holds 112 companies.

    At the same time, I’m not sure that having a home mortgage is the right reason to avoid REITs, that would be like not owning the Total Stock Market because you own an ExxonMobil station and ExxonMobil is 3% of the TSM fund.

    I prefer the 3 major broad indexes for their diversification and simplicity. I know a lot of people have been big on REIT’s lately, but my understanding is that a broad index like the Wilshire 5000, or its equivalent, which is what Vanguard TSM tracks, is that they are basically indexing the market cap of every investable company out there. If the market rate for REIT’s is 1.5%, I don’t think I’m sophisticated enough or interested enough in investing to argue with the market.

    I think you would be have a lot more diversification if you increased your bond allocation by 10% instead of tilting towards REITS…but I’m conservative. A lot of people my age have NO BONDS.

    If you look at the ten year history for the Vanguard REIT Index vs the 500 Index (linked below), with the exception of 2007-2010, they appear to have done fairly similar. I look at that 2007-2010 period, and think losing 80% on 0.5% of my portfolio is a heckuva lot better than 80% of 10%.

    http://www.nasdaq.com/aspx/mutual-fund-chart.aspx?timeframe=10y&index=&symbol=VFIAX&symbol=VGSLX&selected=VFIAX

    • Yeah, the index only having 112 companies seems completely absurd to me. I’m convinced that tilting just makes it more complicated and more difficult to manage.

      I am using a stable value fund in my 401(k) for my bond allocation and I think there’s around 10-17% in cash (Vanguard counts the stable value fund as cash) right now, which I think is an acceptable range.

      The chart you produced is exactly why I’m a fan of diversification… The 500 Index did lose a lot less, but it did also gain less during the other months than the REIT Index.

      When you put it that way, having a mortgage certainly doesn’t seem like a reason to not include the REIT Index in my portfolio specifically. But I think the other points are valid enough reasons to keep the stock portion of my portfolio in market weights.

      • I agree with your logic.

        I’m not sure if I like the idea of substituting a stable value instead of bonds – but it’s certainly a reasonable enough allocation for somebody. It seems like with stable value, you won’t get hit as hard from interest rate increases – in fact you should be one who benefits.

        Our stable value fund isn’t returning much of anything – but that might be because of the 1% expense ratio, heh.

        • I plan on re-visiting the stable value decision later this year. I’m thinking maybe 10% of my overall portfolio in stable value and then the rest of my fixed income allocation in TBM. My stable value fund has an expense ratio of 0.30% and has been returning closer to 3-5% :)

          My idea behind the stable value is that I want at least some of my retirement portfolio to never lose value, especially in crazy downturn. TBM goes up and down, due to interest rate risk. It will also (sometimes) have higher returns thanks to that.

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