Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE


Add REITs?
Like commodities and gold, real estate investment trusts (REITs) are often posited as a way to diversify a plain-vanilla stock and bond portfolio. Investors can opt for exposure to individual REITs, buy an actively managed REIT fund, or buy an index fund that tracks a basket of REITs.

Why add REITs: REITs have historically had a lower correlation with the broad U.S. equity market than most other sectors. REITs are also viewed as a hedge against inflation: When prices at large are going up, the landlords who run the shopping malls, hotels, and apartment complexes that are owned by the REIT are generally able to to push through higher prices to their tenants. REITs are also required to pay out the bulk of their income to shareholders, making REIT yields high relative to other equities.

Why not: Although their correlation with large-cap stocks is fairly low, REITs have historically had a high correlation with small-value stocks. So, if you have small-value exposure in your portfolio, a slice of REITs may be redundant. Investors also pay taxes on REIT income at their ordinary income tax rates, which is higher than the tax they will pay on dividends from other equities.

If you decide to add REITs: First, check your existing exposure to the sector. Many value-leaning diversified equity funds contain REITs. Moreover, if you have substantial equity tied up in your home or directly own other properties such as apartment buildings, think twice before layering on additional real estate exposure.

Add Alternative Funds?

With stock prices not particularly cheap and bond yields meager, many investors have flocked to alternative investments in the hope that they will perform well at a time when conventional asset classes struggle. The alternatives asset class is a big tent featuring a broad array of strategies; among traditional mutual funds employing alternative strategies, the long-short equity and multi-alternative categories are the largest groups.

Why add alternative investments: The key reason to consider alternatives is to obtain diversification relative to stocks and bonds, though it is worth noting that various categories under the alternatives umbrella do not provide as much of a diversification benefit as others.

Why not: Although hedge funds for the ultra-wealthy charge notoriously high fees, many mutual funds plying alternative strategies are not exactly bargains themselves. That is a particularly big consideration given that many liquid alternatives funds have delivered meager returns since their launch. Alternatives may look better in a weak stock-market environment, but over the past five years, many alternatives categories have underperformed both the S&P 500 and the Barclays U.S. Aggregate Bond Index.

If you decide to add alternatives: Because there is such a broad variation in strategies within the alternatives group, make sure you thoroughly understand a prospective investment’s approach, how it is apt to behave in varying market conditions, and what it will add to your portfolio before buying in. Also, carefully consider the fees the fund charges.

 

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