Here at Millionacres, we're big fans of incorporating real estate investment trusts, or REITs, into a well-balanced investment strategy. But how many REITs should you own? Should you focus on just one or two REITs you have a high level of conviction in, or should you spread your money out a bit more?
Unfortunately, this is a more difficult question to answer than you might think. The proper number of REITs depends on a few factors, such as the investor's risk tolerance, goals, and long-term objectives, as well as the amount of time the investor wants to spend on their portfolio. With that in mind, here are a few things to consider.
Where do REITs fit into a portfolio?
Many financial planners (myself included) consider real estate to be a different asset class than stocks or bonds, even though REITs often trade on major stock exchanges. So, as a way to diversify your exposure and/or to boost your portfolio's dividend income, it's a good rule of thumb to allocate 5% to 10% of your assets to REITs.
Of course, this is just a starting point, and the best answer for you could be significantly higher in some circumstances. For example, roughly 30% of my stock portfolio is made up of REITs. As many famous investors have said, it's smart to invest in what you know. Real estate is the sector I feel most comfortable evaluating, so it's the largest sector allocation in my portfolio.
REITs could also be a good candidate for more than 10% of a stock portfolio for income-seeking investors. Let's face it -- today's yields from bonds and other fixed-income investments leave something to be desired. However, there are plenty of REITs with perfectly sustainable dividend yields in the 3%-4% range. So, a retiree or other investor who prioritizes income could do well with a higher allocation of REITs.
How many REITs should you own?
As a general rule, I typically suggest that the average person who primarily invests in individual stocks should have between 25 and 40 different companies in their portfolio. This implies an average position size in the 2.5% to 4% range. So, my short answer is that if you subscribe to the idea that REITs should make up 5% to 10% of your portfolio, you should probably divide this allocation among two to four REITs.
Of course, if you allocate more than 10% of your portfolio to REITs, you'll probably want to divide it a little more. I mentioned earlier that REITs make up about 30% of my portfolio, but that's diversified among a total of 14 different REITs.
As a final point, it's important to stress that the question of what REITs you own can be just as important as how many. In other words, a portfolio that has two rock-solid and long-established REITs can be far less risky than a portfolio with four or five new or speculative REITs.
The ETF approach
Of course, not everyone is comfortable picking out individual REITs to invest in, especially if their retirement income depends on it. In cases like this, it's perfectly fine to allocate the entire REIT portion of your portfolio into a REIT ETF (exchange-traded fund) like the Vanguard Real Estate ETF.
This ETF has a rock-bottom 0.12% expense ratio ($12 per $10,000 invested per year in fees) and owns a diversified collection of 178 different REITs. It pays a 3.1% dividend yield, and for risk-averse investors, it doesn't depend too much on the success of any single REIT.
The Millionacres bottom line
The key takeaway is that there isn't a one-size-fits-all answer to this question. Some investors are comfortable holding a bunch of different REITs, while others prefer to concentrate their investment in just one or two they have a high level of conviction in. And others are perfectly happy to take the ETF or mutual fund approach. None of these are wrong answers. Just make sure that your approach makes sense given your level of risk tolerance and your personal investment goals.