REITs provide a bond-like income stream through regular dividend income.
They also produce stock-like returns when their stock prices rise.
REITs can outperform bonds without increasing the risk profile of your portfolio.
10 Stocks We Like More Than Real Estate Income ›
Building a diversified portfolio is critical to your long-term investment success. While betting big on a few stocks can yield huge profits, this strategy can also backfire. An aggressive approach is not an investment strategy that can be afforded by someone who is nearing retirement or is more risk averse.
But you also don’t have to completely sacrifice returns to lower your portfolio’s risk profile. One of the smartest ways to build a more diversified portfolio is to add a few high-quality real estate investment trusts (REITs). These real estate companies provide steady income through regular dividends, making them similar to bonds, and also offer the potential for capital appreciation like stocks.
Here’s why REITs are smart investments, and some ways to include them in a conservative portfolio.
Image source: Getty Images.
Stocks offer investors the opportunity to earn high returns in exchange for greater risk. For example, over the past century, a 100% stock portfolio has produced an average annual return of 10.5%, according to Vanguard. However, annual returns varied widely. While the stock’s portfolio gained 54.2% in its best calendar year, it also lost 43.1% in its worst calendar year.
Adding bonds to your portfolio can help reduce the risk of a major downturn. For example, the worst year for a 100% bond portfolio was a loss of just 13.1%. However, this bond portfolio would have generated only a 5% average return. Given the lower return on bonds, the more an investor increases his allocation to bonds, the lower his portfolio’s total return. For example, the classic 60/40 portfolio (60% stocks and 40% bonds) produced an average return of 8.8%, with a worst calendar year loss of 26.6%.
REITs give investors the best of both worlds, making them a great addition to a diversified portfolio by combining attractive income and growth potential without increasing risk. morning star found that allocating at least 5% of your portfolio to REITs can produce higher returns with less risk than a traditional 60/40 portfolio. Since tracking began in 1972, REITs have averaged an annualized total return of 12.6%, outperforming stocks over that period. Although REIT returns have been lower in recent years due to the impact of higher interest rates on property values, their 5.5% average annual total return over the past five years is still higher than long-term bond returns.
Given the attractive long-term returns of REITs, it makes sense to add some of these dividend stocks to your portfolio. There are many ways to achieve this goal.
You can build a portfolio of high quality REITs. One high-end REIT that reflects the attractive investment qualities of the sector Real estate income(NYSE:O). The company owns a diverse portfolio of commercial real estate (retail, industrial, gaming and other properties) throughout the US and Europe, leased to many of the world’s leading companies. Realty Income has consistently grown shareholder value. Since 1994 went public, the owner failed to increase adjusted funds from operations (FFO) per share in just one year (2009). Meanwhile, it has increased its dividend every year (often multiple times), increasing the payout by 4.2% annually. Adding the income stream (historical dividend yield of 6%) to the adjusted FFO growth rate (over 5% annual average) has given Realty Income a positive operating return each year (and an actual average annual total return of 13.5%). This combination of durability and continued growth has made real estate stocks 50% less volatile than S&P 500. These characteristics make real estate income an excellent base for REITs.
An alternative to owning individual REITs is to buy shares of REIT ETFs. For example, Vanguard Real Estate ETF(NYSEMKT:VNQ) owns more than 150 REITs, including real estate income, providing investors with extensive information on the entire REIT sector. The fund charges a small fee for passively investing in the space (0.13% ETF expense ratio) and currently has a dividend yield of more than 3.5%. Since its establishment in 2004 the fund has given an average annual return of 7.5%, which is above the long-term return of bonds.
REITs can provide higher returns than bonds without increasing portfolio risk. Whether you’re building a REIT portfolio around a company like Realty Income or buying REIT ETFs like the Vanguard Real Estate ETF, they make smart additions to a conservative portfolio.
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Matt DiLallo has a real estate income role. The Motley Fool has positions in and recommends the Realty Income and Vanguard Real Estate ETFs. The Motley Fool has a disclosure policy.
The Smartest Dividend Stocks for Conservative Portfolios (And Why They Beat Bonds) was originally published by The Motley Fool
