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Real estate in the balance

By Steve Giles

Real estate is becoming a more important component of a well-balanced investment portfolio.

If you look back at 2007 and 2008, you recognize that what did well during that time wasn’t much.

Some individuals might point to that and contend that asset allocation died – that the great experiment of building balanced portfolios didn’t work. But I would argue that most investors just weren’t asset-allocated enough.

Those individuals who had exposure to things like Treasury Inflation-Protected Securities (TIPS) or commodities or even real estate were able to weather that storm and at least have a lot less downside in their portfolios than others who were solely in stocks.

What real estate provides to investors is an income option. Those investors who need an income replacement for low-yielding bonds right now might be able to find it in REITs, or Real Estate Investment Trusts. Those investors who want to hedge against inflation are probably going to find that in REITs, which are publicly traded but also accessible through REIT-focused mutual funds and Exchange Traded Funds.

For further information:

Using Asset Allocation, from the Financial Industry Regulatory Authority

Investing for Different Time Periods, from the Financial Industry Regulatory Authority

But don’t limit yourself to just domestic REITS. Think globally. Consider that 70% of the global real estate market is outside of North America.

As a way to diversify your investment portfolio, you want to find assets that don’t correlate with other things that you own. That’s going to include REITs. That’s going to include commodities. That’s going to include TIPS.

Correlation has to do with the degree of similar activity between two different asset classes. So assets with a correlation of “1” would be completely in synch. A negative correlation is when two asset classes work in complete opposition to each other.

In an environment where there are many variables and many possible outcomes, you ought to have something in your portfolio that goes up if another part of your investments goes down – or goes down if something else goes up. It’s a matter of balancing your portfolio and spreading out your risks.

For those investors who need income in their portfolio, you have to look outside of the traditional income-producing sectors – like fixed income, or even dividend-paying stocks. I think real estate can be a wonderful replacement – in moderation. You don’t want to go overboard.

We’re entering into a period of more sluggish growth than what we saw in the 1990s and a potentially rising inflation environment. That tends to make the more traditional asset classes correlate with one another more closely.

Your stocks and bonds aren’t marching to different drummers anymore. So you need to introduce some kind of non-correlating asset class to offset the reactions that stocks and bonds may have to certain market conditions.

One option is real estate.

Steve Giles is a vice president at Landaas & Company.

initially posted March 1, 2011

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