Add a drop of TIPS and REITs to your mix
Should I add TIPS and REITs to my portfolio, and if so, how much of each should I own?
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NEW YORK (CNNMoney.com) - I'm in my early 30s and have about two-thirds of my portfolio in stock mutual funds. I'm considering also investing in Treasury Inflation-protected securities (TIPS) and real estate investment trusts (REITs). Do you think that's a good idea and, if so, how much of each should I own?
-- Bill, Miami, Florida
Hey, I'm in favor of almost any reasonable move that increases an investor's exposure to a broader range of asset classes. And diversifying your portfolio with a dollop of TIPS and REITs strikes me as perfectly reasonable for two reasons.
First, both can provide good long-term protection against inflation. The need for that sort of protection might not seem pressing now. After all, even after a slight increase in inflationary pressures over the past year or so, major inflation gauges like the Producer Price Index and the Consumer Index appear to be well under control.
But over the long run -- and a Thirtysomething investor like yourself definitely should be thinking long-term -- things can easily change, so it's a good idea to have an inflation-hedge in place before you actually need it.
An excellent way to diversify
The second reason to add REITs and TIPS to your portfolio is that these two asset classes don't move in lockstep with the broad stock market. In technical terms, they have a "low correlation" with stocks, which essentially means when stock prices zig, TIPS and REITs tend to zag.
Which means that adding these investments to your holdings can reduce the overall volatility of your portfolio. That, as Martha would say, is a good thing, because it means that you can earn the same return as a portfolio without these assets while taking less risk.
You can read a more detailed explanation of how TIPS work and how they can help your portfolio by clicking here and here. For more on what adding REITS might do for a portfolio's performance, click here and scroll down to "Ibbotson Update Find REITS Improve Portfolio Over Time.")
How much to put in?
As to the question of how much of your portfolio should be devoted to REITs and TIPS, I don't think anyone, including myself, can profess to know the precise percentage of these assets you ought to hold. As I see it, you want to invest enough in these asset classes to get the inflation-protection and diversification benefits they have to offer. But not so much that you end up relying too heavily on them.
That's a particular concern for REITs right now, in my opinion. They've had such a great run -- returning an annualized 25 percent or so over the past few years -- that many investors might have unrealistic expectations for what they can earn going forward.
Generally, though, I'd say that investing 10 to 20 percent of the stock portion of your portfolio in REITs and, say, 25 percent or so of your bond portfolio in TIPS ought to be enough exposure to give you a decent hedge against inflation and to lower the volatility of your portfolio.
One final note: if you're looking for specific REIT and TIPS funds, I suggest you check out the MONEY 65, MONEY Magazine's elite group of recommended funds.
I can't guarantee that the REIT and TIPS funds on MONEY's list will earn the highest returns. But I can say that all the funds on the list have been screened for consistent investment strategies and low annual costs, which certainly increases the odds that over the long term they'll perform as well if not better than most of their peers.
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