If you haven't already, you may soon notice some investing options from a newer asset class in your 401(k) plan.
Real estate investments are gaining popularity as an employer-sponsored plan offering. So where do they fit into a well-diversified retirement investing strategy?
On the risk continuum, this category falls toward the more aggressive and volatile end because it's a concentrated, less-diverse asset class. To better understand this idea, think about large-cap stock funds that could be invested across several sectors; a dip in the automotive sector wouldn't hurt all large-cap stocks. But, since real estate investments are basically all part of the same sector, volatility within the real estate industry would affect a large concentration of real estate investments.
In the quest to diversify a portfolio, real estate investments can be beneficial as a hedge against inflation. And real estate has traditionally had a low correlation with stock and bond asset classes, which means it doesn't react to economic changes in the same way stocks do or bonds do. Incidentally, stocks and bonds have historically also had a low correlation with each other. Selecting asset classes with low correlations is beneficial because a dip in one asset class often won't mean a dip in other asset classes.
Some REITs are publicly traded, but they aren't required to be. They're structured similarly to mutual funds in that money is pooled and invested. The Internal Revenue Service requires that REITs invest at least 75 percent of assets in real estate and distribute at least 90 percent of taxable income to shareholders.
Mortgage REITs own mortgages or mortgage-backed securities, and they earn revenue through loan interest. Equity REITs own property and earn revenue through rent. Then there are mixed REITs that have mortgage-based and equity-based investments.
As with mutual funds, REIT managers can practice focused investing--purchasing real estate from a particular geographic region or segment of the real estate market, like warehouses or apartment complexes.
Real estate mutual funds sometimes invest in REITs, but they may also have stock holdings in companies within the real estate industry.
If your employer-sponsored plan has a real estate investing option and you're trying to decide whether to include real estate in your asset class allocation, you'll need to do some research. Use your risk tolerance, investing timeline, personal preferences, and the economic climate to determine how aggressive or conservative your allocation should be.
More aggressive investors may want to include real estate as a portion of a diversified 401(k) portfolio, but be certain you're researching the REIT or mutual fund offered by your plan to ensure it fits with your investing strategy.
A retirement adviser should be able to help you understand the intricacies of real estate funds and/or REITs offered through your employer's plan to help you decide whether there's a place in your portfolio for this new asset class.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.
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