REITs within Equity Portion

[TripleB]

I'm thinking of putting REITs into my PP equity portion. I'm leaning towards 20% Total Stock Market, 5% REIT Index Fund for my 25% stock allocation. I would then rebalance between the Stock and REIT internally at appropriate intervals.

It doesn't seem like it would negatively impact my portfolio too much but could juice things nicely if housing inflation kicks in. Especially because I am not a homeowner and do not intend to buy a home in the near future (or possibly ever) so this could help me weather rent increases in that situation.

Of course, I could do the purist thing and pull that 5% out and run it as a VP but that's just semantics. It's not possible for REITs to drop to zero and have an economy. I won't be rebalancing into a black hole with a REIT index Fund.

I will say that I was about 10% of my total portfolio in REITs in 2008 (before I started doing PP) and it did feel like I was rebalancing into the abyss during the housing crisis... however I wound up quadrupling down on my position at nearly the bottom and it paid off huge. I'm not advocating doing that anymore, just to mention that I have been there and done that where my one asset class was dying and I didn't panic sell, and I did rebalance into it.

Truth be told, I split my Equity position between International and Domestic equally (as I describe in other threads) so I'd do the same here. 10% US TSM, 10% International TSM, 2.5% US REITs, 2.5% International REITs.

The international REIT fund was my biggest gainer over the last 1.5 years in my VP. I think I was up around 30% when I decided to sell and move back to a more traditional PP setup.

The talks of Fiscal Cliff and uncertainties around it make me want to do this even more because it gives me greater diversification. As an aside, I don't believe "falling off the cliff" is that bad, my concern is how the government is going to screw it up. If the government did nothing, things will be fine, but they will wind up doing something, and the more of that something they do, the worse things will be.

[melveyr]

I definitely don't think REITs as part of the prosperity section would be breaking anything. I agree that you will probably see small diversification benefit over time as well.

I am a little leery about international REITS though. The withholding tax means it doesn't make sense in a tax deferred account, and the huge dividends mean they don't make sense in a taxable account. What are your thoughts on this?

[TripleB]

I am a little leery about international REITS though. The withholding tax means it doesn't make sense in a tax deferred account, and the huge dividends mean they don't make sense in a taxable account. What are your thoughts on this?

I agree on both parts and I was extremely hesitant to buy them initially and they beat the US TSM by around 15% over the time period I held them, which more than made up for foreign dividend tax.

I think the most optimal situation would be to hold them in taxable during retirement if you can keep your income down so the tax on the dividends gets washed out by the standard deduction and foreign tax credit. That would be a pretty neat trick. You'd have to calculate things just right because the foreign tax credit isn't refundable so it's only worthwhile if you have taxable income... but you don't want to actually pay taxes on the massive distributions. This is actually something I might do when I hit early retirement soon.

In my case it would be something like:

Hold $20k of International REIT in taxable. Receive a $1k taxable distribution per year. Have $200 withheld by foreign governments, and be eligible for a $200 tax credit.

Take ~$10k standard deduction/personal exemption, add the $200 tax credit... subtract the taxable REIT distribution... and then do a Roth IRA Conversion up to the limit of the rest so I pay $0 in taxes. I plan to live off Roth IRA SEPP when I hit early retirement and gradually convert my 401k/T-IRA into Roth IRA, tax-free, each year.

Technically, I'll live off Roth IRA Contribution Returns for the first 8 to 10 years of early retirement before invoking SEPP, because the contributions come out tax-free, penalty-free for any reason. I've been maxing out a Roth for along time and I have several Roth Conversions that hit the 5-year mark and are considered vested principal contributions at this point... so I have about 8 years living expenses considered "contributions" to my Roth.

And each year, I can convert another about $10k tax-free from the 401k to the Roth, which after 5 years will be a vested contribution as well... thus pushing that 8 year period to 10 to 11 years. Fun times with tax law!

[Pointedstick]

I plan to live off Roth IRA SEPP when I hit early retirement and gradually convert my 401k/T-IRA into Roth IRA, tax-free, each year.

I'm not understanding this part; wouldn't it be taxed at your marginal income tax rate, a minimum of 10% federal + x% state? Or are you counting it as offset by the standard deduction, converting an amount equal to or less than the deduction?

If so, that's very clever. I'll have to remember that.

[melveyr]

I think the most optimal situation would be to hold them in taxable during retirement if you can keep your income down so the tax on the dividends gets washed out by the standard deduction and foreign tax credit.

Makes sense because you are going to be drawing down on your portfolio as is.... Thanks!

[TripleB]

I plan to live off Roth IRA SEPP when I hit early retirement and gradually convert my 401k/T-IRA into Roth IRA, tax-free, each year.

I'm not understanding this part; wouldn't it be taxed at your marginal income tax rate, a minimum of 10% federal + x% state? Or are you counting it as offset by the standard deduction, converting an amount equal to or less than the deduction?

If so, that's very clever. I'll have to remember that.

The Roth IRA SEPP should be completely tax-free distributions.

The 401k conversion to a Roth IRA will be done only to the limit of the annual standard deduction/personal exemption such that it occurs tax-free (right now about $10k per year).

[clacy]

REITs are fairly well correlated with the TSM typically, so I think this stays within PP realm.

[frugal]

I was also thinking to make 15% of my savings on:

- Total stock market
- Total Bond market
- Emerging Markets
- Reit (maybe)
- Comodities (maybe)
- Global Inflation-Linked Bond (maybe)

Now I feel that this set, can only increase commissions and at the end the result will be near PP.

I don't know what to do.

Please advice.

[Greg]

I was also thinking to make 15% of my savings on:

- Total stock market
- Total Bond market
- Emerging Markets
- Reit (maybe)
- Comodities (maybe)
- Global Inflation-Linked Bond (maybe)

Now I feel that this set, can only increase commissions and at the end the result will be near PP.

I don't know what to do.

Please advice.

15% of your portfolio? Are you trying to just dip your foot into the Permanent Portfolio then? It looks like you'd be creating a modified one at that. I would read what others have written down on here and make a good argument to state why you believe commodities should be added to your portfolio (as an example). Until you can give a good reasoning (and not just backtesting), it's all just a mental exercise.

Granted a fun exercise, but I'm mainly thinking of what economic scenarios do I think are more likely in the next 10+ years and shifting my VP towards that.

[frugal]

Hello,

It's Bogle's investment style.

Having all the possible assets, all the MARKET.

Isn't it diversification?

Thank you

[Pointedstick]

Hello,

It's Bogle's investment style.

Having all the possible assets, all the MARKET.

Isn't it diversification?

Thank you

It's a different style of diversification. the HBPP diversifies across economic conditions, not asset classes. That way we can be sure we own something that always responds to the condition of the economy. Boglehead-style diversification IMHO focuses too much on diversifying across a single economic condition--prosperity, through all matter of stocks, REITs, corporate bonds, and so on and so forth. Boglehead portfolios do poorly in times of recession because they're so overweight on assets that fall during hard times, and lack flight-to-safety assets.

They'll endlessly debate how many small-caps, mid-caps, REITs, and emerging market stocks one should own, but they're all gonna fall during a recession.

[frugal]

Hello,

It's Bogle's investment style.

Having all the possible assets, all the MARKET.

Isn't it diversification?

Thank you

It's a different style of diversification. the HBPP diversifies across economic conditions, not asset classes. That way we can be sure we own something that always responds to the condition of the economy. Boglehead-style diversification IMHO focuses too much on diversifying across a single economic condition--prosperity, through all matter of stocks, REITs, corporate bonds, and so on and so forth. Boglehead portfolios do poorly in times of recession because they're so overweight on assets that fall during hard times, and lack flight-to-safety assets.

They'll endlessly debate how many small-caps, mid-caps, REITs, and emerging market stocks one should own, but they're all gonna fall during a recession.

Fall means quit the portfolio?

But 10-15% of our savings is too much?

Regards