Home Guides & Resources chevron_right Investing Are REITs Better Than Bonds? Published June 28, 2021 Chris KeithSenior Vice President, Fixed Income Manager This week’s reader question takes us into the realm of income-producing investments: Are REITs a good alternative to bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. in the current market? Are they a safe and solid investment overall? REITs can certainly be a sound investment, but they are not an apt bond replacement in a diversified portfolio. I’ll explain, but let’s start at the beginning. REITs, or “Real Estate Investment TrustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process.,” pool investor capital to finance real estate ventures—think office buildings, shopping malls, industrial complexes, hospitals and hotels. Most REITs are publicly traded, which makes them far more liquid than investments in physical real estate, but it also means their prices are vulnerable to shifts in market momentum. Like bonds, REITs generate a steady stream of income for investors. In most cases, 90% or more of the income from REITs goes back to shareholders in the form of dividendsA cash payment to investors who own stock in the company.. And most REITs have higher yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. than bonds—the caveat here is that they carry higher riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline.. The value of your home changes over time…but the price of a REIT? It can change by the minute. And it’s this volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. that makes REITs an unsuitable substitute for bonds. The chart below (showing monthly price returns of Vanguard Real Estate ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. and the Bloomberg Barclays U.S. Aggregate BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. index since the start of 2020) demonstrates the risksThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. and appeal of owning REITs. From April 2020 through May 2021, as the economy and market recovered from the initial pandemic shock, REITs outpaced bonds by a significant margin, 43% to 2%. However, look at those declines in the first quarter—REITs fell 25% January through March 2020 while the bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. market gained 3%. Note: Chart shows monthly price movements of Vanguard Real Estate ETF (VNQ) and the Bloomberg Barclays U.S. Aggregate Bond index from January 2020 through May 2021; the bond index is not investable and is displayed for illustrative purposes only. Sources: Bloomberg and Adviser Investments. In the current ultra-low-yield environment, it’s reasonable for investors to look for ways to boost the income generated by their portfolios, but if you’re selling bonds to buy REITs, you are assuming significantly more risk. The primary reason to own bonds is to protect your portfolio and offset stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. market volatility. REITs can’t be counted on to do that. Ask Us Your Questions! We’re always interested in the topics or concerns you might like us to comment on. As much as we try to cover the investment and economic fields every week, we know there’s still more that you might want to hear about. Ask us a question about investing, the markets or financial planning and one of Adviser Investments’ experts will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY. 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