A reader left a question asking how much to allocate to REITs in a portfolio. He noted David Swensen’s 20% suggestion and wondered if that number is too high. The reader also asked about foreign REIT exposure.

To me this is kind like asking how much to put in commodities. For either there is no shortage of smart people and well written white papers suggesting big numbers to these asset classes.

To be clear I am not going to out-debate anyone on this point and anytime I write this sort of post someone will leave an articulate comment saying why a diversified portfolio should have more exposure than the sorts of numbers I kick around.

If you think about the various asset classes available that help bring a portfolio away from looking like an index fund you could quickly get to owning nothing but the diversifiers (small hyperbole). There’s REITs, commodities, infrastructure, a call writing something or other, absolute return and you might have a couple to add to the list that I’m missing.

Swensen says 20% to REITs, there are some that would say 20% to commodities and I imagine the other segments I mentioned each have fans that would argue 10%. If you pull in all those disparate opinions you’d be 70% in diversifiers and 30% equities. I doubt too many people think that would be a good idea.

One thing that needs to be incorporated into the thought process is that stocks have been the best performing asset class over long periods of time (we’ve all seen that Ibbotson’s chart). The various diversifiers, from where I sit, are for smoothing out some of the volatility that goes with owning equities, they are not intended to be substitutes.

Additionally, every so often something goes wrong with these sorts of things. Over the last 12 months iShares REIT (IYR) is down more than the Financial Sector SPDR (XLF). Long time readers will know I only had one across the board REIT name at a 2-3% weight, that it did poorly and that I sold it in December and have not replaced it. That one stock, at 2-3%, was it for several years. I generally believe REITs offer diversification benefits but of all of the niche things in my ownership universe my comfort level with REITs has never been that high.

For some of themes I would consider two holdings at 2-3% each but can’t see it for REITs. As far as foreign goes, the Hong Kong markets gets written about like it is the healthiest market out there but I just read something somewhere that said because of HKD’s peg to the greenback, rates in HK were lowered but their inflation rates makes the cuts a bad idea and mortgages their are much cheaper than they should be so this creates visibility for a problem. I have no idea if there will be a problem but the path to one is easy to see.

While I am acutely aware that I am no David Swensen, 20% in REITs is way too much for me. The number I had been using might be too low most of the time but was lucky during the selloff of the last few months.

Last 5 posts by Roger Nusbaum

• The Big Picture for the Week of November 15, 2009 - November 14th, 2009
• Process Drilldown - October 23rd, 2009
• Sunday Morning Coffee 10-18-09 - October 18th, 2009
• A Little Followup From This Morning - October 8th, 2009
• Wednesday Roundup - October 7th, 2009