10 things you need to know about REITs

Four: Short-term performance can break your heart

The short-term performance of REITs can be awful. The Dow Jones Wilshire REIT Index WILREIT, +0.12%  lost half its value in just two years, falling 17.6% in 2007 and another 39.2% in 2008.

Five: Diversification tool

While their long-term returns are similar to the S&P 500 and to U.S. large-cap value stocks, REITs seem tailor-made for diversifying a portfolio. From 1975 through 2006, a portfolio divided 50/50 between the S&P 500 and a REIT index returned 15.2%, vs. 13.5% for the S&P 500 alone. The frosting on the cake: Risk was 12% lower than that of the S&P 500 by itself (see the following item).

Six: Reduce portfolio volatility

The main reason to own REITs isn’t to improve your portfolio’s return, though sometimes that will happen. The bigger reason is to reduce volatility, increase diversification and provide a source of income.

How do REITs reduce volatility? By turning in performance that is often quite different from that of other major equity asset classes. In approximately one out of every four calendar years since 1975, REITs’ returns differed by 25 or more percentage points from those of the S&P 500 Index. In the majority of those years, REITs’ returns were higher.

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