When diversifying your portfolio with alternative assets like real estate, it’s common to wonder how much real estate should be in your portfolio. While many people own the home they live in, generally that’s not considered a real estate investment. Adding real estate to your portfolio can add diversity and growth to your portfolio without adding significant risk. Here’s what percentage you should invest in your portfolio and how much you could take on.
For help building a real estate portfolio as part of your overall investing plan, consider working with a financial advisor.
Why Invest in Real Estate?
There are many reasons why investors choose to invest in real estate:
- Recurring income. Investing in rental real estate provides regular recurring income for investors. Examples include owning individual properties, buying shares in a real estate investment trust (REIT)or investing in a limited partnership.
- Diversification. Many investors own traditional investments of stocks and bonds in their portfolios. Adding real estate investments diversifies your portfolio with non-correlated assets.
- Tax benefits. Owners of individual rental properties may be able to offset their income with depreciation to minimize or avoid income taxes. Some investors can use their rental property losses to reduce their ordinary income taxes as well.
- Tangible asset. Rental properties are physical investments that have a functional use in the economy. Even if the value of the home drops due to market conditions, someone can still live in the house and generate rental income.
Benefits of Diversification
Nobody can predict which investment sectors will perform the best each year with any consistency. Diversification is the process of adding bits of each sector to your portfolio to minimize risk and to ensure that some portion of your portfolio will benefit from the best performance.
This diversification takes two forms – the types of investments and the different sectors within each type of investment. For example, stocks are one of the many types of investments that you could have in your portfolio, along with bonds, real estate, commodities and others. However, you should continue the diversification by adding different types of stocks to your portfolio. These might include both domestic and foreign stocks, while also investing in small and large companies.
Real Estate Investment Options
If you’re interested in investing in real estate, there are different types of investments available. These are a few of the most common options:
Individual Properties
Buying an individual property is the traditional investment option for many investors. You can buy a single-family residence, multi-unit property, commercial property, storage facility or other types of real estate to rent. Some investors manage the properties themselves, while others use a property manager to handle the day-to-day activities.
Real Estate Investment Trust (REIT) Stocks
Publicly traded REITs can be bought and sold quickly and easily through a brokerage or tax-advantaged account. They report their holdings and financials on a regular basis. This enables investors to compare performance and choose the REIT that appeals to them the most. Some REITs can invest in any opportunities, while others focus on specific sectors or geographies.
Real Estate Funds
Investors can choose among numerous mutual funds and ETFs that focus on the real estate market. These funds have professional management and you can easily compare performance against similar options.
Fintech Apps
Many Fintech apps launched in the last few years to make investing in real estate more accessible to the average investor. Many have lower minimum investment amounts and have easy-to-use apps that appeal to busy professionals or novice investors.
Homebuilder Stocks
Stocks of companies that build homes for sale to homeowners. While they don’t hold properties for the long term, they generate regular income from the sale of homes that they build.
Private REITs
Private REITs are funds that are not publicly traded. They have fewer regulations and reporting requirements, so they can be riskier than other options. However, you may receive outsized returns and gain access to opportunities not available anywhere else.
How Much Real Estate Should Be in Your Portfolio?
It can be a good idea to add real estate to your portfolio, but how much is the right amount. Opinions vary based on who you’re speaking with and there is no one “right” answer to this question. Like other alternative assets, it is generally best to keep the allocation a small percentage of your overall portfolio.
Remember, that when we speak about investment allocation of real estate, your primary residence is excluded. Investments in real estate are properties that you are not personally using, just like the gas in your car isn’t considered part of your commodities allocation.
The decision of how much real estate to own in your portfolio is personal. If you’re looking for a rule of thumb, adding 5% to 10% to your portfolio is a reasonable range. However, the best approach is to discuss with your financial advisor how adding real estate would best advance your goals.
The Bottom Line
Many experts agree that adding real estate to your portfolio is a good idea. However, how much real estate should be in your portfolio? The answer depends on your goals, time frame and composition of your existing investments. Since real estate is an alternative asset, a good approach for many investors is to give it a smaller allocation in the range of 5% to 10%.
Tips for Diversifying Your Investments
- When creating your investment portfolio, it is best to diversify the types of investments you own. A mix of stocks, bonds and alternative investments is a good idea. How to allocate them depends on your goals, timeframe and appetite for risk. Our asset allocation calculator guides you to an investment profile based on your answers to a few key questions.
- A financial advisor can help you build an effective diversified portfolio. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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