Helping Your Money Grow

Adding a real estate investment option would enhance the Thrift Savings Plan.

The Federal Thrift Savings Plan serves as an excellent model for well-designed retirement plans. It streamlines choices to three equity and two bond funds, minimizing confusion, and it utilizes low-cost index vehicles that maximize returns for the saver rather than for the investment manager. It could be improved, however, by including an additional class in the mix of funds-real estate investment trusts.

One valuable and enduring investment maxim is simple: The investor who's wise, diversifies. A diversified investor not only varies his or her portfolio by holding stocks in every industry group, size category and risk level, but also holds bonds and other types of assets. The trick is to find combinations of assets that are not highly correlated, so investment returns do not rise and fall together. Thus, negative returns in some securities would be balanced by positive returns in others. If an investor can find classes of securities that have only moderate or low connections with each other, then gains will be higher.

Additional gains can be found in commercial property investments through real estate investment trusts. The Real Estate Investment Thrift Savings Act, legislation to include a REIT option in the TSP, was introduced in the House in April. It has 69 co-sponsors to date.

REITs are common stock investments that enable investors to purchase shares in publicly traded corporations that own and operate a diversified group of properties. Investing in REITs can improve portfolio performance for two reasons: They provide attractive long-run rates of return comparable to other equities, and they serve as effective diversifiers, enabling investors to achieve their return objectives while substantially reducing risk.

Over the long haul, rates of return on commercial real estate have been competitive with stocks. And, in the past one- and five-year periods, REIT returns have exceeded those of the stock market by a significant margin. Real estate equity continues to be competitive.

REITs also are an excellent diversifier. Correlations between real estate equities and other common stocks have been quite low. The correlation between the broad-based National Association of Real Estate Investment Trusts Equity REIT Index and the S&P 500 Stock Index has been low over the past 10 years. REIT and bond returns also have been essentially uncorrelated over time.

Compare a portfolio composed of two-thirds stocks and one-third bonds with an all-equity portfolio for the most recent five-, 10- and 15-year periods. The diversified portfolio had far less risk than the all-equity one. During the most recent five-year period, it also had a higher rate of return, although its return was slightly lower over the past 15 years.

Now look at how the all-equity or the balanced fund portfolio would have fared if 10 percent or 15 percent of the portfolio had been taken out of the S&P 500-which holds an insignificant amount of real estate stocks-and invested in REITs. The addition of REITs to an all-equity or a balanced portfolio would have improved returns over all time periods. Moreover, the addition of REITs would have reduced risk.

All investment funds warn, "Past results do not guarantee future performance." Future returns for all asset classes are likely to be lower than they have been for the past 15 years. Diversification, however, will continue to produce important benefits. Investors should include real estate securities in their portfolios, and the TSP will become even better if REIT securities are offered as a distinct part of the plan.