After I have the core asset classes covered in my investment portfolio — US stocks, international stocks, and fixed income — if I’m looking for a good asset class for diversification, REIT and Precious Metal Equity (PME) are two good candidates.
Real Estate Investment Trust (REIT)
Yale endowment Chief Investment Officer David Swensen had REITs at 20% of equities in his revised model portfolio (down from nearly 30% of equities in the original model portfolio from his book Unconventional Success).
Princeton professor Burton Malkiel also put 20% of equities in REITs in his model portfolio for age mid-50’s who invest roughly 60% in equities.
Investment advisor and author Larry Swedroe had real estate as No. 1 in the list of "the good" in his book on alternative investments.
REITs demonstrated its low correlation to the stock market in late 1990s through the bottom of the dot com bubble. When stocks (orange line) were up 50%, REITs (blue line) went down 20%. When stocks dropped 40%, REITs went up 50%. It was truly a dream diversifier: equity-like returns with low correlation to equities.
Since then, however, it stopped doing that. From 2003 to 2013, REITs (blue line) went up more when the stock market (orange line) went up; REITs went down more when the stock market went down. You don’t see as much diversification benefit as before.
Precious Metal Equity (PME)
Precious metals equity is related to gold, silver, and other precious metals, but it’s not the price movements of those metals themselves. It’s the stocks of companies that produce precious metals.
Investment advisor and author William Bernstein mentioned precious metals equity as a diversifying asset class in his book The Intelligent Asset Allocator, more or less along the lines of this article he wrote in 1997: The Expected Return of Precious Metals Equity.
Larry Swedroe put PME in the "flawed" category in his book. He gave the reasons in this article on IndexUniverse.
PME also did very poorly in the late 1990s, very well in the early 2000s bear market, very well leading up to the top in 2007, very badly in the 2008-2009 financial crisis. It recovered well with the stock market from 2009 to 2011.
However, since 2011, it diverged from the stock market again. From 2011 to June 2013, the stock market went up 20%. The Vanguard Precious Metals and Mining Fund (VGPMX) went down 50%. I think now the gap between the two diversifiers is large enough that I’m willing to start making a switch from REIT to PME. In the chart below, the blue line is REITs, the orange line PME.
I’m sure it won’t snap back just because I bought it. So don’t buy it. You will lose money.
[Photo credit: Flickr user Rantes]
Refinance Your Mortgage
Mortgage rates are still low. I saw rates as low as 3.625% for 30-year fixed, 2.875% for 15-year fixed, with no points and low closing cost. Let banks compete for your loan. Get up to 5 offers at LendingTree.com.