Daniel Fisher

Stocks, Bonds and REITs

Investors have been considering real estate as a useful portfolio component for quite a while. Recently I saw the following quote in Roger Gibson's book, Asset Allocation: Balancing Financial Risk:

"Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve."
                                                               - Talmud, Circa 1000-500 BC

It sounds to me that the Hebrew sages were recommending 1/3 stock, 1/3 bonds and 1/3 real estate. This is at odds with the conventional wisdom from a 20th Century sage - 50% stock and 50% bonds - as can be seen from this quote from Ben Graham's classic, The Intelligent Investor:

"As a fundamental guiding rule the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequence inverse range of between 75% and 25% in bonds. There is an implication here that the standard division should be an equal or 50-50, between the two major investment mediums."

So who has been right the last 10 years? The following "mean variance optimization" study offers insight. This study examines two portfolios, one with REITs and one without:

• Portfolio A: ½ Total Bond Market Index, ½ S&P 500
• Portfolio B: 1/3 Total Bond Market Index, 1/3 S&P 500, 1/3 Wilshire REIT Index

The returns for the portfolios as well as the components are shown as follows:

1=Wilshire REIT, 2=Bond Market, 3=S&P500; the verticle axis is the variance from the mean, and the horizontal axis is the standard deviation.

The winner is the Talmud, as can be seen from the above graph. Indeed, the Talmud's "Portfolio B" is practically right on the efficient frontier, drawn from pure bond returns (low but safe) to pure S&P 500 (high but riskiest). The efficient frontier graphs all the portfolios in between with the greatest return for a given level of risk

Does this mean we should all load up on equity REITs? Not exactly. But the example does illustrate the potential risk reduction and return improvement benefits of multiple asset class investing. In this regard, the Talmud appears to be well ahead of its time.

- Daniel A. Fisher is a Financial Advisor with First Union Securities in Naples, Florida who specializes in Efficient Investing Index-Based Asset Management for the intelligent investor. He can be reached at DFisher@firstunion2.com.

First Union Secuirities Addendum: Indexes are shown for illustrative purposes only. An investor cannot invest directly in an index. The period shown is a period of rising prices and may not be indicative of future performance. Index descriptions are at the end of this report.
The S&P Indexes are registered trademarks of McGraw-Hill Companies, Russell indexes are registered trademarks of Frank Russell Co.,NASDAQ 100 is a registered trademark of the NASDAQ, Pacific Stock Exchange is a registered trademark of the Pacific Stock Exchange, Wilshire Indexes are registered trademarks of Wilshire Associates. All are unmanaged indexes of common stock. Unmanaged indices are for illustrative purposes only.
This and/or the accompanying information was prepared by or obtained from sources which First Union Securities believes to be reliable but does not guarantee its accuracy. Any opinions expressed or implied herein are not necessarily the same as those of First Union Securities research department and are subject to change without notice. Any market prices are only indications of market values and are subject to change. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional Information is available upon request.

The Wilshire REIT Index measures U.S. publicly traded Real Estate Investment Trusts. This index is a subset of the Real Estate Securities Index. Companies must be an equity owner and operator of commercial real estate. Security types excluded from consideration for inclusion in the Index are mortgage REITs, health care REITs, real estate finance companies, home builders, large land owners and sub-dividers and hybrid REITs (companies with more than 25% of their assets in direct mortgage investments will not be included).

S&P 500 Index is a leading market benchmark that seeks investment results that correspond to the performance of U.S. large-cap stocks.

First Union Securities, Inc., member NYSE/SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wachovia Corporation.