Why Not Just Buy Index Funds?

For any reasonably aware investor, the first question for the REIT Dude would be “Why bother with any of this?  Why not just invest in a low-cost S&P 500 index fund like SPY or, even better, a low cost total-market index fund like VTI/VTSAX?  Why, You the Hypothetical Discerning Investor (“YTHDI”) might ask, should you bother increasing your exposure to REITs relative to what can be found in those index funds?  The answer, in all honesty, is that you would be just fine to do that.  You can get extremely wealthy without ever buying a single share of a single REIT.  (In fact, those broad-based index funds will give you some REIT exposure.  Roughly 3% of the S&P 500’s market capitalization consists of REITs.) 

At the end of the day, if you earn a decent living, save a substantial percentage (the Dude recommends 50% but you’re probably fine with less) of it, and plow those savings into reasonably intelligent investments (index funds being maybe the best example here) month after month, you are very likely to end up getting pretty wealthy whether or not you fool with individual REITs.  In fact, the Dude is an index investor himself.  100% of the Dude’s 401(k) is invested in passively managed Vanguard funds.  REITs are a percentage of my portfolio, but not the entire thing or even the majority.

That’s the open secret behind this blog:  Absolutely nothing here is need-to-know information.  You can get rich without paying any attention to REITs, and I can’t even promise that buying carefully studied REITs will make you richer than index funds alone.  This blog exists because (1.) I happen to like REITs, (2.) I happen to like writing, and (3.) I figured I would combine my hobby of learning about REITs with my hobby of writing on the off-chance that anyone on the internet cared.  So, if you’re already a REIT investor or think you might want to become one, stick around, and we can learn together.  If you don’t have the slightest interest in REITs, that’s just fine.  Investing is a bit like cooking, by which I mean (1.) you should do it after several glasses of wine whilst singing along to 80s hair metal ballads and (2.) everyone makes the special sauce their own way.  If you put every dollar you invest into VTI or pay off your mortgage before investing outside of your 401(k), you won’t get any argument from me.  You won’t hear me telling anyone that they need to do things my way. 

But if you want to know why I do things my way, well, here’s a brief overview.

First, REITs provide diversification.  Having exposure to real estate can certainly be a bad thing (the Dude was in his formative post-college years when the 2008 crash hit), but as a general matter having exposure to multiple less-than-totally-correlated asset classes is a good thing.  The 3-ish% REITs I get when I buy a capitalization-weighted S&P 500 index fund doesn’t feel like enough real estate exposure to leave me sufficiently diversified, so I beef it up by adding REITs to the portfolio. 

Second, REITs provide yield.  I explained in my first post why I love dividends.  Passive income is the goal for me, and REITs are a great source of it.  The current dividend yield of the S&P 500 is a bit under 2%, and it’s nowhere near uncommon to find a REIT with a stable payout 3 times that.  If you want to goose up the overall yield of a portfolio, a few well-chosen REITs can really do wonders.

Third, REITs let me be a lazy landlord.  If I wanted to make money on real estate the old fashioned way, I would need to go out, get a loan, buy a property, find a tenant, hope the tenant isn’t some kind of psychopath who is going to turn my new rental property into a wolverine breeding operation/meth lab, collect rent from the tenant, take the tenant’s calls at 2 a.m. when he clogs the toilet, and so forth.  That’s fine for a lot of people, but it’s way too much work for the Dude.  I prefer a laid-back lifestyle of sipping IPAs and watching the San Francisco 49ers take care of business while the dividend payments roll in like waves.  Plus which, I have the mechanical sense of a DMT-addled ferret, which means that I cannot do even the simplest home repairs and would have to hire someone every time something in my rental house breaks.  That would cut into the margin severely – the best landlords are handy, industrious folks.  The Dude is neither of those things.

REITs, by contrast, let me leave the actual work of landlording to someone else.  Granted, I get a smaller return on my invested capital because I have to pay for overhead (the REIT’s office, salaries for the REIT’s employees, strippers for the REIT’s annual holiday party, that sort of thing), but, within reason, I’m happy to do it, because I have outsourced 100% of the work and all I’m doing is cashing dividend checks.  Being a good landlord is a lot of work.  Owning a REIT involves spending 2 seconds on TDAmeritrade buying a couple of shares.  The smaller return (relative to direct landlording) is well worth it to me every time I think about how nice it is that nobody is calling me in the middle of the night to tell me that they burned down my house because they got stoned and forgot that a Mama Celeste pizza was in the oven or that they’re going to sue me because it’s January and the heater isn’t working. So that’s why I like REITs.  You might agree, or you might not.  Either way is fine with the Dude.  My job here is to educate and entertain, not persuade.  But I certainly hope that you’ll stick around and tell your friends.

Published by reitdude

I am an attorney and dividend investor from California with a particular interest in REITs. My fantasy football opinions may well be better than my investing opinions.

3 thoughts on “Why Not Just Buy Index Funds?

    1. I’m a big time dividend investing fan myself. At the end of the day I think as long as people find an investing style that works for them and do it consistently with a big chunk of their income the results are going to be great. I agree that picking your stocks is a lot more fun tho

      Liked by 1 person

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