In my experience, many retirees like to invests in REITs. Some of the reasons many retirees invests in REITs are:
- They tell me that REITs are safer because underlying is backed by properties.
- REITs are safer because of rental income which is easy to understand.
- Even if the REITs' prices drop, it is ok because the investor still get an income and as long as they don't sell it, the capital lost is just paper lost.
But what they don't realised is that it has a volatility that could be even higher than stocks! For instance, as at 2 August 2013, the volatility of the FTSE Singapore Real Estate Investment Trusts Index is 18.47% compared to FTSE Singapore Index at 13.30%. Volatility is defined as the 3 months weekly standard deviation. Since early 2010, the FTSE Singapore REITs' volatility is higher than the FTSE Singapore Index halve of the time. The indices' performance is based on total return (ie. dividends reinvested).
So is REIT safe? I think it is better to address the misconception.
- The underlying is backed by properties and also financed by debt. Do not forget about the debt! Much of this debt could be short term loans. Remember during the financial crisis some REITs got into big trouble because they cannot refinance their debt when credit dried up.
- The pursue of income is what behavior finance called 'Self-Control'. It is an irrational behavior. What is more important is the total return. That is the capital is also important which brings me to the next point...
- There is no difference between realised and unrealised losses. In the west, these two values are not the same because of capital gain tax or tax loss harvesting. In Singapore, there is no tax on gain and tax refund on losses. Hence, a paper lost is not virtual - it is reality! So do not bluff yourself into thinking a paper lost is merely virtual.
That is why financial education is so important. You can gain financial education by attending my course: Investment Course for Dummies
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