Real estate investment trusts (REITs)

Q: Do you think it's illogical to own REITs in a taxable account?
A: Real estate investment trusts (REITs) have several traits that make them ideal for many investors' retirement accounts. But that doesn't mean you must own them that way.

REITs are investment vehicles that typically own collections of commercial property such as office buildings or retail space. For investors, REITs are interesting from several perspectives. First, academic studies have shown that shares of REITs have solid expected returns, but they don't move in lockstep with U.S. stocks. That means by adding REITs to your U.S. stock portfolio, you can reduce your overall risk while maintaining your expected return.

Why are REITs well suited for retirement accounts? REITs are required by tax law to return nearly all their earnings to investors. Much of that money returned to shareholders is usually, but not always, taxed at the shareholder's ordinary income tax rate. REIT income often, but not always, fails to qualify for the lower dividend tax rates.

So, here's the thinking: If you want to own REITs anyway, why not put your shares in a retirement account? You win financially by deferring (or in a Roth IRA, eliminating) the tax into the future when you retire.