Anyone dipping their toe into the vast world of investing can attest to its complexity, even to the point of confusion. However, building your nest egg is key to retirement, so gaining a basic understanding of different investments is essential in making wise financial decisions for your future. Exchange-traded funds (ETFs) and real estate investment trusts (REITs) are two examples that can benefit your retirement account. Here’s what you need to know to find out whether ETFs or REITs could be best for your portfolio.
A financial advisor can help you decide which investments are best for you.
ETFs vs. REITs
An exchange-traded fund (ETF) puts your investment dollars together with dozens of other investors. Essentially, ETFs match the financial gains and losses of an industry, commodity or index. Unlike mutual funds, ETFs share prices change throughout the day and can be bought in the stock market any time before the stock exchange closes. Typically, ETFs fees are minimal compared to other securities.
A real estate investment trust (REIT) is a corporation that creates income from the real estate it owns. This real estate can consist of property such as hotels, individual homes or office buildings. Like ETFs, shares in REITs can usually be purchased in the stock market. However, some REITs are unavailable for public trading.
There are also REIT exchange-traded funds (ETFs), which are securities that mirror real estate on a broad scale. REIT ETFs combine a variety of REITs into one investment vehicle instead of putting money on just one firm in the real estate business. Diversifying among numerous REITs reduces risk while allowing investors to gain from the real estate market.
ETF vs. REIT: Major Differences
ETFs and REITs offer investors the ability to get healthy returns, but the prominent distinction between the two is how the funds are managed.
ETFs passively track the performance of an index or subset of the market and are not given hands-on treatment by a financial professional or company to leverage every investment dollar for maximum gain. Therefore, ETFs are usually inexpensive for the investor.
Conversely, REITs are profitable because a group of people oversees the funds and implements actions to buy, sell and develop real estate. As a result, REITs tend to yield higher returns and, by law, they must deliver 90% or more of the taxable revenue they earn to their shareholders. However, REITs can have higher risks.
ETF and REIT Withdrawals
Turning shares of ETFs and REITs into cash requires knowhow, or the process can be problematic and costly. For example, an ETF held in an IRA is subject to the laws pertaining to IRAs, which include penalties for withdrawal before reaching age 59 1/2. Remember that regardless of when you want to liquidate your investments, withdrawals from both ETFs and REITs are subject to capital gains taxes.
Additionally, selling shares in an ETF can become complicated if the fund closes because of low investor activity or a narrow set assets. In this case, investors in the ETF will either sell their shares to a market maker or receive a payout according to the ETF’s net asset value. If an ETF closes before your shares have appreciated, you probably won’t get the return on investment you intended when you bought the ETF shares.
Like ETFs, REITs can sit in an IRA and help build up your retirement fund. However, withdrawing cash from the fund before retirement can significantly reduce your long-term returns. Again, this is because you will have to pay the penalty for an early withdrawal.
In some cases, it can be tricker to liquidate REITs when compared to ETFs. This is because private REITs may not allow investors to sell their shares. Investors would either need to wait until the ban on selling shares is lifted (during which time the value of the REIT can decline, causing further losses) or sell at a steep discount.
Publicly traded REITs do not face this issue. Since they are traded on national and international stock exchanges, they can be bought and sold more easily.
When Should You Choose an ETF or a REIT?
ETFs offer the investor agility, lower cost and more protection against market instability. Sine you can buy and sell ETFs throughout the day, you can make adjustments to your ETFs throughout the day.
Additionally, ETFs are among the least expensive investment types. The low fees and variety of accounts that follow the performance of part of the market can also be attractive to investors who want to buy into a fund without committing hours of research market niches.
Similar to ETFs, REITs can shield the investor from loss due to volatility, but for a different reason. REITs typically don’t closely follow the stock market’s performance. Therefore, an REIT can diversify an otherwise overly market-dependent portfolio while offering long-term gains.
That said, certain REITs may perform better over the long-run. So, investors looking to make quick gains should do their research before committing. Numerous sources publish REITs’ historical returns and present performance. Therefore, you can research the REIT you are considering investing in before diving in.
Remember, when making any investment decision, it’s always wise to consult with a financial advisor. A financial advisor can help you weigh the pros and cons of all investment decisions.
The Bottom Line
ETFs and REITs allow you to diversify your investments and make gains over time. However, these financial instruments can be difficult to liquidate in certain situations.
An ETF gives you an affordable way to follow the stock market or a particular part of the market. While REITs provide the stability and robust returns of real estate. If you’re thinking about including either or both of these in your investment strategy, partner with a financial advisor to ensure your investment plan is as strong as possible.
Tips to Plan for Your Retirement
- Choosing investments for retirement can be challenging, which is why a financial advisor can save you time and enhance the end result. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Fidelity says your retirement investments should cover 45% of your pre-retirement income. Once you reach age 67, Social Security benefits could cover the rest. SmartAsset’s retirement calculator can help you estimate how much you’ll have saved by retirement.
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