Here is a fairly balanced and informational Morningstar article about real estate investment trusts (REITs). Below are my notes and excerpts:

• Equity REITs are publicly traded companies that own and manage income-generating real estate properties. REITs are required to distribute at least 90% of their income to investors, which allows them to avoid paying corporate taxes. The bad news is that most of their distributions are taxed as ordinary income.
• In order to further improve diversification, investors can hold a portfolio of REITs through a low-cost fund, like the Vanguard REIT ETF (VNQ). (This is how I hold my REITs, via the mutual fund equivalent VGSIX and VGSLX.)
• REITs represent about 3.6% of the CRSP US Total Market Index, which tracks the entire U.S. investable equity market on a market-weighted basis.
• Much like homeowners with mortgages, REITs buy properties using debt financing. This leverage amplifies both gains and losses in real estate values and increases share price volatility. In other words, REIT values will be a lot bumpier than just estimated your home’s resale value whenever a neighbor sells their house.
• From 1972 through September 2014, the FTSE NAREIT All Equity REITs Index generated a 12% annualized total return, while the S&P 500 posted 10.5%.
• Nearly two-thirds of the REIT index’s return from 1972-2014 came from distributions, which are largely derived from rental income. Investors should have modest expectations for capital gains.
• REITs have historically not been a good hedge against inflation in the short term. As noted, long-term returns are significantly above inflation.
• Current REIT valuations as of November 2014 are considered relatively high by traditional metrics.

Random fact: Did you know you can buy partial ownership of the Empire State Building in New York City via the Empire State Realty Trust (ticker ESRT)? You’d be collecting rent from some big name tenants. ESRT currently makes up about 0.17% of the Vanguard REIT Fund, so if you own VNQ you also own a tiny piece.

(Update 10/28: Schwab has indeed announced their free robo-advisory platform called Schwab Intelligent Portfolios, although it won’t actually start opening new accounts until Q1 2015 and not much new was leaked besides confirming that they will not charge any advisory fees, trading fees, or account fees. You’ll need $5,000 minimum to open, $50k minimum for tax-loss harvesting. Media coverage at Reuters, NYT.)

Original post below:

Speaking of robo-advisors, Reuters reports that discount brokerage Schwab is “weeks away” from announcing their own automated online portfolio management service similar to what is provided by Betterment, Wealthfront, and FutureAdvisor. This is big news because:

• Schwab is a well-recognized name brand in the financial industry and has their own army of affiliated financial advisors.
• This service will reportedly be free with no advisory fees, just the cost of underlying ETFs.
• Schwab has their own set of in-house index ETFs with very low fees. Their Core US Index ETF (SCHB) has an annual expense ratio of 0.04%. Their Core International Index ETF (SCHF) charges 0.08%. Their Core US Bond Index ETF (SCHZ) charges 0.06%, and US REIT Index ETF (SCHH) charges 0.07%. (full list)

Theoretically, this could mean you could get a managed ETF portfolio with automatic rebalancing for safely under 0.10% annually or 10 basis points, all-in. If that happens, that would certainly shake up the industry and perhaps light a fire under Vanguard to do something similar. Hopefully they don’t force you to own some of their more expensive niche ETFs. Vanguard Target Retirement Funds offer a diversified portfolio of index funds and internal rebalancing, but the average cost is 0.17% annually.

If the article is correct, it may be worth waiting to see what Schwab has to offer before opening a “robo-advisor” account elsewhere.

Automated portfolio management is the new hotness. In the coming years, I see a continued expansion of players followed by a lot of mergers and acquisitions. ETF.com analyst Elisabeth Kashner has finished her series on robo-advisors with a final comparison of the current field – The Best Robo Advisor … For You . The entire series is interesting for those that care about such things, but here is the final summary chart:

You may (or may not) be surprised by what she actually picks for her son’s starter portfolio.

As mentioned in my Acorns app review, Harry Markowitz won the Nobel Prize in Economics for his pioneering work in Modern Portfolio Theory, which says that a rational investor should pick an “efficient” portfolio that uses a mix of assets to maximize the expected portfolio return for a given level of risk. You can read all about the Harry Markowitz Model on his Wikipedia page.

Implementation of this mathematical theory has produced many “mean-variance optimized” portfolios containing upwards of 10 different asset classes. Basically these are backtested from historical performance numbers. One of the more complex examples is the 7Twelve Balanced Portfolio shown here:

But what did Harry Markowitz actually hold in his own personal portfolio? What was his investment strategy?

Consider this story from Jonathan Zweig in an NYT article about emotions and investing:

Mr. Markowitz was then working at the RAND Corporation and trying to figure out how to allocate his retirement account. He knew what he should do: “I should have computed the historical co-variances of the asset classes and drawn an efficient frontier.” (That’s efficient-market talk for draining as much risk as possible out of his portfolio.)

But, he said, “I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.” As Mr. Zweig notes dryly, Mr. Markowitz had proved “incapable of applying” his breakthrough theory to his own money. Economists in his day believed powerfully in the concept of “economic man”— the theory that people always acted in their own best self-interest. Yet Mr. Markowitz, famous economist though he was, was clearly not an example of economic man.

Next, read this Chicago Tribune interview by Gail MarksJarvis:

Early in his career, he did not take the risks some investment advisers suggest for young investors to maximize returns. Rather, he saved regularly and put half his money into stocks and half into bonds to grow while controlling risks. When he thought he had accumulated too much in either category, he stopped putting money there for a while and directed savings to the neglected group. […]

“I never sold anything,” he said. If stocks were increasing in value, he would let that portion grow for a while, but eventually he would stop stock purchases and beef up the bonds. The idea: The bonds would insulate him from the downturns that crush stocks from time to time without clear warning. […]

“Say you were 65, and invested $1 million, with 60 percent in stocks and 40 percent in bonds,” he said. “It became $800,000 [during the financial crisis], and you are not happy, but you lived to invest another day.”

I happen to think Markowitz’s actions overall were quite rational and even wise. We could all learn some lessons from his personal strategies.

• Rely on saving, not risk-taking. Markowitz understood the pain of losing your hard-earned money in a down market. Young investors are often told to go 100% stock or close to that, but he was 50/50 and stuck with it.
• Don’t worry about fine-tuning to achieve the perfect portfolio, as it’s all based on the past anyway. Nobody knows what will actually be the “efficient” portfolio for the next 20, 30, 40 years. As long as you have your bases covered, keep it simple. Warren Buffett also recommends simplicity for his wife’s trust and even though he would do a 90% stocks and 10% bonds split, you likely don’t have the ability to lose 40% of your portfolio and go… ah well I’ll just live on the remaining $100 million.
• Tweak, but don’t panic. Buy and hold is one strategy that will work “well enough”. However, if you feel like you must, you can do like Markowitz and make some tweaks now and then… just don’t do anything extreme that could catastrophically damage your portfolio.

Regular savings plus a simple 50/50 or 60/40 portfolio plus no panic selling will do quite well over a long period of time. That’s a solid game plan, even for mathematical geniuses.