There’s plenty of advice out there about how to allocate stocks and bonds in a portfolio.  Go all stocks in your early years and 60/40 in retirement.  Have stocks equal to 100 minus your age, then put the rest in bonds.  No, now it’s 120 minus your age. 

But wait.  No one’s talking about real estate.  You have rental property too.  Shouldn’t that be considered before following the standard advice? 

How does real estate fit in? 

I’ve invested in real estate since college and studied personal finance just as long.  Yet I’ve never found anyone who talks about how to allocate physical real estate in a stock/bond portfolio.  Real Estate Investment Trusts (REITs), maybe, but not privately owned properties.  Everywhere I’ve looked, people talk about real estate like it’s a separate topic.  But in your life, as a real estate investor who also has a 401k or IRA, they should be combined! 

It’s all part of your investment portfolio, whether you look at it that way or not.  You have a choice whether to buy more properties or invest new money in stocks.  And if you aren’t looking at your investments as a whole, your mix of stocks, bonds and real estate might not be doing what you want it to do. 

Let’s think about this. 

Do you know the overall risk you’re taking? 

If you have a huge amount of leverage through mortgage debt, do you want to be just as aggressive in stocks?  Or do you want some part of your portfolio to be more stable?  

If you have paid off properties that cash flow, do you really need a bunch of bonds?  Both make your portfolio more conservative. 

The answer to these questions is unique to your specific circumstances and risk tolerance, of course.  You may want to be ultra aggressive or super conservative.  But we can lay out some general ideas and guidelines that will help you decide how to manage and allocate your portfolio as a whole. 

This will enable you to reach your investment goals with more certainty and control. 

Breakdown of investment types 

What do the investment returns of stocks, bonds, and real estate look like? 

Stocks 

Stock returns have two parts: 

  1. Dividends (income). 
  2. Capital appreciation (stock price growth). 

Dividends are a more stable part of stock return.  They don’t move up and down as much. 

Capital appreciation is more volatile, but makes up a larger percentage of the overall return. 

Bonds 

Individual bonds return their yield (interest or coupon payment) as income when the bond matures.  Bond funds technically have the same two parts as stocks since prices move up and down with daily interest rate changes.  However, the long-term returns of bond funds will track with individual bond rates.  So as long-term investors it’s best to see bonds as a more stable income investment. 

Bonds are typically inversely correlated with stocks.  This means they move in opposite directions most of the time.  People hold stocks and bonds in a portfolio to smooth the ride since one tends to do well when the other is doing poorly. 

The exception to this has been in high inflation environments, as we saw in the 1970s and most recently 2022.  High inflation can cause stock and bond prices to fall together.  Otherwise, history shows that bonds often rise when stocks fall and vice versa. 

Rental real estate 

Rental real estate returns have 3 main parts: 

  1. Cash flow from rental income. 
  2. Capital appreciation as home prices rise. 
  3. A leverage multiplier from mortgage debt. 

I could have included mortgage principal payoff and tax deductions in this list.  But they affect cash flow and leverage, so I chose not to. 

The first 2 parts look similar to stocks: income and appreciation. 

However, cash flow can vary more for an individual rental property than an S&P 500 stock fund.  It depends on individual tenants, vacancies, and maintenance.  The more rentals you own, the more stable cash flow becomes. 

And capital appreciation for real estate is often smoother than stock prices.  It mostly moves upward at the rate of inflation.  Again, we have seen exceptions to this during the Great Recession of 2008-2009 and fast-rising mortgage rates in 2022-2023.  But from a long-term viewpoint we can expect appreciation to track with inflation. 

Leverage amplifies the capital appreciation of a property, while reducing cash flow. 

A 75% loan, 25% downpayment property is leveraged 3 times to 1.  Every 1% increase in property value gives the investor a 4% gain—3% from leverage and 1% for equity.  Of course, a 1% decrease gives you a 4% loss as well.  So use leverage wisely. 

Investors can use leverage on stocks and bonds also.  But I wouldn’t recommend it for anything other than real estate.  Stocks are too volatile, and you can easily lose all your money.  Bonds don’t yield enough to make up for loan costs. So I won’t be covering that here. 

Privately-owned real estate is uncorrelated with stocks and bonds.  Its returns have little to do with stock or bond returns.  This makes it a good diversifier in a portfolio, and a great reason to be a real estate investor. 

The following table summarizes the types of return each asset class provides, and why you would include them in a portfolio. Gold is discussed later in this article.

bonds, gold, real estate and stock portfolio considerations
Types of return for various asset classes, and why you would include them in a portfolio

What if the mortgage is paid off? 

A mortgage is the opposite of owning a bond.  You’re paying the lender interest for money they loaned you instead of being paid interest for money you loaned as a bondholder.  Taxes and risks aside, if you borrowed money at 5% and bought a 5% bond with it, you would break even. 

Therefore, if you pay off the mortgage it’s like buying a bond at the principal value and interest rate of the mortgage.  And your cash flow on that property increases by the principal and interest payment. 

So it makes sense that the more paid off mortgages you have the fewer bonds you need in your portfolio!  That’s how I think of my portfolio.  Because I was paying off mortgages, I definitely didn’t need bonds during my accumulation years, on the Ascent.  And I need fewer of them now at the Summit and as I make the Descent. 

If you pay down $100k on a mortgage, you need $100k fewer bonds in your portfolio.  You just bought a $100k bond at the rate of your mortgage. 

The caveat to this rule for paying down mortgages, but not paying them off, is that you still need to pay attention to cash flow and have enough to cover your operation and income needs.  At some point, you may want or need to pay them off to free up cash. 

Public versus private real estate 

Publicly traded REITs are more correlated with stocks because they’re traded on the same stock exchange.  This gives an advantage to private real estate. 

Your privately owned property is very different than what a REIT owns also. Unless you’re privately investing in commercial buildings, warehouses, storage centers, data centers, and cell towers, that is. 

If you own REITs, you can lump them into the stocks category for this discussion. 

You can otherwise look at your REITs and private real estate as one diverse category and decide if you are over-allocated to real estate.  The two should perform very differently from each other, though.  What you decide depends on what you want your portfolio to look like and how much you love real estate! 

What should your portfolio look like? 

I wrote an article called What Should My Asset Allocation Be for Building Wealth Versus Retirement, along with a white paper that goes into a detailed analysis of asset allocations.  If you haven’t read it yet, that’s your next stop. 

In the article, I lay out the Pathway to FI Model Portfolios for each financial stage. 

As you see there, I recommend a well-diversified 100% stock portfolio until you’re financially independent.  Then 10-15% of long-term bonds and another 10-15% of gold as you reach financial independence and beyond. 

You can follow the model portfolios with all of your stock/bond investments or modify according to the points that I’ll summarize at the end of the article. 

I haven’t talked about gold yet.  But as you see in the asset allocation article and white paper, it’s done some amazing things with diversification and safe withdrawal rates historically.  So you might choose to have less gold in favor of private real estate.  If you’re as convicted about the research in the white paper as I am, however, you might want to keep gold to no less than a 5% level at the Summit and Descent stages to get some of the potential benefit.

How much real estate you own is up to you.  If you’re going all-in on real estate and hold very few stocks, I would recommend less leverage, however.  You are less diversified than someone who’s buying small shares of thousands of companies around the world. 

If you ask me, I’d say 10-25% of private real estate is a great place to be at any stage.  And having as much as 50-75% in cash-flowing real estate while building a rental business isn’t a problem at all.  Anything over 75% and you might be missing out on other opportunities that I talk about in Put Your Retirement Savings in These Accounts First. 

Here’s what I did. 

My portfolio 

When I started investing in real estate during the Great Recession, I had virtually zero equity.  Because of leverage, it just kept evaporating.  But when the market finally picked up in 2010-2011, my portfolio quickly became heavy in real estate.  It grew to as much as 44% until I began investing more into stocks to balance it out. 

I still own a good share of private real estate now.  Around 25-30%. But it’s all paid off. And I’ve diversified my portfolio more as I focus on a high safe withdrawal rate rather than high growth.

Sign up at the bottom of the page to see my portfolio over the years.  You’ll also get a free copy of the Pathway to FI Guidebook: 22 Secrets to Building Wealth and Financial Independence. 

Summary 

Privately owned rental properties are a great investment, and a great part of a diversified portfolio.  But most investors think of it as a separate investment outside of their and stock/bond portfolio. 

The best way to look at your investments is to bring everything together as a single portfolio.  Retirement accounts, taxable brokerage accounts, savings accounts, real estate, and other businesses.  Without doing this, you may have much more risk or much less growth potential than you want. 

So figure out where all your wealth is.  Then track and manage it as one big portfolio. 

Account for real estate with these points in mind: 

  • The Pathway to FI Model Portfolios are a great place to start.  Private real estate is uncorrelated from every asset class represented there. 
  • Paying down a mortgage is like buying a bond with the same interest rate.  The more you pay down, the less bonds your portfolio needs.  Particularly if they’re paid off and have great cash flow.  
  • Public REITs are more like stocks than privately owned real estate. 
  • Gold has a big impact on safe withdrawal rate historically.  If diluting it with real estate, consider keeping at least 5% gold to get its diversification potential. 
  • 10-25% private real estate is a good target for those who want rental properties. 
  • 50-75% real estate is okay if you’re building a business.  Above 75% might mean you aren’t diversifying and getting the benefits from retirement accounts and your employer. 

If you haven’t read the Rental Property Series yet, you’ll enjoy these: 

The simple ROI calculator discussed in the first 2 articles is my most valuable tool.   

And don’t forget to sign up for FREE at the bottom of the page to get much more value from PathwayToFI. 

Join me on the Pathway to FI! 

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