I was reminded by a chapter of The Money Coach’s Guide to Your First Million that my investment portfolio lacked any exposure to the real estate market. We don’t even own a house, having decided the time is not yet right to buy into the Bay Area. So, earlier this week I decided to look into real estate investment trusts (REITs).

REITs invest money in companies that build and manage real estate properties and then receive returns in the form of rents and mortgages. By returning 90% of their taxable income to shareholders and meeting some other legal requirements (partially listed in the link above), REITs receive special tax treatment by the IRS. One convenient feature of REITs is that they trade on the stock market exchange, just like other stocks, so they can be one convenient way to diversify into real estate without actually owning your own physical property.

As usual, I decided to look for an ETF that fit my needs. (I’m rapidly becoming the Queen of ETFs among personal finance bloggers I think.) Among the US-based REIT ETFs offered are RWR (streetTRACKS DJ Wilshire REIT), VNQ (Vanguard REIT), ICF (iShares Cohen & Steers Realty Majors) and IYR (iShares Dow Jones US Real Estate). Despite tracking different indices, it turns out their top 10 holdings are nearly identical, though they appear in a slightly different order and with different weightings. Their expense ratios range from 0.12% (VNQ) to 0.6% (IYR).

Here’s a key fact: all four of these ETFs invest in equity REITs involved in the ownership and operation of commercial real estate. Specifically, the companies tracked by these ETFs are involved in building and managing retail, office, storage spaces, and apartments. Finding out about these ETFs’ holdings was particularly important to me, because I initially had no idea if they were exposed to the residential real estate market, an area I wanted to avoid for now because I don’t know where it’s headed.

In the end, I chose to buy some shares of ICF, the REIT ETF that tracks the Cohen & Steers Index. This index is comprised of large and liquid real estate companies that “may benefit from future consolidation and securitization of the US real estate industry” and while its expense ratio is on the high side of the group (0.48%), it has outperformed the other ETFs to more than make up for this amount. I have to suppose this has mostly been due to its greater concentration in a smaller number of assets (ICF has 31 holdings vs. 3 or more times that amount in the other ETFs). I plan on seeing how ICF performs, and if I decide to put more money into US REITs, my next purchase will probably be into VNQ.

If you’re interested in learning more about REIT ETFs, I recommend reading the VNQ prospectus, even if you end up purchasing another fund. Vanguard really does a fine job of thoroughly explaining their ETFs so that anyone can understand them. Businessweek also has a slightly older but useful article discussing the different real-estate indices mentioned above.

I was amused to read last week in the 7/10/06 issue of Barron’s that Ben Stein and I have the same portfolios. We independently arrived upon very similar approaches, though it doesn’t mean much, especially since I’m not familiar with his investment philosophy or performance.

Still, you always get a little tickled if someone famous (and that accomplished, if a bit goofy) agrees with you. He claims, as I do, that he has neither the interest or temperament to invest other people’s money, and that if he ever lost a widow’s money, he’d “probably leave the country or jump off a tall building.” I’d probably do the same.

In the article, Stein advocated creating a so-called fund of funds by using ETFs and index funds, and hedging not with short plays but with cash. Maybe this isn’t that uncommon a strategy, but it turns out that we’ve picked the exact same ones in which to invest, sans Utilities (XLU) and Natural Resources (IGE). (I did own XLE briefly last year but sold it out of being conservative and trying to limit my investments in things I don’t understand. Like oil.) In the interest of full disclosure, I’ll state here that I currently own shares of EEM, EFA, and VTI, and IWN (as Ben recommends). I also have tiny holdings in EWO and EWJ (see below).

So let’s say you decide to invest in an ETF. What is it, and what should you look for?

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This week’s Barrons (dated 7/3/2006) featured an article about PowerShares ETFs in an article entitled “The Odd Couple” (subscription required). Personally, I’ve found ETFs to be a better solution than mutual funds for my investment objectives, but the article pointed out that “ETF assets have more than tripled over the past 4 years to $469B [and] there are more than 212 offerings…expected to grow at an average annual pace of 33%”. Nonetheless, the mutual fund industry is still a much bigger whopper at $9.5 trillion, so I suppose there’s still plenty of room out there for ETFs to grow.

I’d never heard of PowerShares ETFs, which offer a way to invest in extremely specialized industries (such as varieties of clean energy). But I was pretty shocked to read in the article that “Unlike most ETFs, PowerShares fund components are reshuffled quarterly in order to reflect best-in-show stocks within each sector.”

I had to look into this further. I’m not averse to trying out different investment methods (just look at the title of this site), but I couldn’t fathom the point of owning an ETF whose holdings changed every quarter. Not only that, but the problem with funds with high turnover rates is that they tend to go hand-in-hand with higher taxes, since usually whenever an asset is sold, a taxable event occurs.

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