by Archie M. Richards, Jr.
January 29, 2007

Priscilla writes, "I have $550,000 invested mostly in mutual funds, but I have no real estate investments. Is the real estate "boom" over? I don't need to make 30 percent on my investment to be satisfied. I have $10,000 cash available for investment in a taxable account or a traditional IRA. What do you recommend?"

First, Priscilla, let's consider the last two issues you raise.

• It's a darn good thing you can be satisfied with a return of less than 30 percent a year. No one can achieve such a wildly unrealistic rate year after year. If you put $560,000 to work at 30 percent a year, you'd have a breathtaking $7.7 million in 10 years. That kind of thing is nice to dream about, but you should shoot for 10 percent a year, which is a lot higher than most people achieve.

• IRAs are way overrated. (To find out the reasons, see the column dated 5/8/06 in archierichards.com.) Use a regular taxable account or a Roth IRA for your investments.

Okay, now about real estate: Clearly, the upside price boom is over. For the first time in many years, real estate prices have turned down.

The prices increased most on the East and West coasts, where local laws and regulations suppressed real estate construction. In some areas, this raised the prices to levels that only the rich could afford, leaving homes unaffordable for the poor. (In the long run, big government widens the gap between rich and poor.)

Your email, Priscilla, prompts me to consider additional issues:

• Is the real estate downturn over? Perhaps not, but that's just a wild guess.

• Is the real estate bust permanent? Absolutely not. Price trends of asset classes are never permanent. All of us need real estate most of the time. The American economy and population have been growing rapidly. Even at the price peak in 2005, the construction of homes didn't keep up with the underlying demand. The pressure to construct homes remains.

• How have real estate investment trusts (REITs) performed? Surprisingly enough, very well. The prices of homebuilding stocks, such as Lennar (LEN), have been falling since mid-2005. But REITs have held up nicely. To see for yourself, go to www.bigcharts.comand call up a 5-year price chart for streetTRACKS DJ Wilshire REIT (RWR) (an exchange-traded fund representing virtually all publicly-traded REITs that own and operate commercial real estate, including apartments). In January 2003, the price was 40. In January 2005: 60. In January 2006: 70. Now it's 94. No big turndown there.

• What are the long-term prospects for real estate prices? Long-time readers of this column know that I expect inflation to disappear, replaced by a long-term decline in the general price level. I call it "benign deflation." Under these circumstances, real estate prices will go down. But the profits of companies engaged in the real estate business will hold up, and the prices of their stocks will probably rise.

Sonya asks a related question: "In view of the overall stagnation in the housing market, have you changed your recommendation to allocate 20 percent of a portfolio to REITs? (By the way, your past investment advice regarding Vanguard index funds has been most profitable. Thanks!!")

Thank you, Sonya. No, I haven't changed my recommendations for real estate investment trusts (REITs). As explained above, REIT prices have held up well even though home-building stocks fell sharply in the last half of 2005.

Invest a portion of your investment portfolio in an ETF or index fund of REITs. Vanguard's exchange-traded fund VNQ or its index fund VGSIX are fine choices. During your annual rebalancing, react to price trends after they occur. For example, if your REIT has risen a lot, sell a portion and buy more of the funds that fallen substantially.

People who try to outguess short-term market trends in advance do so at their peril. More often than not, they're wrong.