Why REITs Pose Growing Risks to Retirement Nest Eggs

The quiet crisis in retirement planning isn't about market volatility or geopolitical risks—it's about what's missing from your portfolio. While target-date funds (TDFs) are designed to guide investors toward retirement, many fail to adequately harness the inflation-hedging power of real estate investment trusts (REITs). With allocations averaging just 3% in most TDFs, retirees are left vulnerable to eroding purchasing power, while a data-driven approach suggests REITs could—and should—play a far larger role. Here's why underallocation is a ticking time bomb and how to fix it.

The Inflation Conundrum: Why REITs Are Essential

Inflation isn't just a temporary blip—it's a persistent threat to retirement savings. REITs, which invest in income-producing real estate like office buildings, warehouses, and data centers, offer a unique defense. Unlike bonds, which struggle in high-inflation environments, REITs historically have a strong correlation with inflation metrics. For instance, the Vanguard Real Estate ETF (VNQ) has outperformed the S&P 500 during periods of rising prices, thanks to contractual rent increases and property value appreciation.

Yet most TDFs treat REITs as an afterthought. A 2024 ICI report reveals that even as REIT allocations in TDFs have doubled since 2005 (reaching nearly 4% for mid-term portfolios), they remain far below optimal levels. A Morningstar analysis, sponsored by Nareit, found that younger investors—those 45 years from retirement—should hold up to 20% of their portfolio in REITs to balance risk and return. By retirement age, that allocation drops to 11%, yet today's average hovers around 2% for near-retirees.

The Allocation Gap: Where Target-Date Funds Fall Short

The disconnect between optimal allocations and reality is stark. Take Schwab's target-date funds, which max out at 10% REIT exposure—still below the 20% benchmark for younger investors. Meanwhile, the average TDF's 3% allocation leaves retirees exposed to a silent danger: the “denominator effect.” As inflation eats into purchasing power, a portfolio lacking REITs will struggle to keep pace with rising costs.

This isn't just theory. A 60/40 stock-bond portfolio with 10% allocated to REITs has historically delivered higher risk-adjusted returns than one without. The tax benefits are also underappreciated: REIT dividends, though taxed as ordinary income, can be sheltered in retirement accounts like IRAs or 401(k)s.

Risks Beyond Inflation: Overconcentration and Liquidity Traps

Even when REITs are included, many TDFs suffer from another flaw: over-reliance on residential real estate. The majority of REIT allocations in target-date funds flow into housing-related assets, which can be volatile in economic downturns. By contrast, diversified portfolios incorporating industrial, data center, or healthcare REITs—sectors less tied to housing cycles—offer more stability.

Liquidity is another concern. While listed REITs trade like stocks, some TDFs may hold private real estate vehicles that lack daily liquidity. This creates a “trap” for retirees needing to access funds quickly. The solution? Stick to publicly traded REITs, which offer transparency and flexibility.

A Path Forward: Rethinking Retirement Portfolios

Investors must demand better. Start by auditing your TDF's REIT exposure. If it's below 5% for younger workers or 3% for retirees, consider supplementing with a dedicated REIT holding. For example, adding the iShares U.S. Real Estate ETF (IYR) or a global REIT fund like the FTSE EPRA/NAREIT Index ETF (REM) can boost diversification.

Employers and fund providers, too, have a role to play. The ICI report notes that 61% of TDFs now include a dedicated REIT “sleeve,” but allocations must grow. As institutions increase real estate targets to 10.7% by 2025 (per the Institutional Real Estate Allocations Monitor), individual investors should follow suit.

Final Word: Don't Let Inflation Steal Your Retirement

The data is clear: REITs aren't a luxury—they're a necessity. With inflation averaging 3% annually over the next decade, retirees will need every tool to preserve purchasing power. By advocating for higher REIT allocations, diversifying beyond residential real estate, and prioritizing liquidity, investors can build portfolios that withstand the test of time.

The message is simple: Your retirement nest egg can't afford to ignore REITs any longer.