Bonds and real estate investment trusts are historically popular choices for long-term investors, but they work in different ways. Bonds focus on stability, while real estate investment trusts (REITs) give you a way to invest in real estate without owning property directly .

Knowing the difference matters. It can help you match your investments to your financial goals. Bonds and REITs each bring something unique to the table – different risks, return strategies, and income opportunities.

In this article, we’ll break down how bonds and REITs work, what sets them apart, and how they might fit into your investment portfolio. We want to provide information that can help you decide what’s right for you.

What are bonds?

Bonds are essentially loans you give to governments or companies. In return, you expect to earn regular interest payments. Bonds are known for their emphasis on stability and predictable income, which appeals to many conservative long-term investors.

When you invest in bonds, you’re helping fund projects like infrastructure or business expansion. In exchange, the aim is to get your money back, plus interest, at the bond’s maturity date.

Bonds are considered lower-risk compared to other investments, but they’re not risk-free. Economic changes, like interest rate shifts, can impact their value.

If you’re looking to balance your portfolio, bonds can potentially act as a steadying influence. Whether you’re aiming for regular income or a way to hedge against market swings, they might fit your strategy.

What are REITs?

A real estate investment trust (REIT) lets you invest in property markets without buying a home or commercial property yourself. They pool money from investors to own, manage, or finance income-producing real estate.

When you invest in REITs, you’re buying shares in a company that focuses on property. You can invest in different types of REITs, including a publicly traded REIT or private REITs.

Private REITs are not listed on stock exchanges, offering less liquidity but sometimes targeting niche commercial real estate markets. As such, a private REIT will often be funded by private equity. Publicly traded REITs are listed on stock exchanges – like the Australian Securities Exchange (ASX) – making them easier to buy and sell like shares or ETFs. Publicly traded REITs often hold diversified commercial real estate portfolios, including office spaces and shopping centres, spreading risk across different sectors.

REITs seek to stand out for their dividend income. By law, many REITs must return a significant portion of their profits to shareholders. This can make them attractive to investors seeking regular income. However, as you may have suspected, an REIT which doesn't yield a profit won't have any dividends to pay.

How do risk and returns differ between bonds and REITs?

Bonds and REITs come with different risk levels and potential returns, which can influence how they fit into your portfolio. A bond generally offers predictable income, while a REIT provides the potential for higher returns (which commensurately higher risk) through property market exposure.

Bonds are often viewed as lower-risk investments. They usually offer consistent interest payments and can potentially be less affected by market swings. However, as mentioned, they’re not risk-free – rising interest rates or defaults can still impact their value.

REITs tend to carry more risk. Their performance often reflects the real estate market and economic conditions. This can mean greater volatility. Yet, they offer the potential for higher gains, especially during property market booms.

In periods of economic uncertainty, bonds may act as a safer haven. REITs, however, might outperform in a growing economy with strong property demand.

In either case, it’s important to note that performance isn’t guaranteed. Past trends can provide insights, but future returns depend on market conditions and other factors.

How do bonds and REITs generate returns?

Both bonds and REITs can generate income, but the way they do it – and the potential yields – are quite different.

The interest which bonds pay are often called coupon payments. These are typically predictable and fixed, which can appeal to income-focused investors seeking stability. As mentioned, REITs often distribute dividends from the rental income or profits of their property portfolio. Dividend income can therefore vary based on property market performance and economic conditions.

While bonds usually offer lower but steady yields, REITs have the potential for higher total returns. However, this comes with added risk due to market fluctuations.

High-yield bonds, often called "junk bonds," are another type of bond that offers higher returns but comes with increased risk. They’re issued by companies or entities with lower credit ratings, meaning there’s a greater chance the issuer might default on payments.

Neither bonds nor REITs guarantee income. Changes in interest rates, tenant demand, or economic factors can impact how much you earn from either.

Which is more liquid – bonds or REITs?

Liquidity, which means how easily you can buy or sell an asset, differs between bonds and REITs. Your choice may depend on how quickly you might need access to your funds.

Generally speaking, REITs are more liquid. You can buy or sell them like shares on the stock market . This makes them more accessible and flexible for investors.

Bonds can be potentially less liquid, especially for individual investors. While some bonds trade actively, others may take longer to sell, depending on the market.

ETFs provide an easy way to access both bonds and REITs, as they offer added liquidity and transparency for investors. We’ll cover more on that next.

How can I invest in bonds or REITs?

If you're considering bonds or REITs, there are several ways to get started. Each option comes with its own characteristics.

Direct purchase

• Bonds: You can buy bonds directly through brokers or government bond programs. This gives you direct exposure to fixed-income assets.
• REITs: Purchasing shares in specific REITs allows you to focus on particular real estate sectors or companies.

ETFs

Exchange-traded funds offer a simple way to invest in both bonds and REITs, helping you access bonds and property without buying directly. They are easy to trade on the ASX and can help spread risk across multiple bonds, properties and sectors.

Here are some widely known bond ETFs :

· Vanguard Australian Fixed Interest ETF (VAF) : This ETF tracks a mix of Australian government treasury bonds and corporate bonds.

· iShares Core Composite Bond ETF (IAF) : A popular choice, offering exposure to a diversified portfolio of Australian bonds.

· BetaShares Australian Government Bond ETF (AGVT) : Focuses on bonds issued by the Australian government, catering to those seeking lower credit risk.

Examples of popular REIT ETFs in Australia include:

• Vanguard Australian Property Securities Index ETF (VAP) : Tracks a broad range of Australian REITs.
• VanEck Australian Property ETF (MVA): Offers exposure to major property trusts on the ASX.
• SPDR S&P/ASX 200 Listed Property Fund (SLF) : Focuses on property trusts within the S&P/ASX 200 index.

Please note that these ETFs aren’t recommendations, just examples to illustrate the options available.

Managed funds

Managed funds pool your money with other investors to invest in a range of bonds or real estate properties. These funds are professionally managed, meaning a finance professional oversees the fund's investment choices.

Mortgage REITs

Some REITs specialise in securities backed by a mortgage, offering exposure to the debt side of real estate investments.

Each method of investing in bonds and REITs has its benefits and potential risks. Your choice will depend on your financial goals, risk tolerance, and preferences for managing your portfolio.

What risks should I be aware of when investing in bonds or REITs?

Every investment carries risk, and bonds and REITs are no exception. Knowing these risks helps you make informed decisions.

Bonds

• Interest rate changes: Rising interest rates can lower the value of existing bonds, as new bonds may offer higher returns.
• Credit risk: If the issuer defaults, you could potentially lose some or all of your investment.

REIT

• Market fluctuations: REITs can be volatile, influenced by real estate market trends and broader economic conditions.
• Property risks: Factors like tenant defaults, vacancies, or changes in property demand can impact REIT performance.

As mentioned earlier, diversifying your investments can help manage these risks. However, no strategy guarantees protection against market changes or unexpected events.

How do bonds and REITs fit into a diversified portfolio?

Bonds and REITs can prospectively serve complementary roles, helping investors balance risk and return in their portfolios. Choosing between an REIT and a bond depends on your income needs and risk tolerance.

As mentioned, bonds can provide stability, offering predictable income and potentially reducing overall portfolio risk. REITs can add growth potential through exposure to real estate markets and regular dividends. Together, they can balance the ups and downs of market cycles to (hopefully) create a more resilient portfolio.

Who might prefer investing in bonds?

Risk-averse investors or retirees may choose to lean toward bonds. Their generally predictable returns and lower volatility can make them appealing to those prioritising stability.

Who might prefer investing in a REIT?

Income seekers and investors comfortable with higher risks might favour REITs. They enjoy the potential for higher returns, driven by property capital appreciation and regular dividend income. However, REIT performance depends on market conditions, so volatility is a factor.

Hypothetical scenarios

Here are some fictional examples of how investors might use bonds and/or REITs to achieve their investing objectives.

Neve focuses on stability

Neve wants steady returns and minimal risk. She invests in a mix of municipal bonds (issued by the government) and corporate long-term bonds, avoiding market volatility. The bonds provide predictable income, helping Neve feel secure during uncertain economic times. However, performance isn’t guaranteed, and interest rate changes can impact bond values.

Callum seeks growth and income

Callum prefers higher returns, even if it means more risk. He invests in REITs, gaining exposure to real estate without owning direct property. Callum enjoys regular dividends and hopes for long-term growth from property market trends. Still, property markets can fluctuate, and returns may vary over time.

Saskia blends bonds and REITs

Saskia wants both stability and growth in her portfolio. She allocates part of her funds to bonds for steady income and reduced risk. The rest goes into REITs for potential higher returns and property market exposure. This combination balances Saskia’s goals while spreading risk across different asset types. Diversifying across both can offer a mix of security and opportunity, but always remember that returns aren’t guaranteed.

Your portfolio, your way: making sense of bonds and REITs

Bonds and REITs offer different ways to shape a portfolio that reflects your goals and preferences. Bonds can support more cautious strategies, while REITs might suit those open to property market exposure.

The key is understanding how these assets interact with your broader financial plan. Bonds and REITs aren’t opposing choices – they can work together to potentially create balance.

Every investment decision is personal. By exploring the roles these assets play, you can decide what fits your needs and builds your confidence in your portfolio.

Happy investing!