Exchange-traded funds, or ETFs, can be a great way to add income and growth to a retirement portfolio without excessive reliance on any particular stock. However, too many retirees focus exclusively on the headline market indices like the S&P 500 and Nasdaq and don't allocate any of their capital to real estate.

However, real estate investment trusts, or REITs, are not only a great income investment. They can add diversification, lower portfolio volatility, and offer excellent long-term growth potential. And that's why the Vanguard Real Estate ETF (VNQ 0.01%) can be a great ETF to consider for your retirement portfolio.

The Vanguard Real Estate ETF in a nutshell

The Vanguard Real Estate ETF invests, as the name implies, in a portfolio of real estate stocks -- specifically, real estate investment trusts. At the end of May, the ETF owned 171 different REITs in its portfolio, including operators of residential, retail, industrial, healthcare, office, and other types of commercial real estate.

Like most index funds, the Vanguard Real Estate ETF is weighted by market cap, which means larger REITs make up more of the fund's assets than smaller ones. So, the top holdings of the fund are some of the largest real estate owners in the world, such as American Tower (AMT -0.59%), Prologis (PLD -1.69%), Crown Castle (CCI 1.42%), and Equinix (EQIX 0.72%). 

Like most exchange-traded funds, the Vanguard Real Estate ETF has a management fee, but at 0.12% of assets under management annually, it's one of the cheapest ways to get broad exposure to a portfolio of REITs.

Why is this a great fit for retirement accounts?

There are a few reasons why the Vanguard Real Estate ETF can be a great fit for retirement accounts.

The most obvious reason is income. With a 2.4% dividend yield based on the current stock price, the Vanguard Real Estate ETF isn't the highest-yielding investment you can buy, but it is a solid income investment that is a great combination of cash flow and upside potential. Plus, REITs in general have a solid history of raising their dividends over time, so this should be a growing income stream. If you're currently retired, this can be a great way to create income and protect against inflation, and if you're still decades away from retirement, you can be confident that your shares will produce a significantly higher income stream by the time you need it.

Another good reason to consider this REIT ETF for your retirement account is low volatility. While REITs can certainly be volatile at times just like any other stock investment, they have a solid track record of below-average volatility. According to the NCREIF Property Index (NPI), which tracks commercial real estate performance, commercial real estate as an asset class has outperformed the S&P 500 over time and with less than half of the standard deviation in returns. The S&P 500's worst performance was its 37% loss in 2008, while the worst performance of commercial real estate was a drop of 16.9%.

And finally, as briefly mentioned in the last paragraph, just because real estate is seen as a low-volatility income investment doesn't mean you're sacrificing long-term growth potential. In fact, by most long-term indices, real estate has actually outperformed the stock market as a whole. Since 1972, the FTSE Nareit All Equity REITs index has delivered annualized total returns of 12.2%, compared with about 10.7% annualized for the S&P 500. 

How should you incorporate the Vanguard Real Estate ETF into your strategy?

The short answer is that it depends on your overall investment goals and risk tolerance, but it's tough to make the argument that the Vanguard Real Estate ETF isn't a good fit for a retirement portfolio. It offers a rare combination of income, growth, and stability, and can be a great way to add diversification to your retirement investment strategy without sacrificing return potential.