The Long-term Performance of Stocks
Most of us have been advised that stocks are most beneficial when held for the long game, so this bodes well for long-term investing. The annual rate of return on the S&P 500 for the past 20 years (July 1996 through July 2016), for example, is 8.039%. This includes reinvested dividends.
Now, we can pick out different timeframes that will show even better returns, such as those tracking back to the 1920s (which demonstrated double-digit numbers). Or, we could go back to the beginning of the current super bull market, which started in 1982. However, those measures cover periods that are well in excess of the timeframe needed to achieve either early retirement or financial freedom for most people.
Imagine that you were to invest $20,000 per year over the next 20 years in an S&P 500 index fund. Let’s assume the investment earned a rate of return consistent with the historical numbers from the last 20 years (8.039%). Over those two decades, your hypothetical portfolio would grow to $893,157.
Of course, this investment strategy assumes that 100% of your portfolio would be invested in the index. In a real world investment environment, you’d hold a portion of your portfolio in fixed income investments for diversification. Given that interest rates have been so low, particularly over the past seven years, that would reduce your return. It would all depend on how much you commit to fixed income investments.
The Long-term Performance of Real Estate – Physical Real Estate
The long-term performance of real estate is something of a mixed bag. First, though, we need to differentiate between residential and commercial property.
Commercial property is reflected primarily in the performance of Real Estate Investment Trusts (REITs). This investment vehicle has been around for over 5 decades but is often overlooked by investors.
Learn More: Should a Diversified Portfolio Include a REIT?
Residential real estate has had a dismal performance over the past 10 years. According to Zillow.com, the average price of a home in the US stands at $187,300 as of September 2016. That’s down a bit from the same time in 2006 when it stood at $194,000.
A large part of that lingering softness is the hangover effect of the Financial Meltdown of 2007-2009, and the subsequent housing collapse. However, that event can hardly be discounted when considering the viability of residential real estate investing moving forward.
The actual return you will receive on direct real estate ownership has many variables, including:
- The strength of the housing market in your area (it varies considerably from one region to another)
- Your own skills at both buying and managing property
- Whether you plan to buy and hold property for rental income and long-term capital appreciation, or to buy, rehab, and flip property for quick profits
- How strong the rental market is in your area, and how much net rental income you can expect (if any at all)
- The multiplying effect of leveraging (mortgaging) the property you purchase
Complicating this further is the fact that we can’t know for certain where we stand in the longer-term housing cycle. For example, had you bought property around 2009 — at the bottom of the financial meltdown — you would likely have a substantial gain on your property value. If, on the other hand, you bought in the previous market peak of 2006-2007, you’re probably still trying to recover lost ground.
The Long-term Performance of Real Estate – REITs
Investopedia.com reports that as of 2015, REITs turned in an average annual return of 11.8% for the previous 20 years, while the S&P 500 averaged just 8.6%. The S&P returns reflect the net effect of two major market reversals (2000-2002 and 2007-2009), however, the REIT returns also include the real estate meltdown of the 2007-2009 period.
As an example of an individual fund, the Vanguard REIT Index Fund Investor Shares (VGSIX) has had an average annual return of 11.35% since its inception on May 13, 1996. However, the annual performance of the fund since 2001 shows a pattern of volatility. One not unlike that of the stock market, in fact. In that same 15-year time frame, the fund’s performance has swung between a loss of 37.17% in 2008, to a high of 35.92% for 2003.
Now, imagine you were to invest $20,000 per year over the next 20 years in a real estate investment trust, such as the Vanguard REIT Index Fund Investor Shares. This trust would earn a rate of return consistent with what it has been over the last 20 years (11.35%). In this case, your portfolio would grow to $1,311,930. That’s a difference of $418,773 from your hypothetical stock portfolio above… quite the significant jump.
At least based on the performance of both the S&P 500 and REITs over the past 20 years, it looks like REITs will help you to achieve your goal sooner.
REITs or Direct Real Estate Investing
Whichever type of real estate that you consider to be the better investment, there’s no question that REITs are a much “cleaner” investment. You can hold REITs in your portfolio, including your retirement plan, as a completely passive investment.
These are very different from direct ownership of real estate. The biggest perk is that you aren’t involved in the day-to-day management and expenses of the property. If you want to invest in real estate, but you don’t want to get your hands dirty or deal with uncooperative tenants, REITs are the way to go.
REITs have another major advantage over physical real estate, and that’s diversification. Even with a relatively small amount of money, your investment will be spread over several investment properties. These may even be located in different cities or states. This will help minimize some potential damage to your investment. Particularly that which could be done by a serious decline in your own local real estate market.
The Good News: Either Stocks or Real Estate Will Get You Where You Want to Go
The really good news here is that you can succeed either way! Reaching early retirement or financial freedom is possible with both stocks and real estate. And on the real estate side, people have certainly prospered using either REITs or direct real estate investing.
The true moral of this story may be longevity. The ultimate goal is to pick at least one investment and commit to it for as long as it will take to achieve either your early retirement or financial freedom.
Using the Portfolio Method: Including Both Investments
In the performance examples used above, under both stocks and REITs, REITs come out ahead. They give you a portfolio of over $1.3 million after 20 years, compared to just under $900,000 for stocks. This would seem to make REITs a clear choice in planning for either early retirement or financial freedom. It’s important to remember, though, that it only measures what has happened in the past 20 years. The situation could be very different going forward.
For that reason, the best strategy may be to blend both investment types in your portfolio. You can choose a mix of S&P 500 index funds and REITs, which would position you to take advantage of the performance of both asset classes.
In addition, you should also add some fixed income assets for diversification and protection. Considering that both stocks and REITS (and especially residential real estate) both performed poorly during the Financial Meltdown, fixed income assets add a measure of insurance to your portfolio.
This is one of those rare cases in life where you will actually be facing two very good choices!
Which are long-term investment you utilizing for your own portfolio?