Before I show you the 20-year annualized returns by asset class between 1999 – 2018, I want you to guess the following four things:
1) Of the following asset classes, the S&P 500, a 60/40 stock/bond portfolio, Bonds, a 40/60 stock/bond portfolio, REITs, Gold, Oil, EAFE (Europe, Asia, Far East), national real estate, which performed best?
2) What was the annualized return for the best performing asset class +/-0.5%?
3) What was the annualized return for the worst performing asset class +/- 0.5%?
4) What was the annualized return for the average active investor +/- 0.2%?
If you can guess two out of the four correctly, I'll give you a gold star and might even take your child's SAT or ACT exam for you.
If you only get one out of four right, you need to go run five miles immediately. Zero right, then you need to run five miles, do 100 sit-ups, and 100 push-ups.
There's no way any of you are getting four out of four right.
Now that we have a deal, let's take a look at the results to see how reality compares with your biased beliefs. Here are the annualized returns by asset class between 1999-2018.
Annualized Returns By Asset Class Between 1999 – 2018
Below are the results compiled by J.P. Morgan, one of the largest traditional asset managers in the world that charge clients 1.15% – 1.45% of assets under management, based on $1 – $10 million. This is the mass affluent class with growing assets to invest.
Asset managers like J.P. Morgan are the reason why digital wealth advisors like Empower were created during the last financial crisis. People wanted to pay lower fees and weren't satisfied with active management results.
As you can see from the results, REITs is the #1 performer with a 9.9% annualized return. I bet less than 20% of you guessed this one right. REITs is one of the biggest reasons why I like to invest in private commercial real estate. Owning a tangible asset the appreciates and generates rental income is huge.
The S&P 500 only returned 5.6% a year between 1999 – 2018. I think most of you would have guessed a higher return. On a relative basis, Bonds, at 4.5%, doesn't seem too shabby given the lower volatility and risk.
Gold is a real surprise at 7.7% since gold doesn't produce any income and whenever gold is mentioned, it's usually in a negative light unless you’re a gangster.
Meanwhile, Homes returned the worst at only 3.4%. The national home price index generally tracks close to inflation (2.2% in this time period). Therefore, a 1.2% outperformance is not bad. Further, we’re not including leverage, only sales price.
REITs Is The Best Perform Asset class
What's most interesting to me about this chart is how REITs have outperformed Homes by 6.5% for 20 years. This goes to show that professional real estate managers can add tremendous value.
The outperformance also partially explains why experienced individuals who know how to bargain, remodel, expand, and predict demographic changes often prefer real estate as well.
Finally, it's no surprise to me that the average active investor has only returned 1.9% a year during this time period. Trading in and out of investments is a losing proposition long term due to timing errors and fees. Figuring out when to buy is hard enough. Having to figure out when to sell and then get back in consistently is impossible.
The inability to consistently outperform the market is the reason why the vast majority of us should stick to a proper asset allocation model based on our risk tolerance and our goals in life.
Our core tax-advantaged retirement portfolio(s) should be mostly left alone. I'm talking about our 401(k), IRA, Roth IRA, SEP-IRA, 403(b), and so forth.
For our after-tax investments, it's worth adjusting our strategies based on a purpose e.g. getting more conservative if buying a house within the next 12 months.
Why I Chose 1999 As The Starting Point
In addition to the fact that J.P. Morgan had already crunched the numbers for me, 1999 as a starting point is significant for me because it coincides with my graduation from college and when I started to aggressively invest my savings.
I actually started investing money during my sophomore year in 1996, but I only had about a $2,500 portfolio at the time so it was insignificant. Hooray for making $4/hour at McDonald’s though to learn about work ethic!
Given my vintage year is 1999, my outlook on various asset classes is shaped by the performance of these asset classes during most of my working career.
From 1999-2000, we had a tremendous internet stock bubble followed by a 2.5-year decline. Then we had a nice 5-year run in the S&P 500 followed by another 2-year collapse.
You can also look at the best asset class performers from 2001 – 2020 as well, another excellent 20-year time period.
A Bull Market Helps Annualized Returns
Given my working career has only been limited to living in New York City and San Francisco, I have personally witnessed closer to a 6% annualized growth in property from 1999 – 2018.
6% is not much greater than the stock market's 5.6% annualized return. However, once you add leverage, 6% becomes a significant amount. We're talking 12% – 30% annualized returns on a 50% – 80% loan-to-value ratio.
When I calculate my compound annualized net worth growth rate since 1999, the number is between 12% – 14%, depending on how I value some of my assets. This is fine since my annual net worth growth target has always been at least 10%.
However, I would attribute more than 50% of my net worth growth to aggressive savings and building a business rather than to returns. In other words, what you do may matter more than you think.
Lower Your Annualized Returns By Asset Class Expectations
One of my main goals of this article is for readers to keep your return expectations reasonable over the next 10-20 years. If you do so, your risk exposure will likely be more appropriate. You'll also likely work harder to build your net worth through action.
The second goal of this article is to compare your overall net worth growth to your various investments of choice and see how they stack up. You should try to figure out how much of your net worth growth was due to savings versus returns.
Finally, I want everybody to recognize their biases. I'm biased towards real estate because real estate has performed best for me since 1999. Whereas some of you will be biased towards stocks or other asset classes because they have performed best for you since getting your first real job.
Past performance is no guarantee of future performance. It is likely we will experience some performance leadership changes in the future and will have to adapt accordingly.
If you want to combat elevated inflation, then it's best to buy REITs, private real estate, S&P 500, and bonds for the long run. The key is to invest in risk assets that tend to provide returns greater than headline inflation.
How We Plan To Invest Our Money
For our tax-advantaged investments, including our son's 529 plan, I plan on leaving them alone. We've still got between 16-20 years before we want to access the funds.
For our after-tax investments, I'm reducing exposure to stocks, increasing exposure to cash and short-term Treasuries. I'm also diversifying our real estate exposure across non-coastal cities through speciality REITs and real estate crowdfunding. Finally, I'm constantly looking for ocean view fixers in San Francisco.
I'm sure I'll be kicking myself 10 years from now if I don't buy at least one more ocean view fixer today. I just love the combo of identifying high growth potential investments and boosting returns through rehabbing.
If you're curious, here's how I'd invest $250,000 today for more details. With elevated inflation and interest rates, I like Treasury bonds, but also real estate, which I consider a bond plus investment.
Diversify Your Investments Into Real Estate
As we saw from the annualized returns by asset class, REITs have performed best. However, REITs are also very volatile during a stock market downturn. Therefore, I'd much rather prefer investing in private eREITS, like the ones offered by Fundrise.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
In addition to Fundrise, I also recommend CrowdStreet. CrowdStreet focuses on individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. Growth rates tend to be faster as well due to positive demographic trends.
I've personally invested $954,000 in real estate crowdfunding across 18 different deals. It feels great to diversify, earn income 100% passively.
Invest In Private Growth Companies
Finally, consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
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