Before I share the best asset class performers from 2001 – 2020, 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, REITs, Commodity, Emerging Market Equity, Small Cap, Homes, which performed best?
2) What was the annualized return for the best-performing asset class within 0.5%?
3) What was the annualized return for the worst-performing asset class within 0.5%?
4) What was the annualized return for the average investor within 0.25%?
If you guessed two or more correctly, you are very much in tune with the market. Therefore, in terms of how to invest, you may want to increase the actively managed percentage of your overall investments.
If you only got one out of four right, then you’re probably inline with the average investor. And if you got zero right, then you should probably be a 100% passive index investor or let a robo-advisor manage your money for you. All you have to do is electronically send in a check each month and the robo-advisor will asset allocate for you.
Now that we’ve gone through this exercise, let’s compare the actual results to your estimates. When it comes to honing your forecasting abilities, reviewing data and analyzing why you were wrong is very important.
If we can consistently make decisions with a 70% positive probability, we will do very well in life. Waiting until we have 100% certainty is often impossible and unnecessary.
The Best Asset Class Performers From 2001 – 2020
Below are the best asset class performers compiled by J.P. Morgan, one of the largest traditional asset managers in the world. The firm charges clients 1.15% – 1.45% of assets under management. Once you get above $10 million, the AUM fee usually drops below 1%. Can you imagine paying $100,000+ a year in fees on your $10 million portfolio? Ouch.
Digital wealth advisors were created during the last financial crisis to help lower fees. Further, a lot of people started getting tired of active funds underperforming passive index funds.
As you can see from the results, REITs is the #1 performer with a 10% annualized return, followed by Emerging Markets Equity at 9.9%, Small Cap at 8.7%, and High Yield at 8.2%.
The S&P 500 returned a respectable 7.5% a year between 2001 – 2020. I think most of you would have guessed a higher return given the markets have done so well. However, don’t forget that between 2000 to 2012, the S&P 500 essentially went nowhere.
On a relative basis, Bonds at 4.8%, look pretty good given bonds are lower risk and less volatile. However, it’s very hard to allocate new money to bonds here with inflation elevated and the Federal Reserve beginning its bond tapering.
Homes at 3.7% is relatively impressive compared to inflation at 2.1%. One of the arguments naysayers of homes as an investment have argued is that homes generally only increase at the rate of inflation. But this wasn’t true for the 20-year period between 2001 – 2020. Further, once you add on leverage through a mortgage, the cash-on-cash returns for homes easily moves to the teens.
Commodity is disappointing at -0.5%. You would think commodities would do OK given most are finite resources that tend to hold their value during times of uncertainty. Commodities include metals, energy, agriculture, livestock and meat.
The best asset class performers typed out:
- REITs: 10.0%
- EM Equity: 9.9%
- Small Cap: 8.7%
- High Yield: 8.2%
- S&P 500: 7.5%
- 60/40: 6.4%
- 40/60: 5.9%
- DM Equity: 5.0%
- Bonds: 4.8%
- Homes: 3.7%
- Average Investor: 2.9%
- Inflation: 2.1%
- Cash: 1.4%
- Commodity: -0.5%
Hard To Be An Average Investor
Meanwhile, the average investor returning 2.9% a year is clearly not impressive. I’m not sure how J.P. Morgan calculates the average investor performance. However, we know that the average person tends to make too many emotional investing decisions.
The inability to consistently outperform the market is the reason why the vast majority of us should stick to a proper asset allocation model by age. Investors should also try to understand their true risk tolerance. The vast majority (80%+) of our public investments should be in passive index funds or ETFs.
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 taxable 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, retiring within the next five years, etc. If we can pick the future best asset class performers, great. But chances are, we will not or won’t have as much exposure as we like.
REITs: The Best Performing Asset class
REITs outperforming Homes by 6.3% a year for 20 years is impressive. This outperformance may indicate that professional real estate managers can add tremendous value. A savvy manager can acquire at a good price, improve occupancy rates, remodel to attract more visitors, and negotiate a better sale. Further, REITs use leverage.
The real estate market is less efficient than publicly-traded asset classes. Therefore, experienced individuals who know how to bargain, remodel, expand, and predict demographic changes often prefer real estate as well.
The combination of rising asset values and consistent dividends in a low-interest rate environment make REITs and Homes very attractive. Personally, I continue to believe REITs/private eREITs and Homes will be two of the best-performing asset classes over the next decade.
I like the CrowdStreet real estate investing platform, which offers mostly individual deals in 18-hour cities. 18-hour cities tend to have lower valuations, higher yields, and higher growth. With the demographic shift towards lower-cost areas of the country, 18-hour cities, the Sunbelt, and Heartland is where I’ve invested $810,000 of my capital.
An Asset Shift From Bonds To Real Estate Is Possible
Since bond yields are so low, I expect more investors to replace their bond holdings with real estate as well. Given the bond market is even larger than the equity market, even a small asset shift towards real estate from bonds can make a significant difference.
During bad times, real estate has similar defensive properties to bonds. Investors want to own real assets, especially if mortgage rates are declining, making real estate more affordable. During good times, real estate can also significantly participate on the upside with rising prices and rents. We’ve seen this defensive/offense ability play out perfectly for real estate since the pandemic began.
As a result, I will continue to keep roughly a 40% allocation of my net worth in physical real estate, REITs, real estate ETFs, and real estate crowdfunding. My goal is to eventually get my “online real estate” value equal to roughly 25% of my overall real estate value. I’ve reached my limit for how many physical properties I’m willing to manage.
Remembering The Year 2001
2001 was a critical time for me. I was finishing up my two years at Goldman Sachs in NYC and wasn’t going to be asked to stay for a coveted third-year. The dotcom bubble had started to burst in March 2000 and things weren’t looking good.
Luckily, my VP, who sat next to me, passed over the phone when a recruiter called her to move firms. One thing led to another and I joined Credit Suisse in San Francisco a couple of months later.
When I wrote about luck being a significant reason for our good fortune, this was one of those lucky breaks. If I hadn’t been passed the phone, I don’t know what I would have done. It was too late to apply to business schools in April for that year. Further, not many investment banks were hiring back then.
I had dodged a bullet because over 90% of my analyst class was laid off or moved on within two years. At the time, the dotcom crash felt very significant. From June 2000 to December 2002, the S&P 500 declined from 1,517 to 847, or 44%. But the NASDAQ collapsed from 3,860 to 1,329, or 65%!
Today, these levels look insignificant with the NASDAQ over 15,700 and the S&P 500 over 4,600. Invest for the long term, but expect tremendous volatility. Continuing to earn and invest over the long-run is also important.
Sitting here 20 years later, I am pleasantly surprised with how well things have worked out.
Lower Expected Returns Going Forward
2021 was another amazing year for investors, with the S&P 500 up another 27%. However, it’s probably wise to expect lower returns in stocks, bonds, real estate, and other asset classes going forward. The best asset class performers of the past certainly might not be the best performers of the future.
Money management giant, Vanguard, has already come out with its 10-year return assumptions for U.S. stocks, U.S. bonds, and Inflation. Their assumptions seem too low across the board. However, the returns could certainly come true.
For those who plan to retire early, you should consider lowering your withdrawal rate assumptions. Risk assets could easily correct by 10%+ and stay depressed given high valuations and rising interest rates.
Instead of U.S. stocks suddenly starting to compound at only 4.02% a year for 10 years, the more likely scenario is we experience another bear market within this time period. In other words, U.S. stocks might return 10% a year for five years, take a 30% haircut in year six, then return 6.3% a year for the remaining four years.
Looking at Vanguard’s 10-year return assumptions for U.S. stocks and U.S. bonds makes real estate and other asset classes more attractive. For example, earning above a 4.02% cap rate for real estate isn’t too difficult in most parts of the country. And if a 5% cap rate property compresses to a 4% cap rate, that’s a healthy 25% appreciation.
The housing market will most definitely slow from its torrid pace. However, if Vanguard’s return assumptions are correct, then real estate should get comparatively more attractive. Some investment firms, like Goldman Sachs, are forecasting another 16% increase in housing prices in 2022.
And if the U.S. housing market ever turns into the Canadian housing market, I would expect another 35% upside, at least. United States real estate is the cheapest developed-country real estate in the world.
Investing Our Money For The Next 20 Years
20 years feels like a damn long time to invest. However, if I change the purpose of my investing from myself to my children, it doesn’t seem as long. Further, it makes investing feel more meaningful.
Frankly, I am trying to spend more of my investment returns on a better life now. The gains since the pandemic began have been a surprise. Therefore, it would be nice to convert some of those surprise winnings into more tangible things and great experiences.
To get more motivated to invest, the simple solution I’ve come up with is to divide and conquer. My wife and I will continue to invest in our children’s 529 plans, custodial investment accounts, and custodial Roth IRAs for the next 20 years. These accounts will be ring-fenced exclusively for our children.
Hopefully, in 20 years, when our son is 24 and our daughter is 22, they will appreciate that we invested for them when they could not. And if they don’t appreciate our efforts, we’ll just keep the money! Concurrently, my wife and I will continue to invest to retain our financial independence.
20 years will come whether we like it our not. Some of us sadly won’t make it during this time period. Therefore, we must always try to balance investing for the future and making the most out of each day.
Diversify Your Investments Into Real Estate
Stocks are very volatile compared to real estate. Therefore, if you want to dampen volatility and build wealth at the same time, invest in real estate. The combination of rising rents and rising capital values is a very powerful wealth-builder.
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.
Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the easiest way to gain real estate exposure.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio.
The Best Asset Class Performers is a Financial samurai original post. I’ve been helping people achieve financial independence sooner, since 2009.