I explain the 5 main asset classes and which assets return the most over the longest period of time.
When I mention that an asset is highly liquid, it means that it can be easily converted into cash because there is often a high volume of other people dealing in that asset and it can change hands the easiest in the least amount of steps.
- Cash and Cash Equivalents
By default, cash is the most liquid asset because it is considered to be the legal tender that can be used to assign value for and pay for things. Because of inflation, the value of the US dollar is declining every year and losing purchasing power. Its real rate of return has been -1.4% for more than 200 years from 1802 through 2016. People tend to think of cash as being a safe asset, and while it does give some financial optionality over the short term, it is not so safe when held for a long time because it is losing buying power.
Cash equivalents are highly liquid money market funds that involve giving short term debt in return for some interest on the principal for periods of a few months to less than a year. They can take the form of CDs, treasury bills, municipal notes, commercial paper which is short term corporate debt of up to 9 months, and other types of money market securities.
- Commodities and alternative investments
Because these diverse types of assets can yield variable rates of return and don’t have necessarily a long term track record, I’m ranking them above cash but below other assets with more established average rates of return.
Commodities are considered to be tangible assets and include items such as gold, silver, copper, crude oil, coffee, and more.
While there are some people who really like owning gold as a hedge against what’s going on in the stock market, its real rate of return for the last 200+ years has been 0.5%, or barely above 0%. It isn’t super practical to buy the physical gold, find somewhere to store it, and exchange it for other goods. Some people are really into trading commodities so they will buy and sell the future contracts, abbreviated as futures, of what a projected price for oil or coffee might be.
Trading futures is part of the derivatives category, which basically is a contract between two parties betting on a future value of an underlying asset such as equity options or cash flow swaps.
Collectibles such as works of art, pokemon cards, classic cars, comic books, and antique furniture could potentially be alternative investments as long as people believe that they have value.
Cryptocurrencies and non-fungible tokens NFTs might also be a form of alternative investments, but to me it is sort of like a collectible where if enough people believe these blockchain assets have value, then it can be exchanged for legal tender.
- Bonds, Notes, and Bills are part of the fixed income category
A bond is basically debt and is in the form of a loan between at least two parties. This means that someone can earn interest on debt owed to them but they don’t own anything in the company or entity issuing the debt.
There is either a coupon-paying bond that pays a pre-determined amount of interest usually twice a year until the bond’s maturity or due date. Or there’s a zero-coupon bond that you buy at a discount to its face value and you receive the full value at the maturity date.
There are government bonds and corporate bonds. The US government issues treasury bills for up to a year or less, treasury notes for maturities between 2-10 years, and treasury bonds with longer maturities of between 10 and 30 years.
You can also buy US savings bonds starting in increments of $25 through $10,000.
Corporate debt gets rated by credit rating agencies and you can buy these through your brokerage account in increments of at least $1,000 or if you would rather buy a bond mutual fund and many don’t have minimums to invest. Some people also make money trading bonds where they don’t wait for the bond to fully mature, but they seek to profit from changes in price in the form of arbitrage.
Over the last 200+ years, treasury bills have returned 2.6% while treasury bonds have returned 3.5%. Recently these rates have sunk even lower as 10 to 30 year bonds are returning between 1-2% now.
For example, if you bought a 10 year treasury bond for $10,000 at 1% and held it to maturity, that would get you about $1000 in interest and you’d have $11,000. But if inflation is at 3%, over the same amount time you effectively lost more than $2000 because the value of the dollar decreased significantly. If you invested it in stocks and gotten around the 7% historical rate of return, that would have been 9 times the amount of return of the US treasury bond.
- Real Estate
Real estate is a very tangible asset as you’re probably familiar with it because it is the property that you live in, usually a house or an apartment. In addition to residential, there’s also commercial and industrial properties like office buildings and factories. This asset isn’t among something that has an easily measurable 200 year rate of return.
If you ask most people what is the best way to invest money you won’t need for the next 10 years, they will say it is real estate more so than stocks as per a Marketwatch article. However, in this same article they took data from the Case Shiller Home Price Index and found that real estate produced an annualized rate of return above inflation of only 0.4% from 1890 through 2018 or across 128 years, which might even be worse than gold!
But according to an Investopedia citing the Case Shiller index also, housing returned 3.7% between 1928 and 2013 or over 85 years. So even though real estate’s historical rate of return is up for debate, let’s give it the benefit of the doubt and treat it as though it yields better rates of return than bonds are these days.
You can invest directly in real estate by either buying it in cash and/or with a mortgage loan as many homeowners do. Some people buy real estate as rental properties where they can choose to live in it and rent part of the home out or as short term rentals in Airbnb or completely rent out a home or apartment complex to tenants.
That may sound really capital and time intensive to commit to, and alternatively you can invest in publicly traded securities known as real estate investment trusts or REITs that you can buy in your brokerage account.
REITs are companies that own and usually operate income-producing real estate. They often pay out their earnings in the form of dividends which can be attractive to some people.
There are also a few crowdfunding organizations for real estate out there but I’ve not yet tried these so I’m not sure what their track records as investments are like.
- Stocks / Equity
Finally, stocks or equity are a form of ownership where if you own at least one share of a company’s stock, then you are a shareholder. A lot of people just think of stocks as an intangible piece of paper or stock symbol that can be traded, and while you can trade it, you should think of owning stocks as you are a business owner of the company, even if you don’t own the whole company. You’re more likely to hold onto your stocks if you think of yourself as a long term owner of the company rather than someone who wants to trade it away to make short term profit.
Over the last 200+ years, stocks had the best real rate of return of 6.7%. So $1 invested in 1802 became a little over $1 million while $1 in cash became a nickel.
Stocks can be liquid if traded in publicly exchanged companies, but could be illiquid if they are in private companies. One of the main reasons for this is because publicly traded companies are given a daily price by all the market participants in a stock exchange. So they tend to be traded at a premium price, roughly about double that of private companies’ value. Private companies aren’t valued very frequently and not usually until some other entity wants to buy it and then it offers a buy price for the whole company.
Shareholders can vote for the members of the board of directors in the company that usually decides on the company’s management including its CEO. Shareholders might benefit financially if a company and its stock price grows. After their shares have appreciated, they can sell their shares for a capital gain and profit. Or, if the shares have declined in price they might sell for a capital loss.
Some companies also issue dividends or cash payouts that some people also like receiving. However, dividends get taxed at both the company and shareholder level, so if a company is able to generate better than average rates of return on its cash, it might be better off not issuing dividends as the value of the company grows. We’ve seen this with Berkshire Hathaway as it grew its A shares from around $8 a share in 1962 to $430,000 in 2021. Warren Buffett was better able to compound the cash Berkshire generates than if it gave it away to the shareholders in dividends.
One tidbit to note is that if a company files for bankruptcy, the bond holders to whom debt is owed will be paid first while shareholders may not always get to extract any or all of the value of their investment out of a company going through this process.
You can also invest in index funds, which are a passive form of mutual funds that are tracking a stock market index. Index or mutual funds and ETFs are just pools of diversified investments in usually many stocks or other kinds of securities.
Even though there is obviously risk in investing in all forms of assets, the irony is over the long term stocks will grow the value of your money while if you keep it cash that will end up being the riskiest move of all.
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