Before you make an investment the first question you likely ask yourself is what the return will be. It’s a very reasonable question.
And it’s very easy to know the answer with some short-term investments like CDs. You deposit your money for a specific time with a bank. And the day you do so you know exactly when you’ll get your money back and how much you’re going to earn. Better still, it’s all guaranteed.
With stocks, bonds and real estate it isn’t that easy. Let’s consider bonds first. When you buy a bond, you lend your money to a company or government and they promise to pay you a fixed interest amount and they also obligate themselves to pay you back your principal at a fixed date.
Sometimes your investment in the bonds is guaranteed. When the agency standing behind your bonds is the U.S. government for example, you can rest assured that if you hold on to your bonds to maturity, you’re going to get your money back. Of course if you sell the bonds before maturity, even U.S. government bonds, you may get more or less than you invested.
And if your bonds are not backed by Uncle Sam you’ve got an entirely different situation and a lot more to be concerned about. If the organization you make the loan to goes belly up, you may not get your interest payments or your principal back. Obviously if either of these unfortunate events comes to pass it’s going to put a big dent in your returns. You might buy a bond that “guarantees” to pay you 6% for example- and that’s great. But it’s only great if you get your interest and principal payments as promised and when you first buy your bond there is simply no way to know it is going to work out or not.
The profits you potentially could make with stocks and real estate are even more difficult to foretell. Here’s a chart that shows what the S&P 500 did year-by-year from 2000 through 2013:
You can see that returns are over the map.* If you add up all the numbers and calculate the simple average it comes out to a shade over 5.46%.
Does that mean you can be highly certain that you’ll earn 5.46% each year in the stock market from here on? No way. Next year the returns could be anything. Look at the chart above one more time. The best year gave investors a sweet 32.15% return. The worst lost them 36.55%.
In any one year, the market could return far more or far less. That’s a pretty broad spectrum.
Real estate returns vary widely also and are simply impossible to predict on a year-by-year basis.
How Can You Possibly Invest In Something If You Don’t Know What The Returns Are Going To Be?
If the only investments that offer guaranteed returns are bank CDs and government bonds, why would anyone invest in something else?
If you could earn as much with CDs and/or U.S. government securities as you could in real estate or in the stock market, you would forego the risks of the later. Unfortunately, over the long-run, the statistics say you can’t.
Take a look at the chart below:
The column on the extreme left shows different time periods. The column to the immediate right shows the average returns over that period for the S&P 500 (which cannot be invested in directly). The next column over shows the average returns of 3-month T bills and the column on the far right shows the average return of the 10 year Treasury bonds. You can see that during each of the periods presented above, the S&P500 beat the alternatives handily. That is of course no guarantee of future results and is not saying that market beat the bonds over any and all time periods.
But you can see that if you are thinking long-term (10 years or longer) it’s reasonable to invest in equities. The other conclusion we have to draw is, it’s just impossible to know what an investment in the market is going to do any in any one year.
Bottom line? If you ask me what your investments are going to earn I wish I could tell you. The truth is that the answer is unknown for the best investments.