Time is one of the biggest variables in planning as it affects everything from the returns you need to where you can store your wealth. You shouldn’t put money you expect to need a year from now in the stock market. Likewise, you shouldn’t save for retirement with a bank account.
Investments for the long haul
When you do not need immediate access to your net worth, long-term investments offer higher returns in exchange for a longer waiting period.
Long term investments provide higher returns because they have two different kinds of risk. The first risk is volatility. Over history, stocks have provided the best returns in the financial markets. However, from day to day, investors could have been holding large losses. Someone who invested in the market in 2003 would have enjoyed huge profits by 2007, but gone back into the red by 2009. Now, in 2013, investors would be able to sell their investments for more than their initial investment as the stock market reaches new highs.
The other kind of risk is liquidity risk. A piece of real estate is not liquid. You couldn’t sell a home in a day even if you wanted to! When you invest in real estate, your money can be locked up for years and years before you can sell the property reclaim your investment capital. Most people cannot afford to lock up hundreds of thousands of dollars for years and years. Those who can do so stand to reap excess profits over time.
Looking at history
The past gives us a way to make reasonable forecasts about the future. History suggests stocks provide a much better return than bonds. In only one thirty year period (the last 30 years) did bonds beat stocks.
You can read more about the performance of stocks vs. bonds (and their historical mixed performance) in a previous article on diversification. A portfolio of 100% stocks has the highest return, but it also has the largest drawdown from peak to bottom.
Real estate has also offered very good, long-term returns. The cost to build a new home goes up each year. That naturally drives up the price of all existing real estate. Also, rents tend to rise with inflation rates, so the income from real estate goes up but the initial down payment and mortgage payment are exactly the same. A combination of appreciation in a home’s value and rising rental payments reward long-term investors.
If the future is anything like the past, an investment portfolio of directly-owned investment real estate and stocks will be the best long term investment.
”Set it and forget it”
Ron Popeil popularized the phrase “set it and forget it” in his infomercials for countertop rotisserie ovens. The phrase described the ease of use – people could set the temperature and time, and wait for the perfect finished product.
Long-term investments are meant to be hands off in the same way. Investors should remember that stocks are priced based on years and years of the future. If you buy the S&P 500 index of stocks at 15 times earnings, you’re paying a price equal to 15 years of the current earnings power of the 500 stocks in the index. If you pay 10 times rental income for a piece of real estate, you’re paying a price equal to a decade of current cash flows in exchange for rental checks you can cash for the rest of your life.
From point to point, investors who buy stocks or real estate today will likely experience losses. But over the next 20 to 30 years, one would be hard pressed to think the ownership of public companies or rental real estate will not beat the low yields on CDs, bank accounts, or investment grade bonds.