Making a case for <i>real</i> real returns
Which investments offer retirement oriented, long-term investors the best returns?
Which investments offer retirement oriented, long-term investors the best returns?
Before answering that question, let’s first define “returns.” For long-term investors, what really matters is the rate of real real return, which is the nominal return less taxes, inflation and investment expense.
In a recent study conducted by my firm, in which we compared the rate of these bottom-line returns over 20- and 30-year periods, the asset classes that performed best were common stocks and municipal bonds. Over 20 years, a hypothetical $100 invested in U.S. small-cap stocks would have grown in real real terms by 3.37% a year, while the same investment in U.S. large-cap stocks would have grown by 3.76% a year if compounded.
Over a 30-year span, the stock investments would have earned 4.75% and 4.51% a year, respectively, in compounded real real terms.
Over the same time spans, muni bonds earned 3.77% and 2.45%, respectively, on an annual compounded basis, once taxes, inflation and expenses were discounted.
The 30-year time frame is significant because it correlates with the most prevalent time horizon for most investors: the three decades between 30-35 and the typical retirement at 60-70.
In light of recent economic, financial, fiscal and political events, therefore, investors and financial advisers alike should review their investment philosophies when developing long-term investment portfolios. Since nominal returns historically have been used to measure results, the euphoria experienced in rising markets, as well as the gloom experienced in down markets, may be misplaced.
Having more realistic expectations about future market performance may lead many to change the way they invest, as well as their financial goals and objectives.
Given the fact that true returns are much lower than nominal returns, one can’t help but conclude that the maintenance of purchasing power and the accumulation of real wealth are difficult to achieve.
For investors, budgeting and saving become much more significant factors in the achievement of financial goals and objectives. It is likely that we are returning to a time when controlling risk, avoiding loss and achieving increased saving discipline while generating real returns are paramount.
The combination of these three fundamental tenets of investing may be the only way to accumulate real wealth.
Given that most investors have 30 years to accumulate their nest eggs, which must be conserved and preserved through 30 years of retirement, it is critical that advisers and their clients understand the three constant handicaps of investing: inflation, taxes and expenses. Although taxes can be controlled to some degree, expenses to a greater degree and inflation not at all, all three are constant and affect all asset classes in a variety of ways.
As a result, the focus of investors and their advisers should shift from an endless chase for investment performance to finding the most efficient investment strategy and the one most likely to contribute to the accumulation of real wealth. The shift from a total-return model to an after-tax, after-inflation, total-return model will make comparisons to indexes less important.
This new focus on true returns implies that clients will likely develop a greater dependence on their advisers as they realize how difficult it is to generate real wealth. It also implies that we are headed to a time of more realistic expectations.
In recent years, investors have been jumping into real estate, commodities, hedge funds and other alternative investments for the purpose of enhancing total return and reducing risk. But over 30 years, our study found that real estate produced true annual gains of 0.15% on a compounded basis, while commodities lost 4.02% a year.
Given that the overriding goal of all investors is to accumulate real wealth, maintain purchasing power, preserve capital over long periods of time and have a positive experience all the while, it is clear that the relentless pursuit of the latest hot investment is an exhausting and largely futile effort.
Since the two asset classes that continue to contribute most to the accumulation of real wealth over time remain common stocks and muni bonds demonstrates that the basics sometimes are best.
George Strickland is a managing director of Thornburg Investment Management and co-portfolio manager of the Thornburg Municipal Bond Funds and Thornburg Strategic Income Fund.
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