Investors often ask me this: Is it better to invest in multifamily real estate or the stock market? This is a worthwhile question, and while it’s difficult to make an apples to apples comparison, we’ll dive into some of the basic considerations in a series of articles. In this first article, we are simply going to look at Understanding Stock Market Returns.
The first question most investors have is – which will give me the greatest returns? It must first be said that when looking at returns, it’s important to look at the risk vs. return of any given investment vehicle. But in this article, we’re simply going to look at Understanding Stock Market returns.
At times, stock market returns are discussed in terms of average returns. This is different from “annualized returns.” It’s important to understand the difference.
Hard Facts of Stock Market Returns
Many people will look at stock market returns by taking the average return of the S&P 500.
Over the last 15 years ending at the beginning of 2020, the average return has been 8.02%. To calculate this average of 8.02%, we say – this year the S&P went up 12% and last year it went up 6%, the year before that it went down 5% (-5%), etc. We take the average of these numbers and we get the average return of the S&P500.
It’s important to understand however, that if a person were to make a $100K investment in 2005, 15 years ago, in 2020, that investment would not equate to a 8.02% compounded return. This is due to volatility in the stock market. There are often years where the stock market loses value. In years like this, the principal is decreased and messes with the compounding calculation.
Let’s take a closer look.
Hypothetically speaking, if a person were to make a $100K investment in 2005 and that investment were to grow 8.02% year after year, it would increase as the blue bars increase. The gray bars represent the actual S&P performance for a hypothetical $100K investment. The orange bars represent a hypothetical $100K investment that increases at a rate of 6.55% year after year. As you can see the gray and the orange bars end up at the same amount, whereas the blue bars end up significantly higher.
The blue bars (8.02% compounded return) end up at a value of $326,150. The orange and gray bars end up at a value of $259,100. This means that the actual S&P performed at an “annualized return” of 6.55%, where as the “average return” over the same period was 8.02%.
That’s a substantial difference. If you are assessing the performance of the stock market based on the “average return,” be aware that it is substantially different than the “annualized return.”
To provide some additional data points, the annualized return of the S&P500 from 1990-2020 is 7.3%, whereas the average return is 9.33%. And from 2000 – 2020, the annualized return is 5.6%, where as the average annual return is 6.11%.
The purpose of going through these numbers is demonstrate the “average return” is generally not a reliable representation of the performance of the stock market. If there are any years in which the market went down over the period under consideration, the average return will be an inaccurate representation of stock market performance. Make sure you are looking at the “Annualized Return.”
You might be wondering, ok – now how does this compare to the returns of a passive multifamily real estate investment? Real estate syndications vary in their projected returns. In the current market, many real estate syndication firms are projecting something along the lines of a 12-16% IRR over an investment horizon of 5 years. IRR is a similar calculation to an annualized return. Of course, there is risk with any investment and check out articles where we discuss risk assessment, mitigation, and management.[/vc_column_text][/vc_column][/vc_row]