Key takeaways
When you have extra money to invest, the conventional wisdom is to look at three options: stocks, bonds, and commercial real estate. What’s the difference between these three, and which one should you put your money into? In general:
- Stocks might offer the highest returns but come with the highest risk and volatility.
- Bonds provide more stability because they generate steady (but typically lower) returns but carry some credit risk.
- Commercial real estate is somewhere in the middle—it is riskier than bonds but generally offers more stable returns than stocks.
No asset class has consistently outperformed the others over the last decade, so there is no such thing as a ‘best’ choice.
The suitable investment for you ultimately depends on your goals and risk tolerance. To be prudent, diversify your portfolio with a mix of stocks, bonds, and commercial real estate. This combination can help you manage risk and potentially maximize returns.
Introduction
Imagine you had $500,000 to invest, but you can only pick one: stocks, bonds, or commercial real estate. Which investment vehicle can help you maximize your returns?
It’s important to weigh each option’s unique advantages and challenges so you can make the most sensible decision based on your timeline and what you want to achieve within that time frame.
What are stocks?
Companies issue stocks to fund their operations, and you own a slice of the company when you buy them. The stock prices swing based on how well the company performs and how people perceive its future.
If the company thrives and its value grows, so does the value of your shares.
Getting into stocks is relatively easy with so many online trading platforms. You can publicly trade stocks of large companies on exchanges like the New York Stock Exchange or Nasdaq.
You can invest directly in a single company’s stock, like Apple, or spread your risk across various sectors or indexes through mutual funds and ETFs. For a broad view, consider the Vanguard S&P 500 Index Fund, which tracks 500 major U.S. companies.
What are bonds?
Think of bonds as loans you, as an investor, give to borrowers like corporations or governments via agents like banks. In return, they promise to repay your loan with interest by a specific date.
There are two main types of bonds: government bonds and corporate bonds. Governments issue bonds to fund infrastructure projects, which are backed by their ability to tax. Meanwhile, corporations use bond funds for specific projects like building new facilities or launching new products.
As a bondholder, you don’t own a piece of the issuer, so while you miss out on potential growth benefits, you also face less risk during downturns if the issuer can still make its payments. However, problems may arise if the issuer defaults on the bond, meaning they cannot make their interest or principal payments.
You can invest in individual bonds or diversify with bond mutual funds or ETFs, like the Vanguard Total Bond Market Index Fund, which includes a mix of different bonds.
What is commercial real estate?
Commercial real estate investments are properties purchased to earn a profit through rental income or capital gains (or both).
Here’s how it typically works: an investor buys a property using a mix of debt and equity and then leases out spaces within this property to other businesses.
The rent collected from these businesses covers operational costs like taxes and insurance, and any remaining funds are distributed to equity investors at the end of the year.
Investors in commercial real estate have several options. They can buy a property outright — similar to buying an individual bond — or invest in a Real Estate Investment Trust (REIT), which functions like a stock or bond fund.
CRE investors can also invest through a private equity firm offering a different investment opportunity. This can expose them to unique CRE projects that are not publicly traded.
Pros and cons of stocks, bonds, and commercial real estate investments
Each of the three asset classes we’ve defined above has profit potential, but like any investment, they also have distinct characteristics and risks.
Stock investments
Investing in stocks means you own part of the company. This means that if the company does well, the value of your shares can increase significantly.
Stocks are highly liquid so that you can buy and sell them easily. Investing through mutual or index funds can quickly provide excellent diversification at a lower cost, even if you invest in small increments. For instance, a $100 investment in Netflix stock in 2000 would have grown to $23,171 by 2019. Isn’t that amazing?
However, stock investments are arguably the riskiest of these investment types. Prices can be highly volatile, so you must have the stomach to ride fluctuations over short periods, even if the long-term trend is positive.
Stockholders are the last to be paid in bankruptcy scenarios, after creditors such as bondholders and banks. So, you can only receive something if a company’s assets are sufficient to cover all debts.
Bond investments
Bonds will not give you ownership in a company but can provide a steady income stream through interest payments. Certain bonds can also offer tax benefits. They’re generally more stable than stocks. Also, bond investors stand ahead of equity investors in the event of a company bankruptcy so that you can recoup your investment.
That said, bonds still carry credit risk. How safe they are depends on the issuer’s ability to repay the debt. Remember the Enron and WorldCom cases? These high-profile corporate bankruptcies resulted in significant losses for investors.
Generally, bonds offer lower risk but also lower returns compared to stocks. So, if you are seeking to make a quick profit in a short amount of time, then bonds may be too conservative.
Commercial real estate investments
The great thing about CRE is that it offers a blend of benefits from both stocks and bonds.
- Like bonds, these investments can generate passive income and offer tax benefits, such as depreciation.
- Like stocks, they also have the potential to generate significant capital gains.
However, commercial real estate carries risks, including the credit risk from tenants’ ability to meet lease payments and market risks from interest rate fluctuations.
Another challenge is liquidity, as CRE properties can be difficult to sell quickly. If you suddenly want to cash out, be ready to incur substantial transaction costs.
Implementing a property-level investment strategy also requires considerable time. It’s not a passive investment — you’ll need to deeply understand CRE management and market dynamics.
Overall, the risk/return profile of commercial real estate typically lies between that of stocks and bonds.
Historic returns of stocks, bonds, and commercial real estate
It’s difficult to compare the historical returns of stocks, bonds, and commercial real estate because each asset class has a diverse range of investment options. This blog illustrates their performance using representative index funds as proxies.
- The Vanguard S&P 500 Index Fund (representing stocks) has had an average annual return of 13.58% over the past decade. This figure might seem impressive, but it comes with considerable volatility. The fund experienced a decline of 4.58% in its worst year, 2018, and soared to 32.18% in its best year, 2013. This high-risk, high-reward profile may be too risky for some investors.
- The Vanguard Total Bond Market Index Fund (representing bonds) posted a stable average annual return of 3.59% over the same period. Its worst year was 2013, with a 2.15% return, while 2011 was its best year, yielding a 7.69% return. The bond fund’s worst year coincided with the stock fund’s best year. This shows the often inverse relationship between stock and bond market performances.
- The Vanguard Real Estate Index Fund (representing commercial real estate) has averaged an 8.50% return annually over the past ten years. Its performance range included a low of -5.95% in 2018 and a high of 30.32% in 2014, positioning it risk and return-wise between stocks and bonds.
As you can see from these figures, the stock market has historically offered the highest returns. But does this mean that it’s the best choice? Not necessarily. Rather than which option performed best overall, the suitable investment depends more on matching your objectives as an investor and the risk-return profile of the asset class.
Product-investor fit and diversification
The contexts in which investors operate vary widely because they are in different life stages and have different needs and investment objectives.
For example, if you are a younger investor, you might have the luxury of a longer time horizon that allows you to absorb more risk in pursuit of higher returns.
But if you are nearing retirement, your needs shift: perhaps you are now prioritizing capital preservation and, therefore, seek lower-risk opportunities to protect your nest egg.
This is why it’s essential to sit down and think about your risk tolerance, time horizon, return expectations, and liquidity requirements before deciding on any specific investment.
If you want to balance risk and reward, consider diversifying your portfolio to contain all three. By spreading your investments across multiple asset classes, you can tap into their unique risk/return profiles and achieve a robust overall return.
Invest in commercial properties.
Private Capital Investors are nationwide private commercial real estate lenders specializing in Dallas, Houston, Denver, Florida, Miami, Phoenix, Boston, and Illinois. If you’re interested in potentially investing in a commercial property and are looking for a financing partner, tell us about your project.
