Cash Flow,  Financial Freedom

Investments Ranked By Return – Best To Worst

I wrote articles about the return potential of every major type of investment and here are those investments ranked by return.

  1. Business (at least 30% return)
  2. Real estate (at least 27% return)
  3. Stock Market (8-10% return)
  4. Collectibles (8-10% return)
  5. Precious Metals (4% return)
  6. Bonds (3% return)

I really enjoyed digging into each of these investments, and I honestly learned a lot, particularly about the collectibles and precious metals markets.

Ultimately, I’ve been validated in my decision to pursue real estate and business investments, and the army of investors in the stock market have also been proven to be wise as well.

The numbers one, two and three

1. Business (30%)

Purchasing a business has the highest potential for return of any of the investments I investigated. The cost of high returns seems to be time investment. In order to get the highest returns on the purchase of a business, you’ll be putting your own time into keeping everything running

The big drivers of return in a business purchase are leverage + company value and cash flow.

Leverage in business

We’ll come back to this in real estate, but using debt to buy something worth more is a huge driver of returns in investing.

The basic formula is to get a loan with a 20-25% down payment to buy something worth 4-5 times the amount of money you have to invest. Then when the value of the company increases, you get 100% of that (as opposed to 20-25%). This allows you to turn a 3% increase in company value into a return on investment of 12-15%. That’s the power of leverage.

Cash flow in business

As a cash flow investor, I typically put cash flow return on investment before net worth return on investment. So I pay very close attention to my cash flow return.

On a solid business purchase, you can expect cash returns of at least 10% and often as high as 14%. That’s great! That means business is providing cash into my bank account on par with the total returns I would get investing in the stock market.

2. Real Estate (27%)

Real estate is where I’ve invested the majority of my money so far, so the 27% return number is based on the performance of my long terms rentals so far.

We’ve actually had even higher returns on our short term rentals, so perhaps real estate belongs at the top of the list.

The biggest drivers of return for real estate are leverage + property value, cash flow, and tax breaks.

Leverage in real estate

Again, leverage proves to be a powerful tool in real estate investing. It turns 3% property appreciation into 15% return on investment by using debt to our advantage. Let’s look at a quick example to see how it works.

You buy a $100,000 house at 20% down, so you pay $20,000 to purchase a $100,000 house.

After 1 year the house gains value and is now worth $103,000. Your loan doesn’t grow at all, so that entire $3,000 increase in property value goes straight into your net worth.

$3,000 ÷ $20,000 = 15%

That’s a 15% return on investment for a 3% increase in property value. And to further illustrate the power of leverage, let’s say I was able to buy the house for only 10% down.

$3,000 ÷ $10,000 = 30%

That would allow for a 30% return on investment!

Taking on debt to invest does require better due diligence and a certain level of shrewdness in your investing decisions. Some would say it adds a level of risk as well. But the math speaks volumes about how you can use debt to build wealth much faster.

Cash flow in real estate

Your cash flow in real estate is dependent on how much you get in rent every month, your expenses (taxes, insurance, maintenance, repair, etc.) and you mortgage payment.

Expected returns from cash flow can vary wildly from one region to another and even one business model to another (long term vs short term rental). My experience so far tells me that cash flow returns of 7% are entirely possible on long term rentals, and our cash flow is even better on our short term rentals.

Tax breaks

Real estate investors get a huge tax benefit in the form of depreciation. It’s basically a percentage of the value of your investment property that you get to deduct from your taxable income.

And based on the performance of my real estate investments, it is often going to make the entirety of your cash flow earnings tax free.

For most investments, taxes will claim 10-30% of your returns, but with real estate, it’s completely possible to have all your returns remain tax free forever by intelligently using tax breaks including the 1031 exchange.

3. Stock Market (10%)

The stock market is the most popular investment choice by a huge margin, and it’s easy to see why. It has provided competitive returns for decades and anyone can get a piece of those returns with very little knowledge and virtually no effort.

Put simply, the stock market has the best returns among low and no effort investment options.

You can put your money into index funds or exchange-traded funds and reasonably expect to see 8-10% returns over long periods of time. Or you put your money in a mutual fund where a “professional” can make your investment decisions for you and ultimately expect a similar 8-10% return.

Returns in the stock market are driven by stock prices and dividends. It’s also important to note that the government gives us some tax free vehicles for stock investment as well.

Stock prices

Stock prices are usually a fair representation of the value of a company, but the two are only correlated. It’s possible for a stock price to be very different from the true value of a company.

Because of this fact, it’s possible to do much better in the stock market than 10%, if you become adept at identifying undervalued companies and buy up shares of those companies, you can see long term returns of 15% or better.

Dividends

Many established companies offer dividends to their investors. That just means they share their profits with shareholders. So dividends are the portion of stock market investing that result in cash flow.

The dividends typically only account for 2-3% of the total returns, which pales in comparison to business and real estate cash returns. Still dividends allow some additional flexibility in stock investments. You can reinvest them, or you can use them as a way to help support your day to day expenses.

Tax free tools

Another reason why many people choose the stock market is the retirement accounts offered by the government which allow your investments to grow tax free.

This is indeed a great tool for stock market investors, though I still prefer the tax benefits of real estate investing.

4. Collectibles (10%)

Collectibles is such a diverse group of investments that it’s difficult to really put a single number on them. The 10% return number comes from an analysis of a number of studies done in various sectors of the collectibles market. There were studies of the returns on furniture, drawings, paintings, stamps, photographs, prints, ceramics, coins, wine, firearms, and yes even beanie babies.

Succeeding in the collectibles market requires specialized knowledge of whatever field you invest in. There are a lot of scammers and opportunities to be cheated, so you must be able to tell the difference between a legitimate artifact and a fake.

I had a hard time grasping the biggest benefits of collectibles investing. There seem to be a lot of pitfalls, and while there have been opportunities for huge gains, they don’t seem to come around all that often. Over time, the stock market does just as well, and has fewer risks.

Returns on collectibles are driven only by the value that collectors put on the items, and they are taxed very highly.

Perceived value

This argument can be made for a lot of investments, but it’s very obvious in the collectibles market. The inherent value of a baseball card, for example is basically nothing. It’s just a piece of paper.

The value of that card is only what a fellow collector is willing to pay for it. This is what drives returns on collectibles.

As a quick aside, I found no examples of collectibles that provide any form of cash flow. I’m sure you could figure out a way, but I think you’d have to get creative to make that happen.

Taxes

Collectibles have a flat tax rate of 28%. As far as I could find there are no tax breaks or special advantages to investing in collectibles.

5. Precious Metals (4%)

When I started writing the article on return potential for precious metals, I had actually expected to find an investment on par with the stock market. That’s not what I found.

The historical value of precious metals shows a very volatile investment that provides very modest returns. In fact, the most shocking discovery while writing the article is that silver is worth less today than it was 46 years ago!

Precious metals do have real world value, so their returns are driven partially by the investment market and partially by the markets that use them in industry.

Value

For example, gold is used in jewelry, electronics and a handful of other industries. When you purchase gold coins, you’re probably not intending to sell them to Motorola, but the reality is that gold prices can be driven up and down by their demand in other markets.

I don’t know how to go about making a killing in the precious metals market, but perhaps, being aware of how their demand might change in these industries could put you in a position to realize some of the short term gains.

Many of these metals have seen lots of volatility over the years, and volatility means there is potential for excellent return on investment over shorter periods of time. In fact, gold saw an average yearly return of 19% between 2001 and 2011, and silver saw an average yearly return of 23% during that same time frame.

Taxation

Precious metals are taxed as collectibles, so they take the same 28% tax hit. This turns those 20% returns seen between 2001 and 2011 into 14% returns.

6. Bonds (3%)

Bonds being touted as the safest investment around can be misleading. Right now US treasury bonds (said to be the safest of the safe), are yielding a measly 1.4% return on investment.

Considering that the average rate of inflation is around 3%, this safe investment is actually causing your money to lose buying power over time.

I don’t consider low yield investments to be safe. It’s better to call them predictable.

Bonds are a very predictable investment. You know exactly how much you’ll make on your investment, and you know exactly when you’ll receive your payments.

Between the low returns, the lack of compound interest and the effect of inflation, an unbound investor should probably be avoiding bonds unless they are slowing down their investing or they have reason to expect a market crash.

Conclusion

For active investors that want to build wealth as fast as possible, I suggest going for business and real estate investments. For more passive investors, I think the stock market is the best choice.

I’m sure every investment has it’s time, place and purpose, but I’m personally steering clear of collectibles, precious metals and bonds.

Happy investing.

Michael

I'm living the path to financial success and sharing everything I learn in this blog. I believe in the power of cash flowing investments, due diligence and time. This is my journey so far.

I learned everything I know from books, podcasts, conversations with friends and family and of course through real world experience as a cash flow investor. And I'm always pushing to learn more.

To see my investing timeline, check out our about page

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