MarkFord
Every asset class has its own inherent ROI (return on investment) range.History suggests, for example,that it is 8% to 10% for stocks, 5% to 7% for corporate bond, 3% to 4% for municipal bonds, and 5% to 8% for rental real estate. The prudent wealth builder designs his investment strategy accordingly. Rather than trying to beat intrinsic ROIs, he accepts them and, if these do not suffice, finds alternative ways to achieve his goals.
The big mistake most wealth seekers make in regards to return is to try to “beat the market” – i.e., to strive for higher-than-average returns.
This is done for two reasons: ego satisfaction and ignorance. Getting higher ROIs than everyone else is a psychological trophy for those that believe it can be done. And the mainstream financial community does everything it can to encourage investors to believe they can. They themselves are motivated by ego (they have the secrets) and by greed (they make more money when investors pay them for advice on how to do it).
Case in point: Years ago, I made a speech to a room full of affluent investors about an opportunity to make 12% to 25% on a leveraged real estate deal. As early investors, this range of returns was possible.
A large, bald-headed man in the back stood up and interrupted me.
He said he wouldn’t think of investing in my idea. “Unless you can give me a 10-to-1 return, I’m not interested in what you have to say,” he announced.
A few people applauded him.
The coveted “10-bagger.” What investor hasn’t dreamed of that?
The thing is, none of the successful, long-term investors I know advocate or follow this strategy. More importantly, most of the tens of thousands of investors that do chase huge returns live to regret it.
The average stock market return over 100 years is 8% to 10%, depending on how you crunch the numbers. If you accept that and invest conservatively, you can expect to earn that much, over the long run, from stocks. But investors that try to beat at 8% to 10% fail to reach that goal. Countless studies indicate that they get returns of about 3%.
The dream of getting 1000% returns are touted by two groups of people: investment professionals that achieve those numbers very occasionally but make their big money by selling the dream, and inexperienced investors like the man who interrupted me.
Like my bald-headed critic, you may think that 8% to 10% returns are boring. If you do, I can only say this: You are wrong. And this idea will eventually make you poorer than you are today.
But there is a more important reason to accept intrinsic ROIs. It forces you to accept reality. When you calculate the future growth of your investments realistically, you may discover that your current portfolio of stocks and bonds will not get you to where you want to be. Realizing this, you must make a decision: Accept and adjust to a future of lesser wealth or search out other activities – which almost always require more time and effort than stock and bond investments – where you can earn higher intrinsic ROIs.
The intrinsic ROI for real estate in the USA is about 4%. But if you invest in income-producing real estate by buying rental properties at discount prices, you can expect to earn 6% to 8% a year. And if you leverage those investments with mortgages, you can expect to earn 8% to 12%. And if you take it one step further by improving those properties and raising rents accordingly, the intrinsic ROI will be in the 12% to 16% range – sometimes even higher.
Yes, rental income requires more time and work. But if you are willing to take that extra time and do that extra work, you won’t have to abandon your goal of achieving greater wealth in the future.
* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost.