Analyzing historical returns of gold and real estate

[The data on gold and real estate returns in this post were updated in January of 2022.]

Over the past few months, I’ve been posting a series on historical returns of various asset classes including:

For those new to the historical returns series or Mindfully Investing in general, historical returns are an important piece of the puzzle in developing a mindful investment portfolio and investing plan that meets your long-term investing goals.

Today’s post on gold and U.S. real estate marks the last in this series. You might be as tired of reading these as I am of writing them. But given the great interest I’ve seen in the topic of historical returns, I expect that this series will eventually be among the most popular and useful posts that I’ve published. The historical returns posts are turning out like an encyclopedia. Any given article may be very interesting to a particular reader, but few people will want to actually read every article in the “H volume” all at once.

Most people put gold and real estate in the category of so-called “alternative” investments, which also include commodities (gold being one), annuities, syndications, debt, notes, note funds, ATM funds, currencies, and derivatives to name a few. Gold and real estate are by far the most common alternative investments. And if you consider owning a home as an investment, then real estate investing is so common that it’s hardly an “alternative” at all. All the more reason to take a closer look at the historical returns of real estate along with gold, which is nearly as popular. Let’s start with gold.

Historical Returns of Gold

When looking at return histories, it’s best to take the long view. Because gold has been used as money for thousands of years, you can theoretically extrapolate amazingly long histories of gold returns. For example, Claude Erb estimated that gold has produced a nominal annualized return of between 0.5% and 2% over the last 3000 years! While it’s fun to consider millennia of returns, it’s difficult to argue that the value of gold in ancient Egypt as compared to medieval England, for example, has much relevance to future changes in the value of gold over the next few decades.

It seems much more appropriate to examine gold returns since the end of the “gold standard” around 1972, particularly when looking at gold returns in U.S. dollar terms. Prior to 1972, the U.S. government valued the dollar based on gold, which made gold prices in U.S. dollars essentially arbitrary.

Using Portfolio Visualizer data, the long-term nominal (not inflation-adjusted) annualized return (compound annual growth rate; CAGR) from 1972 to 2021 was:

7.6% for gold

As a general comparison, U.S. large-cap stocks returned 11.2% over the same period. While a few percent difference in annualized returns may not sound like a lot, it makes an absolutely huge difference to an account balance when compounded over many years.

However, the 7.6% annualized return for gold is a long-term average, which means that over shorter periods gold returns diverged substantially from this average. Here are some additional descriptive statistics for the nominal annual returns from gold going back to 1972.

Statistic	Gold – Nominal Annual % Return
5th Percentile	-23.27%
25th Percentile	-4.14%
Median (50th Percentile)	5.46%
Average (not CAGR¹)	10.37%
75th Percentile	21.89%
95th Percentile	58.44%

You may be interested in determining annualized gold returns between specific years. Similar to my historical return calculators for stocks, bonds, cash, corporate bonds, global stocks, small-cap, and value stocks, this calculator provides annualized gold returns (both nominal and inflation-adjusted) between any two dates back to 1972 based on the Portfolio Visualizer data.

Historical Returns of U.S. Real Estate

There are many sources of U.S. home price data. And obviously, the growth of home prices has varied widely over time, regions, cities, and even neighborhoods within the U.S. So, aggregating all these data into one set of returns statistics that accurately portrays the entire history of U.S. real estate is unrealistic.

Further, I’ve written before that rental properties are clearly the best type of real estate investment, because they return value both from price changes and rental payments over time, increasing cash-on-cash returns. But rental payments are even more variable across time and place than housing prices, and rentals only represent a small portion of U.S. real estate investing. Indirect real estate options such as mortgage note investing, as well as real estate debt and note funds, are also excluded from this analysis.

Nonetheless, I can at least summarize the data compiled and used by world-renowned experts who have struggled with normalizing all these data into a meaningful “average” of historical returns based on housing price data. Specifically, Nobel Laureate Robert Shiller has compiled statistics on U.S. home prices that have been widely used and accepted as generally representative of U.S. real estate returns in aggregate. Shiller has compiled data going all the way back to 1890. But given that the further we go back, the less applicable the data may be to current modern-day housing markets, I’ve curtailed this dataset to 1928, following the lead of Aswath Damodaran of the Stern School of Business.

So, according to Robert Shiller data, the long-term nominal (not inflation-adjusted) annualized return (compound annual growth rate; CAGR) from 1928 to 2021 was:

4.2% for U.S. Real Estate (based on price changes only)

In comparison, U.S. large-cap stocks returned 10.2% over the same period. To compare more closely with gold returns summarized above, the U.S. nominal real estate return since 1972 was 5.3%, as compared to 7.5% for gold. So, gold substantially outpaced real estate as an investment since the end of the gold standard in 1972.

However, as with all these annualized averages, over shorter periods real estate returns diverged substantially from 4.2%. Here are some additional descriptive statistics for the nominal annual returns from U.S. real estate going back to 1928.

Statistic	U.S. Real Estate – Nominal Average % Return
5th Percentile	-4.68%
25th Percentile	0.92%
Median (50th Percentile)	3.54%
Average (not CAGR¹)	4.36%
75th Percentile	7.63%
95th Percentile	15.03%

And here’s a calculator that will provide the annualized return (nominal and inflation-adjusted) for U.S. real estate between any two years.

Historical Risks for Gold and Real Estate

Because higher returns are usually associated with higher risks of losing money, it’s prudent to evaluate the long-term balance of both returns and risks for every investment. Volatility, as measured by the standard deviation of the routine ups and downs of returns over time, is the most common (but somewhat flawed) measure of investment risk.

In past posts, I’ve gathered volatility and return data for a wide range of asset classes covering the last couple of decades. But the volatility data for some asset classes span a fairly brief period. So, for this post, I focused on asset classes that have volatility data going back at least to 1972, to match the period of available gold and real estate data. Here’s a graph plotting risk versus returns since 1972 for multiple asset classes.

The dotted line in the graph represents the best fit relationship for the risk/return data. For real estate, daily price change data don’t exist, so I estimated comparable volatility for real estate using annual returns data since 1972.

The dotted line suggests that additional return is indeed accompanied by additional risks for most assets. Interestingly, both gold and U.S. real estate diverged substantially from this relationship. And unfortunately, they diverge mostly in terms of lower than expected returns given the risks (volatility) involved, at least in this period.

In fact, cash has produced nearly as good a return as U.S. real estate but with substantially lower volatility. Meanwhile, gold exhibited the highest volatility of all these assets but produced returns not much better than holding a relatively safe 10-year U.S. Treasury bond.

Conclusions

These data all suggest that gold and U.S. real estate are relatively poor investments as compared to most other assets, both in terms of returns and risk-adjusted returns. But as I’ve noted before, the problem with these sorts of conclusions is that they’re highly dependent on the timeframe of the assessment.

For example, in the 10-year period from 2001 to 2010, U.S. large-cap stocks suffered two bear markets while gold outperformed just about everything. Here are the annualized returns of gold and real estate as compared to U.S. large caps in this period:

Gold – 17.5%
U.S. Real estate – 2.6%
U.S. Large-cap stocks – 1.3%

It’s notable that during the 2008 Great Financial Crisis, real estate suffered pretty badly in tandem with stocks. This came as a great shock to many homeowners and real estate investors because in the few decades prior to 2008, real estate had acted as a decent safe haven during periods of stock market turmoil.

As I’ve been noting throughout this series on historical returns, return histories almost always show a cyclical ebb and flow of relative performance when you compare just about any two asset classes or subclasses over the long term. So, we can say that gold and real estate have “usually” underperformed stocks, but that’s no guarantee of what might happen in the next decade or two.

1 – The arithmetic average of annual returns differs from annualized returns (CAGR) as discussed more here, and from COC return.

April 18, 2023

Are Buffered ETFs Worth It?

No Comments

I’ve been wondering about the merits of so-called “Buffered” Exchange Traded Funds (ETFs) for some time now. Buffered ETFs, or “Defined Outcome” ETFs, were first offered by Innovator Capital Management in 2018. I tend to avoid posting about new investment products because they seem to come and go at a dizzying pace. And there’s usually very little historical data to evaluate the likely risks and returns for these new products.

But Buffered ETFs have been around for nearly five years now and are growing in popularity. Since 2020, total investments in Buffered ETFs grew from $300 million to about $10 billion today, a more than 30-fold increase.

What Are Buffered ETFs?

The most common type of Buffered ETFs offer returns that mimic a well-known stock index like the S&P 500, but by using derivatives such as options, they moderate the severity of any losses. But there’s a catch. In return for this downside protection on index investing, these ETFs also have an upside “cap”, where returns cannot exceed a set value, no matter how high the underlying index goes. Buffered ETFs essentially shave off the extreme highs and lows of normal stock index funds.

This graph from Charles Schwab illustrates one example of a Buffered ETF with a 5% downside buffer and a 15% upside cap.

So, in this case, the ETF loses 0% when the index loses anything from 0 to -5% in value. For any index losses greater than 5%, the ETF shaves 5% off of those losses. So, an index loss of say, 20% is moderated to a 15% loss for the ETF. For the upside, the ETF provides the full positive return of the index up to 15%. If the index return is say, 25%, then the ETF returns 15%.

The percentage returns noted here apply over a set period. By far the most common period is one year. So, in most cases, you can think of these buffers and caps in terms of annual returns.

There are myriad types of Buffered ETFs involving a wide range of stock indices as well as varying amounts and styles of downside protection and upside cap. ETF Database lists more than a hundred buffered ETFs, and I suspect the entire universe of such ETFs is even larger.

Rather than investigating all these Buffered ETFs, today I’ll focus on some of the most common and uncomplicated ones. So, here are similar graphs showing the setup of three popular Innovator Buffered ETFs that are based on the S&P 500.

The downside buffers for each ETF are defined above the graphs (9%, 15%, and 30%, respectively). The upside caps are defined at the time the ETF is issued. According to Innovator’s website, the current starting upside caps for these three ETFs, from left to right, were 25%, 19%, and 16%, respectively. The stronger the downside buffer, the weaker the potential upside returns, which is consistent with the investing maxim that lowering risks always results in lower potential returns.

It’s also worth noting that many Buffered ETFs, including the three examples above, are issued on a monthly basis. So, if you buy a Buffered ETF that starts in January, the downside buffers and upside caps apply to a year running from the start of January to the last day in December. This means that if you buy a January Buffered ETF in July, the downside buffer, upside risks, and final returns you receive will vary from the ETF’s description.

March 19, 2023

What Kind Of Economy Do We Want?

3 Comments

grand bazaar with people haggling and bartering — The kind of economy we want.

The Federal Reserve is starting to break stuff in its quest to tame inflation. For example, real estate prices are teetering between stagnation and decline. Segments of the labor market, particularly big tech, are cutting costs and increasing layoffs.

And perhaps most striking, three large banks failed this month. Some key statistics show just how unusual the breakage was:

Silicon Valley Bank (SVB) was the 18th largest bank in the U.S. and the 2nd largest bank failure ever.
Signature Bank was the 36th largest bank in the U.S. and the 3rd largest failure ever.
Silvergate Bank had nearly $12 billion in assets, placing it outside the ranks of the top hundred U.S. banks, but it was more than big enough to stoke anxieties.

The causes of these bank failures are all slightly different. But one common thread seems to be large holdings of anemic-yielding “safe” Treasury bonds and securities that lost billions in value as the Fed raised interest rates and bond prices declined. For example, long-dated Treasuries represented 55% of SVB’s assets.

Another common thread seems to be heavy concentrations of deposits and lending in the relatively risky areas of the tech sector and crypto companies like the failed FTX. The money sloshing around in the tech sector for so many years due to historic, rock-bottom interest rates started to dry up with rising interest rates. This spurred increased withdrawals from cash-strapped tech firms, which ballooned into panic withdrawals as rumors spread about each bank’s health.

Many have been quick to point out that this is not the start of another 2008-style financial crisis for various plausible reasons. Nonetheless, flocks of regional banks suffered steep stock price declines in one day on March 13 as the fear of contagion spread including:

First Republic – down 62%
PacWest Bancorp – down 45%
Western Alliance Bancorp – down 47%
Zions Bancorporation – down 26%
KeyCorp – down 27%.

The SPDR exchange-traded fund (ETF) for a large basket of regional banks (KRE) was down nearly 29% over the last two weeks and has yet to recover as I write this. I don’t know the stories behind all of these banks, but it seems like the basic math of rising interest rates driving bond losses will continue to “stress test” many regional banks. And bank borrowing at the Fed’s Discount Window went from $5 billion last Wednesday to $153 billion, the highest level on record. It seems extremely premature for anyone to sound the all-clear.

Interestingly, higher capital requirements for “mid-sized” banks, like SVB and Signature, from the Dodd-Frank law of 2010 were rolled back in 2018 on a bipartisan basis and signed by Trump in 2018. Some pro-bank observers claim the specific capital requirements and stress testing levels in question, if they still existed, wouldn’t have stopped the SVB collapse.¹ Many anti-bank observers actually agree. They point instead to a multi-decade trajectory of increasingly lax and chummy bank regulation by the Fed and Congress. For example, SVB CEO, Gregory Becker was on the board of the San Francisco Fed up until the day that his bank collapsed. In this case, the regulator was the bad actor, all in one.

In retrospect, it seems stunningly obvious that rising interest rates would hurt banks with huge bond portfolios. And yet, I’ve only seen one prediction of this particular breakage, which was in October 2022 by Douglas Diamond, who won the Nobel prize for his work on bank runs. The recently failed banks clearly made inadequate preparations for the predictable losses, except for selling personal stock holdings and handing out last-minute bonuses. Similarly, the Fed or Treasury could have evaluated the effect of higher interest rates on the banks they ostensibly regulate, but they failed to do so.

More Pain On The Way

And the Fed seems to have no intention of ending interest rate hikes soon. The head of the Federal Reserve, Jerome Powell, said less than two weeks ago in Senate hearings that the Fed’s goal is, for all practical purposes, a recession of unknown length and duration. Specifically, note these two phrases, when put side by side:

“…we understand that our actions affect communities, families, and businesses across the country…the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy.“

I’m sure the Fed desires a level of “affect” and “bumpiness” that falls short of an outright recession. But at the same time, Powell pointed out, “Our monetary policy tools are famously powerful, but blunt.” Taken altogether, this sure sounds like a recipe for more economic breakage.

The Fed is trying to drive inflation back down to around 2% because high inflation is harmful in many ways. And although there have been signs of “disinflation”, as the Fed likes to call it, recent decreases in the inflation rate have been gradual and erratic.

February 20, 2023

Crypto Is Rat Poison

No Comments

I haven’t written a lot about cryptocurrencies like Bitcoin because, until now, I’ve felt ill-equipped to really weigh in. I was hesitant because of two of the four cornerstones of mindful investing: rationality and humility. Rationally speaking, crypto seemed too complicated to navigate. Humility-wise, it seemed like smarter people were describing things way beyond me.

The farthest I ever ventured was to say that crypto was too new to be safe and that the value proposition was based only on the idea that crypto will be incredibly useful in the future. So, up to this time, I’ve been skeptical, but neither for nor against crypto.

Rat Poison

However, I started gravitating toward the “against” position when I read Charlie Munger’s op-ed about crypto. I’ve often quoted Charlie and his partner Warren Buffett on Mindfully Investing because they’re both billionaire investors with a proven track record that embodies most of the principles of mindful investing. Over the last few years, Charlie has called crypto “rat poison”, “venereal disease”, “stupid and evil”, and “almost insane to buy”. Strong words!

Charlie recently wrote: “A cryptocurrency is not a currency, not a commodity, and not a security. Instead, it’s a gambling contract with a nearly 100% edge for the house.” The edge for founders and promoters of cryptos comes from buying in at the ground floor for virtually nothing, “After which the public buys in at much higher prices without fully understanding the pre-dilution in favor of the promoter.” Munger recommends that the U.S. government should ban cryptocurrencies, just like China did in 2021. If his sentiment becomes widespread on Capitol Hill, a total ban could result in all cryptos becoming worthless overnight, regardless of many other potential risks.

Signs of The Poisoning

Recent crypto news is finding traces of poison all over the place. For example, 2022 was the biggest year for crypto theft, with at least $3.8 billion stolen. For something that is touted as “immutable” and “unseizable”, that seems like a pretty leaky hole in the blockchain bucket.

Further, it concerns me that, like the days of profitless companies I observed during the Internet Bubble, the crypto investors losing the most money seem to be poor minorities. It seems likely that this particular demographic may be the least informed on the intricacies of crypto. Just like in 2000, the casino is again “winning” money from the gamblers who are least able to afford it.

And once again, most of the news focuses on price action or the tempting predictions of vast wealth from people who have a huge stake in the outcome. For example, a former Goldman Sachs and Morgan Stanley analyst, who “correctly called the 2020 Bitcoin price boom” has predicted that Bitcoin is poised to go “parabolic”. His reasoning? The Federal Reserve may start to pull back on interest rate hikes. What do interest rates have to do with the value of cryptos? He doesn’t say. Apparently, cryptos are just another “risk on” asset like stocks. But cryptos bear no resemblance to stocks in either substance or function.

And let’s not forget the slew of crypto, crypto bank, and crypto exchange problems over the past few years. From reading just a handful of articles I found reports of failures, legal troubles, or large losses involving: Grin Networks, Bitcoin Gold, Quadringa, Binance, Terraform, Kwon, Blockchain.com, Custodia Bank, Celsius, Genesis, Bitfinex, Kraken, Paxos, Three Arrows Capital, and Bitzlato. Note that I don’t claim to know what any of these companies do exactly or what their specific troubles are.

Of course, the elephant I left out of this list is the FTX crypto exchange fiasco involving founder Sam Bankman-Fried among others. (I like to call him “Sam Bank-Fraud”.) FTX collapsed in November 2022 following reports of leverage and solvency concerns involving FTX-affiliated trading firm Alameda Research, which had received hundreds of millions from FTX. FTX faced a liquidity crisis, failed to find sufficient bailout funds, and subsequently filed for bankruptcy. Around the same time, FTX was hacked and hundreds of millions worth of tokens were stolen. Sam Bank-Fraud has since been arrested and is facing criminal charges. The new CEO identified the core issue as “plain old embezzlement” and said that FTX’s accounting practices were so bad that they now have to navigate a “paperless bankruptcy”! Losses so far have totaled at least $8 Billion and counting.

So, everyone’s learned a valuable lesson with FTX and another outright crypto fraud couldn’t happen again, right? Wait, this just in from Reuters: “Crypto giant Binance moved $400M” to a trading firm that happens to be also managed by the Binance CEO. And did I mention that Binance is under investigation by The Department of Justice and the Securities and Exchange Commission for “potential breaches of financial rules…”? This all sounds suspiciously similar to the FTX shenanigans. And what was Binance’s main response? They said, “Reuters’ information is outdated”. Oh, that’s super helpful, thanks.

The Nail In The Coffin

One could argue that these are all the normal growing pains associated with any new asset in an under-regulated market. But for me, the final nail in the coffin was when I watched an hour-and-half video called, “Blockchain, Innovation or Illusion?” Normally, I don’t watch videos or listen to podcasts because I find reading more efficient. But this video captivated me in the first two minutes. It contains reasonable information about the many oddities of crypto that I’ve never seen before. The video is straightforward, uses common sense, explains jargon, and cites multiple sources for almost all of its claims. That’s a lot more than I can say for most of the stuff I’ve seen describing the benefits of crypto.

So, the remainder of this post contains a longish bullet-point summary of the video. You can probably read all the points below in 10 or 15 minutes, as opposed to watching the video for 1.5 hours. If you’re not convinced that crypto is rat poison after reading the rest of this post, and still aren’t convinced after viewing the details in the video, then I have no reply to you.

By the way, my notes gloss over some points from the video and occasionally add a few of my thoughts. But generally, these notes are pretty faithful to the main ideas and intent of the video. If you have doubts or think I got something wrong, then watch the whole video yourself and comment there.

January 16, 2023

The Consistency of Dismal 2022 Asset Class Returns Was Historic

3 Comments

Each January I consider whether to post a “year in review” of asset class returns. In some years I skip it entirely because nothing particularly remarkable happened. But even before I sat down to study the final returns for 2022, I was pretty sure that last year was extraordinary in several ways. It turns out that 2022 taught us mindful investors some useful lessons.

2022 Asset Class Returns

Here’s my standard graph of nominal (not inflation-adjusted) annual asset class returns in descending order of performance.

The bar colors group the assets into categories: real estate (blue), cash (green), gold (yellow), stocks (red), and bonds (purple). The only things that made nominal money for investors in 2022 were real estate and cash (using 3-month Treasury Bills as a surrogate).

Unfortunately, 2022 also produced inflation rates that we haven’t seen in 40 years as shown in this graph. Inflation decreases the spending power of your money (invested or not), which you can learn more about here.

So, one could argue that the inflation-adjusted returns shown in this next graph provide a better picture of what happened in 2022.

After accounting for inflation, the only major asset class that made money in 2022 was owning and renting out real estate property.

The basic reason for diversifying investments across various assets is that often some assets perform well while others perform poorly. But last year provided almost no place to hide.