Don’t believe anyone who tells you there’s such a thing as a safe investment. Truth is, every asset—from Treasuries to houses to dividend stocks—involves risk.
The “safest” investment, according to the Financial Industry Regulatory Authority (FINRA), is a short-term US Treasury bill. You lend the government $100, say, and you’ll get $105.17 back in a year. Not bad.
But there are some caveats:
- Short-term Treasury rates fluctuate, and the Federal Reserve has said they’ll try to get them lower later this year.
- In a truly apocalyptic disaster, you might find that the Federal Reserve doesn’t pay your money back. In fact, you might find that money itself is worthless.
That second point might sound silly, but I’m pushing the boundary here to highlight the point that nothing in life is risk-free. When investors talk about “risk-free returns,” like with Treasuries, they’re assuming tomorrow will look like today. But it may not.
For this reason, we have to accept that no matter where we put our money, there’s a chance of losing some.
Inflation Risk Is Far More Dangerous Than People Think (Especially Now)
What about cash, supposedly the ultimate safe investment? That’s even riskier. Due to inflation, if you saved $100 in cash five years ago, it’s worth $78.80 now.
The reason for this is that our current 3.5% inflation rate devalues money by that much from just a year ago, but of course inflation ate into money’s value the year before that, and before that, and before that … you get the idea.
In other words, not even cash is safe.
I’m not writing this to worry you! Instead, look at it this way: Your wealth is yours to master and turn into more wealth. The key is to embrace risk and put a bit more focus on the rewards investors get for taking it on.
Consider, for example, how someone who bought short-term US Treasuries five years ago—shown through the iShares Short Treasury Bond ETF (SHV) in orange below—would have done compared to an investor who bought the SPDR S&P 500 ETF Trust (SPY), the benchmark S&P 500 index fund (in purple).
That period included a pandemic, an inflation spike and all kinds of other pandemonium. Even so, stocks crushed short-term Treasuries. It just shows that letting fear rule too many of our investing decisions is more detrimental than we realize.
Sounds reasonable, you might be thinking, but surely there’s a way to ease stock volatility without sacrificing much in returns and ensuring my money is there when I need it.
This concern is perhaps the most common one among individual investors. And (of course!) Wall Street has an answer: the target-date fund.
Here’s how it works: Let’s say we want our money available in 20 years, so we buy a fund with a target date 20 years out, put our money in, keep investing and ride the wave.
It helps to show this through a real-world example, so let’s put together a little scenario.
Let’s say an investor back in 2003 wanted to retire in a bit more than 20 years, so they bought the (then) newly launched Vanguard Target Retirement 2025 Fund (VTTVX).
Our investor is drawn by the fund’s set-it-and-forget-it nature. They also find VTTX appealing because over time it will lower their exposure to stocks and shift to bonds to increase safety and ensure their money is there when they retire. Plus the fund is cheap, with a fee of just 0.08% of assets.
Sounds great, right? Well, not so fast.
With VTTVX (in orange above), our investor’s current value would be less than half of what it would’ve been if they’d invested in the stock market. A $100,000 investment in VTTVX would now be around $261,200, while the S&P 500 index fund produces about $613,100.
In other words, fear cost them over $350,000—the cost of a house or a Lamborghini.
True, SPY’s dips have been worse than those of VTTVX, but this is an illusion. If we zoom in on times of stress, like 2020, we see that VTTVX’s strategy didn’t help much.
VTTVX still fell 20% during the crash, which is better than 30% drop in the S&P 500. But the index also recovered faster. So VTTVX holders were spared the pain of losing an extra 10% of their gains, but they also suffered the pain of a slower recovery.
In fact, their recovery was never fully finished, as VTTVX has underperformed since the COVID crash.
There’s still one issue here: liquidity.
In 2023, VTTVX paid a 4% dividend, while the average S&P 500 stock pays about 1.3%. So a lot of investors point to target funds as a great income option. Sure, you sacrifice profits, goes the thinking, but you have more cash flow as compensation.
Not exactly. At least not when you compare VTTVX with the asset class every investor should be looking to for long-term gains and high dividends: closed-end funds (CEFs).
Below we see the total returns of VTTVX (at the bottom, in purple) versus those of three CEFs that focus on large cap stocks: the Adams Diversified Equity Fund (ADX), in orange, Central Securities Corporation (CET), in blue, and General American Investors Co. (GAM), in green.
As you can see, all three have crushed the target-date fund:
CET, in particular, really took off, thanks to the magic of compounding stemming from the fact that it did much better than its peers during the Great Recession. From the start of 2008 to the start of 2015, CET gained 53.3%, while ADX and GAM returned around 35% each.
Consider also that these funds have paid out over 7% in dividends on average during this period, and you can see why target funds don’t make much sense. They offer less cash flow, lower returns and not much less risk.
The final word is that if you’re looking to grow your retirement savings, target funds may seem compelling, but their low-risk approach also means there’s a high chance of low returns, which, of course, nobody wants.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Steady 10.9% Dividends.”
Disclosure: none
Real estate investment trusts (REITs) can be fantastic investments. They supply investors with passive income. Further, REITs have historically outperformed the S&P 500 over the longer term.
On top of all that, our research has found that many REITs deliver those higher returns with less volatility compared to the broader market. Three REITs have stood out for their ability to produce high returns with lower volatility: Realty Income (NYSE: O), Essex Property Trust (NYSE: ESS), and Public Storage (NYSE: PSA). Here’s a look at these reliable REITs.
A reliable grower
Realty Income stands out among REITs. The diversified REIT has delivered a 13.9% compound annual total return since its public market listing in 1994. While that’s not the highest return over that period, it has delivered one of the best returns per unit of risk as measured by beta:
As that slide shows, Realty Income is in the 90th percentile among S&P 500 members for the return it delivers per unit of risk. A big driver is its low beta, the second lowest among REITs in the S&P 500.
Several factors drive Realty Income’s low volatility. A big one is the overall stability of its cash flow. The company owns commercial properties secured by long-term net leases with high-quality tenants in industries relatively immune to economic downturns and the disruption of e-commerce (e.g., grocery stores, home improvement centers, and warehouses). The net lease structure requires the tenant to cover maintenance, building insurance, and real estate taxes. This business model enables it to generate very stable cash flow, three-quarters of which it pays investors via its monthly dividend.
Realty Income also has one of the highest credit ratings in the REIT sector. The company’s combination of a durable portfolio and strong financial profile allows it to steadily grow its portfolio, cash flow, and dividend (106 consecutive quarterly increases). That drives reliable returns for its investors.
A West Coast focus has driven peer-leading returns
Essex Property Trust has also delivered strong returns for less risk. The apartment REIT has delivered a 13.7% compound annual growth rate in its total return since its initial public offering in 1994. That’s the highest return among multifamily focused REITs. The company has delivered those returns with less volatility than the broader market (0.8 average beta over the last five years).
A few factors have helped drive its reliable returns. A big one is its focus on housing-constrained markets along the West Coast. That has helped drive above-average net operating income growth compared to other REITs due to high occupancy levels and higher average rent growth. The company also has done an excellent job of investing capital to expand its portfolio via high-return acquisitions and development projects. These catalysts have helped drive above-average cash flow per share growth, enabling Essex Property Trust to deliver peer-leading dividend growth (487% over the last three decades).
Essex Property Trust backs its strong portfolio with a rock-solid balance sheet. Its strong credit rating gives it the financial flexibility to make value-enhancing investments.
The low-volatility leader
Public Storage has the lowest volatility among REITs in the S&P 500 (around 0.5 times over the past five years). The self-storage REIT has also delivered an impressive 12.4% average annual return since going public several decades ago.
Its focus on self-storage properties is a big factor driving its reliable, low-volatility returns. They have a low break-even point (40% to 45% occupancy compared to 60% or more for multifamily properties), enabling the company to consistently generate strong earnings. Meanwhile, demand for self-storage properties tends to be relatively recession-resistant. On top of that, demand for space in those facilities has been steadily rising as more people use them to store their stuff. These catalysts have helped drive strong occupancy and rental growth rates for self-storage operators over the years. Since 2004, its same-store net operating income has grown at a 5.1% compound annual rate, much faster than the core real estate sector average of 2.9%.
Another factor driving Public Storage’s low volatility is its fortress-like balance sheet. It has one of the highest credit ratings in the REIT sector. That gives it the flexibility to invest in high-return development projects and make accretive acquisitions.
Reliable returning REITs
Realty Income, Essex Property Trust, and Public Storage have been fantastic long-term investments. The REITs have delivered strong returns with a lot less volatility than the broader market. Given the durability of their business models and their strong financial profiles, these top REITs should be able to continue delivering reliable returns for their investors in the decades ahead.
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Matt DiLallo has positions in Public Storage and Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.
Looking for a Reliable Investment? These 3 REITs Are Less Volatile Than the S&P 500. was originally published by The Motley Fool