As alternative asset classes continue to challenge the returns of traditional asset classes, investors now have more options than ever when it comes to generating long-term wealth. However, it remains important that investors can achieve their return expectations while taking on a level of risk that they’re comfortable with. So understanding the varying risks and returns of each asset class can be key to achieving investment goals.
To give you more insight into this, we’ve outlined the risks and returns of some income-producing asset classes: stocks (equities), real estate (including REITs), bonds, and loans. Then for comparison, we’ve summarized the risk and returns of a non-income-producing asset: cryptocurrency.
Risks and returns of income-producing assets
Stocks (or equities) are among the oldest and most widely regarded asset classes in the investment market. They’re an integral part of economies in developed and developing countries and are responsible for a vast amount of the world’s wealth creation1.
Average stock return
Often traded via stock exchanges, stocks are low maintenance and can generate returns much higher than other traditional asset classes – since 2007, the average annual stock return is around 9%2.
If you look at stock returns on an annual basis, they often reach big highs and lows, and there’s usually little consistency in performance. This is because the stock market is highly volatile, meaning stock prices frequently change, especially in the short-term1. When stocks go through periods of high volatility, the risk that your returns are negatively affected is also high1.
Something that can influence volatility is the media. Historically, bad news in the press has had a sizeable influence on investor sentiment, and in turn, stock prices1. However, recently, the stock market has continued to grow regardless of negative media attention.
Other factors influencing stock prices
Stock returns depend on the success (or failure) of the businesses you’ve invested in. A company’s success can depend on multiple things, such as the strength of its sector, who its competitors are, and the relevancy of its product or service. Although there are many business and sector-specific factors that affect stock prices, there are some factors that influence all stocks:
Local or global events such as financial crises, political instability, or pandemics often impact stock prices.
- Regulatory and legislative
Economic policy and regulatory requirements can quickly impact business operations, affecting the profitability of companies and, subsequently, stock prices.
- Inflationary and interest rates
Inflation and interest rates can weaken or strengthen an economy which affects the profitability of companies and stock prices. Monetary policies implemented by central banks such as quantitative easing can also drive market activity, often causing stock prices to increase.
- Analyst ratings
Analyst ratings estimate a stock’s future performance and can significantly influence investor sentiment and, therefore, stock prices.
Stocks are a powerful force in the global economy, and sustained volatility in the stock market can lead to a global financial crisis1. Nonetheless, stocks continue to be a go-to asset class because of its ability to generate attractive returns – especially for those with long-term investment goals.
We need real estate to live and work, and because of this, it’s an asset class that all investors are familiar with. Real estate investments are illiquid (not easily converted to cash) because the acquisition process is often expensive and time-consuming. However, these investments can produce rental income (returns) for many years, generating long-term wealth for investors. As well as this, a property’s value can grow significantly over time (capital gains), which further increases the attractiveness of this asset class for many.
Average direct real estate return
Since 2007, the average annual direct real estate return is around 5.2%; however, over time, you can see significant fluctuations year-on-year3.
Factors influencing real estate returns
The volatility within this asset class is unique because of the market and physical (property-specific) factors that influence returns. Due to the added physical risks of real estate, it’s often considered a riskier asset class.
Market and regulatory factors4:
- Global markets
Global financial markets affect real estate returns. A prime example is the 2009 Global Financial Crisis, when real estate values plummeted, resulting in massive investment losses.
- Local markets
The supply and demand of properties in local markets change continually, which influences rental and property valuations.
Regulatory changes such as building codes, zoning, or environmental rules can make owning a property more expensive or less desirable.
Physically, properties require maintenance, which can impact your investment returns considerably.
Managing a property investment can be time-consuming and expensive but necessary for maintaining a property’s value. Property values can be negatively affected if not appropriately managed.
Inflation and interest rates can make real estate less or more expensive to own and quickly affect investment returns.
Real estate investment trusts (REITs)
A real estate investment trust (REIT) is a publicly listed company that owns, manages, or funds a group of income-producing properties. Also traded via stock exchanges, REITs are a popular alternative to direct property investments, as they’re cheaper, more easily converted to cash, and come with fewer transaction costs5.
Average REIT return
Since 2007, the average annual REIT return is around 4.7%6, and although returns fluctuate, REITs form an essential part of many investor portfolios. When added to a portfolio of stocks, bonds, real estate, and cash, REITs (across many time horizons) can optimize portfolio performance by increasing returns and reducing investment risk7.
Factors influencing REIT returns
REIT returns depend on the performance of three main factors:
- The stock market
Around a third of REIT risk is a direct spillover of stock market risk, as investors trade REITs on the stock exchange – just like equities8.
- Direct real estate
Around 40% of REIT risk is associated with the direct real estate factors we’ve mentioned – market and physical8.
- The economy
The remaining proportion relates to general economic and business cycle risk, which most investments are exposed to8.
Because of this varying exposure to risk, many investors consider REITs to be a valuable addition to a diversified portfolio.
Bonds form a part of many traditional portfolios as they’re mostly low-risk and provide an easy way for investors to earn a passive income. In addition, adding bonds to an investment portfolio can decrease its overall volatility, especially if your portfolio includes stocks9.
To measure the quality of bonds, they’re given ratings, which represent the risk of the bond issuer (the borrower). AAA-rated bonds, for example, are almost risk-free, whereas CCC to D-rated bonds come with much higher levels of risk.
Many factors can influence bond returns, depending on the bond type; however, there are some factors that all bonds have in common:
- Repayment risk
The bond issuer (borrower) can fail to make repayments on time.
- Inflation rate risk
Rising inflation can chip away at bond returns over time.
- Interest rates
When interest rates are low, many investors prefer the fixed interest rates of bonds, which drives up the prices of bonds. However, if interest rates rise, the fixed rate offered from bonds can be less attractive, and bond prices decline as a consequence.
- Investor perception
Bond prices can decline when people negatively perceive the bond issuer and its ability to make repayments10.
Risk and return of government bonds
Governments issue bonds to support their spending obligations. In the world’s largest developed countries, they’re as close as you can get to a risk-free investment (although this has not always been the case with countries that enter recession or have political instability). However, since the early 2000s, returns from government bonds have been declining. Rising inflation rates are now outpacing bond yields, and in Germany, returns from government bonds are negative.
Despite this, research shows that having a portfolio of government bonds and stocks results in higher returns than a combination of corporate bonds and stocks9.
Risk and return of corporate bonds
Businesses rather than governments issue corporate bonds. Typically, corporate bonds offer higher returns than government bonds – some of this accounting for the fact that in most countries, investors have to pay tax on their returns. As well as this, corporate bonds can be less desirable (and costly) to trade and are inherently more susceptible to default risk than government bonds9. Plus, corporate bond returns are influenced much more by local market factors than global market factors13.
As with government bonds, corporate bond yields are on the decline. The average return for US corporate bonds (the largest corporate bond market) in 2021 was around 2.7%12.
Risk and return of high-yield or ‘junk’ bonds
High-yield bonds are those rated below investment grade (S&P’s BB+ or below) and offer higher returns due to the increased default risk of the borrower. These bonds are illiquid, and there isn’t much information transparency, meaning they can be a riskier investment option10. High-yield bond returns in the US are also declining, with an average return of around 4.3% in 202114.
Many investors purchase high-yield bonds with the hope that the rating will eventually rise to investment grade, leaving the investor with the security of an investment-grade bond and the return of a high-yield bond. However, high-yield bonds downgrade more often than they upgrade10.
Alternative income-producing assets such as loans are continuing to gain momentum. Traditionally, the loan investment market has been exclusive to banks and large institutions. However, through leveraging technology, online platforms such as Mintos have opened up the loan investment market to retail investors. With expected repayment structures and fixed interest rates, loan investments provide investors with a simple way of earning a passive income.
Loan investment returns
Loan investments made on the Mintos platform (which has over 40% market share) have generated an average annual net return of 8.6% for investors from 2017 – 202115.
Factors influencing loan investment returns
As with the nature of most asset classes offering higher returns, investing in loans doesn’t come without risk. These can be categorized as:
A borrower may fail to make scheduled repayments or not pay them on time. In this case, a lending company may or may not recover these payments, resulting in repayments to the investor being affected. In addition, a borrower could repay their loan early, resulting in lower returns for an investor.
- Lending company-specific
A lending company can go out of business or experience financial problems, resulting in it failing to meet its contractual obligations, such as not making payments or defaulting on the buyback obligation.
- Regulatory and compliance
Lending companies and loan marketplaces are subject to laws and regulations that vary by country. These are always subject to change, and there’s a risk that a change could negatively affect business operations.
As with other asset classes during the Covid-19 pandemic, loan investments experienced fluctuations in net returns. However, compared with other debt-based investments, such as bonds (where the returns were already significantly lower), loan-based investments continued to be a valuable addition to investment portfolios.
Risks and returns of a non-income-producing asset
The assets we’ve mentioned so far are all income-producing (excl. growth stocks), which means investors receive returns throughout the investment period. With non-income-producing assets, however, investment returns are entirely dependent on the future resale value.
An example of a popular non-income-producing asset class is cryptocurrency, also known as crypto. Although still relatively new, it’s been in the spotlight of the alternative investment market due to the significant returns that Bitcoin (crypto’s largest coin) has generated for investors – especially for those that invested early.
Crypto as an asset class has a few distinguishing factors17:
- Most investors are non-institutional
- The fundamental value and market drivers are yet to be fully understood
- It’s highly volatile
Unlike most asset classes, crypto doesn’t appear to be as affected by movements in exchange rates, commodity price fluctuations, or general economic conditions17. However, crypto’s high volatility makes this asset class stand out in terms of risk.
Over the last 5 years, Bitcoin has been five to six times more volatile than gold (a traditional hedge in an investment portfolio) and stocks – two of the most volatile asset classes18. With these factors in mind, this asset class demonstrates how although non-income-producing assets can be very profitable, extreme levels of volatility can add high levels of risk to an investment portfolio and make returns unpredictable.
No investment comes without risk, and deciding on which asset classes to invest in can be tricky. However, understanding the differences between the risks and returns of asset classes can help investors understand which investments are best suited to their preferences and investment goals. For more on choosing asset classes for your investment portfolio, read our article on strategic asset allocation.
- Onyele, K. O. & Nwadike, E. C. (2021) Modelling stock returns volatility and asymmetric news effect: a global perspective.
- Backtest by Curvo (Accessed 2022) MSCI World Portfolio composition: Lyxor Core MSCI World (DR) UCITS ETF
- Backtest by Curvo (Accessed 2022) SPDR Dow Jones Global Real Estate UCITS ETF
- DeLisle, J. R. (2010) Real estate risk management: Part 2: Space-time dimensions of real estate, chapter 4: Real estate risk management.
- Cotter, J. & Roll, R. (2011) A comparative anatomy of REITs and residential real estate indexes: Returns, risks and distributional characteristics.
- Backtest by Curvo (Accessed 2022) FTSE EPRA/NAREIT Developed Portfolio composition: Amundi ETF FTSE EPRA NAREIT Global UCITS ETF DR
- Nariet REIT (Accessed 2021) Global Real Estate Investment Overview
- EPRA Research (2014) Are REITs real estate or stocks? Dissecting REIT returns in an asset pricing model
- Luskin, J. (2017) Journal of financial planning: Examining total portfolio performance: U.S. Government v.s corporate bonds
- Vanguard Research (2012) Worth the risk? The appeal and challenges of high-yield bonds
- Organization for Economic Co-operation and Development, Long-Term Government Bond Yields: 10-year: Main (Including Benchmark) for the United States and Germany, retrieved from FRED, Federal Reserve Bank of St. Louis; Accessed on February 2022
- Moody’s, Moody’s Seasoned Aaa Corporate Bond Yield [AAA], retrieved from FRED, Federal Reserve Bank of St. Louis; Accessed on February 2022
- Bekaert, G., De Santis, R. A. (2019) Risk and return in international corporate bond markets
- Ice Data Indices, LLC, ICE BofA US High Yield Index Effective Yield [BAMLH0A0HYM2EY], retrieved from FRED, Federal Reserve Bank of St. Louis; Accessed February 2022
- Net investment return is defined as the total annualized gross return, minus the annualized loss rate. Write-offs have been applied to the loans issued by suspended lending companies based on our recovery estimates.
- Yahoo Finance (Accessed 2022) BTC-EUR Interactive Stock Chart | Bitcoin EUR Stock – Yahoo Finance
- Giudici, G., Milne, A. & Vinogradov, D.(2020) Journal of Industrial and Business Economics 47:1–18: Cryptocurrencies: market analysis and perspectives
- MSCI (2021) Bitcoin: good as gold?