Which Type of Investment Will Earn You the Most Money?

Stocks vs. Bonds, Mutual Funds, ETFs, Real Estate, and Robo-Advisors.

New investors who are considering buying stocks often wonder, “Should I invest in stocks? Or something else instead?”

And investors who already know they want to invest in stocks often wonder, “Should I buy my own stocks? Or just buy a mutual fund or ETF and let someone else do the stock picking?”

These are both great questions.

Based on my experience, the best investment choice for you depends on five things:

1. What type of returns do you want to strive for?
2. What is your risk tolerance?
3. Which type of investing best fits your personal strengths and interests?
4. How much time and energy will you dedicate to investing going forward?
5. How much money do you have to invest?

Before I share more on which type of investment might be best for you, let’s cover a quick overview of each, including their pros and cons.

Just a note, most of the pros and cons below are relative to buying stocks. For example, when I say a con of real estate is that it requires more money to invest, I mean as compared to buying stocks.

Investing in stocks involves buying shares of ownership in publicly-traded companies.

Investing in Stocks: Pros

• Easily diversify. It’s easy to diversify stocks by buying different company sizes, types, countries, sectors, etc.
• Own different business types. Investing in stocks allows you to own many different business types in a liquid way. For example, buying Real Estate Investment Trusts (REITs) allows you to invest in real estate without actually buying physical properties while buying mining stocks allows you to invest in precious metals without actually buying physical gold or silver.
• Superb long-term returns. Over a period of 10–15 years, stocks have a very high likelihood of making a profit (assuming past trends continue, which is never a guarantee). They have a history as one of the highest returning assets in the U.S. (more on that below).
• Stocks are highly liquid. As a liquid investment, you can easily buy or sell your shares for cash anytime the market is open. Many different brokerages make trading fast, easy, and cheap.
• Very little money required. Stocks are good for investors with smaller amounts of money to invest since shares can cost as little as just a few dollars.
• Low trading fees. Brokerage trading fees are cheap and getting cheaper. Most brokerages charge less than $8 per trade and some offer free trading.
• Dividend stocks provide steady income. Buying high dividend stocks can provide steady income, just like bonds. However, they also give you the potential to profit from price gains.
• Shareholder rights. When you become a shareholder, you have a right to vote on company issues such as director nominations, merger decisions, and executive compensation.

Investing in Stocks: Cons

• Mistakes can be costly. Investors risk making costly mistakes when buying and selling stocks without a strategy (for example, based solely on gut or emotion).
• Declines are painful. The stock market can decline during a correction, bear market, or crash, sometimes by quite a lot.
• Owning a few stocks is not diversification. Too little diversity in a stock portfolio can result in downside risk and loss of money.
• More work. Investing directly in stocks requires more work from investors to research and monitor their portfolio.

A mutual fund is a giant portfolio made up of hundreds of stocks (and/or other assets) that are bought and sold by a financial company. Individual investors buy into the mutual fund together and trust the financial company to make smart investing decisions with everyone’s money.

Some mutual funds are actively managed, meaning they trade frequently and the financial managers try to outperform their benchmarks. Other mutual funds are passive, meaning they simply track an index or basic group of stocks over time.

Mutual funds charge an ongoing management fee and some charge additional fees as well.

Investing in Mutual Funds: Pros

• Index funds can be good passive investments. Low-fee index funds can be a convenient “set it and forget it” investment option for passive long-term investors who don’t want to actively research and invest themselves.
• Funds are naturally diversified. Mutual funds can provide easy diversification, allowing an investor to own hundreds or thousands of stocks through a single fund.
• Exposure to many stocks. If you don’t have much money to invest, you can own a tiny slice of many high-quality stocks through a mutual fund, even if you couldn’t afford to buy those individual stocks in your own portfolio.
• Little money required. Many funds offer low or no-minimum investment options, meaning you can buy in regardless of how much money you’d like to invest.
• Managed by a pro. Professionals are making the investment decisions, reducing the likelihood of common investor mistakes.
• Many funds to choose from. There are many different flavors of mutual funds, allowing you to find a fund to match your investing goals.
• No share prices. Rather than having to pay a specific share price, you buy into a mutual fund with exactly the amount of money you want to invest.

Investing in Mutual Funds: Cons

• Slightly less liquid than stocks. Funds are only priced and traded once per day, after the markets close.
• Fees eat away profit. Active mutual funds often come with fees that weigh down their already mediocre performance.
• Nasty fees. Some mutual funds (mostly the actively managed funds) can have nasty transaction fees they charge upfront or when selling the fund.
• Mediocre performance. Most active mutual funds fail to beat their benchmarks over long stretches of time (although some do).
• Tough to beat the market. Buying a simple index fund, which holds hundreds or thousands of stocks, makes it difficult to outperform the market over time.
• Risk being too concentrated. Despite buying a mutual fund which represents many stocks, investors can still not be diversified. For example, buying a finance sector fund may expose you to dozens or hundreds of financial companies, but your money is still highly concentrated in just a single sector: finance.
• Regular taxes. Mutual funds often create capital gains which means a tax bill for you. While you can control when you incur capital gains taxes when trading your own stocks, it’s out of your hands when you invest in a mutual fund.
• Declines are painful. The stock market can decline during a correction, bear market, or crash, sometimes by quite a lot.
• Cash drag hurts returns. Mutual fund performance suffers from “cash drag.” Because funds are never fully invested (holding cash aside for investors who may sell out of the fund), they always have a chunk of your portfolio sitting in low-return cash rather than compounding in the stock market.

When it comes to mutual fund investing, the new wisdom is that actively-managed funds often carry high fees and deliver mediocre performance. In general, investors are shifting away from active mutual funds.

Instead, this chart from Morningstar shows that investors have been choosing low-cost ETFs over mutual funds for years now.

Why?

Research has shown that many actively managed mutual funds barely beat their benchmarks and charge high fees, resulting in investors who pay a brokerage to lose to a simple benchmark.

ETFs, on the other hand, can track the same benchmarks (and more), often for a much lower fee.

As you can see below, investors have been abandoning the more expensive actively-managed mutual funds in favor of the lower fee index funds, which probably look more like simple ETF index funds.

An Exchange-Traded Fund (ETF) tracks the price of many stocks (or other assets) without actually buying or selling any of the positions (it simply tracks their price as a group).

ETFs can track popular indexes (such as the S&P 500 or Russell 2000), groups of stocks (such as large cap dividend stocks), or entire sectors (such as energy stocks or technology stocks).

ETFs charge an ongoing management fee which is usually lower than actively-managed mutual funds (but sometimes the same as passively managed mutual funds).

Investing in ETFs: Pros

• ETFs can be good passive investments. Low-fee ETFs can be a convenient “set it and forget it” investment option for passive long-term investors who don’t want to actively research and invest themselves.
• Low-fees. ETFs are usually not actively managed which means they often have lower fees than mutual funds
• Good range of options. There are many different flavors of ETFs, allowing you to find a fund to match your investing goals
• Many types of indexes, commodities, sectors, and more. ETFs are good for investors who want to trade an entire area of the market (such as tech stocks, gold, or the Russell 2000) with relative ease and liquidity.
• Exposure to many stocks. Even if you don’t have much money to invest, you can own a tiny slice of many high-quality stocks through an ETF, even if you couldn’t afford to buy those individual stocks in your own portfolio.
• High liquidity and order types. ETFs are priced and traded throughout the day just like a stock, meaning you can get your money out at any time. You can also use different order types, such as limit orders when trading ETFs.
• ETFs are naturally diversified. ETFs can provide easy diversification, allowing an investor to own hundreds or thousands of stocks through a single trade.
• Tax-friendly investing. Unlike mutual funds, ETFs usually don’t generate capital gains while they’re being held (except for dividends). This means you can control when you incur a tax liability based on when you choose to sell your ETF.
• Leveraged returns. Leveraged ETFs allow investors to get 2x or 3x or more exposure to certain areas of the stock market.
• Invest in more than just stocks. ETFs can track assets beyond stocks, such as commodities, volatility, and even short positions.
• Little money required. ETFs don’t usually require a minimum investment amount (beyond the cost of a single share).

Investing in ETFs: Cons

• Tough to beat the market. Buying a simple index-fund ETF, which holds hundreds or thousands of stocks, makes it difficult to outperform the market over time.
• Risk being too concentrated. Despite buying an ETF which represents many stocks, investors can still not be diversified. For example, buying a finance sector ETF may expose you to dozens or hundreds of financial companies, but your money is still highly concentrated in just a single sector: finance.
• Declines are painful. The stock market can decline during a correction, bear market, or crash, sometimes by quite a lot.
• Leverage multiplies risk. Leveraged ETFs present high risks to investors, as their losses can be magnified as large as their gains.
• Fees eat into profits. ETFs have ongoing management fees which eat into your returns.

When investing in bonds, investors lend money to a corporation or government entity and receive ongoing interest payments in return.

Investing in Bonds: Pros

• High stability. Bonds are generally stable (as long as the organization issuing the debt is stable) and lack the volatile ups and downs of the stock market.
• High predictability. Based on the bond you buy, you know exactly what your returns will be over time.
• Ratings provide transparency. Stocks are often rated by rating agencies so you know the quality of the bond you’re buying.
• Regular income. Bonds pay you regular income, often at a higher rate than a dividend stock.

Investing in Bonds: Cons

• Vastly inferior long-term returns. Extensive research show that bond returns consistently lag stocks returns by a wide margin over long periods of time. Basically, by investing in bonds you’re probably leaving a lot of money on the table.
• Interest rate risk. Changes in interest rates can significantly impact the value of a bond. For investors that simply hold the bond and collect the interest, this is less of a concern.

Robo-advisors are companies that use computer algorithms to invest in ETFs based on your personal goals. They use no human intervention to make investment decisions and charge a relatively small ongoing management fee.

Betterment and Wealthfront are well-known examples of robo-advisors.

Investing with Robo-Advisors: Pros

• Robo-advisors can be good passive investments. Low-fee robo-advisors can be a convenient “set it and forget it” investment option for passive long-term investors who don’t want to actively research and invest themselves.
• Relatively low fees. Robo-advisors often have lower fees than actively managed mutual funds.
• Natural diversification. Robo-advisors can provide easy diversification, allowing an investor to own hundreds or thousands of stocks through a single trade.
• Exposure to many stocks. Even if you don’t have much money to invest, you can own a tiny slice of many high-quality stocks through a robo-advisor, even if you couldn’t afford to buy those individual stocks in your own portfolio.
• Powerful algorithms. Investment decisions are driven by well-tested algorithms that have shown historical success.
• Little money required. Robo-advisors often have low or no minimum investment requirements if you want to commit just a small amount.
• Automatic rebalancing. Automated rebalancing ensures that your investments stay at your preferred mix without you having to do a thing.
• Tax-friendly investing. Robo-advisors claim to make the most of tax-loss harvesting, which offsets your investment gains with investment losses, thereby reducing the taxes you owe on your investments.

Investing with Robo-Advisors: Cons

• Fees eat into your profits. Ongoing management fees can eat into your long-term profit potential.
• Higher tax bills. Robo-advisors often create capital gains which means a tax liability for you. While you can control when you incur capital gains taxes when trading stocks, you can’t when invested in a mutual fund.
• Lack of track record. Robo-advisors are a relatively new offering, so they don’t have a long track record to show their performance.
• Declines are painful. The stock market can decline during a correction, bear market, or crash, sometimes by quite a lot.
• Giving up on beating the market. By investing with a robo-advisor, you’re embracing passive index-like returns rather than trying to beat the market and earn superior returns trading your own stocks

Investing in real estate involves buying, selling, and renting out physical properties for residential or commercial use.

Investing in Real Estate: Pros

• Good long-term returns. U.S. real estate has provided good returns for investors over the long term (more details on that below).
• Profit from rent and sales. You can make money investing in real estate when you collect rent and when you sell the property for a profit.
• Relatively stable. Real estate tends to be less volatile than the stock market, although housing busts can be painful.
• Steady cash income. Renting out properties can provide steady income through different economic environments.
• Mortgages act as leverage. Borrowing from a bank allows real estate investors to use a mortgage to buy a good-size property with only a portion of the cost coming out of pocket.
• Physical property. A property is a physical asset you can see and touch.
• Hands-on management. You have direct control over the purchase, management, and sale of your property. With stocks, you’re mostly at the mercy of the performance delivered by the company’s executives.
• Tax benefits. Real estate investments can offer a range of tax benefits, increasing your bottom-line profit.

Investing in Real Estate: Cons

• Less transparent information. There is less clear, reliable, public information available on real estate investments. Unlike stocks, which report the state of their finances every quarter, you may need to conduct deep custom research on your own local market, rental industry, properties, etc.
• Income can disappear. If a property isn’t occupied by a paying tenant, your income stream drops to zero until you can find one. However, your costs usually stay fixed, resulting in a loss.
• Getting your hands dirty. Real estate may at times involve more hands-on work, such as finding tenants, evicting bad tenants, repairing the property, filing paperwork, etc.
• You need more money to get started. Real estate tends to require more capital from investors. Unlike stocks, which can be bought for less than $10, real estate usually requires tens of thousands of dollars (or more) to get started.
• High concentration of risk. If you can only afford to invest in one or two properties, you’ll have all your savings tied up in just one or two assets, which is risky.
• Ongoing costs. Real estate property can be damaged or destroyed, requiring more investment to salvage or repair the property and make it rentable again.
• Low liquidity. Real estate is a highly illiquid investment, meaning it will likely take you significant time and money to sell your property and raise cash.
• Hidden costs. Owning a property often comes with lots of hidden costs, such as repairs, taxes, insurance, and more.
• Limited number of buyers. There are many more buyers across the country for stocks you’d like to sell than local buyers for a property you’d like to sell.
• Property value isn’t transparent. The value of your real estate investments isn’t provided on a regular basis like it is with stocks. You only truly know what your property is worth when someone actually buys it from you.

There are many other types of securities that take some advanced training and experience.

Examples include trading commodities, Forex (foreign exchange currencies), derivatives, short selling, levered funds, futures, options, and more.

Since this article is for common investors, we’ll leave those aside for now.

Now that you understand the basics of each type of investment, let’s dig into which is best by returning to our five big questions on your personal investing situation:

1. What type of returns do you want to strive for?
2. What is your risk tolerance?
3. Which type of investing best fits your personal strengths and interests?
4. How much time and energy will you dedicate to investing going forward?
5. How much money do you have to invest?

There’s a big difference in strategy between an investor who wants to maximize their returns and an investor who wants to minimize their risk.

In this first question, let’s focus just on the returns portion:

Which type of investment offers the best returns?

To answer this incredibly important question, let’s zoom out.

Way out.

Research by Jorda et al looked at the average annual returns for a range of U.S. investments from 1870–2015. Keep in mind these figures are real returns, which means the impact of inflation has been removed.

Looking at a wide range of historical data, a few things become clear:

• Stocks have been the best-performing investment over the long-term.
• Real estate has also performed well, trailing just behind stocks.
• In the modern era (1980–2015), stocks have outperformed real estate by a healthy margin.
• Government bonds and treasury bills have kept ahead of inflation but trailed stock and real estate returns by a lot.

Let’s take another look at stocks vs. bonds using this line graph from Morningstar:

Again, we see that the returns for large cap stocks and small cap stocks soar above the returns for government bonds, treasury bills, and cash.

Stocks have an annual return rate of roughly double government bonds, which turns a one dollar investment in 1926 into $7,353 for large cap stocks and $36,929 for small cap stocks, but only $143 for government bonds.

In fact, in this graphic from Bernstein we see that stocks beat bonds, cash, and inflation over 80% — 85% of 10-year periods from 1926–2014:

But, we also see that bonds beat cash and inflation in roughly 70% of 10-year periods from 1926–2014.

So, what’s the lesson?

Over long time periods, stocks tend to return more than bonds and bonds tend to return more than cash.

If all you care about is maximizing your returns, stocks appear to be the best choice, with real estate a close second.

So why would anyone ever invest in bonds?

Because they involve less short-term risk, which brings us to our next big question.

While bonds have historically returned much less than stocks, they do have two advantages over stocks:

1. Bonds are very low volatility because they’re not directly tied to the stock market.
2. Bonds send you steady interest payments regardless of what’s happening in the stock market (assuming the issuer doesn’t default).

This chart from Fidelity does a good job capturing the balance between risk and returns. It shows the returns and downside risk from 1926–2016 for various different portfolio mixes:

On the far left, we see a portfolio called “Short-Term” that’s invested completely in short-term treasury bills (basically just cash that keeps pace with inflation so its purchasing power stays constant over time).

From 1926–2016, this ultra-conservative portfolio returned an average of 3.38% per year, just enough to keep pace with inflation over time, but not much more.

However, if you look at the worst one-year and worst five-year return, that portfolio has basically never lost value.

So, if you’re an investor who cannot tolerate any downside risk to your portfolio whatsoever, then treasury bills or bonds could be good for you. It’s very unlikely you’ll lose money on them.

But, the downside is you’re leaving a TON of potential wealth on the table.

Now, let’s look at the far right side of the chart. This is their “Most Aggressive” portfolio which is invested 70% in U.S. stocks and 30% in international stocks.

This portfolio has returned an incredible 10.02% per year, on average, from 1926–2016. It underscores, yet again, that stocks are some of the best-performing assets for investors.

Great — so what’s the catch?

The worst one-year return for that portfolio was a horrifying -67.6% drop (I’m guessing that was the Great Depression crash of 1929) and the worst five-year return was a -17.4% decline. So again, all that extra upside return comes with some downside risk over the short term.

As brutal as those declines are, it’s critical to keep in mind the market has tended to recover (and then some) over 10-year and 15-year periods.

This chart from American Century Investments shows that if you had invested in the S&P 500 during ANY 10-year period from 1926–2017, you would’ve made money during 94% of those samples. And if you had invested during ANY 15-year period, you would’ve made money 100% of the time.

So, while bond investors definitely look pretty smart during nasty stock market downturns, long-term stock investors have always had the last laugh when it comes to profits, leaving their bond friends in the dust.

If you have a long time horizon to invest in stocks, you can have a decent amount of confidence they should perform well. But if you need your money in the near time (for example, for retirement next year), you could be devastated by a market sell-off and unable to hang tight through a recovery.

The right balance between risk and reward is a highly personal question for investors. Some choose to split the difference by holding some stocks and some bonds and then shifting the mix over time.

Their portfolio might look something like the “Growth” or “Aggressive Growth” portfolios in the Fidelity chart above.

Either way, return and risk are two hugely important factors to consider when deciding which type of investment is best for you.

In addition, investors must ask themselves which type of investment they are most likely to succeed with.

This is another personal question that can make a big difference in which type of investment is best for you.

Some investors are born with all the skills to be great stock market investors. They’re naturally thoughtful, curious, analytical, and enjoy learning about businesses. Others learn these skills over time and perform just as well.

However, some investors are better suited for activities like real estate investing, which might involve traveling around to view different properties, coordinating with repairmen to monitor construction projects, and negotiating with buyers and sellers to turn over their inventory.

Again, this is a highly personal question. Where do you see yourself most likely to succeed?

It’s difficult to provide too much advice here, other than to say this:

Investing in stocks can build tremendous wealth for a wide range of investors interested in a wide range of stocks. However, it does take a certain amount of patience, discipline, analysis, and smart decision making.

If that doesn’t feel like a fit for you, or your passion is calling you elsewhere, then you may be better off pursuing other types of investments.

For this question, I’ll assume you’re interested in investing in stocks because that’s my area of expertise and I can best speak to the time and energy involved.

First, let’s say you want to do all your own original research and have a small amount of time (call it an average of 2–10 hours per month) to put into your investing activities. In my experience, that’s enough time to hand-research and buy your own stock portfolio.

If you wanted to follow an investment newsletter (where experienced investors send you high-quality stock research and recommendations) you could probably reduce that time to 1–2 hours per month (and potentially improve your profits as well).

If you have the time and interest, buying your own stocks could be a good way to get experience investing, have some fun, and most importantly, try to beat the market. This is called “active investing.”

Historically, the S&P 500 has returned somewhere between 7% — 10% per year over long stretches of time.

If you could beat the market and deliver 12%, 15%, or even 20%+ returns each year, you could compound your wealth at an astounding rate.

This is why many investors choose to trade their own stocks: they want to achieve outsize returns that will grow their wealth faster and larger.

But what if you don’t have an average of 2–10 hours each month to trade your own stocks?

In that case, it might make sense for you to buy a few simple ETFs or mutual funds to create a portfolio that matches your return / risk profile and then let them run on their own. This is called “passive investing.”

For most passive investors, the S&P 500 makes an excellent investment. It has a stellar long-term track record, owns 500 high-quality large-cap stocks, and many brokerages offer S&P 500 funds or ETFs for a very low fee.

Some investors choose to put all their investment money into the S&P 500, while others diversify a bit by also buying an international stock fund / ETF, a bond fund / ETF, or an actively managed mutual fund.

When researching mutual funds and ETFs, my one piece of advice would be to look carefully at their after-tax, after-fee net returns.

Research suggests ETFs are better than actively-managed mutual funds at delivering positive net returns (net meaning the percentage return after management fees and taxes are taken out), but each one is different.

Make sure to do your homework.

Robo-advisors could be another good choice for those who prefer a passive investment approach. They manage your portfolio based on your risk profile and implement strategies to minimize your capital gains taxes.

Which brings us to another important point:

Do-it-yourself investors who want to manage their own stock portfolio will pay no ongoing management fees to outside parties, whereas do-it-for-me investors who invest through ETFs, mutual funds, and robo-advisors will pay an ongoing fee for the management of their money.

Over time, these annual fees can add up and significantly eat into your long-term investing profits.

Now, if the returns you achieve by outsourcing your investing to an ETF, mutual fund, or robo-advisor are higher than you could achieve on your own, then the fees could be worth it. It’s just important that you ask yourself whether the fees you pay are resulting in higher profits in your account.

The amount you have to invest could rule out a few of your options.

For example, buying real estate properties is likely to require at least tens of thousands of dollars to get started.

And some mutual funds have minimum investment amounts, but this seems to be going away as robo-advisors accept any size investment and steal mutual fund business.

When it comes to stocks and ETFs, you can start with pretty much any amount. While stock prices vary, you can often buy shares for under $10, making them an accessible option for many investors.

We covered a lot in this article, breaking down the pros and cons of investing in stocks, bonds, real estate, mutual funds, ETFs, and robo-advisors.

Here’s a quick summary of the most important points:

• Stocks have had excellent returns over time, making them one of the best long-term investments to maximize your profit (real estate is close behind).
• In the short term, stocks can have volatile drawdowns, so it’s critical you invest for the long term.
• Bonds offer great stability and steady income, but their long-term returns lag stocks by a ton. Buying bonds leaves a ton of potential wealth on the table over time.
• Actively managed mutual funds are a dying breed as their high fees tend to erode their often mediocre performance.
• Passively managed mutual funds (basically index funds) and ETFs can provide an easy and diversified way to invest in stocks for the passive do-it-for-me investor.
• Fees charged by mutual funds, ETFs, and robo-advisors can eat into your long-term returns in a big way.
• There are no long-term fees for investing in stocks, except for trading costs which are often less than $8 per trade or free at some brokerages.
• Buying dividend stocks can provide steady bond-like returns in the form of dividends with the upside of price gains if the stock goes up.
• Stocks, mutual funds, ETFs, and robo-advisors can all decline painfully during crashes, bear markets, or corrections. But over the long term, they have tended to perform very well. Since 1926, there’s never been a 15-year period where the S&P 500 didn’t earn a profit.
• Investing in stocks doesn’t have to take up a lot of your time. Using the right tools and strategy you can earn fantastic profit trading your own stocks by investing as little as 2–10 hours per month.

Disclaimer: This article is provided for informational or educational purposes only and is not any form of individualized advice. All information is obtained from sources believed to be reliable but cannot be guaranteed for accuracy or completeness. Use this information at your own risk.