If you want to reach financial independence, you’ll not only have to save more money than most other people do, but you’ll also have to invest it where it’s likely to provide higher than average returns over the long run.
You can certainly invest your money in an S&P 500 index fund, but that won’t enable you to outperform the market, since the S&P 500 is generally considered to be the market. Where can you have the prospect of higher returns on your money, without taking on a ridiculous amount of risk?
Except during the bursting of the dot-com bubble in the early 2000s, tech stocks have generally outperformed the general market over the past few decades. Will that trend continued into the future? We can probably assume so.
Perhaps more than any other sector in the market, technology companies are creating whole new economies. We can think of computers, the Internet, cell phones, and robotics. The beginning of each of those technologies created whole new opportunities, as have the companies that have gradually improved the technology along the way.
This isn’t to say that technology stocks will be an elevator ride to the top, but only that it is a higher percentage shot than other sectors.
Not only do healthcare stocks traditionally perform well, but healthcare in general is expanding its share of the US economy. Healthcare has increased from 9% of US GDP in 1980, to 16% by 2008 (by 2015, the percentage had risen to 18%). Healthcare is now bigger than most other industries.
It seems as if that growth is destined to continue. This is particularly true when you consider that the Baby Boom generation is now entering the time of life when the need for healthcare rises. Pharmaceutical stocks in particular seem poised to benefit from this trend.
A quick glance at this chart shows that the healthcare sector has outperformed the S&P 500 in seven of the last ten years.
Real Estate Investment Trusts (REITs)
REITs are like mutual funds that invest in real estate. They are typically invested in commercial real estate, including apartment buildings, but they can also be invested in very specific types of facilities, such as health care properties. They invest in these properties either by holding mortgages against them, or by taking actual equity positions. REITs also hold investments on several properties, enabling you to diversify in a way that is often difficult when it comes to real estate.
Over a recent 15 year period REITs earned an average annual return of 10.6% What’s more, they often tend to perform well when stocks don’t. While stocks can be up 30% one year, and down 10% the next, REITs tend to turn in a more consistent performance.
This is in part because REITs pay dividends, but also because they generally invest in higher quality properties. Also, capital fleeing declining stock markets often finds its way into real estate, with REITs being a popular destination.
Peer-to-Peer (P2P) Lending
P2P lending only began about a decade ago, and has only became popular in the last few years. But it’s catching on quickly, because of the above-average returns it provides. It’s hardly impossible to earn an average annual return in excess of 10% per year.
P2P lending is direct lending to borrowers. They come to P2P platforms, such as Lending Club and Prosper, the two largest lenders in the space, looking for loans. As an investor, you can choose which loans you will fund, and at what interest rates.
Since rates average from the mid-single digits up to well over 30%, it is possible to get double-digit returns, even after making an allowance for defaulted loans. What’s more, the amount of information on P2P lending is growing, so it’s becoming easier to be an educated investor.
Investments that Probably Won’t Get You to Financial Independence Quickly
We’ve been discussing investments that will make it easier to reach financial independence, and that’s because they provide above average returns on your money. Some more traditional investments won’t get you there, because of low returns. That doesn’t mean they are bad investments. On the contrary, they can play an important role in your investment portfolio, mainly as a diversification away from the risk involved in the above mentioned investments. If you want to prioritize financial independence or early retirement, the following investments should occupy a smaller percentage of your portfolio.
Those lower performing investments include:
Bank investments and money markets. The vast majority of investments in this category pay market interest rates (currently less than 1% per year). You can go longer term, and get 1.x%, but that still won’t get you to financial independence. The problem is these accounts rarely even keep pace with inflation, leaving you with less buying power in the long run.
US Treasury securities. Despite the safety that these investments provide, the returns are similar to bank investments. For example, yields as of March 31, 2017 are just 1.03% on the one-year Treasury bill, and only 3.03% on the 30-year Treasury bond. Click for current Treasury rates.
Municipal bonds. The income on these bonds is tax-free, but interest rates on AAA municipals are no higher than what you can get on Treasury bonds with similar maturities.
Corporate bonds. Returns are higher here, but nowhere near double digits. The yield on AAA rated corporate bonds has been hovering around 3.50% of late. It would take you about 20 years to double your money with that rate of return.
“Junk” bonds. These bonds carry higher interest rates than AAA corporate bonds, but that’s because they also involve a much higher level of risk of default. This is especially true of bonds issued by energy companies, since oil prices have plummeted. You may be able to get a higher yield, but all of that goes down the drain if the issuer defaults on the bonds.
If you want to reach financial independence in the shortest amount of time possible, you will have to take on greater risk in search of higher returns. But if you are a long-term investor, those risks tend to even out over the years.
If you’re looking to achieve financial independence, what is your preferred investment strategy?