The Hidden Source of Real Returns

Surprisingly, many investments underperform over time—including bonds, stocks, and real estate. That may sound counterintuitive, but it’s supported by a long track record of data. A significant number of investments tend to deliver mediocre or even poor results for passive investors. This pattern is not necessarily a reason to avoid investing, but it highlights the importance of understanding where returns tend to originate.

If the goal is to find investments that compound wealth over time, history suggests that returns tend to be concentrated in a small number of winners. Whether in bonds, stocks, or real estate, the top outliers account for most of the returns.

Bond Returns The U.S. dollar has been one of the strongest currencies globally for a century—second only to the Swiss franc. The U.S. economy has been the world’s largest throughout this time, and yet, even as the dollar became the world’s reserve currency, U.S. government bonds underperformed just holding gold.

Professor Aswath Damodaran tracks market performance back to 1928. An investor who put $100 in T-bills in 1928 and compounded through 2023 would have $2,249. Opting for longer-term T-bonds would have turned that $100 into $7,278. But this is largely due to inflation. That same $100 in gold would be worth $10,042 today. Meanwhile, the U.S. money supply increased more than 400x in that time.

Gold holders weren’t immune to dilution either, as annual global gold supply grows by about 1-2%, but gold’s purchasing power remained steady over time. Over long timeframes, the price of oil in gold terms has remained relatively stable, suggesting gold’s purchasing power has held up better than fiat currency. Gold didn’t appreciate so much as it diluted at a slower rate than fiat currency.

Stock Returns Studies over the years have shown that most stocks deliver poor returns. Professor Hendrik Bessembinder examined U.S. stocks from 1926 to 2019 and found that more than half underperformed T-bills. Just 4% of stocks accounted for nearly all the market’s excess returns. Of those, 86 stocks were responsible for half the market’s wealth creation. In many cases, most stocks have failed to outperform T-bills over the long term, and only a small minority have produced the kind of outsize returns that drive long-term wealth creation.

The situation is even worse internationally. A study of 64,000 stocks from 1990 to 2020 found that 55% of U.S. stocks and 57% of non-U.S. stocks underperformed T-bills. In fact, just 2.4% of companies worldwide accounted for all stock market gains over those three decades. Outside the U.S., it was even more concentrated—only 1.41% of firms created any net wealth.

Real Estate Returns Real estate is often seen as a reliable investment—and in a lot of ways it is—but the long-term numbers tell a more nuanced story. According to Damodaran, $100 invested in U.S. real estate in 1928 would be worth $5,360 today—better than T-bills but worse than T-bonds or gold.

Looking further back, Professor Robert Shiller’s data since 1890 shows home prices have increased 88x in nominal terms, while gold increased 123x. Factor in maintenance costs and property taxes, and the gap actually widens further.

There are, of course, exceptional real estate investments—like buying land in Manhattan in 1900 or Silicon Valley in 1970—but these are rare. Many properties, like those in Detroit and similar areas hit hard by economic decline, have lost most of their value over time. Even in Japan today, millions of homes are essentially free because there’s no demand. Population growth historically props up real estate but returns become dependent on this.

Owner-Operators Win, Passive Investors Often Don’t

While many investments in businesses, stocks, and real estate haven’t produced strong passive returns, that doesn’t mean they didn’t serve a meaningful role.

Many businesses create tremendous value for founders, employees, and customers- serving communities, meeting real needs, and creating livelihoods—even if their stocks don’t deliver exceptional returns for passive investors. The company provides salaries, benefits, and services to customers. The owner-operator earns a living, but the passive investor—who only collects whatever is left after salaries, expenses, and reinvestment—often doesn’t fare as well.

The same is true in real estate. Actively managed properties that are improved and strategically sold have historically produced stronger outcomes than passive ownership. In contrast, unlevered real estate has typically delivered modest long-term returns.

Turning Mediocrity into Wealth: Leverage

One of the ways investors have historically improved returns is through leverage. Used properly, it turns average investments into winners. Used poorly, it can lead to significant losses—and in some cases, even career-ending mistakes.

Bonds and Leverage Banks borrow from depositors at low rates and use that capital to buy higher-yielding government bonds or make loans. They operate at 10-to-1 leverage or more, allowing them to earn high returns on equity.

Real Estate and Leverage Real estate is arguably the asset class that benefits most consistently from leverage, thanks to its relative stability and the structure of mortgage financing. Most homeowners put down 20% and borrow the rest, often achieving 5-to-1 leverage. Since real estate has relatively low volatility and mortgages aren’t callable, this strategy has worked well historically. Without leverage, unlevered real estate returns have generally lagged behind gold.

Stocks and Leverage Large corporations also use leverage strategically. Procter & Gamble, for example, has maintained over $24 billion in long-term debt—enabled by its ability to borrow at low rates and reinvest in operations or share repurchases . Apple, the most successful company in modern history, borrowed $108 billion in cheap debt to fund share repurchases starting in 2013. It was effectively shorting fiat currency at low rates and using it to buy equity.

Warren Buffett and Berkshire Hathaway take this a step further by leveraging insurance float. Berkshire collects premiums, holds the capital as a float, and rather than investing it in bonds like most insurers, deploys much of it into stocks—many of which are also leveraged companies. The result is a layered system of low-interest borrowing funding investments in cash-generating businesses. Buffett even took out yen-denominated debt at ultra-low rates to buy Japanese stocks. This approach reflects a broader strategy: acquiring low-cost fiat liabilities and reallocating them into productive, income-generating assets.

The Changing Rules of the Game

For the past 40 years, falling interest rates made leverage a winning strategy. Refinancing debt at ever-lower rates and arbitraging capital across jurisdictions has worked well.

But as rates stabilize and debt burdens rise, that game seems to be getting tougher. Governments with high debt levels struggle to maintain high real interest rates for long. Many turn to financial repression—low rates relative to inflation—to keep debt manageable. Capital controls and geopolitical tensions further complicate cross-border financial arbitrage.

Implications for Capital Allocation

The playbook that worked for the past four decades may not work for the next four. The days of ever-lower interest rates fueling asset appreciation may be behind us. This environment may require more selectivity in capital allocation.

1. Acknowledge that many investments fall short of expectations—especially for passive investors. The majority of businesses and real estate investments don’t generate excess returns for passive investors. That’s always been the case, and it’s not likely to change.

2. Focus on the best businesses. The companies that consistently deliver excess returns tend to have network effects, strong brands, intangible assets, and pricing power.

3. Be careful with leverage. Leverage has been a key driver of wealth, but it’s a tool that cuts both ways. The right kind of leverage—long-term, low-cost debt—can still be powerful, but investors need to be aware of shifting economic conditions.

4. Consider hard assets. In an environment where equities face headwinds, gold and other scarce assets may play a more significant role in portfolios.

The environment that fueled easy returns may be changing. While strong investments still exist, identifying them may require more care and selectivity than in past decades. These observations aren’t meant as predictions, but as principles. While the future is always uncertain, understanding where returns have come from in the past can help guide better decisions going forward.