Profitability of Equity, Real Estate and Fixed Income

Subject: Research on the yearly HPRs of Equity, Fixed Income and Real Estate calculated on a month basis

In order to have a better conceptual understanding of return and risk, I conducted a research on the yearly return, risk and efficiency of Equity, Fixed Income and Real Estate, and constructed a correlation matrix among them.

Data gathering

I gathered equity data from Yahoo Finance S&P 500 index, Fixed Income data from Yahoo Finance VBMFX, and real estate data from Case-Shiller from 1998 to 2015. The analysis selects a period from 1999-2014, but we still need 1998 and 2015’s data to fully conduct the research.

Raw data processing

I chose to use formula “HPR=current month index/last year’s corresponding month index-1” to generate yearly return data points on a month basis. There are 12 HPR data points in a single year.

Utilizing Excel, I generated 3 tables presenting the Average Expected Return, Risk (Standard Deviation), Coefficient of Variation of the assets respectively.

In order to acquire the probability of loss of capital, or the probability of a negative return of capital, I assume that the Expected return is 0, and calculated the z-scores of the three assets in different periods. The z-score helps to translate these data into a standard normal distribution, and finally we can get P(loss), which also represents P(x<z) with Excel and raw data above.

Analysis Results

Below are the tables which present the results.

(1)Horizontal analysis

Equity earns the highest average return, with its corresponding high risk (or variance). There’s a nearly 30% chance that you can’t fully get your capital back.

Fixed income earns a more stable and reasonable rate of return. This is consistent with its satisfactory low volatility compared to equity. There’s a very little chance that you can’t fully get your capital back (nearly 0 possibility).

Real estate earns a relatively low rate of return with moderate risk (or variance). However,...