Profitability: What to invest in?
A fundamental question we must ask ourselves before investing is: What return will I get on my investment? In practical terms, return represents the profit earned from investing money in financial assets or institutions and is expressed as a percentage of the initial investment. Investing is essential for growing our wealth, and as investors, our mission is to identify the most profitable opportunities available.
How to Calculate Return on Investment (ROI)
The formula for return is straightforward:
R = (FV - VP)/VP x 100
Where:
FV = Future Value
PV = Present Value
For example, if we invest $1,000 (PV) and after one year it grows to $1,400 (FV), the return is 40%. However, returns diminish over time due to compounding effects.
It is for this reason that we must calculate the compound annual return of our investments with the following formula (CAGR) in this way we can know what the annualized return of an investment is over time.
For the same $1,000 we obtain $1,400 but this time in 2 years, our profitability falls to 18%, in 3 years to 12%, and in 5 years it is only 7%. This method helps determine the annualized return of an investment, smoothing out fluctuations over time.
Common Investment Options
Once we grasp the concept of returns, we can explore traditional and accessible investment avenues based on financial capacity and risk tolerance:
Real Estate: Investing in rental properties is a traditional approach, often requiring high upfront capital with moderate returns.
Entrepreneurship: Starting a business offers high potential rewards but comes with significant risks.
Stocks: One of the most profitable options, but requires knowledge and research to be successful.
Gold & Precious Metals: Considered safe-haven assets, they can be profitable, although recent performance has been inconsistent.
Cryptocurrencies & Other Alternatives: Highly volatile and speculative, offering potential high returns but also substantial risks.
Our goal is to find the best option that combines performance and security , thus maximizing the growth potential of our capital. Of course, before investing, we must take into account our investor profile, our availability of capital and the period we are willing to wait to obtain profits. It is important that we evaluate all investment options carefully to determine which one best suits our profile.
1. US Government Bonds
To begin with, something important that we should know is that there is such a thing as a safe and profitable investment (unless the country declares bankruptcy). I am talking about the 10-year bond from the United States government . This bond is considered the safest investment and serves as a barometer for investors ( investment with low risk and low profitability). Historical profitability is taken as a reference, which has been 2% per year on average, and is compared with other investment options. It can be considered that everything begins from this point.
However, once we have a secure investment base, it is essential to look for alternatives that offer us a return higher than 2%. This implies a process of constant research and analysis that allows us to find interesting opportunities.
If we consider that historical inflation has been 2% on average, it is essential to look for better avenues, since a 2% return with 2% inflation is a real return of 0%. It is important that we evaluate all the available options and find the best possible idea that offers us the maximum return based on our profile as an investor, our availability of capital and our long-term goals.
In the following lines we will analyze investment options, with their possible returns, under different assumptions, in order to allocate our money to the best possible investment.
The Bond is considered the safest investment and serves as a barometer for investments.
It has an average annual historical return of 2%
2. Real estate investment
Real estate investing is a popular choice for many people due to its relative safety and simplicity. It involves buying a property for a certain value and renting it out to make long-term profits from both the rent obtained from tenants and the capital gains from the property.
Historically, this type of investment has given investors an average return of 3%~6% in the American market, and something similar has happened in the Spanish market, with historical returns between 3% and 5%.
Real estate investment case
The calculation is simple: let's say we buy a property for €250,000 and rent it out for €1,000 per month, earning an annual income of €12,000 (cash flow). After deducting some maintenance costs of €2,000 (in the best case scenario), we get an annual net income of €10,000. If we divide this annual net income by the purchase price of €250,000, we get a return of 4% per year (not counting possible unforeseen events and levies).
There is no doubt that investing in real estate is not without risks . Unforeseen events may arise with tenants, levies ( additional costs that may arise in a community of owners to carry out works or improvements in the building) , renovations, extraordinary expenses in the community, and other factors that can negatively affect the profitability of the investment. In addition, new taxes and rates that arise in some countries can also significantly affect the profitability of the investment.
Furthermore, real estate investing requires a high initial investment , which can be an obstacle for many investors considering this option. A common alternative is to invest in a leveraged way, combining part equity and part financed by a loan. However, it is important to keep in mind that interest rates can fluctuate suddenly and affect the profitability of the investment.
Property Returns US
Type of investment with moderate returns and not as safe as is often thought. It is important to consider all the risk factors and perform a cost analysis before making an investment decision.
It has an average annual historical return of 4%
3. Entrepreneurship
While it is true that starting a business can be very profitable, there is also the possibility of losing everything. Running your own business depends on the skills of each person, and unfortunately “not everyone has what it takes to be successful in business” . Statistics indicate that 30% of businesses fail in the first year, 60% of businesses fail by the fifth year, and after 10 years, 90% have disappeared.
People start their small businesses with great enthusiasm, but they forget that entrepreneurship requires more than just enthusiasm; it requires some basic knowledge to be successful, and this knowledge is something that very few people are willing to assimilate, overlooking concepts of accounting, finance, marketing and management, which are necessary for the development of a successful business. Enthusiasm is not enough.
It could be said that entrepreneurship is asymmetric in many cases, high risk - low reward, and this is certainly not a good sign of investment. Obviously, this is not the case in all cases.
The ice cream shop xoco xoco
Let's take the example of setting up an ice cream parlour. A small ice cream business with 4 employees. We initially invest €100,000 and plan to generate annual cash flows of €33,000. In this case, the return on investment is 33% (the investment is recovered in 3 years). This is in the best case scenario, where we have devised a favourable scenario, without unforeseen events. Now, if we add negative assumptions, such as a recession, a health crisis like in 2020, problems in the management of the municipality, or even weather changes, our ice cream business may be affected. In this case, the annual cash flows could be even 20% less than the optimistic scenario, generating a cash flow of €26,400 per year. Now our profitability is 26% (we recover the investment in 4 years), and so on, if we add more layers of unforeseen events to our venture (poor administrative management, inflation, tax increases, interest rate increases, job losses, structural reforms, competition, etc.) our investment could probably achieve returns much lower than those we had initially imagined, not to mention that we would probably make losses.
There are many variables that we must control, in addition to taking care of the business every day, so that everything goes according to plan, and even then, nothing guarantees that our venture will be successful.
The following graph shows the survival rate of companies in Europe after 5 years from their creation, and the figures are really worrying. In Spain, after 5 years only 38.5% of companies survive, this means that 60% of businesses that are started in Spain have failed after 5 years for one reason or another, whether it is due to a skills issue, a change in trends, a poor sales strategy, overcosts, excessive tax rates, or simply an uncompetitive product (with low competitive advantages). The situation is not so different in other EU countries or in the rest of the world, so it is advisable to carefully study the risks and possible returns on investment before embarking on an adventure that otherwise could end up being a problem.
Supervivencia empresarial en Europa
Companies that survive five years after creation in European countries
Risk ~ hard work
The failure rate in entrepreneurship is very high.
Unfortunately, not everyone has what it takes to be successful in business.
4. Gold
Gold is considered by many investors to be a safe haven asset (protection against crises and inflation), as it is an investment that has been shown to maintain its value during periods of economic uncertainty and market volatility.
Historically, gold has been used as a way to preserve wealth, as it has maintained its value over time and has been accepted as a form of payment in many cultures and countries. Additionally, gold is an investment that is uncorrelated to other assets, meaning it does not follow the same trends as other assets such as stocks or bonds.
When investors have concerns about the economy, inflation, politics, or market stability, they may choose to invest in gold as a way to protect their wealth and reduce the risk of loss. Gold can also act as a hedge against currency depreciation and inflation, as its value remains relatively stable compared to paper money.
It is important to note that although gold has proven to be a safe haven asset in the past, it is not a guarantee that it will always perform the same way in the future. Gold prices can be volatile and can be affected by factors such as supply and demand, monetary policy, geopolitical stability and other macroeconomic factors. It is also important to understand that gold is a non-productive asset; it does not generate anything, unlike other assets that we put to work.
Gold has returned an average of 9.8% over the past 20 years (in US dollars) although over the past decade the return has been only 2.1% , which is well below current inflation. This suggests that investors who have invested in gold over the past 10 years have not made a significant return and have in fact seen the value of their investment eroded in terms of purchasing power due to inflation. Gold has therefore not been a good investment choice over the past decade.
The following chart shows the average historical return of gold over the last 20 years.
Annual Return of Gold
An average return over the last 10 years of 2%
It is considered a safe haven asset in periods of volatility.
5. Cryptocurrencies
In recent years, investors, or rather speculators, have been excited about this type of asset. Cryptocurrencies are a type of digital currency that uses cryptography to secure and verify transactions, and to control the creation of new units. Cryptocurrencies are decentralized, meaning they are not backed by any government or centralized financial institution . Instead, they use blockchain technology, which is a permanent, public database that records all transactions.
The first and most well-known example of a cryptocurrency is Bitcoin, but there are thousands of other cryptocurrencies on the market, each with its own characteristics and objectives. Some cryptocurrencies are used as a means of payment, while others are used as investment assets. Cryptocurrencies offer advantages, such as privacy, security and global accessibility, but they also present high risks, such as market volatility , lack of regulation and the possibility of being used in illegal activities . But without a doubt, in my opinion, what may be more doubtful is the fact that there is no total certainty that there will be no more Bitcoins, of the maximum supply of 21 million , in the future. Dilution can be a loss of value of this type of asset.
The following graph shows the Boom and Bust of Bitcoins over the last 8 years, and how having bought Bitcoins at a bad moment in the cycle would have made us lose money, as has happened to many speculators.
There is no doubt that Bitcoin returns in recent years have been impressive, but nothing guarantees that this will be the case in the future. A decline in investor euphoria, strong regulation by governments, the occurrence of scams, security vulnerabilities, among other factors, could lead to a significant drop in the value of Bitcoin, even below its usual prices. Therefore, it is important to carry out a rigorous and cautious analysis of the risks associated with Bitcoin before making an investment decision.
Speculative
Highly volatile
6. Stocks and Long-Term Wealth Creation
We have now arrived at what I consider to be the best way to invest money—stocks in the stock market. Investing in equities, when combined with a disciplined and strategic approach, can be one of the most powerful wealth-building tools over time. While stock market returns can fluctuate due to various factors—including the investor’s skill level, geographic region, industry sector, company size, and investment horizon—history has shown that long-term investing in stocks has consistently delivered strong returns.
In the United States, the S&P 500 Index, which tracks the 500 largest publicly traded companies, has generated an average annual return of 8%–10% since its inception in 1957 through the end of 2021. This includes dividends reinvested and is adjusted for inflation. However, it is important to recognize that these returns are not guaranteed and can fluctuate significantly depending on market conditions. Short-term volatility is inevitable, but the stock market has historically trended upward over extended periods.
S&P 500 Annual Returns Since 1958
While stocks offer superior long-term returns, they also come with inherent risks, including price volatility, economic and political uncertainty, and company-specific risks. To mitigate these risks, investors should focus on diversification across sectors and regions, invest in fundamentally strong companies, and adopt a long-term mindset rather than engaging in short-term speculation. Holding assets in strong economies, stable currencies, and well-managed companies helps reduce exposure to unnecessary risks.
Stock investing can also be seen as a business-like approach to wealth creation. Unlike traditional businesses that require significant capital and constant attention, investing in stocks allows for scalable growth with minimal initial capital. Investors can start small and increase their investments as they gain experience and confidence. Additionally, stock market investing offers flexibility, enabling individuals to combine it with other responsibilities or careers while still building wealth over time.
A key advantage of equity investing is the power of compounding, which allows wealth to grow exponentially over time. The best investors achieve long-term returns that far exceed market averages. Good investors earn +20% annualized returns, while elite investors generate +30% annualized returns. To illustrate, a $10,000 investment growing at 30% per year for 20 years would turn into nearly $2,000,000. Investors like Warren Buffett achieved +50% annualized returns in their early years, and while Berkshire Hathaway now averages 20% annual returns, it still outperforms the S&P 500 and most investors.
The following chart shows the average return of the S&P 500 over the past 60 years, consistently falling between 8%–10%. For those who prefer minimal effort while still capturing the overall stock market return, investing in index funds that track the S&P 500 is an excellent option. This passive investing strategy allows investors to benefit from long-term market growth, reduce the risks associated with individual stock-picking, and achieve solid returns with minimal active management.
By simply holding an S&P 500 index fund, investors can match the performance of the largest U.S. companies without extensive research or market timing. The stock market remains one of the best ways to grow wealth over time, and history has shown that disciplined investing leads to significant returns. The key is patience, diversification, and a long-term vision.
This chart shows the evolution of the index over time, going from 45 points in 1960 to 3200 points in January 2020, a compound annual return of almost 8% (CAGR).
Ultimately, the stock market is the best way to take care of your capital, as long as you do it with knowledge, without rushing and applying a lot of common sense.
Average annual return between 8% and 10%. (S&P 500)
Good investors achieve returns of over 10% with active investment work selecting stocks.
Choosing the Right Investment Strategy
Once we have analyzed various investment options, such as real estate, entrepreneurship, stocks, bonds, gold and cryptocurrencies, it is crucial that each person finds the best option according to their investor profile, their investment capacity and their long-term goals.
To do this, it is important to carefully evaluate each investment or business idea, in order to be prepared to make changes when necessary and opt for opportunities that can provide you with a higher return (avoid losses and maximize your profits).
When investing, it is essential to consider factors such as risk, liquidity and diversification of your investments, in order to make informed and correct decisions at all times.
Entry and exit cycles are also extremely important to achieve good returns on our investments. We may have an excellent investment idea and have done our calculations very well, but if the timing is not correct, our profitability can be reduced simply by having entered at a bad time in the cycle.
In short, stocks are the most profitable and secure asset, diversifiable, and with a high potential for revaluation, as long as a good job of selecting the stock is done. It is worth remembering that when we buy a stock, we are not buying a simple piece of paper, we are buying a piece of a company and however small it may be (yes, very small), we are part of that company, of its profits, dividends, decisions, and of everything that the company does.
I invite all potential investors to reflect on their future investments, carefully evaluating whether they will be profitable, or whether on the contrary, they could become bad investments and a real headache.
Thinking in terms of profitability is crucial for our business and investments. We must allocate our money, time and energy to the most profitable options, so as not to lose two of the most valuable elements of an investor, time and money.
"If you can't find a way to make money while you sleep, you'll work until you die" Warren Buffett