Many more types of investments are available besides stocks, bonds, and cash securities. Many people invest in real estate and in precious metals, primarily gold. What are the risk and return characteristics of these investments and do they provide diversification opportunities to the typical stock investor?

You can invest in real estate in many ways. You can build properties, own rental units, and trade raw land. These activities take enormous time and expertise. One of the easiest ways to invest in real estate is through real estate investment trusts (REITs) that trade like stocks on the stock exchanges. A REIT represents ownership in a portfolio consisting of a pool of real estate assets. An index of all REITs is a good measure of the performance of the real estate market. The following table shows the annual returns for the All REITs Index alongside the returns of the S&P 500 Index. Gold has been a highly sought-after asset all over the world, and has retained at least some economic value over thousands of years. The United States has had a very chaotic history with gold. Americans have sought to “strike it rich” through gold rushes in North Carolina (early 1800s), California and Nevada (mid-1800s), and Alaska (late 1800s). Struggling in the Great Depression, President Franklin D. Roosevelt ordered U.S. citizens to hand in all the gold they possessed. The ban on U.S. citizens owning gold was not lifted until the end of 1974. The table also shows the return from gold prices. The returns for stocks, real estate, and gold are all volatile. However, during many years, the return of one asset is up while the others are down. This looks promising for diversification opportunities.
a. Using a spreadsheet, compute the average return and standard deviation of each of the three asset classes.
b. Compute the annual returns of a portfolio consisting of 50 percent stocks / 40 percent real estate / 10 percent gold. What is the average return and standard deviation of this portfolio? Also compute the average return and standard deviation of the following portfolios: 75 percent/20 percent/5 percent and 80 percent/5 percent/15 percent. How do these portfolios perform compared to owning just stocks?
c. Plot the average return and standard deviation of the three assets and the three portfolios on a risk-return graph like Figure9.3.

  • CreatedSeptember 23, 2014
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