What’s the ideal investment?

Today, I’ll tell you how to define the “ideal” investment… what the ideal investment has been over history (you will likely be surprised)… and I’ll show you the easiest way to invest.

Let’s get started…

Is the ideal investment the one with the highest potential returns? Actually, no…

[ad#Google Adsense 336×280-IA]Some “options” trades, for example, can make hundreds of percent returns (or even thousands of percent returns). But you can also wake up one morning and see the value of that option has literally gone to zero overnight. When the potential returns are ridiculous, the risks are usually ridiculous, too.

So is the ideal investment the one with the least risk? No…

No risk equals no return.

The ideal investment is the ideal mix of these two things… The ideal investment is the one with the highest return, relative to the amount of risk taken.

We have a rough measure of this in the investment world. It’s called the “Sharpe Ratio.” The higher the Sharpe Ratio, the more return you get relative to the risks you’re taking.

Take a look at the returns and Sharpe Ratios of a few major investments over the last 20 years:

A few things immediately pop out…

U.S. small-cap stocks had the highest return, by far. But they had extremely high risk (measured by annual volatility). So they didn’t have the highest return relative to the amount of risk taken.

High-quality, “investment grade” corporate bonds were the more ideal investment over that 20-year period… They had half the return of small-cap value stocks… But they delivered that return with less than a quarter of the volatility. But bonds pay nothing today. And maybe they won’t do as well going forward.

If you’re willing to look beyond stocks and bonds, you can find some investments that are even more ideal…

Timber, for example, has a history of high, stock-like returns with low, bond-like volatility. Using the same time period in the table, timber had a compound annual return of 11.8%, with risk (annual volatility) of only 7.9% – for a Sharpe Ratio of 0.96. That is hard to beat…

That makes timber an ideal investment, based on history.

In the past, I’ve flown around the world with timberland experts looking at timberland investment opportunities. It looks like it might be time to dust off some of that timber research…

I am not alone in thinking this…

Famed investment manager Jeremy Grantham believes “managed timber” will be the best-performing asset class over the next seven years (based on his most recent Seven-Year Asset Class Forecast at www.gmo.com). That’s not the best performer based on the Sharpe Ratio… That’s the best performer, period.

In his latest quarterly letter, Grantham wrote: “For those with a long horizon, I am sure well-managed forestry and farmland will outperform the average of all global assets.”

The ideal investment is one with high returns relative to the amount of risk taken. If you’re willing to look outside the traditional investments of stocks and bonds, you can find some REAL ideal investments.

Timberland should be near the top of that list. Two easy ways to play it are through the exchange-traded funds CUT and WOOD, which hold a basket of timber REITs and timber-related stocks.

Both funds have fallen dramatically in recent weeks. But when the uptrend returns, I may be a buyer.

Good investing,

— Steve Sjuggerud

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Source:  Daily Wealth