Financial Instruments vs. Real Estate Investments: How to Maximize the Risk/Return Ratio?

By José Carlos Palacio, Head of Administration and Finance at Paraguay Sotheby's International Realty

In a context of controlled inflation but fluctuating interest rates, the classic question among investors once again takes center stage: is it better to invest in real estate or invest in financial instruments? Beyond personal preferences, the key lies in objectively analyzing the risk/return trade-off. This approach allows for more informed decisions, especially in economies like Paraguay, where the preference for tangible assets remains high, but financial products are increasingly gaining ground.

Risk and profitability: two inseparable dimensions

In any investment, risk and return go hand in hand. Generally, a higher expectation of profit implies assuming a greater level of uncertainty. While return represents the expected return on the capital invested, risk measures the possibility that this return will not materialize as expected.

In the financial field, metrics such as Internal Rate of Return (IRR), Net Present Value (NPV), volatility, and liquidity are used to estimate both factors. In Paraguay, where many investment decisions are guided by tradition or financial instinct, incorporating these technical concepts can reveal more efficient opportunities, even if they are not the most obvious at first glance.

Financial instruments: diversification and performance with technical management

Sovereign bonds, local and international stocks, mutual funds, stock certificates, and other financial instruments can offer competitive returns, often higher than those of traditional real estate. These vehicles allow for portfolio diversification, greater liquidity, and access to international markets. However, they also entail risks related to market volatility, inflation, interest rates, and issuer performance.

For example, a fixed-income fund can generate annual returns between 6% and 10%, depending on the economic context and the profile of its constituent instruments. Stocks, on the other hand, can double in value in a few years or suffer sharp declines in a matter of weeks. Therefore, it is essential to understand systemic risk (affected by the overall context) and specific risk (linked to the asset itself) when choosing a fund.

Real estate investments: stability, but with active management

The Paraguayan real estate market has shown remarkable stability and sustained growth in areas such as Asunción, Luque, San Lorenzo, and tourist towns like San Bernardino. Legal security regarding property ownership and the cultural tradition of "investing in real estate" strengthen this preference among conservative investors.

A well-located property can offer a net return of 5% to 8% annually if properly managed and occupied. Furthermore, its medium- and long-term appreciation typically balances the more modest initial return. However, unlike some financial instruments, real estate is not a passive asset. It requires maintenance, lease management, utility coverage, taxes, and, eventually, renovations. All of this can impact the asset's actual profitability.

Risk-adjusted returns: useful comparisons

One way to make more technical decisions is to apply the logic of risk-adjusted returns. In this sense, indicators such as the Sharpe ratio (used to assess whether an investment's returns are adequate relative to the risk involved) or the Treynor ratio (which assesses the return obtained per unit of market risk assumed by the portfolio) allow for comparing different assets under a single lens: how much is earned per unit of risk assumed.

Below is a comparison table that shows the main differences between the two investment alternatives, considering key criteria for evaluating their suitability:

Conclusion: Towards a more comprehensive view of investment

It's not a matter of choosing between black and white. Real estate and financial investments are not mutually exclusive, but rather complementary. A balanced portfolio can benefit from the stability of real estate and the dynamism of financial markets.

To achieve a maximization of the risk/return ratio, it is key to:

• Define a clear time horizon.

• Evaluate the liquidity needed.

• Consider transaction and maintenance costs.

• Measure the expected volatility of each asset.

• Diversify to minimize specific risks.

Ultimately, the key lies in combining technique, analysis, and common sense. The most profitable investment isn't always the one that generates the most income, but rather the one that does so with the lowest possible risk within each investor's profile. And in this process, both real estate and financial instruments have a role to play.