How Private Equity vs. Stock Market Returns Compare

Private equity investments can offer returns that significantly exceed those from investments in publicly traded stocks. However, earning these higher returns depends on a number of circumstances, including the specific private equity fund chosen for investment as well as economic and market conditions. In addition to promising different returns, these two asset types also have significantly different characteristics when it comes to important concerns such as accessibility, liquidity, investment horizon and risk. You may want to talk to a financial advisor to understand how each fits into your portfolio.

How Private Equity Returns Work

Private equity typically involves buying shares in private companies or acquiring public companies to take them private. Once a controlling stake is accumulated, the private equity investors aim to actively manage their portfolio businesses’ operations, with the goal of improving their performance and eventually selling them at a profit.

A key trait of private equity investing is that it is generally less accessible than the public stock market. Only accredited investors are typically permitted to invest in private equity, and this category does not include the large majority of investors.

Investors qualified to tap private equity can hope for appealing results. On average, private equity returns have outperformed public market returns over extended periods. According to data from Cambridge Associates, as of Dec. 31, 2023, private equity funds have delivered an average annual return of 13.1% over the previous 25 years, well ahead of the 8.6% average return posted by the S&P 500 during the same period.

However, it’s important to note that private equity performance can vary significantly based on factors such as the industry, the economic climate and the specific strategies employed by the private equity firm. Over certain periods, private equity shows up poorly against the public stock market. During 2023, for example, private equity returned about 9% on average while the S&P 500 generated an approximately 25% return.

Also consider that much of the positive returns from private equity typically are generated by a small handful of funds. In any given year, top-performing funds might achieve returns exceeding 20%, while others may fall short of expectations, delivering single-digit returns or even losses. The skill and experience of the private equity firm play an important role, as successful firms are adept at identifying undervalued companies and implementing strategies to enhance their value.

Additionally, the timing of the investment can impact your return. Private equity Investments made during economic downturns often yield higher returns when the market recovers. The sector in which the investment is made also matters, as some industries may offer more growth potential than others.

Investors should also consider the impact of fees and expenses on private equity returns. Private equity firms typically charge management fees, which can range from 1% to 2% of the committed capital, and performance fees, often around 20% of the profits. These fees reduce the net returns to investors.

How Stock Market Returns Work

Historically, the stock market has provided average annual returns of about 10%. This range is based on long-term data from major indices like the S&P 500. Future returns are not guaranteed and can vary significantly from year to year. For example, during a bull market, returns might soar well above the average, while in a bear market, they could plummet into negative territory.

Other factors that can influence stock market returns include economic conditions, interest rates and corporate performance. Economic growth often leads to higher returns as companies expand and profits increase. But, returns may suffer as businesses face challenges during economic downturns.

Interest rates also play an important role. Lower rates can boost returns by making borrowing cheaper for companies, while higher rates might dampen them. Additionally, individual company performance, driven by management decisions and market competition, can significantly impact returns.

Tips for Choosing the Right Assets for Your Portfolio

Building a well-balanced investment portfolio is key for achieving your financial goals. Here are five general tips to guide you in selecting assets for your portfolio:

Understand your risk tolerance: Before selecting any assets, assess your risk tolerance. This involves understanding how much risk you are comfortable taking on and how it aligns with your financial goals. A higher risk tolerance might lead you to invest in stocks, while a lower risk tolerance might steer you towards fixed-income securities.
Diversify your investments: Diversification can help reduce risk in your portfolio. By spreading your investments across different asset classes, such as stocks, bonds and real estate, you can mitigate the impact of a poor-performing asset. This approach helps ensure that your portfolio remains stable even if one sector experiences a downturn.
Consider your investment horizon: If you have a long-term horizon, you might opt for growth-oriented assets like equities, which can offer higher returns over time. Conversely, if your investment horizon is short, you might prioritize more stable, income-generating assets.
Evaluate asset liquidity: Liquidity refers to how easily an asset can be converted into cash without affecting its market price. It’s important to have a mix of liquid and illiquid assets in your portfolio. Liquid assets, like stocks and bonds, provide flexibility, while illiquid assets, like real estate, can offer long-term growth potential. Private equity is generally less liquid than public stock investments.
Stay informed about market trends: Keeping abreast of market trends and economic indicators can help you make informed decisions about asset allocation. Regularly reviewing financial news and reports can provide insights into which sectors are poised for growth and which might be facing challenges.

Bottom Line

An investor reviewing his stock portfolio.

Private equity can provide higher returns when compared with public stock investments, but returns vary from year to year and among different private equity firms. Over specific periods, an investment in a broad public stock market index can beat private equity performance by a wide margin. Private equity returns also depend heavily on the specific private equity firm, the industry being invested in and other factors. Private equity is also much less accessible than stock market investments and offers less liquidity, requires a longer time horizon and can involve more risk.

Tips for Investing

A financial advisor can help you evaluate investment opportunities and maximize returns. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Whether you’re investing in private equity or another asset, you may owe capital gains tax if you sell your investment for more than you paid. SmartAsset’s capital gains tax calculator can help you get an estimate for how much your tax bill could be.