Looking for Safe Return: Dueling Strategies

Bill Bernstein, a neurologist turned respected investment expert, told Olly Ludwig (in an interview for Index Universe) earlier this year that the anticipated return on an investment portfolio that was 50% stocks and 50% bonds was “as low as it has ever been.”

His statement suggested that the time-honored recommendation to a larger proportion of safe bonds later in life will bring little more than safety. Some advisors try to counter this to boost returns by adding junk or emerging market bonds or T-notes longer than 10 years to client portfolios. Bernstein believes that this tactic is fraught with risk.

If this is so, what is an investor to do? Bernstein says in his recent e-book The Ages of the Investor (55 pages; $4.50), that shareholders don’t have a choice about what to do. If they saved enough for retirement, they can’t afford to lose it by buying risky assets. He includes the three categories just discussed within this broad classification. Bernstein further points out that a careful person who saved for retirement is often not prepared for the magnitude of defaults that could occur in these assets.

There are other views on what to do with money to keep it relatively safe, but that also glean greater return. Burton Malkiel, another investment expert, even a guru, espouses a different approach to the problem of low yielding CDs and short-term T-bills. He suggests replacing some of these instruments with large-cap stocks with healthy dividends. In this way, more yield is gained.

Whether or not this is a good idea was also addressed by Bernstein in his Index Universe interview. The former neurologist points out that with a market fall the dividend probably won’t decrease as much as the stock price. Between 2007 and 2009, the S&P price per share fell by more than 50%, but the dividend yield diminished much less — only 23%. In the Great Depression price per share fell by 90% but the dividends were shaved by only 50%. But, is a careful person who has saved enough for retirement ready for this type of market drop and the mental jolt it produces? Bernstein thinks not and so do I for some of my clients.

Both Bernstein and Malkiel are more than competent individuals in the investing arena. Each has written multiple books about investing. Nevertheless, which of the two is right for the best future portfolios asset distribution is anybody’s guess. It certainly depends on the ability of an investor to psychologically withstand down markets. It also depends on what happens in the future. Since we know more about the former than the latter, it should carry more weight for an individual investor’s decision.

Thereby, those who become queasy if the market tanks might want to follow Bernstein’s suggestions. On the other hand, investors who weather market bumps with more aplomb might be inclined toward Malkiel’s solution. The good news for all is that the market always reverts to the mean. The bad news is that none of us know when.