According to investment guru Burton Malkiel …

In a recent WSJ op-ed,  Burt Malkiel stopped random walking and cut to the chase re: the near-term economic climate and  investment options. 

Malkiel says:

The economic data, as a whole, suggest the economy is growing at a rate nearer to 2% rather than its previous trend rate of 3%-4%.

  • The strong employment gains may well have been aided by our unusually warm winter.
  • Rising gasoline prices will put increased pressure on consumers. And a number of strong economic headwinds still exist.
  • The economies of the euro zone are getting worse, not better.
  • The housing sector has yet to make a convincing turn for the better.

Given the present economic outlook, let’s look at three asset classes ranked them from worst to best – bonds, equities, and real estate.

Bonds are the worst asset class for investors.

Usually thought of as the safest of investments, they are anything but safe today.

At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser.

Even if the overall inflation rate is only 2.25% over the next decade, an investor who holds a 10-year Treasury until maturity will realize a zero real (after-inflation) return.

Even if the inflation rate remains moderate, interest rates are likely to rise to more normal levels as the economy continues to recover.

Given the likely trends, U.S. Treasurys and high quality bonds are likely to be extremely poor investments and are very risky.

Equities on the other hand are still attractively priced.

Despite their substantial rise from the October 2011 lows.

A good way to estimate the likely long-run rate of return from common stocks is to add today’s dividend yield (around 2%) to the long-run growth of nominal corporate earnings (around 5%).

Equity returns should be about 7% — five percentage points more than the safest bonds.

This five-percentage point equity risk premium is close to the historical average.

In other words, while equities appear to be favorably priced relative to Treasury bonds, returns are unlikely to be at the double-digit level enjoyed from 1982 through 1999.

Real estate is a particularly attractive asset class

Real-estate prices have fallen sharply, if not to their absolute lows, then certainly very near to them.

Long-term mortgages are below 4% for those who can qualify.

Housing affordability (a measure based on house prices and mortgage rates) has never been more attractive.

Housing has been a dreadful investment since the housing bubble burst in 2007.

I believe it will be one of the best investments over the next decade.

In today’s environment, the minimization of investment fees is more important than ever.

A 1% investment management fee may appear to be very low when measured against assets.

But when measured against a 7% equity return, that fee represents more than 14% of the return.

Against a 2% dividend yield, the fee absorbs one half of the dividend income.

The only way to ensure that you can enjoy top quartile investment returns is to choose investment funds that have bottom quartile expense ratios.

During 2011, over 80% of actively-managed equity funds were outperformed by the broad-based S&P 1500 Stock Index.

Investors can’t control returns generated by world financial markets.

But, they can control is fees paid to investment managers.

And, the quintessential low-expense instruments are broad-based, indexed mutual funds and ETFs.

* * * * *

Personal note: My very first class at Princeton was Econ 101 taught by Burton Malkiel. He was one of the “inspirers” for my majoring in economics. 

As a senior, he was one of my thesis graders … gave me an A, then wrote a Journal of Finance article debunking my findings.  Ouch.

Still think he’s a great economist and a great guy.

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One Response to “According to investment guru Burton Malkiel …”

  1. Frank Says:

    As an asset mgr, I’m very concerned about the fees I collect and pay away. And there is pressure on managers to reduce fees (but when are service providers in any industry not pressured on fees). One enduring lesson from your class I use every quarter is to force my “commodity” service providers to justify themselves constantly from a price standpoint.

    Look, I believe in alpha- and I believe in diversification (the greatest free lunch going). But diversification is done through minimal correlation. If you can generate alpha, via an uncorrelated investment play, there is justification for fees (including, yes, 14% of your yield).

    As I push my fund business forward, all the interest is in alternatives to alternatives. The world doesn’t need another long-short fund. But funds that feature atypicality- where alpha is generated through say, “new” execution advantages, etc.- have value that justifies a generous fee structure.

    I don’t sit and discuss how to build an alpha generator around a new currency model. We discuss how to bring high frequency trading to, say, art or coins. We don’t theorize how to yield-enhance a corporate bond via repo strategies; we discuss how to find fundamentally AA-assets with an odd component- duration risk, illiquidity, etc.- that will provide a coupon kicker.

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