“We are in both a depressing and boring investment environment.” That not-so-cheery statement came from Cliff Asness, Ph.D., managing and founding principal of AQR Capital Management, LLC, in a recent address to investment advisors gathered at the University of Chicago’s Gleacher Center.
Personally, I can handle “boring” investment environments just fine. Actually, when it comes to my investments I much prefer boring to exciting. I had all the investing excitement I need for a lifetime in 2008-2009. It’s the “depressing” portion of Asness’s remarks that caught my attention.
He maintains that both bonds and stocks are expensive when judged by their historical means—bonds in the 97th and stocks in the 92nd percentile. Does that mean stock and bond markets are in a bubble? Asness says not. Is a stock or bond market crash likely? According to Asness, it’s anybody’s guess, because, “We really don’t know what causes crashes. It’s folly to try and predict a crash.”
While Asness doesn’t believe markets are in a bubble or that a crash is impending, what he had to say about expectations for future portfolio returns was certainly depressing.
Over the past 115 years, according to Asness’s data, the real return on a 60/40 portfolio (one holding 60% stocks and 40% bonds) has ranged from as high as 11% to as low as 2.2%. A real return is net of inflation. So, for example, if the total return is 8% and inflation is 3%, the real return is 5%. If inflation is only 1% and the total return is 6%, then the real return is 5%.
Now for the depressing part. The real return of bonds is currently 0% while that of stocks is 3.7%. Do the math and that’s a 2.2% real return for a 60/40 portfolio. That puts the current real returns from stocks in a historical 8th percentile and bonds in the 3rd percentile.
The bottom line is that if you want high odds that in retirement you will never run out of money, you will need to limit your withdrawals to the real return of 2.2%. This leaves the return that equals the inflation rate in the portfolio to preserve the purchasing power of the portfolio. That means for every $1 million you have in investments you can withdraw $22,000 a year in income on which to live.
That is depressing, especially when you consider the professional norm for withdrawal rates is around 4%. For many years I’ve conservatively advocated for 3% withdrawal rates, which if Asness is right could turn out to be aggressive.
So what’s an investor to do?
Asness’s advice is a bit self-serving, as his company, AQR, is one of the leading mutual fund managers of alternative investment strategies. That said, what he recommends agrees largely with what I’ve written for 24 years: that investors diversify their portfolios among more asset classes than just stocks and bonds. Additional asset classes that can bolster portfolio returns and lower volatility are commodities, real estate, TIPS bonds, and alternative investment strategies such as long/short, arbitrage, and managed futures mutual funds.
Another option is to increase what you are saving for retirement and reduce your withdrawal rate expectations to something less than the traditional 4%.
Whatever you do, there is one thing Asness and I agree you should not consider. Don’t try to time the market. Selling out stocks and bonds, going to cash, and buying back into the market when the time is “right” almost guarantees a depressing future.
Instead, rely on the boring strategy of investing for the long term with asset class diversification. It’s an effective investing anti-depressant.
