Community members have told me that they find it “depressing” to invest in TIPS, IBonds or CDs at a time when the returns paid on them are as low as those that apply today. I don’t think you should find today’s low returns depressing. I think you should find them exciting. The low returns that apply today for the super-safe asset classes are a sign that the investor psychology that has kept stock prices high for so long is in the process of breaking down. That’s very good news indeed for the Valuation-Informed Indexer.
Would you prefer the returns that applied at the top of the bubble, when TIPS were paying in excess of 4 percent real? I of course understand that in a direct sense that’s a far more appealing return than what is available today. I am not so sure that those buying TIPS today are not getting the better deal, however. I think it is entirely possible that that is so.
To understand why, you need to think a bit about why an asset class as safe as TIPS was paying so high a return back in early 2000. One big reason is — the enthusiasm for stocks was off the charts at the time. Stocks offered a terrible long-term value proposition at the time; the likely 10-year return was a negative number. But it was even harder to find “experts” talking straight about how stocks work then than it is today. The value proposition was awful. But stocks have never been more attractive to middle-class investors than they were in those days when the likely 10-year return was a negative number.
What do you think the insane demand for stocks did for the return offered to those buying TIPS? It pushed it up to arguably equally insane levels. In a rational world, a risk-free asset class should never offer a return of 4 percent real. But in the world we actually live in, the demand for stocks was so great back at the top of the bubble that there was no way to get investors interested in TIPS without offering insane rates of return for those willing to buy them. The value proposition for TIPS was outstanding in 2000 because the emotional appeal of stocks was so out-of-control strong.
The super-safe asset classes have outperformed stocks for over eight years now. Investors have noticed. So the price of stocks has dropped. Not to levels anywhere close to reasonable. But prices have dropped considerably. And the interest in alternatives to stocks has grown.
What do you think that has done to the returns offered by the super-safe asset classes? It has pulled them down. You cannot get much of a positive return at all today from TIPS, IBonds and CDs. The days of 4 percent real returns are over.
That’s not depressing news.
I think a good argument can be made that it is exciting news indeed.
I put lots of money into TIPS and IBonds back when they were paying 3.5 percent real. I didn’t do it because I like the idea of earning 3.5 percent real on my investments. I did it because I like the idea of earning a whole big bunch more than that and because I know that owning stocks is the way to earn a whole big bunch more than that and because I know that I will be able to own a whole big bunch more stocks if I buy stocks when they are selling at reasonable prices.
For stock prices to drop, we need to see millions of investors become sick of the low returns stocks have been paying for a long time now. The drop in the returns paid on the super-safe asset classes is a sign that investors are beginning to get that sick feeling. Do you see where I am going with this?
In a surface sense, it is obviously better to earn 4 percent real than to earn 0 percent real or something close to it. But there’s not much money to be made hiding out in TIPS and IBonds and CDs. My super-safe portfolio has been beating the S&P index for over 10 years now. But all things considered, I’d rather be in Philadelphia. Nothing would please me more than to be able to ditch these wonderful TIPS and IBonds paying 3.5 percent real and put the money into stocks paying a likely return of at least double that.
The idea isn’t to beat the S&P index. The idea is to get rich. As TIPS/IBond/CD returns drop, the crazy emotions holding up stock prices get weaker and weaker. We get closer and closer to the day when stocks will be offering a compelling long-term value proposition once again. That’s where we want to be, is it not? The purpose of this game is not to hold TIPS paying an attractive return. It is to own stocks paying an attractive return.
The investor who buys TIPS paying a real return of zero and who is able to move his money into stocks within a year or two or three is better off than the investor who buys TIPS paying a real return of 4 percent and who is not able to move his money into stocks for nine or ten or eleven years. Those who are depressed about the low returns being offered by the super-safe asset classes today are failing to note the extraordinary opportunity opened to them by buying those “low-return” asset classes, in my estimation.
Your true long-term return is not the return you earn by being invested in super-safe asset classes. It is the return you earn by being invested in super-safe asset classes for a time and in stocks purchased at reasonable prices for a longer time. If the day at which stocks will again be available at reasonable prices is drawing nearer, we all are better off. Having to accept low returns on the super-safe asset classes is a small price to pay for having reasonably priced stocks available to us again soon.
It could be that I am wrong about this. The historical data does not permit statistically significant short-term stock-price predictions. It could be that stock prices will remain high for another eight years and that the low rates available today on the super-safe asset classes will end up hurting you big time.
That said, it seems reasonable to me to interpret the big drop in returns paid on the super-safe asset classes as a sign that the insane emotionalism over stocks is beginning to break. For those following rational investing strategies, things appear to be looking up.
Today’s Passion: Stocks are my favorite asset class, for the reasons noted above. But I didn’t let that stop me from writing an article entitled Cash Is King — I’ll Prove It With Numbers.