Scott Burns is not pleased with the zero return being paid by IBonds.
Juicy Excerpt: By having a premium of zero over inflation, the Treasury is sending a simple message to savers: Drop dead.
Scott needs to spend some time studying The Stock-Return Predictor.
IBonds obviously are not offering as good a deal today as they were back when investor emotions re stocks were more out-of-control than they are today. In relative terms, though, they are still offering a strong value proposition.
The most-likely annualized 10-year return on stocks is 1.55 percent real. That’s for an asset class that on the three earlier occasions it was at these price levels suffered an average price drop of 67 percent. Is increasing your return by 1.55 percent per year worth taking a risk of a 67 percent loss? Not in this boy’s estimation, at least not for a large portion of one’s portfolio.
You also need to consider that stocks provide a most-likely annualized 10-year return of 6.3 percent real if prices drop to fair-value levels. So those holding zero-return IBonds are setting themselves up for far higher returns a bit down the road while those holding stocks are setting themselves up for permanenet losses, losses that will grow over the years as the compounding returns effect kicks in.
It certainly can be argued that a zero percent return for IBonds is “irrational.” But so is a 1.55 percent return for stocks. The root problem is that the investors choosing between these asset classes have been making irrational choices ever since stocks went to wildly overpriced valuation levels.
Investors’ emotional take on stocks dominates decision-making in InvestoWorld. When the stock market is priced as absurdly as it is today, other asset classes feel the effect. Today’s IBond return is nuts. But, compared to today’s likely stock return, it’s great. Smart investors are looking at the relative value proposition and their demand for IBonds has brought the return down to a level that appears absurd when considered in isolation but that makes a good bit of sense when viewed in comparison to the return now available from stocks.
If the “experts” gave us the straight story re how valuations affect long-term stock returns, most investors would have abandoned stocks when the long-term return went negative back at the top of the bubble. That would have brought the price down to reasonable levels and we would as a result be enjoying good long-term returns on stocks today. In the world in which we actually live, we have to figure out the truth about stocks for ourselves in this crazy way in which we see prices go down a bit and then hold stable or go up a bit, and then eventually go down a bit more. All that the “experts” accomplish by ignoring the message of the historical data is to stretch out a painful process of price adjustment.
Investors do not have the same confidence in stocks today that they had back at the top of the bubble. That’s a good thing. That’s a step in the right direction. That’s one of the reasons why the return on IBonds is so low. Investors have been gradually moving from stocks to safer asset classes offering a better long-term deal, and the increased demand for those asset classes brings down the return they need to offer to attract money to them. Zero-return IBonds are not entirely irrational; there’s an element of rationality mixed in with the overall irrationality that governs all investing decisions for so long as stock prices remain where they are today.
I certainly would not describe today’s IBond return as exciting. The informed investor was loading up on IBonds back when they were paying a return of over 3 percent real and stocks were offering an even worse deal than they are today. However, IBonds are still a good bit more attractive than stocks.
That’s irrational, and I would like to see that situation change; stocks are the riskier asset class and stocks are the asset class that should be offering the better value proposition for investors willing to take on reasonable amounts of risk. To get to where we all want to be, we all need to get about the business of accepting that the absurdly oversized returns handed out to stock investors of the late 1990s were borrowed from the returns available for stock investors of today and that it is only by acknowledging that reality that we can get to a place where stocks will once again offer a superior long-term value proposition to even zero-return IBonds.
It is the irrationality of Passive Investing enthusiasts (I think it would be fair to describe Scott Burns as such a one) that is causing the problem. When Scott Burns is looking around for people to blame for the unfortunate message being delivered to savers today (zero-return IBonds do indeed send a discouraging message) he should look first at the face of the man in the bathroom mirror.
Today’s Passion: The article entitled IBonds are New and Improved Cash argues that cash is not only for sissies anymore.
Nice Site layout for your blog. I am looking forward to reading more from you.
Tom Humes
Thanks for the encouraging words, Tom.
Rob
“Scott needs to spend some time studying The Stock-Return Predictor
“The most-likely annualized 10-year return on stocks is 1.55 percent real.”
I think you should mention that your Stock-Return Predictor you refer to when predicting ‘the most-likely annualized 10-year return on stocks is 1.55 percent real’ only applies to the S&P 500. Therefore, it is of limited use for investors who hold diversified portfolios that include equity asset classes in addition to the S&P 500.
For example, Scott Burns and many other financial planners recommend holding Value stocks, Small stocks, International stocks and REITs.
One can observe that the S&P 500 had similar poor return prospects starting in 1998 (10 years ago). However, during the preceding 10-year period, Value stocks, Small stocks, International stocks and REITs have performed quite nicely compared to the S&P 500.
This is one example of the benefit for investors who diversify their equity portfolios beyond the S&P 500.
Schroeder
Thanks for those helpful cautions, Schroeder.
You might want to take a look at the article from the http://www.Early-Retirement-Planning-Insights.com site entitled “Applying P/E10 Outside of the S&P500:”
http://www.early-retirement-planning-insights.com/pe10outside.html
Please also keep in mind that a showing that the slices did better than the S&P500 in one 10-year period does not prove that they will do better in another 10-year period. It’s possible that the slices will do better and it’s possible that the slices will do worse. If we all knew in advance what was going to do best we all would be invested in it.
What we know is that valuations always affect long-term returns. It certainly is theoretcially possible to avoid the effects of overvaluation in one asset class by shifting to another. However, I have my doubts as to how many of us are capable of knowing precisely when to make the shifts. I would describe that sort of strategy as one that might work out but one that is best employed by the sophisticated investor. If there have been times when the slices have done better than the S&P as a whole, there also will be times when the slices will do worse than the S&P as a whole.
Rob
At O percent real, is it still possible to retire early? What is one to do? I have a lot of “passion” but it just want be enough. How long can one continue to swim up stream? What does this do to your message?
By the way, I am neither a liberal arts graduate or rich. Am I still allowed to post here? Fight, fight, fight!
“What we know is that valuations always affect long-term returns. It certainly is theoretcially possible to avoid the effects of overvaluation in one asset class by shifting to another. However, I have my doubts as to how many of us are capable of knowing precisely when to make the shifts. I would describe that sort of strategy as one that might work out but one that is best employed by the sophisticated investor.”
I totally agree. However, the premise of the article you refered me to at John Walter Russell’s website does exactly what you and I would agree: while it is “theoretcially possible to avoid the effects of overvaluation in one asset class by shifting to another” it is doubtful and only might work out by the sophisticated investor.
Schroeder
At O percent real, is it still possible to retire early?
Absolutely, Mr. B.
Stock valuations have been high for a long time. Times of high stock valuations are the worst of times for aspiring early retirees.
Stock valuations have been coming down for eight years now and there is every reason to believe that they will be coming down even harder in days to come. When we get back to reasonable price levels, making steady progress on a Retire Early plan becomes a far more realistic prospect for millions of us.
Just don’t fall for that “valuations don’t matter” gibberish and end up losing most of your stash before stocks come to offer a mouth-watering long-term value proposition once again. That’s the key. Keep your head today and the odds are good that you’ll be in the green or at least on your way to it in the not too distant future.
Rob
I am neither a liberal arts graduate…
That’s not good. It sounds like we had all better keep an eye on you, Mr. B.
Rob
…or rich.
Something must be done!
Steps must be taken!
Let’s get to work!
Rob