Investment risk has changed dramatically in the past few years, so much so you might not even recognize the risks implied by owning a “standard” stock-and-bond portfolio, warns Burton Malkiel, the Princeton professor who wrote the investing classic A Random Walk Down Wall Street.
Malkiel literally wrote the book on long-term stock investments. Random Walk is in its 11th edition and has sold 1.5 million copies and counting. A former member of the Vanguard board and presidential advisor, Malkiel is a member of the Investment Committee of my firm, Rebalance.
We both recently appeared on the long-running PBS series Consuelo Mack Wealthtrack, and Mack specifically asked Malkiel to elaborate on the problem of retirement investing risk in the current environment.
In short, there is risk where there used to be stability, and vice versa, Malkiel said. It was clear to the Rebalance Investment Committee that a total bond market fund would be riskier than in years past due to globally low interest rates (and thus high bond prices).
That was one problem to solve: How to find income in a possibly unstable domestic bond market. Secondly, and no less problematic, was understanding where foreign bond risk really is these days, Malkiel explained.
“Are emerging markets really very much more risky than developed markets? Are emerging markets really very much more risky than Europe?” he said. “Where are the defaults likely? They are going to be in places like Greece that are in developed markets.”
Likewise, the Investment Committee looked hard at dividend-paying stocks as a source of steady income in an unsteady bond world. The key was being selective about portfolio composition while not attempting to time the market in any way, he said.
“You can call it active if you want, but all of the individual instruments are passive, are indexed and are low-cost because, let me tell you, all of us need to be very modest about what we know and don’t know about financial markets,” Malkiel said.
However, he added, “the one thing I am absolutely sure about it is, the lower the fee that I pay to the purveyor of the investment service, the more there is going to be for me as the investor.”
That’s an important takeaway for investors who still have a number of years to invest ahead of them. Just because a 60/40 split of U.S. stocks and bonds worked for your parents, that doesn’t mean it will continue to work.
Market timing is absolutely off the table for the serious portfolio investor. Yet thoughtful portfolio composition and diversification are important tools.
Retirement investors should be aiming to mimic the big college endowments and state pension plans. These often rely on at least six asset classes and, within those, sub-asset classes that give their portfolios a specific tilt.
In the case of our bond portfolio, that tilt is away from Treasuries and TIPs and toward bond and dividend investments that offer relatively lower investment risk.
Investment risk reality
For many decades, this kind of “active but passive” approach was out of reach for investors with, say, less than $500,000 in retirement funds. And it doesn’t make much sense for those just starting out.
However, above $100,000 it is possible to construct an effective, powerful investment plan that generates extra return everywhere it can without adding risk.
The reason it’s possible is low-cost funds, specifically index funds and index-style ETFs. You can have the best of both worlds — a sophisticated, diversified portfolio and low cost — using index ETFs as building blocks.
In a changing investment world, every penny counts. Getting to retirement is not about luck or timing but perseverance and skill, plus the added boost from low-cost investing.