Executive Summary
Investors in the U.S. have become increasingly numb to the reality of investing here - a world where stocks pay a dividend barely over 2%, and short-term bonds or CDs give a yield barely more than 0%. Accordingly, we have few options for return aside from investing in risk-based assets to seek - or at least, hope for - capital appreciation. Yet the ultra-low returns on everything in the U.S. - necessitating a significant amount of appreciation just to generate a reasonable total return - is not the norm for U.S. investing historically, nor even currently around the world outside of the U.S., as I was reminded during my recent trip to Australia. In fact, I was somewhat shocked while I was there to wonder: how would investing in the U.S. be different if we, too, could get local short-term bank CDs that paid nearly 6%!?
The inspiration for today's blog post was my discussion last week with financial advisors in Australia, who I met while visiting there to deliver a keynote presentation for the Brillient PortfolioConstruction Forum. As a U.S. advisor, it was somewhat astonishing to be reminded of the investing realities that still exist elsewhere in the world - as my Australian counterparts noted that one-year CDs that pay 6% and a Legg Mason fund manager showed how easy it is to construct a high quality Australian dividend-paying portfolio with a cash yield of 7.5% (further increased to an equivalent of 9.5% when accounting for so-called Franking credits that apply to Australian investors investing in their domestic equities to avoid the double-taxation of corporate income). And while the Australian equity markets did take quite a big hit during the global financial crisis almost 3 years ago, long-term Australian investors (and their advisors) still regularly discuss returns of 10%-12% on equities.
Of course, many of us here in the U.S. now would probably look at a 10%-12% expected return on equities with some combination of laughter and sadness. Yet this is still a reality in other countries around the world that haven't experienced the lost decade we have here in the U.S. And at a much more basic level, such returns don't seem so outlandish when you're looking at 7%-9% dividends on equities!
At a more basic level, though, I couldn't help but wonder what a 6% yield on one-year CDs would do right now to investing here in the U.S.? How many clients would materially reduce their equity exposure if they could have access to a safe 1-year CD yield of 6% from an ultra-high-quality secure bank? How many clients would take a break from equities altogether for a guaranteed 6% short-term fixed return and just wait until equities seemed more appealing? And what would it take to get investors back into equities in a world where you could get a 6% guaranteed short-term return? Well, I suppose a 7.5%+ cash dividend yield on stocks, where the appreciation from there is just a bonus, would probably do it!
Ultimately, this is simply the true manifestation of our current monetary policy in the U.S. playing out. The purpose of holding interest rates at current lows is this exact result - to drive investors towards investing their money in riskier assets (i.e., stocks, real estate, lower quality bonds, etc.) because that helps businesses attract the capital they need to be created and grow. Yet so many years of this type of policy playing out has its consequences - we've driven the normal yield on anything and everything so low, that it sometimes feels like speculating for appreciation is the only choice we have left to earn a return. Yet I think for many clients, it doesn't feel like a particularly desirable option.
So what do you think? Would you invest differently in a world where short-term CDs paid 6%? Would your clients invest differently? Would you demand a different return (or at least, a different dividend yield) to invest in equities in that kind of environment? How would investing be different for you and your clients if you could get a short-term 6% guaranteed return?
Mohammed El Erian in his book ‘when markets collide’ had talked about the need for US investors to diversify their portfolios as much as 50%! He had written the book in 2007! Incidentally I met your colleagues at Pinnacle last year at your office and several other advisors to discover that average asset allocation to international markets including emerging mkts was 5-10%! I guess tbe advisors should be aware and convinced before they could convince clients.. As Richard Kang says “today developed markets are riskier than emerging markets”!
Partha,
It’s worth noting though, that there is a risk for Americans to investing in Australian equities that the Australians don’t face: currency/exchange rate risk.
That can produce a drag on returns even if foreign markets are outperforming (and/or a drag on returns for the cost to hedge the currency risk).
– Michael
Michael,
Right now we are very underweight long only US equities precisely because of what you are describing. We are committed to being patient as painful as it is, and waiting for assets priced to actually give a reasonable return. Certainly we woudl welcome safe ways to earn income while we wait for equities to get cheaper. The damage current monetary policy is doing to savers is in my mind unconscionable.