Considering the uncertainty and muted expectations, what should investors consider as they manage their portfolios and financial plans? Vanguard Global Chief Economist Joseph Davis and Maria Bruno, a senior strategist in Vanguard Investment Strategy Group, tackled this question in an interview with In The Vanguard and discussed the financial planning implications for investors and advisors.
What’s different about this investing environment?Mr. Davis: It’s different from history in certain respects. Two or three decades ago, we had higher interest rates that came with a higher level of inflation. The price differences between higher-risk and lower-risk investments, as well as the valuations in the corporate bond and equity markets, were at more reasonable levels. Today, the expected return is the lowest we’ve seen in years.
Ms. Bruno: That sounds discouraging, of course. But we believe strongly that investors continue to have the tools available to address this environment. It’s just that they may not have the tailwinds that they’ve had when returns were more robust.
Mr. Davis: Being forward-thinking is crucial. Despite the lower-return outlook, the fundamentals of investing haven’t changed. In fact, saving more, staying broadly diversified, and maintaining a long-term perspective have become even more important.
What can investors do in such a challenging climate?
Our standard counsel is to put more assets into the very investments that are underperforming, in order to stay close to your target asset mix. Rebalancing is a contrarian strategy, and it adds value over long periods of time precisely because many investors don’t stick with it.
Ms. Bruno: I’d add that after any major market move down, the temptation is to head to the sidelines. Going to cash, or holding more cash than you need to while waiting for the market to rebound, comes with trade-offs. Because you don’t know when or how the market will turn around, you’re exposed to the cost of missed opportunities.
Also, investors should be aware of the need to balance market risk and inflation risk. For example, if you sit on the sidelines, you may be avoiding market risk, but you’re overexposed to inflation risk, or shortfall risk.
Mr. Davis: Vanguard’s philosophy is to try to minimize the focus on day-to-day events. However, what shouldn’t be lost for retirees, investors, and advisors is the need to appreciate some longer-term forces and trends that are at play in the financial markets and the economy. These forces and trends can have a fundamental, important, and long-lasting impact on return expectations for our portfolios, as well as on how they may help guide our investment decisions.
With so much economic news and accompanying analysis from experts, how can investors put this glut of information in perspective?
Ms. Bruno: The challenge that many investors face is in resisting the urge to react. By thetime events hit the news, the market has already reacted. The question is, what do you do after that?
Vanguard believes that both investors and advisors can prepare portfolios to weather different investing environments by staying broadly diversified. We can’t control what will happen with the markets or the economy. But we can control our reaction.
Going to the sidelines after the market has reacted is counterproductive. It exposes investors to trying to figure out the next move correctly. That’s much trickier than it sounds.
Mr. Davis: We’ve thought for some time that this low-growth world is going to persist. We’re still of the strong opinion that this low-rate environment is secular, which means it’s very long-term in nature.
Looking to the future, what long-term trend do investors and advisors need to be aware of?
Why that matters is that we have the lowest expected returns on portfolios—equity, fixed income, or some balance in between—that we’ve had since 2006. We’re not bearish, but we’re being guarded.
Ms. Bruno: Investors who pursue additional returns need to know there’s an additional cost—that extra yield or return comes with a risk. It may not manifest itself today, but risk surfaces at unexpected times; for instance, during the financial crisis that we endured in 2008.
The long-term trends of slower growth and lower return prospects mean that saving and putting more money to work investing is going to play a larger role in reaching your long-term financial goals.
Ms. Bruno: With Vanguard’s ten-year real balanced-portfolio outlook being just shy of 4%, a 4% spending target is feasible, but retirees need to keep in mind that there’s a high dispersion around that median. This means that flexibility on an annual basis is key. Keep an eye on your asset allocation, rebalance, be tax-efficient, but realize that in up years it’s wise to be diligent in spending so that you have a cushion in the down years.
What does the outlook mean for retirees and the venerable “4% spending rule”?
All investing is subject to risk, including the possible loss of the money you invest.
Diversification does not ensure a profit or protect against a loss.