A “New Paradigm” ?

The Wall Street Journal recently ran an interesting op ed written by Burton Malkiel entitled “Even Amid the Current Turmoil, Stocks Still Beat Bonds”. Malkiel is the Princeton prof who wrote the book “A Random Walk Down Wall Street” and is considered one of the pillars of the Efficient Market Hypothesis (EMH). EMH states that the stock market is completely efficient, discounts all that is known about a stock in the current price, and that it is impossible to outperform the market through trading or investment schemes.

To be sure, EMH has come under question in recent years but Malkiel has been around a long time and is well respected in our industry and I believe his opinions carry some weight. The important points about Malkiel’s article were these:

1.       He believes equities today are more attractive relative to bonds than at any other time in history.

2.       He believes fixed income investments will never earn the returns necessary to meet retirement or pension fund planning objectives.

3.       He believes “the only hope” for generating returns necessary to meet retirement planning goals is to increase investment allocation to equities.

While we agree with Malkiel, the notion of holding more equities at or near retirement flies in the face of a long-held “law” of retirement planning, namely that one should hold a large fixed income allocation at or near retirement. While holding more equities may increase long-term returns, higher equity weightings will result in greater portfolio volatility which increases investment risk.

So for us as financial planners, we are sort of in a “new paradigm”: while increasing equity weightings for retirees may now present a more expedient strategy, the question becomes how do we mitigate the risk of higher volatility which would accompany higher equity exposure? We do this in a number of ways:

§  Make sure client portfolios are adequately diversified both by asset class and market sectors

§  Emphasize income in our investment model as higher portfolio income helps to reduce volatility

§  Take care to understand the risk tolerance of our clients and how this translates to their investments

§  Base investment decisions on fundamental research and reasoned logic

§  Identify and invest in undervalued sector opportunities

§  Make sure all clients have a sound financial plan that keeps them on the proper roadmap particularly with regard to their investments. This reduces the risk of emotionally-driven decisions that can destroy the effectiveness of a sound financial plan.