The Importance of Growth in A Near-Zero Interest Rate Environment - and the Averages Don't Tell the Story
Throughout the years many of our clients have depended on their investments to provide a reliable source of income in retirement. And as years go by, we all notice as the costs of goods and services slowly increase. Inflation over the last 100 years in the United States has averaged about 3.1% annually. Over the last 10 years, however, that rate of inflation has slowed to a range of 1-2%. In that same time frame we have seen yields on bank deposits and government-insured bonds drop significantly. The average yield on a 10-year treasury bond over the last 100 years has been around 5.50% — today that yield is about 0.98%. We share this data with you to help frame the issues we see facing all of us over the next few years regarding risk versus return. Investors don’t seek risk just for the sake of being risky. The way the game works is like this: the more risk you take, the more potential for return (reward) you should get. Sounds simple, but in today’s environment it really is not.
About 10 years ago we started making a noticeable shift away from traditional asset allocation theory toward the practices we use today. In the past, basic rules of thumb based on one’s age have been used to help inexperienced investors manage risk. The old adage told investors that an investor should have an allocation of bonds that equals their age. So, if you were 75 years old then you should have 75% of your portfolio in fixed income (relatively safe) investments. That sounds good in theory, but for the investor who wants to spend some of their money it would have been disastrous over the past decade. In fact, it is likely that with an average withdrawal rate of 4-5% per year, one would have depleted his/her entire account over the last 10 years. Therefore, we have encouraged investors to shun common investment sayings and focus on the reality of the world we live in. Today, we still believe stocks are the answer even as we hit new highs on most of the major stock indices. Bonds are obviously not the answer.
With all the turmoil in the prior year, investors seem to be on edge. The belief that the financial markets will crater and never return to the levels we see today seems to be on the mind of many investors. None of us knows what this year will hold, nor do we know what the next five or ten years will hold. We do know that typically in periods of extreme negativity and pessimism that the markets find a silver lining and move higher. We also know in times of unchecked optimism and euphoria that bull markets mature and begin to head lower.
As we begin 2021, we will continue to favor stocks, albeit in some new areas, for most of our portfolios. Although we celebrate new highs, that does not mean that we are not cautious about the markets. But we are more concerned about clients who want to move to low-return investments for the perceived feeling of “safety.” These clients are simply exchanging perils — trading the discomfort of volatility for the more comfortable risk of diminished purchasing power that results from low rates of return. In the long run, we believe the latter is the more dangerous. Historically, stocks have outperformed every other asset class — and that includes real estate and gold.