Investment Ideas for 2016 from Burton Malkiel

by philg

Burton Malkiel, who inspired the index fund revolution (e.g., Vanguard) and wrote A Random Walk Down Wall Street, offers some 2016 investment advice in a WSJ editorial:

Perhaps the most useful metric to assess valuations is the cyclically adjusted price-earnings multiple (CAPE). This is the ratio of today’s market price to a measure of average earnings over recent economic cycles. CAPEs for broad stock-market indexes do not help in predicting returns one year ahead. But they do have a reasonably high correlation with average returns over, for example, the next five to 10 years.

Today the CAPE stands at over 26 for the U.S. market, well above its long-run average. The CAPE is 20 for Japan, 15 for Europe and under 10 for emerging markets—below their long-run averages. I am not suggesting that you try to time the markets and shift from one to another based on these metrics. But I do suggest that if your equity portfolio is composed entirely of U.S. stocks, you might add some foreign stocks in 2016.

I.e., if you already own U.S. stocks, buy foreign stocks with any new money to invest!

Readers: What are your investment strategies for the coming year?

18 thoughts on “Investment Ideas for 2016 from Burton Malkiel”

  2. Chris: I think that you’re right. Malkiel was an inspiration to Bogle and a director of Vanguard for many years, but not a founder. I’ll fix the original posting.

  3. I assume Philip is asking for investment strategies that involve passive investment, i.e. buy some stocks and just wait for the next 10+ years for them to appreciate and pay dividends. If that’s what you want, why not use a robo-advisor like Betterment (https://www.betterment.com). This is generally what I steer junior employees at my firm towards, assuming they don’t meet the standards to invest in the firm itself …

  4. PN: True! I don’t think it is practical for an individual to trade. Does this Betterment thing produce obviously better returns than just being an ordinary Vanguard customer?

  5. I just bought a bunch of energy-related BBB- bonds of reputable companies on the secondary market at huge discounts. If I hold until maturity in two to five years (and the companies don’t go out of business), I’ll earn an annual return over 10%. Though, normally, I’m pretty risk averse and am invested in a couple of low-cost Vanguard index funds and long-term CDs (earning 3% or less).

  6. Philip,

    I don’t use Betterment, but I do use Wealthfront, which is more or less equivalent in terms of the service it provides. The advantage over just normal Vanguard is that you can set a risk tolerance and it chooses a basket of low-cost ETFs (mostly Vanguard, since they tend to have the lowest expenses and least tracking error) to fit that risk profile. It also chooses a different investment allocation for IRAs vs individual accounts, to account for the different tax treatment of capital gains and dividends.

    If you have enough money (at least $100K) it provides some additional value-added services like daily tax-loss harvesting (strategically selling assets that have an accrued loss and replacing them with equivalent ETFs) to generate capital losses to deduct against capital gains. Assuming that the tax savings are re-invested in the portfolio, and are thus effectively tax-deferred even in a taxable account, they estimate that this can generate an extra few percentage points of returns over the long run.

    They do charge a management fee but it it is very low compared to a human advisor (0.25% annually) and there are no transaction fees or any other expenses that are charged to the client. Since they choose Vanguard or other low-cost ETFs, the total expense ratio of their accounts tends to be under 0.5%.

    It’s really perfect for the buy-and-hold investor.

  7. Philip,

    We live in unprecedented times. Cash and Gold.

    I’ve been reading your stuff intermittently for a decade. I read A Random Walk Down Wall Street because of your review. It’s a good book to have read, though my view of how the market works has evolved past the EMH. My cash and gold portfolio is based on many years of analysis of Eric Janszen here: ituplip.com. Look through the iTulip Record tab on top first. The best economic analysis available for the average (educated) Joe.

    My only affiliation is that I’m a grateful paid member of the private forums where Eric’s latest analysis is available along with contributions of many other intelligent members. The site is a Wild West, but don’t be put off by the lack of design. If you need help navigating to the important stuff quickly, feel free to email me (I believe you can see my email address though it’s not displayed publicly?)

    If you join, please let me know what your handle is so I can follow your posts there. I’m also happy to hear from anyone else who joins as a result of this post. My handle there is geodrome.

  9. Joshua — couldn’t agree more. I think that Betterment and Wealthfront are basically identical. I would expect various brokers (i.e. Schwab) to get steadily squeezed by these kinds of asset managers over the next 5 years, and either buy one of them, or start their own.

    Philip: I’d say any real alpha for these guys comes from Tax-Loss Harvesting, see: https://www.betterment.com/tax-loss-harvesting/. I think that the benefits of the tax stuff basically offset the management fees from the advisor + baked into the ETFs.

  10. People always underestimate boom cycles. Yellen is going to have to backtrack on interest & restart the printing press, sending CAPE higher on less sales. Foreign markets are even more manipulated but putting out less results. Having said that, going to stick with cash because fundamentally, stuff is too expensive & people are too poor. Someday, someone besides Mark Zuckerburg needs to start making 11 figures or the only person who can buy anything is going to be the government, not unlike how housing already works.

  11. Middle of the road, semi-blue/white collar worker-bee residential rental properties in southeastern U.S. college towns. Like the one you visited awhile back, Phil, in Blacksburg, VA.
    I’ve done this for twenty-six years and can proudly (and thankfully) state that I’ve never had a down year and the returns are pretty good to very good. And they don’t stop unless you stop (sell). But you MUST be or have access to an expert in that particular market’s residential investment real estate.
    Translation: don’t try this at home.

  12. @Mark. I’ve been the (sort of) reluctant real estate investor, but it’s paid off. I had been a happy renter, enjoying job mobility and free weekends since I sold my first place on Miami Beach in 1997 at break-even. The real estate crash beginning in about ’09 encouraged me to again buy real estate. I bought four nearby Florida foreclosures at rock-bottom prices over 2010-2011; sold off two at reasonable profits, rent out one, and live in one – all paid off. While my real estate has been profitable at better then 10% annual return, as this blog has debated in the past, there has been quite a bit of hands-on work – nearly every weekend. The work is slowing down now, so I think I can enjoy more profits and free time.

  13. @Joshua, thanks for those tips on Betterment/Wealthfront. I even found a link discussing the differences/advantages of the two, in case others are interested: http://www.thesimpledollar.com/betterment-vs-wealthfront/

    A substantial amount of my money has been sitting in the bank, enough to last me for three years of unemployment in case that happens. But interest rates are rock bottom so the money is doing nothing (and probably losing to inflation). I have money going into pensions/401ks so that’s covered. My problem is, where can I save my extra money and get a decent rate of return above inflation yet still have liquidity in case I need the funds to buy a house/apartment? Also, how much trouble is it to cash out an investment with regard to taxes?

  14. German,

    You’ll have no problems with liquidity with Betterment or Wealthfront. All the assets they invest in are traded on United States exchanges and will sell just like any asset from a stock broker. That is, 3 business days for the trade to settle, and a couple days for the funds to transfer via ACH. Longer than just having it in a savings account, sure, but still readily accessible for all but the most immediate expenses.

    What you won’t get with those sort of investments, however, is freedom from volatility. If you expect to cash your investment out within the span of a few months, they offer no guarantee that your investment may not have lost significant amounts of value, especially with a higher risk profile. You should always keep 6-12 months of expected living expenses in cash or cash equivalents so you don’t end up being forced to sell investments at a loss for a short term cash need.

    This is pretty much investing 101. The more you want your returns to beat inflation, the more volatility you must be willing to abide by. The lower risk profiles on those sites will have most of your investments in longer term US Treasuries and other “safe” investments, but that means you will likely just be matching inflation, probably not beating it.

  16. Joshua, thanks a lot for clarifying, good to know that I can still get the money out if needed. Interesting link from Georgiy. Also, Frontline PBS covered the problem with retirement funds getting eaten up by fees:

    http://www.pbs.org/wgbh/frontline/film/retirement-gamble/

    Basically, I’ve been paralyzed on decision making because I’m scared of investing and risk (and fees).

  17. German,

    If that’s the case, you could do a lot worse than opening up an account with Vanguard and putting all your money in a target retirement year mutual fund. Generally speaking, the more complex the investment, the more knowledge and sophistication you would need to avoid making a mistake. So in your case, since it sounds like you’re not really on top of all that’s out there (this is not an insult, it’s a very complicated thing), you should try to keep things as simple as possible. Vanguard in general is a quality group to invest with, since they are owned by their investors rather than by a separate company. It keeps their incentives aligned with their investment holders, since they are one and the same effectively.

    If you go this route rather than something more complex like Wealthfront or picking your own stocks, you may potentially pay a tiny bit more in fees and/or lose out in some additional tax benefits, but for your own peace of mind it might be better to keep things simple so you know what you are getting.

    Going the Wealthfront way has some significant potential drawbacks depending on your long term needs for your cash. Georgiy’s link expounds on some of them, though I don’t think it’s at all a fair portrayal of Wealthfront’s business, and I think it deliberately wrongly explains how their structure is set up and what their capabilities are in terms of potential expenses, but it is accurate that if you use their service incorrectly, you could inadvertently cost yourself money. Putting your money into a single Vanguard fund would avoid a lot of this, assuming you won’t be needing to make frequent withdrawals.

Comments are closed.