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Should I Stay or Should I Go?

It seems that three of the best and most trusted names in finance are decidedly at odds with one another. In truth, their forecasts are far more similar than dissimilar.

Don Phillips, 10/11/2012

This article originally appeared in the October/November 2012 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000. 

BlackRock’s Larry Fink says be 100% in equities. PIMCO’s Bill Gross claims equities are dead. Vanguard’s Jack Bogle preaches stay the course with a balanced portfolio. To read the headlines, it seems that three of the best and most trusted names in finance are decidedly at odds with one another. In truth, their forecasts are far more similar than dissimilar.

The shared message of these three veteran market observers is that current conditions warrant sober expectations for returns from both stocks and bonds. None expects equity returns to rival the 6.6% real return demonstrated over much of the past century and immortalized in Jeremy Siegel’s Stocks for the Long Run. None expects bonds to produce returns much in excess of their current coupon, so a return of less than 2% on the Barclays Aggregate Index is probable. All three expect bonds to be significantly more volatile in the future and to be particularly vulnerable to government attempts to manage excess debt through inflation.

In short, all see tougher times for financial assets. The easy days of the bull market of the 1980s and 1990s are gone. The markets won’t do the heavy lifting to grow investors’ portfolios. Instead, investors will need to work longer, save more, and invest smarter (and more cost efficiently, Bogle would hasten add) in order to meet their goals. It’s a sobering and valuable message, one echoed by Jeremy Grantham and many other astute investors.

It’s also a message that’s unlikely to spur investors into action. With no carrot to reward investors back into the markets, turning their backs on the markets becomes an appealing option. Saving is hard work and requires great discipline. Grasshoppers have a lot more fun than ants. The days of instant rewards from the stock market, when saving had the immediate gratification usually seen only with consumption, are over. So, let’s roll up our sleeves and dig a bit more into what Bogle, Gross, and Fink see.

Despite the headline that stocks are dead, Gross, like the others, sees stocks offering better returns than bonds. The facile take-away that the Bond King slams stocks wasn’t what Gross really said. Indeed, his sharpest warnings were for holders of long bonds in the higher inflationary environment he foresees. He sees stocks as offering double the nominal return of bonds over the next several years. Unfortunately, the rising inflation he predicts would leave stocks with zero real return (and bonds with negative real returns).

Bogle and Fink both have slightly rosier outlooks for stocks, but neither sees double digit annual returns on the horizon. So, while the three differ in degree, all rank stocks, bonds, and cash in the same order, and all three think that each asset class offers more muted returns than investors expect. It’s the “cult” of equities, not equities themselves, that Gross declared dead. He clearly sees merit in equities—he’s co-CIO of a shop launching equity funds—but he knows that investor expectations must be reined in if they are to deploy stock funds wisely.

Where the three differ most is in how they would suggest building portfolios in this tougher environment. Fink, given his be-fully-inequities statement, would skew much more heavily toward stocks, but BlackRock also advocates more venturesome fixed-income funds and alternative strategies. Gross likely wouldn’t tilt as far to stocks and would feature high-yield bonds, emerging-markets securities, and assets expected to be more inflation-resistant. Bogle would pass on the alternative approaches and stick with a regularly rebalanced portfolio of higher quality bonds and stock index funds, choosing to control the major things an investor can—costs, taxes, and asset allocation. In the lower-return, higher-tax world all three foresee, those things will matter more than ever.

Investors should listen closely to each of these voices. The exact combination of these approaches one chooses to follow is a matter of preference, but there’s no denying that the road ahead will be tougher than the one that baby boomers have traveled for much of their investing lives. Investors must be better disciplined, strategies must be smarter, and cost and tax efficiencies must be more central to the decision process than they’ve been to date. It’ll be a tougher path, but meaningful progress toward client goals can still be made. It’s times like these when advisors truly earn their keep. In the words of Bogle: Press on, regardless.

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Don Phillips is a managing director of Morningstar, Inc.

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