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The Investor Dilemma


By Michael McKeown, CFA, CPA - Chief Investment Officer

My first job started when I was about seven or eight years old.  Mrs. Penner, our neighbor across the street, would pay me $1 each week to take out her trash cans to the street and then back to the garage the next day.  She would also bake our family homemade rolls on occasion.  My great grandparents lived in the same house before my parents and knew the Penners well, who lived on the same street since the early 1900s.

Mrs. Penner was tough, growing up in the depression and in Youngstown through its steel boom and its slow demise.  The house was considered a mansion when it was built and was more than twice as big as any on the street, with ivy growing up the sides.  It had been turned into a two unit house and one day, the little boy who lived in the upstairs unit was locked out.  He told Mrs. Penner his woes after she pulled into the driveway.  Her simple reply, “Tough luck, kid.”  And she shut the door behind her.


It is a phrase that my family said to me many times growing up and still half-jokingly uses as a response to my nephew when he cannot get his way or in approaching tough circumstances.

If she was alive today, Mrs. Penner probably would not have much sympathy for investors and asset allocators, even though interest rates were five times higher back then! 

Government bond yields today are at the lowest levels since the 1950s.  Here is a chart of yield ranges for the last ten years in light blue and the current yields in red.

The Barclays Aggregate Bond Index yields 2.1% and intermediate municipal bond portfolios yield 1.5%.  Stepping up the credit risk to corporate high yield and emerging market bonds offers greater return but also increased risk. 

Turning to stocks, many markets around the world look at above average valuations across several measures.  Interest rates clearly have an affect on price-to-earnings ratios (P/E), yet they were low for most of the last ten-years.  The chart below shows the ten-year range of P/E ratios across 23 countries and where each stands currently.

The U.S. stock market trades at a multiple of 17.3 times its forward earnings estimate, near the top end of its ten-year range. This is at a time when earnings are flatlining for companies.  Towards the bottom of the chart we can see many markets considered riskier such as Taiwan and Brazil trading below the ten-year average. 

The equity returns from these levels are not likely to be annualized at 10% per annum going forward as they have historically.  More likely are results in the mid-single digit range over the next seven to ten years.  That says nothing of the variability that one can see on a one or two year basis, where returns have a much wider distribution.


Howard Marks, the founder and CEO of Oaktree, a $100 billion investment manager,  writes excellent memos discussing risk, return, pyschology, and the choices investors face.  One of his memos neatly sums up the investor dilemma in a section titled Prudent Behavior in a Low-Return World

“The possibilities [for investors] fell into just a few categories: 

  • Go to cash – not a real alternative for most investors.
  • Ignore the lowness of absolute returns and pursue the best relative returns.
  • Forget that elevated prices might imply a correction, and buy for the long run.
  • Reach for return, going out further on the risk curve in pursuit of returns that used to be available with greater safety.
  • Concentrate investments in “special niches and special people”; by this I meant emphasizing strategies offering exceptional bargains and managers with enough skill to wring value-added returns from assets of moderate riskiness.

Of all of these, I consider reaching for return to be the most flawed, especially if it’s done without being fully conscious (which is often the case when return becomes hard to come by).  I’ve described this approach as “insisting on achieving high returns in a low-return world” and reminded people of Peter Bernstein’s admonition: “The market’s not a very accommodating machine; it won’t provide high returns just because you need them.” 

None of these possible solutions is perfect and without pitfalls.  In fact, each brings its own form of risk.  Staying safe entails the risk of inadequate return.  Reaching for return increases the risk of financial loss.  And the search for “alpha” managers introduces the risk of choosing the wrong ones.  But, as the say, “it is what it is.”  When its a low-return world, there are no easy solutions devoid of downside.”

He wrote this five years ago in May 2011 and while asset prices are higher, the message remains relevant.

The silver lining with the lower nominal expectations for asset returns going forward is that inflation has been historically low, so real (or inflation-adjusted returns) are not so bad on a relative basis.  While we can complain to the Fed about holding interest rates too low or the high stock prices, I already know what Mrs. Penner would say, “Tough luck, kid.”


In Mrs. Penner's defense, she finished smoking her cigarette, gave the kid a cookie, and let him inside.


This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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