Ludwig: I’d be remiss if I didn’t ask this: The ETF is at the center of all this, isn’t it?
Malkiel: I think there’s no question that the ETF could be at the center of it, but that doesn’t mean that one wouldn’t use mutual funds. I would say there will probably be a tendency going toward ETFs because they’re lower-cost instruments, and I think I’ve told you before, that all of us need to be modest about what we know and don’t know about investing.
I think I’ve told you before that the only thing I’m absolutely sure of is—and there’s not a lot I’m absolutely sure of—is that the lower the price I pay to the purveyor of the investment product, the more there will be for me. And that will, in many cases, lead to ETFs.
Ludwig: Now, Wealthfront is very algorithmically driven and is trying to take the emotion out of investing, and you are one of the legends of the indexing movement. And that makes me wonder: What are you doing over there as chief investment officer, and how much is there to do in such an automated environment?
Malkiel: Well, I’ve been talking to the people who have been doing the portfolio allocations, and have been coming up with portfolios. Yes, it’s algorithmic—but it makes a great deal of difference what kind of inputs you put into the equation. And the inputs of covariance and expected return are extremely important.
Let’s take one particular example: I’m extremely worried about the bond market. The 10-year Treasury note yields 1.56 percent, and if you hold that to maturity, that’s precisely what you’re going to get.
Ludwig: The 1.56 percent?
Malkiel: Yes. You’re not going to get what Treasurys have done in the past. And this then also leads to the fact that it makes a difference what the time horizon is for the individual. There’s a different way to do Markowitz portfolio theory when you’re talking about a 20-ish engineer working at Google who is just getting into the game and who has an enormously long horizon compared to a 70-year-old who’s looking at a risk and return from the standpoint of someone with a shorter horizon.
All of these things are important, and while they are algorithms, the parameters that you put in place matter. So there’s a lot that’s behind this, and I would say to you—and this is one thing that people at Wealthfront do understand—that there’s also a good deal of judgment that’s involved. Again, even though these are algorithms and are computer-driven, there isn’t anything you get out of something that’s computer driven that you don’t want to look at very carefully and ask, Does this make sense, or not?
And that’s exactly what we’re doing: What do we do about bonds? And if we’ve got the 70-year-old who wants income; who wants low expense; who wants less volatility—are there things like dividend-growth ETFs that can substitute in part for some of the traditional bond portfolio? Should we look, for example, at emerging market bonds? Are they as risky as their past risk and return parameters suggest?