Bill Bernstein: Make Peace With T-Bills

April 02, 2013

In a world of unusually low interest rates, the greatest danger is to reach for yield, Bill Bernstein says.


Bill Bernstein, the former neurologist, and now the author of several books about passive investing, gets that investors looking for yield have a problem these days. Who wants to be heading into retirement at a time when the real return on risk-free Treasurys is literally negative? Well, no one.

But Bernstein, whose recent book “The Ages of the Investor” addresses the challenges of getting the final phase of an investment life right, is adamant that looking to longer-dated debt or taking on bigger risks in places like the junk market is really an accident waiting to happen for people who want nothing more than to quietly clip coupons.

So grin and bear it, Bernstein told Managing Editor Olly Ludwig, because this too shall pass, and the last thing any senior or investor with limited appetite for risk wants is to be holding something like emerging market credits when the inevitable reversion to the historical mean starts taking shape. You often talk about blood in the streets, and that’s all about expected returns, right?

Bernstein: Yes. Now, it’s not outrageous to say the expected returns in fixed income are a little compromised these days, is it?

Bernstein: I would go a step further. I would say the expected return of the average balanced portfolio with a prudent investment policy—half stocks, half bonds—is as low as it’s ever been. It’s pretty darn close to zero in a real sense, because you take a -1 percent return for safe bonds and you combine that with a 3 percent return for stocks, you get a return of 1 inflation-adjusted percent. Even at 10 years, the expected return is still a negative number, and with a 10-year T-note, you’re taking real risk. I want to take my risk with stocks, not bonds. Does this mean the orthodoxy of the previous generation that said you should gravitate increasingly to fixed income late in your life might be—if not turned on its head—tweaked in a significant way?

Bernstein: My philosophy about that, which I put in the book is: Get over it; you don’t have a choice. Get over what, exactly?

Bernstein: Get over the low expected returns of fixed-income instruments, because you don’t have a choice. If you’ve saved up enough assets to retire on, you still want to put it into relatively riskless assets—T-bills, CDs, things like that that have relatively short maturities. If things mean-revert, you’ll be fine; you’ll be back up to the normal historical yields. The yields we’re looking at are obviously artificially low, and will inevitably reverse.

It’s very unfortunate that bonds have a negative expected real return right now. Unfortunately, the best thing to do is just to grin and bear it, because the alternatives—mainly extending durations or buying lower credit quality—are probably going to bite you at some point in the not-too-distant future.



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