Epoch Times: What do you tell savers with a fixed income portfolio who are facing very low yields?
Marty Fridson: The low yields are a major challenge because they are being held artificially low. It would be one thing if they were low because the economy was very depressed. The rates would reflect that and the valuations of stocks would reflect that as well.
What we have now is rates that are artificially low and by implication stock prices that are artificially high. And the Fed has said explicitly that it wants to encourage investors to go into risky assets. It is trying to inflate the price of stocks.
Whatever benefits this may have to the economy currently, the likelihood is that there will be some unfavorable consequences from this policy of keeping interest rates very low; namely the likelihood of inflation.
It’s true that there is no inflationary pressure now. But as the economy continues to expand and excess capacity in capital and labor is used up there likely will be upward pressure on prices.
Epoch Times: And people who are saving for retirement are taking a longer time horizon anyway.
Mr. Fridson: Certainly over a longer period, it’s not realistic to expect that inflation will be as low as it is now. The idea of the Fed struggling to get inflation up to 2 percent. … The Fed’s mission is to maintain price stability but they say “inflation is too low; we have to push it higher.” That’s their policy.
In the future they will have a problem on the other side to keep it down, so it doesn’t go too far above 2 percent.
And then, if it’s only 2 or 3 percent compounded over the working life of someone just entering the workforce today or even someone looking ahead to retirement in their 40s and 50s, that’s going to take a big bite out of their savings. This is going to become an even more severe problem when they retire, at which point they have accumulated all of their savings and don’t have the ability to add to it.
If they are invested purely in fixed income, they find their purchasing power eroding at a compounding rate. Ten to 15 years into retirement, they will feel a pinch in their lifestyle. That’s a critical issue that people should be focused on.
Epoch Times: So what can people do?
Mr. Fridson: You have to have a portfolio that can benefit from growth in the economy over time, which is essentially equities.
You can invest in particular stocks that pay healthy dividends. That doesn’t mean the highest dividend payers that are out there today. In a lot of cases, a high dividend yield can be a sign of trouble. The market might be anticipating that the dividend is going to get cut.
What is really needed is a portfolio of stocks that are likely to increase their dividends over time. They tend to be in companies that are in basic types of products, like consumer products. There are also companies that have decadelong records in increasing their dividends.
This is a way to maintain purchasing power as those dividends grow over time.
Epoch Times: What about asset allocation?
Mr. Fridson: The first thing to think about is what is an appropriate asset mix for you at this stage in your life. One rule that’s commonly used as an example, and I am not personally recommending this, is to subtract your age from 100 percent and put that in equities.
The mix between equities, real estate, preferred stocks, and MLPs, is going to evolve over time. A very young person should be able to live mainly on current earnings and should be saving.
The young person should be mainly or even exclusively in equities to generate growth over a long period. It’s very important to take a longer view.
There is always a reason to be worried about the short-term outlook. Many people make the mistake of having have a large portion of their 401k in cash or very short-term bonds, which at today’s rates doesn’t generate a lot of income.
The long-term record on equities is very good. If stocks don’t produce something along their historical returns over a 40-year period, there will be much more serious problems. It will be because the economy has performed so poorly there is really no way to support people during retirement.
So I don’t think you have to worry about a scenario that dire.
You have to plan along the lines of: My 401k or IRA is appreciating on a tax-deferred basis, which is very advantageous.
Epoch Times: And if taxes rise?
Mr. Fridson: The usual assumption is that you are going to pay a lower rate as a retiree than as a worker. The risk is that tax rates will be higher than they are now and that’s not a wild assumption, when you consider the fiscal situation of the United States.
So you will be paying a higher rate later, but you still get a tremendous benefit from compounding returns at a tax-deferred rate in the meantime.
Epoch Times: But the market is very expensive, shouldn’t investors wait before they pile into equities?
Mr. Fridson: The problem with waiting is there is always a reason to say the market will go down. And if the market is down, people worry even more.
So it’s better to reallocate every year with more or less the same asset mix and then gradually changing that as you age. The question is: What is the probability that you will do better than that averaging strategy by timing the market and avoiding stocks when you see them as overpriced?
I don’t think you are likely to come out ahead by doing that.
Epoch Times: What about government bonds?
Mr. Fridson: Treasurys right now, the yields are so low. There is the fundamental problem of inflation, and interest rates will rise with inflation, so bond prices have to go down.
Marty Fridson is chief investment officer of Lehmann, Livian, Fridson Advisors LLC, an investment management firm. Marty has more than 30 years’ experience on Wall Street, working for Salomon Brothers, Morgan Stanley, and Merrill Lynch. He is the author of investment classic “Financial Statement Analysis” and was ranked in the top 10 of most widely published authors in finance in the period 1990–2001.
The interview has been edited for brevity and clarity.