More Reasons to Prefer Stocks over Bonds in 2012 and Beyond

To repeat our current investment outlook, owning high quality stocks will likely prove to be the best investment opportunity for the next several years.

And we're not the only ones who believe that. We even have some "experts" in our camp.

Where to Put Your Money in 2012 is an editorial by Burton Malkiel, author of the long time best selling book "A Random Walk Down Wall Street" and professor of economics at Princeton.

Here are his reasons for avoiding bonds in 2012:

"But it is possible to make reasonable long-term forecasts. Let's start with the bond market. If an investor buys a 10-year U.S. Treasury bond and holds it to maturity, he will make exactly 2%, the current yield to maturity. Even if the inflation rate is only 2%, the informal target of the Federal Reserve, investors will have earned a zero rate of return after inflation.

With a higher inflation rate, U.S. Treasurys will be a sure loser. Other high-quality U.S. bonds will fare little better. The yield on a total U.S. bond market exchange-traded fund (ticker BND) is only 3%. Bonds, where long-run returns are easy to forecast, are unattractive in the U.S. and Japan, as well as in Europe, where defaults and debt restructurings are likely."

And here's why Malkiel believes stocks are attractive:

"Long-run equity return forecasts are more difficult, but they can be estimated under certain assumptions. If valuation metrics (such as price-earnings ratios) are constant, long-run equity returns can be estimated by adding the anticipated 2012 dividend yield for the stock market to the long-run growth rate of earnings and dividends. The dividend yield of the U.S. market is about 2%. Over the long run, earnings and dividends have grown at 5% per year.

Thus, with no change in valuation, U.S. stocks should produce returns of about 7%, five points higher than the yield on safe bonds. Moreover, price-earnings multiples in the low double digits, based on my estimate of the earning power of U.S. corporations, are unusually attractive today."

{NOTE: It's quite possible that PE multiple expansion will take place along with moderate earnings growth the next few years. If price-earnings multiples increase from ~13 today to ~17 over the next several years, that alone would cause stocks to appreciate by ~30%, excluding the favorable effects of increasing earnings and dividends. Thus, there are lots of good reasons to like stocks going forward.}

Finally, Mr. Malkiel cautions us to remain vigilant about what we pay for investment advice and active account management:

"Whatever the specific mix of assets in your portfolio at the start of 2012, you would do well to follow one crucial piece of advice. Control the thing you can control—minimize investment costs. That is especially important in a low-return environment. Make low-cost index mutual funds or ETFs the core of your portfolio and ensure that any actively-managed investment funds you purchase are low-expense as well."

That last point about watching carefully what we pay for advice and account management is critical. Whatever we are charged for advice, trading activity and altering the portfolio's investment mix must be subtracted from what would otherwise be the portfolio's value.

Thus, if the market value of the portfolio's holdings increases by 10% and the all-in investment costs charged to the portfolio are 3%, that 3% charge represents a 30% commission rate. {Of course, if it's a taxable account, income taxes on gains would have to be subtracted as well.}

So here's the plan. By avoiding the non-value added ~3% annual charge, from inception we'd end up with twice as much money in our non-commissioned portfolio after 24 years, using the rule of 72 as our guide. And we'd have four times as much after 48 years. Of course, the total actual value would be less than a double or quadruple due to periodic investing over the years as opposed to using just the initial amount invested. But you get the point.

Stated simply, commission costs and what we pay for investment advice matter. A lot.

By the way, if you ever want to discuss how to create and/or manage your own customized investment portfolio, whether tax deferred or taxable, feel free to contact Chad and/or me. We'll be happy to help, whether on a one time, periodic, or ongoing basis.

Our only agenda is that we don't have one. And our only charge is that there won't be one.

Our sole motivation would be to advise and help you with investing and related advice.

Thanks. Bob.