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Burton Malkiel Picks Bonds as ‘Worst Asset Class for Investors’

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Burton Malkiel has just published his list of best and worst asset classes for investors, and bonds are at the bottom of the list.

Burton Malkiel “Bonds are the worst asset class for investors,” says Malkiel (left), the author of A Random Walk Down Wall Street, in an opinion piece published in late March in The Wall Street Journal. “Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser.”

The Princeton economics professor reasons that even if the overall inflation rate is only 2.25% in the next 10 years, an investor who holds a 10-year Treasury until maturity will realize a zero real return after inflation. And if the investor sells prior to maturity, he warns, it will likely be for less than the face value of the note if the inflation rate rises.

So given the present outlook for a self-sustaining U.S. recovery tempered by rising gasoline prices and continued euro zone troubles, what is the best strategy for investors? Malkiel looks at three asset classes in reverse order, and after ranking bonds worst, he picks real estate as his No. 1 investment bet, followed by equities—emerging markets, especially —in second place.

“Real estate is a particularly attractive asset class,” Malkiel wrote, asserting that it will be one of the best investments over the next decade. “Investors who are currently renting the place in which they live should strongly consider buying.”

Housing affordability has never been more attractive, he says, noting that real-estate prices have plummeted if not to their absolute lows, then certainly very near to them. “Long-term mortgages are below 4% for those who can qualify. Moreover, under present tax laws there are advantages to owning since mortgage interest is deductible and rent is not.”

As for equities, despite a substantial rise from their October 2011 lows, equities are still attractively priced, according to Malkiel.

“A good way to estimate the likely long-run rate of return from common stocks is to add today’s dividend yield (around 2%) to the long-run growth of nominal corporate earnings (around 5%),” he writes. “This calculation would suggest that long-run equity returns will be about 7%—five percentage points more than the safest bonds.”

Emerging market equities in particular win Malkiel’s favor because price-earnings multiples for emerging markets have traditionally been about 20% higher than for U.S. stocks, but today they are 20% lower. “Over the long run, emerging markets have better demography (younger populations) and better fiscal balances than the developed markets,” he says, “and they are likely to continue to grow at a far more rapid rate than the developed world.”

Read more from Burton Malkiel at AdvisorOne.