There are so many independent, experienced, sober and successful investors who believe that we are in the midst of a low-return world that it is next to impossible to find equally serious and clear-thinking investors who believe the opposite. Why is that?
The common answer is because a low-return scenario is compellingly obvious. The evidence is plentiful, and the arguments are convincing: In almost any outcome, long-term annual returns for conservative bond investors are unlikely to exceed 2%. U.S. common stocks — depending upon what form of valuation you use — are somewhere between moderately to excessively valued; perhaps they are not in bubble territory, but they are not so far removed from it either. The consensus of investors whose opinions I respect conclude that five- to 10-year returns from common stocks are likely to be on the low side of historical averages — and that represents their bullish scenario.
This sets up a challenge for 76 million baby boomers that cannot be understated. When it comes to investing their life savings, they are looking primarily for guarantees. The return from the safest guaranteed investments (10-year Treasury notes) has declined nearly 70% over the last 10 years: from 4.6% to 1.5%.
In dollar terms, the amount of money needed to generate an income of just $25,000 per year has tripled, from $540,000 to $1,660,000. The other option (risking their nest egg in potentially overvalued common stocks) hardly feels like a compelling alternative.
Wall Street has put its best minds to work, searching for creative solutions. Their sensible conclusion is: Don’t chase yield, at least not on traditional sources of income. Instead, they offer up a menu of non-traditional sources of income, and suggest hedging one’s bet by diversifying among them.
It all sounds so well thought out and logical — and in fact, it is. Alternative investments are more sensitive to different types of risk than are traditional investments. What Wall Street neglects to mention is that different risk doesn’t necessarily mean less risk. More likely, it means less-understood risk. Yet what other options do investors have? Surely if there were other sensible choices, we would have heard about them by now.
The narrative of a low-return future is persuasive — built on solid historical evidence, simple mathematics, logic and common sense. It is hard to imagine an alternative narrative as convincing (which explains the lack of commentaries about a high-return world). The strength of a good narrative is that it is likely to be correct. But the weakness of a good narrative is its pull on our attention, which impairs our perceptual flexibility, keeping alternative solutions hidden and increasing our risk.
The Enemy Is Us
The obstacle to identifying alternative solutions to this challenge appears, once again, to be us. We are born with valuable instinctual and biological filters, without which (given the amount of actual input the world throws at us) we would not be able to remain sane. To order and prioritize what we perceive in the course of a typical day, we use various mental models of the world — artificial constructs that tell us what’s important and what’s irrelevant, processing the input through our emotions, memory and value systems.
All of this happens instantaneously and subconsciously. Without these critical filters our experience of everyday life would be (in the words of William James) “A blooming buzzing confusion.” Stories and narratives are important tools we use to communicate our understanding of things. Author Abby Smith Rumsey has a wonderful insight about them. She writes, “We create narratives that make sense of our passage through time just as our maps make sense of our passage through space.”
Filters, mental models, narratives and stories are enormously valuable tools we exploit to make sense of things. But their use also means that our daily perception of the world is, by necessity, a heavily redacted version of the real thing. Cognitive psychologist Chris Firth calls it, “A fantasy that coincides with reality.” And Nobel Laureate Daniel Kahneman, in “Thinking Fast and Slow,” demonstrates in one example after another how simple it is to manipulate our perception of reality by slightly reframing the same narrative.
Thus, we need to be very careful: The same tool that helps us gain clarity in one scenario can be an obstacle to it in another. Maintaining a healthy skepticism of even the most compelling narrative may be our only intelligent option.