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think no one—neither an individual nor an institution—
ought to attempt to do it.
JOI: Should investors be concerned about inflation during the
near term? If so, how can they protect themselves against it?
Malkiel: My sense is that individuals should not be concerned
about inflation over the near term. I think they
should be far more worried about deflation. The world is
awash with excess capacity, and I think all of the pressures
are going to be on the other side; that is, for falling prices
rather than rising prices.
Over the longer pull, I think that inflation is a possibility. I
think it’s a possibility because there is an enormous amount
of liquidity sloshing around the world. Central banks, such
as the Federal Reserve, have expanded their balance sheets,
and there’s no doubt in my mind that eventually that excess
liquidity is going to have to be mopped up.
And I think politically, with very high unemployment and
continuing high unemployment, it’s unlikely that any central
banks are going to do the mopping up early rather than
later. So I think there is a longer-run danger of inflation. But
over the near term, I think absolutely not.
Now, how do you protect yourself against inflation?
I think the only thing you can do is have a very broadly
diversified portfolio. And what that means is that in your
portfolio you’re going to have equities, which are a longrun
inflation hedge, and within those equities, you’re
going to have raw material producers that will certainly
help if there’s long-run inflation. You will have positions
in emerging markets such as natural-resource-rich countries
such as Brazil. And I think that’s the only sensible
thing for anyone to do. The portfolio ought to be broadly
diversified. It ought to have some bonds, which will certainly
be very good in a deflationary environment, which
is what I expect over at least the next year or so. But it
ought to have equities, including equities of companies
that produce raw materials.
So, diversification is, I think, the answer to investors.
You ought to have a portfolio that will work well in any
environment.
JOI: Have you adjusted your investment philosophy during the
last two years?
Malkiel: The one change in my thinking on investing and
asset allocation is that the emerging economies of the world
are continuing to grow, and grow rapidly. Within the next
few years, particularly adjusted for purchasing power, China
will exceed Japan as the world’s second-largest economy.
And I think before too long, adjusted for purchasing
power, China will be bigger than the United States. So the
one adjustment that I have made is, along with the increased
importance of emerging markets such as China, such as
Brazil, I have, for myself, changed the equity allocation to
include a much heavier commitment to these markets, and I
think all individuals should do so.
JOI: What do you see as the biggest danger/opportunity for
investors over the next five years?
Malkiel: Well, the share of world GDP has been growing rapidly
for emerging markets. Those are where I see the opportunities.
Now, where would I see the longer-run dangers? Again,
while I say I do not expect any kind of inflation over the
next year, over the next two years, I do see potential inflationary
dangers over a longer period. I think that, paradoxically,
probably the safest security you can buy—the 10-year
Treasury at 3.25 percent —worries me, because I think if we
have even some moderate inflation of 2 to 3 percent breaking
out three or four years from now, those will not prove to
be profitable investments.
Larry Swedroe, Principal and Director
of Research, BAM Advisor Services
JOI: Is buy-and-hold investing dead?
Swedroe: I almost have to laugh whenever
I get a question like that. It’s similar to
the question, “Is diversification dead?”
Whenever we get some kind of crisis, all those who believe
in active management come out of the woodwork with
this nonsense. All that shows is that they don’t know the
basics of investing. Any student of history and investing
would know that during a financial crisis that is systemic
around the globe, the correlation of all risky assets always
go towards 1. It has happened many times before.
But still, they come out of the woodwork …
There was actually an article in [the Oct. 11, 2009 issue
of] Investment News, titled, “The days of buy-and-hold have
gone and went.” So let’s deal with that issue.
It’s a very simple mathematical fact―which William Sharpe
demonstrated in his nice little paper called “The Arithmetic of
Active Management,”―that active management must lose in any
environment or any asset class. Anyone who says otherwise
should be required to wear a shirt that says, “I can’t add,” in big,
bold letters. There are only two types of investors: active or passive.
So, let’s say you are a passive investor and you just want
to own Vanguard’s Total Stock Market Fund [NYSE Arca: VTI].
If the market goes up 10 percent, before expenses, you must
get 10 percent, as all passive investors do. And that means, in
aggregate, the active investors have to get 10 percent, before
costs. The same math applies in down markets.
Since active investors have higher expenses, active investors
must lose after costs. As Sharpe points out in his article,
anyone who produces a study that finds anything different is
simply measuring the wrong things.
JOI: Should investors be concerned about inflation during the
near term? If so, how can they protect themselves against it?
Swedroe: Let me say it this way: William Sherden was an
economist called to testify in front of Congress on nearterm
inflation. He got the brilliant idea to say, “You know
what? I ought to check the track records of these other
geniuses like me who have previously been called to testify
on the outlook for inflation and see if they got it right.”
And guess what he found? He found these geniuses had no
better forecasting record than what is called the naive fore-
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