Why You Will Never Receive a Great Return on Investment

 In Bond Investing

return on investment

The only reason to make an investment is to see a return on that investment. Without a return, you’re just throwing your money away. It’s a good thing that you’re able to make informed decisions with your money, right?

Actually, Bill Gross from Janus Capital thinks that you might never actually see a great return on investment. In fact, he recently published an investment outlook in which he said: “the stellar returns experienced by both bond and stock investors over the last 40 years are an anomaly that will not be repeated”.

Why does he think your return on investment will be less than you expect?
Bond Investing Fundamentals

The Source of Gross’ Prediction about Return on Investment

To make his claim that return on investment will be much lower than anyone expects, Gross used two different charts. One is the Barclays US Aggregate bond index, and the other is the S&P 500.

Before we dive any deeper, understand that Gross is not new to the realm of doom-saying, and he’s been warning investors about this sort of thing for a while now. One of his recent tweets stated, “Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day.”

Here are the charts on which Gross hinges his claims of eventual catastrophic market implosion:

return on investment

return on investment

In relation to the Barclays chart, Gross pointed out that investment grade bond markets offered a 7.47% compound return to conservative investors, with a very smooth climb. The important things to note here are that while wealth climbed, bond prices dropped.

The higher yields each year helped to smooth out the bumps in the road, and many investors actually saw good returns. The truth though is that there are very few one-year periods where the bond market didn’t see positive returns, which definitely contradicts what Gross is saying about the market implosion.

The second chart shows that the path of stocks has been higher and higher over time, providing more than 3% greater returns than bonds (in exchange for greater volatility and risk).

From this, Gross comes to the conclusion of, “my take from these observations is that this 40-year period of time has been quite remarkable – a grey if not black swan even that cannot be repeated. With interest rates near zero and now negative in many developed economies, near double-digit annual returns for stocks and 7%+ for bonds approach a 5 or 6 Sigma event.”

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For those unsure of the definition of a “black swan” event, it refers to a negative event that happens outside of what would ordinarily be considered possible.

He sums everything up very well by saying, “For over 40 years, asset returns and alpha generation from penthouse investment managers have been materially aided by declines in interest rates, trade globalization and an enormous expansion of credit – that is debt.”

This cannot continue, and debt will eventually swallow everything. Those returns are all based on “carry”, which offers vastly more risk than the potential for a return on investment. Gross goes on to point out that the duration needed to capture positive returns is highly unlikely, and that credit risk brings more potential for loss than return.

It is important for investors to determine which options available to them bring the least amount of risk in a rising tide that threatens to drown the entire ship. Under all of Gross’ hyperbole, the message is this: Despite rising levels of risk, investors will still need to build their wealth so it is crucial to determine which investment options bring the lowest levels of risk while still offering a return.

“Sometime soon enough,” Gross says, “as inappropriate monetary policies and structural headwinds take their tool, those delicious ‘carry rich and greasy’ French fries will turn cold and rather quickly get tossed into the garbage can.”

Where to Put Your Money to Protect Growth

Whether or not Gross is right about the impending supernova for the financial markets remains to be seen. However, his thought process mirrors that of many other less vocal experts who are predicting that we’re about to reach peak valuation for stocks (not bonds).

Once we reach that peak, the stock market will take a plunge and a massive one at that. Many predict that it will be 40 years or more before the market fully recovers from the looming cataclysm.

The only safe option here is to avoid stock investments (with the caveat that diversification is still necessary, so limited stock investments should still be part of your portfolio) and put your money into bonds.

While Gross’ doom-saying might be being downplayed by many pundits intent on seeing the good times keep on rolling, there is some wisdom to be gained here. One of the most important kernels of truth is that bonds, while providing a slightly lower return on investment over time, actually carry with them significantly less risk.

Of course, you need to know where to put your money, which means understanding the question of individual bonds vs bond funds.

In the end, the world of investment isn’t necessarily going to implode, but it will suffer from a serious devaluation as it attempts to right itself from overvaluation.

Cautious investors putting their money into low-risk, moderate return options will be better able to weather the storm and continue building their wealth, while those intent on fast returns and massive growth may find themselves clinging to a life raft in heavy seas.
Bond Investing Fundamentals

Sergey Sanko
Sergey had started an IncomeClub after years of being an investment advisor for high affluent investors and managing fixed income securities. He is the lead investment advisor representative and holds a Series 65 license. Sergey earned his Executive MBA degree from Antwerp Management School.
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