By Arnold Kling
What is a safe investment nowadays? Zvi Bodie argues for inflation-indexed government securities.
The probability that stocks will perform worse than risk-free investments, such as TIPS or I-Bonds, gets smaller the longer you hold them. After 30 years, there is a 95% chance that stocks will beat TIPS. But the severity of a possible shortfall gets bigger. For example, say you have $500,000 and are three years away from retirement. If you suffer three years of 15% losses, your savings will be almost cut in half — and your retirement will be jeopardized.
Bodie is particularly hostile to the view that stocks are somehow less risky the longer the holding period. See this paper.
“There is … [the] quite large risk that people who are heavily into long bonds will be sitting on large capital losses,” Blinder frets. If interest rates on 10-year Treasury notes rise from 4 percent to 6 percent, for example, the value of those notes will drop by almost 14 percent. “You can have a sizable loss, and that’s not well understood,” he says.
Blinder was interviewed in the AARP journal, which presumably explains why he was counseling such strong risk aversion. The recent behavior of bond prices makes his advice seem well timed.
For Discussion. Are investors in stocks and bonds under-estimating the downside risk?