2 Picks from a Fund Guru

Focus: FUNDS

Sometimes it's a very good exercise to take questions from readers and give them the answers they're looking for, notes Samuel Lee of Morningstar ETFInvestor.

The folks at Morningstar.com asked me to respond to a few questions for a special feature they're running. I figured it would be good for ETFInvestor subscribers to get a peek first.

1. What are the biggest challenges or pitfalls facing investors today (and what mistakes do you think investors are making)?

Without a doubt, negative real interest rates. The developed world is still paying down the mountains of debt it stacked up over the past generation. The United States' total debt (public and private) as a percentage of GDP peaked at nearly 390% in 2008. It's now down to around 350%, still a long way from the 150% ratio the post-WWII US economy averaged until 1980. Europe and Japan aren't any better. In past deleveragings, interest rates remained depressed for 10-20 years. Heeding history, the bond market is pricing in zero to negative real interest rates for the next couple of decades.

All financial assets are priced in relation to prevailing interest rates. When rates are low, asset prices rise. When rates are really low, asset prices tend to be really high, all else equal. The biggest challenge is the reality that retirees, in aggregate, can expect to tread water or eke out modest returns. The 60/40 stock/bond portfolio is priced for low-single-digit real returns at today's valuations. This is a devastating outcome for retirees who haven't saved enough or are paying high fees for advice.

The understandable reaction is a scramble for yield.