He suggested looking at alternative asset classes outside of U.S. stocks and bonds. Investors can consider emerging markets, which have lower valuations and higher dividends.
Also, they need to save more, spend less, and plan on working a couple years longer before retiring.
Arnott, who previously served as editor of the Financial Analysts Journal, is best known for developing benchmarks that weight stocks by fundamental factors rather than by market cap.
Invesco PowerShares manages several ETFs hitched to FTSE RAFI benchmarks, such as PowerShares FTSE RAFI US 1000 Portfolio (NYSEArca: PRF). RAFI stands for Research Affiliates Fundamental Index. ProShares sponsors ProShares RAFI Long/Short (NYSEArca: RALS). [Fundamental Indexing Quiets Its Critics]
Fundamental indexing is an approach that avoids weighting companies by market cap like most traditional stock benchmarks, Arnott explained.
Market-cap-weighted indices mirror the market but their “Achilles’ heel” is that the most money is allocated to the most-loved companies with the highest stock price, or the stocks with the greatest growth expectations and loftiest valuations, he asserted.
“Why not index companies based on how good their business is?” Arnott said.
He said fundamental indexing weights companies by their economic footprint and creates a value tilt relative to the market. Also, the indices are constantly re-weighted, which takes advantage of premiums and discounts in the market to economic footprint.
Fundamental indexing “turns volatility into incremental return,” Arnott explained. Boosting returns by a couple percentage points annually with the approach can make a “big difference” over 20 years, he said.