Five years ago this month the Federal Reserve embarked upon a quantitative easing (QE) policy in an effort to bolster an economy that was on the ropes. Though it is difficult to measure QE’s contribution to growth it is clear that QE has created winners and losers among investors.

QE is a technique distinct from a central bank’s conventional monetary policy tools. Normal monetary policy involves a central bank exercising open market operations to target a specific short term interest rate (in the U.S. the Fed targets the federal funds rate). If the central bank wants to reduce current rates, it will enter the market and purchase short-term treasury debt from banks, thereby increasing the money supply within the banking system.

When short-term interest rates are at or near zero, however, open market operations cannot push rates lower. In that case central banks may resort to QE to stimulate economic growth. This often involves central bank purchases of long-term debt from banks or other private institutions in order to further expand the money supply. QE is rarely employed primarily because it runs the risk that when these funds are eventually lent out by banks price inflation will ensue and can be difficult to rein in.

The Fed is in the fifth year of QE and now holds over $4.3 trillion in U.S. Treasuries and mortgage-backed securities on its balance sheet. These efforts have come in stages (dubbed QE1, 2, and 3), and the Fed has been ambivalent regarding whether and how soon it will taper its purchases of these assets. Thus far QE’s success in growing the economy is difficult to gauge; though the recession officially ended in 2009, unemployment remains high and GDP growth has been tepid.

While QE has been a boon to those who can afford to assume the risk of investing in common stocks, others, especially short-term fixed income investors, have endured several years of negative real returns. Investors willing to bear greater risk should be expected to earn greater returns, but the magnitude of the recent risk-return trade-off has bas been extraordinary. Between November 2008, when QE 1 began, and October 2013 the U.S. stock market provided a total inflation-adjusted return of 14.51 percent per year. Over the same five-year period the one- year U.S. Treasury bill returned -0.75 percent per year after accounting for inflation.

The Fed’s low interest rate policy boosts equity prices because common stock prices represent the present value of future earnings discounted at current interest rates. This policy especially benefits the most aggressive investors, who can leverage their returns by borrowing at short term rates to purchase equities. Meanwhile conservative investors, including many of the elderly, currently confront negative real yields on bonds ranging as far as five years out based on current expectations for inflation.

Also In This Issue

The Dow, Creative Destruction, And HYD Investing
A Reader Inquires: Time To Take Gains?
Year-End Tax Swapping
Recommended Fund Change
Charitable Remainder Unitrusts: Advantages Abound
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles