The Lost Decade of Investing: Was All Really Lost?

Stocks May Have Had a Rough Decade, But Prudent Investors Still Made Money

The 2000s are going into the history books as the lost decade of investing. Why? The simple reason is because if you were to invest one dollar into the S&P 500 on January 1, 2000 you’d only have roughly 90 cents on December 31, 2009. This is a pretty big deal when you consider all the financial experts and pundits tout the long-term average of stocks being in the 8-10% range. But actually losing money in stocks over a ten year period? That’s where the media begins to go into a frenzy.

It isn’t just the media making stuff up because these are real statistics. Stocks went through one of the roughest decades in history and in terms of asset classes, as a whole they performed among the worst. In fact, over the same period, had you invested one dollar in U.S. government bonds you would have essentially doubled your money, and government bonds are considered to be among the safest places to put your money.

This is why so many people have lost trust in the stock market and are looking for other places to invest their money. Can you blame them? If you’ve been told that investing in the stock market will give you average annual returns of nearly 10 percent and you actually lose money in the market over the course of ten years, you’ll think about just sticking it in the bank and earn just 1 percent, too. It’s better than not making any money and a heck of a lot better than losing money.

While it’s true that the broad stock market as a whole was worth less at the end of 2009 than it was in 2000, is all this fuss about the lost decade really true or does an interesting statistic just make for good headlines?

Some Problems With the Lost Decade Assumption

Here’s the thing. While the stock market may have appeared to remain flat or even decline slightly in the 2000s, there are a lot of assumptions that just don’t stack up to real world investing which skews the lost decade argument in its favor. Let’s examine a few of them.

First of all, and probably the biggest culprit, is basing the assumption on a lump sum investment on January 1, 2000 and then simply holding onto that investment until the end of 2009. Think about that for a minute. How many people do you know put all of their available money into the stock market at a single point in time, which just happened to be the beginning of a new decade, and never invests another cent over that time? Yeah, I can’t think of anyone who did that either.

Nonetheless, this is what people are using as a reference for the lost decade argument. So, let’s begin to put some numbers and scenarios to the test.

What you have above is the classic example people use to prove that stocks were a bad investment in the 2000s. Here you’ll see someone who invested $50,000 in the S&P 500 at the beginning of 2000 and held it, without making any additional investments or rebalancing, and ended up with less than they started with. In this example (and the rest going forward) I’m using Vanguard index funds and all results are net of fees and include dividends reinvested.

Obviously, investing everything at once in 2000 into the S&P 500 yields a loss over ten years. We have a cumulative loss of nearly 12 percent and an average annual loss of 1.25 percent. This is essentially a worst-case scenario, and not a very good representation of what you and I do with our retirement nest eggs.

A More Realistic Approach

Since most people don’t invest a lump sum and invest regularly over time, either bi-weekly with their paychecks, monthly, quarterly, or even annually, what would those results look like? I was curious myself, so I ran the same hypothetical but this time I took $50,000 and spread it out evenly over the same ten year period. That means an investor would have invested $5,000 each year, and for the sake of realism, I turned that into $1,250 quarterly investments.

The chart looks different for obvious reasons, but what about the end result? Pretty shocking if you ask me. You’ll notice we actually have gains in this scenario. Over 12 percent cumulative return and a little over 1 percent annualized. Does it add up to the historical return of stocks and were there still better performing investments over this time frame? Of course. But the point is that investing small amounts regularly over time, like most people really do, you saw quite an difference over the lump sum numbers that people are so quick to point out.

More Accurate, but Not Good Enough

So, we’ve seen that simply replacing the lump sum model with the more realistic regular investments over time fares better, but that isn’t good enough. How are you invested? I’m willing to bet 100% of your assets aren’t  in an S&P index fund. In fact, most people aren’t invested like this. While younger investors are usually encouraged to have a portfolio that consists of mostly stocks, most still have other investments. There are usually some bonds, maybe some small and mid-cap stocks, international investments, and so on.

Since most people aren’t simply investing in the S&P we should probably take a look to see how some other portfolios may have fared. We will start with the relatively common 80% stock and 20% bond mix. Just for sake of comparison, let’s look at this 80/20 portfolio invested as a lump sum.

This probably doesn’t come as a big surprise, but by adding some bonds to the overall portfolio we fared a little better than having everything in stock. We didn’t make much with a cumulative return of 6.5 percent, but we also didn’t lose money, so that’s good.

Of course, we already know how unlikely the lump sum investment strategy is, so let’s move on to the same portfolio invested slowly over time with regular contributions.

Things are looking up. Even compared to the first quarterly investment scenario above, by holding just 20 percent of our portfolio in bonds we’ve managed to see a total return of nearly 23 percent with annualized returns of 2 percent. It’s still well below the historical average of a stock-heavy portfolio, but we’re already far ahead of the numbers used when touting the lost decade. We turned a negative 12 percent total return into a positive 23 percent return by simply adding a small amount of bonds into the mix. That’s a significant change in fortune.

What About Rebalancing?

I’m glad you asked.  Even though we’ve created a more realistic investing scenario by dumping the lump sum idea and introduced a little diversification into the mix by adding some bonds, we’re still missing out on one key ingredient. Portfolio rebalancing. This gets a little tricky because a lot of people don’t rebalance their portfolio like they should, but there’s a good chance that over the course of ten years you’ll be shuffling things around a few times.

So, what does rebalancing do to our 80/20 portfolio that’s invested quarterly? To find out, I ran the same portfolio as the last chart but instituted semi-annual rebalancing back to the target asset allocation.

The chart doesn’t look much different, but the end result is. By simply rebalancing twice a year back to the target portfolio we were able to squeeze out another few total percentage points. It’s not enough to send you into early retirement, but if you’re willing to jump through hoops to save 0.25 percent on fees each year, wouldn’t you want to get an extra 0.25 percent each year by simply rebalancing?

There’s More to Stocks Than the S&P 500

We’ve done a good job covering sample portfolios and investment strategies thus far, but it still isn’t all that realistic for the average investor. Most people own more than an S&P index fund and a single core bond fund. Some people may be content with this, and that’s fine, but most people have diversified even a bit further.

So, let’s look at another portfolio typical of a 30-something tucking away money with each paycheck into their 401(k) or IRA. This time we’re going to use a 70/20/10 mix of stocks, bonds, and small-cap stocks. The same two Vanguard funds as above, but now introducing the small-cap value index.

Once again, we’ve made money during the lost decade, and it’s the best performance we’ve seen in the examples so far. This example wasn’t rebalanced, but if you run the numbers with the same rebalancing as before you’ll get even slightly higher returns again.

Let’s take things one step further because a lot of people don’t just have a very small allocation of smaller cap stocks. Let’s work with a 40/40/20 mix which includes 40 percent S&P 500, 40 percent of small and mid-cap (split equally), and 20 percent bonds.

Look at that. We’re up to over 43 percent cumulative and over 3.5 percent annualized returns. Of course, it’s still a pretty basic portfolio, but it should be similar to what many investors have as a whole in their retirement portfolios. This portfolio isn’t rebalanced, so what happens if we rebalance it regularly as we should?

Again, it proves to yield even slightly better overall returns pushing us to nearly 4 percent annualized returns. Earning 4 percent investing primarily in stocks when the general consensus is that everyone lost money over this time period is a pretty good result.

So What Does it All Mean?

Clearly, we can’t dispute the original facts that get people all worked up about the stock market over the past ten years. It’s true. Stocks have done poorly, and in most cases even lost money over the decade. There’s no denying that. The real problem is the fact that it doesn’t represent real world behavior or results.

For one, most people don’t go out and plop down tens of thousands of dollars at one time and then just sit on it for years and years waiting for it to grow without investing any more. Second, even if someone does do that, they almost never just dump it all into a single broad index fund and call it a day. Most people are at least diversified among types of stock, and more than likely hold other asset classes for diversification such as bonds, international, REITs, commodities, and so on.

The other main issue is that hindsight is always 20/20. Anyone can look back and say, “boy, if I had just invested in government bonds or gold in the 2000s I’d be much better off.” Thinking about what could have been is a fool’s errand. That’s not how investing works. You can study history all you want and try to base your investment strategy on past events, but it has almost no bearing on what’s to come in the future. So, the people who abandoned the stock market a few years ago could very well miss out an upcoming decade with 15 percent annualized returns. Nobody knows for sure, but if you’re always switching your investments around based on stuff that’s already happened you’ll also miss out on a large part of what’s to come.

Besides, this isn’t the first time stocks have had a poor stretch of returns. Looking back at the decades from the 1930s we can see that there are plenty of periods of time that fared worse than others.

S&P 500 in Decades Past

DecadePrice Change (annualized)
1930s-5.26%
1940s2.98%
1950s13.58%
1960s4.39%
1970s1.60%
1980s12.59%
1990s15.31%

I know most readers are younger and weren’t investing back in the 1970s, but don’t you think people were having the same type of conversation back then as we are today? Stocks performed quite poorly for nearly 20 years but that obviously didn’t mean stocks were dead and should be avoided. As the following 20 years proved, things picked up and went beyond anyone’s wildest expectations.

The Bottom Line

Obviously, a lot of people lost money investing in stocks during the 2000s. There’s no way around that. The point is, money wasn’t lost because of the lost decade. It wasn’t lost because someone bought stock ten years ago only to realize it’s worth less today. No. People lost money because they didn’t have a diversified portfolio. They lost because they reacted to market movements by getting in and out of stocks based on stuff that has already happened.

As bad as the stock market was over the past ten years, a prudent investor that took the time create a diversified portfolio, continued to invest during both good times and bad, actually made money while the majority of investors lost. That is the whole point of diversification’to create a portfolio that will maximize returns while minimizing risk. It worked beautifully over the last ten years! Averaging 4 percent a year while stocks as a whole saw losses is fantastic.

Sure, there will always be people quick to point out that something was a better investment over that time, but again, it’s all hindsight. Anybody can proclaim they are smarter than the market when looking back, but show me one person who in 1999 or 2006 who wanted to be invested in a 3% CD versus taking advantage of a bull market. How many people in 2003 were afraid the value of their home would be dropping by upwards of 50% in coming years? Everybody becomes an expert when picking apart the past.

Since nobody can accurately predict the future, the best thing you can do is create a diversified portfolio and continue to plug away with your investments in a way that helps you prepare for the unexpected. Over time, and with a continuous influx of money, you will come out ahead. Some years will be better than others, but if you stick to your plan you’ll sleep better at night and you won’t have to stress out every few weeks about trying to decide where to move your money in order to take advantage of the next big investment.

The lost decade? Maybe if you’re a glass is half empty kind of person, but a smart investor still made money, and a really smart investor had the foresight to take advantage by being greedy when others are fearful and has the big picture in mind. That will come in handy 30 years from now.

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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.

28 comments
Redleg52
Redleg52

The lost decade lays at the feet of "financial managers". I do not have the time or knowledge to manage my investments. Do financial managers teach school or sell furniture while being a full time money manager. Well I'm a full time engineer and do not have the time or expertise to properly manage money.

Financial managers are paid a fee and also advertise that they will monitor your portfolio. I have been burned more than one time be this account neglect. The stock market will continue to rise long enough for the big money grubbers to make another killing off the back of the middle class. Sorry to be so negative, my perspective comes from first hand experience.

RecardoMandy
RecardoMandy

my friend's step-mother got paid $15299 a week ago. she is working on the computer and bought a $532400 home. All she did was get fortunate and profit by the clues exposed on this web site lazycash23~com~

DGBescu
DGBescu

Hi Jeremy,

Thanks a lot for explaining all of this. I am still confused about the same thing as Michelle above. Can you please explain why you are focusing on Average Annualized Return and Cumulative Return (as defined by Morningstar)? I would think it is more important to focus on Annual Compounded Return. Sure, the numbers would be lower, but to me it looks like they would also be closer to the truth. For example, for the last chart average annualized return is 3.85%, but at the end of the day I would have invested $50,000 (which could have gone into something else, like mortgage payments) over 10 years, and I would have only $60,000 (i.e. a $10,000 return, or a 20% cumulative return- my definition, not Morningstar's). Sure Morningstar's almost 46% cumulative return certainly sounds better, but is it? I didn't really make as much money as it implies.

I am new to this, so I'm probably making a mistake somewhere or not understanding something. So can you please explain the numbers better and also why we should look at these metrics versus the ones I mention here?

Thanks a lot,
DGBescu

Executioner
Executioner

I think the oft-quoted "historical average" of 8-10% return for US stock markets does a disservice to the average investor. It represents a length of time which spans a human life (or longer). It includes the years after WW2 when the US was an economic powerhouse -- mainly because it was one of the few developing nations to not see its infrastructure destroyed during armed conflict. It also incorporates a number of one-time gains which are unlikely to be repeated due to overconsumption of natural resources (see Peak Oil) and favorable political conditions (deregulations during the 80s and 90s which were good for companies in the short term but which resulted in dire consequences in recent years).

When comparing stock investments against other investment choices (such as bonds) or debt reduction strategies (paying off a mortgage early, for example), the 8-10% "return" from the stock market makes this seem like the obvious choice. I think the reason investors like the one quoted in the articles referenced are so reluctant to stay invested is because there is a very big difference between a "long term average" of 8-10% and a short-term drop of 30-40%. Stock investing involves more risk than many investors realize and/or would be willing to accept.

Jeff Turner
Jeff Turner

Great insight. We are in a bond market where the returns are not a great, but conservative. Thank you.

A Carroll
A Carroll

"Besides, this isn’t the first time stocks have had a poor stretch of returns. Looking back at the decades from the 1930s we can see that there are plenty of periods of time that fared worse than others."

You are ignoring the fact that workers had pensions and retiree health benefits in other times that they could depend on, so they didn't have to depend on one source of uncertain and fluctuating income in retirement. Companies haven't included pensions in their benefits packages since the 1990's or late 80's, just 401K's. And more and more employers are eliminating retiree health benefits from their compensation packages.

You also ignore the 25% gap between earnings for women compared to men (we won't even talk about total compensation packages!), making their investments lower, of necessity, as well as any percentage income raises or benefits based on percentage increases. You may be averaging the outcomes in your analysis, but real numbers have real impact in the lives of real people.

Lili
Lili

This is great. I can actualize visualize what occured during this time span with stocks and bonds in a portfolio.

Thanks!

retirebyforty
retirebyforty

Great post! Now I can point to this post when someone ask about mutual fund investing and dollar cost leverage.
I think the most important thing is to keep adding to the investment, it smooth out a lot of the sharp dips.

Michelle
Michelle

Jeremy,

I'm looking at the "cumulative return" rates on the graphs and somehow they don't add up. A $10,481 return on a $50k investment is not a 45.92% cumulative (total) return.

I see similar issues with those rates in the other graphs, with the exception of the first one and the 80/20 stock/bond lump sum graph. It's almost as if Morningstar's program isn't zeroing out prior to subsequent calculations.

Am I missing something here? Thanks in advance for any explanation.

Thomas
Thomas

Intrinsic value (measured by company earnings) of the S&P 500 has roughly doubled while the nominal value is about the same or lower.

Yes, stocks were really that big a bubble in 2010.

PS, try a 2001-2010 comparison or a 2002-2011 comparison. Ideally, compare from right after the dot com bubble burst and stocks would have done pretty well.

Thomas
Thomas

Another way to explain it is that 2000 was the peak of a bull market while we're currently still pretty deep in a bear market.

When you buy stocks then when they're expensive and you compare it to now when they're cheap, you're going to cry yourself to sleep.

My proof of expensive then vs cheap now is earnings. Company earnings have gone up since 2000. Back then during the stock market, PE was like 26 while right now it's around 13.

Therefore the underlying intrinsic value of stocks has roughly doubled in this decade which equates to about 7% growth per year for this decade.

Budgeting Money
Budgeting Money

Most people can’t easily quantify it so they focus on how their stocks are performing.

Ben
Ben

random question, what did you use to find the data and create the graphs of historical trading scenarios?

Josh
Josh

Unfortunately the worst thing you can do is lose money. Losing in the stock market is always worse than gaining. If you have a 20% loss followed by a 20% gain you do not break even. Losses always hurt more. Even if you reverse the order losses still hurt more.

Asset allocation, diversification, these are all just terms stock brokers made up to make you sleep better at night. But the thing you need to focus on is don't lose money, and unfortunately these things don't keep that from happening.

Tara C
Tara C

THANK YOU for publishing this article, I feel a whole lot less depressed about my portfolio now!

Chris Yeh
Chris Yeh

One other aspect you should probably mention--simply looking at the index value doesn't take into account dividend yield, so the calculations underestimate equity returns.

Roshawn @ Watson Inc
Roshawn @ Watson Inc

Jeremy,

Very, very insightful analysis. I keep on reading and hearing about the loss decade. Instinctively, I knew that there was much more to the story, but I never thought through the counter arguments, which you so nicely laid out here.

With regard to comparing where I was 10 years ago to now, yes there is no comparison. We are doing way better now.

Kind Regards,
Shawn

JoeTaxpayer
JoeTaxpayer

I track our net worth and one the regular sheet maintain quarter ending numbers. We are up 62% in dollars over the '00 decade. When normalized (dividing net worth by income) we went from 6.4X to 10.3X, in other words, we ended the decade with 10.3 times our income in net worth. For us, net worth ignores house value. So even if 2.5X came from saving 25% of income, there was an extra return, some from the averaging, some from luck.

Rob Bennett
Rob Bennett

Since nobody can accurately predict the future

I think this is an important article. It's always good to point out things that people are missing by getting too caught up in the emotion of the moment.

I don't at all agree with the comment quoted above, however. Stocks have always provided poor long-term returns starting from the sorts of valuation levels we saw in the late 1990s. None of us should have been surprised by what happened. The Stock-Selling Industry spent so many millions telling us that timing doesn't work that I think a good number began to think that there was something to it!

Another thing we gained over the past 10 years is a lowering of valuations. The lower valuations are, the better stocks perform on a going-forward basis. We are still at high valuations today, but they are certainly better than they were 10 years ago. After the next crash, stocks are going to be offering a highly appealing long-term value proposition.

Rob

Carol@inthetrenches
Carol@inthetrenches

I have two good friends that lost the bulk of their retirement funds investing in what ware considered conservative portfolios. Now at age 60s and 70s they are having to cut back their lifestyle and regroup. The motto on the stock market is the same as it always was "Don't invest more than you can afford to lose." We usually don't even think about what that means until it happens.

2 Cents
2 Cents

While you make some fine points, I tend to agree with Mr. T. The market is extremely risky right now in light of the balance sheet woes that countries and consumers across the globe are facing. Even if we muddle through without another crash, which is a very optimistic assumption, an 80% equity allocation is just too high for the average person.

I'm sure that equity investors in Japan's market thought that it was safe to get back in the water 10 years after their real estate bubble burst in 1989. The reality is that Japanese stocks are still 70% below their peak 20 years later.

Thanks just the same for taking the time to do all of this analysis.

Mr. ToughMoneyLove
Mr. ToughMoneyLove

All of your charts point to this conclusion: The risk-adjusted return of the market over the past decade has been poor to horrible for the traditional buy and hold investor. There is nothing in the data that creates an incentive for anyone to risk assets in the market that will be needed to support them in retirement. If they have money to risk, go for it.

And Sam the Yakezie - You need to cut back on the caffeine.

People focus so much on the market because that's what the salesmen posing as "financial advisors" tell them to do.

Financial Samurai
Financial Samurai

I don't understand why people think it's a lost decade either. Ask yourself what your balance sheet looked like 10 years ago, and what it looks like today. Today BLOWS then away by multiple fold!

Whoever is just counting on the stock market to get rich is an idiot. And whoever says that there's been no progress made is just bitter.

There is so much more money and opportunity out there than ever before! So many people can make $100,000+ if they just tried. $250,000 is probably the new $100,000 now.

Go out there and do it!

Sam
The Yakezie

Money Obedience
Money Obedience

Wow! What a great post. It really explains very well and with enough detail how actual investing works. I suppose other media outlets do not like such a sensible analysis because it does not sell as well. It is much better to talk about the "lost decade."

Jeremy
Jeremy

That is an excellent question, Michelle. In fact, I should probably amend the post to define how cumulative return is calculated. Morningstar defines cumulative return as: "The total money-weighted return of the investment over the entire time period of the illustration."

The key word here is 'money-weighted' return. The reason some of them don't seem to add up is because money is being invested slowly over a period of time. Money-weighted rate of return incorporates the size and timing of cash flows because a dollar invested in a fund 10 years ago is different than a dollar invested in the same fund 10 days ago. In a sense, that's saying some of the money you invested earned higher than the stated cumulative return and some of it earned less, but as a whole for every dollar you invested you saw about an X percent return on your money over the stated time frame.

There are obviously a bunch of different ways to calculate return and each one will give you a slightly different result. That is why it's always a good idea to understand what is being calculated and how.

Jeremy
Jeremy

Ben, this is from Morningstar's hypothetical builder. I don't believe it's a tool available to the public. I think you need to have Advisor Workstation or at least be registered with some of the major fund companies that offer the tool to advisors.

Jeremy
Jeremy

That's very true, and something a lot of people do leave out. That's why in all of my examples, even the first one with just holding the index for 10 years I calculated it with dividends reinvested. Even so, that provided a negative result, but it's still quite a bit better than what some people use when not factoring in dividends.

Good point to bring up.

Jeremy
Jeremy

Yep. People love to focus on market returns when in fact, that's such a small part of people's entire financial picture. Sure, it might be a big number on a quarterly statement, but there's a lot more going on. Most people can't easily quantify it so they focus on how their stocks are performing.

Michelle
Michelle

Thanks, Jeremy! That makes sense. :)

I appreciate the quick reply, too.

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