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 youâd 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? Thatâs where the media begins to go into a frenzy.
It isnât 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 youâve 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, youâll think about just sticking it in the bank and earn just 1 percent, too. Itâs better than not making any money and a heck of a lot better than losing money.
While itâs 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
Hereâs 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 donât stack up to real world investing which skews the lost decade argument in its favor. Letâs 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 canât think of anyone who did that either.
Nonetheless, this is what people are using as a reference for the lost decade argument. So, letâs 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 youâll 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) Iâm 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 donât 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. Youâll 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, weâve seen that simply replacing the lump sum model with the more realistic regular investments over time fares better, but that isnât good enough. How are you invested? Iâm willing to bet 100% of your assets arenât Â in an S&P index fund. In fact, most people arenât 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 arenât 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, letâs look at this 80/20 portfolio invested as a lump sum.
This probably doesnât 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 didnât make much with a cumulative return of 6.5 percent, but we also didnât lose money, so thatâs good.
Of course, we already know how unlikely the lump sum investment strategy is, so letâs 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 weâve managed to see a total return of nearly 23 percent with annualized returns of 2 percent. Itâs still well below the historical average of a stock-heavy portfolio, but weâre 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. Thatâs a significant change in fortune.
What About Rebalancing?
Iâm glad you asked.Â Even though weâve created a more realistic investing scenario by dumping the lump sum idea and introduced a little diversification into the mix by adding some bonds, weâre still missing out on one key ingredient. Portfolio rebalancing. This gets a little tricky because a lot of people donât rebalance their portfolio like they should, but thereâs a good chance that over the course of ten years youâll be shuffling things around a few times.
So, what does rebalancing do to our 80/20 portfolio thatâs 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 doesnât 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. Itâs not enough to send you into early retirement, but if youâre willing to jump through hoops to save 0.25 percent on fees each year, wouldnât you want to get an extra 0.25 percent each year by simply rebalancing?
Thereâs More to Stocks Than the S&P 500
Weâve done a good job covering sample portfolios and investment strategies thus far, but it still isnât 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 thatâs fine, but most people have diversified even a bit further.
So, letâs look at another portfolio typical of a 30-something tucking away money with each paycheck into their 401(k) or IRA. This time weâre 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, weâve made money during the lost decade, and itâs the best performance weâve seen in the examples so far. This example wasnât rebalanced, but if you run the numbers with the same rebalancing as before youâll get even slightly higher returns again.
Letâs take things one step further because a lot of people donât just have a very small allocation of smaller cap stocks. Letâs 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. Weâre up to over 43 percent cumulative and over 3.5 percent annualized returns. Of course, itâs still a pretty basic portfolio, but it should be similar to what many investors have as a whole in their retirement portfolios. This portfolio isnât 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 canât dispute the original facts that get people all worked up about the stock market over the past ten years. Itâs true. Stocks have done poorly, and in most cases even lost money over the decade. Thereâs no denying that. The real problem is the fact that it doesnât represent real world behavior or results.
For one, most people donât 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, âboy, if I had just invested in government bonds or gold in the 2000s Iâd be much better off.â Thinking about what could have been is a foolâs errand. Thatâs 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 whatâs 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 youâre always switching your investments around based on stuff thatâs already happened youâll also miss out on a large part of whatâs to come.
Besides, this isnât 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.
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I know most readers are younger and werenât investing back in the 1970s, but donât 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 didnât mean stocks were dead and should be avoided. As the following 20 years proved, things picked up and went beyond anyoneâs wildest expectations.
The Bottom Line
Obviously, a lot of people lost money investing in stocks during the 2000s. Thereâs no way around that. The point is, money wasnât lost because of the lost decade. It wasnât lost because someone bought stock ten years ago only to realize itâs worth less today. No. People lost money because they didnât 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 diversificationâ’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, itâs 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 youâll sleep better at night and you wonât 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 youâre 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.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.