All is not “Lost”

2009 marked the end of a tumultuous decade for stocks, one labeled the “Lost Decade” by the Wall Street Journal and “The Decade from Hell” by Time magazine. The S&P 500 Index recorded four negative years (2000, 2001, 2002, 2008) and ultimately suffered two of its four most severe bear markets: declining 46% in 2000-2002, and plummeting 57% in 2007-2009. Despite an astounding 68% rebound from the March 2009 lows, the S&P 500 still lost 9.1% for the 2000s – the worst calendar decade in market history, even worse than the 1930s of the Great Depression.

While it’s hard to argue with the “lost decade” headlines, a minority of individual investors (including our clients) actually found the decade to be a productive one. These investors followed a time-tested and academically proven investment strategy that can be boiled down to the following steps: Buy and hold. Diversify. Rebalance. Though the strategy is simple, adhering to it is not easy.

Despite being frequently questioned in the wake of 2008, the merits of diversifying across asset classes are demonstrated in the table below. As you can see, not all equity categories performed poorly over the past ten years. In fact, foreign emerging markets and real estate both produced quite attractive returns.

The data also shows why staying the course can be so difficult. While bonds provide crucial portfolio stability, the best and worst 12 month returns reflect the wild volatility experienced by each of the equity categories. A disciplined investor must not only be willing to maintain these investments, but also add to them (i.e., rebalance) throughout the fear-inducing declines. It is telling to note that the two best performing categories for the decade also posted the two worst 12-month slides.

While the logic of opportunistic rebalancing (buy low, sell high) is clear, disciplined execution is rare among individual investors because of the psychological challenge it poses. For example, buying stocks amid the bursting of the dot-com bubble or the more recent financial meltdown was uncomfortable, to say the least. However, the comfort generated by avoiding stocks comes at a very high price. Never was this more evident than in the final nine-plus months of 2009 as stocks surged nearly 70% while record levels of cash earned next-to-nothing on the sideline.

Despite enduring the single worst calendar decade in the history of the U.S. stock market, an investor whose portfolio was reasonably diversified across the categories displayed above, and who adhered to a disciplined rebalancing strategy, likely achieved a portfolio gain in the neighborhood of 50% for the decade – obviously a dramatic advantage over the -9% produced by the S&P 500 Index.

Additionally, it bears noting that 10 years is not a particularly long time horizon; it’s the lifetime results that are important. The danger in the recent focus on the past decade’s performance is that it could lead investors to misguided decisions regarding their future investment strategy.

During 2009, there was great focus on the investment lessons learned from 2008. However, it is just as important to review the lessons learned from 2009 and the decade as a whole. Though dismal, the past decade clearly demonstrates that if you are broadly diversified, maintain an appropriate asset allocation, and have the discipline to stay the course, almost any storm can be weathered.