A Lost Decade?

By Stewart Farnell, Ph.D., CFP®, EA
Boulder, CO
www.stewartfarnell.com

The investment research company Morningstar reported recently that the average return for the Vanguard Total Stock Market Index Fund Investor Shares for the last 10 years was −0.66%. In other words, the U.S. stock market has had negative, not positive,returns over that time. This isn’t the first time the stock market has shown negative returns over 10-year periods; it happened at least twice in the 20th century. So we should all be in bad shape, crying about our losses, bemoaning a lost decade—right?

Maybe not. As I look at client portfolios, I notice that almost all of them, despite their ups and downs, have done just fine over the last 10 years. But if the stock market has been negative, how can these portfolios have done well?

One possibility is that the portfolios have been swelled by new money going into them, through saving and investing. Undoubtedly such saving and investing has benefited some portfolios, but others have been growing as well. So new contributions into the portfolio can’t be the full explanation.

Another, more promising answer, is that the portfolios have been diversified. Perhaps 30%, 40%, 50%, or more of each portfolio has been invested in less exciting asset classes such as money market and Treasury securities. And these investments have been generating income, at the rate of 3%, 4%, or 5% per year.

Over 10 years, a $100 investment generating 4% a year will grow to $148. So even if the stock market has been negative, the interest earning portion of the portfolios has generated growth. Another part of the explanation involves rebalancing. To maintain a constant risk profile, I work with my clients each year to bring their portfolios back to the asset allocation targets specified in their investment plans. And because the value of different types of assets fluctuates in different ways over the years, plenty of rebalancing has been required. At most rebalancings, we take the excess money (the amount by which the value of a particular asset class, say international stocks, exceeds the target value) out of these appreciated assets and use it to buy assets whose value is below the target. This rebalancing often results in selling some types of assets when their price is high and buying others when their price is low.

The ups and downs of different types of assets over these 10 years have provided many opportunities to rebalance portfolios and often earn returns that may be better than those of the stock market. This compounding of interest over 10 years, and the buying low and selling high of a variety of asset classes, goes a long way in explaining why the last 10 years for most of us have been anything but a lost decade.