The Lost Decade and What it Means

By now you’ve likely heard plenty about the “lost decade” in the stock market:  On January 3, 2000, the S&P 500 index closed the day at 1,455.22, and on May 28, 2010, the index closed at 1,089.41 – for a negative return on the nearly 10 1/2 years… I’m sure you’ve noticed in your investment statements.

But what does this mean?  There are plenty of folks out there (in the mass media) who will tell you that stock market investing is no longer a wise move… why, after all, if you’d had your money in a savings account you’d have done better!  So does this mean it’s time to chuck all of your stock investments and switch everything to bonds?  Of course not.

Remember, it’s long term

No matter who you are as an investor, if you expect to achieve any return above inflation, you have to include equities (stocks) in your portfolio to some extent.  And when developing portfolio allocations, pretty much anyone under age 70 should be considering a time horizon of 30 years or more – and those over age 70 should be thinking similarly, since your chance of living to age 95+ is continuing to increase every year.

What I mean by this long-term view is that you need to stop thinking about stocks in a day-to-day, quarter-to-quarter, year-to-year or even decade-to-decade context, but rather in the context of thirty, forty, fifty and more years.   A college graduate, just starting a new job this year and investing in a sparkly-new 401(k) may likely be continuing to take distributions from that 401(k) in the year 2080, for example.  Even if you’re retiring this year at age 62 – you may still have 30 or more years of investment activity ahead of you.

Think about all that has happened in our history over the past 30, 40, 50, 60, and 70 years – 70 years ago we were still over 18 months away from Pearl Harbor and the US entry into World War II.  We’re talking about a significant amount of history that has occurred – and a likewise significant amount of returns that stocks have provided over that time.

So let’s look at the numbers for the S&P 500 more closely:

* These annualized numbers are inflation-adjusted and include re-invested dividends

Notice how the numbers fluctuate pretty wildly among the 10-year periods, but begin to calm down as you look at the longer-term time horizons.  While there is nearly a 20% differential between the best and worst 10-year periods, when you look at the 30-year periods the differential is less than 4.75%, and over the 70-year periods the differential is even less:  only 2% separates the best period from the worst.

So, while you may have an off decade or two in your overall investing experience, in the long term you’re likely to approach the average return, as long as you keep your head and remain vigilant with your investment allocation in good times and bad.

Why A Decade?

The other thing about this “lost decade” business that bothers me is that it’s an arbitrarily-chosen timeframe – why do we only want to measure in terms of an exact decade?  What if we started these periods in March of the years ending with 3?

* These annualized numbers are inflation-adjusted and include re-invested dividends

As you can see, within reason, these periods averaged out very similar when compared to the exact decades, but the differential between the best and worst decades was much different (this would be referred to as the “deviation” of the returns).  And as we noted in the first table, as the time horizon increases, the deviation reduces to very near the average for that timeframe.

So, don’t get hung up on an arbitrary measure such as this to begin with.  Recent history has a very poor track record for predicting the future (in short term views, especially) – remember how heady the market was after the 1980’s and 1990’s dramatic returns?  No fool would have suggested that you shouldn’t be in stocks at the turn of the millennium – but look at what has happened since then.  Same thing goes for the end of the 1970’s – stocks looked like a terrible place to be, but then along came the bull markets of the 1980’s and 1990’s.

Taking another view – when there’s a downswing in the markets, when you’re in the position of continual investing, you’re actually getting more shares for your money than in the upswing periods.  In the long run this gives you a much better footing than a single lump sum invested at (perhaps) the wrong time.

The Point

The point of all this is that if you have a long-term horizon (and we all do, to some degree) and you hope to earn something more than the level of inflation, stocks are your best bet.  And holding your properly-diversified portfolio of stocks through thick and thin is the best method for investing in the market – lost decade or not.  Because in the long run, stocks are most likely to return their historical long run average – which is much better than any other alternative investment out there.

Photo by Maulleigh