According to a Wall Street Journal report from December 22, 2009, since the end of 1999 stocks traded on the New York Stock Exchange have lost an average of 0.5% a year. The Depression years of the 1930s saw a 0.2% decline in stocks. That makes the last 10 years the worst calendar decade for stocks going back to the 1820s. The Journal quotes Michele Gambera, chief economist at Ibbotson Associates, as saying, “The last 10 years have been a nightmare, really poor,” for U.S. stocks.
However, smart investors know it’s folly to invest in just one or two asset classes like U.S. stocks and U.S. bonds. Your fortunes will rise or fall in direct proportion to their performance. The last 10 years would certainly have seen them fall with U.S. stocks.
What you didn’t read much of in the financial press was that not every asset class had a bad decade. Real estate investment trusts increased around 9% annually. Natural resources returned around 5%, and U.S. bonds gained about 6% a year. Pacific Rim countries’ stock markets, notably China’s, had an excellent decade.
Investors who allocated a static portion of their portfolios to each of nine asset classes and rebalanced periodically earned 4% to 8% annually over the past ten years. That is hardly a lost decade.
You might compare building a good portfolio to the inner workings of a V8 engine. The goal is to select eight investment classes that over a long period of time will produce returns of 5% to 9%. In any one year, one asset class is firing (doing well), one is in total decline (probably experiencing a negative return), and the other six are somewhere in between. This action keeps the portfolio more stable and less volatile, while producing solid returns over the long haul.
A major key to success with this strategy is, during a time of emotional rationality, to set the percentages you will invest in each asset class (the pistons). You then periodically rebalance by selling some of those asset classes that increase above their allocation and buying more of those that go below it.
Investors who followed this strategy saw their portfolios lose less than a total of 10% since the end of 2007. Investors who panicked during the market bottom in March 2009 and lightened up on stocks increased their losses to 25% to 40%.
In most normal years, the returns garnered by my clients lie within a fairly tight range. That was not the case in 2009, where I saw returns range from -8% to 36%. Their portfolio’s annual returns were directly tied to how much they reacted out of fear and sold equities near the market bottom.
Those who stayed the course saw their portfolios rise an average of 30%. Those who got scared and reduced their exposure to stocks during the first quarter of 2009 shaved 10% off their annual 2009 return for every 10% reduction in equities. For example, an investor who had 70% in stocks going into 2009 and reduced it in March to 50% probably reduced the total return from 30% to 10%. If that same investor was unfortunate enough to reduce stocks to 30%, they actually lost -10%.
The lesson I am taking from the past decade is a classic one: a diversified portfolio will never set dramatic speed records, but it will keep moving steadily forward even when investment roads are rocky.