Was the Last Decade Lost?

This is the first post of the new decade. I can’t be sure, but I think that the recent two digit change in the Great Odometer has been a little underplayed this time around, relative to the buzz from, say, 1990.

(Fussbudgets who insist that decades start with years that end in 1 instead of 0 need to stop taking themselves so seriously. Yes, the conventional definition New_Year_Aftermath Crop is not entirely logical. Does it also bother you that fire alarms go "off" when they operate?)

Part of the under-buzz may be due to the fact that we never really got around to naming the decade that just ended. In fact, a large portion of what media coverage the decade got focused on this oversight. I have no helpful suggestions. Personally, I will always think of the 2000-09 period as the Really Fast Decade. Seriously, it feels like it lasted ten months, at most.

For investors and savers, one obvious nominee is The Lost Decade. My main objection to this is that the name is already taken, referring to the 1990s in Japan, where two generations of postwar economic expansion came to a sudden and bewildering halt on or about January 1, 1990. Compared to that, our last ten years wasn’t really all that lost. The Misplaced Decade?

Nevertheless, from an investor’s point of view, the last decade was pretty discouraging. From 12/31/99 to 12/31/09 the S&P 500 lost 9.1%, dividends included. Factor in inflation (the CPI was up about 30% from 12/31/99 to 11/30/09) and you’ve got a decade that wasn’t just time wasted standing in place, it was a period of significant loss of wealth.

Ron Lieber at The New York Times recently tried to put a positive spin on the past ten years, arguing that For Savers, It Was Hardly a Lost Decade. At some level I have great sympathy for what Lieber is trying to do. Many people need an investing pep talk just now, lest they stop putting money in the stock market or, heaven forbid, stop saving. But there is a point at which efforts to sugar coat the truth cost you your credibility, causing the entire effort to backfire.

Lieber begins his stock market apologia by conceding that yes, the S&P 500 went down, and if you had all your money there you would be very unhappy now, "But that is not how most real people invest." Real people, apparently, significantly diversify their holdings away from the S&P 500 and continue to add to their kitty through saving.

For example, Lieber explains, if you had split your investments evenly between a Vanguard US stock fund and an international one, you would have been up 9.3% over ten years. I agree that is a lot better, although it still trails inflation by rather a lot and is about a tenth of what many pundits told investors to expect from the stock market.

But more to the point, who was advising "most real people" to put half their stock market investments overseas in 1999? For that matter, who is saying to do so now? An advisor who recommends putting 15% outside the US is considered enlightened and cosmopolitan. (If not eccentric and possibly reckless.)

Real people exhibit even more wisdom in that they put half their money in bonds. A mix of 50% bonds, 25% international stocks, and 25% US stocks went up about 46% in the decade just ended, beating inflation by about 1.2% a year. Lieber calls this "a much more realistic scenario" than the 100% in stocks story, but I am not so sure. Blow the dust off a personal finance book from ten years ago and you are likely to find that allocations of 50% to stocks were recommended only to the aged and timid. Most people were told to invest more heavily in equities than that, up to, and including, 100% of their savings.

Lieber’s last point is easily the silliest. Real people kept adding to their investments though additional savings. $100,000 put in the 25/25/50 mix on 12/31/99 would have grown to $145,619. That’s not bad, but if the person had added a mere $1,000 a month to the fund over the decade, it would have grown to $313,747. Zowie.

This is a rather absurd example of comparing apples to oranges. $100K didn’t grow to $314K. An additional $120K was added to it. $220K grew to $314K. And if an investment mix with less foresight had been chosen it is more than likely that the real person in the example would have been better off putting the original $100K and the $1K a month in a mattress.

The harsh and somewhat disheartening truth is that the past ten years really were pretty nasty for ordinary investors who followed ordinary advice. Part of this is the arbitrariness of the ten year window. The stock market was particularly expensive on 12/31/99, so returns since then will always look poor. (The S&P is up 13.5% since 12/31/01.)

But the primary source for disappointment in investment returns, particularly stock market returns, over the past ten years is unrealistic expectations. On average, the stock market does go up, beating both inflation and bonds. But to get that higher expected return you have to accept volatility, and that means that stocks may not beat bonds or inflation in any given year, decade, or even in your lifetime.

I do not think that "most real people" understand this, and Lieber is not helping any. But on the other hand, real people tend to invest their savings in more than just stocks and bonds. In particular, for many households the amount in financial instruments such as stocks and bonds is dwarfed by what was invested in the house they live in. That story had its own unhappy ending as the decade came to a close, but it is worth mentioning that, even with all we have been through, from January 2000 to October 2009 the Case-Shiller 20 City Composite was up 47%.

More on that tomorrow.

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