The Lost Decade – Or Maybe Not

01 April 2010

Over the past several weeks I’ve received calls or comments from clients who have seen various articles entitled “The Lost Decade” or such other similar stress-inducing titles. The implication from these articles is that investors would have been better off not investing or at least not investing in stocks.

Is this really true? The answer is that it depends on how the investor invested – and one that strikingly illustrates two of Smart Investor’s fundamental beliefs:

• Broadly diversified investment portfolios can reduce risk and secure capital market rates of return.
• Discipline helps avoid fear and greed.

(Check out our website to see all seven fundamental beliefs.)

While an individual can’t invest directly in an index, indices can serve as a good proxy to reflect certain market segment’s returns over time. Take a look at the following showing the 1 Year, 3 Year, 5 Year and 10 Year annualized returns ending December 31, 2009:

Past performance is no guarantee of future results. Indexes are unmanaged. One cannot invest directly in indexes. Returns sources: S&P 500 from www2.standardandpoors.com; Russell Index from www.russell.com; MSCI Indexes from www.msci.com; Wilshire Index from www.wilshire.com.

What does this tell us? First, during short time periods, market volatility can significantly impact a portfolio’s return, even though different segments of the market don’t always track each other. A broadly diversified portfolio holding positions in each of these market segments over the 10 year period would have done better than just a portfolio composed of the S&P 500. By diversifying into other market segments or asset classes your investment returns are not limited to any one market segment’s return. (The articles I have seen tend to get wrapped up in a single index, for example the S&P 500 – the 500 largest capitalized US company stocks).

Secondly, this illustrates the inconsistency of returns for different market segments. Our view is that nobody has been able to demonstrate that they can reliably and consistently pick where the “hot spots” are going to be (see The Randomness of Returns on the Resources page of our website); so the rational and objective approach is:

• Have a broadly diversified portfolio that is exposed to the worldwide markets consistent with the investor’s objectives, time horizon and risk perspective.
• Institute a disciplined process that periodically rebalances this broadly diversified portfolio (selling high and buying low).

What does all this mean in the real world of investing? Prudent investors have broadly diversified portfolios that give them the opportunity to participate in the capital returns of worldwide markets. They follow a disciplined process that periodically rebalances their portfolios so they can take advantage of the “ups and downs” of the markets while avoiding the emotional stress of fear and greed that seems to dominant much of the financial media today.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Investment advice offered through Smart Investor, a Registered Investment Adviser.