No Sugar Coating Please: It Was a Lost Decade

Happy New Year! With the first decade in the new millennium having come to the end, there’s a lot of retrospection in the media. What happened? What should’ve happened but didn’t? In the investing world, some say the decade was a “lost decade” and some apologists say how it wasn’t.

I read articles from both camps. I’m not convinced by the contrarians who say it wasn’t a lost decade. Hence the title of this post. Although it’s not the news everybody cheers for, I have to respect the facts. It was a lost decade. Let’s not sugar coat it and say it wasn’t.

As in any other debate, the definition is very important. What is a lost decade, really? I define it as a decade in which risk taking wasn’t rewarded. You took risk, you did what everybody says you are supposed to do, but you have nothing to show for after ten years. That’s a lost decade.

Investment advisor and book author Allan Roth wrote Why It Wasn’t a ‘Lost Decade’ for Investors. He included a chart showing that a rebalanced moderate portfolio of 60% stocks and 40% bonds had an average annual return of about 3.5%. Because that number is positive, and because it was above inflation, Roth concluded that it wasn’t a lost decade.

Not so fast. Why would someone compare a portfolio of stocks and bonds against money in the mattress? Shouldn’t it be against a money market fund at the very least?

The 10-year average annual return of Vanguard Prime Money Market Fund is 3.03%. If someone invested in a ladder of FDIC-insured CDs, the return would be even better. The no-risk benchmarks should be money market funds, Treasury Bills, and CDs, not money in the mattress. Being an investment advisor, Roth must know that, but he still chose an easier benchmark to make his argument. That’s cheating.

When you take into account the amount of work and the risk involved in diligently investing in stocks and bonds and rebalancing them versus throwing money in a money market fund or FDIC-insured CDs, you can see how the work and the risk were totally not worth it during the last decade. It’s fair to call it a lost decade.

Reporter Ron Lieber wrote in New York Times For Savers, It Was Hardly a Lost Decade. Ron is more clever than Allan. He showed that $100,000 invested 25% in U.S. stocks, 25% in international stocks, and 50% in bonds would’ve grown to $145,169 after 10 years. That’s a 3.8% return, a little higher than the 3.5% return Allan Roth showed. It’s still not much better than the 3% return from money market funds. When you take into consideration the amount of work and the risk, it’s still not worth it.

Ron Lieber adds a twist of investing $1,000 a month during the decade, on top of having $100,000 at the beginning of the decade. That portfolio would grow to $313,747 with $220,000 invested. If you do the math, that’s a 4.8% average annual return, much better than the 3% return from money market funds. Ron Lieber concluded from this exercise it wasn’t a lost decade.

Again, not so fast. The 25/25/50 portfolio is peculiar. It’s not how people are typically advised to invest. It’s a straw man.

The typical moderate allocation is 60% in stocks. During the last decade, bonds outperformed stocks by 6% a year. By having less invested in stocks, Ron’s hypothetical portfolio had a higher return than a typical portfolio.

He also has 50% of stocks invested in international. The typical recommendation is 20-30% of stocks in international. During the last decade, international stocks outperformed U.S. stocks by 2.6% a year. By having more invested in international stocks, the hypothetical portfolio gained another edge over a typical portfolio.

If we are going to use a straw man,  we might as well say it wasn’t a lost decade at all if people invested 100% in emerging markets, energy, or precious metals and mining. All those investments paid off well in the last decade.

Instead of looking at an atypical portfolio, I think it’s more reasonable to look at the returns of “funds of funds.” These are mutual funds that invest in other mutual funds. Target date retirement funds are such funds. They are supposed to be a one-stop investment for people who delegate the investment decisions to experts.

Vanguard’s Target Retirement funds don’t have 10-year history. Their LifeStrategy funds do. I calculated the returns with the same spec as in the New York Times article: $100,000 at the beginning of the decade plus $1,000 invested every month. Because Vanguard only reports quarterly return numbers on its website, instead of having $1,000 invested every month, I’m doing $3,000 invested every quarter. It should be close enough.

Here’s a summary of how three LifeStrategy funds and a money market fund performed:

Value at 12/31/2009 Dollar-Weighted Rate of Return
Vanguard LifeStrategy Conservative Growth Fund $220,000 $289,948 3.73%
Vanguard LifeStrategy Moderate Growth Fund $220,000 $275,298 3.03%
Vanguard LifeStrategy Growth Fund $220,000 $254,649 1.98%
Vanguard Prime Money Market Fund $220,000 $273,031 2.92%

If you’d like to see how I did the calculation or check my numbers, the spreadsheet is here:

Vanguard LifeStrategy Funds: 2000-2009

Investing in the middle-of-the-road Vanguard LifeStrategy Moderate Growth Fund for ten years beat the money market fund, but only barely. When you take risk into consideration, it was not worth it. That makes the decade a lost decade.

Now, I can understand why they want to make the last decade look better than it really was. They want to encourage people to do the right thing: not lose faith in investing in a diversified portfolio. However, the tortured mental gymnastics is unnecessary. People should understand that a good strategy does not always lead to a good outcome.

Lost decade happens, like it did in the last decade. That’s the risk in investing. Ten years can’t cure that risk. Even if you do everything by the book (have a moderate asset allocation, keep investing through thick and thin, diversify your investments, rebalance your portfolio), you can still end up worse off than putting money into a money market fund or CDs. Risk really means risk. People don’t like to hear it but it’s the truth.

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  1. Wai Yip Tung says

    It was a lost decade. It wasn’t. Let’s not debate on the fine point. Let’s look ahead instead. What will be the evaluation of the coming decade? Another lost decade? And then follow by yet another lost decade?

    This is something hanging over my head. We maybe entering the post-abundance era. (See for example, the article by Michael T Klare). Issues like population aging, shortage of natural resources and the wildcard of climate change are showing their effect. It is not just a economic cycle. Our economy is just not growing any more.

    In another two decades, many of us will be retiring. What if there is nothing to show after all? I’m very impressed by the intelligence of TFB and others. There are so much good advice for investment, so much good knowledge on the complex issues of accounting and taxation, and such a phenomenal grasp of probability and its application in finance. We are applying our best effort. But what if all these intelligence goes into to waste. And we have nothing to show in three decades? I mean we may be just living in a wrong era. All the money to be made may have already been made in the 90s and before. It is all downhill from here.

    I’m not putting my money on these predictions. But they are plausible scenarios. I just want to take a break from number crunching and try to comtemplate a even bigger picture.

  2. Dylan Ross says

    “I define it as a decade in which risk taking wasn’t rewarded. You took risk, you did what everybody says you are supposed to do, but you have nothing to show for after ten years.”

    I think “lost” decade is meant to imply that were in the same place, financially, as we were in 2000. The problem with that thinking for those that have been regularly investing over the last ten years is they actually do have something to show for it. I’m not talking about a 3-point-something rate of return; I’m talking about owning a lot more shares than they would if the market climbed steadily through the decade. Whatever market pricing is 10 years from now, they will own a bigger piece of it because of the low returns of the last 10. It’s too soon to say the risk was or wasn’t rewarded; it may still be.

  3. Harry Sit says

    Dylan – Owning more shares could be achieved by putting money in a money market fund or CDs for ten years and buying those shares now. The risks taken in the last ten years weren’t rewarded. The investors may very well be rewarded for risks taken in the next ten years, but that does not change the fact their last ten years were lost. Taking risks for the next ten years does not predicate on taking risks for the last ten.

    A bad outcome does not necessarily invalidate the strategy. The two articles I commented on, however, attempted to deny the bad outcome in order to defend the strategy. That’s really not necessary. One should evaluate the merits of a strategy on its own and take into account its associated risks such as what would happen in a lost decade like the one we just experienced.

  4. Not Given says

    TFB, you “… should understand that a good strategy does not always lead to a good outcome.”

    Your recent article ‘Conventional Wisdom “Don’t Buy a Distribution” Is Wrong’ makes exactly that mistake.

  5. Harry Sit says

    Not Given – I disagree. It has to do with the likelihood and the severity of the poor outcome. If a strategy generates bad outcome more than half of the time and the magnitude of the such bad outcome is multiple times the expected gain, such strategy is not a good one.

  6. DT says

    Let’s bring to the surface a massive underlying assumption.

    Everything in this post acts like buy and hold is the only way to invest.

    Is it fair to say it was only a lost decade for investors using the classic buy and hold strategy?

    What about other strategies?
    What about strategies that including more selling during those 10 years?

    TFB, I’m not too fond of your analysis in this post.

    I don’t get much from the conclusion, other than your assertion that the decade was, in fact, lost.

    Lost to whom, exactly? I assume the buy and hold investor, or the money market investor … not sure you give me much extra on that.

    After reading it, I felt like I wasted my time, which is rare here.

  7. Harry Sit says

    DT – Fair enough, and thank you for holding me to a high standard. Because I’m a buy-and-hold investor, I often make the implicit assumption that all investors are buy-and-hold, which is not true. The two articles I commented on tried to say the decade wasn’t lost to buy-and-hold investors who had a moderate asset allocation, diversified internationally, rebalanced, and added to the portfolio regularly. I thought my post is at least an improvement.

    The decade was lost to buy-and-hold investors who followed the mainstream advice. It was not lost to investors who were conscious of valuation and bought low and sold high. It was not lost to investors who had the nerve and/or foresight to invest heavily in emerging markets, energy, or precious metals and mining. Of course whether the strategies that worked in the last decade will work in the new decade remains to be seen.

  8. Jimmy says

    For a lot of people including myself it was a very good decade. Every upturn or downturn in the economy has advanages and there are opportunities out there right now that we have never seen before.

  9. Max says

    Since 2003 stocks have beat bonds (and both have beat cash).

    2000 was a terrible time to own stocks, but it’s a little late to sound the warning, isn’t it?

  10. jcarp says

    just finished reading your “rebalance with new cash” and then, found this latest blog. in nov 2008 – i recvd a $30k cash bonus. i put that cash on 70% bonds, 20% short-term investments, and 10% stocks. todate, 2 years later my rate of return is 23%. i am in my 30s. i will be getting another cash bonus – should i rebalance my portfolio to balance out my bonds vs. stocks in view of current market climate?
    appreciate your thoughts, TFB.

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