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:
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.
Refinance Your Mortgage
Mortgage rates hit new lows. I saw rates as low as 3.25% for 30-year fixed, 2.625% for 15-year fixed, with no points and low closing cost. Check mortgage rates in your state.