Lost Decade

March 09, 2012

Exposing the Fallacy of the “Lost Decade”
by Cathy Pareto, MBA, CFP® – March 2010

The last ten years have certainly been an economic disappointment for many, with good reason. From the tech bubble bursting, to the real estate boom/bust, to the grand finale of a financial meltdown, the 00’s started and ended with a bang. Many of the financial pundits have obsessed over how the decade of the “noughts” will go down in history as a total investment dud. It’s true, the 10 years ended 12/31/09 was the worst on record for the S&P 500, the benchmark for U.S. large caps. But it was the only primary global market segment that was negative over the full decade. While the 2000s were lackluster for U.S. large stocks, other asset classes fared quite nicely, and the “lost decade” argument loses some of its validity. In fact, if the past decade teaches us anything, it offers a ringing endorsement for the benefits of global diversification. Let’s dig deeper.

The investment universe is much broader than many people might think. Contrary to some investors’ propensity to concentrate their holdings in a single market index (ie. the S&P 500 or other domestic large cap stocks), many of the profit centers in the last decade were located in other sectors of the market, especially outside of the U.S. A balanced portfolio consisting of 60 percent stocks (both U.S. and foreign, small cap and large cap) and 40 percent bonds had an average annual return of 6.49 percent in the 2000’s. That’s not huge, but it’s far from a lost decade.

Hedging Tools

Along with having global balance of traditional stocks and bonds, by including other hedging tools into your asset mix, like commodities, real estate investment trusts and emerging markets in your portfolio, the likelihood of a lost decade is even more remote. Consider the average annual returns of these diversifiers in the 2000’s.

The FTSE NAREIT Real Estate Investment Trust Index averaged 10.2 percent for the decade. The MSCI Emerging Markets Index returned 10.1 percent per year. Treasury inflation-protected securities added 7.7 percent annually. The Dow Jones UBS Commodity Index averaged a 7.1 percent return. No lost decade there!

It’s easy to try and benchmark one’s returns to the S&P 500 or the Dow because they are so prominently mentioned in the media. However, globally diversified portfolios will not, and should not track those market indices. The reality is the U.S. market, while still prominent, only represents 40%of the global economy (less and less every day, incidentally). Many of the investment opportunities lie outside of our own border.

The “lost decade” is nothing more than a fallacy. Rather than obsessing over how a single U.S. market index has done since a meaningless date, you should focus on your long term goals and incorporate a meaningful strategy to help you reach those goals.

Mixing non correlated or low correlated assets together helps investors dampen risk while trying to maximize returns, in the short term and the long term. Just because markets across the globe had significant declines in 2008 (or the S&P was flat the last ten years) doesn’t mean diversification does not work. It has worked extremely well…just ask somebody concentrated in the S&P 500 alone, or held a handful of stocks (AIG) or was concentrated in industry exposure (financials, energy). Those folks certainly experienced a lost decade, but my guess is that they would have preferred spreading their risks and owning tens of thousands of stocks instead.

Bottom line: exposure to other types of equity and non equity assets is essential in portfolio construction. By including exposure to each of these markets in a balanced investment strategy, you might not only increase returns but reduce risk at the same time.