The Lost Decade

The decade ending December 31st, 2009 was certainly uninspiring for large cap stocks, and most investors. Large cap heavy portfolios lost purchasing power as the consumer price index (CPI) rose 2.52%*. This means a large cap portfolio's real return throughout the first 10 years of this century was -3.47%. We're now calling this the Lost Decade.

The Challenge Investors Faced

Most investors, including professional financial advisors, built portfolios dependent on US large caps. Many still do. It's what they've always done, since for years "the market" was defined by the recognizable names in the S&P 500. Historically, an investor over-subscribing to a single asset class would have had to endure years of flat or negative returns.

We all know that the S&P 500 has handsomely rewarded investors over long periods of time, but imagine the frustration seeing an entire decade end with nothing to show for it. The 2000's weren't an anomaly. A similar phenomenon occurred in the 1970's. US large caps returned 5.86% while inflation checked in at 7.37%*. The real return for the decade ending December 1979 was -1.51%.

What Investors Learned

The concept of diversification became the number one selling tool for financial advisors looking to gather assets after the tech bubble blew sky high in the early 2000's. Emerging market stocks and exotic bonds became the rage. If an investor was smart enough diversify even a little bit into bonds and international stocks during the Lost Decade, their rate of return would have turned positive*.

Investors Can Do Even Better

If an investor had incorporated additional asset classes such as intermediate term bonds, emerging market stocks, and even Factor Investing Premiums such as the small cap and value effects, they would have done even better. Employing more sophisticated diversification as well as tilting the portfolio to factor premiums would have boosted the portfolio return to 4.60%*.

Basic Diversification Better Diversification

With these portfolio adjustments, an investor could have turned a disappointing decade into a much more palatable return scenario. In fact, an investor would've endured only short periods of time (~ 1 year) where their portfolio balance would've dipped below their net investment. Better diversification could have helped many investors stick to their plan, versus bailing to cash like so many mistakenly did.

The Real Effect For Retirees

Imagine for a moment that you had retired in 2000, invested in a large cap dominant portfolio. Do you think your New Year's 2009 celebration would have been enjoyable? No. What about if you were still a few years out from retirement and had that same large cap portfolio? Think you would've been able to retire on schedule. No again.

Either scenario would have created massive implications for your retirement trajectory. If in 2000 you owned a $500,000 portfolio. Here are the portfolio balance ramifications of the portfolios discussed above**.

How You Can Protect Yourself

Don't just assume you're diversified because you own a lot of "stuff" in your retirement accounts. Ask a competent financial advisor for an analysis of your current holdings. Most advisors are willing to generate a summary report for free. I'm a little biased, but I recommend you seek out a Fee-Only Registered Investment Advisor for your analysis. Fee-only companies like Aspen Leaf Partners are obligated to put your interests first, without spinning the investor into an expensive product to earn a big commission. If you value a conflict free relationship with transparency, try giving us a try! Use the Shoot Us An Email function below to reach out.

* All figures generated using Returns Web, courtesy of Dimensional Fund Advisors. Indices used: Citigroup US Broad Investment Grade Bond Index 1-3 Years, S&P 500 Index, MSCI EAFE Index (net div.), DFA US Small Cap Portfolio Class I, DFA US Large Cap Value Portfolio II, MSCI Emerging Markets Index (net div.), Barclays US Aggregate Bond Index. Weighted averages used in "Better Diversification" calculations: 10% S&P 500, 10% DFA US Large Cap Value Portfolio II, 15% DFA US Small Cap Portfolio Class I, 15% MSCI EAFE Index (net div.), 10% MSCI Emerging Markets Index (net div.), 20% Citigroup US Broad Investment Grade Bond Index 1-3 Years, 20% Barclays US Aggregate Bond Index. Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Average annual total returns include reinvestment of dividends and capital gains.

** Dollar amounts generated using time value of money calculations on a financial calculator.