Carl Richards

When people talk about being a buy-and-hold investor these days, they are often confronted by others who declare that the last 10 years were a “lost decade.”

When I wrote about the power of compound interest a few weeks ago, many of the comments focused on this idea that the decade ending on Dec. 31, 2010 was the decade of lost money for most investors. Not surprisingly, people then take the next step and say that it could continue, and the United States could end up looking like Japan — 25 years of negative or flat stock market performance.

I know this isn’t the first time this issue has been addressed. Allan Roth wrote about it on the CBS MoneyWatch Web site in December 2009, and Ron Lieber wrote a Your Money column about it in January 2010. But it seems like we need yet another reminder that the lost decade is a myth.

The lost decade claim starts with the assumption that whenever we talk about investing, we’re talking about owning just American stocks, often using the S.&P. 500-stock index as the proxy for our investment experience.

And if that’s your frame of reference, then the lost decade feels very real. If you had invested in just the S.&P. 500 over that 10-year period (2000-2010) your annualized return, including dividends, was 1.4 percent per year.

But much of the widely accepted research about portfolio design does not involve putting all your money in an S.&P. index fund then letting it sit.

The point of being diversified is that you have a mix of different asset classes included in your portfolio. A properly designed portfolio is not a random collection of individual investments but rather a mix of investments you choose carefully based on the way they interact with the others. If you do it properly, the goal is to have some investments that zig when others zag.

When you view this 10-year period from the perspective of a diversified and balanced portfolio, 2000-2010 was anything but a lost decade. Consider the following (all numbers reflect annualized returns over 10 years and include reinvested dividends):

U.S. large stocks (the S.&P. 500) = 1.4 percent

U.S. small stocks (the Russell 2000 Index) = 6.3 percent

U.S. real estate stocks (the Dow Jones US REIT index) = 10.4 percent

International stocks (MSCI EAFE Index) = 3.9 percent

Emerging markets stocks (MSCI Emerging Markets Index) = 16.2 percent

I’m not recommending that anyone should have all their money invested in a single index. And we also know that no one could have predicted back in 2000 which class would be the best performer.

But let’s assume that we decided to be broadly diversified at the beginning of the 10 years. We didn’t get terribly scientific about it, and since there are five broad asset classes, we simply put 20 percent into each of the five indexes I listed above. This sort of split is standard practice among professionals and amateur investors who know just a bit about how markets tend to work.

Then we just sat there. We did nothing! No rebalancing, no rethinking. Nothing.

The return for this diversified stock portfolio for the same 10-year period was an annualized 8.35 percent. That is a far cry from a lost decade.

It’s also worth noting that earning the 8.35 percent annualized return would have required behaving and not reacting badly during a painful 2008 and early 2009. Resisting the temptation to get out during that period was the cost of earning the 8.35 percent.

That said, most real people wouldn’t (or shouldn’t) have all of their long-term money invested in stocks even if they’re broadly diversified among many different indexes. So what happens if we add bonds to our long-term portfolio to act as ballast to the equity exposure?

Including bonds (sometimes referred to as fixed income) in the portfolio means you’ll have something that’s stable or even gains value slightly when your stocks fluctuate wildly. For our purposes, when I talk about fixed income exposure, I’m referring to intermediate-term bonds with an average maturity of around five years. And for this next example, I use the most widely accepted bond index, the Barclays U.S. government intermediate-term index.

So we build a portfolio that looks like this:

60 percent equities (evenly split among our five categories)

40 percent fixed income (Barclays U.S. government intermediate-term index)

The 10-year annualized return for this portfolio was 7.83 percent. Again, that’s a far cry from a lost decade. And of course the purpose of including these bonds would be to make 2008, for example, a little less painful. While it was still painful, this 60-40 portfolio was down 24.06 percent in 2008 versus the S.&P. 500, which was down 37 percent. That was still painful, but at least it would have been a little more emotionally manageable.

Too often when we hear the market report for the Dow, the S.&P. 500 and even the tech-heavy Nasdaq, we let those numbers become our investing reference point. We often fail to look past those daily reports to what’s happening in markets and investing as a whole.

Clearly things were bad for the S.&P. 500 during the past decade, but singling out one market to declare a decade of investing as “lost” ignores the reality: a broadly diversified portfolio can deliver respectable returns even if individual classes perform poorly.