A Year after the Stock Market Plunge - Why it Should Have Cost You Less than Ten Percent

The past twelve months in the stock market have been pretty crazy. Some of us painfully joke that this is the second time in a decade that our 401(K)s have become 201(K)s. Yet, I'm going to argue that you should be very concerned if your portfolio lost more than ten percent over the past twelve months, and here's why.

One Year Ago
It was just a down market as August 2008 drew to a close. While the market was in danger of having the first year in the past six of having a declining market, who knew that the perfect storm was about to hit? In September, Lehman Brothers became extinct. Then, the U.S. Government extended an $85 billion loan to powerhouse AIG and had to extend another $38 billion in October.

In October, credit markets froze and the word "trillion" was being used in connection with the bail out of our financial system.

Who knew last August that we'd be spending a trillion dollars to bail out our financial system? Hurricane Sub-prime had struck. When the market bottomed out on March 9th of this year, the S&P 500 index had lost over 47 percent of its value.

The Recovery
We all know that the market recovered quite a bit of its value since those ugly days in March. Most experts were predicting the great depression ahead. My favorite radio guru was bragging about telling his mother to get out of the stock market. Experts were calling this a once in a lifetime event and declaring capitalism "dead."

We know that the market recovered quite a bit. The S&P 500 index climbed over 50 percent since those dark days in early March. Unfortunately, a 50 percent loss followed by a 50 percent gain still leaves a large loss. The S&P 500 index is currently 26 percent below what it was at the end of August 2008. You should not have lost 26 percent however. Losing more than ten percent means you are probably doing something wrong.

Why a More Than a Ten Percent Loss is Concerning
While the S&P 500 index lost 26 percent since August 31, 2008, this isn't the market, though many financial experts want you to believe that it is. Actually, it's only the largest 500 U.S. companies and the index strips out all dividends. Thus, it's only part of the return of part of the stock market.

Let's take a look at how the U.S. and international stock markets performed, as well as the U.S. bond market for the twelve months ending August 31, 2009.

Vanguard Total US Stock Market VTI -22.6%
Vanguard FTSE All World Ex U.S. VEU -15.6%
Vanguard Total Bond Market BND 6.2%
A moderate portfolio of 60 percent stocks and 40 percent fixed income, with 20 percent of the stocks in international and 40 percent in U.S. If we had invested in the three index funds above and then done nothing, our twelve month return through August '09 would have been a 9.7 percent loss. Most of our 401(K) would still be intact.

But to have limited your loss to 9.7 percent, there is the requirement of having had to do nothing, which isn't as easy as it sounds. Anyone who was able to ignore the media (and invested in low cost diversified funds) would have been rewarded with only a disappointing year, rather than a disaster.

For those with the courage to rebalance quarterly over the past twelve months, this 60 percent equity portfolio would have lost only 4.9 percent. I admit my own rebalancing wasn't as disciplined as this.

Did you lose more than ten percent?
When you get your August statements later this month, compare them to where you were a year earlier. Chances are you lost more than 10 percent (excluding any additions or withdrawals) and here are some possible reasons why.

1. Your portfolio is more than 60 percent in equities.

2. Your portfolio had higher expenses than the low cost funds used in this example.

3. You are human and couldn't resist the instinct to be fearful when others were fearful.

4. Your bonds or bond funds didn't gain the 6.2 percent like the bond index fund. For the year 2008, the average taxable bond fund lost 8.0 percent while the Vanguard Total bond fund gained 5.1 percent.

5. You or your adviser believed you were smarter than the market and knew which sectors or countries to invest in.

My advice
I admit that I feel a little vindicated for writing last March that stocks were on sale and that investors shouldn't give in to the pain. I'll also admit, however, that I had no clue we were going to have such a fierce rally in the next few months, just as I know I don't know what the next few months hold.

As painful as it is, however, check out your performance over the past year and see how you did compared to the ten percent bogey. From there you can do a little back-tracking to see what you may have done wrong, and how you can reset those sails for the future.
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