Was the Lost Decade Really Lost?

Yesterday, we looked at the "lost decade" of investing. While the past decade may have been lost for investors in the S&P 500 Index, this wasn't the case for investors who prudently diversified their portfolios across other equity asset classes. The following table provides the returns for various equity asset classes for the 10-year period from September 1999 through August 2009.

As you can see, with the exception of the S&P 500 and U.S. large-cap value stocks, other asset classes provided positive returns. Since the return on riskless one-month Treasury bills was 2.9 percent per year, all but those two and the MSCI EAFE Index provided at least some equity risk premium. And since the CPI rose at an annualized rate of 2.6 percent, all but the S&P 500 and U.S. large-cap value stocks provided positive real returns.

We can see further evidence on the benefits of diversification by examining the returns of a diversified equity portfolio. A portfolio with 60 percent in the four domestic equity asset classes (equally weighted) and 40 percent in the four international asset classes (equally weighted) would have returned 4.4 percent per year, assuming annual rebalancing. Thus, while not producing great returns, the decade wasn't entirely lost for those investors who prudently diversified their portfolios beyond the S&P 500. And this was a period that included two of the three worst bear markets since the Great Depression.

Of course, only those investors that stayed disciplined throughout the period earned those returns. Far too many investors sold after bear markets had already occurred and only returned after the bull had already emerged into the arena.