The period between 1999 and 2009 will likely go down as the “decade of pain” for US large-cap investors.
The S&P 500 followed the roaring 90s with a nasty, -2% annualized return over the subsequent ten years.
And yes, that does include reinvestment of dividends.
Source: Patton Funds
Now, what I usually remind readers of this blog is that very few people would see their portfolios perform in the same way as the line chart above.
That’s because few folks would make a lump sum investment and forget about it.
In reality, most investors put their money to work regularly, with every paycheck. One would also hope that the quantum of those investments goes up over time.
However, even that highly disciplined approach wouldn’t save the day here.
The Unluckiest Investor In The World
Last year, I spent a fair bit of time exploring the real path to wealth (hint – it’s certainly not linear).
As part of it, I explored the case study on Sam, an investor who was unlucky enough to start his journey in 1999.
Have a look at those trials and tribulations:
The orange line denotes total cumulative contributions. The blue line – the actual value of the portfolio.
To state the blindingly obvious, having the blue line below the orange line is bad news.
What it means is that even Sam, possibly the best-behaved investor in the universe, had seen his portfolio decline below the value of his contributions.
Talk about tough luck.
Now, I have no idea whether we are in for another “lost” decade, either now or in the future.
That being said, I thought it might be interesting to brainstorm on various ways to hedge our portfolios against yet another painful experience of this magnitude.
As it turns out, not everything was rotten in the kingdom of Demark stock markets in the noughties.
In fact, both mid-cap and small-cap stocks did quite well.
Ditto for emerging markets and real estate.
And the same applies to gold – notwithstanding what both me and the best investor in the world think about it.
Source: Patton Funds
So while “a lost decade” makes for a catchy headline, diversified investors walked away relatively unscathed.
The challenge, of course, is that there’s a price to be paid for diversification.
Emerging market equities have basically gone MIA from 2010 onwards:
And you can trust yours truly when I say that anyone invested in small-cap and value stocks did not enjoy the ride either (until the massive recovery over the past 4 months).
In other words, it’s this:
If you want the diversification that comes with “owning the world”, you need to be prepared for meaningfully lower long-term returns.
Beyond The Wall Stock Market
Of course, you could also look to spread your bets beyond the stock market.
At least in theory, real estate is supposed uncorrelated with equity returns (though as we all know, all correlations go to 1 when the sh$t hits the fan).
Historically, investors had two key options when it came to real estate investing.
The first one is REITs (watch out for tax implications with this one).
The second one is making direct property investments.
For full disclosure, this is my preferred route – but it’s certainly not without its challenges.
Most recently, we’ve also seen a rise in the popularity of real estate crowdfunding.
As far as investor involvement goes, crowdfunding sits somewhere between REITs and direct investments. It also requires a certain level of income to play the game.
Most importantly, however, one could argue that the crowdfunding market is only sufficiently developed in the US, essentially putting it off-limits to international investors.
Theoretically, you could hire a lawyer and accountant who will establish an LLC for you and do all the paperwork but that would be a stretch for most people.
Bitcoin? Art? Wine?
Despite all the recent hype around all three asset classes, I’m really struggling with this category.
The first hint is in the name. As none of the above produce a regular stream of cash flows, you are reliant on price appreciation alone to drive your returns.
Now, I accept that Bitcoin and gold could well have their uses within a well-diversified portfolio.
In fact, much smarter people than me have illustrated the benefits of some exposure to the assets above.
But as far as art and wine goes, I find it a bridge too far.
Unless you have some differentiated expertise in either category (no, boxed wine doesn’t count), you are really taking a punt here.
As they say, hope is not an (investing) strategy.
The Unpopular Answer
Let us go back and check in on Sam, the unluckiest investor in the world.
Unless you’ve been living under the rock, you won’t be surprised to hear that after going through a world of pain in the noughties, Sam has pretty much knocked it out of the park ever since:
Now, it all seems easy in hindsight, but could the answer simply be… stay the course?
The biggest lesson one can take from historical investing data is that most assets have their day in the sun – eventually.
Yes, US large caps have had a horrible beginning – but have been on an absolute tear since 2010.
On the other hand, emerging market equities performed in pretty much the opposite manner.
All the while those capricious small-cap and value stocks posted more fits and starts than I can count.
Sure, they’ve notched up an impressive run over the past few months, but who is to say that will continue?
What is true, however, is that investors who chased the latest and greatest performance could well have ended trading in and out of asset classes above at worst possible times.
On the contrary, it’s the ones who stuck to their investing strategy (like Sam) through thick and thin that ended up doing well for themselves.
Thus, the unpopular answer may be that once you’ve diversified your portfolio, you simply can’t hedge yourself – other than picking a strategy, sitting tight, and having a 20+ investing horizon in mind.
And if that means nursing those recent losses on your growth portfolio, then so be it.
Thank you for reading!
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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