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A lot has been written about the so-called lost decade for stocks including this previous article, Lost Decade for Stock Investors. But was it really a lost decade investors? There has been some debate about this. Some pundits have argued that it has not been a lost decade for investors.**

What Would Be a Lost Decade?
First, what is meant by a lost decade? In this article, I am approaching this question in terms of missed expectations. From this point of view, a decade is lost when actual results fall far short of expectations.

Every investor has some expectations for future returns. Based on expected returns, investors determine how much they need to save in order to reach their goals. For instance, a couple saving for retirement might decide that they need $1 million dollars to retire, so they have to save $2000 per month for the next 20 years if they expect a 7% return from their investments.

Likewise, institutions like company pension funds and endowments also have return expectations. The amount that a company contributes to its pension fund is determined in part by return expectations. If the expectation is too high and that return is not realized, the pension will be underfunded.

What Were Return Expectations in 2000?
At the end of 1999, the stock market had just come off a string of outstanding years. From 1995 to 1999, the S&P 500 gained well over 20 and 30 percent every year. Many individual investors, when asked, said they expected 20% or higher returns each year from the stock market. This was the period of “irrational exuberance”, a phrase used by Alan Greenspan in 1996 to describe the stock market’s euphoria. At the time, it seemed like the internet would change the world and  recessions were a thing of the past. Many people thought “it’s different this time.”

Most experts had not quite as lofty expectations. At that time, the stock market had historically returned 10 or 11 percent annualized, so more thoughtful pundits forecast an annualized return of 10% for stocks. For bonds, the expected returns were just 5%. (There were a few experts that warned of lower returns, but they were few and far between. They were generally dismissed as Nervous Nellies or worrywarts.)

To determine if the decade from 12/31/1999 to 12/31/2009 was a lost decade, I am going to look at the growth of $10,000 for various mutual funds and portfolios and then compare that against how much was expected with a 10% stock return and 5% bond return.

Growth of $10,0000 for Stocks and Bonds
First lets look at some Vanguard mutual funds. All of these are 100% stock funds, except for VBMFX which is 100% bonds. At 10% return, 100% stocks was expected to grow to $25,937. At 5% return, 100% bonds was expected to grow to $16,289. This chart shows the growth of $10,000 for four stock funds. The funds are the Total U.S. Stock Market Index (VTSMX, blue line)  and Total International Stock Market Index (VGTSX, orange line), Value Index (VIVAX, purple line) and Growth Index (VIGRX, green line). International stocks beat U.S. stocks and Value beat Growth. But all are well below the expected $25,937 balance.

VTSMX = Vanguard Total Stock Market Index
VGTSX = Vanguard Total International Stock Index
VIVAX = Vanguard Value Index
VIGRX = Vanguard Growth Index

The next chart shows the growth of $10,000 for some better-performing stock funds. The funds are the Vanguard Small Cap Index (NAESX, orange line)  and Small Cap Value Index (VISVX, purple line). Small and value beat the total stock market handily, but are still below the expected $25,937 balance.

One fund, Vanguard Emerging Markets (VEIEX, green line) was the single class of stocks that came in about at expectation. These are stocks of fast-growing companies in developing markets like Brazil, Russia, China, India and eastern Europe. One caveat for investors: observe the wild swings in the Emerging Markets fund. Investors took on a lot of risk to get the higher return.

VTSMX = Vanguard Total Stock Market Index
NAESX = Vanguard Small Cap Index
VISVX = Vanguard Small Cap Value
VEIEX = Vanguard Emerging Market

Table 1 shows the results for several mutual funds.

VTSMX = Vanguard Total US Stock Market Index
VGTSX = Vanguard Total International Stock Market Index
VIVAX = Vanguard Value Index
NAESX = Vanguard Small Cap Index
VISVX = Vanguard Small Cap Value
VEIEX = Vanguard Emerging Market
VBMFX = Vanguard Total Bond Market

The good news is that the bond fund exceeded the expected balance by 11%. This decade was not lost for bond investors.

For stock investors the decade didn’t go so well. The best stock fund was Emerging Markets VEIEX) which has just 2% less than was expected. Second best is Small Cap Value (VISIVX) which has 19% less than expected. The rest of the stock funds have large deficits. as much as -65%. It was definitely a lost decade for stock investors.

Growth of $10,0000 for Balanced Portfolios
But very few portfolio are 100% stock or 100% bonds. Most investors hold a mixture of stocks and bonds according to their asset allocation. For instance, a conservative portfolio like Wellesley Income holds 35% stocks and 65% bonds. A 35/65 portfolio was expected to return 6.75% per year and grow to $19,217 after ten years. A more aggressive 65/35 like Wellington was expected to return 8.25% per year and grow to $22,094.

This chart shows the growth of $10,000 for four balanced funds. These funds all hold a mxture of stocks and bonds. The funds are the Vanguard Balanced Index (VBINX, blue line) and Wellington (VWELX, orange line), Wellesley Income (VWINX, purple line) and Permanent Portfolio (PRPFX, green line). Refer to Table 2 to see how they did compared to expectations.

VBINX = Vanguard Balanced Index
VWELX = Vanguard Wellington Fund
VWINX = Wellesley Income Fund
PRPFX = Mutual Fund similar to Harry Brown Permanent Portfolio

Table 2 shows the results for several balanced portfolios, plus Berkshire-Hathaway company stock. Berkshire-Hathaway is run by Warren Buffet who is well known as the world’s greatest investor.

VBINX = Vanguard Balanced Index
BRK = Berkshire Hathaway
COFFEE = Coffehouse 60/40 Portfolio
VWELX = Vanguard Wellington Fund
VWINX = Wellesley Income Fund
HBPP = Harry Brown Permanent Portfolio
10M-SMA = Mebane Faber’s 10-Month Simple Moving Average Timing

The results show that portfolios that had a lot of stock, did worse than expected. Wellesley Income at 35/65 ended up the decade with a 2% surplus over the expected balance. But Wellington at 65/35 had a deficit of -18%. The other balanced portfolios also did worse than expected. Even Berkshire Hathaway with Warren Buffet at the helm didn’t fair so well, falling -32% behind the expected return.

The Harry Brown Permanent Portfolio is one portfolio that stands out with a 24% surplus over the expected balance. The Permanent Portfolio has 25% stock, 25% gold and 50% bonds and cash, so is not surprising that it did well during a decade when stock did poorly and gold prices tripled.

One other portfolio that gets an honorable mention is Mebane Faber’s 10-Month SMA. This was included to show another approach to dealing with risk. However, it is not actually a complete portfolio. It only covers the stock portion, so it really should be compared to the funds in Table 1. Mebane Faber’s is a market timing system that uses a 10-month simple moving average. It is described in his 2005 paper A Quantitative Approach To Tactical Asset Allocation. This timing system managed to avoid both big bear markets during the past decade.

Conclusion: Lost Decade for Some but Not For All
Just about every segment of the equity market did worse than expected over the past decade. The only bright spot was in emerging markets, which came in about at expectation. The logical conclusion is that it has been a lost decade for stocks.

For bonds, the decade was outstanding and exceeded expectation. No lost decade for bonds.

For investors portfolios that held both stocks and bonds, the results are mixed and summarized in Table 3.

For investors holding a balanced portfolio, whether or not the decade was lost depends on how much was allocated to stocks vs. bonds. Stock-heavy portfolios definitely experienced a lost decade, falling 20 to 40 percent behind expectations. Even Warren Buffet suffered a lost decade. Bond-heavy portfolios did NOT have a lost decade. Investors in Wellesley Income Fund got just about what they expected.

There were couple of unusual strategies that did not suffer lost decades. One portfolio had a large allocation to gold, which did well this decade. The other was a market timing system. However, only a handful of investors devoted much of their portfolios to gold in 2000. And no one was following Faber’s 10-Month SMA market timing system at the beginning of the decade, although there were plenty of converts after the second big market crash in 2008. So even though there were ways of avoiding the lost decade, practically no one had the foresight to follow them.

**For other points of view, see the cbs moneywatch.com article Why It Wasn’t a ‘Lost Decade’ for Investors by Allan Roth and on Forbes.com read A Decent Decade for Index Investors by Richard Ferri.

The views expressed in this article are those of the author and do not necessarily represent the views of Laguna Beach Bikini, its editors, staff or any other organization.