Beyond Buy-and-Hold #85
Was the return sequence we saw play out from January 2000 through December 2010 a lucky sequence or an unlucky one?
Many people think of these years as “The Lost Decade” (or, speaking strictly, “The Lost Eleven Years”). Did we indeed draw some black cards during that time–period?
By no means!
The Returns Sequence Reality Checker shows that those 11 years were lucky ones for stock investors (the calculator is not yet set up to handle questions relating to 2011). We saw a return pattern over those 11 years that was on the lucky end of the range of possibilities that were available to us beginning in January 2000.
How can price stagnation be lucky?
Say that we were back in January 1981, the beginning of the 30-year time-period that ended in January 2011. The realistic expectation would be that we would see an annualized 30-year return of something in the neighborhood of 6.5 percent real. That’s the long-term return that has applied for stocks going back as far as we have records. So I plugged that number into the calculator as the 30-year return that would apply for the time period from 1981 through 2010.
Then I plugged in the returns we actually saw appear from 1981 through 1999, the 19-year returns sequence that was set in stone at the beginning of the 11-year time-period we are examining in this article. For the first results column in the calculator, I entered the returns we actually saw from 2000 through 2010. I let the calculator complete the second column, with the aim of bringing the annualized return for the entire 30-year period to 6.5 percent real, the long-term annualized return that has applied for U.S. stocks throughout history.
Assuming an investor had a $10,000 portfolio in 1981 and added $10,000 to his account in each of the 30 years, his portfolio amount at the end of 30 years for the Column One return pattern (the one we saw play out in real life) was $921,287. The Column Two return pattern (the most realistic one that could have been anticipated) generated a final portfolio value of $737,497. That’s a difference of over $180,000 in portfolio value.
Stock investors were very fortunate in the years 2000 through 2010
Why was there so much complaining being heard?
Buy-and-Hold thinking confuses us.
The Buy-and-Hold Model for understanding how stock investing works is rooted in a belief in the Efficient Market Hypothesis, an academic construct from the 1960s. This model posits that each day’s stock returns are determined by the economic and political developments of that day. Things that happened a year ago or two years ago or three years ago have no influence on today’s returns, according to this model.
If the model were valid, we would have every right to expect a return of something in the neighborhood of 6.5 percent in every year and in every 11-year time-period. The annualized return for the years 2000 through 2010 was not anything close to 6.5 percent. So the Buy-and-Holders were right to be unpleasantly surprised by the returns they saw during that 11-year time-period.
One time period ALWAYS affects the one behind it
Valuation-Informed Indexers understand that the returns obtained in one time-period ALWAYS influence the returns obtained in the following time-period. Years of good returns are ALWAYS followed by the years of poor returns needed to pull the overall long-term return back to its long-term average. Years of poor returns are ALWAYS followed by the years of good returns needed to pull the overall long-term return back to its long-term average. There has never been an exception. In the event that this model is valid (there is now 30 years of academic research supporting it), there never will be one.
Returns were insanely high in the late 1990s. So we expected to see returns far, far less than the long-term average from 2000 through 2011. And of course that is what we got. We did not see anything close to the worst returns we could have seen, however. Had the returns only been poor enough to bring the 30-year returns sequence back to the historical norm, we would have seen a return pattern for those 11 years that would have generated a final portfolio value of $180.000 less than what we indeed did see.
Your return expectation is determined by the model you use.
If you believe in Buy-and-Hold, you have every right to be disappointed in how things have played out.
If you are familiar with the message of the academic research of the past 30 years (a message that the big shots on Wall Street very, very much would like to keep hidden from you), you knew that we were headed into bad times when stock prices got so out of control in the late 1990s and you took the returns we saw during the so-called Lost Decade in stride, understanding that they were a good bit better than the returns that we all would have expected to see starting from those inflated values had we been thinking clearly.
Rob Bennett believes that the savings and investing go together like a horse and carriage. His bio is here . For background on the Big Fail of Buy-and-Hold and on the need to move to Valuation-Informed Indexing, please check out the “About” page at the “A Rich Life” blog.
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