Recent headlines suggest stocks could be flat (or negative!) for the next 10 years.
The technical for this is “lost decade.”
And these headlines have created more concern for investors who are already on edge.
So, what exactly does a lost decade mean for retirement savers?
How likely is it that we are going to experience one?
If we do, how should investors approach their asset allocation?
Those are the questions I’m answering in today’s episode!
How to Listen to Today’s Episode
- Subscribe to the Stay Wealthy Newsletter! 📬
- Druckenmiller on State of the Markets [CNBC]
- “…the Dow won’t be much higher in ten years than it is today.”
- The Great Depression [The Balance]
- History of Vanguard [Vanguard]
- Historical Returns During Lost Decades [Returns Web]
How to Invest During a Lost Decade
Taylor Schulte: Billionaire investor, Stanley Druckenmiller, recently warned that there is a high probability the stock market will be flat for an entire decade.
In other words, he’s suggesting that we should expect 0% returns from stocks (before inflation is even factored in) for the next 10 years.
The technical term for an event like this is “lost decade.” Stanley is predicting that the next 10 years will be a lost decade. And while his strong negative feelings about the stock market aren’t anything new, his recent statement has made major news headlines and, in turn, has created even more concern for investors who are already on edge.
So, what exactly does a lost decade mean for retirement investors?
How likely is it that we are going to experience one?
And if we do, how should investors think about their asset allocation going forward?
This is the stay wealthy retirement podcast, I’m your host Taylor Schulte, and today I’ll be answering those exact questions.
For all the links and resources mentioned today, just head over to youstaywealthy.com/170.
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Ok, let’s get into today’s topic: lost decades in the stock market.
As mentioned, the latest prediction making headlines is that the stock market is headed toward 10 years of flat returns. I.e., A lost decade, which is just what everyone needs after a global pandemic, 40-year record high inflation, double-digit losses from stocks and bonds, 7.5% mortgage rates, and a looming downturn in housing prices.
But how many times have we experienced a lost decade here in the United States?
Believe it or not, it’s only happened twice.
The first time was in the 1930s and it was, of course, a result of the Great Depression. During this time, from January 1st, 1930 to December 31, 1939, the S&P 500 returned a negative 0.5%.
The second lost decade was from 2000-2009 – it was a result of the tech bubble bursting coupled with the Great Recession, and during that 10-year span, the S&P 500 lost about 9% in total.
If we want to include inflation and its impact on investment returns, we could also consider the 1970s to be a lost decade. As mentioned in last week's episode, the 1970s did deliver healthy returns to investors (close to 6% per year, on average), but record-high inflation ate them all up. This resulted in a 10-year period of negative returns for U.S. stocks when adjusted for inflation.
So, we’ll be generous and say that we’ve experienced three lost decades over the last 100 years. In other words, lost decades are extremely rare.
And while all three of these rare, catastrophic time periods were very, very different, they all had one thing in common:
Investors with diversified portfolios, who didn’t invest 100% of their portfolio in broad-based U.S. stocks, ended all three 10-year lost decades in positive territory. Yes, even after inflation.
Let me break it down for you using historical data gathered from both YCharts and another analytics software called Returns Web. I’ll include links to the results in the show notes, and it’s important to note that I’m using indexes here, some of which were created just for historical research purposes and weren’t directly investable during all time periods.
So, since they are indexes and not publicly traded funds, they don’t include fees like trading costs, expense ratios, capital gains distributions, advisor fees, etc., and the returns stated are therefore going to be higher than what an actual investor would have been able to record in real life. Nonetheless, it’s all we have to work with when doing this type of research, so you’ll have to accept that “perfect is the enemy of good” here.” Lastly, before we start talking about percentages and numbers, just a reminder, this podcast is for informational purposes only and past performance is no guarantee of future results.
Ok, with all of that out of the way, let’s start with the 1930s.
As mentioned, from 1/1/1930 to 12/31/1939, the S&P 500 had a total negative return of about 0.5%. Intermediate five-year US Treasury bonds, on the other hand, returned a positive 56.55% during the same time period. This was the 1930s, and access to investments was quite limited, so we will keep it simple and not introduce any other indexes for this time period.
But if an investor took a diversified approach, and had a basic portfolio comprised of 60% US stocks and 40% 5-year government bonds, their totally hypothetical total 10-year return during the worst period in economic history was a positive 40%. This translates to about 3.4% per year, on average, so nothing to write home about, but certainly better than a negative return or flat decade.
Moving onto the 1970s.
Once again, from 1/1/1970 to 12/31/1979, the S&P 500 had a total positive return of about 76%, or about 5.8% per year, on average. Healthy returns, but inflation averaged around 7% during that time period, so net of inflation, investor returns were negative for the entire decade.
While nobody wants a repeat of the 1970s, it’s important to acknowledge that, like the Great Depression, diversified investors were rewarded. During this 10-year period, small-cap value stocks, as represented by the Dimensional US Small Cap Value Index, returned a positive 275%, international stocks, represented by the MSCI EAFE index returned a positive 161%, and five-year US Treasury bonds returned a total return of 96%.
So, let’s say that instead of putting all of my money in a US Large Cap stock index like the S&P 500 I invested in a balanced 60% stock/40% bond portfolio – a portfolio that had 20% allocated to the S&P 500, 20% to small-cap value stocks, 20% to international stocks, and 40% to US treasury bonds. This hypothetical balanced portfolio had a hypothetical 10-year return of ~146% or about 9.5% per year, on average. Which means that adjusted for inflation, returns were actually positive.
Lastly, let’s talk about the most recent flat decade. The 2000s, from 1/1/2000 to 12/31/2009.
During this 10-year time period, the stock market was cut in half twice. Let that sink in. During what I would call a relatively short investing time period, an investor experienced two 50+% drawdowns – one of these occurred when the tech bubble burst in the early 2000s and the other was a result of the 08/09 financial crisis. It was a challenging decade, to say the least, and it was clearly reflected in the negative 9% total return for the S&P 500 during that time.
Keep in mind, that -9% total return for 10 years assumed that dividends were being reinvested. If you were spending those dividends instead, and not reinvesting them, your return for those 10 years was a negative 24% – almost three times as worse. But, if instead of chasing and spending dividends, an investor had a nice globally diversified portfolio, their hypothetical returns for this terrible 10-year time period was ~68%, or about 5.3% per year, on average.
Like the 1970s scenario, this analysis assumed 20% invested in the S&P 500, 20% in small-cap value stocks, 20% in international, and 40% in intermediate US treasury bonds represented by the Bloomberg Intermediate US Treasury Bond Index.
Once again, diversified portfolios ended one of the most difficult 10-year time periods in positive territory.
Now, before you race to send me all of the reasons why these hypothetical returns aren’t realistic, I want to acknowledge again that, yes, these returns are based on indexes and aren’t exactly indicative of what an investor might have experienced by investing in publicly traded funds.
Throughout the 1900s, investment options were limited, the process to invest was full of friction, and it was expensive. But let’s not forget that Vanguard was founded in 1975 and quickly began bringing low-cost, diversified investment options to retail investors. By the year 2000, investors had a wide range of low-cost providers to choose from and perhaps the only thing working against them was the lack of investor education and an environment ripe with conflicts of interest.
So, while many investors did get sucked into high-flying tech stocks and day trading and making a quick buck (sound familiar?), I’d argue they did have access to all of the right tools to npt just survive, but potentially thrive, during one of the most difficult 10 years in stock market history.
But pushing all of that aside, my goal with today’s episode was to reinforce something I shared last week, which was that while these extreme, catastrophic events are always different, the reward for smart, diversified, long-term investors has always been the same. Maybe a diversified investor's ACTUAL total return, net of fees during the 2000s was, I don’t know, 28% instead of 68% like the backtested index data produced. Whatever it might have been exactly, I would argue that a smart, diversified investor still likely had a better outcome than the -9% total return that always seems to make the headlines when discussing lost decades.
So, when you see a headline predicting a 10-year period of flat returns or the possibility of a “lost decade”, open up the article, read the fine print, and take note that they are most likely referring to a prediction about one single broad-based asset class, and remind yourself that you don’t put all of your eggs in one basket. That you have (or should have!) a prudent, diversified portfolio that matches your unique goals, risk tolerance, and risk capacity.
Sure, the next 10 years might be full of challenges, downturns, out of control inflation, and maybe even negative real returns for large-cap US stocks. I truly don’t know and neither does anyone else. But, historically, during extremely challenging time periods, diversified investors who stayed the course, reinvested their dividends, and remained focused on the things they could control, had a much better experience than the hypothetical investor who put all of their money in a single asset class like the S&P 500 for an entire decade.
So, with all of that in mind, let’s answer the three big questions I posed at the top of today's show.
Number one, what exactly does a lost decade mean for retirement investors? It means we have to be very thoughtful about the construction of our portfolios. It also means that we might need to expect lower rates of return for an extended period of time and continue to stress our retirement plans to ensure they can weather future storms.
A headline suggesting that a lost decade is ahead does not mean that globally diversified investors will experience a decade of negative returns or that we should stuff all of our money under the mattress, chase investments that sound too good to be true, or trash the plan that you worked so hard to put into place. Remember, read through the headlines, and remind yourself that they are likely referring to a single prediction about a single asset class. And then remind yourself that you (hopefully) don’t just own one asset class, and you’ve worked hard to diversify your hard-earned dollars and invest prudently.
Number two, how likely is it that we are going to experience a lost decade? Well, considering the U.S. has truly only had two lost decades in all of history, the odds are quite low. That doesn’t mean it’s not possible and that we shouldn’t be prepared for worst case scenarios, but it’s a low probability event. And it’s an even lower probability event for globally diversified investors.
All we can do is make educated and informed decisions with the information we have access to. We can’t predict the future and we shouldn’t turn our long-term retirement plans upside down just because someone thinks they can. We have to stay focused on the things we can control, one of which is to plan and prepare for catastrophic events from time to time.
Number three, if we do experience a lost decade, how should investors think about their asset allocation going forward? I’ve already touched on this, but I think one action item to consider coming out of today’s episode is to revisit my investing in retirement series where I break down how to think about constructing a portfolio and investing in different asset classes. Lost decade or not, diversification is wildly important to any long-term investor. It’s also wildly misunderstood. So, now is as good of a time as any to ensure you are properly diversified and that your investments (i.e., your prescription) truly matches your plan (i.e., your diagnosis).
Once again, just like last week, I’m not discounting the severity of the current environment. We are faced with some serious challenges and things could certainly get worse before they get better. I’m also not suggesting we ignore current events and just buy and hold and it will all go away eventually. I’m simply trying to provide some perspective to broad-based statements and headlines that can be misunderstood and lead investors to make harmful, sometimes irrecoverable decisions with their money.
I love this topic and I’m open to going deeper on it in a future episode, so please don’t hesitate to send over any questions, comments, or how you might consider approaching a decade of low or flat returns. As always, you can email me at email@example.com.
You can also grab the links and resources mentioned in today's episode by going to youstaywealthy.com/170.
Thank you, as always, for listening and I will see you back here next week.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.