I have heard and read it too many times to count: “Ah, but anyone following an indexing strategy experienced a lost decade over the last ten years!” Active investors and day traders (not to mention: fund companies and brokerages wanting you to become one too) enjoy touting this as fact. The problem? It is a ‘straw man’ argument – one that misunderstands the opposing view, or creates one out of thin air. In short: critics are unable to cite a single author or adviser who recommends a 500-index-only approach to passive investing, which leads us in turn to the first of three key counter-points:
1) No indexing guru or passive-investing expert recommends 100% stocks. Benjamin Graham, father of value investing, had a simple rule of thumb: never have less than 25% of your portfolio in stocks or bonds, and never have more than 75% in either, either.
Beyond such a balanced approach one starts to lose the ‘free lunch’ of diversification between equities and fixed income. Annualized, over the last ten years, the total US bond market (a good benchmark for bonds generally) returned around 7% annualized. Obviously, this bolstered the performance of passive US-stock portfolios.
Critiquing a portfolio or strategy does not make sense unless you account for its performance as a whole – Harry Browne’s 25%-each cash, stocks, bonds and gold portfolio sounds dangerous (perhaps downright silly) if you consider only its individual components, but has performed very well for decades now if you view it (as you should) in total.
2) The S&P 500 is not a proxy for the total US market, let alone the world. While the 500 index was the best-fit fund for a long time, it is no longer the only low-cost, tax-efficient option for broad-market indexing. For a few basis points, one can now easily invest in the whole global market. This, not the 500 index, is thus the obvious starting point for total-market-index investors, and has been for some time.
On this point, however, it must be said that there is a notable expert who disagrees: Jack Bogle. He has been known to say that the 500 index alone is sufficient, and that international diversification is overrated. And it is hard to blame him, since he founded the first index fund – the Vanguard 500 Index Fund, to be precise – back in 1975. He is perhaps understandably attached to his creation. Still, even he often makes model portfolios with 20% international – it might not be market weights (which are closer to 60%) but it suggests even he may be willing to learn.
3) Ten years is a short time horizon for evaluating a long-term portfolio. Why are people attached to the idea of a ‘lost decade’ in particular? Sure, it is a rounded sum of years, easily simplified and described, but what does it have to do with a lifetime of investing? It is time in the market that counts, over long periods of time.
Consider for a moment two types of investor and its impact on them: a young investor has had the last ten years to buy in at low levels throughout the decade, and an older investor should have a higher allocation to bonds anyway. Both fared fine over this period. A new investor should hope for a lost decade, and an older investor should be less exposed to equities. Meanwhile, it is a little too convenient to ignore the 25-year bull run the index had leading up to 2000 – at best, it implies people have 10-year time horizons.
Finally, it is worth pointing out that even the strong-form claim that the S&P 500 index has failed to break even over the last ten years is subject to debate, or, more simply: to the date (on which it is measured). So for those who have cherry-picked the perfect time to analyze it, there may be truth to their statement, but a volatile month one way or the other can easily change that. Nor would it be wise to count large-cap stocks out of the running – what has a bad decade often turns around to have a good one, too. However, none of this changes the underlying fact: this 500-index straw man is for the birds – let us agree to put him back out in the fields to scare crows, accordingly. (Charts Made on Morningstar)