While basking in the afterglow of a 50 percent rise in the stock market, the financial press reminded me that we are closing in on the worst decade ever for the S&P 500 going back to 1927.
After a 17 percent rise year-to-date, the results are basically flat for the 10-year period. Adjusting for 10 years of inflation, we have actually lost 33 percent.
We don't need to mope around over this state of affairs, because there's a solution. If a zero gain for the past 10 years is bothering us, we can just go back fourteen years. Thanks to a 347 percent compound gain from '95 to '99, our average annual rate of return suddenly becomes a compounded 7.5 percent over this longer period, so we can feel great with respect to whatever money we had invested as of 1995.
The balance of what we have contributed since that time has been dollar-cost averaged, which means that we were reducing the average cost of all our shares when the market was down in the early 2000's and also in the most recent few years. The math on these regular deposits since 1995 indicates that their rate of return averages 4.6 percent.
Most of us investing in mutual funds have taken to heart the concept of reducing risk by putting together a mix of fund types. The positive results of so-called diversification have never been more compelling than they are right now.
The S&P 500 index is, indeed, flat for the past 11 years, but an equal mix of an S&P 500 index fund, a small company index fund, and an international index fund would have generated a combined rate of return equal to about 6 percent. To put this in dollar terms, 11 years of $1,000 annual contributions into just the S&P 500 Index would total $11,200 today -- a $200 profit. The same $1,000 in the above-suggested diversified mix would be worth $15,800 -- a $4,500 profit. When the world is otherwise flat, a 6 percent return is a nice reward for taking the time to diversify.
We can just forget about that giddy feeling we experienced in September of 2007, the stock market's high water mark. Our account statements from then had us all calculating that we could retire five years earlier than whatever the original plan might have allowed. After swallowing some disappointment, however, we can see that results are not so bad. For those of us taking the long view, the stock market has been doing its job.
What we can look forward to is the extent to which the market has demonstrated higher than normal returns for the years following any of the past flat decades. While expected returns average 10 percent, the 10-year average after a flat 10-year period has trended toward 13 percent. Warren Buffett predicted back in 2005 that the market would earn an average annual return of 7 percent for the following 10 years. As far in the hole as we are today, an average of 7 percent for the entire period between 2005 and 2015 would require a major bump going forward over the next five years.
We can't lose sight of the broader picture. The financial press can prompt us to view the world with blinders. We don't like 10-year results? Try fourteen. We don't like the S&P 500? Try some diversification to create the path of minimum regret. Adjusting our perspective can do wonders for our dispositions and fortitude at times like these.