The happenings of the “Lost Decade” is fading in our memory, yet for some, especially for those who experienced substantial losses, the unsettling feeling is easy to recall. The “Lost Decade” was one of the worst moments in the recent stock market history as we observe the performance of the popular indexes: S&P 500, Dow and Nasdaq.
It was definitely a very bad time to draw income form the portfolio, unfortunately, this is what many investors were forced to do. Some were already retired and dependent on income from their portfolio, and some were forced to retire during the financial crisis.
Warren Buffet said, “What we learn from history is that people don’t learn from history”. We all know that in the future we will experience recessions, and probably not just one, but many. Recessions will occur and can’t be avoided. We can’t predict when, how long and how bad the next recession will be, but we know someday we’ll get there.
Since evidence and research indicated that getting out of the market on time, just before it happens is almost impossible, we can look at the investment strategies that may allow us to stay invested and not be impacted as the whole market as it is represented by S&P500, Dow and Nasdaq.
While past performance is not a guarantee of future results, we may be able to get some clues and try to prove Warren Buffet wrong by learning from history.
First let’s examine the S&P500 returns during the 2000 to 2010 period. The compounded annualized rate of return from year 2000 to 2010 has been negative 0.9%. The rate is derived from the following annual returns and in dollars, assuming $1,000,000 investment, the portfolio value would look like the following:
(investment management or trading cost are not included in the calculation, you can not invest directly in the index)
It was definitely a very bad time to draw income form the portfolio, unfortunately, this is what many investors were forced to do. Some were already retired and dependent on income from their portfolio, and some were forced to retire during the financial crisis.
Warren Buffet said, “What we learn from history is that people don’t learn from history”. We all know that in the future we will experience recessions, and probably not just one, but many. Recessions will occur and can’t be avoided. We can’t predict when, how long and how bad the next recession will be, but we know someday we’ll get there.
Since evidence and research indicated that getting out of the market on time, just before it happens is almost impossible, we can look at the investment strategies that may allow us to stay invested and not be impacted as the whole market as it is represented by S&P500, Dow and Nasdaq.
While past performance is not a guarantee of future results, we may be able to get some clues and try to prove Warren Buffet wrong by learning from history.
First let’s examine the S&P500 returns during the 2000 to 2010 period. The compounded annualized rate of return from year 2000 to 2010 has been negative 0.9%. The rate is derived from the following annual returns and in dollars, assuming $1,000,000 investment, the portfolio value would look like the following:
(investment management or trading cost are not included in the calculation, you can not invest directly in the index)
2000 |
2001 |
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
-9.1% |
-11.9% |
-22.1% |
28.7% |
10.9% |
4.9% |
15.8% |
5.5% |
-37.0% |
26.5% |
$909,000 |
$800,829 |
$623,846 |
$802,890 |
$890,404 |
$934,034 |
$1,081,612 |
$1,141,100 |
$718,893 |
$909,400 |
We can clearly see why the above period has been called a “Lost decade”, in this scenario we started with $1,000,000 and after 10 years, the investment value is equal to $909,400. It is disappointing, to say the least- no gains for 10 years and a surely a flurry of emotions that the investor had to endure looking at the statements in the bad years.
But this is not the end of the story, a really sobering moment is when we review the same portfolio, assuming the investor had to make withdrawals during that time. We’ll take a conventional approach, which may not be always the best, but this subject will be discussed in another article, and assume 4.5% withdrawal in the first year and increase the withdrawal each year with inflation. To simplify, we’ll assume 3% inflation rate.
The last row added is the amount withdrawn each year and the 2nd row shows the account value after adjustment for the change in the market and a withdrawal.
But this is not the end of the story, a really sobering moment is when we review the same portfolio, assuming the investor had to make withdrawals during that time. We’ll take a conventional approach, which may not be always the best, but this subject will be discussed in another article, and assume 4.5% withdrawal in the first year and increase the withdrawal each year with inflation. To simplify, we’ll assume 3% inflation rate.
The last row added is the amount withdrawn each year and the 2nd row shows the account value after adjustment for the change in the market and a withdrawal.
2000 |
2001 |
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
-9.1% |
-11.9% |
-22.1% |
28.7% |
10.9% |
4.90% |
15.8% |
5.50% |
-37.00% |
26.5% |
$864,000 |
$714,834 |
$509,115 |
$606,059 |
$621,471 |
$599,756 |
$640,785 |
$620,684 |
$334,026 |
$363,828 |
$45,000 |
$46,350 |
$47,741 |
$49,173 |
$50,648 |
$52,167 |
$53,732 |
$55,344 |
$57,005 |
$58,715 |
It is clear that the strategy is not sustainable. From $1,000,000 to $363,828 in 10 years. Not only has it experienced long periods of negative performance, but it looks even worse if the portfolio is used in the distribution phase as a source of income.
One important point is that a portfolio positioned for income should not be in 100% equities, such as the S&P500 or any other combination. We have this subject addressed in the “withdrawals and distribution” article.
Here our goal is to create a better investment experience for investors and attempt to avoid long periods of negative performance.
As we already know, a properly diversified portfolio based on the dimensions of expected returns should include not only the S&P500, but other asset classes as well. See "Dimensions of Higher Expected Returns" article.
As an example, we have a Balanced Strategy Equity portfolio, created by Dimensional (DFA). The portfolio tracks 11 different asset classes and is tilted to dimensions of higher expected returns, value and small companies. It also includes international and emerging markets with the same tilt.
The compounded annualized rate of return from year 2000 to 2010 has been 7.4% (S&P500 produced -0.9%). Annual returns and portfolio values are listed below as we did in the example with the S&P500 above :
(The portfolio is provided as a sample and not as a recommendation, trading or advisory fees are not included in the calculation)
One important point is that a portfolio positioned for income should not be in 100% equities, such as the S&P500 or any other combination. We have this subject addressed in the “withdrawals and distribution” article.
Here our goal is to create a better investment experience for investors and attempt to avoid long periods of negative performance.
As we already know, a properly diversified portfolio based on the dimensions of expected returns should include not only the S&P500, but other asset classes as well. See "Dimensions of Higher Expected Returns" article.
As an example, we have a Balanced Strategy Equity portfolio, created by Dimensional (DFA). The portfolio tracks 11 different asset classes and is tilted to dimensions of higher expected returns, value and small companies. It also includes international and emerging markets with the same tilt.
The compounded annualized rate of return from year 2000 to 2010 has been 7.4% (S&P500 produced -0.9%). Annual returns and portfolio values are listed below as we did in the example with the S&P500 above :
(The portfolio is provided as a sample and not as a recommendation, trading or advisory fees are not included in the calculation)
2000 |
2001 |
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
3.30% |
2.00% |
-9.70% |
47.50% |
23.60% |
13.50% |
24.60% |
0.80% |
-41.80% |
42.40% |
$1,033,000 |
$1,053,660 |
$951,455 |
$1,403,396 |
$1,734,598 |
$1,968,768 |
$2,453,085 |
$2,472,710 |
$1,439,117 |
$2,049,303 |
The portfolio value has more than doubled during the “Lost decade” while the S&P500 was negative 0.9% over the same time frame.
In the next example, we will test how withdrawals impacted the portfolio, but it is important to note, we do not suggest a 100% equity portfolio to be used when withdrawals are needed. The following example is included to complete a fair comparison. It does not matter how well diversified the portfolio is, it will experience volatility, as we noted in this example the declines can be close or more than 40%. The period of time we are reviewing here is just that, a ten-year period. The next recession is not going to be the same, remember “past performance is not a guarantee of future results”. We can only use the history as a guide to understand the relationship between different asset classes, their expected premiums and risk.
An example of income withdrawals from the DFA portfolio:
In the next example, we will test how withdrawals impacted the portfolio, but it is important to note, we do not suggest a 100% equity portfolio to be used when withdrawals are needed. The following example is included to complete a fair comparison. It does not matter how well diversified the portfolio is, it will experience volatility, as we noted in this example the declines can be close or more than 40%. The period of time we are reviewing here is just that, a ten-year period. The next recession is not going to be the same, remember “past performance is not a guarantee of future results”. We can only use the history as a guide to understand the relationship between different asset classes, their expected premiums and risk.
An example of income withdrawals from the DFA portfolio:
2000 |
2001 |
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
3.30% |
2.00% |
-9.70% |
47.50% |
23.60% |
13.50% |
24.60% |
0.80% |
-41.80% |
42.40% |
$988,000 |
$961,410 |
$820,413 |
$1,160,936 |
$1,384,269 |
$1,518,978 |
$1,838,914 |
$1,798,281 |
$989,595 |
$1,350,469 |
$45,000 |
$46,350 |
$47,741 |
$49,173 |
$50,648 |
$52,167 |
$53,732 |
$55,344 |
$57,005 |
$58,715 |
After 10 years, accounting for withdrawals, from $1,000,000 in initial investment value, the S&P500 portfolio finished at $363,828 and the DFA portfolio finished at $1,350,469. Close to a million dollar difference.
Conclusion: Different asset classes and countries are likely to perform in their own way at different times. Proper diversification is essential and as we look at the history, there are asset classes that have done better than the S&P500 over long periods of time.
In this particular example, the “lost decade” was not “lost” for the DFA portfolio.
Critics may call this example a data mining, as it is too short of a period to draw a meaningful conclusion and they would be correct. Our goal in this exercise to examine the worst ten years only, since as of this writing we have been in a bull market for more than ten years now, “bad times” may not be that far ahead. The Fama and French research referred to in other articles is based on more than 90 years of data which allows for an evidence-based conclusion.
As we rereview a much longer period of 46 years, beginning in 1973 and ending in 2018, we should have better data sampling. The same DFA Balanced Strategy 100% Equity model produced substantially better results when compared to the S&P500 index.
Conclusion: Different asset classes and countries are likely to perform in their own way at different times. Proper diversification is essential and as we look at the history, there are asset classes that have done better than the S&P500 over long periods of time.
In this particular example, the “lost decade” was not “lost” for the DFA portfolio.
Critics may call this example a data mining, as it is too short of a period to draw a meaningful conclusion and they would be correct. Our goal in this exercise to examine the worst ten years only, since as of this writing we have been in a bull market for more than ten years now, “bad times” may not be that far ahead. The Fama and French research referred to in other articles is based on more than 90 years of data which allows for an evidence-based conclusion.
As we rereview a much longer period of 46 years, beginning in 1973 and ending in 2018, we should have better data sampling. The same DFA Balanced Strategy 100% Equity model produced substantially better results when compared to the S&P500 index.
- |
S&P 500 Index |
Dimensional Equity Balanced Strategy Index |
Annualized Return 1973 - 2018 |
10.1% |
12.9% |
Twenty-Year Annualized Return 1999 - 2018 |
5.6% |
8.8% |
Standard Deviation 1973 - 2018 |
15.1% |
15.2% |
Growth of $1 1973 - 2018 |
$89.5 |
$256.86 |
DFA Equity strategy produced better results compared to the S&P 500 or as many may call it “The Market”. It is also important to understand that the results were achieved over a long period of time. There were and will be periods of time when the S&P 500 or any other asset class will produce better results over a shorter period of time than a balanced diversified strategy.
Reacting and changing the strategy based on the headlines is likely to diminish potentially better results.
What are the odds the portfolio tilt or dimensions of higher expected returns will do better?
Below is the historical performance of Premiums over Rolling Periods.
US Markets
Value beat Growth
Overlapping Periods: July 1926 – December 2017
10-Year: 84% of the time
5-Year: 75% of the time
1-Year: 61% of the time
Small beat Large
10-Year: 72% of the time
5-Year: 64% of the time
1-Year: 57% of the time
High Profitability beat Low Profitability
Overlapping Periods: July 1963 – December 2017
10-Year: 100% of the time
5-Year: 89% of the time
1-Year: 67% of the time
Developed Markets
Value beat Growth
Overlapping Periods: January 1975 – December 2017
10-Year: 95% of the time
5-Year: 89% of the time
1-Year: 69% of the time
Small beat Large
Overlapping Periods: January 1970 – December 2017
10-Year: 87% of the time
5-Year: 82% of the time
1-Year: 65% of the time
High Profitability beat Low Profitability
Overlapping Periods: January 1990 – December 2017
10-Year: 100% of the time
5-Year: 87% of the time
1-Year: 79% of the time
Emerging Markets
Value beat Growth
Overlapping Periods: January 1989 – December 2017
10-Year: 86% of the time
5-Year: 84% of the time
1-Year: 50% of the time
Small beat Large
Overlapping Periods: January 1989 – December 2017
10-Year: 86% of the time
5-Year: 72% of the time
1-Year: 63% of the time
High Profitability beat Low Profitability
Overlapping Periods: July 1995 – December 2017
10-Year: 100% of the time
5-Year: 100% of the time
1-Year: 76% of the time
By constructing a portfolio to target dimensions of higher expected returns, we’re tilting the odds in your favor.
Please keep in mind, the 100% Equity Strategy discussed here is not appropriate for everyone. Each investor is unique, and each situation is different. Based on our experience, each portfolio should be designed individually, taking into consideration investor goals, time horizon, risk tolerance, risk capacity and many individual factors, constrains and preferences. This is one of the reasons we take time to draft an Investment Policy Statement for each client to lay a foundation and a framework for the portfolio management going forward. An Investment Policy Statement will address asset allocation, investment approach and discuss individual portfolio, including expectations and risks.
Reacting and changing the strategy based on the headlines is likely to diminish potentially better results.
What are the odds the portfolio tilt or dimensions of higher expected returns will do better?
Below is the historical performance of Premiums over Rolling Periods.
US Markets
Value beat Growth
Overlapping Periods: July 1926 – December 2017
10-Year: 84% of the time
5-Year: 75% of the time
1-Year: 61% of the time
Small beat Large
10-Year: 72% of the time
5-Year: 64% of the time
1-Year: 57% of the time
High Profitability beat Low Profitability
Overlapping Periods: July 1963 – December 2017
10-Year: 100% of the time
5-Year: 89% of the time
1-Year: 67% of the time
Developed Markets
Value beat Growth
Overlapping Periods: January 1975 – December 2017
10-Year: 95% of the time
5-Year: 89% of the time
1-Year: 69% of the time
Small beat Large
Overlapping Periods: January 1970 – December 2017
10-Year: 87% of the time
5-Year: 82% of the time
1-Year: 65% of the time
High Profitability beat Low Profitability
Overlapping Periods: January 1990 – December 2017
10-Year: 100% of the time
5-Year: 87% of the time
1-Year: 79% of the time
Emerging Markets
Value beat Growth
Overlapping Periods: January 1989 – December 2017
10-Year: 86% of the time
5-Year: 84% of the time
1-Year: 50% of the time
Small beat Large
Overlapping Periods: January 1989 – December 2017
10-Year: 86% of the time
5-Year: 72% of the time
1-Year: 63% of the time
High Profitability beat Low Profitability
Overlapping Periods: July 1995 – December 2017
10-Year: 100% of the time
5-Year: 100% of the time
1-Year: 76% of the time
By constructing a portfolio to target dimensions of higher expected returns, we’re tilting the odds in your favor.
Please keep in mind, the 100% Equity Strategy discussed here is not appropriate for everyone. Each investor is unique, and each situation is different. Based on our experience, each portfolio should be designed individually, taking into consideration investor goals, time horizon, risk tolerance, risk capacity and many individual factors, constrains and preferences. This is one of the reasons we take time to draft an Investment Policy Statement for each client to lay a foundation and a framework for the portfolio management going forward. An Investment Policy Statement will address asset allocation, investment approach and discuss individual portfolio, including expectations and risks.
For educational and illustrative purposes only. Indices are not available for direct investment and performance does not reflect expenses of an actual portfolio. Past performance is not a guarantee of future results. Source for Dimensional Equity Balanced Strategy Index: Dimensional Matrix Book. See “Dimensional Equity Balanced Strategy Index Description” slide in the Appendix for more information. S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Returns Source: Dimensional Matrix Book 2019
DFA Balanced 100% Equity Allocation:
Large Cap 20%, DFA US Large Cap Value Index 20%, Dimensional US Small Cap Index 10%, Dimensional Small Cap Value Index 10%, Dow Jones Select REIT Index 10%, Dimensional International Market wide Value Index 10%, Dimensional International Small Cap Index 5%, Dimensional International Small Cap Value Index 5%, Dimensional Emerging Markets Index 3%, Dimensional Emerging Markets Value Index 3.%, Dimensional Emerging Markets Small Cap Index 4%
Rebalanced monthly. For illustrative purposes only. The balanced strategies are not recommendations for an actual allocation. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. Real Estate Strategy weighting allocated evenly between US Small Cap and US Small Cap Value prior to January 1978 data inception. International Value represented by Fama/French International Value Index for 1975–1990. International Value weighting allocated evenly between International Small Cap and MSCI World ex USA Index (net dividends) prior to January 1975 data inception. International Small Cap Value weighting allocated to International Small Cap prior to July 1981 data inception. Emerging Markets represented by MSCI Emerging Markets Index (gross dividends) for 1988–1993. Emerging Markets weighting allocated evenly between International Small Cap and International Value prior to January 1988 data inception. Emerging Markets Value and Emerging Markets Small Cap weightings allocated evenly between International Small Cap and International Value prior to January 1989 data inception. Two-Year Global weighting allocated to One-Year prior to January 1985 data inception. Five-Year Government weighting allocated to Bloomberg Barclays Capital US Government Bond Index Intermediate prior to January 1976 data inception. Five-Year Global weighting allocated to Five-Year Government prior to January 1985 data inception.
All performance results of the balanced strategies are based on performance of indices with model/backtested asset allocations; the performance was achieved with the benefit of hindsight; it does not represent actual investment strategies. The model’s performance does not reflect advisory fees or other expenses associated with the management of an actual portfolio. There are limitations inherent in model allocations. In particular, model performance may not reflect the impact that economic and market factors may have had on the advisor’s decision making if the advisor were actually managing client money. Past performance is no guarantee of future results.
US Markets: 1. Profitability is a measure of current profitability, based on information from individual companies’ income statements, scaled by book.
Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Dimensional Index data compiled by Dimensional. Fama/French data provided by Fama/French. S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment. Past performance is not a guarantee of future results. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
Index descriptions available upon request.
Developed markets: 1. Profitability is a measure of current profitability, based on information from individual companies’ income statements, scaled by book.
Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Dimensional Index data compiled by Dimensional. Fama/French data provided by Fama/French. MSCI data copyright MSCI 2018, all rights reserved. Indices are not available for direct investment. Past performance is not a guarantee of future results. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Index descriptions available upon request.
Emerging markets: 1. Profitability is a measure of current profitability, based on information from individual companies’ income statements, scaled by book.
Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Dimensional Index data compiled by Dimensional. Fama/French data provided by Fama/French. MSCI data copyright MSCI 2018, all rights reserved. Indices are not available for direct investment. Past performance is not a guarantee of future results. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Index descriptions available upon request.
Returns Source: Dimensional Matrix Book 2019
DFA Balanced 100% Equity Allocation:
Large Cap 20%, DFA US Large Cap Value Index 20%, Dimensional US Small Cap Index 10%, Dimensional Small Cap Value Index 10%, Dow Jones Select REIT Index 10%, Dimensional International Market wide Value Index 10%, Dimensional International Small Cap Index 5%, Dimensional International Small Cap Value Index 5%, Dimensional Emerging Markets Index 3%, Dimensional Emerging Markets Value Index 3.%, Dimensional Emerging Markets Small Cap Index 4%
Rebalanced monthly. For illustrative purposes only. The balanced strategies are not recommendations for an actual allocation. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. Real Estate Strategy weighting allocated evenly between US Small Cap and US Small Cap Value prior to January 1978 data inception. International Value represented by Fama/French International Value Index for 1975–1990. International Value weighting allocated evenly between International Small Cap and MSCI World ex USA Index (net dividends) prior to January 1975 data inception. International Small Cap Value weighting allocated to International Small Cap prior to July 1981 data inception. Emerging Markets represented by MSCI Emerging Markets Index (gross dividends) for 1988–1993. Emerging Markets weighting allocated evenly between International Small Cap and International Value prior to January 1988 data inception. Emerging Markets Value and Emerging Markets Small Cap weightings allocated evenly between International Small Cap and International Value prior to January 1989 data inception. Two-Year Global weighting allocated to One-Year prior to January 1985 data inception. Five-Year Government weighting allocated to Bloomberg Barclays Capital US Government Bond Index Intermediate prior to January 1976 data inception. Five-Year Global weighting allocated to Five-Year Government prior to January 1985 data inception.
All performance results of the balanced strategies are based on performance of indices with model/backtested asset allocations; the performance was achieved with the benefit of hindsight; it does not represent actual investment strategies. The model’s performance does not reflect advisory fees or other expenses associated with the management of an actual portfolio. There are limitations inherent in model allocations. In particular, model performance may not reflect the impact that economic and market factors may have had on the advisor’s decision making if the advisor were actually managing client money. Past performance is no guarantee of future results.
US Markets: 1. Profitability is a measure of current profitability, based on information from individual companies’ income statements, scaled by book.
Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Dimensional Index data compiled by Dimensional. Fama/French data provided by Fama/French. S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment. Past performance is not a guarantee of future results. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
Index descriptions available upon request.
Developed markets: 1. Profitability is a measure of current profitability, based on information from individual companies’ income statements, scaled by book.
Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Dimensional Index data compiled by Dimensional. Fama/French data provided by Fama/French. MSCI data copyright MSCI 2018, all rights reserved. Indices are not available for direct investment. Past performance is not a guarantee of future results. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Index descriptions available upon request.
Emerging markets: 1. Profitability is a measure of current profitability, based on information from individual companies’ income statements, scaled by book.
Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. “One-Month Treasury Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Dimensional Index data compiled by Dimensional. Fama/French data provided by Fama/French. MSCI data copyright MSCI 2018, all rights reserved. Indices are not available for direct investment. Past performance is not a guarantee of future results. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Index descriptions available upon request.