Thursday, December 30, 2010

Was This Really The Lost Decade For Stock Investing?

One of the fun things about this time of year is reading all of the "year in review" articles.  It is always interesting to step back and take stock (no pun intended) of the events of the past year.  USA Today went one step further with a look back at the stock market over the past decade.

[Interestingly, the author defines the decade as starting in 2001 and ending tomorrow which should please the calendar geeks out there].

According to the article, the period from the beginning of 2001 until today was a terrible one for the stock market.  The S&P 500 stock index, which is the composite price of 500 large U.S. companies, was down almost 5% over this time.  The article notes that this is only slightly better than the stock market returns from 1930 to 1939 when the economy was battered by the Great Depression.  It isn't much consolation to know the most current decade is only slightly better than the worst economic period in U.S. history.  The article goes on to paint a bleak picture of common people whose retirements were put in jeopardy from their stock market investment folly.  One interviewee states that his "faith in capital markets was definitely changed this past decade".  Another says that she "wouldn't go out of my way to invest in the stock market."  Pretty dismal stuff, huh?

But was it as bad as people think it was?  Is the perception that this was a "lost decade" for the stock market really true? 

This figure that the S&P 500 lost 5% over the past 10 years seems pretty damning.  However, it doesn't tell the whole story.  If you woke up on January 2, 2001 (the first business day of the decade), invested $10,000 in the stock market, went back to sleep, and woke up again on December 30, 2010 to check your account balance, you indeed would find that you had lost 5%.  However, this is not how most people invest their money.  Most people invest by making constant periodic investments over time.  We have a set amount invested in our 401(k) accounts every paycheck.  We put money into our IRA's once a year.  The financial experts call this dollar cost averaging.  By making steady periodic investments, most people end up not only buying when the market is high like at the beginning of 2001, but also when the market is low like at the beginning of 2009.

What type of investment result did somebody have who invested a steady $10,000 in the S&P 500 at the beginning of every year since 2001?  Let's check out the numbers:

YearAmount InvestedValue on 12/30/2010% Gain
2010$10,000.00 $11,265.67 12.66%
2009$10,000.00 $13,930.17 39.30%
2008$10,000.00 $8,568.84 -14.31%
2007$10,000.00 $8,870.62 -11.29%
2006$10,000.00 $10,076.83 0.77%
2005$10,000.00 $10,379.23 3.79%
2004$10,000.00 $11,312.68 13.13%
2003$10,000.00 $14,297.02 42.97%
2002$10,000.00 $10,956.38 9.56%
2001$10,000.00 $9,527.37 -4.73%
Total:$100,000.00 $109,184.80 9.18%

The $10,000 that you invested at the beginning of 2001 lost almost 5%.  However, the money that you invested at the beginning of 2003 would have netted you a return of almost 43%!  Yes, there are a number of down years like 2007 and 2008.  However, there are number of good years like 2009 and 2010.  If you stayed the course and continued with making your $10,000 investment every year, you would have ended up with a gain of 9%!  Yes, it probably wasn't the best decade, but at least you would have come out ahead.  This wasn't the lost decade for stock investing that some people are making it out to be.  The secret is to have made consistent periodic investments throughout the entire decade.

Of course, that is easier said than done.  Like the people quoted in the article, there were probably millions like them who pulled out of the stock market during the depths of the financial crisis only to have missed out on the gains that followed.  Nobody can predict what the stock market will do.  However, if history is any guide, the stock market has ups and downs, peaks and valleys.  If you continue to make periodic investments through dollar cost averaging, you can take advantage of these valleys by buying when the stock market is on sale.

And who doesn't love a sale?

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