The first decade of the 21st century has been called a “Lost Decade” for investors because during that time the U.S. stock market went through two bear markets before ending up flat for the ten-year period. This month marks the anniversary of a robust rebound, a regression to the mean, or a “Found Decade.” In early March 2009 the financial crisis hit its bottom, at least as far as the stock market was concerned. From that time until March 7, 2019, the total return of the S&P 500 has been 408%.
These two contrasting periods have me thinking about a question that faces investors when they look to invest in a fund or index: How do I select the right fund? The obvious answer might be to look at its past performance, but that can be deceiving. In the scenario I just mentioned, in March of 2009 the Vanguard Total Stock Market Index Fund had returned an abysmal -32% over the ten years prior. This assumed you had invested into the heights of dot-com mania and held into the troughs of bad mortgage debt. The trailing returns were terrible, but did that make it a bad investment? By contrast, over the same time period, the Vanguard Total Bond Market Index grew over 70%. Did that make it a better investment in March of 2009?
No. Because that is making forward decision with a focus on the rear-view mirror. What we can learn from this chart is that during a period where stocks left much to be desired, bonds did their job. They preserved principal and paid income steadily. An investor in 2009 had a choice to make, though. Do the last ten years tell me anything decisive about the years to come? Here is the chart of the next ten years for stocks and bonds:
Bond performance has been positive, and reasonable, but stocks have been on a meteoric run for ten years. So many people lost faith at the lows, sold their stocks, and missed out on the years to come. This tells us some very important things about making decisions on past performance:
- Past performance, while interesting to look at, is as out of our control as the future.
- The past can’t tell us how an investment will perform in the future, but it can tell us what is possible. Stocks can be volatile. Bonds can underperform in a bull market. Behave accordingly.
- Market cycles can last a long, long time. Patience can be tested, but that is why investing is a “get rich slowly” exercise.
I bring all of this to the foreground because rest assured, there will be mutual funds and investment managers touting their performance over the last ten years hoping that we investors will make decisions based on this advantageous snapshot. Instead of focusing on trailing returns, you should instead weigh these aspects of an investment:
- Comparison to similar assets
- Risk levels
None of them will predict your returns, but these three features are in an investment manager’s control. Not so with the performance of the markets. Be wary of looking backwards, you may miss the opportunity to come.