Did The 2008 Bear Market Put An End To Diversified Portfolios?
The bear market of 2008 has raised some serious questions: Do stocks really outperform bonds in the long-term? Is asset allocation dead?
The Standard & Poor’s 500 Index fell 37 percent in 2008, and other groups of stocks, especially foreign stocks, fell even more.
The 2008 bear market came just five years after the end of another bear market early in the decade. The two events pushed stock market returns well below average. The S&P 500 Stocks index, for instance, lost an average of 0.2 percent per year over the past 10 years.
Meanwhile, long-term government bonds gained 8.0 percent per year in the same period, well over their historic average of 5.5 percent per year going back to 1926.
Bonds even beat stocks over the last 20 years, gaining 8.8 percent per year, while stocks gained 8.0 percent per year.
Diversification dead?
Meanwhile, some investment experts say asset allocation is dead, because it didn’t protect diversified portfolio owners from loss in 2008, when nearly every asset class except for cash and short-term Treasury securities fell in value.
Does this mean the long-accepted wisdom that you should have a portfolio diversified among different asset classes— including bonds, stocks, and cash—no longer works?
Don’t give up yet, because even last year a well diversified portfolio went down less than the stock market did. Yes, it declined, but this was no surprise: asset allocation advocates have always said that it is possible for pretty much everything to move in lockstep for a short time during a panic or a mania.
However, the diversified portfolio did offer some protection. Consider a balanced portfolio of 60 percent stocks, spread among large and small stocks both foreign and domestic, and 40 percent among various short term bonds. It lost only 24 percent in 2008 compared to the market’s 37 percent loss, according to Dimensional Fund Advisors, an institutional mutual fund company.
Long term results
In the longer term, however, the diversified portfolio did well. The sample DFA portfolio has returned 6.5 percent annually in the ten years through September, compared to a loss of 0.2 percent on the S&P 500.
That return beat the returns of cash and medium-term government bonds, and was over twice the rate of consumer inflation. Long-term government bonds still beat the diversified portfolio by about 1 percentage point per year.
Yield is all you get
Those who tout the higher long-term returns of bonds over the last 20 years may not see those returns repeat over the next 20.
The old saying in the bond market is that you “earn your yield,” in other words, the yield on a new bond is about all you can expect to earn during its lifetime. Twenty years ago yields were much higher. Since then, interest rates have fallen, creating capital gains for older bonds and contributing to their good returns.
Today the yield on a 30-year Treasury bond is a little over 4 percent, not 8 percent as it was 20 years ago.
Since no one can predict the next year or 10 years, it still seems wise to maintain a mix of stocks and bonds so that you can benefit from either asset when they rise.