It's Already Worse Than The Depression

It's Already Worse Than The Depression

By Robert Brokamp, Motley Fool Stock Advisor | 23 June 2009

Remember all that talk about whether we were entering another Great Depression? Much of it has subsided since the 30% rally in the S&P 500 and the sprouting of the economy's supposed "green shoots" (or, as skeptics call them, "yellow weeds," "Venus flytraps," or "poison ivy accidentally used as toilet paper"). But you'll still find doomsayers who think the worst is yet to come. (And I mean "doomsayers" in a good way— there should be a little part of all of us that expects the worst and plans accordingly.)

Whether or not our current 'less-bad' economy— when most economic metrics are still ugly, just not as ugly as they used to be— sort of like me in college— is really an indication of "green shoots" or more like the worm-like tongue of the alligator snapping turtle remains to be seen. But I can tell you this: By at least one metric, it's already worse than the Depression at this point in relative time: the Dow then was down only 12% at the apex of the post-1929 crash rally; we're now still down 32%.

It Didn't Have To Be That Bad

But wait. Some investors did see their portfolios grow over the past decade. How did they do it? By owning asset classes other than U.S. large-cap stocks. While those returns won't turn a pauper into Prince (or whatever his name is these days), they're still better than losing money. And investors who had these more-diversified portfolios ended up with almost twice as much money as someone in an S&P 500 index fund.

In my Rule Your Retirement service, I have created model portfolios that contain 10 to 12 asset classes. Let's take a look at how a few fared over the past 10 years using mutual funds (mostly of the index variety) to measure their performance, compared with an investment in the Vanguard 500 (FUND: VFINX), our proxy for U.S. large-cap stocks.

Portfolio	Investment(s)	Total 10-Year Return	$100,000 Turned Into …
100% U.S. large-cap stocks	One fund	(22.8%)	$77,160
100% stocks, of all sizes and countries	10 funds	31.4%	$131,414
70% stocks, 30% bonds	11 funds	47.3%	$147,325

Source: Morningstar Principia software, May 1, 1999, to April 30, 2009. Portfolios are rebalanced annually.

What makes these portfolios different? They're built with funds that invest all over the world, in stocks of all types and sizes. They still have the big-name American companies— such as Microsoft (Nasdaq: MSFT) and IBM (NYSE: IBM)— but also small stocks, such as Seagate Technology (Nasdaq: STX) and ImmunoGen (Nasdaq: IMGN). And they're not limited to America, either, including funds that invest in stocks like Nokia (NYSE: NOK) and China Mobile (NYSE: CHL).

And then there's boring old bonds, which made up 30% of the third portfolio. You should own them— especially if you're within a decade of retirement, or just can't stand the volatility (or, perhaps most important) uncertainty of an all-stock portfolio. [[Not to mention that bonds have outperformed stocks over the past 5, 10, 15, 20 and 25 years!: normxxx]] Of the portfolios above, the one with bonds did best.

Hope For The Future

Just as in the 2000s, holding bonds beat an all-stock portfolio in the 1930s. However, it wasn't until the 1970s that bonds once again reduced risk and boosted return over decade-long time frames. In each case, one bad decade for stocks was followed by a multidecade run of good returns. Put another way, since 1926, U.S. large-cap stocks have never posted two consecutive decades of losses. That gives us some hope for the coming decade.

Of course, there's a first time for everything. In 2005, Ben Bernanke, then an advisor to President Bush, said on CNBC, "We've never had a decline in housing prices on a nationwide basis. What I think is more likely is that house prices will slow, maybe stabilize … I don't think it's going to drive the economy too far from its full-employment path, though". Well, we've since had our nationwide decline in housing prices. (That gnawing sound you hear is Mr. Bernanke eating his words.) Given that history is a useful yet imperfect guide, it's likely— though not guaranteed— that stocks will post decent[!?!] returns over the next decade.

So for those near or in retirement, or for conservative investors of any age, using bonds to balance the risk of stocks makes sense. And every investor should hold stocks of all shapes, styles, sizes, and nationality. It would be grand to know which type of investment will do best over the next decade. But until you've fixed your crystal ball or perfected time travel, a smartly created, well-diversified portfolio should be the foundation of your retirement savings.

See also Paul Merriman's "The Ultimate Buy-and-Hold Strategy" for actual alternative portfolios.