Use ETFs Until 10-Year Returns Return

Once upon a time, Morningstar and all the other fund services prominently reported something called a “10-Year Return,” shown either as a large compounded total return or as an annualized number. Among other stats, extended performance is useful to evaluate and compare the record of fund managers for investment selection.

Investors were duly instructed at every 401k enrollment or IRA rollover, in nearly every financial article, on TV programs or by pop-finance books to “Buy & Hold” and “Invest for the Long Term!” For the simple 401k participant, Ten Year Return was – if no guarantee of future performance – at least a reminder of how far you'd worked towards your retirement savings. Despite the Market's normal ups &downs, “10-Year Return” illustrated the steady long term gain earned by diligent “retirement savers” - that's what the 401k was all about, after all. Long term performance was marketed as validation that “Buy & Hold” works and that was the tacit emphasis of fund company & plan provider reps.

Until recently.

Lately, the “10-Year Return” has disappeared from the front pages of many reports, frustrating those who wish to see the big picture at a glance. Coincident with the Great Bear Market (10/9/07-3/9/09), wretched stats, like “12-month Return” or that pesky Bear Market number are now buried with esoteric beta metrics, intentionally omitted from those pages investors see first and foremost.

You almost get the sense that sites like Morningstar & Yahoo Finance are trying to scrub these numbers from the record. And why does everyone need to see useless stats like 2006's annual return for the next two years, how is that even relevant now? (Better yet, why don't you call Morningstar and ask them.) It's a simple game: out of sight, out of mind. The long-term performance is catastrophic but only gets worse under scrutiny and later on. This is the truth that shills don't want you to see or understand: “Buy & Hold” crushed retail investors.

Consider the Ten Year Return (6/30/99-6/30/09) of the S&P500 and one of the best known retail S&P500 index mutual funds, Vanguard 500 Index Investor (VFINX), you'll see for yourself exactly why. Calculating the return (6/30/99-6/30/09) with dividends reinvested, the 10 Year Total Return for the S&P500 lost -17.8% (CAGR, -1.9%) and the VFINX likewise dropped -20.8% (10 Yr Ann. -2.30%.) However, on an inflation-adjusted basis the returns fall much farther: the S&P500 lost -36.2% (10 Yr Ann. -4.39%) of its value, while VFINX lost -37.8%. (10 Yr Ann. -4.64%)

To put this in real perspective but looking forward, the Vanguard fund investor now requires a +60.8% total return (inflation-adjusted) just to break even & get back to where s/he started in 1999. That's a 5Yr Ann. Return > +9.9% or a 10Yr Ann. Return of > +4.8% (again, inflation-adjusted.) Even if miraculously achieving this zero-sum return, don't forget the VFINX investor still lost fifteen to twenty years' investing opportunity, forever. Now do you understand why the 10-Year Returns get hidden several clicks away, scroll down, fine print?

How many “Buy & Hold” investors thought they'd need almost twenty years just to break even after dropping back to their asset level of Clinton Years as they approach retirement decades into the next century?

Of course, years of contributions will mask catastrophic loss to some degree. Nevertheless, older 'retirement savers' catch-up remains enormous and won't be met without 5-10 years of extraordinary market gains and/or doubling contributions. With the past 100 years as a precedent, it bears mention that significant Bull Markets (> +20% 5 Yr Ann. Return) often follow exceptional Bear Declines. But it's also true that Five Year Returns in high inflation periods tend to be markedly negative ( ~ -2.75%, on average) and witness flat Ten Year Returns as well. If we're likely to enter a grave period of inflation within the next five years, the secular Bear Market may continue for some years yet -

What should long term investors do?

Now is not the time for retirement savers to panic-flee into cash nor to gamble greater risk-return with the same failed managers. Instead, this is the Wake-Up call to abandon “Buy & Fold” managers, embrace defensive asset classes and opportunistically pursue trend investing. If your 'set-it-forget-it' portfolio dropped > -40% in the Great Bear Market (10/9/07-3/9/09), now really is the time for change. The Mutual Fund industry's propaganda is dead & discredited - that's why they're not discussing 10-Year Returns. Take that as your cue and look for new investment models elsewhere: The challenges of the next ten years demand it!

If you wish to remain invested in the years ahead, then ETFs, not mutual funds, will provide convenient hedges for both downside protection & upside gain. With a strategic mix of leveraged & sector funds, commodities and currencies, it's certainly possible to outperform 98% of the “diversified” mutual fund managers: since 10/9/07, my Frugal Yankee Model is up +55%.

Always remember Warren Buffett's Rule #1: The secret to making money is not losing money...

Mark your calendar: on January 1, 2010, look for the Ten Year Returns of the largest S&P500 funds on MStar. With Annualized Returns around -2.5%, these funds will actually have suffered an annualized loss greater than -5%, adjusting for inflation. Let the real Ten Year Total Return of > -40% be the final coffin nail in “Buy & Fold” index investing, please. How much more do 401k plan participants need to suffer?

Disclosure: No positions

Comments

[manthrax3:]

What about Mabelle at the widget factory? Should she be out to create a perfectly hedged portfolio that realizes excess returns in the long and short term? Buy and hold is probably fine for most people as long as they maintain proper asset allocation. That is, as long as they move their returns from equities into bonds to maintain the right allocation over the long term.

Jul 05 06:22 PM

[igggy:]

What the author seems to suggest is that everyone should start running a personal hedge fund with their retirement savings. Considering how many hedge funds (run by full time professionals) fail, that seems like a pretty bad idea. Sorry. Have you tried following your own advice?

Jul 06 12:04 AM

[Crocodilian:]

Author is making the error of picking one point -- a market high in 1999 -- as the entry, and another point -- a market low in 2009-- as the exit.

But that's not what long term investors do: they typically invest small increments over time. An index fund investor who invested throughout the 1990s and 2000s is doing as well or better than any other investor.

Jul 06 04:45 AM

[AndrewBaker:]

The truth is you can't buy and hold with no review because very few investments will give you an ongoing positive return through all phases of the economic cycle. Even cash on deposit loses to inflation over time. So, either be your own investment adviser and check on your holdings regularly or employ a professional who will do it for you.

The best fund manager can't always be ahead, whilst strategic switching can help you to achieve that, or at worst, help you lose less than as much as you would doing nothing.

No-one expects life to be the same always, so why expect it of your investments?

Jul 06 09:40 AM

[Analyste de...:]

I'm addressing Ten Year Returns, because that is, or WAS, the industry standard reporting "long term returns." Are you trying to obfuscate that fact?

If - for whatever contrived reason - you choose to look at 9-, 8-, or 7-year returns, etc., you'll see the US Equity investor STILL gets negative double-digit returns on an inflation-adjusted basis. Does prove "stocks work for the long term" is reality or history? (Reality is what you get, not the hypothetical you were promised.)

Look a VFINX (fund inception date 8-31-76) in Google, MStar, YahooFinance, MSNMoney ... who is reporting 15- or 20-Year Returns?

The 10-Year Return is also absent on most of those sites. Not enough room to tell the truth, eh?

"An index fund investor who invested throughout the 1990s and 2000s is doing as well or better than any other investor" is a non sequitur. (Pointless, nonsensical remark.) But it would be interesting to see how badly 15- or 20-Year portfolios fared, given all the anecdotal evidence of Age 65+ investors with their nesteggs cut in half. Maybe you can show us aggregate investor returns to prove your point?

Average the returns of several well-established retirement target-date products. One example: clicking into the Fido site, the Ten Year Annual Return for the Fidelity Freedom 2000 (FFFBX) is 2.86% (7/2/09), or 1.40% after taxes on distributions (1.67% after taxes on distributions & sale.) The annualized INFLATION rate for the past ten years has been about 2.5%.

How would you calculate this inflation-adjusted negative real return of FFFBX was a "good long term investment" for someone nearing (or in) retirement?

On Jul 06 04:45 AM Crocodilian wrote:

>
> Author is making the error of picking one point -- a market high
> in 1999 -- as the entry, and another point -- a market low in 2009--
> as the exit.
>
>An index fund investor who invested throughout
> the 1990s and 2000s is doing as well or better than any other investor.

Jul 06 04:38 PM

[Crocodilian:]

@ author
"I'm addressing Ten Year Returns, because that is, or WAS, the industry standard reporting "long term returns." Are you trying to obfuscate that fact?
----------------------...

No, I'm pointing out that you're erroneously concluding that the 10 year return number in some way indicts index strategies, when in fact it doesn't.

1) The 10 year number is valuable for comparing different funds to one another. Very few managed funds have outpeformed the indexes in the 10 year or any other periods.

2) The problem with using the 10 year number as you are doing should be obvious from considering the following:
- at the end of 1999, the SPX stood at just under 1500
- 2 years later, the SPX stood at 850, more than a %40 decline

What that means is that we _know_ that if the market remains flat for the next two years, the 10 year return will improve dramatically, even if an investor makes zero dollars, that's just the "rolling window" of the ten year horizon.

So that's why you can't use that figure as you're doing. Its useful as a metric for comparing between funds, but understanding the returns an investor can expect is a very different calculation.

Typical index investment strategies are nearly always averaging strategies, so an investor with an index portfolio today will have bought some SPX in 1999 at 1500, and some in 2001 at 850: your entire piece is based on a scenario where the investor puts all his money in at a market high, and then cashes out ten years later at a market low. That _would_ produce a lousy return, but its highly atypical.

Jul 06 07:12 PM

[Old Trader:]

Another part of the problem is that it seems that most 401ks don't allow for much of a selection of funds, further hobbling the average investor.

Jul 06 08:57 PM

[Analyste de...:]

I wouldn't say my blog entry is an "indictment of indexing strategies" per se (there you go again, another Straw Man Argument!), rather it reveals that LONG TERM BUY & HOLD FAILED for the past Ten Year Period.

Contrary to your suggestion "if the market remains flat for the next two years, the 10 year return will improve dramatically" in fact the annualized Ten Year Return will continue to deteriorate dramatically (SPY estimated 2011: -3.5% 10Yr/annualized TR) because Buy & Hold failed. The enormous loss of the Great Bear compounds - your misunderstanding that a +50% gain can negate a -50% loss to 'break-even' is the erroneous thinking here. Its NOT simply a rolling window. tinyurl.com/lvhwdf

You haven't produced any 15- or 20-Year Returns to show that 'Buy & Hold' working as touted. In fact, two or three flat years matched with likely inflation would lock in these catastrophic losses : I estimated inflation-adjusted performance for a few of the oldest lifecycle/lifestrategy products (Target 2010) with DJ US 2010 data adjusted for expenses. No need to explain how popular these fund-of-fund investments are - despite The Bear their assets keep growing. But this is the return a real investor gets with mutual fund products:

Inflation-adjusted, current 15 Year Returns (mid 1994-mid 2009) range between 3.2% ~ 1.7%, but will drop to 0% - 1% in a weak market (1997-2011). The 20 Year Returns (1990-2009) likewise range between 2.8 ~ 4.1%, but would drop to 1% ~ 2% if the market's flat and mildly inflationary for the next 4 years (1993-2012). Stick a fork in it, done!

Whatever's left will be subject to taxes and any additional fees or penalties... ouch! Yes, these are the withered fruits of "Buy-&-Hold" investing, a far cry from the 7~8% percent once touted (promised?) by those shills, eh?

On Jul 06 07:12 PM Crocodilian wrote:
>
> No, I'm pointing out that you're erroneously concluding that the
> 10 year return number in some way indicts index strategies, when in fact it doesn't blah blah blah
>

Jul 08 04:04 PM