The financial crisis (circa 2008-2009) brought out discussions about “lost decades” in the investment markets, 10-year periods that suffered negative equity returns. It even prodded PIMCO to argue that the investment universe had fundamentally changed, that an “old normal” had been overtaken by a “new normal” characterized by persistently slow economic growth, high unemployment, significant geopolitical tension with social inequality and strife, high government debt and, of course, lower expected returns in the equity markets.
A Journal of Financial Perspectives paper from last summer considers how unusual it really is for equity markets actually to “lose a decade.” As it turns out, lost decades of this sort are not the exceptional episodes that only very rarely interrupt normal steady economic growth and progress that so many seem to think.
In the paper, Brandeis economist Blake LeBaron finds that the likelihood of a lost decade — as assessed by the historical data for U.S. markets via a diversified portfolio — is actually around 7 percent (in other words, about 1 in 14). Adjusting for inflation (using real rather than nominal return data) makes the probability significantly higher (more like 12 percent, nearly 1 in 8). The chart below (from the paper) shows the calculated return (nominal in yellow, real in dashed) for ten-year periods over the past 200+ years, and shows six periods in which the real return dips into negative numbers.
Source: Blake LeBaron
So a “lost decade” actually happens fairly frequently. As LeBaron summarizes:
The simple message here is that stock markets are volatile. Even in the long-run volatility is still important. These results emphasize that 10-year periods where an equity portfolio loses value in either real or nominal terms should be an event on which investors put some weight when making their investment decisions.
The key practical take-away is that those within 5-10 years of retirement (in either direction) who are taking or planning to take retirement income from an investment portfolio should consider hedging their portfolios so as to avoid sequence risk. Losses close to retirement have a dramatically disproportionate impact on retirement income portfolios. As so often happens, the risks are greater than we tend to appreciate.
Above the Market 
“Losses close to retirement have a dramatically disproportionate impact on retirement income portfolios. As so often happens, the risks are greater than we tend to appreciate.” This is pretty much the conventional wisdom. But I believe it to be wrong. The much bigger risk for an investor is to be too conservative with their investments as they approach retirement because of this fear of a huge downturn just as somebody needs to start withdrawing money for their retirement. The conventional wisdom seems to be that you are totally screwed if there is a big market downturn right as you are hitting retirement age. However, just as people invest for a period of 30-40 years, most people need to be prepared for their investments to last 30 years. If you had to take out all of your money in February 2009, then yes, you were screwed by the stock market. But people take out their money over a period of decades, just as they put in their money over a period of decades. So the much bigger risk is being overly conservative with your investments because you fear a big market downturn. People approaching retirement should keep a much larger percentage of their money in stocks than is the conventional wisdom. If you have money in dividend aristocrats, those large companies that have been paying dividends reliably over decades and increasing their dividends steadily over time, your risk is much less than having the overwhelming majority of your investments in cash and bonds, where inflation will eat away at your portfolio year after year. During the average person’s retirement, inflation will ravage the value of your cash. It may seem counter-intuitive, but over a 25 year retirement, the dollar you have in the stock of a company like Johnson and Johnson will almost surely be a better bet than a dollar in cash or in bonds.
The math tells a different story. For example: http://wpfau.blogspot.com/2013/09/you-cant-control-when-youre-born.html
Totally agree, it is too bad that so few realize the power of quality companies with histories of growing dividends. Oh well, let them learn the hard way. Bob, maybe you should read Lowell Miller’s work on the subject, though I do not agree with his passion for high yield dividend stocks.
The issue with sequence risk is not the level of returns, it’s when you get them. When taking income from an investment portfolio, the exact same returns in a different order can result in wildly different outcomes. See here: http://www.raymondeverding.com/files/13323/mfgefl-066_sequenca.pdf For example, based upon a 55% stocks/45% bonds portfolio and 4% annual withdrawals, rising with inflation, a T. Rowe Price study using Monte Carlo simulations concluded that with negative annualized returns for the first five years of retirement, there is a whopping 57% chance of the portfolio blowing up entirely within 30 years. More here: http://mydigimag.rrd.com/publication/index.php?i=38577&m=&l=&p=52&pre=&ver=flex
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Bob, That American Funds piece is showing withdrawals of 5% increasing with inflation of 4%, which I would consider a bit aggressive on both inflation and withdrawal rate. The key that American funds misses is dividends, realistically dividends in an index fund (let’s say S&P) is around 2%, this being the case an investor does not need to realize a great annual return. Taking it further, from a dividend growth invetor way of looking things, one can own a portfilio of high quality dividend stocks with yields of 2.5-4% with RISING dividends that beat inflation and the potential to achieve returns of 5-7% just on stock price alone. I mean this is not rocket science, every year the investor should adjust to his life style the appropriate allocation whether it be through Mutual funds (Low expense, unlike American Funds) or a diverse portfolio of high quality dividend growth stocks.
Regards,
Joe
Such a dividend approach raises the risk level of the portfolio (more stocks) and lowers the diversification benefits to the portfolio (by avoiding non-dividend stocks). Moreover, I don’t see a practical difference between a price gain and a dividend — I can spend either. Larry Swedroe: http://www.cbsnews.com/news/why-a-high-dividend-stock-strategy-isnt-a-good-approach/
Bob, I respect Larry’s work, but he is talking about a HIGH dividend stock strategy…while I am talking about HIGH quality stocks that raise their dividends year over year at levels that are better than inflation. These companies are paying between 2.5 and 4% while growing their earnings, revenues, and have strong balance sheets. Again, I recommend you read another great investor Lowell Miller and his piece on dividend growth investing. After you read let me know what you think.
Regards,
Joe
I don’t know what to make of Miller. His book says that bonds are a bad investment. Using that strategy (100% stocks) in retirement is *far* more risk than I’d be willing to take. I also like equity diversification much more than he does. Even so, some of the mutual funds he manages (or sub-advises) use bonds, and *all* of the mutual funds he manages (or sub-advises) underperform the S&P Dividend Aristocrats Index (the index that’s closest to the strategy we’re talking about), usually by a lot. Finally, I don’t see an intrinsic benefit to dividends over price gains. The approach we’re talking about assumes that spending dividends from such a portfolio is “safe” somehow. That’s a conclusion I have seen no support for.
Miller advised and sub-advised funds: FLRUX, TPYAX, DHDAX, PAGAX, PMPAX, PWMAX, and PGPAX.
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Bob, His funds just like many other fund families can not compete with a passice stategy, though I believe that he lends his advice to the families, but the jist of his book is the increasing dividends among a select portfolio. As for qualified dividend distrubutions over price appreciation, that discussion may be for another time…and wait to the Bond bubble bursts….
Regards and enjoying the discussion.
Joe
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Hello Bob, Joe,
A member of my staff happened to come across your posts, and I thought I’d correct a few comments, if you don’t mind.
First, my firm subadvises TPYAX, DHDAX, and FLRUX. The first two are versions of our “Income-Equity Strategy”—TPYAX has no MLPs, and DHDAX has MLPs. FLRUX is a specialty fund, focusing on utilities and infrastructure, which is a little redundant since utilities are considered part of the infrastructure category by most observers. All of those funds beginning with “P” are the Pax World multi-manager allocation funds (conservative, moderate, etc) which have become fund of funds (for example, they use TPYAX now instead of our managed subadvisory, as the funds didn’t attract enough assets to warrant the multi-manager enterprise). Those Pax funds may have bonds in them, but I assure you that there are no bonds in our funds or sleeves. Your scan was too quick—you didn’t look at what the tickers represent.
Further, in fact our TPYAX has outperformed PFM over the past five years (we replaced another manager on TPYAX in May/June of 2009) despite having a higher expense ratio. Our managed accounts—we are primarily an SMA firm—have done even better, as they don’t have to deal with the fund fees or, most importantly, the performance-ravaging constant inflows and outflows of a fund. The fund has Morningstar’s best rank for low volatility (about 20-30% less than the broad market, depending on time measured), carries four stars under their dubious ranking system, was rated #1 Large Value fund by them and Lipper in 2011, and ranks in the top 2% of Large value Funds year to date (PFM is not even close). Overall returns have been similar to the S&P but with substantially less volatility, a record I think is quite adequate considering the fact that we had two “upside down” markets in which low quality stocks significantly outperformed during the five years—2009 and 2013.
I note a number of biases in your responses which are not necessarily based on fact (the facts are that stocks in the 7-9 deciles of yield, where decile 10 is highest, have outperformed all other categories over the long term, both absolute and risk-adjusted. You don’t have to take my word for it, See Ned Davis data or the Fama-French data on Prof French’s website). You might be interested to know that FLRUX has outperformed the S&P 500 since inception in 1994, both absolute and risk-adjusted, by a large margin, despite painfully high fees. Most people don’t think you can make money in utilities and associated stocks, which certainly provides a fertile playing field for us.
Finally, about bonds. I’m sure you’ll agree that the past five years represent an excellent time for bond investors. Both TPYAX and PFM have more than doubled the total return from TLT (20-year) during the period, a period in which, as noted above, there were at least two quite challenging years for dividend-focused investors. Too, over the past five years the income yield, the yield on original investment (our key metric) has risen from about 5% to about 10% on Income-Equity separate accounts (based on a representative account that had no additions or withdrawals). Having spent some time sitting, our investors now have a 10% tax-favored yield on cost which is unlikely to diminish and quite likely to rise in the future. Where today would you find a 10% yield on an investment grade portfolio? Parenthetically (I am always going parenthetic!) the total income from our portfolio was about 50% greater than that of a long-term bond portfolio over the period. All figures include re-investment of income as earned.
For an investor with a spending need, it seems to me that a strategy providing high current income and rising future income is probably a pretty good idea. True, you won’t find any Amazons here, or Teslas, and they are fun to talk about, but the long-term statistics don’t favor these, as a group. If they did, I’m, sure we’d be interested in greater diversification.
Is spending dividends “safe?” Stock prices will always fluctuate, and the principal values of a dividend portfolio will, too. But dividends are, by definition, positive. They can even be greater or lesser, but they are still positive. I understand you prefer a “money is money” philosophy, but if you have a spending need, aren’t you better off in the short and long terms when spending from the positive portion of your return, insulating yourself from possibly having to spend from selling an asset that has declined in price?
Sorry to be so long-winded. I don’t often mix in debate, as it typically boils down to my biases versus your biases. But I do feel the facts are supportive to mine, here. There are quite a few articles by us and by others posted on our website (www.mhinvest.com) that you might find of interest.
Best…
…Lowell