We recently heard from a person who has some complaints about the last decade’s performance of his 401(k).  He said he’d been putting money in since the beginning of 2000, regularly, and after all this time, the portfolio in his 401(k) is worth a little bit less than the sum of all the money he’d been putting in.  And he was wondering why that was, if the 401(k) was a good vehicle for his retirement savings, and especially, if it made sense to keep money in markets like this when they’ve just not done what they were “supposed” to do.

So we probed for a little more information.  First of all, was there an employer match?  If there were, then even if the money sat in cash and did nothing else, the employer match was “free money” – it’s awfully hard to turn that down.  Unfortunately in this person’s case, no, there wasn’t an employer match.

Were the expenses on the 401(k) particularly high?  Or were the funds really poor funds with high expenses?  No and no.

How was the money invested?  For most of the period, it was a portfolio consisting of both stock funds and bond funds.  Aha – we’re getting somewhere.  What did he mean by “most of the period” and what happened?  He said that just before the crash, he’d realized that his bond funds were not performing well, so he moved money out of bonds and into international stocks – just in time for the crash to take place.  And that is probably why he had a “lost” decade.  Because the numbers are solid – if you’d been investing regularly – a fixed amount every month – into almost any very simple portfolio without trying to time the markets (by making judgement calls like that “bonds had not performed well”), you’d not have had a lost decade.  In fact, you could have made a very nice return.  The following are some results based on putting a fixed amount of money in on a monthly basis and the portfolios are composed of perhaps the simplest possible stock/bond portfolios – Vanguard’s S&P500 index fund for stocks and Vanguard’s Total Bond Index fund for bonds.

If you start by choosing a fixed asset allocation (say, 100% stocks, 100% bonds, 60% stocks/40% bonds, 40% stocks/60% bonds), and you deposit $500 into your account on the first business day of each month, split between the two funds as indicated, and rebalance the portfolio each month to maintain that asset allocation, the results are quite impressive.  Starting on the first business day of January 2000, and running all the way through the month of October 2011, there are 142 months.  You’d have deposited, a little bit at a time, a total of $71,000 into your account.  Here’s what you’d end up with using the four different sample asset allocations:

• 100% bonds: $71,000 ==> $100,844
• 100% stocks: $71,000 ==> $85,056
• 60% stocks / 40% bonds: $71,000 ==> $92,642
• 40% stocks / 60% bonds: $71,000 ==> $95,864

That’s hardly a lost decade.

Note that these results are quite different from the result of a one-time investment at the beginning of Jan 2000 which simply compounds along the way.  This exercise was about systematic investing over the course of nearly 12 years, which is a lot more like what folks actually do during the accumulation phase of their retirement savings – they put away a little bit from each paycheck into their 401(k).

If you’d simply plunked down some cash into one of the four portfolios on Jan 1, 2000, you’d have experienced these annualized returns over the nearly 12 years:

• 100% bonds: 6.2%
• 100% stocks: 0.29%
• 60% stocks / 40% bonds: 3%
• 40% stocks / 60% bonds: 4.2%

That’s probably where the idea that this has been a “lost decade” for stocks came from.  But that’s not a great reflection on the reality of how actual people invest.