"Lessons from the Lost Decade in Stocks" and My Take On It

Morningstar has recently published an interesting article titled "Lessons from the Lost Decade in Stocks," which I'd like to provide my opinion on. The article points out that during the past 10 years overall stock market gains have been negligible, if not negative, after you account for the transaction costs and tax expenses. It then goes on to list several lessons that we can learn from this period. Below I will address each lesson (please see the article to read Morningstar's lessons in full).

• Lesson One: The long haul may be longer than you think. I would certainly agree with this statement since after this "lost" decade we can clearly see that long-term outlook may be longer than you'd expect depending on the market conditions when you started investing. For example, if you have started investing in the market at the peak of the dot-com boom in 1999, you would need to have a substantially longer outlook for your investments to pay off than for someone who had started investing in 2002 or 2008 since it will take much longer to see returns on investments that were bought at the peak of the market.



• Lesson Two: Diversification is your friend. This one is tricky since diversification can be your friend if you do it right or your enemy if you go overboard with it. The article is suggesting that investors that spread their money over different sectors, market caps, styles, and geographic exposures will fare better than investors sticking to a particular market niche. While I would agree that it's a risky proposition to be in just small-caps or just large-caps or in just the domestic market, I would also argue that you have to be weary of over-diversification. If you spread your investments over all the different market sectors, caps, and geographic regions you're bound to perform close to the market average. Another problem with diversifying your investments too much is that it becomes significantly more difficult to keep track of all the areas that you're invested in. If you're invested all over the board, you're less likely to have a good handle on the market conditions and to know when you should get out of a particular market. I believe that diversification works best when investments are spread over a handful of carefully researched market niches (be it gold, Latin America, or large-caps).



• Lesson Three: Dollar-cost averaging is your other friend. I agree with this statement as far as it applies to the mutual funds since you don't incur any transactional costs by buying mutual fund shares in smaller pieces over time. With stocks, though, it's a different story. Although it is not wise to purchase all of your intended stocks of a Company A at once, it also doesn't make sense to buy several shares of it on a monthly basis since the commission fees will more than offset any benefit you may receive from using the dollar-cost averaging technique.



• Lesson Four: Save more. I wouldn't say this lesson is anymore important now than in any other time since it is always important to save as much as reasonably possible. The only other thing that I would add is that people need to make sure that they are saving in the most efficient way possible. For example, if you're already maxing out your employer's match in the 401(k) account, you should start investing in the Roth IRA before you start contributing to the Traditional IRA. The reason for doing so is to hedge your tax position in the future. Contributions to both, 401(k) and Traditional IRA accounts, are done on a pre-tax basis while Roth IRA contributions are your after-tax money. When you retire you are likely to get the most benefit tax-wise by using a combination of pre-tax and after-tax withdrawals.



• Lesson Five: Minimize expenses and taxes. Essentially, this means staying away from loaded funds that are usually more expensive than no-load funds. Also, if you're investing into mutual funds with a high annual capital gains exposure, you'd be better off using those mutual funds in your pre-tax retirement accounts (such as 401(k) and Traditional IRA).



• Lesson Six: The past isn't always prologue. This is another way of saying that market's performance in the past decade isn't a good indicator of how it will perform in the next decade. At the same time, you can look back into the market history and see that this isn't the first time that a "lost decade" has descended upon the market and that it is usually followed by a long bull market. Let's hope that pattern still stands.