How to invest... Peaks and valleys
Want a reason not to buy and hold mutual funds? See the last 10 years. Want a reason to invest for the long haul? See the last 20.
Fund critics can use the last decade to say that fund investing doesn't work, and fund supporters can use the last two decades to show the opposite.
Both sides have valid points, and your view depends mostly on when you started or peaked. If you didn't experience the 1990s but only got in at the end because it looked so easy, you probably don't think funds work. If you began in the early 1990s, you're probably saying that funds did exactly what you expected.
It's hardly a secret that the stock market has a negative return over the last decade. In fact, just this week, the market's Internet bubble peak from 2000 fell off the 10-year performance chart, meaning that those numbers are at their ugliest point right now. So while the strong positive returns of the last year feel great, critics point to the "lost decade" as a reason to shy away from funds.
A bad decade would seem to be enough time to make such a judgment, but it's not. While 10 years of evidence is not short-term thinking, it's a blip on the scale by which average investors use funds.
The idea behind funds was to offer professional management and diversification at a reasonable cost, for life. It wasn't about building a portfolio of funds, with some holding domestic stocks and others foreign, worrying about market-capitalization or filling style boxes. It was giving money to a manager who would try to generate a market return (or better) while the shareholder held on for the ride, barring a need to withdraw their cash. No trading with funds, no timing the market with funds, just buy and hold for a reasonable long-term return.
The advent of retirement accounts made that sentiment stronger, as the idea was to buy funds that were held over a lifetime of employment to deliver a retirement nest egg.
Now apply typical investor thinking to that picture. An individual investor's idea of a reasonable long-term return lands somewhere between 8% and 10%. Funds missed that target by a mile over the last decade when the market was mostly in the tank. But Morningstar Inc.'s database includes nearly 500 equity funds with a 20-year track record, and 65% of them earned an average annualized return of 8% or more over the last two decades. More than one in four of those funds generated a double-digit annualized return over the last two decades. That's enough growth to turn a $10,000 investment into more than $67,000.
Obviously many other funds that started way back when didn't survive long enough to put up 20-year numbers; investment success breeds longevity.
But the numbers show the balancing of two extreme decades. Ten years ago, at the end of the Internet bubble, few investors would have been satisfied with a measly average annualized gain of 10% for a decade. Fast forward to today, and investors would have been thrilled with that return over the last 10 years.
Hindsight and perspective
Some of the problem, of course, is that investors tend to see their account value as "made money," so that they remember it from its peak.
A different way to consider it is to look at real growth and expectations. An investor looking for a 10% average annual gain would have been hoping that $10,000 would turn into about $26,000 over the course of a decade. Letting it ride for another decade, the investor would look forward to that $67,000-plus jackpot.
It's similar to the reaction many investors have to a single huge day on the market. A 500-point decline is seen as the start of Armageddon, while no one regards a 500-point gain as being too much, too soon. In truth, the swing is the same size; it's the direction that drives the emotions.
Obviously, your mileage in funds may vary, and your experience is likely to depend on your starting point. Your judgment of a fund will depend on the lens you use.
It is easy to stick with a fund that delivered the best of the 1990s, even as it stumbled and was much less brilliant in the 2000s. If you bought late in the Internet bubble and never had the glory days, buy-and-hold could have easily become a lesson in pain.
But if the last two decades have shown anything, it's that most investors should let funds do their job over the long haul. For most savers, fund investing is a bit like functioning on auto-pilot, relying on the system to go from starting point to destination without worrying about whether the path is over mountains or valleys.
Ultimately, the last two decades should guide savers on whether they can comfortably make the journey buying and holding mutual funds, or if they should pursue a different path. There's no one right answer, no matter how you slice it.