Debunking the myth of the stock market ‘plunge’

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As August drew to a close last year, the market’s slight downward direction seemed a harbinger that we were in for the first year during the last six of a declining market.

The set-in-stone paradigm that real estate could never go down in value was finally being questioned.  Despite this shake up, however, the market seas were still pretty calm.  Little did we know that it was only the calm before a particularly nasty storm.

Bad as September was, it was a party compared to the October plunge.  And, when the market bottomed out on March 9 of this year, the S&P 500 index had lost more than 47 percent of its value.

So, why then am I saying the market plunge was a myth?  Because it isn’t the whole story.

The rest of the story

We all know that the market recovered quite a bit of its value since those head-for-the-bomb-shelter days during March.

Most experts with a keyboard or a microphone were predicting the Great Depression ahead.  Calls for a run to the lifeboats were everywhere.  Experts were calling this a once in a lifetime event and declaring capitalism “dead.”

The S&P 500 is 25 percent below where it was at the end of August 2008.  Since it only takes a 20 percent decline to qualify as a bear market, surely our current decline qualifies as a plunge, right? Wrong!

While many financial experts want you to believe the S&P 500 index is the stock market, it isn’t.  It’s only the largest 500 U.S. companies and the index strips out all dividends.  Thus, it’s only part of the return of part of the stock market.

Let’s take a look at how the U.S. and international stock markets performed, as well as the U.S. bond market for the 12 months ending Aug. 31, 2009.

Sample Stock Allocation Return
Vanguard Total US Stock Market VTI -22.6%
Vanguard FTSE All World Ex U.S. VEU -15.6%
Vanguard Total Bond Market BND 6.2%

Only the U.S. stock market lost more than 20 percent, with bonds doing their job of acting as a shock absorber.  Sure, these declines are large but they are hardly a once-in-a-lifetime event.

Portfolio performance

Let’s take a moderate portfolio of 60 percent stocks and 40 percent fixed income, with 20 percent of the stocks in international and 40 percent in United States.

If we had invested in the three funds above and done nothing, our 12-month return through August ’09 would have been a 9.7 percent loss.  Not exactly gang-buster returns, but not a plunge.

To have limited your loss to 9.7 percent, you would have had to do nothing, which isn’t as easy as it sounds.  Doing so would have required you to ignore the media blitz of doom, gloom and depressions, and resist your instincts.

Yet as hard as it was to stay the course during the past year with what we were hearing from the media and how we felt about it, it was even harder to muster the commitment to rebalancing.

Getting back to the 60 percent stock allocation noted in this example, while mathematically simple, was far from easy.  To do this, we have to take Warren Buffett’s advice and “be fearful when others are greedy and greedy when others are fearful.”  Not many of us were feeling all that greedy between October and March.

For those brave souls with the courage to rebalance quarterly during the past 12 months, this 60 percent equity portfolio would have lost only 4.9 percent.  Definitely not a once-in-a-lifetime event.

Did you lose more than 10 percent?

When you get your August statements later this month, compare them to where you were a year earlier.  Chances are you lost more than 10 percent and here are some possible reasons why.

1. Your portfolio is more than 60 percent in equities.

2. Your portfolio had higher expenses than the funds used in this example.

3. You are human and couldn’t resist the instinct to be fearful when others were fearful.

4. Your bonds or bond funds didn’t gain the 6.2 percent like the bond index fund.   For 2008, the average taxable bond fund lost 8 percent, while the Vanguard Total bond fund gained 5.1 percent.

5. You or your adviser believed you were smarter than the market and knew which sectors or countries to invest in.

My advice

I admit that I feel a little vindicated for all of the columns I wrote between October and March telling people that stocks were on sale.  I’ll also admit, however, that I had no clue we were going to have such a fierce rally during the next few months, just as I know I don’t know what the next few months hold.

My advice is to embrace uncertainty.  Ignore the experts who don’t know that they don’t know.

Allan Roth, a CPA and Certified Financial Planner, is the founder of Wealth Logic LLC and the author of “How a Second Grader Beats Wall Street.” He can be reached at 955-1001 or at ar@DareToBeDull.com.