Many prominent investors and academics (such as Warren Buffet & Robert Schiller) are predicting a “lost decade” ahead in the stock market.
They are predicting 2-3% returns, a far cry from the last 11 years of mostly double digit returns. With the exception of last years -4%, the previous 8-9 years in the stock market returns were phenomenal.
This could make alternative investments more attractive. It should also be calculated into retirement planning and any plans for FIRE.
Here we lay out a couple strategies for managing this risk.
Slow and steady for the next 10 years?
Prominent folks in the world of investing are predicting that lazy stock index fund investing may only return about 2-3%, But Why?
There are several reasons such a lackluster decade is predicted. For example from things like debt cycles, stagnant wage growth, growing global competition, existential unknown and known threats to the global economy. In other words, there is a lot of crazy big stuff going on that is out of our individual control. Society and the world’s governments will grapple with how to manage and will need to balance competing interests.
The list below shows S&P 500 Index returns since 2000. Since most folks are mainly invested in index funds, this was close to their return each year:
We may not see such high returns over the next decade.
Ray Dalio talks a lot about debt cycles. Debt isn’t necessarily bad. In fact, having too little debt creates economic problems in the form of forgone opportunities. The key is to ensure productive utilization of the borrowed money to produce income needed to service that debt. It’s the whole good debt vs bad debt concept, but on a grand scale.
For example, if we use debt to pay for schools or infrastructure there is a huge return on investment. If we blow the money on some wasteful endeavor, then the return is low or negative.
Here are some general takeaways and breakdown:
Crisis and debt cycles are going to happen due to human nature. Therefore, during bubble times, people are blinded by the present market boom and driven by greed to participate. And then the fear of missing out and being left behind financially kicks in. This continues until debt burden gets too large to be sustained. Creditors begin to worry and increase restrictions.
Here is an excerpt from Ray Dalio as to what is to come:
“In an immediate postbubble period, the wealth effect of asset price movements has a bigger impact on economic growth rates than monetary policy does. People tend to underestimate the size of this effect. In the early stages of a bubble bursting, when stock prices fall and earnings have not yet declined, people mistakenly judge the decline to be a buying opportunity and find stocks cheap in relation to both past earnings and expected earnings, failing to account for the amount of decline in earnings that is likely to result from what’s to come.
But the reversal is self-reinforcing. As wealth falls first and incomes fall later, creditworthiness worsens, which constricts lending activity, which hurts spending and lowers investment rates while also making it less appealing to borrow to buy financial assets. This in turn worsens the fundamentals of the asset (e.g., the weaker economic activity leads corporate earnings to chronically disappoint), leading people to sell and driving down prices further. This has an accelerating downward impact on asset prices, income, and wealth.”
For those seeking FIRE or who are early in their careers, a slower decade of asset growth can be a positive if a person is fortunate to have good employment. This could be a decade long opportunity to acquire more assets that could support you later. This is why I wrote a love letter to the market titled: Dear Stock Market, Please Crash!
Here are some ways I plan on managing the “lost decade”
1. Stick to “Sleep At Night” or Ray Dalio “All Weather” Portfolio
The concept behind portfolio allocations such as these is that they take advantage of boom times and mitigate the impact of down times. For example, most portfolios in Ray Dalio’s opinion, are too heavily weighted in stocks that thrive in good times only. In other words, they do well in good times when the market is going up. And down dramatically in down times when the market is diving in value.
It is important to keep in mind that in the short run or immediate moment a market is a “voting machine”. It is just a reflection of millions of transactions and “votes” in terms of value. Prices fall until someone is willing to pay for the asset. But in the long run of someone’s investing life the market is a “weighing” machine. It is weighing the value of a company based on fundamentals, profits, management, outlook, etc.
2. Consider Alternatives
There is a whole world of alternative investments beyond S&P 500 Index Funds that one can consider. For example:
a. REITs (Real Estate Investment Trusts). See our overview of great Real Estate Investment Trusts. There are all kinds of highly graded and valued REITs that can return some great value. REITs are collections of real estate investments that return most of the profits back to shareholders in the form of dividends.
b. Commodities. Ray’s all weather portfolio suggests a small amount of exposure to commodities such as water or oil. The prices of these raw materials can fluctuate, but they tend to be things people need no matter what.
c. Traditional real estate. A rental property value may fluctuate. But no matter the economic conditions, people still tend to use real estate.
e. Gold. I don’t personally do much with gold. But Ray suggests a small amount in the all weather portfolio. When the stock market crashes and recession hits people tend to flock to gold as a store of value.
3. Focus on dividends
For me and Jerry, part of our strategy is focusing on income streams from dividends. The old adage here is to “not chop down the orange tree.” Just eat the oranges that come off the tree, but keep it intact.
With this approach, one truly cares less about the actual value of the stock on any given day. I just want to make sure my dividends are paid each quarter.
RELATED: My Dividend Investment Strategy4. Cash
In a lot of ways perhaps there is a nice place for some cash in many people’s assets. Cash allows a person to pounce on great opportunities. Imagine when the housing crisis hit over a decade ago. If someone had cash, they could swoop in and buy real estate at bargain basement prices. The big drawback on cash of course is the scourge of inflation. Inflation will come and will diminish the value of that cash each year.
When things get rocky, it is really time to get fundamentals down solid. One of these is making sure debt levels are appropriate. My goal is to be debt free someday, but that takes time, especially with a mortgage.
Also pay attention to the type of debt. Is the debt part of an asset or liability, that is the key question to ask.
6. Tax Considerations
It is important to keep in mind tax considerations. This is where Roth IRA come in handy. Check out our review of the advantages of Roth IRA’s in the future: Rock Out With Your Roth…
Don’t be alarmed, be prepared
It is hard to predict the future. The experts could be wrong and all kinds of things could happen that change the trajectory of markets. What is important is being diversified, having a plan and some see self control. It really does not matter what the market does each day. As long as the overall value of your wealth is growing over time and we continue to save. When it comes time to utilize the assets for income, it comes out in small amounts over time. In many ways, the best reaction may be to simply stay the course and live our lives. Keep calm and carry on as they say.