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Lessons From 20 Years on the Stock Market Rollercoaster

Embrace uncertainty to avoid repeating investment mistakes

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The wild investing ride of the first two decades of the 21st century is over. As we enter the next decade, it's important to look back over the past 20 years for lessons we can take into the future. Let me walk you through the emotional highs and lows many of us experienced and try to draw a few lessons from them.

Highs and lows

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The century began near the height of the dot-com bubble when internet companies with little revenue and huge losses had valuations in the tens of billions of dollars. People who questioned those valuations were told they were stuck in the old economy. The Standard & Poor's 500 stock index peaked on March 24, 2000, and quickly plunged by nearly 50 percent.

During the tech wreck, some clients came to me in shock, wondering how their many stock funds could have lost 70 to 80 percent. Those stock funds, of course, all owned the same dot-com companies. A total stock index fund was far more diversified.

As stocks soared to new heights, the dot-com bubble was soon forgotten. This time the bull was real — as in real estate. You can't print more real estate, right? Between October 2002 and March 2007, U.S. stocks gained 133 percent and international stocks gained 240 percent. Bonds steadily gained 22 percent.

I advised clients that a third of their equities should be in international stocks and the typical response was, “Why only a third – isn't all the growth coming from overseas? We want whatever is hot.”

Of course, this bubble burst as well. Getting mortgages was all too easy. The defaults that soon followed caused the collapse of many Wall Street titans like Lehman Brothers and Bear Stearns.

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This plunge was slightly more than the dot-com bubble, with U.S. stocks losing 55 percent and international stocks dropping 60 percent by the market bottom on March 9, 2009. But it was the fact that the plunge happened so quickly that magnified the pain so much. Only high-quality investment grade bonds and bond funds did well. Morningstar reported that the average bond fund lost about 8 percent in 2008. Many bond funds behaved more like stocks, as investors reached for income but lost much of their principal.

And advisers, who were supposed to keep investors disciplined with a relatively stable asset allocation between risky assets (stocks) and low-risk assets (bonds and cash), timed the market poorly.

After the plunge, some clients asked me if I could promise the bottom was near and, of course, I had to say I couldn't. All I could say is that capitalism will survive, and that selling now guarantees you'll never reach your financial goals. I was saying all the right things in this CBS MoneyWatch video , but inside I was feeling an excruciating pain that I was desperately trying to hide, and my inner voice was pleading, Please, please, please, let me be right.

Though stocks recovered very quickly after the March 9, 2009, bottom, it was a lost decade, with U.S. stocks losing ground and international stocks gaining 25 percent. High-quality bonds were the star, gaining 80 percent.

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The longest bull in history

We all know the rest of the story. On March 9, 2009, the longest bull market in history began, and it still continues. From then to the end of the next decade and into the next, returns were okay for international stocks and bonds and fantastic for U.S. stocks. In the end, returns for the entire period looked as follows, using the same three index funds.

(I'm using the broadest of the low-cost U.S. and international stock funds in my examples, so they include reinvested dividends as well as the costs one would have to pay.)

With international stocks now lagging, I still recommend to clients to put a third of their stock portfolio in international stocks. But now many clients say, “I can't go that high — there are too many problems overseas.”

Mistakes I saw over the past decade:

  • Chasing what worked well in the past
  • Trying to earn extra income but losing principal
  • Waiting for a pullback to get in the market but never getting back in
  • Creating unnecessary complexity
  • Paying too much in fees

Though the roller-coaster ride of the past two decades may be over, investors are lining up to ride the next one, and it could be even wilder. What will the next decade or two look like? Are we in a bubble today? I don't know the answer to either question, and that's the key to investing — embrace the uncertainty and stay disciplined in balanced low-cost diversified portfolios. That is not to say I don't know some things — one being that it's incredibly unlikely the bull will last another decade.

So as we move into the future, I encourage you to have the conviction to heed my predictions for the next decade. Though the new year has begun, it's not too late to make these Five New Year's financial resolutions. Finally, remember these four money rules to take control of your financial future.

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