Making money in a bearish decade

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NEW YORK (Money Magazine) -- Question: Over the past ten years, the stock market has gone nowhere and a buy-and-hold strategy only makes advisers rich. There is plenty of money to be made by buying the dips and selling the rips. Why don't you advise others to do this?

The Mole's Answer: While I completely disagree with your assertion that the market has gone nowhere in the past ten years, I actually do advise clients to do a type of buying on dips and selling on rips. Let me explain.

First, I admit that it hasn't been a stellar decade for the stock market. I also admit that I've heard advisers claim the market has been flat over this time period. I've seen media articles claiming the S&P 500 is nearly exactly where it was ten years ago.

But this doesn't mean the stock market has gone nowhere. It all depends on which measures you're looking at.

The S&P 500 essentially comprises only the largest 500 U.S. companies which, as it happens, have been the worst performing parts of the global stock market. Further, as I noted in How's your global portfolio, the index itself doesn't include the portion of the return that came from dividends.

Granted, over the past ten years, we have seen one of the worst bear markets in history in which many markets lost nearly 50% of their value. And you'll get no argument from me that we are currently in another down market.

Yet, over the ten year period ending June 30, 2008, the U.S. stock market, as measured by the Vanguard Total Stock Market Index Fund (VTSMX) eked out a 3.5% annual gain, after paying fees. Over the same time period, the international stock market turned in a respectable 7.1% annual gain, using the Vanguard Total International Stock Market Fund (VGTSX) as a measure.

If you had invested in these two funds, with a portfolio of two-thirds U.S. and one-third international, the total return would have been 4.89% annually. While this is certainly nothing to write home about, $1,000 invested ten years ago would have been worth $1,606 - not too shabby.

Throwing in some alternative asset classes would have also given your return a boost, and in general can be a good way to hedge against losses. For example, if you had changed the above portfolio to invest 10% of the U.S. portion in Real Estate Investment Trust stocks via the Vanguard REIT index fund (VGSIX), and 10% of your international in Vanguard precious metals and mining (VGPMX), both of which happened to perform very well in the last 10 years, your annual return would have been 7.03% and your $1,000 would have grown to $1,973. Nearly doubling your investment is not exactly horrible.

If these returns come as a bit of a surprise, that's because very few people actually achieved them. And the reason can be chalked up to the two usual suspects; expenses and emotions.

Expenses take from our return in obvious ways, though all of the funds mentioned above have very low costs. By some measure, our emotions also tend to reduce our return by another 1.5%, as we get into certain markets or sectors at the wrong times - after they have been hot.

I may not agree with you that the market has gone nowhere over the past decade, but I'm absolutely on the same page with you that we should buy low and sell high. The problem is that I don't actually know what days the market will go up and which days it will drop. That's one of my strengths as a financial planner - I actually know I don't know.

Nonetheless, I believe in rebalancing a portfolio. If you allocate 60% of your portfolio to stocks and they decline, you have to buy. And if stocks increase, you have to sell some to get down to that target allocation. I think that's essentially what you're advocating, and you can count me in.

Over the past decade, that 60% equity portfolio (comprised of 40% VTSMX and 20% VGTSX), and 40% bond portfolio (40% Vanguard Total Bond (VBMFX)) returned 5.10% annually. But if you rebalanced annually, you boosted your return to 5.45% per year.

In a way, rebalancing is market timing that actually works. Unfortunately, most consumers in the stock market let their emotions get the best of them, and are unable to tough out the market ups and downs.

However, I don't believe in buying one day because the Dow dipped 300 points, and selling the next because it recovered. Fun and exciting though it may seem, there is little evidence that it actually works. I've had some people claim to make 30% in a down market, but so far none have allowed me to audit their account.

My advice: Take the gloomy media reports with a grain of salt and invest for the long-term. Circumstances are usually not as bad as they are made out to be. Don't move in and out of the market on a daily or even monthly basis. The more you move in and out, the lower your returns are likely to be.

The Mole is a certified financial planner and certified public accountant who - in the interest of fairness - thinks you should know what goes on behind the scenes in financial planning. Want to make contact? E-mail themole@moneymail.com.