The S&P 500 index crossed the 5,000 mark in February 2024. On an absolute basis, it marks quite a gain from the 1,036 level the large-cap index was at when I started at AAII in November 2009.

It’s easy to overlook the power of compounding when seeing such a big point rise. The S&P 500’s annualized return during my tenure as AAII Journal editor has been 12.6% so far. This compares to the long-term annualized return since 1926 of 10.1% for large-cap stocks reported in the 2023 SBBI Yearbook. Consistent time in the market has been required to profit from compounded returns.

The stock market is said to follow a random walk. Returns are sometimes very positive and sometimes very negative. When the S&P 500 is at new highs—as it is now—investors forget that the index went nowhere during the so-called lost decade. Our 2010 Mutual Fund Guide showed the Vanguard 500 Index fund (VFINX) with a 10-year annualized return of –1.1% for the period of 2000 to 2009.

You can see visually how the lost decade played out in this month’s Illustrating Trends Dispatch. The S&P 500 needed 199 months to increase from 1,000 to 2,000. Doubling from 2,000 to 4,000 took 80 months.

Fortunately, lousy 10-year periods like the first decade of the 2000s aren’t frequent. There have only been 11 occurrences since 1926 when domestic large-cap stocks realized 10-year annualized returns of below 5%: the Great Depression era, the inflationary 1970s era and the lost decade.

Nonetheless, they are problematic when they occur. This sequence risk is particularly dangerous for retirees and others who are taking or are planning to take withdrawals.

You can see this in my latest portfolio rebalancing update in this issue. The withdrawal portfolios ended the 1999–2023 period with the lowest balances of any rolling 25-year period we’ve looked at so far. The non-rebalanced withdrawal portfolios declined from the starting values regardless of whether the AAII moderate (60% stocks/40% bonds) or aggressive (90% stock/10% bonds) Asset Allocation Model was followed. The rebalanced withdrawal portfolios preserved wealth but did not increase as much as they did during past 25-year periods we studied.

The damage was done when the lost decade occurred. In the most recent 25-year period, the dot-com crash began a little more than one year into the portfolios’ existence. The global financial crisis occurred approximately four years after that first bear market ended.

This sequence risk can be dangerous early in retirement due to large account balances and starting withdrawals. The combination leads to a portfolio incurring a large drop in absolute value at the same time money is being taken out instead of being put in. Rebalancing preserves allocations by prompting you to buy low and sell high.

Another way to protect your portfolio against sequence risk is to include a cash allocation. The advantage of cash is that its absolute value does not fluctuate like the values of stocks and bonds do. This makes cash and its equivalents—money market funds, certificates of deposit (CDs), etc.—a good safe (“buffer”) asset to mix into a broader portfolio allocation strategy. When market conditions turn turbulent, you withdraw from the cash allocation. When market conditions are good, you withdraw from the other allocations (e.g., stocks). This is what AAII founder James Cloonan advocated for with his Level3 withdrawal strategy.

AAII contributing editor Brian Haughey talks about the role cash plays in a portfolio in this month’s feature article. He explains how cash lowers volatility and helps retirees who are taking withdrawals.

Of course, cash does have a drag on returns when stocks are performing well. Some cash is good; too much will cause your portfolio to lose ground to inflation.

On the investment side of allocations, we are launching a new version of our popular series on how to analyze financial statements. This series will help you better judge if a company is financially sound or if problems are starting to brew. In this first article in the series, Jack Gilleland walks you through Alphabet Inc.’s (GOOGL) 2023 year-end statements as an introductory overview.

Wishing you prosperity and good health,