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How Investors Beat the Great Recession

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The worst bear market in a generation sent many investors' portfolios reeling in 2008 and early 2009. But even though the Dow and S&P 500 aren't anywhere near setting new highs yet, many investors have seen their net worth vault past their 2007 levels -- and it didn't take expert stock-picking for them to do it.

The simple art of asset allocation
In this month's brand new issue of Rule Your Retirement, which is available this afternoon at 4 p.m. ET, Foolish financial planner and retirement expert Robert Brokamp takes a close look at the market meltdown and its aftermath. He notes that the S&P 500 hit its peak in October 2007. After that, it plunged nearly 58% to its March 2009 lows. And despite a big comeback that has the broad-market benchmark index close to doubling since then, the S&P 500 is still 17% below that 2007 high-water mark.

That's bad news if the only thing you've ever owned is an S&P 500 index fund. But fortunately, many investors use asset allocation strategies to spread their risk across various types of investments. And by doing so, those investors not only saw less dramatic losses during the bear market but also were in position to benefit from the outperformance of many investments over large-cap U.S. stocks.

Building the perfect portfolio
As an example, Brokamp points to the model portfolios his service recommends. With three different mixes depending on your age and risk tolerance, each of these portfolios is designed to give you a wide array of exposure to investments that will work well together.

For instance, for those within 10 years of retirement, Brokamp recommends a middle-of-the-road risk profile. He doesn't shut out S&P 500-style stocks entirely; he allocates 30% to large-cap stocks, with a slight tilt toward the consistent dividend-paying stocks that are included in the Vanguard Dividend Appreciation ETF (NYSE: VIG  ) .

But Brokamp's asset allocation doesn't stop there:

  • He suggests putting 10% toward mid-cap stocks and 10% in small-caps. You can get that exposure from ETFs like SPDR S&P Midcap 400 (NYSE: MDY  ) and iShares Russell 2000 (NYSE: IWM  ) .
  • Outside the U.S., you should split 15% between the developed market stocks that iShares MSCI EAFE (NYSE: EFA  ) holds and emerging-market stocks through Vanguard Emerging Markets Stock (NYSE: VWO  ) .
  • Those nearing retirement should have significant bond exposure. With ETFs like Vanguard Total Bond (NYSE: BND  ) and iShares Barclays TIPS Bond (NYSE: TIP  ) , the near-retirement portfolio includes a 35% allocation to fixed-income investments.

Sure, this portfolio is more complicated than just a single index fund. But it's also performed better since 2007. In fact, it's returned between 2% and 3% for those who followed it, depending on whether they rebalanced along the way.

What's behind the win?
The key to understanding why asset allocation has worked so well is in the performance of the various investments underlying it. Mid-cap stocks in particular are at new highs, and small-caps are very close to matching their 2007 levels. And while international stocks haven't done all that well in the past three years, bonds have fulfilled their traditional role of dampening portfolio volatility by providing strong gains and consistent income since 2007.

Some other strategies helped out investors even more. Rebalancing added to profits, taking advantage of low stock prices to cash in profits from red-hot bonds and gain even more in the ensuing recovery. Dividend reinvestment had a similar effect, and those who consistently added to their portfolios despite market turbulence got some amazing entry points.

What to do now
No matter whether you've already retired or have decades to go before you quit for good, understanding the value of asset allocation will make a big difference in your investing results. With the introduction of Rule Your Retirement's All-ETF model portfolios, you can easily use these simple investment vehicles to build the perfect portfolio. And while you'll find some of the ETFs mentioned above in his models, Brokamp also uses more specialized ETFs to craft the best mix possible.

To see all the details of these model portfolios as well as keen insight on future prospects for investments and other issues that are important for retirement, take a look at Rule Your Retirement on us. With our 30-day free trial, you'll get a no-obligation, no-holds-barred look at everything the service has to offer.

Bear markets aren't easy to endure, but in the long run, they're unavoidable. If you're prepared for them, bear markets can actually give you opportunities that most investors will never see.

Fool contributor Dan Caplinger thinks investors should always win. He owns shares of Vanguard's Dividend Appreciation and Emerging Markets Stock ETFs, as well as iShares MSCI EAFE and Russell 2000. Motley Fool Alpha has opened a short position on iShares Russell 2000 Index. The Fool owns shares of Vanguard Emerging Markets Stock ETF. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy helps you beat up on the competition.


Read/Post Comments (1) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 06, 2011, at 10:43 PM, 123spot wrote:

    I fit the above 10 yrs to retirement example above and am still catching up with 2007 (but nearly there with SA and RYR help, thanks so much all of you). Question: does a variable annuity within my IRA with a 6% guarantee-bought 2002-- fulfill my bond need? It is 35% of my portfolio, so I've devoted the rest to equities.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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