Pundits repeatedly warn investors not to abandon stocks during tough times. Recoveries are quick and unexpected, they say, and are easily missed, so individuals are best advised to stay fully invested in stocks. Except, says research firm Morningstar, that oft-cited wisdom is wrong. It's best to have some bonds.
A diversified portfolio of stocks and bonds has often easily bested a portfolio of pure stocks, both in the short and longer terms after a financial crisis. "Stocks" in this case means the Standard & Poor's 500 index, and "bonds" means the Ibbotson Long Term Bond Index--high-quality, longer-term bonds.
Morningstar looked at pure stock returns and a 60%/40% mix of stocks and bonds. The diversified portfolio beat pure stocks the vast majority of the time, no matter the crisis. When stocks did beat a diversified portfolio, it wasn't by enough to justify the added risk. (See tables below.)
Morningstar sliced the returns five ways: one month after a crisis, six months after, one year after, three years after and five years after. The periods of crisis measured were after October 1987, or "Black Monday"; August 1989, during the U.S. savings and loan crisis; September 1998, when the Long-Term Capital Management hedge fund was bailed out; March 2000, when the dot-com era crashed; and September 2001, after the terrorist attacks on the World Trade Center and the Pentagon.
John Rekenthaler, vice president of research at Morningstar (nasdaq: MORN - news - people ), says the research proves that buying stocks on the dip is a mug's game and that stocks take longer to rebound than investors typically hear.
"You'd think at the start of a crisis, when they say there's blood on the street, that it would be time to snap up stocks," he says. "Yet it's the time to not be that aggressive and buy a balanced portfolio. In both 1998 and 2000, five years was not long enough a time horizon for stocks alone. Bonds propped up the portfolio."
Worse still for stock lovers, when stocks did win, it was still a race. For example, five years after Black Monday, a pure stock portfolio was up 96.8%, versus 89.9% for a diverse portfolio. But, perhaps surprisingly, the latter was still beating the former after three years, and it was close for all other time periods. And that was the best stocks did, versus a diverse portfolio.
After the S&L crisis of 1989, a diversified portfolio beat pure stocks for all time periods, although stocks were, at least, competitive.
After the Long-Term Capital Management failure, stocks outperformed in the short term but lost convincingly at the three- and five-year marks. In fact, at the five-year mark a diverse portfolio returned 20.3%, versus 5.1% for stocks.
There is one area, Rekenthaler says, where stocks are the champ: 20-year returns, as measured from September 1988 to August 2008. Here stocks boast a 661% return. A mixed portfolio surely lagged that right? Yes, but it was close, at 636%.
In addition, stocks performed more strongly in the late '80s and '90s than they have in the past decade, meaning old buying patterns might no longer apply. "Stocks were more dependently resilient in the '80s and the first half of the '90s than now," Rekenthaler says. "People got trained that a downturn was a buying opportunity. But they got trained out of that this decade."
There are a few lessons to take from all this, he says. One is that stock recoveries can't be neatly divided into five-year periods. Typically, stocks take about seven years to actually recover.
Secondly, even if stocks do outperform over the truly long haul, few investors reap the benefit. All things being equal, Rekenthaler says, the volatility of stocks versus a mixed portfolio plays into investor's most self-destructive habits.
"The more aggressive a stock is, and the more volatile it is, the more likely people are to jump in and time it, and people consistently time it wrong," he says. "A balanced fund keeps you from shooting yourself in the head."
