Investing lessons we've learned

Talking about "average returns" is dangerous. Wishful thinking is even worse.

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By Pat Regnier, Money Magazine assistant managing editor

Pat Regnier's column "The Bottom line," appears monthly in Money Magazine. Email him at
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(Money Magazine) -- I've become my office's champion moper. I made the mistake of checking the numbers: On the day I started work as a financial reporter in 1997, the Standard & Poor's 500-stock index stood at 973. Now it's at 795. You can imagine what my 401(k) looks like, but that's not what has me so gloomy. It's hard not to wonder whether 12 years of work covering investing did anyone a lick of good.

I'm not flogging myself over bad investment picks. My core investing philosophy - like this magazine's - is pretty vanilla. We like low-cost funds here. We especially like index funds. And Money advocates a steady buy-and-hold approach to stocks that I still think is the only realistic strategy for most investors. But this crash reminds me that investing in stocks involves two sets of decisions: what to buy and how much.

Right tools, wrong moves

The what isn't so hard. (See above.) The how much is where you can truly hurt yourself. Lots of people who invested in really good index funds saw their retirements blow up.

A portfolio with 80% in the Vanguard 500 stock fund and 20% in Vanguard Total Bond Market would have lost nearly a third of its value over the past year. If you're young, that's not the end of the world. But for a couple in their sixties or older, it's serious damage.

We typically recommend more conservative stock allocations for people that age. But even 90% wasn't uncommon. We ought to have been saying much more often that while stocks may be a good investment, they'll always be risky. Really risky.

This isn't just an exercise in self-criticism; there are investing lessons here. Even after the tech bubble, it was hard to keep risk in the front of our minds. Why?

Lulled by averages

The way advisers, fund companies, and, yes, the financial media talk about stock returns subtly smoothes over risk. You've probably read that stocks earn 9% or 10% a year in the long run. You may even have read that future returns will be lower. In 2007, I wrote about smart analysts who put future long-run returns as low as 6% - a bearish call. But the low numbers can be misleading too.

Even when you know better, long-run averages can shape your short-term expectations. If returns average 6%, it's easy to imagine a good year as 9% and a bad year as 3%. Of course, you can get to 6% by having a 50% drop followed by high returns much later. But when you're entering positive single digits into a retirement calculator, negative 50% doesn't feel real. Until it is.

Hope trumps reality

Asset allocation is complicated, but it can also be tough emotionally. If you're light on savings, a conservative plan won't get you to your goals. It's tempting to add more stocks and hope they'll fill the gap.

Financial journalists know that most Americans don't save enough. Maybe that made us slower to explore conservative strategies they'd find unpalatable - or to criticize advisers and fund companies that guided people into faith-based aggressive allocations.

There was a lot of wishful thinking. "We may need the stock market to give us another long series of 15% returns," says Vanguard founder John Bogle. "That has absolutely nothing to do with it happening." Don't forget it. I won't.

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