Five years in, here's what we've learned from the market's astonishing rise from the ashes of the financial crisis.
For some milestones, you want to break out the champagne. But the end of the great bear market, which finally occurred five years ago in March, may be one you'd rather forget.
By the time the market hit bottom on March 9, 2009, the Standard & Poor's 500 Index ($INX) had fallen 57 percent from its 2007 peak, the biggest drop since the Great Depression. And there was no telling when the free fall would end. "Dow 5,000? There's a case for it," said a headline in The Wall Street Journal on March 9. "Investors throw in the towel," online magazine Slate proclaimed less than a week before.
Despite the pessimism, though, stocks did turn around -- and they have gone on to stage one of the most powerful rallies in recent history. From the bottom through the end of 2013, the S&P 500 returned 203 percent. Looking back, you could glean many lessons from the stock market's plunge and subsequent recovery.
"It's the painful experiences that are the most valuable," says Jim Stack, who publishes the InvesTech Research newsletter. We've identified five takeaways from the bear market and the years that followed.
Early in 2009, with the S&P 500 down 25 percent in the year's first ten weeks, few investors would have guessed that the index would finish '09 with a 27 percent gain.
Overall, the news was grim. The unemployment rate was on its way to hitting 10 percent. Two of the country's three major automakers, Chrysler and General Motors (GM), filed for bankruptcy reorganization that spring. Congress passed a $789 billion stimulus package to try to revive the economy. Based on the headlines, it didn't look as though things would get better anytime soon.
"There was a belief that the good things that happened in the past would never happen again," says John Rekenthaler, vice-president of research at Morningstar.
Stocks, however, did make a comeback, and the mood-defying reversal was a reminder that trying to call a market's bottom is something few investors can do.
Big market moves can wreak havoc on the balance of stocks and bonds in your portfolio. Let's say you had 60 percent in U.S. stocks (as measured by the S&P 500) and 40 percent in bonds (as measured by Barclay's U.S. Aggregate Bond index) before the bear market started in October 2007. By the end of the bear market, the ratio would have flipped to 38 percent stocks and 62 percent bonds, just because of changes in market values. The timing could hardly have been worse because your portfolio would have been light on stocks just as they were poised to take off.
Rebalancing -- a system of selling and buying investments to maintain your portfolio's asset allocation -- helps you avoid such unintentional shifts. And it forces you to buy assets that have grown cheaper and sell ones that are expensive -- in other words, to buy low and sell high, one of the cardinal rules of investing.
On paper, rebalancing looks simple enough. But from an emotional standpoint, it can be tough to execute. Few people wanted to buy stocks in March 2009. "Rebalancing goes against our strongest investing behavior," says Fran Kinniry, a principal at the Vanguard funds. "We don't want to buy assets that have had negative returns."
Worried you won't have the discipline to rebalance? One solution is to set a fixed schedule -- say, at the start of every year or after your portfolio mix has shifted by five to ten percentage points. Another option: Consider a balanced mutual fund, which will maintain a steady ratio of stocks and bonds for you. Dodge & Cox Balanced (DODBX) is a solid choice. Over the past five years, the Balanced fund returned an annualized 17 percent, nearly as much as the S&P 500's annualized return of 18 percent but with less risk.
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