Since the end of 2009, we've been hearing about the "lost decade" of the '00s or the aughts. Sounds sort of romantic in a dark way, like holing up in a secret place and doing something mysterious when nobody knows where you are. But of course, it refers to the ten-year period, beginning in 2000, when stock market investors actually lost money. Isn't that what we promised would never happen? An entire decade of loss?

It certainly happened to investors who put all their money in large-cap U.S. equities. Every dollar invested in the Standard & Poor's 500 index on December 31, 1999, was worth 75 cents ten years later. But it didn't happen to those with discipline and a plan. And I'll bet it didn't happen to your clients.

Of course, the idea of a lost decade conjures up the mishaps and misfortunes of Japanese investors who suffered through their own bubble while U.S. investors smugly looked on, believing that it couldn't happen here. During the Japanese asset price bubble from 1986 to 1991, real estate and stock prices grew hugely inflated. That bubble didn't burst so much as slowly collapse in a process that lasted more than a decade. Stock prices seemed to bottom in 2003 but the global financial crisis in 2008 brought them even lower.

David Falkof, an analyst at Morningstar, describes the past decade in the U.S. like this:

"It began with the Internet boom and bust, ended with a roaring housing and credit market bubble that imploded catastrophically, featured a mutual fund trading scandal and the rise of ETFs in between, and left most equity fund investors with little to show for their pains on December 31, 2009. During all the turmoil, a lot of investors lost their faith in some big funds, broad diversification, and sober stewardship."

Where do we go from here? Some Americans worry that the U.S. will suffer through the same sort of malaise that Japan has not yet managed to escape. Others argue that everything is fixed now; the global economy has been salvaged and returned to the track. Some of them say that it's even better than that: The stock market returns 10% a year, on average, over time, so doesn't that mean we have a lot of good news and good returns ahead of us?

I called Don Phillips, managing director at Morningstar, to see what he thought about the lost decade. As I suspected, he was annoyed with the whining and grumpiness. "It really gets under my skin," he says, "this assumption that it's up to the markets to do the heavy lifting and that you don't have any responsibility for saving." Don never loses his faith in the market. He sticks to his rules and continues to make regular investment contributions and rebalancing. Last year was no different for him.

But he says he was surprised to see that some financial advisors lost faith in that system. At the Financial Planning Association's national conference and at its retreat, he saw market-timing presenters giving their pitches to rooms full of advisors.

"I never thought I would see market timing pitches to a serious audience of financial planners and also see them seriously considered," he says. "Financial planners are such caring people, and it must have been difficult for them to see clients suffer [through the market chaos]. But not one fund has ever put together a successful record based on market timing."

What can the profession do then? Several observers say the decade provided more evidence that investors must be more geographically diversified and more diversified across asset classes.

Mark Hulbert, writing on MarketWatch on November 9, 2009, says the top-performing advisor in the Hulbert Financial Digest rankings, the "Closed-End Country Fund Report," produced an 11.5% annualized return over the past decade. That advisor wasn't an outlier either: The other advisors in the top five garnered 10.9%, 10.5%, 10.1% and 10%.

Hulbert concludes that these advisors won with a disciplined approach to investing. "Their strategies may not be particularly flashy, but their 'slow and steady wins the race' approaches came out ahead in an otherwise flat decade."

Hulbert also says that of the 86 advisory services that the Hulbert Financial Digest tracks, 71 of them outperformed the market. "So don't let your financial advisor excuse his poor performance with reference to the so-called lost decade," he writes. "A good advisor could have prevented that decade from leading to your loss, too."

Writing in the January 2010 issue of the Fundamental Index newsletter, Rob Arnott says the problem with the 2000s was overconfidence in the equity markets, which he compares to the overconfidence about the infallibility of the Titanic in 1912. The unshakeable faith in the equity risk premium, he writes, "caused the $8 trillion U.S. pension supertanker to charge ahead with massive equity allocations into a decade that did not reward equity investors."

Arnott says it was the worst decade in history for U.S. equity investors, worse than the 1850s and 1930s. In the first decade of the 21st century, the S&P 500 compounded at negative 1.0% per year, which was 3.6% below inflation. In the 1850s, it compounded by a positive 0.5% and in the 1930s by a negative 0.1%.

But not all investors suffered. Three asset classes enjoyed double-digit returns: emerging market bonds saw a 10.9% annual return, REITs enjoyed a 10.2% gain and emerging market stocks returned 10.1%.

Part of the problem is the cap weighting of equity portfolios, Arnott says. In 2000, tech and telecom represented 45% of the market cap but only 15% of the economy. In 2009, the sell-off in value stocks drove them to 22% of the S&P 500 index when they were cheap, despite the fact that they made up 38% of the economy.

In contrast, the Fundamental Index methodology "eliminates price from the portfolio weighting process," he says.

Arnott's portfolio was not the only winner. Vanguard brought in more new assets during the first decade of the 21st century than through the previous three decades combined. On January 1, 2000, Vanguard's total net assets in open-end funds, excluding ETFs, money market funds and funds-of-funds, was $422 billion, according to Morningstar's Falkof. By December 31, 2009, the company's assets had reached $1.07 trillion (making it the biggest fund family in the world). Of that increase, $440 billion was new investor money.

Falkof attributes Vanguard's success to its low costs, broad diversification and sober stewardship. Also, when market perceptions shifted, Vanguard was ready with another low-cost index fund-the Total Stock Market Index-which appealed to investors who wanted to index with something broader than the S&P 500. The company's low-cost bond funds, meanwhile, offered an attractive alternative in the income market, and the company's Treasury Inflation-Protected Securities funds, being the cheapest TIPS on the market, brought in investors worried about inflation.

So can prudent diversification save us from another lost decade as it saved the prudent investors like Vanguard, Rob Arnott and Hulbert's top newsletter advisors? Maybe. But there are some troubling new colors in the picture as we begin 2010. The Financial Times refers to it as the "doomsday cycle."

Writing in an opinion piece for the paper on January 19, 2010, Peter Boone and Simon Johnson suggested that the Western nations are now behaving much like the USSR in the final years of communism's decline. "Soviet bureaucrats argued for futile tweaks to laws that would crack down on speculators and close 'loopholes,' "they write, rather than biting the bullet and starting over from scratch.

The article claims that our financial system is going through the same futile motions and running a doomsday cycle with proposed little tweaks like the bank tax. When the system fails, "we rely on lax money and fiscal policies to bail it out," the authors say, which teaches the players that they should take big gambles and earn a lot of money. "And don't worry about the costs-they will be paid by taxpayers (through fiscal bailouts), savers (through interest rates cut to zero) and many workers (through lost jobs). Our financial system is thus resurrected to gamble again-and to fail again. Such cycles have been manifest at least since the 1970s and they are getting larger."

What an interesting time to be a financial advisor!

Mary Rowland can be reached at [email protected]. She has been a business and personal finance journalist for 30 years and has written two books for financial advisors: Best Practices and In Search of the Perfect Model.