Standing at the precipice, the cash-laden investor turns to the aged guru and asks quietly, "Is now the time to get back into stocks?" After a thoughtful pause, the guru utters one word: "Depends." The investor stands motionless, awaiting the sage. Finally, the investor asks the obvious question, "Depends on what?" "How you get back in," the guru whispers.

Consider the guru's advice. For investors who exited their equity-based portfolios at some point and are now thinking of moving from the sidelines, there are basically two approaches: jump in all at once (lump sum) or ease in by degree (systematic investments each month or year). The past three years-2008, 2009 and 2010-present an interesting time frame in which to study these two reentry options.

TAKING THEIR LUMPS

In 2008, U.S. equities were gutted. In fact, 99.8% of all U.S. equity mutual funds had a negative return. This performance figure is drawn from the universe of distinct (i.e., only one share class per fund) U.S. equity mutual funds that have no more than 15% of their portfolio in cash, bonds or non-U.S. stocks-2,391 funds in total.

The average return for all these funds in 2008 was -37.8%. The worst return was -77.6%, and the best was 10.2%. But only four funds in this universe had a positive return.

In 2009, everything changed. Indeed, 99.5% of U.S. equity funds had a gain. The average one-year return was 32.4%. In 2010, the equity party continued, with 99.8% of the funds delivering a positive return. The average return in 2010 was 19.6% for the same group of funds. By the end of last year, it might have seemed reasonable to assume that the damage incurred in 2008 had been rectified. That is, funds that were beat up in 2008 are now whole after two solid years of positive returns.

Although that might seem reasonable, the concept is largely incorrect. Assuming a single $10,000 investment at the start of 2008, only 38.8% of the 2,391 funds produced a positive three-year annualized return by the end of 2010. That means more than 61% of the funds in this U.S. equity universe were still under water at the end of 2010 (see "Little by Little," on page 128).

Assuming that single initial investment of $10,000, the average three-year annualized return among this universe of funds was -0.9% (the median three-year annualized return was even worse at -1.3%). The average balance at the end of 2010 based on a $10,000 investment on Jan. 1, 2008, was $9,803. The largest ending balance was $22,142, while the lowest was $4,472.

Even after two great equity years, the majority of equity funds still had not recovered from the losses of 2008. Recovering from a huge loss can take years-and that's only considering the mathematics of financial recovery. Emotional recovery is tougher to quantify.

ADDING OVER TIME

There's an interesting twist to the past three years. The percentage of funds (noted in the chart above) that failed to produce a positive return from 2008 to 2010 is based on a common assumption-that of a lump-sum investment at the start of the period in question. In fact, it is this assumption that drives all of the reported performance data for stocks and mutual funds. If we change that assumption, the results are dramatically different.

For example, let's assume a client invested $10,000 systematically over the three year period. That is, he or she invested $3,333.33 at the start of 2008, added another $3,333.33 at the start of 2009 and then added the final $3,333.33 at the start of 2010.

This investing scenario essentially models an IRA investment in which the client makes an annual investment into his or her retirement account. In essence, the investor dollar-cost averaged during the three-year period of the experiment.

Under this systematic investing assumption, 99.3% of all the funds had an ending account balance in excess of $10,000 by the end of 2010. The average ending balance was $12,543.

The average three-year return for the dollar-cost averaging equity reentry approach from Jan. 1, 2008, to Dec. 31, 2010, was 11.6%. This outcome is quite different from the average three-year annualized return of -0.9%, assuming a single initial investment of $10,000. Interestingly, all reported performance figures (Morningstar, Lipper, etc.) are based on a single lump-sum investment.

Now consider another method of investing-monthly deposits into a 401(k) account. This may be the single most common way that people actually invest. This analysis assumes a monthly investment of $277.78 into each of the 2,391 funds starting on Jan. 1, 2008, and ending in December 2010. There were a total of 36 monthly investments over the three-year period for a total investment of $10,000.