Lessons from the 2008 financial crisis
Lessons from the 2008 financial crisis
In September 2008, the brokerage firm Lehman Brothers collapsed due to risky trading in poorly designed securities. This kicked off one of the more dramatic financial crises in American history and what is now referred to as the Great Recession. The 10th anniversary of this event is a natural time to reflect on what we learned from it. Below, in our outline of six fundamental elements of an investment philosophy, we consider: what we thought before the crisis, the common themes during the crisis, what we thought about those themes then, what happened, and what we think today.
Market timing
What we thought before the crisis: Trying to move in or out of markets in anticipation the market will move is a high-risk approach. Over time, it is unlikely to produce superior results.
What were the common themes then: “Buy and hold” is dead. Get out now! You must protect yourself.
What we thought about those themes then: “Buy and hold” doesn’t mean buy and ignore. Have a solid financial plan in place. This is likely to be a good time for some tactical moves within the context of each family’s long-term strategic plans but speculating on the market’s next move is not one of them.
What happened: Markets were very volatile into early 2009, then rose fast. The decade of the 2000s experienced two declines of over 50 percent in the U.S. stock market and recovered from both. If there was ever a time when market-timing could have paid off, it was the 2000s.
What we think now: We have heard many people claim to have predicted the decline or the rise, but we have yet to see any credible party with a verifiable track record beat the market by any appreciable extent over the last 18 years. To succeed, market-timers must be right more than once and by enough to cover the costs of acting on their hunches. Despite some of the best market-timing opportunities ever seen, the “Market-Timing Hall of Fame” remains an empty room. Market-timing is one of the least likely ways to be successful over one’s investing lifetime. Market-timing increases costs and the risk level of a portfolio. We recognize that at times, market-timing may be a tempting tactic, but disciplined investors will not succumb to the temptation. We are investors, not speculators.
Despite some of the best market-timing opportunities ever seen, the “Market-Timing Hall of Fame” remains an empty room.
The role of stocks
What we thought before the crisis: Globally diversified stock holdings are the best assets to own to stay ahead of inflation over long periods of time but are terrible for maintaining a specific value over short periods of time.
What were the common themes then: Capitalism is broken. The economy is in shambles. The market will not recover for years. Retirees have been devastated.
What we thought about those themes then: The economy is in bad shape and may take a while to recover. Capitalism is fine. Markets usually recover faster and before the economy does. Retirees who don’t panic and have sound plans should be fine.
What happened: Capitalism showed its resilience and the markets worked. Companies adjusted to the conditions of the time and stocks thrived. The economy was weak for years. The markets recovered in a relatively short period of time. The fastest rise came from the asset classes which did the worst during the downturn, such as foreign stocks and real estate. Markets recovered long before a patient, disciplined retiree would have had to sell investments to meet expenses.
What we think now: The excellent track record of diversified stock holdings for earning more than inflation over long periods of time looks even better today. It is still true that for truly diversified investors, there has never been a market downturn which failed to recover in a reasonable amount of time. We continue to expect stocks to decline often and dramatically over short time frames. We will seek stability from other sources.
The role of bonds
What we thought before the crisis: Globally diversified bond holdings of high credit quality and short to intermediate maturities are great assets to own and provide stability to offset the volatility of stocks. However, interest income will vary and bonds are not the best for staying ahead of inflation over long periods of time.
What were the common themes then: Interest rates must go up and when that happens, bonds will get crushed in a “bond market Armageddon.”
What we thought about those themes then: Regardless of when interest rates rise, good quality short to intermediate term bonds are less sensitive to rising rates and should provide stability to offset the volatility of stocks.
…when interest rates rise, good quality short to intermediate term bonds are less sensitive to rising rates and should provide stability to offset the volatility of stocks.
What happened: Interest rates remained at the low end of their historic ranges and have only increased notably over the last year or so. Total returns on the types of short to intermediate maturity bonds we favor have been low but stable. There has not been anything even close to a “bond market Armageddon.”
What we think now: Earning excess returns by predicting interest rate movements is as unreliable as trying to time the stock market. The primary purpose of holding bonds in a portfolio is to provide stability to counter the ups and downs of stocks. We continue to favor bonds with high credit quality and intermediate or short-term maturity dates. Income is a secondary consideration.
The role of rebalancing among diverse asset classes
What we thought before the crisis: The purpose of having an investment portfolio is to support a family’s goals. An intelligent rebalancing discipline manages risk and assures that portfolio maneuvers take advantage of the inevitable ups and downs.
What were the common themes then: Don’t buy stocks. They will go lower and stay lower. You will just lose more money. Don’t try to catch a falling knife.
What we thought about those themes then: We must do all we can to keep clients’ portfolios aligned with their goals. This is when patience and discipline are needed the most. The market may go down further but by rebalancing and buying at the depressed prices, the portfolio should recover sooner.
What happened: Markets remained volatile, but investors who exercised the discipline to stick with an intelligent rebalancing regimen and bought stocks in late 2008 and/or early 2009 likely recovered even faster than the market.
What we think now: The purpose of having an investment portfolio is to support a family’s goals. An intelligent rebalancing discipline takes advantage of market movements without having to predict market movements. This is prudent risk management and helps keep portfolios positioned properly.
The importance of tax management
What we thought before the crisis: With good tax planning, significant market moves present opportunities to save on taxes. Taxes can swamp, by many multiples, all other investment costs over one’s investment lifetime.
What were the common themes then: Who cares about taxes. Your nest egg is under siege. You need alternative investments such as hedge funds, managed futures, or products with guarantees like annuities.
What we thought about those themes then: Rubbish. Taxes matter and panicking out of tax-efficient portfolios to get into expensive, heavy tax-generating products of dubious quality, opaque histories, questionable track records, lock-up periods, or high risk makes no sense at any time.
Taxes matter and panicking out of tax-efficient portfolios to get into expensive, heavy tax-generating products of dubious quality, opaque histories, questionable track records, lock-up periods, or high risk makes no sense at any time.
What happened: Most alternative investments, such as hedge funds and managed futures programs, did poorly and still generated tax bills due to tax inefficiency. In fact, many hedge funds froze assets and closed entirely after posting catastrophic losses. The “guaranteed” products proved costly as people sold near market lows to get into products loaded with costs – all to pay for guarantees of dubious value.
What we think now: Taxes are by far the largest expense a portfolio may incur. We employ many tax management techniques but will only employ those strategies and tactics we believe will aid a client in reaching their financial goals. Strategies may include considering the tax efficiency of each investment, tax smart “asset location,” matching gains and losses when rebalancing the portfolio to minimize the tax effect, harvesting capital losses, deferring or accelerating the timing of a transaction into a more favorable tax year, and trying to qualify gains as long term.
The role of the media
What we thought before the crisis: Clients should expect volatility, not fear it. The financial media is an enemy of patience and discipline. Clients who can control or manage their intake of news are more likely to succeed.
The financial media is an enemy of patience and discipline.
What were the common themes then: This is the worst crisis since the Great Depression and things will get even worse. The Fed is printing money. The deficit will explode, causing the national debt to balloon, interest rates to spike and the dollar to collapse.
What we thought about those themes then: This is actually a crisis and not one of the many faux crises we have seen reported over the years. Though we don’t know how long it will take, the markets should recover regardless of which of these bad predictions come true.
What happened: Often referred to as the Great Recession, it was indeed the worst crisis since the Great Depression. The deficit and the debt increased substantially, but interest rates stayed near historic lows for the next decade and the dollar was as strong as ever.
What we think now: Clients should expect volatility, not fear it. The financial media is an enemy of patience and discipline. Clients who can control or manage their intake of news are more likely to succeed. The primary purpose of the financial media is to sell advertising. Provocative, even frightening, headlines draw attention. We do not believe in following investment gurus. We consider the mainstream financial media as an entertainment business and not a meaningful aid to sound decision making. We look for scientifically tested evidence, not media generated anecdotes.
The importance of financial planning
Going through the Great Recession reinforced our belief that real financial planning is valuable. Investing without a broader financial plan is like traveling without a map or GPS. Even if the destination is eventually reached, the journey will likely take longer, be more stressful and cost more.
Financial planning creates clarity about why portfolios are invested the way they are and a set of potential actions to be taken in good times or in bad. The crisis may have been emotionally draining, but it wasn’t a financial disaster to those who had a good plan and exercised discipline and patience.
