Plus ça change, plus c’est la même chose.

Exactly, one year ago Lehman Brothers collapsed, triggering a worldwide financial meltdown that threw millions out of work and devastated the retirement savings of many more millions. One year later, the economy and the stock market have recovered from the near-death experience, though not fully just yet. While some aspects of the financial crisis were surprising, many of the lessons of are timeless and shouldn’t be surprising at all:

  1. Live within your means. If there is a golden rule in personal finance this is it — spend less than you earn. Unfortunately, many had forgotten this basic rule, lulled into complacency by sunny skies, easy credit and a distant memory of the previous recession. Our savings rate was negative and many were unprepared to handle tough economic conditions. It doesn’t seem that this lesson has still sunk in — a depressing recent report suggested that Canadians have trouble establishing a savings habit.
  2. Keep an emergency fund. For me, this is the most important lesson of the financial crisis. I had believed earlier that a line of credit can serve as an emergency fund but not anymore. Though it never actually came to that, this crisis has amply demonstrated that a line of credit could be cut back or even become unavailable in a serious financial crisis — precisely when we may need a credit line the most. Now, I think a stash of cash that will cover three to six months of expenses is absolutely essential, despite the low returns and tax inefficiency of cash holdings.
  3. Use leverage responsibly. Back in 2007, leverage was very fashionable. Credit was cheap and plentiful and the TSX had returned an average of more than 20% for four years and for many, it seemed a no-brainer to borrow at a net of 3% and earn double-digit returns in the stock market. The stock market crash has exposed the risks in such a strategy — it is hard enough watching your own savings evaporate; it must be excruciating to think that you have to make up the difference to a lender. Leverage is unavoidable in certain cases such as buying a home or getting an education but still it must be approached with caution.
  4. A home is not an investment portfolio. With home prices trending upward year after year, a lot of investors fell into the trap of thinking of their home as an investment that could somehow be used to fund a retirement. The collapse of home prices in the United States is once again a reminder that homes are not immune to price corrections and it is best to think of a home as simply a place to live and raise a family — any price appreciation is simply a bonus.
  5. Stock markets can go down in a hurry. Benjamin Graham wrote in The Intelligent Investor: “In any case the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent one-third or more from their high point at various periods in the next five years.” Somehow, investors are surprised when stocks do just that.
  6. Bonds have an important place in a portfolio. As unsexy as bonds are in bull markets, they really shine when stocks drive off a cliff. Firstly, bonds cushion the fall of stocks in a portfolio. Second, they enable an investor to take advantage of low stock prices through rebalancing. Note that bonds here refer to Government bonds, not corporate bonds, which historically have a high correlation with stocks. In the stock market panic of 2008, corporate bonds offered no protection and dropped just like stocks.
  7. Asset allocation still works. The widespread reports on the death of asset allocation are vastly exaggerated. It is true that stocks fell in lock step around the world. However, bonds, as noted earlier, held up their value and cushioned the fall in stock prices. That is exactly how we expect asset allocation to work — reduce the risk of a portfolio by adding asset classes that don’t move in sync together.
  8. Market timing still doesn’t work. The S&P 500 opened at 1,250 on that fateful morning on September 15, 2008. It closed at 1,049 yesterday for a loss of 16%. Add in dividend payments and you are probably looking at a modest loss. It didn’t always look that way. At one point, stocks would have been down by 47% and the market timers came out of the woodwork claiming that investors could have avoided the entire mess by following their timing model. The critical question though is: how many got back into stocks to take advantage of this rally?
  9. Do not load up on company stock. It is like watching the same horror flick over and over again. Every time a company fails, you read press reports of employees who have lost their job as well as their life savings. It happened with Bear Stearns; it happened with Lehman Brothers and probably every other company that filed for bankruptcy in the past year. We already depend on our employer for a paycheck; it doesn’t make much sense to compound the risk by investing our savings in our employer as well.

What lesson did you learn (or relearn) during the past year?

This article has 20 comments

  1. I learnt that I can keep my cool through a big drop in stock prices with 100% of my long-term savings allocated to stocks. Apparently, this isn’t for everyone, but I anticipate better long-term returns that portfolios that include bonds.

  2. The lesson I learned was to stick to a good plan even if the market is going crazy. The automatic transfer to my RRSP kept me from doing anything dumb when the market was going up & down. Twice a month, like clockwork, and it keeps me from meddling.

  3. I’d also add keep some cash on the sidelines specifically *for* major stock price pullbacks. Only once you have your emergency fund, etc., all in place, of course. It was hard to keep buying in October and then February, but if you know you’re buying a quality company with long-term growth, it can be worth it. Now I wish I’d been able to make more discounted purchases. (I’m talking conservative names, here, like the Canadian banks, etc.).

  4. That doing nothing is sometimes better than doing something. I kept being asked what I was doing during the market fall and I said nothing. A paper loss is just that.

    If you have a good plan, as Jaime said, stick to it and don’t be active for the sake of being active.

  5. Market timing doesn’t work? Huh! That’s a head scratcher for me. As you know I use market timing and 2X ETF’s. My trades are available for all to see on Covestor and over the past twelve months I beat the S&P/TSX by 37.7%. Market timing isn’t easy because there are rules to follow and emotions make it difficult to follow rules.

  6. That’s a comprehensive list of good lessons. I suppose my learnings are more or less the same.

    1. Live within your means – know what earn, know what you spend.
    2. Maintain a cash cushion, for 2 reasons. First, for the unforseen emergencies like job loss, and second, for big ticket lump sum expenses that are easy to forget about. On top of the 3-6 months cash designated for bad events, it’s a good idea to be saving the money you know will be required at some point in coming years for a car purchase, new roof on the house, furnace/AC replacement, new deck, new floors. If you fail to put money away for these things in advance, you will have to assume more debt at the time. For example, I have a savings account collecting $300/mo for the day 5 years (hopefully) from now when I will have to replace a car.
    This approach is the philosophy of those who want to see debt continually reduced, and will not find favour with those who prefer a certain amount of leverage – financing purchases at low interest rates, and investing in a rising stock market. Beware, per CC’s no. 3.
    3. In the tense moments of November when the financial world was collapsing around us and jobs were hanging by a thread, I really came became aware of the common reliance on 2 incomes to fund household expenses (the 2 Income Trap, Elizabeth Warren, etc). We all need to plan for and be aware of the impact that job loss, parenthood, and disability would have on our situations. Specifically, this means making concious decisions on the level of debt you want to assume today, based on income and lifestyle events tomorrow.
    4. And like others, I’ve learned that I don’t care a whit when investments are down 35%. Nice to be young I suppose – I don’t think I would take it quite as well in 20 years.
    5. The company stock item is interesting as well – I’ve had a few opportunities to buy company stock over the years and always turned it down. I’ve never believed in putting eggs in the same basket.

  7. Canadian Capitalist

    @Michael: Yes, some may be comfortable with a 100% equity portfolio. As I wrote in an earlier post, I was so comfortable with my own asset allocation that I wondered it was more conservative that I could live with. For now, I’m not making any changes but I did wonder…

    @Jamie: Reports indicate that the much maligned “average” investor did just that — kept investing through the crisis in their retirement accounts.

    @MoneyEnergy: That is something to consider. Personally, I don’t have allocation to cash in my portfolios but perhaps, a 5% allocation may be suitable. I’ll have to think about this because it should be weighed against the fact that cash could be a drag on performance. As it is, I think my allocations are more conservative than I like.

    @Thicken: Yes, sticking to a reasonable plan is a good lesson, something often lost sight of in times of panic.

    @Ben: Good points, especially #2. That’s my biggest lesson from the crisis. Relying in a line of credit is not without its risks. It may not be available when it is most needed.

    Personally, I participate in a ESPP program at work myself. However, I have an iron-clad rule: I’ll sell the shares as soon as they are purchased under the program.

  8. Canadian Capitalist

    @Fred: I remain skeptical that market timers as a group are able to beat the markets. That doesn’t preclude the possibility that some will — I just don’t know who will in advance. I’ll readily admit that your timing efforts so far have been very impressive but I can only go by the long-term record of timers as a group, which isn’t very impressive at all.

  9. Hello everyone. A great post today, and interesting comments. I guess something I’ve learned (although I knew it intellectually) is that the market is related but different than the economy. I was really surprised to see the market sharply recover while the economy still looked horrible.

    Like Michael James, I also learned that I’m able to ride the downturns without losing my head even though I’m 100% in stocks. Since everyone keeps comparing this downturn to the Great Depression, I don’t think we’ll see a collapse like this for awhile, though I might be wrong.

  10. It’s easy to forget how painful the market decline was now that it is back up. Bear in mind that the world’s credit system was days away from complete collapse. Had the actions taken not worked, many investors would be in a much different frame of mind (and financial position) now.

  11. Did anyone see this discussion today on the Globe? http://www.theglobeandmail.com/globe-investor/investment-ideas/buy-gics-only-gics/article1292666/ I know CC posted an article about Mr. Trahair’s claim’s last week but I notice on today’s discussion he’s including dividends in his calculations of TSX performance. I just can’t believe his analysis is correct.

  12. Actually, I learned that it may be better to NOT have a buy & hold attitude and maybe it is better to sell when you’re up on the investment. That flies completely contrary to your “stick with a plan” and “maintain your asset allocation” lessons. I used to hold those philosophies but in retrospect, it would have been so much nicer if I had sold when I was thinking of selling.

    Luckily I did sell enough of my portfolio to wipe out all of my leverage or else I’d be in REAL deep doo-doo. I just wish that I didn’t stop there and kept selling until I was almost all in cash or fixed income. I had a hunch that everything was going south soon, but I stupidly chose to stay in the market, albeit wiping out all of my leverage.

  13. Larry: Asset allocation doesn’t work as well as it did in the past. Sure bonds held up this time, but what other assets did as well as bonds?

    IMHO there are better methods to insure the value of a portfolio. Most people accept the fact that you cannot time the markets. But why do they all believe that you will know which other assets to hold along with stocks?

    To: TMWallet. Considering a ‘paper loss’ as ‘just that’ ignores reality. The money has been lost. Sure you can earn a profit going forward, but right now it’s a loss. The money cannot be spent, loaned, or used as collateral.

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  15. One thing that is neglected in the mainstream media, when they quote “the markets have gone up xx% since March 12-09” is the total dismay, ugly outlook, and the possibility of financial meltdown that was prevelent around that time. It DID look extremely gloomy at that time, and yes, it COULD have gone that way.

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  17. I can’t believe how many of my friends invest in company stock and think that counts for proper financial planning? What also scares me is most of these companies are hiring “financial advisors” to help employees purchase more stock options and “plan for the future”?

    Can you say, eggs in one basket? So sad.

    Mike

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