One Year Later: Lessons we (should have) learned from the crash
Filed under: Retirement, Economy, Investing, One Year Later
Toddlers learn to steer clear of a hot stove after they get burned once, maybe twice. Investors, however, can be a little slower on the uptake. This time last year, banks that were long thought to be "too big to fail" collapsed, investments that were considered safe imploded and retirement accounts got chopped in half. With such harsh lessons learned, some investors remain justifiably chastened. But now with the Dow inching back towards 10,000, it appears others have all-too-soon forgotten the events of last year.
Here are some of the lessons investors should have learned from the crash:
Lesson: Buy and hold doesn't always work.
The typical buy and hold advice goes something like this: Stay the course, ride out the market's swings and your portfolio will eventually bounce back.
Just try doling out that conventional wisdom to someone who was hoping to retire next year, or for that matter, five to 10 years from now. "If you're a long-term investor, your portfolio is now worth what it was worth in 1997," says David Hefty, a certified financial planner and chief executive of Cornerstone Wealth Management in Auburn, Ind.
That doesn't mean investors need to start day trading. Buy and hold still works in healthier markets, but in an environment like the one we're in now -- and may continue to be in for the foreseeable future -- investors need to be a lot more proactive than they've been in the past. "You have to abandon buy, hold and hope," says Hefty. "You have to be more nimble."
Hang onto a long-term investment strategy, but review that plan every six months to get rid of problem assets or make short-term changes, says Michael Kozak, director of wealth management at Cabot Money Management in Salem, Mass.
Lesson: Wall Street is not looking out for your best interest.
Wall Street's bankers and traders are in the business to make money -- often at your expense. "There is no such thing as unbiased advice coming from Wall Street." says Hefty.
The subprime meltdown is a prime example. During the housing bubble, Wall Street made monumental gains by repackaging subprime debt into complicated assets such as collateralized debt obligations. Bolstered by the housing bubble, demand for CDOs soared, surpassing the $1-trillion mark. Too bad many of the bankers touting these investments had no real clue about the true value of what they were buying and selling or the ramifications should the housing market go south (ahem, Merrill). When the bad debt was finally outed and the defaults started pouring in, the collateral damage (pardon the pun) was immense. Banks realized huge write-downs and the credit markets fell into a downward spiral.
If Wall Street is touting the next "big thing," proceed with extreme caution. Seek help from an adviser that has a fiduciary duty to look out for your best interest, says Kozak.
Lesson: Know how much risk you can stomach.
There's little doubt that investors felt helpless as they watched Lehman collapse and the markets fall into a downward spiral, but perhaps nothing was more dispiriting than when money market fund, the Reserve Fund, "broke the buck." In the 37 years since money markets had been around, only one other money market fund had seen its net asset value fall below $1.
Every investment carries some level of risk. The key is determining just how much of it you can stomach, says Carlos Lowenberg, president of Lowenberg Wealth Management Group in Austin, Tex. "Investors cannot view/use the stock market as a savings account," he says.
To help investors determine their risk tolerance, Lowenberg suggests dividing investments into three buckets:
Personal money you cannot afford to lose.
Market money you don't want to touch for several years
Aspirational money that's invested in riskier plays that you can afford to lose. "Some people may not have anything in that bucket," says Lowenberg.
Lesson: Always have an emergency fund.
Enough people have lost their jobs (7.4 million since the recession began in December 2007, according to the Bureau of Labor Statistics) to know that setting aside some cash for emergency situations isn't a luxury.
Typically, financial planners will tell clients that they need between three and six months of living expenses set aside in case of job loss, illness or some other financially devastating situation. But Lowenberg suggests that those with jobs that are at a higher risk of being cut, say in retail or financial services, should carry even more cushion than that.
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Reader Comments (Page 1 of 1)
9-18-2009 @ 6:22PM
Joe Duggins said...
You’re probably familiar with Murphy’s Law: “Whatever can go wrong, will go wrong.” It rears its ugly head when we least expect it. That’s probably why it’s called a law, not a theory. When it comes to personal finances, old Murphy really seems to know when to pile it on. Unexpected expenses and changes in your financial outlook are not a matter of “if”, but “when”. But all is not lost however, with a little prior planning, you can be prepared for when Murphy comes knocking.
It’s a great idea to always have a backup plan, especially when it comes to finances. When times of crisis hit, you’ll need an emergency fund to fall back on. Some cash set aside to deal with life’s little (or big) detours.
How Much?
That depends, really. What kind of lifestyle do you lead and how much will it costs to maintain that lifestyle if you’re out of work? Most experts recommend you save a minimum of three months worth of basic expenses. Figure out your monthly budget (you do have a budget, don’t you?), subtract expenses you can live without, then multiply it by the amount of time you think you’ll need the fund to rely on.
Keep in mind, three months contingency money should be an absolute minimum. If you’re single and have no dependents, the amount is going to be significantly less than if you’re married and have three kids. The more people you’re financially responsible for, the more money you should plan on socking away in this fund. If you have dependents, look to save at least six month’s worth of expenses.
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9-18-2009 @ 11:31PM
ryan said...
That piece of advice about having 6months or more living expenses in case of emergency just sitting around sounds nice. But really, how many average american's really can do this? I suspect a good amount are living paycheck to paycheck let alone 6 months!
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9-19-2009 @ 10:25AM
Eduardo Alarcon said...
I know the Carlos H. Lowenberg mentioned in this article. I would NEVER do business with him again. He's a salesman for the National Heritage Foundation.
Eduardo Alarcon
19319 Inverness Dr.
Spicewood, TX 78669
(512) 217-6655
eduardo.alarcon@sbcglobal.net
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9-19-2009 @ 1:25PM
j.gleason said...
YES THE FED.GOV.HADE TO STEP IN.BUT PEOPLE IN CHARGE OF THE MONEY SYSTEM SHOULD HAVE BEEN STRIPED OF ALL THERE WORTH REAL OR OTHER WISE AND RECEIVED LONG PRISON TERMS FOR TREASON TO THIS COUNTRY FOR THERE GREED.GREED IS WHAT STARTED IT ALL
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9-19-2009 @ 2:47PM
satrianivia07 said...
To those to say it is unrealistic for the average american to have a 6 months emergency fund are wrong. What is unrealistic is for americans to live above thier means and barely save a dime for the future. There are always ways to reduce expenses and at times that means going with out some things.
Also to say buy and hold doesnt work is half true. The reason for its half truth is that most investors dont want to actually work to invest, aka due research and know what they are investing in and what it is worth and buy it only when it is on "sale." Then the research continues to stay aware of whether your investment still matches your criteria or take profits when it gets over valued. If the investment cont. to meet your criteria but agian drops below what it is truely worth but the underliying business is the same then buy more. The problem is no one wants to do the work needed for this to be successful or lacks the discipline to do this.
For the lazy investor then setting a base level of cont investment and using dollar cost averaging works to your advantage and if you apply the technique of doubling your contribution when the markets have had moderate and strong pullbacks you could even further, in theory, increase your returns. The authur says you shouldnt resort to trading but says assess your portfolio every six months and then reassess and adjust. Had you last checked your portfolio in Aug 2008 and then not checked agian till say Feb 09 and removed a sig portion of your portfolio out of stocks. You would have pulled money out near the bottom and then had you checked agian in say 6 months you would have missed a huge rally and still have had a huge loss. That is the same mistake most people make which results in at best mediocre returns.
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