The market decline from October 2007 to early March 2009—known as the Global Financial Crisis—was the worst since the late 1930s. Stocks dropped 60%, investor uncertainty skyrocketed, and trust and confidence were shattered.
As we mark the 10-year anniversary of the start to the Global Financial Crisis, what have we learned?
The importance of a written investment plan. The fallacy of “waiting for signs.” The protection offered by bonds. The prudence of rebalancing. Evidence shows that investors who adhere to these lessons protect and grow their wealth, even through turbulent times.
Lesson 1: Stick to Your Plan
While being an investor today is by no means a worry-free experience, the feelings of panic and dread felt by many during the Global Financial Crisis were distinctly acute.
Unemployment was on the rise, banks were failing, and millions of Americans lost their homes. The decline in global stock markets, the speed of which was nearly unprecedented, wiped out more than twelve years of gains. Investors around the world were left anxious and frustrated by each day’s news, and fearful of the financial pain tomorrow’s markets would bring.
It is precisely for times like this that we develop a written investment plan for each new Vista client. A written investment plan outlines each client’s financial goals and time horizon, tolerance and capacity for risk, and the expectations and guidelines for how the portfolio will be managed.
A prudent investment plan incorporates, before a dime is ever invested, the inevitability of market turbulence. When times get tough, investors can refer back to their investment plan—crafted during a time of relative calm and reflection—to be reminded of their long-term goals and the most sensible strategy to achieve them.
When every fiber in your body tells you it’s time to “do something different,” and gut instincts are reinforced by prominent magazine covers depicting Depression-era soup lines, a written investment plan helps you resist the temptation to engage in emotional, short-term moves. And how investors behave over the decades to come matters more than how their portfolio behaves in the days to come.
Lesson 2: “Waiting for a Sign” Will Cost You
Investing involves uncertainty. It requires giving up a great deal of control and subjects investors to sudden, severe and upsetting short-term drops in the price of their investments. The Global
Financial Crisis was the most extreme example of this since the early 1930s.
By mid-2008, it was common to hear investors say, “I don’t see any signs things will get better.” And they were right—there were no such signs.
By March 9, 2009, large and small cap stocks in the U.S. had each fallen over 50% from their highs, while emerging market stocks had dropped more than 60%. Global REITs were down close to 70%.
That very same day, legendary investor Warren Buffett suggested the U.S. economy had “fallen off a cliff.” Buffett further predicted any economic recovery wouldn’t happen fast, the unemployment rate of 8.5% would continue to rise, and looming inflation had the potential to surpass peak rates last seen in the 1970s.
Amidst this gloomy backdrop, who would have thought stocks would begin rising that very next day?
Likely no one. But they did—moving sharply higher—even though the economy was still fully in recession.
In fact, the U.S. recession didn’t end until four months later in June 2009, according to the National Bureau of Economic Research (NBER). Of course, the NBER didn’t announce the end to the recession until September 2010, a full fifteen months after stocks stopped falling and had begun their swift ascent.
Investors intent on waiting for sure signs the worst was over missed out on high double-digit returns for the S&P 500 (+61%) and small value stocks (+76%), and triple-digit gains for global REITs (+116%) and emerging market stocks (+125%).
Lesson 3: Don’t Take Risk With the Safe Part of Your Portfolio
The economic recession that coincided with the Global Financial Crisis was the longest since World War II. During those sixteen months, U.S. stocks posted negative monthly returns twelve times.
During such periods of extreme market distress, the value of truly safe assets cannot be overstated.
While some investors have the ability and willingness to own an all-stock mix, having a portfolio asset that maintains (if not increases) its value during rough markets can help more risk-averse investors avoid one of the biggest, yet most common, mistakes: giving up on stocks and selling when prices are down.
U.S. Treasury bonds have historically been the most effective hedge against sharp stock market losses. During the Great Depression, when $1 in small company stocks withered to just ten cents, U.S.
Treasury bonds gained 20%. In 2008, U.S. Treasuries again offered this unparalleled protection, gaining 11% while the S&P 500 Index lost nearly 40%.
Keep in mind, that same year corporate bonds slid 5%, high-yield bonds dropped 25%, and dividend-paying stocks lost 32%. Master limited partnerships (MLPs) and commodities fell 37% and 47%, respectively.
Simple, yet safe Treasury bonds helped prevent a terrible year from turning into a disaster. While they may not promise high long-term rates of return, safe bonds do offer one very reliable feature not always provided by more fashionable alternatives: they tend to hold up when investors need them most.
Lesson 4: Eat Your Broccoli and Rebalance
A key ingredient of any sound investment plan is a long-term asset allocation. This target mix of stocks, real estate, bonds and cash should prudently reflect an investor’s goals, time horizon, risk preferences and income needs.
Over time, however, performance differences of each asset class will cause them to drift from their original targets. This was certainly true in the Global Financial Crisis, as asset classes around the world plummeted in value, save for the safest bonds.
A disciplined rebalancing strategy restores a portfolio’s target mix, and in so doing serves an essential purpose—to manage risk. Rebalancing reinforces the decision to adopt a target asset allocation in the first place, adheres to the investment ideal of “buy low, sell high,” and helps investors stick with the original plan.
Like eating your broccoli, rebalancing is good for your financial health. But it isn’t easy, and it rarely tastes good in the short run.
During the Global Financial Crisis, many portions of well-diversified portfolios plummeted 40%, 50% and 60%. Rebalancing required buying more of these asset classes, even though it seemed there was only more pain to come.
And how were these purchases financed? For those not able or willing to add new cash to their portfolios, by selling the only asset class to have held its value—safe Treasury bonds. Without question, rebalancing forced investors to swallow hard.
Despite the perceived short-term pain, rebalancing in 2008 and 2009 proved beneficial in two key ways: First, a rebalanced portfolio experienced lower volatility relative to a portfolio left to drift with the market. Second, and perhaps of greater comfort to investors stung by the markets’ swift decline, a rebalanced portfolio fully recouped its losses by September 2010, months sooner than a portfolio never rebalanced.
While past results aren’t guaranteed in the future, they do offer an example of rebalancing’s potential benefits and the rewards of sticking to the plan.
Go Forward With Confidence
While no one knows for certain what markets will do tomorrow, accurately predicting the future isn’t necessary for investment success. Sticking to sound investment lessons is.
Have a written investment plan and follow it over time. Don’t fall into the trap of “waiting for signs.” Keep a portfolio asset—only the safest bonds will do—that maintains its value when all others are faltering. Eat your broccoli by rebalancing.
If these lessons sound familiar, they should. They are all already built into every engagement we have with our clients.
For now, let’s enjoy the returns we’ve experienced since the last market crash and appropriately frame our expectations for the future. Above all, remember that a little broccoli goes a long way—a well-diversified and regularly rebalanced portfolio remains the best way to emerge financially healthy—regardless of what markets have in store.