5 years later: Lessons from the crash

Lehman Brothers’ collapse in September 2008 sent stocks on a terrifying ride. A year-by-year look back reveals five key takeaways you need to heed today.

  • Lehman Brothers implodes

    Five years ago, you witnessed the worst panic unfold on Wall Street since the Great Depression.

    As home prices fell and mortgage-backed securities soured, the pillars of the nation’s financial system — from investment banks led by Lehman Brothers to thrifts such as Washington Mutual to the insurer AIG to mortgage giants Fannie Mae and Freddie Mac — toppled like dominoes.

    Among the eventual losses: 5,000 points on the Dow Jones industrial average, $7 trillion in wealth, and, of course, your faith in the financial system.

    Fast-forward to the present, and the Dow has returned to pre-crisis levels and is back to setting new highs.

    As you look at the key events that transpired since Lehman’s collapse, you’ll find lessons big and small that are as relevant as ever. It turns out that for better or worse, things haven’t changed nearly as much since the crisis as you might have expected.

    On the slides that follow is a year-by-year look at key events in the financial crisis, with the main lesson to take from each of them.

    Related: What’s your money state of mind?

  • Lesson 1: Don’t bank on one sector

    September 15, 2008: The turmoil after Lehman’s collapse was different — and more frightening — than the tech crash in 2000.

    This time the stocks that took the biggest hits weren’t shares of profitless startups. They were financial titans — some more than a century old — that produced a third of the market’s profits and dividends. No wonder these blue chips were fixtures in many retirement portfolios.

    The love affair is clearly over. Or is it? Financials have been the market’s best performers since September 2011, posting annualized gains of 39%.

    As a result, bank stocks, which made up less than 9% of the S&P 500 in 2009, based on total stock market value, now represent more than 17% of the broad market. That means they’re probably among the biggest holdings in your stock mutual funds and ETFs.

    To limit further exposure, stick with funds that focus on pristine balance sheets and consistent earnings, such as MONEY 50 fund Jensen Quality Growth , where financials make up less than 4% of assets.

    More takeaways from 2008

    October 16: In a month when investors yank $71 billion from equity funds, Warren Buffett says buy U.S. stocks.The moral: You have to be willing to go against the crowd, and fund flows are a good contrarian indicator.

    December 11: Bernard Madoff is arrested in largest Ponzi scheme and financial fraud ever. The moral: Investments that seem too good to be true are. Madoff also demonstrated the risk of letting a single fund manager or financial adviser oversee your entire portfolio.

    Related: Millennials Have No Idea Who Bernie Madoff Was

  • Lesson 2: Buy and hold works – eventually

    March 9, 2009: When the Dow fell to 6547 that day, stocks had already lost more than half their value. And equities wouldn’t fully recover until 2013. So it may seem that investors who pulled $25 billion out of stock funds in March and $240 billion — plowing that money into bonds — over the next three years were on the right track. They weren’t.

    March 2009 marked the start of a bull market that saw stocks return 174% so far, vs. 25% for bonds.

    Had you simply hung on to a basic 70% equity/30% bond strategy from Sept. 1, 2008 — when things started to get scary — you’d have earned more than 7.5% a year. That’s not far off the 9% historical annual return for this mix over five-year stretches since 1926. Of course, you’d have earned that only by staying the course.

    More takeaways from 2009

    March 31: The price/earnings ratio for stocks, based on 10 years of averaged profits, falls to a generation-low 13.3. The moral: The price you pay for stocks is the single biggest determinant of future returns. Since March 2009, the S&P 500 has gained 22% annually.

    October: U.S. unemployment rate peaks at 10%.The moral: Emergencies don’t happen just to other people. Set aside six months of expenses in cash — a year’s worth if you’re over 50, as your job hunt will take longer than a 30-year-old’s.

  • Lesson 3: Reaching for yield can fail

    January 11, 2010: When stocks fall, the stability of cash can cushion the blow. Yet things don’t necessarily work out that way.

    Just ask shareholders of Schwab YieldPlus. This so-called ultrashort bond fund — which was marketed as a cash alternative, though it really wasn’t one — fell 35% in 2008 when the mortgage securities that provided the “plus” in the fund’s name turned out to be riskier than thought. (Schwab settled the charges in January 2011 but did not admit wrongdoing.)

    Before that, there was the Reserve Fund, the first money fund in 14 years to lose value in part because it tried to boost payouts by holding some Lehman debt.

    It makes no sense to take risks with your rainy-day savings, a lesson that’s worth remembering today. Since early 2009, investors have poured $73 billion into floating-rate bond funds, which buy short bank loans that offer higher payouts than basic cash. And $33 billion has gone back into ultrashort bond funds.

    More takeaways from 2010

    May 6:The Dow mysteriously drops 1,000 points in a “flash crash” blamed on computer trading models. The moral: Rapid-fire programmed trading is yet another reason individuals should just stick with buy and hold.

    December 31: Fidelity reports average 401(k) balances have recovered from the financial crisis. The moral: Between December 2007 and December 2010, 401(k) balances rose about 1% annually, while stocks lost close to 3% a year — proving that saving is your most reliable retirement planning tool.

    Related: How much do I need to retire?

  • Lesson 4: Diversification works

    In 2008, only one type of diversification seemed to pan out: your basic mix of stocks and bonds. Among equities, everything pretty much fell in lockstep.

    February 2012: Fast-forward more than three years, when the financial crisis unfolded in a different guise — this time with the debt crisis in Europe. Fear of government defaults peaked in early 2012, with rates on Greek debt reaching 29%.

    Diversification worked here, too, but also in a different guise.

    While conventional wisdom said investors should flee the continent, European shares wound up beating the world in 2012, returning 20.3%. The year before that, it was U.S. stocks that performed the best (despite Uncle Sam’s fiscal woes). And so far in 2013, Japan is leading, despite having just been in another recession.

    Spreading your bets globally eventually pays off, especially given how mercurial equities can be. For investors who are hearing that the U.S. looks like the only promising market these days, this is a clear lesson to heed.

    More takeaways from 2011-2012

    August 5, 2011: In response to the budget stalemate, S&P strips the U.S. of its AAA credit rating. Ironically, Treasuries post their best week in two years. The moral: U.S. debt remains the world’s safe-haven investment of choice, despite Uncle Sam’s fiscal troubles.

    January 31, 2012: Spurred by anemic bond yields, investors pour money into dividend funds, leading to worries of a “dividend bubble.” The moral: While this fear is overblown, it’s a useful reminder that no matter how appealing income-paying shares are, they’re far riskier than bonds.


Market Timing: Not a Good Retirement Strategy

I’ve been working for five years now and save religiously for retirement. But I feel that I’ve begun investing at a bad time for the markets. Most of all I worry about what will happen to my 401(k) if the market tanks again. Am I right to be concerned? — Aaron, Nashville, Tenn.

It would be nice if I could assure you that the market gyrations that have spooked investors recently and over the past dozen years — i.e., stock prices dropping by 50% or more in 2000 and 2007 — aren’t likely to occur again. But I can’t do that.

If anything, recent research shows that these sorts of gut-wrenching episodes — while not exactly the norm — are likely to occur more frequently than we previously believed. So I can virtually assure you that over the course of your career, the market will tank many times.

But I don’t think that’s something you should worry about when you’re investing for retirement. Investors have gone through many tough times before.

Since 1929, we’ve had 14 recessions and 13 bear markets, an average of about one of each every six or so years. And each time stock prices eventually recovered from these setbacks and climbed to new highs. I see no reason for that dynamic to change.

Besides, as counterintuitive as it may seem, you may actually be better off starting to invest in a lousy market if you’re just beginning to save for a retirement that’s many years down the road.

Related: What is an index fund?

A T. Rowe Price study from a few years ago examined how four hypothetical retirement investors who put their savings into a diversified portfolio of stocks would have fared over four different 30-year periods depending on whether they began investing on the eve of a bull market or a bear market.

I’ll spare you the details, but the upshot is that the investors who got their start in a bear market accumulated more than twice as much in savings as those who began investing on the verge of a bull. The reason: the shares that investors acquired at depressed prices during a setback soared in value as the market rebounded, significantly boosting the eventual size of their nest egg.

Of course, neither you nor I really know whether this is, as you fear, “a bad time for the markets.” Bear and bull markets are easy to identify in hindsight, but difficult to impossible to predict in advance. If that weren’t the case, everyone would get out of the market just before it drops precipitously and jump back in just as prices are rebounding.

So it makes little sense to try to time your retirement saving and investing based on what you think the market may or may not do. The most you can do is play the cards you’re dealt as best you can.

As a practical matter, that means investing most of your retirement savings — say, 70% to 90% — in stocks at the beginning of your career when you have plenty of time to recover from those inevitable market downturns. As you get older, you can begin shifting more of your savings to bonds.

You can expand beyond a simple stocks-bonds portfolio if you like. But don’t feel you have to load up on all the gimmicky little niche investments Wall Street’s marketing machine churns out. In general, a simpler mix is better.

Related: What is the right mix of stocks and bonds for me?

By the time you’re ready to retire — and more interested in protecting your nest egg than growing it — you probably want to have roughly 50% of your savings in stocks and 50% in bonds. For a guide of how to achieve this transition, you can check out the “glide path” of a target-date retirement fund. After you’ve retired, you can then shift your focus on the best way to turn your savings into retirement income.

But however worrisome you may feel the outlook for the economy and the markets may seem today, what with the constant talk of the fiscal cliff at home and the debt crisis abroad, you would be making a big mistake if you let your anxiety sidetrack you from continuing to save diligently for retirement and putting 401(k) money into the investment that’s generated the highest long-term returns in the past and is likely to do so in the future — stocks.


Investment Advisers See Some Bright Spots

Nearly 60% of independent advisers think a double-dip recession is unlikely over the next six months, and more than 60% expect the S&P to increase in the same period, according to a survey released recently by Charles Schwab.

But don’t go betting the farm on these optimistic findings just yet. A look at the results from January’s survey of advisers shows that they aren’t necessarily the best augurs. In that earlier survey, 49% of advisers expected inflation to increase in the next six months (it hasn’t); 47% expected consumer spending to increase (it hasn’t); and 40% expected unemployment to increase (it hasn’t). Advisers did get some things right, though. In the January survey, 59% expected consumer savings to increase in the next six months (it did); and 46% thought the housing market would continue to soften (it has).

Schwab acknowledges that the survey has limited forecasting value. “We’re thinking [the study] is more like a national view of what’s going on,” says Bernie Clark, executive vice president for Charles Schwab Advisor Services. “It’s not a predictor as much as where we think that the trends are taking us.”

And what looks like the dominant trend these days? The biggest challenge facing advisers and their clients right now, Clark says, is what he calls the “uncertainty factor.” About half of advisers’ clients feel less optimistic about the economy than they did in 2009. Forty percent of advisers say their clients are less optimistic about their investment performance than they were six months ago, and 50% of advisers say their clients feel less confident they’ll be able to retire when they want to. Advisers report that 47% of clients are reducing expenses, and more than half are spending less on discretionary items.

Advisers have their own doubts, too. Seventy-one percent say it will be difficult to achieve their clients’ financial goals. That’s down from the 84% who held that opinion in early 2009, but up from the 58% who expressed these doubts earlier this year.

In any case, people are increasingly turning to independent advisers for help with financial planning. More than 9 in 10 advisers said they received new assets in the past six months.

For the record, the sector of the market that advisers think will perform the strongest over the next six months is information technology, cited by 47% of them. Of course, if you have your doubts about advisers’ predictive powers (see above), maybe you’d also like to know the sector in which they have the least confidence. And that’s consumer discretionary—the pick of only 9% of professionals. Check back in six months to judge their accuracy.

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