Lessons for the Next Crisis
It is now just over 10-years since the US Stockmarket (S&P 500 Index) hit what was its highest point before losing more than half its value over the next year and a half during the global financial crisis. Over the coming weeks and months, as other anniversaries of major crisis-related events pass (for example, the bank run on Northern Rock or the collapse of Lehman Brothers), there will likely be a steady stream of news looking back and drawing conclusions about today’s investment environment. It is, of course, difficult to draw useful conclusions based on such observations; financial markets have a habit of behaving unpredictably in the short run. There are, however, important lessons that investors might be well-served to remember: Capital markets have rewarded investors over the long term, and having an investment approach you can stick with – especially during tough times – may better prepare you for the next crisis and its aftermath.
Benefits of Hindsight
In 2008, the stock market dropped in value by almost half. Being ten years ago (and the subsequent excellent returns since) may make it feel less painful but at the time it felt very real! Crisis newspaper headlines were common and almost daily the then BBC reporter Robert Peston was predicting more doom and gloom.
While being an investor today (or during any period, for that matter), is by no means a worry-free experience, the feelings of panic and dread felt by many during the financial crisis were distinctly acute. You will probably remember your own. However whilst many investors reacted emotionally to these developments you will recall that you who were able to stay the course, stick with our investment approach and eventually benefit from the subsequent rebound in markets.
It is important to remember that this crisis and the subsequent recovery in financial markets was not the first time in history that periods of substantial volatility have occurred. With Dimensional’s help (see appendix) we have run a simulated balanced (60/40) portfolio through a variety of stock market crashes (ranging from the 1987 crash, through the dot-com bubble bursting and finally the bankruptcy of Lehman Brothers and the subsequent credit crunch).
Although a globally diversified (60/40) balanced investment strategy invested at the time of each event would have suffered losses immediately following most of these events, financial markets did recover, and in all cases provided substantial returns over the next ten-years. In advance of such periods of discomfort, having a long-term perspective, appropriate diversification, and an asset allocation that aligns with your risk tolerance and goals can help you remain disciplined enough to ride out the storm. As they say, it is always darkest before dawn!
In the minds of some investors, there is always a “crisis of the day” or potential major event looming that could mean the beginning of the next drop in markets. As we know, predicting future events correctly, or how the market will react to future events, is a difficult exercise. It is important to understand, however, that market volatility is a part of investing. To enjoy the benefit of higher potential returns, investors must be willing to accept increased uncertainty. A key part of a good long-term investment experience is being able to stay with your investment philosophy, even during tough times. A well‑thought‑out, transparent investment approach like yours really does help in times of uncertainty and gives you the ability to stick it out and ultimately capture the long-term returns of capital markets.