Numerous articles and interviews are recounting the implosion of Lehman Brothers ten years ago. Once that domino fell, we quickly realized how closely positioned world dominos were. Over the next six months the stock market fell another 46%.
People lost homes and jobs along with decades of accumulated wealth.
Instead of recounting every nuanced aspect of the financial crisis it is more instructive to discuss how people can protect themselves from the next crisis.
There will be another crisis, but it will be different, triggered by circumstances beyond an individual’s control over an unknown timeframe. As such, preparing can be difficult, despite non-stop “expert” predictions.
Our best guess is it will happen between tomorrow and 15 years from now. How’s that for precision? The financial markets become unhinged about once every 25 years.
Given so many scary things, what is an investor to do?
Focus on things within your control. Many issues have nothing to do with our own actions. Even if you are careful in your borrowing habits, you won’t be insulated by poor lending standards elsewhere.
Most financial and economic problems come from borrowing too much. Debt does not make you right or wrong. Rather, it magnifies the amount by which you are right or wrong.
There are many things an individual can do to lessen this impact.
Don’t live your neighbors’ life. Jealousy and envy are as harmful as any economic calamity. Live below your means on terms allowing you to borrow little, save and invest over decades.
Regardless of what a banker or finance department claims, borrowing is not a great idea; it puts you at risk. When times are good, borrowing deceptively makes the world look better. We can buy a bigger house, a fancier car or more stuff for our closet. However, this relinquish’ s control of your life to a bank, mortgage company or credit card company. Take control of your life. Use as little debt as possible.
Differentiate between needs and wants. This does not mean a vow of chastity. However, instead of splurging for an 82-inch TV, consider the 40-inch TV selling for a fraction of the price. Get the last generation Android phone instead of the latest iPhone.
Buy a 3 to 5-year-old used car versus a new car with 60 months of payments. Then drive it until the wheels fall off. This is true even if you get “zero percent” financing.
Owning a big house may be the trophy you think you want. However, it obligates you to a big mortgage, property tax, insurance and maintenance. Downsize your house…. or better yet, rent!
Be a value investor in every aspect of your life. Look for bargains.
Insure against things that are important, but unknowable, like hurricanes, car accidents and illness. Have your home, auto, life and health properly insured. Many personal bankruptcies begin with an expense, like a hospital visit, which snowballs from there. In thinking through this, never put yourself in a position to be wiped out.
Emphasize liquidity. Have enough cash on hand to cover six to nine months’ worth of living expenses. Then ask yourself what is most important in taking care of your family. Do you want $1 million dollars in cash and liquid investments or do you want to spend $1 million on stuff? Having $1 million worth of stuff means you no longer have $1 million worth of liquidity. Liquidity offers financial freedom.
Focus on long-term investing. As 2008 should remind us, bad things happen over short time frames. If you borrowed too much, and the market falls by 40%, you risk being wiped out.
Focus on where you want to be ten plus years from now. Ten years is generally long enough to power through a downturn and withstand an economic cycle.
Assume you invested the day before Lehman Brothers collapsed and the markets then fell by 40%. A year later you were still negative. However, if patient, you battled back to break-even in three years. If you stayed invested over the entire 10-year cycle you earned 11% per year or 130% cumulatively. Time heals many hardships in the investment world.
You will never stop market corrections or prevent things beyond your control. However, being proactive now will allow you to be properly prepared when the inevitable drop happens.