Getting ready for the next financial crisis?

30 Jan Getting ready for the next financial crisis?

2017 was another bumper year from the global capital markets, as stock markets in the UK, US and Europe produced double-digit returns. Indeed, since capital markets fell spectacularly in 2008, the main asset classes have experienced an incredible return.

The chart below shows the value of hypothetical £1 invested in a simulated version of the TRAILS™ portfolios in June 1994 to December 2017.

Source: Dimensional. Data for illustration purposes only. Past performance is no guarantee of future results, and current performance may be higher or lower than the performance shown. The underlying indices may not be directly investible. Charges reduce return.

We’re now in the middle of one of the longest bull runs in capital market history. The global economy continues to be buoyant and patient investors have benefited immensely from this. However, it’s important not to get complacent. Indeed, if history is anything to go by, we can’t expect this positive trend to continue indefinitely. We’re not in the business of trying to forecast the future but history suggests that we should expect future returns to be lower than those we’ve seen in recent times. This is because the long-term returns of major asset classes tend to revert to their mean. So, the recent generous returns would suggest we should expect lower returns in the future.

No doubt, we’ll see a major financial crisis in the coming years. There’ll be a lot of panic. No one knows exactly when and how this crisis could hit. No one knows what to do to avoid it. Not even the people whose job it is to forecast the stock market. (And they often do a terrible job of this!) Even I have no idea; it may be next year, in five years or even before you finish reading this article (but let’s hope not).

The economic historian Professor Charles Goodhart of the London School of Economics observed, “almost by definition; a financial crisis is not predictable. If it had been predictable, agents would have taken defensive measures that would have defused the crisis before it hit.

Since records began, periods of economic boom are often followed by dramatic downturns. They’re part and parcel of a capitalist economy, and capital markets deliver returns, despite these crises!

In fact, the capital market is the greatest wealth creation machine ever invented. Over the last 100 years or so, the UK and US capital markets have delivered amazing returns to patient investors! The best an investor can do during these crisis scenarios is to ride out the storm.

So, here are a few ideas to help you prepare for a possible financial crisis:

  • Firstly, make sure your financial house is in order. Keep adequate emergency funds. Everyone is different, but we recommend between three to six times your monthly expenses.
  • Invest regularly. Making monthly contribution to your portfolio ensures that you smooth out the unit price over time. Your contributions buy more when markets are down and less when markets are up. This is known as pound-cost averaging.
  • Stay invested. The worse an investor can do during a market downturn is to cash in their portfolio. This invariably results in converting paper loss to permanent loss. As the legendary investor Jack Bogle once noted, “don’t just do something, sit there!