Investing lessons from the global financial crisis

30 Aug Investing lessons from the global financial crisis

Ten years ago this month, the global financial industry nearly came to a grinding halt. It was the worst financial crisis since the Great Depression.

The credit crunch hit with full force when Northern Rock suffered the first run on a British bank since 1866! The government was forced to step in and the bank fell into state ownership a few months later.

By September 2008, several financial firms including investment banks Bear Stearns and Lehman Brothers had gone under! The government stepped in to bail out several banks, including the Royal Bank of Scotland, Lloyds TSB, and HBOS, hammering out deals over a chaotic weekend to avoid the collapse of the banking system.

Share prices across the world plummeted. It was a very scary time for investors and frankly most people in the developed world. Many investors saw their wealth plummet and many questioned the received wisdom of investing. They were left wondering whether the benefit of diversification had failed.

So, what would have been the best course of action for an investor in this scenario? Hindsight is a wonderful thing. The best cause of action for a long-term investor would have been simply to sit tight and ride it out! Ten years after the financial crisis, share prices in the UK and many other developed countries are at historic highs. A buy and hold investor in UK equities would have nearly doubled their money since the financial crisis. Investing in Global equities would have retuned nearly two and a half times!


Source: FE, data to 31/07/2017. For illustrative purposes only. Past performance is not a guarantee of future results. The index is not available for direct investment. Therefore, their performance does not reflect the expenses associated with the management of an actual fund.

If you invested £100 in UK equities in January of 2008, just before the early signs of the crisis, your investment dropped to £67.54 by February 2009 when the market bottomed. But if you persevered, your investment recovered and would have reached £190 by July 2017!

£100 in global equities in Global equities in January of 2008 was worth over £239 by the end of July 2017!

The return delivered is in spite of the crisis! Thankfully, these types of crises are rare! Nonetheless, they are part and parcel of the capitalist economy. Leading economic historian Charles Goodhart noted that the last 300 years had shown many instances of financial crises and bank failure, with varying effect on asset values and the real economy. He believes that a financial crisis-free economy is ‘chimerical.’

The lesson here is that crises are inevitable. Now and then, something goes wrong with our financial system in spite of the best efforts by governments and regulators. And the best an investor can do during a crisis scenario is to ride out the storm. In his recent letters to investors, legendary investor Warren Buffett sums up why we should invest for the long-term, regardless of occasional economic declines. He states:

American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven helps them if they act on the nonsense they peddle.

Many companies, of course, will fall behind and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

I would hope you can agree that Mr Buffet talks sense. He knows a thing or two about investing.