The financial crisis: lessons learned, 10 years on
The financial crisis was a shocking experience. I was a financial planner in the dotcom crisis, the 2000 correction of the stock market, but I was only five years into my career then so I was less experienced. When this crash came around, I felt I handled it differently, better – but it was still shocking. There was a lot of fear, plenty of it fuelled by the media. It was a scary time.
What we had was a failing of the financial system, which caused certain companies to go insolvent and bankrupt. In the US that started with the Lehman Brothers and in the UK it was Northern Rock, who had overextended themselves, exposing themselves to mortgage debt that was being defaulted on.
Mortgages weren’t being paid, so banks weren’t getting their money back, so assets were being written down, and therefore those companies were insolvent and couldn’t trade any more.
In the US, Lehman Brothers was allowed to go to the wall. In the UK, we bailed out Northern Rock and later other institutions, restructuring it to let it carry on.
The impact – and what it tells us
In both countries, and beyond, it was truly a systemic failure; the whole banking system failed.
The culmination of the crash on the stock market was a fall of around 50% – a similar percentage loss to that seen in the dotcom bubble too. I equate the two because if you look back over the past two decades of financial history, those are the major falls the markets.
That really gives us now as planners some kind of benchmark to say: these aren’t the maximum losses you can see if you invest 100% in equities (the stock markets), but they’ll give you an idea based on the history of how the markets have corrected.
Should we be worried about it happening again?
It’s really important to look at facts and appreciate that investing is a long-term experience. In that case, rather than thinking of market falls as losses, they’re periods of time when the assets you own are priced at a lesser value. In most cases, and certainly for the market as a whole, these assets will recover over time.
So what you need to think about is: what’s my time horizon? You should really only be invested on the market if you don’t need the cash for at least five, and preferably seven or more years. For a lesser time period, you should have minimal, if any, equity exposure. You need time to ride out the waves which are inevitable.
Your age is a big factor; if you’re retiring in the next few years, you probably shouldn’t have all your retirement funds invested in the stock market! In my book The Money Plan I give a really simple but useful rule of thumb: 100 minus your age is a good allocation to consider for your stock market exposure. If you’re in your 20s, you might want 100-20 = 80% exposure to the stock market, because you have all those years on your side for growth.
If on the other hand you’re in your 80s, you probably want only 100-80 = 20% exposure to the market – still some, to capitalise on growth – because you don’t have the same length of time to ride out the peaks and troughs that come.
Where is the market today?
The stock market at the moment is what I call fairly valued. It’s not cheap, but it’s definitely not expensive; it’s sitting around the long-term average. At the peak of the dotcom bubble, the P/E ratio (price/earnings, a valuation measure of the markets) was hitting around 33; typically, the market sits around 15. We’re now at about 14, so within spitting distance of the average.
And that’s despite us having experienced the longest bull market (rising share prices) ever in history. We’re still fairly valued.
Now that doesn’t mean that new occurrences such as the Brexit negotiations, a country defaulting on its debt, terrorism or trade wars won’t have an impact on the volatility of the market. But, markets are priced fairly and should recover if one of those things happened.
So we shouldn’t hold off on investment because of Brexit etc?
The first question you need to ask is: why am I investing? It sounds like an obvious or silly question, but if you don’t know why you’re investing, then what are you doing? Take cryptocurrencies for example: lots of people wanted to jump on the bandwagon but they’ve now crashed hard in value and some people have lost a lot of money.
So, your first question: why? Is it for your retirement, your kids’ education, or something completely different?
Second question: what’s my time horizon? Is it more than seven years? If yes, then the markets are a good option.
Third question: how much can I accept my investment falling before I begin to feel uncomfortable? Whether you’ve got £1,000 or £100,000 to invest, when will you start to feel unsure if the markets and the value of that investment dips – is it 10%, 20%, more? At that point, you can understand what kind of market exposure you’re comfortable risking.
Remember from earlier, if you have 100% of your portfolio in the stock market – which is very aggressive – you should expect the value to fall 50% if the market corrects. If that’s too much but 25% is acceptable to you, then by putting around half your money in the stock market and half in short-term bonds and other low-risk investments, you’ve mitigated your risk to a level you’re comfortable with.
If you go to Lexo.co.uk, an online investment platform I set up, you can see the historical performance of 10 portfolios with different exposure to the stock market, ranging from 10% to 100%.
Financial crisis regulations have changed – are we now in a better position as a country?
There are an awful lot more preventative measures in place to try and stop the same thing happening. The regulator, the Financial Conduct Authority (FCA) were told in hindsight that they were slow off the mark in preventing the crash, but they have certainly tightened the belt since. If you’ve applied for a mortgage lately, you probably appreciate how much more difficult it is now than it was 10 years ago. A lot of work has been done to make things safer in this regard.
Will a financial crisis or something similar happen again in the future? Yes, sure it will. Nobody can accurately predict what will happen or when, because it’s cyclical but not timely. It’s not like there’s a rule saying it will happen every 10 years or so! The previous biggest crisis was the Great Depression in the 1930s. As I said earlier, we’re not in an expensive market at the moment, so that’s not an indicator of a systemic correction on the horizon.
We do of course have Brexit negotiations ongoing and that’s scaring people, and who knows what might be around the corner? As always, the best thing you can do if you need the money in a few years because you’re retiring for example, is to go to the Wayfinder website, find a Certified Financial Planner in your area and take advice from them.
Whether you’re investing in the markets or buying property, the mantra as always is to plan properly. Too many people make financial decisions without thinking about the potential consequences in the future. Focus on the things you can control, and don’t worry too much about the things you can’t – like the market prices or the Brexit negotiations!
Also consider what you’re listening to and reading; when I hear financial matters being discussed in the media, I often think that they’re not giving the whole picture, which I only know because this is my career profession.
At the end of the day, in the last 10 years the stock market is up just over 100%. We’re not talking 10 years after the bottom here, we’re talking after the crash happened, before the bottom, before the worst of it. You’d have doubled your money if you’d invested then and let it sit until today, and we were all told it was a terrible time to invest.
Ask yourself the questions above and plan carefully, and you’ll have a more enjoyable investment experience.