What we learned from the financial crisis: 10 years later
by A. Scott White, CFP® , ChFC® , CLU®
President, Scott White Advisors
As I write this article in September of 2018, it seems appropriate to reflect on the 10-year anniversary of the start of the Great Financial Crisis of 2008. As you may recall, the stock market was down approximately 20% from its highs of October 2007 on the eve of Lehman Brothers declaring bankruptcy on September 15, 2008—sparking the near collapse of the U.S. financial system.1
What followed was unprecedented. The stock market declined an additional 40% by March 2009 1, resulting in U.S. households’ stock market wealth declining $7.4 trillion.2 Home values dropped $3.4 trillion and an additional 500,000 more mortgage foreclosures began than were anticipated. 2 Also, 5.5 million more American jobs were lost than were predicted in a September 2008 report by the Congressional Budget Office. 2 It was a very painful time for both me and my clients. So, what did we learn?
In hindsight, the crisis merely reaffirmed what Scott White Advisors has always preached: don’t panic, don’t try to time the market, and a healthy dose of stocks makes sense for most long-term investors. While these simple lessons may seem obvious at first glance, I can as-sure you in times of stock market crises such as 2008-09, each lesson often comes into question. And I can understand why. Simply put, we humans are emotional creatures. Studies have shown people make their most important decisions in life based on emotion and then try to justify those decisions using logic. 3 After all, it’s a disheartening emotional experience for an individual to review their monthly investment statements and see their lifelong savings shrink month after month and continue year after year. It’s only human nature to do something to relieve the pain.
Don’t panic. Historically, the stock market has crashed (a 20% drop or more) every few years. So why do people panic when it happens?
Perhaps some of the blame might be the fault of the financial industry itself. Rather than spending time to learn about a family’s needs over the next few years and designing an investment portfolio to meet those needs (both expected needs and unexpected needs), many so-called financial professionals build investment portfolios based on a client’s answers on a “risk-tolerance” questionnaire. Clients often assume that the questionnaire will provide the financial advisor the ability to use his or her knowledge to build an investment portfolio so that the client will experience a level of pain that’s tolerable during times of stock market crises. In my opinion, risk/return questionnaires often result in clients experiencing a higher level of pain than they were expecting when markets crash— resulting in panic and often leading to clients abandoning a suitable investment strategy to relieve this pain. This often results in clients not being
able to meet their goals over the long term.
We don’t use risk/return questionnaires at Scott White Advisors. Instead, we build investment portfolios only after completing a com-comprehensive financial plan designed to achieve the family’s goals and objectives. The plan includes a written investment strategy that has a high probability of enabling the family to meet both its short-term and long-term goals and objectives. We acknowledge there will be times when clients might experience pain when portfolio values decline, but we also recognize that changing a portfolio in crisis can often result in the family not being able to meet their identified goals. It might be painful, but we encourage our clients not to panic, because their portfolio was built knowing stock markets occasionally crash—and they also rise again.
The S&P 500 index dropped 40% after September 12, 2008 over the next six months, but three years later it was down only -0.8%.1 By the five- year mark, things seemed on firmer footing: The S&P 500 had been making new record high for months, Silicon Valley was humming, and banks were on sturdy footing. 1
Don’t try to time the stock market. Some believe it is possible to buy stock market investments when stock markets are trading low and
then sell their stock market investments before stock markets crash, believing they’ll know in advance of any coming crisis. But it would require a magic crystal ball for anyone to predict what’s going to happen in the future with certainty. Because even if a model could be developed to predict why a stock market might go up or down, it would only take one natural disaster, an unexpected geo-political event, or terrorist attack to cause that thesis to be invalid.
There’s one thing I know about the future: The unexpected frequently happens. There is a long list of professions that failed to see the financial crisis brewing. “It’s not just that they missed it, (the Financial Crisis of 2008) they positively denied that it would happen,” says Wharton finance professor Franklin Allen, arguing that many economists used mathematical models that failed to account for the critical roles that banks, and other financial institutions, play in the economy. 4 That’s why, at Scott White Advisors, we don’t build investment portfolios based on events that may or may not happen. We build investment portfolios with the understanding that stock market crashes do happen. Whether stock markets are down or up, we want to have a high level of confidence our clients can meet their goals and objectives.
A healthy dose of stocks still makes sense for most long-term investors. If the goods and services you’ll need to purchase to maintain your living standard of living and to achieve your family’s goals and objectives will cost more in the future, then you’ll still need your money to grow over time. After all, money is only worth what you can buy with it, so in the future if you can’t buy as much stuff as you can today with the same amount of money, then you lost money, even if you didn’t realize it at the time. Stocks offer the long-term investor
a good chance of staying ahead of inflation. Consider this: The S&P 500 closed at 1251 on the Friday before the Lehman bankruptcy. In the 10 years since then, the S&P 500 is up 130 percent, an annual average gain of 8.7 percent and yearly total return (including dividends) of 11 percent. 1
At Scott White Advisors, when the next stock market crisis occurs, we will not panic or try to time the stock market by selling out of it. We understand panic and trying to time the market often result in clients not being able to meet their goals. Instead, we’ll remind ourselves of the valuable role stocks play in protecting our standard of living from the devasting effects of inflation over the long term. We understand that sometimes long-term gains are worth short-term pains.
1 “It was a Gutch-Wrenching Trade, but Investors who Bought the Day before Lehman Failed are up 130%”, Michael Santoli, CNBC, September 10, 2018.
2 “Briefing Paper#18, Cost the Financial Crisis”, Phillip Swagel, PEW Economic Policy Group. April 28, 2010.
3 “The Role of Emotion in Economic Behavior”, Scott Rich and George Loewstein, Handbook of Emotions, Third Edition, 2008.
4“Why Economist Failed to Predict the Financial Crisis”, Wharton School, University of Pennsylvania, http://knowledge.wharton.upenn.edu May 13, 2009.
There is no assurance that past trends will continue into the future. The effects of any updates released after the period shown above are not reflected in this data. Past performance is no guarantee of future results. Indices are unmanaged and cannot accommodate direct investments. An individual who purchases an investment product which attempts to mimic the performance of an index will incur expenses such as management fees and transaction costs which reduce returns. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss