Revisiting the Global Financial Crisis

Revisiting the Global Financial CrisisHow did you feel during the depths of the GFC?

With the benefit of time, we tend to forget the strength of emotions we experienced in the past. I recently came across an email that we sent to a couple who were struggling with the uncertainty created by the Global Financial Crisis . It was written on 19th February 2009 – a couple of weeks before world share markets bottomed.

The email is a good reminder of the heightened emotions that prevailed at the time and the irrationality that they can produce. The couple were imagining all kinds of catastrophes and looking for any other solution than patiently sitting things out. Investor sentiment at the time was pretty low, with pessimists outranking optimists by seven to one.

“The secret of success is constancy of purpose” – Benjamin Disraeli

Here are the main points from that 2009 email:

  • The current situation around the world is not healthy and economically it is likely that we will see the effects of this in terms of lower earnings and profitability, lower salaries and wages and higher unemployment. Unfortunately, this will affect almost everyone in our society to some degree. Everyone’s standard of living is expected to be adversely affected in the near future.

    Those who allowed themselves to get carried away with the expectation of a continuation of the good times are likely to suffer the most. Those who showed the sense not to get carried away with the exuberance of that period will suffer less. Everyone who has worked hard to save and build wealth over the past years has seen that diminish – many have seen years of accumulation wiped out completely.

    It’s extremely unpleasant but you are not alone, and on a relative basis you are better placed than most as a result of your relatively modest risk exposure going into this crisis. (Note: Even those who were modestly geared have lost around two thirds of their capital!).

  • The world and markets will continue to be uncertain. We will never know with certainty what the future will bring – even if, occasionally, our predictions prove to be correct. In fact, these are the most dangerous of circumstances. All booms and bust are based to some degree on people’s over confidence about their ability to predict the future. The best and most sensible way to make decisions about uncertainty is on the basis that you may be wrong as much as you may be right.

    Overloading decisions with prediction is part of the cause of the current economic and financial malaise that we find ourselves in. If it was that easy to predict the future, we would not be in this situation. Clearly, it’s not. We advocate intelligent decision making that comes with an element of humility about the ability to predict the future. (Note: During the great depression, US shares increased by 182% in the 12 months to June 1933 …. I suspect very few were predicting that in July 1932).
  • You mentioned your desire for control. The need for control can be a blessing or a curse. In most cases, it’s a blessing when you know what you can control and focus on controlling those factors. It’s a curse when you try to control something you have no control over.

    When it comes to investing, there are two things you can focus on – your risk and your return. They are inextricably related. There are two approaches you can take. Either attempt to control your returns, which will invariably result in a fluctuating level of risk over time. Or, control your risk, which results in fluctuating returns over the short term.

    With investing, we see risk as the cause and return as the effect. That is why we focus so heavily on the risk side of the equation. It is the variable that can be consistently managed and controlled.

    Unfortunately, trying to control returns is attempting to control the uncontrollable. The only way to effectively achieve this is to take no risk – meaning you’d have to settle for the risk free rate of return (cash). I encourage you to shift your desire for control to controlling your level of risk. This means letting go of the need to control the level of returns you get and accepting a certain degree of volatility in the short term.

  • While the short term may be your main focus at present, our focus is on your long term. From this perspective, being wrong in the short term and right in the long term is better for you than being right in the short term but wrong in the long term. I hope you can appreciate our endeavours to provide input from this perspective (even though it may conflict with your views).
  • Making investment decisions based on recent past performance, while natural, is generally not effective. The recent performance of growth assets may suggest to you that things are on the way down, so let’s sell out and get back in after it’s recovered. But choosing when to get back in is far more difficult than it appears. As Warren Buffett aptly puts it “if you wait for the robins, spring will be over.”
  • The worst way to build wealth over time is to increase your risk in the good times and decrease it in the bad times. While it’s natural to behave this way, it’s a poor way to build long term wealth. The best way to build long term wealth is by decreasing risk in the good times and maintaining risk in the bad times. This, unfortunately, is never as easy as it seems.
  • Unlike many, you do not have to sell … and you do not have to sell any of your current assets for many years to come. (In fact, you are likely to be buying assets in the next 3-4 years depending on the risk you choose). The challenge you face is to allow the price of these assets to take their path. The only time price will become a real issue is when it’s time to sell. You may choose to sell today if you wish, but you do not have to.

Good investment decisions often don’t feel “right”

An adviser’s role is not governed by the “customer is always right” principle. In fact, a good adviser will often be recommending action that conflicts with how you feel about the current situation. While this may be challenging for the relationship, it’s driven by an intent to act in your long term best interests.

The reality is that achieving the financial future you want is most unlikely if you let your emotions override a well conceived, long term strategy as soon as the going gets tough.

Post Script: – The market bottomed in early March and then rallied 25% over the next 2 months. The couple resisted their emotional desire to sell (protecting themselves from the cost of having to buy back in at much higher prices).

Receive monthly notification of new articles by signing up to our Smart Decisions blog now.

Revisiting the Global Financial Crisis

Leave a reply