By Michael Gold, CFP®, MBA
What do you remember from the last recession, the economic crash in 2007/2008? We all know we can learn from the past and the financial mistakes we have made, but there are also encouraging aspects we should remember as well.
Let us review 4 financial lessons the last recession taught us, how that recession can actually be encouraging, and how we can move forward after our current recession due to COVID-19.
Credit cards are a means for buying things today with money you do not have. One of the harsh realities that many learned in the last recession (and many are realizing again) is that debt is more than just money you must pay back; it carries risk. The more debt you have, the more risk you carry. Having debt increases your bills, which increases your monthly living expenses, which ultimately puts a lot of pressure on you to make ends meet. I’ve heard it many times: “But, Michael, they’re having a sale, and if we act now, we can get 25 percent off.” Well, if you don’t pay in full when the bill comes at the end of the month, credit cards generally charge high levels of interest, and if yours is 25 percent, then you paid full price; so be patient.
When you are approved for a certain amount of debt, that does not automatically mean it is in your best interest to borrow that much money. When job loss, reduced pay, or other emergencies come up, you are still responsible for paying all that back. Plus, your income is your largest wealth-building tool, and it is difficult to increase your wealth when too much of your income is going toward servicing your debt.
Although debt carries risk, not all risk is bad. To build wealth, you will always have to entertain a certain level of risk—whether it is in the house you buy, the stocks you purchase, or the career you choose. However, you can be proactive about making sure you have emergency savings for a short-term crisis and someone you trust to help make long-term financial decisions with you. The benefits of having a recession-proof financial plan and a trusted advisor who can help manage your investment portfolio greatly outweigh any risk you incur. I have always advocated for my clients to understand exactly what their monthly spend is, and once they know that, to build an emergency fund of up to two years’ worth of living expenses in reserve. When you know you can sustain your life for at least two years without ever having to sell stocks at declining values, you have sustainability and clarity to make smart rational decisions about your wealth during volatile times. As John Maynard Keynes said back in the 1930s, “Markets can stay irrational longer than you can stay solvent.” With a solid emergency fund in place, the markets can behave as irrationally as they want—you have the wherewithal and the fortitude to stay rational.
I am not suggesting “active” management is better than “passive,” or vice versa. In reality, that does not matter. For example, let’s say you are holding a portfolio of active management strategies and I am holding a portfolio of passive strategies. Then, as history has demonstrated, the market does what it has always done every five years or so since the end of WWII; the broad equity markets drop by about a third of its value (sometimes more, sometimes less), taking about 15 months to go from peak to trough. Along the way down for every one of those 400 days, all we hear (or watch) is the financial news, market prognosticators, and economic forecasters shrieking that the economic apocalypse is upon us. Now, let’s say this becomes too much for me and I sell out and go to cash, waiting for the dust to settle and for a clear picture to come back in. All the while, you ignored the news and steadfastly continued with your plan in disciplined fashion. You rebalanced, reinvested dividends, buying up shares at panic prices which most likely you may never see again. You tax-loss harvested, helping to mitigate the future tax drag; you looked toward advanced planning techniques to capitalize on a variety of strategies that work well when asset values temporarily drop. So my question is, what difference did the philosophy of active vs. passive make? It was and is all about investor behavior, but I digress.
We do not know exactly what will happen to our economy in any given month, but we do know that actively managing your portfolio can ensure the integrity of maintaining the proper asset allocation based on your financial plan. This is done by focusing on diversification and rebalancing your investments. It sounds fancy, but simply put, broad diversification among different asset classes, equity sectors, and styles means one critical truth: We will never own enough of any one idea to make a killing in it, and we will never own enough of any one idea to get killed by it. This is the equivalent of the old saying, “You shouldn’t put all your eggs in one basket.” For example, instead of having all your money tied up in a few single stocks, you broadly spread out that value between bonds, stocks, and real estate; that is the 10-thousand-foot view of diversification.
Rebalancing is making sure your portfolio remains diversified as your investments increase or decrease. Rebalancing returns your portfolio to its original target allocation determined by your financial plan. By doing this, you harvest some of the gains in the parts of your portfolio that have gotten relatively expensive, and reinvest them in whatever has gotten relatively cheap. Unfortunately, this is the exact opposite of what many people do. From my professional and personal experience, it seems many people suffer from what is known as recency bias. Recency bias at its core is when an investor extrapolates that recent performance, both good and bad, will continue into the foreseeable future. We see this time and time again—investors buying up stocks and adding risk at market peaks when valuations are high, sometimes unrealistically high, like the tech bubble of the late ’90s. The opposite tends to be true as we witness a mass exodus from equities during bear markets and corrections. It seems that many investors tend to be their own worst enemy, thinking the good times will never end and then when they do, believing this time is different and the markets and economy will never recover. Fortunately, we are not most people, we do not succumb to the herd mentality. We build and implement financial plans that capitalize on the ebbs and flows in all market environments, and we are ruthlessly disciplined in pursuit of achieving our financial goals. I love one of Warren Buffet’s most famous quotes: “Be fearful when others are greedy and be greedy when others are fearful.” Rebalancing automatically capitalizes on Buffet’s quote.
The market has recovered extremely well since the last recession, and if the past is any guide, it will do so again! In the course of our history, the market has always recovered, and more quickly than most might remember. This should be a huge encouragement to you and/or anyone concerned about their investments or retirement. The fact that all bear markets are caused by a new set of circumstances, usually never seen before, makes them seem scary, which causes many to utter the four most dangerous words in investing: “This time it’s different.” Although each bear market generally occurs for a different reason than the previous one, the one common thread that every single bear market shares is that it eventually gave birth to a new bull market reaching new highs. Look at this graph below and you will see the recovery over two years, starting from the worst point of the recession.
Were you already practicing the lessons you learned from the previous crash or do you find yourself relearning them again? Ask yourself, how did I react and what did I do after the tech bubble burst, 9/11, the Financial Crisis, the Flash Crash, etc.? Wherever you find yourself in these current circumstances, it is never too late to learn from them and implement the changes necessary to secure your financial future and your dreams for retirement.
We at Gold Family Wealth, LLC are here to support you, provide knowledge, resources, and strategies for you to move forward and recover from any loss you’ve incurred. Reach out to me at firstname.lastname@example.org or (800) 303-2533 to schedule a complimentary consultation and start taking control of your finances!
Michael Gold is the founder, president, and CEO of Gold Family Wealth, an independent wealth management boutique and named one of the Top 100 People in Finance. Michael has 20 years of experience in the financial industry. He earned a bachelor’s degree in business and economics from the State University of New York College at Oneonta, an MBA from NYU Stern School of Business, specializing in Quantitative Finance and Leadership, and holds the CERTIFIED FINANCIAL PLANNER™ (CFP®) credential. He serves business owners and entrepreneurs by stress-testing their financial plan to identify red flags and missed opportunities. Michael strategically outsources professional experts from various fields, such as tax, insurance, retirement and trust, and estate law to collaborate on potential solutions to help position his clients to achieve their desired goals.
Michael currently lives in Westport, CT. When he is not working, you can find him spending time with his wife, Giselle, their three children, Sebastian, Aria, and Pierce, and their dog, Charly. To learn more about Michael, connect with him on LinkedIn.
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