It’s the one year anniversary of the fall of Lehman Brothers. The media marked that event as the start date of the financial crisis. Several financial podcasts I listen to all ran features on "lessons from the financial crisis." I’m more interested in the lessons at a personal level, not so much at the macroeconomic level because there’s nothing I can do about macroeconomics.
After the dot com debacle, people learned it’s bad to speculate in stocks, but they also learned they can’t lose money in real estate. We all know how that lesson worked out. Today, after another crisis, people are learning more lessons. Will all of them be the right lessons?
Sell at the first sign of trouble. An acquaintance told me she moved all her stock funds into money market in early 2008 because she got nervous from the news of mortgage writedowns. That move was brilliant. It saved her tens of thousands of dollars. She dodged the proverbial freight train. I’m sure she will take that to heart — "when you see trouble, sell." Is it the right lesson? I’m not so sure.
Follow the technical signals. 200-day simple moving average (200 SMA) is a simple technical indicator. A trading rule based on 200 SMA says sell when the price falls below 200 SMA and buy when the price goes above 200 SMA. A modified version of this rule adds a small cushion on either side: sell when the price falls x% below 200 SMA and buy when the price goes x% above 200 SMA, with x% being 1% to 3%.
This signal worked very nicely in the global financial crisis. Investors who followed this signal for S&P 500 sold in November 2007 when S&P 500 was about 1,400. They bought back in June 2009 when S&P 500 was about 950.
They didn’t sell at the top. Nor did they buy at the bottom. But that wasn’t necessary. Selling after stocks already went down and buying after stocks already went up still protected them from a 33% loss (950 / 1,400 – 1 = -33%).
The same 200 SMA signal also worked well in the 2000-2002 bear market. If an investor followed the signal, they would have sold in September 2001 when S&P 500 was 1,400 and bought back in April 2003 when S&P 500 was 900, avoiding a 36% loss.
Such a simple indicator worked miracles twice in a row. Math indicates that whenever there is a severe bear market, the 200 SMA signal will always protect the investor from big losses. I’m sure some investors will take the 200 SMA as a learned lesson from the financial crisis. I’m not sure it’s a good lesson though.
The right lessons are the simple ones that work all the time, not just in a financial crisis:
- Carry no debt except mortgage
- Live below your means
- Invest conservatively in a low cost, diversified portfolio
They are so simple they don’t need any further explanation.
What lessons did you learn from the financial crisis?