Five years on – what lessons can investors learn from the Financial Crisis?

Posted on November 09, 2013

Huge values were wiped off investment holdings as stock markets around the world plunged. In the space of a little over one year the FTSE 100 index fell from over 6,700 to below 4,000 with over 40% wiped off their value. It took massive international government financial intervention to prevent events spiraling further and a number of years later we are still dealing with the consequences of these measures.     

Looking back on these events, and with the benefit of hindsight, what lessons can be learnt from these events and how should this influence the habits and behaviors of everyday investors.

We believe there are six key lessons that can be taken on board by investors:

1) Diversification is key to successful investment – Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimising risk and volatility. 

All investment portfolios, whether large or small, should be highly diversified containing different asset classes such as stocks and shares, bonds, absolute return and property funds. There should be diversification within each asset class – for example stocks and share funds should not be overly focused on the UK or US but should have overseas representation in Europe, Asia Pacific and even Emerging Markets. 

Each fund in your portfolio will itself will be diversified to a greater or lesser extent containing a number of individual shareholdings. Each portfolio should maybe contain at least eight funds which helps to diversify manager risk i.e. the risk that your fund manager underperforms the market or has overexposure to a particular sector.     

Diversification will serve you well during times of crisis, and although all risk can never be entirely eliminated, it will put you in a much stronger position than a narrow approach to investment.  

2) Take the long view and stick to your original plan of action – at the outset of any investment it is important to understand exactly what you are investing for (security in retirement, educating your children, moving to a larger house…) and agree the timescale involved. Any investment should be for the medium to longer-term meaning that it should be for a minimum of five years possibly closer to ten years in term.

At times of financial crisis and market volatility remember your long-term goals and what you are saving for. Being blown off course during troubled times will inevitably hamper reaching your longer-term goals. In the five years since the crisis of 2008 the FTSE 100 index (as a broad measure of markets) has only posted a negative return year on year in one year (2011 minus 5.5%) with positive returns in 2009 (24%), 2010 (9%), 2012 (9%) and 2013 (11% year to date). Looking at the longer view rather than short term trends is important when looking for investment returns.    

3) Review and amend regularly – these remain volatile times – never has it been as important as now to review your portfolio on a regular basis.

For most portfolios a comprehensive annual review will be appropriate, for larger portfolios, or for those approaching their financial objective such as retirement, then it may be appropriate to review on a more regular basis. Should your circumstances change during the course of a year between review meetings, such as a decline in health, windfall or change of career, then an ad-hoc review will be appropriate.

The most common outcome of a review meeting is to reach agreement on the rebalancing a portfolio. During the course of a year the diversification that it achieved at outset is eroded by areas of over and underperformance. For example, the best performing market this year has been the Japanese stock-market rising over 60% to date. At the start of the year a portfolio’s exposure to Japan may have been 5% and at the end of the year this may have increased to 8%. It would therefore most probably be appropriate to rebalance this exposure to this volatile market down from 8% to 5%.   

4) All investment carries a degree of risk – successful investment is about understanding risk involved and agreeing a degree of risk that is acceptable.

Savings accounts, where in return for a deposit a set rate of interest is paid, carry no risk other than default of the counterparty or deposit provider where sums exceed £85,000 (the current limit under FSCS for single savings accounts). For all financial objectives with a term of less than five years only savings accounts should be considered.

For objectives with a term of over five years then an investment may be appropriate and all investments (to a greater or lesser extent) carry a degree of risk. What is crucially important is that you have an understanding of the risks involved and that the risks are closely matched to your objectives.

So, for example, if you need £50,000 in seven years time and you have £40,000 now you will need to achieve a net return of 3.25% per annum over the course of seven years to meet your goal. If that return of 3.25% can be met by using a simple savings account then why accept any degree of investment risk whatsoever. 

Using the same example, if you need £50,000 in seven years but only have £30,000 now then you will need to obtain a net return of 7.6% per annum something that is unlikely to be delivered by a savings account. Some degree of investment risk will be necessary to meet your goals but is this risk acceptable? Understand the risk associated with your portfolio and think carefully about whether the risk involved are acceptable to you.   

5) Seek and Invest in high quality advice – we believe, now more than ever, the need for well-informed, impartial and independent financial advice.

You probably do not have the time or inclination to read and understand the masses of information available to make well-qualified financial decisions. Our highly qualified team of chartered adviser, technical assistant and operations manager have a huge amount of experience in such matters and are committed to keeping their skills and knowledge at the cutting edge of the profession. We can understand your objectives and preferences and deliver a plan that offers you the best chance of meeting your goals.

Our advice comes at a cost and we regularly benchmark our fees against others in the industry to ensure that it is competitive and demonstrable.

A good adviser will be in contact with you during a time of crisis to offer you their steady hand and opinion on events, remind you of your longer term objectives and to assure you that the risks that you are taking are aligned to your attitudes and outlook.       

6) Don’t believe the headlines – the media is not your friend when it comes to investing.

Sometimes news stories are inspired by real news events but all too often ‘expert’ commentary come from those with vested interests. The problem is that in the face of such a barrage of often conflicting and sensationalist news and information investors often find it hard not to be seduced into taking actions that they will later regret.

One example of poor reporting would be at the end of each year the quality weekend newspapers will invite a panel of five respected UK fund managers to comment on where they believe the FTSE 100 index will close at the end of next year. Invariably (and unsurprisingly) the experts will suggest, whilst hedging their bets and sitting on the fence, that the index will close between 5 – 15% higher at the close of the next year. This looks very attractive to investors especially when you consider that cash accounts are currently offering such poor returns.

Although investors should have an interest in markets and opinion please remember that these forecasts are put together by managers who invest in markets – it is their job to talk things up and to attract money into their funds - therefore they have a vesting interest to focus on market appreciation and growth.

At Atherton York we believe in agreeing a robust financial plan and objectives with measurable outcomes. We offer sound and impartial advice with a diversified approach to investing, helping you to ignore the unhelpful media noises whilst understanding the risks involved. We believe that these five issues are fundamental to successful investment and reaching your goals.