Kiwi Wealth Senior Economist John Carran on key learnings from the global financial crisis.
An evaporation of trust
The bankruptcy of Lehman Brothers investment bank in September 2008 turned a US banking crisis into a global financial crisis (GFC) and a deep and prolonged economic recession.
It wasn’t the underlying or only factor to cause this catastrophe, but the collapse caused trust and confidence in the core banking system to evaporate.
After the collapse, all the economic excesses and vulnerabilities of the world were laid bare. Shock waves have reverberated since and it has taken almost a decade for a sense of stability to emerge in the global economy.
What are the main lessons for share investors from the crash in share markets following the GFC?
Large market declines won’t happen every day… but they will happen!
The first lesson is that markets can go down…a lot! Many share markets around the world fell by over 50% in 2008. Declines of this magnitude are rare, but not unprecedented.
The US share market fell by 20% or more 14 times since World War II. Declines in US shares of around 10% have happened once every year on average. In the past, large declines have lasted anywhere from around a month to two years.
If you are in KiwiSaver investment funds that hold a significant chunk of share investments, such as Growth or Balanced, you will likely notice a big drop in their value when share markets are selling off.
No one has a crystal ball
Secondly, large declines in markets can’t be consistently predicted. Many investors and commentators claim to have foreseen the GFC crash. Far more have been predicting further calamity since.
Even if you do successfully predict a crash, if you are not bang-on with your timing – selling and getting back into the market at exactly the right time – you are likely to end up worse off than if you had remained in the market all the way through.
If you are lucky enough to predict and get the timing right for one large sell-off, you probably won’t be as lucky for the next one, or the next one after that.
Shares rise over time as economies and profits grow
Thirdly, although shares have had awful periods in the past, they have invariably bounced back.
Despite the economic and psychological scars from the largest economic shock since the 1930s, share prices now are substantially higher than their peak before the GFC, as the chart shows.
The gains have been for good reason. Company earnings, a basic driver of the value of companies, have risen strongly. For instance, average US S&P 500 company earnings per share rose 304% from their bottom in September 2009 to August 2018. As long as economies and company profits continue to grow, share prices will generally rise over time.
Prepare for a market downturn ahead
The collapse of Lehman Brothers and the ensuing market chaos was an uncomfortable time that no one wants to relive.
Although the world economy and global banking system are in many ways in better shape now than back then, a large fall in markets will almost certainly happen again at some stage in the future - probably for completely different reasons than last time.
But, perseverance can pay off!
As inevitable as market downturns are, the past shows that over time share markets generally trend up and deliver better returns than potentially less riskier investments, like bank deposits and bonds.
Investing in shares requires perseverance, patience, and investing goals that allow you to ride out the ups and downs. Talking to an Authorised Investment Adviser can help you decide which are the best investments for you given your financial circumstances.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any investment decisions.
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