Fears the financial system was on the brink of collapse in 2008 made many focus on the return of their investments as well as the return on their investments. Three years later hindsight gives a clearer view of the lessons we can learn from the crisis in 2008.
1. Don't borrow more than you can afford to repay
The housing boom between 1995 and 2007 was fuelled by a classic combination of overconfidence and easy credit. A generation of buyers who had never experienced a fall in house prices, borrowed too much money and, in some cases, treated their homes like a cash machine. The aftershock of the fall in house prices has been limited to an extent by the lowest interest rates in 300 years.
2. Your cash may be at risk
Once, it was almost impossible to imagine a UK bank going bust. The Financial Services Compensation Scheme (FSCS) limit, then £33,000, was almost an afterthought and few people talked of cash savings being at risk. The failure of Northern Rock and the Icelandic banks has meant savers are now as concerned about safety as they are about their rate of return. Many choose to restrict their savings to the new FSCS limit of €100,000 (currently set at £85,000 in sterling terms) per person per institution or use government-backed products from National Savings & Investments.
3. It's important to have an emergency fund
A cash cushion is a fundamental basis of any financial plan, yet many ignore this during booms, relying on credit cards, overdrafts or future pay and bonuses to tide them over. It's wise to have an emergency fund of 3-6 months' expenditure in an instant access account to cover the unexpected, such as health problems or redundancy, and provides greater financial security.
4. Diversify your portfolio
Those who were overexposed to certain assets or holdings (e.g. property or banking shares) were hit the hardest, as were employees with large shareholdings in their employer companies. The old adage of not holding all your eggs in one basket has never been a better tip.
5. Understand your investments
Many investors didn't truly understand the risks of some of their investments. Perhaps the best example was structured products (guaranteed equity bonds) backed by the likes of Lehman Brothers. Some people were unaware of the risks they were taking on, believing that the word 'guaranteed' in the name offered their capital protection against falls. Similarly, property investors bought new flats off-plan both in the UK and abroad only to find that rental demand was lower than expected and prices plummeted. If something sounds too good to be true then it probably is - there is no such thing as a sure thing. The value of any investment and the income you receive from it can fall as well as rise.
6. Don't be afraid to take profits (even if it means paying tax)
Some of the biggest gains are lost by waiting too long before selling. Falls in the property market in 2007 is a good example. Shares in the now called Lloyds Banking Group lost nearly 90% of their value between April 2007 and March 2009. Investors who hang on for the peak can regret not banking some of their profits earlier.
7. Past performance is not a guide to the future
Investors should be more concerned about how an investment will perform than how it has performed. As Warren Buffett once said, "the dumbest reason in the world to buy a stock is because it's going up". I believe the best time to invest is usually at the point of maximum pessimism rather than maximum optimism.
8. Keep your investments flexible
What do with-profits bonds, structured products and buy-to-let property all have in common? Restrictions on accessing your money. Withdrawals can often be made only at fixed times or incur a penalty or costs. There is nothing more frustrating than watching an investment fall in value and being unable to act. Whenever possible, I'm a firm believer in keeping as much of a portfolio as liquid as possible and limiting the numbers of investments with restricted access to your money.
9. The stock market and the economy are not the same thing
The UK economy continues with the dangerous cocktail of low growth and high inflation. So-called austerity measures aimed at tackling the budget deficit, will only restrict what we borrow in the future, not begin to repay the debt mountain already accumulated.
Against this backdrop of doom and gloom, the UK stock market has risen by over 70% since March 2009*. Stock markets are always looking to the future, whereas economic data must necessarily look at the past - this means they will not always be telling the same story.
10. Economies are cyclical - good and bad times will happen again
Investors can be affected by emotion and often have short memories. For example, the property market has crashed every 18 years since the 1970s and, based on this, I expect it to crash again in or around 2025. This is unlikely to stop the next property boom then bust, whenever this happens. However if only investments were that simple and we could predict markets with even reasonable probability (which we cannot).
Investing in the stock market over the long term is likely to provide the best opportunity to grow wealth above inflation. Investors should be making long-term decisions with their portfolios, and invest with talented fund managers who could make shorter term decisions for them.
Please note that past performance is not necessarily a guide to the future. The value of stockmarkets will fall as well as rise and you may get back less than you invested.
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