Lehman Lessons (Part 4)

After five years, what have investors learned from Lehman?

Lehman’s bankruptcy and the pricking of the housing bubble created chaos, disruption, and market opportunities on a scale that hasn’t been seen in the markets for decades. Indeed, not since 1974, with double-digit inflation at home and foreign policy failures abroad had the market been so cheap. The bear market of the ’70s offered its own lessons to investors–inflation matters, price matters, government policies can change–which were incorporated into the bull market of the ’80s. Does the financial crisis offer similar schooling?

One clear instructional gem is that diversification works, but only if you let it. A portfolio of 25 banks is not diversified; a portfolio split between government bonds, muni bonds, large-cap stocks, and small-cap stocks is. Many all-stock portfolios went down 50% or more after Lehman failed; balanced portfolios declined about half as much. And that diversification served you well, if you had the stomach to rebalance during the Winter of Discontent in 2009.

But that’s another lesson: it’s much easier to say "I’ll be greedy when others are fearful" than to act on the principle. Almost everyone–including myself–should have been more aggressive when the market crashed. But it’s hard: all those negative stories with fears of bank nationalization and Great Depression 2.0 were paralyzing for many. Just riding out the cycle was a white-knuckle experience.

And five years on we’re back to all-time highs in the market. That’s the final lesson. Recessions happen. Bubbles happen. Keeping your head and viewing the market in perspective is hard, but if you did, you saw some outstanding bargains: excellent companies offered at excellent prices. There were also some value traps. But the opportunities created by the general panic were real, and level-headed investors bought in and then moved on.

Investing is hard work. But if you can keep your head when everyone else is panicking, the market is yours.

Douglas R. Tengdin, CFA

Chief Investment Officer

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