COLUMN-Five investment lessons from the Lehman Brothers blow-up
CHICAGO, Sept 17 (Reuters) - Five years ago I was watching the world financial system implode after the failure of Lehman Brothers in real time. Since I'm largely a buy-and-hold investor, I grimaced while my retirement savings took a pummeling in 2008-2009.
What have we learned since that calamitous year? There were certainly a few gut-wrenching surprises as well as some enduring truths that still hold in personal investing for the future.
1. Gravity is stronger than diversification
For years, we adherents to the Modern Portfolio Theory of diversification have practiced the fine art of blending our portfolios with assets that don't typically move together. In 2008, many, including me, were surprised when commodities funds, which were supposed to move in the opposite direction of stocks, followed stocks into the abyss. When nearly everything declines in a global meltdown, there are few safe havens.
In late 2008, worldwide demand for commodities also plummeted. An exchange-traded fund like the PowerShares DB Commodity Index Tracking Fund holds a variety of commodities contracts from crude oil to zinc. The fund dropped nearly 32 percent that year, nearly matching the 37-percent loss of the S&P 500 stock index.
The fund remained a poor investment over the past five years as global commodity demand is relatively sluggish and China and India slowed down. It has fallen almost 5 percent annually, on average, during that period through Sept. 13.
Long term, commodities may be a winner as the world population grows, but short term, they are incredibly volatile and not a good stock hedge.
2. Staying the course is no sin
I didn't bail out of stocks at the nadir of the market and have since recovered all of my losses - and then some. The S&P 500 has averaged an 8-percent average return over the past five years.
If you just stayed in a plain-vanilla index fund like the SPDR S&P 500 Index ETF over the past year, you'd be up nearly 20 percent. For those who can handle the short-term volatility of stocks, the long-term growth can be rewarding.
3. Boring bonds still make sense
Even with the current anxiety over the Fed's widely-telegraphed, wind-down of its stimulus program - and accompanying rising interest rates - owning bonds is still a good idea, too.
Why? Because they are not stocks and a reliable hedge during a stock-market meltdown. In 2008, a broad-based bond fund such as the iShares Core Total US Bond Market ETF gained nearly eight percent when stocks and most everything else got creamed. Although the fund is down almost 3 percent over the past year through Sept. 13, it's averaged just over 4 percent over the past half-decade.
That's hardly impressive, but the low volatility and steady returns are far better than sticking with commodities over that stretch. I continue to own the iShares fund as a core holding.
4. Concentration can be a curse
Sometimes you can pick a single stock or sector, lady luck smiles and it comes up a winner. And then everything can go haywire. Housing started its steep decline prior to the Lehman failure; funds like the iShares US Home Construction ETF lost nearly 58 percent in 2007 and 42 percent in 2008.
Timing is everything, of course. For investors who bought at the bottom, the fund has averaged a 23-percent return during the past three years through Sept. 13, compared to 17 percent for the S&P 500 index.
5. Don't invest in fear, invest in confidence
It's easy to think that traditional, hard assets are going to protect your nest egg. Such was the thinking with gold, which many regarded as a back-up currency when everything else looked like lead.
An exchange-traded fund like the SPDR Gold Shares ETF , which holds bullion, was up about 5 percent in 2008 and made money from 2009 through last year.
But as fears about the global economic system subsided in recent years, so has the price of gold. The SPDR fund is off more than 25 percent for the year through Sept. 13 and has averaged less than 2 percent over the past three years.
You would have been much better off holding common stocks, which pay dividends and have averaged more than 17 percent over that same three years (if held in an S&P 500 Index fund).
While it's normal to be nervous about stocks, don't overindulge in your fears and retreat from them entirely. Even with a sluggish rebound, soaring corporate profits, low inflation, rising home sales and continued low interest rates are all positive drivers for the U.S. economy.
"It's not a broken recovery, it's just different," said Jim Paulsen, chief investment strategist of Wells Capital Management, speaking at the Chicago CFA Society on Sept. 10. "It's different and should turn out to be okay. The biggest stimulus is rising confidence."
The main lesson of the Lehman legacy is to craft a portfolio plan based on how much you can afford to lose and forget about projected returns. The future can be elusive, but the past should be instructive.