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Lessons learned from the debacle
Old 05-09-2009, 02:03 PM   #1
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Lessons learned from the debacle

Now that the immediate flames appear to be out (still lots of smoldering going on), I have been thinking about what lessons I can take from the recent debacle in pretty much every market there is. No doubt there are lots and you guys can offer more lessons learned, but these are the ones I take away from the last year and a half:

- You jump in while things are still falling at your peril: I was early and often and suffered for it. Simply put, next time I wait for things to convincingly bottom before jumping in and pulling out the stops.

- Make sure you are reasonably diversified: I had no real big positions blow up and go permanently away, but I did have a couple smaller ones do so. In the future, I will be more diversified even wen I find something to be compelling.

- Buy insurance: After several years of throwing money away on index puts as a hedge, I finally gave up and stopped throwing money away. Bad idea. I drifted away from the fundamental bargain of insurance: as the buyer of protection, you willingly lose small amounts in normal times so that you don't lose big amounts in the bad times.

- Consider your whole personal balance sheet, not just the portfolio: I had the right risk tolerance for my portfolio, in hindsight. I knew in a big downdraft I would lose a chunky percentage and I was OK with it. What I failed to fully consider is that my job was also quite sensitive to market downdrafts and economic slowdowns. With the benefit of hindsight, I would have reduced risk in my portfolio or bought more hedges to offset the employment risk.

- Be certain of your e-fund and liquidity: This one I got right. I wasn't unemployed for that long and I actually only collected unemployment for two months, but having a healthy e-fund to fall back on was a great comfort. I also had an untapped HELOC which I drew down on when I thought I was in danger of losing my job, although I never ended up touching any of the funds.

- Leverage has its uses, but act like a commodity producer: Commodity producers (at least the ones that survive for any period of time) are countercyclical in their use of leverage. When times are good, they pay down debt and pile up cash. When times are bad, they use their strong balance sheets to expand on the cheap so they can benefit from the next up-cycle. I have been steadily paying down my mortgage (took a 15) and that's my only debt aside from a trivial amount of student loans. I should have been more aggressive in my paydowns, though.

Hopefully we have seen the worst of it for this cycle. Now I just have to remember this stuff when the next down-cycle comes around.
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Old 05-09-2009, 03:06 PM   #2
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Excellent insights Brewer!

Moshe Milevsky agrees with your point about considering your whole personal portfolio:
To maximize your investment returns and protect yourself and your family, you must learn to think of yourself as a small company, with assets, liabilities, a balance sheet, an income statement, and real shareholder equity. The composition and choices you make with your financial capital should reflect the nature and security of your career or job, which is your unique “human capital.” So, for example, if You, Inc. is like a “stock,” make sure your retirement savings are tilted toward “bonds.” If your job is more secure and You, Inc. is essentially a “bond,” then make sure your retirement savings are tilted toward “stocks.” Get personal with your investments and make your financial capital serve and protect your human capital. Factoring in your unique “human capital” adds a new dimension to financial planning which is a critical next step for sound and effective investing.

Moshe Milevsky, Are you a Stock or a Bond? FT Press, 2008

My personal lessons learned:

1. Capital gains are illusory unless realized. (Luckily I did some of that before the crash).
2. My risk tolerance is just as high as I thought it was. (Nerves of steel). Looking forward, I will not be quite so sanguine.
3. Nobody is as interested in your financial welfare as you are. Look out for yourself. Read finance and economics.
4. Bargain for the best rates.
5. Build and keep a significant emergency fund.
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Old 05-09-2009, 03:10 PM   #3
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I knew that intellectually, Meadbh, but I guess it didn't sink in. Ironically, now I have an iron-clad job so I can take whatever risks I please in my investment portfolio.
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Old 05-09-2009, 03:15 PM   #4
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...now I have an iron-clad job...
Didn't realize you went to work for the gummit...
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Old 05-09-2009, 03:16 PM   #5
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Didn't realize you went to work for the gummit...
Sort of, but not exactly. Not a civil servant.
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Old 05-09-2009, 03:24 PM   #6
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Sort of, but not exactly. Not a civil servant.
A spy?
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Old 05-09-2009, 03:28 PM   #7
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I knew that intellectually, Meadbh, but I guess it didn't sink in.
That's exactly what my accountant said when I thanked him for advising me to take advantage of my corporate capital gains in 2008. It's funny how professionals don't take their own advice! (which reminds me, I need to schedule my colonoscopy and mammogram)
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Old 05-09-2009, 03:48 PM   #8
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I learned that I'm really risk tolerant when times are good not so risk tolerant in the bad times . I learned buy and hold is not an absolute . Sometimes buy and sell is in order . I learned forget what other people are saying it's your money and if your gut is telling you to take some off the table just do it .I learned if you are retired it's easier to look at the income lost ($4,000 for every $100,000) then the total amount and the final thing I learned is do not retire without a lot of padding in your budget . It's easy to cut travel not so easy to cut back on basics .
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Old 05-09-2009, 04:48 PM   #9
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I'm afraid that I may not have learned anything, other than events are unique, so that it is very hard to generalize effectively. I guess one thing pretty safe is not to be so damn sure of myself.

One other thing- I am not convinced that it's yet time for gin and tonic on the terrace.

Ha
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Old 05-09-2009, 05:09 PM   #10
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Nice post, Brewer. Specially 1&2

I thought I learned plenty from the last time this happened (’01&’02). Seems I was mistaken. They say you learn mostly from your mistakes – so I must be getting smart.

Not sure I can afford much more learning, though – and I thought my kid’s college bills were expensive.
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Old 05-09-2009, 05:31 PM   #11
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Brewer,
I think you would like the book about Jesse Livermore
The popular book Reminiscences of a Stock Operator, by Edwin Lefevre,

Jesse Lauriston Livermore - Wikipedia, the free encyclopedia
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Old 05-09-2009, 05:47 PM   #12
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- Leverage has its uses, but act like a commodity producer: Commodity producers (at least the ones that survive for any period of time) are countercyclical in their use of leverage. When times are good, they pay down debt and pile up cash. When times are bad, they use their strong balance sheets to expand on the cheap so they can benefit from the next up-cycle. I have been steadily paying down my mortgage (took a 15) and that's my only debt aside from a trivial amount of student loans. I should have been more aggressive in my paydowns, though.
Thanks for the great post.
I like this point. When times are good, I'm going to ease up on my equity allocation and keep more money in ST. Bonds & Cash so as to use it if the market goes bad.

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My personal lessons learned:

1. Capital gains are illusory unless realized. (Luckily I did some of that before the crash).
Do you mean - realized and used to rebalance your portfolio or add to cash? If not, I don't see how it makes a difference. In fact it could be worse because you have to pay tax on the realized gains.
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Old 05-09-2009, 06:03 PM   #13
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I learned that my asset allocation is just fine and I can sleep through a 35% cumulative loss knowing that there will be a bottom and things will eventually recover just fine.

I learned that I should rebalance periodically and I don't have to hit the top correctly nor the bottom correctly and I will do just fine.

I learned to keep my fixed income in my tax-advantaged accounts so that those accounts lose the least amount of money and to keep my equities in taxable where I can get Uncle Sam to pay some of my losses for me. It's important to not lose so much in your tax advantaged accounts because you only have so much "space" for fixed income in your portfolio and once you have losses in those accounts, there is no easy way to "top them up".

I also learned that retiring in the midst of a market and economic debacle makes people very jealous of you.
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Old 05-09-2009, 06:30 PM   #14
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Do you mean - realized and used to rebalance your portfolio or add to cash? If not, I don't see how it makes a difference. In fact it could be worse because you have to pay tax on the realized gains.
My corporation issued a corporate dividend to shareholders (me) for 50% of the capital gain. This is known as a capital dividend and was not associated with any further tax liability.

Your tax laws may vary....
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Old 05-09-2009, 06:33 PM   #15
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I'm your average buy and hold investor. I feel stupid because I didn't learn anything from all this. Well I did learn I sleep fine with a 35% loss from the peak.
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Old 05-09-2009, 06:35 PM   #16
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Boy oh boy oh boy do I love doing absolutely nothing on full auto:

Target Retirement 2015 - 65/35 give or take - da big dog on the porch.

Like 1948 Dividends are still good even with a -18% dent from the financials et al and I still can't speak Norwegian but sweeping dividends to my MM checking and some SEC yield from Target - 16th yr of ER is good to go.

The more things change - the more things stay the same.

heh heh heh - The boredom will eventually end - football season is coming.
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Old 05-09-2009, 06:57 PM   #17
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As an inexperienced investor with no prior interest in or exposure to the market, and dealing with a relatively large windfall acquired in 2008, I learned a lot.

I learned that my asset allocation is just about right, since despite being utterly terrified, I never came anywhere near selling low.

I learned that I can do this.

Most importantly I learned that with Vanguard, determination, and intense study of the books on this list and as many others as I could manage, I could even manage to do just as well as if I had gone to a random investment advisor, and I didn't have to pay their fees. That was a huge relief.

I do believe we may be moving into a less frightening market, as well!
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Old 05-09-2009, 07:01 PM   #18
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I confirmed that I have a strong contrarian instincts. I most want more cash to buy stock in Nov, although by March my conviction was weaken. I was never tempted to say screw it sell everything.

I learned that trying to buy falling knives will result in lots of blood loss. I also painfully learned that companies can and will cut dividends, for the first 25 years never had a single company cut a dividend this market suffered about a dozen cuts.
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- Consider your whole personal balance sheet, not just the portfolio: I had the right risk tolerance for my portfolio, in hindsight. I knew in a big downdraft I would lose a chunky percentage and I was OK with it. What I failed to fully consider is that my job was also quite sensitive to market downdrafts and economic slowdowns. With the benefit of hindsight, I would have reduced risk in my portfolio or bought more hedges to offset the employment risk.
I came to exactly the same conclusion as Brewer. My back up plan was if I ever got below X dollars, I'd go back to work. I knew it might be hard to get a job having not worked for 5 or (now almost 10) years but what didn't occur to me was that same events that would trigger my portfolio to drop below my failsafe number would make it virtually impossible to find a job. Now that my portfolio is above X again, I need to figure out some way of hedging these risks.

The most important thing I learned is that while technically money markets, CDs and short term government bonds are all safe cash investment. In my hands cash in money market, will be invested in falling knives. While, cash in a CD will remain safely untapped awaiting an emergency. I wrote covered calls on several of my positions this last week. Baring a correction it looks like several of them will be exercised in June.

Although, I am going to hate locking my money away in Pen Fed CD for 3 to 5 years at the low rate of 3.50- 4% I am going to set up a CD ladder finally.
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Old 05-09-2009, 07:05 PM   #19
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The most important thing I learned is that while technically money markets, CDs and short term government bonds are all safe cash investment. In my hands cash in money market, will be invested in falling knives. While, cash in a CD will remain safely untapped awaiting an emergency.
I have the same issue, but I figured it out after the '01-'02 thing when I couldn't stand not to buy all the unconsidered trifles. So I make use of Pen Fed CDs because they offer relatively generous rates and have small surrender penalties if I ever need the money.
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Old 05-09-2009, 07:26 PM   #20
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I learned AA works for me
I learned having wide "bumpers" on my equity allocation so that I'm not constantly rebalancing works for me
I learned having 4 years worth of expenses in a cash bucket lets me sleep at night
I learned that being debt free (including no mortgage) really really helps with the sleep at night thingy
I learned that the news thingy scares the s**t out of me and counters the benefits of the planning above because my imagination on how things may blow up has no limit
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