Ten years ago this month, investment bank Bear Stearns collapsed in a spectacular way, thanks, in part, to risky investments that tanked. It was sold, essentially for parts, at $2 per share. A mere 15 months earlier, the firm had posted record earnings and shares hit $171. Translation: Bear lost 99 percent of its value in a little more than a year.
This should have been the canary in the coal mine for the housing market collapse and Great Recession. Instead, an arranged marriage with J.P. Morgan (temporarily) satiated Wall Street, and the S&P 500-stock index would test all-time highs again within weeks. The real market collapse—in which major stock indexes would eventually shed 50 percent—was postponed until fall.
Still, the 10-year anniversary of Bear Stearns’ collapse is a good time to revisit what happened next, and the lessons we should have learned. But did we?
Lesson #1: If you don’t understand it, don’t invest in it.
You might’ve heard that the “subprime mortgage crisis” and subsequent devaluation of mortgage-backed securities were big causes of the recession. But most people don’t understand what that means—and that was part of the problem.
Basically, a lot of people were qualifying for mortgages they couldn’t afford, and some investment banks started selling risky, but high-return, bonds that were backed by those mortgages. Firms like Lehman Brothers bet big on those bonds—even borrowing money to do so—and some investors did, too, without really understanding them or the risks involved. When homeowners began defaulting on those mortgages, the investors and banks holding the bonds lost out, too.
The lesson? If you don’t understand it—or it sounds too good to be true—don’t invest in it. Unfortunately, that hasn’t sunk in yet with all investors. Take those who invested $15 million last year into an initial coin offering of “PlexCoins” (lured, the SEC says, by the promise of “a 13-fold profit in less than a month”) and a reported $600 million into “AriseCoins”—both of which were later halted and called out as scams by U.S. regulators.
Lesson #2: Don’t buy just because you can.
One reason people found themselves carrying unaffordable mortgages was because banks were aggressively pushing large loans. (The bigger the loan, the more they make in interest and fees.) While that practice has declined somewhat, banks may still approve you for a mortgage amount that’s more than you budgeted. Don’t bite. (A good rule of thumb: Keep total mortgage payments to 35 percent or less of your monthly gross income.)
On this score, too, it looks like we have more learning to do. The average size of a home loan reached an all-time high last year, surpassing the hefty loans of the housing bubble. And first-time home buyers put down an average of just 6 percent. Most financial planners recommend aiming for a down payment of at least 10 percent. That’s particularly important in the event that the value of your home falls (as many homebuyers learned the hard way during the Great Recession).
Lesson #3: Stick with it.
Long-term investing is the key to building wealth over time, so it pays to stick with it—but it can be a bumpy ride, as it was throughout the Great Recession. For example, if you had $142,000 invested in an S&P 500-stock index fund in mid-May 2008, it was worth just $75,000 that November. Ouch. It took some time, but if you’d held tight until September 2012, you’d recouped those losses. And if you let it ride until today? You’d have more than $260,000.
It seems like many investors have embraced this lesson. A Bankrate survey found that just 6 percent of Americans sold investments because of February’s market correction—and 15 percent considered it an opportunity to buy stocks while they were cheaper.
Lesson #4: Diversify.
Prior to the Great Recession, so much money was being made on Wall Street and in banking that investments in the financial sector seemed like a sure bet. Except there’s no such thing—which is why diversification is so important. Spreading your money across a mix of stocks lowers the risk of your portfolio tanking when one company or sector struggles.
Investors seem to have learned this lesson, too. Exchange-traded funds—low-cost investments that provide broad exposure to hundreds of stocks and thus broad diversification—have become so popular that in 2016, only one of the 15 top-traded “stocks” on Wall Street was actually a company stock—the other 14 were ETFs.
March 23, 2018