Investors can learn a lot from the GFC, whether or not it can happen again in the future. The initial tremors of the GFC happened in 2007 when shares took a hit before recovering to new highs ahead of a 55% decline in 2009.
After the Great Depression, GFC was the worst financial crisis, freezing lending between multiple financial institutions, banks, share market falls and the post-war global economic contraction. However, the GFC taught investors that the economic and investment cycle is consistent. Great returns are invariably followed by a fall back and returns that are too good to be true often are.
The GFC also teaches us that high returns come with higher risk and that risks that are dormant for a long time often returns with a vengeance. It was apparent in the GFC that each boom bust cycle is different and markets become ultra-cheap when investors are highly pessimistic.
Investors also now know that they have to be skeptical of hard-to-understand products or financial engineering because these often lead to the biggest losses. They should also avoid too much or wrong gearing as it can magnify losses when things reverse. These can force positions to close at a big loss when lenders lose confidence or margin calls force investors to sell instead of adding to it.
The GFC highlighted the importance of diversification and asset allocation as well. Investors should not only have property trusts and hedge funds but also low-yielding government bonds. Asset mix matters and exposure to individual shares or fund managers is second order.
The GFC tells us that crashes are part of the process that leads to an increase in material prosperity in capitalist countries. The recovery from major financial crises can take years and there will surely be another boom and bust in the future. However, the signs of excess which often precede recessions are not present right now.
Monetary policy has not tightened and inflation remains low. There’s no over-investment in housing or technology and financial regulations have been tightened. Still, it is important that each generation learns from history to avoid the mistakes of the past.
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