Economist tells investors to learn 7 lessons from the GFC

Ten years ago on this day, Lehman Brothers collapsed and triggered the Global Financial Crisis. What can investors learn from this historic event?

AMP Capital chief economist Shane Oliver has pointed to seven lessons that investors should heed from the GFC:

1. There is always a boom-bust cycle
2. Markets get pushed to extremes during cycles
3. High returns come with higher risk
4. Be wary of financial engineering or hard-to-understand products
5. Avoid accumulating too much debt, and debt of the wrong sort
6. Diversify
7. Invest in the right mix of assets

Dr Oliver said the first lesson of the GFC was that long economic summers are always followed by winter. “If returns are too good to be sustainable, they probably are,” he said.

The second lesson was that while each boom-bust cycle is different, markets are always pushed to extremes. The asset at the centre of the upswing gets “overvalued and over-loved at the top and undervalued and under-loved at the bottom”.

The financial crisis also taught us the link between risk and reward, according to Dr Oliver. “While risk may not be apparent for years, at some point, when everyone is totally relaxed, it turns up with a vengeance, as seen in the GFC.”

Dr Oliver said the fourth lesson was to avoid ‘magical’ products. “The biggest losses for investors in the GFC were generally in products that relied heavily on financial alchemy, purporting to turn junk into AAA investments that no one understood.”

The GFC also highlighted that debt is a double-edged sword. “Gearing is fine when all is well. But it magnifies losses when things reverse and can force the closure of positions at a loss when the lenders lose their confidence and refuse to roll over maturing debt, or when a margin call occurs forcing an investor to sell just when they should be buying.”

Lesson number six, according to Dr Oliver, was the importance of diversification. Listed property trusts outperformed government bonds before the GFC – but once the crisis hit, those positions flipped.

Finally, the GFC emphasised the importance of asset allocation. “The GFC reminded us that what matters most for your investments is your asset mix – shares, bonds, cash, property, etc. Exposure to particular shares or fund managers is second order,” he said.

If you’re thinking about taking out a personal loan to buy shares, please think carefully before doing so.