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20 Lessons the 2008 Crash Can Teach You About Investing

March 26, 2014
Following on from the 3 key takeaways from Seth Klarman’s 2013 letter, here’s a little throwback to 2008 and what it can teach you about investing.

The 2008 wasn’t just a market crumble. There are so many lessons you have to keep in mind.

But I’ve got Seth Klarman (Trades, Portfolio) to thank again.

You would think that the best and brightest minds on Wall Street would avoid such a catastrophe, but nope. Many institutions got hammered and very few even knew what was coming.

Maybe a few predicted the crash but no one knew when it was going to happen.

Right now, it’s impossible to tell when the next market crash is occur, but it doesn’t hurt to look at past lessons as a reminder or what could happen.

So, in view of the 2008 financial crisis, here are 20 lessons to take from Seth Klarman (Trades, Portfolio) on the 2008 crash. See if you can apply it to recent events.

20 Lessons from Seth Klarman (Trades, Portfolio) on What the 2008 Crash can Teach You

Seth Klarman (Trades, Portfolio) 2008 Lessons

Lesson #1: Expect the Unexpected

The classic “expect the unexpected” is true for the market. Take measures to prepare for the worst because the market reality can be worse that what you imagined. Nassim Taleb popularized the term “black swan” based on rare and hard to predict events happening. But it does happen.

Lesson #2: Too Much of a Good Thing

Watch out when there is too much of a good thing. Markets constantly rising? Loans available to anyone? Interest rates constantly hovering near zero? This environment creates a false sense of security and when things fall back to the mean, it will trigger a crisis.

Lesson #3: Control Risk First

Don’t try to milk the last drop from your investments. Always consider risk and downside first over potential returns. When entering a crisis, you have to make your positioning conservative and be able to pounce on new opportunities while others are forced to sell.

Lesson #4: Paying Less is Less Risky

Risk comes from the price you paid for the stock. It isn’t uncertainty or volatility. When there is great uncertainty and it drives prices down, you buy with less risk.

Lessons #5: Financial Risk Models are Useless

Market risk models done by computers are a waste of time. Reality is impossible to model. Human logic based on actual and real time facts is more accurate than boxed formulas and numbers.

Lesson #6: Don’t Invest for Short Term Gains

Don’t be tempted to invest for short term gain simply to earn something off cash that’s doing nothing. This is a higher risk strategy which increases the likelihood of losses and illiquidity precisely when the cash is needed.

Lesson #7: Stock Price is Not an Indicator

The stock price is not the fair value of a stock. People mistake that the stock market is completely efficient. During good and bad times, the stock price is not an indicator.

Lesson #8: Expand Your Circle of Competence

When a crisis hits, your investment approach has to be flexible. Don’t get too stuck on one method because opportunities can come in many different ways. If your investment approach is too rigid, start to expand your circle of competence.

Lessons #9: Buy When Prices Go Down

Buy when the price is going down. Volume is higher, there is less competition. It’s better to be too early than too late. Don’t be afraid to buy things on sale.

Lesson #10: New Financial Products are Not For Your Benefit

Be wary of new financial products. They are always created in times of exuberance and never questioned. The sub prime loans were the rage as institutions only saw the upside. Then it got killed.

Lesson #11: Rating Agencies are Useless

Ratings agencies are useless and always a step late. What’s the point in lowering or increasing a rating after it’s happened?

Lesson #12: Illiquid Stocks Come at a Price

Illiquid stocks will cause high opportunity costs. Make sure you are compensated for that illiquidity.

Lesson #13: Public Investments Still Rock

All things being equal, public investments are better than private ones. During a crisis, you have a better change to average down with public investments over private ones.

Lesson #14: Debt is Evil

Stay away from all forms of leverage. Don’t assume a maturing loan can be rolled over since you have no idea what the capital markets will do.

Lesson #15: LBOs Are Disasters Waiting to Happen

LBOs (Leveraged BuyOuts) are stupid man made disasters. If the price paid is too high the equity portion is an out of the money call option.

Lesson #16: Financial Stocks are Risky

Financial stocks are very risky. For example banks are highly leveraged, very competitive and difficult to run businesses. Unless you have deep experience and knowledge of the industry, invest in safer industries that you understand.

Lesson #17: Long Term Clients is Key to an Investment Fund’s Success

If you manage funds, having clients with a long term orientated mindset is crucial. You don’t want investors pulling out their money during a crisis.

Lesson #18: Government Officials Don’t Know Anything

When a government official says that a problem has been “contained”, it’s a contrarian signal. Pay no attention.

Lesson #19: The Government is the Ultimate Short Term Trader

The government is the ultimate short term oriented player. It will do anything to quickly ease the pain with band aid patches on the economy or financial markets without thinking about the implications. If the pain can be deferred to the future, the government will take on huge amounts of risk to do so.

Lesson #20: No One Cares About You More than Yourself

No one is going to take responsibility for the crisis so you have to look out for yourself and manage your risk well. Why? Because no one will take responsibility for making you lose money.

And Today…

History may not repeat, but it sings a nice rhyme.

It’s been more than 5 years since the last crash but mostly everything is still applicable today. I’m no Debbie Downer, but remember to focus on the risks and downside regardless what type of market we are in.

About the author:

Jae Jun
Founder of Old School Value (http://www.oldschoolvalue.com) dedicated to offering the most complete and detailed stock valuation and analysis spreadsheet. Investing made easy by importing 10 years of financials and 5 quarterly statements directly to excel for your analysis needs. Save time, make smarter decisions and make more money.

Visit Jae Jun's Website


Rating: 4.2/5 (15 votes)

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Comments

wescileppi
Wescileppi - 6 months ago

Mostly common sense but still an excellent post. It is amazing how many people have absolutely no idea about the aforementioned items.

ArjenvS
ArjenvS - 6 months ago

Good tips

SeaBud
SeaBud premium member - 6 months ago

Thanks for the good article. I like all except 16, which I do not believe to be inherently true. WFC is not, I believe, "risky". I think you must have a circle of competence to read balance sheets, and especially leverage, to understand financial stocks, but to define a class of stocks as inherently carrying more risk seems odd.

Consider that some say "technology" stocks are inherently risky while consumer cyclicals are inherently safe. At todays valuations, is JNJ safer than INTC? I would argue not even thought INTC is certainly harder to understand as a business. Based on margin of safety, dividend income, stability of revenue, INTC's manufacturing prowess and valuation metrics, i just don't see JNJ as less risky. But that is me and my circle of competence. Again, though, good article, and my point is I am agnostic as to product being manufactured as long as i understand the business, balance sheet and competitors (moat).

traderatwork
Traderatwork - 6 months ago
Because of leverage, sometimes financial companies is a bad investment while other times it's the opposite. Buying WFC for $40+ in 2007 is risky, buying WFC for $10 in 2009 is not

(or buying AXP for $13 in 2009 for that matter)

"Risk is come from not knowing what you doing." - Warren Buffett (Trades, Portfolio)

vgm
Vgm - 6 months ago

A number of these seem extreme statements that need some accompanying comment. Or maybe Seth intended their nakedness to shock!

I agree financials are not inherently risky but do need people of the caliber of Buffett to be able to assess them rigorously. Looked at from the other direction, Buffett would not be in if WFC, BAC, USB, MTB were risky propositions. (BAC was risky pre-crisis, to Trader's point)

On Lesson 14, debt clearly has real and terrible dangers. But it depends who is borrowing and why. Even the great Henry Singleton at times borrowed to buy back Teledyne stock. Today exceptional companies like DTV are borrowing at low cost to repurchase undervalued stock in a shareholder-friendly fashion. Explosives are a total danger in the hands of amateurs, but powerful and useful tools when used by explosives experts.

anfiskapritchard
Anfiskapritchard - 5 months ago

Not just investment plan, retirement plan or taxes should be taken into consideration in order to improve one’s financial standing. There is a need to create a carefully deliberated budget and to essentially cut back on expanses. It is important not to forget that sometimes emergences occur but you can always use Installment Credits and get financial aid.

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