Watch Out For The Next Economic Crash

Credit crunch. Dot-com bubble. Housing collapse. Financial crisis. Doom, gloom and despair. We are all familiar with the tag-lines and headlines. The story of where it all went wrong and how ‘This time it’s different.’

Every time there is an economic downturn it seems so unexpected and it horribly affects not just the portfolios people hold, but also the attitude of future investors.

Research has shown that most people who experience a particular economic climate or trend during their ‘formative years’ of exposure to savings and investment (typically from the age of 25-35 in western society) will tend to let that form their view of assets and markets for the rest of their life.

Take for example the baby-boomers who were at that age during the 80s when stocks and shares were all the rage. This group will tend to prefer stocks to other assets even now.

Those who turned 30 during the real-estate boom of 2002-2008 will lean towards bricks and mortar. Those who were unfortunate enough to have their first meaningful employment around the time of the Tech Bubble bursting after the turn of the millenium will shy away from technology stocks and web-based companies.

Equally, those who saw the recent financial crisis at this important point in their life are more likely to avoid stocks, be wary of banks and prefer to hold cash or solid assets.

The rationale is clear. We form opinions and patterns of behaviour based on experience but this can be damaging.

We know that, although economies and markets move in cycles, big crashes in the same sector or even region, rarely repeat close together.

In fact, by harbouring a lingering prejudice against something that collapsed before could be vastly increasing your risk of exposure to the next big disaster.

Consider the Credit Crunch in 2008. Since the collapse, global financial stocks and global real-estate have both more than doubled, according to their respective MSCI indices.

Only now, after five years of growth, does there seem to be widespread confidence in them. I suggest that we have this all backwards. The response of a market after a crash is to shore up that market to prevent a recurrence. On this basis, the safest place to be after a collapse could be right where it just happened. The best response is certainly not to avoid that sector or asset class altogether.

Diversification is key. Eliminating one particular asset class is not as dangerous as picking one and forsaking all others. However, by ruling out a large portion of the investment world, you are increasing your overall risk level. If you must rule something out, rule out the one that has performed best in recent years, not the one that has just fallen.

Whatever your financial goals, think of the different asset classes and forms of investments as separate roads that you can send your money along in order to reach them.

Firstly, if you choose to to send everything down one road, even a small traffic jam will hold you up on your journey. A big accident could prevent you ever arriving at all. If one road saw a huge crash recently and as a result has been resurfaced and had speed limits imposed, it may seem daunting but will often be a safe route to choose.

If you split your assets onto different vehicles taking separate roads then some will be very fast, some might be slow but you know that at least most of it will arrive safely. If you have your options open and a good financial map, you have the best possible opportunity of success.

Finally, when it comes to the next big crash, where will it come from?

In short, I don’t know. Nobody does. I have my suspicions but they are just that.

There are markets that seem over-inflated at the moment and there are assets that have seen (in my humble opinion) far too much speculation in recent years.

The one thing that I can say with absolute confidence is that there will be another crash. It will happen somewhere. If the boom-bust cycle should ever end then capitalism will end with it.

The only way to protect yourself against future crises is to expect them. A balanced and diversified portfolio is essential. Everyone is told not to put all their eggs in one basket. I would go further than this. You might have many baskets but why would you only buy eggs?