Lessons Learned from a Financial Meltdown

April 16, 2010, By Jeff Waddle 0 comments

It wasn’t long ago that the D Word was being bandied about in financial circles. Who knows how close we came to an actual depression late last decade. It’s scary to think about it and best to move on, but before we do, what did we learn from the crisis?

Quite a bit, says Terry Kelly, CFA, a senior portfolio manager at Bartlett & Co., an investment advisory firm founded in 1898 that’s now a wholly owned subsidiary of Legg Mason.  With 26 years of investment advising experience, Kelly has seen a lot of financial cycles, but he says this one offers a lot of lessons.

“What happened in this last cycle was unlike any other cycle I’ve ever encountered in that many people accumulated far more debt than either their income or assets could support,” says Kelly, a Chartered Financial Analyst. “People lived beyond their means and, under any circumstances, you can’t do that.”

Exactly where we’re headed from here is subject to change as always, but here’s what Kelly believes you should take away from the most recent financial mess.

Re-adopt a long-term view. Kelly believes that many people fell victim to the fallacy that the price of their home and the value of their stock portfolios were going to keep going up. “We became very short-term oriented and thought if we bought something like a house or investments, it would go up in a very short period of time,” he says. “That’s not the real world, as we found out.” Kelly thinks some aging baby boomers still haven’t learned the lesson of adjusting asset allocation to a long-term view. “They’re going to go from accumulating assets to consuming those assets to live on at some point and that should drive a long-term perspective.”

Planning is important. “Everyone needs to have a specific plan—not a dream—and follow it,” says Kelly. He adds that the plan should be reviewed frequently (at least once a year) because life circumstances can change and many people now work in jobs that yield variable incomes. “Incomes can go down and you can’t live at a level that will exceed your worst-case scenario for income.”

You need a Nest Egg. Saving for a rainy day apparently is a good thing after all. Kelly believes the old rule of thumb of having six months of income in reserve is solid advice. “That doesn’t necessarily mean it has to sit in a no- or low-interest bearing account because you’re unlikely to need all of it in one day,” he says. “But, it should be liquid, accessible in fairly short order and in something that has relatively stable value like laddering certificates of deposit that come due on a staggered schedule.”

Paying off debt is a priority. One positive takeaway from the recent financial meltdown is what many people are calling the New Normal—people saving more and borrowing less. “I think you should pay cash for everything you can because if you do that, it sets spending discipline automatically,” says Kelly. “If you’ve got $1,000 to spend, you can’t buy $1,300 of goods. “One thing you should always keep in mind is to pay yourself first, even if it’s a small amount. You should be accumulating money for that long-term goal first, not after you buy that boat.”

Save by investing as much as you can afford in the company 401-K. Kelly says you should invest at least as much as your employer is willing to match in your 401-K—no less than 5% of your income. “You’re simply a fool if you don’t sign up and participate in your company’s 401-K because you can’t save any faster or better than that,” he says. “I believe that, for most of us, savings is not something we accumulate to give away to our heirs. It’s something we accumulate and then live off at some point and the goal is to build as big of a pile as you can.”

Jeff Waddle is a featured contributor to ManoftheHouse.com.