September 16th, 2008
It’s no small thing when two of the very pillars of Western capitalism bite the dust in one weekend! It’s really a big deal and if you haven’t been paying attention, I’m here to tell you that you should. And let’s not forget that the giant insurance company, AIG is still tottering and were it to fall, we may be in territory we’ve never been in before.
Lehman Brothers has a long and venerable history. It grew to have billions and billions of dollars in assets—not the money of its clients, mind you. That money is pretty safe. But they are not too very different from banks in taking money in and using it to make more money for itself. Only brokerage companies are not supposed to commingle client funds with company funds. So when Lehman Brothers goes down the tubes, one of the really valuable assets that it has (and certainly this is also true of Merrill Lynch) is that they have retail accounts with billions and billions of dollars safely tucked away in them. This doesn’t mean that if you had a brokerage account, for example, that had only Lehman Brothers’ stock in it, you wouldn’t be in big trouble. It only means that these thousands and thousands of accounts with assets deployed in all sorts of investments are cash cows. The brokers of these accounts call their clients every day and say, in so many words, “Sell this and buy that.” And for so many ill informed clients, these recommendations are followed even while the broker has a huge conflict of interest: if he doesn’t sell and buy investments, he doesn’t get paid. So, as far as Lehman Brothers’ assets are concerned, being able to sell this “book” of client accounts is a big thing. So the first lesson here is that even though brokerage companies go down the tubes, generally speaking, your money is relatively safe.
But the real issue with Lehman Brothers’ collapse is that we now clearly know with certainty that there are still some very bad loans on the books of a variety of very large companies, like Washington Mutual Bank. What his means is that in the event of additional collapses, the average person in the street comes to the obvious, but erroneous conclusion that the entire financial system will fail. We know, historically, there have always been “unforeseen” events that arise that totally jolt the market irregularly appearing, but also regularly appearing, meaning, you don’t know exactly when or what will trigger these financial crises, but they always come along. So, Lehman Brothers’ collapse, Merrill’s sell off to the Bank of America and AIG’s pending collapse sends panic to the person on Main Street and his/her natural reaction is to grab what money is left and head for the mattress to hide in under!
What the best and brightest of my colleagues are telling their clients is to keep your focus on your existing investment strategy. What this means is that the Asset Allocation model of investing is built specifically for situations like this. We set your mix of equities (stock mutual funds) and interest earnings (CDs, corporate and government bonds and bond mutual funds) and then wait and see what the market does. It the equities market goes up (prosperity) we sell some of your equities and move them to safe interest earning accounts. If the stock markets go down, we tap into our interest earnings accounts and buy enough equities to restore our balance. This means that you are buying your stocks at a discount and selling them for a profit—the way it’s supposed to work. And the financial planner is the guy who gets to twist your arm on both sides of this structure. He or she has to convince you to sell when everything you own is going up and buy when everything is going down.
So as I approach the year end with all of my financial planning clients, as well as my own money, as we do our year-end investment strategies and tax planning meetings, is to prudently look to take some of the tax losses where appropriate for the tax benefits. At the same time, I'm planning to buy some replacement and new equity investments to bring these portfolios back into balance. So that’s it: don’t get caught up in the herd mentality here. Be disciplined; keep the long term view in mind. Do your balancing.
Here’s a nice link to a page on the New York Times that gives a healthy perspective on all of this:
http://www.nytimes.com/2008/09/16/business/yourmoney/16consumer.html?ref=business&pagewanted=print
As ever, with all good wishes,
Michael
