5 Money-Making Lessons from 2008's Market Crash

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Five years ago this month, the U.S. financial system began a downward spiral that would bring it to the brink of collapse. Stock markets plunged as the bankruptcy of Lehman Brothers and the seizure and sale of Washington Mutual's banking assets shook the foundations of the global economic system, requiring unprecedented responses from governments worldwide to prevent total collapse.

Financial markets have largely recovered from 2008's crash, but the impact of the financial crisis is still being felt.

In honor of this fifth anniversary, here are five lessons from the crash that you can use to make more money from your investments now and in the future.

Lesson 1: Investing Is Risky

Investors came into 2008 having seen a huge five-year market recovery from the bursting of the Internet bubble early in the decade. Despite the Dow Jones Industrials (^DJI) and other market benchmarks having hit record high levels, investors seemed convinced that stocks would keep rising smoothly well into the future.

That optimism left many investors woefully unprepared for the risks of serious downturn.

Today, U.S. stock markets are again at or near record highs. If you've taken advantage of rising markets by investing in equities, now's a good time to look at the overall risk level in your portfolio with an eye toward selling off portions of assets in which you're over-concentrated. A crash might not happen anytime soon, but stocks do fall as well as rise. Preparing for a decline now is far better than waiting until after the crash has happened to adjust.

Lesson 2: Markets Can Recover Even From Huge Losses in the Long Run

Unfortunately, many investors never got the chance to recover their losses from the stock market crash. That's because they sold off their stock holdings while the markets were falling. As the various reforms and government programs designed to stabilize the system to took effect, and the financial system rebounded. But many who had lost money were still too skittish to wade back into stocks.

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Of course, stock markets didn't recover overnight. But after only a few years, they regained their former heights, and have gone on to rise even higher. Those who let short-term panic drive them out missed much of that recovery.

Not letting fear drive your responses during market drops is essential to long-term investing success. Emotionally driven decisions can sabotage years of careful financial planning. If you want to be a successful investor, it's essential for you to build and maintain discipline that will withstand even sharp declines.

Lesson 3: Diversification Doesn't Always Work

One basic lesson investors are taught is that owning different assets can protect you from market downturns. From 2000 to 2002, for instance, when the Internet bubble burst, tech stocks plunged. But many blue-chip stocks based on so-called "old-economy" business models actually posted gains. Similarly, in past downturns for U.S. stocks, international markets often thrived.

But during the 2008 crash, just about everything fell in tandem, leaving investors with few places to hide from serious losses.

The lesson here isn't to give up on diversification entirely. But you need to recognize that in a wide-ranging crisis situation, you can't always count on some investments going up to cover losses in others. Planning accordingly in your investing strategy is crucial to avoid ugly surprises.

Lesson 4: Even Experts Make Major Mistakes

One lingering question many Americans have is why so many expert economists and market trackers failed to foresee the bursting of the housing bubble and the subsequent crashes in home prices and the stock market. Yet much of their complacency likely came from the conceit that financial experts had managed to tame the markets.

As Robert Samuelson wrote in 2009 in his review of economist Niall Ferguson's "The Ascent of Money," economists "widely assumed that deposit insurance and the existence of the Federal Reserve would prevent financial panics." That simple assumption proved catastrophically wrong, leading to a failure to take steps to resolve potential problems until it was almost too late.

That's why it's critical to come to your own judgments about investing. Relying solely on experts can put your entire wealth at risk if they turn out to be wrong.

Lesson 5: Panics Bring the Best Investment Opportunities

In 2008, most investors were looking for ways to get out of stocks. But brave investors found that even solid companies with plenty of potential had seen their stock prices punished, leaving them huge bargains.

Fears that consumers would stop buying $4 coffee sent Starbucks (SBUX) shares below $8, but those concerns proved ridiculous, and the stock has recovered to nearly ten times that value since. Priceline.com (PCLN) shares fell to nearly $50 as travel activity fell. But the assumption that travelers would never again take to the skies in the numbers they once had was equally misguided, and the stock is now approaching the $1,000 mark.

As painful as crashes can be for your existing investments, they can give you your best future investing opportunities. Be ready for them before they come, and have your wish list prepared in advance to give you the best chance of getting a great deal.

Learn From Your Mistakes

Few investors did everything perfectly five years ago during the 2008 crash. But the lessons the crash taught you can help you avoid the most common mistakes the next time the markets tumble.

5 Money-Making Lessons from 2008's Market Crash

Warren Buffett is a great investor, but what makes him rich is that he's been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time.

Most people don't start saving in meaningful amounts until a decade or two before retirement, which severely limits the power of compounding. That's unfortunate, and there's no way to fix it retroactively. It's a good reminder of how important it is to teach young people to start saving as soon as possible.

Future market returns will equal the dividend yield + earnings growth +/- change in the earnings multiple (valuations). That's really all there is to it.

The dividend yield we know: It's currently 2%. A reasonable guess of future earnings growth is 5% a year. What about the change in earnings multiples? That's totally unknowable.

Earnings multiples reflect people's feelings about the future. And there's just no way to know what people are going to think about the future in the future. How could you?

If someone said, "I think most people will be in a 10% better mood in the year 2023," we'd call them delusional. When someone does the same thing by projecting 10-year market returns, we call them analysts.

Someone who bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012. That's great! And they didn't need to know a thing about portfolio management, technical analysis, or suffer through a single segment of "The Lighting Round."

Meanwhile, the average equity market neutral fancy-pants hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average long-short equity hedge fund produced a 96% total return -- still short of an index fund.

Investing is not like a computer: Simple and basic can be more powerful than complex and cutting-edge. And it's not like golf: The spectators have a pretty good chance of humbling the pros.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time -- every single time -- there's even a hint of volatility, the same cry is heard from the investing public: "What is going on?!"

Nine times out of ten, the correct answer is the same: Nothing is going on. This is just what stocks do.

Since 1900 the S&P 500 (^GSPC) has returned about 6% per year, but the average difference between any year's highest close and lowest close is 23%. Remember this the next time someone tries to explain why the market is up or down by a few percentage points. They are basically trying to explain why summer came after spring.

Someone once asked J.P. Morgan what the market will do. "It will fluctuate," he allegedly said. Truer words have never been spoken.

The vast majority of financial products are sold by people whose only interest in your wealth is the amount of fees they can sucker you out of.

You need no experience, credentials, or even common sense to be a financial pundit. Sadly, the louder and more bombastic a pundit is, the more attention he'll receive, even though it makes him more likely to be wrong.

This is perhaps the most important theory in finance. Until it is understood you stand a high chance of being bamboozled and misled at every corner.

"Everything else is cream cheese."
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You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+. He has no position in any stocks mentioned. The Motley Fool recommends Priceline.com and Starbucks. The Motley Fool owns shares of Priceline.com and Starbucks.

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