Lessons to Learn from the Market Meltdown

I don't think I have to rehash the events of the past few days. I've put together a quick list of possible lessons or takeaways. If you've lost money, at least learn from it.

You don't have to be in on every trade or every situation. When Fannie Mae (FNM) and Freddie Mac (FRE) were teetering on the brink, they experienced periods of sharp gains amidst the sharp declines. Even during the week before the government stepped in, both stocks posted in excess of 100% gains from intraday low to intraday high. Most people were predicting a stock price of zero, but some still felt compelled to make the trade, to "buy a lottery ticket." That is not how investing works. If you find yourself thinking along these lines, turn off your computer and go out for a sandwich. That sandwich will probably turn out to be a wise investment.

Sometimes you can beat the market by staying in cash. Money managers are lauded for their ability to "beat the market." This year the indexes are down in excess of 25%. This means that you could have beat the market by more than 25% simply by staying in cash.

Lower prices don't make stocks bargains. This runs somewhat counter the purpose of the 8 Stock Portfolio, but it's true. Ask anyone who thought Lehman was a bargain at $4. If you are dabbling in beaten down stocks, at least stay away from the epicenter of the problem. When I selected the 8 stocks for this portfolio, I intentionally avoided all financial stocks.

You should understand how companies that you own make money. Did the average shareholder of FNM, FRE, Lehman (LEH), or AIG (AIG) really understand how the companies made their money? And more importantly, did they understand the corresponding risks associated with those methods? Of course not. It's becoming apparent that even management did not have a grasp of this.

Nothing is sacred. The largest insurance company in America and a component of the Dow Jones Industrial Average was brought to the brink of insolvency. The stock price declined from over $70 to $2 per share. The fourth largest investment bank in the US with a history stretching back to 1850 has just declared bankruptcy. Blue chip stocks and financial icons can meltdown, too. Even if a company is "too big to fail" common shareholders can still be left with little or nothing.

You should know exactly what you will do in the event of a market meltdown. What did you do this week? Did you dump shares of your favorite stocks? Did you join the mad rush to buy GLD? Or did you use this as an opportunity to buy shares in companies that you carefully selected months before?

Disclosure: Long GLD.

Comments

[Kelly Liebe...:]

I sure as heck didn't fall for Govt backed treasuries..that I can tell you. I have no faith in the credit of the US government. We are officially broke.

2008 Sep 18 11:09 AM

[daytrader:]

you are so right when you say you don't have to be in on every trade or every situation.i used to force trades.you have to let the trade come to you.i.e.,buy it at the price you want.patience is a virtue!

2008 Sep 18 11:15 AM

[toomuchgas:]

Really boring muni bonds have done better than cash. You get to sleep at night and thumb your nose at the taxman at the same time. It's best to "ladder" them so you don't have to buy and sell.

2008 Sep 18 11:39 AM

[williambanzai7:]

Sympathy for the Devil
(Lyrics by WilliamBanzai7)

Please allow me to introduce myself
Im a man of wealth and taste
Ive been around for a long, long year
Stole many a mans nest egg and faith
And I was round when Livermore
Had his moment of doubt and pain
Made damn sure that Milken
Washed his hands and sealed his fate
Pleased to meet you
Hope you guess my name
But whats puzzling you
Is the nature of my game
I stuck around AIG
When I saw it was a time for a change
Fired the CEO and his SVPs
While Bernanke screamed in vain
I owned a bank
Was best friends with Hank
When the markets raged
And the cold Pizzas stank
Pleased to meet you
Hope you guess my name, oh yeah
Ah, whats puzzling you
Is the nature of my game, oh yeah
I watched with glee
While your investment banks bleed
Fought for ten decades
For the junk paper they made
I shouted out,
Who killed LTCM and the SEC?
When after all
It was you and me
Let me please introduce myself
Im a man of wealth and taste
And I laid traps for bond traders
Who get fired before they reach Mumbai
Pleased to meet you
Hope you guessed my name, oh yeah
But whats puzzling you
Is the nature of my game, oh yeah, get down, baby
Pleased to meet you
Hope you guessed my name, oh yeah
But whats confusing you
Is just the nature of my game
Just as every banker is a criminal
And all the investors saints
As heads is tails
Just call me Merrill, Bear, Drexel, Lehman, Kidder & Chase
cause Im in need of some restraint
So if you meet me
Have some courtesy
Have some sympathy, and some taste
Use all your well-learned risk controls
Or Ill lay your trading book to waste, um yeah
Pleased to meet you
Hope you guessed my name, um yeah
But whats puzzling you
Is the nature of my game, um mean it, get down
Woo, who
Oh yeah, get on down
Oh yeah
Oh yeah!
Tell me baby, whats my name

2008 Sep 18 12:32 PM

[mwswi:]

<<You should know exactly what you will do in the event of a market meltdown. >>

I admit that I'm using the current economic climate as an opportunity to buy additional shares. Right or wrong, I've been purchasing more shares in deeply discounted companies on a weekly basis. Hopefully, this will play-out to be a strategically correct move. Only time will tell...

2008 Sep 18 12:44 PM

[sumosama:]

AWESOME, William, simply AWESOME!

2008 Sep 19 12:10 PM

[Kelly Liebe...:]

William Rocks!

2008 Sep 19 12:54 PM