Financial Crises Aren't So Rare. Invest Accordingly.

The financial crisis we’ve just experienced is a once-in-a-century phenomenon, right? The fallout and repercussions we’ve seen from the big banks, like Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , or Wells Fargo (NYSE: WFC  ) , are unlikely to be repeated anytime soon, right? Wrong. Financial crises occur more often than you think.

According to Bob Pozen, chairman of MFS Investment Management and author of the book Too Big to Save? How to Fix the U.S. Financial System, most people’s perception is that financial crises happen once every 20 or 30 years. “What I argue in my book -- and the statistics are compelling -- is that we have more and more financial crises, and they occur in advanced industrialized societies as well as emerging markets,” Pozen said on a recent visit to Fool HQ.

In fact, Pozen says he can assure you that in the next 10 to 12 years, there will be two financial crises. He says that on average, we’re having a crisis every five or six years. However, “we don’t know when, we don’t know where, we don’t know exactly how,” he says. “These things happen regularly in the statistical sense, but not in the sense that we can predict them exactly.”

Pozen instructs us to examine the statistics. Between World War II and 1975, there were roughly 30 to 40 financial crises around the world. But between 1975 and 1995, the number jumped to more than 130. Out of those 130, at least 18 were banking crises in major industrial societies. Since 1995 we’ve seen the Asian financial crisis (1997), the dot-com crisis (2000, when technology stocks from AOL-Time Warner (now simply Time Warner (NYSE: TWX  ) ) to Motorola (NYSE: MOT  ) to fiber-optics and LCD component manufacturer Corning (NYSE: GLW  ) plummeted), and now the global financial crisis.

“So if you put it together, the reality is that financial crises are not a once-in-a-century and once-in-a-lifetime exception,” Pozen says. “They actually occur a lot. It’s the severity that separates this crisis.”

The thing about a financial crisis or a bubble, as Pozen points out, is that we never know when it’s going to end. Yale finance and economics professor Robert Shiller (who shared his own thoughts in a recent interview) showed persuasively in 2004 that the housing market was overvalued. But if you had sold then, you would have lost three years of appreciation. “So we don’t know when these bubbles are going to burst, but we can say now -- and this is a very important thing for investors -- if we look at the data, that people ought to shift their mind-set,” Pozen says. “They ought not to say, ‘Gee, things are going to be stable and it will only be this rare event’ ... I think if you start to see that you start to have a different perspective. Things aren’t as cheery.”

What this means for investors
Given the frequency of crises, Pozen suggests investors take a very different view of investing. He says that means taking a more active approach to investing, with an emphasis on asset allocation and diversification. That means holding stocks and bonds. It also means paying close attention to the underlying businesses to monitor their health.

Pozen also warns investors to be very careful about momentum. “Momentum is carrying this crisis, but momentum at some point gets away from fundamentals,” he says. “Then, you know it’s going to break -- you just don’t know when.”

For related Foolishness:

Fool contributor Jennifer Schonberger owns shares of Bank of America, but does not own shares of any of the other companies mentioned in this article. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 10, 2009, at 8:05 PM, DDHv wrote:

    Sounds like it would be a good idea (if properly handled) to concentrate on low beta stocks with a history of steady prices when prices are up. And to choose higher volatility stocks when things are down. If there is some sort of crisis every 5>6 years, there would be enough volatility to make planning to take advantage of it a useful trait.

    We should not worry about things going up or down, but should learn to recognize the symptoms of them being up or down.

  • Report this Comment On December 11, 2009, at 5:09 AM, lotontech wrote:

    "He says that means taking a more active approach to investing, with an emphasis on asset allocation and diversification."

    ..and perhaps some downside protection in the form of Stop Orders that lock in accrued profits, and which trigger automatically when you don't have time to reconsider the fundamentals -- or when you're not even watching.

    "Then, you know it's going to break -- you just don't know when."

    ..so you raise your Stop Order (not too tight) gradually as the bubble inflates, and rely on it to get you out 'whenever' the bubble bursts.

    But this need not be mutually exclusive of effective -- and I mean 'effective', not indulgent -- diversification and monitoring of the fundamentals.

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