Age old wisdom for dealing with the financial crisis

photo credit: Brian-Progressive Spin

Lately I’ve been fielding a lot of questions about the financial crisis. What should I invest in? When will the market recover? What is causing it?

I pause before I answer. The truth is no one can answer these things with much certainty. My own opinion is to buy and hold and think a lot about lowering risk. I suspect most people feel this way deep down, but they are wondering if this time will be different.

Perhaps it might, but perhaps not. Financial crises have happened before and they will happen again. Smart people have been analyzing booms and busts and their thoughts can still guide us now. Here are some nuggets of wisdom that can help you:

Be cautious of confident people

People used to roll their eyes upon hearing I studied economics at Stanford. Nowadays, they light up as if I had a magic crystal ball. I guess people care about the dismal science only when things are dismal.

I hesitate in my answers and that confuses some people. Why am I not confident? The reason is I’m aware of other sides to what I say. Economics has given me a sense of perspective. In physics, one very complex problem is modeling the motion of three-moving bodies, like the interaction of the Earth, Moon and Sun. If that problem is hard, think about the complexity of modeling millions of adaptive people in our economy.

Yet some people think they can, and they make a quick buck by duping people. Confidence does not equate with expertise. In fact, the opposite often holds. As the famous logician Bertrand Russell once quipped, “The trouble with the world is that the stupid are cocksure and the intelligent are full of doubt.”

If you’re ditching buy and hold, think about Churchill

While Churchill never saw this market, his wisdom lives on. It inspired a clever answer from registered investment adviser Scott Burns. Burns was encouraging someone to stick with buy and hold, even though his friends were not, and here is why:

Your friends are timing the market. They are playing crystal ball. The real test of their investing ability will come when the market turns. They will probably miss the turn. And they are likely to miss far more of the upswing than you lost on the downswing. You, meanwhile, are benefiting if you continue to invest and rebalance at regular intervals.

I certainly understand how you feel about “buy and hold.” It doesn’t feel good. It reminds me of a famous quote attributed to Winston Churchill: “It has been said that democracy is the worst form of government except all the others that have been tried.” Buy and hold is the worst investment strategy— except all the others that have been tried. (source)

Be skeptical, very skeptical of vested interests

I am very skeptical when people tell me things like “this is a great buying time.” Market investments are at a minimum very difficult to time, and some academics think good timing is a result of luck (though this is taking things too far). It’s hard to say when the market will bottom out, so be skeptical.

In fact, people who advise you to buy often have vested interests. In the “pump and dump” scheme, people hype a company through false statements and get others to buy. After the price is inflated, the scammers sell the stock for a large profit to an unsuspecting public. Be skeptical of someone promising you a deal that’s too good to be true.

This is a lesson Warren Buffett related entertainingly in the 1995 annual letter to shareholders of Berkshire Hathaway:

Specifically, sellers and their representatives invariably present financial projections having more entertainment value than educational value. In the production of rosy scenarios, Wall Street can hold its own against Washington.

In any case, why potential buyers even look at projections prepared by sellers baffles me. Charlie and I never give them a glance, but instead keep in mind the story of the man with an ailing horse. Visiting the vet, he said: “Can you help me? Sometimes my horse walks just fine and sometimes he limps.” The vet’s reply was pointed: “No problem -when he’s walking fine, sell him.” In the world of mergers and acquisitions, that horse would be peddled as Secretariat. (source)

When all else fails, buy American (or local)

I got this one in my email. The original source is claimed to be Dr. Marc Faber’s June 2008 newsletter. This is on shaky economically ground, but it is too good so I’ll include it:

The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I’ve been doing my part.

And if you’re interested in learning which news is worth reading, I suggest you try the “Test of Three” passed down from Socrates.