However, everyone took notice on Monday, September 15, 2008, because the Dow closed at 10,900, down 500 points in one day. The peak of the market was in October 2007, so the markets had been on a slow decline for several months already, but this day was different because it was triggered by a specific event, one which truly shook the confidence of the most seasoned investors. Not just investors, the rich investors.
At this point, I should define a couple insensitive terms. The individuals I have classified as the "rich" are by no definition evil or manipulative. Their actions were not greedy and there was no intent to harm others. They are the individuals who have amassed wealth by various means, and one of their top financial goals is maintaining existing assets. I would not even classify them as risk-adverse, but rather very risk-aware. Likewise, the "poor" are by no means living on the streets. In fact, they probably are not living paycheck-to-paycheck either. They are educated individuals who are either uneducated on the finer points of investing or (equally likely) undisciplined on maintaining the finer points they know.
Immediately after Lehman filed for bankruptcy, the markets tumbled and tumbled, and then, they tumbled even further. They turned around eventually, and today the markets are currently at 11,300, just about the same level where these events began. There are thousands of explanations and theories by professionals on how and why the markets reacted the way they did, but in hindsight of three years later, I believe part of it was the quintessential tale by which the rich get richer and the poor get poorer.
The Lehman Brothers was the fourth largest investment bank in the United States at the time of its bankruptcy. At that point, I knew the Lehman Brothers for its bond ratings because they were the most respected in the industry. In fact, I could not even name another bond rating. All I knew was Lehman Brothers. The idea of the Lehman Brothers filing for bankruptcy baffled me immediately. Ignorance was bliss. For those in the know, it frightened them greatly. As a result, they continued to shift their investments from stocks and bonds to money markets, the safest investment option by far.
Personally, I don't remember what the Vanguard Prime Money Market fund was yielding back in September 2008, but I would guess that it was probably a 3% yield. It did not matter though. The fact that investors could protect what they had without incurring further losses was the main attraction. Indeed, those savvy investors acted correctly in their movement.
Speaking again in my defined yet generalized terms, the rich were the first to move their money because they had the most to lose. Perhaps they were the most informed as well, or at least, they had the most informed professionals managing their investments. At the time, I know skeptics of the purported "worst case scenario" dismissed the initial decline as "sour grapes" over the 2008 election in which Barack Obama was elected to replace the "rich"-friendly Bush on a platform of change.
Regardless, the stock markets declined at a rapid pace, falling to 8,775 by the end of the year. Looking back now, I believe that the high net worth investors were protecting their investments at a rapid pace, which pushed the markets down as rapidly. The fourth quarter is often the strongest of the year, so for the markets to fall at least 3,000 points in the fourth quarter worried more than just the rich investors.
As 2009 began, I believe more of the average investors were caught up to speed. Perhaps fueled by the advice of some wealthier neighbors, or more likely, emotionally reacting to their declines, they started to place their own money from stocks to the safer money markets. The markets continued to fall, reaching 6,547 on March 9, 2009. At that point, the markets inexplicably started to turn around. The reasons why it happened at that point remain a mystery for random speculation. And I have my own theory.
In my belief, the rich realized the probability of the markets increasing was much higher than the probability that the markets would continue to fall. Maybe not even "much higher," but simply higher. In fact, we can put it in terms of money, and think through it logically. Those money markets where the rich had placed the bulk of their assets in October were offering less than 1% so stocks would only have to gain 1% to be a more profitable investment. While it's true that the markets could have fallen from 6,500 to 5,000 or lower, that possibility is the nature of the beast. Investors cannot escape risk. But when money markets pay less than 1% interest, there is no incentive to be stock-adverse regardless how risk-aware you are.
The rich understood this shift. However, the poor could not afford to lose more. In my prior scenario, the poor had already lost 60¢ on every invested dollar. Meanwhile, the rich shifted to a stable investment when (or before) their portfolio fell 30%. As things changed, the poor stayed in the money markets to protect what was left but the rich risked losing their 70¢ to gain a little more. In this case, it was a lot more! The markets went from a low of 6,547 in March 2009 back to 10,000 a mere 7 months later. The markets continued to climb, so once again, the rich had $1.07 on every invested dollar while the poor continued to protect the remaining 40¢ of every invested dollar. At the end of this scenario, the rich now have three times as much as the poor for every invested dollar. No greed, no deception, and no malicious intent were involved.
Considering the Vanguard Prime Money Market fund yields 0.03% today (not 3% but 0.03%), there is a strong likelihood that there are many people who are still protecting the 30¢ left from each dollar. When they do venture back into stocks, they will be buying higher than the rich did when they shifted back into stocks. And most likely, their gains will not be as phenomenal as the rise was in those 7 months of 2009.
The key to successful investing is simply to "buy low, sell high," but this cautionary tale epitomizes how investors can innocently "buy high, sell low." To avoid this pitfall, revisit a few of the other entries in this blog, especially the quarterly updates discussing asset allocations and the importance of a periodic rebalance. As luck would have it, I started this blog on February 10, 2009, four weeks before the infamous 6,547 closing.
