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7 lessons from the GFC

The GFC went into full force around 10 years ago when the Lehman Brothers collapsed.

A decade after that event, AMP Limited (ASX: AMP) chief economist and head of investment strategy Shane Oliver has shared some lessons from the GFC on Livewire:

There is always a cycle

Long periods of good growth, low inflation and great returns are invariably followed by something going wrong according to Mr Oliver. If returns are too good to be sustainable they probably are.

Some cycles are quick and some cycles take many years to play out – think of banking cycles and housing markets, this relates to Commonwealth Bank of Australia (ASX: CBA) and its peers. Whilst we are getting closer to the next crash, we are also getting closer to the next growth stage.

While each cycle is different, markets are pushed to extremes

Mr Oliver said that contrarian investors can profit from asset prices that are overvalued in the good times and undervalued at the bottom of the cycle.

Indeed, the best time to buy cyclical shares, such as BHP Billiton Limited (ASX: BHP), is at the bottom of the cycle.

High returns come with higher risk

Sometimes the risk of some shares or other assets doesn’t become apparent until there is an economic dip or meltdown. Trying to look back at the GFC for specific measures of volatility is like trying to drive whilst looking at the rear-view mirror.

A high-risk investment may not be dangerous in a single year, but over time it is much more likely to blow up, causing severe losses that may never be recovered.

Be sceptical of financial engineering or hard-to-understand products

The biggest losses during the GFC were for investors in products that had ‘financial alchemy’ which turned junk into AAA investments that no-one understood.

I think this is a key reason why investors should stick to their ‘circle of competence’. Even the Royal Commission is showing how financial products go become problematic.

Avoid too much gearing and gearing of the wrong sort

Debt can be a useful wealth creation tool when times are good, but when the music stops it can magnify losses, forcing sales at the worst possible time.

Too much debt can ruin individuals and businesses alike. Just look what happened to Slater & Gordon Limited (ASX: SGH).

Importance of true diversification

Whilst it may seem as though most assets are different to each other, such as companies and real estate investment trusts (REITs), a panic tends to hit the value of all assets. It’s the underlying value and performance of those assets that matters most.

The importance of asset allocation

Mr Oliver reminded investors that during the GFC having a good diversification of assets such as shares, bonds and cash can be a strategy to reduce the damage.

Foolish takeaway

I like most of these lessons by Mr Oliver, particularly about avoiding dangerous investment products. You don’t want to be invested in that type of thing when problems hit.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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