And once the storm is over, you won’t remember how you made it through, how you managed to survive. You won’t even be sure, whether the storm is really over. But one thing is certain. When you come out of the storm, you won’t be the same person who walked in. That’s what this storm’s all about.

Haruki Murakami, Kafka on the Shore

The Global Financial Crisis was the second significant market event I was conscious of. My investing journey began at the same time as the 2000 ‘Dot com’ bubble. I have few distinct memories of that latter event, though I do recall a work supervisor who had a sizeable investment in an actively managed global technology focused fund, ruefully reflecting on market events.

The Global Financial Crisis was different – it emerged in the early phases of my investment journey, around seven years after I started building an investment portfolio by making regular contributions, and after I had already read a number of investment books and researched some financial market history.  Indeed, By mid-2006 I had already set an early FI goal of achieving investment returns equal to average expenditure, with an ambitious deadline of December 2008. This shows how far I was from anticipating the shape of events to come.

This post results from reader questions received about my direct experience with the Global Financial Crisis. It focuses on the period of the crisis and initial recovery, from 2007 through the 2010 and aims to cover:

• what investments were made leading up to and through the crisis period
• the overall asset allocation of the portfolio through the period
• the impact of the crisis of the portfolio – including overall portfolio value and distributions; and
• how the experience of the Global Financial Crisis has shaped the rest of the financial independence journey

In short, how – or indeed was – this storm weathered?

Answering that question needs to start at the beginning, however, with a description of the context in which the crisis developed.

Before the storm – initial position and first signs

Relevant to the picture is the fact that the Global Financial Crisis occurred just following the purchasing of a house in late 2006. Saving for this purchase had been the focus of the previous several years.

As it was, therefore, the FI portfolio was at an early stage at 2007, less than 10 per cent at least in nominal terms to its value in January 2019. The only investments owned at that point were several Vanguard diversified funds, and some small shareholdings in Insurance Australia Group and Telstra.

As early 2007 arrived, the last of several lump sum mortgage payments were made. With their completion, a major opportunity to refocus cashflow towards building a FI portfolio emerged. Yet this was not without some small foreshadowing events pressing themselves onto my consciousness

In fact, I recall a disquieting sense building through small scraps of information in early to mid-2007 that unusual pressures were building in the banking and monoline insurance sector (which often offered insurance on credit default swaps and other exotic residential mortgage backed securities).

I also remember registering the decision by French bank BNP Paribas to suspend three US mortgage focused funds in August 2007. Similarly, the failure of the UK bank Northern Rock in September 2007 signalled these were not normal times.

Steering the ship – actions through the storm 

So, putting aside what was thought, seen or missed – what matters is what actions were actually taken through the period.

During the period 2006 to 2010 my annual investments into the market increased every year. This evolved from final payment of the house mortgage, to increased investment in what were my primary investment vehicles then, the Vanguard retail funds.

During the sharpest phase of the GFC, around September 2008 to March I was investing between $3400 and $4400 per month into the most aggressive of these funds – the Vanguard Diversified High Growth fund.

As an example of the power of regular investing in this time of serious equity market decline, I purchased units of that fund at prices as low as $0.92c per unit – less than half the current unit price in nominal terms, and nearly 45 per cent lower in real terms.

The majority of these new investments – over two-thirds – were made into indexed growth orientated Vanguard funds – the High Growth fund receiving the most. Smaller contributions were also made to the Vanguard Growth and Balanced funds. Additionally, I invested around $24 000 in Vanguard’s Diversified Bond fund across 2009-2010 – primarily because I had closed a higher cost actively managed ‘Conservative’ Colonial First State Managed Fund and wanted to invest the proceeds in a close substitute.

Between May and July in 2009 I also made my first purchases of gold (purchasing the ETF code GOLD.ASX). It is possible this represented some late emerging panic – however, at the time I was also growing more interested in putting together a portfolio of non-correlated assets, and learning more, so this is not the only interpretation to place on that move.

Rather, at the time I believe I considered it a small hedge against even more extreme states of the world than I had been experiencing. This is illustrated by the fact the amount invested was less than 10 per cent than total new contributions in that period.

Complicating the overall picture of savings and investment in the 2008 to 2009 period is the fact that I had changed jobs in early 2008, and then was briefly out of work in the second half of 2009. It also meant some pre-emptive building up and then use of cash reserves as a cushion, which should not be mistaken for pre-cognition. This change in life circumstances introduced an involuntary and early phase of portfolio draw-down for these months, in what felt like delicate market times.

What is difficult to convey is the overall sense of crisis across the media and institutions. One trivial but symbolic example of this was listening to the then new Planet Money podcast, and learning almost on a nightly basis of the significance or unprecedented movements in obscure interbank markets in the US – the ‘Ted spread’ measure.

In the most dramatic phase of the crisis, September 2008, I even acted to ensure cash holdings were spread around banking institutions in a way that diversified my risk to any one of Australia’s big four banks being unable to meet their obligations, as well as maximised coverage of the deposit insurance scheme in place. At the time, to be sure, I considered the risk of a major bank failing and not being supported by the Federal Government to be very low.

Asset allocation through the global financial crisis

In a storm, steering and the set of the sails is one matter, the direction travelled is another matter.

What is perhaps most remarkable through this time is the relative stability in overall portfolio allocation at this time. This is illustrated by the chart below.

Through the period the equity allocation stayed in the range of 65 to 71 per cent, increasing slightly over the first three years. Bond exposure likewise was stable at between 20 to 24 per cent.

The most significant overall changes evident are the elimination of cash holdings through that time, and the gold purchase. Throughout the period, average allocations to shares and bonds remained at exactly their longer-term averages since 2007.

Boxing the compass – tracking directions in the storm

To illustrate what actually happened to the overall value of the portfolio through the Global Financial Crisis the chart below sets out the half-yearly progress from mid-2007 to January 2010.

What can be seen from this is growth until January 2008, and then essentially a near ‘levelling off’ in the total value for six months, followed by a small increase (of less than $10 000) in the second half of 2008 – the sharpest phase of the crisis.

Superficially, this might look like a relative non-event, especially as upward movement then resumes throughout 2009. Yet, looking only at the total portfolio value obscures the fact that significant  contributions were being made during this ‘levelling off’ period.

To understand this better, examining just the change in market values of assets held, and removing the contributions impact is a better measure.

This makes it clearer that contributions were in fact backfilling continued market falls. For example:

• In the year from October 2007 to October 2008 the portfolio faced market losses of more than $50 000 – or around 30 per cent of its average value at this time; and
• Across the broader period of the crisis from July 2007 through to March 2009, the total losses through market falls in the portfolio were around $75 000, equivalent to around 47 per cent of its value through this time.

With the regular investments discussed above, the result of this was the portfolio struggling to maintain forward movement.

For around seven months from the third quarter of 2008 to March 2009 the level of the portfolio simply did not rise, despite significant regular investments.

Assessing the stability of distributions through the 2007-2010 

Distributions and dividends are often discussed as being inherently more stable in periods of market volatility. The key question to answer here is: compared to what?

The portfolio data I have provides at least one window into this question over the period.

The chart below sets out the ‘adjusted’ portfolio income over 2007 to 2010 (income such as dividends and bond coupon payments, excluding any distributed capital gains as detailed here). This measure also excludes some cash and at call high interest savings, to focus purely in on the portfolio income of market exposed assets.

Broadly, through this time as mentioned above, the asset allocation was equity dominated, around 68 per cent, with a 22 per cent bond allocation.

From 2007 to 2008, with growing investments, distributions nearly doubled. From 2008 to 2009, however, portfolio distributions in the form of dividends and bond income fell by more than 50 per cent. This is a significant fall, and not easily reconcilable with a view about the reassuring stability of dividend income, for example.

The performance is even starker when considering the income yield of the portfolio – and looking at not the absolute numbers of distributions, but the yield based on the average value of the portfolio over the relevant yields.

This is illustrated in the chart below.

From this it can be seen that in 2008, the adjusted income yield was 5.1 per cent.

In 2009, this fell to just 1.9 per cent, even though no significant shift in the type of assets owned had occurred – equivalent to an over 60 per cent fall in the income produced by the portfolio. This shows the potential risks in planning to directly live off dividend income from a portfolio, with no buffer.

Both the yield and absolute level of distributions bounced back somewhat over the next year. Yet, the average income yield between 2009 and 2016 was still only 2.3 per cent, less than half the pre-GFC yield.

After the storm – the same person who walked in?

So how has this storm affected the rest of the voyage?

My personal learnings from the period are many, but in fact none relate to the timing of unpredictable markets. Rather these lessons are:

• Recognising the value of automatic investments – Although at the time I had a tiresome tendency to over-finesse automatic fortnightly contributions between the main Vanguard funds, the existence of these automatic scheduled investments itself played a useful role in keeping on investing through the worst of the crisis. The question ‘should I invest now, or later?’ simply never arose, thanks to already established automatic investment mechanisms.
• Avoid over-reliance on the supposed stability of dividend income – This can change significantly, and it is dangerous to leverage annual spending too closely to an expectation that dividends or other distributions cannot fall substantially and stay low for some time.
• Reading about other financial crises helps gain perspective – Reading accounts, history and studies of other periods of market turmoil can help recognise the common features of such events, gauge their potential severity, and help reassure that relatively few equity market falls have been without opportunities, or recovery.
• When investing amidst paper losses, focus should be on acquiring assets – Seeing regular investment contributions apparently ‘disappear’ in a days market movement is hard, and we should expect it to be so. Yet, the opportunities to acquire attractive income generating assets in a time of low market confidence should form a powerful counter-acting force.
• Manage your whole capital portfolio (including human capital) not just your investments – For most people encountering a market downturn or crisis early or mid-career, potential lifetime earnings from work (i.e. human capital) will still be your largest asset. It makes sense to focus on that, work hard at maximising your human capital portfolio, which is far more in your control, rather than seek to over-optimise on managing your smaller pool of liquid investments.

So with those learnings, its arguable that the same person did not walk out of the storm. Rather, it has helped prepare for the next storm – which will inevitably come.