What to do when the next financial crisis unfolds.

One of my favorite Hemingway quotes is from The Sun Also Rises. When Mike Campbell, a Scottish war veteran and one of the main characters in the novel, is asked how he went bankrupt, he replies: “Two ways. Gradually and then suddenly.”

The quote succinctly describes the reality of financial crises and the challenge of protecting yourself from them.

In my 35+ years as an advisor, every significant financial crisis has happened gradually and then suddenly. The 1987 stock market crash. The Asian financial crisis in the late 90s. The dot com implosion of 2000-2003. The great recession of 2007-2009. The COVID financial meltdown of 2020. And perhaps we are in another now. No one knows with certainty.

In hindsight, there were warning signs with each case. The crisis was unfolding gradually. But it wasn’t obvious. Then, after weeks, months or even several years, the financial market reaction was sudden. And it was severe.

The truth: Crises are unpredictable.

• When a market drops violently, by definition, it is a surprise to most investors. Otherwise, the market would have already fallen. Don’t try to predict the timing or nature of the next crisis.

The myth: Crises are predictable if you know where to look.

• That’s only in hindsight. Yes, after the fact, you can connect the dots. COVID was reported a few months before the global financial melt-down and we could track the spread across the globe. But investors did not appreciate what could happen to stocks, which dropped one-third in a few days. There was talk of a housing bubble in 2005 and 2006. But few people understood how it was infecting the financial system, with the toxic brew of sub-prime mortgages, mortgage-based securities, credit default swaps and the like. If our current banking turmoil turns into a crisis, we may look back and identify the start at Silicon Valley Bank (SVB). Or no crisis may ensue. We just don’t know what the future holds.

The challenge:

• How do you create a financial plan to achieve your goals with high certainty in a world with little certainty?

The solution: Plan, don’t predict.

1. 1. Diversify across multiple types of investments, because you don’t know which will suffer most in the next crisis.That means stocks and bonds from the US and outside the US. It may also mean owning real estate or other alternative investments that may zig when the market zags – but not too much, given the difficulty in selling at short notice. For most investors, owning broadly diversified mutual funds or exchange traded funds (ETFs) is the easiest way to diversify.
   2. Have enough cushion to ride out a crisis. A cushion includes cash, high-quality bonds, and guaranteed sources of income. Sources of guaranteed, reliable income could include employment, Social Security benefits, a pension, or an annuity.
   3. Keep debt or other fixed financial commitments like an auto lease or monthly subscriptions as low as possible. That makes it easier to manage through a difficult economic environment.
   4. Don’t forsake assets like stocks that will grow over the long-term. We may be years away from a crisis and you don’t want to miss years of growth. Own as much as you can without putting your financial plan at risk. For some people that may mean 80%+ of their investments. For others it may mean 50% or less. This ratio is unique for each person because each person has a unique financial plan.

With the benefit of hindsight, it’s easy to see a crisis coming. But in the moment, it’s much harder. Make sure your financial plan is fortified for a future crisis. Whenever a crisis arrives, in whatever form, for whatever duration, you will be ready. You won’t see it coming, but you will be ready.