Lessons Learned from the Greek Tragedy

Last Updated May 17, 2010 11:05 AM EDT

The equity market rally that began in March 2009 was stopped dead in its tracks by the crisis in Greece. After closing at 1,217 on April 23, the S&P 500 Index dropped to as low as 1,066 (a loss of about 12 percent) on May 6 before closing at 1,136 on May 14.

Once again, risk had reared its ugly head. And many investors began to panic (as usual). On May 7, we discussed why it's wrong to think things like "It's obvious this is going to be bad for stocks. I need to sell." Today, we'll discuss the question, "When will things get back to normal?"

Each year the market provides us with many lessons, or, what more appropriately should be called remedial courses -- because the market teaches the same lessons over and over again. Paraphrasing Harry Truman, there's nothing new in investing, just the investment history you don't know. The Greek crisis is just another example.

Because most investors don't know their history (dooming them to repeat the same mistakes), they're unaware that crises occur with great frequency. The following is a list of just some of the crises that have occurred since 1973.

So we have 15 crises in less than 40 years, or about one every three years. Experiencing crises is the norm, not the exception. And note that this list isn't even close to being all-inclusive. It ignores many other "minor" events like the two Iraqi wars, the SARS virus that threatened to shut down world trade, North Korea gaining and testing nuclear weapons and so on.

And how did stocks perform during this period filled with crises? From 1970 through April 2010, the S&P 500 returned 10 percent per year, and the MSCI EAFE Index returned 10.1 percent.

The Greek crisis was a reminder both that stocks are always risky and that crises are "normal." In fact, it's the regularity with which crises occur that makes stocks such risky investments. And that's why stocks have historically been priced to provide a large equity risk premium. If crises were rare, equity investing would be less risky, the equity risk premium would be smaller, and equity returns would be lower. In other words, bear markets are a necessary evil.

As much as we would like to think otherwise, none of us has a clear crystal ball to protect us from financial crises. Thus, the right strategy is to recognize that financial crises and the bear markets that accompany them will occur, and they will likely continue to occur with great persistence. The only things we don't know are the sources of future crises, when they will happen, how long they will last and how deep they will be.

Therefore, you're best served by having an investment plan that accepts the inevitability of such events and having the wisdom to know that the best strategy is learn what Warren Buffett learned: "We continue to make more money when snoring than when active."

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.