What you can learn from the Stock Market Crash - Part 1

With most global stock markets down 30-50% year to date, and many individual investment accounts down even more than that, now is a particularly good time to see if there are any lessons we can learn from a period that, quite frankly, has been an awful experience for almost all investors. Here are seven lessons to take away from the recent stock market crash:

1) ALWAYS BE LIQUID

No matter how good things may seem in the market, and no matter how confident you are in your future, always keep a healthy amount of liquid assets available at all times. These assets can be in the form of cash, short-termCDs or money market funds. Ideally, this money should be in addition to a fully funded 6-12 month emergency fund. You never know when you might need extra capital for an attractive investment opportunity, or to fund a large unplanned liability, or to support your family during an unexpectedly long period of unemployment. And most importantly, you never want to be in a position where you are forced to sell your long-term investment assets during a severe market correction.

How much liquidity is the right amount? A good rule of thumb is to keep 20-30% of your investment capital in risk-free, shorter-term interest bearing investments, but I often suggest to people to keep up to two years of expenses in readily available, liquid form.

2) AVOID CATASTROPHIC LOSSES AT ALL COSTS

If you happen to suffer losses of 50% in a mutual fund or in your retirement account (something not uncommon to many investors this year), a curious thing happens: in order to get back to even, you will need to double your money. And assuming an average annual return of 7% (which is looking more and more like an optimistic assumption for stock market returns going forward), doubling your money will take you roughly ten years of compounding time.

Recognize that it can take many years to claw back to breakeven after heavy losses. When you decide what percent of your investment dollars to allocate to stocks, particularly when you are nearing retirement age, keep this concept in the very front of your mind. During certain periods of aninvestor's life, stocks can be far riskier than you might think.

3) ANY STOCK CAN GO TO ZERO (OR GET VERY CLOSE)

A year or two ago, it would have seemed laughable that a company like AIG, trading at above $70 a share with all of its enormous competitive and economic advantages, could have close brush with bankruptcy and have its stock nearly wiped out. And yet that is exactly what happened: the stock is down 97% from its all time high and thecompany's prospects are permanently impaired.

Unfortunately, this isn't as unusual an occurrence as it may seem, especially during severe bear markets. So far in 2008 alone, several airlines, a number of retailers (including Circuit City and Linens'N' Things) and more than 20 financial companies (including major names like Lehman Brothers, Bear Stearns and WaMu Bank) fell into bankruptcy. And in each of these cases, stockholders were left either with nothing or very close to nothing. As a stockholder, you are the first to be wiped out if a serious event occurs to a company in which you hold stock. Respect this fundamental risk inherent in owning stocks.