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Lessons Learned from Detroit's Bankruptcy

Seth Jentner07/26/2013

In 1948, the Secretary of Commerce, Charles Sawyer, called Detroit’s automobile industry, “A symbol of the way in which the American economy could best provide the average American with a steadily increasing abundance of the things he wants and needs.” As a result, Detroit enjoyed a thriving economy, but unfortunately in 2013, Detroit filed for bankruptcy.

So what lessons can be learned from Detroit? I believe it would be wise to heed this recommendation from Morgan Housel of The Motley Fool, a leading investment publication:  “Things change unexpectedly, and often for the worse. Diversification is the best way to mitigate that risk.”

According to The Motley Fool, the fall of Detroit can teach investors three important lessons.

  1. Detroit shows how organizations that can’t adapt eventually crumble. Detroit enjoyed the auto boom but never found its second act.
  2. Detroit provides a sad but important lesson in the need to save for one’s self. Thousands of retired Detroit public workers wait anxiously for word on how much their pension benefits may be cut. But their story is not unique. 97% of S&P 500 companies with pension plans are underfunded. “By any measure, nearly all state and local pension plans are underfunded,” according to the Congressional Budget Office in 2011. The hard lesson is that you can only rely on yourself to save for retirement and look after your investments.
  3. Detroit was overwhelmingly reliant on one industry. The same mistake often trips up investors. The lack of diversification can be one of the surest routes to disappointment. One study from the University of Texas demonstrated that the least diversified investors underperform the most diverse investors by an average of 2.4% annually.

I recommend that you avoid concentrating your investments, no matter how safe or promising they appear. Instead, use global diversification as you seek reasonable returns while mitigating risk.

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