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What We Can Learn from Detroit’s Bankruptcy

Seth Jentner12/18/2014

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.”

Unfortunately, Detroit filed for bankruptcy.

This quote was published by The Motley Fool, along with a recommendation that we would all do well to pay attention to: “Things change unexpectedly, and often for the worse. Diversification is [one of] the best way[s] 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’ pensions were jeopardized by the bankruptcy and were eventually cut from what they were originally promised. Their story is not unique. 97% of S&P 500 companies with pension plans are underfunded. The Congressional Budget Office has said, “By any measure, nearly all state and local pension plans are underfunded.” 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. A study by William Goetzmann of Yale University and Alok Kumar of the University of Texas demonstrated that the least diversified investors underperform the most diverse investors by an average of 2.4% annually.

I recommending that you avoid concentrating your investments, no matter how safe or promising they appear. Use global diversification as you seek reasonable returns while mitigating risk. Call me if you want to discuss this concept.

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