Learning from loss

On this day last September, most of us couldn't imagine how bad things were going to get.

But the failure of investment bank Lehman Brothers a year ago Tuesday is seen as the catalyst that sent stocks into a free fall that lasted months and wiped out nest eggs.

The market appears to have hit bottom in March, with the Dow Jones industrial average rising nearly 47 percent since that low point. We're less afraid to open our 401(k) statements. And many of us are adjusting to the new reality that we will have to work longer, save more and spend less.

As we approach the anniversary of that fateful fall, this is a good time to reflect on what investment lessons we can take away from the past year. Here are some of them:

Diversification works, mostly So many asset classes lost ground last year that some proclaimed diversification was dead. But the obituary is premature.

"We learned last year that diversification doesn't solve all the problems," says David Wyss, chief economist for Standard & Poor's.

For example, stock markets around the world now move more in tandem with our market than they used to, so diversifying among them offered little protection.

Nevertheless, there's no surefire way to predict what investments will do well. By spreading money across stocks, bonds, commodities and real estate, you stand a better chance that some of those investments will go up as others go down.

Rebalance regularly Annually rebalancing your portfolio wouldn't have prevented losses last year, but the exercise likely would have limited the pain.

"Rebalancing is absolutely critical to manage your risk," says David Stepherson, portfolio manager with Hardesty Capital Management in Baltimore.

Ideally, you decide what percentage of your portfolio should be in stocks, bonds or cash based on when you need the money and your stomach for risk. Then at least once a year, you rebalance the portfolio to return it to the original mix.

Investors who did this would have been selling stocks in 2003 through 2007 as prices rose, Stepherson says. Instead, many didn't rebalance and wound up with sizable positions in stock that got hammered in 2008.

Never be hands off Target-date retirement funds have been an answer for investors who don't want to make the tough choices. You select a fund with the date closest to your expected retirement and a professional manager makes the investment decisions for you based on that time frame.

But as stocks tanked, many older workers suffered steep losses and discovered the funds held more stock than they realized. And we learned that funds with the same date held wildly different amounts of stock.

You don't have to give up on target-date funds, but it's clear you can't just pick one by the date. You need to look at the fund's mix of stocks and bonds, how that will change over time and whether the strategy fits your appetite for risk.

Keep it simple Even Wall Street firms got burned by investments they didn't understand. Avoid complex investments that can disguise high fees or risks, says Bill Reichenstein, an investment professor at Baylor University. "If you don't know what it is or how it makes those returns or understand the strategy, then get out of it," he says.

Be skeptical Investors felt so lucky to invest with Bernie Madoff that they never asked questions, such as how he managed to achieve consistently high returns when no one else could. Even regulators dropped the ball on Madoff, who pulled off a huge Ponzi scheme and now sits in prison.

"Healthy skepticism isn't the worst thing," says John Coyne, president of Brinker Capital in Philadelphia. "They should seek advice and verify the advice."

Work longer Retirement experts for years have advised workers to delay retirement because of longer life spans. Workers are now heeding that advice.

The Employee Benefit Research Institute's annual retirement confidence survey released in the spring found that 28 percent of workers in the past year changed the date they planned to retire. Most are postponing retirement because of the weak economy or to make up market losses. And 72 percent say they plan to work in retirement, up from 63 percent a year earlier.

Less debt, more savings Consumers have long lived beyond their means with the help of easy credit. The financial crisis is turning us into savers.

The personal savings rate in the second quarter this year reached 5 percent, compared with 1.8 percent two years earlier. And July marked the 10th month in a row that consumers reduced credit card debt, according to the most recent figures.

"People are getting more nervous of having high levels of debt," Wyss says.

Besides, he adds, "If you don't tighten your belt, the bank will do it for you." Banks for months have been lowering credit card limits for customers who appear risky.

It's only one year Don't assume that 2008 is now the new norm, and you should change your investment strategy for decades to come based on a single year, says Stuart Ritter, a financial planner with T. Rowe Price Associates in Baltimore.

That could cause you to shun last year's losers, Ritter says, and put all your money in one of the few winners - U.S. Treasuries. But what works one year, might not the next.

An index of medium- and long-term Treasuries rose nearly 14 percent last year, but it was down about 4 percent in the first seven months this year, Ritter says. In comparison, high-yield bonds fell about 26 percent last year, but were up 38 percent at the end of July.

Bad things can happen to good investors You diversified and rebalanced but still took a hit last year from events out of your control.

"Sometimes you can do all the right things, and something bad happens. It doesn't mean what you did was wrong," Ritter says. "That's a lesson for life."