Investors hold some $1 billion in Detroit general obligation bonds, and $5.3 billion of bonds backed by the city’s water and sewer revenue. That’s barely a rounding error in the $3.7 trillion municipal bond market. And not all of Detroit’s bonds’ value will be lost; part will be recovered post-bankruptcy, and parts are backed by bond insurance companies. The direct investing fallout from the city’s bankruptcy is nil.
Symbolically, Detroit teaches us three things about investing.
Firstly, it was overwhelmingly reliant on the auto industry. When the fate of three companies — General Motors Company (NYSE:GM), Ford Motor Company (NYSE:F), and Chrysler — turned, so went the entire city’s fate. Evan Soltas of Bloomberg wrote: “Detroit’s dependence on cars wasn’t exactly the problem. It was dependence itself. Cities should never go all in on any industry, cars or otherwise. It didn’t realize that until it was too late.”
The same mistake often trips up investors. We preach diversification at The Motley Fool because a lack of it can be one of the surest routes to disappointment. William Goetzmann of Yale and Alok Kumar of the University of Texas once showed that the least diversified investors underperform the most diverse investors by an average of 2.4% annually. Things change unexpectedly, and often for the worse. Diversification is the best way to mitigate that risk.
Secondly, Detroit shows how organizations that can’t adapt eventually crumble.
Before it was a technology hub, San Francisco relied on shipping, and before that, gold mining. Before New York was the financial capital of the world, it was the garment capital of the world. Detroit enjoyed the auto boom, but it never found its second act.
Adaptation is a key requirement for any organization’s survival, including companies. We’re always looking for companies that adapt to changing circumstances. Amazon.com, Inc. (NASDAQ:AMZN) started as an online bookstore and adapted into the world’s largest store, period. Netflix, Inc. (NASDAQ:NFLX) started as a DVD-by-mail company and adapted into a streaming video service. History provides two constants: Change, and punishment for organizations that don’t adapt to change.
Lastly, Detroit provides a sad lesson in the need to save for one’s self. Tens of thousands of retired Detroit public workers wait anxiously for word on if, and how much, their pension benefits may be cut. Their story may not be unique. According to Credit Suisse, 97% of S&P 500 companies with pension plans are underfunded. The Congressional Budget Office wrote in 2011 that, “By any measure, nearly all state and local pension plans are underfunded.” The hard lesson is that you can only truly rely on one person — yourself — to save for retirement and look after your investments.
Never let a serious crisis go to waste. That includes learning from Detroit’s fall.
If you’re interested in more on how debt impacts the economy, check out my new report, “Everything You Need to Know About the National Debt.” It walks you through step-by-step explanations about how the government spends your money, where it gets tax revenue from, the future of spending, and what a $16 trillion debt means for our future.
The article What a Bankrupt Detroit Teaches Us About Investing originally appeared on Fool.com is written by Morgan Housel.
Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Ford, General Motors, and Netflix. The Motley Fool owns shares of Amazon.com, Ford, and Netflix.
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