PERSONAL FINANCE:NEXT MONTH marks the second anniversary of the "credit crunch", the global financial crisis which has led to the worst economic downturn Ireland has experienced in a century, writes FIONA REDDAN

For investors, the past 24 months have been a nightmare, with stock markets crashing, banks nearly facing runs and the property bubble bursting at home and abroad.

However, these experiences can be put to good use by informing future investment decisions. While the most obvious lesson to be learnt from the crisis is that nothing is certain and anything is possible – who could have predicted that Anglo would be nationalised – there are basic investment fundamentals that got lost during the boom years that should be borne in mind.

1 Diversify, diversify, diversify:

Diversification, whereby you spread your investments across asset types, industries and economies, is a fundamental investment technique aimed at reducing risk and increasing long-term returns.

During the celtic tiger, when Irish property prices soared and bank stocks led the Iseq to boom, investors were loath to spread their investments away from the Irish economy. That has resulted in disaster for many when the bubble burst.

Nowhere are the risks of not diversifying as clear as in Irish pension funds, which experienced some of the most dramatic falls in values among developed economies. Too many so-called balanced funds managed by Irish firms were not only overweight in equities compared to international norms, but were also top heavy in Irish stocks, particularly financials. That led to drops of over 30 per cent in values. The five-year average for managed funds is still in the red and they have not even compensated for inflation over the 10-year period.

Although the situation has improved since the creation of the euro zone – up to 10 years ago it was not unusual for an Irish fund to have 40 per cent invested in domestic equities – most funds were still overweight until the credit crunch, thus exacerbating losses. According to the Mercer Market Insight report, in the first quarter of 2008 the average allocation to equities was 73.4 per cent, of which 14.6 per cent was invested in Irish equities.

With Irish financials accounting for almost half of the Iseq index at the time, there was not enough diversification, either in asset class, industry or economy.

Now however, the collapse in values of Irish shares, combined with a concerted effort to diversify, means that funds are becoming more appropriately balanced. For the first quarter of this year, equities account for only 64 per cent of the average Irish managed fund, while the proportion allocated to fixed-interest investments has increased from 14.8 per cent to 22.2 per cent, with cash accounting for an increased share at 7.3 per cent.

Most dramatic however, is the decline in importance of Irish equities, which now make up just 6.8 per cent of the average fund – but it is still some way away from the 1 per cent allocation recommended by experts. In part, this will be a function of the collapse of the prices of the Irish banks rather than any conscious reallocation.

Another obvious lesson in the need to diversify is illustrated by the collapse in Irish property values. If you had put all your eggs in this basket, you would have seen your investment decline considerably and would also find it very difficult to liquidate your position by selling your properties.

2 Property prices move in two directions

A few years ago, the general feeling in Ireland was that you couldn’t lose money on property and that if you failed to buy at a particular time, you would pay 10-20 per cent more a year later.

Now however, with purchase prices in freefall and rents falling, the risks of investing in property are evident. While in the long term capital appreciation is possible, investors should pay closer attention to yields and ensure their properties generate enough cashflow to weather the recession.

3 Beware of incentivised property investments

During the boom, investors rushed into property purchases at home and abroad on the back of additional incentives, such as tax relief or guaranteed rental income. However, property investments should stand up on their own, in terms of likelihood of capital appreciation and rental potential. Many people were blinded by the incentives and now are stuck with a depreciating asset that will be very difficult to shift.

In Ireland, tax incentivised property investments were first introduced during the 1980s to encourage urban renewal. While purchasers of Section 23 properties were often in a win-win situation – property prices soared and the property investment reduced their tax bill – the sheer volume of houses and apartments built in the last 10 years has led to a glut of properties on the market leading to major declines in value.

At the same time, the tax attractiveness of such schemes has also considerably deteriorated as the amount of rental income looking for a shelter has declined.

While some people may have inadvisably bought Section 23 properties as they didn’t have enough rental income in the first place to warrant such investments, a more serious problem was the purchase of property in remote areas of the country.

There are now large rural housing estates all over the State lying vacant with little possibility of being sold or rented.

Similarly, problems have also beset investors in French sale and leaseback properties, which were developed by the French government to develop in tourist areas. The main advantage of the scheme was a VAT rebate and guaranteed rental income. However, some of the management firms have gone to the wall, bringing rents with them, which means investors are often stuck with properties in difficult to rent areas.

As the guaranteed rental income was often factored into the price, many will have paid over the odds for their investment and will find it very difficult to sell at a satisfactory price. So while incentivised property investments can be beneficial, remember that you should approach a purchase in the same manner as if there was no incentive.

4 Take your profits

If the credit crunch has taught us anything, it is that blue-chip stocks do not necessarily mean risk-free stocks – see the Irish banks, particularly the collapse of Anglo – as a case in point.

Don’t be afraid to cash in your investments once your returns have reached a certain level and move your gains into a less risky asset. While you may miss out on potential gains, such an approach will give you more control and a more stable portfolio.

For example, markets have rebounded significantly over the past few months, including the Irish market, which is up by over 40 per cent since March. However, many analysts suggest that this is not the start of a new bull run but rather a bear market rally, and that markets won’t stabilise until the economy does.

So if you have recently invested in the market rather than adopting a strategy of old, which may have been to buy and hold for the long-term, consider taking your gains now.

Similarly, by setting a stop-loss on your investment, whereby if it falls to a certain level you sell, you will also limit the downside. If you had set a stop-loss on AIB at a fall of 20 per cent value in value, for example, you might have cashed in your investment at about €18 a share – instead of losing far more as is the case at present.

The key to such an approach is to set your limits before you invest and be disciplined to follow through. While it means you end up selling the next Microsoft before its price soared, it also means that you won’t end up in the position so many people are in now whereby their investments have been decimated.

5 Cash is king

It used to be enough to keep a small emergency fund on deposit in case of emergencies, but, with the asset rich now falling bankrupt due to a lack of cashflow, cash should take up a larger chunk of your portfolio.

Traditionally, wealth managers advised that you keep 5-10 per cent of your portfolio in cash, either on deposit or in money market funds, but unless you are certain that you won’t need access to your money in the short term, it may be prudent to increase these levels.

While mega-rich investors like Warren Buffet recommend you avoid cash due to the negative effect of inflation, this crisis has highlighted the illiquidity of property and stocks compared to cash, leaving many smaller investors short on money and unable to sell their properties and shares because of market conditions.

Having a ready supply of cash also means you will be able to invest if opportunities appear – for example the dramatic decline in Irish property prices means that people who are sitting on piles of cash can get excellent value.

6 Dividends aren’t guaranteed

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in,” US industrialist and philanthropist John D Rockefeller once said. However, in the current environment he wouldn’t have seen much activity as companies cut dividends to conserve cash.

AIB and Bank of Ireland have axed their dividends, leading to hardship for many who depended on dividends as a source of income in retirement. At its height AIB paid a dividend of €0.79 a share, so a shareholder with 10,000 shares would have received €7,900 in 2008 before tax.

While many expressed outrage at the cancellation of the banks’ dividends, companies are under no obligation to continue paying dividends, and just because they were generous in the past does not mean this will always be the case. So if you buy shares to collect dividends, you must be prepared for the consequences if the company stops paying them.