Switching to Cash
High levels of market volatility often seem to bring up the same question: “why not put 100 percent of our investments into cash, and wait for just a little while until things calm down?”
Given the recent sell-offs in the equity markets, it would appear that a number of investors are doing just that. However, by fleeing for the comfort and safety of cash and FDIC insured deposits, investors with a time horizon that is longer than just a few years could be doing real harm to their long-term finances. If you are like some investors who are tempted to move to cash right now, you would essentially be doing something called “market timing”. Market timing is an implied statement that you somehow have the ability to determine the right moment to get out of stocks…and the right time to get back in.
Let’s look at the first part of this option. The “right time” to get out of stocks in 2011 was late April. If you missed that opportunity, you are hardly alone. If you were to sell now, you’d be locking in your losses. Once you sell, there is no upside. In fact, with interest rates being so low for cash deposits, inflation will likely eat up the after-tax returns you would receive on money market or CDs.
Right now, a guarantee of a small loss might sound like a good thing, but if you are not getting out of stocks once and for all, how will you know when it is the best time to get back in? The reality is that any financial peace of mind you would gain from going to cash could be quickly offset by the stress of seeing how much harm you can do to your portfolio when you miss out on much of the rebound.
A 2005 study completed by professor of finance H. Nejat Seyhun at the Ross School of Business at the University of Michigan, tested the long-term damage that investors could do to their portfolios if they missed out on the small percentage of days when the stock market experienced significant gains. From 1963 to 2004, the index of American stocks that were tested gained 10.8% annually. For people who missed the 90 biggest-gaining days during those 42 years, the annual return fell to just 3.2%. Less than 1% of the trading days accounted for 96% of the long-term compounded market gains!
Markets will eventually stabilize, confidence will improve, and investors will be willing to add more to the markets, helping to push prices up. There won’t be a press release when this is about to happen. It will only be evident after the fact when markets have surged and are able to sustain those gains.
The story is actually worse for investors who think they won’t have any trouble investing in stocks later. Long-term investors who are considering moving to cash right now are likely making an emotional decision, at least in part. For investors who follow through, the same instincts will probably hurt them when trying to figure out when to reinvest in stocks. For most people in this situation, things won’t feel better until the stock market has already moved back up. In fact, many investors in this situation won’t get back in until the market has already risen significantly, often at higher prices than when they cashed out, only hurting their long-term returns even more. Investors risk feeling worse by missing out on the bounce back that will eventually come, than they would had they just hung in through the down period.
The truly discouraged investor may not see the bounce back as inevitable. However, such an outlook is like taking our current situation and betting that this time is so different that the equity markets won’t bounce back at all, even though it has survived the market crash of 1929, the Great Depression, the 1987 crash, 9/11, and the financial crisis of 2008. We certainly don’t feel that the market is in some sort of permanent decline or turmoil, nor do other professionals we speak with.
With that said, some investors may find that they need to modify their portfolio if it has breached their risk tolerance or they determine that they just aren’t equity investors. In this case, they will need to lower their return expectations because risk and return are related. Moving to a less risky portfolio or a portfolio with little or no risk means that future returns will be much lower than investing in a portfolio that has risk and volatility. Lowering one’s return expectations may result in the need to work longer, save more, or reduce one’s withdrawal rate to reduce the risk of running out of money.
Investors who are in it for the long-run should look at their investment portfolio the same way they do their home. If you are not moving anytime soon, then your home is also a long-term investment. Think of your investment portfolio in a way that gives you the opportunity to look at today’s price not as your price. Your price could be 5, 10 or 20 years from now, when you or your heirs want to cash in some of the investments, likely at much better prices than today. In the meantime, for investors who need funds today, drawing from cash reserves and their bond portfolio may be the alternative solution.
Our continual goal is to help you in achieving financial peace of mind as you define it. We often do that by helping you to not get too caught up in the current market difficulty, but rather help you to maintain a long-term view. No one can consistently and accurately time the market, and we certainly do not propose that we can do that at Premier. Long-term investing takes patience, discipline, confidence, and objectivity, and it is our hope that you continually experience our support and diligence in these areas.
As always, Premier’s team is here and available to talk with you about any of your concerns. We would be happy to schedule a time to discuss your portfolio and your future financial plan. We are well versed in retirement planning, tax issues, estate planning, and portfolio management and encourage you to schedule a meeting or conference with us to chat about any of these topics you’d like to discuss.
We may be reached at (707) 443-2741
