Originally published on March 16, 2020
Editor's note: This post was originally published on the Russell Investments blog in December 2018. Due to popular demand, we've published an updated version.
In recent weeks, how many times have you fielded the question, should I be moving to cash? Or maybe it's come in the form of a bold (panicked?) statement: I need to move to cash.
We have certainly seen an uptick in this sentiment accompanying the increase in market volatility these past few weeks.
Skittish investors are eyeing the current CD rates and thinking, a 2-3% return looks pretty attractive relative to a market correction.
Are investors best served by abandoning their long-term allocations to move to the safety, but limited return potential, of cash? It's never been easy to correctly time markets - but is this time different?
Let's put emotions aside for a minute and look at some of the data. Historical perspective on how frequently portfolios have lost money may help investors wrestling with the notion of exiting the market.
Before considering a move to cash, investors should assess a few factors:
It's true that capital markets have produced negative results for investors at times. The shorter the time horizon, the more frequently this occurs. Looking back over the last 50 years, diversified portfolios1 have produced negative returns approximately one-third of the months. One in every three months is rather frequent. For those investors with an extremely short time horizon, cash may be a viable option.
If you extend your time horizon out to one year, diversified portfolios have delivered negative results approximately 15% of the time. That may still be too great a risk for investors with a short horizon. However, as the time horizon begins to lengthen, the negative numbers come down quickly, as seen in the chart below.
Note: Hypothetical analysis provided for illustrative purposes only.
1 Diversified Portfolios: Three Index Portfolios Comprised of S&P 500 Index (S&P 500), MSCI EAFE Index (EAFE), and Bloomberg Barclays U.S. Aggregate Bond Index (AGG); 30% Equity: 20% S&P 500/10% EAFE/70%AGG, 50% Equity: 34% S&P 500/16% EAFE/50% AGG, 70% Equity: 47% S&P 500/23% EAFE/30%AGG
At one year, a 50% equity portfolio has produced positive results 86% of the time - and this jumps to 95% and 100% over three- and five-year horizons. Over the last 50 years, the occurrences of negative investor returns stretching much beyond 12 months has been relatively small. To attempt to correctly, and consistently, time those narrow windows of negative results seems a difficult exercise.
To address the "sure it's a narrow window, but this is a clear sell signal" argument, let's review historical signals that were obvious sell warnings.
In hindsight, that certainly seemed like a sell signal. Or was it?
For investors in a hypothetical 50% equity index portfolio (as shown above) who anticipated the Lehman bankruptcy and got out of the markets on August 31, 2008, their timing helped them avoid a -4.2% loss over the following 12 months (ending August 2009).
For investors who experienced the bankruptcy and decided to get out of the market on September 30, 2018, they missed out on a 4.4% gain over the following 12 months (ending September 2009). Yes, there was a significant equity market drawdown in the midst of this, but investors who stayed invested profited from the 2009 market rally.
So, in the case of the Lehman Brothers bankruptcy, there was a very narrow window of time during which investors benefited from selling out a hypothetical 50% equity index portfolio.
The next step for those investors who exited the market is: When would it feel good to get back in? That's a whole other can of worms - and emotions. Some investors have never gotten back in post 2008.
A signal that occurs more frequently than the Great Financial Crisis is an inverted yield curve - when the yield of short-term Treasuries is above that of the 10-year U.S. Treasury Yield Curve.
This signal has sounded five times over the last 50 years, and in each case, a recession - typically accompanied by a significant equity correction - has followed. A challenge has been that these recessions have fallen anywhere from six months to 24 months after the curve initially inverts - and these periods often experience positive returns that should not be missed.
So, the inverted yield curve may not be an immediate market signal despite its recession warning capability. In fact, actual historical results suggest that the inverted yield curve may not give much of a warning signal at all.
Note: Hypothetical analysis provided for illustrative purposes only.
Diversified Portfolios: Three Index Portfolios Comprised of S&P 500 Index (S&P 500), MSCI EAFE Index (EAFE), and Bloomberg Barclays U.S. Aggregate Bond Index (AGG); 30% Equity: 20% S&P 500/10% EAFE/70%AGG, 50% Equity: 34% S&P 500/16% EAFE/50% AGG, 70% Equity: 47% S&P 500/23% EAFE/30%AGG.
On average, time periods following inversions have produced positive returns. Moving out beyond one year shows a pattern of lower risk (lower equity) portfolios producing greater returns than higher-risk (higher-equity) portfolios. This is likely the result of bonds getting a post-inversion boost as interest rates are lowered to combat economic slowing and stocks retreat due to that same economic slowing. Regardless, the hypothetical index portfolios have appeared to post positive results on average following yield curve inversion.
The Lehman Brothers bankruptcy and the inverted yield curve scenarios - both strong sell signals - are examples that timing cash moves around market events or certain conditions can be difficult. Conditions or events that investors may view as clear get-out signals can be cloudier than thought.
The recent increase in market volatility has appeared to stir up questions about moving out of the market for the safety of cash. We may caution against market timing for most investors, because that decision is often not rewarded. If investors ignore this and insist on doing something in the face of perceived increasing risk, one idea might be the temporary reduction of market exposure.
Reducing the equity allocation by 10-20% may provide additional cushion if the market does pull back, and still provide participation if markets snap back quickly or don't draw down at all. One final consideration for those contemplating this path is to document the reasons for getting out and the catalyst for getting back in. These decisions are often driven by emotions and not by long-term perspective, so having a written plan in place may help improve the odds of success or mitigate the amount of harm made by a bad call.
Performance quoted represents past performance and does not guarantee future results.
Indices and benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Index return information is provided by vendors and although deemed reliable, is not guaranteed by Russell Investments or its affiliates. Due to timing of information, indices may be adjusted after the publication of this report.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI.
Bloomberg Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. (specifically: Barclays Government/Corporate Bond Index, the Asset-Backed Securities Index, and the Mortgage-Backed Securities Index).
MSCI EAFE (Europe, Australasia, Far East) Index: A free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.
The S&P 500® Index: A free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. The stocks included in the S&P 500® are those of large publicly held companies that trade on either of the two largest American stock market exchanges: the New York Stock Exchange and the NASDAQ.
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
This material is not an offer, solicitation or recommendation to purchase any security.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.
Russell Investments' ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments' management.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the "FTSE RUSSELL" brand.
The Russell logo is a trademark and service mark of Russell Investments.
Copyright © 2020 Russell Investments Group, LLC 2020. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.
Russell Investments Financial Services, LLC, member FINRA (www.finra.org), part of Russell Investments.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
This article was written by