During these last few weeks of market instability I have heard one question from investors more frequently than any other, “The market seems to being doing badly, should I move to cash until things get better? “
While the response depends on the particular investor, the answer is usually, “no.”*
It is human nature to want to avoid short-term discomfort, even when we know it may cause greater pain down the road. There are many cases when people look to ease their current burdens, not thinking of the problems it may cause in the future. As investors we are sometimes tempted to act this way during periods of high market volatility or market downturns.
Moving your portfolio to cash in the wake of a significant downturn is another example of trying to avoid short-term pain at the detriment of your long-term prosperity. A diversified portfolio contains, at least in part, shares of stock, bonds and possibly, money market or stable value issues. The value of your portfolio rises and falls as the price of these options fluctuate. To realize a return on your investment it is necessary to sell investments in your portfolio for a higher price than they were purchased. Sell high – buy low is the name of the game in investing.
Moving to cash when the market is down is essentially selling your portfolio at sale prices. Re-entering the market after it recovers means you are then purchasing similar holdings at a higher price. While this may allow you to avoid the short term pain of watching your account value fluctuate, it can be a serious setback when it comes to achieving your long term goals.
To put this in perspective let’s take a look at something most of you use on a daily basis, dishes. Now imagine the value of your dishes is tracked constantly and reported on the news every night. One day you see that the value of them has fallen to levels much lower than the amount that you purchased them for. In a panic you sell you the whole set. After some time passes the value of the dishes has recovered. Feeling relieved, you take the cash from your sale and set off to buy back all of the dishes. You will quickly realize that you do not have enough cash to get the whole set of dishes. You now can only afford part of the set.
While this may be a tongue-in-cheek example, thinking in these terms can help you understand the effect of selling low and buying high. The fact is that market volatility at the level we have recently experienced magnifies the importance of having a well thought out plan for managing your retirement investments, and shows how crucial it is to be honest with yourself when deciding how aggressive you really are.
The next time you are inclined to move to cash as you see the market go down, take a few minutes to review your investment plan first. If your plan calls for a change to meet your long-term goals, then move forward. If you are not acting on the plan, but only on an urge to avoid the short-term discomfort, well, maybe it’s time to rethink that strategy.
Contact the Smart401k adviser team at info@Smart401k.com or 877.627.8401 if you have any questions. Also, feel free to let us know of your comments and thoughts in the comment section below.
Charlie Koch, MBA, CFP®, CFS®