When Cash is King

If you force yourself to read my retirement musings every once in a while, then you undoubtedly know the following:

1) I don’t believe in market timing

2) I’ve been raising cash as the market has been rising

Now that I’ve crossed the 50 yard line in my life, I feel that the NEXT big market run will be key for my retirement. (Notice, I’m not referring to this current bull market - which has raged for what seems like forever (8 years) and will end at some point. They always do,)

No, I’m speaking of the future. Sometime, down the road, there will be a time to buy the stocks of great companies, or sectors, or indexes at prices that are much more appealing than today. The key is when - which nobody knows, which is why the financial industry is full of professionals exhorting you to stay invested at all times.

Why is this the case?

Simply, they make more money when you’re fully invested; so they spread language like this from a WSJ piece called The Market Timing Myth.

“For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times, no matter how high stocks go or what’s going on in the economy. ‘You can’t time the market,’ they warn. ‘Studies show that market timing doesn’t work.’

And they trot out a fact that you’ve seen in various forms - of how terrible your returns would be if you missed out on the biggest stock market days. Let me explain. We know based on all forms of research and human behavior that stock market investors are an emotional breed. That many of us buy when we should sell and sell when we should buy and that forces of psychology are often to blame. So when markets rise as they have since the election, people will continue to plow money into investments they manage passively with no help from professionals. Then, when markets fall and they grow weary of their tears soaking every brokerage statements, they sell at the wrong time.

Yes, don’t miss the big days. I agree; but that’s only half the story. What about the disastrous days? Should you sit those out?

We know how returns are positively affected if you miss the great days, but would you be surprised to know how returns are affected if you have the good fortune of missing the really, really bad days?

A finance professor from a school in Spain studied this. Per the WSJ article referenced above it was noted:

“Over an investing period of about 40 years, he calculated, missing the 10 best days would have cost you about half your capital gains. But successfully avoiding the 10 worst days would have had an even bigger positive impact on your portfolio. Someone who avoided the 10 biggest slumps would have ended up with two and a half times the capital gains of someone who simply stayed in all the time."

This chart from www.realinvestmentadvice.com summarizes this with a pretty picture. I’ve also included a chart showing how much your investments have to recover from a big drawdown. (See the line highlighted in orange. It’s not pretty!)

To be sure, the green line (enjoying the best days) is better than employing a "buy and hold” philosophy; however, the red, which indicates your return had you missed the bloodbath days is even better.

So let’s review. Don’t try to time the market as that doesn’t work. I always have say 30 - 50% of my portfolio in equities at all times because markets move faster than I do and, to me, being all cash or all equities is a mistake.

Raise some cash if you can. At the very least, use this time of incredible strength to rebalance your portfolio. Although it may not seem intuitive, if you aim for a certain split (let’s say 60% stocks / 40% bonds), use this opportunity to get yourself back to that allocation. I see a lot of retirement accounts that are out-of-balance because stocks have run so much in the last 3 or 4 months. This will force you to take some of the winners - which is good.

And get rid of the losers in your portfolios. If they’re not performing in an up market, they’re not going to in the down market.

That’s just the way it works!

Required disclosures: Investment advisory services offered through Brookstone Capital Management, LLC (BCM), a registered investment advisor. BCM and (Strataxa Retirement Advisors, LLC) are independent of each other. Insurance products and services are not offered through BCM but are offered and sold through individually licensed and appointed agents.

Information provided is not intended as tax or legal advice, and should not be relied on as such. You are encouraged to seek tax or legal advice from an independent professional