Am I Better Off Holding Cash During Market Turmoil
This is a question we get asked all the time by clients. In fact, some clients will take the reins and move to cash at the very hint of a market drop.
And it happened again at the start of 2020. The phone started ringing with concerned investors not knowing what to do as the panic surrounding a new global virus started to take its toll.
There were few places to hide that’s for sure. Global share markets headed south quickly. Forecasts of a looming apocalypse caused many to make the switch to cash and get out of riskier assets like shares.
Cash Flooding the Exits
Ridding ourselves of riskier assets likes shares is nothing new of course. Many investors took the flight to safety during the Global Financial Crisis in 2008-09.
Selling seems a natural reaction for nervous investors who’ve worked their whole lives saving for retirement. You start to think about what happened during recessions past, such as the GFC, and start wondering if your retirement nest egg will evaporate into thin air.
Memories of the GFC and other events like a new pandemic can make it tough to stick with your investment goals and a steady mix of assets.
But is it in your best interests to abandon ship without considering the longer-term consequences first?
True, we don’t know if there is further selling to come with government debt at an all-time high and reserve banks left with little ammunition to stimulate the economy (the cash rate in Australia was reduced to an all-time low of 0.10% in the first week of November, 2020).
But let’s look at a hypothetical situation and we’ll let you decide if switching to cash during a panic is in your best interests.
Timing the Cash Run vs Holding for the Long-Haul
To illustrate a point, let’s consider four hypothetical investors and their fork in the road during two major crises.[1]
Now, assume each investor starts with $100,000 in a balanced portfolio on January 1, 2006.
- Our first investor is Brian and Brian stays
invested through thick and thin because he’s stubborn as a mule.
- At the end of the 14-year period between 2006 and 2020, Brian’s portfolio is worth more than $230k. Despite going through both the GFC and the COVID-19 crisis, Brian’s portfolio had a cumulative return of 128%.
Nice work Brian.
- Now let’s look at Dianne. Dianne learnt her
lesson from the GFC and decided to stay invested during the COVID-19 crisis.
- Dianne invests the same way as Brian—slow and steady—although Dianne moved to cash at the end of December 2008 when her portfolio was worth $95,000 at that time.
- Even though Dianne lost principle during the GFC, she managed to get out of shares before the bottom of the GFC on March 9, 2009.
- On Jan. 1, 2010, when the GFC rebound was seven months old, Dianne comfortably re-entered the market and moved her cash back into a balanced portfolio.
- By the end of June 2020, Dianne’s portfolio is now worth about $206,000 or roughly $25,000 less than Brian.
Not bad Dianne.
- Now consider Pete. Pete tries timing the market
because he’s a read a few books about investing and he thinks he’s got this
investing game sorted.
- Pete has a similar strategy to Dianne, although he waits an extra year before re-entering the market in early 2011.
- Then, after being invested for over nine years, he moves back into cash at the end of March 2020. On April 13, 2020, Pete has some serious fear of missing out after he sees equity markets show signs of bouncing back.
- He decides to pour funds back into a balanced portfolio.
- By the end of June 2020, Pete’s account is worth just under $197,000, a full $35,000 less than Brian’s account and almost $10,000 less than Dianne’s.
Not so good Pete.
- Now consider Betty. Betty is a bit flighty at
the best of times and can’t fathom the thought of investing in the stock market
at all.
- Betty plays it safe and holds cash.
- Betty started off using the same investment scheme as Dianne. However, after leaving the market in 2009, she was never comfortable resuming her previous investment strategy.
- Betty cashed her chips and stayed in cash whilst spending any income received.
- Betty now shows a cumulative loss of -6.4% and her portfolio is worth $95,000. That’s a loss of approximately $4,600 since her starting balance of $100,000 in 2006.
Time to let go of the cash box Betty.
Timing the Roller-Coaster
Yes, the market goes up and down and even the hardest of downturns tests the mettle of the most temperate investors (Finance professionals included).
And sometimes the swings feel much larger than usual due to media hype and forecasts for Armageddon.
But buying into the panic and checking your investment account daily can create unnecessary stress and worse, major investment setbacks when it comes to timing the market.
A good mental trick is to consider your home as an investment. And like the share market, the housing market also sees swings in value.
But do you check the value of your home each day? Or worse, does a selling agent come and knock on your door with a quote each day? Guessing not.
We believe the same logic should hold true for your other investments as well.
If you find yourself tempted to cash in when the next crisis rears its ugly head, then it makes sense to discuss your situation further with a financial adviser.
We can help you understand the implications of trying to time the market. Ultimately, staying invested may pay off, even in times of crisis.
It’s easier said than done we know, but the costs of NOT doing this are far greater (as we can see above).
If you’d like to speak with one of our qualified financial planning experts today, then feel free to give us a call today on (03) 5224 2700.
[1] https://russellinvestments.com/au/blog/the-risks-of-fleeing-to-cash-in-times-of-crisis?utm_campaign=APAC-AIS_20_10_VOA_C%20Article_E&utm_medium=email&utm_source=Eloqua