The biggest mistake worried equity investors can make
Key takeaways
- The stock market is performing well in 2019, but a major geopolitical event or market correction could very well happen.
- Fleeing the market for cash will create a tremendous challenge: market re-entry.
- Moving away from underperforming assets is best accomplished with strategic asset allocation and rebalancing.
The numbers don’t lie: the stock market got it done in 2019. Even amidst rising political and global uncertainties, stocks experienced a bull run. And all those major market corrections the pundits predicted? Well, they haven’t really happened … yet.
Despite this, I still have one major concern regarding the future for equity investors. But it’s not a major market correction or even a catastrophic geopolitical event — which may happen. My concern is what investors will do when/if it happens. Will they flee the market and run toward the safety of cash?
That is the biggest mistake they can make.
The short-term security that cash might provide could cause them to miss out on the long-term benefits that can come with a market rebound. In addition, leaving for the security of cash will present another challenge — the decision of when to re-enter the market, since few investors ever really remain in cash.
What we learn from history - our most reliable predictor
While no investor can see into the future, we can rely on what we learn from history and what the numbers tell us. Consider this example from research conducted by Putnam Investments. An investor with a $10,000 investment who stayed fully invested in stocks for the 15-year period from 2002 through 2016 would have reaped an annualized return of 7.28%, with an ending balance of $28,698. During this stretch, being out of the market on its 10 best days would have cut the annualized return to 2.6% and the ending value to $14,697. A bit of cherry-picking data, perhaps, but still a seriously relevant point.
It’s also important to note that seven of the Dow’s 10 best days in the last 15 years came within a year of the worldwide financial crisis. Similar research by J.P. Morgan generally confirmed this premise. Even the worldwide financial crisis didn’t do the damage many seem to recall, as evidenced by the fact that seven of the Dow’s 10 best days during this stretch occurred between October 2008 and March 2009.
Market timing is everything
While cash can provide short-term security, it does create the long-term challenge of re-entry. Investors who pull out of the market often feel that no re-entry point is safe. If the market rises after they exit, they may be compelled to purchase back in at higher prices, which could have them fearful of another fall. Conversely, if the market declines as they predicted, they may be reluctant to re-enter for fear that prices will continue to fall. In short, no time will seem like the right time for re-entry and very few investors ever do get it right.
A long-term approach
With all the talk about a “big correction,” it’s human nature to be worried. At some point, that correction is likely to happen. But fleeing for the perceived safety of cash will bring about new worries — and may end up costing you more over the long term.
Retreating from underperforming assets in challenging economic times isn’t a bad strategy. However, that has historically been accomplished through strategic asset allocation and re-balancing, and not by fleeing toward cash.
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